Bearish News

Bruce Krasting is a 25-year Wall St. vet, and runs one of my favorite finance/econ blogs.

#1 – If you were advising President Obama, what would your #1 economic action item be? Ignore political viability, if possible.

On a “big picture” basis I would set an agenda that was clearly moving in a direction of unwinding many/all of the emergency measures that were introduced in 08. For confidence to be restored we have to get the sense that the crisis is behind us. There is nothing that can be done “tomorrow” that can magically restore home values and reduce unemployment. Bernanke will try to save the day with QE-2, but it will not work any better than QE-1 did. A short term benefit at most. Same with fiscal policy. We can have another stimulus and borrow another $1 trillion. That would give us a few quarters more of anemic growth. But after that we would fall off the shelf when the life support ends. Our policies appear to me to be a bridge to no-where. A smooth ride till the end of the ramp and then a crash.

I think the Europeans have it closer to “right” than we do. They are moving in the direction that I think is better if one is looking out five years and asking, “What do we want to look like?” We are headed in the direction of Japan. We will have 1% growth (disaster) and debt to GDP of 150% (death).

But you asked a narrow question. What would I do?

I think we do need a stimulus. But it has to be different this time. We need the private sector to pick up the slack. So let’s give them a chance. I want a one year (18 months?) Payroll tax holiday. That tax is currently 12.4%. For 2011 that tax will be equal to about $700 billion. A very big drag. I want to cut SS by 60% during the holiday. I want the reduction to be shared by workers and and their employers. I would have a ratio of 60% for the workers and 40% for the employers. I want to put $400b in the hands of the private sector. This is money that does not even get collected by D.C.. So the government can’t spend it. I believe that the 150 million American workers will make the best use of that extra $240B. They will spend some of it and they will save some of it. The companies that get a break will also spend it. I would require that the savings that the employers get have to be re-invested.

BUT. This has to be PayGo. This can be done. I estimate that a ~4 year cut of SS benefits for those who are getting checks now but also have taxable income in excess of ~$200k PA is required. I call this the Bill Gates/Warren Buffet tax. These guys do not need the extra 1500 a month SS is paying them. This is a means test. It taxes wealth. I do not like that, but it is necessary. We have to raise revenue.

The percentage of people that this would affect is small. Therefore it is politically “sale-able”. It is a significant change of the rules of SS. But those changes would be temporary. To attempt to make this “fairer” I would give those that lost benefits a tax credit. That tax credit would be available to offset (dollar for dollar) any federal estate taxes that would be due at death. What would this do? It would put more “wealth” back into the hands of the next generation. Everything we do robs from the next generation. This has the opposite impact. It puts more in the hands of our children.

Some would object to this. But my guess is that Bill and Warren and many others who would lose benefits would be happy to do so. Those that would be impacted by this have a great stake in America. These are the ones who have the most to lose if we fall into a debt spiral or a depression. They are getting the money, but only after they are dead.

Trust me. A $400b reduction in PR taxes would be a very effective stimulus. It would work. The economy would stabilize. But it must be paid for. If we just borrow and spend we will have accomplished nothing. Making it PayGo would instill confidence.If confidence is restored markets will improve and interest rates will return to more normal levels. Those that lost SS benefits would rejoice at that result.

Disclosure: I would lose my benefits if this plan were implemented.

#2 – You have written extensively about Social Security. Which aspect of this program do you feel is most misunderstood? How much of a threat are baby-boomers to entitlement programs?

Hmmm. Most misunderstood? There are so many aspect of this that are misunderstood.

The $2,500,000,000 Trust Fund has to be at the top of the list. I typed all the zeros to show just how big the number is. $2.5 Trillion. Hard to think of.

Some say there is no money or assets in the TF. That it was robbed by some prior administration. Many refer to it as a ponzi scheme. Just a fictional accounting scam.

Those on the extreme other side look at this as massive pile of AAA Treasury bonds that will mature and be available to pay scheduled benefits for the next 25 years or so. They think that SS is sound and nothing need be done about it.

Both of these views are wrong in my opinion. The bonds in the TF will be paid on time. They are legally just as sound as those held by the Chinese central bank. We exclude these debts when evaluating our current Debt/GDP ratios.  We are doing ourselves a disservice, this is real money that is owed.

But to honor these debts means that the Debt Held By the Public will increase $ for $. That can’t and will not happen. Yes there are real assets, and no they can’t be used without a (my word) disastrous consequence to the bond market. There is a limit to what can be sold. I think we are dangerously close to that limit today. Adding in another 2.5t will make us lose our AAA and our financing cost will go up. We will become Greece.

On the Boomers. They have been the problem for decades. This demographic bulge is probably our most significant medium term challenge. When the boomers were born they created a housing boom. That has not stopped until 2007. 2008 is the first year of the boomers getting to 65 folks. That is not a coincidence. The mcmansions, second and third homes are coming up for sale now. The boomers are downsizing. This will go on for many years.

