- Where the next financial crisis will start
- Ponzi finance the “experts” didn’t see coming… but you will
- Ray Blanco handicaps the race for the next lucrative hepatitis C drug
- The failing backstop for traditional pensions
- Waiting on the Fed… newspaper reporters doubling up as delivery people… epic reader rant about, well, we’re not sure… and more!
The following chart is flashing a warning… a warning two of our editors want to bring to your attention.
Iron ore prices have collapsed more than 40% this year. Yesterday, they fell 3.8%. to a five-year low. The catalyst — news that new home prices in China have dropped year over year in 67 of 70 major cities. China is a huge factor in the iron ore market, importing 75% of its supply.
Even the clueless elite media are piecing the puzzle together: “In some ways,” said yesterday’s Financial Times, “China today resembles Japan in the early to mid-’90s or the U.S. in 2007-08 on the eve of their respective financial crises, both triggered by overvalued property.”
The problem is these stories are relegated to the inside pages, despite eye-popping details.
To wit, a story from page C4 of The Wall Street Journal on Oct. 27: It said several big European banks were on the losing end of a $475 million loan, thanks to fraud. Money quote, from an understandably anonymous bank executive: “It was a surprise to all the banks. We didn’t know.”
“Of course they didn’t know,” snarks our recovering banker Chris Mayer. “How could anyone suspect there would be fraud in China? Let’s see, there are only about half a dozen lenders involved in a suspected fraud case at Qingdao Port. Those lenders are in for a billion dollars. There’s also the case of Nomura. It lent $60 million to a Chinese shoe company just months before the CEO disappeared… along with the money.”
“The debt problem in China is not hype,” says our Jim Rickards, editor of Rickards’ Strategic Intelligence.
“The collapse of the debt and property bubble there could well be the catalyst for a global economic crisis,” Jim tells an interviewer at International Finance Magazine.
“About 45% of Chinese GDP is infrastructure investment, and a substantial portion of that is wasted on nonrevenue-generating and unneeded projects and financed with unpayable debt. This debt is funded in part through wealth management products (WMPs).”
We brought WMPs to your attention earlier this year. We’ll refresh your memory about what they are and why they matter momentarily…
“The next financial crisis will begin in China,” says Chris Mayer — not to put too fine a point on it.
“In China, ‘shadow banking’ has quadrupled in size since 2008. The definition can vary, but generally, a shadow bank is a lending institution that does not have the public backstop that normal banks do. (Read: a lifeline from the central bank.) They can also use greater leverage and evade certain regulations.”
Key to the shadow banking system are trusts and WMPs. “These are vehicles you can invest in that will then pay you a higher interest rate than a bank deposit will. The problem is people tend to think these are as safe as bank deposits.
“In fact, owning them is about as safe as swallowing a box of nails,” says Chris.
“Trusts, for instance, use a lot of leverage. The average is about 40 times for the largest trusts.
“To show you how fragile a 40-times leverage ratio is, let me use an analogy. Imagine you owned your house at 40 times leverage. That would mean for every $100 of value in your house, you’d have just $2.50 of your own money in it. In such a case, just a 2.5% drop in the value of the house would mean you’d suffer a 100% loss of your equity.
“The WMPs are just as bad. To an investor, they look like time deposits. But they pay higher rates because they take your money and invest it in risky loans to small businesses. Worse, according to professor Yan Liang at Willamette University, shadow banks often issue new WMPs to pay off old ones and dodge reporting bad loans. It’s like a big Ponzi scheme.”
And then there’s the sheer growth of loans in China. “For six years in a row,” says Chris, “China’s banks have extended net new credit.”
That’s new credit to the tune of $5 trillion — per Hong Kong-based researcher Charlene Chu, who spoke at a conference in New York Chris attended.
But for all that credit growth, China is slowing down — hence the falling property prices, hence the falling iron ore prices. Chu calls into question the huge divergence between the banks’ financial data and reality on the ground. “I was in Beijing a couple of weeks ago,” she said. “Across the board, everybody is expecting a slowdown.”
“China’s bust will be nasty and shake global markets to the core,” Chris concludes.
“Big credit problems don’t go quietly into the night. Authorities, even Chinese ones, have no magic wands to wave and make problems go away.
“I would treat Chinese investment ideas as if they have Ebola. Stay away from China. Stay away from firms lending money in China.
“Those are easy steps. More difficult is to predict the ripples a financial crisis in China would create. Commodities China buys heavily — like iron ore, oil, copper and potash — would seem to be vulnerable to disappearing demand.
“I have no doubt China will be a much bigger economy in 10 years. But that doesn’t mean investors have to make money, especially foreign ones.”
[Ed. note: Chris is only days away from taking the wraps off a project he’s had cooking ever since he left the banking industry more than decade ago. I’ve been sworn to secrecy about the nature of this project, but I can let on this much: While there’s no “sure thing” in investing, Chris has identified the “next best thing.” Stay tuned…]
Stocks are drifting lower as traders mark time until the release of minutes from the Federal Reserve’s October meeting. Those are due out around the time this episode of The 5 hits your inbox.
As we write, the S&P 500 is off a half-percent from yesterday’s record close, to 2,041.
Indeed, nearly every asset class is selling off this morning: Treasury prices are falling, sending the yield on a 10-year note up to 2.35%.
And gold has put $1,200 in the rearview again, down to $1,182. Can’t blame it on dollar strength — the dollar index is up only a smidge, to 87.7. Crude is back below $75, at $74.69.
If you’re lucky enough to have a traditional pension plan, don’t expect the government to backstop it if anything goes wrong.
The Pension Benefit Guaranty Corp. — think of it as the FDIC of pensions — is now running a $62 billion deficit. That’s nearly double last year’s figure, and it’s the highest in the agency’s 40-year history.
Blame it on the worsening finances in multiemployer plans of the sort that unions set up with several companies at once.
No, the agency didn’t name any names. Of course not. But PBGC Acting Director Alice Maroni said this: “Plans covering over 1 million participants are substantially underfunded, and without legislative changes, many of these plans are likely to fail.”
Meanwhile, the PGBC’s plans for those workers are on the road to insolvency in another 10-15 years. After that, any make-goods on failing pension obligations will come directly from the federal budget. Good times…
Before year-end, we’ll know whether a new competitor will emerge in the red-hot market to treat hepatitis C.
Back in June, we told you how hepatitis C infects 150 million people worldwide and kills 350,000 each year. Late last year came a breakthrough, a drug called Sovaldi from Gilead Sciences. “Gilead owns this market, and it charges a high price,” says Ray Blanco of our tech team.
“Gilead hasn’t made many friends by charging $1,000 for a pill. Payers, whether public or private, have balked at the high cost and are looking for alternatives. There are even rumors of patients being ‘warehoused’ in wait for new drugs from other developers. I don’t know the truth in these rumors, but the fact that they are circulating points to, I think, a major market need for a more affordable therapy.”
Ray has his Technology Profits Confidential readers in a smallish player teamed up in a lucrative deal with the pharma giant AbbVie. “An FDA decision is expected by the end of the year,” he says.
We had no idea times were this tough in the print newspaper biz.
The Orange County Register had a storied history during decades of ownership by the Hoiles family — even taking a stand on the editorial page against the internment of Japanese-Americans during World War II.
These days, the paper is in the hands of out-of-state investors. And reporters are being asked to help with home delivery of the Sunday edition.
Until recently, the Register had a deal with the Los Angeles Times for delivery services. Then the contract ran out. Now all Register employees have been offered $150 gift cards if they deliver between 500-600 papers.
“It’s strictly voluntary,” editor Rob Curley tells Reuters.
Bonus points: The Register still owes the Times $2.5 million in fees from when the delivery contract was still in effect.
“You guys are as superficially wretched as it gets,” writes a reader.
[Oh, this is going to be good.]
“Yes, house flippers are back,” he writes after our episode on Monday, “that slice of profitunist has been spamming me for years, who offer nothing useful to the marketplace beyond lining their own wallets, should be 1) outlawed, 2) castrated, 3) shot and tossed in unmarked graves)… so Americans can get some relief from the artificially high prices and cost-of-living stresses those amoral punks help to create.
“Word up: The buyers are institutional hedge funds mainly, disenfranchising homeowners who can’t keep up, thanks to globalism’s outsourcing of U.S. jobs.
“And if I recall some of your readers’ comments (‘It’s not about patriotism, it’s about profits’… or ‘Money goes where it’s best treated’)… you are collectively responsible for the general malaise of U.S. economy’s crappy conditions.
“That nice new door that washed up on the beach didn’t just happen, it was manufactured overseas by slaves. But keep lying by omission when it serves your interests, if anyone deserves a good beheading…”
The 5: Ummm…
A couple of thoughts: We’d love nothing more than to see the Fed, Fannie, Freddie and all the rest go out of business so a comfortable home could be bought for one or at most two times annual income.
We’d also love nothing more than to indulge in a diet of pizza, Fritos and chocolate and pay no consequences.
Meanwhile, a valid point about institutions buying up single-family homes. But that trade’s been blowing up on them for, well, years. That’s why they packaged up the houses as real estate investment trusts (REITs) that you can buy on the stock market.
Every one of those REITs has been a turkey. Did you buy in? Is that why you’re so mad? (We advised readers to stay as faraway as possible.)
“Oy!” a reader inveighs. “Watch it with what you say about those Sprint ‘framily’ commercials,” a reader writes after yesterday’s episode.
“Possibly just an idiot, but I loved those goofy ads. The little blonde girl was cute. Maybe there’s a spot for the ex-chief marketing officer in Hollywood.”
“I wonder,” muses our final reader on the subject of Obamacare, “if ‘Pajama Boy’ is afraid to go home for Christmas?”
The 5: Heh… good one.
Best regards,
Dave Gonigam
The 5 Min. Forecast