Real Crash 2014
Messing With The Bull
Posted by Peter Schiff on 02/08/2013 at 11:45 AM

With the announcement this week of its massive $5 billion lawsuit against ratings agency Standard & Poor's, the Federal Government took a bold step to squelch any remaining independence of thought or action in the financial services industry. Given the circumstances and timing of the suit, can there be any doubt that S&P is paying the price for the August 2011 removal of its AAA rating on U.S. Treasury debt? In retaliation for the unpardonable sin of questioning the U.S. Treasury's credit worthiness, the Obama Administration is sending a loud and clear message to Wall Street: mess with the bull and get the horns. Shockingly, the blatant selectivity of the prosecution, however, has failed to ignite a backlash. But as the move violates both the spirit of the Constitution and the letter of the law in so many ways, I can't help but look at it as a sea change in the nature of our governance. Call it Lincoln with a heavy dose of Putin.   

Given the nature of the U.S. economy during the housing mania of the last decade, charging S&P with fraud is like handing out a speeding ticket at the Indy 500. Like nearly every other mainstream financial firm in the world at the time, S&P believed that the U.S. economy rested on a solid foundation of accumulated housing wealth. By 2006, the housing market was closing out one of its best decades in memory. Developers, speculators, financiers, real estate agents, bankers and even ordinary Americans had become charmed by the easy wealth of serial home purchases. The party had been orchestrated by a cadre of politicians and regulators who wanted to keep the party going and take credit for the good times.

To a degree that few Americans understand even to this day, it was not irresponsible lending, bad ratings, or excess greed that finally doomed the mortgage market, it was the simple fact that national home prices started falling. As long as prices stayed high, refinancing would have been open to borrowers, and defaults would have been manageable. Among the hordes of analysts, academics, and reporters who covered the market there were few if any standing who believed that national home prices could fall of a cliff. I know this to be true because I spent many years trying, unsuccessfully, to warn them.

From 2005 to 2008, I made scores of appearances on national television and at investment conferences around the country in which I stated that national home prices were set to decline by at least 30% and that the resulting mortgage defaults would devastate the financial sector and bring down the economy. I may have just as well been arguing that pink unicorns were about to resurrect the Soviet Union. At the 2006 Western Regional Mortgage Bankers conference I told attendees that many highly rated mortgage-backed securities, including some rated AAA, would become worthless. My debate opponent claimed that such predictions only come to pass if "an atomic bomb landed on either Los Angeles, Chicago, or New York!"

The idea that home prices could decline at all, let alone by 30% was considered beyond serious consideration. The models used by the banks, investors, government agencies, academics, and rating agencies predicted that national home prices would continue to rise, or at least stay stable. They were ALL wrong. Calls for even a 5% decline would have put S&P in the extreme minority. I know because I WAS that extreme minority and would have noticed any company joining me.   Absent such opinions, the analyses put out by S&P, Moody's, and Fitch were justifiable. So why pick on S&P? Perhaps because the other two agencies never downgraded U.S. government debt.

As proof of S&P's institutional culpability, the Justice Department provided a few e-mails sent by S&P analysts during the final stages of the housing bubble. The messages contain cynical awareness that the mortgage market was built on a house of cards. So what? To avoid guilt would S&P have to prove 100% agreement among all employees? The company readily admits that it reached its opinions through a consensus and that feelings within the firm varied.  Opinions are, by definition, nuanced and varied. During the years before the crash I received emails from many people who agreed with me but who said that their friends and co-workers believed that they "were nuts" for harboring such fears. I lost count of how many people told me that  I was nuts. Many of these e-mails could have come from S&P analysts.  

