- Shantytown, Stockton, California, USA
I made a visit to Stockton, California the other day and came across a jarring sight: an actual shantytown, here in America.
(Click on images for a larger view. Note: all images are Creative Commons (CC BY-NC-SA 4.0) Attribution-NonCommercial-ShareAlike 4.0 International by chumbawamba@zerohedge)
This is at the corner of S Grant Street and E Worth Street. To give some geolocational context, this is the start of the neighborhood literally next door to the shantytown:
Here’s more of the shantytown, which is sprawled out over several acres, with lots of empty space in between each hovel (for now at least…plenty of room for development!) The first photo is around the corner from the part shown above as viewed from S Stanislaus Street. The second is a few hundred feet away as seen from E Hazelton Avenue:
You’ll recall that the City of Stockton declared bankruptcy in 2013. I’ve had business in Stockton since about 2009, primarily around the dead center of the downtown, and the place is definitely depressed. A lot of small businesses in and around the downtown are closed. A small general store that I patronized to make photocopies one day wasn’t there when I needed copies made a few months later. It’s hard to even find a convenience or liquor store to get something as simple as a soda. The only place I see doing a bustling business is the county courthouse, and the surrounding legal firms and notaries. I think Stockton will eventually recover, as there are a lot of good real estate deals to be had, and they’ve made some infrastructure investments and improvements (primarily in prettying up the downtown harbor area with a nice cinema and shops) but any real recovery is probably not going to come until private money starts to flow in to re-develop this old, large and very interesting city. But what do I know. It might just get worse and stay a shithole for decades, like Detroit.
After I got back home I did a search and found this report on a local Fox News affiliate (includes video of the shantytown) from July 10 of this year. It includes this quote:
“People don’t get moved out they’ll sort of set up shop for awhile,” Jon Mendelson, the Associate Director with Central Valley Housing told FOX40. The Central Valley Housing Organization said a lack of shelters and support programs may be contributing to these semi-permanent communities.
“Well the tents and shantytowns are certainly not a permanent solution,” Mendelson claimed.
The organization said a more viable option would be to provide housing and rehabilitation programs.
“It includes just basic life skills and support that a lot of folks on the streets don’t have right now,” Mendelson told us.
They want to teach these people “basic life skills”? I’d say the ability to assemble your own shelter (if crude) is a basic life skill. These people don’t need social services, they need a fucking revolution in government, as do we all. The Banksters that have commandeered our government created this fucking disgrace.
I’ve traveled a fair bit to various parts of the world and have seen shantytowns in the Middle East and central and South America, so it’s not like I haven’t witnessed something like this before. But when I accidentally came across this shantytown right here in America–the ostensibly “greatest nation on earth”–it was a disconcerting sight. I know we had tent cities form at the peak of the last crisis a few years ago, but this is a straight up shantytown: destitute people making shelters with whatever garbage they can find. As an aside, it should come as no surprise that the streets around this area are filled with hookers, drug dealers, and all manner of shady characters.
A big part of this, I’m sure, is the lack of affordable housing anywhere. These people are just at the last rung of the housing ladder. Housing prices in California (for both sales and rentals) are at all time highs. It’s ridiculous. I see shacks in the part of the SF Bay Area where I live renting for $500+/mo.
A big component of this price inflation in housing we have now is the result of unchecked American consumption throughout the 2000s. Sow and reap. Follow me now: the Fed made credit cheap, everyone partook of the credit binge buffet and bought enormous loads of shit like new cars, boats, vacation homes, etc. All this shit (or major components of) was manufactured in China. Americans sent gobs of money to China which, in return, sent back gobs of cheap products and raw materials. So Americans became shit rich but money poor, and the Chinese (the connected ones at least) became nigger rich. Now, these newly rich Chinese with more dollars than they know what to do with, trying to keep them from the clutches of the Chinese government (understandably so), are coming to America with their piles of dollars, and what are they doing with them? Investing in American real estate. Paying cash for million dollar houses, bidding them up 50-100% over asking price. So as a result we have $2 million shacks for sale in Palo Alto, and shantytowns in Stockton.
I saw this coming years ago. Jim Willie talked about a “Chinese colonization” in his newsletters, and that’s exactly what is happening. I don’t believe it’s a concerted strategical move by China (though it could be) but rather the result of an organic move of capital naturally fleeing a despotically greedy regime. Whatever the case, the fact remains the Chinese are taking over California real estate (and I believe single-handedly propping up Tesla), and pricing natives (like me) out of the market, and at the lower end of the spectrum the result of this inflation is shantytowns. Oh well, this is still (if vaguely) a capitalist system. I don’t complain, I just wait for the next down cycle (I believe we’re peaking now), and will take advantage of Chinese dumping their formerly very desirable California properties for whatever they can get, just like the Japanese had to do in the early 90s after they bought up the USA with all their imported dollars (acquired selling cheap shit to the USA from the 70s through the 80s) and forgot or were just too ignorant to understand that things work in cycles: what goes up shall eventually come down. History doesn’t always repeat, but it rhymes, so I’ll be a patient boy and wait in the shadows for the next trough.
In the meantime, I expect to see this shantytown expand. Perhaps some cash rich Chinese will come in and buy up the best plots.
I am Chumbawamba.
- The Constitution's Big Lie
Submitted by Antonius Aquinas via AntoniasAquinas.com,
One of the greatest hoaxes ever perpetrated upon Americans at the time of its telling and which is still trumpeted to this very day is the notion that the U.S. Constitution contains within its framework mechanisms which limit its power. The “separation of powers,” where power is distributed among the three branches – legislative, executive, judicial – is supposedly the primary check on the federal government’s aggrandizement.
This sacred held tenet of American political history has once again been disproved.
Last Friday (October 23), the Attorney General’s office announced that it was “closing our investigation and will not seek any criminal charges” against former Internal Revenue Service’s director of Exempt Organizations, Lois Lerner, or, for that matter, anyone else from the agency over whether they improperly targeted Tea Party members, populists, or any other groups, which voiced anti-government sentiments or views.
The Department of Justice statement read:
The probe found ‘substantial evidence of mismanagement, poor judgment and institutional inertia leading to the belief by many tax-exempt applicants that the IRS targeted them based on their political viewpoints. But poor management is not a crime.’ (My emphasis)
Incredibly, it added:
That the DOJ will take no action against one of its rogue departments demonstrates the utter lawlessness and totalitarian nature of the federal government. The DOJ’s refusal to punish documented wrongdoing by the nation’s tax collection agency shows the blatant hypocrisy of Obummer, who promised that his presidency would be one of “transparency.”
It can be safely assumed that Congress will not follow up on the matter, as Darrell Issa (R-Ca.), who chaired a committee to investigate the bureau’s wrong doings, admitted that its crimes may never be known. The DOJ and Issa’s responses are quite predictable once the nature of the federal government and, for that matter, all governments are understood.
Basic political theory has shown that any state is extremely reluctant to police itself or reform unless threatened with destruction, take over, or dismemberment (secession). The Constitution has given to the federal government monopoly power where its taxing and judicial authority are supreme. It will not relinquish such a hold nor will it seek to minimize such power until it is faced with one of these threats.
While it was called a federated system at the time of its enactment and ever since by its apologists, the reality of the matter is quite different. As the Constitution explicitly states in Art. VI, Sect. 2, the central government is “the supreme law of the land.” The individual states are inferior and mere appendages to the national government – ultimate control rests in Washington.
In fact, it was the Constitution’s opponents, the much derided Antifederalists, who were the true champions of a decentralized system of government while their more celebrated opponents such as Madison, Hamilton and Jay wanted an omnipotent national state.
Thus, in the American context, the only method for those oppressed by the federal government is to either threaten or actually go through with secession. Attempts to alter its dictatorial rule through the ballot box or public protests are futile. While there will naturally be outrage at letting the IRS off the hook, focus and anger must be redirected away from participation within the current political system to that of fundamental change.
Congress’ refusal to prosecute an executive bureau that has deliberately used (and is still using) state power to oppress and harass opponents of the Obama regime demonstrates the bankruptcy of the idea that separation of power limits tyranny. Federal power and the corresponding tyranny and corruption which it has bred has never been countered by the checks and balances and separation of powers of the supposed “federal republic” created a little over two centuries ago.
Until the “big lie” of the Constitution is realized, agencies like the IRS will continue to target and tyrannize anti-government organizations, groups, and individuals. The Constitution provides no real mechanism for the redress of grievances from the subjects which it rules. Only when the breakup of the federal Union has taken place, will American liberties and freedoms be secured.
- Dear Janet, Seriously!!
The Fed's confidence trick this week was, once again, the Keyser Soze gambit (via Beaudelaire)- "convincing the world of Yellen's hawkishness, when no such character trait exists." However, unlike the movies, stocks and FX markets have already seen through the con, leaving Fed Funds futures alone to believe the hype. As we noted previously, "The Fed Can't Raise Rates, But Must Pretend It Will," repeating its pre-meeting hawkishness to dovishness swing time and again in a "Groundhog Day" meets "Waiting For Godot"-like manner. Time is running out Janet, tick tock…
This is what we are to believe a "data-dependent" Federal Reserve is thinking…
And for now, Fed Funds Futures are falling for it…
But the broad equity markets aren't…
Nor are Financials…
And nor is The Dollar…
Because, as we noted previously, the market (and The Fed) know perfectly well that raising short-term rates would be like taking away the punch bowl just as the party gets going. As rates rise, the economy’s production and employment structure couldn’t be upheld. Neither could inflated bond, equity, and housing prices. If the economy slows down, let alone falls back into recession, the Fed’s fiat money pipe dream would run into serious trouble.
This is the reason why the Fed would like to keep rates at the current suppressed levels. A delicate obstacle to such a policy remains, though: If savers and investors expect that interest rates will remain at rock bottom forever, they would presumably turn their backs on the credit market. The ensuing decline in the supply of credit would spell trouble for the fiat money system.
To prevent this from happening, the Fed must achieve two things.
First, it needs to uphold the expectation in financial markets that current low interest rates will be increased again at some point in the future. If savers and investors buy this story, they will hold onto their bank deposits, money market funds, bonds, and other fixed income products despite minuscule yields.
Second, the Fed must succeed in continuing to postpone rate hikes into the future without breaking peoples’ expectation that rates will rise at some point. It has to send out the message that rates will be increased at, say, the forthcoming FOMC meeting. But, as the meeting approaches, the Fed would have to repeat its trickery, pushing the possible date for a rate hike still further out.
If the Fed gets away with this “Waiting for Godot” strategy, savings will keep flowing into credit markets. Borrowers can refinance their maturing debt with new loans and also increase total borrowing at suppressed interest rates. The economy’s debt load can continue to build up, with the day of reckoning being postponed for yet again.
However, there is the famous saying: “You can fool all the people some of the time and some of the people all the time, but you cannot fool all the people all the time.” What if savers and investors eventually become aware that the Fed will not bring interest rates back to “normal” but keep them at basically zero, or even push them into negative territory?
