Dear Reader,
With my (more or less) trusty computer online again, I’m back in business. I would like to start off today's missive by sharing a few recent experiences. Before I do, however, I want to share another song by Everlast, a band that has caught my attention of late. The song is called “Ends,” and its lyrics are appropriate for a number of the stories in today’s edition. You can listen to it here.
And with that, it’s on with the show…
Mind Your Own Business
Presenting myself for a routine medical checkup earlier in the week, I was asked to take a clipboard in hand and answer a variety of mostly health-related questions. No problem.
But then, at the end of the form, I was surprised to find a series of questions that, according to the doctor’s office, they were required to have answered by the federal government. The first was whether or not I was of Hispanic origin – not Polynesian, or Eskimo, or anything else -- just Hispanic. Followed immediately by asking me how many people live in my household.
I was then asked to fill in a blank with the dollar amount of my annual income. Before I could think of a properly worded response to write in, in lieu of my financial details, I noticed that the next line had a check box followed by… "I respectfully decline to provide the details of my household income."
Now, I don't know what bureaucrat dreamed up the idea of requiring a doctor's office to collect and report this sort of information, but if the intention was to get my blood pressure up, they succeeded. Why not ask about my sex life while they are at it? And why stop at doctor’s offices?
Why not at the gasoline pump?
Or maybe down at the barber’s shop? “Hey, before I give you that trim, I’m required to ask you a few questions. Are you Portuguese? Do you keep any cash around the house?”
Why Medical Care Costs So Much
Recently my regular doctor moved out of town, leaving me in the care of a new doctor who gave me the just referenced physical. As he looked over my records, he noted that I've had a lot of medical tests over the last couple of years. And he was right. With my former doctor, the slightest anomaly in an examination resulted in a flurry of script writing, followed by the better part of a day spent in residence at a nearby hospital in the company of any number of specialists armed with expensive equipment.
Furthermore, my new doctor informed me, the pills previously prescribed for my very borderline elevated blood pressure (one of these days, I must switch to weaker coffee) were about the most expensive on the market. Specifically, he pointed out, they were costing me about $168 a month – whereby much the same drug in a generic version would cost just $4 a month. So, that’s $2,016 a year vs. $48.
Given this was not a discussion I had ever had with my former physician, I asked the new guy if the old team might have had a financial incentive for prescribing the more expensive drug or the many tests they had subjected me to over the last few years.
He said he wasn't sure about the medicine, but confirmed that doctors do get a cut of the costs of any tests they order. Funny, I never thought to ask about this before. Because, of course, with a third-party payer system, I really don’t need to know.
I did, however, ask how much my dental cleaning was this morning – because that comes out of my pocket – and it was $128 for about half an hour with a hygienist. That's not chump change – but if the service had been provided in a doctor's office and was covered by my insurance, you can bet the final tally would have been much, much more.
How to Sleep at Night
Earlier in the week I had a couple of mostly sleepless nights. This occurs, I have discovered over the years, only when something is bothering me. In this case, it was a recent issue with a friend that I had been too busy and too preoccupied to address.
If I’ve learned one thing in my life, however, it is that you don't let things fester. And so I called my friend and we had a long, candid conversation that cleared the air of any misconceptions and grievances. Last night, I slept the sleep of the innocent.
I mention this because we all know so many people who carry a world of troubles on their backs, day in, day out, week after week, and sometimes even year after year. But they do so, in my experience, only because they are afraid of actually dealing with those troubles head-on. The result is a constant pressure on a person’s psyche and, over time, a steep degradation in the quality of life. Which is a shame, because even the heaviest load can be lifted if you're not afraid to tackle it. The alternative of living with a gnawing malcontent is, to my way of thinking, unimaginable and unacceptable.
Okay, enough of that.
JP Morgan Review Q3
One of the great things about being a part of this organization is that when I see something that doesn't make sense to me or that I don't fully understand, I’m able to reach out to some really smart individuals and benefit from their perspective.
In that regard, our own Bud Conrad was kind enough to look into the widely touted third-quarter results from JPMorgan. Here's his take.
JPMorgan had a very strong Q3 report this morning (October 14, 2009). Highlights presented by Bloomberg are here:
http://www.bloomberg.com/apps/news?pid=20601087&sid=ayuVj77yROCA
Their net income by sector jumped around wildly in recent quarters, with both investment banking and corporate/private equity swinging back and forth.
(Click to enlarge)
The key management problem for banks is to adequately cover ongoing and potential loan losses. The following chart summarizes the risky part of their portfolio of non-performing loans (NPL) and the provision for the losses called loan loss reserves (LLR). The credit crisis has Morgan holding $17.7 billion of non-performing loans. That is still a low number compared to its total loan portfolio of $653 billion. The reserves of $30.6 billion are only 5%. Are their loans really that strong? It requires a detailed look at each category to be more confident of potential write-downs. We know how bad some sectors are, like mortgages. They are saying they have an adequate position.
(Click to enlarge)
T
The summary measure is the loan loss reserve divided by the non-performing loans. As non-performing loans have increased, the ratio has declined even as the reserve has been expanded. The ratio is at 212%, enough perhaps for the current situation, but declining.
The hidden risk in JPM is not its official profit numbers but its huge book of derivatives. They have been taking some of the biggest risks of all the banks in their holding of derivatives. The following table from the Office of Comptroller of the Currency for the second quarter of 2009 shows JPM holding 283% of risk-based capital as credit exposure. It has come down, but it’s still higher than its peers, except for Goldman Sachs.
(Click to enlarge)
It is hard to see all the potential problems in the official numbers from the banks, but we know that they have been given a green light to legally hide how bad their loan portfolio is by relaxing the requirement of mark-to-market loans that would be hard to sell in today’s risk-averse market. While the third-quarter bottom line number today of $0.82 cents per share (times 4 and divided by today’s price of $47) is a P/E of 14, which is attractive, I think the risk in this whole sector is higher than they are letting on.
Bad Loans, Bad Business
David again.
On the topic of bad loans, there was this out today from Bloomberg…
Oct. 15 (Bloomberg) -- U.S. foreclosure filings climbed to a record in the third quarter as lenders seized more properties from delinquent borrowers, according to RealtyTrac Inc.
A total of 937,840 homes received a default or auction notice or were repossessed by banks, a 23 percent increase from a year earlier, the Irvine, California-based seller of default data said today in a report. One out of every 136 U.S. households received a filing, the highest quarterly rate in records dating to January 2005.
“The problem is prime loans going into foreclosure and people being underwater and losing their jobs,” Richard Green, director of the Lusk Center for Real Estate at the University of Southern California in Los Angeles, said in an interview. “It’s a really bad number.”
Mounting foreclosures mean U.S. home prices probably will resume falling, analysts from Amherst Securities Group LP in New York said Sept. 23. A “shadow inventory” of 7 million properties are in the foreclosure process or likely to be seized, up from 1.27 million in 2005, they said.
When it comes to real estate, Andy Miller is another really smart person we regularly communicate with. This morning he sent across a couple of items.
The first, an article from Reuters, had to do with the imminent bankruptcy of Capmark, a $10 billion real estate conduit. As Andy puts it, "Capmark, with $10 measly billion, is the tip of the iceberg. The CMBS (commercial mortgage-backed securities) world is over $800 billion.”
The second article Andy sent along was from Bloomberg. His message…
David, this is the start of something big. This is the incipient stage of rewriting the banking rules to allow the banks to survive.
The "something big" are new federal bank regulations now brewing that, when released, will be designed to head off a wave of bank failures due to an overhang of bad real estate loans. This was entirely predictable, given that anyone with decent vision or an up-to-date prescription from their local optician can see the commercial real estate debacle speeding this way.
You can read the article here.
The problem, of course, is that there is no such thing as something for nothing. Well, I suppose you could walk outside and grab a handful of dirt and you'd have something for nothing – but when it comes to hundreds of billions of dollars of bad real estate loans, there is no magic wand to make this go away.
Either the investors in the various real estate projects connected to those loans are able to meet the terms of their agreements – or arrange for those loan agreements to be rolled over on terms they can afford – or the banks are eventually going to have to foreclose.
With either of those outcomes, the banks will have to recognize a loss. In the case of a renegotiation, it will almost certainly have to involve a reduction in principal, because commercial real estate is off, depending on the market, somewhere between 25% and 50%. And, should a bank have to foreclose, there's no way it is going to be able to flip those properties for anywhere near the loan values. Which means the banks will no longer be able to hide behind the current accounting fiction – not when they have to recognize actual, tangible loan losses. When that happens, the desperately undercapitalized banks in their many hundreds will collapse.
Maybe the new regulations will consist of an impressively constructed combination of words that will somehow not ultimately transfer the burdens of the banks onto the backs of the taxpayers – but call me skeptical.
Straws in the Wind – from the UK
Dear friend and correspondent Sadia sent over a few items this morning I thought you’d find of interest. The first is a report from the Telegraph that Harrods will begin selling gold bullion for the first time. And I quote…
It is renowned for its glitzy clientele and upmarket Knightsbridge location, but shoppers at department store Harrods will from today be able to buy the ultimate luxury accessory – gold bars. You can read the article here.
Then there was another article, out of the Times Online, that once again demonstrates an odd quirk in the British personality that appears to make them favorably inclined toward the nanny state… or worse.
Now, I don't know whether this is a result of the tradition of English boarding schools – complete with stern headmasters and brutalizing upperclassmen – but I have a hard time explaining this odd flirtation with totalitarianism in any other way.
I think you'll understand what I'm getting at when you read the following excerpt from the Times article "Crime Spotting: the New Way to Make Money on the Internet."
Britain, already one of the most snooped-upon nations on Earth, is about to become a nation of snoopers.
A network of citizen crimewatchers will be given the chance of winning up to £1,000 by monitoring CCTV security cameras over the internet.
The cameras’ owners will pay a fee to have users watch the footage. The scheme, Internet Eyes, is being promoted as a game and is expected to go “live” next month with a test run in Stratford-upon-Avon.
Subscribers will be able to register free and will be given up to four cameras to monitor.
Eventually the consortium behind the idea hopes to have internet users around the world focused on Britain’s 4.2 million security cameras, waiting to see and report a crime in return for cash prizes.
Were it not so terrifying, or were you generally in favor of such things, you might give a tip of the hat to this latest initiative for its creativity. With millions of people now unemployed or living in poverty, the potential pool for CCTV snoops is nearly unlimited.
However, not being in favor of such things, I have to believe that if I were a citizen of the United Kingdom, I would be packing my bags as soon as I could.
Meanwhile, if you are a wannabe snoop, just below is a link to one site now accepting new recruits. You, too, can compete for prize money from the comfort of your couch… check it out.
When you click on that link, you’ll see a photo of a model snooper. I had to snag it and drop it in here. Admire, if you will, the vacant stare as the couch potato monitors a CCTV camera, watching for “anti-social behavior” while reclining comfortably on her sofa, to quote the web site on the sort of activity she should report to get a ticket in the lottery drum.
U.S. Corporate Issues Soar!
Another item that I would have commented on yesterday if I hadn't had computer problems had to do with the blaring headlines that U.S. corporate bond issues surpassed the $1 trillion level in 2009 – which was taken as yet another green shoot. Here's a quote from Bloomberg on that topic…
Borrowers have sold more than $1 trillion in U.S. corporate bonds in 2009, the fastest pace on record, taking advantage of lower rates and government support to bolster cash holdings after last year’s credit freeze.
Having tossed that item over the fence to our own Terry Coxon, I received the following back...
This doesn’t mean that the credit window has been thrown open to corporate borrowers. The story is about gross borrowing through issuing bonds. It’s not about net borrowing, and it’s not about borrowing through other means.
Gross, not net. Even with today’s higher risk premiums (for corporate issuers vs. U.S. Treasury), rates are lower for many corporate borrowers than what they’ve been paying on older, callable bonds. So they call and reissue at a lower rate.
Not total borrowing. Today’s terrified banks have cut back on corporate lending, so some part of corporate bond issuance is a replacement for bank lending.
No question about it, we live in a world that has become so complex, it is near impossible to see to the truth of just about anything. As such, if you are not a skeptic, it's a given that you will become a dupe.
That’s It for Today…
And with that, dear reader, I must sign off for the day. As I do, I note that the stock market, which was down a bit earlier, is now mostly flat on the day, and gold, which came close to taking out the $1,050 level, has bounced back up a bit.
So, business as usual.
According to the folks at Sumitomo Mitsui, however, it won’t remain business as usual for much longer. Agreeing with us that there is likely going to be a double dip in the economy, that bank's chief strategist has joined the chorus saying that he sees the U.S. dollar approaching a tipping point.
Once that tipping point is reached, according to Daisuke Uno, "The dollar’s fall won’t stop until there’s a change to the global currency system.”
Rubbing it in, he went on to say...
“We can no longer stop the big wave of dollar weakness,” said Uno, who correctly predicted the dollar would fall under 100 yen and the Dow Jones Industrial Average would sink below 7,000 after the bankruptcy of Lehman Brothers Holdings Inc. last year. If the U.S. currency breaks through record levels, “there will be no downside limit, and even coordinated intervention won’t work,” he said.
If there is one thing you can say about this old world of ours, it is that there is rarely a dull moment. I can hardly wait to see what tomorrow brings...
Until then, thanks for reading and for subscribing to a Casey Research service.
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