Banking Record, Washington Spends, Psychological Shift, Major CDS Event, Data Disaster and More!

by Addison Wiggin & Ian Mathias

  • U.K. sets serious record… the drawbacks of nationalization exposed
  • Obama budget dwarfs even the worst of G.W.… $1.75 trillion deficit for 2009
  • Eric Fry notes an important swaps benchmark… U.S. more likely to default than IBM?
  • Chris Mayer on a “major psychological shift” in the markets
  • Data disaster… durable goods, jobless claims, new home sales get slammed

  The Royal Bank of Scotland lost $34.7 billion in 2008 — the biggest corporate loss in the history of the United Kingdom.

And the loss came AFTER the British treasury quasi-nationalized the bank with a $30 billion injection.
“Last year was undeniably tough,” said RBS Chairman Philip Hampton, “and a worsening economic environment means that 2009 will present significant challenges in all of our markets. The path to recovery will be neither smooth nor straight."

RBS also unveiled a restructuring plan that pulls the bank out of emerging global markets and focuses its business in the U.K.… a locale already awash with banks and one of the most defunct developed economies in the world.

  Nouriel Roubini suggested over the weekend, "We are still in the third and fourth innings… of a severe banking and financial market crisis — and it’s getting worse."

  “I suspect the majority of banks in the West will be nationalized,” writes our friend Puru Saxena from Hong Kong with a stern warning . “This would mean a total catastrophe for those who invested in bank stocks or corporate bonds. So no matter how strongly your broker pushes you to load up on ‘cheap’ financial stocks, please DO NOT go ‘bottom-fishing’ in this bankrupt industry.

“Banking is no longer a growth industry and financials will disappoint investors for many years.”

“Further, if you have any exposure to hedge funds, structured products, accumulators or derivatives of any kind, I sincerely urge you to get rid of all this highly toxic garbage. Such Ponzi schemes were very good for the private bankers (due to the huge amounts of commissions involved), but they are a disaster waiting to happen. Today, our planet has roughly US$600 trillion worth of derivatives, and this is roughly 10 times the size of the global economy!

“Please get rid of your derivatives-based ‘investments’ immediately.”

  Trying to avert nationalization, FDIC chairwoman Sheila Bair announced this week that her wing of the government will embark on a six-week “stress test” of the 19 largest U.S. banks.

Apparently, they plan to set up a war games simulator, where testers will decide if each bank could withstand further economic contraction and double-digit unemployment.

Question: Hasn’t the market already administered this test? After all, you can now buy two shares of Citigroup for less than a gallon of milk.

“The markets need to calm down,” Bair replied, suggesting that she’s simply trying to figure out “what type of additional capital investments the government may need to make."

  President Obama’s team leaked their updated budget for the rest of the fiscal year this morning. Oy. Do you really want to read these figures?

We’ll try to take it easy on you: For starters, they’re projecting a record-setting $1.75 trillion budget deficit. The highlights include a $750 billion “placeholder” for more potential financial bailouts/takeovers in addition to the $700 billion already allocated, a “down payment” exceeding $635 billion for health care reform and $140 billion more for U.S. warmongering in the Middle East.

  The Federal Reserve will launch an $800 billion program of their own this week.

First up? The Term Asset-Backed Securities Loan Facility (TALF 2.0). The program aims to resuscitate the asset-backed securities market, which flat-lined in November 2008. The Fed will loan as much as $200 billion to those brave enough to buy and hold securities backed by student, credit and auto loans.

Another $600 billion will go straight to Fannie Mae and Freddie Mac, your friendly neighborhood mortgage enablers. The Fed plans to buy Fannie and Freddie debt hand over fist in hopes of dragging down mortgage rates and kick-starting the housing market.

  “The cost of buying a five-year credit default swap (CDS),” notes Eric Fry this morning , “to insure against the possible default of U.S. Treasury bonds reached 100 basis points for the first time yesterday. In English, the price of insuring $10,000,000 worth of Treasury bonds for five years now costs $100,000 — up from just $5,000 one year ago.

“Your editors do not exactly know what the 20-fold jump in CDS prices means, but we are pretty sure we know what it does NOT mean. It does NOT mean that the U.S. government is becoming MORE creditworthy.

“As the nearby chart indicates, the price of insuring Treasury debt against default now costs more than the price of insuring the debt of almost any AA or A+ rated company in the country. In other words, the Treasury is not quite as AAA as it should be, according to the buyers of credit default swaps.

Pepsi and IBM are now more creditworthy than the U.S. government. How do you say “holy crap” in Chinese?

  There seems to be only one guy in Washington who seems to have a real problem with all this, and he’s clearly having a hard time getting anyone’s attention.

(Love that video… the reaction of the CNBC hosts makes it.)

  Befuddled stocks investors continue to be cautious. Most of the market was bummed out by the usual suspects yesterday, including a way-worse-than-expected existing home sales report . But then a sudden rise in energy prices (see below) gave oil and gas stocks a kick in the pants, thus limiting the carnage.

In the end, despite a late-session rally, the Dow and S&P 500 ended down about 1%.

  “The last 10 years gives us a stark portrait of what’s done well and what hasn’t,” Chris Mayer begins. “And we’re starting to see a major psychological shift in where investors want to put their money as a result.

