The Market Ticker

Gee, I thought the economy was improving?

SEPT CHICAGO PURCHASING MANAGERS INDEX: 46.1 V 52E
**sub-indices:
- Prices Paid: 51.3 v 50.0 last
- New Orders: 46.3 v 52.5 last
- Employment: 38.8 v 38.7 last
- Inventories: 38.9 v 27.5 last
- Supplier Deliveries: 49.3 v 54.6 last
- Production: 47.2 v 52.9 last
- Order Backlogs: 36.7 v 45.8 last

Let's see.... besides the topline miss, we have prices paid up (bad), new orders down (bad), employment up 0.1% (marginally better to flat), inventories up (bad if you're not selling 'em!), supplier deliveries down (bad), production down (bad) and order backlogs collapsing (really bad.)

I know it probably gets old, but I told 'ya you were smoking 'dem "green shoots"!

(Still bullish are 'ya?)

It was just a matter of time....

A global regulator would ensure that U.S. banks aren’t subject to tighter regulations than the rest of the world, Mack said. A push for regulation during the financial crisis has weakened as the administration of President Barack Obama pursues other tasks, he said.

Got it? 

The way this game works is that you find a significantly-large nation that is willing to allow all sort of accounting games and extreme leverage (cough-Germany-cough!) and then you whine and bitch because you can't get the same rules over here.

Heh, it worked for Paulson, right?  Remember that investment banks were limited to 14:1 leverage - until 2004 when Paulson went to the SEC and got them to lift the cap.

What was Lehman and Bear's leverage when they blew up?

Oh, and what is the actual leverage at Deutche Bank?  Does anyone know?  What are they holding on their balance sheet (and off), and does anyone know what their actual risk on those alleged "assets" are?

Nope.

The ECB-space banks are in many ways worse than ours in terms of disclosure. 

But what Mack wants, having been bailed out after running his organization at an untenable level of risk and leverage, is to be able to take on even more leverage and risk!

This sort of perversion must be stopped; if Mack doesn't like reasonable leverage limits (like 12:1, with no off-balance sheet exposures and everything marked to the market) then he should move to Germany.

I'll buy him a one-way first-class ticket - provided he renounces his US Citizenship and agrees to a permanent bar on ever entering this nation again on the jetway.

Here we go again.....

Sept. 30 (Bloomberg) -- CIT Group Inc., the commercial lender that has said it may be forced to file for bankruptcy, is considering an offer of financing from Citigroup Inc. and Barclays Capital, people familiar with the situation said.

The 101-year-old company’s bondholders are also seeking to provide about $2 billion in loans as a restructuring deadline approaches tomorrow, said the people, who declined to be identified because the negotiations are private. New York-based CIT may choose other options, the people said.

This would be the third time they've gone to the well this year - the previous being a $3 billion "rescue" back in July.

For those who are math-challenged this means they're running at a roughly $1 billion a month "burn rate" (to use a phrase from the old Internet Bubble); isn't "capitalism" grand?

The problem with this firm is that it shouldn't be in trouble.  "Factoring", which is the primary business CIT is engaged in, is usually an insanely-profitable enterprise.  So what went wrong?

Simple: They started eating the rest of the financial industry's cooking - the belief that they could branch out into various other forms of lending and ignore credit quality.  This put them squarely in the same box as the rest of the banks (except that unlike BAC, C and others, they haven't been allowed to cook the books and steal from the taxpayer!)

The result was technical insolvency. 

Now they're trying to stave off a full-on default and bankruptcy filing. 

It is unlikely to work.

Even if they strike a deal this week there's a nasty $2.1 billion line from Citibank and Bank of America (yes, really, two banks that themselves are insolvent on a mark-to-market basis!) that has to be paid in April of next year.  Where's that going to come from?

