Bernanke's Race to the Bottom

With two rounds of Quantitative Easing complete, the US economy appears to be looking for firmer footing. Ahead of Helicopter Ben's speach tomorrow, expectations are low for QE3.  Inflation expectations are bound to take hold, eventually. I advocate going against the recent grain, buying stocks on any dips.

Money supply is extremely high (http://en.wikipedia.org/wiki/Money_supply).  Banks will eventually move the cash off their balance sheets in search for higher yields, as soon as they find an asset class they can believe in.  My first guess would be apartment REITs as renters in high cost areas such as Washington DC pay extremely high rents.  I like Avalon Bay of Arlington, VA (http://www.google.com/finance?q=avb).

The debasement of the dollar through Quantitative Easing is Bernanke's race.  How quickly can the Fed chief single-handedly cause asset price inflation? Devaluing the dollar will have the following effects on the economy:
- asset price inflation
- cheaper exports, increased manufactured goods
- wipe away household debt (i.e. mortgage, credit card, stud loan)
- increased purchase of T-bills by China as they seek to retain the fixed rate of money exchange
- larger spread between actual and theoretical value of yuan, opens door to currency speculators
- less incentive to hold cash

At what point does M2 move through the system? My guess is the money moves to emerging markets and domestically into mixed-use commercial buildings.  After all, real estate is currently very cheap in many areas, making commercial and multifamily development more enticing.

Gold will eventually shatter. I was wrong buying puts at 1,000/ounce. Two thousand an ounce is very tempting.  The big picture is people don't trust governments to do what is in their economic best interests.  However, by the time the bus falls off the cliff, it will be too late. Does anyone remember oil in the summer of 2007? The only reason to buy gold is fear. If a country is forced into pulling out of the Europen Union, this may be your final chance to get out.  After all, a couple of hedge funds could easily have access to more capital than the Italian government. There is a giant game of chicken, and usually, whoever puts the most money on the table wins. Think Soros shorting the British Pound.

In June 1879, William Tecumseh Sherman gave a speech to the cadets of Michigan Military Academy.  There before a crowd of 10,000 people he had this to say,“…I’ve been where you are now and I know just how you feel. It’s entirely natural that there should beat in the breast of every one of you a hope and desire that someday you can use the skill you have acquired here.  Suppress it! You don’t know the horrible aspects of war. I’ve been through two wars and I know. I’ve seen cities and homes in ashes. I’ve seen thousands of men lying on the ground, their dead faces looking up at the skies. I tell you, war is Hell!”

            Hell is what we as a nation have been in for the better part of a decade.  But this hell had an upside.  During this last decade the United States has had to re-grow its’ military from the drawdown of the 1980’s - 1990’s to the state we are in today.  Prior to 9/11 the Defense budget was around $370 billion, today the Defense budget is $550 billion dollars.  This buildup in personnel and equipment led to many things; jobs and an industrial military complex that has benefitted greatly from America’s decade of confict. 

            The military has around 1.4 million men and women serving on active duty.  This is a far cry from the previous decades when there were over 2 million people serving on active duty (Defense Budget for FY2003: Data Summary", CRS Report for Congress). It is easy to do the math, since the end of the Cold War the U.S. has cut over 600,000 from its active duty force.  From this downturn the military has had to rely more heavily on defense contractors.  The last fiscal year alone the “Department of Defense has spent $316 billion dollars on contracts… and at the start of Desert Storm there were 50 people serving in the military for every 1 contractor over seas.  In Afghanistan now, there are approximately 100,000 contractors, a ratio of 1:1  (Singer, Peter W. "The Regulation of New Warfare", The Brookings Institution, February 2010.).  Cuts to the Defense Department are being felt on Military bases all across the United States.  Security officers on posts are getting laid off, soldiers with a spotty past that the military turned a blind eye to, as little as 3 years ago, are now being chaptered from the because they never could shake their criminal behavior.  It won’t stop there, soon it will be PT failures, or soldiers that can’t progress in ranks and if the Defense Department can’t meet it’s numbers from chapters then the cuts will come.

            Cuts too are already being felt in the defense industry.  “Honeywell, which sells aircraft engines and other kits to the military, expects the base budget to decline about 1 to 2 per cent a year over the next decade, resulting in a 2 per cent to 4 per cent annual decline in revenues for its defense unit for three years...expect these budget cuts to affect the large prime contractors and to ripple across the supply chain to smaller, specialized providers,” (Industry feels the sting of US Defense Cuts, By: Jeremy Lemer, Financial Times).  The talk now isn’t about when change is coming, because it has already.    

