Category Archives: U.S. Economy

Gold Set Up For Big Move This Year – What About Cryptos?

Gold and silver had a sharp run-up in the last two weeks of 2017.  However, the abrupt move in gold has been accompanied by a rapid rise in the gold futures open interest on the Comex. Furthermore, based on the last COT report the banks have dramatically increased their net short position and the hedge funds have gotten, once again, extremely net long.  I don’t like the looks of the COT report right now plus I anticipate a possible brief “relief” rally in the dollar index.

But what about cryptocurrencies?  Over the past few weeks the largest and most actively traded cryptocurrencies have been massacred in price.  This follows on the heels of the news that the founders of Bitcoin and Litecoin sold 100% of their holdings.  Nothing like insider selling as a signal about the value of what was sold…

Phil Kennedy invited me on to his podcast to discuss precious metals, cryptocurrencies and the U.S. dollar. We engage in a friendly (I want to emphasize “friendly”) debate on the merits of cryptocurrencies:

The bottom line for me is that gold has been declared a Tier 1 bank asset by the Bank of International Settlements. This means that gold is considered the highest form of bank asset. I believe there’s a good chance gold will move toward and over $1400 this year. As for a price prediction for the cryptos – it depends on the degree to which the fear of losing money overwhelms the fear of missing out on gains for the momentum-chasing speculators – most of whom are Asian-based. We may be approaching that point of no return:

Who’s Going To Stop The Madness?

Every month consumer debt in aggregate hits a new record. Auto loans and student loans have been hitting monthly record highs for quite some time. In November credit card debt hit a record high in total and increased a record monthly amount for any one month. Mathematically this can’t go on forever. In fact, there are signs – indicators not reported widely by the financial media and, predictably, completely disregarded by Wall Street – that indicate the debt party is coming to an end. Events that follow the end of the party will be less than pleasant for the majority of U.S. households.

Every week in the Short Seller’s Journal I present data which reflects the deteriorating condition of middle class America. For definitional purposes, “middle class” is defined as any household that is unable to afford their own politician, which means 99.5% of all households.

As an example, buried in Wells Fargo’s Q4 earnings presentation was data that showed charge-offs in WFC’s credit card loan portfolio in Q4 soared 21% vs. Q3. The charge-off rate as a percent of average loans outstanding increased to 3.66% in Q4 from 3.08% in Q3. This is a 19% increase in the charge-off rate. While this might seem like a low number outright, not only is it headed in the wrong direction, it’s not too far below the nationwide bank credit card charge-off rate in 2007 of 4.15%. Again, this fits my thesis that the financial condition of the average household is deteriorating.

In addition, the dollar volume of auto loan originations at WFC declined 33% and home mortgage originations fell 26%. in Q4 2017 vs 2016. WFC’s mortgage applications in Q4 dropped 16% in dollar volume from Q4 2016. And its application pipeline (applications submitted and waiting for the purchase to close) declined 23% for the quarter vs Q4 2016.

WFC is the second largest mortgage originator after Quicken Loans. It is also a major player in auto loan underwriting. If auto and mortgage loan origination statistics are declining at a double-digit rate at WFC, it’s a good bet that this is a secular trend across the industry. Simply put, middle America – the 99.5%’ers – are running out of capacity to assume even more debt. This in turn will translate into a unexpectedly precipitous drop in consumer spending, especially on large-ticket items like cars, furniture and homes.

I stumbled on a blog a couple weeks ago called  A Cold War Relic. The proprietor works at an auto dealership and presents valuable insight on the factors that will drive auto sales into the ground and send auto loan defaults soaring. His latest post, “What’s Going To Stop Me,” is well worth reading:

This dark momentum could strangle the industry, but everyone refuses to stop it. Every time a customer accepts a $500 monthly payment on another overpriced compact crossover, they are feeding that momentum. When dealers structure deals for far more than the car is worth, they are feeding that momentum. The problem is: who is going to actually tell anybody “no?” Customers want their cars and refuse [do not have the funds] to put money down to get them. A large number of dealerships are fighting to attain sales numbers the market can’t currently support.