“In short, people seem to have had enough of stocks. They’re moving into bonds. Oddly, and as strange as it sounds, this inflection point just might be the turning point for stocks. Put another way, investors as a group just got the last 10 years wrong. Thinking in contrary fashion, they may get the next 10 years wrong as well.

“Stocks, as a group, have not done well now for 10 years. As of yesterday, if you had put $10,000 in the S&P 500 10 years ago, you would now have about $6,200 — a loss of 38%. And it’s worse than that considering the effects of inflation. If you look at bonds, they’ve done much better. The Merrill Lynch U.S. Corporate Master index, a measure of high-grade debt, for instance, has gained 58% in the last 10 years.

“So the stock market has been cut in half… and NOW these advisers are all cheerleaders for the bond market. Already this year, bond funds have added some $15 billion to their assets. Last year, investors took out nearly $200 billion from their stock mutual funds.

“The best deals become available during times like now. That much is a fact. I’m not saying it’s easy. I’m not saying all stocks will rise. Some of them are going to go to zero. Some of them are never going to come back. But some of them are great businesses and have great assets that will certainly come back at some point.

“Looking over my watch list right now… I’m looking to recommend stocks with a price-to-earnings ratio greater than 5 and/or a stock trading for more than 50% of replacement value or net asset value (NAV).”

  In the data patch today… ugh, it’s getting ugly .

  First out today: Initial jobless claims rose to 667,000 last week, the worst since 1982. Continued claims for unemployment benefits continue their horrid trend… a record 5.1 million people are on the unemployment tab.

  Moments later, the Commerce Dept. said orders for durable goods fell for a record sixth straight month in January. Orders for items meant to last at least a couple years fell 5.2%, twice as bad as the Street forecast.

  And at 10 this morning, we saw the worst new home sales data in recorded history. Sales of new houses plunged 10% from December to January and 48% annually. That brings us to a yearly pace of 309,000, easily the lowest level since the Commerce Dept. started keeping track in 1963.

The median home price crashed over 13% year over year, to $201,100. Despite a record 13.3-month glut of new home inventory, builders began work on new homes at an annual pace of 466,000 houses during the month. Umm… guys… maybe it’s time to stop?

  All these lousy data, all of it worse than anticipated… naturally, the market opened up over 1% this morning.

  Continuing to parade around as the best-looking horse in the glue factory, the dollar remains near yesterday’s levels. In fact, the dollar index has been tending up since Monday, and now goes for 87.4.

  Yesterday’s gold sell-off continues today. As we write, the spot price is down about $40 from yesterday’s high, to $935 an ounce.

  Oil, on the other hand, has taken off in the later half of this week. The front-month contract busted through resistance at $40 a barrel yesterday after a surprising Dept. of Energy inventory report. The government said gasoline demand was on the rise again and crude oil investors weren’t growing quite as fast as Wall Street anticipated. Crude closed at $42 yesterday.

Traders then tacked on another three bucks this morning. The UAE promised to cut crude supply to Asia in April, a sign OPEC may cut output worldwide. The world’s most pernicious cartel meets again in March.

  “I’ve got some questions that I really need some intelligent answers for,” writes a reader. “I’ve been reading The 5 Min. Forecast every day for over a year (the movie and book were decent, by the way), so I understand what you’re saying about the national debt and not spending more.

“But I still don’t know where I stand on the ‘banks too big to fail’ debate. Aren’t they? You say the big banks shouldn’t be bailed out, and it’s easy enough to see why. The incentives that doing that creates are not in our best interest. Could you paint a picture of what would happen if a Citigroup or a Bank of America failed? What if they both failed? In a ‘real’ free market, I don’t believe we’d be in this position.

“However, we have only a semi-free market and these banks were aided by the low interest rates and poor regulation that helped them grow out of control. They became addicted to cheap money and now you say we should stop them cold turkey. I don’t necessarily disagree, but I can’t help but wonder what would happen to the economy on a macro level if you let one or more of these mammoth banks fail. The only picture that’s been painted has been of economic Armageddon.

“Is this the case, and are you saying that would be better than a bailout?”

The 5: We’re not necessarily saying they should fail or that they should be cut off cold turkey. We’re saying the government can’t fix this mess. When it keeps failing banks alive on life-support, they reward bad behavior and punish good. And they’re changing the rules of the game midstream. No one knows what’s going to happen next. It’s rule by men, fickle and unsure, rather than the rule of law.

What’s the alternate scenario? It wouldn’t be pretty, either. The bad banks would have to declare bankruptcy and restructure. Speculators, unwittingly or otherwise, would lose their collective tuchis. But those who’d planned accordingly would be stronger. And consequently would be in a better position to pick up the pieces and rebuild. You have to ask: Who would you rather have making decisions about the future?: People who carelessly wrecked the financial system… or those who were smart enough to get out of the way?

Would better regulation have prevented a meltdown? Fannie and Freddie, two of the biggest players of the mortgage-backed securities market, were chartered by Congress, propped up by Barney Frank and the House Banking Committee and had their own special oversight committee. In 2005, at the height of the housing boom, you couldn’t have found a more heavily regulated group of actors in the economy. On the way up, no one cared… in fact, they even covered up Enron-style accounting shenanigans to keep the two giants in business. What’s worse, as we reported many times during those years, Fannie and Freddie became the model for doing business in the mortgage market and spurned acolytes like Countrywide.

Our argument is more of a question… if the market is not allowed to correct bad decisions, who will?


Addison Wiggin
The 5 Min. Forecast

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