People today are tired of war and look at the military as the biggest offender of an overspent federal government.  They are tired of the nation building in countries that many of them will never set foot in. So politicians will go after the defense budget, because most of their constituents will clamor for that happen then to see cuts in their medicare or social security.  But the Defense budget has an unforeseen effect on these two programs.  The Defense Budget is what has made the American economy the powerhouse it is today.  We have freedom of the seas because of the power of the US Navy.

  The United States needs to be strategic in allocating future resources.  Human rights in developing and land-locked countries depend heavily on foreign assistance.  Better appropriations procedures and auditing can go a long way to ensure that mouths are truly being fed. Budget constraints will be felt on domestic and international economies.  It will be as Sherman said, "hell".    

Outlook for S&P/Moody's: 'Negative'

On August 8, 2011
Congratulations Standard and Poor's. You have created an enormous buying opportunity for anyone who cares to take notice.  As a matter of fact, the yield on US T-Bills declined today as investors flocked to US securities in search of a safe haven investment, whether it be AA+ or AAA or AAAAAAAAAAA, doesnt really mean anything as far as this blog is concerned. I would buy more deep in the money leaps (jan13 or later) on WFT, POT, PM, MO, XOM, CVX. I own call options on WFT and POT.

In light of Standard and Poor's recent rise to fiscal responsibility, I would like to formally request a copy of all bonds and securities rated since the year 2005. In this report, I am specifically interested in cash flows for mortgage backed securities originated between 2005 and 2007, the payoff date of the security, the interest payments expected to be received by the investor,  the actual interest received by the investor and of course the correspond 'official' rating.
http://www.washingtonpost.com/wp-dyn/content/article/2010/08/31/AR2010083106192.html


On August 2, 2011

Moody's has posted an 'Outlook Negative' on the US credit rating (<http://finance.yahoo.com/news/Moodys-backs-US-tripleA-apf-2668047537.html?x=0&sec=topStories&pos=main&asset=&ccode=>).  I must think that too much austerity as the US is coming out of a recession is certainly not a good thing for the economy. At the same time, we need tax increases to close the deficit. The lawmakers did the right thing and got the debt deal done. Wasn't too good. Wasn't too bad. Good enough.  Let us move on.

I like how Moody's/Standard and Poor's are all of a sudden the steward of fiscal responsibility.  In Michael Lewis' book The Big Short,  he notes that anybody who doesn't get a job at a big investment shop has to settle for a job at Standard and Poor's, Moody's or Fitch.  He also points out that those betting against the housing market found plenty of ammunition in the pay to play scheme concocted in so called AAA ratings.  We should not forget that in the not too distant past a AAA rating was assigned to every subprime security in the TBA market.

The purpose of ratings agencies is to provide an opinion on the collateral that backs the debt of a corporate or government entity.  Typically, ratings agencies (and analyst opinions) are simply following the lead of bond investors in the market. They provide a reactionary opinion based on what has already happened based on bond yield spreads.  Since the subprime debacle, the agencies attempt to get out in front of credit problems of the US or European governments. They are simply translating what the bond markets are saying into plain English.

We should acknowledge the agencies in their plight to make themselves whole to the stewards of credit and simply ignore them when it comes to economic policy.  As they say, let the money do the talking; Bond yields will speak for themselves.    Even better, perhaps the ratings agencies should make statistics available on opaque securities that earn their stamp of approval, reference expected cash flows, debt percentages, and verify collateral to weed out fraudulent entities.

CIA vs. ISI

CIA vs. ISI

IN islamabad, the pakistani government approved of a joint ISI-CIA led taskforce to engage in sharing intelligence.  Yet, the government has refused the visa applications of their US counterparts.

It is clear that there are factions within the Pakistani ISI that support and operate in tribal areas with diplomatic immunity.  The only intellegent sharing happens to be when the Pakistanis tip off bombmaking factories before the so called 'raids'.  The pakistani armed forces actually ask permission before even entering certain tribal areas.  

The CIA asking the Pakistani armed forces to politely raid bombmaking facilities, clearly isn't working. A policy of identifying the facilities and asking permission is not exactly the US/CIA strongest quality.  It is at least evident in the media outlets that the internal leaks have identified targets on multiple occaisions that have been well aware of upcoming raids.  It was a good thing we did not use this policy before nabbing Bin Laden. 

Pakistan has always been insecure about its sovereignty with INDIA and used the tribal areas as a hedge against its fierce competitor. Will future terrorist attacks within the country change this view?  Or will extremist groups provide more hope, jobs, and opportunities for the youth of Pakistan? how much evolution is resisted before the step in the wrong direction turns to be catastrophic? 

A focus on economy, jobs, education and opportunities for the youth will yield the best return on invested capital.  

A war has never been won on a battlefield and lost in the economy at the same time. 

