“The Dark Side of the Gold Boom” is a series of special reports on Bloomberg Television, Bloomberg News, Bloomberg.com and Businessweek.com that examines gold’s longest bull run in six decades.
Part I is here
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Now that we have gotten that little Lehman thingie behind us, we can concentrate on what really matters: Bonuses!
You see, we only like free markets when they go up. We hate government intervention during those periods. But when these excesses cause market problems, that’s when we want the government to intervene, to spread their socialist love to bankers, to swing that BSD federal largesse. We love the warm embrace of the taxpayers during times of crisis.
The rest of the time, keep your damned interventionist noses out of our business. You are killing confidence and destroying jobs.
<Sarcasm Off>
As we are on the cusp of rapping (pun intended) up 2010, one of the main issues that impacted markets that of sovereign European debt problems, remains in full force. After seeing bailouts for Greece and Ireland and now the implementation of a permanent bailout facility we’ve learned that outside of temporarily saving senior bank bondholders, the actions have done nothing to calm investor concerns as funding costs are still very elevated. While markets are thin this week and let’s not read too much into this just yet, and I emphasize yet, French 5 yr CDS today is rising to a record high at 109 bps. They are now above Panama and are approaching Columbia. As Germany and France take on more financial responsibility for their friends, their own respective financials will be more heavily scrutinized. Greek CDS is back above 1000, Ireland’s 10 yr bond yield is back above 9% and nearing a 17 yr high and Moody’s put Portugal on review for a downgrade by 1-2 notches.
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Source:
More Than Two Years After Lehman’s Crash, NY’s Cuomo Targets Auditor Ernst & Young
Peter Gorenstein
Tech Ticker Dec 20, 2010
http://finance.yahoo.com/tech-ticker/more-than-two-years-after-lehman%E2%80%99s-crash-ny%27s-cuomo-targets-auditor-ernst-&-young-535739.html
The Muni Herd Redux
December 21, 2010
David R. Kotok
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Some emails came in challenging us about last week’s “Herd” commentary. Writers asked for examples of the bargains we described as available in Muniland. “Were these non-rated bonds or junk bonds?” some suggested rhetorically.
The answer is emphatically No!
These are very good-grade credits. The point of our recent piece is that the pricing in Muniland is dysfunctional for a variety of reasons. We have explained why in previous writings. The issue now is to take advantage of this market anomaly by doing the homework. Here are live trade examples.
We were able to buy our clients a block of Nebraska Housing Authority. The actual trade was Nebraska Investment Fin. Auth. Single Family Housing Revenue, CUSIP 63968MEG, 6.05% of 9/1/2041 at par. The bonds are call-protected for ten years and the first call is at par on 9/1/2020. There is a sinking fund structure to retire the issue. The bonds are rated “AAA” by Standard & Poor’s. This is a natural rating on the new scale and is not dependent on any bond insurer. JP Morgan Securities was the underwriter; Wells Fargo Bank is the trustee. The maturity size is $34 million and the total issue was $196 million.
Ok, there it is: a 6%, tax-free, AAA-rated bond. This is an actual trade in a current-coupon bond at par. This is NOT a junk bond. This is NOT a non-rated bond. Meredith W. this bond is NOT likely to default.
Some thoughtful emailers asked us about reinvestment risk. In other words, what are we going to do with the income when the short-term rate is zero? That is a fair question. When you see the answer, the opportunity to take advantage of the market dysfunction gets even better. This is especially true for those who are long-term investors and do not need the current income.
Here is a live trade example of a block of zero-coupon tax-free bonds. This one yielded over 7%. It is a high-grade credit rated A2/AA underlying by Moody’s and AAA-rated by S&P because it is secondarily insured by Aa3-rated bond insurer Assured Guaranty, one of the very few remaining credible Muni insurers. The bond is non-callable and compounds the return until maturity in 2046. Therefore, the investor does not face any reinvestment risk.
It is Metropolitan Pier & Exposition Authority, Illinois dedicated tax revenue bonds CUSIP 592248BD. It has very long duration because it is a zero-coupon. Moreover, in the Muni world today, the longer the duration, the better paid you are as the investor. Think about it this way. I put out $86.46 now and get back $1000 in 35 years. I pay no taxes. My risk is very low. What a lovely gift to a new grandchild. In addition, as a tax-free Muni, it is exempt from the “Kiddie Tax.”