I get cursed out every month when our store misses the targets set for us by the manufacturer, even though I’m fighting against larger stores offering deeper discounts on new cars. On top of that, it’s not just your credit criminal customer that isn’t reading what they’ve signed anymore. When you have consumers with 700+ FICO scores rolling over portions of debt they already couldn’t handle on top of new debt and financing the whole thing over increasingly long terms at interest rates they arguably no longer deserve. The problem is that prime credit customers are slowly becoming credit criminals.

You can read the rest of this here (highly recommended):   Auto Loan Crack-Up Boom Coming

In the latest issue of the Short Seller’s Journal, I present a no-brainer homebuilder short idea plus I illustrate the mechanics of shorting a stock for those who only use put options.  In addition I review the Company’s fundamentals.  This is probably the only homebuilder for which unit sales are dropping – in this case falling at a double-digit percentage rate. I believe shorting this stock is good – at the very least – for a 30% ROR by the end of the year, if not sooner. You can find out more details about the Short Seller’s Journal here: Subscription Information.

The Blockchain Name-Change Game And Securities Fraud

The rape and pillage of the blockchain name-change game took on a whole new dimension with Kodak (KODK) this week.  KODK was on the way to its second bankruptcy filing this decade (first one was January 2012).  On January 9th it announced that it implement a “major blockchain initiative.  This “initiative” would use digital ledgers to help photographers license and get paid for their work.  The stock soared:

Notwithstanding whether or not this “block chain initiative” will ever generate meaningful profits for KODK, it turns out that insiders at the Company filed S-4’s with the SEC disclosing that they were awarded 10’s of thousands of “restricted stock units.” The problem with this? The RSU’s were awarded on January 8th, the day before the “blockchain” announcement was released on January 9th.  The timing of this filing is quite curious.

The Company released its Q3 10-Q on November 8th.  Revenues plunged 32% yr/yr for the 3rd quarter; operating income swung from $15mm in Q3 2016 to a $54mm loss in Q3 2017. The Company is dying on a vine.  Ordinarily compensation stock in the form of RSU’s is awarded at the end of each quarter. The issuance of RSU’s is disclosed in the 10-Q.  No mention whatsoever of management or employee stock compensation awards.  No mention whatsoever in the MD&A of a plan to incorporate “blockchain” in any part of the business model.

All of the above, in conjunction with the sudden disclosure of large quantities of free stock in the form of RSU’s the day before KODK’s “blockchain initiative” announcement tells me that this was a scheme hatched sometime well after the Q3 10-Q was filed by unscrupulous corporate executives who saw an opportunity to exploit the massive blockchain stock and cryptocurrency bubble.

In all probability, these insiders have likely arranged to hedge the gains on the underlying stock represented by the RSU’s using OTC derivatives underwritten by Wall Street banks. These would be derivatives structured in a way that would escape the requirement to disclose the transaction in an SEC filing.  Instant profits on derivative stock that was awarded the day before news was released by the Company – news that upper management knew would send the stock to the moon.

Based on the black and white letter of the law, KODK upper management technically has not violated a strict interpretation of insider trading laws.  However, 20 years ago it’s highly likely that, if lawsuits were pressed, KODK’s upper management and board of directors would have been prosecuted and convicted of insider trading.

Fast-forward to 2018, near the end of a stock and fraud bubble that is multiples of the one that occurred with dot.com’s in the late 1990’s, and everyone looks the other way including the NYSE, SEC and Justice Department.

It’s a good bet this “blockchain initiative” will never generate any meaningful profits for the Company.  Most likely KODK is headed for a Chapter “22” filing before the end of this decade because bleeding cash profusely and it is mired in large pension and debt liabilities.

This is an example of the blatant fraud and corruption that accompanies the top of stock market bubble and the collapse of a political and economic system.  The blockchain and cryptocurrencies will not revolutionize life as we know it nor will they generate real economic wealth for anyone other than those in a position to exploit the greed and fear of missing out of the idiots who buy into the fairytale.

As expressed by Fred Hickey in his High-Tech Strategist newsletter, {Bitcoin/blockchain} “is the cherry on top of the world’s first truly global market bubble.”

The Household Debt Ticking Time Bomb

I fully expect the Government’s Census Bureau to post a mind-blowing headline retail sales number for December.  Hyperbolic headline economic statistics derived from mysterious “seasonal adjustments” based on questionable sampling methodology is part of the official propaganda policy mandated by the Executive Branch of Government.

