Congressional Legislation Introduced By Barney Frank Pre-Approves $4 Trillion For Next Crisis

Barney Frank introduced H. R. 4173 purportedly "To provide for financial regulatory reform, to protect consumers and investors, to enhance Federal understanding of insurance issues, to regulate the over-the-counter derivatives markets, and for other purposes."

The bill is 1,279 pages long. I did not read it in entirety but Bloomberg columnist David Reilly did. It is amazing the things Barney Frank buried in a bill that is supposed to protect consumers. The bill does nothing for consumers, but does allocate $4 trillion to fighting the next financial crisis.

Please consider Bankers Get $4 Trillion Gift From Barney Frank: David Reilly.

To close out 2009, I decided to do something I bet no member of Congress has done -- actually read from cover to cover one of the pieces of sweeping legislation bouncing around Capitol Hill.

Hunkering down by the fire, I snuggled up with H.R. 4173, the financial-reform legislation passed earlier this month by the House of Representatives. I quickly discovered why members of Congress rarely read legislation like this. At 1,279 pages, the �Wall Street Reform and Consumer Protection Act� is a real slog.

Here are some of the nuggets I gleaned from days spent reading Frank�s handiwork:

For all its heft, the bill doesn�t once mention the words �too-big-to-fail,� the main issue confronting the financial system.

Instead, it supports the biggest banks. It authorizes Federal Reserve banks to provide as much as $4 trillion in emergency funding the next time Wall Street crashes. So much for �no-more-bailouts� talk. That is more than twice what the Fed pumped into markets this time around. The size of the fund makes the bribes in the Senate�s health-care bill look minuscule.

Oh, hold on, the Federal Reserve and Treasury Secretary can�t authorize these funds unless �there is at least a 99 percent likelihood that all funds and interest will be paid back.� Too bad the same models used to foresee the housing meltdown probably will be used to predict this likelihood as well.

The bill also allows regulators to �prohibit any incentive-based payment arrangement.� In other words, banker bonuses are still in play.

The bill isn�t all bad, though. It creates a new Consumer Financial Protection Agency, the brainchild of Elizabeth Warren, currently head of a panel overseeing TARP. And the first director gets the cool job of designing a seal for the new agency. My suggestion: Warren riding a fiery chariot while hurling lightning bolts at Federal Reserve Chairman Ben Bernanke.

Best of all, the bill contains a provision that, in the event of another government request for emergency aid to prop up the financial system, debate in Congress be limited to just 10 hours. Anything that can get Congress to shut up can�t be all bad.

There's much more in Reilly's article. I was hoping this was a spoof, but sadly it is not. Here is the section of H. R. 4173 allocating up to $4 trillion.

FINANCIAL CRISIS MANAGEMENT
(1) IN GENERAL.

In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, upon the written determination, pursuant to section 1109 of the Financial Stability Improvement Act of 2009, of the Financial Stability Oversight Council, that a liquidity event exists that could destabilize the financial system .... and with the written consent of the Secretary of the Treasury (after certification by the President that an emergency exists), may authorize any Federal reserve bank, ....

Upon making any determination under this paragraph, with the consent of the Secretary of the Treasury, the Financial Stability Oversight Council shall promptly submit a notice of such determination to the Congress. The amounts made available under this subsection shall not exceed $4,000,000,000,000.

Don't worry there is a 99% chance the money will come back as low quality collateral is excluded.

CLARIFICATION OF �SECURED TO THE SATISFACTION OF THE FEDERAL RESERVE BANK�.

No member of the Board of Governors of the Federal Reserve System shall vote to authorize any action permitted under paragraph (1) and the Secretary of the Treasury shall not provide the written consent required by paragraph (1) unless that member believes and the Secretary of the Treasury believes:

��(A) that there is at least a 99 percent likelihood that all funds disbursed or put at risk by such action will be repaid to the Federal Reserve System; and ��(B) that there is at least a 99 percent likelihood that all interest due on any funds disbursed will also be paid to the Federal Reserve System.

��(3) LOW QUALITY ASSETS EXCLUDED.

The notes, drafts, and bills of exchange available for discount for purposes of paragraph (1), and the security for those notes, drafts and bills of exchange may only include any of the following assets if such asset is used to further enhance the security for those notes, drafts and bills of exchange which shall be fully secured with assets that are not any of the following assets: ....