Another point is important to consider. This zero-coupon bond is compounding 7%, which means the value is doubling every 11 years. This is a marketable issue, so a sale before maturity is available if you need to raise cash.
Some say they would avoid this bond because it is in Illinois and that state has unfunded pension problems. That’s true for the state but the pension is not the issue here; this bond is secured by tax revenue. I will extract from the press release. Full details are outlined in the Official Statement; see www.mpea.com .
“The debt will be paid back through tourism-related taxes collected by the MPEA, which includes a 6% tax on auto rentals in Cook County, a 2.5% tax on Chicago hotel rooms, a 1% tax on downtown restaurants, and a departure tax on airport taxi rides. If there is a shortfall in those collections, State sales tax deposits are drawn on to cover the shortfall. The three major rating services reaffirmed their ratings of the credit structure supporting the Authority’s bond issue – Standard & Poor’s Ratings Services at AAA, Fitch Ratings at AA-, and Moody’s Investors Service at A2.”
There you have it. A direct pledge of tax revenues is secondarily enhanced by a shortfall pledge of state sales tax deposits. Lastly, a credible bond insurer is a guarantor if all this fails. Note that the ratings are new scale and post-crisis. In our view these ratings are more credible now than at any time in the last 30 years.
Ok, let’s compare these apples with some oranges. Think about what an investor needs to expect in an annual return in order to match 7% tax-free, when adjusting for personal income taxation and for risk. At the 35% top federal income tax rate, this bond grosses up to a taxable equivalent yield of 10.78%. That is without adding your state’s income tax if you pay one. Is the risk adjusted option of an alternate investment 11%? Or 12%? Or higher?
Let’s look at some alternatives. Remember: no tax on the Muni; there will be income or cap gain taxes on the alternatives.
Compare this 7% Muni with other options for an individual investor. By the bond’s maturity, gold will have to go to $16,000 an ounce to match the after tax return from the bond and that assumes no taxes will be paid on the gold trade profit. Add your estimate of taxes over the next 35 years to get a gross up amount needed for gold to equal the bond. The NASDAQ must reach 30,000 to match the bond; and, you will have to sell at the right time and pay no taxes. If this Muni bond had been available when Jimmy Carter relinquished his presidency to Ronald Reagan, you would have paid for it with the Dow Jones Industrial Average then and you would have the Dow Jones value now. And that would be before taxes are in the Dow comparison equation.
Ok. Let’s go from tax-free to the taxable Muni space. Here again the BABs crunch created massive anomalies. Emotional investors panicked. Skilled ones seized the moment.
We will offer proof with one example in the taxable Muni space. BMO Capital Markets showed us this one (December Outlook). They illustrated the dysfunctional pricing that occurred during the month of November and when the BABs issuance onslaught hit the market as it became likely that the legislation would not be extended beyond December 31, 2010. Remember that BABs spreads impact Muni spreads, so if BABs spreads widened, Munis followed. This added to the dysfunction and therefore made more bargains available to the astute investor.
BMO wrote that the corporate bond “10-yr Detroit Edison (DTE) bonds traded +70bps over the 10-year Treasury.” Around the same time, Missouri Joint Municipal Electric Power (MJMEUC) issued 10-year BABs at +295 to the Treasury. BMO noted that the credit quality by rating is about the same on each of these bonds. They added, “DTE operates in one of the worst credit areas of the country while MJMEUC operations are in an area with greater stability.” Think about it: the BABs issue yielded 225 basis points higher than the corporate bond of the same investment-grade rating.
Dysfunction is not uncommon in the Muni world of bond pricing. Media fear-mongering only makes it worse. When you see dysfunction, you have two choices. One is to declare that something is wrong and therefore the market price is correctly reflecting a risk that the bond buyer does not see. We call this the self-doubt, follow-the-herd syndrome. The other option is to do your research and then determine that a bargain exists and seize it.
At Cumberland, we believe the market is engaged in mispricing because it is consumed by emotional behavior. We believe that the bond market often offers bargains for those who are willing to ferret them out and seize them. The three examples prove it.
Speaking of bargains, let us offer one to our readers.