But I also believe that retail sales were likely more robust than saner minds were expecting because it appears that households have become accustomed to the easy credit provided by the banking system to make ends meet. Borrow money to “spend and pretend.”  The Fed reported that consumer credit hit an all-time record in November.  The primary driver was credit card debt, which hit a new all-time high (previous record was in 2008).  Credit debt also increased a record monthly amount in November.

“Speaking of signposts, households have grown increasingly comfortable with leverage to maintain their living standards, which of course economists cheer. That’s worked for 24 straight months as credit card spending growth has outrun that of income growth” – Danielle DiMartino Booth, who was an advisor for nine years to former Dallas Fed President, Richard Fisher.

The graph above shows the year over year monthly percentage change in revolving credit – which is primarily credit card debt – and real disposable personal income. Real disposable personal income is after-tax income adjusted for CPI inflation. As you can see, the growth in the use of credit card debt has indeed outstripped the growth in after-tax household income. The credit metric above would not include home equity lines of credit.  At some point, assuming the relationship between the two variables above continues along the same trend, and we have no reason to believe that it won’t, credit card debt will collide with reality and there will be a horrifying number of credit card defaults. Worse than 2008-2010.

This chart shows household debt service payments as a percent of after-tax income:

“Debt service” is interest + principal payments.  With auto loan and credit card debt, most of the debt service payment is interest.  This metric climbed to a 5-year high during a period of time when interest rates hit all-time record lows.  Currently the average household is unable to make more than the minimum principle payment per the information conveyed by the first graphic.  What happens to the debt service:income ratio metric as households continue to pile on debt to make ends meet while interest rates rise?

Household debt service includes mortgage debt service payments.  Household mortgage debt outstanding is not quite at the all-time high recorded in Q2 2008.   The current number from the Fed is through Q3 2017. At the current quarterly rate of increase, an new all-time high in mortgage debt outstanding should occur during Q2 2018.  However, it should be noted that the number of homes sold per quarter during this current housing bubble is below the number of units sold per quarter at the peak of the previous housing bubble.  This means that the average size of mortgage per home sold is higher now than during the earlier housing bubble.  This is a fact that overlooked by every housing and credit market analyst, either intentionally or from ignorance (I’ll let you decide).

The graph to the right shows that access to credit is about as easy as it gets right now. A financial conditions index (Goldman’s is not the only version), measures financial variables that influence economic behavior. This includes the supply and cost of credit.

A declining index value reflects easier financial conditions. The current index is equal to the low-point of this metric going back to 1992. Unless history does not repeat, this index is set to head higher again. We are already seeing signs of this with higher interest rates, rising CPI/PPI-measured price inflation and accelerating consumer credit default rates.

It has been my argument that, on average and in general, the average U.S. household has reached, or will soon reach, the limit in its ability to support an increasing amount of debt. The use of debt has prevented consumer spending from falling off a cliff. Using debt to consume does not accomplish economic growth. It simply shifts consumption from the future to the present. Unless by some miracle the average household experiences an unforeseen jump in income – enough to enable it pay down debt and continue consuming at the present level, consumer spending will hit a wall.

I have no idea what kind of rigged, statistically manipulated vomit the Government is going to report for December and Q4 2017 retail sales but auto sales are already reflecting a serial decline in sales. Unless the banks open up the credit spigots even more – with reckless disregard to rising delinquency and default rates – consumer spending in general, and retail and auto sales in particular, is going to decline precipitously during 2018.  This will wreak havoc on the economy.  The bigger problem is going to be the rising delinquency and default rates. I suspect that this will begin to accelerate over the next 12 months regardless of Fed monetary policy. Speaking of which, I expect the Fed to begin dragging its feet on hiking rates as we move further in the new year.

A portion of the commentary above is an excerpt from the latest Short Seller’s Journal.  This weekly subscription newsletter provides insight to the economic and financial data not reported by the financial media and Wall Street.  In addition to economic analysis, I present ideas for shorting individual stocks.  Currently the path of least resistance to make money shorting is with retail and retail-related stocks.  I also provide ideas for using options. You can learn more about this unique service here:  Short Seller’s Journal information.

