Jun 27, 2010

Housing on Life Support

Housing on Life Support

June 28, 2010

“We have market forces that are deflationary and policy response that is inflationary. The next bubble – and this is the lesson of what this Greek drama was all about – is sovereign debt. The government’s official stance is that these deficits are just temporary. And the Fed says we have an exit strategy to reduce the liquidity of the U.S.’s balance sheet. If the notion becomes widespread that this is permanent and that they have to do even more in terms of more of this bad medicine, that’s the kind of thing that could lead gold to go up dramatically from here.”-John Hathaway, Tocqueville Gold Fund

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: 2.9%
SPX: 3.7%
COMPQ: 3.7%
RUT: 3.3%


All 10 industry groups in the S&P 500 fell last week as macro concerns over-whelmed the psyche of the market. The biggest drop in housing starts since March 2009 and ongoing sovereign debt concerns overshadowed better-than-estimated growth in industrial production, in line employment data, and a revaluation of the Yuan to drag the market lower. In Europe the debt problems in Spain have moved to center stage, allowing Spain to replace Greece as the Spruce Goose of Europe.

Among the negative factors pressuring the market, a series of weak real estate releases seemed to create the highest level of concern. We have been contending that residential housing prices should experience a second leg down, somewhere in the 10-20% range, and it finally looks as though this second correction may be coming. As the government’s residential real estate stimulus programs wane, demand appears to be waning as well. We think this is healthy for this market and feel the Feds should have allowed the real estate market to find a bottom on its own. Now we’ve spent trillions trying to prop up housing and it looks as though the only impact is a delay in finding the ultimate bottom, and an expensive delay at that.

The financial services stocks staged a rally on Friday when the details of the new financial reform package were announced. We’ll discuss more of the details later, however, it seems that the extensive lobbying efforts by the big commercial and investment banks was money well spent as the reform not only is without teeth, the bill wouldn’t have even slowed down the prior financial crisis. What will happen when the next crisis occurs?

This appears to be a great time to begin fundamental research and find those quality stocks becoming oversold. As the market’s focus has turned more to macro concerns (think housing, sovereign debt, double dip recession, etc), company fundamentals have taken a backseat and good companies are being penalized along with companies whose fundamentals are deteriorating. This weekend’s Barron’s noted that the correlation amongst stocks has increased to its highest level since the financial panic in 2008. In prior periods with higher correlations than normal, great opportunities have arisen for individual stock selection. Do your homework, look for entry points!

Actual Consensus Prior

Existing Home Sales 5.66 mil 6.10 mil 5.79 mil
New Home Sales 300K 430K 446K
Housing Starts 593K 655K 659K
Durable Orders -1.1% -1.3% 3.0%
Durable Orders ex Transports 0.9% 1.3% -0.8%
Initial Claims 457K 460K 476K
Continuing Claims 4648K 4580K 4693K
GDP-third estimate 2.7% 3.0% 3.0%
GDP Deflator 1.1% 1.0% 1.0%
U of Michigan Consumer Sentiment 76.0 75.5 75.5

May new home sales were a disaster as the first time home buyer’s tax credit expired. The measure came in 27% below estimates. Even April sales, which included the credit, were revised down by 58k. The May sales level of 300k is the lowest on record since at least 1963! Inventory for sale jumped from 5.8 to 8.5 months due to the lower sales volume. Sales in the West fell 53% from April and foreclosures continue to flood the market. Median home prices also fell 9.6% from a year ago and 1% from April.

While it’s doubtful anyone anticipated strong results post the tax credit, the magnitude of the decline was shocking. It would appear that the tax credit pulled forward sales from future months, the question remains how long until volumes return? We would guess that the tax credit pulled demand from as far forward as September, and that all things being equal we won’t see positive housing data until October, at the earliest.

“Builders still remain very cautious and are aware that several factors could impede the nascent housing recovery, including serious problems in obtaining financing for the production of housing, faulty appraisal practices and competition from short sales and foreclosed properties.”

Part of the pressure on the real estate market continues to be the ongoing rise in defaults, not just from subprime borrowers but also prime borrowers. The chart below, courtesy of Bloomberg, shows the increase in defaults amongst these “superior credits”.

Floating Yuan!
China announced that they would relax the yuan’s fixed peg to the dollar, and the currency posted its largest single day gain in almost two years. Treasuries and the dollar initially fell while global commodities, equities and the yuan rose. An appreciating yuan could be marginally positive for mid-cycle stocks with global exposure such as industrial, energy, and materials producers as their products become more affordable to China. A stronger currency will also help China’s inflation problem, but could add inflationary pressures to the US as profit margins get squeezed for domestic manufacturers reliant upon inexpensive Chinese labor markets. A stronger yuan could also increase pressure on Chinese textile manufacturers who have flourished due to their lower cost of labor and currency advantage.

While these changes may seem dramatic, in reality they will be subtle and occur over the long term. Typically currency impacts do not result in an immediate shift in competitive dynamics or pricing.

Thank You BP

Is anyone else thinking that Congress and the bankers are breathing a sigh of relief and thanking BP for getting the heat off of them for the time being?

Beggar thy Neighbor

According to the Bank for International Settlements, banks in Germany and France are owed more money by European nations that are in financial distress compared with other countries' financial institutions. Greece, Ireland, Portugal and Spain had borrowed nearly $1 trillion from French and German banks by the end of 2009, the BIS said!

That’s a lot of motivation to help the PIIGS.

Credit Demand, Not Credit Availability is the Issue

The National Federation of Independent Businesses (NFIB) surveys a sample of its 300K or so members each month. A recent survey found that only 3% of its members reported financing as their top business problem. A third cited “weak sales” as their top problem while 92% reported all of their credit needs met (or having no desire to borrow). Thirteen percent of regular borrows reported credit “harder to get” than previously.

The First Quantitative Easing

The Federal Reserve Bank of St. Louis just published a 20 page tomb on the quantitative easing that took place in the 1932. It’s a bit dense, but informative.


Thanks to reader Doug.

The Best President for the Environment?
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Commercial Real Estate

Morningstar writes that the pace of commercial-property acquisition is picking up in a way that might continue for some time. "We believe the large amount of capital that real estate investment trusts, pension funds, and private investment funds have amassed for commercial real estate investment has, to date, overwhelmed the available supply of assets for purchase."

It’s Not California!

A few weeks ago we talked about the fiscal problems in Illinois looking worse than those in California. Last week the state issued $300 million of Build America Bonds at a yield premium over treasuries about 40% higher than two months ago as investors showed concern about the state’s $13 billion budget deficit. The paper priced almost 300bps over treasuries to yield 7.1%. In April the state issued similar term bonds at 210bps above treasuries.
Governor Pat Quinn is pushing to issue an additional $3.7 billion in debt to make pension payments and help with the gaping shortfall. The state presently has unpaid liabilities totaling $4.5 billion. The cost to insure Illinois debt has surpassed that of California, with CDS at 309bps vs. 299bps to insure California debt. Moody’s and Fitch both downgraded the state’s debt this month.

Test Run from the Fed

The U.S. Federal Reserve started testing its tool for credit tightening, selling $1.15 billion through its term deposit facility. Chairman Bernanke plans to use the program to drain funds from the banking system and help policymakers increase interest rates when the Fed begins pulling back on liquidity. In addition to the deposit facility, the Fed also said it will use reverse-repurchase agreements to soak up liquidity. "The use of reverse repos and the deposit facility would together allow the Federal Reserve to drain hundreds of billions of dollars of reserves from the banking system quite quickly, should it choose to do so," Bernanke told lawmakers earlier this year.