The irony of one insolvent entity borrowing from two more effectively-insolvent entities isn't lost on me.  This is really no different than finding that you can't make the credit card payment so you find someone who will "roll over" your credit card balance into a new card, and "whew!" - you don't have to make a payment on the "new" line for 30 more days.

This sort of shell game is really nothing different than playing "hot potato"; legal under the rules of accounting, but a clear sign of desperation by everyone involved.  The continued claims of economic improvement by the media and Washington have to be squared against the fact that debt defaults are not abating and ability to pay is not improving; indeed, we continue to see a pattern where people are simply "kicking the can" for another month or two, piling up yet more debt that they can't cover.

The back story that is not being talked about with CIT is that there's a major problem with many small and mid-sized businesses - they have fallen into the trap of "pulling forward" their financial condition.

Credit, when used to buy plant and equipment for productive purposes, can be a net positive for an enterprise.  When used to finance inventory in a heavily-inventory-laden business it is more dangerous, in that the failure to meet gross margins due to a bad guess on product mix and quantity can sink you.

Factoring is more dangerous still, in that one is giving up a percentage of the gross billed ticket in exchange for "money now."  When a business is driven to this sort of gimmickry it calls into question the viability of one's customers; if you have to pass the risk of slow (or no) pay customers to someone else, how viable is your company and its customer base?  Remember, the reason you "factor" is that you believe that the discount on that paper is less than you'd spend on a traditional credit line - or you can't qualify for that traditional line with your bank!

How long this goes on before someone finally throws up their hands and says "no more!" is difficult to determine - but the outcome is not.

All we're arguing over is the timing.

Following up on the quick mention now that I have a story to cite from Amherst:

Cure rates for these distressed loans remain low. Amherst noted a near 0% cure rate of all loans in foreclosure, 0.8% for 90 plus days delinquent, 4.4% for 60 days delinquent and 26.5% for 30-day delinquencies. All told, Amherst expects 12.42% of units (from the 13.54% of properties delinquent and in foreclosure) to eventually liquidate.

Let's put some numbers on this.

There are roughly 125 million single-family homes in the US.

Of those, roughly 30% have no mortgage on them at all.  This leaves 87.5 million single-family homes with mortgages.

Let us assume the average outstanding balance is $200,000 across the entire set and will take a 40% loss severity.  This is less than S&P has estimated for subprime loans and only assumes a roughly 20% market deficiency in the home price (the rest is from legal, rehabilitation and marketing expenses.)

These numbers are, with a high degree of confidence (90%+) low - that is, losses will exceed these estimates, perhaps dramatically so.  It is, for example, quite reasonable to believe that due to the concentration of defaults in higher-priced areas (e.g. California and Florida) that the average outstanding balance could be close to double that $200,000 value and the loss due to negative equity higher.

From this we can develop a "cocktail napkin" view of the losses to be taken in home mortgages for single-family homes (remember, this does not include condos, apartment buildings and similar "commercial" paper.)

$200,000 X 40% = $80,000 loss per foreclosure.

87.5 million homes with mortgages X 12.42% = 10,867,500 foreclosures.

10,867,500
x    80,000
=============
$869,400,000,000

or $869 billion in losses remaining in single-family mortgages alone.

What if the average outstanding is higher and negative equity greater than 20% (which is likely)?  Losses will almost certainly be well north of a trillion dollars.

The entire banking system and likely The Fed, given the quantity of Fannie and Freddie paper it has been and is "eating", is insolvent.  These facts are why the government is lying - they're well-aware of the near-zero cure rates and know that these facts mean that the banking industry has nowhere near sufficient capital to withstand these losses without folding like a paper cup getting stomped on by an elephant.

(Remember that these numbers do not include any commercial real estate losses and we have found that banks are frequently over-stating their claimed values for these loans by 50% or more - as was seen with Colonial.)