At most, S&P was guilty of a culture of complacency and group think. Ironically that spirit was engendered by the bizarre regulatory environment created for ratings agencies by the government itself. In 1973, in order to "protect" investors from unregulated markets, the SEC designated certain ratings firms as "Nationally Recognized Statistical Ratings Organizations." Thereafter, only bonds rated by sanctioned firms could be purchased by pension funds and federally insured banks. Before that time the ratings agencies were paid for their advice by bond investors. As the rule change limited the abilities of investors to choose who to ask, the ratings firms began charging bond issuers instead. This arrangement meant that interests of investors would be subordinated. In any event, the law may have mandated who could perform ratings, but it did not require anyone to take them seriously. Any decent portfolio manager recognized this conflict of interest and performed their own due diligence.

The problem was when it came to housing mortgage bond buyers who were just as clueless as the ratings agencies.  In fact, even those few buyers who knew the party would end badly, decided for themselves to keep dancing until the music stopped. It's completely hypocritical to sue the band after-the fact. Given that the SEC required investors to use these ratings agencies, should not the Justice Department be suing them instead?

The 2011 downgrade came as the government passed a weak and inconclusive patch to the debt ceiling crisis. Now, a year and a half later, we see that they have slithered out of that poorly constructed straight jacket. With the new debt piling up faster than ever, and the government showing itself to be blatantly incapable of making hard choices, it should be clear to anyone with a half semester of accounting that the Treasury debt should be downgraded. Yes the government has a printing press, but that only means that the value of the bonds will disappear through inflation rather than default. S&P was far too lenient. 

Smaller ratings agency Egan Jones (which never had the official sanction of S&P) issued harsher reports about government debt, and they have also been duly punished for their candor. In 2011 the other major ratings agency, Moody's, argued that the fiscal cliff deal agreed to by Congress and the President improved the country's fiscal position and forestalled any need to downgrade Treasury debt. However, since we never actually went over that conveniently erected fiscal cliff, why has Moody's not responded with a downgrade? Perhaps they want to stay out of court? 

Let's hope that it is still possible to get a fair hearing in a U.S. court of law, even when squaring off against the biggest and most powerful opponent the world has ever known. But even if S&P wins, we have all already lost. If it survives it will only do so after incurring huge legal bills and seeing its share price slashed. It's a foregone conclusion that no more downgrades will be coming.    

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show. 

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Tags:  Ben BernankeStandard and Poortreasury
Twist Paves the Way for QE III
Posted by Peter Schiff on 09/23/2011 at 1:33 PM

Earlier this week the Federal Reserve ignited a firestorm in the global markets by admitting that the U.S. economy is facing downside risks. Although it continues to sugar coat the unpleasant reality, never has such a stunningly obvious statement resulted in so much turmoil.

Once again we are seeing the knee-jerk market reaction to seek refuge in the perceived safety of the U.S. dollar and U.S. Treasuries. However I expect investors will soon discover that such assets are firmly in the eye of the storm.  As the tempest moves on, those enjoying the dollar's current stability may soon find themselves battered by a category five monster.

Market disappointment was compounded when the Fed failed to follow up its dire outlook with a new round of quantitative easing (QE). Instead, through a policy entitled "Operation Twist" the Fed promised to sell $400 billion of short-term Treasuries and use the proceeds to buy an equivalent amount of long-term Treasuries. The markets evidently perceived this "balance sheet neutral" policy as too timid.

From my perspective, the Twist really amounts to another Fed "Hail Mary" pass that will fall short of the end zone. But, by putting the squeeze on banks and further restricting credit availability to small business the move will likely do more harm than good.

The policy rests on the false premise moving already historically low interest rates even lower will stimulate the economy into recovery. But low interest rates are part of the problem, not part of the solution. 

Even by the government's debased standards, trailing headline inflation is already hovering above 4%, and, at current rates, 30-year Treasuries are negative by 100 basis points. This distortion is inflicting untold damage on the economy. Pushing rates further into negative territory seems only to invite more problems in the future.