From Fox News:

The seven experts who advised President Obama on how to deal with offshore drilling safety after the Deepwater Horizon explosion are accusing his administration of misrepresenting their views to make it appear that they supported a six-month drilling moratorium -- something they actually oppose.
The experts, recommended by the National Academy of Engineering, say Interior Secretary Ken Salazar modified their report last month, after they signed it, to include two paragraphs calling for the moratorium on existing drilling and new permits.
Salazar's report to Obama said a panel of seven experts "peer reviewed" his recommendations, which included a six-month moratorium on permits for new wells being drilled using floating rigs and an immediate halt to drilling operations.
"None of us actually reviewed the memorandum as it is in the report," oil expert Ken Arnold told Fox News. "What was in the report at the time it was reviewed was quite a bit different in its impact to what there is now. So we wanted to distance ourselves from that recommendation."
Salazar apologized to those experts Thursday.
"The experts who are involved in crafting the report gave us their recommendation and their input and I very much appreciate those recommendations," he said. "It was not their decision on the moratorium. It was my decision and the president's decision to move forward."
In a letter the experts sent to Salazar, they said his primary recommendation "misrepresents" their position and that halting the drilling is actually a bad idea.
The oil rig explosion occurred while the well was being shut down, a move that is much more dangerous than continuing ongoing drilling, they said.
They also said that because the floating rigs are scarce and in high demand worldwide, they will not simply sit in the Gulf idle for six months. The rigs will go to the North Sea and West Africa, possibly preventing the U.S. from being able to resume drilling for years.
They also said the best and most advanced rigs will be the first to go, leaving the U.S. with the older and potentially less safe rights operating in the nation's coastal waters.

Oil Spill Positive for Economy?

I mentioned this a few weeks ago, and got a lot of blowback from readers (which of course makes me want to say it again). Bloomberg is now estimating that jobs associated with the cleanup will exceed 15K, more than the estimated 8K workers being displaced by the spill. That excludes the 30K rig workers being displaced by the offshore drilling moratorium.

The Katrina cleanup effort was effective at stimulating the area’s economy after the devastation of the hurricane. The BP cleanup effort could go on for a decade or more, helping to offset the decline in tourism, fishing, and other water related businesses.

The Benefits of War?

Pentagon scientists uncovered a vast array of mineral deposits in Afghanistan that could provide money to rebuild the war-torn economy. According to an internal U.S. government memo, Afghanistan could end up as the "Saudi Arabia of lithium," a mineral essential to the manufacture of batteries for computers and other electronic devices. Geologists estimated that the deposits could be worth nearly $1 trillion.

Opportunistic Brazilians

Sensing an offshore drilling opportunity, Petro Bras has announced plans to invest $224 billion over the next three years in oil exploration and production. The company is looking to increase its development of offshore reserves just off their own, very oil rich coast.

Chinese Liquidity Crunch

We have discussed a possible liquidity crunch in China a number of times in the past. Blogger Tyler Durden noted this week that repo rates between Chinese banks have bee surging recently, a sign the liquidity crunch may be worsening. As the chart below demonstrates, the 30 Day repo surged by 19 bps to a record 4.25%, up from 1.75% six weeks ago. Could the bad loans in China finally be hitting a boiling point?

Financial Non-Reform

Congress announced a deal on reforming financial services and supervision which failed to keep banks from participating in hedge funds or buyout investing, limiting their exposure to 3% of total capital. Derivative trades on interest rates and foreign-exchange rates are also still allowed, although other trading on derivatives is banned.

The net of the bill is that banks are still allowed to continue their investment banking activities, with some minimal limitations.

After all the crowing and posturing coming from the Administration, this bill is effectively a worthless pile of paper that does little to address any potential problems, doesn’t get rid of TBTF, and wouldn’t even stop the most recent crisis much less any crisis that could be looming in the future.

No wonder financial stocks all jumped on the news.


Credit default swap rates on Spanish sovereign debt widened this past week as the market began acknowledging another source of problems in Europe. Remember that Spain’s economy is 4x that of Greece, and a default would have a much greater impact on Europe and the global economy than the sneeze we just experienced from Greece.


The Baltic Dry Index, which tracks international shipping prices, has been highly correlated to commodity prices and economic activity over the past decade plus. The chart below, courtesy of thechartstore.com, shows that the index has been range bound since bottoming in December 2009, down 90% from its peak. If the support lines are accurate, it suggests the index may be correcting once again. If that is true, it could be another indicator supporting the double dip recession scenario.

Debt-Yours, Mine and Ours

Alliance Global Investors created the chart below showing the liability per tax payer and citizen of our national debt. The numbers are daunting.


The market continues to trade within the ranges we outlined early in the year, and still has support around the 1050 level. As we have discussed more than once, use that level to add to positions, however, if the market breaks significantly below 1050, 950-980 could be the next stop, an additional decline of 7-9%.

If you are interested in receiving daily economic results, subscribe to Twitter via the “Follow Me” link in the upper right hand side of the note. I try to put them out around 10 EST since most reports are released around that time. Also, thank you once again for supporting our advertisers.

Have a great week.


“Ratings firms fear litigation more than they fear regulation because past regulation efforts haven’t “been that draconian.” -Scott McCleskey, a former Moody’s compliance officer who has testified before Congress about the industry.

Jun 13, 2010

Market Follows a Well Worn Path

Market Follows a Well Worn Path

June 14, 2010

"Big banks that took on high risks and generated unsustainable losses received a public benefit: TBTF ["too big to fail"] support. As a result, more conservative banks were denied the market share that would have been theirs if mismanaged big banks had been allowed to go out of business. In essence, conservative banks faced publicly backed competition."—Dallas Fed President Richard Fisher

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: 2.81%
SPX: 2.51%
COMPQ: 1.10%
RUT: 2.37%

Almost on queue the S&P 500 corrected from its mid-April high of just over 1200, correcting back to support around 1050. The index has bounced off that level twice, and closed this past week at 1091. In prior notes we have focused on these levels as trading points, and will continue to do so in the near term as the markets continue to consolidate. There are two questions in our minds. First, will the market break through the mid 1000 support level? If so, then we could see the S&P correct back to the 950-980 range. Second, will the trading range continue to widen with increasing volatility, or will it tighten up?

There has been quite a bit of discussion over the past few weeks about a double dip recession coming in 2011. If you recall from our beginning of the year note, we assigned a 20% probability to a double dip. Today we would suggest the economy has three possible scenarios. First, a meandering, slow growth recovery, which we would say is the most likely scenario with a 60-70% probability. Second is the double dip scenario, which we still think has a 20-30% probability. Finally, we think a rapidly growing recovery is the outlier, with a less than 10% probability yet the scenario that isn’t priced into many models today.

David Rosenberg of Gluskin Sheff, produced the chart below. We have written about business cycle investing many times in the past, and have shown similar graphics. David’s chart below suggests that, based upon the recent slowdown in the growth rate of the ECRI Weekly Leading Economic Indictor, we are now in Phase III-slowdown. If he is correct, and we believe he is, then its time to focus investments on late cycle stocks while underweighting early cycle stocks. Additionally, this type of environment is poor for higher risk assets such as high yield credits and small caps.


Actual Consensus Prior
Consumer Credit $1.0 bil -$2.0 bil -$5.4 bil
Wholesale Inventories 0.4% 0.5% 0.7%
Initial Claims 456K 450K 459K
Continuing Claims 4462K 4600K 4717K
Trade Balance -$40.3 bil -$41.3 bil -$40.0 bil
Retail Sales -1.2% 0.2% 0.6%
Retail ex-auto -1.1% 0.1% 0.6%
Michigan Consumer Sentiment 75.5 74.5 73.6
Business Inventories 0.4% 0.5% 0.7%

The chart below, courtesy of the NY Times, shows unemployment since the beginning of each recession going back to the 1970’s. The chart demonstrates that unemployment in this recession is worse than any of the others, and has taken longer to begin showing improvements in hiring. The second chart, courtesy of shadowstats.com, shows the official unemployment rate (red line), the BLS U-6 rate (gray line), and the SGS alternative measure (blue line). The differences are that the U-6 includes short-term discouraged workers and those working part-time because they can’t obtain full time work. The SGS alternative includes long-term discourage workers, who were eliminated from the official measures in 1994.