Gee, I sure hope that makes you feel better.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Steel Tariffs Show Protectionism On The Rise

Price of steel is going up. Is that a good thing? For who? Please consider U.S. Trade Panel Rules for Domestic Steelmakers Against Chinese Imports.

The U.S. International Trade Commission sided with U.S. steelmakers in a case over Chinese steel Wednesday, voting that U.S. industry has been damaged by a flood of imports of subsidized steel from China.

In the ITC's largest-ever steel case, all six commissioners voted in the affirmative that imports of so-called oil country tubular goods from China have injured U.S. manufacturers. The commission will provide details of its decision later Wednesday.

The ruling, which will likely result in duties on future imports of Chinese steel pipes, adds more tension to the U.S.-China trade relationship. Ties between Washington and Beijing are already frayed by the Obama administration's imposition of duties on Chinese tire imports and China's criticism of U.S. moves as protectionist.

Last month, the Commerce Department imposed countervailing duties on the steel pipes ranging from 10.4% to 15.8%. The ITC's decision Wednesday allows the government to finalize those duties. The commission will make a separate decision on antidumping duties next spring.

In the case, brought by U.S. steel manufacturers and the United Steelworkers union, the domestic industry has framed its case in terms of potential job losses -- thousands of steel workers have been laid off or had their mills closed. In China, job losses have been few, as Chinese mills continue to operate despite weakened world demand.

The case was filed by Maverick Tube Corp.; United States Steel Corp.; TMK IPSCO; V&M Star LP; Wheatland Tube Corp.; Evraz Rocky Mountain Steel; and the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial and Service Workers International Union.

Steel Grating Tariffs

It's not just steel pipe under review. Please consider US imposes duties on China steel grating.

The US Commerce Department said on Tuesday that it has set preliminary anti-dumping duties (AD) on imports of steel grating from China, a move that might escalate trade disputes between the two countries.

The department said it "preliminarily determined that Chinese producers/exporters have sold steel grating in the United States at 14.36 to 145.18 percent less than normal value."

As a result of this preliminary determination, Commerce will instruct US Customs and Border Protection to collect a cash deposit or bond based on these preliminary rates.

The Commerce Department said it set a preliminary anti-dumping duty of 14.36 percent on four Chinese producers or exporters in the steel grating investigations.

All other Chinese exporters or producers received an anti-dumping duty rate of 145.18 percent, the Commerce Department said.

The new case followed US President Barack Obama's recent decision to impose punitive tariffs on all car and light truck tires from China for three years, a move quickly denounced by China as a "serious act of trade protectionism."

145% tariffs?!
Wow.

Who Benefits From This?

Essentially no one. Potentially a few hundred steel workers get jobs back, but everyone using those products has to pay more. Demand will slow and price pressures will increase on everyone using those products. In aggregate, more jobs will be lost as a result of these tariffs than gained.

And that is just on the surface. Think China will not react? A nice clear message would be for China to cancel plane orders from Boeing or industrial goods from GE. Even if China is not so overt in its message, it is foolish to think there will be no repercussions over this.

The rising tide of protectionism is not a good thing. It never is.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Union Battles In Las Vegas, Simi California, Hawaii, Massachusetts

Union battles over benefits are starting to appear all over the place. Here are a few stories from the past two days.

Las Vegas: City firefighters launch campaign against cutbacks

Las Vegas� firefighters union has taken a hard stance against the city�s budget cuts, alleging that reductions will hurt emergency responses along with fire insurance rating for homes and businesses.

City officials, meanwhile, said the union is engaging in irresponsible �scare tactics� at a time when the city is facing economic difficulties.

The back-and-forth comes as the city readies for a series of town hall meetings scheduled from January to March to hear resident feedback on what city services are most important.

It also comes as the city is considering back-to-back 8 percent salary rollbacks and freezes for all employees, including firefighters, although a union official declined to comment today on the union�s positions on these wage proposals.

The union has created a Web site as well as a radio advertisement warning that cuts could increase response times, result in fewer people on duty, reduce the city�s ability to respond to disasters and hurt the city�s fire insurance rating, which is at the highest level.

This discussion is just one part of the ongoing wrangling over the city�s budget, which has seen an ever-widening deficit since the economic downturn began.

