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Mark's Market Blog

7-15-12: Bankruptcy: coming soon to a city near you.

By Mark Lawrence

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The markets leaped up Friday on no particular news, the market was just oversold. We've seen this behavior before, last summer in similar circumstances. The market is currently trading in a rising channel, shown on the chart below in blue lines. This won't last forever, nothing does, but it would be unremarkable if the S&P went up to about 1390 next week, then turned around downwards again. We're getting very close to the election, and markets are not allowed to crash in the run-up to an election. Although I'm a firm believer in the idea that no one can control a market forever, a rather amazing amount of manipulation can be done over the course of months or even years. Clearly in the absence of the FED printing money, this market would be much lower.

S&P 500 January 22 2012 to July 13 2012

In June the US economy added 80,000 new jobs. Also in June 85,000 people applied for social security disability. In June we had 8,733,461 people of working age who received a SS disability check. Since 2009 twice as many people have been enrolled in SS disability as have gotten new jobs. A bit over half of those 8.7m disabled - 5.4m - were added during Obama's presidency. A typical disability check is about $1100 per month, so we're talking about $115 billion total in disability payments per year coming out of the SS trust fund. Just about exactly a third of the people receiving checks from SS are disabled or "survivors," and those people accounted for just under a third of SS total outlays. We passed another key benchmark in SS last month. The private labor force is 111m, and there are 56m receiving SS or disability. Just under two private workers for each recipient. When you hear that SS is broke and your retirement checks will have to be cut back, this will be a big part of the reason. This is also a big part of the reason why state worker's pensions are so much better: those of us depending on SS must pay out for old people who barely worked, the disabled, orphaned or abandoned children, families of the disabled. State workers pension funds only pay out to people who actually worked and paid in, typically for a minimum of five to ten years. Like many, I'm not counting on ever getting a penny from SS.

The German high court announced that by the end of July they will decide if they will grant a temporary injunction against Germany participating in the ESM, the new European body that will magically come up with $500b then fix a $2t problem. The ESM was supposed to be started by July 9th, several days ago - that didn't happen, and now it won't start until at least September or October. They also announced it would take them three months to decide on the constitutionality of the ESM. The court held hearings for 8 hours with participants limited to 5 minutes each. Passionate speeches were given on the outcomes of the various possibly court decisions, but very few facts were offered. And for each passionate speech, a little later there was an equal and opposite passionate speech. Maybe there's a new law of physics here.

German President Merkel is widely disliked in Europe for her habit of saying "no." How is that working for her? She's up for reelection next year, and her popularity is over 66% in Germany, an all-time high for her. Expect more no's. Indeed, expect her to get help: Timo Soini, Chairman of the True Finns Party, leader of the Finnish opposition and likely their next prime minister, recently said "It is not the little guy who benefits. He is being milked and lied to in order to keep the insolvent system running. He is paid less and taxed more to provide the money needed to keep this Ponzi scheme going. Meanwhile, a symbiosis has developed between politicians and banks: Our political leaders borrow ever more money to pay off the banks, which return the favor by lending ever more money back to our governments." Sound familiar?

One of the big fights in Europe is over retirement age. The Germans are raising theirs to 67 with every sign that it will continue to increase; the French are about to lower theirs from 62 to 60. With the lowered birth rate and increased life expectancy around the world in general and Europe in particular, I think the French are on the wrong side of history here; I think lowering the retirement age coupled with state retirement and medical will bankrupt France as certainly as it already has Greece and is looking to in Spain and Italy. We will address this same theme in the not too distant future as the individual US states grapple with public employee retirements and budget deficits, and medicare / medicaid / Obamacare look to bankrupt the entire country.

Another big theme in Europe is immigration. 25 years ago Europe made a huge push for multiculturalism, the believe that strength comes from diversity and that all people have the same potential at birth. Today in much of Europe this is no longer believed as their muslim immigrants have completely failed to assimilate or become productive; indeed in several countries immigrants and their offspring consume far more than a proportional share of welfare money (often half the total), produce more than their share of babies and criminals, and get educated at record low rates. One reaction to this is that even in famously left-leaning countries like France and Belgium the right is rising up, espousing closing borders and ejecting many immigrants. Sound familiar?

How bad is the job situation in Europe? Europeans are paying Brazilian women to marry them so they can get a residency card in Brazil and a job.

In a recent poll, 58% of all Germans favored a return to the Deutsche Mark, up from 39% a couple years ago.

The EU examiners who regularly tour Greece and examine their books to see that reforms are happening report that of the 320 agreed upon reforms that were to be done by now, 210 have been completely ignored. Greece and the EU continue to play a game of chicken; it's hard to see how Greece stays in the Euro in the long run.

Last week Barclays got fined for manipulating LIBOR rates. Other banks have now been implicated, including the Royal Bank of Scotland, Swiss bank UBS, Citigroup, HSBC, Deutsche Bank, JPMorgan Chase, Lloyds, and Bank of Tokyo Mitsubishi. How far does this spread? Just Coca- Cola has a bit over $1b in LIBOR linked loans. Since the manipulation has apparently been ongoing since 2005, analysts say the total amount of affected loans could be $800T - over ten times the world's GDP. The New York Attorney General has announced an investigation. Can bankers manage to do more damage to their image? I don't really see how, but these guys are bright, clever and hard working, and perhaps they have yet more surprises for all of us.