It gets better.  The FDIC has a negative balance both in its fund balance and the reserve ratio projected for the end of the quarter, which is, big surprise, tomorrow. Oh, and there is this pesky problem that the FDIC has - contrary to its mandate - been issuing bond guarantees for banks, so if and when that banking insolvency is recognized the FDIC will implode into a gravity well also, since it is on the hook for the entire deficiency of those bonds that were issued with its "guarantee" should they default.

Care to argue with the math folks?

You have to love the "moral outrage" expressed in articles like this:

The information that flowed from the banks, the ratings agencies, the regulatory agencies, and the mainstream media—the bedrock of the financial markets, in a sense—was viewed with great suspicion, and that created an opportunity for financial bloggers: a motley assortment of amateurs and professionals from all over the map. There are traders, economists, venture capitalists, financial advisers, and pajama-clad cranks all vying to explain the complex machinations that got us into this mess and to critique governmental solutions.

Complex machinations?  On the contrary.

The only thing that is complex is the web of lies put forward to cover up what is simple mathematical reality: You cannot expand credit at a rate faster than GDP forever without suffering a financial panic and collapse.

This isn't something from a "pajama-clad crank" - it is a mathematical fact.  The sort of fact that you were supposed to learn in sixth grade.

Really.

Sixth grade.

Yet our so-called "mainstream media", New York Magazine included, dropped math in the 5th grade and thus never participated in class.  The editor and financial page folks, along with those in ToutTV either never attended that class or are intentionally lying about what the math says must happen.

Take your pick: either we have "writers" and "reporters" in the mainstream media who lack a sixth-grade education or we have those who are willing to lie for money - on purpose - to the population.

Neither explanation is very complimentary.

Willful suspension of disbelief - and mathematical fact - is necessary for all financial frauds to be sustained for any length of time.  As soon as someone pulls back the curtain on that fraud they must be immediately savaged and called names, lest someone remember their sixth grade math class.

In the 1990s I read through literal dozens of S-1s from nascent Internet Companies that later failed.  Rhythms, Northpoint, Covad, Pets.Com, Infospace, Digital Island, 724 Solutions and many more.  Jim Cramer wrote a famous piece on "Winners of The New World" which, if you followed him, cost you nearly all of your money in just a couple of years' time.

Why?

Because of willful suspension of mathematical review and fact.

A read through those S-1s disclosed that these firms had laid claim to literally more than one hundred times the world's GDP. 

At best 99 of 100 of those firms were destined to blow up.  It was a mathematical certainty. 

In reality 999 out of 1000 blew up, because the "old world" - the WalMarts of the world - didn't give up their share willingly, or at all.

After the tech market cracked I gave one of the few interviews that was published in a "durable" media you can still find in which I said:

"I refused to take any stake in the acquiring firm. The shell game being played by these corporations is astounding," he said.

Denninger has also steadfastly avoided investing any of his personal fortune in the Internet: "I refuse to have anything to do with the Nasdaq 100. There will be a shake-out, and when it comes, it will be ugly and it will happen fast."

He might as well have been speaking of Black Week, April 10 through April 14, when the Nasdaq crashed.

The volatility of Net stocks in the past few weeks makes Denninger seem prescient, but his dislike for the unseemly marriage of breathless hype and dubious business plans is visceral.

"Amazon.com has proven there is a race to zero in margins. It should be a US$2 stock," he said.

Amazon bottomed in the $5s - from a high of $113.

More importantly, what changed from 2000 to now in this regard?  Margin improvement?  Not really.  Competitors went bankrupt?  Yes.  GDP expanded?  Yes, or did it?  Did we really see expansion of output or did we lie about it by expanding leverage (credit), borrowing more and immediately consuming it, calling this "GDP"?

Technically that is GDP, but it's not sustainable.  You can only press such a bet as long as you have available margin to pick up more and more debt against something that people consider "collateral." 

But when you do so to consume the steak dinner you ate this evening has turned into fertilizer within 48 hours while the debt you took on remains and demands to be serviced.  You've not advanced actual output in the economy in terms of sustainable growth one iota - all you've done is pulled forward tomorrow's earned dinner into today.  When tomorrow comes you can't buy that same dinner again, unless you once again pull forward yet more demand.

