Weekend Edition

Dear Reader,

Welcome to the weekend edition of Casey's Daily Dispatch, a compilation of our favorite stories from the week for the time-stressed readers.

Of course, if you want to read all of the Daily Dispatches from the week, you may do so in the archives at CaseyResearch.com.

Stuff in the Fan

I hesitate to comment too frequently on short-term market actions. However, given that Friday saw a significant sell-off in the DJIA, and the sell-off continues this Monday morning, a comment or two are called for.

As we have previously mentioned, perhaps to the point of being tiresome, the structural imbalances in the economy that brought us to this place remain largely unaddressed. And many of those imbalances, for example government deficits, grow exponentially worse.

While I don’t think it’s a good idea to actively look for bad news, there is so much of the stuff lurking about that taking any more than a step or two in any direction causes you to bump into it.

For example, this morning our own Chris Wood sent along an item from The Wall Street Journal that puts the lie to the idea that the banks are on the mend or that the government is effectively coping with the situation. An excerpt…

Banks in the U.S. that failed in the past two years were in far worse shape than those that collapsed during the industry's last crisis, a looming problem for the government agency charged with insuring deposits.

At three of the five banks that failed Friday, increasing the total to 77 so far this year, the financial hit to the agency's deposit-insurance fund is expected by the Federal Deposit Insurance Corp. to be about 50% of their assets.

The biggest hit on a percentage basis is coming from Community Bank of Nevada, a Las Vegas bank with $1.52 billion in assets and an estimated cost of $781.5 million. The failure of Colonial Bank, a unit of Colonial BancGroup Inc. that was sold to BB&T Corp., will cost $2.8 billion, or 11% of the Montgomery, Ala., bank's assets.

For the 102 banks that have collapsed in the past two years, the FDIC's estimated cost averaged 25% of assets. That is up from the 19% rate between 1989 and 1995, when 747 financial institutions were closed by regulators, according to the FDIC.

The agency's insurance fund already has dipped to $13 billion, with more than 300 battered banks and thrifts still on an undisclosed FDIC list of problem institutions.

One problem is that so many banks took risks when the economy was booming, and are seeing their capital dissipate with alarming speed.

"Compared to the savings-and-loan crisis, banks these days have gotten much bigger and the economy has gotten much bigger," said Bob Patten, an analyst at Morgan Keegan & Co. "This crisis won't eclipse the last one in size, but the costs to the FDIC are showing the amount of leverage they really had on their books."

… As the number of bank failures escalates, FDIC officials have been trying to find investors and buyers for terminally ill financial institutions, increasingly by agreeing to shield acquirers from certain losses on assets of the failed bank.

The FDIC and BB&T entered into a loss-share transaction on approximately $15 billion of the $22 billion in Colonial assets bought by the Winston-Salem, N.C., bank. FDIC Chairman Sheila C. Bair said in a statement that losses from Friday's failures "are lower than had been projected."

Joe Bel Brumo, writing in The Wall Street Journal

Note that bit about the government “agreeing to shield acquirers from certain losses on assets of the failed bank.” This sort of guarantee has become a popular backdoor way for the government to deal with various elements of this crisis, without the more overt method of writing a check to cover losses or, heavens forbid, actually letting the equity holders bear the brunt for having made a bad investment in a poorly run bank.

Instead, the government jiggers things to hand off the good assets of a bad bank to one of their buddies, while agreeing to shift the liability for the poor assets onto the backs of taxpayers – with the IOU due and payable at some point down the road.

Likewise, today, the Fed announced that it was extending its backstop and bailout for commercial real estate and similar enterprises with underlying assets crumbling under unmanageable levels of debt.

Aug. 17 (Bloomberg) -- The Federal Reserve extended by three to six months an emergency program aimed at restarting credit markets, a move that may cushion the commercial real-estate industry from rising defaults and falling prices.

The Term Asset-Backed Securities Loan Facility, with a capacity of as much as $1 trillion, will expire June 30 for newly issued commercial mortgage-backed securities, instead of Dec. 31, the Fed and U.S. Treasury said today in a statement in Washington. For other asset-backed securities and CMBS sold before Jan. 1, the plan was extended three months to March 31.

Property values have fallen 35 percent since peaking in October 2007, according to Moody’s Investors Service. That’s making it tough for owners to refinance almost $165 billion of mortgages for skyscrapers, shopping malls and hotels this year. The Fed is “paying very close attention,” Chairman Ben S. Bernanke said in congressional testimony last month.

