Union Battles In Las Vegas, Simi California, Hawaii, Massachusetts

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

Las Vegas: City firefighters launch campaign against cutbacks

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

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

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

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

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

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

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

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

Simi California: Simi, police union agree to contract

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

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

Significant provisions of the MOU approved Wednesday include:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Boston: Judge rejects transportation workers effort to block benefit cuts

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

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

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

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

Understanding the Massachusetts Bay Transit Authority [MTBA] problem

Please consider Time to end ludicrous MBTA benefits

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

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

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

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

The Man Who Never Returned

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

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

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

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

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

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

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

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

...

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

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

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

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Craftalicious

One of my sweet bloggy friends, who has a little old blog called The Lettered Cottage (maybe you�ve heard of her? Hmmm?), asked me today to share a few thrifty tips. I was happy to oblige, and as I was looking through old posts for ideas, I was feeling a little nostalgic about some of the cauuute projects I�ve worked on this year.

I will do another recap of the year like I did last December (probably tomorrow?) but I couldn�t pass up sharing a few of my favorite crafty projects that may not make the cut (I determine the recap by posts with the most comments).

Looking back through the blog is like looking at old photo albums. Some of you have seen all of these, but it�s fun to reminisce, eh?

First project I loved � Squishy�s gumball machine casa! I don�t know if this is really considered a craft, but it involves glue and fish, and what craft project would be complete without fish? I mean, really�

To see how I made the gumball fishbowl, click here.

Next up, my placemat and table runner pillows:

Umkay, again, maybe not so crafty. But easy and cheap and WOW, these have held up GREAT!! I�m so pleasantly surprised. To see how I made them, go here and here.

My jute lurve started when I saw something I had. to. have. in the Ballard Designs catalog (shocker) and knew I could recreate something similar for cheap:

The vase was a project from the spring. I love the natural look of these jute items. Usually I crave more color but they are a great accent, and they are perfect for this time of year � fresh and simple. Want to know how I made them? Huh? Do ya? Go here and here.

I had a ton of fun working on my son�s playroom this year. I used paper to create fun, functional storage. I also took an old tool box from Goodwill and made it into a cute art caddy:

To see more of these project, go here. Or here for the whole look at the playroom.

I�m all about trying to figure out how to fill wall space in inexpensive ways. Inspired by Ballard Designs yet again, I made this wall art for very little cash. I think it was $20?:

To make your own Ballard Designs art, check it out here.

And I can�t forget the holidays. A couple of my favorites are from the past few months. I love the little ghouly votive holders for Halloween, and the Santa craft still makes me giddy when I walk past it!:

To see the votive holders, go here. For the Santa cones, go here.

Did I forget anything fun?

OH MY GOODNESS, I am soooo itching to get moving on new projects! I have a few lined up, and a list a mile long written down, so there should be plenty of content for 2010. I actually wonder sometimes if I�ll run out of things to blog about! Ha! That�s crazy talk.

Credit Card Delinquencies, Chargeoffs Rise Again; Bank of America Has Credit Card Headaches

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

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

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

Bank of America Now Choking on Growth at any Cost Policy

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

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

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

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

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

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

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

Bank of America Credit Chargeoffs vs. Allowances



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

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

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

Assets at Banks whose ALLL exceeds their Nonperforming Loans



The above chart courtesy of the St. Louis Fed.

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

Excess Reserves? Please be serious.

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

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

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

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Hussman on Valuation; Stocks Higher? Bulls Dance On Edge Of Cliff

Inquiring minds are reading Clarity and Valuation by John Hussman.

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

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

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

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

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

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

Stocks Higher? New Bull Market?

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

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

What's not to like?

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

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

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

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

What he's saying now:

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

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

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

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

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

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

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

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

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

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

El-Erian Is An Optimist

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

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

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

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

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

I think the probabilities look something like this:

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

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

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

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

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

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

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

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Morgan Stanley Predicts 5.5% 10-Year Treasuries, 30 Year Mortgages at 7.5%; I'll Take the Under

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

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

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

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

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

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

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

I'll Easily Take The Under

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

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

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

Six Factors In Play

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


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


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


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


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


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

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

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

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

26 Mile Long Glut Of Idle Oil Tankers

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

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

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

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

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

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

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

Storing Crude

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

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

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

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

Crude Prices



Click on chart for sharper image.

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

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

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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The Most Redeeming Feature of Capitalism is Failure

There is an interesting interview in Barron's with two hedge fund managers called Shorting the Economic Recovery.

The fund managers who correctly predicted the housing collapse and the rise in gold, now predict the economy's next leg down. The second theme in the article is on capitalism, fractional reserve lending and what the government should have done.

Here are some interesting interview snips pertaining to capitalism and fractional reserve lending. The rest of the article is by subscription only.

PERHAPS ONE OF THE greatest failings in the run-up to the financial meltdown was a lack of perspective -- an inability by many market participants to see the big picture. Not so with Kevin Duffy and Bill Laggner, principals of the Dallas-based hedge fund Bearing Asset Management. With the help of their proprietary credit-bubble index, developed in 2004, the managers sounded early warnings on housing and credit excesses, and capitalized handsomely on their forecasts by shorting Fannie Mae, Freddie Mac, money-center banks and brokers, builders, mortgage insurers and the like.

Students of the Austrian school of economics, which espouses a free-market philosophy that ascribes business-cycle booms and busts to government meddling with interest rates, the pair is solidly in the contrarian camp, believing that the worst for the markets may be yet to come.

Barron's: You've said that perhaps the most redeeming feature of capitalism is failure. Please explain.

Duffy: Any healthy system needs a way to correct error and remove waste. Nature has extinction, the economy has loss, bankruptcy, liquidation. Interfering in this process lengthens feedback loops. Error and waste are allowed to accumulate, and you ultimately get a massive collapse.

Capitalism is primarily attacked by two groups: utopians who wish to impose a more "compassionate" system, and political capitalists who want to enjoy the fruits of success without bearing the pain of failure. They use the coercion of the state to gain privileges, at the expense of everyone else.

As a country we've become less tolerant of economic failure. The result has been a series of interventions, such as meddling in the credit markets, promoting homeownership and creating a variety of safety nets for investors. Each crisis leads to an even greater crisis. The solution is always greater doses of intervention. So the system becomes increasingly unstable. The interventionists never see the bust coming, then blame it on "capitalism."

Barron's: What would you have done differently as the credit bubble was bursting and the Fed and the Treasury were declaring that the world would come to an end without an $800 billion bailout package?

Duffy: Allow those who essentially bet wrongly to fail, instead of bailing out people with friends in high places.

Barron's: What about the argument that a financial panic would have ensued and crushed the little guy?

Duffy: The little guy actually has been crushed. The little guy is always going to be the last one in the soup line. So he will get a bone tossed to him, like cash for clunkers. But if you are Goldman Sachs or if you have got essentially the red bat-phone to Washington, D.C., you are first in line.

Laggner: There is still a multi-trillion dollar shadow banking system that FASB [the Financial Accounting Standards Board] wants to address next year. The central planners have already spent $3.15 trillion on various bailouts, credit backstops, guarantees, etc., and given approximately $17.5 trillion of government commitments, etc., while allowing many of these institutions to remain in place, with the same people running them.

Barron's: What else could have been done?

Laggner: We could have isolated the money centers and put them in temporary receivership. Then, we could have created -- with a mere $100 billion -- a thousand community banks. If you believe in fractional reserve lending [in which banks lend multiples of their deposits], something we don't support, they could have created a trillion dollars in new credit that would have flowed to small and medium-sized businesses. Those are the parts of the economy that are choking.

Barron's: What kind of financial reform would you like to see?

Laggner: We don't believe in a central bank. The idea that banks can speculate with essentially free money from the [Federal Reserve], which ultimately is the taxpayer, and that when they lose money the Fed bails them out and then passes that invoice to the taxpayer -- that whole model is broken and needs to go away.

Duffy: To get to the heart of the problem, we need to address fractional-reserve banking, which is causing the instability. We have essentially socialized deposit insurance and prevented the bank run, which used to impose discipline on this unstable system. At least it had some check on those who were acting most recklessly. Until we address the root of the problem, we are going to have a series of crises, greater responses and intervention, and more bubbles -- and the system will keep perpetuating itself.

Misguided Blaming Of Capitalism

Duffy hits the nail on the head when it comes to regulation and intervention: The interventionists never see the bust coming, then blame it on "capitalism."

Intervention created Fannie Mae, Freddie Mac, and the "AAA" rating of pure junk via government sponsorship of Moody's Fitch, and the S&P.

Furthermore, FDIC regulation designed to prevent bank failures and runs on banks did nothing of the kind. Instead, the FDIC created a false sense of security for decades, followed by a massive collapse of banks, including the largest bank failures in history.

In 2009, 140 banks failed and that number will likely be topped in 2010.

FDIC is a moral hazard as well as Ponzi scheme of immense proportion. It allows marginal banks to raise needed funds by offering above market government guaranteed CDs. Such guarantees helped fund ridiculous condo projects by Bank United, Corus Bank, and others. Indeed, many regional banks jumped on board with enormous leverage in commercial real estate.

Very few understand how destabilizing FDIC is to the banking system.

Fractional Reserve Lending Disaster

I also agree with Laggner that Fractional Reserve Lending is a bad idea.

For example, if Fannie and Freddie had to back up their mortgages 100% with bonds of matching duration instead of the mere 3% now in place, if 100% reserves were required on checking accounts, and if there was no FDIC, it is highly doubtful things would have gotten so out of hand.

Laggner suggests the creation of 1000 new community banks with deposits of $100 billion would have kicked off a $trillion in lending. I disagree on this point given that reserves are not the primary lending constraint as noted in Fictional Reserve Lending And The Myth Of Excess Reserves.

Excess Reserve Recap

1) Lending comes first and what little reserves there are (if any) come later.
2) There really are no excess reserves.
3) Not only are there no excess reserves, there are essentially no reserves to speak of at all. Indeed, bank reserves are completely "fictional".
4) Banks are capital constrained not reserve constrained.
5) Banks aren't lending because there are few credit worthy borrowers worth the risk.

In Laggner's scenario, unless those 1000 banks did not care about losses, points number 4 would and 5 would have come into play.

Of course government could have decided to bankroll capital losses at those new banks, just as it now does with Fannie Mae and Freddie Mac.

Please see All Hail The Grand Poobah; Blank Checks For Fannie and Freddie for a discussion of Obama's Christmas eve decision to cover an unlimited amount of losses at the mortgage-finance giants Fannie Mae and Freddie Mac over the next three years.

Interestingly, the legislation that created Fannie and Freddie explicitly states that its securities are not backed by the government. Supposedly, the GSE's were to receive no direct government funding or backing.

Both president Bush and president Obama (as well as the treasury departments under each administration) have shown little concern for such technicalities. Increasingly presidents are of the mind "we have to destroy capitalism to save it" or as President Bush stated (and Obama practices)�I�ve abandoned free-market principles to save the free-market system.�

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