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oftwominds-Charles Hugh Smith: After Seven Lean Years, Part 2: US Commercial Real Estate: The Present Position and Future Prospects
The fundamentals of demographics, stagnant household income and an overbuilt retail sector eroded by eCommerce support only one conclusion: commercial real estate in the U.S. will implode as retail sales and profits weaken.
© 2014 Real Capital Analytics, Inc. All rights reserved. Source: Real Capital Analytics and Moody’s Investors Service. http://www.rcanalytics.com Used by permission.
These three graphs of relative prices show that in CRE the “core” is doing better than the “periphery”. The gap in relative price performance of major metro CRE over smaller cities and towns has approximately doubled from where it was in 2008.
And as with residential real estate, some CRE sub-sectors and cities are obtaining far greater benefit from bailout, stimulus and quantitative easing programs than other areas:
© 2014 Real Capital Analytics, Inc. All rights reserved. Source: Real Capital Analytics and Moody’s Investors Service. http://www.rcanalytics.com Used by permission.
Commercial real estate has a more complex structure than residential real estate. There is greater specialization in function. For instance strip shopping centers and indoor malls are generally not exchangeable with warehouse facilities.
We can simplify this a bit by classifying CRE by consumer sector and function. Industrial real estate will not be considered in detail. Current industrial construction spending is near a record high. But the value of current industrial CRE can still be depressed due to existing plant obsolescence and rapid shifts in activity location.
This leaves us to consider consumer retail and consumer service CRE.
Consumer Retail Spending & Retail CRE
The value of commercial real estate is driven by the revenues and profits earned by the businesses occupying CRE. This relationship is similar to the relationship between residential real estate prices and average household income.
The Two Drivers of Consumer Spending: Population Size and Average Household Income:
These two parameters show continuously increasing population size and declining average household incomes. The subsequent data shows this is resulting in a small increase in total consumer spending and also large shifts in spending patterns.
Real inflation adjusted total retail spending has increased slightly over its peak in 2007.
Essentially all of this increase has occurred in food spending. (A smaller portion has gone into clothing). And this is the only reasonable expectation given the twin conditions of an increasing total population and a declining average income per consumer. We can also note that “food” is a minuscule part of eCommerce. The retail food trade occurs almost entirely in neighborhood groceries, markets and convenience stores. The other non-food retail sectors are flat to declining. But within these sectors there is a large zero-sum game being played out between eCommerce and local bricks ‘n mortar stores:
The Rise of eCommerce
Since 2008 eCommerce retail sales have nearly doubled. But as we just saw, the entire increase in total consumer spending since 2008 is accounted for by the increased food sales which occur at local markets. “eCommerce” is therefore taking sales away from other local retail sectors. And the biggest single loser is:
Local Retail Department Stores
This macroeconomic data is well-supported by the current financials of both Sears and JC Penney. Sears’ trailing twelve month (ttm) earnings per share are – $14.11. This loss will increase once Sears reports its fourth quarter earnings at the end of February, 2014. Sears is widely expected to lose one billion dollars in 2014. J.C. Penney meanwhile is currently reporting ttm losses of -$7.32 per share.
One or both of these chains will be in bankruptcy by 2015 even if the current “recovery” continues. And outright liquidation of one or both companies is at least as likely as reorganization. There is little reason to believe either of these companies would be more viable following mere debt reduction.
The third major department store chain is Macy’s, which is still reporting profits. Oddly enough Macy’s management celebrated their 2013 holiday season by announcing 2,500 permanent layoffs from their local retail department stores. This was paired with a mid-December announcement of an increase of 1,500 employees in a new eCommerce fulfillment center in Oklahoma.
In these circumstances it is unsurprising that retail CRE prices are showing weak recovery.
© 2014 Real Capital Analytics, Inc. All rights reserved. Source: Real Capital Analytics and Moody’s Investors Service. http://www.rcanalytics.com Used by permission.
The Coming Implosion of the Regional Indoor Shopping Mall
(and adjacent strip shopping centers)
There are approximately 1,100 indoor shopping malls in the USA. Sears has about 2,000 stores. JC Penney’s has almost exactly 1,100 stores. There are very few malls that don’t have at least one of these chains. The vast majority of malls have both as major anchor stores. Macy’s is typically the third major anchor now. A regional department store chain or two round out the large anchor stores.
A virtual stroll down the typical mall concourse will reveal plenty of other money losing chain retailers with names like Radio Shack et al. Adjacent strip shopping centers
This should not be surprising. The regional indoor mall is a middle class income institution. It grew up with the post-WWII rise in average incomes. As middle class incomes now disappear so are the former favorite shopping venues of the middle class.
Every time a mall store closes shoppers lose another reason to go to the mall. “Dead mall” syndrome will soon afflict most of this sector.
In addition to decaying tenant revenues the mall owning Real Estate Investment Trusts are dangerously overleveraged with low-cost to free ZIRP and QE funding. Now that the Federal Reserve is tapering QE their financing costs will be rising as commercial balloon mortgages come due and have to be rolled over. And since the typical commercial mall mortgage does carry a large balloon payment at the end they have to be refinanced. Assuming honest loan underwriting a higher risk premium will also be attached due to the deteriorating retail fundamentals of the tenants.
