The Big Picture |
- Did Greenspan Steal the Phrase “Irrational Exuberance?”
- 10 Monday PM Reads
- Conference Presentation: What is Driving Today’s Investors?
- Ask the Sketch Guy: Earn Your Returns
- What’s the State of the Economy?
- Japanese budget seems optimistic
- Inventory and the Low Equity/No Equity Homeowner
- 10 Monday AM Reads
- The True Cost of the AIG Bailout
- 10 Ways to Simplify Your Investing
- Back in the Saddle
- Godfather Collection, Coppola Restoration [Blu-ray] $20
| Did Greenspan Steal the Phrase “Irrational Exuberance?” Posted: 28 Jan 2013 04:40 PM PST
In other words, Greenspan cribbed Shiller’s phrase for his speech! Perhaps this explains why Shiller named his book “Irrational Exuberance” — he was taking back the phrase from Greenspan as his own. Fascinating stuff . . .
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| Posted: 28 Jan 2013 01:30 PM PST My afternoon reads:
What are you reading?
How Apple’s Fall Bit Bondholders, Too |
| Conference Presentation: What is Driving Today’s Investors? Posted: 28 Jan 2013 12:00 PM PST Saskatchewan CFA Winnipeg CFA |
| Ask the Sketch Guy: Earn Your Returns Posted: 28 Jan 2013 11:45 AM PST Source: NYT |
| What’s the State of the Economy? Posted: 28 Jan 2013 11:30 AM PST |
| Japanese budget seems optimistic Posted: 28 Jan 2013 11:18 AM PST The Japanese Parliament reconvened today. Details of their proposed budget for the fiscal year starting 1st April have been released. Total expenditures are expected to be Yen 92.6 Tn, with new government bond sales to amount to Yen 42.9 Tn and with tax revenues of Yen 43.1 Tn. The numbers do not add up, suggesting that further revenue receipts will come in. According to the budget, it will be the 1st time in 4 years that tax revenues exceed funds raised through the sale of bonds. The Japanese have assumed that the economy will grow by +2.5% next fiscal year, up from +1.7% previously, resulting in higher revenue generation. Nominal growth is expected to be +2.7%, up from +1.9% previously – no 2.0% inflation predicted there. Indeed, CPI is expected to rise to just +0.5% in the next fiscal year, though the 1st positive figure since 2008. GDP has been reduced to +1.0%, down from +2.2% previously, for the current fiscal year. The government intends to increase income tax and inheritance taxes on the wealthy. I believe, as do most analysts, that the governments growth targets are optimistic and, as a result, their assumption for tax revenues. Indeed, I believe that the eventual outcome is likely to be (materially?) worse. The government’s aspirations of a primary budget surplus in fiscal 2020 – well, lets just say thats optimistic, as well. Japan intends to sell its 1st inflation linked bond in almost 5 years; Overseas funds keep pouring into the Indian market. Some US$3.01bn of foreign funds were invested into the Indian market YTD till 23rd January. Inflows rose to US$24.5bn in 2012. Investors have been lured by the policies and general reforms introduced by the Finance Minister, though a number of these reforms have not been implemented, so far. Personally, I think that the optimism is overdone – a credit downgrade is likely and, as we head into next year’s elections, the government will become more reluctant to agree to and/or implement reforms. Furthermore, the market is not cheap – trading around a multiple of 15.9 times. In addition, the government is likely to privatise assets to raise funds to keep the budget deficit within its target, suggesting quite a lot of supply will be coming. However, in the shorter term, the RBI is likely to cut interest rates tomorrow by 25 bps to 7.75%, which should help markets. (Source Bloomberg); The Bank of Italy has approved a E3.9bn bailout of Monte di Paschi di Siena. However, this is unlikely to be the end of the matter and the "rescue" of this bank could well impact politically on the impending general elections, helping Berlusconi and his colleagues, whilst hurting Mr Monti and the current leader in the polls, Mr Bersani's Democratic Party. Recent polls suggest the Mr Bersani's DP will get 33.8% of the votes, with Mr Berlusconi's coalition in 2nd at 26.6% and Mr Monti on 12.8%. Mr Bersani and Mr Monti have dropped by 1 point, whilst Mr Berlusconi has gained a point. A politically unstable Italy, will be bad news for the EZ; US December new home sales declined by -7.3% to an annual rate of 369k homes, down from an upwardly revised 398k rate in November, and below the 385k annual rate expected. In 2012, builders sold a total of 367k homes, the most since 2005. Supply of new homes at the current sales rate is 4.9 months. Whilst December new home sales were lower than expected, home construction rose to an annual rate of 954k homes in December, with the median price up by +13.9% Y/Y. I continue to believe that the pace of building/sales will increase this year, which will provide continued stimulus for the US economy. The NAR advised that there were 1.82mn existing homes on the market in December, the lowest since January 2001; Increasingly, it looks as if the US$1.2 tn of proposed cuts to the US budget will be triggered, as sequestration looks like taking effect on 1st March 2013. Negotiations between Congress and the White House suggests that a compromise will prove impossible to agree. Of the US$1.2 tn, defence will be cut by US$600bn over the next 10 years, with the balance representing cuts in discretionary spending. It is estimated that sequestration will reduce US GDP by -0.75% this year; US durable goods orders rose for the 4th consecutive month by +4.6% M/M, higher than the 2.0% forecast and the +0.7% rise in November. A surge in aircraft orders impacted the numbers. Ex aircraft and defence, durable goods orders rose by +0.2%; December pending home sales declined by -4.3%, as opposed to a revised increase of +1.6% in November and worse than the unchanged expected, the 1st decline since August; Outlook Asian markets closed higher, ex Japan which was down -0.94%.European markets closed flat though Germany and Spain were lower. US markets are flat though the Nasdaq is trading higher. Government bond yields continue to rise – the US 10 year is currently yielding 1.98%, up over 25 bps since the start of the year. The Euro is at US$1.3456 (the French seem to be getting uncomfortable, following its recent rise) with the Yen pretty volatile and currently at Yen 90.80 having once again traded above 91. Gold is at US$1654, with Brent at US$113.25. Markets look remarkably complacent, though I continue to believe that they are overbought and due a correction. Kiron Sarkar |
| Inventory and the Low Equity/No Equity Homeowner Posted: 28 Jan 2013 09:23 AM PST Pending Home Sales index for December 2012 was released this morning. The data itself was mixed — down 4.3% from November (SA) but up 6.9% year over year. The index is a measure of housing contract activity, based on signed real estate contracts (existing single-family homes, condos and co-ops). The spin from the NAR is always amusing, and this report is no different. How the NAR framed this, and what it might mean going forward, is rather interesting. NAR chief economist Lawrence Yun made the following statement: “The supply limitation appears to be the main factor holding back contract signings in the past month. Still, contract activity has risen for 20 straight months on a year-over-year basis.“1 Yun is onto something, but he doesn’t seem to really understand what it is. Supply limitation is an important factor, but why supply is limited is an even more important factor. Understanding the inputs into this directional vector is significant if we want to discern where housing may be heading this year. Said differently, the factors underlying the limited supply matter much more than the supply itself. On the positive side:
On the negative side:
Those last two data points come from Jonathan Miller, who calls the current environment a “Pre-covery.”
There is the reason for what the NAR has correctly identified as the basis for falling prospective sales index: The lack of inventory. But it is not the kind of shortfall they think it is. It is not “If we only had more houses, we could sell them.” Rather, its more of “The lack of equity is causing both a lack of homes for sale and a lack of potential new buyers.” What fixes these problems? More Household formation, increased employment — and increased wages. As those three go, so goes Housing.
See also: Falling Inventory Has Created a Housing "Pre-Covery," not "Recovery" A New Housing Boom? Don't Count on It ___________________________ 1. Note that when home sales were falling, their emphasis was on monthly data, but let’s save that for another time.
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| Posted: 28 Jan 2013 07:00 AM PST My morning reads:
What are you reading?
Overbought and Oversold Markets |
| The True Cost of the AIG Bailout Posted: 28 Jan 2013 05:30 AM PST It Was Not a Free Lunch: The True Cost of the AIG Bailout
"If it's too good to be true, it probably is." This old adage came to mind on December 11, 2012 when the U.S. Treasury made the announcement, reiterated unthinkingly by the press, that the AIG bailout was coming to an end with American taxpayers making a tidy profit on the deal. In an effort to capitalize on the news, AIG has spent millions of dollars on a primetime ad campaign thanking America for the bailout, highlighting its success: "We've repaid every dollar America lent us. Everything, plus a profit of more than 22 billion." Unfortunately, this cleverly designed public relations maneuver deceives the taxpayer by distorting the perception of what has been a contentious use of government funds.
