Greater Depression

New Fed Chairman to trigger historic stock market crash in 2018 – ZH

DDB24C47-8D86-482E-985A-EF395C905228

ZeroHedge writes that the new Fed Chair will trigger an historic stock market crash in 2018. Glad to have loaded up on put options in recent weeks. Perhaps the cheapest priced products in an asset bubble everywhere world. Some shorter dated put options priced as little as 2c in the dollar. Risk is definitely not being priced for fear. Maybe why Blackstone has built up $22bn of short positions in recent months.

Should we trust ratings agencies on US state credit?

D42A75BB-58A4-49A5-B084-32343877CFFF

The Financial Crisis Inquiry Commission concluded in 2011 that “the global financial crisis could not have happened without the ‘Big Three’ agencies – Moody’s, Standard & Poor’s and Fitch which allowed the ongoing trading of bad debt which they gave their highest ratings to despite over three trillion dollars of mortgage loans to homebuyers with bad credit and undocumented incomes.” The table above tabulates the deterioration in US corporate credit ratings since 2006. The ratings agencies have applied their trade far more diligently.

As written earlier in the week, US state public pensions are running into horrific headwinds. Unfunded pension liabilities are running at over double the level of 2008. With asset bubbles in stocks, bonds and property it is hard to see how plugging the gap (running at over 2x (California is 6x) the total tax take of individual states) in the event of a market correction is remotely realistic. However taking a look at the progression of US states’ credit ratings one would think that there is nothing to worry about. Even during GFC, very few states took a hit. See below.

1693D305-D977-4EEE-8C91-76F6463D5FCB.jpeg7F0DF445-9C0E-4009-9E13-328F1710E6B1

Looking at the trends of many states since 2000, many have run surpluses so the credit ratings do not appear extreme. It is interesting to flip through the charts of each state and see the trajectory of revenue collection. A mixed bag is putting it lightly. Whether the rebuild after Hurricane Katrina in 2005, since 2008 revenue collection in Louisiana has drifted.

7DA0A5DA-D554-4BDE-87C6-DA1EC03F228C

Looking through S&P’s own research at the end of last year it included an obvious reference.

U.S. state and local governments can use pension obligation bonds (POBs) to address the unfunded portion of their pension liabilities. In certain cases, POBs can be an affordable tool to lower unfunded pension liabilities. But along with the issuance of POBs comes risk. The circumstances that surround an issuance of POBs, as well as the new debt itself, could have implications for the issuer’s creditworthiness. S&P Global Ratings views POB issuance in environments of fiscal distress or as a mechanism for short-term budget relief as a negative credit factor.”

Perhaps the agencies have learnt a painful lesson and trying to stay as close to being behind the curve as possible. It doesn’t seem like public pensions are being factored at levels other than their actuarial values. Marked-to-market values would undoubtedly impact these credit ratings.

As mentioned in the previous piece on public pensions, a state like Alaska has public pension unfunded liabilities equal to $145,000 per household, treble the 2008 figure. It is 3.5x annual tax collections. The state’s per capita operating budget of $13,728 per person is way above the national average of $6,826 per person. Alaska relies on oil taxes to finance most of its operating budget, so a sudden drop in oil prices caused tax revenues to sharply decline. The EIA’s outlook doesn’t look promising in restoring those fortunes in any scenario. So S&P may have cut Alaska two places from AAA in 2015 to AA in 2017.

E0E4BB0B-D7FC-4E45-82BB-063A4CCBB692.png

While pension liabilities aren’t all due at once, the last 8 years have shown how quickly they can fester. It wasn’t so long ago that several Rhode Island public pension funds reluctantly agreed to a 40% haircut, later retirement ages and higher contributions with a larger component shifted from defined benefits to defined contributions raising the risk of market forces exerting negative outcomes on the pension fund.

In 2017, despite a ‘robust’ economy, 22 states faced revenue shortfalls. More states faced mid-year revenue shortfalls in the last fiscal year than in any year since 2010, according to the National Association of State Budget Officers.

0D29429A-6AAD-401B-8F8F-CF143BFCD9A8.png

Pew Charitable Trust (PCT) notes in FY2015 federal dollars as a share of state revenue increased in a majority of states (29). Health care grants have been the main driver of this. FY2015 was the 3rd highest percentage of federal grants to states since 1961.

44BF39DF-FA6C-4B5E-9707-7BD4EC46DE5C.jpeg

By state we can see which states got the heftiest federal grants. Most states with higher federal shares expanded their Medicaid programs under Obamacare (ACA) and got their first full year of grants under the expanded program in FY2015.