If a rush for the credit market exit would set in, it would be upon the Fed to fill debtors’ funding gap in order to prevent the fiat system from collapsing. The central bank would have to monetize outstanding and newly originated debt on a grand scale, sending downward the purchasing power of the US dollar — and with it many other fiat currencies around the world.
The “Waiting for Godot” strategy does not rule out that the Fed might, at some stage, nudge upward short-term borrowing costs. However, any rate action should be minor and rather short-lived (like they were in Japan), and it wouldn’t bring interest rates back to “normal.” The underlying logic of the fiat money system simply wouldn’t admit it.
- Offshoring The Economy: Why The US Is On The Road To The Third World
Submitted by Paul Craig Roberts,
On January 6, 2004, Senator Charles Schumer and I challenged the erroneous idea that jobs offshoring was free trade in a New York Times op-ed. Our article so astounded economists that within a few days Schumer and I were summoned to a Brookings Institution conference in Washington, DC, to explain our heresy. In the nationally televised conference, I declared that the consequence of jobs offshoring would be that the US would be a Third World country in 20 years.
That was 11 years ago, and the US is on course to descend to Third World status before the remaining nine years of my prediction have expired.
The evidence is everywhere.
In September the US Bureau of the Census released its report on US household income by quintile. Every quintile, as well as the top 5%, has experienced a decline in real household income since their peaks. The bottom quintile (lower 20 percent) has had a 17.1% decline in real income from the 1999 peak (from $14,092 to $11,676). The 4th quintile has had a 10.8% fall in real income since 2000 (from $34,863 to $31,087). The middle quintile has had a 6.9% decline in real income since 2000 (from $58,058 to $54,041). The 2nd quintile has had a 2.8% fall in real income since 2007 (from $90,331 to $87,834). The top quintile has had a decline in real income since 2006 of 1.7% (from $197,466 to $194,053). The top 5% has experienced a 4.8% reduction in real income since 2006 (from $349,215 to $332,347). Only the top One Percent or less (mainly the 0.1%) has experienced growth in income and wealth.
The Census Bureau uses official measures of inflation to arrive at real income. These measures are understated. If more accurate measures of inflation are used (such as those available from shadowstats.com), the declines in real household income are larger and have been declining for a longer period. Some measures show real median annual household income below levels of the late 1960s and early 1970s.
Note that these declines have occurred during an alleged six-year economic recovery from 2009 to the current time, and during a period when the labor force was shrinking due to a sustained decline in the labor force participation rate. On April 3, 2015 the US Bureau of Labor Statistics announced that 93,175,000 Americans of working age are not in the work force, a historical record. Normally, an economic recovery is marked by a rise in the labor force participation rate. John Williams reports that when discouraged workers are included among the measure of the unemployed, the US unemployment rate is currently 23%, not the 5.2% reported figure.
In a recently released report, the Social Security Administration provides annual income data on an individual basis. Are you ready for this?
In 2014 38% of all American workers made less than $20,000; 51% made less than $30,000; 63% made less than $40,000; and 72% made less than $50,000.
The scarcity of jobs and the low pay are direct consequences of jobs offshoring. Under pressure from “shareholder advocates” (Wall Street) and large retailers, US manufacturing companies moved their manufacturing abroad to countries where the rock bottom price of labor results in a rise in corporate profits, executive “performance bonuses,” and stock prices.
The departure of well-paid US manufacturing jobs was soon followed by the departure of software engineering, IT, and other professional service jobs.
Incompetent economic studies by careless economists, such as Michael Porter at Harvard and Matthew Slaughter at Dartmouth, concluded that the gift of vast numbers of US high productivity, high value-added jobs to foreign countries was a great benefit to the US economy.
In articles and books I challenged this absurd conclusion, and all of the economic evidence proves that I am correct. The promised better jobs that the “New Economy” would create to replace the jobs gifted to foreigners have never appeared. Instead, the economy creates lowly-paid part-time jobs, such as waitresses, bartenders, retail clerks, and ambulatory health care services, while full-time jobs with benefits continue to shrink as a percentage of total jobs.
These part-time jobs do not provide enough income to form a household. Consequently, as a Federal Reserve study reports, “Nationally, nearly half of 25-year-olds lived with their parents in 2012-2013, up from just over 25% in 1999.”
When half of 25-year olds cannot form households, the market for houses and home furnishings collapses.
Finance is the only sector of the US economy that is growing. The financial industry’s share of GDP has risen from less than 4% in 1960 to about 8% today. As Michael Hudson has shown, finance is not a productive activity. It is a looting activity (Killing The Host).
Moreover, extraordinary financial concentration and reckless risk and debt leverage have made the financial sector a grave threat to the economy.
The absence of growth in real consumer income means that there is no growth in aggregate demand to drive the economy. Consumer indebtedness limits the ability of consumers to expand their spending with credit. These spending limits on consumers mean that new investment has limited appeal to businesses. The economy simply cannot go anywhere, except down as businesses continue to lower their costs by substituting part-time jobs for full-time jobs and by substituting foreign for domestic workers. Government at every level is over-indebted, and quantitative easing has over-supplied the US currency.
This is not the end of the story. When manufacturing jobs depart, research, development, design, and innovation follow. An economy that doesn’t make things does not innovate. The entire economy is lost, not merely the supply chains.
The economic and social infrastructure is collapsing, including the family itself, the rule of law, and the accountability of government.
When college graduates can’t find employment because their jobs have been offshored or given to foreigners on work visas, the demand for college education declines. To become indebted only to find employment that cannot service student loans becomes a bad economic decision.
We already have the situation where college and university administrations spend 75% of the university’s budget on themselves, hiring adjuncts to teach the classes for a few thousand dollars. The demand for full time faculty with a career before them has collapsed. When the consequences of putting short-term corporate profits before jobs for Americans fully hit, the demand for university education will collapse and with it American science and technology.
The collapse of the Soviet Union was the worst thing that ever happened to the United States. The two main consequences of the Soviet collapse have been devastating. One consequence was the rise of the neoconservative hubris of US world hegemony, which has resulted in 14 years of wars that have cost $6 trillion. The other consequence was a change of mind in socialist India and communist China, large countries that responded to “the end of history” by opening their vast under-utilized labor forces to Western capital, which resulted in the American economic decline that this article describes, leaving a struggling economy to bear the enormous war debt.
It is a reasonable conclusion that a social-political-economic system so incompetently run already is a Third World country.
- Why Do We Have Wars?
- Paul Brodsky: "Expect The Unexpected. It Might Be Time To Duck And Cover"
From Paul Brodsky of Macro-Allocation Inc.
Shift Happens
The Economist ran a special report October 3 entitled “The sticky superpower”, a long essay that questioned America’s ongoing status as an effective global economic and monetary hegemon. At times the report was unsparing in describing today’s reality: “the global monetary system is unreformed, unstable and possibly unsustainable” and the world has no “credible lender of last resort”.
The piece is noteworthy in that the Economist has a reputation for editorial conservativism; not in the libertarian sense, but in a politically centrist sort of way. It encourages a not-so obtrusive form of Keynesian economics, supporting reasonable fiscal, monetary and trade policies conjured, executed and overseen by enlightened authorities. Unlike the far Right, the magazine seems willing to play along with the notion that free market capitalism actually exists, even though the political environments in which our economies produce and distribute resources do not allow broad failure, economic contraction, or price and wage scales to be set by the marketplace. Its center-Right orientation accepts government participation as necessary when “animal spirits” drive the marketplace and capital markets to extremes. The magazine also implicitly abides un-extinguished credit as an acceptable driver of demand, and, by implication, of economic cycles.
And so one could not read the essay without marveling how far the public conversation has shifted. Suggesting a few short years ago that the global financial architecture might very well fail to overcome compounding leverage, naturally slowing output growth, and conflicting trade incentives was economic blasphemy, radical rantings uttered only on the fringe.
To be sure, the Economist supports the current regime where nation-state policies guide and support the commercial marketplace and capital markets, and in which sound fiscal, trade and monetary policies are supposed to provide solutions: “What the world needs is an engineer to design smart ways to tame capital flows, a policeman to stop beggar-thy-neighbor policies, a nurse to provide a safety net if things go wrong, and a judge to run the global payments system impartially”. It is a Keynesian call to arms – an S.O.S. – and its provenance is startling.
The report needed an antagonist to advance the narrative, and used China. It suggested political competition brewing in which the US and China compete to dominate trade and soft power over other national economies, concluding “China will not be a counterbalance to or substitute for America soon”. The report’s main concern: “so what will fill the vacuum?”
The piece had a curious conclusion; a happy ending possible through the suspension of disbelief. It called for “a fantasy American administration and Congress (that would) act in its own enlightened self-interest…to the benefit of the world.”
The point of the report seemed to be the need for better manipulation of producer, consumer and investor incentives…and soon. Things are beginning to seem ominous to the political center. It might be time to duck and cover.
Intermission
We took the liberty of updating Billy Joel’s “We Didn’t Start the Fire”:
Billy Clinton, Robert Rubin, Alan Greenspan,
Vlady Putin, dubya, nine-eleven, off to Tehran…Hank Paulson, Countrywide, Bear Stearns, no place to hide,
Lehman Brothers, all the others, quite a Black Swan…Save the bank, Dodd Frank, Gentle Ben, tell us when,
QE, Obamacare, Vlady Putin’s back again…Nukes for Iranians, Janet Yellen has no friends,
ZIRP, ISIS, buy the dips, Donald Trump in the chips…We didn’t start the fire
Their model’s forecast
That we’d start to hire…Political Shades of Gray
These days it’s hard to tell the players without a scorecard. Actually, we know the players, but the challenge now is in recognizing which team each player is on. As it stands, Janet Yellen, the Chair of the Fed, is publicly jawboning a rate hike while Christine Lagarde, the Managing Director of the IMF, is warning against one. Meanwhile, Larry Fink, Chairman of the world’s largest asset manager is openly touting interest rate normalization while Larry Summers, the third of three de-activated members of Time magazine’s Committee to Save the World, can’t seem to get enough air time to argue against it. And those are just the progressives.
Geopolitical alliances are also not as straightforward as they once were. We know Russia’s Crimean annexation triggered broad sanctions by a US-led coalition; however, Russia’s help was instrumental in allowing the West to negotiate the Iranian nuclear agreement. Meanwhile, the US in the process of cozying up to Iran and Russia as it shifts its position on Syria, signaling it will let Bashar al-Assad stay in power. (What will this mean for US relations with Israel or the Kurds?) It seems “the enemy of our enemy is our friend” has evolved into “our enemies are our friends, but being our friends may not be such a prize”.
Speaking of Syria, the mass emigration of Syrian refugees into Germany has caused major riffs between Angela Merkel’s and one of her staunchest backers, the state of Bavaria, which is suffering from the massive inflow. If you want a friend in Washington (or Berlin), get a dog.
