Mish's Global Economic Trend Analysis |
- Market Participants "Learn the Wrong Lesson" from Bernanke; Conflicts of Interest in "Stay the Course" Advice
- Missing the Big Picture Part II
- Marc Faber on Investing Opportunities for the Short-to-Intermediate Term
- FCIC Investigation Misses the "Big Picture" Cause of the Crisis; Next Financial Crisis Brewing Already
| Posted: 26 Jan 2011 04:00 PM PST The risk trade marches on. It's another day and another high in the DOW. What have investors learned from this? Alan Hartley writing for Morningstar explores that question in A Potent Brew for a Tall Glass of Regret While it is clear economic data has improved, we must be conscious of the risks that remain.Why Wildly Differing Conclusions? Hartley hits the mark with his analysis and even more with his conclusion "the Fed's largesse always ends in tears." However, he misses one key point: Most analysts, money managers, and broker-dealers are perpetually bullish because they have a vested interest to be perpetually bullish. Just as real estate salesman do not sell houses if they tell potential clients houses are too expensive, broker-dealers don't make commissions if people are not buying. Moreover, most money managers earn no fees at all if their clients sit in cash. Conflicts of Interest in "Stay the Course" Advice In January of 2009 before the final 20% plunge in the stock market, an investment advisor from Wachovia Securities called me up and stated "Mish, I am sitting on millions because I see nothing I like". I told the person I did not like much either and that Sitka Pacific was heavily in cash and or hedged. His response was "Well, I do not get paid anything if my clients are sitting in cash". I called up a rep at Merrill Lynch and he said the same thing, that reps for Merrill Lynch do not get paid if their clients are sitting in cash. Massive Conflict of Interest Notice the massive conflict of interest possibilities. Reps for various broker dealers have a vested interest in keeping clients 100% invested 100% of the time, even if they know it is wrong. And so during every recession and every boom alike, bad advice permeates the airwaves and internet "Stay The Course". By the way, that person at Wachovia mentioned above did the right thing. He did not see investment opportunities he liked, so he kept client funds in cash. Such action is not the norm. Bullishness Sells The fact that managers do not get paid if clients sit in cash accounts for a great deal of the long-term-buy-and-hold mentality you see. The rest of it comes from analysts who have a vested interest via relationships to broker-dealers to be optimistic. Moreover, clients never want to hear that stocks are going down, that valuations are stretched, or that risk is high. The industry capitalizes on that by seldom saying such things. History shows that no matter how stretched valuations get, analysts invent new metrics to justify stock prices. Remember the concept of tracking "click counts" instead of revenues for dot-com companies? How about the "Gorilla Game" and Pro-Forma earnings? Now its "stocks are cheap relative to bonds". For further discussion, please consider The Question "Are Stocks a Screaming Buy Relative to Bonds?" Creates False Premises We also see the old-standby regarding "forward PE's". Analysts do not care how ridiculous those PE's are or that earnings are a function of $trillions in stimulus. Nor do analysts care that bank earnings are blatantly fraudulent and based on mark-to-model fantasies not marked-to-market reality; nor do analysts care about the sustainability of those earnings. Note that rating agencies fraudulently marked pure garbage "AAA" because the more garbage they rated AAA, the more business they got. This all boils down to a simple statement of fact: Analysts do not care about sustainability of earnings, about valuations, about mark-to-fantasy, about currency risks, about risk in general, or about anything at all because they make more money by not knowing and by not caring if they do happen to know. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific. 
