By John Galt
August 25, 2008
Here you go again!
It does not take this author, blogger, semi-sane writer and all around nice guy (cough) much to imagine just what people are thinking when they read the title of this editorial. The emails will say “oh but you’re pimping gold because you are selling it into the highs and running for your mountain cave with 40 years of supplies to emerge only do discover the apes have taken over and you’re going to battle them as a bitter old man while trading with the orangutans and their gold based currency!”
Gratuitous “Planet of the Apes” Reference to Pump up Gold Prices
I’m just becoming an older bitterman who envies our bitter old man Republican candidate for President because he married a wealthy hottie. In reality, this has nothing to do with the old “survivalist” theme or the idea of pimping gold, silver, platinum or sea shells. This is just this writer’s opinion that the fiasco created first by Countrywide Financial, then by Bear Stearns and now, as predicted by many back in 2003, the disaster known as Freddie Mac and Fannie Mae.
John Lee wrote an excellent article in November 2007 titled Freddie’s Insolvency and Gold’s Immediate Outlook which highlighted a lot of what I was thinking but for this article, I’m going to add to his perspective and try to wake a few sleeping souls up to the real danger we are about to encounter. From the article that referred to the problems in September of 2007, this bears repeating:
Fannie Mae’s decision to exclude SOP 03-3 losses coincide with their shocking rise: In the third-quarter ended Sept. 30, 2007, the company’s SOP 03-3 losses came to $670 million, up from $37 million in the same period a year ago. It’s not clear why SOP 03-3 losses are skyrocketing, but it suggests that Fannie Mae is having credit problems and is having to buy a lot more bad loans back from bondholders”
Why is that important? The credit problems have not been solved. Bondholders are facing the threat of getting killed with some prices declining by 50%. The recent auction earlier this week was 113 bp over the 5 year bond. And the issues that the Markit Indices have been indicating in subprime and Alt-A paper barely scratch the surface of problems that the GSE’s are about to encounter. The specter of plain vanilla prime mortgages starting to implode is becoming a realization by the financial industry. Where did this revelation come from? Besides the obvious, which is also known as my state, check out the Reuters headline:
Now I’m not a professor at a famous college in the Northeast United States nor a bald headed stock pumper and dumper on a popular infomercial, er, financial “news” channel, but I do have more than one working brain cell. This was not hard to see coming. There were some hints and God Bless Fitch for giving them while the world ignored their actions. So just what was the first key points from the story on August 22? Check this out:
Total delinquencies on prime “jumbo” loans and “Alt-A” loans made in 2007 rose at a 7.3 percent and 9.12 percent rate, respectively, from June, the rating company said. These loans require less proof of repayment but were made to borrowers with credit scores above subprime. For subprime loans, the rate of delinquency rose 7.0 percent rate last month.
Overall, delinquencies on 2007 prime jumbo loans rose to 3.22 percent in July, while Alt-A loan delinquencies increased to 14.56 percent, S&P said. Defaults on subprime loans from last year hit 31.25 percent.
Ouch. That’s going to leave a mark. And that mark is squarely on your forehead and mine where we slap our head up against it over and over again when we scream into a mirror “we’re paying for what and we voted for the idiot that said ‘Otay bail dem out’!!!!!!!”
Fitch began warning the world about this ages ago. As this crisis has worsened a very ignored reality is starting to sink in and the so-called “subprime crisis” has expanded into what this writer said it would over one year ago; a solvency crisis. As Fitch started downgrading tranch after tranch of the various RMBS on the markets not just for subprime but for Alt-A, Jumbo, and traditional prime mortgages the world proclaimed that famous Glenn Beck song that it was just “another isolated incident” and we had nothing to fear but fear itself.
Unfortunately for the subject of this editorial, the Fannie and Freddie impact of these downgrades has been felt far beyond the 2004 to 2007 time period which the mainstream media wishes to paint as the “crisis” mortgage period. RMBS from the 2004 period and before (see example here) have been downgraded as noted back in 2007 and that should have sent a shudder through the financial world. Instead it sent a shudder through the entire dark world of bond holders and retirement fund managers who realized that the promises of GSE solvency could and would now be brought into question.
Why is this such a critical matter to the overall inflation discussion the blogosphere has been having? Glad you asked….
