Archives for October 2013

General Dynamics: Short-term Uncertainty, Long-term Opportunity?

Courtesy of www.fastgraphs.com.

General Dynamics (GD) is a leading business aviation, combat vehicle, weapons, marine and information system company. Founded in 1952, General Dynamics has integrated and acquired more than 60 different businesses – growing revenues to about $32 billion and employing approximately 95,000 employees today.

The company’s sales are divvied up roughly equally between four basic areas. Specifically aerospace makes up about 22% of yearly revenue, combat is 26%, information and systems technology at 31% and marine coming in at 21% of annual sales. Given this, it should not be much of a surprise that the firm gets about two-thirds of its business from the U.S. government. In other words, if anyone should be concerned with the government shutdown hoopla, it’s General Dynamics.

Morningstar analyst Neal Dihora describes General Dynamics’ risk well:

“General Dynamics faces significant uncertainty from government decisions as it generates nearly 66% of sales from the various U.S. government agencies. Further, defense procurement is a lengthy and often politicized process that swings with the priorities of the administration in power.”

In turn, a current investor – or one considering the partnership – would expect that management is on top of this situation. And this is precisely what we see. In General Dynamics’ most recent earnings call General Dynamics’ CEO Phebe Novakovic indicated the following with regard to the government shutdown:

“This is not news to anybody; the government took the nation to the edge on the debt ceiling extension. And in my mind, we were forced to gaze into the abyss, where we saw the full faith and credit of our principal customer at risk. That was sobering and suggests that we need to be cautious with cash as we finish the year and move into next… I think it is premature to assume that the conditions cannot repeat in January… So I think all of that suggests that we need prudence and caution as we move into the rest of the year and the beginning of next year, until we can get a more stable plan from the government with respect to both the debt ceiling and funding for our principal customer.”

With the stock trading below a 15 P/E multiple for the last half decade, it would seem as though the market is also waiting for this more stable plan. Yet it’s important to underscore the idea that management is well aware of the situation at hand. While this by itself would not reassure a potential investor, future comments with this information in hand might. For instance, Phebe Novakovic also offered the following:

 “Let me turn to our EPS guidance for the remainder of 2013. Last quarter, we increased our guidance to $6.85 to $6.95 of earnings per diluted share. We are again increasing our guidance somewhat to $6.90 to $7… I think our guidance is not overly cautious and [is] consistent with the current environment.”

Despite the potential for a looming government debacle, General Dynamics is still relatively optimistic. Now, I don’t want to take away from the true risk of government dependence. It’s a risk that should not be overlooked. Yet if one’s investment thesis supports a reasonable continuation of future business prospects, then I would advocate that there might be several lasting positives.

First and foremost, the stock has been somewhat out of favor; or as Warren Buffett would indicate:  

“Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”

If the future were clear, the prospective opportunities for General Dynamics rosy, then it would follow that the stock would likely be trading at a premium valuation. Instead, we see the exact opposite. Perhaps this is well founded, but then again, there is a more upbeat possibility for the long-term investor who believes in the enduring prospects of the company. 

As an addendum to this point, it’s always good to place one’s investing decision in context. For instance, if General Dynamics is only able to grow at 2% for the next 5 years – roughly a third of the  analysts’ consensus  – and trade at a 15 multiple, this would indicate an 8% annual compound growth rate including dividends. Perhaps your expectations are higher or lower, but in a general sense the business doesn’t have to do anything that spectacular. Or looking at the prospects of the company from a different angle, perhaps you believe the cost cutting measures will take hold or that the aerospace segment will make up for the lackluster performance in other areas. That is, you generally believe in the business.

Finally, General Dynamics has shown a great propensity to reward shareholders. General Dynamics has not only paid but also increased its dividend for 22 consecutive years. In the past decade these increases have come in at a tune of about 13% a year. In addition, the company has done a great job of reducing share count – in the past 13 years General Dynamics went from having about 401 million shares outstanding to today’s number closer to 349 million.

Overall, the point is not that General Dynamics is a riskless, must-buy investment. Rather, there’s usually a reason why the stock price doesn’t necessarily reflect the business results of the company in the short-term. Your job is to determine whether or not these concerns are warranted or near-sighted. With that being said, let’s move on to the operating results of the company.

15 Years of Growth

General Dynamics has grown earnings (orange line) at a compound rate of 11.1% since 1999, resulting in a 30.9+ billion dollar market cap. In addition, General Dynamics’ earnings have risen from $2.17 per share in 1999, to today’s forecasted earnings per share of approximately $6.95 for 2013.  Further, as noted, General Dynamics has been increasing its dividend (pink line) for the past two decades and has been able to increase this payout at a robust pace.

For a look at how the market has historically valued General Dynamics Corp, see the relationship between the price (black line) and earnings of the company as seen on the Earnings and Price Correlated F.A.S.T. Graph below.

Here we see that General Dynamics’ market price previously began to deviate from its justified earnings growth; starting to become undervalued during the most recent recession and staying somewhat undervalued in the years to follow.  Today, General Dynamics still appears undervalued in relation to both its historical earnings and relative valuation.

In tandem with the strong earnings growth, General Dynamics’ shareholders have enjoyed a compound annual return of 8.9% which correlates fairly closely with the 11.1% growth rate in earnings per share. A hypothetical $10,000 investment in General Dynamics on 12/31/1998 would have grown to a total value of $35,264.11, without reinvesting dividends. Said differently, General Dynamics’ shareholders have enjoyed total returns that were roughly 2 times the value that would have been achieved by investing in the S&P 500 over the same time period. It’s also interesting to note that an investor would have received approximately 2 times the amount of dividend income as the index as well. 

But of course – as the saying goes – past performance does not guarantee future results. Thus, while a strong operating history provides a fundamental platform for evaluating a company, it does not by itself indicate a buy or sell decision. Instead, an investor must have an understanding of the past while simultaneously thinking the investment through to its logical, if not understated, conclusion.

In the opening paragraphs a variety of opportunities and risks were described. It follows that the probabilities of these outcomes should be the guide for one’s investment focus.  Yet it is still useful to determine whether or not your predictions seem reasonable. 

Twenty-one leading analysts reporting to Standard & Poor’s Capital IQ come to a consensus 5-year annual estimated return grow rate for General Dynamics of 5%. In addition, GD is currently trading at a P/E of 12.9, which is inside the “value corridor” (defined by the orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, General Dynamics’ valuation would be $131.82 at the end of 2018, which would be a 10.5% annualized rate of return including dividends. A graphical representation of this calculation can be seen in the Estimated Earnings and Return Calculator seen below.

Now, it’s paramount to remember that this is simply a calculator. Specifically, the estimated total return is a default based on the consensus of the analysts following the stock. The consensus includes the long-term growth rate along with specific earnings estimates for the next two upcoming years. Further, the dividend payout ratio is presumed to stay the same and grow with earnings. Taken collectively, this graph provides a very strong baseline for how analysts are presently viewing this company. However, a F.A.S.T. Graphs’ subscriber is also able to change these estimates to fit their own thesis or scenario analysis.

Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low risk treasury bonds. Comparing an investment in General Dynamics to an equal investment in a 10-year treasury bond, illustrates that GD’s expected earnings would be 4 times that of the 10-year T-Bond Interest. This comparison can be seen in the 10-year Earnings Yield Estimate table below.

Finally, it’s important to underscore the idea that all companies derive their underlying value from the cash flows (earnings) that they are capable of generating for their owners. Therefore, it should be the expectation of a prudent investor that – in the long-run – the likely future earnings of a company justify the price you pay. Fundamentally, this means appropriately addressing these two questions: “in what should I invest?” and “at what time?” By viewing the past history and future prospects of General Dynamics Corp we have learned that it appears to be a strong company with reasonable, yet risky upcoming opportunities. However, as always, we recommend that the reader conduct his or her own thorough due diligence.

Disclosure:  Long GD at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

Please click here to read more articles at FastGraphs.com.

NSA Breaks Into Secure Communication Links of Google and Yahoo; Italian Magazine Claims NSA Monitors Pope

Courtesy of Mish.

The Washington Post reports NSA infiltrates links to Yahoo, Google data centers worldwide, Snowden documents say

In this slide from a National Security Agency presentation on “Google Cloud Exploitation,” a sketch shows where the “Public Internet” meets the internal “Google Cloud” where user data resides. Two engineers with close ties to Google exploded in profanity when they saw the drawing.

According to a top secret accounting dated Jan. 9, 2013, NSA’s acquisitions directorate sends millions of records every day from Yahoo and Google internal networks to data warehouses at the agency’s Fort Meade headquarters. In the preceding 30 days, the report said, field collectors had processed and sent back 181,280,466 new records — ranging from “metadata,” which would indicate who sent or received e-mails and when, to content such as text, audio and video.

The NSA’s principal tool to exploit the data links is a project called MUSCULAR, operated jointly with the agency’s British counterpart, GCHQ. From undisclosed interception points, the NSA and GCHQ are copying entire data flows across fiber-optic cables that carry information between the data centers of the Silicon Valley giants.

The infiltration is especially striking because the NSA, under a separate program known as PRISM, has front-door access to Google and Yahoo user accounts through a court-approved process.

At Yahoo, a spokeswoman said: “We have strict controls in place to protect the security of our data centers, and we have not given access to our data centers to the NSA or to any other government agency.”

Note the Smiley

Please note the Smiley in the lower center part of the image. The adjacent text says “SSL added and removed here!”.

For those interested in “SSL” technology, Wikipedia offers this explanation.

Transport Layer Security (TLS) and its predecessor, Secure Sockets Layer (SSL), are cryptographic protocols which are designed to provide communication security over the Internet. They use X.509 certificates and hence asymmetric cryptography to assure the counterparty whom they are talking with, and to exchange a symmetric key. This session key is then used to encrypt data flowing between the parties. This allows for data/message confidentiality, and message authentication codes for message integrity and as a by-product message authentication. Several versions of the protocols are in widespread use in applications such as web browsing, electronic mail, Internet faxing, instant messaging and voice-over-IP (VoIP). An important property in this context is perfect forward secrecy, so the short term session key cannot be derived from the long term asymmetric secret key.

Th diagram suggests the NSA is somehow able to add its own “secure” layer or simply remove the security layers of Google and Yahoo!

Italian Magazine Claims NSA Monitors Pope

This story is not yet confirmed but Reuters reports Italian magazine says U.S. spies listened to pope, Vatican says unaware.

An Italian magazine said on Wednesday that a United States spy agency had eavesdropped on Vatican phone calls, possibly including when former Pope Benedict’s successor was under discussion, but the Holy See said it had no knowledge of any such activity.

Panorama magazine said that among 46 million phone calls followed by the U.S. National Security Agency (NSA) in Italy from December 10, 2012, to January 8, 2013, were conversations in and out of the Vatican.

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Walmart Set Sights on Clean Energy Kingdom

Courtesy of Joao Peixe of Oilprice.com

Walmart is attempting to position itself as the key mover and shaker in the renewable energy sector, and indeed, when Walmart makes a clean energy move it reverberates through the market.

Walmart’s status as a leading company in terms of renewable energy adoption was furthered on 15 October with the release of the Solar Means Business report, which noted that Walmart remains America’s commercial solar leader, followed by Costco, Kohl’s, Apple, IKEA, Macy’s, and  Johnson & Johnson—all in the top 25.

Walmart currently has 89 megawatts of solar power at 215 locations.  

"As we work toward our ambitious goal to be supplied 100 percent by renewable energy, solar energy continues to be an important part of our renewable energy portfolio," Kim Saylors-Laster, vice president for energy at Walmart, said in a statement. "With our size and scale, Walmart is in a unique position to encourage innovation and accelerate the adoption of cost-effective, clean energy alternatives, including solar power."

By 2020, Walmart wants to procure 7 billion kWh of renewable energy–the equivalent of powering 620,000 average American homes for a year.

Some will go as far as to say that Walmart is the key driver of the renewable energy industry.

“Every time Walmart makes a green commitment, it has reverberations throughout entire industry sectors. That's just what happens when you're the world's largest corporation. And that's why Walmart's work in renewable energy could have a major impact,” writes the Energy Voice.

Since Walmart first announced its ambitious sustainability goals back in 2005, it has reached several milestones that keep it in the limelight for renewable energy followers. Not only do those goals include powering its operations 100% through renewable energy, they also include creating zero waste and selling environmentally sustainable products.

In 2012, Walmart reached a goal of a 20% reduction in its greenhouse gas emissions.

As for solar, Walmart’s status as the American leader has come about in partnership with SolarCity, which handles the majority of Walmart’s solar installations.

Walmart plans to install solar systems in 6,000 more stores over the next six year.

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Obamacare Personal Story

Courtesy of Larry Doyle.

With Secretary of Health and Human Services Kathleen Sebelius taking center stage this morning to address the train wreck that defines the roll out of Obamacare, the lives of countless citizens in our nation are being impacted like never before.

Who in our nation would not want comprehensive and affordable coverage for all our citizens? The question is, obviously, how to attain that?

