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

The End of QE2?
By John Mauldin
March 18, 2011

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New York Times Bestseller
The End of QE2?
Producer Prices Up 35-40% in the Last Six Months
What Happens When We Come to the End of QE2?
London, Malta, Milan, Zurich, Salt Lake, and New York

What happens when the Fed is finished with QE2? I have been letting that filter into my thinking lately as I look at the economic landscape and the data we have seen the past few weeks. Correlation is not causation, as I often say, but all we can do is look back at what happened last time and speculate about the future. A very dangerous occupation, but your fearless analyst will plunge on ahead into the jungle of a very hazy future. You come with me at your own risk!

New York Times Bestseller

Quickly, a big Mauldin thanks to those who already bought my book, Endgame, as it made the New York Times bestseller list yesterday, earlier than I thought it would. That would be my 4^th, and that and my kids are about my only small claims to fame. I have ruthlessly promoted the book to you, and so this week I resist my inner promotional demon and simply provide a link to Endgame: The End of the Debt SuperCycle and How It Changes Everything, where you can read the reviews and buy the book if you have not, or get it in your local stores. At the end of the letter, I note that I will be at a book launch party in London Monday evening, and would love to have you stop by. Details below. And now to this week’s letter.

The End of QE2?

The Fed committed to buying $600 billion of Treasuries between the beginning of QE2 in November and the end of June. June is 3 months away. What will happen when that buying goes away? The hope when QE2 kicked off was that it would be enough to get the economy rolling, so that further stimulus would not be deemed necessary. We’ll survey how that is working out, with a quick look at some recent data, and then we go back and see what happened the last time the Fed stopped quantitative easing.

First, the guy on the street is getting squeezed. Real US consumer spending slowed in January and looks like it did only marginally better in February. The Fed argues that inflation is mild, as they prefer to look at “core” inflation (inflation without considering food and energy). If you look at it that way, they are right. And in normal times, I can kind of see why we strip out energy and food, as they are very volatile price points and can move a lot from month to month.

But that argument gets a lot weaker when your main policy, that of significant quantitative easing, is perhaps CAUSING the rise in food and energy (as well as weakening the dollar)! If the Fed policy is at least contributing to the cause of total inflation, arguing that food and energy don’t count doesn’t hold water. Let’s look at the following chart from economy.com.

In particular, notice the rise in the last three months since the beginning of QE2. Inflation is running at over 5% on an annualized basis. Companies like Kimberly (diapers, etc.), Colgate, P&G, and others all announced 5-7% price increases this week. These are companies that provide staples we all buy. Those prices matter. Even Wal-Mart will have to pass those increases on. To say that food and energy don’t matter misses the point. These items have real economic impact.

As my friend David Rosenberg wrote this morning:

“In February, there was no inflation at all in average weekly wage-based earnings but there was 0.5% inflation in consumer prices, meaning that real work-related income was crushed 0.5% and has now deflated in each of the past four months and in five of the past six months, during which it has contracted at a 2.3% annual rate. Once the effects of fiscal stimuli wear off, this negative income trend will show through in a much more visible slowing in real consumer spending that we doubt the markets have fully discounted. So far, what has happened in equities has been treated as a financial event – just wait until the economic event follows suit. And it’s not only fiscal stimulus that is soon to subside. We still have that 86% correlation over the past two years between movements in the Fed balance sheet and the direction of the S&P 500 – this too will come home to roost before long, whether or not we end up seeing a resolution to the crises in Japan, Libya or Bahrain.”

Read the rest of this entry »

Putting an end to Wall Street’s ‘I’ll be gone, you’ll be gone’ bonuses
By Barry Ritholtz
Washington Post
Saturday, March 12, 2011; 6:08 PM

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Want to reform Wall Street bonuses? Try clawbacks.

That’s right. We need to make executives personally liable for their reckless bets if we want to remove the risk for taxpayers. That means giving shareholders, boards of directors and regulators the ability to “clawback” past gains when new speculations go horribly wrong.

The Federal Deposit Insurance Corp. and the Securities and Exchange Commission have floated proposals on performance-based compensation for traders and bankers. Firms that have more than $1 billion in assets would have to disclose incentive-based bonuses. The largest firms (those with more than $50 billion in assets) would have to pay at least half of their bonuses in compensation that is deferred for three years. The SEC could, in theory, deny plans that encourage excessive risk-taking or outrageous bonuses.

While this approach is well-intentioned, Wall Street has proven itself especially adept at circumventing compensation laws. Rules that seek to limit bonuses will likely shift compensation more to salary and commissions.

Private profit, public risk

Understand this: I do not care what shareholders and their boards pay the people who create enormous value. Whether it’s a chief executive such as Steve Jobs of Apple or a hedge-fund manager such as Steve Cohen of SAC Capital, the people who are paid handsomely for creating incredible profit are not the problem.

On the other hand, many others received huge bonuses for bankrupting their firms and driving the economy into recession. Their job performance should be the subject of your ire and of regulators. They brought the world to the abyss of economic collapse because they had incentives to do so.

If that sounds unbelievable, consider:

• Subprime mortgage brokers who were paid based on the quantity – not the quality – of their mortgage writing. The loans lenders sold to Wall Street to be securitized carried a 90-day warranty. Hence, the brokers’ jobs were to find people who would make the first three monthly payments of a 30-year loan. After that, it was no longer their concern.

• Derivative traders who knew that what they were buying was going to blow up. In 2007, I published an e-mail from one such trader who wrote, “We knew we were buying time bombs.” The motivation was deal fees and bonuses. Once the derivative machinery was in motion, they had to “keep buying collateral, in order to keep issuing these transactions.”

• Collateralized debt obligation managers whose job it was to assemble pools of mortgages, yet had little or no understanding of the underlying loans. The salespeople, traders and managers working in the mortgage sector had incentives that were upside down. The greater the risk they took, the more they were paid. But brunt of those risks was on third parties, never themselves. It was shareholders and taxpayers who shouldered them.

This is backward. The people who should bear the downside are the ones who have the upside. Instead, the system was perversely one of private profit but public risk.

Note that it wasn’t merely the staff that engaged in this reckless risk-taking. At investment banks, senior managements were so reckless that they managed to destroy their firms. For this act of gross incompetency, they were rewarded with vast bonuses in cash and stock options. By the time their firms collapsed, they had cashed out hundreds of millions of dollars in legal booty.

Consider:

• Lehman Brothers Chairman and CEO Richard Fuld Jr. made nearly a half-billion – $490 million – from selling Lehman stock in the years before it filed for Chapter 11 bankruptcy.

• Countrywide Financial (now owned by Bank of America) founder and CEO Angelo Mozilo cashed in $122 million in stock options in 2007; His total take is estimated at more than $400 million dollars.

• Stanley O’Neal, who steered Merrill Lynch into financial collapse before it was taken over in a shotgun wedding with Bank of America in 2008, was given a package of $160 million when he retired.

• Bear Stearns former chairman Jimmy Cayne, rescued by a $29 billion Fed shotgun wedding to JPMorgan Chase, received $60 million when he was replaced;

• Fannie Mae CEO Daniel Mudd received $11.6 million in 2007. His counterpart at Freddie Mac, Richard Syron, brought in $18 million. In 2008, the two were forced into government conservatorship.

Add to this list Washington Mutual, Wachovia, IndyMac and other bankrupted firms whose senior management took a boatload of money and ran.

Nice work if you can get it – and still live with yourself.

Blame game

How did this happen? Some people blame excessive greed; others say crony capitalism is at fault. I believe we can sum it up in one word: liability.

In recent years, there was no legal liability for extreme recklessness. Take a healthy company, roll the dice and if it comes up snake eyes, all you lose are your unvested stock options. Most management does not have significant capital at risk.

The cost for pushing a healthy firm into insolvency by excessive risk-taking is some snickering at the golf course. In terms of lost monies, it is minimal.

You might be surprised to learn that it was not always this way. Before these firms went public in the 1970s and 1980s, bank management had full liability for their firm’s losses. During the era of Wall Street partnerships, if employees were so reckless as to lose billions of dollars, the partners were on the hook for the full amount. This meant that after the firm was liquidated to pay its debts, the partners’ personal assets were next on the auction block: Houses, cars, boats, even watches were sold to satisfy the debt.

Not surprisingly, partnership liability worked wonders in focusing attention on taking appropriate risks.

Once a bank or investment firm went public, this liability shifted from management to the company’s stockholders and creditors (namely, the bond holders). Add to this the rise of stock-option compensation, and you have a recipe for extreme short-termism.

In his book “The Accidental Investment Banker,” Jonathan Knee described this mercenary attitude with the phrase “IBGYBG.” As bankers signed off on increasingly risky deals, IBGYBG meant “I’ll be gone, you’ll be gone” by the time the really messy stuff hit the fan. Call it what you will – smash and grab, take the money and run. Without partnership liability or clawback terms, IBGYBG was perfectly legal.

The simple solution to IBGYBG is legal liability.

How this works: There must be a civil liability for recklessness that caused a collapse or loss. Liability for loss accrues when a trader knew and disregarded the risk or, failing that, should have been aware of the risks they were taking.

The ability to clawback past gains in the event of a subsequent collapse should accrue to the board of directors, the shareholders and the SEC.

It is too late to force the big banks and investment houses to go private and become partnerships again. However, we can return the liability for their recklessness back to where it belongs – on the traders, fund managers and executives who profited from extreme risk-taking.

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Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, The Big Picture.

Originally published in the Sunday Washington Post, March 13, 2011

John Gerzema says there’s an upside to the recent financial crisis — the opportunity for positive change. Speaking at TEDxKC, he identifies four major cultural shifts driving new consumer behavior and shows how businesses are evolving to connect with thoughtful spending.

Record Aug 09, Posted Oct 09

Interesting cover on Barron’s this week:

This is hardly a contrary view — I’ve heard from lots of people saying they are doing the same thing.

As mentioned previously, stick with the small cap funds (DFJ, SCJ, and JSC). The large market cap ETF (EWJ) is not the ideal investment for the bounce back (already underway)

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Source:
Invest in Japan
LESLIE P. NORTON
Barron’s MARCH 19, 2011
http://online.barrons.com/article/SB50001424052970203757604576204523501069008.html

Succinct summation of week’s events:

Positives:

1) Bilateral intervention halts yen spike
2) China and India continue to tighten policy to offset rising commodity prices
3) Philly Fed survey best since ’84 and NY also good but old news?
4) Housing starts awful but I say good with too many existing homes for sale
5) Europe agrees to expand EFSF and gives Greece more rope. Spain sells 10 and 30 yr paper successfully

Negatives:

1) Japan cannot stabilize damaged reactors but hopes alive that they’re getting close
2) Commodity inflation still elevated as CRB back to flat on week on rebuilding bets and Libya/Bahrain unrest after mid week selloff
3) CPI, PPI and Import Prices rise above forecasts
4) Will China and India engineer a soft landing with more policy tightening
5) Housing starts awful, bad for construction
6) Europe will learn hard way that more debt on too much debt won’t end well, Moody’s downgrades Portugal to in line with S&P.

By Joey Tosi

The film features interviews with Brad Plunkett, the inventor of the pedal, plus many other musical luminaries such as Ben Fong-Torres, Eddie Van Halen, Slash, Buddy Guy, Art Thompson, Eddie Kramer, Kirk Hammett, Dweezil Zappa, and Jim Dunlop

Cry Baby: The Pedal That Rocks The World from Joey Tosi on Vimeo.

CNN/Money jumps on the fear bandwagon with this interactive graphic:

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click to see how soon you will die of radiation poisoning

Hey, look! NYC is only 32 miles from Indian Point! We’re all going to die! (eventually)

The Fed is giving the green light to banks to resume paying divvies. I guess this means things are okay, everything is getting back to normal. This must also mean their extraordinary accommodation via zero interest rates should be ending soon as well, right?

“The Federal Reserve cleared some of the 19 largest U.S. banks to increase dividends, buy back shares or repay government aid after “significant improvement” in their capital and the economy.

The banks, including firms such as Goldman Sachs Group Inc. and JPMorgan Chase & Co., have increased common equity by more than $300 billion from the final quarter of 2008 through the end of 2010, the Fed said in a paper released today in Washington on its most recent review of bank capital.”

Here is the punchline to the joke:

“Overall, both the quantity and quality of capital at many large bank holding companies have improved since the financial crisis,” the Fed said. “The return of capital to shareholders under appropriate conditions is a step in the process of improvement in the financial sector and will help to promote banks’ long-term access to capital.”

If I didn’t see the humor, I might end up crying . . .

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Source:
Fed Says Some Banks Can Resume Dividends After Stress Tests
Craig Torres and Josh Zumbrun
Bloomberg, March 18 2011  
http://noir.bloomberg.com/apps/news?pid=20601087&sid=a7BT9GzEj0.E&pos=1

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Over at Curbed, Jonthan Miller (of Miller Matrix) looks at who has the more resilient RE market, New York or Washington DC. The result is the above chart  (click to make giant).

In light of yesterday’s charts on US debt (Who Does the US Owe Money To?), let’s take a quick look at two more, via Ron Griess of The Chart Store:

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When ever I see an econ chart with “Gross” in the title, I cannot help but remember an All in the Family, when Archie Bunker was fighting with Meathead, he defend the nation’s honor by  saying “The US of A has the highest standard of living! The grossest national product!