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The “extended period” language is putting us in a box, Saint Louis Federal Reserve President James Bullard tells CNBC.

Airtime: Mon. Mar. 22 2010 | 8:03 AM ET

running time 17:03

Without getting into a discussion on healthcare and its politics, one reality of our soon to be new system is the inevitable further rise in government spending that is headed to 25% of US GDP from its long term average of about 20%. In order to finance this, there will be a smaller private sector and as a result, there will be slower economic growth as nothing is for free. Should the average P/E ratio over the past 100 years of 15x still apply going forward or should there be a revaluation of the multiple paid for US corporate earnings? The one hope that can sustain average multiples over time is the growing mix of exports to earnings as long as the US can make things at a competitive price that the rest of the world wants. I digress, India’s Sensex fell 1% in response to Friday’s rate hike and the rest of Asia followed ex the Shanghai index. With Germany still unclear on what direction they will take with Greece, Greek bonds are down sharply.

With Health Care now out of the way, we can get to what I consider to be the more important issue: Reforming Wall Street and the banking sector.

As I noted 6 months ago, the White House emphasis on Health Care over Finance was a significant tactical error. I would imagine with their weekend health care victory, the White House might push for finance reform. I expect they will see some significant traction.

I do not know what the political fall out from being for or against health care will be. But I can tell you that it will be much harder to oppose re-regulating banking. While the banks have succeeded in buying Congress, I think their attempts to stop a major overhaul of financial regulation will be far more difficult. Political opponents will paint anti-reformers as pro-banks and anti-family.

Ideally, what should that overhaul look like? I can identify at least six areas that need total overhaul:

1. The Ratings Agencies: The prime enablers of the crisis, their pay-for-play business model is a debacle. Their status as Nationally Recognized Statistical Rating Organization (NRSRO) should be stripped, and the space opened up for real competition.

2. Derivatives Must Be Regulated like all Financial Products: Put derivatives on exchanges; require counter-party disclosure and transparent open interest reporting. Capital requirements for trading is needed — and like other insurance products, there should be reserves for losses; Lastly, we should repeal the CFMA.

3. Regulate Non Banks lenders like Banks:  The unregulated non-bank lenders were at the heart of this crisis. It doesn’t matter if you aren’t a depository institution, if you loan money, you must be regulated like any other bank PERIOD.

4. Reinstate Net Cap Leverage Rules:  Over turn the SEC Bear Stearns exemption via Congress. Reinstate the former 12-to-1 leverage rules.

5. Eliminate Too Big To Fail:  Nixon Treasury Secretary George Shultz famously said “If they are too big to fail, make them smaller.”  Put caps on percentage of total US assets allowed. I suggest 1%. Break up insolvent, incompetent megabanks — like Citi and Bank of America. And I would carve up JPM as well. Separate the Depository Banks from the investing houses. (restoring Glass-Steagall will do that).

6. Do not give the Federal Reserve MORE Authority:  The Fed should focus on monetary policy. They can work closely with whoever is ultimately the bank regulator — but I do not believe having them be be the prime over seer of banks can work.

7. Stop Regulatory Forum Shopping:  The alphabet soup of various bank regulators OTS, FDIC, OCC, etc. should be replaced with one regulator. The FDIC is the only office that did a good job this entire crisis, put all regulatory responsibility under Sheila Bair’s office.

8. Overhaul the SEC:  They need to have numerous improvements: Start by making them less of a law firm and more of a finance shop. Expand the hotline/whistleblower division, offer bounties for discovering and reporting fraud. Add a quantitative division to look for issues mathematically.

9. Reform Compensation:  The system of privatized gains, socialized losses must be thwarted. Exec compensation is totally disconnected from their performance. Major overhaul from shareholders is needed. Require custodians — Mutual funds, pension plans, etc. — to vote their holdings (shares) as a fiduciary.

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Essentially, I am advocating a “Do Over.” Reverse the past 3 decades of radical deregulation. The alternative is an even bigger financial crisis, and sooner than you imagine.

The next time around, I plan on watching it all unfold from St. Barts . . .

Wow, we are on quite the pace this year!

click for larger chart

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

March 20, 2010
By John Mauldin

O Canada
The Threat to Muddle Through
Back to 1971
The fault, dear Brutus, is not in our stars
GDP = C + I + G + Net Exports
An Optimistic New Venture, San Diego, and New York

If the Chinese allowed the renminbi to rise, would that make the USA better off? That is the contention of a cabal of critics from Senators to Nobel laureates. Paul Krugman wants to see a 25% tariff on Chinese goods. Today we examine that idea, and look at the real problems that we face. If only it were so easy. The numbers just don’t add up. The fault, dear Brutus…

O Canada

But first, and quickly, and in keeping with the spirit of the recent Olympics in Canada, I want to let my Canadian readers know that I am excited to announce a new Canadian partner, Nicola Wealth Management, based in Vancouver. Why Nicola Wealth Management? I have spent some time getting to know them and have come to have a great deal of trust in and respect for John Nicola (President) and his team. In my opinion, they are one of the premier wealth management firms in Canada. Further, they are as committed to helping you find high-quality investments, including absolute-return strategies, as I am.

If you are from Canada, get started now by going to www.accreditedinvestor.ws and signing up, and I will make sure one of the team at Nicola Wealth Management will call and qualify you to receive our Accredited Investor Communications.

And of course, if you are in the US, Latin America, Europe, or South Africa, and if you are an accredited investor (basically a net worth of $1 million or more), you can go to that link and I will have one of my partners in those areas contact you about the various absolute-return strategy funds that are available to you. (In this regard, I am president of and a registered representative of Millennium Wave Securities, LLC, member FINRA.)

The Threat to Muddle Through

I have pretty well laid out over the past decade that I think the US will Muddle Through what promises to be a period of below-trend growth and a long-term secular bear market. It will not be pleasant or fun – there will be a lot of pain – but we will get through the coming crisis (note: I think the Big One is still in our future). That is what we do in a more or less free-market world. But, as I wrote 7 years ago and have written since, there is one caveat that turns me from a Muddle Through-er into a real doom and gloom type, and that is the threat of protectionism and trade wars. As in Smoot-Hawley, which made the Depression into something much worse than it should have been.

Yet that is the prescription that Paul Krugman is advocating. In a commentary in Sunday’s New York Times (“Taking on China“), he called for an across the board 25% tariff on Chinese goods:

“In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action – except that this time the surcharge would have to be much larger, say 25 percent.”

Krugman doesn’t think the Chinese can really retaliate by dumping their hoard of dollars. He points out:

“It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies, such as the euro. But that would be a good thing for the United States, since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around.”

I probably shouldn’t take on a Nobel Laureate who got his prize for his work on trade, but this truly scares me. People pay attention to this nonsense, including the five Senators, led by Schumer of New York, who want to start the process of targeting China.

First, the Chinese have got to be wondering what they have to do to make these guys happy. In 2005 they were demanding a 30% revaluation of the Chinese yuan. And over the next three years the yuan actually rose by 22% at a gradual and sustained pace. Then the credit crisis hit, and China again pegged their currency. From their standpoint, what else were they to do? Force their country into a recession to appease our politicians?

They responded by a massive forcing of loans to their businesses and governments and huge infrastructure projects. Kind of like our stimulus, except they got a lot more infrastructure to show for their money. It remains to be seen how wise that policy was, and how large the bad (non-performing) loans will be that came from that push – just as there are those (your humble analyst included) who do not think the way we went about the stimulus plan in the US was the wisest allocation of capital.

But the reality is that the Chinese will do what is in their best interest. I wrote in 2005 that the yuan would rise slowly over time. The political posturing of Schumer, et al., was counterproductive then, and it still is now.

My prediction? The Chinese will begin to allow the yuan to rise again sometime this year, just as they did three years ago, because it will be to their advantage. A stronger yuan will act as a buffer to inflation, which they may face due to the massive stimulus they created. They are going to need some help in that area. But it will be 5-7% a year, so as not to create a shock to their export economy. Not 25% at one time. And at some point they will allow the yuan to float against the dollar. They know they will have to get the currency status they want. As an aside, are we going to put a tariff on every country that pegs their currency to the dollar? That is a whole lot of countries.

Back to 1971

By the way, let’s go back to the 1971 that Krugman mentions. The Japanese yen was around 350 to the dollar. They revalued by 10%. Oh goody, salvation for the US. The yen is now at 90, and the Japanese are still producing massive trade surpluses, about half the size of Chinese surpluses, with less than one-tenth of the people. That is an almost 75% devaluation, and yet the world keeps buying Japanese products.

Read the rest of this entry »

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/

Dangerous Minds:

It was the blog post heard ‘round the world. When Charles Johnson wrote Why I Parted Ways With The Right in the space of a few minutes and posted it on his popular Little Green Footballs blog, he had no idea the firestorm it would set off. Nasty denunciations, death threats and a New York Times magazine feature article later, Charles Johnson joined me for a lively discussion about what happened to him, the Darwin-hating, know-nothing Creationists and the frenzied insanity (and racism) of the anti-Obama right. Part one of two.

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Charles Johnson: Why I Parted Ways with the Right from DANGEROUS MINDS on Vimeo.

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