The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

I got 2 funny emails this past week — both about the health care bill.

I was admonished (by KF) to participate in the debate:

“Why haven’t you said anything about health care? You must have a view!!!

Three exclamation points? That’s a clear sign of an emotional, rather than logical perspective. I see that as a pointless debate, one I have no desire to engage in. So I ignore them.

However, this email (from JW) intrigued me:

“Your logical and data driven approach to markets and human psychology is refreshing. I am curious as to your thoughts regarding the pending health care legislation from that perspective (logic, rather than politics).

In that spirit, I will repeat what I told him, a) this isn’t an issue that I am particularly insterested in, and 2) I have no particular expertise in this area. And I am unfamiliar with the bill that is about to become law.

However, I can tell you what I think is wrong with the current US system — its a utter mess, and should be tossed out wholesale. Throw it out, start over, rebuild it from the ground up.

Here’s what I emailed JW about what is wrong with the current system:

“When it comes to health care, I will share with four factors that I find to be significant. Others have already beaten certain aspects of this to death — so these may not even be the most important factors overall. But in my experience, these are things that keep coming back to me about the health care issue:

1) Most of the industrialized world has national heath insurance — they (mostly) like it a lot. Speak to people from  England, Switzerland, Japan, Netherlands, Germany, France, Japan and especially Australia, they all love their natty health care. (Canadians, much less so). People in my office lived in Sydney for 10 years, swear by it. Talk to Europeans about our debate, and they will tell you Americans are insane.

2) We pay for medical care for 45 million people in the most inefficient way possible. Taking a kid with a high fever to the ER instead of the pediatrician makes a $60 office visit cost $8,000. Those parents don’t pay that bill, and so the costs are passed along to everyone else. That makes no sense whatsoever. I don’t know if its even possible to make medical care less efficiently priced than this arrangement if you tried.

3) Having a for-profit middle man between medical personnel and the patient is a recipe for disaster. This is an enormous inefficiency, and as as applied in the US has worked to raise costs and deny coverage. And, it make medical administration much more complex and costly than it should be. That seems like a lose/lose/lose to everyone — but the insurance cos.

4) Our system is weird: I can only speak from personal experience, and I can say as a person who has been fortunate enough to be relatively healthy. Our insurance system is simply freaky. I have a quick story about this in comments . . .

Those are my views about what’s wrong; I have no idea how to fix it . . .

I almost called this “EBRI Says Workers Are “Clueless” About Retirement Needs” but then that would have given the whole thing away too soon.

The issue we are discussing today comes to us from MacroMaven’s Stephanie Pomboy, via Alan Abelson in Barron’s. The subject: Our vastly underfunded public and private retirement system(s).

It seems there is a surprising disconnect between reality and what the respondents in the Employee Benefit Research Institute (EBRI) latest retirement survey seem to believe. Workers have a rather unwarranted expectation of actually being able to afford retirement — despite seeing their retirement savings rate shrink. In 2009, it fell from 65% to 60%.

Here’s Abelson with the specifics:

“Perhaps something like 40% of workers may not be saving because they believe assets — their house or portfolios, for example — will once more increase in value. In that regard, she speculates that it is significant that the last time households saved so little for retirement was when the stock market hit its peak in 2007 (and, of course, housing hadn’t yet crashed), and the only time they saved less was in 2004, when stocks bounced back strongly from the dot.com collapse.

If workers are really making this kind of bet, she believes, it would be good news, near term, anyway. For it would avoid the big hit to spending necessary to bring savings into alignment with current net worth. To return to an 8% rate, she reckons, would require a savings increase — or a spending decrease — of $513 billion. Nice piece of change, any way you look at it.

However — and, of course, there’s always a however — if the rebound in net worth proves illusory and the Fed can’t reflate assets on the household balance sheet, then, Stephanie sighs, “we’re in a dilly of a pickle.” And the price of delusion, she fears, will be dear. According to the EBRI survey, a “staggering 27% of workers have saved less than $1,000 toward retirement.”