The Best Investment of All

We’ve shown these hats many times since this note began, and have commented what a great investment they were in 1998 when the Dow first topped 10K. With the Dow criss-crossing this much ballyhooed level again, it seemed an appropriate time to break out these well worn, fully amortized chapeaus (before I get pummeled by my more critical readers, I do realize this hat isn’t a true chapeau).

Credit Conditions
The Bank of Canada became the first Group of Seven country to raise rates since last year’s recession, and said further moves will be “weighed carefully” against future growth in Canada and elsewhere. Canadian GDP grew at twice the rate of the US last quarter, 6.1%.

“Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments,” the Ottawa-based central bank said in a statement.

Finally Some Reality

Federal Reserve Chairman Ben Bernanke told the House Budget Committee that the U.S. isn't creating enough jobs to pay for all of the people who will retire during the next 20 years. He urged Congress to take decisive action to reduce the structural deficit because spending cuts and tax reform alone can't close the gap. "Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth," Bernanke said.

Why does it take people in power so long to state the obvious?

A Return to Smoot-Hawley
Treasury Secretary Timothy Geithner said he is considering trade restrictions on Chinese products in response to China's failure to allow the value of its currency to rise. "The distortions caused by China's exchange rate spread far beyond China's borders and are an impediment to the global rebalancing we need," he told the Senate Finance Committee.

Are we doomed to repeat every mistake of the Great Depression?

Leading by Example

Germany announced its biggest spending cuts since World War II, saying Europe's largest economy must set an example. The austerity plan aims to reduce spending by $95.7 billion by 2014. German Chancellor Angela Merkel said the move is a "unique show of strength" that demonstrates Germany's commitment to dealing with Europe's debt crisis.

Austerity is important and much needed in the US and most of the developed world, but I wonder if eliminating another slug of spending in Europe while the economy falters is the right medicine at this time?

Jobs and the ISM
According to Barry Ritholtz at The Big Picture, the ISM usually does not spend much time above 60. It printed at 60.4 in April and dropped slightly in May to59.7. In the previous 485 readings, it has printed above 60 just 48 times, or 9.9% of the time. As it relates to jobs, the year over year change in payrolls lags ISM by about seven months.

The chart below shows the ISM in blue and non-farm payrolls in red. By lagging payrolls seven months, the correlation rises to 0.73, suggesting we should start seeing an improvement in the jobs picture any month. On the flip side, with the ISM approaching historical peak levels and suggesting we are in the late cycle, yet hiring hasn’t picked up significantly, we could be in for a long employment downturn.

They Call Me Coach

Even though I’m a USC fan, John Wooden had a significant influence on my life. As a boy I read his book “They Call Me Coach”, and had his pyramid of success tacked onto my wall. He was a great coach, teacher, and man whose focus on persistence, loyalty, honesty, hard work and process are timeless lessons that transcend professions. I have included some of his greatest quotes below:

"Things turn out best for the people who make the best of the way things turn out."

"Never mistake activity for achievement."

"Adversity is the state in which man mostly easily becomes acquainted with himself, being especially free of admirers then."

"Be more concerned with your character than your reputation, because your character is what you really are, while your reputation is merely what others think you are."

"Be prepared and be honest."

"Be quick, but don't hurry."

"You can't let praise or criticism get to you. It's a weakness to get caught up in either one."

"You can't live a perfect day without doing something for someone who will never be able to repay you."

"What you are as a person is far more important than what you are as a basketball player."

"Winning takes talent; to repeat takes character."

"A coach is someone who can give correction without causing resentment."

"If you don't have time to do it right, when will you have time to do it over?"

"If you're not making mistakes, then you're not doing anything. I'm positive that a doer makes mistakes."

"It isn't what you do, but how you do it."

"Consider the rights of others before your own feelings and the feelings of others before your own rights."

"Do not let what you cannot do interfere with what you can do."

"Don't measure yourself by what you have accomplished, but by what you should have accomplished with your ability."

"It's not so important who starts the game but who finishes it."

"It's what you learn after you know it all that counts."

"It's the little details that are vital. Little things make big things happen."

"Talent is God-given. Be humble. Fame is man-given. Be grateful. Conceit is self-given. Be careful."

"The main ingredient of stardom is the rest of the team."

"Success comes from knowing that you did your best to become the best that you are capable of becoming."

"Success is never final; failure is never fatal. It's courage that counts."

BP Gets a Tongue Lashing

The President, who for some reason seems to periodically forget he is in the US, continued his verbal attack on BP by saying they shouldn’t market, buy ad time, or pay dividends to its shareholders.

I’m speechless.

Regulatory Reform?
From Barry Ritholtz

“Even for Washington, the revolving door between government and Wall Street spins at a dizzying pace. More than 1,400 former members of Congress, Capitol Hill staffers or federal employees registered as lobbyists on behalf of the financial services sector since the start of 2009, according to an exhaustive new study issued Thursday. The analysis by two nonpartisan groups, Public Citizen and the Center for Responsive Politics, found that the “small army” of financial lobbyists included at least 73 former lawmakers and 148 ex-staffers connected to the House or Senate banking committees. More than 40 former Treasury Department employees also ply their trade as lobbyists for Wall Street firms.”

Alternative Energy
Given the BP oil spill and what appears to be an overriding drive to move us even further away from fossil fuels, I have reproduced a piece I wrote about a year ago (April 19, 2009) on alternative energy. I recently read a study suggesting that we will need to double our energy production between now and 2030, and that the technologies required for that type of capacity increase don’t exist. The only way we can get there is through a combination of carbon based energy and alternatives, not just alternatives.

Here is the text from my note last year:

“US consumers pay average of $.11 per kilowatt-hour (kWh) for power derived from coal, natural gas, nuclear and hydroelectric. The proposed $10 per ton carbon tax would increase the price of coal-fired electricity by $.01 per kWh or 9%. In an effort to help the environment, the new administration is pushing renewable energy sources hard, regardless of the economic impact. Below I have shown some alternative energy sources, their costs, and some of the benefits/drawbacks of each. The pricing estimates are from Scientific American, and are estimates at full deployment (current pricing is much higher).

Solar-Thermal-At a cost of $.20-$.28 per kWh, this technology is expected to cost three times current sources. The advantage is that it may be one of the only renewable sources which allows for the storage of energy to meet peak demand. The drawbacks are the need to locate in deserts, far from existing transmission lines and available water for cooling.

Ocean Wave Power-The price is unknown at this point as the technology is still in its design phase. The advantage is that most of the population is located near the coasts. A major drawback will be designing a building that can withstand 50-75 years of heavy waves.

Geothermal-At a cost of $.062-$.076 per kWh, geothermal is actually cheaper than the existing technology. The advantage is that the supply is very reliable, and can generate to meet daily demand patterns. The downside is the pollution given off by the steam from underground water can be highly toxic and corrosive.

Solar-Photovoltaic-Right now this technology is one of the furthest along in commercial deployment; however, it is heavily subsidized by governments due to its high cost, $.47-$.71 per kWh. The major advantage is the ability to overlay the technology in heavily populated areas to save the cost of new distribution lines. The drawback-cost!

Wind-The US is undergoing a major wind generation deployment program over the next 12 years. The advantages include no cooling water requirements and its low cost of $.06-$.085 per kWh. The disadvantages are location (typically far from population centers) and most generation occurs at night, which doesn’t match the demand requirement patterns. There are also issues with birds and bats flying through the turbines.”

