The Wrongologist

What’s
Wrong Today:

Robert
Gordon gave a TED
Talk last February about economic growth. Dr.
Gordon is Professor of Economics at Northwestern University, and one of the
world’s leading experts on inflation, unemployment, and productivity growth.

He thinks
that economic growth at historical rates is over. He says that we grew at an
average rate of 2% from 1891 to 2007, and slower since then. But, he concludes that we will have trouble
exceeding .8% annual GDP growth going forward. His talk lasts about 12
minutes. Go check it out.

He talks
about the fundamental disconnect between
technology and employment that has occurred since the start of the .com era.

In fact,
the Wrongologist believes that when the history of the last 10 years is
written, one of its darkest chapters will be devoted to the economic devastation
wrought by the de-industrialization of America. The American
Prospect wrote:

Last May, Wonkblog
reported that: (emphasis by the Wrongologist)

Today, US
manufacturing output is 2½ times greater than 40 years ago, while employing
one-third fewer workers. This is great if you are a manufacturer but not so
great if you are a factory worker.

For
most of the 20th Century, economic production involved a combination
of capital and labor. However in the 21st Century, programmable machines
and robots, some powered by artificial intelligence, are capable of doing many jobs
with little labor input. This makes for a different economy. Robots toil for
their owners, (let’s call them corporatists) who make the profits, but
obviously, the manufacturers need buyers for those goods. Buyers are harder to
find if many are falling out of the middle class.

A study
by the Massachusetts Institute of Technology (MIT) concluded that the loss of
so much manufacturing capacity in the US over the past decade has had a
negative impact on the country’s ability to innovate, which has long been
considered the nation’s greatest economic strength. The United States no longer
has the industrial “ecosystem” necessary to bring new ideas to the market, the
study says.

Today,
those with capital and the latest technologies have access to the global
marketplace. They are very same companies that have been cannibalizing our
economy for their own benefit by offshoring jobs and closing factories. Along
the way, they have reshaped our society.

Capitalism
has not been very good at working with our democratic institutions in the past
30 years. But they have gotten very good at working with captured politicians to rewrite
the rules of the game in the corporations’ favor. Long ago, companies worked
together with governments and people to build a middle class economy and
society. This was best demonstrated in the years after World War II up to the
1970s.

Yet, there
is no obvious alternative on the horizon that appears likely to employ the
millions of workers whose jobs have been outsourced to China, or turned over to
robots, or simply eliminated entirely in cost-cutting moves.

Dr. Gordon
speaks about the “4 headwinds” that will hold back growth in America. One of
those was Personal Debt. Let’s talk a bit about personal debt. The Wrongologist
has written about the economic dead end of student debt here
and here.

Even
though mortgage and consumer debt plunged in the wake of the financial crisis,
student loan balances nearly tripled from 2004 to 2012, to roughly $1 trillion,
according to a recent study
by the Federal Reserve Bank of New York. A total of 39 million people have
student debt, including more than 40% of 25-year-olds. According to the Fed
study, 35% of borrowers under the age of 30 are delinquent on their loans, up
from about 25% in 2008!

In the
20th century, no institution had a greater ability to raise people out of
poverty or had contributed more to the development of a robust American middle
class than higher education. And yet in this century, it is willingly
sinking its target market in a sea of debt.

The
Wrongologist was in a Home Depot over the weekend. There was a brochure at the check-out
that described “Project
Loans”. Apparently, Home Depot is willing to make loans up to $40,000 to
homeowners, a role that was handled by banking institutions before they discovered
derivatives.

Giving students
or shoppers at Home Depot easy access to credit is a stop gap substitute for a better
paycheck. It helps keep consumption up, but it is not a sustainable economic
strategy, since economies only succeed when there is equilibrium between buyers
and sellers. And it is that healthy balance between producers and consumers
which is a more important driver of economic prosperity than the imperative
to maximize profits which drives our economy today.

Politicians
speak of the “knowledge economy”, but the question is, knowledge for and about what?
Facebook is touted as a prime player in the knowledge economy, but it employs just
5800 to service 1 billion customers! Twitter has 200 million active customers
and 400 million registered users. It has 2300 employees.

What
is the value of Facebook and Twitter to the economy? These are two of our “best”, and they only
employ 8100 so-called knowledge workers. They have had a huge impact on society, but
cause barely a ripple in the economy. Their total employees are only a rounding
error in our economy.

Consider
Wal-Mart: this paragon of capitalism has 140 million customers and 1.2 million
employees. Its low-wage employees are the largest concentration of users of
food stamps in America.

Something is radically
wrong with the American economy. A once-robust system of “traditional
engineering”, the invention, design, and manufacture of products, has given
way to low wage jobs, while most higher wage jobs are in financial engineering
and software development.

Given automation, people have to figure out how to do much more to
be of value to corporations. The most successful will use technology to their
advantage while everyone else who can’t master the tech revolution may only
aspire to be low-wage employees or worse–jobless–and ultimately at the mercy
of others, (like the state).

In
closing, as we look out to the middle of the Century, most people will find
that if they have little to offer from a productivity perspective, much of their
consumption will have to cease and they will drop out of the middle class.

Those
that prolong their stay in the middle class by borrowing will reach a point
where their debt payments will be high enough to cut into their consumption of
food or their ability to pay rent. When maintaining their credit cuts into
their subsistence, there can be no more consumption.

What will Washington
say the solution is then?

 

 

What’s Wrong
Today:

From the Wrongologist:

Yes, every Republican President since Eisenhower has left
office with a larger deficit than he inherited, so says a study by Stephen Bloch,
a PhD mathematician at Adelphi University. Yesterday, the Ritholtz
Blog took the opportunity to compare Mr. Obama’s performance over the past
5 years with his 4 predecessors. We have all heard something like this:

Truth or
Fiction? Ritholtz contributor, TBPInvictus, took a unique look at Federal government
spending for the last five administrations, (Regan, Bush I, Clinton, Bush II, and
Obama). The data are from the Federal Reserve Bank of St. Louis, (FRED).

Each
administration is color coded and its record in government spending is indexed
to 100 at the start of the first quarter of their administrations. This index
approach allows us to view the performance of each administration against
itself. Did they start low and go lower? Did they spend like drunken sailors? There
are some data issues that are obscured by strictly recording each
administration’s results based on the quarter in which it takes power. You can
read about them at Stephen Bloch’s site linked above.

What is represented
by the charts below is the relative growth or decline in expenditures vs. the starting
point, the quarter in which each President took office. Let’s start by looking
at the overall expenditure picture:

Reagan and
Bush II saw the greatest increases in quarter-over-quarter federal expenditures
from their entry into office to the ends of their administrations. Expenditures
grew the least under Clinton. The Obama
administration is the only administration to see a sustained downturn in the
growth of federal expenditures.

Stripping
out the defense portion of federal expenditures for each administration shows
this result:

It is
clear from this view of the data that Bush II wins the prize for profligate non-defense
spending when compared to the date he took office, while Obama doesn’t fare as well with non-defense spending.

Still, whenever you hear someone
say, “We don’t have a revenue problem, we have a spending problem,” show them these
charts and ask where that spending problem came from.

In 2011, The WaPo had an article by Deval
Patrick, Governor of Massachusetts:  

When
you look at these charts and the record of spending they demonstrate, it is
clear that only Republicans can govern
as a Democrats.

The NYT wrote
on 11/8 about the impact of the cuts in the Supplemental Nutritional Assistance
Program (SNAP, otherwise known as food stamps). The damage being done to those
who can least afford it is hard to overstate. Beyond the pain inflicted on poor
families, an adverse “trickle up” effect is happening:

For some
perspective on food stamps, the program cost $78.4 billion in the 2012 fiscal
year. The amount given to each household averages $272 per month. In the 2010
fiscal year, 40.3 million people were enrolled. Two years later, that number had
jumped by 16%. Just over 45% of those getting food stamps are children,
according to the Agriculture Department.

Here is how
the SNAP program stacks up vs. federal defense spending:

(Source: BEA Table
3.12 Government Social Benefits and BEA Table 3.11.5. National Defense
Consumption Expenditures and Gross Investment by Type)

Does
this demonstrate a moral government position or does it show a lack of morality?
To Republicans, the poor are nothing but political poker chips. They are poster
children for the ever expanding government, as well as the preferred sacrifice
for the defense of principles. Anyone who suggests that we must care for the
poor, is considered to have an ulterior motive. The defense contractors? That’s
another story. You have to spend on defense, or the terrorists win.

Here is a small
step towards greater clarity of thought: Contrary to Republican claims, the deficit is not increasing—it peaked in 2009 and
has been dropping ever since, declining by $200 billion last year with
another $450 billion drop projected this year. These numbers have no partisan
bias:

As
all of the above show, this administration has turned the corner on spending. We need to start to fix the revenue problem.

Corporate
real income tax rates are at an all time low. Corporate America needs to
contribute more to tax receipts. We could start by ending “corporate welfare”.
That would put us on the path to fixing our revenue problem.

Veteran’s
Day came into being on June 1, 1954 as a date to honor all who served in the US
Military. Memorial Day is a day for remembering those who died while serving in
the Military.

We
celebrate Veteran’s Day on the date of the WWI armistice, the 11th day
of the 11th month in 1918 that ended the fighting. That was
exactly 95 years ago today.

A
few facts about veterans:

• There
  are 21.2 million military veterans in the US

• 1.6
  million veterans are women

• The
  Vietnam War has the most living veterans, 7.4 million

• The
  two Gulf Wars have 5.4 million

• The
  Korean War has 2.3 million

• World
  War II has 1.6 million

• 3 states have more than 1 million vets. California (1.9
  million), Texas (1.6 million) and Florida (1.6 million)

• 9.6 million veterans are 65 and older, while 1.8 million
  are 35 or younger

3.6 million vets have service connected disabilities. Veterans should read the article at https://www.fraudlaw.org/fraud-in-veterans-disability-claim-what-you-need-to-know/ before making a disability claim. A “service-connected”
disability is one that is a result of a disease or injury incurred or
aggravated during active military service. However, veterans can receive compensation for their service-related injury, and law groups such as grebelaw.com show how you can caluclate your disability claim. Disabilities are rated on a scale
from 0 to 100%, and eligibility for compensation depends on one’s rating. 881,981
veterans have a rating of 70% or higher.

14.7 million
(69%) of veterans voted in the 2012 presidential election.

Turning to
employment, according to the BLS Report this October,
veterans have lost ground since October, 2012. Their unemployment rate moved up
from 6.3% in October 2012 to 6.9% in October 2013, still better than the 7.3%
experienced by the country as a whole, but significantly worse than last year. Iraq
and Afghanistan-era Veterans, (called Gulf War II-era Veterans by the BLS), do
not fare as well. Their monthly unemployment rate remained unchanged year over
year at 10%.

Let’s
also remember that Post Traumatic Stress Disorder (PTSD) is at epidemic levels,
as is suicide by vets. According to a study
by the Department of Veterans Affairs, 22
vets a day commit suicide. The Fiscal
Times quoted Craig Bryan of the National Center for Veteran Studies: (emphasis
by the Wrongologist)

Far
too many vets experience shamefully hard times upon discharge; too many
families continue to pay a price for having their loved ones serve. The National Coalition for Homeless
Veterans estimates that 62,619 vets are homeless on any given night in
America.

Our
leaders need to spare no expense at making these folks whole again. Period.

We are
quick to say, “Thank you for your service”. Returning veterans are getting more
respect today than they did when the Wrongologist served during the Vietnam era, but gratitude
alone has never paid a bill. We also
need a plan. Hopefully, America’s public and politicians will act on
behalf of veterans when it comes to both the fiscal and political decisions that
affect this group of people to whom we owe so much. Here are a few suggestions:

• Give
  any company who hires and
  retains for a period of one year, an unemployed veteran (or any long-term
  unemployed American for that matter), a tax credit equal to 50% of the 1st
  year salary plus FICA.

• Give free resume writing and interview
  training
  at local community colleges.

• Get
  the F1000 to offer 50 one year internships each to unemployed veterans. Give
  the company the 100% of the salary plus FICA for each intern. This might be the best use of $1.25
  billion, if we ever prioritize government expenses.

In
the meantime, huge thanks to the guys/gals who follow orders, who do really
hard and dangerous things and who too often pay a high price for doing so.

We
had an election. It was over analyzed all week.

We
also had another week of Obamacare blues. The insurance industry hits Mr. Obama
with a 2×4. He apologizes because he can’t control the private sector, but he
should have apologized for his failure
to understand the insurance industry. Any excuse to raise fees was
going to be used by the industry, and it really is the state insurance regulators that should
be the focus of anyone who is “disenfranchised” by their insurer.

In
other news, Iran may hit the trifecta:

1. It’s likely to see the sanctions currently crushing its economy loosened without
   having to halt uranium enrichment.
2. Its
   client Iraq is going to get US help to defeat its radical Sunni adversaries.
3. The
   Assad regime, its other main client, got a free pass from the West to stay in
   power for the foreseeable future.

Turning to Israel’s poutrage, how
did Mr. Netanyahu get so outfoxed? He has been neutralized by Mr. Obama. He
now functions as the principal spokesman for the Kingdom of Saudi Arabia (which
wants to see Iran go nuclear even less than Israel does), but, throwing public
tantrums about US policy only makes him look impotent.

One
Western diplomat told Reuters that Israel’s fury at the proposed deal might
actually make it easier for Mr. Rouhani to sell an interim deal to skeptics among
Iran’s security and clerical elites who are wary of US overtures to Tehran, 33 years after Washington
broke off diplomatic relations.

Use the quote below from Albert Einstein to write a homily about
smart people like Netanyahu who turn out to display weapons-grade stupid, at
precisely the wrong time:

The 3 types of people in politics. Is Netanyahu in box #3? Should the world be running away?

The race for 2014 begins:

Tea Party was not a big help on Election Day:

Christie Landslide validates the hug:

Obama’s hope for the end of November:

What’s
Wrong Today:

There seems to be a
deal emerging between Iran and the P5+1 Group, who have been negotiating about
Iran’s nuclear program. As this is written, US Secretary of State Kerry is in
Geneva, soon to be joined by the French, German and British foreign ministers.
The Russian minister, Lavarov, is on his way. Word is that there may be an interim deal signed with Iran in the next few
days. 

At the
same time, it appears that there is a move
by the US away from Israel. This seems to be happening for multiple
reasons, but the flash point appears to be the intransigence of Mr. Netanyahu,
who can’t seem to get behind any peace initiative with his neighbors.

After trying many times to get Mr. Netanyahu
to accept serious negotiations with the Palestinians, this week, Mr. Kerry finally
started to talk tough: On Thursday, he criticized Israel’s
decision to build 5,000 new housing units in East Jerusalem and other
settlements, after announcing the release of a group of Palestinian prisoners.
Kerry said settlement expansion sends a message that “perhaps you’re not really
serious,” during an interview which aired on Israel’s Channel 2, as well as in
Palestinian media. Mr. Kerry:

Kerry added an additional warning to
the Israeli public. He urged making peace “with a [Palestinian] leadership that
is committed to non-violence,” otherwise Israel “may wind up with [Palestinian]
leadership that is committed to violence.”

Second, Mr. Netanyahu after two
meetings with Mr. Kerry this week called the emerging deal with Iran a
“historic mistake” and a very “bad deal”
(video). He appears to be losing the ear of the Obama Administration, if not
those of Republicans in DC. All
this was said in front of a group of visiting US lawmakers, according the NYT.
Despite his objections,
the Iranian deal may still go forward, so
Israel is getting a diplomatic beat
down even as a temporary deal with Iran is in the making.

Iran’s new government
showing a friendlier face and explaining its nuclear program in English while maintaining its basic
position on its program, is giving the US a chance to back down somewhat from its increasingly
untenable position. It may be that the current sanctions will soon
begin to be difficult to maintain. Robert Einhorn, a former State Department
official who supports the administration’s negotiating strategy, recently dismissed
Mr. Netanyahu’s maximalist position (total elimination of enrichment
activities) as “not achievable”. The NYT reported that he told the following to the Israel Project: “I
don’t think any Iranian government could sell that deal at home”. He also said:

The other party
against a deal with Iran is Saudi Arabia. They view Iran as their major Middle
East competitor. Yesterday, the BBC had an article about the Saudi’s quest to acquire Pakistani-built nuclear
weapons.

There is nothing new
in the piece. That the Saudis financed those weapons and could have short-notice
access to them has been known for decades. However, the BBC relaunched the
story with this:

The BBC
talks about a “NATO-decision maker”, but the quote is from an Israeli.

So, are the Saudis gearing up to create a new
balance of nuclear power in the Middle East? Are they
calculating that, with sanctions lifted, Iran will export more oil, earn more
foreign exchange and bankroll their nuclear weapons program before the West can
respond? Is the leak about Saudi nuclear weapons an implied threat to the P5+1?

As the
Wrongologist reported last week, Saudi
Arabia’s foreign policy is undergoing significant shifts. It made a decision
not to accept the UN Security Council seat, and criticized the US policy in
Syria. The Middle East situation has simply become less predictable. In some ways,
Sunni Saudi Arabia is the Taliban with mega-bucks.

Moreover,
Saudi has a newly discovered missile site. It was revealed in July, 2013 by IHS Jane’s
Intelligence Review.
They reviewed images showing a surface-to-surface missile base deep in the
Saudi desert, with capabilities of hitting Israel or Iran. The base, believed
to have been built within the last five years, gives an insight into Saudi
strategic thinking at a time of heightened tensions in the Gulf. It is designed
for Saudi Arabia’s arsenal of DF3 missiles, which have a range of 1,500-2,500
miles and can carry a two-ton payload. The Telegraph provided this map
demonstrating the range of the Saudi missiles:

The Telegraph reminds us that a confidential
diplomatic cable revealed in the 2010 “WikiLeaks” disclosures said
that King Abdullah of Saudi Arabia repeatedly exhorted the United States to
launch military strikes against Iran’s nuclear program and “cut off the
head of the snake”.

We
now know that the Saudis have ballistic missiles minus warheads ready for
action. It is a crafty move. The Saudis can to continue as a signatory of the NPT
(Nuclear Non-Proliferation Treaty), potentially pass any inspection and at the
same time, be 30-60 days away from being a member of the nuclear club. Interesting. That is exactly the Iranian strategy
that worries Israel and Saudi Arabia.

Still, it
is doubtful that Pakistan is ready to send nuclear weapons to Saudi Arabia
today. They are friendly with Iran and Pakistan’s reputation suffered the last
time they assisted other countries with nuclear weapons technology sales by AQ
Khan, (with governmental support), to North Korea, Iran and Libya.

If Pakistan
did transfer nuclear weapons to Saudi Arabia, the Saudis would have to withdraw
from the NPT. Any US military sales to either Pakistan or to Saudi Arabia would
have to stop. Also, Saudi Arabia has no need today for nuclear weapons. It can
wait to see if Iran’s program will be blunted through diplomatic means.

The Saudis
are constantly calibrating the costs and benefits of all of their
relationships. The bet here is that they are a long way from calling in their nuclear
chit from Pakistan. But it clearly serves Israel and Saudi Arabia to have another
proliferation story front and center while US and Iran sit down in Geneva.

There is a
change going on in the US’s relationship with the Islamic world, as Sunni Islam
becomes more extreme and sectarian conflict grips the Middle East. The West may
be starting to back the Shia minority as a counter balance, thus the warming
relationships with Iran. Perhaps the Obama Administration sees the wisdom in a
balance of power, even if old friends are angered.

Realpolitik
in action.

What’s Wrong Today:

Now that the 2013 election is behind
us, let’s revisit the issue of voter suppression. Let’s focus on Virginia. As
you know, the Democrat, Terry McAuliffe beat the Republican Ken Cuccinelli on
Tuesday. Mr. Cuccinelli had wanted to make
felons out of consenting couples who engage in oral or anal sex in the privacy
of their own homes, I wonder what he’d have to say on this article… He supported a law that was struck
down by federal courts after he blocked efforts to bring it in line with
the Supreme Court’s 2003 Lawrence v. Texas
ruling.

So, with only
37% of Virginia voters turning out, Cuccinelli lost. It was African-American
voters that provided the margin of victory. Keep in mind that in November, 2012,
80%
of Virginia voters turned out, but this November, only black turnout was the
same as in 2012.

This shows why Republicans are working
overtime to suppress voters all over the country. While voter suppression is
not just a race issue, there have been overwhelming attempts to stop blacks from
voting in Virginia. From The
Advancement Project:

By law, the only way
to restore the voting rights of any Virginian is through individual approval by
Virginia’s Governor. Even with a Democrat in the state house, that is not
likely to make much of a difference. But voter suppression efforts are
not limited to Virginia. This chart from the Advancement Project shows how pervasive these
efforts are:

Anyone who cares about 2014 and 2016 should be
making voting rights and turnout efforts their No. 1 issue.

Virginia’s 2013 election shows that it’s
not impossible for Democrats to make 2014 the kind of “wave” election that
could let them take back the House of Representatives, as they did in 2006. Virginia
also shows that the so-called Obama coalition can survive without his name on
the ballot. Put differently, for the
second year in a row, African Americans turned out at a rate above their
percentage of the population, and supported the Democrat by a 9-to–1 margin.

In McAuliffe’s case,
that meant that more than 37% of his vote total came from African Americans.
A four percentage point drop in
black turnout would have slashed roughly 80,000 votes from McAuliffe’s total,
enough to turn Cuccinelli’s loss into a victory.

The right to vote is
our most important civil right. As the Supreme Court said a long time ago, this
is because the right to vote preserves
of all of our other rights. The voting booth is the one place where we all
are presumed equal, yet the reality is that the playing field for potential
voters is far from level.

More than in the
past, citizens are denied an equal opportunity to cast a ballot and have it counted.
This is due to the Roberts Court’s decision in Shelby County vs.
Holder that struck down elements of the Voting Rights Act. Since that
decision, the Brennan
Center reports that as
of October 24, 2013, restrictive
voting bills have been introduced in more than half the states:

• At least 90 restrictive bills were
  introduced in 33 states
• Of those, 18 restrictive bills are
  pending in 7 states
• 8 states have already passed restrictive bills this session

The SCOTUS vote to gut the Voting Rights
Act was 5-4. No one should say that voting doesn’t matter: There is a direct
line from 2000, when Nader’s 3% of the vote was enough to throw Florida into
chaos and hand the Presidency (via SCOTUS) to George W. Bush. Consider the
following:

• There is a direct line from
  November 2000 to Chief Justice John Roberts and Justice Samuel Alito
  

• And there is a direct line from
  2010, when the 2008 voters stayed home and handed the House of
  Representatives to Republicans while Republicans won state houses 21-12

• There is also a direct line from November
  2010 to the SCOTUS Voting Rights Act ruling

Will
you be energized and organized to take on the challenge in 2014? Will you donate to get out the vote
efforts? Will you volunteer to drive voters to the polls? Will you make calls?
Or will you sit at your computer complaining because the mean nasty Republicans
remain mean and nasty?

Our democracy is only as good as we make it. Without significant participation,
the loudest voices win. We have to be the loudest voices.

Anything less, and we
deserve what we get.

What’s
Wrong Today:

We
remember all too well the real estate bubble that culminated in the Great
Recession. We are still paying a huge price for letting the real estate mortgage
market and the associated risk lay-off mechanisms, Collateralized Mortgage Obligations (CMOs) and
Credit Default Swaps (CDS) turn into a financial bubble.

The
price was the loss of middle class net worth, the loss of middle class jobs and
the massive run-up in debt to support the banks that caused the problem,
because otherwise, they might have failed.

But
we learned not to let that happen again, didn’t we?

Maybe
not. Things are starting to get bubbly in the high yield corporate debt market. Corporations issue debt routinely.
The loans can be for short durations (6 months) to 20+ years. The high yield market
describes companies that have a higher risk of repayment of the borrowed funds.
These loans are sometimes called “leveraged loans” when the risk is high. Investopedia
defines leveraged loans as follows:   

Demand for corporate leveraged loans has
been growing and continues to stay unusually strong. These loans are more risky
than high yield loans. Senior loan closed-end funds, Business Development
Companies (BDCs),
Collateralized Loan Obligations (CLOs),
hedge funds and even insurance firms are clamoring for senior loans of
sub-investment-grade companies. The chart below shows the growth in leveraged
loans:

Source:
Deutsche Bank

The most alarming
element in this trend is the sharp relaxation of lending terms. These deals
have detailed terms and conditions called “covenants”, which typically restrict actions by the company that could impact its
creditworthiness. Failure by a borrower to continually meet the requirements of
its covenants can give lenders early warning of a possible default.

Most investment
advisors would say that strong covenants make these loans a safer risk than
other high risk forms of debt like Junk Bonds, (a colloquial term for a high-yield or
non-investment grade bonds).

But covenants are no
longer a big part of new leveraged loan volume. Now many leveraged loans are called
“cov-lite”
(covenant-light). Over 70% of
recent deals have been structured as covenant-light. The chart below
shows the rapid growth of covenant-light loans as a percentage of total
corporate debt:

Doesn’t this sound familiar? Banks
relax credit standards to build loan volume. They use sophisticated financial
instruments to move the credit risk off their balance sheets to other
investors, mostly funds and insurance companies. Bankers make big fees for
arranging the deals. They make their budgets and thus get their bonuses. The
last guy in the game of musical chairs winds up holding the loan, and is
screwed.

Welcome to the son of the mortgage
debacle.

Today’s
investors are poorly compensated
for the risks they are taking compared to the recent past. In
2007, a three-month certificate of deposit yielded more than junk bonds do
today. Average yields on investment-grade debt have dropped to 2.45%
from 3.4% a year ago, according to Bank of America Merrill Lynch’s Global
Corporate Index.

Wilbur
L. Ross Jr., chairman and CEO of WL
Ross & Co. has noted that 1/3 of first-time issuers in the leveraged
loan market have credit ratings of CCC or lower (ratings go from AAA
downwards). In the past year, more than 60% of high-yield bonds were
refinancings. None of that capital was to be used for expansion or working
capital, just refinancing balance sheets.

Some
might say that it is good that there is no new leveraging, but it is really much
worse. This means that many companies
had no cash on hand to pay off old debt and had to refinance.

Bloomberg
reports that regulators are taking an interest in the possible leverage loan bubble.
The Federal Reserve and the Office of
the Comptroller of the Currency sent letters to some of the largest US banks
asking them to avoid arranging debt that may be classified by regulators as
having a deficiency that may result in a loss. In March, they had issued guidelines
for junk-rated loans, citing deteriorating underwriting conditions. The guidance update was the first since 2001.
Regulators are seeking to cut down on excessive risk taking as typical lender
protections have been stripped from credit agreements at a record pace. From
Bloomberg:

Unsurprisingly, the Loan
Syndications and Trading Association LSTA, with 350 members
consisting of banks, investors and law firms, said the regulators’ request will
hurt the least-creditworthy companies. Bloomberg quotes Meredith Coffey, EVP of the
association:

Remember
that these leveraged loans are rated by Moody’s, who according to Bloomberg, is
forecasting that the speculative-grade
default rate will rise to 3% percent for this year, from 2.8% in September,
2013. The measure peaked at 13.73% in November 2009. Many argue that weak loan covenants
and high risk don’t matter much when corporate default rates are as low as they
are.

Didn’t
we hear similar arguments in 2006 with a different asset class?

This doesn’t
rise to same level of risk that the $Trillions of credit default swaps and
collateralized debt obligations that traded on top of the $14.6
Trillion of mortgage debt that was outstanding in 2008. But in October
2013, junk bonds outstanding are more than $2.2
Trillion, while leveraged loans are $1.3
Trillion. More and more retail-oriented funds are including leveraged loans
in their Exchange-Traded Funds (ETFs), held by
many average American investors.

A possible
financial bubble could be waiting, particularly since NOTHING has been done to change
the behavior or incentives of the banks that arrange these loans.

US financial
bubbles are frequent. In the 1970s, gold went from $35 to $850 before crashing.
The NASDAQ experienced the dot-com bubble and stocks went from 440 to 5,000
before crashing spectacularly in 2000. The NASDAQ lost 80% percent of its value
in less than two years.

The US stock
market has crashed in: 1929, 1962, 1987, 1998, 2000, and 2008. Every time, the
bubble was driven by different sectors. In 1929, radio stocks were the Internet
stocks of their day. In 1962, the electronic sector crashed. The previous year,
most electronic stocks had risen 27%, with leading technology stocks like Texas
Instruments and Polaroid trading at up to 115 times earnings. In 1987, the
S&P had risen more than 40% in less than a year and over 60% in less than
two years. In 2000, it was the Internet bubble.

Eventually,
all bubbles burst. Fundamental values re-assert themselves and markets crash.

Do
yourself a favor, stay away from this game of musical chairs.

 

What’s
Wrong Today:

Most Obama
supporters are shaking their heads at the mis-management of the roll out of www.healthcare.gov. Here is a quick
summary of the problems: delayed funding; delayed procurement; rushed
development by multiple contractors; poor program coordination; insufficient
and late quality assurance; severe problems not bubbling up to decision-makers;
lack of accountability; and more.

We
learned from CNN that the Obama administration was
given clear warnings in August that the federal healthcare site was not ready
to go live. The caution came from the main contractor CGI, who warned of a
number of open risks and issues for the healthcare.gov web site, even as
company executives were testifying publicly that the project had achieved key
milestones.

In their August
status report marked “confidential”, the CGI
document describes “top risks currently open” and
“outstanding issues currently being mitigated”. It said the testing
timeframes are “not adequate to
complete full functional, system, and integration testing activities”
and lists the impact of the problems as “significant”.

One
comment was that “hub services are intermittently unavailable”. That
is techie for: “the site’s not working
sometimes“. A concern, listed as “severe” warned: (brackets
and emphasis by the Wrongologist)

When your main contractor says they need
debugging information to get the web site up, wouldn’t you give it to them?

When you
hear that there is “not enough time in schedule to conduct adequate performance
testing”, wouldn’t you make sure that it happened, even if it caused a
roll-out delay?

Let’s
look at what professionals are saying about the healthcare.gov rollout. Here is
Tony Byrne of the Real Story Group, who thinks that the specifications
for healthcare.gov were extraordinarily complex. In fact, he says that they hit
the web application trifecta. Their task was to:

Byrne,
who has had the US Treasury as a client, explains why the task was very
daunting:

Byrne
concludes:

On the
plus side, the term HealthCare.gov could become part of the techie
vernacular, including usage as a verb. “This has all the makings of a HealthCare.gov,”
or, “We need two more weeks of QA or this is going to go all HealthCare.gov
on us.”

Given
the leaked CGI document, it’s unimaginable that senior Administration officials
didn’t know there were major implementation issues with the website and that big
trouble was ahead. The
DHHS and the Administration just seem to have been terrible clients.

So, here’s another crisis that the White House has handled badly. On the other
hand, the ruckus the Republican Party is raising about the website is a thing
of beauty. The calls for heads to roll, the lamenting that no apologies were offered, etc. are simply not
believable given the party that is asking for them.

From Ezra
Klein in Wonkblog:

If accountability is back
on the table, how about House Republicans who refused to appropriate the money
the HHS said it needed to properly implement Obamacare?

• How about Senate
  Republicans who tried to intimidate Sebelius out of using existing HHS funds to
  implement Obamacare? Sen. Orrin Hatch demanded at one hearing:

It’s difficult to imagine the scale of the disaster
if Sebelius hadn’t moved those funds.

• How about Republican governors
  who told the Obama administration they absolutely had to have the right to build their
  own health-care exchanges (you may remember that the House Democrats’
  health-care plan included a single, national exchange). And they then refused to
  build them, leaving the construction of 34 insurance marketplaces up to HHS?

• How about the Republican
  effort to get the law declared unconstitutional, an effort that ultimately
  failed, but that delayed program implementation as government and industry waited for
  the uncertainty to resolve?

• How about the Republican
  governors who refused to take federal dollars to expand Medicaid, leaving about
  5.5 million low-income people who’d be eligible for free, federally-funded
  government insurance to slip through the cracks?

Republicans made clear that any
issue with ACA and the rollout would be exploited rather than fixed, including
shutting down the government because the funding bill contained money for
Obamacare.

The Obama administration
deserves all the criticism it’s getting for the poor start of the health care law.
Their job was to implement the law effectively, even if Republicans were
standing in their way. So far, it’s clear that they weren’t able to deal with
either the complexities of the law or the technical tour de force that the roll
out required.

But the GOP’s complaints
that their plan to undermine the law worked too well and someone has to pay,
borders on the comic. If Republicans actually believe Ms. Sebelius is responsible for the
law’s poor launch, they should be pinning a medal on her.

Neither
side escapes; there is plenty of blame to go around.

On one
side, we have incompetence. On the other, we have obstruction.

And what do the people have? Nothing.

They have nothing for all of the effort, nothing for all of the emotion, nothing for all of the dollars spent. 

The
World Series ended before November! Congrats to the Sox. The Wrongologist and
Ms. Oh So Right are in Boston, but sadly, no champagne remains inside the city
limits.

No
Halloween fun for St. Louis:

Another difficult week for the Obama administration: the NSA proves that it is more than a 4th branch of government; it is its own country with its own foreign policy. And yet more faux outrage about Healthcare.gov along with some real outrage about Mr. Obama’s promise that “you can keep your doctor, you can keep your health insurance”.

Can government get this country back on track? We have had enough of the endless DC theater that pretends to govern. Congress thinks that if it talks long enough and loud enough, no one will notice that they are not accomplishing anything. Use the quote below from Will Rogers to write your homily about government dysfunction:

Faux Outrage:

Shouldn’t Republicans stop pretending to be upset that the website isn’t working properly when they would rather it didn’t work at all? Where is the Republican plan?

Bed mates:

Obama Halloween:

NSA makes no friends for USA: