Wednesday, August 29, 2012

The Bond King Says Stocks are Dead

Bill Gross of Pimco is basically stating that the inflation adjusted returns in the stock market in the last century of 6.6% are over.  I understand that this was news almost a month ago, but it is still worth pondering.  The following article is from the WSJ.  By the way, it is worth reading the original Pimco Investment Outlook, which can be found at Pimco.

Bill Gross, Pimco’s co-founder and co-chief investment officer, says stock investors should think again about the age-old “buy-and-hold” investing mantra. He says consistent, annual returns are a thing of the past.
“The cult of equity is dying,”  “Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of ‘stocks for the long run’ or any run have mellowed as well.”
Gross points out stocks have averaged a 6.6% annual gain on an inflation-adjusted basis since 1912. But he labels that rate of return as an “historical freak” that isn’t likely to be duplicated anytime soon, due to slowing economic growth around the globe. From Gross:
“The 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes — a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. If an economy’s GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, laborers and government)?”
Gross wonders how stocks can keep appreciating at a 6.6% annual rate in this “new normal” economy, in which GDP growth remains stubbornly low.
U.S. second-quarter GDP, reported on Friday, grew at a meager 1.5% rate. That growth rate is well below historical standards, and is partly why the unemployment rate remains stuck above 8%.
“The legitimate question that market analysts, government forecasters and pension consultants should answer is how that 6.6% real return can possibly be duplicated in the future given today’s initial conditions which historically have never been more favorable for corporate profits,” Gross says. He says it cannot, “absent a productivity miracle that resembles Apple’s wizardry.”
In addition to being pessimistic on stocks, Gross is also down on bonds. “What you see is what you get more often than not in the bond market, so momentum-following investors are bound to be disappointed if they look to the bond market’s past 30-year history for future salvation, instead of mere survival at the current level of interest rates,” Gross says.
With lower expected returns for stocks and bonds, the average American is the big loser in this new investing environment.
“The commonsensical conclusion is clear: If financial assets no longer work for you at a rate far and above the rate of true wealth creation, then you must work longer for your money, suffer a haircut on your existing holdings and entitlements, or both,” Gross says.
Investors looking for a “magic potion” that will solve the world’s problems shouldn’t hold their breath. Policy makers in the past have tried to “inflate their way out of the corner,” he says. . . . .
 “Unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades,” Gross says. “Financial repression, QEs of all sorts and sizes, and even negative nominal interest rates now experienced in Switzerland and five other Euroland countries may dominate the timescape.
“The cult of equity may be dying, but the cult of inflation may only have just begun.”

Monday, August 27, 2012

Are we in the Next Phase of the Euro Crisis?

The currency crisis surrounding the Euro is moving to the next level.  A year ago people and companies were moving their money out of less stable countries like Greece and Portugal into more stable European countries like Germany.  Now these same people and firms are starting to move their money out of the Euro.  Stay tuned, this crisis is far from over.  In addition the Euro crisis coupled with the fiscal cliff could be forming the "Perfect Storm".  

Article is in italics with the bold portion as my emphasis.  From the Washington Post:

 Insurance giant AIG startled markets last week when it signaled its waning faith in the euro by moving tens of millions of dollars worth out of the currency zone, reducing its holdings in banks in Germany, France, Spain and Italy.

The news came on the heels of a similarly unsettling announcement by International Airlines Group, the parent company of British Airways, which said Aug. 3 that it had reduced its exposure to Spain and formed a committee to prepare for the worst-case scenario of Spain exiting the euro zone.

The one-two punch is the latest in a series of efforts by corporations, central banks and individuals to move money out of crisis-stricken euro-zone countries as the debt crisis envelops an ever-larger part of the continent.

Such currency moves are bets on the future of national economies. The recent capital flight, analyst say, is a vote of no confidence in the euro that some worry could snowball into a series of silent bank runs. If institutions and consumers lose faith in the euro, a massive flight could lead to economic collapse.

