The Fallout From a Frozen Fed (Michael Pento)

Euro Pacific Capital
By: Michael Pento
August 10, 2011

The Federal Reserve ventured into unchartered territory yesterday when announcing that the target for the Federal Funds rate would remain near zero percent for two additional years. That will amount to be, at a minimum, four and a half years in duration. But the move is exactly the wrong strategy and does nothing to heal the structural problems of the economy.

The market rebounded sharply yesterday on the back of the promise of free money in perpetuity. However, it will soon be surprised at how little Bernanke’s largess goes towards rectifying our problems. Zero percent interest rates can’t make European debt solvent. And two more years of free money won’t automatically repair America’s severely damaged public and private sector balance sheets.

Let’s be honest, nobody was expecting the Fed to significantly tighten monetary policy in the near future anyway. Therefore, providing a definite time frame of two years does not add much additional information because it isn’t far off from what most in the investment community had been expecting--especially in light of the recent weakening economic data.

But by punishing savers for a couple more years, it will only decrease the money available to create capital goods and only encourage reckless speculation in high-risk assets and the perpetuation of rolling asset bubbles.

What is also likely to occur will be the economy to become completely addicted to artificially-produced low interest rates. Banks borrow short and lend long and are very susceptible to interest rate shocks, just as occurred during the savings and loan crisis in the 80’s and early 90’s and the credit crisis of 2008. Banks’ assets will be collecting interest on low-yielding, long-term loans that will have been prevalent in the economy for over four years. Those interest rates are now about 500 basis points below the average going back to 1970.

But interest rates must soon significantly rise either due to the overwhelming supply issuance of Treasuries in the pipeline or through the inflation that always occurs from free money and a $2.9 trillion Fed balance sheet. Once rates rise, depositors will earn more than banks’ assets collect, and insolvency will result. Not only will banks' balance sheets be under stress but also the consumer and the government are in for a massive interest rate shock coming from skyrocketing debt service payments.

Years more of free money will result in tremendous economic imbalances, a crumbling currency, rising commodity prices and a ridiculously out of control bond market bubble. And that cannot at all end well.

Michael Pento, Senior Economist at Euro Pacific Capital is a well-established specialist in the “Austrian School” of economics. He is a regular guest on CNBC, Bloomberg, Fox Business, and other national media outlets and his market analysis can be read in most major financial publications, including the Wall Street Journal. Prior to joining Euro Pacific, Michael worked for a boutique investment advisory firm to create ETFs and UITs that were sold throughout Wall Street. Earlier in his career, he worked on the floor of the NYSE.

The Fed is discriminating against the elderly (David Merkel)

 it is reasonable to call Bernanke the enemy of savers,

because he is the enemy of savers

Wall Street Pit
By: David Merkel
June 24, 2011

Today, Charles Rotblut, CFA who is the AAII Journal Editor wrote:

Federal Reserve Chairman Ben Bernanke continues to be the enemy of savers. Yesterday, the Boston Red Sox fan reiterated his belief that interest rates should be kept at rock-bottom levels for an extended period of time. He views this as necessary in order to keep the economy growing.

When you run an investment group that is largely composed of retirees and near-retirees, it is reasonable to call Bernanke the enemy of savers, because he is the enemy of savers. When one can’t earn anything over one year without risk, something is wrong. Better that the economy grow more slowly, than that savers not get their due for not consuming.

Saving deserves a return. Let the Fed raise the Fed funds rate by 1%, and they will see that there is no harm to the banks, and little harm to the economy. Once you have 1% slope between twos and tens you have more than enough oomph to make the economy move. What, does the AARP have to bring a age discrimination lawsuit against the Federal Reserve to make this happen? The Fed is discriminating against the elderly.

But now consider another issue — money market funds. I consider them to be superior to banks because their asset-liability mismatch is so small, and they have generated small losses relative to banks and other depositary institutions.

Prime money market funds in the US have been investing 50% of their assets in the Commercial Paper [CP] of Core Eurozone Banks. Well guess what? If the Greeks and other fringe members of the Eurozone default, and the core governments don’t bail the situation out, those holding CP of core Eurozone banks may take a loss. And this is at a time where French and German Banks are facing liquidity issues. Take time to review your money market funds.

The problems of the US and China are significant, but the problems of the Eurozone are pressing. The endgame there will arrive more rapidly because the underlying structure is unstable. One currency can’t serve multiple cultures. Also, there should have been an Eurozone exit plan designed in from the beginning. It was hubris to think it would never need that level of adjustment.

It seems like the ECB is becoming a repository of euro-fringe debt, and perhaps the IMF as well. After all, it doesn’t cost the ECB anything to absorb those debts, but it indirectly spreads the risk to the euro-core nations if there is ever a default or unfavorable restructuring. A central bank can’t go broke, but it can impose problems on those that use the currency if defending the central bank exacerbates other problems in the economy. (E.g., printing money to cover over bad debts absorbed by the bank, while inflation rolls on.)