She can only hope the 27% are young’uns right out of school, sharing apartments and still scraping to come up with the rent. Alas, the survey doesn’t break down the numbers by age.

If, by chance, the panel is representative of the nation as a whole, she winces, with 54% of the labor force over 40, “the figures are truly alarming. Doubly so given the increasingly retractable nature of pension promises.”

Ordinary people can be excused to some extent for not grasping how deep a financial hole they’re in. But that doesn’t hold for banks, Stephanie asserts, whose “affliction is no less acute.”

She cites the notion that reserving for losses no longer need be done and, by way of evidence, notes that a $10 billion reduction in the banks’ loss provisioning last year was a major contributor to their gain in fourth-quarter earnings. Further, loan-loss reserves cover barely over half — 58%, to be exact — of loans past due.

And to make matters worse, at the end of last year, 51% of commercial-bank assets were tied to real estate. Obviously, not a very desirable exposure with housing back in the dumps. And finally, there’s the possibility that banks are forced to mark to market all the toxic securities they carry at cost. If they were to follow the example of the FDIC, which in a sale last week marked down a batch of kindred securities, they’d have to take a 50% haircut.

What might this mean? I expect over the next decade, there will be significant changes to Social Security.  We’ll save that discussion for another time . . .

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Source:
Kiss Zero Interest Goodbye?
ALAN ABELSON
Barron’s March 22, 2010
http://online.barrons.com/article/SB126903941736164847.html

On Wednesday, I posted my disgust with the kindle fanboys trashing of Michael Lewis’ new book, The Big Short.

I was surprised to hear from a number of literary agents who wrote to thank me for that. They have apparently been having all manner of issues with Amazon reviewers over the years, and the kindle kooks have ignited a small firestorm. I even heard from someone who works with Lewis who informed me that Amazon called him (Lewis) to apologize over the fanboy rage against the book.

That, however, does not address the underlying conflicts between the three distinct roles Amazon.com plays. They are:

1) Book seller;
2) Publisher of book reviews;
3) Designer/manufacturer of a new book reading technology.

It is in this last capacity that Amazon has the greatest conflict (let’s hold the debate as to whether they as a bookseller have a bias towards better, pro-book reviews for another time).

The delay in selling the kindle version is a situation of Amazon’s own making.

Why? The mandatory kindle book pricing scheme.

If you want to know why the kindle version is not available immediately, it is because the publisher wants to charge full boat for their newest hardcover books. They consider that their “theatrical release,” with the kindle being the equivalent of the HBO version and the paperback the DVD. This is their decision, and while I may not necessarily agree with it, it is the publishers’, and not my choice.

The rampant 1 star fan boy reviews are nothing more than collective bullying. Give me your lunch money (kindle version), or I will beat you up during recess (give you one star reviews).

These release dates are a function of the mandatory Amazon price point. Bezos has foisted upon the publishers a price scheme which they don’t care for. The wounded publishing industry needs to max out their revs, and they believe selling kindle versions during the first few months of the hard cover hurts sales. Again, you and I may not agree with that belief system, but it is not our place — or Amazon’s — to dictate release terms and prices to publishers.

Two other factors worth considering:

1) Amazon’s super useful crowd sourced reviews were a great innovation. From their own selfish perspective, AMZN should be more protective of that. They should carefully consider how Yahoo allowed their comment streams (for just about every property) to become polluted with touts and spam and trolls and haters to the point where it is no longer useful. Then Bezos might want to notice the long slider in YHOO’s stock price over the same period. Coincidence? I doubt it.

If Amazon is going to allow a major asset of theirs to become devalued, it could hurt the actual value of the company.

2) I have no plans for getting the Apple iPad, but Apple’s willingness to let publishers set their own price is a very interesting development. I wouldn’t be surprised to see the Apple iPad version of books released BEFORE the kindle version due to this pricing scheme.  (note: this is my own wild speculation, and I haven’t heard anything from my Apple contacts).