The reality of compound growth eventually derails all such plans.  All we argue over in that regard is timing - something that the mavens of Wall Street never bother to talk about in public.

Even as the market has improved, the economy has shown glimmers of stability, and many of his fellow bears have capitulated, Ivandjiiski has clung ever more tightly to his convictions.

"The market"?  Oh, you mean fraud street?  Well sure, when The Fed buys up a trillion dollars of questionable assets, including those that have a near-certainty of monstrous losses, thereby overpaying for them and spitting out printed money, you can expect some of it will go into the stock market - and it did.

Speaking of the market, what part of a P/E of 129 sounds reasonable?  Yes, I know, that includes the nasty earnings quarters that will roll off next year.  But even disregarding those and looking at rosy estimates for the next year the market (given its low yield) is pricing in GDP growth of 5-7% for the next 4 sequential quarters.  No economist with any shred of credibility has such a rosy forecast for actual economic growth, and with good reason - there is absolutely nothing in the employment and industrial capacity numbers to suggest that such an outcome is remotely possible.

"The economy is showing glimmers of stability?"  Where?  Jobs?  No - employment is not only still falling but we need to add more than 250,000 jobs a month just to keep even with immigration and the birth rate.  Never mind that while the government said we lost 200,000-some jobs last month, the household survey - that is, the actual count of people who aren't working - disclosed nearly a million fewer people in the workforce than the month before.  The difference?  Government doesn't count you as "unemployed" if you give up looking, and further government is counting tens of thousands of "new small businesses starting" (in excess of those closing.)  Do you believe the latter, and why would you omit the former?  Let me guess - someone who gave up looking for work magically has gained the ability to spend money at the store and foreclosed homeowners will set up shop selling gas and sodas on the nearest corner?

I think not.

"Fellow bears capitulating?"  Yep.  Lots of people have capitulated.  They've bought into the Fraud Street and DC pontifications that "math doesn't matter", just like Dick Cheney's famous screed that "deficits don't matter."

In the short term, perhaps.  One can lie, cheat and steal for quite some time, and the famous saying "the market can remain illogical for longer than you can remain solvent" is absolutely true.  If you're a short-term trader there's money to be made there - I made a nice wad of it from close to the 666 lows up into the upper 800s on the S&P, simply because bets on the end of the world can only win once - and if you do win, you're not around to collect.  As such I'll take the other side of that bet - when Hell's Gate beckons.

But in the end the math always wins and fraud is always exposed. 

It may take years to happen, but it always does.

Daytraders and speculators can make a lot of money on speculative froth and lies, but investors - those who are in the market for decades as a method of building wealth for retirement - have a more-pressing problem - they have no control of or way of knowing in advance when the fraud-laced games will fail.  As many boomers have discovered in the last year these games have a habit of coming apart at the seams right about the time you think you'd like to retire, blowing your carefully-laid plans that have spanned decades into dust.

The impact on the real economy that inevitably must filter down from boomers losing half or more of their retirement along with their house cannot be overstated.  While their combined wealth remains formidable the fact that they've taken horrific losses in the last two years is a fact - and one that the mainstream media would prefer to ignore.

That willful ignorance becomes perversion, however, when that very same media prints derisive articles like this one, as it is likely to lure a not-insignificant number of those boomers, already kicked and bloodied, back into the ring of fraud at the top - just in time to lose yet more money - and perhaps enough this time to drive them to destitution.

For the long-term investor there is no argument to be made for returning to a froth-driven market until and unless the fraudulently-granted credit is flushed from the system and one can once again read a balance sheet with some reasonable expectation that it reflects reality.

Given the proclivities of the government and media that day appears to be merely a glimmer on the horizon - a glimmer that in fact may be nothing more than a mirage.

Proceed at your own risk.