While financial-market conditions “have improved considerably in recent months,” the markets for ABS and CMBS “are still impaired and seem likely to remain so for some time,” the Fed and Treasury said.

Increasingly, it seems, we are not alone in our steady pessimism about how long it will take for this crisis be resolved. Bud Conrad, chief economist of this operation, sent over the annual report from the Bank for International Settlements today, along with a snippet summing up their view of the outlook for the economy. Here’s that snippet…

So far, the crisis has developed in five more or less distinct stages of varying intensity, starting with the subprime mortgage-related turmoil between June 2007 and mid-March 2008 (Graph II.1). Following this first stage, during which the primary focus was on funding liquidity, bank losses and writedowns continued to accumulate as the cyclical deterioration slowly translated into renewed asset price weakness. As a result, in the second stage of the crisis, from March to mid-September 2008, funding problems morphed into concerns about solvency, giving rise to the risk of outright bank failures. One such failure, the demise of Lehman Brothers on 15 September, triggered the third and most intense stage of the crisis: a global loss of confidence, arrested only after unprecedented and broad-based policy intervention. Stage four, from late October 2008 to mid-March 2009, saw markets adjust to an increasingly gloomy global growth outlook amid uncertainties over the effects of ongoing government intervention in markets and the economy. Stage five, beginning in mid-March 2009, has been marked by signs that markets are starting to show some optimism in the face of still largely negative macroeconomic and financial news, even as true normalisation – the end of the crisis – still appears some way off.

You can read the full report, and see the chart in better detail, here… http://www.bis.org/publ/arpdf/ar2009e2.pdf

While it is still far too early to say whether we are seeing the beginning of the next stage down, when true capitulation sets in, the facts on the ground suggest it’s coming sooner rather than later. This is bad news only if you are sitting on a portfolio of overvalued stocks, but good news if you’re keeping a close eye on excellent companies with an intention to buy them on the cheap.

For instance, in The Casey Report we are watching a regional energy provider that has posted year-over-year gains in net profit of over 47% but is still selling for close to half of its book value. Which means you are buying a dollar’s worth of assets for 50 cents. With each passing day, the market is bringing the share price of this giveaway stock closer to our buy point, after which we fully expect to be rewarded with 50% or better gains… almost regardless of what the stock market does thereafter.

While many investors fail to realize it, this remains a buyer’s market – meaning you can take your time, pick your battles, and call your own shots. There are good times ahead, at least for the attentive.

Sponsor Advertisement

Our first-ever Casey Research Energy & Special Situations Summit is scheduled Sept 18-20 at the beautiful Westin Tabor Center in Denver. Featuring an all-star faculty, including Doug Casey, Dr. Marc Faber, Lukas Lundin, Rick Rule, Ross Beaty, Marin Katusa, Frank Holmes - and that's just for starters! You'll learn everything you need to make the big profits in the coming upcycle for energy – as well as special situations in rare earths, potash, lithium and more. Stay home and you'll miss a once in a lifetime chance to get fully up to speed on today's most compelling opportunities in energy. View the updated schedule by clicking here… and learn more about the event by clicking here. See you in Denver!

Foreign Purchases of U.S. Assets Slow

By Bud Conrad

Cross-border flows of capital investments of all kinds have dramatically fallen off. The big picture, as reported in the United States Treasury's International Capital (TIC) System, shows a decline in the 12-month sum of flows through June.

The annual sum peaked in August 2006 at just under $1.2 trillion of foreign capital flows. That number has collapsed to under $200 billion. The 12-month sum gives a better indication of the situation than the latest monthly data, because numbers jump around surprisingly. The data here were reported August 17, 2009.

A big component of flows, investments in all long-term securities over the last 12 months, has dropped almost to zero.

And the composition of investments has shifted, with the world moving away from riskier assets towards Treasuries and government-supported agency debt.

An even closer look into the Treasury debt investment by foreigners shows a dramatic shift from longer-term paper of over one year duration to shorter-term T-bills:

The shift to three-month Treasury bills as the investment vehicle of choice is probably due to foreigners fearing that higher interest rates on the longer-term paper could cause their investments to decline. Perhaps investors also want the flexibility of redeploying their money in other places within a short period of time. It could be from a lack of confidence in the long-term prospects for the U.S. dollar. Then there is even some speculation that excess dollars created by the Federal Reserve in swap transactions could perhaps be reinvested in short-term U.S. Treasuries to provide liquidity for the U.S. government.

An important reason for slowing investments is that the U.S. trade deficit is becoming less negative. That means foreigners have less money to reinvest in the U.S. from their trade surpluses. The investments of choice, away from the less secure and longer-term and into shorter-term, government-supported debt, suggest that the appetite of foreigners for U.S. investment is waning.

Along similar lines, there was a story out today that is more important for its position as the lead story in the China Daily than for its content. I take it as a message from China to the U.S. to be careful with the dollar or face further selling. Here’s the story…

China cuts US Treasury holdings in June

NEW YORK: China reduced its holdings of US Treasury debt in June by the biggest margin in nearly nine years, according to a US Treasury Department report issued on Monday.

China cut its net holdings by 3.1 percent to $776.4 billion in June from $801.5 billion in May, the report says. This is also the first large-scale reduction of US Treasury debt by China so far this year.

However, its June holdings were still larger than April's $763.5 billion and $767.9 billion in March, according to the statistics of the Treasury Department.

Reuters data show the drop in China's Treasury holdings in June was the biggest percentage reduction since a 4.2 percent cut in October 2000.

On the other hand, Japan, the second-largest holder of US Treasury securities, increased its holdings to $711.8 billion in June from $677.2 billion in May.

The United Kingdom, the third largest holder, also increased its holdings to $214 billion in June from $163.8 billion, a surge of 30.6 percent.

The UK buying is probably indirect from somewhere else, as they are an international center.

Bud

Speaking of Knives

There are two sides to every enterprise, expenses and revenues. We don’t need to tell you about the government’s many expenses, if for no other reason that we have beaten that drum fairly constantly over the past few years.

Turning to the question of revenue, we know how the government won’t be generating more of the green stuff – by actually producing something of value. You know, turning on a machine (other than a printing press, that is) and creating something that consumers or industry actually want to own and are willing to trade good value for.

Which leaves D.C. bankrupt to turn elsewhere to try and repair the gaping hole below its waterline. The options it has are limited but not insignificant – starting by raising taxes of all description and including just printing money out of thin air. But as the latter activity could cause the Chinese, among others, to accelerate their divesting of dollars, the government must look elsewhere.

In ancient Rome, Caligula instituted policies whereby a citizen could rat out another citizen for any one of a number of real or imaginary offenses and, on scant proof, the state would – before dropping them as an unwilling entertainer in a bloody circus – strip the purported offender of their assets and give the informer half of the assets seized. (Of course, once the rat had amassed a sufficient amount of wealth themselves, then they, too, became a target – so there was a modicum of justice in the system.)

The motivation of the Swiss bank UBS in turning over thousands of U.S. account holders to the IRS was no less self-serving. While they won’t get to share in any of the assets the U.S. government ultimately grabs, they will avoid the penalties and worse that they would have otherwise been burdened with if they hadn’t rolled over. Principle and a good-faith agreement with their account holders to preserve their financial privacy be damned.

Of course, any U.S. citizen stupid enough to try and hide money from the U.S. government is asking for trouble. But the trend toward destroying financial safe havens is disturbing, for the same reason it would have been disturbing back in World War II, when individuals looked to protect at least some of their wealth from a government gone amok by shipping it elsewhere. In today’s world, that option is all but gone – especially if you are from the U.S., because there are hardly any foreign institutions remaining that will even open an account for you.

Once the trap is closed, the government is then free to change the rules, or raise your taxes, at will. And there will be nowhere to hide.

Flopping back to the expense side, in case you missed it, even Warren Buffett has gone public in agreeing with our contention that the government’s proliferate spending will lead to a serious degradation in the value of the dollar. Here’s his opinion piece. http://www.nytimes.com/2009/08/19/opinion/19buffett.html?_r=1

About That Whole Greedy Insurance Company Thing

As I have mentioned recently, the Obama administration admits to paying very close attention to polls, and those polls tell them that the masses hold a low opinion of health insurance companies. No political neophytes, the president and his smarter-than-us team have been quick to shove the insurance companies and their obscene profits in front of the mob, shouting and pointing at them as the evil, greedy bastards they surely are.

A quote from the horse’s mouth:

“There have been reports just over the last couple of days of insurance companies making record profits, right now…” – President Obama in a July 22, 2009, press conference

The implication being that excessive profit taking by the insurance companies is the root cause of what now ails us.

Ignoring the simple truth that providing health insurance should not, in and of itself, make healthcare more expensive -- anymore than car insurance makes a trip to the body shop more expensive – let’s look at the claim about excessive profits.

Are health insurance companies making obscene profits? A look at the numbers, which you can take by arming yourself with a magnifying glass and then following the link just below, says no. http://static.seekingalpha.com/uploads/2009/8/13/saupload_profits.png

To save you the reading time or eye stress: out of all the various business sectors tracked, health insurance companies rank 86th, with a profit margin of just over 3%.

If you look further up the list to #3, you see that REITs that specialize in healthcare facilities pull in a hefty 24.6% profit margin. Maybe Obama et al. should demonize and nationalize healthcare facility REITs instead? I suspect not, as that would require actually providing some hard explanation, versus the more simplistic “Health insurance companies, bad” mantra.

It’s propaganda at its worst. Or maybe its “best”?

Green Shoots

By Terry Coxon

If the heralded “green shoots” of economic recovery – a worldwide rally in stocks, a rebound in the price of oil, the slowing in the rate of job losses – are really just an illusion, if the little tastes of good news are masking a slide into an even deeper recession, where does the illusion come from?

Dig into the warnings from Germany, and you’ll find a clue about how the illusion might work. Bundesbank chief Axel Weber cautioned over the weekend:

"I must warn that it is too early to talk about the end of the financial crisis. Unemployment is going to rise as “Kurzarbeit” [government subsidies to keep unneeded workers on private payrolls] expires, and that could hurt consumption."

"The first round of disruption in the bank balance sheets from structured credit products is behind us. Now we are threatened by stress from our domestic credit industry through the rise in the insolvency of firms and households," he told the Süddeutsche Zeitung.

Writing in the London Telegraph, Ambrose Evans-Pritchard explains, “the problem for Germany is that car scrappage schemes and pent-up orders for German goods built up during the freeze in global trade finance over the winter may have disguised the underlying weakness of the economy.”

Here’s the model the news from Germany seems to fit.

1. Shock. For most people, last fall’s revelation that the world’s biggest financial institutions were really just a band of beggars was a frightening surprise.

2. Panicky reaction. The shock wasn’t a little one. It was off the scale. So the reaction wasn’t measured or proportionate, it was extreme and indiscriminate. One element of that panicky reaction was the near total unavailability of financing for international trade, hence the “pent-up orders for German goods.”

3. Relief and catch-up. When the feeling of shock passes and the immediate facts aren’t as terrible as expected, people begin to catch up on the spending and other activity they had postponed. In the German example, lenders returned to the credit window and resumed financing for export goods that had been waiting on the docks. Compared to what had been feared just a few months before, the tentative revival in economic activity looks like… look closely now and you can see that it looks like… like… green shoots!

That pattern also matches the U.S. experience. The demise of Lehman Brothers and the near-death experiences of so many of its fellow giants shocked the U.S. economy into near paralysis. The money blasts from the Federal Reserve and the Treasury calmed the panic, and by springtime many businesses and consumers had taken a half step back from the spend-nothing-lend-nothing attitudes that had prevailed during the winter. That half step produced what looks like the beginnings of economic recovery.

What emerges when green shoots illusion fades (and proves that it was nothing but illusion) is…

4. Ugly facts. While the wavelet of panic and relief is rippling across the economy’s surface, the underlying mechanism of contraction continues. Borrowers that two years earlier had looked like good risks no longer are. Each weak borrower (in many cases with the cooperation of its weak lender) can postpone the day of reckoning for a while, but not forever. Time runs out and then another credit crisis erupts. That’s what the Bundesbank chief was warning against.

If such ugly facts are indeed a-building, when will they become apparent?

In Germany’s case, Hartmut Schauerte, state secretary of the Ministry of Economics and Technology, refers to the need for many businesses to roll over their loans and points to the time of maximum stress. "The most difficult phase for financing is going to be in the first and second quarter of 2010."

Perhaps it’s only a coincidence. In the U.S., forecasts from credit analysts dealing with the commercial mortgage market range from gloomy to mortuary. Press for details on timing and they will cite the first or second quarter of 2010 as the time when owners of tall, $100 million buildings will start giving their lenders the bad news they should have faced up to months earlier.

You can read Ambrose-Pritchard’s take on the German situation by following the link here:

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/6050822/Germany-braces-for-second-wave-of-credit-crunch.html

And that, dear reader, is that for this week. See you Monday!

David Galland
Managing Director
Casey Research