Posts filed under “Think Tank”

Moody’s, Munis & Cousin BABs

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).


Moody’s, Munis & Cousin BABs
August 16 2009

In their August 13 “Special Comment” Moody’s outlined the current condition of the state budgets and of the various revenue sectors like airports, toll roads, higher education facilities, and hospitals. Nearly two years into a recession, the report is not pleasant reading.

Expenditure budgets are being cut. Tax receipts continue to arrive below projections, which necessitates further budget cuts. A downward spiral seems to be underway. The Muni sector appears to be in a depression.

In part, the damage to state and local budgets has been blunted by huge federal stimulus. This is viewed as temporary by government finance officers, since they must attempt to balance their budgets and may only count on federal assistance that is funded. The term “funded” means that they have the money in hand or will definitely receive it so that they can pay the bills. Thus unfunded items do not count even though they may be anticipated.

Forward-looking projections for municipal bond issuers are truly bleak. They show reduced revenues based on the most current projections of economic weakness. Tax receipts are forecast at extreme recession levels. These budgets do not include any unfunded federal help. Projections are based on all federal programs expiring as determined by present law. Credit ratings by Moody’s and other agencies are based on these worst case scenarios, which is why so many issuers are on credit watch or have been downgraded.

Direct payments are one form of help from the feds to the states and locals. Indirect forms are another. Build America Bonds (BAB) are an example of the indirect form. When certain qualifications are met, the federal government will reimburse the state or local issuer 35% of the interest cost on BABs issued in 2009 and 2010. The current law that authorized BABs expires after 2010. No one knows if Congress will extend it; hence, local government savings from using BABs is not projected after 2010.

In 2009, between $60 billion and $80 billion of BABs will be issued as taxable fixed-income securities; these are substitute issues for what would normally be tax-free Munis. Buyers of these new instruments include tax-deferred accounts like pensions or IRAs in the US and various foreign investors who find the yields on BABs attractive. Neither of these bond-investor groups would be interested in lower-yielding tax-free Munis, since they are not paying taxes to the US government. But they are seizing the opportunity to own BABs.

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Category: Fixed Income/Interest Rates, Think Tank

Protected: Early Morning Look: Broad sell off this morning

There is no excerpt because this is a protected post.

Category: Think Tank

Don’t ignore China anymore

While many are surprised by the pullback in global equities this morning, people forgot last week what lifted the global economy off the mat in March and that was China. Chinese stocks as of Friday fell 12% over the past week and a half, with the S&P’s mostly ignoring that correction, and another 5.8% today….Read More

Category: MacroNotes

Sucker’s Rally: Sixth Largest Bank Failure in U.S. History

Joel Bowman is managing editor of the Rude Awakening and author of its Weekend Edition. His keen interest in travel and macroeconomics first took him to New York where he regularly reported from Wall Street, and he now writes from and lives all over the world. This missive comes from Taipei, Taiwan: It’s a good…Read More

Category: Think Tank

Words from the (investment) wise — August 16, 2009

Words from the (investment) wise for the week that was (August 10 – 16, 2009)

During the week marking the second anniversary of the start of the credit crunch, stocks, copper, nickel, zinc and sugar recorded fresh 2009 highs. But the celebrations came to an abrupt end as caution crept back into investors’ vocabulary on Friday when it dawned upon pundits that markets were running away from economic reality. On top of that, Chinese equities – a leading stock market on the way up – saw a reversal of fortune and declined to a five-week low.

This is where the Ecclesiastes-based lyrics of the Byrds’s classic, Turn, Turn, Turn, started resounding in my head: “To everything (turn, turn, turn), There is a season (turn, turn, turn), And a time for every purpose, under heaven, A time to gain, a time to lose” (Click here for audio.)


Source: Mike Keefe (hat tip: The Big Picture)

Paul Kasriel, chief economist of Northern Trust, reports that the meeting statement of the Federal Open Market Committee (FOMC), released on Wednesday, was a bit more optimistic about the near-term economic environment, changing its language from “the pace of economic contraction is slowing” at the June 24 meeting to “economic activity is leveling out”. However, the communiqué also said that household spending would be constrained by “sluggish income growth”, in addition to the other constraining factors mentioned in the June 24 statement – “ongoing job losses, lower household wealth, and tight credit”.

“Given our current view that the recovery is going to be subdued and uneven over the next several quarters, we do not expect any federal funds rate increases from the FOMC until June 2010, at the earliest,” said Kasriel.

Shorter-dated US, UK and other government bond yields – securities that are sensitive to interest rate movements – declined on indications that benchmark interest rates would remain at low levels for an extended period of time. Longer-dated US yields also fell after the Fed announced that its Treasury purchase program would be extended until October. “The point is the Fed said it would keep the punch bowl open an extra month but it would not increase the punch that is already in the bowl. It will just dole it out in smaller increments over an extra month,” remarked Bill King (The King Report).

To James Grant (Grant’s Interest Rate Observer) the level of Treasury yields spells danger. He said: “Vacation-time thought experiment: With the knowledge that the US government will be borrowing as much as $3.5 trillion from the public in fiscal years 2009, 2010 and 2011, approximately matching the Treasury’s cumulative borrowing between 1789 and 1994, would you have guessed that the yield on the 10-year Note would today be hovering in the neighborhood of only 3.7%? If ‘yes’ is your answer, you must not go away on vacation this month. You have too hot a hand to stay away from the office.”

The past week’s performance of the major asset classes is summarized by the chart below, showing risky assets starting to take a breather.



A summary of the movements of major global stock markets for the past week, as well as various other measurement periods, is given in the table below.

The MSCI World Index (+0.1%) and MSCI Emerging Markets Index (unchanged) marked time last week, but are still showing solid year-to-date gains of +15.6% and +50.4% respectively. As weakness crept in towards the close of the week, the US and a number of other markets snapped a winning streak of four straight weeks. Emerging markets underperformed developed markets for the second week running since the beginning of May, indicating signs of risk appetite abating somewhat.

Click here or on the table below for a larger image.


Top performers in the stock markets this week were Bulgaria (+9.4%), Lithuania (+6.7%), Estonia (+6.5%), Vietnam (+5.5%) and Venezuela (+4.5%). The top three positions were again occupied by countries from Eastern Europe that are still playing catch-up as the scare of a banking collapse in the region dissipates. At the bottom end of the performance rankings, countries included China (_6.6%, last week -4.4%), Nigeria (-4.5%), Luxembourg (-3.6%), Cyprus (-3.2%) and Israel (-2.8%).

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Category: Think Tank

The Statistical Recovery, Part Two

The Statistical Recovery, Part Two
August 14, 2009
By John Mauldin

The Statistical Recovery, Part Two
A Recovery Statisticians Can Love
A Few Thoughts on the Housing Market
Some Thoughts from Maine
Tulsa, Birthdays, Weddings, and Paul McCartney

A few weeks ago I first used the term “statistical recovery” to describe the nature of today’s economic environment. Today we are going to further explore that concept, as it is important to have a real understanding of what is happening. This coming “recovery” is not going to feel like a typical one, and those expecting a “V”-shaped recovery are simply making projections from previous economic recoveries, which, based on the fundamentals, are not warranted. And of course, a few thoughts coming back from Maine are in order. There is a lot to cover, and this may take more than one letter.

But first, let me note to subscribers to Conversations with John Mauldin that we have posted my Conversation with George Friedman of Stratfor and will soon post a very interesting Conversation I had with John Burns (of John Burns Real Estate Consulting) and Rick Sharga of RealtyTrac. These may be the two most knowledgeable people on the housing market in the country. There is a lot of poorly informed speculation about the housing market, and I think this Conversation will help clear away a lot of the fog. PLUS, they both agreed to allow me to post their eye-opening PowerPoint stacks to Conversation subscribers (normally only available to their clients), so you get a very special bonus. And finally, David Galland of Casey Research is allowing me to post a most thought-provoking interview he did with Neil Howe. This is one of the best things I have run across in a long time. I do work on giving my Conversations subscribers good value.

George and I are going to be doing a regular quarterly Conversation called Geopolitical Conversations with John Mauldin and George Friedman. We believe that these new Conversations will help you better understand not only the global political landscape but also how it affects the financial umbrella that we are under. In this first Conversation, we talked about the “exogenous” risks to the markets (those from outside the markets themselves) posed by the geopolitical world.

We will offer this service, which will be priced separately, at some point in the near future. Now, here is the important part: all current subscribers and anyone who subscribes now will receive these Geopolitical Conversations free, as a thank you. (Current members can log in now.) If you have not yet subscribed, you can do so and receive a discount by clicking the link and typing in the code JM49 to subscribe for $149. This is a large discount from our regular price of $199; plus, we are including the bonus Geopolitical Conversations that are worth $59. And now, to the regular letter.

The Statistical Recovery

The unemployment numbers came out last Friday, and Steve Liesman of CNBC did several interviews live from Leen’s Lodge in Maine. I postponed an hour of fishing to be on air with Martin Barnes (of the Bank Credit Analyst) to comment on the numbers. Everyone seemed quite excited that the US lost “only” 247,000 jobs. However, it is still almost twice as large as a year ago, and at that time 128,000 lost jobs seemed pretty bleak. However, comparing it to the average of 692,000 lost jobs per month in the first quarter, those looking for good news immediately started talking about how a recovery is around the corner.

The unemployment numbers are some of the most seriously revised numbers in all of government data. The first monthly estimate is notoriously imprecise. Why people make investment decisions based on this release is beyond me. As I mention continuously, because of seasonal adjustment factors, the unemployment numbers understate job losses in a recession and also understate job gains in a recovery. About the most we can get from the current data is the broad trend. Admittedly, the trend is getting better, but we are still in a hole and no one has stopped digging.

What we can see is that we are down 6.7 million jobs since the beginning of 2008! We have roughly eliminated the job growth of the last five years. And that does not take into account the 150,000 new jobs that are needed each month just to maintain the employment rate because of the increase in population. It took 55 months once the 2001 recession was officially over to get back to the previous employment peak. That is 4.5 years, gentle reader, and we are further down now and faced with massive deleveraging. It is going to take a lot longer this time. Let’s look at some of the reasons why.

I took a different tack in the CNBC interview. I pointed out that even though it is possible (likely?) we will see a positive number for GDP for the third quarter, it is not going to feel like a recovery for quite some time.

By the middle of next year (2010), when I think we will finally hit an unemployment bottom, we will be down close to 8 million jobs, wiping out all the jobs created since the middle of 2004. Unemployment is likely to be more than 10%, unless they keep playing games with the number.

A Recovery Statisticians Can Love

What I mean by that remark is that the unemployment number went down even though we lost 247,000 jobs. How can that be, you ask? Well, the government assumes that if you were not looking for a job within the last month, then you are not unemployed; therefore, on a statistical basis the number of people unemployed went down by 400,000. (There are 2.3 million such discouraged workers.) More in a minute on the problem that will cause down the road.

Assume that we will need 9 million jobs over the next five years (150, 000 jobs a month for 60 months) and add the 8 million lost jobs. That means we have to add 17 million jobs in the next five years to get back to the 4.5% unemployment of 2007, let alone the under-4% we saw in 2000.

That means we need to grow employment by about 12% over the next five years. But it’s worse than that. What is known as U-6 unemployment is over 16%. There are another approximately 8.8 million people who are either working part-time but want full-time jobs or are among the 2.3 million discouraged workers as mentioned above.

(The definition of U-6 unemployment from the BLS web site: “Marginally attached workers are persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past. Discouraged workers, a subset of the marginally attached, have given a job-market related reason for not looking currently for a job. Persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule.”

Let’s make the assumption that the part-time workers want to go to full-time (which they say they do). Typically employers will increase the hours of part-time employees before adding new workers. That will be a major drag on potential job growth. It is the equivalent of creating at least 4 million jobs, except that no new jobs are created. Plus, those who want jobs but are not looking will come back into the market if jobs are available. That adds another 2 million. Now we are seeing the need for 23 million new jobs in five years, to get back to the “Old Normal.”

That is an increase of 15% total employment from today’s levels over the next five years. That type of jobs growth will only happen with significant economic growth. Normally, you should expect the economy to rebound to at least 3% trend GDP growth. That is what has happened historically. But we are not in the Old Normal. We are entering the era of the New Normal, where looking back at historical trends will prove to be misleading at best.

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Category: Think Tank


July CPI was flat headline and up .1% ex food and fuel, both exactly in line with forecasts. But, because of rounding, the y/o/y drop in CPI was 2.1%, .2% more than expected and the biggest drop since ’49 while core CPI rose 1.5% y/o/y. Owners equivalent rent, 24% of the overall CPI, was flat,…Read More

Category: MacroNotes

Ricardian Equivalence

Ricardian equivalence

August 14, 2009

The Obama-Summers-Geithner federal deficit financing plan assumes success because it ignores the principle of “Ricardian equivalence.” And it is based on the assumption of the Alan Blinder-Robert Solow argument that over a longer term the outcome of government borrowing will be an offsetting higher wealth effect.

It will fail. We could see an offsetting positive wealth outcome if the borrowed money were all spent on productivity-enhancing societal improvements. Sadly, it is mostly spent on current consumption; hence, the Blinder-Solow argument fails.

Let’s examine Ricardian equivalence applied to the stock and bond markets.

David Ricardo (1773-1823) is ranked among the classic British economists, along with others like his good friend Adam Smith. He sponsored the notion that consumers were able to distinguish between currently financed government expenditures (through taxes) and debt financing of the same expenditures. Ricardian equivalence equalized them.

An American classical economist, Robert Barro, advanced and modernized this theory in his writings. Others like Thomas Sargent and Robert Lucas, Jr. were part of the chorus that argued that consumers and agents were “rational” and that “expectations” would act as a prompt and current adjusting force when government ran large deficits.

The risk of failure with those theories arises from what economists call “inconsistencies.” In today’s world those risks are both in time and in composition of the actors. For Ricardian equivalence to have a chance, there has to be homogeneity among the agents and policymakers in the economy. In the US today, we do NOT have it.

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Category: Think Tank

Industrial Production

July Industrial Production rose .5%, .1% more than consensus and it’s the first gain since Oct ’08. Capacity Utilization rate was 68.5%, .2% more than expected, up from 68.1% in June and rose also for the first time since Oct ’08. The rise in IP was led by a 20.1% gain in auto production as…Read More

Category: MacroNotes

At this point, what the market wants is different than what the Fed

The key CPI report is expected to be flat m/o/m but down 1.9% y/o/y, the biggest decline since 1949. The core rate though remains sticky and is expected to rise .1% m/o/m and 1.6% y/o/y. While the markets want inflation to be in line to less than forecasts because it will keep the Fed with…Read More

Category: MacroNotes