The relationship between the two largest global economies, the US and China, is also becoming more complicated. The countries directly exchange nearly $600 billion of goods and services annually, and yet China’s construction of potentially militarized islands in the South China Sea endangers America’s absolute hold on global shipping lanes, which has given the US enormous influence not only over materials and energy destined for China, but also over the entire region’s bilateral trade.
Sino-American relations have been further complicated through China’s successful establishment of the Asian Infrastructure Investment Bank (AIIB). The Bank was formed to give sovereign borrowers an alternative to the World Bank and IMF – US dominated lending organizations that dole out American soft power around the world. The only major nation absent from the AIIB’s founding was the US.
And what really happened behind the scenes that prompted the sudden opening of diplomatic relations between the US and Cuba this year? We don’t know, but the point is it occurred.
Clearly, things are changing quickly around the world, as they were destined to at some point. Following the demise of the Soviet empire, the US stood as the world’s only superpower, enjoying almost absolute control over the global monetary system and terms of trade. This unilateralism would eventually have to be challenged and current events seem to suggest that the geopolitical landscape is now experiencing major tremors. They have become so obvious and frequent that the established order (i.e., the Economist) cannot ignore it.
There is little in the political dimension today that investors can hang their hats on. It would be a mistake to assume that stated positions or even ostensibly bedrock principles are static, whether they are related to geopolitics or trade, fiscal, tax and monetary policies. Warm, fuzzy political blankets we can wrap ourselves in to escape the reality that politics = expedience are gone. We should expect the unexpected.
Shift Happens
Eventually, and then all at once, “over time” becomes yesterday. The future becomes the past. Hopes are tested. Expectations are met, or not. Time moves on and only then do we know what we don’t know now.
Most investors don’t take kindly to change. “The market” chooses to stay in the here and now; each human component vibrant and alert while the whole is passive and inert…like a herd of wildebeests, protected by its mass and collective wisdom that each one of them is statistically safe from lions as long as they stay together.
In the current investment environment, marked by near zero sovereign interest rates, tight credit spreads, full equity valuations, over-leveraged balance sheets, expedient politicians performing daily volume triage, and policy makers stringing new high wires and walking them without a nets; risk-adjusted opportunity lies in change.
The Economist’s special report should be taken seriously, if not for its conclusion than for its mere existence. They don’t normally do hyperbole, but they surely did this month.
Our challenge is to imagine where the wildebeests will be, and our sense is that the herd will migrate over time towards liquidity. With the return on money near zero, we don’t feel intense pressure to pick when it will go there, at least for our MACAW portfolio.
- Tsipras Blames Western Military Meddling For Syria Crisis: "You Reap What You Sow"
As anyone who followed Greece’s protracted bailout negotiations with creditors is no doubt aware, Athens had very little in the way of leverage when it came to countering German FinMin Wolfgang Schaeuble at the bargaining table. Try as they might, Alexis Tsipras and Yanis Varoufakis were ultimately unable to use the threat of Grexit to extract concessions from Brussels and the IMF.
In hindsight, what’s interesting about the incessant back and forth between Athens, Brussels, and Berlin is that both sides were attempting to use a euro exit to bolster their positions. That is, Germany was attempting to scare Greece with the prospect of a depression in the event the country reverted to the drachma and Greece was attempting to scare Germany by throwing the entire idea of the euro’s indissolubility into question. In the end, Berlin prevailed as the purse string proved mightier than Syriza ideology.
But while tacitly threatening to disprove the notion of the euro’s indissolubility proved insufficient as a bargaining chip, one thing that Alexis Tsipras and, before he was banished from the party, Panagiotis Lafazanis, were able to employ somewhat effectively was the idea of a Russian pivot. On a number of occasions, it appeared as though Moscow was ready to come to the aid of the Greeks in defiance of the EU and predictably, the proposed partnership centered around an energy deal. In effect, there were rumors that Gazprom would advance Athens some $5 billion against future revenues from the Greek section of the Turkish Stream pipeline and although that deal never panned out, it was enough to worry Angela Merkel, as the last thing the EU wanted in the midst of the Ukraine crisis was to see Russia effectively annex Greece.
Fast forward four months and Greece is on the front lines of Europe’s migrant crisis and while Alexis Tsipras may not be the man he once was thanks to the troika’s deplorable campaign to strip Syriza of everything it stood for in January just to send a message to Spain and Portugal, sometimes the old Tsipras shows up out of the blue to remind the world that the fire hasn’t been completely extinguished. Case in point: on Friday, Tsipras lashed out at Brussels for the bloc’s handling of the migrant crisis but more notably, he also suggested that the West’s military meddling is the root cause of Syria’s prolonged civil war. Here’s AP:
Greece’s prime minister lashed out Friday at European “ineptness” in handling the continent’s massive immigration crisis after 31 more people — mostly children — drowned in shipwrecks in the Mediterranean Sea.
“I want to express … my endless grief at the dozens of deaths and the human tragedy playing out in our seas,” he told parliament. “The waves of the Aegean are not just washing up dead refugees, dead children, but (also) the very civilization of Europe.”
“What about the tens of thousands of living children, who are cramming the roads of migration?” he said.
Tsipras blamed the migrant flows on western military interventions in the Middle East, which he said furthered geopolitical interests rather than democracy.
“And now, those who sowed winds are reaping whirlwinds, but these mainly afflict reception countries,” he added.
“I feel ashamed of Europe’s inability to effectively address this human drama, and of the level of debate … where everyone tries to shift responsibility to someone else,” Tsipras said.
So apparently, there’s at least one European leader who “gets it” when it comes to explaining why hundreds of thousands of people who were living with a repressive regime for decades suddenly decided it was time to flee to Europe.
That is, it’s not like Syrians didn’t know their government had autocratic tendencies – a couple of hundred thousand people didn’t just wake up one day and say “hey, this guy might be a dictator, let’s leave and settle in Germany.” Rather, the West and its regional allies armed multiple Sunni extremist groups on the way to starting a civil war and now, Europe is discovering what happens when you foment sectarian violence in the Mid-East.
Of course it won’t matter. No one listens to Tsipras anymore thanks to the troika’s efforts to subvert democracy in Greece and discredit someone who might otherwise have become an important figure in the world of geopolitics. And so, the charade will continue: first blame the “brutal dictatorship,” then claim the Russians are making it worse.
- How We Got Here: The Fed Warned Itself In 1979, Then Spent Four Decades Intentionally Avoiding The Topic
Submitted by Jeffrey Snider via Alhambra Investment Partners,
It bears repeating and re-emphasizing, but had the guts of the actual global financial system been fully appreciated in a timely manner the current state of the global “dollar” would be cause for celebration. It would matter not that the eurodollar is in full and often violent retreat because that is the exact method by which a real recovery would be born; if only there were a reasonable market for money (actual, not ephemeral and pliable) and money dealing in place to absorb the transition. The happenstance of the current state of the “dollar” owes itself to the rededicated financialism of every central bank as if 2008 never happened. Rather than look for an actual solution, views of cyclicality ruled where the panic was judged nothing more than a temporary disruption.
It is that general outline that accounts for the recovery, lack of. Market forces practically begged for a total re-alignment, especially since the status quo only survived through the greater oligarchy in money of TBTF. The larger banks have only gotten larger and now they have very little competition since there are practically no new banks anymore. Wholesale continues to dominate, amazingly even more so now than pre-crisis which more than suggests the rotten nature of the very antics proclaimed as monetary heroism.
Except that the wholesale banks themselves no longer want the job of supporting that system. Before 2008, prop trading and spreads were not just favorable but undoubtedly so as any number of unrelated firms suddenly became FICC centric. GE Capital became a leading provider of mortgage warehousing as well as “investing” while formerly uninteresting insurance companies like AIG transformed into both securities dealers and prime purveyors of dark leverage, especially CDS. It was all, of course, artificially inflated by the nature of that time, the Great “Moderation” because the whole system long ago departed basic and operational sense.
Behind it all was the eurodollar. As I wrote at the outset above, some timely appreciation for it might have saved a whole lot of acute trouble and maybe would have pushed for some real reform (and then a real recovery to follow). What is really frustrating, maybe criminally so, however, is that monetary officials were debating eurodollars not in 2006 but rather 1979. At that early stage, the Fed along with other central banks couldn’t quite make out what it was, how it got there or where it was all going. They were even debating at that time whether a eurodollar was actually “money” at all:
It has long been recognized that a shift of deposits from a domestic banking system to the corresponding Euromarket (say from the United States to the Euro-dollar market) usually results in a net increase in bank liabilities worldwide. This occurs because reserves held against domestic bank liabilities are not diminished by such a transaction, and there are no reserve requirements on Eurodeposits. Hence, existing reserves support the same amount of domestic liabilities as before the transaction. However, new Euromarket liabilities have been created, and world credit availability has been expanded.
To some critics this observation is true but irrelevant, so long as the monetary authorities seek to reach their ultimate economic objectives by influencing the money supply that best represents money used in transactions (usually M1). On this reasoning, Euromarket expansion does not create money, because all Eurocurrency liabilities are time deposits although frequently of very short maturity. Thus, they must be treated exclusively as investments. They can serve the store of value function of money but cannot act as a medium of exchange.
In other words, at least parts of the Fed all the way back in 1979 appreciated how Greenspan and Bernanke’s “global savings glut” was a joke. Rather than follow that inquiry to a useful line of policy, monetary officials instead just let it all go into the ether of, from their view, trivial history. But the true disaster lies not just in that intentional ignorance but rather how orthodox economists and policymakers were acutely aware there was “something” amiss about money especially by the 1990’s. Because these dots to connect were so close together the only reasonable conclusion for this discrepancy is ideology alone. Economists were so bent upon creating monetary “rules” by which to control the economy that they refused recognition of something so immense because it would disqualify their very effort.
And so, the Fed and central banks bent over backwards to avoid the eurodollar, even taking to ridiculous efforts to do so. Not only was Greenspan waddling on in the “global savings glut”, the Fed itself discontinued M3 in 2005 just to avoid the topic altogether. That part has to be considered purposeful negligence, because by that point the eurodollar figures were not unimportant but simply too immense to calculate.
When M3 was discontinued, the Fed wrote that it, “does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years.” Given the time period, that was a material discrepancy upon reality. It was, after all, Greenspan himself in 1996 (the “irrational exuberance” speech) who first reported that traditional monetary figures like M2 were no longer correlating much to economic expectations. So cutting out M3 by 2005 is nothing but a tangled mess of contradictions that, again, point to nothing but religious-like expedience over proper science.
It would, as we know now, come back to haunt the world only a few years later:
But the second part of that official justification should have been something of a warning about all things in the monetary realm. The “costs of collecting” excuse was greeted by Fed critics with more than a hint of derision since it smacked of too much disingenuousness. It seemed like a lame attempt to hide banking gone into overdrive.