Human rights have never been won with diplomacy. 

Human rights are lost when economies are destroyed.  People who have nowhere to turn, usually find outlets on the extremes to vent their frustrations.  This happens in developed and undeveloped economies, equally.  Exhibit A, Oklahoma City Bombings.  

Government policy should take the following factors into consideration when attempting to evaluate the sovereignty of a nation:

- unemployment rate

- infant mortality rate

- regime structure

- economic output 

  - inflation

  - gdp per capita

- Healthcare/disease control

- water quality

- percent of homes with electricity

- percent of homes/land with running water

- military capabilities

- do they control their own territory efficiently? 

- overall happiness  

Many of these measurable outputs are psychological factors that affect a country's future path.


yahoo
ap news sources
<http://news.yahoo.com/s/ap/us_us_pakistan>

When has the market fully priced in the end of QE2?

Commodity stocks and inflation bulls have taken a nice hit the past week.  The Market appears to be pricing in the end of Fed QE2 monetary policy.  As the Board stops monetizing the debt by purchasing treasury securities, interest rates should rise, albeit slightly.  Keep in mind the Fed funds rate is still at 0-0.25% range (<http://en.wikipedia.org/wiki/Federal_funds_rate>).  I do not expect the target rate to be raised anytime soon.

At what point does the market have QE2 fully priced in?  Does the FOMC factor in Chinese inflation to their monetary policy decisions?

The exported inflation is essentially soaked up when China buys T-Bills to keep the currency peg in place.  If they stopped buying T-Bills and let the currency float, interest rates in the US would rise, increasing the cost of US borrowing.  This would also encourage US exports as they become more competitive in the global market.

Michael Fletcher of the Washington Post published an article in today's paper about manufacturing jobs in the Rust Belt (<http://www.washingtonpost.com/business/economy/in-rust-belt-manufacturers-add-jobs-but-factory-pay-isnt-what-it-used-to-be/2011/05/17/AFDmL55G_story.html>).  These jobs are a direct result of easy monetary policy.

How long will these manufacturing jobs last? When does the FOMC initiate the first rate increase? Do they miss the boat and increase 0.5%? Or do they gradually lift the rate by 0.25%?  What role does China play in the FOMC target rate decision?

The European Central Bank is consistently ahead of the Fed in terms of raising the target interest rate.  The ECB has too much political power concentrated within the German economy.  While America lowers its target rate to help the struggling economies of MI, CA, FL and NV;  the ECB raises its target rate as Greece, Portugal, Ireland and Spain pay higher interest rates to finance their debt.  If the entire Eurozone were as healthy as Germany there would not be a problem, but this is not the case.   

Are Drugs Really Illegal in America? A Bachelor's guide to strip clubs in Charm City:

Well, it depends on where you are. And the level of acceptance versus enforcement. I will get to the politics in just a moment.

I recently attended a bachelor party for a buddy from college. The destination of choice for these east coast kids: Baltimore, Maryland, AKA Charm City. Is there a better place for a bachelor than 'THE BLOCK' (http://en.wikipedia.org/wiki/The_Block_(Baltimore) ? They say this is the place where boys travel to become Men.  

Located a stone's throw from the inner harbor on East Baltimore Street directly beside the Baltimore City Police Station; the Block is a strip of all strips..lined with strip clubs.  Some, such as the Hustler Club are very nice, while others make you feel like you are getting ripped apart by a pack of pumas at night in the amazon jungle. On the block, this area is usually disguised as a basement entry strip club with a permeating smell of rank vagina.

Rule number 1: its always better to go to heaven than hell; so for your average strip club going male (once or twice a year), avoid the clubs leading down a long stairwell. If its free admission, there is a reason for it.

So we went upstairs to the Hustler Club and ordered a couple bottles of Absolut and watched in amazement as the employees climbed a three-story fire pole, only to drop themselves upside down by one leg and stop on a dime before ever hitting the floor. This my friends is quite a skill to acquire. And they somehow manage to perform this gracefully and fulfill their fiduciary duties as true professionals.  Two thumbs up and 5 out of 5 Stars.

After a few hours and a nice evening at Larry Flint's establishment, the group decided it would be a good idea to club hop. The first place, right next door, had the oldest and most worn out strippers you could imagine. These girls did not work regular hours or live day by day. They lived minute by minute, fix by fix, dollar by dollar. The pimps either stood near the door or located within shouting distance at the other clubs, just in case an unhappy customer tried to walk out on his tab (not that anything in here could or should cost very much). 


Luckily for me, I had grown the thickest beard possible in about 7 weeks, kept my head down attempting to avoid the stinch and getting eye fucked at the same time.  Part Mark Ruffalo (as I would say), part Unabomber, part guy from The Hangover (as my buddies would say).  The shadier you look, the better you fit in.  Black shirt, dark jeans, thick beard, grey newbies, black guess watch.

