January 23, 2013
- Killing the bearer of bad news: Feds silence the first rating agency to call BS on Uncle Sam (but maybe not completely!)
- George Bailey back in business? Mainstream catching on to Chris Mayer’s case for smaller banks
- Higher dividends, lower taxes: How some of our readers skated past the fiscal cliff… and why it’s not too late to join them
- The total destruction of the Japanese yen: Amoss on how it will change investment flows
- When central bankers laugh… reader skewers “overcredentialed blind groupthink proponents”… why Argentina’s worse than we let on… and more!
Well now… Maybe this will stop U.S. Treasury debt from being downgraded.
To avoid any further harassment by the Securities and Exchange Commission, the boutique rating agency Egan-Jones will stay out of the business of rating government bonds and asset-backed securities for the next 18 months.
Longtime readers know of our fondness for Egan-Jones, whose business model lies far, far away from the Big Three — S&P, Moody’s and Fitch. “Its analysts,” Addison wrote in Apogee Advisory three years ago, “are paid by the buyers of the securities it rates, not the issuers. What a novel idea!”
Or as author William D. Cohan wrote at Bloomberg last year, Egan-Jones is “the one rating firm not on Wall Street’s take.” This independence freed Egan-Jones to be rather more honest and forthright when issuing its ratings.
It also opened up the firm to the potential for retribution.
No, we can’t prove a cause-and-effect relationship. But we can quickly run down the sequence of events, documented every step of the way here in The 5…
- Jul. 18, 2011: Egan-Jones downgrades U.S. Treasury debt from AAA to AA-plus, citing “the relatively high level of debt and the difficulty in significantly cutting spending.” The move pre-empts S&P’s much more famous downgrade by nearly three weeks
- Apr. 17, 2012: Days after a further Egan-Jones downgrade to AA, a story turns up in The Wall Street Journal saying the SEC granted Egan-Jones approval to rate bonds and other securities in 2007 “despite having serious concerns about the firm’s internal procedures and staffing levels”
- Apr. 25, 2012: The SEC files an “administrative action” accusing Egan-Jones of “material misrepresentations and omissions” when filing its 2007 application
- Sept. 20, 2012: Egan-Jones, undeterred by the SEC, reacts to the Fed’s launch of QE3 by further downgrading Uncle Sam to AA-minus.
Which brings us to the present moment. Egan-Jones, evidently eager to make the whole thing go away as quickly as possible, agreed yesterday to cease rating government debt and asset-backed securities through July 2014.
Presumably, the ban will not apply to the joint venture Egan-Jones launched last October with China’s Dagong and Russia’s RusRating. That’s because the trio had the foresight to headquarter the venture in Hong Kong. Heh…
The SEC, meanwhile, can get back to the important business of surfing the Web for porn and forwarding tips about genuine securities fraud (i.e., Madoff) to a full voice mailbox.
The major U.S. stock indexes are a mixed bag this morning. The Dow is adding points to yesterday’s latest post-2007 high. The S&P is down a bit, the Nasdaq up a bit.
Both the Dow Transports and the Russell 2000 hit all-time highs yesterday. Both indexes are in modest retreat as of this writing.
Precious metals are pausing for breath – gold at $1,68, silver at $32.20. Crude sits at $96.31.
“I still like banks,” said Chris Mayer at our editorial meeting last week.
We should clarify. Chris is one of the reformed bankers on our team. In 2011, he started making the case for his readers that smaller banks — not the too-big-to-fails — are attractive investment opportunities. And he began making the case here in The 5 last summer.
Now the Dallas Fed has stepped forward with a similar thesis. “A multipart series from the bank,” reads a Yahoo Finance story, “advocates the idea that community banks, or those with no more than $10 billion in assets, were better off in terms of loan quality than the global banking giants during the financial crisis and that they now should be encouraged to flourish, rather than be encumbered by unneeded regulations.
