FDIC Chairman Bair Warns Banks On Bond Bubble

From Dow Jones:

Federal Deposit Insurance Corp. Chairman Sheila Bair on Monday warned that the so-called bond bubble could pose a threat to financial institutions that are unprepared for rising interest rates.

"Private and public borrowers should avoid over-reliance on short-term funding that could leave them vulnerable to higher debt-service costs if rates rise, or even liquidity problems if financial markets should balk at rolling over large volumes of private debt," Bair said in prepared remarks to the Risk Management Association in Baltimore.

Bair said that many investors appear content to hold safe, low-yield Treasurys in an uncertain economic environment. But regulators should place heightened scrutiny on the interest-rate exposure of financial institutions," and ensure that these institutions can withstand interest-rate increases of as much as 500 basis points over a two- to three-year period," she added.

I am not in the bond bubble crowd. The current egregiously low bond yields are the result of Federal Reserve manipulation, not speculative activity by investors. Will bond yields rise? Sure, when the Federal Reserve decides to stop supporting the market. Until then, you can expect a prolonged period of low rates because no one wants (or has the money) to fight the Fed.

However, Ms, Bair makes a good point regarding the risks of short term funding (repo, wholesale funding, etc). This type of funding works great until it doesn't as Lehman and Bear Stearns demonstrated. But with a complete government guarantee, financial institutions have little incentive to change their habits. Worse case scenario you get free money from the Fed as an emergency loan. If you are financial institution, why would you tinker with this great situation?

The last sentence of Ms. Bair's quote assumes we have a rational Fed Chairman. We obviously don't so it is unlikely the Fed would ever raise rates that aggressively. Most forecasters expect 0% interest rates through 2012 if not later. If the banks have any problems with rising rates, don't worry the taxpayer protection team will be there for a new bailout. God Bless America!

Black Swan Insights

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FDIC Chairman Bair Warns Banks On Bond Bubble

Home Builder Confidence Improves In October

The National Association of Home Builders released its monthly housing survey popularly refereed to as home builder confidence. The index increased by 3 points to 16--still a very depressed number. This number is closely correlated with new home starts and might indicate that housing starts increased slightly in October. From the NAHB:

Builder confidence in the market for newly built, single-family homes rose three points to 16 on the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) for October, released today. This was the first improvement registered by the HMI in five months, and returns the index to a level last seen in June of this year.

"Builders are starting to see some flickers of interest among potential buyers, and are hopeful that this interest will translate to more sales in the coming months," said NAHB Chairman Bob Jones, a home builder from Bloomfield Hills, Mich. "However, because most builders still have no access to credit for building homes, there is a real concern that we will not be able to meet the pent-up demand when consumers are ready to get back in the market. This problem threatens to severely slow the housing and economic recovery."

All three of the HMI's component indexes registered gains in October. The index gauging current sales conditions rose three points to16, while the index gauging sales expectations in the next six months rose five points to 23 and the index gauging traffic of prospective buyers rose two points to 11.


Builder confidence also improved across every region in October. The South and West each posted four-point gains, to 18 and 12, respectively, while the Northeast and Midwest each posted single-point gains, to 17 and 13, respectively.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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Home Builder Confidence Improves In October

Even CEOs Are Bearish On The US Economy

A new poll released from the Conference Board surveyed CEOs on their outlook for the US economy. It seems that even CEOs are negative about the economy. From the WSJ:

Chief executives' confidence in the economy deteriorated in the third quarter, according to the Conference Board Inc., a nonprofit research association.

The Conference Board's measure of CEO confidence hit 50 in the third quarter, down from 62 in the second quarter. It was the lowest score since the first quarter of 2009, when the metric stood at 30.

"The overall slowdown in economic activity is causing CEO confidence to taper off," said Lynn Franco, director of the consumer-research center for the Conference Board. "It's a downshift from optimism to cautious territories."

Only 22% of CEOs surveyed thought economic conditions would improve in the next six months, and only 28% thought their own industries would improve. Within industries, utilities and business services were slightly more optimistic, but optimism slipped across the board, Franco said.

The last paragraph is key. The economy will never recover if 78% of CEOs are bearish on the future. This will keep capital spending depressed and prevent companies from hiring more workers, leading to a permanent unemployment rate of around 9%. It also pretty much ensures a prolonged period of economic stagnation where it feels more like a perpetual recession. The scenario is eerily similar to Japan where confidence was lost, and no one wanted to make a move until economic conditions improved. This led to a downward spiral as consumers and businesses retrenched, stopped spending, and dramatically reduced debt. Once the cycle begins, it is impossible for central banks to stop as was the case with the BOJ.

Money printing does not make people more optimistic about the economy. All it does is lead to higher commodity prices during a depressed economy. This makes consumers more negative and more likely to save money in order to compensate for higher food and energy prices. Consumer spending now accounts for almost 70% of GDP because we have outsourced our entire manufacturing sector to China. Without strong consumer spending, this economy has no chance. Ironically, if Bernanke wanted to stimulate consumer spending, he could attempt to craft monetary policy in a way which would lower commodity prices. This would mean reversing QE and raising interest rates to perhaps 3%. Commodities would fall sharply, increasing the amount of disposable income for consumers. Higher interest rates would allow retirees and people with money to earn more on their investments, which could be spent in the economy. This seems like a better idea than giving the banks a back door bailout through ZIRP. The banks borrow from the Fed, and the public at 0-0.2% and purchase 10 year treasuries at 2.5%. Rinse. Wash. Repeat. This activity does not stimulate anything except banks profits. Why on earth would banks increase lending, which has numerous risk when they could collect free money from the Fed? We have tried ZIRP for banks, and it has failed. It is time to try something different, which actually benefits people and not globalist banksters.

Black Swan Insights

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Even CEOs Are Bearish On The US Economy

Some Negative Divergences To Keep Your Eye On

The recent rally in equities has certainly been impressive to say the least. But what interests me is the major divergence developing between equities and bonds. In addition, the general stock market has now decoupled from financial stocks. Together, these negative divergences may indicate that something is not quite right with the market's relentless rally. In fact, it feels a lot like the last melt up back in April 2010, when the market was completely ignoring Greece's imminent collapse. The difference is that the market's rise has been based on QE 2, which it is believed will support higher asset prices.

Below is a chart which compares the 10 Year Treasury with the S&P 500. I have previously showed this chart and commented that one markets is going to be wrong. You cannot have both surging equity markets and rising bond prices indefinitely. Why? Because you buy stocks when the economic outlook is favorable, and you buy bonds when the economic outlook is bleak. You can't have it both ways. Bonds are signaling economic problems while the equity markets are completely drunk on QE 2.

Click charts for larger image.

Below is a chart which compares the XLF (financials) to the S&P 500. You can see that until recently they have moved in perfect unison. Financials are an important sector for the general market as they led us on the way down back in late 2007 and early 2008. They were also the initial leaders off the March 2009 lows, so they are worth keeping your eye on. If financials continue to falter, it is hard to imagine that the market can continue to melt up.     

Black Swan Insights

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Some Negative Divergences To Keep Your Eye On

West Coast Port Volume: Imports Continue To Surge

The ports of Los Angeles and Long Beach together account for 40% of total port traffic in the US, so they are important economic indicators worth following. Overall port traffic was strong in September, thanks to a surge in imports offsetting some weakness in exports (at least in Los Angeles). The data indicates the US trade deficit will continue to increase and negatively impact GDP.

LA Port Volume:
September                                  2010            2009              Percent Change

Loaded Inbound                    373,249.35     309,078.30            +20.76%
Loaded Outbound                 139,800.25     140,271.00              -0.34%
Total Loaded                        513,049.60     449,349.30            +14.18%
Total Empty                          198,563.40     134,207.70            +47.95%
Total                                     711,613.00     583,557.00            +21.94%

Long Beach Port Volume:
September                                2010                2009              Percent Change

Loaded Inbound                     288,905          224,924                 +28.4%
Loaded Outbound                  124,021          109,337                 +13.4% 
Empties                                  161,864          106,103                 +52.6%
TOTAL (T.E.U.)                      574,790          440,364                 +30.5%

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West Coast Port Volume: Imports Continue To Surge

State Pension Funds Face Looming Crisis

A little piece about the upcoming pension crisis. While most people are aware of the problem of underfunded pension funds, many fail to recognize how soon this will impact state budgets. From the economist:

Joshua Rauh, of the Kellogg School of Management at Northwestern University, and Robert Novy-Marx, of the University of Rochester, estimate that the states’ pension shortfall may be as much as $3.4 trillion and that municipalities have a hole of $574 billion. Mr Rauh calculates that seven states will have exhausted their pension assets by 2020—even if they make a return of 8%, a common assumption that looks wildly optimistic. Half will run out of money by 2027. If pension promises are to be kept, this will place immense strain on taxes. Several have promised annual payments that will absorb more than 30% of their tax revenues after their pension funds are exhausted.

The severity of states’ pension woes was disguised for years, because asset markets were so strong and because of the way states accounted for the cost of pension provision. But the 21st century has been dismal for stockmarkets, where most pension money has been put. State budgets came under huge pressure as a result of the 2008-09 recession, which caused tax revenues to plunge. Meredith Whitney, an analyst who made her name forecasting the banking crisis, believes the states could be the next source of systemic financial risk.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The pension problem is compounded by the fact that we live in a ZIRP world thanks to the Federal Reserve. Most pension plans assume a 7-8% average annual return which is impossible to achieve in today's environment. The only way you could get those kind of returns would be to massively increase risk (and jeopardize asset quality) or use leverage to enhance low returns. Despite the fact that we just witnessed a massive financial collapse in 2008-2009, pension funds are already starting to use leverage to juice returns as has been reported by the WSJ. This of course has financial ruin written all over it as most of these plans are already mismanaged and the use of leverage will only compound the problem. Not only will these plans lose all of the pension money, but they will be left owing money to creditors. I guess the goal of these underfunded pension plans is to become too big to fail so that they can qualify for a federal bailout (financed by the Fed's money printing). The argument will go something like we have to bail out these pension plans because their failure will hurt their creditors (major banks), which will in turn damage the general economy. So to save the economy we have to save the pension plans and voila you have the justification for another taxpayer funded bailout.  
 
