The equity market rally has gained steam over the last few weeks not because of the much discussed possible economic recovery but because of the falling US$. As the US$ sinks to new lows cash in short term instruments is forced to seek refuge. Gold and silver are obvious choices for shelter, but these markets are tiny compared to the amount of US$ looking for cover and so the entire equity market structure is enjoying the massive flow of funds.

In fact, the market capitalization of the entire precious metals mining group is only about $225 billion compared to over $3 trillion in U.S. money markets. Can you see why we have made precious metals and the mining companies a major focus of the Fortune’s Favor Family of Funds?

But I digress, an increase in foreclosures will force the Fed to continue the easy credit solution. Monetization of U.S. treasuries will continue, world demand for a new reserve currency will get even louder and as a result the US$ will continue to decline in value forcing cash into assets that will outstrip the ever increasing inflation. “Here endeth the lesson.” (Another movie quote! “Somebody stop me!” I did it again!?!? The Jaime Lee Curtis quote from Wednesday’s post was courtesy of the movie A Fish Called Wanda.)

“Option” mortgages to explode, officials warn - Reuters.com
Reuters.com reports the federal government and states are girding themselves for the next foreclosure crisis in the country’s housing downturn: payment option adjustable rate mortgages that are beginning to reset. “Payment option ARMs are about to explode,” Iowa Attorney General Tom Miller said after a Thursday meeting with members of President Barack Obama’s administration to discuss ways to combat mortgage scams. “That’s the next round of potential foreclosures in our country,” he said… Because the new monthly payments can be five or 10 times what borrowers are accustomed to paying, they “threaten a much greater hit to the consumer than the subprimes,” Goddard said, referring to the mortgages often extended to less credit-worthy borrowers that fed the first wave of the financial crisis… The mortgages tend to be “jumbo,” or for significantly large amounts, Goddard said, making it even harder for borrowers to sidestep foreclosure. He said he expected to see an increase in scams as distressed homeowners become more desperate to refinance big debts.

Does the following story mean the U.S. Treasury is in effect stealing the premiums asset managers have paid for money market insurance? I would welcome any thoughts on this matter.

U.S. Treasury to keep $1.2 billion money fund premiums - Reuters.com
Reuters.com reports the U.S. federal government will keep about $1.2 billion in payments collected to backstop money market funds even after its insurance program ends on Friday, a U.S. Treasury official said. The money “will stay with the Treasury,” the official told Reuters on Thursday, speaking on condition of anonymity because the decision has not been officially announced. The payments, from asset managers, were essentially insurance premiums used to fund guarantees the Treasury put in place a year ago to prop up the $3.5 trillion money market fund industry.

Is the development in the story below the coup de gras for Goldman Sachs? Last year the broker was forced to become a bank to gain access to Fed handouts. Now it seems there is an attack building on the very core of Goldman’s earning power.

Volcker calls for restricting banks’ risk, trading activity – WSJ
WSJ reports former Federal Reserve Chairman Paul Volcker on Wednesday said banks should operate in a much less risky fashion, including not making trading bets with their own capital, comments that could provoke intensified debates over the future of financial regulation.

Mr. Volcker, who currently is chairman of the White House’s Economic Recovery Advisory Board, suggested banks should be restricted to trading on their client’s behalf instead of making bets with their own money through internal units that often act like hedge funds. “Extensive participation in the impersonal, transaction-oriented capital market does not seem to me an intrinsic part of commercial banking,” he said in a speech to the Association for Corporate Growth in Los Angeles.

Will the discussion about a new reserve currency continue to pick up steam? If so, the recent slide in the US$ could become a little steeper and in turn the Gold rally above $1,000 a little more secure.

September 30th:

“Sept. 30th is the fiscal year end for the U.S. Treasury. It is also the date when ALL banks across the globe must become Basel II and Basel III compliant.” Bill H. GATA The rules state banks that are not compliant will be restricted from trading with compliant banks. Due to the massive “off balance sheet” derivative exposure that U.S. banks have Basel III compliance will be problematic. Will this development create renewed weakness in the US banking system? We will need to monitor credit spreads closely in the coming weeks for clues of any Basel impact.

Tags: basel, g20, gold, obama, option arms, precious metals, silver, subprime, US Treasury, US$, volcker

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Cerberus denies talk of fund defaults – Reuters
Reuters reports Cerberus Capital Management yesterday dismissed market speculation that some of its hedge funds, which have suffered losses and heavy redemptions, are in danger of default. Traders in London and Frankfurt were buzzing with talk that a major hedge fund was headed for default. Much of the talk was directed at Cerberus, a private-equity and hedge-fund firm hit hard by losses at Chrysler and GMAC. “There is absolutely no truth to the speculation,” said Tim Price, a Cerberus spokesman.

Where have we heard this type of denial before? Oh yes, I remember, last year with Bear Stearns and Lehman denials to name just a few. We better keep an eye on this story. We learned last year that big hedge fund failures can lead to big problems for the equity markets.

Weak back-to-school sales spell trouble for holidays - WSJ
WSJ reports shoppers are focusing on deals and limiting buying mainly to necessities, based on August sales estimates that herald another tough holiday season for beleaguered retailers. Despite sales tax holidays in several states designed to spur sales, back-to-school spending remains lackluster, according to industry experts.

Retailers’ recent efforts to shake customers from deep discounts and spur buying by tightly controlling inventories are fizzling. Now, retailers that traditionally rely on back-to-school sales as an barometer of demand for the remainder of the year face tough choices on stocking and hiring. Customers should find ever slimmer pickings and fewer clerks (this doesn’t bode well for those thinking unemployment is close to the peak) as stores hold off on early holiday orders and further trim costs…

We have seen an equity market recovery in the first half of this year based on a return to normalcy in the credit markets. Going forward, a new catalyst will need to develop to push the equity markets higher. One such catalyst will be an economic recovery and in turn better earnings in Q3 and Q4. However, stories like the one above cast a pall over a possible economic recovery and raise the question: Can the equity markets continue to move higher if positive earnings momentum does not materialize?

The following two stories add to the shroud being drawn over any possible recovery in Q3 and Q4…

FDIC’s Bair says commercial loans “looming problem” - Reuters.com
Reuters.com reports the chairman of the FDIC said commercial real estate issues will increasingly drive U.S. bank failures. FDIC head Sheila Bair told CNBC Tuesday evening that commercial real estate loans remain a “looming problem” for banks’ balance sheets and she expects the area to increasingly be a driver for bank failures during the remainder of this year and 2010.

Bair said she would try to avoid tapping its line of credit with the Treasury Department. “We’d like to try to avoid that,” Bair told CNBC in an interview… Bair said the FDIC has not yet decided whether to charge the bank industry more special assessments to replenish the fund. She defended the loss-share agreements that the FDIC has extended to acquirers of failed banks, saying the arrangements have saved the agency billions of dollars over the past two years.

Pace of delinquencies for prime borrowers is accelerating – WSJ.com
WSJ.com reports the long recession and rising joblessness are taking an increasing toll on the nation’s most credit-worthy borrowers, who are now falling behind on their mortgage and credit-card payments at a faster pace than people with poor financial histories.

The mortgage-delinquency rate among so-called subprime borrowers reached 25% in the first quarter but appears to be leveling off, rising only slightly in the second quarter. The pace of delinquencies for prime borrowers is accelerating. Since prime loans account for 80% of U.S. bank exposure to mortgages and credit cards, these losses could ultimately exceed those from weaker borrowers. Such delinquencies on mortgages made to prime customers rose 5.8% in the second quarter, compared with a rise of 1.8% among subprime customers. Still, the delinquency rate for prime loans was 6.4%, far below the 25.4% rate for subprime loans, according to the Washington-based trade group.

Periodically I will post the EPS news or other relevant coverage of companies we find interesting. This is not a recommendation to purchase or sell the shares. I will not engage in the hackneyed approach of other bloggers and give advice about when to buy or sell. The purpose of these posts is to give you, the reader, an idea of what companies our research department deems worthy of review.

Tags: back-to-school, blair, cerberus, CNBC, defaults, FDIC, july retail sales, prime borrowers, subprime, treasury department, virtualization, VMW, VMware

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RCM Comment: I am loath to bore you with the same story over and over but the story’s far reaching ramifications demand that we cover this story like the wet blanket it represents. You see, there is a fire raging in the U.S.. Our government is burning paper (US$s) at an alarming clip as it spends aggressively to avoid the inevitable. Let’s not debate the simple fact that government spending plans have never in history helped drag an economy out of a recession. Even the oft-praised New Deal of the ’30s didn’t save the country from the depression; WWII accomplished that feat.

So, paper is burning and the only way to get more paper, short of ‘cooking the books’, is to issue Gov’t debt and hope our trading partners continue to fund our addiction. Enter the wet blanket. The cry to dethrone the US$ as the reserve currency is building and now Japan in an ‘et tu Brute’ moment adds its voice to the majority….

July 13 (Bloomberg) — Japan’s opposition party, leading in polls ahead of next month’s election, said the nation should consider shifting its $1 trillion of foreign reserves away from the dollar and buying International Monetary Fund bonds. “In the medium to long term, we need to do what we can to avoid the risk of currency losses or economic turbulence that could result if the dollar were to swing,” Masaharu Nakagawa, the shadow finance minister in the Democratic Party of Japan, said in an interview in Tokyo on July 9. “Many countries are starting to diversify their reserves.” Read more…

RCM Comment: Troubles continue to brew in the real estate arena and by extension the banking sector. The EPS announcements over the next few weeks should be very interesting. Question: Will creative accounting be condemned as it should or will it continue to be ignored as has been the case?
NEW YORK (Dow Jones)–For the third straight month, option adjustable-rate mortgages are generating proportionally more delinquencies and foreclosures than subprime mortgages, the scourge of the housing crisis. A further acceleration of troubles among the loans could mean higher-than-expected losses for Wells Fargo & Co. (WFC) and JPMorgan Chase & Co. (JPM), as well as the Federal Deposit Insurance Corp.’s own insurance fund. “The realization of the issues related to option ARMs is just beginning,” says Chris Marinac, director of research at Atlanta-based FIG Partners.

Example of creative accounting: WaMu by Karl Denninger

“In March of 2006, Washington Mutual recorded net income of $985 million dollars. 4Q06 they booked $1,058 mln. This last quarter, they booked $784mln. But in those three quarters they booked $194mln, $333mln and $361 million, respectively, in PayOption ARM “Capitalized Interest.” This was booked and recognized as EARNINGS.

Now here’s the problem: In 1Q 06, 194 million out of $985 is 19.7%. In December, it was 31%. But this last quarter, it was FORTY SIX PERCENT, more than a DOUBLE over the year ago levels. And what’s worse, not one dime of that “income” can be spent! It is entirely phantom. This is the same sort of crap that sunk Lucent and Enron – booking “income” that is not in fact spendable, as it has an impairment associated with it (the LTV is INCREASED by this negative amortization) AND it is not CASH!”

RCM Comment: This story does not bode well for emerging market investments…
MT Russia region threatens to seize ArcelorMittal mines – Reuters (29.87 )
Reuters reports Russia’s Kemerovo region has notified ArcelorMittal (MT) that it will seize two of the world’s largest steel maker’s mines if production levels do not increase, a statement from the Siberian region said. “If your team is not able to stabilize production at these facilities, then we propose that you hand them over without compensation,” Kemerovo governor Aman Tuleyev said in a telegram addressed to the multinational’s chief executive, Lakshmi Mittal, and cited in the statement on the Kemerovo website. Reuters has been unable to reach ArcelorMittal’s Siberian operations for immediate comment on the telegram. ArcelorMittal acquired three Siberian coal mines from Russia’s Severstal in 2008, becoming one of the few foreign companies to enter the market.

Tags: ArcelorMittal, delinquencies, foreclosures, Japan, option adjustable-rate mortgages, Russia, subprime, U.S. Dollar

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- If you don’t read the newspaper you are uninformed, if you do read the newspaper you are misinformed. –Mark Twain

I’m sorry did I just write something? I must have been dreaming. Tax breaks would help everyone equally and this would never do for those controlling Washington. Government handouts, in the form of “stimulus”, can be directed at special interest groups and those who donate to political campaigns. Did you really believe Obama’s campaign promise to rid Washington of lobbyists and special interests? If, so then you must go directly to jail without passing go or collecting $200. Your punishment for naivete: stay in jail until the Community Chest gets around to authorizing a “get out of jail free” card. This authorization should take about as long as it takes for the stimulus package to actually stimulate. My advice: bring a good book. Something written by Thomas Sowell perhaps such as “The Housing Boom and Bust”.

Stalled stimulus programs deter investments in renewable energy - WSJ
WSJ reports the U.S. government stimulus package passed in February promised to reinvigorate the renewable-energy industry with new capital and programs, but the prospect of large flows of government money to the industry is holding up private-sector investment. New incentive programs haven’t yet been defined, and uncertainty about program rules has deterred investors from backing companies that also may get government money. At the same time, companies are holding off from accepting private capital because of the possibility of getting it more cheaply from the government. “It artificially slowed the recovery,” Matt Cheney, chief executive of Renewable Ventures, the U.S. subsidiary of Fotowatio SL, a Spanish developer of renewable-energy projects, said of the stimulus plan.

Reality vs. “Green Shoot” Redux…Combine this story with the commercial real estate story from the 7/8 post and you get a good idea of the real headwinds facing economic recovery.

Subprime resurfaces as housing-market woe – WSJ
WSJ reports the U.S. housing market is facing new downward pressure as holders of subprime-mortgage bonds flood the market with foreclosed homes at prices that are much lower than where many banks are willing to sell. While nationwide figures are scarce, a review of thousands of foreclosures in the Atlanta area shows that trusts managing pools of securitized mortgages sold six times as many properties as banks during the six months ended March 31. And homes dumped by subprime bondholders sold for thousands of dollars less on average than bank-owned properties, the data show.

Experts say this is a bad omen for residential real-estate prices and homeowners trying to sell or refinance, because the fire sales, many to cover soured subprime loans, put downward pressure on the value of nearby homes. All of this undermines federal efforts to stabilize the housing market and revive the broader economy. “While the banks are trying frantically to get loans off their books, they face the problem of large shadow inventories of housing being dumped on the market, which would depress prices further,” said Anthony Sanders, real-estate finance professor at George Mason University in Fairfax, Va.

RCM Comment: I continue to run these stories about the US$ because you must appreciate that change is coming and protect your assets accordingly. Should you need help devising a plan may I suggest you visit our website. I will also entertain any and all questions as promptly as possible whether they are received via blog comments, email or phone.

China attacks dollar’s dominance - Financial Times
Financial Times reports China has launched its highest-profile criticism of the dominant role of the US dollar as a global reserve currency at a meeting of the world’s biggest economies. Dai Bingguo, Chinese state counselor, raised the issue on Thursday when he joined the leaders of four other emerging economies for talks with the leaders of the Group of Eight industrialized nations — including US President Barack Obama — in L’Aquila. The remarks, in front of Mr Obama, caused concern among western leaders, some of whom fear that even discussion of long-term currency issues could unsettle markets and undercut economic recovery.

Gordon Brown, Britain’s prime minister, said he did not remember Mr Dai making the remarks. But he said the focus should be on moving the world out of recession. “We don’t want to give the impression that big change is around the corner and the present arrangements will be destabilized,” said Mr Brown. (In other words, Gordon would rather lie about the situation than give an honest impression.)

“We should have a better system for reserve currency issuance and regulation, so that we can maintain relative stability of major reserve currencies exchange rates and promote a diversified and rational international reserve currency system,” said Mr Dai, according to the Chinese foreign ministry. While he did not name the dollar, Mr Dai was unequivocal in calling for the world to diversify the reserve currency system and aim at relatively stable exchange rates among leading currencies.

Tags: ACORN, China, dollar dominance, housing boom and bust, housing market, mark twain, renewable energy, Stimulus spending, subprime, thomas sowell

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