The Destroyer of Finance

 ”Full a piss an’ vinegar,” said Grampa.

“And I cast out the demons…”

Dear Santa,

     When I die, please make me come back to life as, like, a prehistoric giant frog with a big mouth and teeth and stuff, so that I can, like, eat dinosaurs?  I’ve been a really good boy, I promise, and I didn’t throw stuff at the neighbor’s cat, and I won’t do it again neither.  And Obama told be to believe in hope and change for America, and America’s about getting what you want, so Obama says you should give me this.  I think that’s what he said, but I passed out right about then.

Thanks Santa,

Sam

Seriously, can we get a handle on the passing out at Obama rallies?  We’re not going to see a televangelist “healer,” we’re going to see a politician.  I don’t think that the fainting thing is a campaign plant, because the risk of backlash is too high.  I do think that it has turned into a bit, though, with people at the rallies wanting the attention it draws.  Just like the people who cast “feign death” on themselves while listening to a televangelist.  Rally in Dallas today?  I figure up to 6 people might “start feeling faint” or something before the others who were going to try it realize that it’s getting overdone.

“It don’t take no nerve to do somepin when there ain’t nothin’ else you can do.”

Primarily speaking…

Obama wins in Wisconsinin and Hawaii by somewhat noticeable margins, adding to his delegate lead.  Depending on the poll source, recently Clinton has shown a lead in Texas of anywhere from 2 to 16 percentage points over Obama.  Her leads in Ohio are more consistent, and if she can win a majority of delegates from both Texas and Ohio, Clinton would throw it back into a virtual tie for pledged delegates, almost certainly ensuring a fractured and high tension national convention.

McCain might be able to super officially lock up the GOP nomination with a big enough margin in Ohio and Texas.

“She ain’t breathin’ at all. She’s awful dead.”

How is the US like South Africa?

No, it has nothing to do with AIDS or demographics.  It has to do with electrical generation.  It’s been well exposed recently that South Africa has a dire shortage of electrical power, crippling it’s economy.  Now similar warnings are being made in the US.  Quite simply, the US cannot afford to do to coal power what it has done to nuclear power for the last 30 years (re-shun).  As much as some would like to believe that we can cover our incremental power needs with natural gas generators, it’s not going to happen.  Natural gas is used for a variety of things in the first place (not just power generation, which is nearly the only thing that coal is used for), so additional demand will have a greater price effect on other aspects of life that just more expensive power.

 Further, it ought to be telling that the only people who are proposing to rely on natgas generation are people not in the generation business.  Natural Gas generation is great for “peaking” power supply, like 3PM on a hot summer day when your “baseline” generators are getting maxed out.  Later, when power demand drops, you can take the gas generators offline.  Why?  Because natural gas generation is expensive, and it only makes economic sense when you know you really need the power, and because natural gas generators can be brought on and off line quickly.  It takes days to bring a coal or nuclear generator online, and hours at least to safely shut them down, and coal and nuclear are both cheap to operate so you can just leave them on 24/7.  Electrical generators have gone bankrupt trying to run solely on natural gas, and that was a few years ago when gas was about 50% as expensive.

 So, we’re faced with a need for continued power growth, much like South Africa was a decade ago.  A steady, reliable power source is just as important to a modern economy as roads, and if we might forget this, again South Africa helps remind us.  Unfortunately, we’re also faced with a need to restrain carbon emissions.  There are experimental technologies out there, like the IGCC coal plant that was going to be built in Illinois.  It runs on coal, and theoretically emits no carbon into the air (it sequesters it deep in an underground rock formation).  Unfortunately, the government bailed on the project, so it’s status is in limbo.  It’s possible that it will get done anyway, but it’s an expensive project without certain results.  A resurgence of nuclear power would really help this situation, but too many people still have mental blocks where that topic is concerned.

 Ultimately, I think we’ll just have to face paying more for electricity, both for new natural gas generation and to pay for whatever carbon tax the utilities are faced with because of their coal plants.  Still a better option than being South Africa and suddenly finding yourself in the dark.

And the failure hangs over the State like a great sorrow.

Ask the Devil Toad: What do Vale mean?

Companhia Vale do Rio Doce, aka Vale, aka RIO [and I mean all caps, since there is also Rio Tinto, another mining company] is a really

really

really big Brazilian mining company.  And, they do other stuff.  On any given day they are valued by the markets as being worth $160-190 Billion, which is not chump change, and does not suck.  In addition to being the world’s largest supplier of iron ore to the steel industry, they also mine a number of other minerals including copper, platinum, and some gold, and produce a variety of chemicals, sometimes as a by-product of mining, other times with materials they mine, that are used in many different industries, but notably for fertilizer.

 The question that Devil Toad ponders is: do they be value?  Fundamentally, the answer is yes.  Their P/E ratio is reasonable and lower than that of their peers, as is their level of debt, and their price/book value ratio.  Another ratio that is good to consider is the PEG ratio, which is PE / Growth (expected).  This takes the PE ratio and divides is by the expected growth in earnings over X time frame (in yahoo’s case, 5 years).  A 15 PE might seem to be a better value than a 25 PE, but if the 15 PE is expecting 5% growth (a PEG of 3), and the 25 PE company is expecting growth of  30% (a PEG of .83), then maybe things look different.  RIO’s PEG is well less than 1, which means that very solid growth is expected.

 So what are the downsides?  RIO is obviously heavily dependent on commodity prices.  If the price of steel goes down, the price of iron goes down, and takes a good chunk of profits with it.  Not only are commodity prices even less predictable that stock prices, most commodities are very sensitive to the global economy.  Global recession = no construction.  No construction = no need for large amounts of steel.  Or copper.  RIO does temper this by producing a wide array of commodities, and is probably making tons of money on its fertilizer business while everyone focuses on it’s iron activities.

mmmm, Carnival…

 The other downside is that it’s a brazilian company.  While many are in love with the BRIC countries (Brazil, Russia, India, China), they all are wrought it mortal political peril.  In Brazil’s case, despite hot women, Carnival, and a voracious appetite for anal sex, their track record with business is…eh, poor.  It IS a South America nation, and almost by definition prone to bouts of economic populism.  Its recent track record is good, however, and the economy as a whole looks positive.

 So, if you think the external factors (commodity prices, global demand, political risks) are reasonable risks, the the fundamental factors of RIO pose no barriers.  It’s not an exciting investment, but it looks like it could do well in the next few years.

A fella builds his own sins right up from the groun’.

For a sobering closing thought, some more FT via yahoo:

By Martin WolfTue Feb 19, 1:25 PM ET

“I would tell audiences that we were facing not a bubble but a froth – lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy.” Alan Greenspan, The Age of Turbulence.

That used to be Mr Greenspan’s view of the US housing bubble. He was wrong, alas. So how bad might this downturn get? To answer this question we should ask a true bear. My favourite one is Nouriel Roubini of New York University’s Stern School of Business, founder of RGE monitor.

Recently, Professor Roubini’s scenarios have been dire enough to make the flesh creep. But his thinking deserves to be taken seriously. He first predicted a US recession in July 2006*. At that time, his view was extremely controversial. It is so no longer. Now he states that there is “a rising probability of a ‘catastrophic’ financial and economic outcome”**. The characteristics of this scenario are, he argues: “A vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe.”

Prof Roubini is even fonder of lists than I am. Here are his 12 – yes, 12 – steps to financial disaster.

Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000bn and $6,000bn in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.

Step two would be further losses, beyond the $250bn-$300bn now estimated, for subprime mortgages. About 60 per cent of all mortgage origination between 2005 and 2007 had “reckless or toxic features”, argues Prof Roubini. Goldman Sachs estimates mortgage losses at $400bn. But if home prices fell by more than 20 per cent, losses would be bigger. That would further impair the banks’ ability to offer credit.

Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The “credit crunch” would then spread from mortgages to a wide range of consumer credit.

Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150bn writedown of asset-backed securities would then ensue.

Step five would be the meltdown of the commercial property market, while step six would be bankruptcy of a large regional or national bank.

Step seven would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.

Step eight would be a wave of corporate defaults. On average, US companies are in decent shape, but a “fat tail” of companies has low profitability and heavy debt. Such defaults would spread losses in “credit default swaps”, which insure such debt. The losses could be $250bn. Some insurers might go bankrupt.

Step nine would be a meltdown in the “shadow financial system”. Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.

Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.

Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.

Step 12 would be “a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices”.

These, then, are 12 steps to meltdown. In all, argues Prof Roubini: “Total losses in the financial system will add up to more than $1,000bn and the economic recession will become deeper more protracted and severe.” This, he suggests, is the “nightmare scenario” keeping Ben Bernanke and colleagues at the US Federal Reserve awake. It explains why, having failed to appreciate the dangers for so long, the Fed has lowered rates by 200 basis points this year. This is insurance against a financial meltdown.

Is this kind of scenario at least plausible? It is. Furthermore, we can be confident that it would, if it came to pass, end all stories about “decoupling”. If it lasts six quarters, as Prof Roubini warns, offsetting policy action in the rest of the world would be too little, too late.

Can the Fed head this danger off? In a subsequent piece, Prof Roubini gives eight reasons why it cannot***. (He really loves lists!) These are, in brief: US monetary easing is constrained by risks to the dollar and inflation; aggressive easing deals only with illiquidity, not insolvency; the monoline insurers will lose their credit ratings, with dire consequences; overall losses will be too large for sovereign wealth funds to deal with; public intervention is too small to stabilise housing losses; the Fed cannot address the problems of the shadow financial system; regulators cannot find a good middle way between transparency over losses and regulatory forbearance, both of which are needed; and, finally, the transactions-oriented financial system is itself in deep crisis.

The risks are indeed high and the ability of the authorities to deal with them more limited than most people hope. This is not to suggest that there are no ways out. Unfortunately, they are poisonous ones. In the last resort, governments resolve financial crises. This is an iron law. Rescues can occur via overt government assumption of bad debt, inflation, or both. Japan chose the first, much to the distaste of its ministry of finance. But Japan is a creditor country whose savers have complete confidence in the solvency of their government. The US, however, is a debtor. It must keep the trust of foreigners. Should it fail to do so, the inflationary solution becomes probable. This is quite enough to explain why gold costs $920 an ounce.

The connection between the bursting of the housing bubble and the fragility of the financial system has created huge dangers, for the US and the rest of the world. The US public sector is now coming to the rescue, led by the Fed. In the end, they will succeed. But the journey is likely to be wretchedly uncomfortable.

*A Coming Recession in the US Economy? July 17 2006, www.rgemonitor.com; **The Rising Risk of a Systemic Financial Meltdown, February 5 2008; ***Can the Fed and Policy Makers Avoid a Systemic Financial Meltdown? Most Likely Not, February 8 2008

 If you think this is what’s going to happen, RIO probably isn’t so good for you.  Depressed yet?

Good, let’s follow up the roundhouse boot the the face with a Chuck Norris bearded grin and some inflation news:

The core consumer price index, which excludes volatile energy and food prices, rose 0.3 per cent in January, after rising by 0.2 per cent in every month since March of last year, according to figures from the Labor Bureau. Economists had been expecting another reading of 0.2 per cent.

The rise in inflation was driven by higher prices on clothing, medical and education costs, and by a jump in hotel costs.

“The Fed will be disappointed by the lack of significant progress on the consumer price inflation front in 2008 despite a tepid economy,” said Stephen Stanley, chief economist at RBS Greenwich Capital in a note.

“Just imagine Chairman [Ben] Bernanke standing in the middle of his office, closing his eyes, clicking the heels of his ruby loafers together three times, and chanting ‘there’s no core inflation, there’s no core inflation, there’s no core inflation,’” added Mr Stanley.

Including energy and food costs, the CPI rose by 0.4 per cent for the second month in a row. Food costs were up by 0.7 per cent, the sharpest increase in a year.

 Hmm!  Imagine that.

No funeral,

Tom Joad