“People are not frantic yet, but the concern is increasing and they are thinking, ‘How can I protect myself?’ ” said Enrico Cantarelli, a former adviser to the Italian treasury department who is a managing partner of Phinance Partners, a financial consulting firm.

Smaller firms are also reassessing their exposure. In Rome, Davide d’Atri, chief executive of Soundreef, a start-up that collects royalties on behalf of recording companies from music played in stores and other public venues, said his company’s finances could be devastated if the value of the euro were to drop further. So he has opted to keep most of the company’s cash in British pounds rather than euros. “We don’t have any control of this, and you want control of your finances,” he said.

Uneasiness about the future of the single currency has weakened the euro against nearly all the 16 counterparts in recent months. It is down about 4 percent against the U.S. dollar this year.

Capital flight has been at the root of the European financial crisis since it began more than two years ago. In the beginning, the issue was mostly a reshuffling of money within the euro zone, such as investors moving assets from smaller, troubled countries such as Ireland, Portugal and Greece into more stable euro-zone countries such as Germany.

Starting around July 2011 — when it became clear that some of the larger economies such as Spain and Italy were also in danger — the pace accelerated as investors shed a broader range of euro-zone investments.

Now money is starting to leave the euro zone altogether, said Jens Nordvig, a managing director at Nomura Securities who researchers currency and bond issues.

Nordvig said that in the past two months he has seen echoes of what happened in Mexico and Indonesia when their currencies began to collapse in the 1990s: “This is something very serious to watch, because if this type of dynamic escalates, it really will make the situation look like an emerging market currency crisis.”

It’s impossible to get a comprehensive picture of international money flows, but estimates of the amounts involved are staggering.

Citigroup’s Matt King has calculated that capital outflows from Italy and Spain in 2011 totaled 160 billion and 100 billion euros respectively, or 10 percent of the countries’ gross domestic product. King, global head of credit products strategy for Citigroup, said that the situation in Italy seems to have stabilized in recent months but that the rate of capital flight from Spain continues to be in the range of tens of billions of euros a month. That pace, King said, “is ominous.”
Separately, a study published in April by Central Banking Publications, a London research firm, found that nearly a third of 54 central banks surveyed had reduced their euro holdings in the past 12 months. Even more said they planned on selling euros in the coming months.
Those shrinking holdings are also reflected in International Monetary Fund data. In the first quarter of 2012, euros represented 24.9 percent of central banks’ allocated reserves, down from 27.3 percent in the same period of 2010, according to the IMF.
Indeed, Michael Derks, chief strategist for FxPro, a currency-trading firm based in London, said that in the past six to eight weeks, he’s seen deposits moving out of relatively strong euro-zone countries to places that don’t use the euro, such as Britain.
“A lot of French nationals are turning up in London right now and Germans and Dutch who are high net worth investors, and they are looking to diversify some of their wealth out of the single currency,” Derks said. Their assets are being moved into British pounds, U.S. dollars, Swiss francs and Japanese yen, he said, with some “bits and pieces” going to other currencies such as the Norwegian krone and Australian dollar.
Derks said he thinks the current rate of outflows is just the beginning: “This process of moving money out of Europe — not just by high net worth investors but also by sovereign wealth funds and corporate treasurers — still has some way to run.”
Fearing massive outflows of capital, European regulators have begun talking openly about ways to restrict the movement of money should Greece or another country leave the euro zone.
In Switzerland, where the Swiss franc has become a popular investment for those worried about the euro, the central bank has said it may limit foreign deposits. The Swiss franc has seen a sharp rise in value that is threatening the competitiveness of Swiss exports. The Bank of England, meantime, has been discussing whether to impose taxes on foreign inflows to limit appreciation of the pound.
While traditional capital control measures, such as imposing quotas or shutting down automated teller machines, are restricted within the 17-country euro zone, governments and financial institutions have been taking less draconian steps to slow down the movement of money. (Some of these measures are aimed as much at stopping tax evasion as stemming the flight of capital.)
Spain has banned cash business transactions over 2,500 euros, while Italy is requiring paperwork for all cash purchases over 1,000 euros. Some Portuguese banks are trying to reduce the outflow of money by requiring that large transactions be done in person, in hopes that the inconvenience will discourage hasty action.

