Monday, October 14, 2013 - Canned Goods and Cigarettes

Canned Goods and Cigarettes

by Sinclair Noe

DOW + 64 = 15,301
SPX + 6 = 1710
NAS + 23 = 3815
10 YR YLD + .01 = 2.69%
OIL + .12 = 102.14
GOLD + .10 = 1274.30
SILV - .07 = 21.37

Earlier today President Obama warned that if the standoff is not resolved by Thursday’s deadline to raise the debt ceiling, “we stand a good chance of defaulting.” And then he postponed a scheduled meeting with congressional leaders. That's the good news.

No, seriously, that's the good news; Senate leaders were closing in on a deal to raise the federal debt ceiling and end the 2 week old government shutdown, so the president stepped aside to let the legislators work a deal.

Senate Majority Leader Harry Reid said on the floor that he was “very optimistic” about what he called the “constructive, good-faith negotiations” aimed at avoiding the nation’s first default on its debt. Senate Minority Leader Mitch McConnell said he expected that “we’re going to get a result that will be acceptable to both sides.”

Of course, if they don't reach a deal by tomorrow, you might want to stock up on canned goods and cigarettes; there's a good chance cigarettes will be more valuable than gold in the debt-pocalypse. And the meltdown could start prior to the actual deadline of Thursday; folks will wait it out tomorrow, but before the close of the markets on Wednesday, if there is no deal, it could get ugly. So stock up on the canned goods and cigarettes tomorrow.

If this whole mess seems surreal, it is, but that doesn't mean you know how it works. So, allow me to provide the Readers' Digest version of everything you need to know about the federal deficit.

When the government spends more than it collects in tax revenue it must borrow to finance the difference. The national debt now stands at $16.7 trillion dollars; that's the total amount the federal government has borrowed throughout the years to finance cumulative cash deficits; plus the money it owes to itself, primarily the Social Security Trust Fund. The publicly held debt is owed to a wide variety of investors, including international investors, domestic private investors, the Federal Reserve, and state and local governments. The federal government has carried debt throughout its history. Typically the nation has run up deficits during wars and recessions, but then paid down the deficit when the war ended or the economy recovered. In recent years however, sharp increases in deficits have driven the debt to historic levels even as government spending was poised to explode to care for an aging population.

The debt ceiling sets a legal limit on borrowing by the federal government. Legislation to raise the debt limit usually leads to some partisan political posturing but little real drama. The past few years have been different. The United States hit its 16.7 trillion debt ceiling in mid-May. Treasury Secretary Jack Lew started to borrow from retirement funds from federal workers, a move that has bought a few months before he hits a point where he will be unable to borrow more to continue to pay the nation's bills. If Congress does not vote by Thursday to raise the limit, Secretary Lew says the government will default on its obligations.

House Republicans have demanded a number of concessions in exchange for granting the Treasury an additional year of borrowing authority. Among their concessions demanded for not shutting down the government was the repeal of the Affordable Care Act, also known as Obamacare; they then merged the shutdown concessions into the debt ceiling concessions, only to slowly but surely abandon those concessions as they realized they were running into a brick wall; The next concession to fall was a one year delay in implementation of Obamacare; which they have now abandoned as impossible; then a demand for repeal of the medical device tax which was a part of Obamacare, and nobody quite understands it or care about it unless you happen to sell medical devices. President Obama says he will not negotiate over the debt limit. Congress passed the spending measures that racked up the debt and now they have to pay the bills.

In its effort to extract concessions from Democrats in exchange for opening the government, the GOP has faced a fundamental strategic obstacle: They don't have the votes. A majority of the members of the House have gone on record saying that if they were given the opportunity to vote, they would support what's known as a "clean" continuing resolution to fund the government, in other words a resolution that deals only with the debt ceiling and doesn't have all sorts of concessions tacked on.

But a funny thing happened right as the government was shutting down; on September 30, the House Republicans passed a measure that prevents anyone other than the Speaker of the House from bringing the clean CR to a vote. Which means Speaker John Boehner is the only person who can bring this mess to a vote in the House of Representatives, and Boehner is still holding out for something; nobody knows exactly what, but it might involve cigarettes.

Now, you might think there is no rational reason to shut down the government to preclude what is essentially a Republican-designed health law, first pitched by Newt Gingrich in response to HillaryCare, the original version of ObamaCare was actually created by the Heritage Foundation, and then implemented by a Republican governor in Massachusetts, only to be abandoned in pursuit of a White House run, which ironically resulted in a less than winning 47% of the vote. The conservative health care plan that would create the conditions for finally attaining universal health coverage in the United States, a goal that all the other advanced nations have achieved decades ago. In particular, the alternative to “Obamacare” proposed by the GOP is nonexistent, and basically means leaving millions of Americans without proper medical care.

On top of that, the shutdown, together with the previous sequestration, and the overall contractionary fiscal stance, will most likely make the very slow recovery even slower, maintaining an unnecessarily large portion of the labor force unemployed.

The debt ceiling, which we are still approaching, even if at a slower pace because of the shutdown, will make matters even worse. How much worse? Nobody knows; somewhere between bad and debt-pocalypse.