FAF8A263-93E6-4974-B371-40FAC25BBA44.jpeg

PCT also wrote “At the close of fiscal year 2017, total balances in states’ general fund budgets—including rainy day funds—could run government operations for a median of 29.3 days, still less than the median of 41.3 days in fiscal 2007…North Dakota recorded the largest drop in the number of days’ worth of expenses held in reserves after drawing down almost its entire savings to cover a budget gap caused by low oil prices. It held just 5.4 days’ worth of expenditures in its rainy day fund at the end of fiscal 2017 compared with 69.4 days in the preceding year… 11 states anticipate withdrawing from rainy day funds under budget plans enacted for fiscal 2018

651662A3-B4C1-4957-BA49-6CB3B0A258FB.jpeg

Looking at the revenue trends of certain states, the level of collection has been either flat or on the wane since 2010 for around 26 states. As an aside, 23 of them voted for Trump in the 2016 presidential election. The three that didn’t were Maine, NJ and Illinois.

Optically US states seem to be able to justify the credit ratings above. Debt levels aren’t high for most. Average state debt is around 4% of annual income. Deficits do not seem out of control. However marking-to-market the extent of public pension unfunded liabilities makes current debt levels look mere rounding errors.

Considering stock, bond and property bubbles are cruising at unsustainably high levels, any market routs will only make the current state of unfunded liabilities blow out to even worse levels. The knock on effects for pensioners such as those taking a 40% haircut in Rhode Island at this stage in the cycle can only feasibly brace themselves for further declines. This is a ticking time bomb. More states will need to address the public pension crisis.

A national government shelling out c.$500bn in interest payments on its own debt in a rising rate environment coupled with a central bank paring back its balance sheet limits the options on the table. Moral hazard is back on the table folks. Is it any wonder that Blackstone has increased its short positions to $22 billion?

DDB24C47-8D86-482E-985A-EF395C905228.jpeg

Truly sickening US Public Pensions data

1 MKT PER HH DEBT 2016

Following on from the earlier post and our 2016 report on the black hole in US state public pension unfunded liabilities, we have updated the figures to 2016. It is hard to know where to start without chills. The current state of US public pension funds represents the love child of Kathy Bates in Misery and Freddie Krueger. Actuarial accounting allows for pension funds to appear far prettier than they are in reality. For instance the actuarial deficit in public pension funds is a ‘mere’ $1.47 trillion. However using realistic returns data (marking-to-market(M-2-M)) that explodes to $6.74 trillion, 4.6-fold higher.  This is a traffic accident waiting to happen. US Pension Tracker illustrates the changes in the charts presented.

Before we get stuck in, we note that the gross pension deficits do not arrive at once. Naturally it is a balance of contributions from existing employees and achieving long term growth rates that can fund retirees while sustaining future obligations. CM notes that the problems could well get worse with such huge unfunded liabilities coinciding with bubbles in most asset classes. Unlike private sector pension funds, the states have an unwritten obligation to step up and fill the gap. However as we will soon see, M-2-M unfunded liabilities outstrip state government expenditures by huge amounts.

From a layman’s perspective, either taxes go up, public services get culled or pensioners are asked politely to take a substantial haircut to their retirement. Apart from the drastic changes that would be required in lifestyles, the economic slowdown that would ensue would have knock on effects with state revenue collection further exacerbating a terrible situation.

CM will use California as the benchmark. Our studies compare 2016 with 2008.

The chart above shows the M-2-M 2016 unfunded liability per household. In California’s case, the 2016 figure is $122,121. In 2008 this figure was only $36,159. In 8 years the gap has ballooned 3.38x. Every single state in America with the exception of Arizona has seen a deterioration.

The following chart shows the growth rate in M-2-M pension liabilities to total state expenditure. In California’s case that equates to 3.2x in those 8 years.

1 MKT PER HH DEBT EXP GROWTH

Sadly it gets worse when we look at the impact on current total state expenditures these deficits comprise. For California the gap is c.6x what the state spends on constituents.

1 MKT PER HH DEBT TAX EXP 2016

Then taking it further,  in the last 8 years California has seen a 2.62-fold jump in the gap between liabilities and state total expenditures.

1 MKT PER HH DEBT TAX EXP 2016 VS 2008

This is a ticking time bomb. Moreover it is only the pensions for the public sector. We have already seen raids on particular state pension funds with some looking to retire early merely to cash out before there is nothing left. Take this example in Illinois.

Sadly the Illinois Police Pension is rapidly approaching the point of being unable to service its pension members and a taxpayer bailout looks unlikely given the State of Illinois’ mulling bankruptcy. Local Government Information Services (LGIS) writes, At the end of 2020, LGIS estimates that the Policemen’s Annuity and Benefit Fund of Chicago will have less than $150 million in assets to pay $928 million promised to 14,133 retirees the following yearFund assets will fall from $3.2 billion at the end of 2015 to $1.4 billion at the end of 2018, $751 million at the end of 2019, and $143 million at the end of 2020, according to LGIS…LGIS analyzed 12 years of the fund’s mandated financial filings with the Illinois Department of Insurance (DOI), which regulates public pension funds. It found that– without taxpayer subsidies and the ability to use active employee contributions to pay current retirees, a practice that is illegal in the private sector– the fund would have already run completely dry, in 2015…The Chicago police pension fund held $3.2 billion in assets in 2003. It shelled out $3.8 billion more in benefits to retired police officers than it generated in investment returns between 2003 and 2015…Over that span, the fund paid out $6.9 billion and earned $3.0 billion, paying an additional $134 million in fees to investment managers.”

1 MKT PER HH DEBT TAX EXP 2016 FUND REV.png

To highlight the pressure such states/cities could face, this is a frightening example of how the tax base can evaporate before one’s eyes putting even more pressure on bail outs.

This problem is going to get catastrophically worse with the state of bloated asset markets with puny returns. Looking at how it has been handled in the past Detroit, Michigan gives some flavor. It declared bankruptcy around this time three years ago. Its pension and healthcare obligations total north of US$10bn or 4x its annual budget. Accumulated deficits are 7x larger than collections. Dr. Wayne Winegarden of George Mason University wrote that in 2011 half of those occupying the city’s 305,000 properties didn’t pay tax. Almost 80,000 were unoccupied meaning no revenue in the door. Over the three years post the GFC Detroit’s population plunged from 1.8mn to 700,000 putting even more pressure on the shrinking tax base.

「misery kathy bates」の画像検索結果

The $6.7 trillion US public pension black hole

4AB447BC-DAE8-4137-A62D-3D118C229F6C.jpeg

Zerohedge published this report today on the $1.2 trillion public pension black hole in America. Time to update the latest stats of a report CM wrote in August 2016 on the very same topic. Here is betting things have only got worse.  Taking California Public Employees Retirement Scheme (CalPERS). In 2014 market pension debt per household was $77,000. In 2016 it hit $122,000. In 2008 it was only $36,000. US Pension Tracker reports that the 2016 marked-to-market figure of the total US public pension deficit is $6.734 trillion vs actuarial basis of $1.467 trillion.

Plunging credit quality more troubling than market rout

D42A75BB-58A4-49A5-B084-32343877CFFF.png

The Dow plunged 1175 points (-4.6%) overnight. 4.6% is a lot and yes 4-digit drops optically look worse but off the higher base we get higher (record) point drops. One thing to contemplate in a rising bond yield market is corporate credit quality. Since 2006 the average credit ratings for US corporates issued by the big agencies have seen the number of top rated (to the left) fall while those with deteriorating grades (to the right) soar. That’s right, the 4 categories before “junk” have risen sharply. After many years of virtually free money many corporations have let the waistline grow. When refinancing comes around just how will credit ratings influence the new spreads of corporates who’ve shifted to the right?

The IMF highlighted in 2017  that US companies have added $7.8t in debt & other liabilities since 2010. The ability to cover interest payments is now at the weakest level since 2008 crisis.

This despite near full employment, record level equity markets and every other word of encouragement from our politicians.

However if this is the state of the corporate sector at arguably the sweet spot of the economic cycle CM shudders to think the state of potential bankruptcies that will come when the cycle truly takes a turn for the worse. This is a very bad sign.

Madoff wasn’t so long ago

89DCC612-C930-4241-97C5-13C9C2D0535E.jpeg

It was just over 9 years ago that Bernie Madoff pleaded guilty to a Ponzi scheme that cost investors over $65bn. While many happily point fingers at greedy banksters we tend to forget that despite Harry Markopolos, handing the SEC (the US regulator) the details of the case in 1999 on a platter it failed to act. His testimony points directly to the kind of problem that exists with government regulators – no track record in the fields they legislate. In the 9 years prior to Madoff pleading guilty, Markopolos caught him at the $6bn stage. The SEC after multiple investigations turned nothing even with a treasure map provided by Markopolos that someone with markets experience would have discovered in 30 minutes. Throw on all the other scandals (ratings agencies etc) that the SEC failed to capture and it cost taxpayers $700bn.

Willful negligence? I gave a speech at the Japanese financial regulator (FSA) on fraud and insider trading  at the time of the Kobe Steel data scandal. When presented with comparable data with other exchanges the blind eye is no less scandalous. So before hanging the financiers out to dry perhaps people ought to question the regulators whose incompetence and inaction is at fault. If you give a child a box of matches unsupervised then don’t be surprised if the whole house burns down.

Why buy a Rolls-Royce without a Rimowa??

764137F2-C48C-469D-9FB0-6A3F5848ABF6.jpeg

I guess even the some of well heeled are strapped for cash. Surely the pomp of being able to buy a Rolls-Royce is the theatrics of handing the dealer a Rimowa briefcase stuffed with crisp bank notes. The RR offer is a combination of a $10,000 special buyers support and 0.99% financing. Maybe RR realizes that its customers are probably punting bitcoin so need the extra leverage a 0.99% loan provides?

In the old days as an industrials analyst, I used to cover a stock called Ferretti which made ridiculously large motor yachts where the average price was $15 million +. When Asking the company how the tech-wreck internet bubble collapse would impact sales they responded “our customers do not experience recessions”. One wonders if RR are requiring discounted financing to shift product that costs as much as a house that perhaps their customers “do experience recessions