The city has already cut operating costs, eliminated vacant positions and announced some layoffs. City management has also proposed an 8 percent wage rollback in each of the next two budget years to avoid layoffs, a proposal being evaluated by the unions that represent city workers.

My recommendation to Las Vegas is to declare bankruptcy and let the unions see what they can get in court.

Simi California: Simi, police union agree to contract

The Simi Valley City Council on Wednesday approved a new agreement with the Simi Valley Police Officers� Association for an 18-month employee contract that includes a 3 percent salary decrease for sworn police officers and sergeants.

The unanimous approval came after the council went into a closed session meeting late Wednesday afternoon with attorneys and representatives from both the city and police association.

Significant provisions of the MOU approved Wednesday include:

For fiscal year 2009-2010, the base salaries and monthly salary ranges for all police unit classifications will be decreased by 3.43 percent. To address the issue of retroactivity, the city will capture the decrease by reducing base salary of all police unit employees by 6.86 percent Dec. 21, 2009 to June 20, 2010. Effective with the payroll period beginning on June 21, 2010, base salaries will be increased so that the reduction is back to 3.43 percent.

A two-tiered retiree medical program, with any new employees hired after Jan. 1, 2010, receiving a defined contribution retiree medical benefit. Police unit employees as of Dec. 31, 2009, who retire from the city are eligible to remain on the city�s group health plans and the city will contribute to the full amount of the premium. Employees hired after Jan. 1, 2010 are not eligible to receive retiree health insurance benefits, but rather will receive a contribution in the amount of $300 per month placed in a type of retiree health savings account.

Modified provisions regarding assignments, shift scheduling, and the use of annual leave.

A provision providing for an expanded Civilian, Volunteer and Reserve Officer program ....

I had to read that twice. The police union agreed to work rule changes, pay cuts, and benefit cuts including a two-tiered program for new officers. Wow. I commend the city of Simi for standing tough and of course I commend the police union for seeing the writing on the wall and recognizing the need to phase out defined benefit medical plans. I am sure there there is much more work to be done in regards to pensions but this appears to be a genuine start.

Hawaii: University of Hawaii will reduce faculty pay by 6.7 percent

The University of Ha-wai'i will cut salaries for most faculty by 6.7 percent beginning Friday.

UH President M.R.C. "Marci" Greenwood said she decided to cut salaries because negotiations with the faculty union were at an impasse and time was running out to reduce the school's budget.

J.N. Musto, executive director and chief negotiator for the University of Hawai'i Professional Assembly, said Greenwood's decision violates an existing agreement and the union "will take action to protect the rights of the faculty and to preserve a legitimate collective bargaining agreement in whatever court or venue is necessary."

It may ultimately be up to a judge to determine what happens.

"It may very well be that this will get resolved in the courts," Greenwood said.

Greenwood said if the salary cuts are not instituted, layoffs and other actions will have to be considered to help make up for a $154 million loss in revenue, about 13.8 percent, from the state over the current fiscal year and the next.

Systemwide, the average salary for a UH faculty member is about $84,000. The payroll reduction affects UHPA's roughly 3,500 members, consisting of lecturers and professors. Those faculty members paid through nonappropriated funds such as extramural contracts and grants won't be affected, nor will faculty members who retire before June 30, 2010.

The current UHPA contract ran out on June 30, but Musto said UH is bound to follow it until a new contract is negotiated.

What is it that unions in general do not understand about layoffs and budget deficits? Things clearly have to change and not just salaries either.

Boston: Judge rejects transportation workers effort to block benefit cuts

A Suffolk Superior Court judge has dealt a significant blow to MBTA employees fighting a cut in their benefits, saying in a key ruling released yesterday that a group of 22 labor unions was unlikely to win a lawsuit attempting to block Governor Patrick's transportation plan.

The unions had argued in a lawsuit filed in September that Patrick's plan to save up to $30 million a year through cuts to worker and retiree benefits illegally subverts collective bargaining rights by changing their benefits without going to the negotiating table.

They say they earned the benefits over many years and that the T's real problem is the debt that has piled up from years of unfunded expansion projects.

But Judge Christine M. Roach denied an attempt by the union to block benefit cuts on an emergency basis. The initial cuts are targeted at a small group of employees and retirees starting Jan. 1; the majority of employees would be affected on July 1.