Dirty Secrets and Obvious Problems
The dirtiest secret on Wall Street is that the obvious is usually the most ignored. The obvious in this case refers to the disaster that GSE’s will create for the retirement programs for well, everyone. For those that do not look at who owns the equities for Fannie and Freddie, allow me to shed some light.
Here are the top ten mutual funds for Fannie Mae and their holdings, plus the value at the reporting time(all from Yahoo Finance as of 6/30/08 but available anywhere; all figures rounded):
GROWTH FUND OF AMERICA 49.8 M SHARES $972 MILLION
DODGE & COX STOCK FUND 39.4 M SHARES $770 MILLION
INVESTMENT COMPANY OF AMERICA 29.1 M SHARES $568 MILLION
WASHINGTON MUTUAL INVESTORS FUND 25.5 M SHARES $498 MILLION
CAPITAL RESEARCH GLOBAL INVESTORS 116.9 M SHARES $2.28 BILLION
CAPITAL INCOME BUILDER, INC. 15.8 M SHARES $309 MILLION
VARIABLE INSURANCE PRODUCTS FD II-CONTRAFUND PORTFOLIO 15.8 M SHARES $308 MILLION
LORD ABBETT AFFILIATED FUND 14.1 M SHARES $401 MILLION
DODGE & COX BALANCED FUND 12.1 M SHARES $237 MILLION
AMERICAN FDS INSURANCE SER-GROWTH/INCOME FD 10.8 M SHARES $211 MILLION
And now for Freddie Mac, the same thing:
GROWTH FUND OF AMERICA 25.1 M SHARES $411 MILLION
LEGG MASON VALUE TRUST 16.9 M SHARES $427 MILLION
INVESTMENT COMPANY OF AMERICA 16.3 M SHARES $267 MILLION
CAPITAL RESEARCH GLOBAL INVESTORS 64.8 M SHARES $1.06 BILLION
CAPITAL INCOME BUILDER, INC. 11.8 M SHARES $193 MILLION
JOHN HANCOCK CLASSIC VALUE FUND 8.6 M SHARES $218 MILLION
WASHINGTON MUTUAL INVESTORS FUND 7.8 M SHARES $128 MILLION
DWS DREMAN HIGH RETURN EQUITY FD 7.7 M SHARES $196 MILLION
VANGUARD 500 INDEX FUND 6.1 M SHARES $155 MILLION
AMCAP FUND 6.0 M SHARES $99 MILLION
Great you say, the author knows how to read some really basic things on a page which displays some really basic financial information. What does this have to do with Gold $2000, Planet of the Apes, and Weimarica? Patience Cornelius, it all ties together in a nice neat package.
If you look at the mutual funds listed above and the major stock owners of the GSEs you start to tie some things together. First that the funds listed above appear in many of Mr. and Mrs. Main Street’s 401K portfolio or options when they become eligible to sign up for that value trap. Next if you look at the companies that have major holdings in these walking zombies, you begin to realize that the overlap is frightening. Why does this concern me? Simple. Look at the various news articles over the years about Americans not saving enough for their retirements. Then look at the big problem which connects the mutual funds and some of the disastrous performances they have endured (yes, I heard an actual local yocal bragging about being “only down 16%” this year as something good) and tie that in with the true Planet of the Apes moment:
The pension programs of many major corporations invested in these boneheads and now might become relatively bankrupt.
PBGC and The “Guarantee” That Isn’t; Yet
The problem with the logo displayed after what I’m sure was a multi-million dollar study conducted in West Virginia thanks to Senator “Klan” Byrd is the lack of accuracy. To add the phrase “1/3 of” between the words “America’s” and “Pensions” would reflect current reality.
That is a 10 year chart of the S&P 500 index for those of you in Rio Linda. If you notice the nice thick line starting at this past Friday’s close, you’ll note that the market is essentially still in the hole since the start of this century and worse, that is not adjusted for inflation. When you take that into consideration and start to apply that to the typical mutual fund or pension program you realize that the entire scheme concocted during the go-go 90’s which encouraged everyone at age 18 or 80 to pile their monies into a mutual fund and “trust the manager” to insure their future, you begin to see a pattern and a problem emerging.
If some schmuck like me realizes that I can draw a straight line on a chart like that above and doing some napkin math to figure out that “oh crap, we’re in the hole and deep” then start multiplying that by hundreds of billions of dollars. Then start dissecting what these pension programs and 401K mutual funds piled money into. That’s right, the GSEs, the financial industries new creations because “real estate never goes down” and the various derivative instruments created by the investment banks and brokerages which were all considered “safe” for pension programs providing decent returns. Heck, those returns to the parent companies by the Cayman Cowboys kept the industry afloat the last ten years, yet the obvious is ignored and the truth will only come to light during grand jury testimony.