General Growth Properties (GGP) is probably in the best condition. This is because GGP just exited a Chapter 11 reorganization in 2010. It was placed into involuntary bankruptcy in 2009 by two mortgagors holding matured recourse balloon mortgages. GGP was understandably unable to refinance these balloons in the spring of 2009.
This entire sector will collapse when the next recession appears.
And since history hasn’t ended, the next recession will appear at some point. It may be appearing already. At the beginning of October, 2013 the analyst consensus for retail profit growth for the strongest October – December holiday quarter was 5.5%. At the beginning of the reporting cycle in January expectations were down to 0.5% profit growth. That is a 90% reduction in analyst expectations in just three months.
Barring a turnaround, many retail chains still reporting profits will be reporting quarter-on-quarter profit declines in April. And by the end of the third quarter more will start reporting outright losses.
Part 3 will examine the other major part of local consumer oriented CRE. These are consumer services like neighborhood banking, investment, insurance and other services. Experience to date demonstrates that in the next few years the internet, expert software systems and robotics/automation will eliminate 50% and more of the jobs formerly associated with these businesses. These same trends will also shift most of the surviving positions away from the traditional storefront strip center and local office park locations.
“I was part of that strange race of people aptly described as spending their lives doing things they detest, to make money they don’t want, to buy things they don’t need, to impress people they don’t like.” ― Emile Gauvreau
If ever a chart provided unequivocal proof the economic recovery storyline is a fraud, the one below is the smoking gun. November and December retail sales account for 20% to 40% of annual retail sales for most retailers. The number of visits to retail stores has plummeted by 50% since 2010. Please note this was during a supposed economic recovery. Also note consumer spending accounts for 70% of GDP. Also note credit card debt outstanding is 7% lower than its level in 2010 and 16% below its peak in 2008. Retailers like J.C. Penney, Best Buy, Sears, Radio Shack and Barnes & Noble continue to report appalling sales and profit results, along with listings of store closings. Even the heavyweights like Wal-Mart and Target continue to report negative comp store sales. How can the government and mainstream media be reporting an economic recovery when the industry that accounts for 70% of GDP is in free fall? The answer is that 99% of America has not had an economic recovery. Only Bernanke’s 1% owner class have benefited from his QE/ZIRP induced stock market levitation.
The entire economic recovery storyline is a sham built upon easy money funneled by the Fed to the Too Big To Trust Wall Street banks so they can use their HFT supercomputers to drive the stock market higher, buy up the millions of homes they foreclosed upon to artificially drive up home prices, and generate profits through rigging commodity, currency, and bond markets, while reducing loan loss reserves because they are free to value their toxic assets at anything they please – compliments of the spineless nerds at the FASB. GDP has been artificially propped up by the Federal government through the magic of EBT cards, SSDI for the depressed and downtrodden, never ending extensions of unemployment benefits, billions in student loans to University of Phoenix prodigies, and subprime auto loans to deadbeats from the Government Motors financing arm – Ally Financial (85% owned by you the taxpayer). The country is being kept afloat on an ocean of debt and delusional belief in the power of central bankers to steer this ship through a sea of icebergs just below the surface.
The absolute collapse in retail visitor counts is the warning siren that this country is about to collide with the reality Americans have run out of time, money, jobs, and illusions. The most amazingly delusional aspect to the chart above is retailers continued to add 44 million square feet in 2013 to the almost 15 billion existing square feet of retail space in the U.S. That is approximately 47 square feet of retail space for every person in America. Retail CEOs are not the brightest bulbs in the sale bin, as exhibited by the CEO of Target and his gross malfeasance in protecting his customers’ personal financial information. Of course, the 44 million square feet added in 2013 is down 85% from the annual increases from 2000 through 2008. The exponential growth model, built upon a never ending flow of consumer credit and an endless supply of cheap fuel, has reached its limit of growth. The titans of Wall Street and their puppets in Washington D.C. have wrung every drop of faux wealth from the dying middle class. There are nothing left but withering carcasses and bleached bones.
The impact of this retail death spiral will be vast and far reaching. A few factoids will help you understand the coming calamity:
- There are approximately 109,500 shopping centers in the United States ranging in size from the small convenience centers to the large super-regional malls.
- There are in excess of 1 million retail establishments in the United States occupying 15 billion square feet of space and generating over $4.4 trillion of annual sales. This includes 8,700 department stores, 160,000 clothing & accessory stores, and 8,600 game stores.
- U.S. shopping-center retail sales total more than $2.26 trillion, accounting for over half of all retail sales.
- The U.S. shopping-center industry directly employed over 12 million people in 2010 and indirectly generated another 5.6 million jobs in support industries. Collectively, the industry accounted for 12.7% of total U.S. employment.
- Total retail employment in 2012 totaled 14.9 million, lower than the 15.1 million employed in 2002.
- For every 100 individuals directly employed at a U.S. regional shopping center, an additional 20 to 30 jobs are supported in the community due to multiplier effects.