My friend Chris Whalen wrote an excellent piece about the coming development with FDIC insurance premiums for brokered deposits in banks. Chris is a very thoughtful and smart fellow. He rates banks and has followed the crisis closely.
He gave us permission to post his piece on our website. You may view it here.
The list of banks that are impacted and their ratings may be found here.
We thank Chris Whalen for allowing us to share this with our readers.
Since this commentary was written the Muni market has started to rally. Meredith Whitney’s unsupported assertions on 60 Minutes were not debated on the TV show. Since her appearance bond prices are up and yields are down. We have presented the positive value side here. You did not hear it on 60 Minutes. The 7% zero coupon tax-free bond is now trading higher and currently yields 6.75%. We bought some more yesterday.
All the best for the New Year.
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David R. Kotok, Chairman and Chief Investment Officer
I never want to make excuses for the excesses of Wall Street or the horrific judgment exercised by iBank management — you cannot, its inexcusable — but it long past time we begin holding the Street’s grand enabler’s responsible for their actions.
Which brings me to the accountants.
The New York attorney general may be bringing a civil fraud lawsuit against Ernst & Young, “accusing the accounting firm of helping Lehman mislead investors,” according to the WSJ.
The accountants were the pushers to the Street’s junkies. They allowed all manner of shenanigans to go on, under their imprimatur of legitimacy. From WorldCom to Tyco to Enron and now to Lehman Brothers, most of these frauds would not have been possible without the loving assistance of large and credible accounting firms.
And they did it for the money. Ernst & Young earned approximately $100 million in fees for its auditing work from 2001 through 2008 for Lehman Brothers.
Some people assumed that the death penalty for Arthur Anderson would have kept the industry in line. But such restraint was not to be. Thanks to yet another piece of radical deregulation, the accounting industry was given carte blanche to run wild. The Securities Litigation Reform Act of 1995 had created a civil liability out for the accountants. It allowed them to legally become Wall Street’s pushers, no longer answerable to Investors who were defrauded due to their accounting audits. It practically decriminalized accounting fraud.
Here is a piece of trivia about this ruinous legislation: Prior to becoming SEC Chair, Christopher Cox was one of the authors of the Securities Litigation Reform Act. When a radical deregulator becomes Wall Street’s chief cop, what could possibly go wrong?
Here is what I wrote in Bailout Nation about the Securities Litigation Reform Act of 1995:
“This legislation was supposed to be a way to eliminate class action lawsuits that were the bane of public companies’ existence. Buried in the legislation was a little-noticed clause that eliminated “joint and several liability” for those who contribute to securities fraud. The consequences of the change were significant. It removed liability for fraud from the accountants who audited quarterly statements for public companies.
What do you think happened once accountants were no longer liable? An explosion of accounting fraud! The accounting scandals of the late 1990s and early 2000s were directly attributable to this small legal change. So too was the collapse of Enron, which led to the corporate death penalty for Arthur Andersen. We can probably pin the subsequent enactment of Sarbanes-Oxley, which is undoubtedly having all sorts of its own unintended consequences, on that same clause. These all trace back to what the industry itself had requested.
As the saying goes: Be careful what you wish for; you may get it.“
We are left to wonder: Who else has questionable accounting . . .?
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See Also:
Auditors Face Fraud Charge
LIZ RAPPAPORT And MICHAEL RAPOPORT
WSJ, December 20, 2010
http://online.wsj.com/article/SB10001424052748704138604576029991727769366.html
A Lehman Case Emerges More Than 2 Years After Collapse
PETER LATTMAN
NYT, December 20, 2010
http://dealbook.nytimes.com/2010/12/20/after-ernst-young-who-may-be-next/
Ernst & Young Said to Face Fraud Suit Over Lehman
Karen Freifeld and Linda Sandler
Bloomberg, December 20, 2010
http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=a.FUd6bUfTvo
Nothing to worry about, plenty of time to shop — I don’t know why people panic, its totally unnecessary these days. You can find lots of very cool, reasonably priced stuff for however you is on your list. (Our previous goes here and here, plus our Holiday Shopping for Audiophiles).
I continue to collect unusual items, some of which you may find amusing. These are some of the more intriguing items on my list:
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• Musgo Real Shave Cream Portugal’s economy may be in shambles, but their shaving products are top notch. To wit: Musgo Real, a formula of lanolin, coconut oil and glycerin.
I shave with a brush and this tube of shave cream, introduced to me many years ago by the nice folks at Barclay Crocker in Southampton. It makes shaving a pleasure. ($10)
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• The Padron 1964 Anniversary Exclusivo Maduro (5″1/2 x 50), is my favorite Robusto cigar. Rated 93 in Cigar Aficionado. Tobacco Locker has them for $245 a box.
For a longer smoke, j’adore the Diamond Crown Figurado No. 6 Maduro.
Both of these make Cigar Aficianado’s all time great cigar list.
And my favorite lighter is the twin flame Lotus 21 — its one of those well designed well engineered items that just feels right in your hand. ($46)
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• The Office: The Complete BBC Collection (First and Second Series Plus Special
I like the US version of the Office with Steve Carrell, but its gently funny. The original BBC version is grittier, nastier, more working class-in-your-face funnier. It makes the American version almost genteel.
Price: $39.98 $23.49
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• For the Science nerd in your life, this t Shirt from xkcd says it all: Science: It works Bitches ($19)
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• Papa Bear’s Chocolate Haus: Every year, a friend in California sends us the chocolate toffee with nuts, from this Mendicino shop — and it is heavenly. This is quite simply the most delicious stuff I’ve ever had.
Astonishingly, they don’t have a webpage (707) 937-4406
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• What every sci-fi geek needs: Star Trek: U.S.S. Enterprise Haynes Manual: In-depth information about every Enterprise, from the Enterprise NX-01, to Captain Kirk’s Enterprise NCC-1701 and Captain Picard’s Enterprise NCC-1701-D. Includes histories of each vessel, technical information about their systems, and discussions of key technologies.
The price is a strange $17.82
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• Pocket Chainsaw: For your campers and outdoorsman — a fast cutting pocket saw that cuts a 3” diameter limb in under 10 seconds.
Made of high strength heat treated steel and is coated for rust resistance. Saw is 28” long with 124 bi directional cutting teeth. Before this year, I didn’t even know things like this even existed.
(Handle with care, this is a very dangerous object) $20.24
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• For any driving fan, Two-Day High Performance Driving School from Skip Barber is a gift that keeps giving, Learn to drive safely within the performance envelope of your vehicle. (I did this a few years ago and loved it) $3,199 $2,719
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• If you do go to Laguna or Lime Rock (not Sebring — terrible track), don’t forget the Pocket Personal Speed Radar ($200)
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• Prefer two wheel fun? Try the Ural Patrol T, with sidecar (found at Cool Hunting).
A bargain at $9,995
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Part I: Gold ETFs
“The Dark Side of the Gold Boom” is a series of special reports on Bloomberg Television, Bloomberg News, Bloomberg.com and Businessweek.com that examines gold’s longest bull run in six decades.
December 20, 2010
According to NASA:
“This lunar eclipse falls on the date of the northern winter solstice. How rare is that? Total lunar eclipses in northern winter are fairly common. There have been three of them in the past ten years alone. A lunar eclipse smack-dab on the date of the solstice, however, is unusual. Geoff Chester of the US Naval Observatory inspected a list of eclipses going back 2000 years.
“Since Year 1, I can only find one previous instance of an eclipse matching the same calendar date as the solstice, and that is 1638 DEC 21,” says Chester. “Fortunately we won’t have to wait 372 years for the next one…that will be on 2094 DEC 21.”
How often do you get to witness an event that has not been seen since the year 1378, over half a millennium, 632 years ago?
We are supposed to have a clear night this evening, so we should get a nice show.
"I sincerely believe, with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale." -Thomas Jefferson (letter to John Taylor in 1816)
After 3 quarters in a row that averaged just 1.2%, Q4 GDP grew 2.8%, a touch below expectations of 3.0% BUT Nominal GDP grew well below forecasts. Because the price deflator was up just .4% vs the estimate of 1.9%, Nominal GDP was up 3.2% vs the estimate of 4.9%. Personal Consumption rose 2.0% vs the forecast of 2.4%. Fixed Investment rose 3.3% helped by a 5.2% increase in equipment and software spending and residential construction rose by 10.9%. Trade was a slight drag on GDP growth and government spending was as well led by a 12.5% decline on national...
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