And then this afternoon, came word of progress, maybe, sort of. Wall Street traders were optimistic that a deal might be reached; there was a quick round of buying that pushed the major indices into positive territory. We may get a deal, maybe not, but again, if nothing is worked out by tomorrow afternoon, it's probably a good idea to load up on canned goods and cigarettes, and maybe some single malt Scotch.

Three Americans were awarded the Nobel prize in economics Monday for work that helped answer this crucial question: What determines the prices of an asset, whether a stock, bond or a house?

The winners of the $1.23 million prize were Eugene Fama and Lars Peter Hansen of the University of Chicago and Robert Shiller of Yale. Their work has led to everything from low-fee index mutual funds to a deeper understanding of why home prices can become irrationally high, as they did in the last decade.

Fama and Shiller are considered direct opposites in their views of how markets sort out the prices of financial assets. Fama is a father of the "efficient markets hypothesis," the idea that because markets are very good at incorporating all known information about the value of an asset, it can be a fool's errand to try to predict in what direction the price of a stock or bond will go. Shiller is a leading proponent of the idea that markets, driven as they are by human psychology, can create large and sustained mispricings, such as in the late 1990s when excessive optimism drove the stock market into bubble territory. He is a student of "behavioral economics," the study of how quirks in human psychology can create results that traditional economic theory would not predict.

Fama's "efficient markets hypothesis" holds that investors can do just as well or better by investing in stock index funds as they can by trying to time the market and pick individual stocks. Anything they think they know about the future prospect of a company, in other words, is almost certainly already reflected in its share price.

Shiller challenges some key aspects of the efficient markets hypothesis. In a 1981 paper, for example, he demonstrated that stock prices are much more volatile than the underlying trends in the dividends they pay would suggest. He went on to show that periods when stock prices are high relative to corporate earnings tend to be followed by periods of below-par returns, and vice versa.

Hansen built on Shiller's work in important ways by using new statistical methods to test what exactly was driving all that stock price volatility. Hansen's work established more strongly the idea that the mispricings Shiller identified had to do with fluctuations in how much appetite for risk people had. When times are good more investors are willing to pay high prices for assets, and when times are bad, investors become more cautious. Today Shiller said the Federal Reserve's economic stimulus and growing market speculation were creating a “bubbly” property boom.

So, it just seems like a prudent thing to load up on canned goods and cigarettes and Scotch. Better safe than sorry.

Monday, October 15, 2012 - Coffee First Then the Prize

Coffee First Then the Prize

-by Sinclair Noe

DOW + 95 = 13,424
SPX + 11 = 1440
NAS + 20 = 3064
10 YR YLD un = 1.66%
OIL- .11 = 91.74
GOLD – 16.90 = 1738.40
SILV - .78 = 32.80
PLAT – 14.00 = 1646.00

Americans Alvin Roth and Lloyd Shapley were awarded the Nobel economics prize on Monday for research that helps explain the market processes at work when doctors are assigned to hospitals, students to schools and human organs for transplant to recipients.

The Royal Swedish Academy of Sciences cited the two economists for "the theory of stable allocations and the practice of market design."

Roth, 60, is a professor at Harvard. Shapley, 89, is a professor emeritus at UCLA.

"This year's prize concerns a central economic problem: how to match different agents as well as possible," the academy said.

Shapley made early theoretical inroads into the subject, using game theory to analyze different matching methods in the 1950s and '60s. He examined "pairwise matching”. Roth took it further by applying it to the market for US doctors in the '90s.

"Even though these two researchers worked independently of one another, the combination of Shapley's basic theory and Roth's empirical investigations, experiments and practical design has generated a flourishing field of research and improved the performance of many markets," the academy said.

While I think it's safe to say most of us believe that capitalism is the best economic system, in part because of the ability to efficiently allocate resources, it turns out that there are ways to improve the efficiencies of allocation.

Signing up to attend high school used to be a big mess for more than 90,000 New York City students. That is, before Alvin Roth and his team overhauled New York City high-school admissions in 2003, eighth-graders would select up to five of the city’s more than 500 high-school programs, send their preferences in the mail and wait. Principals would rake through applications and apply their individual filters. Schools had different admissions practices: some schools were open-admission, others gave priority to those who live nearby, some evaluated students individually and still other schools had quotas.

In this first round of admissions, principals would send offers to about 50,000 students. Many students wouldn’t get a single offer from any high school, while about 17,000 students received multiple offers. Students would accept an offer, and schools would go through another round of offers.

Many students would end up disappointed; about 30,000 would be automatically assigned to schools that weren’t in their top five, they were sent wherever there was an opening. What Roth and co-researchers realized was that the system was congested.

In 2003, the city decided enough was enough. They asked Roth, whose specialty was non-traditional markets, and his colleagues to try to create a system similar to one they’d designed to match medical-school students to resident programs.

They created an algorithm that would allow students to rank up to 12 schools. Then a central clearinghouse for applications would match students to schools based on multiple, internal rounds of application and acceptance. Instead of going through only one round of internal applications and rejections before making offers, the city would run an algorithm and try to get as many matches as possible between where the students wanted to go to school and which students the schools wanted to accept.

For fall 2004-2005 admissions, the first year the new system was in place, about 3,000 more students received one of their top five preferences than before. In addition, only 3,000 students were automatically assigned to a high school that wasn’t on their original list.

Is it a perfect system? Far from it; critics say it is complicated and it doesn't work for all students, but even the critics admit it is vastly superior to the old system.

Maybe more important than the practical application of getting students to class, were practical applications that save lives, including pairing kidney donors with recipients. Kidney-exchange programs using Roth's algorithms have already saved hundreds of lives in the U.S. Judging from his research, they could save more -- and save a lot of money on dialysis costs -- if Medicare covered the expenses of kidney donations.

Roth said he was sleeping when he got the call from the prize committee in California, where he is a visiting professor at Stanford University.

"I'm sure that in class this morning my students will pay more attention," he told a news conference in Stockholm by phone.

Asked how he would celebrate, he said: "I haven't made any plans yet; coffee."

All I can say is this guy deserves the Nobel prize.

Elsewhere, last week the IMF switched sides. For years the IMF and the World Bank have been of the opinion that when a country ran up too much debt, the answer was to impose harsh, sometimes crippling austerity. The game plan was to typically announce the sky was falling, demand bailouts for banks, crush the public sector, sell-off large chunks of national holdings, and privatize others.

So has the IMF suddenly woken up the fact that demanding every government slash spending and raise taxes is, in many cases, counter productive because they have underestimated the fiscal multiplier in government spending ?  No, the IMF along with its new President have been well aware for some time that their theories on expansionary fiscal contraction have underestimated the negative effects of attempting government sector austerity at a time of private sector de-leveraging, specifically in a fixed currency environment.

Tightening fiscal policy in the absence of increased private sector investment or external surpluses leads to weaker growth, which in turn worsens public finances further. Without external debt relief and/or the ability to externally devalue this becomes a spiral downwards as domestic retrenchment adds to this counter-productive dynamic. Again, this is the IMF game-plan  why the change in policy? I suspect the driving force was that Spain wasn't going to play ball. The Spanish people took to the streets in overwhelming numbers, and that forced the Spanish government to reject the bailouts and austerity plans. And the Troika of the IMF and World Bank and European Central Bank may be very powerful, but not enough to risk the wrath of millions of people in the streets of Madrid.

Of course the ECB is waiting in the wings with its OMT and this latest ratings downgrade could be the trigger that finally forces Rajoy to seek external help. And while the IMF may have switched away from austerity, it is still popular among the Germans. As the economic weakness continues to spread across the Euro-zone, even the most stringently fiscal responsible countries might change their tune. Last week the Euro-union won the Nobel prize for peace. Maybe they should remember that after the first war, the plan was austerity for the vanquished. It did not work out well. After the second world war, the plan was called the Marshall Plan; it called for massive investments at a time when nobody in Europe could pay for anything. We know what works and what doesn't. Maybe, the Nobel Prize people were just trying to get people thinking again.

When a bank, at least a really big bank, reports earnings you can ask “how money did they make on fees?” and “how much money did it make on selling mortgages?” and that's nice.

If you asked those questions of Citi, you might or might not get answers that might or might not be useful, but you’d be hard pressed to translate them into the headlines on Citi’s earnings. Big banks are bundles of accounting legerdemain, and this is never more apparent than at earnings time and it doesn't have much correlation to the real world of economic activity.

Today, Citigroup reported third quarter earnings. Here are a couple the stories:

Citigroup Inc.’s third-quarter profit fell 88% as the bank took charges tied to the value of its debt and the sale of a stake in its brokerage joint venture …

OK, then there was another report that said:

Citigroup Profit Beats Estimate on Bond-Trading Gains ...

Take your pick! It is fun to say things like “non-cash accounting charges are fake and you should back them out and concentrate on recurring items with economic significance” but that’s just, like, your opinion man.

Goldman Sachs issued it's own opinion in a quick research report this morning on Citi's earnings.

Basel 3 capital increased to 8.6% from 7.9% last quarter on capital accretion from the MSSB sale, continued runoff in Citi Holdings and retained earnings. Encouragingly, Citi is now within range of it’s fully phased in Basel requirement after factoring in additional capital accretion to come from the remaining MSSB sale (~+40bp). …We expect shares to respond favorably today given strong top-line performance, positive operating leverage, and better than expected Basel III capital.

It was positive response because Citi has been trying to raise dividends, but was stymied by its regulators’ view that doing so would leave it without enough capital to deal with stress. Now that it has more capital than expected, it has a better chance of raising dividends. I just can't figure out how they did it.

If you wanted a model of how to react to Citi’s earnings you could I suppose build one based on your special and unique comprehension of real economic factors. Things like actually growing sustainable lending businesses would look good; I couldn't find that stuff in the earnings report. Citi uses things like debt valuation adjustments, or DVA, which turns debt into profit. It tends to twist logic. I think it has something to do with alchemy.