With the Twist, the Ben Bernanke wing of the increasingly divided Fed is offering debtors the short-term gain of low long rates in exchange for its own long-term pain of limited balance sheet flexibility and diminished power to deal with surging inflation. By selling on the short end (thereby pushing up short term yields) and buying on the long end (thereby pushing down long-term yields), the Fed will flatten the yield curve. But to attain these insignificant benefits, the plan exposes the Fed, and the economy, to great risks.

First the "benefits": Mortgage rates are already at generational lows and have recently lagged the declines seen in long dated Treasuries. Is it reasonable to believe that mortgage rates will go much lower as a result of this policy?  Even if they do, what would be the net economic benefit of a new refinancing wave? Do we really want to encourage consumers once again to use their homes as ATM machines? Even if they do, any short-term boost in consumer spending would be transitory and counter-productive to a genuine recovery.  The last thing we want to encourage is more spending, particularly on the imported products that would likely be purchased by those who refinanced. 

What's more, the program will actually increase borrowing costs for small businesses. By increasing the cost of short-term borrowing and lowering returns on long-term loans, it will severely pressure the profitability of the beleaguered financial sector. In other words the borrower's gain is the lender's pain. In such conditions, should we expect banks to provide more credit to small business? In fact, the move will be a devastating blow to bank balance sheets and further enfeeble a financial sector on life support.  Business credit will instead be diverted to dead end consumer spending, resulting in less business activity to grow the economy and create jobs. 

Now the costs: The Fed severely underestimates the danger of loading up its own balance sheet with long dated securities. Not only does the move expose the Fed to severe losses when interest rates inevitably rise, but it drastically reduces its ability to withdraw liquidity to fight inflation. Short-term securities provided flexibility as they could be sold into a falling market with little price risk, or if need be, held to maturity. Such options do not exist with bonds maturing in 6-30 years. So when inflation continues to rise, as I'm sure it will, the Fed will be powerless to slow it without crushing the bond market and causing yields to soar.

In any event, the markets did not want the Twist program, they wanted additional liquidity injections in the form of QE III. In this respect, the market is like a heroin junkie. It needs ever-greater doses of money to continue moving higher. When it gets its fix, it will rally.

But a growing popular mistrust of stimulus is currently pressuring the Fed to forestall the launch of QE III. But a few more whiffs of financial turbulence could cause the Fed to fold. When the market rally ensues the Fed will claim victory.  But the celebration will be hollow. The nominal gain in stock prices will likely be eclipsed by dollar declines and a more rapid gain in gold, oil, or other commodity prices. The result for investors will be higher nominal portfolio values but lower real purchasing power and a reduced standard of living.

But many of those who oppose QE3 do so because they believe the economy doesn't need more stimulus not because the stimulus itself is causing the economic weakness. As a result when the economy deteriorates, support for QE III could grow. In the end QE3 will likely be far more popular than another bank bailout (possibly to be called TARP II), which may be on the table if the Fed fails to rescue the banks it may be pushing over the edge with the Twist.

But our zombie economy does not need to be perpetuated by more QE. It must be allowed to die so that a living, breathing, self-sustaining economy can replace it. By feeding our addiction now the Fed is impeding the recovery. QE may goose the markets and provide a short-term boost to spending, but it will also increase debt and grow the government. This process exacerbates the structural imbalances underlying the U.S. economy, making what may be the inevitable crash that much more spectacular. 

Tags:  Ben BernankefedGeithneroperation twistqetreasury
ANDREW SCHIFF: The Center of Gravity Shifts Slowly
Posted by Andrew Schiff on 08/05/2011 at 1:39 PM

To an extent not fully appreciated by the investing public, financial markets are influenced by human emotion just as much as they are by economic data, corporate earnings, and dividend yields. Of all human motivations, fear is perhaps the most powerful. When people get scared, the "fight or flight" instinct forces us to take action.


Simple dangers prompt simple responses. If we unexpectedly encounter a bear on our driveway, we immediately run into the house and call animal control (or, in the country, grab the shotgun). But it's harder to know what to do when financial danger stalks the stock market. To be honest, most investors are clueless. Is that really a bear? Is it dangerous? What qualifies as a house?