The collapse in foot traffic to the 109,500 shopping centers that crisscross our suburban sprawl paradise of plenty is irreversible. No amount of marketing propaganda, 50% off sales, or hot new iGadgets is going to spur a dramatic turnaround. Quarter after quarter there will be more announcements of store closings. Macys just announced the closing of 5 stores and firing of 2,500 retail workers. JC Penney just announced the closing of 33 stores and firing of 2,000 retail workers. Announcements are imminent from Sears, Radio Shack and a slew of other retailers who are beginning to see the writing on the wall. The vacancy rate will be rising in strip malls, power malls and regional malls, with the largest growing sector being ghost malls. Before long it will appear that SPACE AVAILABLE is the fastest growing retailer in America.
The reason this death spiral cannot be reversed is simply a matter of arithmetic and demographics. While arrogant hubristic retail CEOs of public big box mega-retailers added 2.7 billion retail square feet to our already over saturated market, real median household income flat lined. The advancement in retail spending was attributable solely to the $1.1 trillion increase (68%) in consumer debt and the trillion dollars of home equity extracted from castles in the sky, that later crashed down to earth. Once the Wall Street created fraud collapsed and the waves of delusion subsided, retailers have been revealed to be swimming naked. Their relentless expansion, based on exponential growth, cannibalized itself, new store construction ground to a halt, sales and profits have declined, and the inevitable closing of thousands of stores has begun. With real median household income 8% lower than it was in 2008, the collapse in retail traffic is a rational reaction by the impoverished 99%. Americans are using their credit cards to pay their real estate taxes, income taxes, and monthly utilities, since their income is lower, and their living expenses rise relentlessly, thanks to Bernanke and his Fed created inflation.
The media mouthpieces for the establishment gloss over the fact average gasoline prices in 2013 were the second highest in history. The highest average price was in 2012 and the 3rd highest average price was in 2011. These prices are 150% higher than prices in the early 2000′s. This might not matter to the likes of Jamie Dimon and Jon Corzine, but for a middle class family with two parents working and making 7.5% less than they made in 2000, it has a dramatic impact on discretionary income. The fact oil prices have risen from $25 per barrel in 2003 to $100 per barrel today has not only impacted gas prices, but utility costs, food costs, and the price of any product that needs to be transported to your local Wally World. The outrageous rise in tuition prices has been aided and abetted by the Federal government and their doling out of loans so diploma mills like the University of Phoenix can bilk clueless dupes into thinking they are on their way to an exciting new career, while leaving them jobless in their parents’ basement with a loan payment for life.
The laughable jobs recovery touted by Obama, his sycophantic minions, paid off economist shills, and the discredited corporate legacy media can be viewed appropriately in the following two charts, that reveal the false storyline being peddled to the techno-narcissistic iGadget distracted masses. There are 247 million working age Americans between the ages of 18 and 64. Only 145 million of these people are employed. Of these employed, 19 million are working part-time and 9 million are self- employed. Another 20 million are employed by the government, producing nothing and being sustained by the few remaining producers with their tax dollars. The labor participation rate is the lowest it has been since women entered the workforce in large numbers during the 1980′s. We are back to levels seen during the booming Carter years. Those peddling the drivel about retiring Baby Boomers causing the decline in the labor participation rate are either math challenged or willfully ignorant because they are being paid to be so. Once you turn 65 you are no longer counted in the work force. The percentage of those over 55 in the workforce has risen dramatically to an all-time high, as the Me Generation never saved for retirement or saw their retirement savings obliterated in the Wall Street created 2008 financial implosion.
To understand the absolute idiocy of retail CEOs across the land one must parse the employment data back to 2000. In the year 2000 the working age population of the U.S. was 213 million and 136.9 million of them were working, a record level of 64.4% of the population. There were 70 million working age Americans not in the labor force. Fourteen years later the number of working age Americans is 247 million and only 144.6 million are working. The working age population has risen by 16% and the number of employed has risen by only 5.6%. That’s quite a success story. Of course, even though median household income is 7.5% lower than it was in 2000, the government expects you to believe that 22 million Americans voluntarily left the labor force because they no longer needed a job. While the number of employed grew by 5.6% over fourteen years, the number of people who left the workforce grew by 31.1%. Over this same time frame the mega-retailers that dominate the landscape added almost 3 billion square feet of selling space, a 25% increase. A critical thinking individual might wonder how this could possibly end well for the retail genius CEOs in glistening corporate office towers from coast to coast.
This entire materialistic orgy of consumerism has been sustained solely with debt peddled by the Wall Street banking syndicate. The average American consumer met their Waterloo in 2008. Bernanke’s mission was to save bankers, billionaires and politicians. It was not to save the working middle class. You’ve been sacrificed at the altar of the .1%. The 0% interest rates were for Jamie Dimon and Lloyd Blankfein. Your credit card interest rate remained between 13% and 21%. So, while you struggle to pay bills with your declining real income, the Wall Street bankers are again generating record profits and paying themselves record bonuses. Profits are so good, they can afford to pay tens of billions in fines for their criminal acts, and still be left with billions to divvy up among their non-prosecuted criminal executives.
Bernanke and his financial elite owners have been able to rig the markets to give the appearance of normalcy, but they cannot rig the demographic time bomb that will cause the death and destruction of our illusory retail paradigm. Demographics cannot be manipulated or altered by the government or mass media. The best they can do is ignore or lie about the facts. The life cycle of a human being is utterly predictable, along with their habits across time. Those under 25 years old have very little income, therefore they have very little spending. Once a job is attained and income levels rise, spending rises along with the increased income. As the person enters old age their income declines and spending on stuff declines rapidly. The media may be ignoring the fact that annual expenditures drop by 40% for those over 65 years old from the peak spending years of 45 to 54, but it doesn’t change the fact. They also cannot change the fact that 10,000 Americans will turn 65 every day for the next sixteen years. They also can’t change the fact the average Baby Boomer has less than $50,000 saved for retirement and is up to their grey eye brows in debt.
With over 15% of all 25 to 34 year olds living in their parents’ basement and those under 25 saddled with billions in student loan debt, the traditional increase in income and spending is DOA for the millennial generation. The hardest hit demographic on the job front during the 2008 through 2014 ongoing recession has been the 45 to 54 year olds in their peak earning and spending years. Combine these demographic developments and you’ve got a perfect storm for over-built retailers and their egotistical CEOs.
The media continues to peddle the storyline of on-line sales saving the ancient bricks and mortar retailers. Again, the talking head pundits are willfully ignoring basic math. On-line sales account for 6% of total retail sales. If a dying behemoth like JC Penney announces a 20% decline in same store sales and a 20% increase in on-line sales, their total change is still negative 17.6%. And they are still left with 1,100 decaying stores, 100,000 employees, lease payments, debt payments, maintenance costs, utility costs, inventory costs, and pension costs. Their future is so bright they gotta wear a toe tag.
The decades of mal-investment in retail stores was enabled by Greenspan, Bernanke, and their Federal Reserve brethren. Their easy money policies enabled Americans to live far beyond their true means through credit card debt, auto debt, mortgage debt, and home equity debt. This false illusion of wealth and foolish spending led mega-retailers to ignore facts and spread like locusts across the suburban countryside. The debt fueled orgy has run out of steam. All that is left is the largest mountain of debt in human history, a gutted and debt laden former middle class, and thousands of empty stores in future decaying ghost malls haunting the highways and byways of suburbia.
The implications of this long and winding road to ruin are far reaching. Store closings so far have only been a ripple compared to the tsunami coming to right size the industry for a future of declining spending. Over the next five to ten years, tens of thousands of stores will be shuttered. Companies like JC Penney, Sears and Radio Shack will go bankrupt and become historical footnotes. Considering retail employment is lower today than it was in 2002 before the massive retail expansion, the future will see in excess of 1 million retail workers lose their jobs. Bernanke and the Feds have allowed real estate mall owners to roll over non-performing loans and pretend they are generating enough rental income to cover their loan obligations. As more stores go dark, this little game of extend and pretend will come to an end. Real estate developers will be going belly-up and the banking sector will be taking huge losses again. I’m sure the remaining taxpayers will gladly bailout Wall Street again. The facts are not debatable. They can be ignored by the politicians, Ivy League economists, media talking heads, and the willfully ignorant masses, but they do not cease to exist.
“Facts do not cease to exist because they are ignored.” – Aldous Huxley
The market just hit a fresh all time high today which means another major default must be just around the horizon. Sure enough, the FT reported moments ago that a Puerto Rico default “appears increasingly likely” and is why creditors are meeting with lawyers and bankruptcy specialists (most likely Miller Buckfire, fresh from its recent league table success with the Detroit bankruptcy) on Thursday in New York. The FT cited a restructuring advisor, supposedly desperate to sign the engagement letter with creditors and to force the bankruptcy, who said that “the numbers are untenable” and “to issue new debt the yield would have to rise and where they can’t raise new money they will have to stop paying.”
The untenability of PR’s cash flows results from a “debt service burden that requires paying between $3.4bn and $3.8bn each year for the next four years. As doubts grow about the ability of the commonwealth to service that debt, the cost of doing so will inevitably rise.”
For Puerto Rico bonds, such an outcome would not be exactly a surprise, most recently trading at 61:
The rest of the story is largely known:
If Puerto Rico is forced to take that step, the effects will ripple through the entire $4tn municipal bond market. Because the debt is generally triple tax free, in a world of zero interest rates demand is high and it is distributed widely, including in funds that imply they have no exposure to Puerto Rico.
But yields have gone up nevertheless – and prices down – suggesting the markets are increasingly nervous about prospects for repayment. Estimates on how much of that debt is insured range from 25 per cent to 50 per cent of total issuance.
“Everyone thinks they can get out in time,” the restructuring adviser said.
Puerto Rico cannot really raise taxes much more, since the debt per capita is more than $14,000, while income per capita is almost $17,000, a ratio – at 83 per cent – that makes California, Illinois or New York – each at 6 per cent – models of prudence. Meanwhile, at 14 per cent, the unemployment rate is twice the national average.
What would make a Puerto Rico default more interesting is that as in the case of GM, political infighting would promptly take precedence over superpriority and waterfall payments. According to the FT, “any radical step, which the local government denies considering, would involve significant legal wrangling. Congress could step in and create an insolvency regime, lawyers say, since it has comprehensive jurisdiction, but that too would give rise to partisan fighting. The Democrats would say that pension claims have priority while the Republicans would uphold the priority of payments to bondholders, citing the constitutional sanctity of contracts.”