So what does all of this have to do with the Pension Benefit Guaranty Corporation and the disaster of the GSEs and the fact that I’m writing a very long way around to point out the hyperinflationary nightmare we area bout to endure?
Start with the PBGC. Let’s look at one of my all time favorite editorials from the Ludwig Von Mises Institute’s home page titled “Pension Pain: The Other Social Insurance Crisis” which was published on July 17, 2004 by Carl F. Horowitz. There was a salient point made in this article which hit the crux of the problem we are seeing now and which will only accelerate in the future:
A second reason for underfunding has been the double-whammy in the stock and bond markets for much of this decade. A sharp decline in stock prices during 2000–02 diminished the assets of company pensions and the PBGC alike. Over the course of the 1980s, according to Ibbotson Associates, annual real equity returns averaged 11.9 percent, rising to 14.8 percent during the 90s.
By contrast, during the 2000s (through August 2003) equities incurred an annual average loss of 10.8 percent. Meanwhile, low bond interest rates inadvertently have raised funding requirements. In a pension plan, liabilities are calculated by adding up the value of promised future benefits and then discounting that sum to obtain a present value.
That extract points out that not only is the PBGC underfunded and one of the contributing reasons as to why, but if you start to recall the numerous corporate bankruptcies, planned or not, the impact on the bottom line for this government enterprise become down right terrifying, even at 33 cents on the dollar. The impact is just now being realized as the fees collected on businesses still offering pension plans will either have to be raised to a point that is unsustainable or the Congress will have to allocate more resources to address the problem.
Unfortunately for America, this same PBGC has invested heavily into the GSEs and their various bonds and derivatives for the perceived safety much like many private plans have also. It does not take a lot of imagination looking at the stock charts to determine the return they are getting now, especially on the GSEs but the corporate bonds they invested in starting in 2005. From the same article:
To set PBGC on the right track, Congress recently passed temporary two-year legislation, the Pension Funding Equity Act, which President Bush signed into law this April. The law’s key feature, worth about $80 billion, would switch the basis for calculating pension plan liabilities from ostensibly risk-free, 30-year Treasury bonds to long-term, high-yield corporate bonds. Employers, seeking to reduce levels of mandatory contributions, had been clamoring for this. Call it what one will, but this provision is a loan by any other name. Employers, in effect, will be borrowing from their pensioners. And in the event their pension plans default, taxpayers ultimately will be liable.
The bottom line is that because the PBGC was allowed to invest in non-traditional safe investments and no longer mandated to respect a safety margin to insure that short term returns would not become long term additional liabilities to their future existence. With over 40 million Americans dependent on the PBGC the new investment program is even riskier than the one undertaken in 2004 described from the quote above yet the problem is dismissed as the talking schmucks on Wall Street have assured the bureaucrats that somehow, some way, equities will increase in price guaranteeing that the PBGC should not remain in debt much longer.
In reality, the collapse of Fannie and Freddie plus the pending implosion of the PBGC and their casino mentality is what will trigger some consequences that America is not ready for. And despite the beliefs of the deflationistas, this outcome is not going to be what many think it will be.
“Help! I’ve fallen and I can’t get up!”
Who can ever forget the famous commercials with the little old lady slipping then pressing the button on her “Lifecall” device and help arriving promptly? Well honey, keep pressing it because as each day goes by, your pension, your retirement plan, your social security check is losing value and will continue to do so. Despite the implications of a real estate collapse, credit seizure and perception (though quite incorrect) that monetary contraction is occurring, the reality is that the theoretical side of economics fails to accept political reality.
Let’s address these one at a time and see if we can get that little old lady back on her feet……
1. The PBGC Will Never be Allowed to Fail
Demographic reality dictates this simple fact. You can not have over seventy million baby boomers and half or more losing over 50 percent of their benefits due to the collapse of GSEs or the financial system. Politicians have woven such an intricate socialist safety net that to abandon these souls now would be the equivalent of sending in jack booted thugs to pour gasoline on the little old lady in the picture above and setting here on fire. It is not happening. You can invest in a deflationary plan all you would like, but before the government abandons its primary voting base they will create via fiscal stimulation the hundreds of billions necessary to insure the agency continues to function. In light of that little piece of reality, let us see who else gets bailed out.