The Fed, however, was actually honest here, and that should have been, and should be still, meaningful in the context of monetary engineering and the economy’s paradigm shift in 2008/09. Those two elements of M3, repos and eurodollars, were the epicenter of crisis. The fact that it would have cost the Fed too much to attempt to measure these “money” aggregates shows just how far the banking system strayed from the light of the regulated regime. Yet, as the Fed demonstrated in the first sentence of its official rationale, our central bank had little interest in that monetary/banking arena.
Nothing has changed in that regard, as global central banks still have little interest in wholesale banking. The reason is just as simple and the same; they haven’t figured out how to incorporate the factor into their “rules.” As it was, nobody had any idea just how far the eurodollar system had expanded and penetrated because they weren’t even looking at it – and we still don’t know (witness now China and the potential for an “Asian dollar”). The BIS in October 2009 came up with a conservative estimate just in the “global dollar short” of at least $2.5 trillion for European banks alone. But that was just the money dealing, as that liquidity support was angling about:
The outstanding stock of banks’ foreign claims grew from $10 trillion at the beginning of 2000 to $34 trillion by end-2007, a significant expansion even when scaled by global economic activity (Figure 1, left panel). The year-on-year growth in foreign claims approached 30% by mid-2007, up from around 10% in 2001. This acceleration took place during a period of financial innovation, which included the emergence of structured finance, the spread of “universal banking”, which combines commercial and investment banking and proprietary trading activities, and significant growth in the hedge fund industry to which banks offer prime brokerage and other services.
So while the US central bank was showing and delivering even less appreciation for wholesale banking, the scale was an enormous up-to-30% per year expansion by 2007. I have never worked for a central bank but even an outsider would be easily impressed that a $24 trillion increase in offshore banks’ “foreign claims” should have been not just a part of the monetary setting but perhaps the lone and central focus. That is especially true as the great and massive increase during the ultimate mania (in finance) occurred exactly as the Fed was raising its federal funds target; as with dark leverage, we see now what should have been easily seen then, that the Fed’s traditional mode of operation was wholly and totally obsolete. Monetary policy had not just been reduced, it had been disemboweled and obliterated by an “outside” force. The lack of curiosity, let alone appreciation, is staggering and telling.
Again, going back to 1979, the FRBNY discussion predicted the exact manner of liquidity crash that followed just more than a quarter-century later:
One of the traditional responsibilities of any central bank is to act as lender of last resort – to supply funds to a solvent bank or to the banking system generally in an emergency that threatens a sharp contraction of liquidity. This role normally has been framed with respect to commercial banks in the domestic banking system. But the emergence of the extraterritorial Euromarket created ambiguities about which central bank would be responsible for providing lender-of-last-resort support for overseas operations.
No final resolution of those ambiguities has yet been reached, and it is doubtful that central bankers will ever codify their respective roles or lay down conditions for lender-of-last-resort assistance.
Here was the Fed debating in 1979 the very geographic divide in the “dollar” that would condition the full weight of panic by September 2008. Worse, it continues now especially after the events of 2011 and with the amplification of wholesale eurodollar retreat post-June 2014. There is a great deal that disqualifies orthodox economics from the levers of economic power, but this is not close to the top but the very top of that list. When that prescient conjecture was written nearly forty years ago, the eurodollar intrusion had already grown to an estimated 10% of M3 (and that was just, again, what was reported on-the-books).
Yet, from 10% to wiping out M3 altogether over three decades, the Fed studiously ignored it all. They took greater care in not looking anywhere close in the direction of the eurodollar than they did about their own ridiculous attempts at soft central planning. It could not be, now, anymore asinine than what we have: the Federal Reserve religiously neglecting to incorporate the very case the institution warned itself about four decades ago even though that warning has now been applied in two separate and dangerous episodes (one still to reach its ultimate settled state). There is no analogy or metaphor suitable for this level of carelessness and deliberate stupidity. You might make the argument that it wasn’t clear in 1979 the trajectory of the wholesale direction, but by at least the mid-1990’s there was no longer any doubt. Again, it could only be ideologically-driven blindness that would prevent acknowledgment and appreciation of such obvious shifts and alterations – especially of that magnitude.
The relevance to today’s discontinuity is as I wrote at the beginning; if the eurodollar decay was occurring in a regime of planned obsolescence and retreat, with a waiting solution ready to take up the slack of the global work eurodollars still, badly, engage, then the cause of financialism would be welcomed toward extinction. Rather than that useful paradigm alteration, however, central banks simply persist as if there has been no wholesale violence at all at any time; leaving the global “dollar” system to again bear the brunt of the obvious and again gaining savagery. After all that has transpired and the great cost in terms of time and bubbles (globally) we remain on Step 1 in the program out of a “lost decade.” We are still fighting to recognize that we have a problem and to plead the obvious about what that exactly is.
That is why the only answer, in my opinion, will be political. If after all that has taken place in the past forty years (really fifty or sixty) and orthodox economics still denies direct and easy observation then it is equally obvious that it never will (and why that is). “Markets” may still aspire in pieces to central banks as the ultimate guarantor, but that is just the business end of intentional financial illiteracy.
- Macro Dump, Earnings Slump & Hawkish-Fed Pump Spark 4th Best October For Stocks Since 1929
Why we rallied… (BTFD short squeeze)
Because… (the central banks conditioned traders)
How it will end… (The markets are at 2:00 in this clip)
* * *
Before we start… This!
And this…
October – Just For Fun
Everything is awesome around the world (except Ukraine and Venezuela)…
- This is the 4th biggest October S&P rally since 1929!!
- Best overall month for the S&P since October 2011
- Nasdaq's best month since September 2010
In The US, Nasdaq the big winner and Trannies underperformed (weak close today)…
With Materials, Energy, and Tech the huge winners…
Leaving stocks the most overbought since Nov 2014…
And then there's Valeant…
The Dow still did not quite make it back to green for 2015… even as The S&P surge back into the green (and Nasdaq nears cycle highs once again)
While October was a big month for stocks, it was less exciting across the other asset classes…
Treasury yields tumbled initially on poor payrolls.. then yields went nowhere for 3 weeks til The FOMC…
The US Dollar managed some modest gains (once again driven by China rate cuts, ECB and FOMC moves)
Silver surged over 7% on the month as copper slid over 1% amid China growth concerns. Crude and Gold (after the former's meltup) were equally higher on the month…
* * *
So back to this week…
The Dow actually closed lower of 4 of the 5 days this week, but the melt-up after The FOMC turned hawkish-er saved stocks for the week..
And stocks have given all of the fomc gains back…
Although today was weak..with an ugly close…
Most mind-blowingly, "Most Shorted" was notably weak post-FOMC and stunningly roundtripped to perfectly unchanged on the month – after the massive squeeze post-payrolls…
Since The FOMC Statement…Gold is the loser, stocks gave back gains, with only crude higher…
Something remains majorly broken in The VIX Complex…
Treasury yields pushed on higher this week with the long-end outperforming overall (after yesterday's ugliness which was rumored to be dominated by rate-locks on heavy issuance)…
The USDollar drifted lower again today, giving up all of its Hawkish FOMC gains…
And it seems US equities are catching on to what FX markets think…
Commodities generally drifted lower on the week, apart from crude…
Crude ripped higher on the latter half of the week – running stops above last week's highs before fading…
Charts: Bloomberg
- Obamacare Is A Disaster: Co-Op Insurers Across America Are Collapsing, And Now There Is Fraud
Two weeks ago we reported that in what at the time was still a rather isolated incident, Colorado’s largest nonprofit health insurer (aka co-op), Colorado HealthOP is abruptly shutting down, forcing 80,000 Coloradans to find a new insurer for 2016.
At the time, we said that the health insurer had been decertified by the Division of Insurance as an eligible insurance company because the cooperative relied on federal support, and federal authorities announced last month they wouldn’t be able to pay most of what they owed in a program designed to help health insurance co-ops get established.
In other words, one of the 24 co-ops funded with Federal dollars and created to give more policyholders control over their insurers – especially those who wished to stay away from various corporate offerings, had failed simply because the government was unable to subsidize it: the same government that spends $35 billion in global economic “aid” but can’t support its most important welfare program.
Fast forward to today, when we learn that another co-op, this time New York’s Health Republic Insurance – the largest of the nonprofit cooperatives created under the Affordable Care Act – is not only shuttering, but was engaging in fraud.
The fate of Health Republic Insurance was first revealed a month ago when the WSJ reported it would shut down after suffering massive losses “in the latest sign of the financial pressures facing many insurers that participated in the law’s new marketplaces.”
The insurer lost about $52.7 million in the first six months of this year, on top of a $77.5 million loss in 2014, according to regulatory filings. The move to wind down its operations was made jointly by officials from the federal Centers for Medicare & Medicaid Services; New York’s state insurance exchange, known as New York State of Health; and the New York State Department of Financial Services.
In a statement, Health Republic said it was “deeply disappointed” by the outcome, and pointed to “challenges placed on us by the structure of the CO-OP program.”
Health Republic has about 215,000 members, with about half holding individual plans and half under small-business coverage, a spokesman for the insurer said.
Today we learn that not only was this largest Co-op insolvent, it had also committed fraud. According to Politico, the collapsing insurance company that is creating headaches for hundreds of thousands of New Yorkers, misled state and federal officials about its finances, and will not be able to remain in business through the end of the year as originally hoped.
Because incompetence is one thing, but corruption: now that’s real government work, right there.
The accelerated wind down is clearly a problem: the more than 200,000 customers insured with the co-op will lose their coverage Dec. 1, and must find a new plan by mid-November, according to the state and federal government. Health Republic insures about 20 percent of the state’s individual market.
As Politico adds, the plan had been for Health Republic to make it through the end of the year. As recently as last week, company officials said there was enough in cash in reserve. But that apparently wasn’t true.
Health Republic’s finances are “substantially worse than the company previously reported in its filings,” according to the state Department of Financial Services, which oversees insurance in New York, and the Centers for Medicare and Medicaid Services.
One wonders just how much of the over $100 million “lost” in under two years was due to incompetence, and how much due to pure embezzlement by the co-ops operators. Somehow we doubt we will find the anwer where this taxpayer money has gone.
This does, however, lead to a more serious question: the implosion of Health Republic is merely the latest in what has become an epidemic of governmental failure. In fact, there are a total of ten co-ops, all of which were created by the Affordable Care Act and seeded with billions in federal funding, that have now failed, leading to questions whether the entire business model underpinning Obamacare is unsustainanble for everyone but a select few corporations.
For some more thoughts on this disturbing, if perfectly predictable epidemic, we go to Forbes’ Edmund Haislmaier who answers “Why Obamacare Co-Ops are failing at a rate of nearly 50%”
Cooperative health insurers (or co-ops) created under a federal grant and loan program in the Affordable Care Act seem to be falling like dominoes.
It started in February, when CoOportunity Health, which operated in Iowa and Nebraska, was ordered into liquidation. In July, Louisiana’s insurance department announced it was shuttering that state’s co-op. The following month brought news that Nevada’s co-op would also close. On September 25, New York ordered the shutdown of Health Republic Insurance of New York, which had the largest enrollment of all of the co-ops. Then, within the space of a week in mid-October, the number of failures doubled from four to eight, as state insurance regulators announced that they were closing the co-ops in Kentucky, Tennessee, Colorado, and one of the two in Oregon. Last week came news that South Carolina’s co-op will be closed, followed this week by the announcement that Utah’s co-op is also being shut down.
In sum, of the 24 Obamacare co-ops funded with federal tax dollars, one (Vermont’s) never got approval to sell coverage, a second (CoOportunity) has already been wound down, and nine more will terminate at the end of this year.
So what is behind this, so far, 46 percent failure rate?
To start with, the program was a congressional exercise in not merely reinventing the wheel, but doing a bad job of it.
Far from being a new idea, member-owned insurance companies—called “mutual” insurers—have a long history. For instance, life insurer Northwestern Mutual has been in business for over 150 years. Health insurers organized as mutual companies include, among others, Blue Cross plans in 10 states. Indeed, one of them, Florida Blue, converted into a policyholder-owned mutual company just last year. If having more health insurers owned by their policyholders was the goal, then there was no need for federal government action.
On the other hand, if the goal was to increase competition by stimulating the creation of new health insurers, then the ACA’s co-op program was, like other parts of the legislation, badly designed.
* * *
The program offered federal loans and grants to startup insurers but required that they be non-profits, not have anyone affiliated with an existing health insurer on their boards, and not spend any of their federal funding on marketing.
Co-ops are also subject to another provision of the ACA requiring all health insurers to pay out in claims at least 80 percent of premium revenues, or refund the difference to policyholders. By law, insurers can retain no more than 20 percent , out of which they must fund sales and administrative costs before booking any remainder as free cash. That significantly constrains a non-profit carrier’s ability to accumulate capital needed for growth, as it can’t raise funds through equity or debt offerings.
As if that wasn’t daunting enough, the law also required co-ops to focus “substantially all” of their activities on offering health insurance in the individual and small group markets—just as other provisions of Obamacare were thoroughly disrupting those markets by imposing new rules on insurers and complicated new payment arrangements for many of their customers.
Given all of the foregoing, 10 co-ops failing within two years is less surprising than the fact that 23 of them actually got to market in the first place.
As we pointed out two weeks ago, following this avalanche of failures, it will merely force even more individuals into plans offered by corporations, who as a result of the failure of their co-op competitors will have even more pricing power and premium hiking leverage.
Which means that “sticker shockers” such as the one below kindly informing them their health insurance premiums are rising by 60% crushing any desire to splurge modest “gas savings” on discretionary purchases…
… will only get worse, as the premium increase even more with every passing year, as more Co-Ops fail, as more of the publicly-held insurers merge, and as a single-payer system, one which benefits not taxpayers but a select handful of shareholders, becomes the norm.
Haislmaier’s take: “The bottom line: Obamacare has made health insurance costlier and the business of offering it riskier. To survive in that new world, health insurers need to be cautious, or even pessimistic, and hope that their customers can continue to pay escalating premiums. It’s not a pretty picture.”
It isn’t but what are customers going to do: after all the “Affordable Care Act” is a tax (one which “boosts” GDP every quarter no less) and you must pay it by law; sadly the Supreme Court forgot that when it makes a service mandatory, corporations can charge any price they want.
And that’s precisely what they are doing.
- First They Jailed The Bankers, Now Every Icelander To Get Paid Back In Bank Sale
Submitted by Claire Bernish via TheAntiMedia.org,
First, Iceland jailed its crooked bankers for their direct involvement in the financial crisis of 2008. Now, every Icelander will receive a payout for the sale of one of its three largest banks, Íslandsbanki.
If Finance Minister Bjarni Benediktsson has his way — and he likely will — Icelanders will be paid kr 30,000 after the government takes over ownership of the bank. Íslandsbanki would be second of the three largest banks under State proprietorship.
“I am saying that the government take [sic] some decided portion, 5%, and simply hand it over to the people of this country,” he stated.
Because Icelanders took control of their government, they effectively own the banks. Benediktsson believes this will bring foreign capital into the country and ultimately fuel the economy — which, incidentally, remains the only European nation to recover fully from the 2008 crisis. Iceland even managed to pay its outstanding debt to the IMF in full — in advance of the due date.
Guðlaugur Þór Þórðarson, Budget Committee vice chairperson, explained the move would facilitate the lifting of capital controls, though he wasn’t convinced State ownership would be the ideal solution. Former Finance Minister Steingrímur J. Sigfússon sided with Þórðarson, telling a radio show, “we shouldn’t lose the banks to the hands of fools” and that Iceland would benefit from a shift in focus to separate “commercial banking from investment banking.”
Plans haven’t yet been firmly set for when the takeover and subsequent payments to every person in the country will occur, but Iceland’s revolutionary approach to dealing with the international financial meltdown of 2008 certainly deserves every bit of the attention it’s garnered.
Iceland recently jailed its 26th banker — with 74 years of prison time amongst them — for causing the financial chaos. Meanwhile, U.S. banking criminals were rewarded for their fraud and market manipulation with an enormous bailout at the taxpayer’s expense.
- China's Communist Party Bans… Golf
Submitted by Simon Black via SovereignMan.com,
High up Yuntai mountain in China’s Henan province is a glass bridge that lets tourists walk out across the sky and look down at the lush valley floor over 3,000 feet below.
Glass walkways like this are quite popular across China, stunning visitors with both beauty and the thrill of danger.
Recently, this one cracked. And many tourists took to social media claiming that pieces of glass in the walkway broke away altogether.
The government of course is spinning a different story.
They reported that the glass walkway is completely safe, even though they’ve decided to close the bridge ‘temporarily’.
This is probably the best metaphor for the entire Chinese economy right now, because the glass is cracking everywhere.
China’s manufacturing sector has been weak for months, and its industrial sector is completely in the dumps.
This week the deputy head of the China Iron and Steel Association said that “China’s steel demand has evaporated at unprecedented speed as the nation’s economic growth slowed.”
There are more signs of contraction all across the economy.
Most notably, years and years of idiotic capital allocation are beginning to muster serious consequences.
In an effort to stimulate growth and create employment, China’s national, provincial, and local governments have spent unfathomable amounts of money on useless infrastructure, primarily funded with debt.
You’ve heard of these infamous bridges to nowhere and empty train stations.
Now several Chinese companies have started to default on these debts, including two state-owned enterprises.
The bursting of this debt bubble has already caused major problems in the banking sector (which is a massive 3x the size of China’s economy), as well as in financial markets.
Chinese stocks saw a major collapse several months ago, and we may see a major crisis in the banking sector very soon.
Local Chinese with any real savings have been scrambling for months to move their money offshore.
And this ‘capital flight’ is reaching epic levels. In August alone, $141 billion was sucked out of China. That’s more than the entire GDP of Nevada or Ukraine.
Sooner or later (probably sooner) the combination of loan defaults and capital flight is going to cause major problems in the Chinese banking sector.
Chinese banks simply won’t have enough liquidity, or reserve capital, to remain operating.
I expect we’ll see the mother of all bank bail-ins and withdrawal controls in China.
But what really gets me is the Chinese government’s Jekyll and Hyde approach to the crisis.
The Chinese are known for being strategic thinkers. This goes back thousands of years to the days of Sun Tzu. Leaders don’t act haphazardly, they make long-term plans and execute in a disciplined manner.
But it’s becoming pretty obvious now that the Chinese government is in REACTION mode.
The stock market crash over the summer wasn’t planned. So they reacted. Poorly, at that.
In response, they jailed stock speculators, and even did the unimaginable–encouraging citizens to borrow money using their homes as collateral, then invest the loan proceeds in the stock market.
They promised several times to not devalue the renminbi. But then they did.
Then in order to stem the debilitating capital flight, they imposed even more severe capital controls and withdrawal restrictions for Chinese citizens traveling overseas.
But then yesterday in a nod to the IMF, they announced a pilot program to EASE capital controls and allow citizens to directly purchase foreign assets.
Last week they went on a crazy anti-corruption binge, banning excessive drinking, golf, and even extramarital sex.
And now, poof, they ended three decades of the One Child Policy.
None of this makes any sense. There’s no common thread or direction in Chinese policies anymore. No more long-term thinking.
Now it’s all extremely reactive. The grand plans and strategy have gone out the window, and instead they’re taking it day-by-day, making it up as they go along.
To me, this is a sign of how bad things really are.
Their system is based on a bunch of unelected policymakers sitting in a room and making decisions to control one of the largest economies in the world.
This just doesn’t work.
As China’s example shows, there are too many moving parts, too many levers to control. And it’s impossible to expect that some committee is going to get it right without eventually faltering.
But as you can probably realize, it’s not just the Chinese who have engaged this absurd system. Most of the world does it too. In fact, the West invented it.
The US and Europe have their own unelected committees sitting in rooms making policy decisions that affect the lives and livelihoods of everyone engaged in economic activity.
And for us to simply sit back and trust them to be smart enough to flawlessly steer the ship is incredibly foolish.
- IIF Warns Household Wealth Gains Will Disappear Unless Fed Normalizes Rates Soon
"Easy policy has passed the point of diminishing return and keeping it longer would only increase moral hazard and distort financial markets," exclaims the Institute of International Finance, warning that the gap between the value of Americans' holdings of stocks, bonds and other financial assets and the trend growth rate of the economy is still large and not far off the level that prevailed in 2007 before the financial crisis. "The Fed should start to normalize policy as soon as possible," removing the excess as the 'gap' "typically ends up being narrowed by a correction in the stock market."
As Bloomberg details, household financial assets have ballooned, far outstripping the growth of the economy since 2013, as the Federal Reserve's ultra-easy monetary policy fuels excesses in the markets…
That's the message from a measure compiled by the Institute of International Finance (which represents close to 500 banks and financial services companies worldwide) which compares the rise in the value of Americans' holdings of stocks, bonds and other financial assets to the trend growth rate of the economy.
While the gap between the two has narrowed in recent months as the bull market in equities has stalled, it is still large and not far off the level that prevailed in 2007 before the financial crisis.
Hung Tran, an executive managing director at the institute, said the inflated level of asset prices is one reason the Fed needs to begin raising interest rates from the near-zero levels that have prevailed since 2008.
"The Fed should start to normalize policy as soon as possible—meaning liftoff this year," he said. "Easy policy has passed the point of diminishing return and keeping it longer would only increase moral hazard and distort financial markets."
Under the IIF's measure, a positive financial asset gap suggests that stock and bond prices are overvalued relative to their long-term trends and the underlying growth of the economy. When it is negative, as happened in 2009, it implies that financial assets are undervalued.
When the difference is large and positive—as it is now—it typically ends up being narrowed by a correction in the stock market. Tran said that's what he expects to happen again, although the timing of the price decline is difficult to predict.
* * *
For now, The Fed appears to have listened (talking hawkish despite the economic turmoil) and has the market starting to believe in December liftoff.Charts: Bloomberg
- Weekend Reading: Fed Stampedes The Bulls
Submitted by Lance Roberts via STA Wealth Management,
What a difference a day can make? Last week the world was consumed with fears of a slowing economy, weak demand and volatile markets. But that was "so last week."
As I penned this past Tuesday:
"In a more normal market, I would already be well convinced that the bullish trend had ended, particularly against the backdrop of an earnings recession and weak economic data. But this is by no means a normal market given the ongoing interventions by the Federal Reserve to support asset prices.
It is worth noting that contractions/expansions in the Fed's balance sheet have a very high correlation with subsequent market action as liquidity is pushed into the financial system. As shown in the chart below, the Federal Reserve has already once again began to quietly expand their balance sheet following the recent downturn. Not surprisingly, the market has responded in kind with the recent push higher. My suspicion is that if such minor interventions fail to stabilize the market, a more aggressive posture could be taken."
"Tomorrow, the Fed will announce their latest FOMC rate policy decision. My expectation is that they will once again forgo hiking rates with few changes to their verbiage of their decision. However, any indications that recent economic weakness will push rate hikes further into the future will likely be cheered by the "bulls" pushing the index back towards recent highs."
That is precisely what happened. Despite continued weak economic data, stocks soared toward market highs as the promise was made that "rates would be lifted in December."
The interesting part of this is that "tighter" monetary policy is not good for equities longer term. Furthermore, with economic growth at 2%, there is very little margin of error for the Fed with respect to monetary policy mistakes.
However, those are just my thoughts.
This weekend's reading list is a compilation of views, both "bullish" and "bearish" with respect to the Fed's recent rate decision, the markets reaction and the potential of future outcomes. The bulls are cheering, the bears are growling, but for investors the only thing that matters is how to position yourself for what happens next.
THE LIST
1) A Most Confused Critique Of The Fed by Lawrence Summers via Washington Post
“My friends Mike Spence and Kevin Warsh, writing in the Wall Street Journal on Wednesday, have produced what seems to me the single most confused analysis of U.S. monetary policy that I have read this year. Unless I am missing something — which is certainly possible — they make a variety of assertions that are usually exposed as fallacy in introductory economics classes.
My problem is not with their policy conclusion, though I do not share their highly negative view of quantitative easing (QE). There are many harshly critical analyses of QE, such as those of Martin Feldstein, which are entirely coherent and consistent with the macroeconomics of the last 50 years. My differences are based on judgements about empirical magnitudes and relative risks — not questions of basic logic."
Read Also: An Unsteady Hand At The Fed by Desmond Lachman via American Enterprise Institute
2) Connecting The Dots by Market Anthropology
“Outstanding of Fed policy, a major near-term potential catalyst to help instigate a move higher in yields is the hint by Draghi last week of his willingness to advocate a material increase in the ECB's stimulus program. With some now speculating (see Here) – as we comparatively suggested in September (see Here), of more than doubling the initial size; it would follow the Fed's playbook of how they expanded (2X) and built out their own stimulus programs in March 2009.
Our general take on the intermediate-term effects – which have been borne out in the markets since 2009 (*including the ECBs initial salvo this March – Figure 2), is that QE has historically supported yields as investors are shaken out of the safe-haven corners of the government bond market and into more reflationary asset positions that invariably weakens the dollar (Figures 6 & 7).
Moreover, from our perspective – and despite conventional wisdom that sees a weaker euro as the best remedy for what ails Europe, we would argue that a broadly weaker US dollar would have the greatest efficacy in the long-term, as it could reflexively affect inflation expectations worldwide – most notably in emerging markets that the IMF estimates will account for more than 70 percent of global growth through the end of this decade.
"
Read Also: Dollar Breaks Out As Fed Stands Pat by Michael Kahn via Barron's
3) Four Takeaways From The Fed's Announcement by Mohamed El-Erian via Bloomberg
“Of critical importance to markets is that a decision to raise interest rates for the first time in almost 10 years is now more of a "live" possibility at the Fed's next policy meeting, in December. In reasserting this policy flexibility and making it explicit, the central bank refrained from providing specifics about the elements that would drive the decision.
The Fed's message conveyed greater unity among its policy-making officials. Only one member of the Federal Open Market Committee — Jeffrey Lacker, the president of the Richmond Fed, dissented. The near unanimity was an important accomplishment by Chair Janet Yellen, especially given the range of views expressed in the weeks leading up to the meeting, including by the usually united governors."
Read Also: Fed Sets Stage For December Rate Hike by Brian Wesbury via First Trust
4) The Fed Lives In A Flawed Delusional World by John Curdele via New York Post
"Let me make a prediction now: The Fed won't have another chance to raise rates until seasonal anomalies in government statistics next spring make the economy look better than it really is.
But that's not the real story that came out of the Fed's policy-making meeting this week. This is: The Fed remains delusional.
In its statement, the Fed said the economy was expanding 'at a moderate pace' and 'household spending and business fixed investment has been increasing at solid rates in recent months.'
Solid? That statement stands in contradiction to retail sales reports, consumer spending, durable goods orders, consumer confidence surveys and a raft of other economic data."
Read Also: Just One Question For Janet Yellen by Tyler Durden via ZeroHedge
Read Also: 5 Bad Reasons To Raise Rates by Paul Kasriel via Advisor Perspectives
5) Rate Hikers At Fed Running Out Of Ammo by Jeff Cox via CNBC
Read Also: Yellen Has 6 Million Reasons To Wait by Craig Torres via Bloomberg
Other Reading
- Presidential Cycle Flashes Bear Signal? by Mark Hulbert via MarketWatch
- This Recession Indicator Hit A 6-Year Low by Akin Oyedele via Business Insider
- A Tale Of Two Recoveries by Jeff Snider via Alhambra Partners
- Debate – GOP Elevated, CNBC Eviscerated by David Stockman via Stockman's Contra Corner
- Are Share Buybacks Jeopardizing Future Growth by Tim Koller via McKinsey & Co.
- Don't Go For The Exacta by Cliff Asness via AQR
- A Different Perspective On Deviation by Greg Morris via Stockcharts.com
- Causes Of US Economic Stagnation by John Hussman via Hussman Funds
“It wasn't raining when Noah built the ark.” – Howard Ruff
Have a great weekend.
- 'Happy' Halloween Kids!
- MOMO Rules: In A "World Of Disappointments" Trade Like An Idiot, Citi Recommends
In a “world of disappointments”, where beta is king and where alpha has become a joke (or, now that equity is a risk-free asset and debt is risky, is outright punished) where growth no longer exists, drowning under the weight of $200 trillion in debt, and where value strategies have been all but forgotten replaced instead with “stories” about companies that have no cash flows but just might be “the next big thing” (one day), what should one to do? Why, engage in the most idiotic of strategies: chase momentum.
At least that is Citi’s recommendation, and – we are very sad to say – in this broken “market”, it works.
Here is the summary from the note by Citi’s Jonathan Stubbs
World of disappointments… — The post-GFC world has been consistently disappointing, in terms of growth expectations. Economists and analysts have both consistently lowered GDP and EPS growth expectations at a global level.
…has not stopped equity bull — Despite this backdrop, equity markets have performed strongly over the same period. There has been enough growth to support rising share prices. The growth “hurdle rate” on Planet QE appears to be pretty low.
Disappointments drive momentum bull — This world of disappointment has been responsible for one of the most important equity market themes of the past few years: outperformance of momentum strategies, eg earnings, dividends, estimates.
Favoured Research Quant style — Our research Quant colleagues, Chris Montagu and team, have placed a strong emphasis on the importance of Estimates Momentum over the last few years. It remains one of their preferred Quant styles.
Momentum winning — We show that investors who have run disciplined earnings and dividend momentum strategies over the last 5 years in Europe have performed strongly. Our Research Quant colleagues show the same on a style basis.
Momentum strategies — We show momentum strategies using relative earnings trends and a) P/E relative, b) P/E relative vs 10-year range, c) normalised P/E, d) price/book relative. Insurance, Banks, Autos and Utilities appear in all four. We also show momentum strategies using relative dividend trends and DY relative. Three sectors look attractive on both measures = Media, Insurance and Banks.
Momentum stocks — Stocks with positive earnings momentum and a) low P/E relative = UBS, Unicredit, Daimler, IAG, b) normalised P/E = Peugeot, KPN, Aegon, Total, Aviva, c) low price/book relative = UBS, Intesa Sanpaolo, Veolia, Bouygues. Stocks which score well on positive relative dividend trends and DY above market DY = Next, Lloyds, ING, Allianz.
* * *
Missed out on “trading” like an idiot? Don’t worry: the global economy is in a tailspin, so you will have ample opportunity to give your inner idiot access to an E-trade terminal.
This cycle has disappointed, in terms of growth. But, asset prices, including share prices, have enjoyed super-strong nominal and real returns. Economists and equity analysts have been under-whelmed by (almost) perpetually downgrading GDP growth and EPS growth estimates. But, this has not hampered the post-2009 equity bull market. Disappointments = a lot and often; European equity returns since 2009 lows = 170% (global = 187%).
This world of disappointment has been responsible for one of the most important equity market themes of the past few years — outperformance of momentum strategies, eg earnings, dividends, estimates. Companies, and sectors, which have been able to avoid disappointments (or downgrades) have tended to outperform in the last few years. We have consistently allocated a high weight to momentum within our models, eg we currently have a combined 20% weight to earnings and dividend momentum in our European Sector Attribution Model.
Economists and analysts have tended to over-estimate potential GDP and EPS growth rates since 2009. Both groups have spent most of their time downgrading respective forecasts.
Well that’s great news right? Maybe not. But this is:
Despite a backdrop of consistent downgrades to GDP and/or earnings growth forecasts over the last 5 years, equity markets have performed strongly. Growth has been disappointing, consistently so. But, overall, there has also been enough growth to support rising share prices so far in this cycle. As we have previously argued, the growth “hurdle rate” on Planet QE appears to be pretty low.
Figure 17 and Figure 18 show the performance of a disciplined earnings momentum strategy in Europe, using our own European Forecast Monitor database. At the start of every quarter we “buy” or “sell” stocks based on the 6-month change in their 12- month forward earnings relative to the market. A 6-month change above 8% goes into the long bucket and below -8% goes into the short bucket. We then hold and observe for the following 6-months. Each bar in these charts represents the 6- month relative return of these buckets.
Positive momentum strategies continue to do better than negative momentum ones. We have written much over the years about this. In short, positive momentum stocks tend to have longer duration. Negative momentum stocks have often underperformed in the months leading up to inclusion in the short bucket and can perform better should relative earnings underperformance slow.
The summary:
This cycle has disappointed, in terms of growth. But, asset prices, including share prices, have enjoyed super-strong nominal and real returns. This world of disappointment has been responsible for one of the most important equity market themes of the past few years — outperformance of momentum strategies.
Citi’s economists continue to see a world of low/modest/disappointing GDP growth in 2016-17. Additionally, they acknowledge downside risks, primarily from China, to their modest forecasts. If this plays out, then it is likely that momentum strategies will continue to perform well within the equity market. This report looks at where investors should be positioned currently on this basis.
Why is this a strategy for idiots? Because, as the “heatmap” below shows, all you do is go long the green and short the red and pray it works. Rinse. Repeat.
As we said, a “strategy” for idiots.
Thank you Ben and Janet for forcing all of us to become idiots if we want to make any money in your “market.”
- S&P Downgrades Saudi Arabia On Slumping Crude, Ballooning Fiscal Deficit
Over the course of the last several months, the consequences for Saudi Arabia of deliberately keeping crude prices suppressed in an effort to, i) bankrupt uneconomic producers in the US, and ii) pressure Moscow into giving up Bashar al-Assad have begun to make themselves abundantly clear.
Not only has the kingdom been forced into liquidating its SAMA reserves…
… but the pressure from simultaneously maintaining the riyal peg and preserving the standard of living for everyday Saudis has driven Riyadh back into the debt market in an effort to offset some of the pressure on the country’s vast store of USD-denominated petrodollar assets (see second pane below).
Meanwhile, the war in Yemen is also weighing on the budget and now, the Saudis are staring down a fiscal deficit that amounts to some 20% of GDP and the first current account deficit in years.
All of the above have caused to market to lose faith in Riyadh’s ability to keep the situation under control and now, S&P has downgraded the kingdom to AA- negative citing “lower for longer” crude and the attendant ballooning fiscal deficits.
* * *
From S&P:
We expect the Kingdom of Saudi Arabia’s (Saudi Arabia’s) general government fiscal deficit will increase to 16% of GDP in 2015, from 1.5% in 2014, primarily reflecting the sharp drop in oil prices. Hydrocarbons account for about 80% of Saudi Arabia’s fiscal revenues.
Absent a rebound in oil prices, we now expect general government deficits of 10% of GDP in 2016, 8% in 2017, and 5% in 2018, based on planned fiscal consolidation measures.
We are therefore lowering our foreign- and local-currency sovereign credit ratings on Saudi Arabia to ‘A+/A-1’ from ‘AA-/A-1+’.
Standard & Poor’s is converting its issuer credit rating on Saudi Arabia to “unsolicited” following termination by Saudi Arabia of its rating agreement with Standard & Poor’s.
The outlook remains negative, reflecting the challenge of reversing the marked deterioration in Saudi Arabia’s fiscal balance. We could lower the ratings within the next two years if the government did not achieve a sizable and sustained reduction in the general government deficit or its liquid fiscal financial assets fell below 100% of GDP.
* * *
Of course this will only get worse should Riyadh decide to launch a sequel to “Operation Decisive Storm” in Syria and indeed, the IMF recently warned that absent higher oil prices, the Saudis could literally go broke in the space of five years:
Sharply lower oil prices have significantly affected the fiscal prospects of oil exporters across MENA and the CCA.1 The Brent oil price is projected to average $53 a barrel in 2015, down from almost $110 a barrel in the first half of last year. Exporters’ fiscal balances have turned from sizable surpluses to large deficits, with MENA and CCA export revenues dropping by $360 billion and $45 billion, respectively, this year alone.
For oil exporters, the main policy issue is fiscal adjustment and rebuilding buffers over the medium term. The Brent oil price is projected to recover only modestly to about $66 a barrel by the end of the decade, with MENA and CCA export receipts remaining $345 billion and $30 billion, respectively, below the 2014 level, even in 2020. In the absence of adjustment, fiscal balances will remain in deep deficit in most countries, with public debt ratios rising rapidly (red lines in Figure 4.2).
Even under the IMF baseline scenario, however, public debt ratios will continue to rise in many GCC and CCA exporters (blue lines in Figure 4.2). In a number of countries, mediumterm fiscal balances will fall well short of the levels needed to ensure that an adequate portion of the income from exhaustible oil and gas reserves is saved for future generations (Figure 4.3). Bahrain, Oman, and Saudi Arabia have medium-term fiscal gaps of some 15–25 percentage points of non-oil GDP, while conflict-torn Libya has a gap of more than 50 percent of non-oil GDP.
The large and sustained drop in oil prices has increased fiscal vulnerabilities in MENA and CCA oil-exporting countries. The issue of fiscal space has become critical as oil exporters decide how quickly to adjust their fiscal policies to the new reality of persistently lower oil prices. This box considers several alternative measures of fiscal space. A good starting point is the size of governments’ financial assets—commonly referred to as “fiscal buffers.” In general, countries with larger buffers can afford to maintain fiscal deficits further into the future, so as to reduce the impact of lower oil prices on growth. On current trends, however, all non-GCC MENA oil exporters are already projected to run out of liquid financial assets in the next three years (see Chapter 1). In, contrast, CCA oil exporters have at least 15 years’ worth of available financial savings,1 while GCC countries are split evenly between countries with relatively large buffers (Kuwait, Qatar, and the United Arab Emirates—more than 20 years remaining) and countries with relatively smaller buffers (Bahrain, Oman, and Saudi Arabia—less than five years).
As a refresher, here’s BofAML’s sensitivity analysis which shows how long Riyadh’s SAMA reserves will last under various scenarios for crude prices and debt issuance:
One important takeaway from the above is that if the Saudis were to burn through their reserves it would represent a nearly $700 billion global liquidity drain as Riyadh dumps its USD-denominated assets. That would amount to a complete reversal of the petrodollar virtuous circle that’s underwritten decades of dollar dominance and which has served to underpin the global economic order for as far back as most market participants can remember.
And while it’s by no means a foregone conclusion that oil prices will remain “lower for longer” as the Saudis are to a certain extent the masters of their own destiny in that regard, one thing worth noting is that not only is Iranian supply set to come back online, but Tehran seems determined to supplant Riyadh as regional power broker. Both of those eventualities will have very real consequences for crude prices and thus for the future of The House of Saud.
So enjoy it while it lasts King Salman…
- Mother Yellen's Little Helper – The Rate-Hike Placebo Effect
Via ConvergEx's Nicholas Colas,
Americans are increasingly likely to respond positively to a placebo in a drug trial – more so than other nationalities. That’s the upshot of a recently published academic paper that looked at 84 clinical trials for pain medication done between 1990 and 2013. Over that time, Americans reported an almost 30% incremental reduction in pain symptoms when given a sugar pill or other placebo as compared to a 10% reduction for in non-U.S. studies. Why the difference? The paper’s authors suggest that drug advertising – only allowed in New Zealand and America – may be giving trial populations more confidence that a drug – any drug – will work. Also a factor: drug trials are better funded now, and therefore have more participants and go longer. All that may well spark more confidence in trial participants, even those taking placebos.
These findings, while bad for drug researchers, does shed some light on our favorite topic: behavioral finance.
Trust and confidence makes placebos work, and those attributes also play a role in the societal effectiveness of central banks. That’s what makes the Fed’s eventual move to higher rates so difficult; even if zero interest rates are more placebo than actual medicine, markets believe they work to support asset prices.
I keep a mental list of underappreciated scientific developments of the 20th century, and near the top is the placebo. While you can argue that the roots and herbs of ancient societies were the first faith-based medicines, modern placebo research dates to a relatively recent 1955. That was the year Harvard research Henry Beecher published “The Powerful Placebo” in the Journal of the American Medical Association. It was essentially a huge “You’re doing it wrong” to the pharmaceutical industry and showed that drug tests needed to be performed against a placebo and dual blind (neither subject nor researcher knows whether they were taking/dispensing a real medicine or a sugar pill).
The only problem is that placebos are really stiff competition. As Beecher noted, many subjects in non-placebo trials reported feeling better even when the drug in question was later found to be totally ineffective. And over the years, researchers have found ways to make placebos “Work” even better: yellow placebos work great as antidepressants, red pills are “Uppers”, branded pills work better than generics, and a placebo painkiller given 4 times a day performs better when you take only twice daily. The upshot of all this is that in highly competitive areas like depression medication, drug companies have to spend billions to produce products that beat the placebo.
Medical researchers know that the placebo effect has risen over the last 15 years, but one recent paper attributes this to a very specific reason: Americans. Dr. Jeffrey Mogil and his team at McGill University in Montreal looked at 84 drug trials dedicated to ameliorating pain caused by nerve damage. Here’s a summary of their findings and working theories:
Since the mid-1990s, Americans in drug trials to assess pain medication have reported a 30% increase in the efficacy of placebos. In Non-U.S. studies, that number is closer to 10%. Taken as a whole, therefore, American drug trials explain most of the increase in the global placebo effect.
The researchers at McGill do not have an explanation for this disparity, but suspect the changing scale of U.S. drug trials. We know that placebos tend to work better when patients trust their doctors (Kelley et al 2009). American drug companies have been extending the time involved in drug trials over the last decade as well as increasing their population size, in part to compete against the potentially wide variance of the placebo effect on smaller groups. As it turns out, large drug trials where researchers get to know the patients well after weeks of contact are exactly the type of environment where placebos can shine.
The other idea forwarded in the press coverage around this study is that the U.S. is one of only two countries (New Zealand is the other) where drug companies can advertise directly to the population at large. Pharma companies spend just over $4 billion/year on U.S. advertising, mostly on television ad buys. Some of the study’s authors posit that this has a halo effect on drug companies generally, since Americans are unique in viewing these advertisements. If called to participate in a drug trial, they may increasingly assume that they are going to get something new, innovative, and (presumably) effective. Even if it’s just a sugar pill.
We see the placebo effect as medicine’s version of behavioral economics, that wing of the dismal science that recognizes the fallibility of mankind rather than assuming an economic actor will always behave as the models say they should. If human psychology played no role in drug testing or medicine, you wouldn’t need a placebo option. If humans behaved like the wealth/utility maximizing animals described in economic models, you wouldn’t need a behavioral part of the discipline to explain why they often don’t. The truth is human emotion gets in the way of both, so we need placebos and psychologists.
The central lessons placebos have for medicine is remarkably simple.
First, the patient/doctor bond plays a large role in the success of a placebo. We know that from earlier studies and from surveys of doctors (one released two years ago in the U.K) which show they routinely prescribe placebos to their patients. The doctors mean no harm, and the most often given reason for the practice was to ward off requests for medication inappropriate to the patient’s condition.
Second, as the McGill study seems to show, is that some populations will react to placebos more readily than others. The preconditions seems to be background messaging (all those ads no TV) and large/lengthy trials that encourage confidence among the patients in the company performing the trial as well as the researchers on staff.
To draw the analogy to economics, try this model on for size:
- Central bankers around the world are the researchers, looking for effective treatments for slow global growth and sluggish price inflation.
- The general population are the people engaged in the trials to see which treatments are most useful.
The American Federal Reserve ran the most successful trial with its Quantitative Easing program. Asset prices went up, unemployment went down, and we don’t really have to care what parts of those outcomes were caused by the actual medicine of zero interest rates/bond buying versus the placebo effect of trust in Federal Reserve. Now, the Bank of Japan and the European Central Bank are running the same experiment and hoping for the same outcome. Whether the actual cure shows up or just the placebo effect is the big question just now.
The challenge for the Fed now is that no one is quite sure how much of the “Cure” was medicine and how much was the placebo effect. The first Fed rate hike will begin to tell the story, whenever that is, especially for equity markets. It will all come down to how much investors actually trust the Federal Reserve to reduce the dosage of low interest rates and at what speed. That is where the comparison to medical science is frustratingly inadequate. Medicine cures, but when it comes to economics there’s always another illness coming around the corner.
- Tying The Valeant Roll-Up Together: Presenting The Goldman "Missing Link"
While the Valeant soap opera has had constant, heart-pounding drama for weeks and following yesterday’s report that it allegedly fabricated prescriptions, even an element of career-ending (and prison-time launching) criminality, so far one thing had been missing: an antagonist tied to Goldman Sachs.
Thanks to a profile by Bloomberg, we are delighted to reveal the “missing link”, one which ties everything together. Its name is Howard Schiller.
Schiller was, between December 2011 and June 2015, the CFO of Valeant, and is currently on its board of directors.
More importantly, prior to joining Valeant, he worked for 24 years at Goldman Sachs as chief operating officer for the Investment Banking Division of Goldman Sachs, responsible for the management and strategy of the business.
How and why did Schiller end up at Valeant? Jeff Ubben, of the hedge fund ValueAct Capital, helped bring in J. Michael Pearson from McKinsey to run Valeant. Pearson then helped lure Schiller from Goldman Sachs.
And, as Bloomberg notes, “Goldman Sachs and other banks brought in investors, making many millions in fees in the process.”
All thanks to the “roll-up” strategy that blossomed and ballooned under Schiller.
Because much more important than using Valeant as a Wall Street fee piggybank, which in turn resulted in a circular loop whereby virtually every analyst covering the company had a “buy” recommendation as we showed two weeks ago…
…. which then pushed its price ever higher, making it even easier to acquire smaller (or larger) companies using the stock as currency, and creating the impression of virtually perpetual growth (simply due to the lack of any purely organic growth comps), and even more important than the company’s current fiasco involving Philidor (which may or may not involve a criminal investigation before too long), was that Valeant was nothing more than a massively indebted serial acquirer, or a “roll-up”, taking advantage of the recent euphoria for specialty pharma exposure, and with Ackman on board, a sterling activist investor to provide his stamp of approval (recall the surge of Weight Watchers stock just because Oprah Winfrey came on board).
That aggressive roll up strategy was the brainchild of Schiller (and Pearson) which in turn was developed with Wall Street’s help in one massive monetary synergy, whereby everyone profited, as long as the stock kept going up.
With the price crashing, the entire business model of the Valeant “roll-up” has now come undone.
So now that the time to count bodies has begun, let’s meet the architect who was the brain behind Valeant aggressive expansion spree.
Schiller ran Goldman Sachs’ health-care practice until 2009, when he became the chief operating officer of Goldman’s investment bank. The next year, the bank advised Valeant on its breakout purchase of Biovail Corp.
After Schiller arrived at Valeant, in late 2011, the drug company orchestrated some of its most controversial deals. In the process, Valeant enriched its shareholders. Its market value soared from $14 billion to $70 billion during Schiller’s tenure as CFO, as one Wall Street analyst after another placed “buy” on its stock.
It also enriched Wall Street:
Under Pearson and Schiller, Valeant became a lucrative client for Wall Street. Goldman Sachs, for instance, was entitled to more than $15 million in fees for the Biovail deal. The firm also earned about $55 million for helping the drug maker raise $9.3 billion in debt and equity financing for the 2013 acquisition of Bausch & Lomb Inc., including its role as sole underwriter of a $2 billion stock sale, regulatory filings show.
… Goldman at this point, of course, was Schiller’s former employer. Surely there was no conflict of interest there.
Goldman Sachs Lending Partners served as the lead lender among a group of banks that provided a credit line and term loans to Valeant. Later, the same banking group agreed to raise as much as $8 billion in financing for Valeant’s proposed acquisition of Allergan Inc. Goldman Sachs didn’t participate in that group offering financing and stepped down as the banking group’s administrative agent because it was involved in defending Allergan against the deal.
We don’t understand: why would that stop the bank that was just fined a whopping $50 million for wilfully and criminally stealing inside information (which helped it make who knows how many billions in profits) from the New York Fed?
And then, just as abruptly as when Hank Paulson quit Goldman to join the Treasury just so he could cash out of his GS stock tax free, Schiller announced his resignation one short month after Valeant’s failed attempt to acquire Allergan (in collusion with Bill Ackman who made hundreds of millions buying calls on Allergan having material non-public information that a hybrid strategic/financial bid was coming) fell appart after it was outbid by Actavis Plc.
As Bloomberg observes, “it was an opportune exit.” Under the terms of his departure, he stands to continue vesting in a stock and options package that made up the bulk of his $46 million in pay through 2014, according to company filings.
It gets better: before stepping down, he sold $24 million of Valeant stock to pay taxes, including a portion when the shares were trading above $200, company filings show.
Call him lucky, just don’t call him a criminal.
But while he is no longer CFO, he most certainly has present this past Monday on a conference call in which Valeant defended its relationship with Philidor: “Valeant turned to him, rather than to a company officer, to walk investors through a big part of Valeant’s presentation about its ties to Philidor.”
Schiller told listeners that Valeant had launched a pilot prescription-fulfillment program through Philidor, and based on its success decided to strengthen its relationship with the specialty pharmacy. Then, last December, Valeant “acquired the option to acquire Philidor,” he said.
Just four days later, after news broke that Philidor was fabricating prescriptions, that view changed at 5 am this morning when the company announced that “we have lost confidence in Philidor’s ability to continue to operate in a manner that is acceptable to Valeant and the patients and doctors we serve.”
Call it unlucky, just don’t call it criminal.
During the Monday call, Umer Raffat, an analyst at Evercore ISI, raised a question on many people’s minds: Why did Schiller leave when he did? “I feel like no one’s satisfied, and I keep getting that question from many investors in many meetings. So, would appreciate all your input there,” Raffat said.
Schiller reiterated that after two careers over 30 years, he wanted to “do some things on my own.”
He continued: “The timing was right. And again, just to be absolutely crystal clear, if I had –- and which I’m guessing, it could be an undertone of the question, if I had any concerns whatsoever about Valeant or Mike I would not have stayed on the board. It’s as simple as that.”
Pearson quickly followed up. He said Schiller had called him shortly after the stock-commentary site Citron Research, run by short-seller Andrew Left, sent Valeant’s stock into a tailspin with a report questioning the company’s accounting and its relationship with Philidor, the pharmacy. Pearson has since called for authorities to investigate Citron.
Good, and when those authorities find nothing wrong with Citron, which merely blew the whistle on a rollup that many others had suspected for years, they can focus all their attention on Valeant.
For their benefit, here is a quick primer from HBS on the rapid rise and even more rapid collapse of some of the best known (and most infamous), as well as unknown roll-ups yet, and what exactly bursts their bubble:
The notion behind roll-ups is to take dozens, hundreds, or even thousands of small businesses and combine them into a large one with increased purchasing power, greater brand recognition, lower capital costs, and more effective advertising. But research shows that more than two-thirds of roll-ups have failed to create any value for investors.
We were interested to find that many roll-ups were afflicted by fraud—among them, MCI WorldCom, Philip Services, Westar Energy, and Tyco—but we won’t focus on those in this article because for the most part the lesson is simply, “Don’t do it.” Instead, let’s look at the fortunes of Loewen Group. Based in Canada, it grew quickly by buying up funeral homes in the U.S. and Canada in the 1970s and 1980s. By 1989, Loewen owned 131 funeral homes; it acquired 135 more the next year. Earnings mounted, and analysts were enthusiastic about the company’s prospects given the coming “golden era of death”—the demise of baby boomers.
Yet there wasn’t much to be gained from achieving scale. Loewen could realize some efficiencies in areas like embalming, hearses, and receptionists, but only within fairly small geographic proximities. The heavy regulation of the funeral industry also limited economies of scale: Knowing how to comply with the rules in Biloxi doesn’t help much in Butte. A national brand has little value, because bereaved customers make choices based on referrals or previous experience, and being perceived as a local neighborhood business is actually an advantage. In fact, Loewen often hid its ownership. And it damaged whatever reputation it did have with its methods of shaming the bereaved into buying more expensive products and services (such as naming its low-end casket the “Welfare Casket”).
Nor did increased size improve the company’s cost of capital. Funeral homes are steady, low-risk businesses, so they already borrow at low rates. The cost of acquiring and integrating the homes far outweighed the slight scale gains. What’s more, the increase in the death rate that Loewen had banked on when buying up companies never happened. Fast-forward several years and the company filed for bankruptcy, after rejecting an attractive bid. (Relaunched under the name Alderwoods, Loewen was sold to the same suitor for about a quarter of the previous offer.)
Often roll-ups cannot sustain their fast rate of acquisition. In the beginning, all that matters is growth—buying a company or two or four a month, with all the cultural and operational issues that accompany a takeover. Investors know that profitability is hard to decipher at this point, so they focus on revenue, and executives know that they don’t have to worry about consistent profitability until the roll-up reaches a relatively steady state. Operating costs frequently balloon as a result. Worse, knowing that the company is in buying mode, sellers demand steeper prices. Loewen overpaid for many of its properties. In another case, as Gillett Holdings and others tried to roll up the market for local television stations in the 1980s, the stations began demanding prices equal to 15 times their cash flow. Gillett, which bought 12 stations in 12 months and then acquired a company that owned six more, filed for bankruptcy protection in 1991.
Finally, roll-up strategies often fail to account for tough times, which are inevitable. A roll-up is a financial high-wire act. If companies are purchased with stock, the share price must stay up to keep the acquisitions going. If they’re purchased with cash, debt piles up. All it took to finish off Loewen was a small decline in the death rate. For Gillett, it was an unexpected TV ad slump. When you go into a roll-up, you need to know exactly how big a hit you can withstand. If you’re financing with debt, what will happen if you have a 10%—or 20% or 50%—decline in cash flow for two years? If you’re buying with stock, what if the stock price drops by 50%?
This is precisely what just happened to junk-rated Valeant (which has leverage of just over 6 times) which – even if found innocent of any Philidor wrongdoing – is essentially finished: the rollup bubble has burst and now it has to show it can be profitable and generate cash.
Judging by its stock price today, few are hanging around to see if it can.
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