On a slightly different level, I’m not sure that the banking regulators in the US or Europe really got the main lesson from the crisis. Risk management is liquidity management. I still think that banks rely too much on short liabilities to finance illiquid, longer assets. One advantage of mark-to-market accounting is that it can reveal those mismatches to investors, or perhaps, to regulators. Extra capital can help, but it is usually not enough when there is a run on short-term liquidity, particularly because capital is the excess of assets over liabilities. If there are not enough liquid assets to meet the redemption of liquid liabilities, the result is insolvency.

“But that’s a liquidity problem, not a solvency problem — just give it time and the market will normalize, the assets are worth more than the liabilities anyway.” But at such a time, no one wants to buy the longer, less liquid, lower quality assets. If the bank could raise liquidity, it would. It can’t, so it is not only illiquid, but insolvent. It’s always cheaper to issue liquid liabilities, because those are attractive to savers and investors, but they a poison in a crisis.

My fear here is that there may be another call on liquidity that forces the Fed or the ECB to backstop banks. Not sure what would cause it; it’s always hard to pick which straw will break the camel’s back.

Thus I say be cautious at present; have some safe assets available in case we have a panic that emanates out of Europe, and has second-order effects on the US.

Bernanke doing his best to make our seniors the forgotten generation

"Americans who have done everything right,

have worked hard, saved their money

and stayed out of debt are the ones

being punished by low interest rates..."

Richard Fisher-Pres. Federal Reserve

Bank of Dallas

The Wall Street Journal
By Mark Whitehouse
April 4, 2011

PORT CHARLOTTE, Fla.—Forrest Yeager, a 91-year-old resident of this seaside community, had been counting on his retirement savings to last until he died. The odds are moving against him.

With short-term bank CDs paying less than 1%, the World War II veteran expects his remaining $45,000 stash to yield just a few hundred dollars this year. So, he's digging deeper into his principal to supplement his $1,500 monthly income from Social Security and a small pension.

"It hurts," says Mr. Yeager, who estimates his bank savings will be depleted in about six years at his current rate of withdrawal. "I don't even want to think about it."

Mr. Yeager is among the legion of retirees who find themselves on the wrong end of the Federal Reserve's epic attempt to rescue the economy with cheap money.

A long spell of low interest rates has created a windfall worth billions to banks, mortgage borrowers and others it was designed to benefit. But for many people who were counting on their nest eggs, those same low rates can spell trouble.

Mr. Yeager's struggle highlights a nagging dilemma facing Fed Chairman Ben Bernanke. The longer the central bank keeps interest rates low to stimulate the economy, the more money it pulls out of the pockets of millions of savers. Among the most vulnerable are retirees, who have few options to restore lost income on investments built up over entire lifetimes.

In 2009, according to the most recent data available from the Labor Department, average annual investment income for the 24.6 million American households headed by people 65 and older amounted to $2,564. That figure is down 34% from 2007, and is the lowest since 2003.

A recent survey by the Employee Benefit Research Institute indicated that one in three retirees had dipped deeper than planned into their savings to pay for basic expenses in 2010.

Most economists agree that the Fed's interest-rate policies, together with other measures, have helped avert a much deeper economic slump. Still, the situation for savers has become progressively worse since the Fed first lowered its interest-rate target close to zero in late 2008.

As of January, the average interest rate paid on relatively safe vehicles such as short-term savings accounts, time deposits and money-market funds stood at only 0.24%. That's one-tenth the level of late 2007 and the lowest on records dating back to 1959. Such depressed rates don't come close to compensating for inflation, which was running at an annualized rate of 5.6% in the three months ended February.

"Americans who have done everything right, have worked hard, saved their money and stayed out of debt are the ones being punished by low interest rates," says Richard Fisher, president of the Federal Reserve Bank of Dallas and a voting member of the Fed's policy-making open market committee. "That state of affairs is not sustainable for a long period of time."

The pain inflicted on savers could have political repercussions. Retirees are among the country's most active voters, with the power to influence a wide range of issues, such as who will bear the burden of fixing the federal government's finances and whether politicians should rein in the Fed.

Over the past few years, seniors have taken a conservative turn: In the 2010 elections, Republican congressional candidates attracted 59% of the over-65 vote, compared to 48% in 2008, according to exit polls—a larger shift than that seen among the general populace.

To be sure, many retirees have no savings at all or don't recognize the extent to which interest rates affect them. The subject isn't at the top of their list of concerns, which include health-care costs and Social Security benefits, says David Certner, legislative policy director at the AARP. Still, he says, "we hear a lot of complaints from people who were counting on a certain return from their fixed-income investments."

