So What, Who Cares

I have been willfully ignorant of whatever is going on in Washington. When I do hear snippets here and there on Bloomberg I want to do this:

If I listen at this point it will only be a detriment to prudent wealth management:

• T = 0: Self-inflicted issue (e.g. the debt ceiling) that could have a “catastrophic” impact on the markets and the economy starts being chatted about in investment circles

• T = 1: Self-inflicted issue begins to pick up steam as a “legitimate” threat; markets largely ignore

• T = 2: Politicians dig in and hope for a comprise is lost; markets pick up volatility

• T = 3: Now the only thing that will save us is a last minute deal; market moves down a few percent, not enough for me to put cash to work and buy (annoying), but also not triggering any sell signals for existing holdings

• T = 4: At the last minute whichever party is losing the popularity poll caves; market back to where it was before

• T = 5: Self-congratulating politicians save the world from a problem they created; everyone vomits

• T = 6: For real?  Those insufferable mutants only kicked the can down the road, again not solving their own problem

• T = 7: Wait until we get to do this same charade all over again

I am fairly sure the above blueprint can be written in stone.  Thus, if you care to tune out Washington like I do then take a nap for a month and that’s where we will be.

Note: The Debt Ceiling talks of August 2011 coincided with a near collapse in Europe, thus the almost 20% decline in the markets doesn’t count.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

Presidential Race

First, this blog is non-partisan for a variety of reasons.  Second, this is not a partisan post; I just want to bring to light observations on the Presidential race.

One of my favorite “news” sites is Drudge Report mainly because it’s totally headline driven, contains some very good pop culture links, and funny pictures.  I also frequent the NYT.  What appears clear to me is that in national polls Obama and Romney seem tied.

Where it gets interesting is the Intrade betting markets, where Obama is more heavily favored with Romney making ground.  Intrade problems aside, why the disconnect?  The election isn’t decided by the popular vote but by the Electoral College.

Econbrowser did a nice job of laying this out drawing on Real Clear Politics and Intrade numbers.  I again liked to look at the Intrade map, which outlines Electoral College bets on each state.  It’s a nice to play with the math and see the different outcomes.

The one conclusion I came to, and as Econbrowser pointed out, Ohio is really the only state that matters.  I took it one step further and put together a chart of the Obama values (higher = more likely to win) since September 1, when contract volume picked up:

The correlation is almost 1, which advances the theory “as Ohio goes, the election goes”, or whatever it is they say.

Does Iran’s Hyperinflation Mean for Everyone Else?

I have no clear idea, however…

Historically, incidences of hyperinflation result in high levels of social unrest – protesting, rioting, anger, regime change, etc.  This makes total sense; if the masses can’t afford food they get mad and such conditions are ripe for mobs and rioting.

As Walter Kurtz points out, “The only question now is who will be the target of people's rage and desperation this time.”  Will it at be at the regime, the West, or another group?

I want to look at the former (the regime), mainly because the latter two don’t totally change the current dynamic.  In fact, the only two other hyperinflations this century involved Zimbabwe and North Korea.  To my knowledge neither experienced regime change (Note: I think Zimbabwe does have some joint power agreement) and the discourse regarding either country has not really changed.  Still, I should note that both economies are much smaller than Iran.

The whole reason I started on this Iran post (aside from brining attention to it) is to think about the impact of social unrest and possible regime change.  I am not sure what the conventional wisdom is on an Iranian regime change, but even though they are the most destructive actor in the world arena, I think at least in the short-term it would not be a positive geopolitical event:

1. I believe that in most cases those with power, especially in extractive governments, want to stay in power and will do what it takes to do so.  As a result, saber rattling now may turn into action if the regime feels threatened.
• The analogy may be of an angry pit bull that’s cornered and probably has only one move left.
2. Who fills the power vacuum?  See Libya and Egypt.
3. Contagion to the rest of region.  As I look at a map, Saudi Arabia would essentially be surrounded by social unrest.
4. Rising oil prices could tip the world into recession again at a time of high fragility.

Caveat: I am painting this with the broadest of brushes here and shooting from the hip. There could be some important cultural, social, religious, etc. details of which I am unaware, which could derail my hypothesis.

Still the risk is important to consider, especially since we could be at an inflection point.  “Turmoil in the middle east” is always an investment risk.  Seriously, if you find a list of market threats that doesn’t list, or that hasn’t listed that in the past 6 years, please forward it to me. 

So to conclude, while the past couple posts have drifted into world affairs, I believe that what is happening in Iran is at the very least a thought when considering asset allocation going forward, especially given the current state of affairs. 

Iran Economic Collapse

I tend to avoid watching the news and focus the bulk of my reading to aggregators or sources outside traditional media for a variety of reasons.  I am going to presume that many are not that Iran is, or could be, on the brink of an economic collapse as I haven’t really heard it discussed.

Regardless, I have seen an explosion of Iran related articles and blog posts over the past few weeks (I believe it started with The Atlantic) and here are some facts:

• Iran’s monthly inflation is roughly 70%.  This is considered hyperinflation based on a widely accepted definition (> 50% a month).
• This means prices double in 40 days.
• $1 bought you 24,600 Rials (Iran’s currency) on 09/24 in Iran’s Black Market.  On October 2^nd  39,000 Rials is what you got for $1.  The Rial is least valued currency in the world relative to USD.  The official value is 12,260 Rials for a dollar.
• Sanctions began in Summer 2010: since then the Rial has depreciated 70%+ vs. USD and the monthly inflation rate has risen to 70% from 0.70%. 

And why they are having hyperinflation:

1. Iran is heavily dependent on oil exports.  The sanctions are de facto do business with Iran (mid 20s in comparative size) or do business with the US (largest economy in the world).  Thus, production takes a hit while currency in the system stays the same or increases.  Less production + more currency = less demand and greater supply of currency = inflation.
• Simplistically, if an economy produces $100 worth of goods and has currency supply $102 then overnight only has $50 worth of goods there are now $50 less of output to soak up the currency.  As a result, the excess currency goes to purchase the remaining $50 of goods, pushing up prices.
2. As #1 happens, whoever is holding Rials wants to convert those to something with a store of value – USD.  But since the USD is essentially cut off from Iran, the supply of USDs fall rapidly as people begin converting the Rial ASAP.  This reinforces #1.

So what is happening now?

• Hoarding.  Buying goods now instead of later before the price goes up.
• Rioting.  If you can’t buy bread for your family, what else can you do?
• Withholding of goods.  Why sell today when tomorrow’s price will be higher?
• More black markets.  If you want the USD why go to central bank when a guy in alleyway will give you 3x that?
• Outlawing exchange.  Prices rising, currency collapsing, so try and prevent USD demand to prop up Rial.

So now what?  Next post I will touch on this.

TARP “An Abysmal Failure”

Those were the words of Neil Barofsky (appointed by Bush, registered Democrat), former special inspector general for TARP, in a recent interview with Yahoo! Finance.  Here is the video:

And here are some key takeaways:

• Banks could dictate terms of their own bailout
• No difference between the Bush administration and the Obama administration
• Most of blame goes to executive branch, and thus Treasury (again both parties)
•  Program was intended to restore lending, help homeowners, but nothing in program to compel the banks to do so 
• Geithner essentially acknowledged that the program was to allow banks to soften the blow and extend the foreclosure process
• Government just looked the other way in the face of misconduct
• Accounting tricks and spin have essentially showed TARP is a gain, but losses were still less than expected
• Further, the above “gain” doesn’t take into account all other bailouts
• It did help prevent financial Armageddon, but did little in the way of helping the broader economy and households, which is the reason why Congress passed TARP in the first place

In hindsight without the world on the brink of returning to a hunter-gatherer society it’s much easier to criticize the program.  It was really scary in the Fall of 2008.  I admit that.  Further, I will concede I don’t think Paulson, Bernanke, Geithner, etc. created this massive wealth transfer out of malice.

Having said that, I think Barofsky is correct – consumers are still over leveraged, unemployment is high, consumption is weak, growth is slow, etc.  While all are improving, none are indicative of a robust economy.  There could have been a better way to handle TARP (e.g. controlled bankruptcy, greater controls) and if there wasn’t, why wasn’t there?

Ultimately I think TARP is another example of treating the symptoms and not the disease.  The banks were in trouble because they made excessive loans to consumers who were leveraged to the gills.  The economy won’t feel any better until the consumers repair their balance sheets.  TARP, monetary easing, and other policies have done little to address that.

HT to Big Picture for alerting me to the video.

Here is Barofsky’s book.

Europe Again & Again & Again – Part III, Some DIY Tips

Given all the news that comes out of Europe, I figured it would be a good idea to provide readers with a quick way to find easy to read news stories and then see how markets react. 

First, here is some good source material from the NYT.  I choose Spain and Italy given they are the rage right now. The pages are set up rather nicely, with a summary of all relevant information at the top, followed by the newest NYT articles on the bottom:

• Greece
• Spain

Next, when a new piece of information comes out how will the markets react?   I like to follow the yield on government bonds.  Bloomberg provide 10-Year yields and I picked three of the riskier Euro nations and then Germany as a way to compare:

• Greece
• Spain
• Italy
• Germany

Basically if things in Europe are worsening riskier Euro nations will have their yields rising and Germany should have its yield falling (note: this might not hold in the remote worst care scenario). 

There is also Intrade to see a market prediction on a county leaving the Euro.  Without getting into detail, essentially just look at the % chance.

There are obviously many more places to mine for data.  I think these are the most basic and direct. 

One thing to note, it appears the trend is that markets are reacting less and less favorably after every “positive” announcement.  To me this indicates markets aren’t buying what Europe is selling.  Again, as I mentioned in my previous post, I don’t think this will happen until Germany backs substantial systemic change. 

Update:  I wrote this a few weeks ago, but since then there has been a relatively big (well bigger) development – basically banks will now be able to borrow directly from the ECB, not their own Central Bank.

This is bigger than any news out of the EU in awhile.  While the restructuring I think is needed, it is certainly a step in the right direction:

1. A step toward UNITY.  This is key, all countries need to start moving together, not apart.
2. By recapitalizing the banks directly through the ECB, the risk of the worst case scenario credit crisis scenario (bank runs) appears to be reduced, although not eliminated.  

Europe Again & Again – Part II, Too Much of Nothing New: What to Expect

When I say “nothing new” I mean anything that isn’t a total restructuring of the Euro.  This should be approached with either new rules/institutions (e.g. Eurobonds, EU backstop, etc.) or with a change in members (e.g. weaker members leave, Euro disbands, etc.).   Status quo will not do - something new, something systematic is required if some semblance of the Eurozone is to survive.

What does not constitute something new is what I outlined in my last post – Spanish bank bailout, and  a Greek coalition to stay in the Euro.  These are stop gap measures that will only kick the can down the road.  The market apparently agrees.

So if Europe continues to kick the can down the road what should we expect?  More of the same from late last summer to now:

• Downward pressure on the Euro vs. Dollar (i.e. the Dollar continues to strengthen versus the Euro, making your European vacations cheaper and our exports more expensive)
• Steep VIX futures curve
• The VIX is a forward looking volatility measure.  The steep curve implies the market expects volatility to be greater in the future than it is now.
• Upward trend in yields of weaker EU countries (Greece,  Spain,  Italy)
• Downward trend in German yields
• Low Treasury yields
• Choppy equity market, perhaps range bound

How long with this continue? I am not quite sure, but I would think the above trends will probably hold until there is a resolution one way or another.   That isn’t to say there won’t be movements against the trends whenever some news comes out, just that over the course of “kicking the can down the road” they will persist. 

The ball is in Germany’s court.

Update:  I wrote this a few weeks ago, but since then there has been a relatively big (well bigger) development – basically banks will now be able to borrow directly from the ECB, not their own Central Bank.

I will comment more on this in my last post of this 3 part series.

Europe Again – Part I, Too Much of Nothing New

While I would like to stop writing about Europe, unfortunately it doesn’t appear that I can.  I gave my most recent breakdown here, here, and here.  Since then, Spain announced a bank bailout and Greece had new elections.  Here is what has happened since my last blog:

Spain – “Euro zone finance ministers agreed… to lend Spain up to 100 billion euros ($125 billion)”

Greece – “Greece’s two traditional political rivals are in a race to forge a coalition as the state’s cash dwindles, bank deposits flee and Europe demands renewed austerity pledges before releasing more emergency aid… New Democracy won 129 seats in the 300-seat parliament, according to Interior Ministry projections with 99 percent of the vote counted. Pasok, which has alternated in power with New Democracy over the past four decades, won 33 seats, enough for the two of them to forge a coalition that backs the creditors’ austerity demands.”

So what do these two events mean?  It appears not a whole lot.  Markets were unmoved by either.  The Spanish bailout at first created some optimism but that quickly dwindled.  Why?

I can’t answer with certainly, but it would seem both of these are stop gap measures that do nothing to address the major concern of the Euro – disconnected monetary and political/fiscal policy (via Pragmatic Capitalist, Goldman Sachs).  So where is the game changer?

There is a lot of noise, so it’s difficult to tell when something substantial (like our TARP program) will change the dynamic; however, one thing is very clear: Merkel will be the key.  Whenever Germany starts talking and acting on the inevitable wholesale change that must develop is when there will be some resolution.  

Update:  I wrote this a few weeks ago, but since then there has been a relatively big (well bigger) development:

“Euro-area leaders asked for proposals this year to unify banking supervision and soup up the ECB’s powers. They referred to a clause in the EU treaty that allows them to give the ECB prudential oversight of banks and other non-insurance financial companies.

The move paves the way for the European Commission, the EU’s regulatory arm, to augment its proposals on deposit insurance, capital requirements and how to handle failing banks…

Once Europe establishes a single banking supervisor, leaders said they may allow cash-strapped lenders to be recapitalized directly instead of through their home governments. ”

I will comment more on this in my last post of this 3 part series. 

What now with the “Fiscal Cliff?”

So I explained what the fiscal cliff is and why it is bad, but what will ultimately happen?  I have no idea, trying to figure out what a bunch of politicians are going to decide seems like a fool’s game.  Who can predict that?

Still, what we can try and do is estimate probabilities.  Now, I am not a forecaster, but I can give you the good news – the CBO says the forced austerity would probably throw the economy into recession.

Why is this good news?  Well the severity of going over the“fiscal cliff” is severe, so my thought is reason will dictate the discourse and if reason fails there is the insurance that these politicians like to keep their jobs.  I would actually bank more on the latter.   

Further, the two big items are the Bush tax cuts expiring and the “sequester”, there seems like a natural compromise here.  Republicans get the tax cuts, Democrats get to push back the automatic spending cuts.  Maybe the stimulus measures don’t get renewed, but hopefully the Bush tax cuts staying and "sequester" leaving will be enough to keep this 2% growth train moving!

Here is how Goldman Sachs econ team handicaps it:

1. 35% chance of temporary expiration of growth policies in 2013
2. 40% chance of short-term extension of growth policies with longer-term solution in later 2013
3. 20% chance of extension of growth policies for more than a year
4.  5% chance of “grand bargain” of fiscal and tax reform

The problem with the above (as with Europe) is that temporary measures are just that and create even more uncertainly.  Still, the above paints a 65% chance of outcomes I believe would be intermediately (through Q2 2013 maybe) good for the market, of course absent any exogenous shocks.

At the end of the day, I think the “fiscal cliff” big risk parallels another one of my big risks – Europe.  That is to say, the severity of the situation should yield at least a semi-positive result (I hope).  Still, the risks are large, real, and should be met with caution.  My other big risks are much harder to handicap – war Iran (seems low, but who knows) and a Chinese hard landing (black box).

Why the “Fiscal Cliff” is Bad

I have covered many times why I am against austerity at the present moment.  In fact, it was one of my big risks to economy and market going forward.

The problem with the fiscal cliff and the austerity it will bring – the same problem Ben Bernanke speaks of – is that what picks up that slack?  If GDP is comprised of consumption + investment + net exports + government spending and government spending is cut, which one of the other 3 is going to increase to offset that?

I don’t model GDP, but the bullets below should give you an idea of the growth versus austerity trade off:

• The Congressional Budget Office reckons that the combined effects of the “sequester” and the expiring tax cuts would add up to 3.6% of GDP in fiscal 2013.  (Source 3)
• David Greenlaw of Morgan Stanley, which puts the total effect at almost $700 billion at an annual rate, argues that the calendar-year impact is at around 5% of GDP.  (Source 3)
• David Rosenberg estimates the drag equates to roughly 4% of GDP from reduction of those tax benefits to spending.  (Source 1)
• According to Goldman Sachs, the total of amount of dollars the US government will be taking out of the economy is about $600 billion.  (Source 2)  

Such reductions have happened in the past, but with poor results:

• The last two times, 1960 and 1969, that there was a fiscal retrenchment of the same magnitude both ended in recessions. (Source 1)
• In 1968, when individual, corporate, excise and payroll taxes collectively rose by the equivalent of 3.1% of GDP, mostly to pay for the Vietnam War and to damp down inflation. The next year, the economy fell into recession.  (Source 3)

Now, the flip side would argue that at least we will reduce the budget deficit, but who cares?  At the expense of growth this seems silly.  Further:

• Austerity hasn’t worked for Europe.  Take a look at Spain, where austerity is taking place.  There GDP is falling and unemployment is at 24% and rising.  Further, the benefits austerity should have brought aren’t happening as bond yields are increasing and the deficit is growing.
• Why do we need to cut the deficit now?  Interest rates are low, very low, inflation is tame, and GDP growth is still sluggish.  What exactly is the risk at the present moment?

In the last post I will discuss the probabilities of what will ultimately happen with the “fiscal cliff”.

Source 1 – Lance Roberts and David Rosenberg.

Source 2 – Walter Kurtz and Goldman Sachs.

Source 3 – The Economist. 

What is the “Fiscal Cliff?”

I decided to do this series because a friend of mine asked why Fed Chairman Ben Bernanke was warning Congress about a “fiscal cliff.”  Coincidentally that afternoon I found an article discussing the “fiscal cliff” and its ramifications, so I decided to do some digging.

The “fiscal cliff” refers to the end of many stimulus tax measures (payroll-tax cut, investment tax credit, enhanced unemployment insurance), the Bush tax cuts, and automatic spending cuts called “sequester” at the end of 2012.  It is automatic austerity.  Here is a rundown:

• Tax Increases
• Under status quo at the end of 2012 roughly 42 tax benefits will expire at the end of 2012.  (Source 1)
• The 2001 and 2003 tax cuts are set to expire. This includes tax rates on those making over $250K as well as qualified dividends and in particular the 15% rate on long term capital gains.  (Source 2)
• The Payroll tax cut will expire at the end of 2012, increasing from 4.2% back to 6.2%.  (Source 2)
• The Alternative Minimum Tax (AMT), currently at 28% for those filing jointly with incomes of $74K or greater, will drop down to $45K.  (Source 2)
• Numerous temporary research and development tax benefits to corporations will expire.  (Source 2)
• Spending Cuts
• Automatic, across-the-board cut in domestic and defense spending, called the “sequester”, takes effect, cutting about $100 billion from government spending next year. (Source 3)
• Unemployment benefits for workers who have exhausted the standard 26 weeks of benefits will be phased out. (Source 2)
• At the end of the year the infamous debt limit will hit again, potentially forcing further cuts. (Source 2)

In my next post, I will discuss why this is bad.

Source 1 – Lance Roberts and David Rosenberg.

Source 2 – Walter Kurtz and Goldman Sachs.

Source 3 – The Economist. 

Europe – Now What

In my last two posts I covered what happened in the Greek elections and the potential repercussions of those elections.  Now it’s time to look at what will happen to the EU.  Aside from the previously referenced NYT and Spiegel articles, I used a couple different sources (Krugman, The Big Picture, The Reformed Broker, Kotok) for this post.  My key takeaways are as follows:

• Unless the EU renegotiates its rescue package with Greece, it’s highly likely they will leave the Euro.

• The chances of a renegotiation increased as elections in France and Germany indicate there is a growing backlash against austerity.  Still, Germany seems dead set against a renegotiation and they are the key player.

• Even if the rescue package with Greece is renegotiated, given all the previous aid these appear to be stop gaps that just kick the can down the road

• Thus, unless there is a complete overhaul to the system (e.g. Eurobonds, ECB backstopping banks, etc.) it seems likely Greece will eventually leave even if another new stop gap measure is added.

• Despite the anti-austerity elections there just doesn’t appear to be enough support (e.g. Germany) for an overhaul and the support probably won’t come until Greece leaves and the rest of the EU has to deal with the fallout, which would be…

• Anybody’s guess.  EU leaders appear to have enough resources to weather a Greek exit; however, no country has left the Euro before so it’s really an unknown.

• The real concern is a country like Spain or Italy having massive withdrawals from their banks as markets panic.

• If that happens the ECB will need to backstop the withdrawals and/or institute capital controls, then subsequently guarantee their sovereign bonds and put together some sort of fiscal policy (e.g. Eurobonds).

• Or let the Euro collapse, bringing on an even greater recession to all EU economies simultaneously. 

• Again, the big risk here is not Greece leaving but the potential domino effect that it could create with other EU countries.

• However, the best case scenario is that the elections and a Greek exit are a wakeup call to overhaul the Euro and make it a workable currency.

Greek Elections – The Fallout

In my last post I provided an overview of the Greek elections; now it’s time to look at the Greece faces.  Aside from the previously referenced NYT articles, I used this Spiegel article.  My key takeaways are as follows:

• The parties that initially negotiated the bailout terms are willing to renegotiate some of the bailout terms, but that won’t be enough for Syriza, which is needed for the coalition to have legitimacy.
• As a result new elections will most likely be called with anti-bailout parties primed to pick up more votes.  The new election will basically be a referendum on whether Greece will remain in the Euro.
• Presuming the EU will not finance Greece without the bailout terms, if Greece officially refuses the provisions of the bailout package they will default and leave the Euro, unless the EU relents.  
•  At this point Greece leaving seems likely.  Intrade probability has it around 60% by then end of 2013 for one country to leave the Euro.  That one country would be Greece.
• Assuming that happens, Greece will return to the Drachma.  This will be significantly devalued relative to the Euro, in turn making imports expensive and exports cheaper; thus, making Greece more competitive.  Currency devaluation could be between 50% and 80%.
• It also becomes cheaper to invest in Greece, which would attract FDI (foreign direct investment).
• Private companies with debts denominated in Euros would no longer be able to pay those debts and bankruptcy would then follow.
• Given all that, the IMF estimates a decline in Greece GDP by more than 10% is possible in the first year, but then after that the recovery should be quicker given the devaluation.  
• Such a plan has worked before; however, there is still a risk of a government collapse.  Further, savers essentially have their savings inflated away.
• Note:   Greece is currently in year 5 of their recession.  Unemployment is 22% with youth unemployment at 53%.  In the 3 years unemployment rose by nearly 100%.

 In my final piece on this subject, I will take a prospective look at the fallout in the EU.

Greek Elections – What Happened

Elections were just held in Greece and probably will be held again in June.  Being that I am new to how the Greece Parliamentary system works, I decided to do some digging.  I used some NYT articles (here and here and here) to try and figure out exactly what happened.  My summary is below:

• The two main parties in Greece – New Democracy (center-right) and Socialists – lost seats in Parliamentary elections.
• Syriza (Coalition of Radical Left) and Golden Dawn (far-right) both picked up seats.
• There are now 7 parties in Parliament, which means that a coalition government is going to be very hard to get, and will probably lead to new elections.
• The vote seems to be a clear rejection of the bailout terms; thus, the parties gaining seats are refusing to accept the previous ruling parties negotiated austerity package. 
• Polls indicate that with new elections, parties opposed to the bailout will pick up more seats.
• Further, since Syriza has the second most seats now (16% compared with New Democracy – 20%, and Socialists – 14%) any coalition government formed without them could stoke even more civil unrest.
• The EU’s financial support is dependent on those negotiated austerity measures.  Without those spending cuts, in the absence of a change in policy, the EU will stop financing Greece.
• If the EU pulls the plug Greece will default and be out of the Euro.
• Note:  the EU + international community has pumped in roughly $312B, still debt to GDP is at a peak and the recession worsens.

Next, I will cover what the fallout will be to Greece.

MF Global, Now What & How to Protect Yourself

So given that it appears MF Global was running an apparent ponzi scheme at the end of its life, and one would assume the executives behind this would be going to jail.  One would be wrong.

Joe Nocera of the NYT reports (via another NYT article) that prosecutors can’t identify a “smoking gun“ linking anyone to the theft.  Further, “a number of federal prosecutors have expressed doubts… that anyone at MF Global… intentionally misused customer money.” 

Translation, it was chaotic at the end: people at the firm were racing to find money, and maybe accidentally took it from client accounts.  I don’t buy this.  Neither does Nocera, who also suggested maybe executives thought they could repay the money back.

Those would have to be the two most good natured excuses outside of downright theft; however, it would seem neither would be grounds to escape prosecution as may happen.  In fact, some executives might still get their bonuses in hopes maybe they can assist in finding the missing money.  

Nocera mentions why a lack of prosecution sets another terrible precedent:

A failure to prosecute anyone at MF Global would be, if anything, even worse. It would mean that executives at a broker-dealer can indeed steal customer money and get away with it — so long as it was “unintentional.” And it would only deepen the cynicism so many people feel about government.

This quote points to my growing concern of crony capitalism, which is non-partisan.  CEO Jon Corzine was Democratic Senator, Governor of New Jersey, and big fundraiser for President Obama. 

Regardless of my feelings and the fallout, how can investors protect themselves?  Barry Ritholtz, listed a few ways:

1. Don’t leave your money with a firm that trades with their own funds.  They might raid your accounts for cash.
2. Use a third party custodian that only holds your cash and investments.  

I will add, have online access, for an extra layer of protection, and lastly just read the news.  If it appears your broker is in trouble get your funds out of there.

MF Global Customers, What Happened?

Roughly $1.6B in customer cash went missing after the MF Global collapsed.  This was almost 25% of customer funds.  Who were these customers?  Farmers, grain operators and hedge funds who used MF Global to trade in commodities.

Initially it was believed that these funds would be hard to recover.  Luckily, it appears most claims will be settled for 90% of face value.   Does anyone want to take a 10% haircut?  Of course not, but at this point getting 90 cents on the dollar is better than 0.

When I started reading about this I was a bit shocked.  I was under the impression that MF Global could not touch this money.  If a broker-dealer goes bankrupt, client accounts are supposed to be segregated and safe, held at a custodian.  

But in this case, it appears executives stole money from these accounts in hopes that they could save the business.  The firm was highly leveraged and largely went bankrupt in October from bets that went south on European debt.  Essentially these funds would have been used as collateral for their creditors, to pay off creditors or used to double down on existing trades.

In the end, MF Global may have intended to pay the money back to customers, just like Madoff or any other Ponzi scheme.  In my next post, I will update the current prosecution against MF Global and how you can protect yourself against this type of broker-dealer raiding.  

What are Investors Most Worried About?

Business Insider recently ran a poll on “What's the #1 thing you're worried about for the US economy?”  Once I answered, it provided the current results. Here were the top 3 answers:

1. A debt crisis in the US
2. Gasoline prices
3. A war in Iran

Here are my thoughts on those 3.

1. I am not quite sure what this means.  If we are referring to US public debt I have mentioned many times why I am not overly concerned now about a rise in Treasury rates or the inability of the US government to “fund” itself.  If we are talking about private debt, then I think that has more to do with the mess in Europe spilling over here. 
2. This is a concern, but not at current levels.  Check out this blog post from Econbrowser.  You can see gas prices, while at the high end of the range over the last 6 years are not at the peak.  Further, as a percentage of consumer spending on energy goods we are below the average since 1960.
3. Above I said at current levels.  A war with Iran would I imagine cause gas prices to sky rocket.  So this would be a concern on many fronts, but the likelihood is hard to gauge.  Recently a former Mossad head came out against an attack, but there are also articles making an attack seem imminent. The more imminent an Israel military mission looks, and the more economic pressure applied, the more likely Iran is to find some diplomatic solution. This is nearly impossible to handicap.

What are my top 3 concerns?  Below I listed my top three choices from the poll, and do so in bullet form as I give them all roughly an equal weighting:

• European collapse.  This points to the first concern of the masses.  Again, this would be all on the private side (e.g. US banks holding sovereign debt or insuring that debt).
• Fiscal tightening in 2013.  I have mentioned again and again my preference is for more or at least status quo short-term spending.  While I think we are closer to a self sustaining recovery, I see no reason to chance it by cutting back fiscally or monetarily.
• Tie: A war in Iran or a China hard landing.  For the former, see above.  On the latter, there seems to be solid reasons on both sides (hard and soft landings).  A hard landing would certainly have a large impact.

Thanks to TheArmoTrader for highlighting the poll and providing some insight.