While the boomers did pay a lot of taxes and funded the surpluses in SS they are now going to start costing us big time. The aging of our population is accelerating. We still have a decade to peak.

If the economy were growing by 4-5% we could afford this transition. But that is the least likely thing to happen. Because of the boomers, we will be lucky to grow at 1.5%. Should that be the case the boomers will sink the economy.

Resources are are scarce. Allocations will have to be made. It will not be pretty. We have the risk of “age warfare”. We may be faced with the choice, “Who do we protect?” The health and education of people 25 and younger, or the health and well being of those over 80. If we are faced with triage we will have to support the former over the latter.

Socially, we may be looking at a bad end for the boomers.

I am a boomer.

#3 – Reports of under-funded pensions at corporate, state, and federal levels are widespread. Are you concerned?

Not my area of expertise.  I read the reports as you do. I am certain they are right. We are on a train wreck with this. The problem is that there was an assumption about how quickly assets would grow (8%) and and how big future contributions will be. Both are wrong. The lines are crossing in public and private PFs all over the country.

Cuts will have to be made. But these were promises that were made in ink, so it will not be easy. To a very significant extent this is another boomer problem. I will repeat from above:

Socially, we may be looking at a bad end for the boomers.

#4 – Could you briefly sum up your thoughts on U.S. equities?

Briefly? What a tough assignment.

There are today some excellent investment opportunities in the capital markets. That will be the case every day for the next ten years. But I don’t know what they are and if I did I would not share them. Those that “share” are just selling their book. I am convinced of one thing:

THE “BUY AND HOLD” IS DEAD. DEAD. DEAD….

Thanks to Bruce for taking the time. He’s one of the more level-headed and knowledgeable finance bloggers out there, and has the real-world experience many of us lack.

Controversial geologist Chris Landau weighs in with his latest thoughts on the Macondo well disaster. Snippets:

• He has little confidence in new cap and relief wells
• ‘We know the formation is destroyed, they destroyed it while drilling’
• ‘You cannot seal a blownout formation from the top or bottom’
• ‘Can’t seal a tire with 50 holes in it through the valve stem’
• Recommends drilling 8 total relief wells to relieve pressure

I don’t pretend to possess the expertise necessary to judge Mr. Landau’s claims. For me, his commentary is food for thought, and provides some balance against the rose-tinted views presented by BP and Wall Street analysts.

We should welcome outside perspectives on the Macondo well blowout. After all, official oil flow-rate estimate were still 5,000 bpd when NPR investigations suggested 50-100k bpd. We know now that the BP/govt numbers were likely underestimating flow by 10x. Whether this lowballing was intentional is secondary to the fact that it may have hampered response efforts.

We need input from independent experts. When they’re wrong, it will be refuted. If they’re right, it may assist response and containment efforts.

Here’s the interview with Mr. Landau. It’s worth a watch, plus it has some of the better leak footage I’ve seen so far. My advice: Consume with salt, but consider.

I did some quick research on Mr. Landau to make sure he is at least quasi-legit, and am happy to report he passed a quick PH test. He’s an oil & gas geologist with drilling experience, and has some rather unorthodox theories outside of the Macondo well.

I checked out a few of his peer-reviewed papers. And they’re quite intriguing. Chris is a proponent of Inorganic Oil Theory (inorganic, as opposed to fossil). Some of his peer-reviewed work on that can be found in PDF form here on page 94 and here on page 17. It’s a little chemistry-heavy, but there’s some good meat there.

Inorganic oil is an intriguing prospect. It’s not as if fossil fuels would be the first ubiquitous knowledge to be debunked.

Disclosure: I own BP puts

2012 BP puts offer some interesting possibilities. I’m using them as a speculative bet on a worst-case Gulf scenario, but they could also make a nice hedge for longs.

Jan ’12 BP LEAP puts expire 566 days from today (7/14/2010). That’s a lot of time for something to go wrong.

For example, there will be two hurricane seasons between then and now. Just one poorly-placed hurricane could push millions of gallons of crude further into sensitive areas along the Gulf Coast, multiplying the eventual bill for BP. Warm water conditions mean NOAA is forecasting an abnormally high 13-23 named storms in the Gulf of Mexico in 2010.

Potential Profit from BP Puts

Let’s use Jan ’12 $2.50 BP puts as an example. They closed with an ask price of $0.16 today. One hundred contracts at that price would cost $1600 + commission. Each put gives its holder the right to sell 100 shares of BP stock at $2.50 on date of expiration (Jan 21 2012 in this case).

If BP shares are wiped out, the maximum potential profit on 100 $2.50 puts would be $23,138 (assuming a $.02 share price at option expiration). Max loss is the initial cost of the puts, $1600 + commission.

So the max ROI would be 1446%, or around 14x the initial investment. BP filing for bankruptcy is still a highly hypothetical scenario, but I think the risk/reward ratio is good here.

The fact that you can make 14x your money on these options means investors are essentially betting on a 1 in 14 chance of BP going bust by the expiration date, Jan 21 2012. I think there’s more like 1 in 4 chance of bankruptcy, hence the bet.

Buying the $2.50 puts is an aggressive strategy. It’s betting on total disaster. A more conservative strategy use puts closer to the money ($15, $25, etc). The potential upside would be less, but it’s a little bit safer. I own a few different 2012 strikes, including some $2.50s.

BP is an international giant with deep pockets and political clout to match. But its risks are high too. The litigation costs alone will be staggering. Other potential potholes include legislation, reputation, well casing degradation, environmental devastation, and other “ations” we have yet to fully grasp.

On the legislation front,  today the U.S. House Natural Resources Committee passed an amendment which could effectively ban BP from future offshore drilling leases. More on that over at Bloomberg BusinessWeek.

For BP, it all adds up to unknown liabilities, slower growth, and higher drilling costs going forward (no more shortcuts, hopefully). That’s why I think that even a behemoth like BP could buckle under the weight of this mess.

Bankruptcy Scenario

One big question that would emerge from a BP bankruptcy is how claim seniority is handled. Would bondholders and other creditors retain seniority over economic and environmental claims?

I’m guessing common shareholders would be wiped. But a Bear Stearns-esque buyout, with Exxon or Shell reprising the role of J.P. Morgan and U.K. gov’t subbing in for the Yanks is certainly possible. We won’t know until the situation plays out and the full extent of the damage is known.

Further harm to BP investors would be unfortunate. It’s a staple of retirement funds and the demise would have widespread financial impact. However, if it comes down to a lack of funds at some point, it would be an even greater tragedy to punish innocent parties adversely affected by the spill, and shortchange cleanup efforts in favor of investors. An investment comes with risks, always. If someone has to suffer, it’s gotta be stakeholders of the at-fault party.

But that probably won’t happen based on what I’ve read. In the fallout from asbestos/mesothelioma bankruptcies, creditors were placed above victims in most cases (as I understand it). More on that here.

Disclosure: Long BP puts including Jan 2012 $2.50s.
Note: This is NOT financial advice. It is provided for informational purposes only.

• Bought more GOOG this week, it is really really cheap here. I wrote a bull-case article for Wealth Daily on Tues.
• Re-shorted BP today @ $32.50 with a stop @ $36. Still holding some pure gamble 2011/12 LEAP puts at multiple strikes ($2.50 to $29).
• Bought XOM this week, partially as a pair to the BP short, but mostly cause it looks cheap and I needed more energy.
• Trimmed AAPL to near the bone, used proceeds to buy GOOG. Recent developments in China may look bad for Google, but I think they’ll be worse for Apple in the long run (labor costs set to skyrocket).
• Trimmed PGJ (domestic-driven Chinese ETF) a bit. Nothing against this China really, just finding other options more attractive and taking some profits.
• Bought Acergy (ACGY), a Norwegian offshore drilling services firm. Among other things, ACGY are some of the guys who run those ROVs hovering around BP’s Macondo well. Co. just merged with Subsea 7, which should work out well for both parties.

Anyone else got ideas? This market is obnoxious.

Karl catches some suspicious activity in the futures markets, live.

I’ve never traded futures, but this does seem pretty sketchy. I’ve followed Karl for a while, and he is a smart dude. Any other explanations for those bids appearing like that? You gotta assume huge bids like that could mess with the lesser algos, at least.

That’s the official story, for now. But what a schizo day in the markets. I suspect there is a catalyst at play we’re not aware of yet. Something nasty coming down the pipeline.

Does anyone really believe this panic was caused by a simultaneous collective realization that the EU is in deep sh*t?Anyone who follows business and has a frontal lobe has known this is coming for the past 12 months (expect a similar American crisis within 2-5 years, with similar levels of seashell-collecting until the tsunami hits).

Point is, this can’t be all EU/Greece scare. Lots of potential issues to ponder here. Off the top of my head, here’s three:

• Banks may actually be forced to bring all that toxic sh*t back on their books, and they’re not happy
• Another unknown in the Financial reform bill (possibly breaking up the TBTF crew)
• Bad Spain/Italy/Portugal news coming soon (hidden debts maybe)
• German voters reject Greece bailout package

Whatever the cause, it was a hell of a day. Stocks crashed, dollar soared, and gold skyrocketed. What’s wrong with this picture? Gold pops 3% on a day where the dollar is up almost 1%? Not your typical action to say the least.

Pondering Gold’s Future

I think this could be the start of a big move up for gold.  Yesterday David Rosenberg made a  $3,000 price call, saying it should hit that in the next few years. Targets like that were laughed off just a year ago.

Now even people who don’t follow metals are telling me about $5k gold. Could be a contra-indicator, but I don’t think we’re there yet.  I’d guess 95% of investors have zero exposure to gold, through bullion or miners.

Plus, I am convinced that the Fed will be forced to re-start the printing presses very shortly. And when it does, gold’s going to go even higher. Forget about Fed tightening. They can’t/won’t. Too much political risk, as the situation could get ugly temporarily if they stopped pumping. That’s my opinion, anyway. Take it with a healthy pinch.