THE BAILOUT Readers may remember that AIG's bailout began on September 16, 2008. That day, AIG's stock dropped 60 percent at the opening of the New York Stock Exchange. Investors feared the imminent collapse of the insurance giant from a series of collateral calls on its derivative contracts. With a ratings downgrade the night before, AIG needed to deliver collateral of over $10 billion. Later that evening, the Fed created a 24-month credit-liquidity facility from which AIG could draw up to $85 billion in exchange for a 79.9 percent equity stake in the company. By May 2009, this and other programs of support from the Federal Reserve and the United States Treasury amounted to more than $180 billion. The White House, Treasury, and the Fed have never failed to remind the citizenry that the several bailouts of 2008-09 "succeeded" in the narrow sense that most of the nation's largest financial services firms survived. By contrast to these privileged firms, over 400 smaller banks were allowed to fail, millions of people lost their jobs, and millions lost homes to foreclosure, many of the latter in proceedings later found to be of dubious legality. We should also remember that when these bailouts were authorized, there was no clear expectation that the loans would be paid back in full. In fact, a report by Bloomberg revealed that a draft of a presentation summarizing the Treasury's proposed investments described them as "highly speculative." As things stand today, the Treasury has completely exited its AIG investment. Its December 11, 2012 sale of stock resulted, we are told, in the full recovery of the government's commitment along with an approximately $22.7 billion combined return for the Treasury and the FRBNY, marking an incredible reversal of the original expectation of catastrophic loses. Sadly, the Treasury's statements are highly misleading. In its accounting for the AIG bailout, the Treasury simply left out a number of salient facts when it announced that American taxpayers made a profit. Stated simply, we did not. The Treasury claims to have achieved a return of $5.0 billion, but neglects to mention that the Federal Reserve gifted them more than 500 million shares of AIG. Moreover, they simply ignored the unique and preferential tax treatment accorded to the company that is estimated to have inflated its share price by at least $5. Additionally, its estimates fail to compensate taxpayers for the true cost of capital or the risk assumed in its investments. After adjusting for the aforementioned factors, we find that the Treasury's investment in AIG was actually very costly for taxpayers. As mentioned, the bailout began on September 16, 2008. After a series of complicated restructurings and additional government support, the Fed's credit facility was repaid in full, including interest and expenses. By the time it was all over, the Treasury had acquired a 92 percent common equity stake in the company, which was sold over time subject to market conditions at an average price of $31.18. At least initially, the terms of the secured loan were designed to protect the interests of the U.S. government and taxpayer. Share Gifting Among the shares the Treasury sold were 562,868,096 gifted to them from the Credit Facility Trust. This trust had previously been established by the Federal Reserve Bank of New York for the sole benefit of the Treasury Department. When these shares are taken into account, only 65.99% of the total returns from the Treasury's sale of AIG common stock can be attributed to its original TARP investment, and the remainder should be credited to the FRBNY. The Treasury's calculation, however, does not adjust for this transfer of shares. The effect is to artificially boost the returns on its politically contentious TARP investment at the expense of the Federal Reserve. Not counting these gifted shares, the Treasury assumes a break-even price of $28.73, but if we examine its investment in isolation, the true break-even is $45.53. After adjusting all cash flows associated with sale of stock, the Treasury's profit of $5 billion becomes a loss of $12.7 billion. Deferred Tax Assets As is well known, AIG's rescue was necessitated by the enormous operating losses it had accrued by recklessly insuring mortgage-backed securities ("Net Operating Losses" or NOLs). Now, United States' tax law typically allows corporations to carry forward NOLs to offset future tax liabilities, but with one exception: "In general, the rules of section 382 apply to limit a corporation's ability to utilize existing net operating loss carryovers once the corporation experiences an 'ownership change.'" () Stated simply, if a company files for bankruptcy or is taken over, it sacrifices any pre-existing NOLs. For this reason, AIG should have lost its ability to carry forward these NOLs since a controlling stake in the company had passed to the federal government in the course of its rescue. In late 2008, however, the Treasury issued a series of IRS Notices regarding § 382, which stated that the rule did not apply to the government's investments—both its purchase and, within limitations, its subsequent sale of shares in private companies. () Consequently, AIG claimed "Deferred tax assets: Losses and tax credit carryforwards" of $26.2 billion and an additional "Unrealized loss on investments" of $8.7 billion in its 2009 Annual Report. An accurate evaluation of the Treasury's investment in AIG should incorporate the effects of this tax advantage. So, rather than an average sale price of $31.18, a more telling number would be the share price controlling for this preferential tax treatment. According to estimates by analysts at Bank of America and JPMorgan Chase, doing so would reduce AIG's share price by $5 to $6 dollars a share. ( ) If we were to adjust the sale price by $6 per share, the Treasury's return is reduced from nearly $5 billion to a loss of more than $5 billion. Compounding this adjustment with that from the shares gifted by the Federal Reserve described above, the Treasury's return is further reduced to become more than a $19 billion loss. When questioned about the rule bending, officials claimed AIG's tax benefit would help taxpayers by raising the insurer's share price. One might suppose that the federal government would come out close to even because, as the major shareholder, it was the primary beneficiary of this artificially inflated stock price. The drawback was that this tax-enhanced share price also benefited AIG's private stockholders and AIG executives, as the latter were heavily compensated through stock options. Damon Silvers, former member of the Congressional Oversight Panel for TARP explained, "By doing it this way…billions of dollars leak out to the benefits of private parties, who really should not be benefiting from public policy in this way." Most importantly for our purposes, "This special tax deal also masks the true cost of TARP by increasing the value of the government's AIG stock at the expense of future tax revenue." Discounting Returns Had the government actually earned the $5 billion profit that they claim, the bailout would appear to be a successful investment (although one might continue to raise questions of favoritism). However, adjusting for the level of risk and the "opportunity cost" of money in these investments drastically alters the picture. If the government were to extend a 30-year loan at a fraction of a percent of interest, and be repaid in full, it could claim to have made a profit. But this is not how accounting is ordinarily done. When evaluating an investment, it is necessary to take into account both the cost of capital, in this case the interest expense on Treasury bonds, and the level of risk assumed. For instance, if one were to discount the cash flows received by even the modest rate of 2 percent, the Treasury's return falls from roughly $5 billion to $1.5 billion. Moreover, the normal procedure would discount returns by a rate that also accounts for the level of risk implicit in the transaction. Let us recall that the government initially believed that its investments were "highly speculative." If, for instance, we were to discount returns by the initial rate charged by the FRBNY for the revolving credit facility (12 percent), the adjusted return would be a $10.8 billion loss before factoring in the tax advantage and gifted shares, and a $32.9 billion loss if we account for the latter. The latter number, we believe, is closer to the cost of the AIG bailout (so far). PROTECTING TAXPAYERS Finally, and beyond the three adjustments described here, a complete analysis of the government's investment in AIG would include the full range of social costs that are not typically captured by the profit and loss statement of a private firm. One would have to consider the cheap money the Federal Reserve used to keep the financial system afloat: one consequence of which is depressed rates for savers. Additionally, the government ultimately provided AIG and its counterparties with a sweetheart deal that, whether intended or not, in effect preserved and even exacerbated the problem of "Too Big to Fail" financial institutions and the perverse incentives and outcomes that such a doctrine promotes. The implications of this policy decision are as of yet unknown, but it is at least arguable that it has set the stage for the next financial disaster. CONCLUSION With the sale of the last of its stake in AIG, the Treasury has reported a $5 billion profit. Given the "creative" nature of the accounting used to derive this number, one is inclined to speculate on the motivations behind this announcement. Perhaps the Treasury hoped to reduce the public's anger over a series of bailouts that appeared to exhibit the worst features of crony capitalism. As described above, Treasury's estimate neglected to mention that approximately one-third of the AIG stock it sold came from the Federal Reserve rather than the initial TARP investment. Special tax treatment afforded uniquely and singularly to AIG also buoyed the share price — and will continue to provide AIG with billions of dollars in tax liabilities over the coming decade. The Treasury also failed to discount their returns by an amount even remotely reflecting the degree of risk involved. By including these omissions in the estimate it can only be concluded that the Treasury, and thereby United States' taxpayers, actually lost money in the course of bailing out AIG. |
| 10 Ways to Simplify Your Investing Posted: 28 Jan 2013 05:00 AM PST My Sunday Washington Post Business Section column from yesterday — Keep it simple, avoid the pitfalls — described 10 ways to keep your investing simple. Here are my 10 (plus 2 corollaries)
You can see the explanation for each of these here.
Avoid becoming these dudes: Source: |
| Posted: 28 Jan 2013 04:30 AM PST Back from a long week of travel in the frozen northern tundras. I have a lot of things on my agenda this week, and a few interesting posts coming up. Be back soon . . .
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| Godfather Collection, Coppola Restoration [Blu-ray] $20 Posted: 28 Jan 2013 03:45 AM PST
THE GODFATHER Plus these additional features: Featurette: "The Masterpiece That Almost Wasn't"
That is a ridiculous deal ! |
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