Amazon.com, you have been warned!

Bottom line: This is a problem that is more or less of Amazon’s own making. Their allowance of this book review abuse has the appearance of impropriety. It looks especially self-serving. I have been a huge Amazon fan over the years, and I expect better from Bezos & Co. I was hoping they wouldn’t turn out to be just another collection of corporate douche bags intent on profit regardless of how they have to screw over their suppliers and consumers.

There is still time for them to avoid this fate — but its their call. Take a page from Google’s While”Don’t Be Evil” mantra and do the right thing.

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Previously:
Hey Bezos! Fix Your eejit Pro-kindle Anti-Author Book Reviews!
http://www.ritholtz.com/blog/2010/03/hey-bezos-fix-your-eejit-pro-kindle-anti-author-book-reviewers/

Mike Santoli asks an interesting question this morning in his Barron’s column.

“The important question isn’t whether the market retrenches a bit, but whether that retrenchment would segue into a more definitive and momentous market top.”

This is a worthwhile query for exploration.

Mike calls a market pull back more likely than a top. He challenges da Bears to explain how a new top can form:

- During a broad rally, with “new highs swamping new lows?”

- While the LPL Current Conditions Index is at a post-2008 high?

- When credit spreads are tight and issuance of cheap corporate bonds and convertible securities rampant

- With percolating merger activity, and when Merrill Lynch bond strategists warned last week that “LBO risk” was on the rise?

- Do bull markets end amid public apathy toward equities? The typical investor has mostly shunned stocks, with outflows or weak inflows into stock funds the rule.

– With Vanity Fair magazine hyping the anti-greed sequel to the film Wall Street?

I will have to take issue with a few of Mike’s bullet points:

• The Current Conditions Index may be near highs, but the ECRI index has turned decisively lower. Further, the Consumer Metrics Institute real time daily economic data of the ‘demand’ side of the economy has been shrinking at an annualized rate of over 1.5% during the trailing quarter.

• Both the AAII survey and the Federal Reserve analysis of household total financial assets now shows they are at historical median equity exposure.

• I am less sure that a Annie Leibovitz cover photo of Michael Douglas in the celebrity obsessed Vanity Fair will qualify as a legitimate contrary indicator reflecting anything about he current market rally.

My own views are that this is a cyclical bull rally within a secular bear market, and that it ends with an approximate 20-30% correction, followed by a broader trading range. As of today, we see no signs that the end is imminent. However, the closer we get to the day when the market believe a Fed removal of accommodation is imminent, the closer we will be to the top.  Alternatively, once the current unwind of the armageddon trade encounters the heavier resistance of Dow 11,500k and S&P 1250, the upwards momentum is likely to wane.

Until then, the bias remains to the upside.

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Previously:
The Most Hated Rally in Wall Street History  (October 8th, 2009)   
http://www.ritholtz.com/blog/2009/10/the-most-hated-rally-in-wall-street-history/

Source:
Down, But Not Out
MICHAEL SANTOLI
Barron’s March 22, 2010  
http://online.barrons.com/article/SB126903945323364875.html

Some links for today:

• Rival Merrill warned regulators over Lehman (FT)
• Federal Reserve Must Disclose Bank Bailout Records (Bloomberg)
• Rosier Views + Easier Comps = Profit Growth (WSJ)
• Martin Wolf: China and Germany unite to impose global deflation (FT)
• S&P 500 in ‘Air Pocket,’ Could Reach 1,225: Technical Analysis (Bloomberg)
• It wasn’t us! Alan Greenspan and Ben Bernanke still do not believe monetary policy bears any blame for the crisis (The Economist)
• Philip K. Dick after seeing a glimpse of Blade Runner (PKD)
• New College Graduates To Be Cryogenically Frozen Until Job Market Improves (The Onion)
• The best video you will have watched this year: Benjamin Zander on Music and Passion (TED)

What are you browsing ?