Stockton, CA filed for bankruptcy last week as expected, the largest municipal bankruptcy ever. They sent out a notice to their retirees this week that they would no longer be paying for their health care; the responding union lawsuit has already been filed asking for a restraining order. Stockton retirees have been getting a health insurance deal that I would personally consider premium - extremely low co- pays and deductibles at a price that's double what I pay. Stockton Vice Mayor Kathy Miller said the lawsuit was not unexpected. "All I can say is that there is a group of retirees who think it's more important for the taxpayers to pay 100% of their retirement than to keep police officers on the street," she said. "They know the situation. They know 80% of our discretionary income is for public safety. There is no way we can close the budget gap without these cuts. But they think they should come first." In 2007 Stockton sold $121m worth of bonds and gave the money to Calpers to partially catch up on their pension backlog - that is, future generations are on the hook to pay for benefits for employees who retired before the taxpayers were born. Now in bankruptcy the insurer behind the bonds says Stockton didn't try hard enough to avoid bankruptcy, they have assets they could sell and ways to cut their budget. Meanwhile, Oakland is trying to sell $224m worth of bonds to partially pay off their Calpers backlog.

This week the San Bernardino city council voted to file for bankruptcy in the face of a $45m cash shortage and an inability to pay their workforce, putting them at #2. State governments have been laying off workers non-stop for a couple years now - if the states had simply maintained their employment levels, employment would already be nearly back to normal. Oh well. Expect more city bankruptcies, this trend is just getting started. Who's next? Strong candidates in California include Antioch, Hercules, Lincoln, Santa Ana, San Jose, Costa Mesa, Long Beach, Oakland and Los Angeles. Elsewhere, Providence RI and Detroit are in pretty bad shape. The CA cities of San Carlos and Half Moon Bay have already started outsourcing services including police. One day one of these cities is going to set the precedence of renegotiating pensions inside of bankruptcy, and then that will be the crack in the dam.

Healthcare for life is more significant than most realize -- including many of those getting the benefit. Most employees don't really know the cost of those premiums until they have to pay them. Organizations who offer healthcare for life sign up for an open-ended obligation that frequently costs more than actual pensions for their retirees. Big corporations went through thi 20-25 years ago. GM eventually offered a monthly stipend in lieu of paying premiums to cap their costs. It's not hard to predict either a stipend to cap costs or elimination of the benefit in public agencies as well in coming months/years. Over half of all personal bankruptcies in the US involve large uninsured medical expenses. Now it seems the medical expense / bankruptcy disease is hitting our cities.

Scranton, the town almost destroyed in the movie Unstoppable, is now headed for a new type of train wreck. The PA city is effectively bankrupt - they are down to $5,000 in cash and have no money to meet their payroll. The Mayor announced that everyone working for the city - police, firemen, bureaucrats, even himself - were now making minimum wage of $7.25 / hour. He was promptly sued, a court ordered that he pay full wages, and he didn't. Now there's contempt proceedings. Why? Everyone knows Scranton is bankrupt, why don't they just file? Pennsylvania law says cities cannot file for bankruptcy without state approval. Eight months ago Harrisburg PA filed for bankruptcy without state approval and their case was thrown out of court. Pennsylvania unions and pensions are out of control, and bankruptcy is not an option - this situation is clearly going to continue to deteriorate until all options are exhausted.

The US is having extreme drought conditions over much of the country. In the map below tan is bad, reds are tragic. "S" means things are expected to get better, perhaps next year. "L" means get used to it. Notice that there's a "L" region than encompasses much of Kansas and Texas and all of New Mexico, Arizona, Colorado, Utah, Nevada, Oregon, Washington and California. There's another long-term drought belt starting in all of Arkansas and working up through Missouri, Illinois and Indiana, and yet another covering Mississippi, Georgia and South Carolina. Basically the US south is going to become a far harder region in which to farm. In the short term, the second map shows the USDA has declared about half the of US a drought disaster area. Corn prices are already up by 15% and continuing to rise; soybeans are up by 20%; wheat prices are up by 30%. Ranchers are rushing to sell cattle now as feed prices just start to skyrocket; expect cheap beef for the rest of this year and expensive beef next year.

Obama is bashing Romney rather continuously and effectively on Romney's Bain investments. What's up? When Romney was doing corporate takeovers in the 90s, Bain would issue new stock in the takeover company with two classes of shares. There would be preferred non-voting shares with a guaranteed dividend, and normal voting shares with no dividend. Before the company would go public it was up to Bain to value these shares. In such cases other firms would typically value the preferred shares at 20% to 50% more than the voting shares. Bain would value the voting shares as low as 1% the value of the preferred shares. They would then put the maximum value allowed of voting shares in their IRAs. When the company went public their preferred shares, owned personally, would go up in value by a small taxable amount. The voting shares would skyrocket in price, but were tax-sheltered inside their IRAs. This is how Romney built up his personal fortune. Clever, legal, and demonstrating our despicable tax code. Let me re-write the tax code and it will shrink from 40+ volumes to a small pamphlet, and these sort of abuses will disappear.

The election is still four months away and a lot can happen in four months. But it's not too soon to make some decent guesses based on no imminent disasters. Obama is leading with 332 electoral votes to Romney's 206. Romney has a very decent chance to take Florida and Michigan, getting him to 251. That's still 19 short. He's trailing rather more significantly everywhere else. This election is currently Obama's to lose. While I have great disrespect for Obama as a leader and administrator, he's a fantastic campaigner and I think it would be a grave mistake to think he'll trip over his own feet. A poll taken this week by the PEW institute shows clearly that 1) the voters trust Obama better than Romney on most issues, and 2) I'm seriously out of sync with the electorate.

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