Low rates don't just hurt retirees. They also penalize people of any age hoping to build up funds for the future, and discourage rainy-day savings that could make U.S. consumers more resilient to job losses and other financial jolts. Americans' net contributions to their financial assets, such as bank and 401(k) accounts, amounted to 4% of disposable income in 2010, according to the Fed. That's the lowest level since it began maintaining records in 1946—except for 2009, when people actually pulled money out. Keep Reading

"It makes you kind of feel like the forgotten generation,"

says Roger Cohen, a 66-year-old who retired to

the Isles from Boston, where he headed a national

coffee-service company. He says he supports the Fed's efforts

to stimulate the economy by lowering interest rates,

but "you have a lot of folks who feel there's a lack of fairness."

The Charles Evans Show (Michael Pento)

Fed policy had little to do with soaring

commodity and food prices

Monday, March 7, 2011
By: Michael Pento

CNBC was competing with viewers from the Comedy Channel this morning when it aired an interview with Charles Evans, the President of the Chicago Federal Reserve. Mr. Evans claimed that U.S. inflation is currently low, even though oil prices were surging past $105 a barrel during his interview. He went on to explain that Fed policy had little to do with soaring commodity and food prices. As it is, of course, global growth that is to blame.

The Fed President didn’t care to opine at all as to why gold was hitting an all time high as he was speaking. I wondered--while struggling to watch the interview--if the record high dollar price in the monetary metal is telling him anything. I guess he would explain that the Fed doesn’t have anything to do with gold prices either and it is probably a sign that this year’s Indian wedding season will be a real gangbuster.

Some more comic relief came from his GDP predictions. Mr. Evans sophomorically stated that he expects 4% GDP growth this year and the next. But contrary to what that previous guess may have you believe, the interview didn’t give much hope for monetary responsibility returning to the country any time soon. In fact, even though the evidence of rampant inflation were scrolling under his feet on the ticker, Evans said that interest rates should stay low for an extended period of time.

Maybe that’s why consumer credit has reversed course and is now growing once again. Total consumer credit (both revolving and non-revolving) has now expanded for the fourth month in a row and is accelerating at a 2.5% annual pace in January. That’s after falling 4.4% in 2009 and dropping 1.6% for 2010. One of the baneful effects of the Fed’s zero percent interest rate policy is that it entices the consumer to borrow when they should be deleveraging. The truth is that Household debt as a percentage of disposable income is still well above historical levels and is now headed back in the wrong direction.

Yes Mr. Evans, the Fed is responsible for rising commodity prices and for encouraging the accumulation of debt. And they may soon share equal blame with the government for inflicting soaring interest rates on the American public.

Michael Pento, Senior Economist at Euro Pacific Capital is a well-established specialist in the “Austrian School” of economics. He is a regular guest on CNBC, Bloomberg, Fox Business, and other national media outlets and his market analysis can be read in most major financial publications, including the Wall Street Journal. Prior to joining Euro Pacific, Michael worked for a boutique investment advisory firm to create ETFs and UITs that were sold throughout Wall Street. Earlier in his career, he worked on the floor of the NYSE. Other Michael Pento Posts

CNBC Transcript of Evans Interview

A Mockery of a Sham (Peter Schiff)

By: Peter Schiff
Friday, January 28, 2011

Back in October of 2009, when Congress first announced the formation of a commission to investigate the cause of the 2008 financial crisis, I knew immediately that their ultimate conclusions would support the agendas of their respective political parties. (Watch the video blog I recorded that day) Particularly, I knew that the commission's Democrat majority would use the crisis to justify more government involvement in the financial markets. These concerns have now been fully validated.

Given that I was one of the few people who had accurately predicted the magnitude of the housing bubble, and had laid out in my 2007 book Crash Proof the specific consequences for the banking system and the economy when it burst, I immediately contacted the commission offering my services as a witness. In particular, I assumed that the Republicans on the panel would appreciate hearing from someone who thought that the crisis resulted from too much rather too little government regulation. (see my 2008 Washington Post op-ed)

To burnish my credentials, I sent the commission a list of articles I wrote between 2004 and 2008. Much of that pre-crash critique is summarized in a speech I gave in 2006 to The Western Regional Mortgage Bankers Association.

However, despite these supporting materials, my repeated outreach to the commission bore no fruit. At that point, I realized that they had no interest in giving any visibility to the narrative that I favored, namely that the ultra-low interest rates engineered by the Greenspan-Bernanke Federal Reserve were the primary factor behind the financial crash of 2008.

Ignoring how low rates created the crisis is like blaming the crash of the Hindenburg on bad weather, poor piloting, lazy ground crews, and overly emotional broadcast journalists, while ignoring the 200,000 cubic meters of flammable hydrogen gas that the airship held in its structure.