Thursday, August 23, 2012

The Disappearing Middle Class

According to the Pew Research Center the middle class is disappearing.  It slid from 61% of adults in 1971 to 51% in 2010.  Also the levels of optimism have declined significantly for certain demographic groups in the US and increased for others.  If you want to read the original Pew Research Center study it can be found at Pew.  The article below is from the Huffington Post.Huffington Post.

Also see Elizabeth Warren talks about the disappearing middle class at

Things aren't looking great for America's middle class, and they know it.
A significant share of the middle class say it will be a long time before they recover from the severe shocks of the past 10 years, dubbed "The Lost Decade" in a Pew Research Center report released Wednesday.
"There's not a lot of good news for the middle class," Rich Morin, senior editor at the Pew Research Center and a co-author of the report, told The Huffington Post. "The middle class has shrunk in size, it's declined in income and in wealth, and has lost a little bit of that characteristic faith in the future that defines Americans broadly, but particularly the middle class."
The report suggests that five years after the financial collapse, middle-class Americans have yet to fully recover, and many think it will be years before they do. Of those middle-class households who said they're worse off since the recession, 51 percent said they won't recover for at least five years and 8 percent said they never will. And 85 percent of people who described themselves as middle class said it's harder to maintain a middle-class standard of living now than it was a decade ago.
The consequences of a disappearing middle class could be dire. Morin noted that political scientists speculate a functioning middle class could be key to a functioning democracy.
"If you lose the middle class, you're in danger of losing a lot," he said.
As middle-class households -- which the report defines as those making between two-thirds and twice the national median income -- feel they're struggling to make ends meet, their wealthier neighbors are making gains.
Over the past four decades, upper-income Americans have increased their share of overall U.S. household income, from 29 percent in 1971 to 46 percent in 2010, according to the report. During the same period, the middle-class share of income dropped from 62 percent to 45 percent.
Unless steps are taken to reverse this trend, Morin predicted, America will see "the rich getting richer and more numerous as the poor grow poorer and more numerous and the size of the middle class dwindling."
In addition to losing a major share of America's income, the middle class saw its wealth wiped out over the last decade. A volatile stock market and a major housing bust pummeled middle-class assets, decreasing their net worth by almost 30 percent and "erasing two decades of growth," according to the report.
"The fact that for the first time since the end of World War II incomes have declined, that's amazing,” Morin said. "We've obviously had recessions in the past -- we've had two in the past 10 years -- but there's always been a bounce back."
Within the middle class, some lost more than others. Yet one of the more surprising findings of the report, said Morin, is that minorities and young people -- two of the groups that were hit hardest -- are actually the most optimistic.
Seventy-eight percent of blacks and 67 percent of Hispanics said they're optimistic about the country's future, compared to 48 percent of whites. Sixty-seven percent of 18- to 24-year-olds said the same thing, while only 52 percent of those 50 and over -- a group who emerged as one of the biggest winners of the past decade -- said they're upbeat about the country's future.
Minorities and young people, "according to the economic data, were disproportionately negatively affected by change in the past decade," Morin said. "But they remain as a group less likely to say that it's harder to maintain a middle-class lifestyle, they're less likely to say it's harder to get ahead, and they tend to be a little bit more financially secure now than 10 years ago."