Chart of the Day takes a broad — perhaps over broad– look at trading rallies. They found that major rallies (73%) result in a gains ranging from 30% to 150%. Typically, they last between 200 and 800 trading days.

Based on this data, you can conclude that the present rally is still young, and potentially has a long way to run.

That might be a premature assumption.

As we’ve discussed before, there are huge differences between cyclical and secular markets. I have been describing the current short sharp run as a cyclical bull within a longer, secular bear.

If we were to look at the duration and intensity of rallies between 1929-38 or 1966-82, or 2000-09, I suspect we would find they are both shorter, sharper. By definition, cyclical bulls are of smaller duration than secular bull markets.

Here’s your daily chart porn:

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Age and Duration of Rallies

Source: Chart of the Day

As noted last night, Alan Greenspan has blamed the crisis on a lack of regulation rather than ultra-low rates. (You can find his Brookings institute paper The Crisis here).

While the lack of regulatory enforcement — ironically, mostly notably by the Greenspan Fed — was no doubt a large part of the problem, his exoneration of ultra low rates is belied by history.

I detail all of this elsewhere; but perhaps the impact of low rates would be more easily understandable to the Maestro if we put it into numerical bullet point form:

1. Starting in January 2001, the FOMC began lowering rates, eventually to 1%. They kept rates below 2% for 36 months, and at 1% for over a year. This was unprecedented.

2. While these rates had myriad effects, lets focus on just two: The impact on Housing, and on global bond managers.

3. Since homes are (typically) a leveraged credit purchase, lowering the cost of that credit has an inverse effect on prices — i.e., cheaper mortgages = more expensive houses. Since most people budget monthly, carrying costs are more important than actual purchase prices. Hence, a big drop in interest rates can cause a spike in home prices, with monthly payments remaining fairly similar.

Bottom line: Ultra low rates were the initial fuel sending home prices higher.

4. At the same time, bond managers were scrambling for yield. Pension funds, trusts, foundations require a certain annual gain, and without it, they have issues. Note that most of these managers by their own charters cannot purchase junk, they can only buy investment grade paper.

5. Wall Street had been securitizing collateralized debt for years. They turned credit cards, student loans, auto financing, and of course, mortgages into paper.

6. Making loans to people with weaker credit scores, lower incomes, or more debt was a risky proposition, and hence, generated higher yields for that risk. By collateralizing these subprime mortgages, Securitizers could generate higher yielding paper for the managers of bond funds. And because the rating agencies — Moody’s, S&P, and Fitch were totally corrupt — the securitizers could purchase AAA ratings. Hence, all manner of unqualified junk paper could be sold to these funds that were only allowed to purchase investment grade paper.

Here is the first point where lack of oversight comes in (vis-à-vis the ratings agencies). But we never would have gotten to that issue BUT FOR the ultra low rates.

7. The triple AAA rated junk paper sells well, increasing demand for more of it. Huge Wall Street demand for more junk to feed into the maw of the securitization beast compels all manner of non-bank lenders to issue even more sub-prime mortgages. And since they was a finite number of people who afford mortgages, they got creative with ways to make mortgages even cheaper. First came the 2/28 variable loans, with a cheap teaser rate the first two years.

Then came Interest Only (I/O), where there was no principal repayment.  I called these loans “Rent with an option to default.”  Lastly, we had the Negative Amortization (Neg/Am) mortgages, where the borrower paid less than the monthly interest charges, with the difference added to the principal owed. Hence, with each passing month, the mortgagee actually owed more on the house than the month before, rather than less. These loans defaulted in enormous numbers.