The Democrats clearly wanted to place the blame squarely on “greedy” bankers and “derelict” regulators who had fallen under the spell of the "laissez-faire" impulse favored by Republicans. These conclusions would sanction Democrat plans to garner even greater government power.

Yet, even the Republican minority opinion widely missed the mark. In their dissenting opinion, three Republican commissioners blame the crisis on global factors beyond the ability of US policymakers to control. While it is true that other nations suffered housing bubbles, they did so because their own central banks also kept interest rates too low.

The best result was a third minority report, authored by Peter J. Wallason. He correctly blamed government-insured mortgages and government-mandated loans to non-creditworthy minority borrowers for the housing bubble, yet omitted the key role played by the Federal Reserve in making those loans “affordable.”

The government has been subsidizing housing since the Roosevelt administration, and we never had a bubble of this proportion. It was not until these guarantees were combined with a 1% federal funds rate that they became supercharged. It was the unfortunate combination of government guarantees and cheap money that produced such a toxic brew.

During the bubble, a large percentage of loans, particularly those in high-priced markets like California, had adjustable rates. These rates were popular as a direct result of the ultra-low fed funds rate, which made them significantly cheaper than traditional thirty-year fixed-rate mortgages. Some of the most popular subprime loans were of the "2/28" variety, where borrowers enjoyed artificially low "teaser" rates for the first two years only. For conforming loans, Fannie and Freddie actually guaranteed mortgages based solely on borrowers' ability to afford the teaser rate, even if they could not afford the resets. Therefore, without low rates from the Fed, most of these ARMs never would have been originated.

Most importantly, it was low rates that made overpriced homes seem affordable. Buyers paid attention to monthly payments, not home price. These mortgages were tailor-made for real estate speculators and home flippers, whose only intention was to make quick profits on the resale. Higher rates would have put a lid on home price appreciation, as potential borrowers would not have been able to swing the higher payments.

Meanwhile, the low rates themselves created investor demand for mortgage debt. With Treasuries and CDs offering pitiful returns, investors were encouraged to look elsewhere for (seemingly) low-risk investments with higher yields. This created unprecedented demand for Fannie- and Freddie-insured debt as well as new varieties of mortgage-backed securities.

Since Wall Street needed additional mortgages to package, lending standards steadily eroded to meet the demand. Much of the demand came from foreign sources looking to recycle large trade surpluses, which would have been much smaller had the Fed not kept rates so low.

The reality is that no one wants to blame the crisis on loose monetary policy because monetary policy is even looser now then it was then. If the commission had correctly blamed the housing bubble on easy money, then it would have called into question current Fed policy. Given the fragility of our economy and its continued dependence on low rates, no one has the guts to open that can of worms. If so much economic damage was done by a 1% fed funds rate, imagine how much damage is being done by 0% rates, supercharged by quantitative easing.

Neither Democrats nor Republicans want the Fed to turn off the monetary spigots for fear of the short-term shock. That is why even the most vigilant government regulators would not have prevented the financial crisis. Any official who tried to rain on the real estate parade would have been out of a job.

Of course, the fact that three separate reports drew three separate conclusions – strictly along party lines – shows that politics was the driving motivation behind the entire farce. Even with the benefit of hindsight and $9 million taxpayer dollars, this commission still came up empty.

The conclusion that should have been drawn is that we do not need more regulation. Government interference has done enough damage already. We simply need to return to a sound monetary policy and get the government out of the mortgage and housing markets. Unfortunately, that’s not going to happen.

Rising Rates Reveal Debt Reality (Michael Pento)

By: Michael Pento
Thursday, December 30, 2010

The Fed's lucky streak of luring bond investors with low interest rates may be drawing to a close. Nevertheless, the extended period of low borrowing costs has bred a new breed of investor. To the bulls and bears, we can now add the ostriches – those who bury their heads in the sand of declining debt service ratios while refusing to face up to intractable levels of total US government debt. If these ostriches were to actually look at the numbers, they would realize that it is their investments which are made of sand.

As the issuer of the world’s reserve currency, the US government has enjoyed the benefits of low interest rates despite its inflationary practices. When we run a trade deficit with a country like China, they have a strong incentive to 'recycle' the deficit back into our dollars and Treasuries. This practice has hidden what would otherwise be much higher borrowing costs and much lower purchasing power for the dollar. This artificial price signal allows people like Paul Krugman to claim that the Obama Administration’s stimulus programs should be much larger. Because our yawning fiscal deficits have not driven bond yields significantly higher, he sees no reason to curtail spending. Krugman wants to spend like its World War III, and then has the nerve to call those worried about the budget mindless zombies!