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| Missing the Big Picture Part II Posted: 26 Jan 2011 12:03 PM PST In FCIC Investigation Misses the "Big Picture" I made the case that the cause of this crisis is
Barry Ritholtz responded with an email "We agree about ultra-low rates, but I have seen no credible evidence that "Fractional lending" was a causal factor; Nor have I found any evidence that the deficit as a cause of the credit crisis" He also commented on my post in The Crisis Was Caused by [Insert Pet Peeve Here]. Let' focus on Barry's main rebuttal: Never mind that this form of credit creation has been around for centuries, he is a vociferous critic of it. Yep, Fractional Reserve Lending is centuries old. However, what kind of logical rebuttal is that? The fact is FRL has caused problems for centuries. The best example is the John Law Mississippi Bubble. However, FRL has arguably made every bubble in history worse. The idea that something cannot be a problem because it has been around for a long time is preposterous. So why do we have it? FRL has suited the interests of bankers and politicians. That is why it has been around for centuries. Indeed, inflation and credit expansion benefit those with first access to money: banks, the wealthy, and governments (via increased taxes, especially property taxes and sales taxes). Those at the bottom of the economic totem pole get hammered. In regards to deficit spending, the fact remains that it cheapens the currency and fosters a flight to assets like stocks or housing. This adds to the problems of FRL. Cheap money eventually makes its way into the economy and a flight to asset mentality takes over. We saw that in spades with housing. Instead of looking at the root problem, people expect regulation to stop the effects of cheap money. The idea is silly if a few minutes of logical thought processes are spent analyzing the situation. Public-Union Time Bomb Secondly, and this does not pertain to Barry but others commenting on his post, I never said public unions are the cause of all problems. In fact it is ridiculous to see such allegations given I just clearly stated the Fed and FRL is. I have certainly said that public unions have destroyed cities and states, and they have. Indeed, public unions are the #1 problem cities and states face. Pensions are $3 trillion in the hole at the state level alone. I do not have an accounting of how much bigger the problem is at the city level but it is gigantic. Might I point out that with a stroke of a pen, President Kennedy authorized collective bargaining of public unions. The result has been an increasing power grab by unions getting in bed with corrupt politicians demanding untenable salaries and benefits over the years. Most see the crisis now. Very few have traced it back to a regulatory move by Kennedy, a move designed to buy politicians votes, and it did. It has bought corrupt politician votes ever sense. Now states are in a crisis level, and people ignore the problem and the cause as if bankers created that mess. Well bankers did not create that mess. Unions using tactics of coercion, bribery, and fear-mongering got us to this sorry state. Such actions are just what one should expect as a function of exponential systems. People do not see the problem until it is too late. Are Humans Smarter than Yeast? Here is a video Bernanke needs to ponder with his 2% inflation target, and the World Economic Forum with its 4% GDP target and 6% credit growth target. After playing the video, think about China's 10% target with its economy overheating already. Most importantly, think about public union pension plans with expected annualized rates of return at 8% per year! Please play that video to the end. It gets better as it progresses. In FRL credit-based fiat systems, credit expands until the system blows up. History proves it, and no regulation has ever stopped it. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific. 
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| Marc Faber on Investing Opportunities for the Short-to-Intermediate Term Posted: 26 Jan 2011 10:57 AM PST Here is an interesting video of Marc Faber on Bloomberg about politicians in general, Obama specifically, and about investment themes for the next few months. Here's the link on Bloomberg in case that video does not play: http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=aGQI_w8IwQnU Points Faber Emphasized
The Bloomberg interviewers repeatedly tried to put word in Faber's mouth he never said, or remove words that he did say. For example, the Bloomberg interviewer dropped the word relative with statements like "You would advise investors to invest in the US." That happened 2-3 times, forcing Faber to reiterate the opinion that US stock would likely go down, they just may go down less. In regards to treasuries, the Bloomberg interviewer quipped "You said US treasuries are a suicidal investment causing quite a stir. ... Marc, things are better than they were a couple years ago, how is that Fraud?" Faber replied "If you print money, and you have huge fiscal deficits, it would be horrible if the data isn't any better than it is. So we have a crack-up boom. The question is, how sustainable is it and how healthy is it? It's all money printing and fiscal deficits. One day the burden of these deficits will have to be paid by someone. … The economy is like a drug addict and you are not going to solve this by injecting more drugs." It was a good performance by Faber in spite of the interviewer's efforts to twist his statements by dropping the word "relative" and by failing to distinguish between the near and long term. Faber handled it well, laughing when those things happened. On one occasion, in reference to Obama, Faber joked that the interviewer was an optimist. In general, I am in agreement with Faber, including the outperformance of the US stock market on a "relative" basis for a while. However, I am much more bearish on US equities over the long haul than is Faber. In regards to treasury bonds, there may easily be one more push higher in yields before we see a good buying opportunity. Shorter durations are safer for now. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific. 
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| Posted: 26 Jan 2011 12:35 AM PST The Financial Crisis Inquiry Commission (FCIC) held 19 days of hearings interviewing 700 witnesses and just released a 576-page book of its findings. The FCIC concluded the Financial Crisis Was Avoidable. The 2008 financial crisis was an "avoidable" disaster caused by widespread failures in government regulation, corporate mismanagement and heedless risk-taking by Wall Street, according to the conclusions of a federal inquiry.What Caused the Financial Crisis Barry Ritholtz at the Big Picture Blog discusses "causes" mentioned in the New York Times article above. Please consider Barry's article What Caused the Financial Crisis
Missing the Big Picture I cannot dispute any of those points. They are all correct. Yet every one of them happened as a failure "of" regulation, not a failure "to" regulate. The actual cause of the financial crisis is easy to explain.
Had there not been Fractional Reserve Lending, and had the Fed not cut interest rates to absurd levels while fostering a "too big to fail" attitude at banks, this would not have happened. Perpetual Congressional budget deficits and the Fed's willingness to finance those deficits too cheaply is icing on the "what happened" cake. To expect smart regulation from those who did not see it coming, the Fed and nearly all of Congress, is preposterous. Moreover, had there been (by some miracle) regulation to prevent the housing collapse, liquidity would have flowed somewhere else and there would have been a bubble in some other thing. Regulatory Failures
Every one of those is a failure "of" regulation, not a failure "to" regulate. The US government has no business sponsoring housing and if there was no Fannie or Freddie, there would be nothing to regulate in the first place. Look at what solar energy regulation produced in France. The story is not financially earth-shaking. But it is typical of what one should expect from regulation. Bear in mind I am not against all regulation. I certainly do not want people shouting fire in movie theaters or polluters to poison my water. Laws against robbing banks are quite fine too. I even agree with Glass-Steagall because the intent to to build a firewall to prevent fraud. However, and as a side note, Glass-Steagall would not have done anything to prevent this crisis. Glass-Steagall would not have stopped securitizations, rating agency fraud, liar loans, excessive leverage or anything else of merit. In short, regulation designed to preserve property rights, human rights, and safety are fertile grounds for reasonable types of regulation that have a high probability of success and will do minimal damage if written poorly. Cogs in the Wheel of Financial Destruction Please note the allegation that credit-rating agencies were "cogs in the wheel of financial destruction." I agree with that idea completely. However, the rating agency cog is one of the biggest failures "of" regulation you can find. I discussed the issue at length in Time To Break Up The Credit Rating Cartel. If Moody's, Fitch, and the S&P got business based on how accurate they were, and competition was opened up, the problem with rating agencies would go away overnight. If you read my article you will see that is the way rating agencies used to work. However, the SEC came along, demanded that all debt be rated, and instead of getting paid on how well they did their jobs, the rating agencies got paid on the volume of business they did. This of course created an incentive to give high ratings to everything to get more business. The only thing that needs to happen to fix the rating agency problem is for government sponsorship of rating agencies to end. Fannie Mae and Freddie Mac Regulation created Fannie Mae and Freddie Mac as well. The first thing any regulator in his right mind would do to Fannie and Freddie now is shut them down, yet they still exist. Does anyone even remember why these agencies were created? Here is the reason: To foster affordable housing. Did it work? Amazingly, now that home prices are falling, everyone wants to prop up home prices. No one really wants affordable housing nor did they ever want it. Politicians only want to appear as if they want affordable housing. That promise buys votes. What About Leverage? Look at the blame placed on leverage. Do we need a mountain of regulation to rein in leverage or do we need to kill Fractional Reserve Lending? I suggest the latter. Regulators in Bed with Those they Regulate Here is a pair of interesting findings in the report:
You can have all the regulation in the world but it will but do a damn bit of good if the regulators get in bed with those they are supposed to regulate. How are you supposed to fix that? A super-regulator to regulate all the regulators? Hopefully that sounds idiotic (because it is), but that is exactly what some have proposed. Can You Get Good Regulation in the First Place? Before the worry about "who might get in bed with who" even comes up, there is a presumption that you can get good regulation in the first place. Can you? Please consider these points from the report:
Here we have an interesting situation where Greenspan, Bernanke, Paulson, and sponsors of financial institutions in Congress (notably Barney Frank), are supposed to write financial regulation that will work, when none of them could see the crisis coming, nor would they listen to anyone who did see it coming! Yet, everyone is screaming for more regulation. The whole idea sounds preposterous because it is preposterous. Preventing the Last Crisis Nearly everyone is running around like headless chickens screaming for more regulation to prevent another housing crisis. They don't have to. We will not have another housing crisis like this for decades if ever, whether another piece of housing regulation is written or not. The Next Crisis I do not know what the next financial crisis to bring the global economy to its knees will be, but here are five likely candidates
Please note that not a damn thing is being done about any of those except the first one. Even then, regulators are avoiding the only thing likely to offer a permanent solution: writedowns of sovereign debt. Instead the EU is inflating money supply hoping to avoid the one thing likely to help! The problem is we have a massive amount of debt that cannot be paid back, which means that it won't be paid back. With that we have come full circle with still more rock solid evidence that the root cause of this mess is as I stated above (with a few small refinements to take in the global nature of the crisis).
Sustainability of Exponentially Growing Systems Finally, I have not seen any of the bloggers screaming for more regulation discuss a crucial point I made recently regarding the sustainability of exponentially growing systems. Here are the pertinent posts.
Will financial crises go away until the exponential problem is addressed? I think not, yet no one is even discussing the issue. To show you how screwed up things are, Bernanke openly endorses exponentially growing systems with his inflation-targeting proposals. So you can write all the regulation you want and it will not do a thing if credit or price inflation (as Bernanke wants) is growing at an exponential rate. Instead, most regulation will simply increase problems just like the creation of Fannie Mae or the humorous solar energy regulation did in France. The rest of it will be ignored by regulators in bed with the industries they are supposed to regulate, assuming of course the regulation was written properly in the first place, which is highly unlikely given Congress and high ranking officials did not see this coming. Regulation is the Cause of the Crisis, Not the Solution Barry Ritholtz at the Big Picture Blog is a bright guy. He is one of the few who saw this coming. He wrote a good book about the crisis. This post is not an attempt to take any of that away. As I said at the outset, I do not disagree with any of the points he made in his post. My only dispute is those points miss "The Big Picture". The Big Picture is that regulation is the cause of this crisis not the solution. The solution involves abolishing the fed and putting the US on a sound financial footing. In turn, that means we need to kill fractional reserve lending. If we fail to do that, Bernanke specifically, and central bankers in general, will cause the next financial crisis by supporting exponentially growing systems that cannot possibly be sustained. No regulation other than reversing the regulation that created the Fed, then abolishing fractional reserve lending can possibly prevent the next crisis. Are Humans Smarter than Yeast? Here is a video Bernanke needs to ponder with his 2% inflation target, and the World Economic Forum with its 4% GDP target and 6% credit growth target. After playing the video, think about China's 10% target with its economy overheating already. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific. 
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