When The Music Stops. Italy! Iran

Baltic Dry Index. 1077 -32    Brent Crude 75.10

The whole history of civilization is strewn with creeds and institutions which were invaluable at first, and deadly afterwards.

Walter Bagehot.

We open this holiday Monday, with Italy. Will Italy bring down the euro and with it the dying, unloved, unreformable EUSSR?  Time to start the EU over and invite the UK to join and have input from the “reformation?” Vested interests in Brussels will ensure that this never happens. The EUSSR is headed towards an USSR like ending, probably triggering the end of the fiat currency scam as we know it. Add to gold and silver holdings.

All the best stories in the world are but one story in reality - the story of escape. It is the only thing which interests us all and at all times, how to escape.

Walter Bagehot.

May 28, 2018 / 12:45 AM

Italy's president calls in former IMF official amid political turmoil

ROME (Reuters) - Italy’s president is expected to ask a former International Monetary Fund official on Monday to head a stopgap government amidst political and constitutional turmoil, with early elections looking inevitable.

President Sergio Mattarella has called in Carlo Cottarelli after two anti-establishment parties angrily abandoned their plans to form a coalition in the face of a veto from the head of state over their choice of economy minister.

In a televised address, Mattarella said he had rejected the candidate, 81-year-old eurosceptic economist Paolo Savona, because he had threatened to pull Italy from the single currency.

“The uncertainty over our position has alarmed investors and savers both in Italy and abroad,” he said, adding: “Membership of the euro is a fundamental choice. If we want to discuss it, then we should do so in a serious fashion.”

Financial markets tumbled last week on fears the coalition being discussed would unleash a spending splurge and dangerously ramp up Italy’s already huge debt, which is equivalent to more than 1.3 times the nation’s domestic output.

After Mattarella’s move, the euro gained ground, adding 0.6 percent against the Japanese yen EURJPY= and ticking up against other major trading partners as well.

The far-right League and anti-establishment 5-Star Movement, which had spent days drawing up a coalition pact aimed at ending a stalemate following an inconclusive March vote, responded with fury to Mattarella, accusing him of abusing his office.

5-Star leader Luigi Di Maio called on parliament to impeach the mild-mannered Mattarella, while League chief Matteo Salvini threatened mass protests unless snap elections were called.

“If there’s not the OK of Berlin, Paris or Brussels, a government cannot be formed in Italy. It’s madness, and I ask the Italian people to stay close to us because I want to bring democracy back to this country,” Salvini told reporters.

---- Shortly afterwards, the president’s office summoned Cottarelli, the IMF’s former director of fiscal affairs, for a meeting on Monday. Such a call is usually a prelude to being offered a mandate to form a government.

Cottarelli would be a calming choice for the financial markets, but any technocratic administration would likely only be a short-term solution because the majority of parliamentarians have said they would not support such a government.

If, as expected, he fails to win parliamentary backing, Cottarelli would simply ferry Italy to elections that would most likely be held in September or October. It would be the first time in postwar Italian history that such a re-vote was needed.

Polls have suggested that the League, which won 17 percent of the vote in March, would surge in any early ballot, while support for 5-Star remained strong on around 35 percent.

More
https://uk.reuters.com/article/uk-italy-politics/italys-president-calls-in-former-imf-official-amid-political-turmoil-idUKKCN1IS0VC

Next, when the music stops. The next Enron, Bear Sterns, Lehman, Madoff, AIG, is out there and getting closer by the day. Today, for those not attending barbecues, visiting the beach or the pool, or sheltering from the rain, a little scary reading. What happens when the music stops? The end of the fiat money world as we knew it.

There can be few fields of human endeavour in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.

J. K. Galbraith.

Don’t get burned: June is the second-worst month of the year for the Dow

Published: May 25, 2018 10:07 a.m. ET

Trading is particularly fraught in midterm years

The month of May is set to be a positive one for the U.S. stock market, bucking a seasonal tendency for weakness and potentially giving historically minded investors reason for optimism since June usually isn’t a good time for stocks either.

According to the Stock Trader’s Almanac, June ranks among the worst months of the year for major indexes. The results are especially poor in midterm election years, as is 2018.

The Dow Jones Industrial Average DJIA, -0.24%  has seen, on average, a decline of 0.3% in June, according to data that goes back to 1950. That makes June the second-worst performing month of the year. Over the past 67 years, June has been negative for the blue-chip average 36 times, and positive in 31 years.

For the S&P 500 SPX, -0.24% June ranks as the third-worst performing month of the year. The benchmark index’s performance is essentially flat over the month, with an average decline of 0.03%, according to the Almanac. Of the past 67 Junes, 35 have been positive, while 32 have been negative.

Historical statistics paint a more positive picture for the Nasdaq Composite Index COMP, +0.13% which is currently the best-performing of the three major indexes in 2018. It’s seen an average rise of 0.7% over the month, and over the past 46 years, 25 Junes have been positive while 21 have been down.

Despite the gain on the month, June’s performance only ranks as the eighth-best for the Nasdaq.

----An additional element of uncertainty, however, could come from the runup to the November midterm elections. Per the Almanac, the Dow has seen an average fall of 1.7% in June during midterm years, while the S&P has seen an average fall of 1.9% and the Nasdaq loses 1.6%. For both the Dow and the S&P, June has historically been the worst month in midterm years, while it’s been the third worst month for the Nasdaq.

More

https://www.marketwatch.com/story/dont-get-burned-june-is-the-second-worst-month-of-the-year-for-the-dow-2018-05-25

Italy's New Goverment Is Bad News for the Euro

Two populist parties are set to take over the government reins in Italy and about the only thing they seem to agree on is their desire to spend huge amounts of money. That's bad news for Italian finances and terrible news for the eurozone. By DER SPIEGEL Staff

May 25, 2018  06:41 PM  

Signor Fabio doesn't think it will take long. The new Italian government, he believes, is destined for a brief tenure: "In September, we will be voting again," says the slender man in the center of Rome. Signor Fabio is the giornalaio -- or newsstand proprietor -- with the most attractive kiosk location in the capital, situated as it is fewer than 100 meters from the prime minister's office. He knows what's going on in the world and that people are once again looking to his homeland with concern.

"Rome Opens Its Gates to the Modern Barbarians," was the headline chosen by the Financial Times 10 days ago in an editorial about the new government, which pairs the Five Star Movement (M5S) under the leadership of Luigi Di Maio with the right-wing nationalist party Lega, led by Matteo Salvini. But Italian papers weren't any less critical. The daily Il Manifesto went with the headline "Populandia," in reference to the populist natures of the two parties. "The Third Republic Is Formed as the Whole World Laughs," wrote Il Foglio. And Libero wrote: "Mattarella Chooses the Rotten Apple: Mini-Premier Conte."

The latter is a reference to Salvini's and Di Maio's inability to agree on which of the two should become prime minister, so they chose the completely inexperienced law professor Giuseppe Conte. While he is closely connected to the Five Star Movement, Conte has never held public office -- and now he is being asked to lead Europe's third largest economy, with a population of 60 million people.

This government, the 67th in the last 70 years, is perhaps the most unusual and least experienced of them all. At the top are two populists who are critical of the EU and friendly to Russia, two coalition partners who share few joint political goals and whose supporters hate each other. The one party, Lega, draws the majority of its support from the wealthy north while the other, M5S, has its roots in the comparatively poor south.

"It's like if Germany were governed by Sahra Wagenknecht (from the Left Party) and Alexander Gauland (from the right-wing populist Alternative for Germany)," says Markus Ferber, vice-chair of the Committee on Economic and Monetary Affairs in European Parliament and a member of German Chancellor Angela Merkel's Christian Democrats.

Making the Problems Worse

The difference being, of course, that Italy holds 2.3 trillion euros in sovereign debt, the equivalent of 132 percent of its gross domestic product -- a debt ratio that is only exceeded within the EU by Greece. In addition, the country is still suffering from the consequences of the financial crisis, including high unemployment, particularly among young people, and it is struggling to deal with the strain of the thousands of migrants who are still streaming across the Mediterranean to Italy.

The country has been among the EU's problem children for years. As such, the election victory by the populists is hardly surprising, rather it is the logical consequence of the problems facing the country. But at the same time, it has the potential to make those problems much worse.

To satisfy the desires of their vastly different constituencies, Salvini and Di Maio included tax cuts, a minimum basic income and the retraction of the recently passed pension reform in their coalition agreement. According to the calculations of Carlo Cottarelli, a former director of the Fiscal Affairs Department, these measures will cost at least 109 billion euros per year.

Jörg Krämer, chief economist at Germany's Commerzbank, warns that if the new government pushes through its proposals, the country's budget deficit, which currently stands at 2.3 percent of GDP, would spike to fully 7 percent.

The two parties refer to their coalition agreement as the "Contract for the Government of Change," but in actuality, it is a blueprint for destroying state finances. And the consequences for Europe will be impossible to ignore. "The eurozone is threatened by a new crisis," says Clemens Fuest of the Center for Economic Studies in Munich.

----French Economics and Finance Minister Bruno Le Maire is more direct. "If the new government takes the risk of not respecting its commitments on debt and the deficit ... the financial stability of the eurozone will be threatened," he told French broadcaster CNEWS last Sunday.

Death Knell

Indeed, even if the EU and the euro might have been able to withstand Grexit, an Italian departure from the common currency zone would likely be its death knell. Italy's economic output is almost 10 times higher than that of Greece. "Given its systemic importance, the Italian economy is a source of potential spillovers to the rest of the euro area," the EU warns in its most recent set of country-specific recommendations released on Wednesday of this week.

More
http://www.spiegel.de/international/europe/the-risks-posed-by-the-new-government-in-italy-a-1209566.html#ref=nl-international

But Italy’s not alone, in Uncle Scam’s America, the unrepayable debt burden, is about to hit the wall, with or without President U-turn’s global trade wars.

High Yield Train Wreck

By John Mauldin  May 25, 2018

My still-unfolding Train Wreck series is getting a lot of attention. It’s not exactly good news, but people at least appreciate the warnings. Thanks to all who sent thought-provoking comments. I always consider them carefully.

A few readers characterized the crisis I foresee as being a repeat of the 2008 fiasco. That’s partly right, in the sense we will have a painful economic and market downturn, but the causes will be quite different.

Last time around, the root problem was excessive residential real estate debt. Reckless lenders made unwise loans so unqualified borrowers could buy overpriced homes. These loans morphed into securities and derivatives and all blew up. I don’t think it will happen that way again. The next crisis will spring from corporate debt, equally imprudent but structurally different.

This train wreck will be similar in one respect, though. The first defaults will occur at the lowest end of the problematic market: high yield or “junk” bonds. They will play a role comparable to subprime mortgages in the last crisis. We’ll see mortgage problems as well, but I think overleveraged companies will be the core problem.

----Today, we’ll look at a not-so-prime example of the reckless investments people are making in high-yield bonds, then consider how big the problem can get.

But we’ll start with a little history.

Older readers will remember a Houston-based company called Enron that blew itself, its employees, and investors to smithereens during the 2001–2002 recession. Investigations followed. Some management (properly) went to prison.

In the late 1990s, Enron engaged former Reagan speechwriter and Wall Street Journal columnist Peggy Noonan to help explain itself to the world. Noonan, possibly the greatest business writer of her generation, couldn’t do it. She described the experience in a 2002 column.

----Enron wasn’t entirely vaporware. Those people Peggy Noonan saw really did trade electricity. Before the collapse, it spun off a subsidiary called Enron Oil & Gas which survives today as EOG Resources, a major shale player. But most of the dreams went nowhere, disguised by accounting fictions that eventually fell apart.

This is all obvious now. Back then, it wasn’t. Intelligent, seasoned investors believed Enron really was “the future!” and gave it their hard-earned money not only for equity but for debt. Lots of debt. Enron's bankruptcy filings showed $13.1 billion in debt for the parent company and an additional $18.1 billion for affiliates. But that doesn't include at least $20 billion more estimated to exist off the balance sheet.

Now other investors are buying into today’s dreams. Maybe some will end more happily than Enron did. But you might not want to bet your own financial future on it.

Office Space

I’ve talked about potential problems in the high-yield bond market. That’s the polite name for “junk” bonds, issued by companies that can’t earn an investment-grade rating even from our famously lenient bond rating agencies.

This is a two-layer threat. First, many of these companies are so marginal that even a mild economic downturn could render them unable to make bond payments. The second layer is that bondholders will want to sell those bonds, but the liquidity they presume probably won’t be there.

I could point to many examples, but we’ll take one that was in the news recently: WeWork. The still-private company issued bonds last month, giving the public a peek into the books. The offering raised $702 million at 7.875%—a nice yield if it lasts the full seven-year term. That is if you get your capital back at the end of those years. I’m not convinced investors will.

WeWork, at least, has a clear business model, one proven by other companies, and they are executing with panache and flair. It signs long-term leases for office space, then subleases to the hordes of freelancers and independent contractors who need an inexpensive workspace. Much of it is just tabletop space in open suites. This is apparently attractive to the younger set who like being close to peers, and the price is certainly right. WeWork provides all sorts of amenities which create an enjoyable workplace. Founder Adam Neumann is a charismatic executive who’s obviously adept at raising capital. So, it could last for some time.

The risk is that WeWork’s renters could disappear quickly if their own income dries up, as will happen for many when the economy breaks. Investors seem to believe this risk isn’t just manageable, but negligible.

Grant Williams featured a lengthy WeWork analysis in this month’s Things That Make You Go Hmmm... (You can read it here if you’re an Over My Shoulder subscriber. If you’re not, learn how to become one.) After walking through the numbers and comparing WeWork’s current $20 billion valuation with comparable companies, Grant says investors have essentially gone insane.

Here’s the truly scary part: WeWork isn’t unusual. The landscape is littered with similarly tenuous corporate borrowers. It is the inevitable consequence of a free-cash decade. Here’s Grant Williams again.

Ten years into the ongoing laboratory experiment being conducted by the world’s central banks, everywhere you look there are multiple examples of the kind of lunacy those policies have fomented by reducing the cost of capital to virtually zero and forcing investors to take risks they would ordinarily avoid in order to find some kind of return.

WeWork is one example of a company for whom, in the face of rapid growth, massive negative cashflows aren’t a problem, but there are plenty of others. Uber, AirBnB, SnapChat and, of course, Tesla have all captured the imagination of investors thanks to lofty dreams, articulated by charismatic CEOs—but the day things turn around and the economy begins to weaken or, God forbid, investors seek a return on their investment as opposed to settling for rolling promises of gigantic, game changing revenues to come, it is over.

More
http://www.mauldineconomics.com/frontlinethoughts/high-yield-train-wreck

The true costs of very low interest rates

Artificial distortions can cause ‘clusters of errors’ by businesses

Caitlin Long  August 11, 2010

Markets tend to cheer falling interest rates. Low interest rates, however, can entail real economic costs that become evident over time.

During the earlier period of monetary stimulus, from 2001-04, many businesses made economic calculation errors that later led to losses. Examples include investments in housing, commercial real estate and mining exploration, as well as the provision of defined benefit pensions to employees.

Interest rates are the most important prices in the economy, according to Nobel laureate F.A. Hayek, because they reflect the collective time preference of individuals to consume either now or later. Accordingly, interest rates co-ordinate allocation of capital across the economy by signalling to businesses whether they should invest. Distortions in interest rates can cause “clusters of errors” in which large swathes of businesses unwittingly miscalculate at the same time.

Hayek observed that interest rate stimulus interfered with economic calculations, causing managers to invest in projects that would not otherwise have appeared profitable. Losses can subsequently materialise as customer demand fails to meet forecasts that were, in retrospect, optimistic. Long-term projects are highly sensitive to interest rates and are therefore more susceptible to such distortions. Pension obligations and long-term, capital-intensive projects are at high risk of miscalculation based on artificially low rates.

More

https://www.ft.com/content/2838c142-a560-11df-a5b7-00144feabdc0

Finally, while President Trump isolates America with his new cold war against everyone else in the Rest of the World, China and Russia sense a once in a lifetime opportunity.

May 28, 2018 / 3:19 AM

China to host Iran to avoid project disruption amid nuclear deal doubt

BEIJING (Reuters) - China will host Iranian President Hassan Rouhani next month at a regional summit aimed at avoiding disruption of joint projects, its foreign ministry said on Monday, as major powers scramble to save Iran’s nuclear deal after the United States pulled out.

Rouhani will pay a working visit to China and attend the summit of the China and Russia-led security bloc the Shanghai Cooperation Organisation, the ministry said.

It did not give exact dates for his visit, but the summit is scheduled to be held on the second weekend of June in the northern Chinese city of Qingdao.

Iran is currently an observer member of the Shanghai Cooperation Organisation, though it has long sought full membership.

“Our hope is that China and Iran will have close consultation on the basis of observing the deal and push forward development of bilateral cooperation,” Chinese deputy foreign minister Zhang Hanhui said at a briefing.

“We should together look into how to avoid major disruption of joint projects between the two sides,” he added.

Russia has previously argued that with Western sanctions against Tehran lifted, it could finally become a member of the bloc which also includes four ex-Soviet Central Asian republics, Pakistan and India.

The 2015 agreement between Iran and world powers lifted international sanctions on Tehran. In return, Iran agreed to restrictions on its nuclear activities, increasing the time it would need to produce an atom bomb if it chose to do so.

Since U.S. President Donald Trump withdrew the United States this month, calling the agreement deeply flawed, European states have been scrambling to ensure Iran gets enough economic benefits to persuade it to stay in the deal.

More

https://uk.reuters.com/article/uk-china-sco-iran/china-to-host-iran-to-avoid-project-disruption-amid-nuclear-deal-doubt-idUKKCN1IT04M?il=0

Never interrupt your enemy when he is making a mistake.

 

Napoleon Bonaparte

Crooks and Scoundrels Corner

 The bent, the seriously bent, and the totally doubled over.

Another day, another red flag that stocks are dancing in the last chance saloon on borrowed time.  While Sprott makes the case for gold, they also highlight just how late at the dance it is for stocks. Haven’t we all been here before? How well did that turn out last time?

“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.”

Citigroup chief executive Chuck Prince, FT, July 10 2007.

Sprott Gold Report: Gold Shows Up At The Berkshire Hathaway Shareholder Meeting

May 25, 2018  By Trey Reik
An annual highlight of the financial calendar is the Berkshire Hathaway shareholder meeting. The Berkshire meeting has evolved into a high holiday of American capitalism, uniting 40,000 crusading attendees with millions of global investors in collective celebration of the joys and rewards of investing. Over the long history of financial markets, Warren Buffett is generally regarded as the greatest investor of all time. What makes Mr. Buffett’s story so compelling is the popular belief that his virtuoso performance relies on simple and patient faith in iconic American brands. To this end, Mr. Buffett has long cultivated a public persona as indefatigable cheerleader for American entrepreneurial spirit.


While Mr. Buffett’s everyman affinity for Cherry Coke and See’s candy delights crowds (Figure below), Berkshire aficionados are keenly aware that the company is actually a highly geared financial behemoth. As a supremely calculating financial architect, Mr. Buffett has mastered, more than any American CEO –  save Jeff Bezos, the formidable power of float. Charming gecko aside, the massive, negative-cost float of Geico and Berkshire’s reinsurance group have underwritten Berkshire’s long-term growth. This critical aspect of Berkshire’s success, especially at the company’s current half-trillion-dollar market capitalization, ties the company’s fortunes far closer to Fed liquidity-provision than is commonly appreciated.

----By most historical standards, current bull markets for U.S. financial assets are substantially long in the tooth. In a 2001 Fortune Magazine interview, Mr. Buffett cited the ratio of U.S. equity market-cap to GDP as “probably the best single measure of where valuations stand at any given moment.” Since then, the Buffett Indicator has become a popular tool in evaluating where equity indices stand versus historic valuation cycles. Perhaps the most straightforward variant of the Buffett indicator is the simple ratio of the Wilshire 5000 market-cap to U.S. nominal GDP.

As shown in the chart above, the Buffett Indicator now stands at a fresh all-time high of 142.0% of GDP. With stock valuations this stretched, many money managers are wrestling over whether prudence dictates reducing equity exposures. As blasphemous as the concept might first appear, we would suggest that at this point in the market cycle, a gold allocation could improve risk-adjusted returns even for Berkshire Hathaway! At year-end 2017, Berkshire’s balance sheet was dominated by three investment categories: $182 billion of public equites, $84 billion of short-term Treasury bills, and $32 billion in cash. Messrs. Buffett and Munger have long telegraphed the opportunistic utility of maintaining Berkshire’s $116 billion short-term hoard. In our estimation, however, redeployment to gold of just 50% of Berkshire’s $32 billion cash balance would help to insulate Berkshire’s portfolio from potential equity-market disturbances, whenever they might occur.

----Well, if his eponymous market indicator holds much personal significance, it is likely Mr. Buffett recognizes that probabilities for a significant market correction continue to climb.

Berkshire’s balance sheet now commands $702 billion of assets with tangible book of $271 billion. No matter how high quality the assets, nor how understated the book, Berkshire is no longer immune from the contemporary math of market shocks. It is one thing for us to suggest that the size of Berkshire’s book, coupled with eight years of asset inflation fueled by QE and ZIRP, have combined to link Berkshire’s prospects more closely to Fed liquidity programs than ever before. It is quite another for Messrs. Buffett and Munger to acknowledge this connection from the CenturyLink stage, which is precisely what Mr. Munger did in addressing Question # 21 (related to Treasury issuance):

It was unfair [for the Fed] to reduce savings rates as much as they did, but they had to do it to fight the Great Recession appropriately. It was weird, and in my lifetime it only happened once, but it benefited all the people in this room with the rise in asset prices including Berkshire stock. We are all a bunch of undeserving people and hope to continue to be so.

More than anything else, Berkshire’s business model has always been based on rational deployment of capital. Mr. Buffett popularized the notion of the fat pitch — letting the vast majority of investment opportunities pass by, awaiting only the perfect combination of valuation and business conditions before taking a swing. Unfortunately, eight years of ZIRP and QE have clouded visibility even for batters with eyes as good as Mr. Buffett. Zero percent interest rates destroy time preferences and jam the synapses of capitalism so completely that rational capital deployment becomes nearly impossible. Today, no one can properly evaluate what true demand is for anything. Through no fault of their own, Messrs. Buffett and Munger have been stripped of their comparative advantage in recognizing the fat pitch. In the absence of a touchstone of stable unit of account (hard money), all investment decisions are more akin to swinging blindfolded.

When time preferences are extinguished, corporate behavior and decision-making begin to trend toward average. There is no longer sufficient payoff to reward excellence because marginal returns compress towards the marginal costs of ZIRP. Corporate focus becomes today over tomorrow. For the vast majority of businesses, the trend to mediocrity can be masked — plummeting capex and productivity are dressed up by mechanical share repurchase and deceptive “strength” in per-share earnings. But for truly exceptional American businesses, the only option is involuntary acceptance of relaxed standards. Throughout his career, Mr. Buffett has always been known to champion integrity with inspirational quotes such as:

“It takes 20 years to build a reputation and five minutes to ruin it.”

“We can afford to lose money — even a lot of money. But we can’t afford to lose reputation — even a shred of reputation.”

“Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm and I will be ruthless.”

No event epitomizes the erosion of ZIRP-era corporate standards more poignantly than the Wells Fargo fake-account scandal. We are certain that Messers. Buffett and Munger are disheartened that one of America’s iconic financial institutions succumbed to pressure to create profits in the ZIRP world of compressed returns.

Their exasperation was evident in answering Question # 7 (relating to the Wells Fargo new-account fraud):

Mr. Buffett: “We can’t have 387,000 employees and think everyone is behaving like Ben Franklin … All the big banks have had troubles, and I see no reason why Wells Fargo, from an investment or moral standpoint, is inferior.”

Mr. Munger: “Wells Fargo will be better going forward. Harvey Weinstein has done a lot for improving behavior too.”

Truth be told, we believe the quality of Berkshire’s business is unparalleled, the acumen of Berkshire management is second to none, and the strength of Berkshire’s balance sheet is formidable. Nonetheless, for great investors like Warren Buffett and Charlie Munger to be forced to rationalize morally bereft behavior at our nation’s third largest bank speaks volumes about how much effort it will require to rekindle American exceptionalism across the full spectrum of corporate America. We expect the process of revitalizing functional time preferences and rational capital allocation, after so many years of textbook mal-investment, will prove both long and arduous.

More

https://www.sprottmedia.com/gold-shows-up-berkshire/

Citigroup’s Chuck Prince wants to keep dancing, and can you really blame him?

By wpcomimportuser1 July 10, 2007

Citigroup bossman Chuck Prince had something interesting to say in the FT today:
The Citigroup chief executive told the Financial Times that the party would end at some point but there was so much liquidity it would not be disrupted by the turmoil in the US subprime mortgage market.

He denied that Citigroup, one of the biggest providers of finance to private equity deals, was pulling back.

“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,” he said in an interview with the FT in Japan.

Now the prospect of Chuck Prince dancing is in itself unsettling. But his account amounts to quite an elegant explanation of why financial bubbles persist. Even if Citigroup’s executives were worried that private equity valuations have gotten too frothy and loan terms too loose, it would make little sense for them to pull back. Because they can never know for sure when the music’s going to stop, and they’d be crazy to forego all those underwriting fees for the year or two or three before it does. So they keep dancing.

Then again, maybe some of us are just too eager to call this boom a bubble. Yesterday Moody’s reported that global defaults of speculative-grade debt (a.k.a. junk) in the second quarter were at their lowest level since 1995. I would bet that default rate is about to start rising, but still: The world’s big corporations are doing spectacularly well at the moment. Can you blame Chuck Prince for wanting to throw more money at them?

Update: Blogger Yves Smith points out the big problem with Prince’s approach:
Even if Citigroup has only limited exposure to LBO paper by virtue of keeping little on its books, I guarantee you that when the credit tightens further and the economy weakens, enough of these deals will come a cropper that there will be a hue and cry to find who was responsible. At a minimum, Citi will have a lot of explaining to do.

… Prince has in essence said he knows that when the music stops, it won’t be one chair that will be removed, but several, perhaps most. He seems supremely confident in his ability to know when to exit, but with everyone planning to stay as late as they can, he is likely to be underestimating how quickly conditions can change.

http://business.time.com/2007/07/10/citigroups_chuck_prince_wants/

“It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those [Credit Default Swap] transactions.”

Joseph J. Cassano,  former head of A.I.G. Financial Products, London, August 2007. AIG was bailed out with 85 billion September 2008, after Cassano’s riskless CDS blew up.

Technology Update.

With events happening fast in the development of solar power and graphene, I’ve added this section. Updates as they get reported. Is converting sunlight to usable cheap AC or DC energy mankind’s future from the 21^st century onwards?

No update today, I’m off to a barbecue at Mickey D’s.

The monthly Coppock Indicators finished April.

DJIA: 24,163 +255 Down. NASDAQ: 7,066 +282 Down. SP500: 2,648 +188 Down.

All three slow indicators moved down in March and continued down in April. For some a new bear signal, for others a take profits and get back to cash signal.