2. Fannie and Freddie Shareholders May Get Toasted BUT…..
While enduring my daily review of Bubblevision’s Fast Money program last week, Joe Terranova reminded everyone on the panel in the midst of the FNM and FRE meltdowns that they had approximately $223 BILLION (yes, “B” as in Billion) in short term debt that they had to roll over. The concerns on the panel were obvious that it was not going to happen based on the recent auction bid well over the 5 year note. Add in the fact (my thoughts) of the massive supply of U.S. Treasury debt issuance’s coming in the next sixty days and you can see where there might be a problem or worse when the end of September rolls around. Especially when some of the largest bond holders like Russia elect to cash out instead of rolling their holdings into the next fiscal period.
This leaves these poor (cough) mutual fund managers, pension fund managers and oh, I forgot, state pension fund managers stuck holding the bag with probably worthless equities and of course bonds of a questionable nature. Before you fire off a gazillion emails reminding me that bondholders always get paid first in a default, let’s take a quick look at the GSEs.
The Chinese are the largest bondholders. The consequence of a whiff or hint of default might collapse their communist version of a financial system but the retaliation for this action would instantly put American into the Zimbabwe economic reform program. While I do fear inflation will get much worse in this nation, the idea of 11,000,000% inflation is beyond any reasonable comprehension. Thus to assume the Treasury and Fed would not guarantee the bond holders is a non starter. The company will be nationalized first and foremost and that means the taxpayers take on hundreds of millions in obligations which will only decline once housing stabilizes and returns to some semblance of normalcy. Of course the normalcy I refer to would be the 1997 housing market, but hey, that would be better than what we have now.
Gretchen Morgenson hinted at this point in her August 23, 2008 article in the New York Times titled “What Will Mac ‘n’ Mae Cost You and Me?”
From the article:
It is widely assumed that debt issued by Fannie and Freddie will be backed by the taxpayers. Call it “too big to fail times two.”
But in our highly interconnected financial world, where one company’s ills have the potential to infect many others, no bailout exists in a vacuum. And the ripple effects that may result from shoring up these giants extend from the obvious — hammering their shareholders — to the fairly obscure, involving participants in the market for credit default swaps.
This is the huge arena where participants buy and sell insurance to protect against defaults by issuers of debt. Some $62 trillion of insurance has been written, with a fair value of $2 trillion at the end of 2007.
There is a perception that the holders of this insurance would never be paid during a credit crisis or in the event of a default but let us go back to the underfunded gamblers, the PBGC, and the issue de jour about retirement programs taking uncharacteristic risks to recover from losses incurred over the last decade. For example, does anyone think that a large state which holds billions in swaps will be told “too bad, so sad” in the event they are unable to collect? Not without crippling the state and putting a greater responsibility on the entire tax base to cover a state pension fund collapsing.
Then consider the average citizen who has no clue what their mutual funds invest in. They go to fund manager or brokerage and take their word that they have the fiduciary responsibility to insure their futures are not like the little old lady above. Then after ignoring statements for months they open up their mutual fund statement and see a negative 33% return year to date and freak out. Add in a collapse of Freddie and/or Fannie and you get the idea. The government has to find a way to keep the enterprise functioning and Ms. Morgenson adds in the new feature of “moral hazard” to our banking system should the government not act:
Investors holding the preferred stock already issued by Freddie and Fannie could also be vulnerable if the bailout puts the taxpayers’ investment ahead of them for dividend payments. Regional banks and savings and loans hold most of these shares; with these institutions already hurt by the mortgage mess, it seems unlikely that the Treasury would structure a Mac ’n’ Mae rescue in a manner that would pound them again.
She hits the nail on the head again, pointing out that there is no way they Treasury could allow the collapse to accelerate and trash the preferred stocks impacting not just regional banks and savings and loans but ultimately pension plans and 401Ks across the nation. This tab is getting expensive but guess what? She points out more:
As UBS analysts point out, because Fannie’s and Freddie’s subordinated debt is used when they calculate capital — the financial cushion regulators require to support the companies’ operations — interest payments on the debt may have to stop if a bailout occurs. Such a hiatus could last up to five years.
Boom. The bailout expands. So if they do bailout the bond holders, the subordinated debt holders and preferred stock holders will or could get toasted. Eventually they will be made mostly whole, but in the five year hiatus, the retirees who watch their statements will be dusting off the resumes as they board the bus to the local grocery store to bag salamis or WalMart to greet people at the doors and wipe down the shopping carts.
It will not be pretty but someone will force the issue. And the government can not leave 20, 30 or 50 million retirees twisting in the wind because they failed to regulate the agencies as they legally were empowered to do.
3. Somebody Turn the Printing Presses from “High” to “Ultra” Please
This means that ultimately more debt has to be issued at the government level. It also means that since there is essentially a credit seizure underway, the only way to prevent a depression era like unemployment fiasco is for the Federal government to start cranking up jobs programs to repair America and widen the bike path for Senator Dumpin Britches from West By God Virginia. After all is said and done, the GSEs will both be nationalized as will the pensions of thousands of corporations, including the automakers in all likelihood.
Without breaking out a scientific calculator or actually freaking everyone out, this means that the government has a choice to make:
Inflate or die.
The United States government has sworn off a repeat of the 1930’s at every level and thanks to the constant meddling into the ebb and flow of the economy they have created a situation which will enable a far worse scenario than that era. The failure to act and prevent a repeat falls squarely on their shoulders. Needless to say I am of the pure capitalist point of view and would prefer to let everyone eat cake, preferably the bankrupt Interstate Bakeries’ Twinkies, but then again I thought old Marie Antoinette was a fox.
The reality though is that our politicians and the people who vote for these assclowns do not have the intestinal fortitude to tolerate a real economic downturn for one day, one month or one year to flush the system of its excesses and deal with the problems of the magnitude we have now. As a result the lender of last resort, a computer, will be fired up to increase the monetary supplies far in excess of the approximate 16% figure we see for M3 now and probably above the 25% figure to put us on par with those Russians whose eyes are so soulful.
Think about that one folks. If we do not stop them now, before the election, they will engineer a program in the next six months which will accelerate the monetary base at a pace which will trigger a serious bout of inflation, far worse than the 1970’s, and eventually hyperinflation. The theory that monetary aggregates and short term reports are all that are needed to forecast a deflationary scenario are total horse fertilizer when you have to consider reality and the political fundamentals that face these cowards in state houses and the District of Columbia. To take a tough course of action is not within their vocabulary so look for the ‘me’ generation to stick it to the ‘us’ generation. And that is where they are mistaken.
Gold $2000, “Thanks Mom”
There are numerous technical reasons why I could justify a forecast of gold to skyrocket above $2000 in the next few years, but stop hyperventilating, step back from the keyboard and use some common sense. Do you honestly want to see your Mom and Dad suffer? I do not. Does this mean I personally want to have the government bail them and everyone else out?
But I am different that way. So who does want their Mom and Dad eating Friskies Captain’s Choice? No one I know which means that political expediency will be the rule of the day. The Government and banksters will take a look at the big picture and remember that in every major societal upheaval bad things usually happen to the banks and the central bank especially.
New laws are created, grand juries empowered in every nook and cranny, and of course the political class who did nothing gets punished by losing their jobs, derided and called every name in the book (I would love to add to that book). Needless to say the ruling elite have the ultimate power sharing agreement worldwide so why upset the apple cart? If you and I have to pay more for apples and gas they could care less. As long as they are allowed to maintain the system and create new guarantees of a future debtor class they will inflate to ride the crisis out. Gold should easily skyrocket past $1000 next year if not sooner depending on geopolitical events. Add in the strong probability that the candidate with the tag “Stupid-D” or “Stupid-R” will become President and you can see a new wave of fiscal dynamite blowing up in our faces.
The short term thinkers are missing the big picture once again and I reiterate that the failure to address these problems by allowing the recession of 2002-2003 to deepen and flush the system created the dilemma we face today. Greenspan’s folly has only complicated the issue because the lack of proper constraints allowed the securitization of anything that was not nailed down and thus as the bills come due, he figures out that his tenure may have created a problem or two. Duh! The final consequence of the past ten years of insanity will be a short term but violent inflationary period in America which could easily be called “The Last Surge” as our empire fades into the sunset.
As for precious metals skyrocketing in value and the bailout society expanding that is the biggest hanging curve ball ever served up over anyone’s home plate. And when you hit that ball and start to jog around the bases, just remember the generation that gave you that opportunity and say it: