Wednesday, July 27, 2011

SOLD: 100 EXC @ 44.67, 100 APF @ 17.47, 50 DLN @ 49.38, 100 PEO @ 30.62, 100 MSFT @ 27.9/Mortgage REITs and U.S. Debt Downgrade/ What Are the Reasons for a Continuation of the Fed's Jihad Against the Saver Class/BDGE WASH UBSI EK SVU

In his  Barrons.com column, Jim McTague discusses a study by two economists that attempts to quantify some of the harmful effects of the Federal Reserve's Jihad against savers. I referenced that study in an earlier post: The Real Cost of The Federal Reserve's Jihad against the Saver Class The saver class is very large in the U.S. Over 24 million homes are owned free and clear for example. census.gov/pdf. The authors of that study found that interest rates are now about five percent points lower than at comparable times in history. Given the sheer size of yield sensitive and safer investments, this translates into anywhere from $256 billion to $587 billion in lost consumption which has an adverse impact on job creation and GDP.  

While the Federal Reserve maintains that a continuation of its Jihad is necessary now to support the economy, that argument has more than a few flaws in it. The lost consumption derived from savers spending their interest income is just one counterpoint to the Federal Reserve's position.

It is also true that corporations and individuals, capable of refinancing their debt to lower their interest payments, have already done so. I have lost over one-half of my bonds to corporations refinancing their debt. Large public corporations have already reduced their interest payments on existing debt and many have raised cash for no current reason other than to take advantage of abnormally low rates. Individuals capable of refinancing their mortgages have already refinanced and will have more funds to devote to spending and/or saving as a result. A continuation of abnormally low rates does not help those entities or individuals, but unquestionably harms the vast saver class. 

Contrary to the Federal Reserve's position, the abnormally low interest rates have not caused a flight from safety. As McTague points out, savers still have their money in money market funds, bank CDs and and savings accounts. 

I suspect that the Fed's Jihad will continue primarily to assist the government in refinancing its debt. Currently, a short term treasury bill yields almost nothing (just say nothing really), and the ten year treasury note is close to 3%. If those rates were anywhere near normal, the already bloated federal deficit would became an even more serious problem.  Even with historically low rates, the U.S. paid over 413 billion in interest payments in the F/Y September 2010.  Government - Interest Expense on the Debt Outstanding That could easily double with a less accommodative Federal Reserve. A 1% rise in interest rates would result in approximately another 150 billion in the deficit.

The Reserve Bank of India hiked its key lending rate by 1/2% to 8%. This is the 11th increase since the bank started to increase rates in March 2010. The higher than expected increase was due to rising inflation. One of my concerns is inflation in emerging markets, and the efforts being undertaken to tame surges in the inflation rate.

I knew that Eastman Kodak (EK) must have released its earnings report yesterday after I noticed that its 2013 bond had fallen to around 81-82. The market does not have high hopes that EK will survive until November 2013 to pay off that senior bond, which I own, and that is not an irrational belief. The last report was stunningly bad. Kodak: Investor Center: News Release I suspect that many individual investors considering the purchase of that bond are failing to even review earnings reports, a lazy and reckless practice.  I have never held out any hope for EK's long term survival, meaning survival beyond 10 years from now.  I was just making a small "bet" that it would survive until November 2013.  That is starting to look more questionable.

Unlike my 2 EK bonds, I am in the black on my three Supervalu (SVU) bonds and have sold two already for profits.  Supervalu reported first quarter earnings of 35 cents, beating the consensus estimate by 2 cents, and reaffirmed its guidance for the current 2012 Fiscal Year. Reuters  SUPERVALU Earnings Press Release

The new managing director of the IMF, Christine Lagarde, said that a U.S. debt default or downgrade would be a "very, very, very serious event", The Washington Post. Apparently, she thought that the TBs would pay more attention by using "very" three times in conjunction with "serious". Ms Lagarde is French and the TBs will not pay any attention to anyone who is from France.  Remember their temporarily successful effort to rename the "French Fry" to "freedom fries" after France cautioned the U.S. about invading IRAQ. Before spending a trillion or so of borrowed money, and sacrificing the life and limb of so many people, one would hope that future TBs in Congress will actually spend a moment or two questioning the rational for invading a country who had not attacked the U.S. and actually look at the evidence then existing which the TBs refused to do in 2003. Going to War Decisions: Conservative or Liberal vs. Competent or Incompetent?  Accurate Information is Not a Side to an Issue/ Lying Works In Politics Curveball  Do not hold your breath.  Making decisions on reliable information is not important to them.

According to the latest Pew Research Center poll, most republicans do not see a major problem in Congress refusing to raise the debt limit.

Boehner will likely need some Democrats to vote for his scaled down budget plan tomorrow. Representative Jim Jordan, one of the leading reactionaries in the House, said yesterday that he would vote against Boehner's budget plan. WSJ.com Jordan's group thought that they were compromising by backing off their demand for 9.5 trillion dollars in cuts.  GOP's "Cap Cut and Balance" Plan Those individuals are not conservatives, and no one should assign that label to them. The only appropriate words would be extremists, radicals, and reactionaries.

Last night, Boehner delayed the House vote on his plan, due to opposition within his own party.  His latest plan is not draconian enough. NYT  Washington Post CNN.com (4 trillion in cuts plus no tax increases is necessary to satisfy the reactionaries). I am going to the WP web site frequently now, since that paper has the best coverage of events taking place in D.C.  The CBO said that Boehner's plan only had 850 billion in cuts in its first phase, as opposed to the advertised 1.2 trillion. www.cbo.gov/.pdf

In several recent stories, recent tax collections by the treasury have exceeded expectations so some argue that it may be possible to extend the 8/2 deadline for one week. NYT I have done my part to help our destitute Uncle Sam in his hour of need by mailing an estate income tax payment earlier this week.

Whites now have 20 times the net worth of blacks, up from 7 to 1 in 1995. CBS News

This chart, based on IRS data, shows how various income groups have fared under Democrat and Republican Presidents from 1948 to 2005. The Great Divergence

The stock and stock fund sales mentioned in this post completed my ongoing stock allocation reduction. I am just going to mention those sales briefly.

1. Regional Bank Earnings (BDGE WASH UBSI)(own: Regional Bank Stocks' basket strategy):

Bridge Bancorp (BDGE) reported second quarter net income of $2.5 million, which included $265 thousand in after tax acquisition costs, or 38 cents per diluted share. Core net income without the costs related to the Hamptons State Bank acquisition was 42 cents per share. The estimate, originating from one analyst, was for 34 cents. The E.P.S. for the 2nd quarter of 2010 was $.34. As of 6/30/11, the tier 1 capital to risk-weighted assets was at 13.1%; the NPLs to total loans was at 1.21%; the allowance for loans losses as a percentage of NPLs was at 132.95%; and the net interest margin was at 4%.  I am reinvesting the dividend. I am also in the hole on this one: Bought 50 BDGE at 23.11 Bought: 50 BDGE @ 22.14

United Bankshares (UBSI) reported net income for the second quarter of 17.5 million or 40 cents per share, which included a non-cash impairment charge of $4.1 million on investment securities. The consensus estimate from 9 analysts was for 40 cents. UBSI Analyst Estimates. As of 6/30/11, the net interest margin was 3.83% (up from 3.69% 6/10); the efficiency ratio was 52.03%; NPLs to total loans was at 1.22% (average for peer group as of 3/31/2011=3.89%);  the total risk-based capital was 13.9% (10% well capitalized); and the Tier 1 capital ratio was 12.5% (6% well capitalized).  I am not reinvesting the dividend. Bought 50 of UBSI at 16.65 (November 2009). While I have a good unrealized long term capital gain, I have kept this one due to the dividend yield at my cost which is around 7.2%. United Bankshares Inc., UBSI Stock Quote

Washington Trust (WASH) announced net income of $7.6 million for the 2nd quarter or 46 cents per share. The consensus estimate generated from 3 analysts was for 44 cents. WASH Analyst Estimates This was an increase over the 33 cents earned in the second quarter of 2010. I have already booked a profit on 1/2 of my 100 shares bought at $15.26 (January 2010) Sold 50 of 100 WASH @ 22.44 I am content to hold the remaining 50 shares. The dividend yield at my constant cost basis is good, close to 5.8%. WASH Stock Quote

50 SHARES WASH AVERAGE COST PER SHARE=$15.34
50 Shares 2010 Realized Gain =347.03


If I reduce the cost of the remaining shares by the before tax gain, which is something that I will just do in my head, then the yield would become 21%, lower of course after adjusting the $347.03 gain for taxes.

2. Sold on Monday: 100 Microsoft (MSFT) at $27.90 /100 PEO at $30.62/100 EXC at $44.67/50 DLN at $49.38/ Sold 100 APF at 17.47-Tuesday  (see Disclaimer): All of these positions were sold as part of the ongoing reduction of my stock allocation. These transactions brought me to a comfort level based on currently known information.

I may buy some or all of those positions back at lower prices. I am reinvesting the dividends on my MSFT and EXC positions. To buy back EXC, it will have to lower my average cost. I sold my highest cost MSFT and EXC shares shares using FIFO accounting. This lowers my average cost for the remaining shares. I still own 131 shares of MSFT: Added 30 MSFT at 24.15 (May 2011); Added 50 MSFT at $25.55 (May 2011); ADDED 50 MSFT at 25.81 (March 2011). I am not likely to add the MSFT shares back at over $25.

I do not believe that there is a zero chance of a non-temporary worldwide economic slowdown, nor do I agree with the market that the politicians in Washington are certain to raise the debt limit and/or avoid a downgrade in U.S. sovereign debt.

PEO was sold for a small profit. It is a CEF that invests in energy companies.  Bought 100 of the CEF PEO at 29.77 (2/28/11 POST). I will buy the stock ETF DLN back only after a 10% decline from current market levels.

Exelon shares were up a $1 when I pared my position on Monday, due to an upgrade of merchant power producers by Merrill Lynch/Bank of America, MarketWatch.

With the exception of the EXC transaction, these sales were of recently purchased stocks.  The only one generating a significant profit was the 103+ shares of OEF, netting over a thousand.  Sold 103+ of the Stock ETF OEF at $59.98 (7/25/2011 Post) I was growing pessimistic before the Crazies put into play the full faith and credit of the U.S. government. Jobs (6/6/2011 Post); Item # 1 Consumer Debt Levels-Still Way too High (7/1/2011 Post);   LB is In a Slow Mo Trading Mode While Preserving Recently Raised Cash Stash (6/7/11 Post); Underlying Cause of the Current Long Term Bear Market is Too Much DebtThe Roller Coaster Ride of the Long Term Secular Bear Market.  The recent pares were made due the increasingly worrisome dysfunction in Washington.  When doing an asset allocation pare, I will frequently jettison recently acquired positions, particularly reductions where I can reduce my average cost for the remaining shares while realizing a gain.

I also decided to continue de-risking some on Tuesday and sold 100 of the stock CEF APF, recently bought at   $16.84. (7/1/2011 Post).

3. Mortgage REITs and the Possible U.S. Debt Downgrade:  I mentioned in a previous post that Mortgage REITs would react negatively to a U.S. debt downgrade since they use considerable leverage to buy GSE mortgage-backed securities.

One investor, who writes frequently about Mortgage REITs, published an article at Seeking Alpha recommending that investors sell all of their MREITS. If I had a significant position in them, I would have already pared the position some in response to the latest dysfunction in Washington. Instead, I recently added 50 shares of MFA, bringing my total to 100 shares, a totally immaterial investment for me. GOP's "Cap Cut and Balance" Plan Added 50 MFA at 7.78 in Roth IRA (7/21/2011 Post, where I mentioned that I hoped the Crazies will not cause a default which would have adverse effects on MREITs).

The article does provide a number of factual reasons why a U.S. debt downgrade would negatively impact MREITs. Since they borrow so much money, and use the GSE mortgage backed securities as collateral for the short term loans, their creditors may require them to post more collateral and to pay more interest.

I am not the kind of person to hyperventilate about anything. If I did not panic during the Near Depression period, then I am not likely to panic at all. I am not likely to add to my small position in MREITs until there is more clarity about events in Washington.

Randall Forsyth also discusses this issue in his recent Barrons column. The subject is also discussed in this recent column found at MarketWatch. As noted in that last article, the CME will increase this Thursday the "margin haircuts" for Treasury and GSE debt from 10% to 11%: cmegroup.com.pdf

If there is a significant decline in MREITs before there is any firm news on default, I may even add a few shares to a MREIT holding as a contrarian move.

A Reuters poll of economists found that a majority of them believe that the U.S. will suffer a downgrade from at least one credit agency.  

2 comments:

  1. I realize the threats of the credit rating agencies are meant to be taken seriously, but after their widespread deceptive practices during the run-up to the financial meltdown, handing out AAA ratings on all those toxic mortgage bundles, why should we take them seriously now?

    It's no wonder their threats to downgrade the US rating are being met with shrugs. They've lost a lot of credibility in a lot of people's minds...deservedly or not.

    Maybe this partially explains the playing of this irrational game of "chicken" with the credit rating of the US govt.

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  2. Cathie: I would agree that bond ratings are not to be taken entirely seriously. And, I doubt that Moody's and S & P will have the nerve to downgrade U.S. debt unless Congress fails to raise the debt limit and the government is forced to prioritize.

    S & P has threatened to downgrade if the budget cuts are not deep enough, even if the debt limit is raised in time, but they do not have the balls to do that. For one, the U.S. government is their regulator and the agencies might find a piece of legislation down the road impacting their business model of collecting fees from the entities rated by them rather than by their customers.

    For sovereign debt ratings, the ratings are generally behind the curve when a nation starts to become less creditworthy. This has been seen repeatedly in the European sovereign debt crisis where the market took the PIIGs down long before the credit rating companies started to downgrade. In my view, the U.S. is not a AAA credit now anyway. I do not even view our government as AA. Google or KO are more creditworthy in my opinion than the debt crazed and dysfunctional U.S. government.

    The main impact of a debt downgrade would be psychological at first, making consumers less willing to spend for example, and possibly the market will react by increasing the cost of U.S. borrowing. There are companies like the MREITs which will be adversely impacted. It would also likely have an adverse impact on the dollar. If the downgrade occurs in the context of more political dysfunction, the credibility of the USD as a reserve currency would come into question, as well as the willingness of foreign governments to subsidize the U.S. budget deficits.

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