Krugman is just one partisan Democrat shouting at mirrors, but the misunderstanding has struck the right-wing as well. Last week, in a debate with me on CNBC’s The Kudlow Report, Brian Wesbury, Chief Economist of First Trust Advisors and writer for The American Spectator, claimed that our $9.3 trillion national debt is of little consequence because our GDP is a far greater. However, he failed to note that our $14.7 trillion of GDP only yields about $2.2 trillion in revenue for the Treasury. To fully access that entire GDP, the government would have to raise all tax brackets to 100% without producing any reduction in output or decrease in revenue. This is, of course, preposterous. As was demonstrated in the 1970s, even small increases in marginal tax rates have a substantial negative impact on output. A healthier appraisal would center on the fact that our publicly traded debt is now 422% of our annual tax revenue.

Wesbury did mention that if the government could not raise revenue to pay off the bonds, it could simply monetize the debt with few significant consequences. Apparently, paying back one's creditors in worthless paper is not technically "default" to an economist.

So neither Krugman nor Wesbury, both intelligent, highly educated economists, see our current course leading to imminent crisis. Unfortunately, both have been led astray by the low debt service ratio which has masked our economy's underlying insolvency. To see through the haze, you have to look at the numbers behind this so-called “deleveraging consumer” and then look at the debt of the nation.

The data point most utilized by those who espouse the idea of a healthy consumer is the household debt service ratio (DSR), a metric that relates debt payments to disposable personal income. This figure peaked at 13.96% in the third quarter of 2007; it has since dropped by 15%, to 11.89%. It is hard to see this as a significant amount of deleveraging, especially when looking at longer term trends. But it gets worse! Most of that modest decline is simply a function of lower interest rates, which have made debt easier to bear. Total household debt has gone down much less. This figure peaked at $13.92 trillion in Q1 2008, and has since declined only 3.5% to $13.42 trillion. How’s that for deleveraging?!

It's also worth noting that back in the first quarter of 2008, most homeowners were sitting on a pile of home equity to offset that debt. Today, most of the equity has vanished, yet the debt still remains.

When looking at the national debt, the situation is even more depressing. At the end of 2006, total debt held by the public was $4.9 trillion. According to the Treasury Department, the average interest rate paid on that debt was 4.9%. Therefore, the annualized interest payment at that time was $240 billion. At the end of 2010, our publicly traded debt has increased to $9.3 trillion, but the average interest rate on that debt has plummeted to just 2.3%. So, despite an 87% increase in debt in just a 4-year time span, the annualized debt service payment actually fell 11% to $213 billion. Krugman and Wesbury look at this and see progress.

Meanwhile, the average maturity on our debt has declined to 5.5 years. Compare that with the UK's gilts, which average about 14 years, or even to Greece's bonds, which average about 8 years. Falling interest rates and reduced durations have merely given the illusion of solvency to the US as compared to these other ailing sovereigns.

By 2015, our publicly traded debt is projected to be at least $15 trillion. Even if interest rates simply revert to their average level – not a stretch, given surging commodity prices and endless Fed money printing – the debt service expense could easily reach over $1 trillion, or about 50% of all federal revenue collected today. Just imagine what would happen if rates were to rise to the level of Greece, nearly 12% on a 10-year note, as opposed to our current 10-year yield of just 3.5%. I bet Athens, Georgia wouldn't look much better than its namesake. Don’t forget: as interest rates rise, GDP growth slows, sending the debt-to-GDP ratio even higher.

Earlier this year, it wasn’t the nominal level of debt that suddenly sent euroland into insolvency, but rather a spike in debt service payments. Right now, the US national debt is the biggest subprime ARM of all time. Much like homeowners who thought they could afford a mortgage that was 10 times their annual incomes, Messrs. Krugman and Wesbury are blinded by deceptively low current rates of interest. These ostriches won't poke their heads up to see the writing on the wall: low rates and quantitative easing cannot coexist for long. As rates continue to rise, the reality of US insolvency will be revealed.

David Einhorn: fears a 2nd crisis if interest rates are kept low

By Richard Blackden
Add'l Richard Blackden Articles
U.S. Business Editor
The Telegraph
12//26/10

America is storing up a second financial crisis by keeping interest rates at record low levels, according to David Einhorn, the hedge fund manager who first publicly warned about the financial catastrophe facing Lehman Brothers.

"The crisis that required zero interest rates has passed," said Mr Einhorn, who co-founded and runs Greenlight Capital, a $6.5bn (£4.2bn) fund. By not raising rates "it increases the chance that governments will over-borrow and fall into a debt trap".

The criticism of the Federal Reserve comes as it embarks on another $600bn (£380bn) of quantitative easing – or printing money – in an effort to fire up a stronger recovery next year.

Interest rates around the western world, including in Britain, have sat at or below 1pc since the near collapse of the financial system in 2008 triggered a global recession.

"If interest rates ever do go up again, you have another crisis," Mr Einhorn told The Sunday Telegraph.

Those in favour of very low interest rates point to the support it has given the real estate market in the US and that, as in the UK, it should encourage politicians to begin to tackle the $1.3 trillion budget deficit without fear of damaging the economy.

Greenlight, which Mr Einhorn founded in 1996 with about $1m, including an investment from his parents, has its single largest position in gold – an asset that many investors have historically turned to during periods of economic uncertainty.

The gold price, which is closing in on a tenth straight year of gains, reached a record $1,432.50 an ounce earlier this month.

Mr Einhorn admits that he is having to pay far more attention to the broader economic picture when making decisions about which companies to invest in than he has ever done. He declined to say what he thought of either the UK or eurozone economies at the moment.

The 42 year-old, already well known within the hedge fund industry, shot to wider prominence in 2008 after using a lecture in May of that year to voice criticisms of how Lehman was valuing its assets. The lecture had echoes of one he gave six years earlier on Allied Capital, a lender which he accused of using misleading accounting practices.

That lecture sparked an almost decade-long battle with Allied, which is recorded in Mr Einhorn's 2008 book Fooling Some of The People All of The Time. The financial crisis, he says, has done little to ensure that the regulators are any better at detecting either fraudulent or financially weak companies.

Both lectures drew stinging criticism from some investors and parts of the media, who accused the fund manager of stirring up concerns because it had short positions in both companies that would see Greenlight benefit if their share prices dropped.

Mr Einhorn has responded that he only holds short positions if he has serious worries about a company.

Though Mr Einhorn is best known as a short seller, Greenlight typically has more long positions than short positions.

Greenlight, which hasn't taken any new money from investors since the early part of this decade, has delivered an average annual return of 21pc since it was started.

Vodafone is currently one of his largest positions and he also owns shares in Apple.

For Whom the Bell Tolls (Peter Schiff)

Peter Schiff
More of Peter Schiff
Friday, December 17, 2010

There is an old adage on Wall Street: no one rings a bell to signal a market top or bottom. Yet, I have found that bells do ring; it’s just that few people know exactly what sound to listen for.

Perhaps the biggest and most liquid of all markets is for US government bonds. That market has been rallying for almost thirty years. The bull can be traced back to 1981, when Treasury bond yields peaked at about 15%. At that time, high inflation and a weakening dollar had justifiably squelched demand for Treasuries. Even the ultra-high interest rates were not enough to attract buyers.

But this was also when the proverbial bell was rung. Fed Chairman Paul Volcker had signaled, by jacking up interest rates so high, that he would stop at nothing to break the back of inflation. Volcker's iron will, and Reagan's unflinching support, restored demand for Treasuries for the next three decades.

We have arrived today at a similar inflection point. After falling steadily for 30 years, bond yields are now heading north with a full head of steam.

Many are taking the recent moves in stride. The consensus is that despite the recent spike, yields are still historically low, and that they are unlikely to go much higher from here. Once again, most on Wall Street are either tone deaf or plugging their ears.

For years, the Fed has been able to prevent market forces from correcting our growing economic imbalances by inexorably pushing rates lower. This happened in 1991, 2001, and most notably in 2008. These easing campaigns succeeded in boosting the economy in the short term by greatly increasing the amount of debt held by both the private and public sectors. As such, these episodes have allowed our economy to delay and magnify the ultimate reckoning.

Just like a junkie who requires ever-increasing doses of heroine to achieve the same high, the Fed has needed to take rates ever lower to boost the economy after its previous stimulants had faded.

To stimulate after the bursting of the housing bubble (which itself resulted from the low interest rates used to juice the economy following the bursting of the dot-com bubble), the Fed lowered interest rates to practically zero. At that point, rates could go no lower. However, when that stimulus failed, the Fed decided to bring on the heavy artillery in the form of “quantitative easing,” or as it is known in the vernacular, “printing money to buy government debt.”

Lowering the federal funds rate, its traditional weapon, tends to make the most impact on short-duration debt. By its own words, the goal of quantitative easing (QE) was to lower long-term interest rates. It was hoped that this would achieve what low short-term rates had not: an increase in stock and real estate prices, a rise in household wealth, and consequently greater consumer spending, economic growth, and job creation.

However, the Fed’s plan backfired. The selling pressure on long-term bonds is overwhelming the Fed’s buying pressure. Spiking rates (which move inversely to price) are powerful evidence that the bond bubble has finally burst. The Fed threw everything but the kitchen sink at the bond market to force yields lower, yet they rose anyway. If bond prices failed to rise given such a Herculean effort to lift them up, there can be only one direction for them to go: down.

In true form, few on Wall Street hear the ringing. In a shocking display of rationalizing cognitive dissonance, some (such as Wharton Professor Jeremy Siegel in a WSJ op-ed) have even suggested that the spike in yields is proof that quantitative easing is working. Siegel heralded higher rates as indicative of economic resurgence, which supposedly was the Fed’s goal all along. In other words, QE2 worked so well, we skipped the lower rates and went directly to the higher rates that go with growth!

There is also a widespread belief that long-term rates will remain contained at historically low levels. Four percent is seen as the ceiling above which ten-year yields will not rise. I believe this ceiling will prove to be of the thinnest glass. Once yields easily break that level, they may quickly rise above five percent, where they will likely encounter some resistance, before heading significantly higher.

In fact, if rates approach six percent next year, we will be seeing a ten-year high in ten-year yields. If our economy is this fragile with record low rates, image how much weaker it will be with rates at ten-year highs? If the Fed believes that lower rates revive an economy through the 'wealth effect,' what does the Fed feel will happen when higher rates produce a reverse 'wealth effect'?

Not only does this bell herald the end of the bond bull, but it also marks the end of the Fed’s ability to artificially engender economic “growth” through monetary policy. More significantly, the new tax compromise President Obama is about to sign will add more than $900 billion in new debt onto the government’s balance sheet over the next 10 years. This will put additional upward pressure on interest rates, and more political pressure on the Fed to monetize the debt. It is no coincidence that the real upward movement in yields began immediately after the tax/stimulus deal was brokered in Washington.

What lies ahead is a new era of rising interest rates, soaring consumer prices, increasing unemployment, economic stagnation, and lower living standards. Instead of stimulating the economy, quantitative easing and deficit spending will prove to be a lethal combination. Bondholders beware, the bell tolls for thee.

Wall Street Gives Uncle Sam Too Much Credit (Michael Pento)

By: Michael Pento
More Michael Pento
Monday, December 13, 2010

Despite the fact that the S and P is up over 80% in the last 21 months, US financial firms are currently tripping over each other in their zeal to raise their S and P 500 and GDP targets for 2011. JPMorgan's chief US equities strategist, Thomas Lee, came out on December 3rd with a target of 1425 on the S and P for 2011, which would be a 15 percent gain.

Barclays Capital last Thursday released a 1420 estimate. Not to be outdone, Goldman Sachs also recently released its forecast, and it sees a more-than-20 percent increase next year, to 1450. Meanwhile, PIMCO’s idea of a “new normal” has translated into a 2011 GDP forecast raised from 2-2.5% to 3-3.5% due to “massive” government stimulus.

In the midst of this collective 'hurrah,' very little attention is being paid to what is going on over in the bond market. With my due condolences to Fed Chairman Bernanke, the yield on the 10-year Treasury note has increased from 2.33% on October 8th to 3.29% today. And, if there is any notice at all given to that recent run-up in yields, it is merely explained away as a sign of robust growth returning to the economy.

In reality, growth doesn’t cause an increase in interest rates; it is either lack of savings or inflation that is responsible. To refute the 'robust growth' reasoning, turn your attention to the fact that the spike in yields just happened to coincide with the news that the unemployment rate jumped to 9.8% in November.

A slightly broader explanation for the surge in borrowing costs might be the failure of the Bowles-Simpson deficit commission to implement any cost cutting measures. Or, perhaps it was the intimation from Bernanke himself that QE III may already be under construction in his infamous interview on 60 Minutes. Or, maybe it is the fact that the $150.4 billion November budget deficit was the highest total for that month... ever, and was the 26th straight month of red ink! I often wonder to myself, where in the midst of all this good news do I summon a bearish attitude?

I think it's pretty clear that 'robust growth' is going the way of 'green shoots' and knickers – right into the dustbin of history.

So, what will the increase in interest rates – ignored by all of Wall Street – actually mean for the economy in 2011?

For starters, the National Home Price Index already fell 2% in the third quarter of 2010. On a national basis, home prices are 1.5% lower year-over-year, and 15 out of the 20 cities measured were down over the last 12 months. On a month-over-month basis, 18 cities posted a price decline in September, compared to 15 MoM drops in August, and just 8 cities experiencing price reductions in the July report. Therefore, home prices, which were already headed lower before this recent spike in mortgage rates, are set to take another tumble downward. According to Freddie Mac’s weekly survey of conforming mortgages, the average rate on the 30-year fixed is at its highest level in six months. 30-year rates averaged 4.61% for the week ending Dec. 9, up from 4.46% last week.

It’s the fourth week in a row that the mortgage rate has increased. The ramifications for the real estate market and bank lending are clear. Lower home prices will send more mortgages under water and force many more homes into foreclosure. Higher borrowing costs will lower the demand for borrowing and place more strain on the capital of lending institutions.

On top of that, household debt as a percentage of GDP still stands at a lofty 91%. It should be clear that with near double-digit unemployment, the last thing consumers can now tolerate is a significant increase in debt-service payments.

The rising cost of money is even worse news for the federal government and its chronically ballooning debt problem. According to the Federal Reserve’s Flow of Funds Report, total non-financial debt reached an all-time high of $35.8 trillion in the third quarter of 2010. In fact, household debt, business debt, and government debt increased at a 4.2% annual rate last quarter.

To put that record level of nominal debt into perspective: in 1980, the total non-financial debt-to-GDP ratio was 144%. In the height of the credit boom, at the end of 2007, that figure was 226%. Today, the figure stands at a mind-blowing 243%! So you can forget about all that deleveraging talk. The US is in fact still leveraging up, both in nominal terms and as a percentage of GDP.

I think the rising cost of money will become the story of 2011. Its effect on consumers, the real estate market, and government borrowing costs will be profound. Apparently, most major brokerage firms have no fear of soaring interest rates causing our economy to implode. However, it's clear to me that the bond market has already started to crack due to inflation and massive oversupply from the Treasury. Prudent investors should think twice before overlooking what could be the initial holes in the biggest bubble in world history – the full faith and credit of the United States.

Freddie Mac: 30 year mortgage at 4.19%, lowest since 1951

By: Nathan Becker
The Wall Street Journal

Longer-term mortgage rates declined the past week, with the average rate on 30-year fixed-rate mortgages furthering its all-time low for the third consecutive week to 4.19%, according to Freddie Mac's weekly survey of mortgage rates.

The 30- and 15-year fixed-rate mortgages and the five-year adjustable-rate all sit at their record lows, with Freddie tracking the 30-year since 1971, the 15-year since 1991 and the five-year since 2005. Freddie said that using data from the Federal Housing Administration, the last time the 30-year was this low was April 1951.

Rates have slumped for months, setting record lows in the process, as yields on Treasurys have fallen amid economic uncertainty. Mortgage rates generally track the yields, which move inversely to Treasury prices.

The 30-year fixed-rate mortgage averaged 4.19% for the week ended Thursday, down from the prior week's 4.27% average and 4.92% a year ago. Rates on 15-year fixed-rate mortgages were 3.62%, falling from 3.72% and 4.37%, respectively.

Five-year Treasury-indexed hybrid adjustable-rate mortgages averaged 3.47%, flat on the week and down from 4.38% last year. One-year Treasury-indexed ARMs were 3.43%, up from 3.4% the prior week but down from 4.6% a year earlier.

Credit Card Interest Rates at 9 year highs...Gotta love financial reform

By RUTH SIMON
Wall Street Journal

Credit-Card Rates Climb

Levels Hit Nine-Year High as New Rules

Limiting Penalty Fees Help Fuel Rise

Interest rates continue to tumble for the U.S. Treasury, companies and home buyers alike. But for a large portion of 381 million U.S. credit-card accounts, borrowing rates have been moving only one way: up.

And average rates are likely to climb further in the near future.

New credit-card rules that took effect Sunday limit banks' ability to charge penalty fees. They come on top of rule changes earlier this year restricting issuers' ability to adjust rates on the fly. Issuers responded by pushing card rates to their highest level in nine years.

In the second quarter, the average interest rate on existing cards reached 14.7%, up from 13.1% a year earlier, according to research firm Synovate, a unit of Aegis Group PLC. That was the highest level since 2001.

Those figures look especially stark when measuring the gap between the prime rate—the benchmark against which card rates are set—and average credit-card rates. The current difference of 11.45 percentage points is the largest in at least 22 years, Synovate estimates.

By comparison, the spread between 10-year Treasurys and a standard 30-year fixed-rate mortgage is just 1.93 percentage points, near historical averages, according to mortgage-data provider HSH Associates.

The moves are driven by a combination of forces. The Credit Card Accountability Responsibility and Disclosure Act of 2009 has given card issuers less flexibility to raise interest rates as they wish. At the same time, issuers are still dealing with credit-card delinquencies that remain above historical levels.

"The rules have changed and the goalposts of risk have changed," says Paul Galant, chief executive of Citigroup Inc.'s Citi Cards unit.

Banks used to boost rates in a hurry on borrowers who fell behind on payments or otherwise turned out to be surprisingly risky. However, under the Card Act, financial institutions must warn customers at least 45 days before making substantial changes to rates or fees. People can avoid future rate increases and pay off existing balances over time.

As a result, most changes affect only new credit-card purchases. New rules that took effect Sunday limit what banks can collect in penalty fees, too.

Now bank executives say they need to be smarter when setting the initial interest rates on credit cards. In many cases, that means starting off with a higher rate. "We can't come up with penalty pricing or if we can, quite frankly, it's too late to do much good," says Stephanie Keire, head of consumer credit-card risk management at Wells Fargo and Company. Link to complete article