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State Pension Funds Face Looming Crisis

Consumer Sentiment Remains Anemic

Today we got the University of Michigan's Consumer Sentiment which fell slightly in October to 67.9 from 68.2. What is interesting is how the current conditions index fell sharply, but expectations rose. I guess hope springs eternal. From Reuters:

The consumer mood darkened in early October, as consumers think current economy is worsening, according to a report released Friday.


The Reuters/University of Michigan consumer sentiment index's preliminary reading for October fell to 67.9 from the 68.2 final reading in September and the preliminary September reading of 66.6.

Economists surveyed by Dow Jones Newswires had expected the early-October index to rise to 69.0.

The early-October current conditions index stood at 73.0 down from 79.6 in end-September and 78.4 earlier that month, while the expectations index rose to 64.6 from the September final 60.9 and the September preliminary reading of 59.1.

Here is a chart of Consumer Sentiment, you can see how low it is from a historical perspective. More importantly it peaked back in 1999-2000 and has been in decline ever since.

Click chart for larger image.

Black Swan Insights

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Consumer Sentiment Remains Anemic

More Dismal Housing Data: Record Number of Bank Repossessions In September

Depressing news regarding foreclosures and bank repossessions. There was a record number of homes repossessed in September. From realtytrac:

For the third quarter of 2010, which shows that foreclosure filings — default notices, scheduled auctions and bank repossessions — were reported on 930,437 properties in the third quarter, a nearly 4 percent increase from the previous quarter but a 1 percent decrease from the third quarter of 2009. One in every 139 U.S. housing units received a foreclosure filing during the quarter.

Foreclosure filings were reported on 347,420 U.S. properties in September, an increase of nearly 3 percent from the previous month and an increase of 1 percent from September 2009. A record total of 102,134 bank repossessions were reported in September, the first time bank repossessions have surpassed the 100,000 mark in a single month.

“Lenders foreclosed on a record number of properties in September and in the third quarter, taking a bite out of the backlog of distressed properties where the foreclosure process was delayed by foreclosure prevention efforts over the past 20 months,” said James J. Saccacio, chief executive officer of RealtyTrac. “We expect to see a dip in those bank repossessions — and possibly earlier stages of the foreclosure process — in the fourth quarter as several major lenders have halted foreclosure sales in some states while they review irregularities in foreclosure-processing documentation that has been called into question in recent weeks.”

The real question is how long it will take to sort out all of these improperly prepared foreclosure documents. This could delay foreclosure sales for months and lead to chaos in the non-conforming MBS market. One thing that surprises me is the phony uproar by politicians regarding these foreclosure issues. In 99.8% of all cases there is no doubt that the homeowner had a mortgage and was in default. Yes, the banks incorrectly prepared the foreclosure documents, but this will not stop the banks from eventually repossessing the home. The only uncertainty is if this fiasco will delay the process by a few weeks or months. The point being that it does not matter if the banks made mistakes, the mortgage was in default and the homeowner will lose the home. I think politicians are using this issue to increase their chances of re-election in November. They want to appear concerned about homeowners and position themselves against the banks despite the fact almost all congressman voted for TARP.

Black Swan Insights

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More Dismal Housing Data: Record Number of Bank Repossessions In September

NAAIM Manger Sentiment Declines

Usually we get the NAAIM number on Wednesday, but their site was down so we will cover it today. The NAAIM sentiment survey asks active investment managers to describe their total equity exposure. This week total equity exposure fell to 67.14% from 76.42% last week indicating some caution among investment managers. The NAAIM survey should not be relied upon on its own as a trading indicator, but rather combined with other indicators. Personally, I like to compare it to AAII retail sentiment so I can see what the retailers are thinking and what investment managers are doing. They both show that people are starting to get cold feet about the rally in the markets.

Here is a chart which compares NAAIM sentiment survey with the SP 500.

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AAII Sentiment Down Despite Strong Market

Bullish sentiment among investors declined this week, according to the weekly online survey of members of the American Association of Individual Investors. Bullish sentiment fell slightly to 47.10% from 49%, while bearish sentiment also fell to 26.8% from 27.74%. The percentage of investors who described themselves as neutral on the stock market increased to 26.1% from 23.23%.

This is where you have problems trying to use AAII sentiment as a trading indicator. Despite the market's relentless rise, retail investors are starting to turn cautious--the exact opposite of what they historically do when the market is strong. Ideally, you would have wanted to see bullish sentiment rise to around 55% in order to clearly signal a top in the market, but Mr. Market is making things difficult with this little twist. So while bullish sentiment is still high, it does not currently mean that the market cannot move higher from here. However, you rarely make money by following the retail traders and they are currently bullish. The bottom line is that right now may not be the best time to initiate new long positions. 

Here is a 6 month chart of AAII sentiment.

Click charts for larger image.

Next is a longer chart which compares AAII bullish sentiment with the SP 500.

Here is a chart which compares AAII bearish sentiment with the SP 500.

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AAII Sentiment Down Despite Strong Market