So far BP has lost roughly $95 billion in market cap. The company is self-insured, which means the potential liability from the spill could be limitless unless they qualify for some legal caps. There has been discussion of a possible bankruptcy filing to isolate the company from its spill liabilities, which adds a key question to the discussion on whether the equity is a good investment or not.

The Congressional Oversight Panel has concluded that the Federal Reserve could have acted earlier to find a privately funded solution for New York-based AIG before the September 2008 rescue. The $182.3 billion bailout transformed banks’ financial bets into fully guaranteed obligations, the panel said.

“The government’s actions in rescuing AIG continue to have a poisonous effect on the marketplace,” said the panel, led by Harvard University law professor Elizabeth Warren. “The AIG rescue demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the collapse of America‘s largest financial institutions and to assure repayment to the creditors doing business with them.’’

European Banks
Jean-Claude Trichet, president of the European Central Bank, said stress tests on major financial institutions across the eurozone are nearly complete and the results should be made public to calm financial markets. The U.S. has been urging Europe to follow its lead with banks' stress tests as a way of restoring investor confidence and encouraging banks to raise capital, if necessary. The Committee of European Banking Supervisors is conducting the tests.

What do you do with $2 trillion in Foreign Reserves?

China is taking a big stake in Greece’s recovery, making investments that eventually could be worth billions of Euros. The modernization and expansion of the Piraeus seaport to become a gateway to Europe and North America for China's exports is one of the first big projects. Shipping giant Cosco took over a major Piraeus container-cargo facility this week and plans to spend $700 million on improvements.

When the first charges against Goldman and their marketing of mortgage backed securities arose we suggested that this would only become a nightmare scenario for the firm if additional securities were identified. The Wall Street Journal reported this week that a second tranche of securities is now being reviewed for similar improprieties.

A second (or more) security could indicate an institutional problem versus just a one off event, which could carry much more severe financial and criminal ramifications.

Fuel for the “Anti-Wall Street” Crowd
According to data from Thomson Reuters, Wall Street investment banks have received more than $670 million in commission and charges from sales of Build America Bonds. The fees are an average of 20% higher than those charged for conventional tax-exempt debt.

Brazil, Ole!

Brazil reported first quarter GDP growth of 9%, the fastest in a decade. The Real gained 1% vs. the dollar, and the Bovespa, the country’s equity index, rose 1.1% YTD.

One Boot on the Brake, One on the Accelerator

China's central bank pumped $24.3 billion into its financial system this past week through the use of repurchase agreements and bill issuance. It marked the third consecutive week of net injections by the central bank.

Meanwhile, China's CPI rose 3.1% last month compared with the same month a year earlier. Over the same period, retail spending on consumer goods soared 18.7%.

The U.S. House recently approved a tax increase on certain compensation paid to investment managers, known as carried interest, but the Senate has watered down the proposal slightly. Carried-interest income is taxed at the capital-gains rate of 15% versus 35% for incomes in the highest federal bracket. The Senate proposal would raise the tax to as much as 33% by 2013. The House's proposal would raise the rate to 35%.

Chinese Trading Becoming More Liberal

The China Securities Regulatory Commission, encouraged by initial results of a trial program, approved a limited expansion of margin trading and short selling. The regulator added five securities firms to the program, which already had six, and relaxed capital requirements to encourage smaller brokerages to participate.

Money Supply
We have discussed the slowdown in growth of M3 over the past two years in spite of the Fed’s massive attempts at increasing the monetary base. As we discussed last month, the main culprit is the lack of velocity caused by banks holding back on lending as they attempt to shore up their balance sheets. The chart below, courtesy of shadowstats.com, shows the discontinued measure of M3 in blue (actual measure in red, SGS’s continuation in blue).

Readership has been soaring lately, thank you all for the referrals and as always thank you for supporting our sponsors. If you are reading this via one of the 15+ websites that carries these notes, thank you as well.

Have a great week.


“The collapse of the financial system as we know it is real, and the crisis is far from over,” Soros said today at a conference in Vienna. “Indeed, we have just entered Act II of the drama.”