HBO's hit series The Wire portrays inner city Baltimore in a very chilling light. The show is a fictional tale based on experiences of a journalist and a former Baltimore city cop. The term 'eye fuck' is a very real term. For more information, watch the series or walk down East Baltimore Street and Gay Street at 2 o'clock in the morning.

After finishing out our rounds at heaven and hell, it was time to call it quits around 2am.  What better place to eat in the middle of a Red Light District than Subway, made fresh daily.  I ordered my club melt sub and proceeded to wait outside for the rest of the crew to finish ordering their late night snack.  I was half drunken, half sober after 14 hours of drinking, baseball, and strip clubs and watched the hoppers as they casually sold drugs on the corner in the middle of Gay street, between The Block and the police station.  Was this the real life Hamsterdam (http://en.wikipedia.org/wiki/Hamsterdam)?

After observing for a few more minutes, it was time for most of the establishments to close for the evening.  The people emptied onto the street.  One police officer was very eager to keep the crowds moving.  As I watched cars stop in front of the police station to buy drugs, the officer proceeded to spray pepper spray in the street to keep the foot traffic moving briskly.  Mission accomplished.  Tear gas grenades would have been slightly more efficient, but he still managed to got his point across.  After dealing with pepper spray in my eyes, three of us left to walk back to the hotel where the others joined shortly after. No arrests, no fights, no deaths, and one bachelor accounted for.  I would consider that a glowing success.

Rule #2:  No loitering. When the officer tells you to move at 2am, get the f*k out of there for obvious reasons.

The interesting question is, how on earth does this kid (probably no more than 16 years old) in a white t-shirt sell drugs on the corner in front of the police station?  I assume he was directing traffic to the corners where they could deliver and exchange payment, but it was blatantly obvious.  I just thought it was funny that I was the one getting pepper spray in my eyes.

From this experience, I pose a few questions:
What is the service fee for the turf in a high traffic, high volume corridor next to a police station?
Does Baltimore have De facto legalization?
Does the prevalence and high usage rates by residents influence the enforcement policies?
Can you measure the contribution of this black market to the local economy?
At what point does the government decide to collect tax revenues?

It is true the market exists.  Whether you support it or not, is not relevant.  The dollars that feed wars in Latin America could be used for filling budget gaps in cash strapped cities.  Depriving cartels of marijuana revenues have been conservatively estimated at 10 billion. This budget gap would force cartels to find other sources of revenue and deplete gangsters of their precious blood money egos.

If inner city and suburban youth cannot make money selling drugs, they will be forced to get an education to become successful.  Perhaps, they will then look up to the teenagers that are inspired to become pharmacists, engineers, financial professionals, and real business owners.

Conforming limit set to decrease October 1st

The maximum allowable loan eligible for sale to the GSEs is currently 730k. Beginning October 1st, this limit will decrease to 625k.

What does this mean for consumers?

Obtaining loans above 625 will be dependent upon institutions without the government insurance provided by Freddie Mac and Fannie Mae. This mean loans made by banks will either be retained on portfolio or sold into private label securities. In other words, higher down payments and higher interest rates are inevitable without the government guarantee.

Financing will become more difficult as banks will require larger down payments and higher interest rates. Financing for loan amounts between 625k and 730k will see the largest impact. These loans will pay jumbo rates similar to mortgages above 730k.

Higher interest rates in the future does not mean you should necessarily rush out and buy a home now or before the Oct 1st deadline. Sellers and agents will push for homes to be sold between 625 and 730k leading up to the deadline because financing will be tighter. The lower interest rate is essentially baked into the sales price of the home. In many cases, it may be in the buyer's best interest to wait for a price drop and take the higher interest rate. You can always refinance (if in positive equity). You cannot change the price you paid for the house. The higher interest rate means you will be paying down the principal at a slower rate. Interest rates will be reflected immediately after October 1, while it may take sellers a few months to adjust sales prices accordingly.

If supply and demand remained constant before and after October 1st, the monthly payment should not change. Do you want a higher interest rate and lower price? Or lower interest rate and higher price? Personally, I'll pay a higher rate for my mortgage if I get a better price on the house. The higher interest rates imply a smaller pool of buyers that can afford a home in the 625k to 730k range. Less people able to afford means less demand and less demand means prices need to adjust. This will have a larger effect in higher cost areas such as California.


For those calling for less government involvement in the mortgage market, this is one result.

Remember:
High land leverage ratio
Structures ALWAYS depreciate over time
Value is in location
If you can rent your property for the same price you pay the bank, it is probably a safe investment....