Quantifying Confidence

First, the debt deal.

1. Debt ceiling gets raised $400 billion. That's enough to get through August.
2. Debt ceiling get raised another $500 billion. That's enough to get through another 5 months. Congress can renege on this part of the deal, but that would require another vote - which Obama will veto.  So if Congress chooses to waste time voting on it, it will be a political statement to pander to more votes for next year.
3. Spending cap: Almost $1 trillion will be cut over the course of 10 years starting in October. The cut for 2012: Just $21 billion, enough for a politician to claim "I voted for budget cuts".
4. Starting in November, a 12 member panel will devise a plan for another $1+ trillion in cuts.
5. Balanced Budget Amendment proposal gets sent to the states for a vote. The result will determine whether Obama can increase the debt ceiling another $1.2 trillion (no BBA) or $1.5 trillion (new BBA). Congress can revote on this debt ceiling raise and decide "no", but Obama will veto.

Here are the problems with #4:

• Congress votes on the panel's recommendations as presented - no changes can be made. That pretty much guarantees a "no" vote.
• Didn't we just have a debt commission recently give its recommendations? What happened to that?
• If there is a "no" vote, cuts are triggered in all departments except the sacred cows - Social Security and Medicaid. Medicare might get some cuts.
• The debt is $14+ trillion. These proposed cuts roughly covers just the interest on our debt.

In short, I'm not seeing anything bold in this.  The decision was to vote "no" on cuts later.  Just not now.

Confidence Matters

Now that the "ideology first, country second" debt ceiling debate has concluded, two of the three credit rating agencies, Fitch and Moody's, evaluated Congress's commitment to a debt plan and decided not to downgrade the US, but issued a negative outlook. The negative outlook simply means that they will downgrade the US in the future if the government continues to do a lousy job on fiscal policy. Standard & Poor's on the other hand, followed through with the downgrade threat, going from AAA to AA+. S&P is less optimist about the future Congressional debt panel vote. Yes, credit rating agencies base their decisions on the degree of optimism they have about our government. Very scientific those people are. Case in point: S&P downgraded Greece recently from CCC to CC. Nevermind that Greece has been this close (I'm pinching two fingers together) to default for quite some time. The idea of confidence is very big in the credit world. For example, prior to 2008, many banks and brokerages levered up more than 30 to 1 - that means for every $1 they had, they borrowed $30. Despite that, their credit ratings were investment grade. That works just fine for a business model as long as other institutions had confidence in the institution's ability to make money and come up with the dough upon demand. Confidence has always been a part of the business model for banks. A lack of confidence means a run on the bank. So if confidence is part of the foundation for your business, one would think that you should be risk adverse to guard against the downside, because the risk isn't just the loss of money. It's bankruptcy. That, of course, did not happen. Confidence tapered, then disappeared. Institutions wanted cash, not credit. Since there wasn't enough cash, the house of cards toppled.


China is not as confident in the US. China's leading credit rating agency this past week downgraded the US from A+ to A, five levels below the highest rating possible (AAA). That means in China's eyes, we are at the same risk level as Russia which defaulted thirteen years ago on its bonds. No one is really paying any attention to China, because of their propensity for fuzzy mathematics. That's ironic, because confidence also incorporates fuzzy mathematics.


The confidence credit rating agencies assign to our lawmakers and President a number and that number gets plugged into whatever formulas they use.  After a few (some would say "bogus") calculations, they sausage out a rating. There's no public reference or formula one can check as each agency keeps its rubric confidential. The fact that these confidence numbers can trump everything else is mesmerizing. Again, Greece just got downgraded a week and one-half ago. That means there is now even less confidence that Greece will make good on interest payments on its debt. The fact that there was any confidence at all before the downgrade is quixotic.


Prior to 2008, credit ratings agencies routinely rated mortgages as AAA. That means the ability for borrowers to make payments was as secure as a savings bond from the federal government. Yet, they were more risky since they paid higher interest rates than a savings bond. Huh? Yep, confidence bridges that gap. Confidence got them AAA rated. Or maybe it wasn't confidence in the borrowers paying off their mortgage. Rather, it was confidence that the banks that issued the financially-engineered mortgaged-based paper would make payments to the ratings agencies for rating them AAA. Hard to tell.


Currently, S&P's downgrade matters little because the other two have yet to follow suit. It also matters little because S&P itself has little credibility. Consider this statement from S&P on its decision to downgrade:

"More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011."

Simply put, S&P feels less confident than Fitch and Moody's in the government's political climate and its commitment to sound fiscal policy. On this basis, Congress should immediately eliminate S&P as part of the oligopoly status the credit rating agencies currently enjoy. Not for retaliation for screwing the taxpayers yet again, though that would be a great way for Congress to say, "Don't mess with Daddy." Instead, Congress should exclude S&P because of a lack of confidence in its ability to credibly rate debt. Consider: how is this Congress and White House any different than the last few? The debt has gone up for decades. Congress still plays the games it plays. How is now different than then? If there is no difference, then why is a different credit rating necessary?


Suppose a teacher incorporated confidence into grades. If asked, could I say, "Yes, Johnny has an F on paper, but I'm rating him a B because I have confidence that he will attain that grade in the future based on effort and trend." What if Johnny doesn't earn the B and still deserves an F? Can I downgrade him? Sure, but I can't revise past report cards (not without administrative help) the way government revises economic data. And if enough time has past, then Johnny has already moved on to the next level and there's no going back from that. I'd be lumped into the conversation of grade inflation and possibly labeled a bad teacher. Johnny's education gets screwed in the process, because we will be denied the ability to learn what he should have in the first place. Heck, he might even develop some more bad habits in the process, because he has learned how to pass a class with an F.


This is similar. When a credit agency overweights confidence, it becomes an enabler. It enables more of the same decisionmaking from the institutions it rates and all other parties tangentially involved. Because of flawed ratings, we have had:

• more toxic mortgages getting rated AAA,
• more mortgages from speculating house-flippers since any and all mortgages were virtually guaranteed a AAA rating,
• more risk-taking from banks and brokerages through excessive borrowing,
• more inadvertent risk-taking from retirement funds (they were buying these toxic mortgage-backed products because they were highly rated), and
• more irresponsible fiscal policy from the government.

Thus you have an economic crash and a stagnant recovery. While many players are guilty for their roles in the economic crash, credit rating agencies are probably the most culpable (after Alan Greenspan). So why not eliminate the oligopoly status? If no one in Congress has the spine to hold hearings and throw some of those people in jail, then at least eliminate the special treatment.


Do I think that will happen? No. I have no confidence in Congress in making intelligent decisions. Because now is no different from then.

Stock Market Stuff

Dive! Dive! Rates are plunging as people flock to safety. Even silver (SLV) started selling off. Many believers in gold feel that silver should be shorted in favor of the yellow shiny metal. However, silver is out of balance with respect to its historical value in relation to gold. Relatively undervalued. The shorts may be right with respect to momentum, but they are wrong on the fundamentals. ... With the market falling, supports are being sliced through like butter. As a result, ignore supports on stocks on your watch list. At this moment, people are just picking numbers. At what number will the market bottom (some say 1138 on the S&P b/c of a H&S measured move from head to neck)? In 2008, we had the Devil's bottom - that is, the S&P bottomed at 666. The fact that the market crash arrested at that number is no coincidence. The trick is to start buying at that magical number the rest of market will step in. Since I'm continually losing week in and week out in the lottery, I'm not inclined to rush out and buy until someone else does first. I'm just not good at picking numbers. ... All the gains made from QE2 have been erased. Just like Japan, only it didn't take 10 years for it to happen. Just 10 months. Who said the market isn't becoming more efficient? ... It took a while, but fear finally crept into the market Thursday as the VIX spiked to over 30. When the VIX is high, it's time to buy. How high is "high"? Some say 30's, but I'd love it in the 50's. ... And what about breadth? Less than 4% of stocks in the S&P 500 were above their 50 day moving averages. That extreme typically makes the market a screaming buy. ... Since emerging from bankruptcy, GM has shown itself to be leaner and meaner. Great earnings. ... The QE3 whispers are getting louder.


Bottom Line: It's nasty out there, but in this nastiness, there will be a bounce that will lead to a nice rally. So is Friday that bounce? Lots of volume but the move was suspect. Don't forget that Thursday saw a huge drop. Friday could have simply been a one day snapback. Being Friday muddies things. Not many were willing to go long over the weekend, especially with headline risk in Washington (S&P downgrade for example). Don't try to catch the bottom, just wait for that one strong positive day. Then jump in on day 2.


Current Positions: 95% cash - After being in cash for close to two weeks, I bought a little AAPL on Friday.

Stuff The May Only Interest Me

Many Chinese citizens like to eat at places like KFC, Dunkin' Donuts, and McDonald's not just because it's fast food. They also cite that those places are healthy. "Huh?" you might ask? Yes, healthy. The ingredients used by American franchise restaurants are streamlined and consistent. Since Chinese restaurants have quality food control issues, American-style fast food chains are a healthier alternative. Go to some other place and you might find that eating "flied lice" is no joke. ... The stock market is going down in flames and pundits on the idiot box are dishing out blame in all directions. The most common one I'm hearing is the lack of common sense displayed by politicians in the debt-ceiling debate shows that they are incapable of fixing the economy. However, the answer for why the stock market is crashing and burning could be a lot more grounded: during the whole debt-ceiling saga, a lot of bad economic numbers came out indicating less manufacturing and production than expected. In addition, we had a revision of previous GDP numbers that showed that the country wasn't growing as fast as previously thought. The stock market tends to price in future expectations and those expectations simply got lowered. That could be what we are seeing. A simple correction. As far as another recession is concerned, I don't buy that we will enter a double-dip recession because from my vantage point, the first one never ended. ... The argument by union-bashers that unions are the reason for what's wrong in the economy just got a little weaker. A recent study  has linked shrinking union representation with shrinking wage growth over the last three decades. Wage growth is key to a growing economy. If the majority earns a weak salary, then their purchasing power suffers. Thus fewer goods bought means less production which means a decelerating economy. ... Food stamp users now number close to 46 million - 15% of the population - the highest ever. What makes this remarkable even more than the sheer number is that Alabama's contribution to this total doubled in one month. I'm sure people wouldn't mind flocking to a nearby state for better prospects, but when it's bad all over, does it really matter? ... Cell phone companies are offering free cell phones and service to qualifying patrons . I can only guess why: charity means tax relief. Except that money has got to come from somewhere, right? So when I look at my wife's cell phone bill (I technically don't have a cell phone) and gander at the "other fees" line, it makes me wonder if really means "paying for others' fees". And as far as the tax relief is concerned, that tax credit comes from somewhere too. Yup, ordinary taxpayers fill that gap. That's a double whammy against John Q Taxpayer. ... Starting next year, if you want a caffeinated beer, you'll have to leave California to buy one. Though caffeinated drinks are nothing new in today's bars, I wasn't even aware of it in beers too. The legislation advocating decaf is inspired by FDA warnings, and while I can understand wanting to protect the public from unsafe products, it makes me wonder why such people (namely college students) who favor fruity-flavored beer with caffeine and taurine over a real beer SHOULD BE protected from themselves. ... This will be bad for tourism: the entire police force in Ascension, Mexico, has resigned . Ascension, which is just a few miles south of El Paso, Texas, has seen its police chief and a handful of officers gunned down this year - three recently this week. It's sad to hear about such things as they are ongoing in Mexico, and I'm curious what kind of shine Mexican PSAs will put on it when they generate their next round of radio advertisements. ... Quickie weddings in Las Vegas are on the decline . Is it because people are becoming more lucid with their life decisions? Nah. Before, people would go to Vegas, get hitched, spend all their dough in the casinos, then lose the rest of their money in a subsequent divorce. Now, there just isn't enough money to go to Vegas in the first place to do all that stuff. ... It pays to be healthy if you're a Netflix employee. Netflix employees get a $10000 health benefits allowance. If they do not go over that mark, then they get to keep the rest. That would never fly in education where teachers are treated like cattle. ... Italy is shaping up to be Greece II. The ECB voted to commit to buying Italian bonds only if Italy agrees to jump through certain hoops for them. Expect Italians rioting in the street soon when they learn their entitlements will take a haircut. ... Jared Bernstein is a frequent contributor to MSNBC. Whenever he comes on, I tend to switch channels. Why? He was Joe Biden's chief economic advisor. He was the one who told Biden that the 2009 Stimulus package would prevent unemployment from surpassing 8%. Spewing that stuff got it passed through Congress. It's hard to take that guy seriously. ... Lawmakers are crying foul at the calculations used by S&P as the basis for its credit downgrade. It's like a failing math student correcting the test of another failing math student without an answer key.

Articles

• Rating Agencies Exploit Debt Drama to Regain Trust 
• The Great Debt Ceiling Debate (Illustrated) 
• Hijacking the IKEA Experience 
• 10 Things That Must Change

Last Week's Best

-R