Of course, since in the US a bond contract now is only worth the number of offsetting votes it would cost, nobody really knows what will happen. And so, we sit back and watch, as yet another muni quake appears set to hit the US, in the process obviously sending the S&P to higher, record highs.
In the meantime, keep an eye on bond insurers AGO and MBI which have taken on water in today’s session precisely due to concerns over what a Puerto Rico default would do to their equity.
Between lack of cash flows, insurmountable liabilities, an untenable pension funding, even insider fraud, we thought we had seen all the various reasons for filing for Chapter 11 bankruptcy protection. And then along came the Catholic Diocese of Stockton which announced that it would join its host city and seek bankruptcy protection “in the wake of the church’s sexual-abuse scandal.” As WSJ reported, Bishop Stephen E. Blaire said in a news release Monday that the diocese would seek bankruptcy protection Wednesday, explaining that reorganization was the only option for dealing with mounting legal costs related to abuse by priests. The bishop said the diocese has spent $14 million in legal settlements and judgments over the past 20 years dealing with abuse allegations, and doesn’t have funds available to settle pending lawsuits or address future allegations. The punchline: “Very simply, we are in this situation because of those priests in our diocese who perpetrated grave, evil acts of child sexual abuse.”
In the Stockton diocesan bankruptcy, the parties will likely agree on a figure that the diocese would pay, in addition to potentially pulling in funds from insurers. However, the diocese says it holds “relatively little property and assets.” Other holdings, including schools, parishes and several parcels of land, are incorporated separately.
And so the Stockton Catholics became the 10th US Diocese after Milwaukee; San Diego; Spokane, Wash.; Davenport, Iowa; Portland, Ore.; Tucson, Ariz.; Fairbanks, Alaska; Wilmington, Del.; and Gallup, N.M. to file bankruptcy. In addition, the Christian Brothers Institute, which operates Catholic schools and orphanages, also filed because of sexual abuse liabilities.
The Chapter 11 filing would halt pending litigation against the diocese and likely would ultimately allow it to discharge liabilities stemming from sexual-abuse allegations by setting up a trust to compensate victims. The diocese said it hopes to arrive at a resolution with victims and insurers through the process.
Joelle Casteix, western regional director of the Survivors Network of those Abused by Priests, called the bankruptcy “problematic on a lot of different levels,” noting that it would let the diocese avoid future civil cases.
However, while the local catholics’ financial woes may be put on temporary hold, their civil troubles are only starting:
Separately, a grand jury Monday indicted a former priest with the diocese, Michael Eugene Kelly, and a warrant for his arrest has been issued. Calaveras County authorities are seeking Mr. Kelly’s extradition from Ireland to face charges of three counts of lewd and lascivious conduct on a child, and one count of oral copulation with a child. Mr. Kelly faces 14 years in prison if convicted.
Not surprisingly, the Catholic church which itself is embroiled in numerous financial scandals recently, was unable to come to the Diocese’s rescue even though it has already paid out an estimated $2.2 billion to cover settlements, therapy for victims, support for offenders, attorney fees and other costs, according to a report by the U.S. Conference of Catholic Bishops.
And with this filing, we are fairly confident we have seen every possible bankruptcy filing reason.
As powerful as it may be, the Fed is not the market. And since the Fed failed to restore trust in the system by forcing all bad debts to light, the financial world has grown increasingly volatile and broken as investors grow increasingly distrustful of the system and begin to pull their money from it: see market volumes continuing to plunge.
Nowhere is the lack of trust more apparent than in the financial sector. Indeed, it was a lack of trust between banks (inter-bank lending) that caused the credit markets to jam up in 2008, which resulted in the Crash.
That lack of trust continues to this day. In the post-Lehman collapse, instead of forcing real derivative and credit risk out into the open, the Federal Reserve and regulators instead suspended accounting standards and allowed financial firms (and other corporate entities) to continue to lie about the true state of their balance sheets.
As a result of this, the financial sector remains rife with fraud and impossible to accurately value (how can you value a business that is lying about its balance sheet?).
Those times in which a company was forced to value its assets at market prices have always seen said values losing 80%+ value in short order: consider Washington Mutual, which sported a book value north of $70 billion right up until it was sold for… $2 billion.
This type of fraud is endemic in the system. Indeed, we got a taste of just how problematic a lack of transparency can be with MF Global’s bankruptcy, in which a firm with $42 billion in assets lost over 80% of its value since August only to reveal in bankruptcy that it had stolen over $700 million worth of clients’ money.
That MF Global engaged in fraud and stole clients’ money is noteworthy. However, the far more important issue is: HOW did this company receive primary dealer status from the NY Fed nine months before imploding?
The Primary Dealers are the banks that actively engage in day to day activities with the New York Fed regarding the Fed’s monetary policies. Primary Dealers also participate in US Treasury auctions.
Put another way, Primary Dealers are the most elite, well-connected financial firms in the world. They have unequal access to both the Fed and the US Treasury Dept. In order for MF Global to have attained this status it must have passed through a review by:
1) The New York Fed
2) The SEC
This is not a quick nor superficial process. According to the NY Fed’s own site:
Upon submission of a formal application, a prospective primary dealer can expect at least six months of formal consideration by the New York Fed. That consideration may include,among other things, on-site reviews of front, middle, and back office operations, review of compliance programs and discussions with compliance and credit risk management staff, discussions with senior management about business plans, financial condition, and the ability to meet FRBNY’s business needs, review of financial information, and consultation with primary supervisors and regulators.
MF Global passed through all of these reviews to became a primary dealer in February 2011. A mere nine months later, the firm is in Chapter 11 and has admitted to stealing clients’ funds to maintain liquidity.
These developments reveal, beyond any doubt, that financial oversight in the US is virtually non-existent. This returns to my primary point: that trust has been lost in the system. And until it is restored, the system will remain broken.
A final note on this: the NY Fed is the single most powerful entity in charge of the Fed’s daily operations. How can any investor believe that the Fed can manage the system and restore trust when the NY Fed granted MF Global primary dealer status a mere nine months before the latter went bankrupt?
If the NY Fed cannot accurately audit a financial firm’s risks during a six month review, then there is NO WAY an ordinary investor can do so.
This is one of the biggest risks in the system: that no one has a clue what financial entities are sitting on in terms of garbage derivatives and debts. As MF Global proved, this risk can result in a TOTAL loss of funds.
This type of fraud will continue until the system breaks. At that point hopefully the bad debts will finally clear from the system and we can actually lay a foundation for growth.
For a FREE Special Report outlining how to protect your portfolio from this, swing by: http://phoenixcapitalmarketing.com/special-reports.html
Phoenix Capital Research
So far, city employees of bankrupt Detroit have stoically withstood all direct and indirect eliminations of their entitlements and retirement benefits, which was to be expected: after all as per a recent finding, they are merely an unsecured claim in an insolvent entity. However, following the latest shot across the bow from Detroit’s emergency manager Kevyn Orr, which freezes pension plans for all non-uniform employees, said stoicism will likely be acutely tested.
Emergency Manager Kevyn Orr has frozen the city’s pension plans for all non-uniform employees, closing the General Retirement System effective Jan. 1.
Orr’s Dec. 30 action freezes earned pension benefits for employees in the General Retirement System and creates a new 401(k)-style defined contribution retirement plan for existing and future city workers, according to a copy of the emergency manager’s order obtained by The Detroit News.
As part of the order, Orr also eliminated the pension “escalator,” effectively eliminating any future cost-of-living increases for all retired city employees in the General Retirement System.
The emergency manager’s order also closes the pension system’s Annuity Savings Fund, an added benefit for some municipal workers.
City employees who were not already vested in the retirement system “shall not be entitled” to pension benefits, according to the order.
Tina Bassett, a spokeswoman for the General Retirement System, called Orr’s pension freeze “an outrageous and over-zealous action.”
“Again the EM’s office demonstrates a lack of integrity and willingness to make a good faith effort when negotiating with our pension system,” Bassett said in a statement. “Currently we are in the midst of mediations that we thought were going rather well. We can only wonder, why take this action now and for what purpose?”
About The Author
Senior Washington Correspondent
Neil Macdonald is the senior Washington correspondent for CBC News, which he joined in 1988 following 12 years in newspapers. Before taking up this post in 2003, Macdonald reported from the Middle East for five years. He speaks English and French fluently, and some Arabic.
America’s rugged individualists have argued for many years that governments can’t be trusted. Turns out they were right. More so than they probably ever realized.
Municipalities, utilities and states across the U.S., faced with debts and liabilities piled up by irresponsible elected officials over the years, now want to renege.
Cities are seeking, and obtaining, permission to walk away from their commitments. State governments are simply giving themselves that permission.
And U.S. conservatives, who preach financial accountability (Bush-era Republicans saw to it, for example, that credit card debt collectors can follow ordinary Americans all the way to the grave), are not just cheering those faithless governments, but demanding that they go even further.
The shrunken city of Detroit is the latest and biggest example.
It just secured a judge’s permission to declare bankruptcy, and will now begin imposing “haircuts” on its creditors, who it appears will end up shaven nearly bald.
The most vulnerable of them are Detroit’s 23,000 retired municipal pensioners.
People like Gwendolyn Beasley, a 67-year-old who worked as a Detroit library clerk for 34 years and now collects $13,085 a year.
“I am very angry,” she tells reporters, futilely.
Michigan’s constitution, she points out, explicitly protects government pensions.
Tough luck, ruled the judge. Beasely’s pension is now in the barber’s chair.
In America’s Hunger Games economy, nothing is protected anymore.
(Except, of course, the banks and big corporations like Chrysler and General Motors that had to be rescued with tax dollars when everything crashed five years ago.)
In the state of Illinois, the legislature just passed a legislative “fix” for the $100-billion hole in its workers’ pension plan, which actually won’t come anywhere near to fixing it.
At least, though, Illinois is trying to respect the pension deals it already signed, and is focusing the financial pain on younger workers, who still have the option of finding work elsewhere and retaking control of their futures.
Illinois has also raised taxes to pay for its pensions, provoking the fury of conservatives.
The Wall Street Journal’s editorial page, scourge of taxation everywhere, blames the whole mess on greedy unions and cowardly politicians.
And in one respect, at least, the Journal is right: Of course unions are greedy, just as businessmen are greedy. Greed, otherwise known as acting in your own economic interest, is what makes the U.S. economy work.
The real villains are the politicians who agreed to labour deals they likely knew were unsustainable.
A ‘fraud’ on the public
“These jurisdictions didn’t face up to how much money they would need to put in to meet the commitments they made,” says Chester Spatt, a professor at Carnegie Mellon University and the former chief economist for the Securities Exchange Commission.
“Frankly, in other contexts, one calls that fraud.”
Politicians, who usually want to be re-elected, have a long record of incurring big debts, then walking away and leaving the mess to successors, who, if they can, then pull the same stunt.
And their pension plan advisers, anxious to please, play along.
Even now, pension funds across the U.S. are assuming “ridiculous” returns of seven and eight per cent to try to show how solvent they are, says Spatt: “It’s stunningly irresponsible.”
But as the bills arrive, politicians, especially Republicans, are choosing to demonize the victims, and it is easy to see why.
Campaigning against the rapacious clerks, teachers, librarians, police and firefighters who had the nerve to accept these pension deals has become a surefire political win.
Many voters don’t have pensions at all. Why, they ask, should government workers?
Indeed, some public servants do enjoy pensions and benefits that look shockingly generous and would be difficult to sustain without imposing higher taxes, which is definitely not a vote-getter.
The point, though, is that these workers signed deals to which governments agreed, in many cases accepting lower salaries than they would have earned in the private sector.
And they held up their end. Whatever you might think of the value of their services, they supplied them, as contracted.
More questionable debt
A deal is supposed to be a deal. But in post-crash, jobless-recovery America, what is supposed to be is not what is.
Spatt calculates the total unfunded liability of government pensions in the U.S. is probably in the trillions of dollars.
But the problem goes further than that. In fact, the vast majority of Americans, whether they realize it or not, will be looking to collect from government someday, and chances are the money won’t be there.
The Social Security system, America’s biggest pension plan, is basically broke. Successive governments have raided the Social Security fund, and shied away from increasing premiums. By some calculations, it owes $20 trillion more over the long term than it can pay.
Detroit’s bondholders – a lot of them senior citizens who purchased municipal bonds as a form of substitute pension – have now learned that not all government debt is safe.
They, along with the city’s pensioners, have reportedly been offered pennies on what they are owed.
Federal and state debt is less risky, but only because those levels of government can borrow more easily and Washington can print money. (Which, of course, has lowered interest rates and further put the screws to retirees who are getting miserable returns on their savings.)
In Detroit’s case, there is no talk of Washington stepping in, and Spatt, for one, says that is a good thing.
Not only would federal involvement set off an endless chain of government-to-government bailouts (the city of Chicago’s pension hole is $20 billion), Spatt says it would ultimately do nothing to stop irresponsible politicians from creating the same situation again.
Ultimately, says Spatt, workers must understand that pensions are risky benefits, and investors must understand that “the full faith and credit of government doesn’t mean what it used to mean.”
I would never, of course, suggest any of this would apply in Canada.
Canada, as we are all constantly told, is far more prudent and better managed, and Canadians trust their governments more.
Still, it might not hurt to take note.
Detroit Bankruptcy Judge Rules To Allow Pension Haircuts, Says Detroit Eligible To File Chapter 9 | Zero Hedge
Update, and it’s official:
- JUDGE: DETROIT ELIGIBLE FOR IMMEDIATE BANKRUPTCY PROTECTION
- DETROIT TO REMAIN UNDER BANKRUPTCY COURT PROTECTION, JUDGE SAYS
As somewhat expected – though hoped against by many Detroit union workers – Judge Steven Rhodes appears to have confirmed Detroit is eligible for bankruptcy protection (after pointing out that the city’s accounting was accurate and it is indeed insolvent) making this the largest ever muni bankruptcy.
- JUDGE RHODES SAYS HE WILL ALLOW PENSION CUTS IN DETROIT’S BANKRUPTCY
- DETROIT JUDGE: NOTHING SEPARATES PENSIONS FROM OTHER DEBT
The city will now begin working toward its next major move – the submission of a plan to re-adjust its more than $18 billion in debt – including significant haircuts for pension funds (possibly 16c on the dollar recovery) and bondholders. With Detroit as precedent, we can only imagine the torrent of other cities in trouble that will be willing to fold.
He did provide an “out” though:
- RHODES WARNS THE CITY THAT JUST BECAUSE PENSION RIGHTS CAN BE IMPAIRED, DOESN’T MEAN HE WILL APPROVE A PLAN WITH STEEP CUTS
Before the bankruptcy, Orr proposed canceling $3.5 billion in future pension obligations and at least $1.4 billion in unsecured bonds. The debts would be replaced with a $2 billion note paying 1.5 percent interest.
But, of cours,
Detroit must ask “what is necessary to invest to attract business?” Spiotto said in a phone interview. “If you don’t solve the systemic problem, you are just going to repeat it.”