“One of the pieces in the series argues that local banks make better decisions on loans because they can truly get to know the businesses in their area. The smaller firms ‘tap direct knowledge of customers, going beyond the credit scores, financial statements or other quantitative assessments on which their larger competitors depend.'”
Nice to see the Fed catching on. Meanwhile, Chris’ readers have piled up double-digit gains in a niche sector of the small banking business — one of them jumping 86% over the last two years.
It’s not too late to get in. One of his more recent recommendations — going back to last September — turns out to be the top dividend grower in the entire banking sector.
“SNL Financial reports that only 22 banks have increased their dividends by at least 4% per year since 2007,” says Chris by way of explanation.
“This was a tough time for banks, as I don’t need to remind you.” The top performer was one of Chris’ picks. Its dividend has grown 312% since 2007. “The firm purchased two failed banks in 2012 and paid a special $1 dividend. It’s a great little package that should reward us over time. Still a buy and still a great price.”
This banking niche is one of Chris’ favorite “special situations” right now. For access, look here.
“Uncle Sam always gets something from everyone,” says our new income specialist Neil George. But Neil is on the case of another niche sector that can help you keep the IRS’ take to a minimum — even with higher tax rates on dividends.
“Passthrough investments,” says Neil, “are shares in operating companies in varied industries and businesses that pass through the majority of their profits to shareholders and, in the process, do not have to pay corporate income taxes. The industries include real estate, natural resources, transportation and other businesses with larger capital assets that generate large cash flows.
“So investors get the majority of profits in some cases, such as those involving real estate — U.S. federal law mandates that 90% is the minimum that has to be paid out. And in many cases, the payout is much higher.
“Passthroughs include partnerships, limited partnerships, master limited partnerships, investment trusts and limited liability companies. But generally, all of these behave the same. They are structured under U.S. tax code to own high-capital assets that generate cash flows that are paid out to their shareholders without the consequences of double-taxation, and the publicly traded ones trade right on the major U.S. stock exchanges.”
“It shouldn’t be a surprise to learn that these shares perform well,” says Neil, getting to the most important point.
“For in just the past 10 years alone — as measured by the Alerian MLP Total Return Index — passthroughs have generated a return in excess of 381%, equating to an average annual return of over 17%. This has dwarfed the general market as measured by the S&P 500. And this is continuing so far this year — despite the initial gains in the S&P 500:
What’s the catch? “In the case of sheltered dividends, that amount that isn’t taxable as current income is reduced from the cost of buying the shares in the first place. So if and when you might sell, you might have to pay capital gains taxes — which should be less than ordinary income tax rates.”
Higher dividends, lower taxes: What’s not to like? For access to the names and tickers of Neil’s favorites, give this a look. Bonus: The income you pull in can help you defray the rising cost of filling your gas tank.
“The Bank of Japan just took a big step in its quest to destroy the yen,” says our Dan Amoss. “It’s now targeting an inflation rate of 2%. Starting in 2014, it will purchase an unlimited amount of bonds to reach this goal.
“Prime Minister Shinzo Abe called the BOJ’s announcement ‘a bold review of monetary policy, an epoch-making document.’ What he really meant to say is ‘Thanks, Gov. Shirakawa, for throwing me a bone on the 2% inflation target. Now the stage is set for my new central bank governor to break out the big monetary guns when I appoint him in 11 weeks.'”
Markets interpreted the BOJ announcement as disappointing, but the real action is yet to come, Dan suggests. “Former BOJ Deputy Gov. Toshiro Muto, a top contender to be the next governor, said even the most radical measures to create inflation shouldn’t be off the table. ‘I don’t think it’s right to consider any possible measure as taboo, as the flexibility or boldness of monetary policy will be lost,’ Muto said in a recent interview.
“Japanese investors are starting to recognize the danger of hoarding yen deposits and government bonds,” Dan concludes.
Those Fed governors… What a bunch of cut-ups.
Moments before we went to virtual press on Friday, we noted the release of transcripts from the Federal Open Market Committee’s August 2007 meeting. The assembled worthies appeared clueless that subprime mortgages would fail to be “contained.” Days later, the global financial system showed early signs of locking up, and the Fed made emergency moves to “inject liquidity.”