Understanding the Massachusetts Bay Transit Authority [MTBA] problem

Please consider Time to end ludicrous MBTA benefits

I turned on the local news this morning, and heard, once again, that the MBTA has to increase fares and reduce service in order to make ends meet this fiscal year. As a business person who has had total profit and loss responsibility for several firms over the years, I was curious how reducing product quality and increasing the price charged to customers could ever work in the marketplace. So, I started to look into the MBTA budget for 2009. The first thing I noticed (and you can also go to the MBTA Web site and follow along) is that salaries and fringe benefits are nearly HALF of the total operating expenses. Having been the vice president of a major ground transportation company at one time, it was a rule that salaries and fringe could not exceed 1/3 of total operating expenses in order to remain viable and competitive. But unlike a "for profit" private sector business, the "T" doesn't have to control costs - it just has to increase fares and cut services.

As I continued to peruse the budget, I searched for the cost of pensions and health insurance for retirees - since they have to be fully funded and increased each year to keep up with the rising costs, and since they combined to be the Achilles heal for General Motors, I thought I'd be able to find out what kind of burden they continue to impose. Unfortunately, unlike any other public agency in the commonwealth, the MBTA does not have to publish its pension obligations because it operates outside the state's retirement agency. I was able to find out a few of the generalities of the burden all commuters are paying - maybe you knew this, but as a daily commuter looking at working to pay off my home, my kid's college debt and keep up with rising taxes, I was appalled - especially since I will still be working at age 75 in order to pay everything off!

MBTA workers can receive a full pension after 23 years of service, regardless of age. So, if an MBTA worker graduated from high school and got a job at age 19, he or she is eligible to receive a full pension at age 42! Not only that, he or she will also receive free health insurance for life. And, since 42 is a prime working age, MBTA pensioners can work at other jobs and earn as much as possible, unlike other state retirees, and pile those wages on top of their MBTA pension.

So, when I heard that commuter rail weekend service may be suspended, and that there is a real potential for weekday service reductions - AND, fares may have to be increased dramatically, I asked myself, "Why are the struggling commuters who are paying the salaries of these people, just sitting there and taking it?" The MBTA general manager, Dan Grabuaskas, says his hands are tied. In fact, according to a local daily paper, Grabuaskas even tried to give his management team a 9 percent pay raise, until pressure from the governor's office convinced him to back it off to 3 percent. ....

The Man Who Never Returned

In honor of the Massachusetts Bay Transit Authority it's time for a Kingston Trio song:

Let me tell you the story
Of a man named Charlie
On a tragic and fateful day
He put ten cents in his pocket,
Kissed his wife and family
Went to ride on the MTA

Charlie handed in his dime
At the Kendall Square Station
And he changed for Jamaica Plain
When he got there the conductor told him,
"One more nickel."
Charlie could not get off that train.

Chorus:
Did he ever return,
No he never returned
And his fate is still unlearn'd
He may ride forever
'neath the streets of Boston
He's the man who never returned.

Now you citizens of Boston,
Don't you think it's a scandal
That the people have to pay and pay
Fight the fare increase!
Vote for George O'Brien!
Get poor Charlie off the MTA.

The above part of the lyrics of a great Kingston Trio song Charlie on the MTA

In the 1940s, the MTA fare-schedule was very complicated - at one time, the booklet that explained it was 9 pages long. Fare increases were implemented by means of an "exit fare". Rather than modify all the turnstiles for the new rate, they just collected the extra money when leaving the train. (Exit fares currently exist on the Braintree branch of the Red Line.) One of the key points of the platform of Walter A. O'Brien, a Progressive Party candidate for mayor of Boston, was to fight fare increases and make the fare schedule more uniform. Charlie was born.

The text of the song was written in 1949 by Jacqueline Steiner and Bess Lomax Hawes. It was one of seven songs written for O'Brien's campaign, each one emphasized a key point of his platform. One recording was made of each song, and they were broadcast from a sound truck that drove around the streets of Boston. This earned O'Brien a $10 fine for disturbing the peace.

...

In 1959, The Kingston Trio released a recording of the song. The name Walter A. was changed to George to avoid problems. Thus ended Walter O'Brien's claim to fame.

Walter A. O'Brien lost the election, by the way. He moved back to his home state of Maine in 1957 and became a school librarian and a bookstore owner. He died in July of 1998.

There are more verses and more information in the above link.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Credit Card Delinquencies, Chargeoffs Rise Again; Bank of America Has Credit Card Headaches

Given there has been a financial recovery of sorts, but no recovery at all on main street, it should not be surprising to see Credit-Card Delinquencies Rise Again.

The rate of charge-offs on U.S. credit cards rose more than a half-percentage point in November, snapping a two-month run of drops from an all-time high in August, and delinquencies rose for the fourth consecutive month, Moody's Investors Service said.

Charge-offs, which are those loans a credit-card company doesn't think it will be able to collect, were 10.6% for November, compared with 10% in October. The ratings firm also said the delinquency rate, which gives a glimpse of issuers' potential losses and how much they may need to set aside in reserves, rose to 6.2% in November.

Bank of America Now Choking on Growth at any Cost Policy

Please consider New Chief at Bank of America Seeks Credit-Card Fix

When Bank of America Corp.'s new chief executive takes over next week, one of the first problems he will face is one he's already been grappling with�the bank's credit-card business.

"We gave a lot of cards out to our customers," Mr. Moynihan said in a Nov. 5 speech. "We were giving them to too many people." He discussed a "repositioning" of the business that would rely less on borrowing and more on card transactions, while acknowledging that the business won't be as big or as profitable as it used to be.

Bank of America is the second-largest U.S. card issuer, after J.P. Morgan Chase & Co., and the card division accounts for 23% of BofA's revenue through the first nine months of 2009. Yet cards also lost $4.5 billion during that same period, making it the worst-performing Bank of America business line. It also had a default rate higher than other major rivals, at 13%.

The current problems have their root in Bank of America's push to become No. 1 in the card business. In 2006, it purchased MBNA Corp., one of the nation's biggest credit card issuers, for $35 billion, hoping to combine the card company's marketing and underwriting skills with its own massive branch network.

But in its pursuit of market share, Bank of America made poor underwriting decisions and the banking crisis of the last two years exposed many of those flaws. While trying to become the nation's No. 1 small-business lender it offered unsecured credit lines of up to $100,000 to start-ups, some in business for only one day. Bank of America's small-business default rate hit 17.5% in the third quarter of 2009.

Another misstep for Bank of America, said FBR Capital Markets analyst Paul Miller, was that it took too long to cut credit lines as customers went delinquent. BofA "always took a more optimistic view of the economy," he said.

Bank of America Credit Chargeoffs vs. Allowances



Chart from the WSJ article above, I added the arrows.

Note that chargeoffs are increasing while provisions are collapsing. Also note that the chart only pertains to credit cards. What about residential real estate, home equity loans, commercial real estate, industrial loans, etc etc?

While some keep pretending there are excess reserves to be lent out, I scoff at the idea.

Assets at Banks whose ALLL exceeds their Nonperforming Loans



The above chart courtesy of the St. Louis Fed.

Because allowances for loan losses are a direct hit to earnings, and because allowances are at ridiculously low levels, bank earnings (and capitalization ratios) are wildly over-stated.

Excess Reserves? Please be serious.

For more on excess reserves please see Fictional Reserve Lending And The Myth Of Excess Reserves.

With unemployment at 10% and not headed significantly lower for years, and with allowances for loans and lease losses in the gutter, expect banks to be forced to raise more capital as credit card losses continue to mount.

Still more shareholder dilution via secondary offerings is on the way.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Hussman on Valuation; Stocks Higher? Bulls Dance On Edge Of Cliff

Inquiring minds are reading Clarity and Valuation by John Hussman.

Last week, the dividend yield on the S&P 500 dropped below 2%, versus a historical average closer to double that level. While part of the reason for the paucity of yield in the current market can be explained by the 20% plunge in dividend payouts over the past year, as financial companies have cut or halted dividends to conserve cash, the fact is that current payouts are not at all out of line with their historical relationship to revenues, and even a full recovery of the past year's dividend cuts would still leave the yield at a paltry 2.5%. The October 1987 crash occurred from a yield of 2.65%, which was, at the time, the lowest yield observed in history, matched only by the 1972 peak prior to the brutal 1973-74 bear market.

Those two periods had a few other things in common. In the weeks immediately preceding the market downturn, stocks were overbought, had advanced significantly over prior weeks, bond yields were creeping higher, and investment advisory bearishness had dropped below 19%. All of those features should be familiar, because we observed them at the 1987 and 1972 peaks, and we observe them now.

On the basis of normalized profit margins, the average price/earnings ratio for the S&P 500, prior to 1995, was only about 13. Higher historical �norms� reflect the addition into that average of extremely high �recession P/Es,� based on dividing the S&P 500 by extremely low, but temporarily depressed earnings. For example, the P/E for the S&P 500 currently is 86, because earnings have been devastated, but it would be foolish to take that figure at face value, and equally foolish to work it into a historical �average� P/E. The pre-1995 norm of 13 for price-to-normalized earnings is important, because at present � and again, we are not using current depressed earnings, but properly normalized values � the S&P 500 P/E would currently be over 20. That's higher than 1987 and 1972, and about even with 1929. Of course, valuations have been regularly higher in the period since the late 1990's (and not surprisingly, subsequent returns, even after the recent advance, have been dismal overall, with the S&P 500 posting a negative total return for the past decade).

So overvalued, check. Overbought, check. Overbullish, check. Upward pressure on yields, check. Market internals? � certainly mixed, but not bad � and there's the wild card.

It's important to recognize that when I quote probabilities, I am generally using a form of Bayes' Rule. So when I say, for example, that I estimate a probability of about 80% of fresh credit difficulties accompanied by a market plunge over the coming year, that figure is based on various combinations of historical evidence, and what has (and has not) happened afterward, and how often. As a side note, a �market plunge� in this context need not be a �crash.� In the context of a credit-driven crash and rebound (which is what I believe we've observed), a typical post-rebound correction would be about -28%, but even that would take stocks to less than 20% above the March lows.

From current valuations, durable market returns appear very unlikely. As I noted last week, whatever merit there might be in stocks is decidedly speculative. That doesn't mean that the returns must be (or even over the very short term, are likely to be) negative. What it does mean is that whatever returns emerge are unlikely to be durably positive. Market gains from these levels will most probably be given back, possibly very abruptly.

Stocks Higher? New Bull Market?

New bull market for the new year? Famed bond investor El-Erian of Pimco says don't bet on it.

Homes are selling at their fastest clip in nearly three years, the unemployment rate is falling and stocks are up 66 percent since their March lows -- the best performance since the 1930s.

What's not to like?

Plenty, according to Mohamed El-Erian, chief executive of giant bond manager Pimco. The investor says the recovery may be gaining steam but is no different than a kid who eats too much candy at one of the birthday parties his 6-year-old daughter attends.

"We're on a sugar high," El-Erian says. "It feels good for a while but is unsustainable."

His point: This burst of economic activity fed by government spending and near-zero interest rates will soon peter out.

As CEO at Newport Beach, Calif.-based Pimco, El-Erian, 51, oversees nearly $1 trillion in assets, more than the gross domestic product of most countries. So when he talks, people listen.

What he's saying now:

--Stocks will drop 10 percent in the space of three or four weeks, bringing the Standard & Poor's 500 index below 1,000 -- though he's not predicting when.

--The unemployment rate will be hovering above 8 percent a year from now.

El-Erian says people are fooling themselves if they think all the bullish data of late means a strong recovery is in the offing. So he's buying Treasurys and selling riskier stuff.

His bet: Investors will get scared again and want U.S.-guaranteed debt so they know they'll get repaid.

James Paulsen, chief strategist at Wells Capital Management in Minneapolis, with $355 billion under management, has been pounding the table for months to buy stocks. Just like in the early 1980s, the recovery will take the form of a "V," he says. The reason: Companies have cut inventories and payrolls to the bone, so just a little revenue growth could translate into a bumper crop of profits.

El-Erian says many of the bulls don't appreciate just how much the government props still under the economy are masking its weakness. Instead of focusing on the fundamentals today, he says, they're looking to the past, expecting a quick economic rebound because that's what's happened before.

We're trained to think the "farther you fall, the higher you'll bounce back," El-Erian says. "We're hostage to the V."

El-Erian says we've probably seen the worst of the crisis but consumers, and not just Washington, need to start spending again for the recovery to really take hold.

He doesn't expect that to happen soon. Like in the Great Depression, Americans are saving more and borrowing less -- a shift in attitudes toward family finances that Pimco thinks will last a generation.

That, plus the impact of more regulation and higher taxes, El-Erian says, will crimp growth for years to come.

El-Erian Is An Optimist

As I see it, El-Erian is an optimist. A year from now it is extremely unlikely the unemployment rate will approach 8%. Please note El-Erian is not calling for 8% unemployment, he is only saying it will be above 8%.

How much above 8% are we talking about? Arguably, the answer to that question is another question: How nuts will Congress get with more stimulus packages? Then again, the current stimulus package did not create any lasting jobs, so why would the next one?

It is pretty clear the bulk of the current stimulus efforts is behind us. We will see the results in 4th quarter GDP, with some additional but smaller effect in the 1st quarter 2010 GDP. What then?

Hussman's viewpoint is very similar to mine. I think the bottom may be in, but returns going forward are unlikely to be very good, and a strong pullback is very likely.

Other possibilities include a scenario in which the market goes nowhere (say +-150 S&P points) in either direction, for a number of years. There is also a 20% chance Congress and the administration totally wrecks the US dollar and stocks magically go flying.

I think the probabilities look something like this:

• 20% chance of a durable rally
• 20% chance the market meanders nowhere for as long as 5 years
• 30% chance of of a hard 25-30% correction
• 30% chance the bottom is not even in

Unlike Hussman, I have not done any statistical analysis of those estimates. Certainly his "estimate a probability of about 80% of fresh credit difficulties accompanied by a market plunge over the coming year" is reasonable enough.

Note that Hussman's 80% probability of a plunge encompasses a plunge where the bottom holds and also where it doesn't.

The key for me is that on average it does not pay to be fully invested here, regardless of what the stampede of bulls say. Bear in mind, the bulls were saying exactly the same thing as they are now right at the October 2007 high. I received taunts for several months for my market top call late summer of 2007, about 3% and 3 months early.

Is the top in now? No one knows, but that is not even the right question to be asking. A far better question to be asking is "Is the bottom in?" Even if it is, a major test coming of that bottom down the road is highly likely and that will gore a lot of overly complacent bulls along the way.

In 2007, Chuck Prince former CEO of Citigroup proclaimed �When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you�ve got to get up and dance. We�re still dancing."

Once again, bulls are dancing on a clifftop, oblivious to the fact that the next step might be right over the edge.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Morgan Stanley Predicts 5.5% 10-Year Treasuries, 30 Year Mortgages at 7.5%; I'll Take the Under

David Greenlaw, chief fixed-income economist at Morgan Stanley Sees 5.5% Note as U.S. Faces Deficits.

If Morgan Stanley is right, the best sale of U.S. Treasuries for 2010 may be the short sale.

Yields on benchmark 10-year notes will climb about 40 percent to 5.5 percent, the biggest annual increase since 1999, according to David Greenlaw, chief fixed-income economist at Morgan Stanley in New York. The surge will push interest rates on 30-year fixed mortgages to 7.5 percent to 8 percent, almost the highest in a decade, Greenlaw said.

When you take these kinds of aggressive policy actions to prevent a depression, you have to clean up after yourself,� Greenlaw said in a telephone interview. �Market signals will ultimately spur some policy action but I�m not naive enough to think it will be a very pleasant environment.�

Speculators, including hedge-fund managers, increased bets that 10-year note futures would decline more than fivefold in the week ending Dec. 15, according to U.S. Commodity Futures Trading Commission data. Speculative short positions, or bets prices will fall, outnumbered long positions by 52,781 contracts on the Chicago Board of Trade. It was the biggest increase since October 2008.

Edward McKelvey, senior economist in New York at Goldman Sachs Group Inc., the top-ranked U.S. economic forecasters in 2009, according to data compiled by Bloomberg, expects yields to drop to 3.25 percent. Goldman Sachs says unemployment will average 10.3 percent in 2010, hindering the recovery.

�This is the re-emergence of the bond market vigilantes,� said Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management, who oversees $22 billion. �The vigilantes are saying, OK guys you want to do this, you�re going to pay a higher price for it.�

I'll Easily Take The Under

5.5% on 10-year treasuries? I'll take the under. I'll also take the under on 7.5% mortgages as well.

Goldman Sachs' call for 3.25% on the 10-year based on the unemployment rate averaging 10.3% seems like a very good guess. However, anything from 2.75% to 4.75% should be in the ballpark.

I freely admit 2 points is a very large park. Yet, as wide as that range is, it is quite possible that we see something near both ends of that range at some point during the year given the factors in play.

Six Factors In Play

1. If there is a spike, it is far more likely earlier in the year than later and we are headed into 2010 currently at 3.84%. Another 75 basis points certainly seems possible with the "hate treasury trade" back in vogue.
   


2. Treasuries are in an unseasonably favorable period right now, and that lasts all the way through May.


3. If there is a chain of favorable data such as a surprise to the upside in GDP for the 4th quarter of 2009 or 1st quarter of 2010, that too can contribute to a spike in yields. But all the way to 5.5%? Sustained? I'll put the odds of that at 15%.


4. Most analysts seem cock-sure the bottom in the stock is in and we are off to the races. The bottom may be in, but even if so the odds of a hard correction are very high in my opinion. Should that happen, there can easily be another flight to safety trade.


5. Unemployment is unlikely to dip substantially below 10% in 2010 and could easily rise to 11%+. That would kill a sustained rise in consumer spending, put a damper on earnings, and lead to higher chargeoffs on credit cards. Such events would be favorable for treasuries.


6. The global recovery can easily falter in the second half of 2010. That too would be favorable for government bonds in general.
   

Wildcard: Congress may go berserk with additional fiscal stimulus efforts. Note this would be a two-edged sword. If Congress does go berserk , the economy would likely be in the gutter and yields already falling even though the action itself would be supportive of higher yields.

The concentration of upside yield risks in the first half, and downside yield risks in the second half account for the large ballpark for where yields may go in 2010. For where the 10-year note ends 2010, I will guess a much narrower 3.0% to 3.5%.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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26 Mile Long Glut Of Idle Oil Tankers

Bloomberg is reporting Tanker Glut Signals 25% Drop on 26-Mile Line of Ships.

A 26-mile-long line of idled oil tankers, enough to blockade the English Channel, may signal a 25 percent slump in freight rates next year.

The ships will unload 26 percent of the crude and oil products they are storing in six months, adding to vessel supply and pushing rates for supertankers down to an average of $30,000 a day next year, compared with $40,212 now, according to the median estimate in a Bloomberg News survey of 15 analysts, traders and shipbrokers.

That�s below what Frontline Ltd., the biggest operator of the ships, says it needs to break even.

Traders booked a record number of ships for storage this year, seeking to profit from longer-dated energy futures trading at a premium to contracts for immediate delivery, according to SSY Consultancy & Research Ltd., a unit of the world�s second- largest shipbroker. Ships taken out of that trade would return to compete for cargoes just as deliveries from shipyards� largest-ever order book swell the global fleet.

�The tanker market has been defying gravity,� said Martin Stopford, a London-based director at Clarkson Plc, the world�s largest shipbroker. Stopford has covered shipping since 1971.

More than half of the ships are in European waters, with the rest spread out across Asia, the U.S. and West Africa. Lined up end to end, they would stretch for about 26 miles.

Storing Crude

Traders are storing enough crude at sea to supply the 27- nation European Union for more than three days. Royal Dutch Shell Plc, Europe�s biggest oil company; London-based BP Plc; JPMorgan Chase & Co.; and Morgan Stanley were among those that sought vessels for storage.

The storage trade is profitable so long as the spread between energy contracts exceeds ship rental, insurance and financing costs. A year ago, the spread between the first and sixth Brent crude-oil contracts traded on the London-based ICE Futures Europe exchange was 23 percent. Now, it�s 4 percent.

Speculation is one of the things propping up energy prices. Belief in a sustainable recovery is another, and rampant money supply growth in China is a third.

Regardless, with contango spreads tightening, demand for 26 miles of oil tankers will collapse.

Crude Prices



Click on chart for sharper image.

The floating storage trade is becoming riskier and riskier. The spread all the way out to January 2011 is only $7 and there is certainly no guarantee or even likelihood oil prices will be that high then. One also has to factor in lease and crew costs.

It was one thing to store oil when crude was below $40 and future months were much higher. Risk factors are much higher now and the floating tanker trade will soon be unwound.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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