Do I think President Obama intentionally misled the American public that they could continue their health care coverage if they liked it so as to sell Obamacare? Yes, I do. Why? I think that like many a politician from both sides of the aisle our President believes the ends justify the means. Yet, let’s dispense with the politicking and finger pointing and look at the trauma facing an individual family from an Obamacare site launched to solicit stories such as this: 

Thank you for the opportunity to share our story.

Facts: we are a family of 4 living in the middle class bracket. Our daughter (4 yrs old) has Down Syndrome.

My husband and I make an average gross income of 150K annually. He is self employed and I work as a professional.

Prior to Obamacare we could afford all medical/therapy related Needs for our daughter.

Post Obamacare we cannot and have bills coming at us weekly from any doctor/hospital or lab/therapist that we see in a given month.

It is not my daughter’s fault that she needs help so I take full responsibility for her needs and care. Unfortunately, even with all other living arrangements being equal, I have lost 8,000 in income to out of pocket expenses and that amount is what I have been able to pay out of pocket. I am now on a payment plan with 4 providers because I can’t pay them. This is after insurance offered by my company and my investment of 3,500 into flex spending has been used up.

I now am having to consider cutting therapy sessions (she has apraxia) and we want her to have the help she needs to learn to speak but the bills aren’t getting paid because of limits in care by my firm and me being able to pay the bills for more care and not having income left to do so.

Finally, next year the limit for flex spending is going from 8,000 to 2,500. This is honestly unimaginable to those of us trying to care for our own. This is by far the biggest shock as you would expect more help not 40% less!

I am meeting with a social worker next week to determine if working hard and having an income is a detriment to my daughter’s ability to qualify for the care she needs. If I make less money and can qualify for government help and let my fellow Americans pay a portion, I will likely have no choice but to do it because my purpose in life is to care for my children who cannot do it themselves.

This has been a very depressing 2 years as Obamacare in the short term has dramatically changed our way of living and providing for our family.

While I am trying to remain optimistic, the results speak volumes to me as a citizen.

I beg you to consider my example, as there are 1,000′s of my story out there and there will be more and more as companies change their healthcare plans to reflect the market trend.

I do not want to ask my fellow Americans to pay my bills through Medicaid and I do not want to give up my career just to qualify to get her the help she needs either. There has got to be a better way and this current system isn’t it.

Respectfully,

Stacey Y

And how does the representative of Obamacare respond to the plight of this troubled woman?

ANSWER: Coming Soon

Coming soon? As in “trust us?”

Do you trust Uncle Sam to deliver quality and affordable healthcare for every citizen in our nation? Or will Obamacare be little more than a government program that runs with all the efficiency of the Post Office and compassion of the IRS?

All comments and personal stories encouraged and appreciated.

Still Feel Confident About Collecting Your Pension After This?

Courtesy of The Automatic Earth.

If your answer to that question is affirmative, I suggest you take a good hard look at what's coming out of Detroit these days. Why don't we just call it a bail-in model, not unlike Cyprus, where the waters are tested for forcing parties who historically thought they were safe from cuts, find they no longer are.

And if you think Detroit is the only American city that has these kinds of problems, think again. It's merely the first, count on it. It's not just an American issue either, of course, and although retirements plans are set up in myriad different ways, they have one thing in common: they are in essence pyramid schemes, eat your heart out Charles Ponzi, and it's just a matter of time before the walls start crumbling.

But it's not just that. The game is stacked and fixed in favor of certain parties at the cost of others. We can all grasp how, without even knowing any details, because we should know how America, and the world at large, works these days. All games are fixed.

If you still have trouble understanding what is going on here, please do read Nicole Foss' Promises, Promises … Detroit, Pensions, Bondholders And Super-Priority Derivatives from early September. Here's one quote from that article:

Promises that cannot be kept will not be kept. It is as simple as that. To complicate matters, however, the architecture of the financial system prioritizes promises, in a perhaps counter-intuitive, and certainly self-serving, manner. This will make the task of allocating extremely scarce resources to stakeholders lower down the financial food chain very much more difficult. It is time for a good look at the range of promises made, the competing needs of the recipients, the leverage enjoyed by powerful players in shoring up their own position, and the real world implications for municipalities far beyond Detroit.

And here's another one:

Both pensioners and general obligation bond holders argue that they should have priority in claiming from the city's inadequate assets in bankruptcy. However, a different class of creditor has legally senior status. Holders of financial derivatives enjoy super-priority in bankruptcy. Thanks to changes to bankruptcy law in 2005, they are not subject to the 'automatic stay' provision intended to prevent a disorderly grab for collateral by competing creditors. As such, they are able to press their claim immediately, prior to bankruptcy proceedings and therefore before claims by competing creditors are considered. This may potentially leave nothing for other creditors to divide during subsequent proceedings.

The piece below is from Fox of all sources, but in this case that doesn't make much difference: it is abundantly clear what's going on. Still, it's curious to say the least that this comes out only now there's a trial going on to determine whether or not Detroit is indeed bankrupt, and is eligible to file for it.

Detroit bankruptcy proposal would leave pensioners with 16 cents on the dollar

It was the politicians, and not longtime city workers like Olivia Gillon, who brought Detroit to the brink of insolvency, but now Gillon can only watch as lawyers negotiating the Motor City's bankruptcy bid place a new value on her hard-earned pension: 16 cents on the dollar.

The beleaguered city, facing debt of as much as $20 billion and led by a state-appointed manager, tried nearly a year ago to renegotiate with creditors. When those talks broke down, the city filed for bankruptcy last July, but the filing was ruled unconstitutional by a judge. A series of state and federal rulings followed, culminating in a trial that began last week in which the city must show it is eligible to enter bankruptcy. That's when the frightening magnitude of the "haircut" being sought for some 21,000 retirees emerged.

"It’s wrong on every possible level," Gillon, 68, told FoxNews.com. "I earned my pension. I retired expecting it and I feel that I should have it."

The retirees include police officers, firefighters and other municipal workers, but not teachers, who are covered by a state-administered system. The affected workers have been promised some $3.5 billion in pension payments and another $6 billion in health care benefits, money most agree the city can't pay. But for a retiree counting on a modest annual pension of, say $30,000, the proposed cut would leave him or her with $4,800. Of all the once-proud city's creditors, including banks, vendors and bondholders, retired workers are the least able to take the hit, said Gillon.

"Some people are going to be hit hard," Gillon told FoxNews.com. "I’ll have to change the way I live."

Gillon is a member of the Detroit Retired City Employees Association, which, together with the Retired Detroit Police & Fire Fighters Association, represent about 70% of the city’s approximately 21,000 retirees. Along with the Michigan chapter of the American Federation of State, County & Municipal Employees, they are fighting the bid by claiming the city of Detroit has not proven it is insolvent, has not negotiated in good faith with its creditors and the bankruptcy filing violates the state constitution protecting retirement benefits for public workers.

Bob Gordon, who represents the two pension funds, argued in court last week that the city can restructure without cutting pensions, which are protected by the state in a manner that he said is "binding" and "impermeable." The Michigan state constitution does contain a provision that bans any action that threatens to cut the pension benefits of public employees, but several experts have said the federal bankruptcy code would trump the state statute, especially if the city can demonstrate it has no way of making an estimated 100,000 creditors whole.

The Michigan-based Mackinac Center for Public Policy, which sounded a warning about Detroit's fiscal problems more than a decade ago, said the old-style defined benefits pensions that have long been a centerpiece of civil service leave pensioners at the mercy of politicians.

"It’s just another example of the flaws of a defined pension system," said Ted O’Neil, a Mackinac analyst. "The problem with putting trust in government to invest and save your money is that they don’t always make the best choices."People who worked hard for their pension many end up being scapegoats," he added.

Indeed, the Mackinac 2000 study looks prophetic now: "If Detroit's future expenditures were relatively stable, this financial snapshot still would be cause for concern. But the city is looking at two new outlays of monstrous proportions: funding the pension obligations of current and future city employees, which could cost up to $3 billion, and fulfilling requirements under several federal environmental acts, which will cost billions more," read the report.

The 16 cents on the dollar estimate could be a message to unions, which previously refused to negotiate cuts.

Reading this reminded me of a very old song, I can't remember the name or artist, it goes something like this:

"They're coming to take it away, hi hi, ha ha."

 

Photo top: O. Winston Link "Midnight Special" 1957
"The Birmingham Special gets the highball at Rural Retreat, Virginia."

 

Fukushima Amplifies Japanese Energy Import Dependence

Fukushima Amplifies Japanese Energy Import Dependence

By Ned Pagliarulo at Global Risk Insights, at OilPrice

When Typhoon Wipha flooded Japan with heavy rains last week, the operator of the Fukushima nuclear power plant ordered precautionary measures to prevent leakage of contaminated water. Ever since the March 2011 earthquake and tsunami caused a reactor meltdown at the plant, Fukushima has become a symbol of a Japanese nuclear strategy and energy supply in disarray. As the clean-up from the disaster continues, all fifty of Japan’s nuclear reactors have been taken offline, creating a large shortfall in energy production that Japan has had to fill from abroad.

Growing dependence on imports

According to the U.S. Energy Information Administration (EIA), Japan falls far short of providing enough energy for its domestic uses, with only 16% domestic energy production. Not surprisingly, Japan needs to import heavily — it is the world largest importer of liquefied natural gas (LNG). Before the disaster at Fukushima and the following reevaluation of nuclear power in Japan, nuclear sources supplied 13% of Japan’s energy consumption. The EIA notes in another report that “Japan’s electric power utilities have been consuming more natural gas and petroleum to make up for the shortfall in nuclear output…” With this shift, fossil fuel use has jumped 21% in 2012 compared to 2011 levels.

High energy costs in the near term (the IMF forecasts that the spot price for crude will remain above $100/barrel for 2014) pose a problem for Japan’s trade balance. As Japan imports more fossil fuels, its trade deficit widens (Japan ran a surplus before 2011). This hurts its current account, which has shrunk considerably. While the depreciation of the yen would usually helps by making exports competitive, the IMF’s Article 4 consultation with Japan noted that the weaker yen has yet to improve the current account.

Between a rock and a hard place 

The higher energy costs in Japan have not, however, turned consumer opinion back in favor of nuclear power. According to a recent poll, 31% of 1,085 Japanese citizens surveyed said they had not felt any pinch from higher utility bills, and 41% said they felt the effect “a little.” This poses a political challenge for Japan. Japan’s leaders would undoubtedly prefer to be able to rely on domestic nuclear energy production, but restarting nuclear reactors with Fukushima continuing to make headlines is political poison.

That leads to a muddled energy strategy. Former Prime Minister Naoto Kan made a promise to end the use of nuclear power in Japan, but his successor (Yoshihiko Noda) ungracefully retreated from a 2040 goal of phasing out all nuclear power. The current Japanese government finds itself caught between businesses who favor nuclear energy production and citizens who still doubt those reactors can be overseen responsibly. For example, a legal claim filed recently appealed the decision not to indict the former heads of Tokyo Electric Power (which oversaw Fukushima). Furthermore, Junichiro Koizumi, a former prime minister and a political heavyweight, recently declared he had changed his stance on the nuclear issue and now opposes atomic power plants.

Energy costs have also intertwined themselves with “Abenomics,” Prime Minister Shinz? Abe’s new stimulus plan. Ending Japan’s dogged deflation is a primary goal, and the economy shows signs of inflation picking up. However, as covered previously on GRI, much of that inflation has to do with the higher energy costs that have come with increased imports. While Abe is eager to claim that inflation as a success, it needs to be broad-based in a way that can contribute to wage growth and boost the economy further.

Bloomberg’s editorial board recently urged the government to better manage the Fukushima issue to rehabilitate the image of nuclear power in Japan. They also noted that restarting reactors would be critical to Abe’s economic plan. While all the reactors do not need to be brought on at once, Japan’s government needs to build a credible strategy, which instills confidence in the Japanese public. The public needs to be reassured that the government can properly regulate and ensure the safety of nuclear power plants. With a stronger domestic energy supply, utility costs for businesses and consumers would hopefully decline and Japan’s economic fundamentals might improve to help further growth.

****

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Hidden debt must still be repaid

Hidden debt must still be repaid

Courtesy of Michael Pettis 

Five or six years ago, a few skeptics first started pointing out that the credit dynamics underlying Chinese growth was creating an unsustainable increase in debt. This, they warned, would ultimately undermine the banking system and cause growth to collapse if it were not addressed in time.

There were three standard rejoinders to the warnings. First, analysts argued that investment was not being misallocated, and because credit growth poured mostly into investment, it did not therefore follow, as the skeptics argued, that debt was rising faster than debt servicing capacity. Although I think few analysts still support this argument, there remain some analysts who do not think China has an overinvestment problem. For example my Carnegie colleague Yukon Huang, who has argued, for example in one of the FT blogs that China is actually underinvested:

The perception that China has invested too much is also misleading. Actually, China’s capital stock relative to GDP is lower than other comparable east Asian countries. Moreover, much of the surge in investment over the past decade is due to housing construction, where the country is still making up for the shortfalls from the Mao era.

Because I have addressed this issue many times before in my newsletters, especially the common and distressingly ahistorical fallacy that one can determine whether a very poor country like China is over- or under-invested by comparing its capital stock per capita to more advanced countries with much higher levels of social capital and the consequent ability to absorb investment efficiently, I will not do so again. Needless to say, I think that the evidence of investment misallocation has continued to rise, and in the past two years the number of analysts that are not worried about a systematic tendency for debt to rise faster than debt-servicing capacity has dropped significantly. I have no doubt that their refusal to accept the consensus on the subject is useful in that it helps sharpen the debate, but this is a losing battle and, like the capital stock argument, distressingly ahistorical.

The second rejoinder, which has also largely faded away as an argument over the past few years, is that debt in China doesn’t matter. Sometimes, these analysts argue, it doesn’t matter because it is funded domestically. Sometimes it doesn’t matter because the banks are implicitly guaranteed by the central government. Sometimes it doesn’t matter because China was able to resolve its last debt crisis, 10-15 years ago, in an environment of rapid growth and at no cost, and so of course it can do so again.

Again I have addressed all of these arguments as to why debt doesn’t matter in China many times before and it is pretty easy to show that all of these claims are fairly nonsensical, and this is especially obvious from the very wide range of historical precedents. Debt always matters. Either it must be repaid out of the proceeds of the investment that was funded by the debt, or – if the debt funded consumption or was misallocated into insufficiently productive investments – it must be repaid by transfers from some other sector of the economy, and these transfers reduce growth by reducing real demand.

The third rejoinder should have been, in principle, the easiest to refute, and for a while it looked like it had been refuted to everyone’s satisfaction, but in the past year I have seen a revival. China doesn’t have to worry about rising bad debts in its banking sector, according to this argument, because the PBoC’s extensive reserves will make it easy to recapitalize the banks.

Ray Chan, of the South China Morning Post, for example, had an interesting article last Saturday that made this point. He starts off the article by warning that the rapid growth in credit in China has uneasy parallels with rapid credit growth in the US before the 2007 crisis:

Parallels between the United States and China have started to look more ominous after several years of rampant credit growth and the emergence of an increasingly uncontrollable and unsustainable shadow banking system. China’s massive foreign reserves could, however, be the last tool in the bag for its bank-centric financial system if no timely regulations are implemented.

With the memory of the collapse of Lehman Brothers in 2008 still fresh, investors are fretting over the growth of thinly regulated shadow banking activity. Trusts, entrusted loans and bank acceptance bills shot up sharply to a record 294 billion yuan (HK$370 billion) last month. According to Moody’s Analytics, China’s core shadow banking products, which are often opaque and subject to little or no regulation, almost doubled to 20.5 trillion yuan last year from 11.7 trillion yuan in 2010. The US firm excludes entrusted loans and trust loans as they own underlying assets.

Debt and reserves

The article does a good job of listing many of the problems that have emerged in the past few years, but then quotes a number of analysts who argue that China’s problems is very different from that of the US and it is unlikely to suffer the same kind of crisis. The article continues:

China’s credit situation is somewhat different, though, as it has a high saving rate and massive foreign reserves. Mervyn Davies, a former head of Standard Chartered and British government minister, said: “China is very rich in reserves … At the end of the day, the [Chinese] banks do need recapitalising, which is not a huge challenge to them because the government can recapitalise the banks.”

I agree that China is in a very different position than the US, but this isn’t necessarily a good thing. The main relevant difference is that because all the banks are perceived to be guaranteed by the central government, and Chinese households have a limited number of ways to save outside the banking system, it is unlikely that China will experience a system-wide bank run as long as the credibility of the guarantee survives, and runs on individual banks can be resolved by regulatory fiat (banks that receive deposits will be forced to lend to banks that lose deposits). We are not likely to see a Lehman-style crisis.

We are also not likely to see, however, the advantages of a Lehman-style crisis, and these are a relatively quick adjustment in the process of investment misallocation. I have always said that the resolution of the Chinese banking problems is far more likely to resemble that of Japan than the US, and instead of three of four chaotic years as the system adjusts quickly, and at times violently, we are more likely to see a decade or more of a slow grinding-away of the debt excesses. The net economic cost is likely to be higher in a Japanese-style rebalancing, but American-style rebalancing is risky except in countries with very flexible institutions – financial as well as political.

But I do disagree very strongly with Mervyn Davies’ claim that because the PBoC is “very rich in reserves” it will not be much of a challenge to recapitalize the banks. China’s reserves only matter to its credit position if China faced a problem of external debt.

It doesn’t, and so the amount of reserves are almost wholly irrelevant, Because this argument seems to be reviving, it makes sense, I think, to repeat why central bank reserves cannot in any way help China resolve the crisis. I will leave aside the problems of whether the reserves are transferred in the form of foreign currency, in which case it does little to satisfy domestic RMB-denominated funding needs, or in RMB, in which case the PBoC must stop buying dollars in order to hold down the value of the RMB and in fact must sell dollars, which would cause the value of the RMB to soar, thereby wiping out the export sector in China.

A much more important objection is that the idea that reserves can be used to clean up the banks (or anything else, for that matter) is based on a misunderstanding about how the reserves were accumulated in the first place. There seems to be a still-widespread perception that PBoC reserves represent a hoard of unencumbered savings that the PBoC has somehow managed to collect.

But of course they are not. The PBoC has been forced to buy the reserves as a function of its intervention to manage the value of the RMB. And as they were forced to buy the reserves, the PBoC had to fund the purchases, which it did by borrowing RMB in the domestic market.

This means that the foreign currency reserves are simply the asset side of a balance sheet against which there are liabilities. What is more, remember that the RMB has appreciated by more than 30% since July, 2005, so that the value of the assets has dropped in RMB terms even as the value of the liabilities has remained the same, and this has been exacerbated by the lower interest rate the PBoC currently earns on its assets than the interest rate it pays on much of its liabilities.

In fact there have been rumors for years that the PBoC would be insolvent if its assets and liabilities were correctly marked, but whether or not this is true, any transfer of foreign currency reserves to bail out Chinese banks would simply represent a reduction of PBoC assets with no corresponding reduction in liabilities. The net liabilities of the PBoC, in other words, would rise by exactly the amount of the transfer. Because the liabilities of the PBoC are presumed to be the liabilities of the central government, the net effect of using the reserves to recapitalize the banks is identical to having the central government borrow money to recapitalize the banks.

This is the point. Any government that is able to borrow money can borrow money to recapitalize its banks, whether or not it has large amounts of foreign currency reserves. The amount of central bank reserves that China or any other country has is wholly irrelevant, except perhaps to the extent that without those reserves the central government would lack the credibility to borrow domestically, which hardly seems to be a concern in China’s case.

Bailing out the banks, it turns out, is conceptually no different than transferring debt from the banks to the central government. China can handle bad debts in the banking system, in other words, by transferring the net obligations from the banks to the central government, and the large hoard of reserves held by the PBoC does not make it any easier for China can resolve any future debt problems. In fact if anything it should remind us that when we are trying to calculate the total amount of debt the central government owes, the total should include any net liabilities of the PBoC, and that these net liabilities will increase by 1% of GDP every time the RMB strengthens against the dollar by 2%.

Does hidden debt matter?

Before finishing on this topic, I want to address another related fallacy that pops up a surprisingly large number of times when I discuss the net liabilities of the central bank. I am often told that because these liabilities are hidden in the central bank books, and so no one really knows how much debt the PBoC adds to the central government’s debt burden, they really shouldn’t matter in our calculations. The central bank will presumably never default because its obligations are guaranteed by the central government, and the its net liability position is hidden, so why bother even consider the PBoC’s balance sheet when assessing China’s debt position?

Even those who do not understand why this reasoning is incorrect should know that it must obviously be incorrect. If it weren’t, any country could solve all of its debt problems merely by borrowing in a non-transparent way through the central bank. As the Greeks and the Italians most recently showed us, non-transparent borrowing may cause us to recognize a problems later than we otherwise would have, but it cannot solve the problem.

The reason is because in any case debt must either be serviced or the borrower must default. If the assets which were funded by the debt do not create enough wealth with which to service the debt, and if the borrower does not default, then by definition there must have been a transfer from some other entity to cover the difference between the debt servicing cost and the returns on the asset.

Typically this other entity, in China and elsewhere, has been the household sector, and in the case of China the transfer occurred primarily in the hidden form of severely repressed interest rates. Whether the transfer is from the household sector, however, of from other sector, this is where the problem of debt lies for China.

If the central bank (or the commercial banks or any other borrower whose obligations are covered by the central government) is unable to service its debt – and remember that the “economic” debt servicing cost is not the coupon, which is repressed by policymakers, but consists of whatever the “natural” interest rate would have been – the difference will be paid for by someone else, and the economy will suffer slower growth because of the reduction in demand caused by the transfer payment.

So who is likely to cover the cost of NPLs in Chinese banks? This isn’t an easy question to answer. If the household sector continues to pay, either in the hidden form of repressed interest rates, or in the more explicit form of taxes, the existence of bad debt in the Chinese banking system must act to repress future household consumption growth. The transfers from the household sector to pay what may turn out to be a huge NPL bill will significantly lower the household income share of GDP, making it very unlikely that the household consumption share of GDP will rise.

If however the state sector covers the difference (perhaps by privatizing state assets and using the proceeds to pay down debt), we are left with the very difficult political problems, which China currently faces, of assigning the costs to different sectors or groups that control the state sector in China. The potentially very large cost of cleaning up NPLs must be assigned to groups that are likely to be both powerful and reluctant to pay the cost.

Debt always matters because it must always be paid for by someone –even if the borrower defaults, of course, the debt is simply “paid” by the lender. This is why the fact that debt in China seems to be growing much faster than debt-servicing capacity implies slower growth in the future. If the debt cannot be fully serviced by the increase in productivity created by the investment that the debt funded, unless it is funded by liquidating state sector assets it must cause a reduction in demand elsewhere, most probably in household consumption. This reduction in demand implies slower growth in the future and, of course, a more difficult rebalancing process.

This is an abbreviated version of the newsletter that went out three weeks ago.  Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at chinfinpettis@yahoo.com, stating your affiliation, please.  Investors who want to buy a subscription should write to me, also at that address.

Wall Street’s Biggest Banks Had a Trading Scheme With Madoff

Courtesy of Pam Martens.

The trial of five former employees of Bernard Madoff’s Ponzi operation is currently playing out in Manhattan as the U.S. Justice Department weighs bringing charges against JPMorgan Chase, where Madoff had his primary business banking account, for ignoring flashing red lights that a fraud was taking place.

According to lawsuits filed by Irving Picard, the Trustee handling the Madoff recovery fund, JPMorgan knew that Madoff was supposed to be engaged in managing stock portfolios for hundreds of clients. JPMorgan even created structured investments that allowed investors to make leveraged bets on the returns achieved by Madoff. But the Madoff business bank account that JPMorgan Chase oversaw, showed billions of dollars in cash being wired in and out but no payments ever going to any party engaged in processing or clearing a stock trade. Under Wall Street’s Know Your Customer Rule, the activity in the account should have been reported to U.S. regulators because it was completely incompatible with transactions that would be happening in a legitimate investment advisory account.

On October 28, 2008, less than two months before the Madoff Ponzi scheme collapsed following a confession by Madoff, JPMorgan finally did reveal its suspicions to a regulator that Madoff was running a fraud – to the Serious Organized Crime Agency. That regulator is based in the United Kingdom. According to Picard, JPMorgan never reported its suspicions to U.S. authorities.

But there are four other major Wall Street firms and their high-priced lawyers who have some explaining to do. According to prosecutors trying the current case against the five former employees, Madoff was funneling tens of millions of dollars that he was stealing from his investment advisory clients into his broker-dealer operation. Madoff has heretofore said this was a legitimate business. One such check for $31 million was dated December 28, 1999.

That was a little more than three months after Madoff started a business with four of the biggest names on Wall Street, effectively putting these primary dealers to the U.S. government’s Treasury auctions in business with the biggest financial felon in U.S. history.

On September 14, 1999, Citigroup’s Smith Barney, Morgan Stanley, Merrill Lynch and Goldman Sachs partnered with Madoff to compete with the New York Stock Exchange in a venture called Primex Trading. When Wall Street behemoths create a joint venture with a much smaller firm like Madoff’s, it would be expected that the top law firms on Wall Street would have been crawling all over its books and conducting a thorough due diligence.(Major European banks were harmed in the Madoff collapse. No major Wall Street bank had any serious exposure.)

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Fukushima Amplifies Japanese Energy Import Dependence

Fukushima Amplifies Japanese Energy Import Dependence

By Ned Pagliarulo at Global Risk Insights, at OilPrice

When Typhoon Wipha flooded Japan with heavy rains last week, the operator of the Fukushima nuclear power plant ordered precautionary measures to prevent leakage of contaminated water. Ever since the March 2011 earthquake and tsunami caused a reactor meltdown at the plant, Fukushima has become a symbol of a Japanese nuclear strategy and energy supply in disarray. As the clean-up from the disaster continues, all fifty of Japan’s nuclear reactors have been taken offline, creating a large shortfall in energy production that Japan has had to fill from abroad.

Growing dependence on imports

According to the U.S. Energy Information Administration (EIA), Japan falls far short of providing enough energy for its domestic uses, with only 16% domestic energy production. Not surprisingly, Japan needs to import heavily — it is the world largest importer of liquefied natural gas (LNG). Before the disaster at Fukushima and the following reevaluation of nuclear power in Japan, nuclear sources supplied 13% of Japan’s energy consumption. The EIA notes in another report that “Japan’s electric power utilities have been consuming more natural gas and petroleum to make up for the shortfall in nuclear output…” With this shift, fossil fuel use has jumped 21% in 2012 compared to 2011 levels.

High energy costs in the near term (the IMF forecasts that the spot price for crude will remain above $100/barrel for 2014) pose a problem for Japan’s trade balance. As Japan imports more fossil fuels, its trade deficit widens (Japan ran a surplus before 2011). This hurts its current account, which has shrunk considerably. While the depreciation of the yen would usually helps by making exports competitive, the IMF’s Article 4 consultation with Japan noted that the weaker yen has yet to improve the current account.

Between a rock and a hard place 

The higher energy costs in Japan have not, however, turned consumer opinion back in favor of nuclear power. According to a recent poll, 31% of 1,085 Japanese citizens surveyed said they had not felt any pinch from higher utility bills, and 41% said they felt the effect “a little.” This poses a political challenge for Japan. Japan’s leaders would undoubtedly prefer to be able to rely on domestic nuclear energy production, but restarting nuclear reactors with Fukushima continuing to make headlines is political poison.

That leads to a muddled energy strategy. Former Prime Minister Naoto Kan made a promise to end the use of nuclear power in Japan, but his successor (Yoshihiko Noda) ungracefully retreated from a 2040 goal of phasing out all nuclear power. The current Japanese government finds itself caught between businesses who favor nuclear energy production and citizens who still doubt those reactors can be overseen responsibly. For example, a legal claim filed recently appealed the decision not to indict the former heads of Tokyo Electric Power (which oversaw Fukushima). Furthermore, Junichiro Koizumi, a former prime minister and a political heavyweight, recently declared he had changed his stance on the nuclear issue and now opposes atomic power plants.

Energy costs have also intertwined themselves with “Abenomics,” Prime Minister Shinz? Abe’s new stimulus plan. Ending Japan’s dogged deflation is a primary goal, and the economy shows signs of inflation picking up. However, as covered previously on GRI, much of that inflation has to do with the higher energy costs that have come with increased imports. While Abe is eager to claim that inflation as a success, it needs to be broad-based in a way that can contribute to wage growth and boost the economy further.

Bloomberg’s editorial board recently urged the government to better manage the Fukushima issue to rehabilitate the image of nuclear power in Japan. They also noted that restarting reactors would be critical to Abe’s economic plan. While all the reactors do not need to be brought on at once, Japan’s government needs to build a credible strategy, which instills confidence in the Japanese public. The public needs to be reassured that the government can properly regulate and ensure the safety of nuclear power plants. With a stronger domestic energy supply, utility costs for businesses and consumers would hopefully decline and Japan’s economic fundamentals might improve to help further growth.

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CPI Drops, Misses By Most In 14 Months

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

If there was another reason for the Fed to keep its foot 'through' the floor, it is the fact that despite a record growth in the Fed balance sheet YoY, CPI (ex food and energy) dropped to 1.7% and missed by its biggest margin in 14 months. This is the 2nd lowest print in two-and-a-half years. Perhaps most dismally, real hourly wages rose at only 0.9% year-over-year – around half the rate of inflation. Overall, energy costs rose the most MoM (+0.8%) while Apparel fell 0.5% MoM (its biggest drop in 6 months as we suspect the JCP-driven sales deflation has begun already); and given Sebelius' testimony today we note that healthcare costs are up 2.4% YoY (almost triple the rate of wage increase).

CPI YoY Ex Food and Energy saw its biggest miss in 14 months…

 

As overall CPI also dropped with Energy and utilities costs rising the most…

Illinois Teachers Pension Fund is 40% Funded, Drops Deeper Into Hole Despite Investment Return of 12.8%; What’s the Solution?

Courtesy of Mish.

In spite of a 12.8% annual return, with an 8% return assumption, the Illinois Teachers Retirement System (TRS) fell another $3.5 billion in the hole. TRS pension underfunding grew to $55.73 billion as of June 30, 2013.

Via email, the Illinois Policy Institute explains the growing liability.

First, TRS only has $0.40 in the bank for every dollar it should have today to make necessary pension payouts in the future. That means the high investment returns in 2013 were earned on less than half of the assets that TRS should have

TRS acknowledged this in a recent press release:

“Despite these strong returns, TRS cannot invest its way out of the funding hole we are in,” Ingram added. “This increase in the System’s unfunded liability, even with good investment results, is another wake-up call to state officials and our members that TRS long-term finances continue to head in the wrong direction.”

“Without changes to the pension code to ensure sustained and adequate funding, TRS faces the very real possibility that in a few decades the System will not have enough money to pay benefits to retirees. We cannot guarantee that TRS will have enough money to pay the pensions promised to every member in the System.”

Second, the inherent flaws of the state’s defined benefit pension system have driven up the shortfall significantly. According to the Commission on Government Forecasting and Accountability, the state’s pension shortfall grew by $41 billion from 1996 to 2012.

Of that amount, nearly $23 billion came from some form of missed “assumption” that continually plagues defined benefit pension plans:

  • The investment returns for the state’s five pension funds were lower than their assumed 8% expectation. Cost to taxpayers: $9.5 billion.
  • Unplanned benefit increases for employees. Cost to taxpayers: $1.1 billion.
  • Changes in actuarial assumptions. Cost to taxpayers: $4.9 billion.
  • “Other” actuarial factors. Cost to taxpayers: $7.2 billion.

TRS fails to acknowledge the failures of the defined benefits plan and instead chooses to blame taxpayers for not contributing enough to the system.

Who is to Blame for Shortfalls?

Please consider the Illinois Policy Center report State pension contributions: Taxpayers bear the brunt of increasing pension costs

A common refrain sounded by public sector unions is that government workers have consistently “paid their share” into Illinois’ pension systems and the state has not. However, the facts tell a different story.

While government worker contributions to Illinois’ five pension systems have increased by 75 percent since 1998, taxpayer contributions have increased by 427 percent over the same period. In 2012 alone, Illinois taxpayers contributed $3.5 billion more to the pension systems than state workers did….

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The Second Dot-Com Bubble Is Raging, But “This Time Is Different”

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

"It's gotten pretty frothy," is how one portfolio manager describes the behavior in internet-based companies currently as signs of pre-2000 exuberance can be seen in Silicon Valley and the nearby area. As WSJ reports, home prices in San Francisco and surrounding counties rose more than 15% in the past year. Office rents in San Francisco are 23% above their 2008 peak.

As SnapChat, Pinterest, and Twitter are set to join such illustrious names as RocketFuel, asset managers are careful to remind suckers investors that it's not at all like 1999 – companies going public are more mature, the leadership teams more seasoned, the business models more proven – but the "reach for growth" at all costs echoes Kyle Bass' remarks that "financial memory is no longer than two years," with even younger and more revenue-deprived companies come to market at massively elevated multiples.

Via WSJ,

"It's gotten pretty frothy," says Daniel Cole, a senior portfolio manager at Manulife Asset Management who has invested in highflying IPOs, including for Rocket Fuel Inc. The Redwood City, Calif., online-advertising company sold shares to the public last month at $29 each. They traded at $61.72 a share Friday, giving Rocket Fuel a market valuation of $2 billion, without having recorded a profit.

Technology and finance veterans say this time is different—and it is. Companies going public are more mature, the leadership teams more seasoned, the business models more proven. Social networks such as Twitter and Pinterest are drafting off the success of Facebook Inc., which sports a market value of $126.5 billion, or about 70 times next year's expected earnings.

But the current surge is accelerating, aided by some little-appreciated factors. Big companies are scarcely growing, and interest rates remain near zero, boosting zeal for investment opportunities in companies with high-growth potential. Moreover, a federal law enacted last year will allow startups to raise money from smaller investors, opening a vast new pool of potential funding.

"People are reaching for growth,"

"The big difference now, is companies like LinkedIn, Twitter, Facebook have demonstrated an ability to generate sales, and with the exception of Twitter, profits," Mr. Ritter says. In the dot-com days, "there were all sorts of companies going public that were essentially startups."

But investor enthusiasm is filtering down to younger, less-proven companies today, too. Pinterest, an electronic-scrapbook service that began testing ads this month, said Wednesday that it had raised $225 million from venture-capital firms. Pinterest didn't need the money; the company said it hadn't spent any of the $200 million it raised in February when it was valued at $2.5 billion.

The new investment values the three-year-old company at $3.8 billion, a 52% jump in eight months.

Snapchat, a two-year-old mobile-messaging service popular with teens, is considering raising up to $200 million at a valuation exceeding $3 billion, people briefed on the matter said Friday. That would be more than triple the valuation that venture firms placed on Snapchat in June, when it raised $60 million.

Another factor: Last year's Jumpstart Our Business Startups Act soon will make it easier for less-wealthy individual investors to back startups. Already, the law has made it easier for financiers to pool money from individuals.

Some people worry that the looser rules may end up hurting small investors.

As less-sophisticated investors jump into backing embryonic companies, "the odds aren't in those people's favor," he says. A lot of those companies will fail, "then all of a sudden all you have is a piece of paper to stick on the wall."

Four New Challenges to Obamacare: Can Any of Them Possibly Work?

Courtesy of Mish.

A few days ago an article the LA Times announced LA Times More legal trouble for Affordable Care Act.

The Affordable Care Act proposes to make health insurance affordable to millions of low-income Americans by offering them tax credits to help cover the cost. To receive the credit, the law twice says they must buy insurance “through an exchange established by the state.”

But 36 states have decided against opening exchanges for now. Although the law permits the federal government to open exchanges instead, it does not say tax credits may be given to those who buy insurance through a federally run exchange.

Apparently no one noticed this when the long and complicated bill worked its way through the House and Senate. Last year, however, the Internal Revenue Service tried to remedy it by putting out a regulation that redefined “exchange” to include a “federally facilitated exchange.” This is “consistent with the language, purpose and structure … of the act as a whole,” the Treasury Department said.

But critics of the law have seized on the glitch. They have filed four lawsuits that urge judges to rule the Obama administration must abide by the strict wording of the law, even if doing so dismantles it in nearly two-thirds of the states. And the Obama administration has no hope of repairing the glitch by legislation as long as the Republicans control the House.

This week, U.S. District Judge Paul Friedman in Washington, a President Clinton appointee, refused the administration’s request to dismiss the suit. Instead, he said the challengers had put forward a substantial claim, and he promised to issue a written ruling.

“This is a problem,” said Timothy Jost, a law professor at Washington and Lee University. “This case could have legs,” although “it was never the intent of Congress to establish federal exchanges that can’t do anything.

Might Such a Challenge Work?

After reading the LA Times article, I pinged a couple of very bright lawyers and asked if there was any chance such a strategy might work. One of them replied ….

Hello Mish

It’s hard to say, especially since there were probably matching changes in the Internal Revenue Code as well.

Usually you can make arguments to help interpret language like this from its context by reading other sections of the law. But what if other sections of the law are worded similarly?

I tend to think that no one intended this result. Will the court rule on intent?

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Michael Pettis Cautions China’s Hidden Debt Must Still Be Repaid

[Note: This article has been posted here without the intro and emphasis of Zero Hedge]

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

Debt always matters because it must always be paid for by someone – even if the borrower defaults, of course, the debt is simply “paid” by the lender. As China Financial Markets' Michael Pettis notes, this is why the fact that debt in China seems to be growing much faster than debt-servicing capacity implies slower growth in the future. The author of "Avoiding The Fall", explains that if the debt cannot be fully serviced by the increase in productivity created by the investment that the debt funded, unless it is funded by liquidating state sector assets it must cause a reduction in demand elsewhere, most probably in household consumption.

Therefore, in spite of all the hope among global stock-buying hope-mongers, this reduction in demand implies slower growth in the future and, of course, a more difficult rebalancing process.

Via Michael Pettis of China Financial Markets,

Five or six years ago, a few skeptics first started pointing out that the credit dynamics underlying Chinese growth was creating an unsustainable increase in debt. This, they warned, would ultimately undermine the banking system and cause growth to collapse if it were not addressed in time.

There were three standard rejoinders to the warnings.

First, analysts argued that investment was not being misallocated, and because credit growth poured mostly into investment, it did not therefore follow, as the skeptics argued, that debt was rising faster than debt servicing capacity. Although I think few analysts still support this argument, there remain some analysts who do not think China has an overinvestment problem. For example my Carnegie colleague Yukon Huang, who has argued, for example in one of the FT blogs that China is actually underinvested:

The perception that China has invested too much is also misleading. Actually, China’s capital stock relative to GDP is lower than other comparable east Asian countries. Moreover, much of the surge in investment over the past decade is due to housing construction, where the country is still making up for the shortfalls from the Mao era.

Because I have addressed this issue many times before in my newsletters, especially the common and distressingly ahistorical fallacy that one can determine whether a very poor country like China is over- or under-invested by comparing its capital stock per capita to more advanced countries with much higher levels of social capital and the consequent ability to absorb investment efficiently, I will not do so again. Needless to say, I think that the evidence of investment misallocation has continued to rise, and in the past two years the number of analysts that are not worried about a systematic tendency for debt to rise faster than debt-servicing capacity has dropped significantly. I have no doubt that their refusal to accept the consensus on the subject is useful in that it helps sharpen the debate, but this is a losing battle and, like the capital stock argument, distressingly ahistorical.

The second rejoinder, which has also largely faded away as an argument over the past few years, is that debt in China doesn’t matter. Sometimes, these analysts argue, it doesn’t matter because it is funded domestically. Sometimes it doesn’t matter because the banks are implicitly guaranteed by the central government. Sometimes it doesn’t matter because China was able to resolve its last debt crisis, 10-15 years ago, in an environment of rapid growth and at no cost, and so of course it can do so again.

Again I have addressed all of these arguments as to why debt doesn’t matter in China many times before and it is pretty easy to show that all of these claims are fairly nonsensical, and this is especially obvious from the very wide range of historical precedents. Debt always matters. Either it must be repaid out of the proceeds of the investment that was funded by the debt, or – if the debt funded consumption or was misallocated into insufficiently productive investments – it must be repaid by transfers from some other sector of the economy, and these transfers reduce growth by reducing real demand.

The third rejoinder should have been, in principle, the easiest to refute, and for a while it looked like it had been refuted to everyone’s satisfaction, but in the past year I have seen a revival. China doesn’t have to worry about rising bad debts in its banking sector, according to this argument, because the PBoC’s extensive reserves will make it easy to recapitalize the banks.

Ray Chan, of the South China Morning Post, for example, had an interesting article last Saturday that made this point. He starts off the article by warning that the rapid growth in credit in China has uneasy parallels with rapid credit growth in the US before the 2007 crisis:

Parallels between the United States and China have started to look more ominous after several years of rampant credit growth and the emergence of an increasingly uncontrollable and unsustainable shadow banking system. China’s massive foreign reserves could, however, be the last tool in the bag for its bank-centric financial system if no timely regulations are implemented.

With the memory of the collapse of Lehman Brothers in 2008 still fresh, investors are fretting over the growth of thinly regulated shadow banking activity. Trusts, entrusted loans and bank acceptance bills shot up sharply to a record 294 billion yuan (HK$370 billion) last month. According to Moody’s Analytics, China’s core shadow banking products, which are often opaque and subject to little or no regulation, almost doubled to 20.5 trillion yuan last year from 11.7 trillion yuan in 2010. The US firm excludes entrusted loans and trust loans as they own underlying assets.

Debt and reserves

The article does a good job of listing many of the problems that have emerged in the past few years, but then quotes a number of analysts who argue that China’s problems is very different from that of the US and it is unlikely to suffer the same kind of crisis. The article continues:

China’s credit situation is somewhat different, though, as it has a high saving rate and massive foreign reserves. Mervyn Davies, a former head of Standard Chartered and British government minister, said: “China is very rich in reserves … At the end of the day, the [Chinese] banks do need recapitalising, which is not a huge challenge to them because the government can recapitalise the banks.”

I agree that China is in a very different position than the US, but this isn’t necessarily a good thing. The main relevant difference is that because all the banks are perceived to be guaranteed by the central government, and Chinese households have a limited number of ways to save outside the banking system, it is unlikely that China will experience a system-wide bank run as long as the credibility of the guarantee survives, and runs on individual banks can be resolved by regulatory fiat (banks that receive deposits will be forced to lend to banks that lose deposits). We are not likely to see a Lehman-style crisis.

We are also not likely to see, however, the advantages of a Lehman-style crisis, and these are a relatively quick adjustment in the process of investment misallocation. I have always said that the resolution of the Chinese banking problems is far more likely to resemble that of Japan than the US, and instead of three of four chaotic years as the system adjusts quickly, and at times violently, we are more likely to see a decade or more of a slow grinding-away of the debt excesses. The net economic cost is likely to be higher in a Japanese-style rebalancing, but American-style rebalancing is risky except in countries with very flexible institutions – financial as well as political.

But I do disagree very strongly with Mervyn Davies’ claim that because the PBoC is “very rich in reserves” it will not be much of a challenge to recapitalize the banks. China’s reserves only matter to its credit position if China faced a problem of external debt.

It doesn’t, and so the amount of reserves are almost wholly irrelevant, because this argument seems to be reviving, it makes sense, I think, to repeat why central bank reserves cannot in any way help China resolve the crisis. I will leave aside the problems of whether the reserves are transferred in the form of foreign currency, in which case it does little to satisfy domestic RMB-denominated funding needs, or in RMB, in which case the PBoC must stop buying dollars in order to hold down the value of the RMB and in fact must sell dollars, which would cause the value of the RMB to soar, thereby wiping out the export sector in China.

A much more important objection is that the idea that reserves can be used to clean up the banks (or anything else, for that matter) is based on a misunderstanding about how the reserves were accumulated in the first place. There seems to be a still-widespread perception that PBoC reserves represent a hoard of unencumbered savings that the PBoC has somehow managed to collect.

But of course they are not. The PBoC has been forced to buy the reserves as a function of its intervention to manage the value of the RMB. And as they were forced to buy the reserves, the PBoC had to fund the purchases, which it did by borrowing RMB in the domestic market.

This means that the foreign currency reserves are simply the asset side of a balance sheet against which there are liabilities. What is more, remember that the RMB has appreciated by more than 30% since July, 2005, so that the value of the assets has dropped in RMB terms even as the value of the liabilities has remained the same, and this has been exacerbated by the lower interest rate the PBoC currently earns on its assets than the interest rate it pays on much of its liabilities.

In fact there have been rumors for years that the PBoC would be insolvent if its assets and liabilities were correctly marked, but whether or not this is true, any transfer of foreign currency reserves to bail out Chinese banks would simply represent a reduction of PBoC assets with no corresponding reduction in liabilities. The net liabilities of the PBoC, in other words, would rise by exactly the amount of the transfer. Because the liabilities of the PBoC are presumed to be the liabilities of the central government, the net effect of using the reserves to recapitalize the banks is identical to having the central government borrow money to recapitalize the banks.

This is the point. Any government that is able to borrow money can borrow money to recapitalize its banks, whether or not it has large amounts of foreign currency reserves. The amount of central bank reserves that China or any other country has is wholly irrelevant, except perhaps to the extent that without those reserves the central government would lack the credibility to borrow domestically, which hardly seems to be a concern in China’s case.

Bailing out the banks, it turns out, is conceptually no different than transferring debt from the banks to the central government. China can handle bad debts in the banking system, in other words, by transferring the net obligations from the banks to the central government, and the large hoard of reserves held by the PBoC does not make it any easier for China can resolve any future debt problems. In fact if anything it should remind us that when we are trying to calculate the total amount of debt the central government owes, the total should include any net liabilities of the PBoC, and that these net liabilities will increase by 1% of GDP every time the RMB strengthens against the dollar by 2%.

Does hidden debt matter?

Before finishing on this topic, I want to address another related fallacy that pops up a surprisingly large number of times when I discuss the net liabilities of the central bank. I am often told that because these liabilities are hidden in the central bank books, and so no one really knows how much debt the PBoC adds to the central government’s debt burden, they really shouldn’t matter in our calculations. The central bank will presumably never default because its obligations are guaranteed by the central government, and the its net liability position is hidden, so why bother even consider the PBoC’s balance sheet when assessing China’s debt position?

Even those who do not understand why this reasoning is incorrect should know that it must obviously be incorrect. If it weren’t, any country could solve all of its debt problems merely by borrowing in a non-transparent way through the central bank. As the Greeks and the Italians most recently showed us, non-transparent borrowing may cause us to recognize a problems later than we otherwise would have, but it cannot solve the problem.

The reason is because in any case debt must either be serviced or the borrower must default. If the assets which were funded by the debt do not create enough wealth with which to service the debt, and if the borrower does not default, then by definition there must have been a transfer from some other entity to cover the difference between the debt servicing cost and the returns on the asset.

Typically this other entity, in China and elsewhere, has been the household sector, and in the case of China the transfer occurred primarily in the hidden form of severely repressed interest rates. Whether the transfer is from the household sector, however, of from other sector, this is where the problem of debt lies for China.

If the central bank (or the commercial banks or any other borrower whose obligations are covered by the central government) is unable to service its debt – and remember that the “economic” debt servicing cost is not the coupon, which is repressed by policymakers, but consists of whatever the “natural” interest rate would have been – the difference will be paid for by someone else, and the economy will suffer slower growth because of the reduction in demand caused by the transfer payment.

So who is likely to cover the cost of NPLs in Chinese banks? This isn’t an easy question to answer. If the household sector continues to pay, either in the hidden form of repressed interest rates, or in the more explicit form of taxes, the existence of bad debt in the Chinese banking system must act to repress future household consumption growth. The transfers from the household sector to pay what may turn out to be a huge NPL bill will significantly lower the household income share of GDP, making it very unlikely that the household consumption share of GDP will rise.

If however the state sector covers the difference (perhaps by privatizing state assets and using the proceeds to pay down debt), we are left with the very difficult political problems, which China currently faces, of assigning the costs to different sectors or groups that control the state sector in China. The potentially very large cost of cleaning up NPLs must be assigned to groups that are likely to be both powerful and reluctant to pay the cost.

Debt always matters because it must always be paid for by someone –even if the borrower defaults, of course, the debt is simply “paid” by the lender. This is why the fact that debt in China seems to be growing much faster than debt-servicing capacity implies slower growth in the future. If the debt cannot be fully serviced by the increase in productivity created by the investment that the debt funded, unless it is funded by liquidating state sector assets it must cause a reduction in demand elsewhere, most probably in household consumption. This reduction in demand implies slower growth in the future and, of course, a more difficult rebalancing process.

Sitting on the Sidelines: Fear & Selective Memory

Sitting on the Sidelines: Fear & Selective Memory

Courtesy of Wade of Investing Caffeine

Sidelines.sxc

Fear is a motivating (or demotivating) emotion that can force individuals into suboptimal actions.  The two main crashes of the 2000s (technology & housing bubbles) coupled with the mini-crises (e.g., flash crash, European crisis, debt ceiling, sequestration, fiscal cliff, etc.) have scared millions of investors and trillions of dollars to sit on the sidelines. Financial paralysis may be great in the short-run for bruised psyches and egos, but for the passive onlookers, the damage to retirement accounts can be crippling.

Selective memory is a great coping mechanism for those investors sitting on the sidelines as well. Purposely forgetting your wallet at a group dinner may be beneficial in the near-term, but repeated incidents will result in lost friends over the long-run. Similarly, most gamblers frequenting casinos tend to pound their chests when bragging about their wins, however they tend to conveniently forget about all the losses.  These same reality avoidance principles apply to investing.

A recent piece written by CEO Bill Koehler at Tower Wealth Managers, entitled The Fear Bubble highlights a survey conducted by Franklin Templeton. In the study, investors were asked how the stock market performed in 2009-2012. As you can see from the chart below, perception is the polar opposite of reality (actual gains far exceeded perceived losses):

Source: Franklin Templeton via Tower Wealth Managers

Source: Franklin Templeton via Tower Wealth Managers

With so many investors sitting on the sidelines in cash or concentrated in low-yielding bonds and gold, I suppose the results shouldn’t be too surprising. Once again, selective memory serves as a wonderful tool to bury the regrets of missing out on a financial market recovery of a lifetime.

Humans also have a predisposition to seek out people who share similar views, even though accumulating different viewpoints ultimately leads to better decisions. Morgan Housel at The Motley Fool just wrote an article, Putting a Gap Between You and Stupid,  explaining how individuals should seek out others who can help protect them from harmful biases. A scientific study referenced in the article showed how the functioning of biased brains literally shuts down:

“During the 2004 presidential election, psychologist Drew Westen of Emory University and his colleagues studied the brains of 15 “committed” Democrats and 15 “committed” Republicans with an MRI scanner. Each group was shown a collection of contradictory statements made by George W. Bush and John Kerry. Not surprisingly, the partisans were quick to call out contradictions made by the opposing party, and made up all kinds of justifications to rationalize quotes made by their own side’s candidate. But here’s what’s scary: The participants weren’t just being stubborn. Westen found that areas of their brains that control reasoning and logic virtually shut down when confronted with a conflicting view of their preferred candidate.”

Rather than letting emotions rule the day, the proper approach is to stick to unbiased numbers like valuations, yields, fees, and volatility. If you continually make mistakes; you aren’t disciplined enough; or you don’t like investing; then find a trusted advisor who uses an objective financial approach.  Opportunistically taking advantage of volatility, instead of knee-jerk reactions is the preferred approach. For those people sitting on the sidelines and using selective memory, you may feel better now, but you will eventually have to get in the game, if you don’t want to lose the retirement account game.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

Need a Hand? Boy Gets Prosthetic Hand Made by 3-D Printer (Cost $5 vs. $30K Medical Device)

Courtesy of Mish.

What do you do when you cannot afford a $30,000 prosthetic hand that your son needs?

Two years ago, Paul McCarthy began searching for an inexpensive yet functional prosthetic hand for his son Leon, who was born without fingers on one of his hands.

McCarthy came across a video online with detailed instruction on how to use a 3-D printer to make a prosthetic hand for his son. McCarthy made a prosthetic hand for his son for a cost of $5 and free time on a 3D printer.

Link if video does not play: prosthetic hand made by 3-D printer

Large Mechanical Hand

A “large mechanical hand” invention by Ivan Owen is what kicked off the technological progression to “Robohand”.

Here is an interesting, 49 second Video on Owen’s Mechanical Hand

Dexterity To Children With No Fingers

As noted by NPR, 3-D Printer Brings Dexterity To Children With No Fingers followed “Mechanical Hand”. Here are a couple of images.

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Senator Harry Reid Supports Giving Illegal Aliens Tax Credits for Kids Not Even Living in US

Courtesy of Mish.

U.S. Rep. Sam Johnson, R-Texas, left, wants to end the practice of giving illegal immigrants tax credits for kids, but U.S. Sen. Harry Reid, D-Nev., won’t let the House-approved measure H.R. 556 through the Senate.

The System is Working Fine” says Senator Harry Reid, even though the Joint Committee on Taxation calculates that enactment of H.R. 556 would save taxpayers $24.4 billion over the next decade.

The House of Representatives repeatedly has passed an IRS bill that could save U.S. taxpayers up to $24.4 billion over the next 10 years — but Harry Reid’s Democratic Senate will not hear it.

The Refundable Child Tax Credit Eligibility Verification Reform Act, or H.R. 556, would require tax filers to provide Social Security numbers to claim child tax credits.

Currently, the IRS allows undocumented residents to collect the $1,000 credits for dependents not even living in the country. Watchdog reported that illegal immigrants received $4.2 billion from the tax agency in just one year.

“My bill (targets) billions of dollars in waste, fraud and abuse. Instead of hitting up taxpayers for even more taxes, Washington needs to go after these billions of dollars,” said U.S. Rep. Sam Johnson, R-Texas.

Though the GOP-controlled House has passed Johnson’s measure three times, Senate Majority Leader Reid, D-Nev., refuses to allow the bill to come up for a vote in his chamber.

“The IRS has been doling out the credit to tax filers claiming children who do not even live in the country,” Johnson charged.

Tax preparers agree that the system is broken — and that the IRS must fix it. They say the agency has to stop disbursing ACTC refunds based on Individual Taxpayer Identification Numbers, which are available to undocumented residents.

Tax preparers told Watchdog they have seen clients from Guatemala, El Salvador, Honduras and Nicaragua claiming Mexican children as dependents.

A 2009 TIGTA audit concluded that the child tax credit “appears to provide an additional incentive for aliens to enter, reside, and work in the U.S. without authorization, which contradicts Federal law and policy to remove such incentives.”

Johnson’s bill would impose a 10-year ban on tax filers who commit fraud and a $500 penalty on tax preparers who knowingly bilk taxpayers through the ACTC program….

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JPMorgan Slides on “Deal” Breakdown Chatter

(…Then Gets Back Up)

JPMorgan Slides On "Deal" Breakdown Chatter 

Courtesy of ZeroHedge

JPMorgan shares have dropped modestly (though any drop is notable in the new normal) as the WSJ reports that the $13bn deal with the Department of Justuice may be at risk:

  • *JPMORGAN FALLS 0.6% AS DOW JONES SAYS DOJ DEAL AT RISK
  • *JPMORGAN, JUSTICE DEPT SAID TO DISAGREE ON FDIC REIMBURSEMENT
  • *JPMORGAN PROPOSED SETTLEMENT SAID TO FACE U.S. RESISTANCE

It appears the 'breakdown' is over JPMorgan's demands that they offset payments to the DoJ from the FDIC fund (i.e. they wanted to use FDIC to fund this penalty on the basis of some possible indemnification from the WaMu deal). DoJ lawyers are not amused (for now)…

 

*****

Then Gets Back Up

Ilene: The WSJ reports: Part of J.P. Morgan's Deal With U.S. at Risk of Collapse (subscription required).

It would have been a mistake to sell on this news. See Yahoo's one day is chart below:

 

Selling a new CMI put option

By Paul Price of Market Shadows

We closed-out our Cummins (CMI) January 2014 $110 put for $1.40 per share on September 19 when the shares were riding high. We booked a $960 gain in just over seven months.  The details of that Sold to Open/Bought to Close (STO/BTC) transaction are shown below.

CMI closed-out trade                       

This morning CMI shares are down more than 8% after a badly received quarterly report. We still like the stock. Accordingly we sold a new CMI January 2015, $110 strike price put contract for $1040.00 ($10.40 per share).

 CMI  Quote and Put Price

As long as we are short the put, we are committed to buy 100 CMI shares at a net cost of $110 (the strike price) minus $10.40 (the put premium) = $99.60 per share. Thus $99.60 is our break-even. Cummins has not spent one day in 2013 below our break-even price on this trade. Cummins traded as high as $139.17 just days ago.

 CMI  1-year chart with 'If Put' price

The great put price comes from the combination of today’s big drop and the increased implied volatility–factors which contribute to great timing for put sales.

The new trade will be recorded in our Virtual Put Writing Portfolio.

Maximum profit would be keeping the $1,040 we received upon sale of the put without ever having to buy the stock. We'll achieve that result if CMI remains above $110 on the Jan. 17, 2015 expiration date.  Our maximum risk is to be forced to buy 100 shares of CMI at less than $100 (net). Since I think CMI is at a good price below $100, I don't mind committing to buying it cheaper at $99.60.

Full details of all closed-out and open put positions: Virtual Put Writing Portfolio.

Visiting with Lee Adler

Lee Adler of the Wall Street Examiner talks with Lindsay Williams about quantitative easing.

****

Listen to a couple of podcasts with Lee Adler at Radio Free Wall Street:

Lee discusses the market with Russ Winter on October 3 here. > 

Lee answers some of my questions on October 25 here. >

 

JPMorgan Is In a Boatload of Trouble Over Madoff: Here’s Why

Courtesy of Pam Martens.

There are five words that neatly sum up JPMorgan Chase’s dilemma in its efforts to avoid a deferred prosecution agreement or a more serious outcome over its handling of Bernard Madoff’s business account for more than two decades: the “Know Your Customer Rule” and recidivism.

The Know Your Customer Rule is ingrained in every banker and broker on Wall Street by the legions of compliance officers who send out terrifying memorandums depicting recent examples in the news or the courts of what happens to unwitting financial reps who didn’t know their customers. The memos are backed up with equally terrifying compliance meetings and compliance handbooks that one must acknowledge receiving in writing. Some firms now require brokers to take computer-based continuing education classes which further enshrine the mandates of the Know Your Customer Rule.

The object of this rule is to make the banker or broker responsible for determining the legitimate line of work the customer is engaged in while monitoring the account regularly to see if the transactions correlate to that legitimate business. The overall goal is to protect the Nation’s banking system from being a conduit for money laundering or other illicit activities.

It is not uncommon to receive a phone call from the bowels of the compliance department if something appears amiss. I once received such a call because a parent who was a client wanted to transfer a large sum from his account to his son’s account to help him buy a home. These were both long term clients whom I knew from my own town and who had done nothing more alarming in a decade than collect muni bond interest in their accounts. I had to get a copy of the purchase contract on the home to satisfy the inquiring minds in compliance.

On another occasion, I filled out a new account card for a science professor who was the husband of a long term client. I got a call from the compliance department suggesting he wasn’t really who he said he was. It took about 30 seconds to pull up his 20-year resume at his university, complete with his email address, and email it back to the compliance department to make their own contact.

Understanding intimately how the Know Your Customer Rule plays out every day on Wall Street makes it next to impossible to understand how JPMorgan Chase could have legitimately maintained the Madoff account. According to lawsuits filed by the Trustee handling the Madoff recovery funds, Irving Picard, JPMorgan knew that Madoff was engaged in an investment advisory business for hundreds of clients; but the Madoff bank account that JPMorgan Chase oversaw showed billions of dollars in cash being wired in and out but no payments going to any party engaged in processing or clearing a stock trade.

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Energy Is A Power Game – 3 (They Cheat And They Lie)

Courtesy of The Automatic Earth.

My personal view of how communities should manage the production and distribution of their basic necessities is very different from what has become the accepted model in the western world. The running mantra says that private industries are better at anything and everything than governments are, and hence, than communities are.

What I think is that even if that were true, and from what I see it's much more of an ideology than a proven fact, even if it were true it wouldn't make any difference. Because as far as I can see, it's essential and crucial to the well-being, and indeed the survival of a community, to control production and distribution of its basic needs. It may not be evident at all times, but, like with so many things, when shortages or other problems set in, so does reality. And a community will realize too late that it's fine to pay a small prize for its independence.

And here, after Energy Is A Power Game – 1 and Energy Is A Power Game – 2 (Britain Is Losing), I return one more time to Britain and its energy politics. After Thatcher was done, the British people were left with very little ownership of both their energy sources and the relevant distribution systems. It may have taken 25 years or so, about an entire generation, but today the bills are due for what was decided under her leadership and her alleged free market beliefs. And now the people are stuck. Exactly how stuck they are is what they will find out from here on in, and they're not going to like it one bit.

But there's little left to do, the die have been cast. There are voices now clamoring for a "full-scale" reform, but they had one of those 25 years ago, and it created, instead of the promised increase in competition and decrease in prices, an – often foreign-owned – energy cartel that now has an iron grip on Britain.

Today, October 29, the Commons Energy and Climate Change Select Committee will start doing a lot of posturing when they get to "grill" the heads of their big six energy corporations. But other than a ton of questions, mucho posturing and a few superficial changes, plus lots and lots of promises made to allow everyone to save face at least to some degree, the MPs are powerless and toothless. They can ask any question they want, but control over power generation and distribution in Britain has already been squandered away.

They could hypothetically elect to re-nationalize the entire industry, but while it may be the only possible way to go down the line (as industry insider Euan Mearns also suggested), that's not going to happen any time soon.

UK household gas prices have risen faster than in any other major European country

Household gas prices in Britain have risen faster than in any other major European country, the Sunday People can reveal. Research shows they rocketed by nearly 200% in 10 years, compared with less than 40% in Denmark. And the whopping increases show no sign of being curbed after ScottishPower became the latest Big Six energy company to put up its prices. The firm announced a rise of 8.5%, joining Npower's 11.1%, SSE's 8.2% and British Gas on 8.4%.

The rises will hit five million British families already choosing between heating and eating and push them even further into fuel poverty. And it makes the UK second only to Estonia for customers struggling to pay their energy bills. Shadow energy secretary Caroline Flint told the Sunday People: "These figures lay bare the full scale of the cost of living crisis facing Britain."

Energy prices in Britain are double those of the US, although lower than in Germany, France, Ireland and Spain. But France and Spain cap rises by making prices fit an index-linked formula. Labour leader Ed Miliband is planning something similar by freezing energy prices for 20 months if he becomes PM in 2015. That is predicted to save 27 million homes an average of £120 a year.

I have no idea if the people in Britain were aware of this, but it seems obvious that once they do, it's not going to make them happy. A 200% rise in a decade looks pretty insane, especially when that decade contains a full-blown financial crisis. And the questionable behavior continues:

Energy firms raised prices despite drop in wholesale costs

Some of Britain's big six energy companies have seen their wholesale electricity costs fall over the last three years while still putting up prices for millions of households. The figures will put yet more pressure on the firms to explain why bills and UK profits have been going up, as they appear before a influential House of Commons committee of MPs.

According to Ofgem, Npower paid an average of £59.61 per megawatt-hour for electricity in 2010. The average wholesale price fell by 4% to £57.32 in 2011 and rose by less than 2% to £58.39 in 2012. The company increased retail prices by 5.1%, 7.2% and 9.1% respectively in those years.

Similarly, EDF paid wholesale prices for electricity supplied to households of £58.16MWh in 2010, falling by 0.6% to £57.82 in 2011 and rising less than 5% to £60.68 in 2012. In those years EDF's electricity prices to customers went up by 7.5%, 4.5% and 10.8% respectively.

Meanwhile E.ON paid £57.64MWh for its electricity in 2010, rising by 7% to £61.82 in 2011 and falling by 4% to £59.44 in 2012. It raised its power prices twice by a cumulative 20% in 2011, before cutting them by 6% in 2012.

Asked why wholesale prices appeared to be out of kilter with increases in bills, companies said network and environmental costs had been the biggest factor in higher electricity bills, which are now around £600 a year on average. However, figures from Ofgem indicate electricity network costs have only risen by £10 in each of the last four years, while green costs are rising by a similar amount. Green and social levies make up £112, or less than 9%, of the average household energy bill.

Perhaps an even bigger problem, however, from an ethics point of view, is what the energy companies have been pulling behind the curtain:

British Gas rakes in £20 million profit from overestimated bills, says whistleblower

Energy giant British Gas is siphoning off millions of pounds of extra profits annually by keeping hold of money owed to former customers who have built up credit on their accounts. A whistleblower has told the Observer that £20m-worth of "credit balances" was put into the annual accounts of British Gas in one recent financial year. The shadow energy secretary, Caroline Flint, said she was "shocked" by revelations about the credit windfall, which she said was "unacceptable".

Under the current system, energy companies estimate customers' future usage and charge accordingly. If less energy is used, credit is built up which can be reclaimed or used to offset higher-than-expected subsequent bills. The profits from "credit" were taken by British Gas in cases where private or business customers had been overcharged on the basis of estimated bills, and then changed to another supplier, or ceased using British Gas for other reasons, with the outstanding sum owed to them still on their accounts.

British Gas – which argues that it is unable to track down all customers who have left them, changed addresses, or gone bankrupt – used to wait six years before taking the cash. But the whistleblower claims a special team was set up – partly based at a Leicester call centre – to fast forward this process so that investigations to locate people would be launched, and the money then taken into company accounts over a much shorter timescale.

Under this new arrangement, British Gas then took years of accumulated credit owed on accounts to augment its income. While there is nothing illegal about this, the source said British Gas was apparently nervous about how the move would be viewed if it became public. "We were briefed about how sensitive this was and there was endless talk about how this would look if it ended up on the front page of a newspaper," said the whistleblower. He believes that all the other power companies also take this kind of money back into their accounts as profit but only after six years.

These guys are pretty shameless. And why shouldn't they be? Who's going to touch them? Who do we think controls what here?

Record numbers fight to claim back £1.2 billion overpayments which make energy companies £12 million interest a year

Sunday Mirror research shows that energy firms are sitting on direct debit customers' credit – and raking in £12m a year interest. Record numbers of customers are battling power giants to claw back the £1.2 billion they have overpaid. The independent energy ombudsman is being flooded with billing complaints after the Sunday Mirror last week revealed the massive scale of the scandal. Our research found energy firms were sitting on the fortune that belongs to direct debit customers in credit – and raking in more than £12 million a year interest.

Nine out of 10 complaints to the ombudsman are about bills. The most common problems are mistakes on charges and inaccurate meter readings. In the past two months alone the ombudsman has agreed to investigate 3,304 complaints – up from 1,533 in the same period last year. A spokesman said: “These are cases we have accepted for investigation. “We have dealt with thousands of complaints from people who say they have been overcharged.”

Not that they're ready to give a single inch, and again: why should they?

Energy giants: Our profits aren't large… as direct debit interest helps them rake in £3.7billion

The head of Energy UK has claimed the Big Six energy firms do not make large profits – despite the £3.7 billion they raked in last year. Angela Knight, chief executive of the body that represents the energy giants, made the claim as details emerged of the widespread tax avoidance employed legally by energy firms. It was also revealed that companies are making an estimated £36 million a year in interest on the credit built up by customers paying via direct debit.

Miss Knight, a former Tory MP, said: ‘They might be politically popular, but price freezes have never worked and never will work,’ she said. ‘Windfall taxes have taken place in the past where there have been windfall profits. The profits here of four or five pence in the pound aren’t particularly big.’ [..]

While the Big Six – British Gas, SSE, nPower, E.On, EDF and Scottish Power – make profits of around 4 or 5% from supplying energy to households and businesses, they make an average of 22% from generating electricity, sourcing and storing gas, and transporting energy. [..]

More than three million older people are worried about staying warm indoors this winter – with six million anxious about rising fuel bills, says Age UK. But the charity said many are unaware of the potentially fatal consequences of living in poorly heated housing.

A 22% profit ratio. That's quite something for an industry that should serve a society's basic needs. Still, this next bit is at least as tasty:

The other energy scandal – power giants use loophole to cut their own tax bills

As Britons buckle under the pressure of soaring energy bills, The Independent on Sunday can reveal the energy companies that are saving millions by exploiting a legal tax loophole.

Scotia Gas, 50% of which is owned by SSE, the energy giant which is about to put its prices up by more than 8%, has avoided an estimated £72.5m in tax. UK Power Networks and Electricity North West, responsible for running large sections of Britain's electricity network, have both saved more than £30m.

UK Power Networks, which owns and maintains power cables and lines for eight million people in London, the South-east and East of England, has avoided an estimated £38m since 2010 from paying £164.4m via the Cayman Islands to firms controlled by Li Ka-shing, a Hong Kong tycoon and Asia's richest man. His Cheung Kong group also owns Northumbrian Water, among several water firms that use the quoted Eurobond exemption.

Electricity North West owns and operates the region's electricity distribution network, connecting 2.4 million properties to the National Grid. It has avoided an estimated £30m in tax after sending £107.2m to its owners, JP Morgan Infrastructure Investments Fund and Colonial First State, since they bought it in 2007.

More than 30 UK companies have cut taxable profits by racking up interest on debt from their owners. In doing so, this minimises – in some cases wipes out – their UK corporation tax bill. As most of the owners are based abroad, 20% of the interest payments would usually have to be sent straight to HMRC, minimising the overall saving. But as the money is lent via offshore stock exchanges that qualify for a regulatory loophole called the "quoted Eurobond exemption", no tax is withheld.

Scotia Gas is the second-largest gas distribution firm in the UK, serving 5.8 million people in Scotland and in the South and South-east of England. While half of it is owned by SSE, the rest is owned by the Ontario Municipal Employees Retirement System and the Ontario Teachers' Pension Plan. After they bought the networks from National Grid Plc in 2005, the new owners lent the majority of their money – about £530 million at a 12.5% interest rate – through the Channel Islands Stock Exchange rather than investing it in shares in the company. Scotia has since paid interest of £537.3 million on these loans.

The Ontario Teachers' Pension Plan also owns National Lottery operator Camelot and Bristol Airport, both revealed to be using the tax-avoidance scheme last week. It is among several foreign pension funds investing through this legal loophole. [..]

The Eurobond exemption was introduced in 1984 to encourage third-party investment into UK companies. But analysis of listings on the Channel Islands Stock Exchange and UK company accounts shows firms across the economy are using it to minimise tax bills by borrowing from their owners. More than £2bn a year has left the UK as interest payments to owners, avoiding an estimated £500m, compared with if loan amounts had been invested in companies' shares. Given that other stock exchanges such as the Cayman Islands and Luxembourg qualify for the exemption, the total tax avoided is likely to be even higher.

UK Power Networks owner, Hong Kong tycoon Li Ka-shing's Cheung Kong group, which also owns Northumbrian Water and several other water firms, avoids taxes through the Caymans. Scotia Gas, co-owned by energy giant SSE and the Ontario Municipal Employees Retirement System and Ontario Teachers' Pension Plan, does it through the Channel Islands. The MO: they buy a company and lend it money at very high rates. On the case of Scotia Gas, since 2005, the new owners already made more in interest than the principal they put in in the first place. And counting.

This Eurobond exemption Thatcher set up may be a great profit machine for investors with deep pockets, but it's mayhem for both the British nation as a whole, which loses £100s of millions in tax revenue, and for the taxpayer, who also doubles as client of one of the Big Six energy corporations. AND has already seen her/his energy bill rise 200% in 10 years, AND gets another 10% slapped on just in the next year. AND may want to check to water bill too, because that's at least partly foreign owned as well.

Which makes me wonder how Thatcher followers, like Cameron, would today defend the decision to sell off all the public utilities she could get her hands on. Would they want to claim that it would have been worse if she hadn't done it? Is that even possible? You deliberately set up an instrument to allow foreign investors to not pay taxes that a domestic investor would have had to pay?

Five questions that the big six energy firms must answer

The bosses of the big six energy companies will appear before the energy and climate change select committee on 29 October. The powerful group of MPs, chaired by Tim Yeo, will grill them on green levies, profit levels – and why consumers face such big increases in their bills. These are the questions they should ask: [..]

The companies will argue that their costs have risen hugely because of wholesale power price increases and "green" levies. Don't take this at face value: companies buy a portfolio of future contracts lasting many years to ensure that their wholesale supplies will meet future retail demand. If they have underestimated their needs, that is their responsibility – and they could choose to absorb that cost. No one knows how much the power companies have bought in advance – and at what price – so independent experts have to take their arguments on trust. Green levies make up only 9% of the overall bill currently, a figure that will rise to 14% by 2020.[..]

Why is it that 30 years since the market began to be liberalised, a group of enormous firms still have a stranglehold over the sector? And why do they all put their prices up pretty much at exactly the same time, if they are not acting in concert in some way?[..]

Days ago, the last of the big six, Scottish Power, paid an £8.5m fine after Ofgem found inadequate training and monitoring of staff had led to inaccurate information on annual charges, consumption calculations and tariffs being given out. E.ON, which was fined £1.7m in 2012 for overcharging, had to pay an additional £2.5m this summer to help its poorest customers meet their fuel bills this winter after it was found to be selling low-energy light bulbs it should have given away. SSE was fined £10.5m for "prolonged and extensive" mis-selling, while British Gas was fined £1m two years ago for misreporting how much energy it had supplied.

Here's a certain Dr. Phillip Lee, not coincidentally, I'm sure, a Conservative MP, calling for that full-scale reform which Thatcher already pushed through. He starts off with "Britain's energy market is broken.", and I'm thinking yeah, well, it was your guys and gals that broke it. And if you get to shape the next "reform" as well, what are the chances that this time around you’ll get it right, that you will actually put your voters' interests first? If so, please explain what has happened to change your position. If you think the first round was badly bungled by your own party, then undo it. Retrace your steps. Engage the people, ask what they think needs to be done.

But that's not Dr. Lee's agenda. Quite the contrary, really. He's a reconnaissance trooper, a first line combatant, ordered to promote the notion that what is wrong in the UK's world of energy, is that pesky and very unfortunate 2008 Climate Change Act, which legally binds the government to all sorts of emissions standards.

After all, let's be honest, how can domestic and foreign deep pockets maximize their profits selling power to British homes if they have to take all these CO2 related issues into account that they don't even "believe" in? It's just not fair …

Only full-scale reform of our energy market will prevent endless price rises

Britain's energy market is broken. The most recent hike in prices is just the latest sign. There are more to come, and the unedifying thinking aloud from the political establishment is not going to fix it. We need full-scale energy market reform.

There is nothing we can do with today's UK energy market to stop consumers from being hit by even more unfair price increases. Just as worryingly, it is impossible to guarantee that the UK's current market and our energy policies will make it possible to meet the demand for affordable energy, which is mushrooming as our economy grows, our population rises. It does not work like that.

In fact, it is not clear that a true market in energy exists. Fears about an energy oligopoly – a market dominated by a few huge companies – are being replaced by ones of a monopoly as price rises are announced almost simultaneously by the "Big 6" companies. [..]

Britain needs to take a much longer-term view of how it uses energy. Over the last four decades California's economy has grown eight times without its energy usage increasing. We can do the same here. Our focus needs to be on energy efficiency, not on subsidising intermittent, renewable energy generation. In our increasingly populated and energy-demanding world, wholesale energy prices will not go down any time soon. We must be honest about that and introduce policies which will mitigate the impact of that reality on our lifestyles and our children's future.

In this context, we need to revisit the decarbonisation targets set under the previous government. Not because I believe we should abrogate our climate change responsibilities, but because they are destroying important parts of our economy. If this continues unchecked, there will be one less powerful, democratic nation around to effect beneficial change to the environment. A low-carbon Britain with no jobs and no money will not help save the planet. Real progress on decarbonisation must not undermine our global economic position.

The present UK government is legally obliged to reduce greenhouse gas emissions by at least 80% by 2050, but they're thinking: why should we care about the law when we are the ones making the law?! And if the government so obviously flaunts the law, how can it force companies to uphold it? How can it? It doesn't even want to. It’ll just change the law. That's what Dr. Lee's letter to the editor is announcing in veiled terms. Accompanied, of course, by the scare tactic that if people don't comply, their electricity and gas bills will rise even further. It's like a 21st century scorched earth strategy.

And they really don't give a rat's derriere about the law. Any law. Not if it stands in the way of increasing profits. These people just use the billions they ostensibly spend on reducing emissions as a further profit vehicle for their friends, paid for by the taxpayer. Who will invariably be left with less money and more emissions.

Statistics suggest UK is not on track to reduce emissions by 2020

The government has announced it is on track to reduce emissions by 34% by 2020, yet key statistics suggest that carbon dioxide emissions are actually on the rise. Government figures from the Digest of UK energy statistics (DUKES), published in July, state that UK emissions of greenhouse gases between 2011 and 2012 increased by 4.5%.

Under the 2008 Climate Change Act, the UK government is legally obliged to reduce the UK’s greenhouse gas emissions by at least 80% (from the 1990 baseline) by 2050. The UK was the first country in the world to establish a legally binding climate change target. But despite mass green-energy schemes, the figures suggest that the UK is relying heavily on coal, as opposed to renewable energy. [..]

So far, £35 billion has been invested in low-carbon initiatives since 2010, but according to the government this will have to increase by 310% in order for them to hit their targets.

The government's "lavish" subsidies on renewable energy programmes have faced growing criticism, with the TaxPayers Alliance arguing that the schemes are simply being funded by consumers through higher household energy bills.

But Davey said: “We’ve already had record amounts of planned investment in the energy sector and today we have given further confidence to the industry of the support available from government for new energy infrastructure out to 2021. [..] Our latest projections show that we are on track to meet our first three carbon budgets, but we recognise the scale of the challenge that we face in delivering further emissions reductions and meeting the target of the fourth carbon budget".

The government claims emissions are down, and they'll make their 34% 2020 reduction target, but in reality those same emissions rise 4.5% per year. What do the people know? And who cares anyway? What does it take to scare them enough? If you claim prices will rise by 20% per year, will they agree to let you soften the emissions rules? How about 50%? Everybody has a price, right?

And Cameron is in "good" company. The Canadian government thinks the same way, no matter what anybody says, as of course does just about any other government on the planet: done with the niceties once the bottom line gets in sight.

Canada says falling short of emissions reduction target

Canada acknowledged on Thursday that it will miss its target for greenhouse gas emissions by a wider margin than expected unless it takes further action to offset emissions in the oil industry.

The admission in a report by the environment ministry comes as the Conservative Prime Minister Stephen Harper is actively pushing development of the Keystone XL pipeline, which critics say will encourage production in the Alberta oil sands, a top emitter.

Canada signed the Copenhagen Accord in December 2009 and committed to reduce its greenhouse gas emissions to 17 percent below 2005 levels by 2020. It estimates the country will produce 734 megatonnes (MT) of greenhouse gases in 2020, or 122 MT (20%!) higher than its promised target.

Of course, one way to make sure complaints about emissions targets go away is to get rid of those whose job it is to keep track of them:

Massive job cuts at the Environment Agency

The Environment Agency is to shed 1,700 of its staff as it faces larger than expected government-led budget cuts. The 15% cut was reported in "The Ends Report" magazine on Friday [..] 11,400 members of staff make up the non-departmental agency, which is a body of the Department for Environment, Food and Rural Affairs (DEFRA). The cut will come into force by next October.

The organisation monitors the implementation of environmental regulations and delivers the government’s green commitments. DEFRA itself is facing budget cuts of 10% as part of Westminster’s austerity measures, meaning the Environment Agency's cuts are deeper than expected.

The energy companies cheat and lie, and so does the government. Not a great thing to realize, certainly when you face huge future problems because of a fast shrinking domestic energy supply. One source we've not looked at yet is imported (shale) gas, an option the Cameron team has its eyes on. Unfortunately for them, even Royal Shell's own CEO says this bubble will burst before it goes anywhere. Nor does Shell want anything to do with British shale. Another major blow to the government.

Shell CEO Peter Voser: cheap shale gas is a myth

It is a "myth" that exports of cheap shale gas from America will cut gas prices in Europe and Asia, Peter Voser, chief executive of Royal Dutch Shell has warned. America is sitting on a glut of shale gas that has seen prices plummet to as little as a third of UK prices. It is now in the process of developing export terminals where the gas will be cooled for shipping abroad as liquefied natural gas (LNG).

UK politicians have hailed the prospect of Britain importing cheap gas from the US as one solution to help consumers struggling with rising energy bills as domestic gas production dwindles. But Mr Voser said that the idea of "cheap US gas going into the rest of the world and therefore changing the pricing structures across the world" was a "myth". The price impact of US exports would be "not that significant" because the additional costs of liquefying, transporting and then re-gasifying the gas would mean its eventual cost was comparable to existing market prices, he said.

Earlier this year British Gas owner Centrica struck a £10bn deal to export LNG from the US, welcomed by David Cameron, the Prime Minister, who claimed that "future gas supplies from the US" would help provide British consumers with a new "affordable" source of fuel. Former energy secretary Chris Huhne last month urged the UK government to pressure the US to allow more exports, which he claimed would "gradually equalise the gas price in the US with the rest of the world" and help reduce UK prices.

Shell has repeatedly played down the prospects for shale gas development in Europe and the UK. It has shunned involvement in the embryonic UK shale industry – which the Prime Minister has also suggested will cut energy bills. It is involved in shale gas exploration in other areas like China but Mr Voser said that Chinese shale gas would be consumed by the country's domestic gas market and would not "alter the pricing mix and the volume in Asia-Pacific".

So is there anything left to keep the lights on in Albion? Let's see. Wind and solar can and will be expanded, but as intermittent sources will ever only have a limited impact keeping the electricity grid alive.

Domestic oil and gas – including North Sea are falling of the proverbial cliff. Total discovered gas reserves peaked at 1,985.0 billion cubic metres in 1997, and declined 64.3% to 709.0 billion cubic metres in 2011.

 

 


 


Still, while declining oil production has a negative effect on revenues, it's not a major factor in electricity generation.

 


But as you can see, coal is. And coal is the one thing Britian still has substantial reserves of:

 


 


It becomes a matter of simply ticking off the boxes then. Wind and solar have limited impact, domestic oil and gas numbers are plunging, imported gas is prohibitively expensive.

That leaves nuclear, which nobody really wants because of the risks involved, and coal, which nobody wants either, because of CO2 emissions.

Add to that a political and corporate system that is only interested in maximizing profits for investors, and more than willing to use both the people's money, and their fear, to achieve it.

Put together, it seems to make it inevitable that in the future the British grid will either be run on domestic coal and nuclear plants owned by Chinese, or not run at all.

And again, my personal view of how communities should manage the production and distribution of their basic necessities is that they should keep control of them in their own hands, and close to their chest. The UK has signed away control of their power to the likes of an Ontario pension fund with offices in the Channel Islands, and a Hong Kong tycoon who does business via the Caymans. And controls substantial parts of the UK water supply as well.

There are no good reasons to sign away such controls to anyone outside your own society, and there are very good reasons not to sign them away. The first step for the British should be to regain control of their energy and water. And then take it from there. It's going to be far from easy, but at least you won't have anyone but yourselves deciding your fate. And that's not just something that should be a priority for Britain of course, it is a universal truth. After all, why on earth would you want someone 5000 or 10,000 miles away decide if you can heat your home or switch on your lights?

 

Photo top: Harris & Ewing "Greek philosopher Thales, representing electricity" 1912
One of Louis St. Gaudens' six statues symbolizing "The Progress of Railroading" at Union Station in Washington, D.C.
The six Saint-Gaudens statues, each weighing 22 tons, which are to grace the facade of the Union Station, are now being placed on pedestals at the tops of the entrance columns. Each of the statues was loaded upon a flat car for shipment to this city, and 20 horses drew the dray which hauled the first one to the station from the railway yards. — Washington Post, Oct. 27, 1912

 

Housing Indicator Review – Pending Home Sales- No Hype, Just the Facts

Courtesy of Lee Adler of the Wall Street Examiner

Is the latest episode of the long running US housing bubble saga actually coming to an end? From the way the NAR reported that pending home sales  had a year to year decline you would think so. The only problem is that that was not true. Their actual PHI index was 91.4 in September. That compares with 90.4 in September 2012. As far as I can tell that’s a 1.1% increase, which isn’t good, but it’s not a decline.

The NAR compared two fictional seasonally adjusted numbers, both from the exact same time each year, making a seasonally adjusted comparison inappropriate. They managed to finagle that into a year to year decline. Dow Jones Marketwatch reported a year to year decline without further comment in an example of how financial “journalism” simply regurgitates industry PR without further comment or qualification. Where is the interest in the facts?  Bloomberg, to its credit, reported the facts accurately in this case. “The Realtors’ report showed purchases rose 1.1 percent from September 2012.” However, they are just guilty of misrepresentation at times. I won’t let them off the hook just because they got this one right.

The NAR reported a seasonally adjusted headline decline of 5.6% month to month  in September. That was a lot worse than economists’ consensus expectations of -1.3%. Economists fooled again! Who’d a thunk?

The seasonally adjusted headline number may or may not represent reality. It isn’t the actual number. It’s essentially an idealization based on a few years of past performance for the same month, based on the assumption that an average of the past is “normal.”

The actual index plunged 21.1% in September on a month to month basis. That sounds awful, but is it really? Since this is an unadjusted number, in order to judge whether this represents exceptional weakness we must compare it with past Septembers. The average change for September over the prior 7 years was a decrease of 14%. A year ago, September was down 19.8%. This month was much weaker than average and slightly weaker than last September.

Contracts To Purchase Existing Homes- Click to enlarge

Contracts To Purchase Existing Homes- Click to enlarge

Keeping this weakness in context, excluding September 2009, which was goosed by the first  Federal housing tax credit subsidy this September had the largest sales total since September 2006 which was just after the housing bubble peaked. While sales did slow, the overall level was still better than any year since 2006 where there wasn’t a government subsidy.

Were rising mortgage rates to blame for the slowdown in September, or was it something else? First, rates actually fell steadily after Labor Day. I suspect that the month long buildup to the government shout down and all the media hysteria surrounding it, may have shaved a couple of points from sales. If so, those buyers would have come back in the past 10 days since the budget deal was done. November data will be the first full month where the data is not negatively impacted by the shout down. If my suspicion is correct, then the number should snap back then. October may even be “less bad” than September.

Historically, rising rates have stoked an inflationary psychology in housing, motivating people to buy now to beat both rising prices and rising interest rates. That psychology was probably at work through August with prices rising nationally on average at the rate of nearly 17%. But that has cooled to 10.8% annually according the latest data from Dataquick as of October 24 representing closed and recorded sales for the previous 4 weeks.

Electronic real estate broker Redfin reports real time contract data collected from MLS services in 19 major metropolitan markets. That data showed September contract prices up 15.9% year over year. These are very large, more active markets and may not be representative of the nation as a whole. Dataquick’s data is more comprehensive, but less timely since it only counts closed and recorded sales, similar to other national indexes.

With the slowing of sales volume, the inventory to sales ratio rose sharply in September. The inventory to contracts ratio stood at 6.0, up from 4.8 in August. This month’s reading only tied September 2012 at a record low September reading for that ratio. If sales bounce back in October-November, tight inventories will continue to impact the market, driving the price bubble and possibly restricting the number of sales. If demand rebounds from the soft September, a larger increase in inventories would be required to put a lid on the price gains.

Existing Home Inventory/Contracts Ratio- Click to enlarge

Existing Home Inventory/Contracts Ratio- Click to enlarge

The data shows that there’s been a stutter step in Bubble Junior. We don’t know yet if the cause is buyer fatigue, or fears triggered in September by the approaching government shout down along with the attendant media hype. The deal to end the shout down didn’t come until October 16. October data will be interesting to see if there’s any rebound in sales. November will be the first full month not adversely impacted by the Federal budget shenanigans.

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Unnecessary Surgeries? You Bet! Doctors Treat Patients as ATMs; US Healthcare System Explained in Six Succinct Points

Courtesy of Mish.

There is little to no incentive in the healthcare industry to hold down costs. Worse yet, the rewards for performing unnecessary surgeries is huge, while the risks of doing them are essentially nonexistent. Here are a couple of articles that show what I mean.

Prostate Cancer Radiation Therapy Rises as Doctors Profit

Bloomberg reports Prostate Cancer Radiation Therapy Rises as Doctors Profit.

Urologists who buy their own equipment to provide expensive radiation treatment are more likely to use it to treat prostate cancer even when the benefit for patients is unclear, research shows.

Prostate cancer is the most common tumor diagnosed in the U.S., where an estimated 238,590 men were told they had the disease this year. While only about 12 percent, or 29,270 men, will die from it this year, all will have to decide how, and whether, they want to treat the cancer.

A study published in the New England Journal of Medicine suggests that profits urologists make from referring patients to their own radiation facilities play an outsized role in the treatment decisions. One third of men whose doctors own radiation equipment get the therapy at a cost of about $35,000 per treatment course. The same doctors prescribed the therapy for just 13 percent of their patients before they had their own equipment and could profit directly.

“The results are striking,” said Jean Mitchell, the author of the report and a professor of public policy at Georgetown University in Washington, D.C. “It does appear that what’s driving this is financial incentives linked to ownership. Their behavior changes dramatically.”

Claims Data

Using claims data from the U.S. government’s Medicare insurance program for the elderly, Mitchell found that urologists who didn’t own the equipment prescribed IMRT for 15.6 percent of their patients in 2010, compared with 14.3 percent five years earlier. Its use among the NCCN doctors stayed constant at about 8 percent, while it soared to 44 percent among a matched-group of doctors who started to refer patients to their own radiation treatment facilities.

Self-Referral

“It’s crazy the way the system is set up,” Mitchell said in a telephone interview. “The patients are going to do what their physician tells them to do. The patient becomes almost like an ATM machine, with the doctor extracting as much revenue as they can.”

Ethical Practices

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