Wednesday, August 5, 2009

Don't Put Your Money on a U.S. Recovery; Bud Conrad on the Trouble the FDIC is Facing

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The Daily Reckoning
Wednesday, August 5, 2009

  • A real bull market would require an economic boom...
  • The 'Cash for Clunkers' scheme is certainly not unpopular...
  • You'll want to hedge your bets on this recovery...
  • Bud Conrad on why the FDIC is in Trouble...and more!

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    Don't Put Your Money on a US Recovery
    by Bill Bonner
    Ouzilly, France

    The future cometh...

    Cash for bankers! Cash for Detroit's clunkers! From one scam to the next...

    But first, let us turn to the latest market update.

    The Dow rose again yesterday - up 33 points, to close at 9,320. We set 10,000+ as our objective for this bounce. We'll stick with it for a while longer.

    Make no mistake though. No one knows how long this rally will last - certainly no one here at The Daily Reckoning vacation headquarters. It will continue until it runs out of gas. That could be tomorrow. It could be months from now.

    It will run out of gas sooner or later, and probably this fall. A real, durable bull market would require an economic boom - a genuine recovery. We don't see that happening...

    But people must think it is happening...

    "There are signs of a recovery in the US..." was a popular line at last night's cocktail party. Several friends mentioned it. Each time, we had the same reply - we wouldn't bet on it.

    Yesterday, the price of oil rose; it ended the day at $71. And the dollar stayed where it was - at $1.44 per euro. Investors are betting on recovery - despite our advice.

    And when the recovery turns out to be a clunker, they'll probably put these trades into reverse. Oil will go down; the dollar will go up.

    You want to speculate, dear reader? Sell the dollar. Wait for another crash this autumn.

    Why will there be another crash?

    Because people believe something that isn't true. People believe that there is a recovery...and that it is the result of stimulus efforts by the feds. The results from the second quarter show the economy still contracting...but at a slower pace, just -1% annually, rather than the -6.4% recorded in the first quarter. This is heralded throughout the world as proof that the crisis is receding.

    "It if weren't for stimulus spending, the contraction [in the 2nd quarter] would have been closer to 4%," says the editorial in the International Herald Tribune. "The stimulus is helping...and more stimulus would help even more."

    Oh? Would it? Let's look at stimulus-in-action:

    'Cash for Clunkers' is a hare-brained scheme...but that doesn't make it unpopular. The idea is to stimulate demand by, well, giving people money. But instead of just giving them money and letting them choose what to do with it, the feds decide they need a new car. In order to the get the money, people have to buy one.

    According to the press reports, the program has been a great success wherever it has been put in place - in France and Germany, as well as in the United States.

    If so, why not apply the concept elsewhere? How about cash for houses? Cash for liquor? Cash for newspapers? Cash for trips to Europe?

    [We all know none of those suggestions will ever really happen...but there is a way you can get your slice of the stimulus pie. A completely legal 'loophole' (that's been missed by millions of Americans) could be the key to your financial survival during this major downturn. Read all about it here.]

    What's so special about autos, in other words? And why is it a good thing for people to buy cars?

    Oh c'mon, dear reader...don't pretend you don't know. The auto industry is huge...with many lobbyists and many organized groups interested in its wellbeing. It is an old and well-established industry with plenty of political clout.

    Tomorrow's industries, by contrast, have no organized pet political action committees. So who gets the money?

    More news from The 5 Min. Forecast:

    "Now that the subprime, low income crowd has taken their lashings, there's a new Great Recession victim - the faux rich," reports Ian Mathias in today's issue of The 5.

    "Jumbo mortgages - home loans exceeding $417,000 - now have the fastest rising default rates of any mortgage class. According to recent data from First American Corelogic, 7.4% of these larger-than-life mortgages are currently in some form of default, nearly three times the rate at the start of 2008.

    "As you can see, when stocks tanked in late 2008, the market for super- sized mortgage loans followed suit:


    "Is there any reason for this trend to improve? The Obama administration has done plenty to help out their beloved middle class the $8,000 first time homebuyer credit, artificially low FHA mortgage rates and several mortgage modification programs. But those programs don't apply to jumbo loans. Even Fannie and Freddie, masters of mortgage speculation, will no longer stand behind jumbo mortgages.

    "And the market is blowing jumbo loans a stiff headwind, too. Mortgage rates are roughly 100 points higher for jumbos, and inventory - geesh - this is pretty remarkable:


    " accelerating rate of default, a government cold shoulder, higher than typical lending rates and a huge, growing glut of supply? Could get interesting."

    Ian writes every day for The 5 Min Forecast, an executive series e- letter that provides a quick and dirty analysis of daily economic and financial developments-in five minutes or less. It's a free service available only to subscribers of Agora Financial's paid publications, such as Resource Trader Alert. RTA's latest report details a 'no- brainer' trading strategy that will help you rake in some nice gains in a short period of time...without having to touch stocks. And if you act now, you can get in on these 'no-brainer' gains risk-free - and at a significant discount... But only until midnight tonight. See here.
    And back to Bill, with more thoughts:

    Here's the problem: the meddlers are not only up against tomorrow's industries...they're up against tomorrow itself. It's not as if Americans needed cars. Not at all. They've got plenty of wheels already. Three car households are typical. And they're fairly new cars. Americans were on a buying spree during the bubble era, 2001-2007; they bought new cars along with everything else.

    So, the goal of the 'Cash for Clunkers' scheme is not to increase the size of the US auto fleet, it's to make it newer. People don't need more cars. They only need to replace cars that get worn out. If they bought a car five years ago, they may be ready to buy another one. Or, they could probably wait until next year. Along come the feds with cash...and the buyer decides to replace his car this year rather than next.

    This is heralded as a success. The feds have stimulated demand. But what about next year?

    We'll have more to say about this on Friday...but the auto example helps us see what a scam these stimulus schemes really are. They claim to boost demand. But they can't really increase demand. All they can do is roll next year's buying into the present year.

    Sound familiar? That's the very thing that has been happening for the last two generations. Consumers didn't want to wait until they'd made the money to take their vacations or buy their houses. They turned to credit. They borrowed against future earnings. They spent money they hadn't earned yet...thus bringing forward purchases that should have been made in the future. That's why we have a depression; now, we're in the future!

    It had to come sooner or later. After drawing consumption forward for decades, Americans had to stop. Time had to catch-up. Homeowners had to pay down debt. Ken Rogoff, Harvard professor of economics, believes it will take them 6-8 years to do so.

    But consumers spent more than they could reasonably be expected to pay back. They out-spent the future! They bought a ticket to somewhere beyond the a place where they would never actually arrive. In many cases - especially in the housing market - lenders discovered they couldn't get their money back, which is what led to the credit crunch and the collapse of Wall Street. Of the big five - Bear, Lehman, Goldman, JPMorgan and Merrill - only two survived intact. And we know now that Goldman only survived because Henry Paulson, former CEO of Goldman, then Treasury Secretary, arranged a hidden bailout. He had the government step in to save AIG, which owed Goldman $13 billion.

    From one scam to another...that's the way the feds do it. From bailing out Wall Street they now turn to bailing out the entire world economy - in a similarly fraudulent way. Tim Geithner told the Chinese last week that the United States would revive thanks to increased private demand. But the feds cannot really increase demand in the private sector. Increasing real demand would mean increasing real wages. And there's no sign of that. To the contrary, incomes are going down.

    Yesterday's news tells us that personal incomes went down 1.3% in June. Incomes had gone up in May, by precisely the same amount - 1.3%, thanks to stimulus payments. Then, too, commentators saw it as a sign of recovery. But what the feds gave in May was taken away in June. The future caught up with the Obama administration's stimulus efforts within 30 days. Net result = zero.

    The June number reflected the biggest drop in income in four years. It is not surprising. We're in a depression, remember? Salaries and wages fell 0.4% in June...the 9th drop in the last 10 months.

    [It's clear that the government isn't going to 'bail out' those who are funding these stimulus packages: the American taxpayers. That's why we've made all the resources necessary for your own 'personal bailout' easily accessible to you...find them here.]

    "It looks like there are finally some signs of recovery in the US," said more than one person we talked to last night.

    The occasion was a cocktail party...held on the grounds of a stately chateau. The summer social season is underway in Poitou. We are attending dinners, plays, cocktail receptions, barbecues and weddings.

    Last night, waiters in tuxedos passed out champagne, foie gras canap├ęs, and desserts while hundreds of guests milled about and talked.

    "You might want to hedge your bets on this recovery," we told one Daily Reckoning reader. "It's probably not going to work out."

    "But I'm confused about something," he continued. "You've been urging me to buy gold for years. And now you seem to be changing your mind."

    " at all. I'm still a gold bug. It's just that I expect this rebound to end...and for stocks to go down, possibly down a lot. The dollar is what people want when they are frightened. The dollar is going down now because they think there's no longer anything to be frightened about. But when this recovery disappoints them, investors are going to be more frightened than ever. Because they'll realize that we're faced with a depression...and that the feds can't do anything about it. They're going to rush to the safety of least for a while. Probably long enough to shake out a lot of gold buyers."

    Until tomorrow,

    Bill Bonner
    The Daily Reckoning

    P.S. As we point out in our recently updated book, Financial Reckoning Day Fallout: Surviving Todays Global Depression, written with Addison Wiggin, we are still sticking with our Trade of the Decade - after all, the decade isn't over yet. You can get your copy of this newly updated book by clicking here.

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    The Daily Reckoning PRESENTS: It's no secret that the FDIC is hurting - how could they not be with 64 banks going belly-up since the beginning of 2009? Casey Research's Bud Conrad looks at the trouble the FDIC is facing and what steps they are taking to batten down the hatches against future crises. Read on...

    The FDIC Is in Trouble
    by Bud Conrad
    Los Altos, California

    As we all know, the Federal Deposit Insurance Corporation (FDIC) guarantees depositors that they'll get their money back if a bank fails, at least up to a certain amount. To fund its operations, the FDIC collects small fees from the banks that are held in reserve for the purpose of taking over troubled banks and paying off depositors.

    Since the Great Depression, a period marked by widespread runs on banks, the FDIC has done a good job of fulfilling its mandate. So how are they doing in this crisis?
    "...using any reasonable accounting method, the FDIC is already bankrupt and will require hundreds of billions of dollars in government bailouts just to keep the doors open."

    In a nutshell, they are in trouble.

    The FDIC insures 8,246 institutions, with $13.5 trillion in assets. Not all of them are going bankrupt, of course. Yet as of late July, a disturbing 64 banks had gone belly up this year - the most since 1992 - costing the FDIC $12.5 billion. At the end of Q1, the agency was already asking for emergency funding.

    And worse, much worse, is likely yet to come. The following chart shows the total assets on the books of the FDIC's list of 305 troubled banks. The list doesn't include the biggest banks that are considered too big to fail, as they are being separately supported with bailouts. By contrast, if the banks on this list fail, the FDIC is on the hook to have to step in and take them over and, of course, make depositors whole.


    Other measures of how serious the losses at banks are becoming can be seen in the chart below, which shows charge-offs and non-current loans at all banks. You can see that the Net Charge-offs remain stubbornly high, with banks charging off almost $40 billion in bad loans in the last two quarters alone. And the number of non-current loans - loans where payments are not being kept up - is soaring.

    Together, these measures indicate the potential for more big failures and more big bailouts coming down the pike.


    Into the battle against bank insolvency the Fed brings a level of reserves that can best be described as paper-thin. From almost $60 billion last fall, the FDIC's reserves have been drawn down to only about $13 billion today, a 16-year low. A quick look at the FDIC's own data shows us how inadequate those reserves are compared to the deposits they are now insuring.

    The chart below says it all:


    As you can see, the Federal Deposit Insurance Corporation currently covers each dollar on deposit with a trivial 2/10ths of a penny.

    And even that understates the seriousness of the situation: the $4.8 trillion in deposits the FDIC is providing coverage on doesn't include the expansion that now extends insurance coverage from $100,000 to $250,000 for normal bank accounts. That likely brings the exposure of the FDIC closer to $6 trillion. But that's pretty inconsequential at this point: using any reasonable accounting method, the FDIC is already bankrupt and will require hundreds of billions of dollars in government bailouts just to keep the doors open.

    So, given the dire shape of its finances, what measures is the FDIC taking, you know, to batten down the hatches and all that?

    For starters, they are expanding their mandate by guaranteeing bank loans - $350 billion and counting at this point. And the government has tapped the FDIC to play a pivotal role in guaranteeing the loans issued to buy toxic waste through the government's highly problematic and fraud-prone new Private Public Investment Partnership (PPIP). The FDIC's commitment to the PPIP is and may become limited based on its resources.

    It is hard to draw any other conclusion but that hundreds of billions in new funding will be required to keep the FDIC operating. Given the catastrophic consequences of the FDIC failing, starting with a bank run of biblical proportions, there's no question it will get whatever funding it needs. By loading the new loan guarantee responsibilities and the PPIP onto the FDIC's back, the administration will go back to Congress and ask for the next large bailout.

    Of course, in the end, all of this falls on the taxpayer, either directly in the form of more taxes or indirectly via the destruction of the dollar's purchasing power. Another bale of straw on the camel's back, and another reason to be concerned about holding paper dollars for the long term.


    Bud Conrad
    for The Daily Reckoning

    P.S. If you still trust the government to take care of you and yours when the you-know-what hits the fan, you're on the path to financial disaster. But even in times of crisis, there are things you can do to protect yourself - for example, by betting against the insane machinations of the government and Fed. You can't make them stop, but at least you can profit from them. Read about my favorite investment of clicking here.

    Editor's Note: Mr. Conrad holds a Bachelor of Engineering degree from Yale and an MBA from Harvard. He has held positions with IBM, CDC, Amdahl, and Tandem. Currently, he serves as a local board member of the National Association of Business Economics and teaches graduate courses in investing at Golden Gate University. Bud Conrad, a futures investor for 25 years and a full-time investor for a decade, is also a regular lecturer for American Association of Individual Investors. In addition he produces original analysis for Casey Research, including unique charts and research on the economy and investment markets.

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