Via Paul Singer of Elliott Management,
In the U.S., states cannot file for bankruptcy. Cities can, however, and there is a special provision in federal bankruptcy law reserved for cities. Furthermore, unlike countries, states and cities cannot print their own currency. When they overspend or overpromise, they beg for money from the federal government (or state government, in the case of cities), reduce their spending and/or default on their obligations. When the cash register is empty, it is lights out – literally. By contrast, the ability to print money allows countries to get away with long-term insolvency (at least until markets wake up and force them to restructure their obligations).
What is happening in Detroit – a combination of poor and corrupt civic leadership, shortsighted business leaders and overreaching labor unions – is interesting because it was 40 years in the making, but just months in the denouement. It turns out that Chapter 9 of the Bankruptcy Code gives judges tremendous leeway to chop obligations quickly and severely, regardless of the expectations of pension-holders and bondholders.
We see Detroit as the “coming attraction” to a significant number of municipal insolvencies in the months and years to come. Perhaps the pain of the restructurings will improve the behavior of city governments, labor groups and businesses, and perhaps it won’t.
But there is no question that this episode is a precursor to what will happen on the federal level as national promises prove to be empty.
- Paul Singer In Q3 Letter Warns Of Growing Dangers To Economy (valuewalk.com)
- Paul Singer On Detroit, Obamacare And The Uselessness Of Computers (valuewalk.com)
- How Detroit bankruptcy could alter the key assumptions of municipal bond finance… (mostlyeconomics.wordpress.com)
- Elliott’s Paul Singer Warns “Something Is Wrong And Dangerous” (financialsurvivalnetwork.com)
- Detroit’s finances ‘shocking,’ city manager testifies (nbcnews.com)
Doing more of what failed spectacularly will not save the day a second time, as the scale required to create yet more phantom collateral and more asset bubbles will collapse the system.
The financial storm clouds are gathering, ominously darkening the horizon. Though the financial media and the organs of state propaganda continue forecasting blue skies of recovery and rising corporate profits, the factual evidence belies this rosy forecast: internal measures of financial and economic activity are weakening across the globe as the state-central bank solutions to all ills–massive increases in credit creation, leverage and deficit spending–have failed to address any of the structural causes of the 2008 Global Financial Meltdown.
This failure to address the causes of 2008 Global Financial Meltdown is disastrous in and of itself–but the status quo has magnified the coming disaster by scaling up the very causes of the 2008 Global Financial Meltdown: excessive credit expansion, misallocation of capital on a grand scale, an opaque shadow banking system constructed of excessive leverage and a dependence on phantom collateral, i.e. risks and assets that are systemically mispriced to skim stupendous profits for financiers, bankers and their political enablers.
This is what I have called doing more of what has failed spectacularly.
Extremes inevitably lead to collapse, but even the most distorted system has some feedback mechanisms that attempt to counter the momentum toward disaster. Just as the body will try to mitigate the negative consequences of a diet of greasy fast food, our grossly distorted financial and political systems still retain some modest feedback loops that attempt to mitigate rising risks.
These interactive forces make it impossible to predict the moment of collapse, even as systemic failure remains inevitable. Precisely when the heart of an obese, unfit person who eats nothing but fast food will give out cannot be predicted, but what can be predicted is the odds of systemic failure rise with every passing day.
Doing more of what has failed spectacularly–inflating new asset bubbles in housing, stocks and bonds via quantitative easing, obfuscating financial skimming operations with thousands of pages of new regulations, and so on–is the equivalent of pushing an obese, unfit person to run uphill. Rather than repair the system, doing more of what has failed further stresses the system.
But even if the financial system were cleansed of bad debt and phantom collateral, the status quo would remain only partially repaired. For it’s not just the financial system that has reached the point of negative return: the entire economic foundation of the developed world–credit-dependent consumerism–is as bankrupt and broken as the financial system that fuels it.
The state’s response to this economic endgame is depersonalized welfare, both corporate and individual. When favored sectors can’t succeed in the open market, the state enforces cartel-capitalism that enriches the corporations at the expense of the citizenry. When the cartel-state economy no longer creates paying work for the citizenry, the state issues social welfare benefits, in effect paying people to stay home and amuse themselves.
This destroys both free enterprise on the corporate level and the source of individual and social meaning, i.e. the opportunity to contribute in a meaningful way to one’s community, family and trade/skill.
The status quo is thus not just financially bankrupt–it is morally bankrupt as well.
The status quo is as intellectually bankrupt as it is financially bankrupt. Our leadership cannot conceive of any course of action other than central bank credit creation and expanding state control of the economy and social benefits, paid for with money borrowed from future generations.
Let’s take a wild guess that the obese, unfit person won’t make it up the second hill, never mind the third or fourth one. The status quo responded to the financial heart attack of 2008 by doing more of what had failed spectacularly. That injection of trillions of dollars, euros, yen, renminbi, quatloos, etc. revived the global financial system in the same way a shot of nitroglycerin resolves a life-threatening crisis: it doesn’t fix the causes of the crisis, it simply gives the system some additional time.
The next global financial storm is already gathering on the horizon. Doing more of what failed spectacularly will not save the day a second time, as the scale required to create yet more phantom collateral and more asset bubbles will collapse the system.
Intellectual, moral and financial bankruptcy all go hand in hand. There isn’t just one storm gathering on the horizon–there are three, each adding force and fury to the other two.