When confronted with fear AND confusion, investors tend to look around to see what other people are doing - hoping that others know something they don't. This is a big part of our natural and instinctive drive to seek safety in numbers. When financial markets panic, investors follow the herd. If the herd does something illogical, like buying US Treasuries when they pay almost no yield and when the government is essentially bankrupt, it is evidence that people have decided to seek safety in numbers.


But here's the thing: this herd doesn't have a leader. As much as we would like to think that there are rational, or sinister, individuals who decide where the herd goes and how fast it will take to get there, in reality, we just have a center of gravity around which the herd coalesces. Individuals may make an impact but the mass has a mind of its own. The center of gravity does move, but it tends to do so glacially.


As a result, we can expect that market movements in the current correction will largely resemble past corrections. However, there will be slight differences, which should be studied intently to determine where the center of gravity is drifting. It's particularly important to notice where the herd is seeking safety. 


Yesterday's sell-off in the US markets saw the the S&P 500 lose 4.8% of its value. The Dow's loss was, at 513 points, the biggest one day drop since December 2008. It capped a horrific 10-day plunge that knocked more than 10% off stock prices overall.


The carnage has many investors queasily recalling the nightmare days of the credit crunch of 2008. In one particularly brutal phase of that crisis, between December 16, 2008 and March 9, 2009, the S&P 500 sold off more than 25%. Fear drove investors to seek safety in traditional havens. During that time, the US dollar rallied by 8.4% while foreign currencies sold off heavily, including a 9% dip in the Australian dollar and a 3% haircut for the vaunted Swiss franc. Gold rallied 7.4% during that period, but failed to beat the dollar's run up.


The next major correction in stocks showed a slightly different result. Between April 23, 2010 and July 2, 2010, the S&P 500 dropped 16%. During that time, the dollar rallied just 3%. Notably, this time around, the Swiss franc did not sell off, but rather rallied by about 1%. More importantly, gold rallied nearly 5%, taking from the US dollar the title of "fear asset of choice."


These trends have gained momentum in the current sell-off. From April 29, 2011 to August 4, 2011, the S&P 500 lost 11.3%. During that time, the dollar managed just a skimpy .3% gain. Meanwhile, the Swiss franc jumped almost 13% and gold surged 5.6%. It does appear that the crowd has changed at least some of its assumptions. It no longer runs blindly into US dollars. It considers other options.


There are many theories as to what moves the herd's center of gravity. Here, I don't think it's much of surprise. Since 2008, a steady drip of news stories have highlighted the staggering indebtedness of the US government, the unwillingness of its policymakers to confront the crisis, and the stubborn persistence of economic stagnation in the face of growing inflation. Although the dollar is still regarded as a place to go when the going gets rough, that opinion is not as strong as it was in the days before our economy imploded and our government became the economy itself.


I would expect the broad trends outlined here to continue. As economic data continues to disappoint, look for the stock market to continue to fall. If the drop goes too far too fast, look for an early launch of the next round of quantitative easing. QE3 may help stabilize stock prices, but it will further erode confidence in the US dollar. As a result, when the next panic hits, look for the dollar to perform that much worse than it did this time around. 


Although the dollar's doom is clearly written on the walls, the center of gravity in the financial world has moved very slowly and will likely continue to do so. Fortunately, for our readers, the direction of the movement is clear. Thus, we are positioned well in front while Wall Street brings up the rear.

Tags:  reservestreasury
The Treasury Auction Shell Game
Posted by Peter Schiff on 03/24/2011 at 9:31 AM
Very few people have either the time or patience to sift through the data released by the Treasury Department in the wake of its bond auctions. But the numbers do provide direct evidence of the country's current financial condition that in many ways mirror a financial shell game that typifies our entire economy.

Despite continued deterioration of America's fiscal health, the Treasury is still attracting adequate numbers of buyers of its debt, even with the ultra low coupon rates. Market watchers take these successful auctions as proof that our current monetary and fiscal stimulus efforts are prudent. But who's doing the buying, and what do they do with the bonds after they have been purchased?

Most people are aware that foreign central banks figure very prominently into the mix. They buy for political reasons and to suppress the value of their currencies relative to the dollar. And while we think their rationale is silly, we don't dispute that they will continue to buy as long as they believe the policy serves their own national interests. When that will change is harder to determine. But another very large chunk of Treasuries go to "primary dealers," the very large financial institutions that are designated middle men for Treasury bonds. In a late February auction, these dealers took down 46% of the entire $29 billion issue of seven year bonds. While this is hardly remarkable, it is shocking what happened next.

According to analysis that appeared in Zero Hedge, nearly 53% of those bonds were then sold to the Federal Reserve on March 8, under the rubric of the Fed's quantitative easing plan. While it's certainly hard to determine the profits that were made on this two week trade, it's virtually impossible to imagine that the private banks lost money. What's more, knowing that the Fed was sure to make a bid, the profits were made essentially risk free. It's good to be on the government's short list.

Given that the Treasury is essentially selling its debt to the Fed, in a process that we would call debt monetization, some may wonder why it doesn't just cut out the middle man and sell directly. But the Treasury is prevented by law from doing this, so the private banks provide a vital fig leaf that disguises the underlying activity and makes it appear as if there is legitimate private demand for Treasury debt. But this is just an illusion, and a clumsy one to boot.

Tags:  fedquantitative easingtreasuriesTreasury
The Treasury Department's Racial Favoritism
Posted by Ira Stoll on 10/19/2010 at 11:44 AM

The Treasury Department this morning announced plans to sell another 1.5 billion shares of Citigroup common stock: "Treasury currently owns approximately 3.6 billion shares of Citigroup common stock and expects to continue selling its shares in the market in an orderly fashion. The sale of 1.5 billion additional shares of Citigroup common stock, as authorized pursuant to the fourth trading plan, would bring Treasury's holdings of Citigroup common stock to approximately 7 percent of total shares outstanding — down from a high of approximately 27 percent."

What caught my eye in the bottom of the press release, though, was the news that "As part of the disposition program, Morgan Stanley agreed to provide opportunities for involvement by small broker-dealers, including minority- and women-owned broker-dealers. Morgan Stanley has entered into agreements with the following 12 broker-dealers: Cabrera Capital Markets, LLC; Great Pacific Securities, Inc.; Guzman & Company; Kaufman Bros., L.P.; Loop Capital Markets; M. Ramsey King Securities, Inc.; Mischler Financial Group; M.R. Beal & Company; Sturdivant & Co. Inc.; Valdes and Moreno, Inc.; The Williams Capital Group, L.P.; and Wm Smith & Co."

An earlier Treasury press release gives details on the 12 firms:

Cabrera Capital Markets, LLC is a Hispanic-owned full-service broker-dealer headquartered in Chicago, IL. Cabrera specializes in the execution of domestic and international securities for institutional financial customers whose client base includes unions, governments, corporations, hedge funds, and foundations and endowments.

Great Pacific Securities is an Institutional full service broker-dealer located in Costa Mesa, CA that has been certified as Service Disabled Veteran-owned for 20 years. Great Pacific provides domestic and international trading capabilities in equities and fixed income securities.

Guzman & Company is a Hispanic-owned broker-dealer headquartered in Coral Gables, FL. Guzman & Company is a member firm of the NYSE that provides top-ranked, agency-only program and block equity trading, and fixed income trading, underwriting and analytics, to the nation's leading investment managers, plan sponsors and financial institutions.

Kaufman Bros., L.P. is a Hispanic-owned and operated full service investment bank and broker-dealer based in New York, NY. KBRO delivers proprietary research, advisory and sales and trading services to issuers and institutional clients including multi-strategy hedge funds, mutual and pension funds and private equity funds.

Loop Capital Markets is an African American-owned full service investment bank and brokerage firm headquartered in Chicago, IL. Loop Capital Markets provides capital solutions for corporate, governmental and institutional entities, including financial advisory services, equity, taxable and tax-exempt securities sales and trading, and analytical services.

M. Ramsey King Securities, Inc. is a Native American- and woman-owned broker-dealer based in Burr Ridge, IL. M. Ramsey King facilitates agency-only individual and program executions for domestic and international securities on behalf of institutional clients.

Mischler Financial Group is a Disabled Veteran Business Enterprise (DVBE) Broker-Dealer headquartered in Corona Del Mar, CA. Mischler provides financial services in equities, fixed income, and cash management to state and local governments, financial institutions, insurance companies, hospitals, universities, private and public pension funds.

M.R. Beal & Company is an African American-owned full service broker-dealer headquartered in New York, NY. M.R. Beal specializes in municipal, corporate finance and equity execution for institutional clients including U.S. corporations, state and local government, and not-for-profit entities.

Sturdivant & Co. Inc. is an African American-owned agency broker-dealer based in Voorhees, New Jersey. Founded in 1988, the firm specializes in providing highly rated boutique-like large, mid and small cap equity research and execution services, including algorithmic program trading, commission recapture, transition management and equity underwriting services.

Valdes & Moreno, Inc., founded in 1994, is a Latino-owned broker-dealer based in Kansas City, Missouri focusing on institutional and retail investors alike. The business of the firm includes financial advisory and underwriting services for issuers of corporate and municipal securities, liquidity management and private equity in the socially responsible investing space for institutional investors, as well as a broad range brokerage services for retail investors.

The Williams Capital Group, L.P. is an African American-owned full service broker-dealer based in New York, NY. Williams Capital provides equity, taxable and tax exempt fixed income, corporate finance and investment management services to institutional and corporate clients.

Wm Smith & Co. is a woman-owned broker-dealer based in Denver, CO. Wm Smith provides special situations fundamental equity research on 13D Filings and Insider Transactions, capital markets, and sales and trading services to institutional clients.

I can understand and sympathize with the impulse behind these sorts of programs. Rather than simply cutting government checks to disabled veterans or historically discriminated against minority groups, it's better to help them build businesses, which generate jobs and real wealth, the argument goes.

The other side of the argument, though, is that in a situation such as the Citigroup share sale, the government ends up choosing its business partners based not on who can get the best sale price on the stock for the taxpayers, but on the race, gender, or disabled veteran status of the owners of the firms. The minority-owned firms wind up marketing themselves not primarily on their excellence but rather on their minority status: Look, for example, at the home page of the Mischler Financial Group Web site or of Kaufman Bros. Many of the individuals involved were well on their way to success via Ivy League educational institutions before getting any help from these preferences for minority-owned businesses; Kaufman's CEO, Benny Lorenzo, for example, has a Harvard MBA, while the Williams Capital Group's Christopher Williams has an MBA from Dartmouth's Tuck School of Business. Getting certified as a minority or women-owned business is a time-consuming process that can involve spending lots of money on well-connected lawyers. And sometimes a second injustice is committed in an effort to rectify an initial injustice. Suppose a child of Carlos Slim, according to Forbes the world's richest man, moved from Mexico to America and set up a Hispanic-owned broker-dealer. Should that firm get a preference over one begun by the son of a poor Italian-American janitor?

Disentangling America from Citigroup is a complicated matter in its own right. Righting or rectifying America's historical record of discrimination is also a complicated matter in its own right. Trying to combine the two in one transaction seems like it's asking an awful lot.

The Treasury press releases don't disclose how much money this business will end up being worth to each of the firms.

Ira Stoll at Future of Capitalism

Tags:  CitigroupTreasury
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