“The transcripts provide a word-for-word recitation of what people say at the FOMC meetings,” writes former Chicago Fed economist Bill Bergman, “and they also provide notations for intervals when what people say provokes laughter around the room. The transcript reads “(Laughter)” when these moments arise.”
Evidently, the laughter became more frequent as the housing bubble blew ever bigger. Mr. Bergman has gone to the trouble of tallying the appearances of “(laughter)” in every available FOMC transcript going back to 1999:
Granted, this doesn’t tell the full story. Fed meetings — and thus, the transcripts — have been getting longer over time. So Bergman also calculated a ratio of “(laughter)” appearances relative to the number of pages in each transcript.
We’ll spare you the figures and jump to his conclusion: “FOMC meetings have been getting more laughterlike over time, even heading into the worst economic and financial crisis since the Great Depression. From 2004-06, amid a developing bubble in housing and credit markets, things were apparently getting very funny.”
Next year, we get the 2008 transcripts — including six emergency meetings held that year. Perhaps the humor will be of the gallows variety…
“Double duh duh?” a reader writes after Dan Amoss observed in this space last week that “few central bankers understand that the economy is not a machine to be fine-tuned with printing operations.”
“Except for the University of Chicago,” our reader says, “is there any other graduate-level economic program that doesn’t teach the myth of the ‘science’ of economics that can be managed by simply tweaking a few settings on the fuel injectors?
“The current crop of economists is nothing more than overcredentialed blind groupthink proponents.
“And as for the CPI — how about The 5 launching a campaign to eliminate this malarkey and use the price of gold in dollars as the official indicator of inflation?”
The 5: Hmmm, which literary allusion do we want to invoke here? Don Quixote tilting at windmills? Or the little boy futilely pointing out The Emperor’s New Clothes don’t exist?
“The situation in Argentina is significantly worse than indicated in The 5,” another reader writes, “as any investor in YPF or Repsol can tell you.
“Recently, the Argentinian government nationalized (stole) the interest of the large Spanish oil company Repsol in the Argentinian oil company YPF, based on a series of contrived pretexts. That had the effect of destroying the stock value of both Repsol and YPF. But for some reason, the last time I looked, YPF is still allowed to list on the NYSE and is quoted in the U.S.
“The world hasn’t evolved as much as we would like to think, and much of South America is still a corrupt banana republic, including especially Argentina. You might want to look at this one. It’s sheer theft.”
The 5: We spotted it at the time. “The nationalization has not yet had the effect the government wanted,” The Economist reports this week by way of following up.
“In the third quarter of 2012, YPF’s production of oil barely grew, while its output of natural gas fell by 2% and profits were down by a third, compared with the same period in 2011 (when the company was hit by strikes).”
Repsol, meanwhile, is still waiting for the $10.5 billion it claims in compensation. Presumably, the accountants aren’t counting it on the books under receivables…
Cheers,
Dave Gonigam
The 5 Min. Forecast
P.S. Email gremlins attacked Agora Financial headquarters yesterday, but we’ve beaten them into submission. Nearly everyone should have gotten The 5 in spite of the glitches on our end, but in case you missed it you can catch up at this link.
P.P.S. “Must-see TV,” says Big Picture blogger and Vancouver stalwart Barry Ritholtz of last night’s PBS Frontline. Titled “The Untouchables,” it explored why not one senior Wall Street banker has been prosecuted for the blatant frauds that preceded the Panic of 2008.
Frontline is on after your editor’s bedtime, so it will have to wait for online viewing this weekend. But one question cannot wait: “The real mystery from all this,” writes Guardian blogger Glenn Greenwald, “is that it has not led to greater social unrest. To some extent, both the early version of the Tea Party and the Occupy movements were spurred by the government’s protection of Wall Street at the expense of everyone else…. Far less injustice than this has spurred serious unrest in other societies.”
So why has it not? Shoot us your thoughts here.