8. The lack of regulation of these non bank lenders was a key factor. Ironically, it was the Fed’s job to regulate them, and moving beyond irony to surreal absurdity, it was then Fed Chair Alan Greenspan who called these non bank lenders “innovators” and refused to regulate them. (This was around the same time, with rates at record low levels, when he was advising people go for variable mortgages). Their innovative business model was lend-to-sell-to-securitizers.

9. Numerous states had on their books anti-predatory lending laws. These made it illegal to make loans to people who could reasonably not afford them (nor could they charge usurious rates or excessive fees that would make defaults much more likely).

The Bush White House issued its doctrine of “Federal Pre-emption,” which essentially told the States to step out of the way of these lenders. The data shows that states with anti-predatory lending laws had much lower defaults and foreclosures than states that did not; the Federal Pre-emption significantly raised default rates in these states.

Hey, where were all those States right advocates back then? My Spidey-Sense is tingling! I suspect these new states rights people are not at all concerned with states rights at all, and are more likely little more than hypocritical partisans.

10. The lack of regulatory enforcement was a huge factor in allowing the credit bubble to inflate, and set the stage for the entire credit crisis. But it was intricately interwoven with the ultra low rates Alan Greenspan set as Fed Chair.

So while he is correct in pointing out that his own failures as a bank regulator are in part to blame, he needs to also recognize that his failures in setting monetary policy was also a major factor.

In other words, his incompetence as a regulator made his incompetence as a central banker even worse.

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Class dismissed.

Apparently, Congress screwing around with SEC defunding goes back 20 years, if not further.

The villain of the discussion is (of course!) Phil Gramm, the intellectually bankrupt Texas Senator whose economic arguments  are invariably proven to be wrong, with grave economic consequences. Gramm argued in 1994 that SEC fees “made it too expensive to raise money in the capital markets, and thus deterred growth.”

As per usual, Gramm had it precisely backwards at exactly the wrong time:>

click for larger image

Hat tip Dan B, who adds:

“The post on the SEC and staffing levels today reminded me of the fight over SEC budgets for 1995. Congress has its fingerprints all over this. They bring people in and berate them under lights and in front of cameras. They cast their failings onto others.”

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Source:
Agency Funding Caught Up in SEC Budget Dispute
Rob Wells
Associated Press, August 15 1994
http://news.google.com/newspapers?nid=1957&dat=19940815&id=wXchAAAAIBAJ&sjid=kokFAAAAIBAJ&pg=1427,3574721

Here’s a laugher:  “In a detailed review of the causes of the financial crisis, former Federal Reserve Chairman Alan Greenspan acknowledged a range of regulatory failures but strongly disputed the widely held view that the Fed left interest rates too low for too long.”

Oh, it gets even worse:

“In Mr. Greenspan’s 48-page review of the causes and consequences of the crisis, the text of which was released by Brookings, he acknowledged that the regulatory system failed, that Fed officials didn’t take seriously enough the risks building in the subprime mortgage market last decade, that regulators more broadly didn’t demand that banks hold enough capital and that he didn’t do enough to rein in “megabanks,” that posed a risk to the financial system.

He offered a full-throated defense of the interest-rate policies he championed. Low rates did play a role in spurring a housing bubble last decade, Mr. Greenspan said. But it wasn’t the short-term rates he controlled, he said. It was longer-term rates, which were driven lower by a flood of savings released by emerging markets into the global financial system.

The Fed pushed its benchmark interest rate—the federal-funds rate—to 1% in 2003, to fend off a dangerous bout of deflation. Some critics say this fueled adjustable-rate mortgage borrowing, bank risk-taking and the housing boom.

Mr. Greenspan says rates on 30-year fixed-rate mortgages drove the housing boom, not the overnight lending rates the Fed controls. Because of the flood of foreign capital, he said, longer-term rates became less closely linked to the federal-funds rate during the boom, something he described at the time as a “conundrum.”"

Discuss . . .

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Amusing Cartoon — I suspect the worst of the Greek scare is behind us, and push comes to shove, the ECB and the EU wont let the European Union spin a part:

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