Dave, each week I am reminded of the degree to which you do highly disciplined, fact based, and insightful work. Thank you – subscriber, “Rod”

The Fatal Mistake Crypto Investors are Making Now

I find it amusing that the stock market is attributing so much value to the “blockchain” technology.  In reality, blockchain technology is just a piece of software that increases the degree of security for digital transactions.  I fail to see how this will revolutionize our lives the way the roll-out of the internet or the implementation of mass production or the invention of the internal combustion engine or the harnessing of electricity  changed and affected our daily lives.  I believe the technology has been egregiously over-hyped by promoters who make unrealistic claims about the potential for blockchain software.

But for now it sure is a great “buzzword” for unscrupulous operators to make  a lot of money selling blockchain “snake-oil” to suckers.   Just add the word “blockchain” to the name of your company and the stock will triple in a day.  It’s like the dot.com bubble when any stock with “dot.com” in the name of the company soared.  99.9% of those stocks disappeared completely by 2003.

This article was written Josh Brown of The Reformed Broker

Let’s start our discussion with the technology which made Bitcoin possible called “blockchain”. In very simple terms the blockchain technology is a record of all transactions ever done in Bitcoin. Imagine a gigantic piece of paper that lists every transaction ever completed. Then imagine that there are thousands of copies of this paper, and all of them are automatically updated when any two people agree to exchange Bitcoins. Every time a transaction takes place all these copies are checked for consistency to make sure you actually have the Bitcoins you claim to have. If everything checks out the new transaction is added to all the pieces of paper at once.

This is the heart of the truly genius idea that is blockchain, and it is what it makes it possible to have certainty over a Bitcoin balance someone owns, without needing any central party (like a bank) to verify it. If all the pieces of paper agree then the balance is correct, and trying to doctor or fake all the pieces of paper at once is impossible. The best (and worst) thing about this technology is that it has been made available for absolutely FREE to anyone who wants to use it.

You can read the rest of this here:  The Fatal Mistake Crypto Investors are Making Now

Returning to a Gold Standard – Why and How

This article is from Dr. Fraser Murrell via The Daily Coin:

In the 1600s, Sir Isaac Newton presided over a (bi-metal) Gold and Silver Standard, with the flaw being the fix of silver to gold. In the 1900s, John Maynard Keynes “revolutionized” economics, with the result being certain economic collapse. In both cases there was a logical error in the key definition of “price”, which is critical to the stability of the economy. This note examines the problem and then goes on to present a workable Gold Standard, which it is argued, is the most stable frame of reference for our economy.

You can read the rest of this here:   Returning to a Gold Standard

The Four Most Dangerous Words In Investing…

“This time it’s different.” That quote is from Sir John Templeton, a legendary investor who is considered the father of the modern mutual fund industry. For most of the month of December, I’ve been hearing ads from mortgage brokers who are promoting the idea of refinancing your house in order to take care of holiday bills. It reminded of the early 2000’s when then Fed Chairman, Alan Greenspan, was urging Americans to use their house as “an ATM” by taking on home equity loans as a means of drawing out cash against home equity for consumption spending. Adding more debt against your house to pay off big credit card balances merely shifts household debt from one creditor to another. What’s worse, it frees up room under the credit card accounts to enable the consumer to take on even more debt.

In reference to the mortgage and housing market collapse in 2008, Ben Bernanke wrote, “Clearly, many of us at the Fed, including me, underestimated the extent of the housing bubble and the risks it posed.” It’s hard to know if that statement is genuine or not, given that many of us saw the housing bubble that was developing as early as 2004.

The Federal Government’s low-to-no down payment programs via Fannie Mae, Freddie Mac, the FHA, VHA and USDA, combined with the hyper-promotion of cash-out refinancings (bigger 1st mortgages and/or second-lien mortgages) tell me that, once again, most people in this country believe – or rather, hope – that the outcome will be different this time.

The graphic just below  is an interesting way to show the affect that Central Bank monetary inflation has on asset valuation vs income. Asset valuation should be theoretically derived from the income levels connected to the assets. Either the asset requires a certain level of income level to purchase and maintain the asset or the asset itself generates income/cash flow.

You’ll note the pattern that developed starting with the tech bubble era. Prior to the Clinton administration the Fed subtly intervened in the financial system by been printing money in excess of marginal wealth creation (GDP growth) once Nixon closed the gold window. But, in conjunction with the Greenspan Fed, the Government’s willingness to print money as an official policy tool took on a whole new dimension during the Clinton administration.  Note:  I’m not making a political judgment per se about the Clinton presidency, because the Fed’s ability to print money to prop up the stock market was established with Reagan’s Executive Order after the 1987 stock crash. You’ll note that the household net worth to income ratio began to rise at a sharp rate starting in mid-1994, which was when the Clinton-Rubin strong dollar policy was implemented. It’s also around the time that Greenspan began regularly printing money to address the series of financial problems that arose in the 1990’s.

