The Threat Right Now is Deflation - Not Inflation!

Too many people are preaching a gloom / doom scenario where the Chinese (and others) reject U.S. bonds because of the debt, we have to raise interest rates, and suffer hyperinflation.

That is just a fantasy at this point.

Since the "downgrade", investors have been piling into treasuries - S&P's view was completely rejected. U.S. bonds are still considered the safest and most liquid investment. There are no other options. Swiss bonds are considered safe, but their market is not nearly large enough.

Right now, we are more in danger of deflation than inflation. There is currently a liquidity trap. Companies are awash in money, but not spending. So there is no demand.

Proof: Bank of New York just started charging negative interest on large cash deposits. Any return the bank can get by investing its balances in overnight / short term paper can't even cover the insurance / overhead of holding deposits!

Even though everyone wants the debt burden eased and don't want any more government stimulus, that might end up being the only course of action. The Fed can't cut interest rates any further. Companies have money, but there is not enough demand for goods/services. Cutting government spending right now will reduce demand. The time to reduce the deficit by spending cuts will be after the economy recovers out of recession.

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The S&P Downgrade of U.S. Debt is Over-hyped

The news media has been making a big deal about the S&P downgrade:

1. The republican candidates are trying to take advantage of it.

2. Yesterday's stock market decline was blamed on the downgrade.

3. CNN had a psychologist on about how people's esteem would be affected.

4. Someone on TV said in 20 years, we will ask "where were you when the U.S. was downgraded?"

The truth, as Paul Krugman has stated on his blog, is that a tarnished ratings firm was quick to downgrade the U.S. - possibly for political reasons, since they botched the numbers.

The downgrade isn't justified because AAA rated countries like France have more debt per GDP and, because borrowing costs are so low, the U.S, could take on another $1 trillion of debt and future debt servicing cost growth would be negligible (0.07% GDP).

On Monday, the market rejected the downgrade because treasury bonds went up. No matter what S&P says, the world knows that U.S. treasuries are the safest and most liquid investment.

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Unions Alone Aren't To Blame For The Fiscal Mess of Our Cities and States

I read an article yesterday about Central Falls, Rhode Island filing for bankruptcy.

A lot of the comments were blaming the unions, and how they have unsustainable benefits and pensions.

I made a comment that the issue can't be entirely blamed on the unions:

To be fair, unions aren't the sole cause of the fiscal problems happening in our cities and states. In many cases, the contracts signed decades ago would have been affordable if the politicians had made the required contributions when they were due, so the amounts would have compounded. (For investment success, "time in the markets" is more important than "timing the markets".)

Instead, they skipped payments and used the money for other entitlements to buy votes. Then, they turned over management of the funds to the investment managers with the best political connections, and let them take investment risks to make up for the missing or late contributions. Instead, this resulted in investment losses and under-performing the markets. Anyone remember the rare coin investing fiasco from Ohio?

Here in Illinois, the lawmakers not only didn't make required contributions, but they kept changing the pension formulas - against the advice of their own actuaries. Now we have a big unfunded pension liability.

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Effect of Japanese Earthquake on U.S. stocks

I hesitated to write a post on how the Japanese earthquake / tsunami affected the stock market, because it is so trivial compared to the loss of life and struggle of the survivors.

When I think of the disaster, the first things that pop into my mind are the tragic deaths, admirable way the Japanese people are coping with quiet dignity, and the heroism of the engineers / operators risking radiation exposure to bring the nuclear reactors back under control.

As for stocks: Japanese insurance, finance, and manufacturing companies went down, while American construction companies like Fluor (FLR) went up because they may get a lot of business in rebuilding Japan.

Oil showed its price volatility by defying initial expectations. Oil prices had gone up because of the unrest in Libya and other MidEast nations, and it was expected that oil prices would go up more because Japan would have to buy more oil on the open market - because of damaged refineries and the nuclear plants.

The Japanese crisis may drive up oil prices before its all over but, in the short run, the price of oil actually dropped because speculators figured Japan (the world's third largest economy) would slow down and actually cause less demand for oil.

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Why The City of Chicago Pension Funds Are In Trouble

Last week, the Chicago Tribune had a two-part investigation into the city of Chicago's pension plans. The article is really disheartening because it shows how we have let incompetent individuals run things.

The whole country has probably heard that the state of Illinois is broke, and has unfunded pension liabilities. But this is about the city of Chicago itself. It has unfunded pension liabilities of either $20 billion or $40 billion (the politicians say $20 billion, but that is assuming an 8% average annual return, while the average return this decade of the pension funds has been around 4%).

The problem is that the politicians did not make required contributions to the pension funds - while also raising the employee's salaries and benefits. The politicians took the short-term, easy way out. They wanted to keep labor happy NOW, and who cares about decades from now, when they might be out of office?

The Tribune article looked at the example of the Chicago Teachers pension plan. Back in 1995, the plan was founded 100%. Then, in 1995, Mayor Daley took over control of the Chicago public school system, and he lobbied Springfield to allow property tax income (that went directly into the pension funds) to go to the school system's general fund.

In 1996, his administration went one better and got the law changed so that they didn't have to make a payment as long as the retirement fund was at least 90% funded. Because of the bull market, they didn't have to pay in for 10 years.

In 2006, they had to pay because the fund was below 90%. They contributed a little, then got the law changed again to let them make reduced payments for the next 3 years. Their excuse? Even though they didn't need to pay into the pension plan for 10 years, and thus got to keep an extra $1.5 billion, the school system spent it and was running a deficit.

Now, the fund is only about 73% funded and, by 2033, they will need to contribute $1 billion a year.

Some of the other pensions are even more seriously underfunded. Municipal workers are at 47%, police at 37%, and the fire fighter's pension is only funded for 30%.

Does this mean that the workers might lose their pension benefits? Maybe - but the Illinois state constitution was amended in 1970 to require that pensions to unionized government workers have to paid. So, slashing benefits may be unconstitutional. So, tax payers may be on the hook.

By the way, I don't think the workers are to blame. The main problem is the financial irresponsibility of elected officials.

Why do we have such incompetence?

I think the problem is that life is really hectic these days - people work long hours, then sit, burned-out, in front of their televisions at night.

Then, when it comes to voting, they either don't, or else just vote for the incumbents.

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Real Estate Agent Sells House - and Herself!

A 42 year old divorced real estate agent in Palm Beach, Florida - named Deven Traboscia - is offering both her house - and a chance to marry her.

This is probably the ultimate in stunts for a desperate real estate market...

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FHA to Raise Fees and Down Payments

Here is another piece of news that shows that the real estate market has still not regained its health:

I read that the FHA (Federal Housing Administration) is planning to raise fees and increase down payments for certain borrowers.

As a little background, the FHA doesn't issue mortgages, but insures them. Up until a few years ago, FHA-backed loans only accounted for about 3% of the mortgage market.

Since then, they have accounted for 30% of all new loan activities, because they have become one of the only options for home buyers with low incomes and/or poor credit. They only require a 3.5% down payment.

While they probably helped slow down the real estate free-fall, the problem is that about 9% of their borrowers are three or more months behind on their payments, and their default-rate is skyrocketing.

This has pushed the FHA's capital reserve funds to less than 2% of outstanding loans (which is the minimum threshold required by Congress).

As a result, the FHA is implementing two changes:

1. The upfront charge to borrowers for insurance will rise from 1.75% of the loan to 2.25%. The monthly insurance premiums won't change.

2. Borrowers with a FICO score below 580 won't qualify for the 3.5% down payment. They will have to put down 10%.

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