2014 Outlook and a Soapbox Rant

2014 Outlook
Last year, in the annual outlook notes I went out on a limb and stated that: “We do feel that his year, while volatile, will be positive in the markets (barring any major unforeseeable event).” Apparently I could have gone a little further out on the limb with the S&P 500 ending the year up 29.6% and the Dow Jones Industrial Average up 26.5%. I was very accurate in stating it would be a volatile year. Both the Dow Jones Industrial Average and the S&P 500 went through three different corrections of 5% or more. The historical average length of time between these types of corrections is 7.6 months. The market remained very nervous throughout the year as Fed Chairman Bernanke, Washington, Health Care costs, and corporate earnings all stayed on the news 24/7. What will we see in 2014? While I don’t believe in crystal balls, I again have a list of areas I believe should be at the top of our watch list for the year. Some of them the media will do a fine job of keeping in front of us on a constant basis, others I will watch and try to keep you updated in my commentaries throughout the year.

Margin, Earnings, and Bears…Oh my!
I really could not resist using that as my headline for this section. It just fit too well. Many of the economists and market prognosticators that I read on a regular basis have been discussing this triple threat for the last year. I definitely see it as a finger of instability, but, as with all of these things, there is no way to time exactly when it might reach a critical point and collapse. I am watching charts closely and will be ready should it show signs of reaching critical mass. So, what is the story behind this triple threat exactly? It all comes down to the Federal Reserve and historical patterns. The Federal Reserve’s current 0% lending rate has been in place since December of 2008. That is why the media and investors in general have been so focused on the Fed’s meetings and change in leadership with the ending of Chairman Ben Bernanke’s term. With the Fed essentially flooding the system with liquidity (which actually hasn’t seeped out to the economy as much yet) investors have driven up market valuations (as measured by Price to Earnings, or P/E ratios) to highs.

Here is the critical information. From January 1, 2012 through January 17, 2014 the S&P 500 returned 32%, excluding dividends. During that same time frame, real earnings grew by less than 8%. The trailing 12-month price-to-earnings multiple has expanded by nearly 30% from 12.8x to 17.3x. The Shiller P/E metric, when compared to the S&P 500, is at levels last seen near market tops reached in 2000 and 2007. These high levels signal to me a sentiment driven market, which comes into our rule of “Beware the crowd at extremes.” Corporations do seem to feel that sales will pick up in 2014 given the major increase in inventories in the 3rd and 4th quarters of 2013. That could help boost that earnings number, but so far forward guidance has not moved the needle in terms of expected earnings growth. Corporations are also enjoying record high profit margins that are 70% above their historical norms. With revenues rising at a slower pace, the concern is that if margin dips, earnings will not show the growth that analysts are forecasting. Many feel that the markets will return back to historical movements and there is a lot of data to back that viewpoint. Bulls look to the tightening that corporations conducted after 2008’s recession and the extremely low inflation rate to say that these levels are supportable. These high profits are supporting higher valuations in stocks.

Finally, we tend to roll through a bear market once every 3.8 years. We have gone along in our current bull market (I use the definition of a bull market as one that has not seen a greater than 15% correction) for 4.6 years. History is telling us it is time for a correction. The three of these areas combined lead me to believe we are in for a 15-20% correction. Does that mean we need to sell now and run for the hills? NO! It just means I am going to be extra careful this year to protect the profits we gained in 2013. Should the markets have another up year, like many of the analysts I follow are predicting, we will do our best to participate.

However, if during the year we begin to see a correction (we are kind of seeing one as of my writing of this commentary) I will exercise caution so that we do not participate in all of the downside. There are a number of technical indicators that I watch closely to try to see the signals of a potential drop. On the macroeconomic side there are a few other things I am watching that can potentially suck the wind out of the sails of the optimists or continue pushing them ahead.

Cash
There are three sides to the cash story that could mean good news for the markets. First, Investors (both individual and institutional) are sitting on quite a bit of cash. As of January 23rd $2.707 trillion was sitting in money market funds which were paying an average yield of .01 percent. Despite the volatility in both the fixed income and equity markets, some of that money will find its way back into the markets. Investors can’t lose money to inflation for too long before it will be time to add risk for some yield and jump back in. Second, non-financial U.S. corporations are sitting on $1.76 trillion in cash. Considering Apple owns nearly 10% of cash, this wealth is not widespread, but as business investment increases the markets could benefit. Of course, a lot of this cash is tied up to balance out some leverage, so not all of it can go into investment or shareholder returns. It is, however, comforting to know that corporations are not as likely to be caught as terribly unawares as they were in 2008.

Finally, as it relates to the velocity of money, it will continue to be important to watch the velocity of money levels to see if the unprecedented amount of money the Fed has been pumping into the economy will actually get out and we see the inflation the Fed has been shooting for over the last several years.

Overseas 
Overseas markets will be very interesting to watch this year. Central banks are playing a key role in the growth prospects all over the world. I thought that Riverfront Investment Group did a good job of summarizing a few of the key countries in their 2014 Outlook. Here are their comments by country: “Japan is in the early innings of engaging in modern history’s most aggressive quantitative easing (QE) program, and the country ahs been responding. Whereas QE has so far failed to spur bank lending in the US, Japan’s banks have used the excess reserves provided by QE to fuel much faster loan growth. Japan’s economy is strengthening and finally exiting deflation – a ‘poster child’ for QE, in our opinion.” I would add here that of the “three arrows” that Prime Minister Shinzo Abe outlined the third, and most important to long-term growth, has yet to be released. I think investors will react in a big way, either positively or negatively, depending on that release.

“Europe: While its balance sheet hasn’t recently expanded, ECB intervention with long-term refinancing operations (LTROs) has significantly dropped funding rates, helping to bring about a nascent economic recovery. Financial conditions suggest a continued easing bias, in our view.” “China displays strong current account positioning, but we believe financial conditions are generally tightening; municipal credit growth and asset inflation in key sectors such as housing may limit policy flexibility.” “India: New central bank governor Rajan, a widely respected economist, is suggesting the use of consumer price inflation as a main guide for monetary policy going forward. This could lead to continued rate hikes in India (the country had two hikes since Rajan took over a few months ago), but trade deficits have narrowed as the rupee has weakened, a trend to watch for potential signs of improvement.” In general we will continue to see emerging markets try to battle their way back against the inflationary policies of developed markets. Despite their oversold nature, which does put them on my watch list for opportunities, I don’t see them having a better year this year than developed markets.

Conclusion 
While you have probably seen a lot of reports and numbers on “As goes January so goes the year.” I will say that the winner of the super bowl has a greater predicting percentage than this adage when January is a down month. I think a better thing to do this year, as it comes to managing your investments, is keep an eye on the macroeconomic news but focus on our holdings in both a fundamental and technical light. While I am more cautious this year, I don’t believe we will end the year with a negative market return.

Soapbox Rant

I read an article from Stratfor today that brought my mind again to something that really bothers me about my generation and the next.  Please understand that my comments do not fit everyone in either of these generations, but apparently fit the majority.  Just a quick quiz to find out which camp you are in:

What is currently happening in Kiev and how is that affecting global politics?
What is currently happening with Justin Beiber?

What is the current standing of the debt ceiling debates here in the U.S.?
What did your favorite celebrity do for valentines day?

The Federal Reserve has begun to taper its asset purchases, how is that going to affect your bank?
How many of the top contestants of American Idol can you name?

Hopefully you have understood the general direction of my rant.  Why are we so focused on celebrity and reality tv over what is truly important?  I think there are a number of answers to that and none of them are appealing.  One option, in particular, bothers me.  How much does the media play in directing your attention?  Are you digging for information or just watching the major news networks for your news?  Keep in mind these news agencies are in the business to get you to watch.  They will cover what is going to keep you glued to the tv and that apparently is violence, sex, and greed because that is the majority of what I see on the major news hours.  Are you relying on posts from friends on Facebook to keep you up to date, or are you subscribed to news outlets and organizations that will update you on specific areas of importance?

If you are not keeping yourself involved in what is going on around you in the world then please start.  Elections are rolling around and both parties are going to do their best to play off the general ignorance of voters to prove their points.  Don't be fooled and know what you are voting for.

A Couple of Debt Thoughts

I thought this was a really good point made by John Mauldin [who, as a side note, is from Texas and a Republican].

"As we bring government spending down, unless it is accompanied by private-sector growth, we will see overall real GDP shrink. That is just the how it works. Now, the smaller government expenditures and deficit will mean more money for private-sector investment and productivity growth, but the process of simply getting the deficit under control is going to mean slower growth. Wrap your head around that. While Republicans (including me) want to control Congress and the presidency in 2012, the policy choices made in 2013 will not be met with a robust return to 4% growth and immediate jumps in employment levels. It is going to take a lot of education to convince voters that there is no magic in spending cuts (or even tax increases) and that we will need to stay the course, even while there is a general malaise in the economy. My advice to my fellow Republicans? Do not sell the concept that voting Republican will provide a quick fix. It will get you slaughtered in 2014."

I think the real key is for the Republicans is to communicate the above very clearly in their campaigns. I don't have much hope for their ability to do that given their exceptionaly poor communication skills in the last two elections (and right now for that matter), but maybe more of the voters at least understand this than last election... maybe... hopefully...please? The way I see it, the solutions that need to be implemented are going to take a while and we will have to stick to the plan, even though it will hurt. If we decide, prematurely, that we would rather kick the can down the road then it is going to hurt all that much worse the next time we are almost forced to get our finances in order.


I also thought, given all the problems going on economically worldwide, that the following link to an article by Diane Swonk of Mesirow Financial is a great, down to earth, explanation of all of the pitfalls out there and how this all could play out. Obviously the U.S. debt and policy decisions made because of it are at the center of most of the problems. Click Here for the link.

Pulling the Splinter Out

“Where would U.S. incomes, earnings and corporate cash-flows be today if it weren’t for the $4.5 TN increase in federal debt over the past 10 quarters? Ponder for a moment the liquidity backdrop in the Treasury market had the Fed not intervened in the marketplace with quantitative easing (#1) and “QE2” - in the process convincing the marketplace that the Fed had committed to operating as a reliable market “backstop bid?” What would be the state of the household balance sheet today if not for the unprecedented fiscal and monetary policy response? Is it sound analysis to trumpet the pristine state of the corporate balance sheet and celebrate the improving household balance sheet - when the Fed is doing unconscionable things to its balance sheet and the federal government is in the process of destroying theirs?”

“How would global markets and economies be functioning these days had it not been for the almost $1.6 TN increase in international central bank reserve holdings over the past 12 months – or the $2.75 TN, 40%, growth in two years, to $9.45 TN?”

“Today, ECB President Trichet stated that “it is important that the dollar is a strong currency.” He also said that “fixing imbalances must focus on deficit countries.” To this day, Greenspan argues that foreign central bank Treasury purchases were instrumental for the rate environment that inflated our nation’s housing Bubble. And the argument that our trading partners – and their undervalued currencies and steady accumulation of American I.O.Us – are most responsible for global imbalances will not be resolved anytime soon.”

“Let the world adjust; just ensure that the Fed keeps doing what it's doing. And I just scratch my head in disbelief at how little we’ve allowed ourselves to learn over a turbulent 20 year period of interplay between “activist” policymaking and serial market Bubbles. After doubling mortgage Credit in seven years, our system is now on track to double federal debt in 4 years. And the markets couldn’t be more pleased with it all. It leaves one pondering what type of circumstance will be necessary to finally force us to start getting our house in order – to return to some semblance of disciplined central banking and fiscal responsibility.” David Nolan - Weekly Commentary


As I was reading the above quote I really started to think about everything our government has inserted itself into and had to start thinking: Where would our economy be if our government had not made money and services so easily accessible to all?

I think that really you can take two views on that. You can either say that we would be in a complete pit of depression for years (probably what the fellow I quoted believes) after each economic correction or you can believe that deep down that Americans are workers. When our backs are against the wall, and sometimes even when they aren’t, we step up to the plate and work harder putting us into a new boom cycle.

So where do I think we would be without government “help”? I think we would be regularly going through the boom and bust cycles we have been, but with a lot less of the extremes like we saw in 2008, and in general we would be prospering. Of course the government and central bank did step in too much and now they will have to get out or we will again have a huge burst. When they do step out of the way it is going to hurt. This interference has become very much like a splinter that has been allowed to fester for too long. Sure we could leave it there and keep covering it up or we can remove it (with all of the complaining and whining that comes with it) and finally start the healing process. While I don’t believe that many of our current representatives have the stomach for it, some do. Also, while there is a lot of anger out there and most can’t agree on how to start getting the splinter out, most agree (according to some polls I have read) that it has to come out now.

If Only...

"Winds of Change in Unionland" by Holman Jenkins

How's the view from Solidarity House? Just asking.

Solidarity House is the headquarters of the United Auto Workers in Detroit, whose windows gaze figuratively across the labor hinterland of the upper Midwest. At least it used to be a labor hinterland, though its politicians this week are taking an axe to public-sector unions. In Indiana and Michigan, proposals even target private-sector unions with bills to turn those states into "right to work" states, like Tennessee or South Carolina.

It all serves to underline the improbability of the agenda rolled out in January by the UAW's new boss, Bob King. Mr. King's grand plan is to organize Toyota and other transplant factories in Southern states where unions already aren't popular, where the laws already are unfriendly, and where previous campaigns have yielded nothing but defeat.

That Mr. King is not dumb is illustrated by his success in a previous job. He led the UAW's successful drive a decade ago to organize the auto parts suppliers. He won by playing the only card the UAW has to play, its politically-protected labor monopoly over the Big Three. He leaned on the Big Three to lean on their suppliers to accept the union on a card-check basis—without a secret ballot vote. In return, the UAW agreed to stand aside while the Big Three shut down some of their own plants and laid off workers.

That was the deal, and the episode offers three important insights. The union had little else to offer supplier companies or their workers, who folded simply under threat of losing their Detroit contracts.

Secondly, the supplier campaign was a distraction from the fact that the Big Three's own workers were giving ground on jobs and job security.

The third lesson, bluntly, is that Mr. King is blowing smoke about Toyota. The UAW has no card to play. The union's labor monopoly gives it no leverage over the transplant factories, and the union's appeal to their nonunion workers, realistically, is less than zilch right now.

The UAW finale has begun. It's the beginning of the end for the union, except as administrator of its membership's retiree health-care benefits (which increasingly looks like a bone thrown the union by the Big Three to give labor honchos a reason for living).

Let us put away our Woody Guthrie records. Detroit's "turnaround" has come not because everyone got a warm feeling and pulled together as a team. Accurately stating matters, the New York Times recently noted that the homegrown industry's "cost structure has been reduced substantially, first through worker buyouts and plant closings and then by eliminating debt during its bankruptcy."

This has the virtue of getting the chronology right. The big labor concessions all came before a government-sponsored bankruptcy that reorganized GM and Chrysler in 2009. In each case, the union gave ground because it knew the one way to outrun its all-important political support in Washington would be to drive the Big Three into Chapter 11.

Bankruptcy came to GM and Chrysler anyway in the financial crisis, followed by a taxpayer bailout. Mr. King knows, in the current political atmosphere, he can't go back to playing his monopoly card to extract anticompetitive terms from the Big Three.

He says the union has changed and wants a new nonadversarial relationship with management. But what exactly has the UAW got to offer? Evidence is lacking that organized labor actually adds value, creating gains workers and stockholders can share. If it did, Toyota et al. would be clamoring to have the UAW in their factories. They're not.

Mr. King's dilemma is evident in his lukewarm response to the Big Three's opening gambit in this year's quadrennial contract talks, an offer of enlarged profit-sharing. Here's the problem: Incentive pay is earned pay; workers see profits as something businesses create, not something union bosses create. And the foreign transplants will only be too happy to compete on the basis of performance-related pay. If the industry is headed toward compensation based on success, what are workers getting for their UAW dues? Good question.

Mr. King must have figured out the handwaving about Toyota no longer is going to fly. Expect him soon to change the subject to management compensation, especially the stock option and bonus payouts white-collar workers are enjoying as a result of the turnaround. Look for the Obama administration to pitch in with rhetoric about workers being denied their "fair share."
All the while Mr. King will be praying, praying—beseeching the heavens for some change in the political atmospherics to allow the union to go back to playing its monopoly card. Don't bet on it anytime soon.

Government Programs

"The government's mortgage assistance program has helped just one in four of the 2.7M homeowners who applied to the program. The bulk of the applicants either failed to qualify for HAMP or were disqualified after initially being accepted into the program. As a result, just $1B has been spent on HAMP, a far cry from the government's initial estimate that $75B would be needed for the program."

So do we see this as being successful?

I was reading another article which pointed out that whenever the government tries to remove the consequences of the risk people/corporations (yes, there is risk when you purchase a home) take they create a more disastrous bubble within the economy, than the normal cycle bubbles we will always see.

While I believe the economy will be able to withstand the bubble that has probably been created from all of the recent government activity, we are going to see this pop later on, and it isn't always in a predictable sector that the bubble manifests.

The President's Budget

My new favorite line regarding the President's budget:

"Claiming budget savings by freezing spending at today’s levels is like an alcoholic who says he’s sober because he’ll never drink more than yesterday’s bender. Trouble is, this alcoholic doesn’t even pay his own tab." - Brian Wesbury

2011 Outlook

With 2011 already speeding by I thought it would be a good idea to get my annual outlook to you. There are so many things going on in the world and in particular here in the US that it has been difficult to narrow down exactly what we wanted to focus on. However, I feel that really there are four key themes that we will be watching play out this year which will have the greatest impact on the direction the economy and the market take: Politics, Debt, China, and Inflation.

Politics
I find it a little funny that over the last year people have become downright furious about the deficits. The topic itself isn’t funny at all, but what is funny to me is that these deficits are not new. We have spent in excess for quite a while. It is the result of asking for more and more “handouts” from our federal government and even getting some for which we didn’t even ask. Now, rather suddenly it seems, we have become enraged by this excess spending and have demanded it stop.

The problem of course comes when what we think is a misuse of federal funds happens to be the bread and butter (quite literally sometimes) of someone else who isn’t willing to part with that money. Who are we to say that funds sent to states for higher education is more important than the subsidies a farmer receives for continuing to farm?

Obviously there are the “easy” ones. Some were even outlined in the State of the Union recently (can we say too many federal government departments?). Unfortunately cuts to these programs is not really going to knock down the annual deficit in a meaningful way. What really has to be cut are the entitlements. We can’t keep increasing what and who we pay for social security. We also have to reign in Medicare and Medicaid. If you mention cuts to these of course you’ll get the massive push back from those about to or already receiving these benefits. It would almost be political suicide to disrupt those outflows. I don’t personally have the answers to the problem, but what the Social Security trustees have proposed seems fairly reasonable and necessary (i.e., push out full retirement age, raise tax slightly, and/or reduce payments).

Entitlement programs and the other necessary spending cuts aside, the real problem to be discussed right now is how much of these cuts can be done without severely hurting the system. Let’s face it, whether we agree with it or not the government has wormed its way rather deeply into the economy right now. If they were to rip themselves out now there would be some pain and perhaps so much pain we would relapse into another severe recession. It is an exceptionally difficult balance that those in Washington are trying to keep between supporting job growth (currently the focus of the Fed despite their dual mandate) and reducing spending.

While I’d like to tell you I am confident that the right long-term decisions will be made, I am concerned that the short-sighted mindset in Washington doesn’t appear to be going away quickly. It will be important to watch throughout the year as the election gets closer what we hear from Washington. Will tackling the deficit continue to take precedent over job creation or will they somehow be able to find the balance necessary to keep the economy moving while reducing spending? I have found it somewhat confidence boosting to hear that discussions are in the works to lower the corporate tax rate and more pressure has been placed on China. It will be interesting to watch those discussions continue and see what, if anything, comes by way of change to corporate tax laws after the President’s speech.

The good news is that job growth is expected to improve this year. However, even with job growth we will not likely see the unemployment numbers drop by much. This will likely keep the consumer on a slower spending rate than where we were at the peak (though the consumer spending numbers as measured by GDP for the 4th quarter of 2010 were impressive), but consumer spending will be one of the most important numbers to watch throughout the year.

China
Before we dive right into the issue of China, I want to review a few concepts which are directly related to the relationship between China and the United States. The current economical relationship between the majority of developed counties and developing countries is that developed countries are increasing their debt levels to fund their spending habits. This contributed to developed countries importing more goods than exporting. This relationship is known as ‘vendor financing’ and occurs when vendor countries (i.e., China, Germany, Brazil, etc.) buy bonds sold by major importing countries (i.e., the US and UK) and the money received by the importing countries for their bonds is then spent on purchasing goods from the vendor countries.

Over the years, this type of relationship between the US and China has been frustrated due to China’s currency devaluation policy of having the renminbi tied to the US dollar. This devaluation policy has the objective of holding the renminbi at a consistent price level below the US dollar. Basically this means that China is manipulating their currency so Chinese goods are cheaper than US goods and consumers are more inclined to purchase Chinese goods than more expensive US goods – of course there is the discussion of quality but that has yet to deter consumers to a large degree.

Of course, the Chinese are able to maintain their currency peg to the US dollar by either printing or selling bonds to control the amount of cash in the market. In the current situation of the US-Chinese currency relationship, the US is increasing the money supply (aka Quantitative Easing and QE2) in hopes of helping the recovery process. Keep in mind they have the dual mandate of keeping inflation in check and supporting the economy primarily through low unemployment; they have prioritized the latter mandate as the more important lately. With an ever increasing money supply in the US, China, has had to “print” large amounts of their own currency so it will stay below the deflated US dollar value. The Chinese currency which is now flooding the market due to the governments’ policy has the potential to cause inflation and move asset prices skyward. If the Chinese government does not stop pegging the renminbi to the US dollar or at least let their currency appreciate a greater amount than they have conceded of late, we could see more severe Chinese inflation.

You also need to factor in the effect of foreign investors heavily investing in developing markets because they currently offer the highest returns in the global market. This massive inflow of money is causing developing countries to experience a large amount of inflation which has begun to erode their production edge of cheap labor and raw materials. You will need to keep this in mind with your international investments this year.

China has recognized this potential issue and has implemented domestic policies with the objective of controlling inflation and drastic asset price increases. These policies have been somewhat successful and the rise in Chinese asset prices has not been explosive, but has been creeping upwards. I believe that the current Chinese policies are just a band-aid for the problem and need to be addressed in the near future lest we see severe inflation which has begun to erode their production edge of cheap labor and raw materials.

Our politicians have started to chime in on China’s policies and have even threatened stiffer trade regulations. I’ve talked about our focus on exporting our way out of this mess and China’s policies are making it hard to do that. Ben Bernanke has also joined in on highlighting this problem when he explained:

“Current policies of export dependent growth countries [China] have led to an unnatural balance of import/borrowing countries and export/savings countries. There should be a continuous balancing act between importing/borrowing powers and exporting/savings powers which is dependent upon the natural changes of currency prices. This means that countries with weaker currencies should be in the exporting/savings seat while those with stronger currencies should be in the importing/borrowing seat. Over time the export/savings countries accumulate wealth and their currency begins to rise in price while the importing/borrowing country’s currency begins to weaken and the countries switch places. It should be a continuous cycle of switching places, but China is purposefully keeping their currency price artificially low to stay in the export/savers position so they can fuel their growth through exports”

Bernanke believes that for the world to recover at a faster rate, China needs to relinquish control of the export/saving position and let their currency price rise. He does not want China to drastically decrease their GDP, but to focus on GDP growth through internal investing rather than relying on exporting goods.

U.S. Deficit
The main topic on everyone’s mind of late, it seems, has been the skyrocketing deficit, however, it seems that it is rare to find the reasoning written out as to why it is such a big deal (other than the rather ubiquitous statement of we are burdening our children). What it comes down to is: What is the lending rate we are paying on our debt?

As we add to our debt each year through excess spending (i.e., the deficit) the interest we are paying on the debt we owe becomes larger. For now we have a fairly low lending rate on our debt, however, should that rate rise even a small amount, we would begin paying more to interest payments than most other government programs. It is the excess spending that must be stopped. As mentioned before however, the government is in a little bit of a bind. How much can they cut spending while not sending unemployment shooting up again? What programs should be cut and what programs should remain?

There is also the much discussed predictions of state and municipal governments defaulting on billions of dollars of their debt in the coming year. The current situation facing most states and municipal governments are high debt levels and underfunded obligations. At the start of the crisis the federal government swooped in on their white horse and gave the states lots of funding and helped states raise or refinance their debt. Now, however, the federal government is not going to be able to do as much for individual states or municipals. As a result non-federal level governments will have to cut their deficits the old fashioned way by decreasing spending and increasing their revenue through budget cuts and taxes respectively. There is the chance that some will go bankrupt, but I do not believe that the problem will be as wide spread as many are predicting. States and municipalities will get their budgets back in line, albeit with a good amount of pain, and as we have seen plenty lately, refinancing the debt is possible and at reasonable rates.

These federal, state, and municipal issues will mean that throughout the year more research will have to be done for your fixed income investments. We will continue to keep an eye on the state and municipal levels to monitor the risks and plan accordingly.

Europe
News out of Europe has played a major factor in economic and market movements of late, and I believe that with some decisions that must be made we might see that role diminish. The critical decision point for Europe that I believe must be made within the upcoming year must be made by the European Central Bank (ECB). They are currently faced with a situation where a relatively small portion of European Union (EU) countries (i.e., Germany) are prospering due to their well established economies and manageable debt levels while the rest of the EU (i.e., Spain, Portugal, Greece, etc.) are experiencing high levels of debt and unemployment because of excess spending and the inability to export their way out of their problems due to the relatively high currency value. This situation will force the ECB to make one of two decisions:

1 – Maintain a strong currency and high interest rate thus keeping inflation stable in Germany and helping Germany attract new investment. For the southern European economies, this will result in increased competition with different export dependent countries with lower valued currencies and possible deflation resulting in a much slower recovery rate from their current recessionary states.

2 – The ECB will provide some form of stimulus by increasing the money supply and/or lowering interest rates. This will weaken the euro and cause Southern European goods to become more competitive in the export market. It will cause high inflation levels in Germany and the country will begin to shift from an exporting/saver model to an importer/borrower model.

I believe the ECB will eventually change to following a policy that is catered to the larger number of member states thereby following the second option, but no one should discount the power of Germany’s position.

So, what do you think? What are your thoughts on these four areas and is there some other critical area we should be watching for the year?

"Higher" Education

I thought this recent study was interesting. If it is true (I haven't read the actual study, just this article about it), then we need to stop focusing so much on cranking out more college grads and focus on how we can increase the quality of education being provided. I would say that a big part has to do with the students not really going to learn, but to complete the next requirement, so I'm not sure how much the government can do for it, but obviously something has to change.

http://www.cnbc.com/id/41139685

China

I have been reading as much as I can lately about China. I don't think I have a full grasp of it yet so there will probably be a better post later, but I came across this article and wanted to share and get some opinions.

Personally I don't think China can keep playing its game for too much longer because it has already started to hurt its own citizens enough to cause rumblings (it's hard to find evidence of these rumblings but they are there).

Anyway, here is the article: http://www.cnbc.com/id/41134710

"It's Not As Bad As You Think"

I have to say that I really like Brian Wesbury. He is labeled as a perma-bull and I don't think he would have a problem with that in that long-term he believes in the US economy. Oddly enough however, one of the times he was named the top economist for the year it was back in 2000 and he was one of the few who was calling for a bear market. I think that too many out there are pessimistic in regards to our country's future. I think we can partly thank our politicians and media for that attitude because all of them have been saying that things are horrible and the world will end because the "other" party is in power and if you would just elect them they would be able to work on fixing the mess. Personally I think we should all take a step back, look at history, and start believing in what Americans are capable of accomplishing.

I love this video that he posted to their blog, which brings me to the other reason why I like Wesbury. He is with an independent firm and they say what they think without a care to who they might offend; unlike some of the other asset managers out there.

http://www.ftportfolios.com/retail/blogs/Economics/index.aspx

I would suggest that after watching the video you take a look at the pictures below it. Too funny!

Tax Proposal and Compromise

I have read a lot in the media (mostly left-wing media, and I am including the official White House press release) about how President Obama offended everyone with his press conference regarding the tax cut deal he struck on Tues. night. I agreed that a lot of his comments were pretty offensive all around. He obviously was going into it with a very defensive mind set and took it too far in my opinion. However, most of the liberal media were emphasizing the Republicans staunch defense of the affluent income tax and talking about how President Obama gave up too much (most insinuated that he gave up quite a bit of his soul to have the audacity to allow the wealthy keep more of their earned wealth, but one or two didn’t go that far). I would suggest you read the transcript of his speech (you can get a copy by going here.), but there is something he said that I did like. It wasn’t necessarily how he said it, especially since I don’t agree with what the health care bill did (which is kind of his point here), but it was that he said it. It was in defense of striking a deal. He said:

“So this notion that somehow we are willing to compromise too much reminds me of the debate that we had during health care. This is the public option debate all over again. So I pass a signature piece of legislation where we finally get health care for all Americans, something that Democrats had been fighting for for a hundred years, but because there was a provision in there that they didn’t get that would have affected maybe a couple of million people, even though we got health insurance for 30 million people and the potential for lower premiums for 100 million people, that somehow that was a sign of weakness and compromise.

“Now, if that’s the standard by which we are measuring success or core principles, then let’s face it, we will never get anything done. People will have the satisfaction of having a purist position and no victories for the American people. And we will be able to feel good about ourselves and sanctimonious about how pure our intentions are and how tough we are, and in the meantime, the American people are still seeing themselves not able to get health insurance because of preexisting conditions or not being able to pay their bills because their unemployment insurance ran out.”

“That can’t be the measure of how we think about our public service. That can’t be the measure of what it means to be a Democrat. This is a big, diverse country. Not everybody agrees with us. I know that shocks people. The New York Times editorial page does not permeate across all of America. Neither does The Wall Street Journal editorial page. Most Americans, they’re just trying to figure out how to go about their lives and how can we make sure that our elected officials are looking out for us. And that means because it’s a big, diverse country and people have a lot of complicated positions, it means that in order to get stuff done, we’re going to compromise.”

Personally I don’t think it would be a big deal to allow the tax cuts for the “affluent” only to expire. It would affect things but not as greatly as many think. I also don’t think that with it in place it really affects the bottom line significantly (at the very least not enough to warrant such vehement backlash). This opinion piece agrees with me. I think it is far more important that we focus on the education system in the country and get out of the way (removing the red tape and lowering the taxes) of companies.

Clear Explanation of the Health Care Bill

This is probably the clearest explanation of the Health Care bill that I have seen. It is long and has several graphs and pictures (Particularly illustrative is the one showing the bureaucratic structure created by the bill) so I didn't copy and paste it here. Instead you'll have to visit this LINK. If you have ever wanted a clear explanation of the actual bill (If you're like me and started to look at the summary of the bill and didn't get it and didn't want to read the hundreds of pages then you too have probably been relying on the various media outlets' highlights) from someone who really gets it, then this is it. For full disclosure the author uses as a main source the Heritage Foundation which is a very conservative group and the author works for fortune 500 companies consulting them on the benefits they offer. So obviously they are very biased, but hey, so am I since my costs went up due to the bill.

One of the criticisms that I heard, which really stuck, during the presidential campaign was that President Obama had pushed as a senator a bill for equal rights for women in the workplace, which would have required all companies to submit to a government agency the number of workers on their payroll, their salaries, and the explanation of differences in pay if there were any (I know there was a consequence if the person monitoring it thought there was an inequality, but I can't remember what it was). The article I was reading referred to it as being the same as using a sledgehammer instead of a flyswatter to kill a fly. Their main point was that if elected President Obama was likely to follow the same pattern and overshoot or miss completely the mark on the major issues of the day.

To me, this Health Care bill was similar to his previous work only, instead of a sledgehammer it's as if they just decided to bulldoze the house the fly was in. Hopefully more of it can continue to be repealed.

President Obama and Foreign Policy

The following article is from Stratfor.

Global Expectations and Obama's Challenge

Having traveled a great deal in the last year and met a number of leaders and individuals with insight into the predominant thinking in their country, I can say with some confidence that the global perception of Obama today is as a leader given to rhetoric that doesn’t live up to its promise. It is not that anyone expected his rhetoric to live up to its promise, since no politician can pull that off, but that they see Obama as someone who thought rhetoric would change things. In that sense, he is seen as naive and, worse, as indecisive and unimaginative.

No one expected him to turn rhetoric into reality. But they did expect some significant shifts in foreign policy and a forceful presence in the world. Whatever the criticisms leveled against the United States, the expectation remains that the United States will remain at the center of events, acting decisively. This may be a contradiction in the global view of things, but it is the reality.

A foreign minister of a small — but not insignificant — country put it this way to me: Obama doesn’t seem to be there. By that he meant that Obama does not seem to occupy the American presidency and that the United States he governs does not seem like a force to be reckoned with. Decisions that other leaders wait for the United States to make don’t get made, the authority of U.S. emissaries is uncertain, the U.S. defense and state departments say different things, and serious issues are left unaddressed.

While it may seem an odd thing to say, it is true: The American president also presides over the world. U.S. power is such that there is an expectation that the president will attend to matters around the globe not out of charity, but because of American interest. The questions I have heard most often on many different issues are simple: What is the American position, what is the American interest, what will the Americans do? (As an American, I frequently find my hosts appointing me to be the representative of the United States.)

I have answered that the United States is off balance trying to place the U.S.-jihadist war in context, that it must be understood that the president is preoccupied but will attend to their region shortly. That is not a bad answer, since it is true. But the issue now is simple: Obama has spent two years on the trajectory in place when he was elected, having made few if any significant shifts. Inertia is not a bad thing in policy, as change for its own sake is dangerous. Yet a range of issues must be attended to, including China, Russia and the countries that border each of them.

Obama comes out of this election severely weakened domestically. If he continues his trajectory, the rest of the world will perceive him as a crippled president, something he needn’t be in foreign policy matters. Obama can no longer control Congress, but he still controls foreign policy. He could emerge from this defeat as a powerful foreign policy president, acting decisively in Afghanistan and beyond. It’s not a question of what he should do, but whether he will choose to act in a significant way at all.

This is Obama’s great test. Reagan accelerated his presence in the world after his defeat in 1982. It is an option, and the most important question is whether he takes it. We will know in a few months. If he doesn’t, global events will begin unfolding without recourse to the United States, and issues held in check will no longer remain quiet. Read more: The World Looks at Obama After the U.S. Midterm Election STRATFOR

CEOs on America

This is a must watch video. I wish we could see the whole thing with all of the interviews.

In particular I want to point out the CEO of American Express and what he said. I couldn't agree more with him. That is the primary problem we face in the U.S., I believe. We need to change our education process (for example reward the good teachers regardless of how hard it is to measure "good" and get rid of the bad ones) and people need to let go of the idea that what worked for their grandfather and father as far as careers go will work for them. There is almost no way we can compete with other countries in areas of manufacturing and still keep up with our own cost of living. We also have to understand that we are very much in competition for the same jobs with those from other countries. That has nothing to do with what the representatives in Washington can or can't do. Honestly all they can really do in my opinion is hurt us in that competition. The competition comes about due to the global nature of the economy and despite what many think it is not a bad thing.

A Republican Win

This is an excerpt from John Mauldin's weekly email. It is definitely something to focus on as you vote. The people we are voting in this week are the ones who are going to be driving local and a few national issues over the course of the next, economically critical, five years.


Be Careful What You Wish For

Everyone by now is predicting the Republicans to take the House and pick up anywhere from 6-8 Senate seats. We'll see. This is going to be a very interesting election, as there is a whole new dynamic in place.

Let's look down the road. I think we will at best be in a Muddle Through Economy for the next two years. Unemployment is going to be above 8%, best-case, in 2012. If the Bush tax cuts are not extended, in my opinion it is almost a lock that we go into recession next year, unemployment goes to 12%, and underemployment gets even worse. That is not a good climate for Obama and the Democrats in 2012. It is especially bad when you look at the number of Democratic Senate seats up for re-election that are in conservative states. The Republicans could take a serious majority in the Senate.

And then what? Right now Republicans are running on promises that they will not cut Medicare and Social Security, but are going to reduce spending and get us closer to a balanced budget. But everyone knows that the only way to get the budget into some reasonable semblance of balance will be to either cut Medicare benefits or increase taxes.

There are only the two options. Yes, you can reform medical care, and I think much of Obamacare should certainly be repealed, but that does not get us anywhere close to dealing with the real issue, and that's a fact. There are tens of trillions of unfunded liabilities in our future, which must be dealt with.

Let me be very clear on this. I am not really worried about the supposed $75 trillion in unfunded Medicare liabilities in our future. That is an impossible number. If something can't happen it won't happen. Long before we get to that apocalypse, we find a bond market that simply refuses to fund US debt at anywhere near an affordable cost. Crisis and chaos will ensue. Remember the quote that led this letter?

People only accept change when they are faced with necessity, and only recognize necessity when a crisis is upon them.
- Jean Monnet

The simple reality is that if We the People of the US want Medicare, in even a reformed and more efficient manner, we must find a way to pay for it. It will not be cheap. Raising income taxes on the "rich" is not enough. You have to go back and raise income taxes on the middle class, too. Oh, wait, that will be a drag on the economy and consumer spending. And in any event it will not be enough.

The only real way to pay for those benefits will be a value-added tax, or VAT. And while it could be introduced gradually, let there be no mistake that it will be a drag on economic growth. Government spending does not have a multiplier effect on the economy. It is at best neutral. What creates growth is private investment, increases in productivity, and increases in population. That's it. Tax increases have a negative multiplier.

A significant VAT along with our current income taxes will give us an economy that looks more like the slow-growth, high-unemployment world of Europe. Can we figure out how to deal with that? Sure. But it is not growth-neutral.

Republicans in 2013 will be like the dog that caught the car. What do you do with it? The last time they (embarrassingly, we) really screwed it up. The defining political question of this decade will not be Iraq or Afghanistan, or the environment or any of a host of other problems. The single most important question will be what do you do with Medicare? Cut it or fund it? Reform it for sure, but reform is not enough to pay for the cost increases that will come from an increasingly aging Boomer generation.

There is no free lunch. At some point, you cannot run on "no cuts in Medicare" and "no new taxes" and be honest. At least not this decade. Maybe when we have cured cancer and Alzheimer's and heart disease and the common cold at some future point, medical costs will go down, but in the meantime we have to deal with reality.

You may be able to fool the voters, but you will not be able to fool the bond market. Not dealing with reality will create a very vicious response. Ask Greece.

And that is the national conversation we must have with ourselves. There is a cost to government. There is a cost to extended Medicare benefits. (I am blithely assuming we deal with all the "easy" stuff like Social Security, and make real cuts in other areas.)

The State Income Tax Issue

"Comparing the nine states with the highest tax rates on earned income to the nine states with no income tax shows how high tax rates weaken economic performance. In the past decade, the nine states with the highest personal income tax rates have seen gross state product increase by 59.8%, personal income grow by 51% and population increase by 6.1%. The nine states with no personal income tax have seen gross state product increase by 86.3%, personal income grow by 64.1%, and population increase by 15.5%."

—Arthur Laffer, Laffer Associates, as quoted in the WSJ, 10/6/10

We Need a Real Leader

“The United States has stumbled into empire. It now faces the crisis of Rome that the empire will annihilate the republic. I argue that of all the institutions of our Constitution, it is the president who can preserve the republic while managing the empire. I also argue that the greatest threat to the republic is living in denial about what the United States has become. The issue, then, is how to manage the unintended and unwanted in the next decade.” – George Friedman, Stratfor.

I was reading this quote on the cover of an email I received from Stratfor (if you aren’t signed up for their free emails then you better get signed up!) and I immediately thought about President Lincoln. If you have never had the chance to actually read about him then I highly suggest you do. I made the mistake of just going by what I learned about him in school. I recently finished a biography on him which I really enjoyed because it would talk a good deal about his life and what was going on in the country at the time and then it would go to several pages of his letters, excerpts from talks and full speeches, and statements made to small groups of friends that illustrated his thoughts and feelings during the time period being discussed.

Our nation is being ripped apart because there is no clear and powerful leadership in the country. When Lincoln came into office the Presidency was looked at as more of a pomp role and the nation was literally being ripped apart for well known reasons. He came in and changed the role of the president and pushed the Union to be something better and led the war as wars should be led (He ran the war in the same way another hero of mine led in a war). While everything he did was not popular, in fact he was a rather embattled president, he had the reputation (and his letters reinforce that reputation) of being a man who would listen to all sides and then clearly make a decision with plenty of explanation as to why the decision was made. All of Lincoln’s decisions stuck to who he was and his core beliefs. While he was willing to listen to all sides and admit when he was wrong, he never wavered from his core belief in the constitution and his interpretation of what that document meant.

I believe President Obama started out on the campaign trail wanting to do the same thing with high hopes and a great vision but he is not strong enough of a leader and because of that he has given in on too many issues and he has allowed others to drive how things are run. He has turned the Presidency into a pomp role again. I would be interested to see if any previous President while in office sat in on so many talk shows and ran so many “town hall” meetings, in essence continuing their campaigning throughout their presidency.

My concern is that we have yet to hear about anyone from any party who would be strong enough of a leader, who could take up the mantle of being another Lincoln. Anybody know of anyone who might fit?

Barney Frank Caught in a Lie

Barney Frank, Then and Now
A news story from 2003:
The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry....

Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing.

''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''

A news story from yesterday:
In a sharp-edged debut debate, US Representative Barney Frank, a Democrat, and Sean Bielat, his Republican challenger, squared off yesterday over national security, illegal immigration, and the roots of the mortgage crisis....

Bielat, a former Marine officer from Brookline, said Frank had contributed to the downfall and subsequent recession by supporting lenient lending standards for prospective home buyers.
“He has long been an advocate for extending homeownership, even to those who couldn’t afford it, regardless of the cost to the American people,’’ said Bielat, 35.

Frank, a leading liberal who has represented the state’s Fourth Congressional District for nearly 30 years and became chairman of the House Financial Services Committee in 2007, said he and other Democrats fought to curb predatory lending practices before the recession but were thwarted by Republicans. He said he had supported efforts to help low-income families rent homes, rather than buy them.

“Low-income home ownership has been a mistake, and I have been a consistent critic of it,’’ said Frank, 70. Republicans, he said, were principally responsible for failing to reform Fannie Mae and Freddie Mac, the mortgage giants the government seized in September 2008.

Short Post

Tell me what's wrong with this picture (if you can't see it, the top line is spending, the bottom line is revenue):

"The lessons of history, confirmed by the evidence immediately before me, show conclusively that continued dependence upon relief induces a spiritual and moral disintegration fundamentally destructive to the national fiber. To dole out relief in this way is to administer a narcotic, a subtle destroyer of the human spirit"
-- Franklin Delano Roosevelt, 1935 State of the Union address

Outside the Regular News

I read this piece this morning and thought I would share. To me it makes a lot of sense, but I don't have a law background at all. Hopefully this will generate some comments as to the reality of this. This is from John Mauldin's eLetter and he is quoting someone else within it who is quoting someone else (Isn't there some rule that by the time it passes 3rd person recounting it automatically becomes fact?)

OK, in a serendipitous moment, Maine fishing buddy David Kotok sent me this email on the mortgage foreclosure crisis just as I was getting ready to write much the same thing. It is about the best thing I have read on the topic. Saves me some time and you get a better explanation. From Kotok:
"Dear Readers, this text came to me in an email from sources that are in the financial services business and with whom I have a personal relationship. The original text was laced with expletives and I would not use it in the form I received it. Therefore the text below has had some substantial editing in order to remove that language. The intentions of the writer are undisturbed. The writer shall remain anonymous. This text echoes some of the news items we have seen and heard today; however, it can serve as a plain language description of the present foreclosure-suspension mess. There is a lot here. It takes about ten minutes to read it. - David Kotok (www.cumber.com)
"Homeowners can only be foreclosed and evicted from their homes by the person or institution who actually has the loan paper...only the note-holder has legal standing to ask a court to foreclose and evict. Not the mortgage, the note, which is the actual IOU that people sign, promising to pay back the mortgage loan
"Before mortgage-backed securities, most mortgage loans were issued by the local savings & loan. So the note usually didn't go anywhere: it stayed in the offices of the S&L down the street.
"But once mortgage loan securitization happened, things got sloppy...they got sloppy by the very nature of mortgage-backed securities.
"The whole purpose of MBSs was for different investors to have their different risk appetites satiated with different bonds. Some bond customers wanted super-safe bonds with low returns, some others wanted riskier bonds with correspondingly higher rates of return.
"Therefore, as everyone knows, the loans were 'bundled' into REMICs (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then "sliced & diced"...split up and put into tranches, according to their likelihood of default, their interest rates, and other characteristics.
"This slicing and dicing created 'senior tranches,' where the loans would likely be paid in full, if the past history of mortgage loan statistics was to be believed. And it also created 'junior tranches,' where the loans might well default, again according to past history and statistics. (A whole range of tranches was created, of course, but for the purposes of this discussion we can ignore all those countless other variations.)
"These various tranches were sold to different investors, according to their risk appetite. That's why some of the MBS bonds were rated as safe as Treasury bonds, and others were rated by the ratings agencies as risky as junk bonds.
"But here's the key issue: When an MBS was first created, all the mortgages were pristine...none had defaulted yet, because they were all brand-new loans. Statistically, some would default and some others would be paid back in full...but which ones specifically would default? No one knew, of course. If I toss a coin 1,000 times, statistically, 500 tosses the coin will land heads...but what will the result be of, say, the 723rd toss? No one knows.
"Same with mortgages.
"So in fact, it wasn't that the riskier loans were in junior tranches and the safer ones were in senior tranches: rather, all the loans were in the REMIC, and if and when a mortgage in a given bundle of mortgages defaulted, the junior tranche holders would take the losses first, and the senior tranche holder last.
"But who were the owners of the junior-tranche bond and the senior-tranche bonds? Two different people. Therefore, the mortgage note was not actually signed over to the bond holder. In fact, it couldn't be signed over. Because, again, since no one knew which mortgage would default first, it was impossible to assign a specific mortgage to a specific bond.
"Therefore, how to make sure the safe mortgage loan stayed with the safe MBS tranche, and the risky and/or defaulting mortgage went to the riskier tranche?
"Enter stage right the famed MERS...the Mortgage Electronic Registration System.
"MERS was the repository of these digitized mortgage notes that the banks originated from the actual mortgage loans signed by homebuyers. MERS was jointly owned by Fannie Mae and Freddie Mac (yes, those two again ...I know, I know: like the chlamydia and the gonorrhea of the financial world...you cure 'em, but they just keep coming back).
"The purpose of MERS was to help in the securitization process. Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially where the digitized mortgage notes were sliced and diced and rearranged so as to create the mortgage-backed securities. Think of MERS as Dr. Frankenstein's operating table, where the beast got put together.
"However, legally...and this is the important part...MERS didn't hold any mortgage notes: the true owner of the mortgage notes should have been the REMICs.
"But the REMICs didn't own the notes either, because of a fluke of the ratings agencies: the REMICs had to be "bankruptcy remote," in order to get the precious ratings needed to peddle mortgage-backed Securities to institutional investors.
"So somewhere between the REMICs and MERS, the chain of title was broken.
"Now, what does 'broken chain of title' mean? Simple: when a homebuyer signs a mortgage, the key document is the note. As I said before, it's the actual IOU. In order for the mortgage note to be sold or transferred to someone else (and therefore turned into a mortgage-backed security), this document has to be physically endorsed to the next person. All of these signatures on the note are called the 'chain of title.'
"You can endorse the note as many times as you please...but you have to have a clear chain of title right on the actual note: I sold the note to Moe, who sold it to Larry, who sold it to Curly, and all our notarized signatures are actually, physically, on the note, one after the other.
"If for whatever reason any of these signatures is skipped, then the chain of title is said to be broken. Therefore, legally, the mortgage note is no longer valid. That is, the person who took out the mortgage loan to pay for the house no longer owes the loan, because he no longer knows whom to pay.
"To repeat: if the chain of title of the note is broken, then the borrower no longer owes any money on the loan.
"Read that last sentence again, please. Don't worry, I'll wait.
"You read it again? Good: Now you see the can of worms that's opening up.
"The broken chain of title might not have been an issue if there hadn't been an unusual number of foreclosures. Before the housing bubble collapse, the people who defaulted on their mortgages wouldn't have bothered to check to see that the paperwork was in order.
"But as everyone knows, following the housing collapse of 2007-'10-and-counting, there has been a boatload of foreclosures...and foreclosures on a lot of people who weren't sloppy bums who skipped out on their mortgage payments, but smart and cautious people who got squeezed by circumstances.
"These people started contesting their foreclosures and evictions, and so started looking into the chain-of-title issue, and that's when the paperwork became important. So the chain of title became crucial and the botched paperwork became a nontrivial issue.
"Now, the banks had hired 'foreclosure mills'...law firms that specialized in foreclosures...in order to handle the massive volume of foreclosures and evictions that occurred because of the housing crisis. The foreclosure mills, as one would expect, were the first to spot the broken chain of titles.
"Well, what do you know, it turns out that these foreclosure mills might have faked and falsified documentation, so as to fraudulently repair the chain-of-title issue, thereby 'proving' that the banks had judicial standing to foreclose on delinquent mortgages. These foreclosure mills might have even forged the loan note itself...
"Wait, why am I hedging? The foreclosure mills did actually, deliberately, and categorically fake and falsify documents, in order to expedite these foreclosures and evictions. Yves Smith at Naked Capitalism, who has been all over this story, put up a price list for this 'service' from a company called DocX...yes, a price list for forged documents. Talk about your one-stop shopping!
"So in other words, a massive fraud was carried out, with the inevitable innocent bystanders getting caught up in the fraud: the guy who got foreclosed and evicted from his home in Florida, even though he didn't actually have a mortgage, and in fact owned his house free -and clear. The family that was foreclosed and evicted, even though they had a perfect mortgage payment record. Et cetera, depressing et cetera.
"Now, the reason this all came to light is not because too many people were getting screwed by the banks or the government or someone with some power saw what was going on and decided to put a stop to it...that would have been nice, to see a shining knight in armor, riding on a white horse.
"But that's not how America works nowadays.
"No, alarm bells started going off when the title insurance companies started to refuse to insure the titles.
"In every sale, a title insurance company insures that the title is free -and clear ...that the prospective buyer is in fact buying a properly vetted house, with its title issues all in order. Title insurance companies stopped providing their service because...of course...they didn't want to expose themselves to the risk that the chain of title had been broken, and that the bank had illegally foreclosed on the previous owner.
"That's when things started getting interesting: that's when the attorneys general of various states started snooping around and making noises (elections are coming up, after all).
"The fact that Ally Financial (formerly GMAC), JP Morgan Chase, and now Bank of America have suspended foreclosures signals that this is a serious problem...obviously. Banks that size, with that much exposure to foreclosed properties, don't suspend foreclosures just because they're good corporate citizens who want to do the right thing, and who have all their paperwork in strict order...they're halting their foreclosures for a reason.
"The move by the United States Congress last week, to sneak by the Interstate Recognition of Notarizations Act? That was all the banking lobby. They wanted to shove down that law, so that their foreclosure mills' forged and fraudulent documents would not be scrutinized by out-of-state judges. (The spineless cowards in the Senate carried out their master's will by a voice vote...so that there would be no registry of who had voted for it, and therefore no accountability.)
"And President Obama's pocket veto of the measure? He had to veto it...if he'd signed it, there would have been political hell to pay, plus it would have been challenged almost immediately, and likely overturned as unconstitutional in short order. (But he didn't have the gumption to come right out and veto it...he pocket vetoed it.)
"As soon as the White House announced the pocket veto...the very next day!...Bank of America halted all foreclosures, nationwide.
"Why do you think that happened? Because the banks are in trouble...again. Over the same thing as last time...the damned mortgage-backed securities!
"The reason the banks are in the tank again is, if they've been foreclosing on people they didn't have the legal right to foreclose on, then those people have the right to get their houses back. And the people who bought those foreclosed houses from the bank might not actually own the houses they paid for.
"And it won't matter if a particular case...or even most cases...were on the up -and up: It won't matter if most of the foreclosures and evictions were truly due to the homeowner failing to pay his mortgage. The fraud committed by the foreclosure mills casts enough doubt that, now, all foreclosures come into question. Not only that, all mortgages come into question.
"People still haven't figured out what all this means. But I'll tell you: if enough mortgage-paying homeowners realize that they may be able to get out of their mortgage loans and keep their houses, scott-free? That's basically a license to halt payments right now, thank you. That's basically a license to tell the banks to take a hike.
"What are the banks going to do...try to foreclose and then evict you? Show me the paper, Mr. Banker, will be all you need to say.
"This is a major, major crisis. The Lehman bankruptcy could be a spring rain compared to this hurricane. And if this isn't handled right...and handled right quick, in the next couple of weeks at the outside...this crisis could also spell the end of the mortgage business altogether."