The current ratio of household net worth to income is 6.75 – the highest household net worth to income ratio in history. It peaked around 6.5x in 2007 and 6.1x in early 2000. You’ll note that from 1986 to 1995 the ratio averaged just around 5.1x.

A graphic that is correlated to the household net worth/income ratio is the household net worth to GDP.  The pic to the right shows household net worth (assets minus debt) vs. a plot of the U.S. nominal GDP. As you can see, when the growth in household net worth deviates considerably from the growth in nominal GDP, bad things happen to asset values. Note: household assets consist primarily of a house and retirement funds. Currently the level of household net worth – that is, the value of homes and stock portfolios – relative to GDP is at its highest point in history. This will not end with happiness.

I wanted to present the two previous graphics and my accompanying analysis, in conjunction with the theme that “it is not different this time.” The extreme degree of household asset inflation relative to incremental GDP wealth output is yet another data-point indicating the high probability that a nasty stock market accident will occur sooner or later. To compound the severity of the problem, household asset inflation has been achieved primarily through massive credit creation. The amount of debt per home sold in this country currently is at a record level.

During this past week, the bullish sentiment of investors continued to soar.  A record level of investor bullishness never ends well for the stock market. Speaking of which, there has been an interesting development in the Conference Board’s Consumer Confidence metrics. The headline-reported index showed an unexpected declined from 129.5 to 122.1 vs 128 expected. This is a big percentage drop and a big drop vs Wall Street’s crystal ball. However, while the “present situation” index hit its highest level since April 2001, the “expectations” – or “hope” – metric plunged from 113.3 to 99.1. It seems the current euphoria connected to the stock and housing markets is not expected to last.

The chart above shows the spread in consumer confidence between “present conditions” and “future conditions” (present conditions minus future conditions). A rising line indicates that future outlook (“hope”) is diverging negatively from present conditions. I’ve marked with red lines the peaks in this divergence which also happen to correlate with stock market tops (1979, 1987/1989, 2000).

The above commentary in an excerpt from the last issue of IRD’s Short Seller’s Journal.  I think retail stocks are going to be hit relentlessly beginning some time this quarter. In fact, one stock I presented as a short in early December was down over 12% yesterday after it released an earnings warning.  Some of the best SSJ short ideas in 2017 were retailers.  You can learn more about this short-seller newsletter here:  Short Seller’s Journal subscription information.

“Congrats on the [retail stock short] call. What a disaster. You have to love how the chart collapsed with the news. These algos are going to destroy people when they unless selling on stocks eventually. I made a 8X on my puts. Now I need to roll them into something else.” – SSJ subscriber who actively trades

Toxicity Plus Toxicity Does Not Equal Purification

Paper is a check drawn by legal looters upon an account which is not theirs: upon the virtue of the victims. Watch for the day when it bounces, marked, ‘Account overdrawn.’ – Francisco’s “Money” Speech – from “Atlas Shrugged”

You have to love it – the City of Houston issues $1.01 billion  “pension obligation” bonds to “ease” the underfunding of the underfunded public pension fund.  “Pension underfunding”  is the politically acceptable euphemism for “debt obligation.”  Underfunding occurs when a pension investment returns PLUS future beneficiary contributions are not enough to cover current beneficiary payments.

Some might say it’s the difference between the NPV of future payouts and the current value of the fund. But that’s horse-hooey. Houston had a cash flow deficit it had to address and it did that by issuing taxpayer obligation debt – $1.01 billion dollars of taxpayer debt.  Furthermore, let’s use a realistic NPV and ROR assumption on any pension fund plus throw-in a real mark to market of illiquid assets like PE fund investments.  Every pension fund in the U.S. is tragically underfunded.

The rational remedy would be to cut beneficiary payments or force larger contributions from current working stakeholder or both.  The problem is that implementing either or both of those remedies might cost elected officials their jobs in the next election.

Instead, the proverbial can is kicked further into the sewage ditch by issuing more debt and using the the proceeds to help the pension fund cover current cash outflows to beneficiaries.  Regardless of what you call it, an underfunded pension liability is simply “debt”.  This bond issue might ensure that Houston’s retired public employees will continue, for now, to receive their expected flow of monthly pension payment, but this bond deal in no way whatsoever “eases” the debt burden of the pension fund.  Rather, it shifts wealth from the taxpayers to the retired public employees.

Similarly, the Trump Tax Cut does nothing more than shift the distribution of wealth from 99.5%’ers to the 0.5%’ers plus big corporations.  In this case, it’s not wealth per se.  Rather, it’s shifting the burden of supporting the Government’s spending deficit from the tax cut beneficiaries (billionaires and big corporations) to the rest of the population.

I could care less what CBO projections show – CBO forecasts are always appallingly inaccurate – the Government’s spending deficit is going to accelerate next year.   Between the cut in tax revenues from Trump’s Tax Cut and the big jump in spending built into the budget for defense and re-paving the roads that were paved during the Obama era, total spending will soar.  The gap between inflows and outflows will be bridged with more Treasury bond issuance.

Remember the narrative about systemic “deleveraging” after the great financial collapse crisis? Turns out that story-line was a fairy-tale.  Treasury debt hits a new all-time everyday  and has more than doubled since the end of 2008.  Non-financial corporate debt hits a new all-time high every and is 71.4% higher than it was at the end of 2008.  Auto debt hits an all-time high every day;  credit card debt is close to an all-time high and student loan debt hits an all-time high every day.  Household debt not including mortgage debt hits an all-time everyday and is 43% higher than at the end of 2008.   The household numbers do not include NYSE margin debt, which is at at all-time high and an all-time high as percent of GDP.

The stock market is impervious to the accelerating level of debt at all levels of the U.S. financial system – at least for now.  At least until enough households and businesses get a message that says “account overdrawn,” like this person received directly from the bank teller last week (from a reader):

Great post Dave, Had a bit of a real world experience on this yesterday. Heading out to make the last biz deposit yesterday and met the mailman end of driveway and got another check. No deposit slip so asked the drive-in teller to just use my account number on the checks to deposit this. He left the intercom on. In rolls one of those massive bubba-mobiles big enough to blot out the sun..it looked like a pretty/very new one but could be wrong. I hate these loud diesel stinking machines. Anyway Bubba was trying to make a withdrawal out of his home equity credit line for $300. The teller came on and told him he was maxed. He fumed how can it be maxed?…”Well” he said “there have been 3 withdrawals in the last 2 weeks for $2200.” He whips out his phone and calls his wife (?) Raises his voice, guns the engine and off he goes…..with no cash. How often is this being repeated around the country every day…

Will The Real Phillips Curve Please Stand Up

No society that depends on money can work for long if nobody knows the true value of things, including the value of money itself. The price of attempting to live in a culture of pervasive dishonesty is that a re-set is inevitable. When it happens, it will be hugely destabilizing. – James Kunstler

Phillips Curve R.I.P. –  Paul Craig Roberts

For a decade central banks have printed enormous quantities of new money. The excuse is to stimulate the economy by reviving inflation. However, the money has, for the most part, driven up the prices of financial assets instead of consumer and producer prices. The result has been a massive increase in the inequality of income, wealth, and opportunity.

The quantitative easing policy followed by central banks is based on belief in an economic relationship between inflation and GDP growth—the Phillips curve—that supply-side economics disproved during the Reagan administration. The belief in the Phillips curve persists, because supply-side economics was misrepresented by the financial media and neoliberal junk economics.

The fact that something as straightforward and well explained as supply-side economics can be misrepresented for 35 years should give us all pause. When successive chairmen of the Federal Reserve and other central banks have no correct idea what supply-side economics is, how can they formulate a workable monetary policy? They cannot.

The Phillips Curve is the modern day version of the Unicorn. People believe in it, but no one can find it. The Fed has been searching for it for a decade and the Bank of Japan for two decades. So has Wall Street.

Central banks’ excuse for their massive injections of liquidity in the 21st century is that they are striving to stimulate the 2% rate of inflation that they think is the requirement for sustained rises in wages and GDP. In a total contradiction of the Phillips Curve, in Japan massive doses of central bank liquidity have resulted in the collapse of both consumer and financial asset prices. In the US the result has been a large increase in stock averages propelled by unrealistic P/E ratios and financial speculation resulting in Tesla’s capitalization at times exceeding that of General Motors.

In effect pursuit of the Phillips Curve has become a policy of ensuring financial stability of over-sized banks by continually injecting massive amounts of liquidity. The result is greater financial instability. The Fed is now confronted with a stock market disconnected from corporate profits and consumer disposable income, and with insurance companies and pension funds that have been unable for a decade to balance equity portfolios with interest bearing debt instruments. Crisis is everywhere in the air. What to do?

The Phillips Curve has been working its mischief for a long time. During the Reagan administration the Philips Curve was responsible for an erroneous budget forecast. In the 21st century the Phillips Curve is responsible for an enormous increase in the money supply. The Reagan administration paid a political price for placing faith in the Phillips Curve. The price for the unwarranted creation of money by central banks in the 21st century is yet to be paid.

You can read the rest of this, which I recommend, here:   PHILLIPS CURVE R.I.P.

Is Sub-Prime Auto Loan Armageddon Coming?

I experienced a real eye-opener this past week. The lease on my fiance’s Audi A3 terminates soon. I was scanning the “pre-owned” inventory at the two largest Audi dealers in Denver expecting to see some good deals on 2013/2014 Audi A4’s that had come off lease. Instead, I was shocked to see at both dealers a large selection of 2016/2017 A4s with less then 20k miles. Some under 10k miles. I even saw a 2018 with something like 6k miles on it.

Why was I shocked? Because most of these vehicles had to have been repossessed. If there were only a couple almost brand new Audi A4s with very low mileage on them, it’s plausible that the buyers/lessee’s traded them in because they didn’t like them. The bigger dealer of the two had six 2017’s, all of them with 11k or less miles. Most if not all of these cars had to have been repo’d because of lease/loan default. We plan on waiting a couple more months because her lease expires in March and I suspect that the inventory of near-new Audis will be even larger and the prices will be even lower.

My theory was confirmed when I came across a blog post from a blogger (Cold War Relic) who is a car salesman (What’s Going On?): “People are buying cars they can’t afford or shouldn’t even have been able to buy.” He goes on to explain that: “I went to my buddy Paris’ repo lot. He called me to check out a 2016 BMW 435i he jacked for BMW Financial Services…as we walked through [the lot] I noticed all of the cars seemed to be nearly new. Paris confirmed my fears when he told my about nine-out-of-ten vehicles he’s repossessed in the last few months were model year 2016 or newer” (emphasis is mine).

Here’s the coup de grace: “To make matters worse Paris only does work for prime and a few captive lenders, meaning a majority of these cars went out to consumers with good credit.” In a past Short Seller’s Journal issue in which I discussed the rising delinquency and default rates on auto loans, I suggested that, in addition to the already soaring default rates on subprime auto loans, I believed the default rate on “prime” auto loans would soon accelerate. This is in part because a lot of prime-rated borrowers would have been considered subprime a decade ago. But it’s also in part due to the fact that the average household’s disposable income is getting squeezed and what might seem affordable in the present – e.g. an brand new Audi or BMW lease/loan payment – can quickly become unaffordable.

A recent article from Bloomberg discussed “soaring” subprime auto loan defaults in connection with the fact that several Private Equity firms bought out subprime auto lending companies starting about six years ago. The investment rationale was based on expanding the loan portfolios and cashing out the “value” created in the IPO market. One company, Flagship, was bought out by Perella Weinberg in 2010. It took the loan portfolio from $89 million 2011 to nearly $3 billion. Bad loan write-offs have soared. PW tried to IPO the company in 2015. It’s still trying. Based on the two anecdotes of new car repossessions described above, it’s a good bet that the investments in most subprime auto lenders will eventually have to be written-off entirely.

The total amount of subprime auto loans outstanding is nearly $300 billion. This number is from the NY Fed. I would argue that, in reality, it’s well over $300 billion. If you add to that the amount of subprime credit card debt outstanding, the total amount of “consumer” subprime debt is in excess of the amount of subprime mortgage debt ($650 billion) at the peak of the mid-2000’s credit bubble. This is not going to end well. In fact, I suspect the eventual credit implosion will be much worse than what occurred in 2008.