Wednesday, August 22, 2012

The Real Cost of the Fiscal Cliff

I new analysis by the CBO indicates that if nothing in the fiscal cliff is changed at year-end the US will face a recession in 2013.  However, there would be a significant reduction in the federal deficit.  The article details the costs and benefits of each.  Tough choices ahead.  If you want to read the report try CBO.  The article is from

 If the so-called fiscal cliff takes effect in 2013, the U.S. deficit outlook will improve, but scheduled tax increases and spending cuts would push the country into recession and unemployment up to 9%.
That's one of the main takeaways from an analysis Wednesday by the Congressional Budget Office, which released its updated budget and economic projections for 2012 through 2022.
The fiscal cliff is made up of an enormous amount of tax hikes and spending cuts set to take effect starting in 2013.
Among them, the expiration of the Bush tax cuts and the enactment of $1 trillion in automatic, across the board spending cuts that are being triggered because Congress has failed to come up with an alternative debt-reduction plan.
If all the policies are allowed to go into effect, the CBO projects that the economy, as measured by GDP, will shrink by 0.5% between the fourth quarter of this year and the fourth quarter of next year. Unemployment, currently 8.3%, will rise to 9% in the second half of 2013.
The CBO's forecast for 2013 has worsened since May, when it first forecast the fiscal cliff would cause a recession.
The fiscal cliff would, however, improve the deficit picture greatly. The CBO forecasts the deficit will hit $1.1 trillion this year -- or 7.3% of GDP. But for 2013, it would fall to $641 billion, or 4% of GDP under the fiscal cliff. That would represent the biggest single year drop in the annual deficit as a percent of the economy since 1969.
Looking ahead to the rest of the decade, the CBO projects deficits would continue to fall dramatically through 2018 before starting to rise again as the costs of supporting an aging population start to take hold. Net result: the debt held by the public would fall to 58.5% of GDP by 2022, from a projected 73% this year.
By contrast, if lawmakers did not allow the fiscal cliff to take effect, the economy would continue to grow, albeit at a slow 1.7% pace. It would also create 2 million more jobs than if fiscal cliff policies were enacted, leaving the unemployment rate at 8%.
While that would result in a better economy in the short-term, over the next decade, the debt picture would worsen considerably and weigh on the economy in the later years.
In the absence of the fiscal cliff, the CBO forecasts the deficit in 2013 would again hit $1 trillion. And by the end of the decade, debt held by the public would rise to 90% of GDP, the highest it has been since shortly after World War II.
If lawmakers choose not to reduce deficits next year in order to preserve the economic recovery, they'll need to do so eventually, said CBO director Douglas Elmendorf.
"The key issue [for policymakers] is not whether to reduce budget deficits. The question is when and the question is how," Elmendorf noted.
At the moment, it's not at all clear how Congress will handle the fiscal cliff. Neither party wants all of the scheduled policies to take effect, but in the midst of a bruising campaign season, neither is willing to budge on their partisan views regarding how to replace the cliff.

Wednesday, August 15, 2012

How Long Will Low Interest Rates Persist?

An excellent article by Ken Rogoff (co-author of This Time It Is Different) explains that the reason rates are so low is that there is a world-wide savings glut, central banks efforts to combat the financial crisis, and concerns about a global meltdown.  Eventually, these issues will dissipate, but it could take a long time, however it could change very quickly.

Article is in italics and the bold is my emphasis.  From

How long can today’s record-low, major-currency interest rates persist? Ten-year interest rates in the United States, the United Kingdom, and Germany have all been hovering around the once unthinkable 1.5% mark. In Japan, the ten-year rate has drifted to below 0.8%. Global investors are apparently willing to accept these extraordinarily low rates, even though they do not appear to compensate for expected inflation. Indeed, the rate on inflation-adjusted US Treasury bills (so-called “TIPS”) is now negative up to 15 years.

Is this extraordinary situation stable? In the very near term, certainly; indeed, interest rates could still fall further. Over the longer term, however, this situation is definitely not stable.
CommentsThree major factors underlie today’s low yields. First and foremost, there is the “global savings glut,” an idea popularized by current Federal Reserve Chairman Ben Bernanke in a 2005 speech. For various reasons, savers have become ascendant across many regions. In Germany and Japan, aging populations need to save for retirement. In China, the government holds safe bonds as a hedge against a future banking crisis and, of course, as a byproduct of efforts to stabilize the exchange rate.
CommentsSimilar motives dictate reserve accumulation in other emerging markets. Finally, oil exporters such as Saudi Arabia and the United Arab Emirates seek to set aside wealth during the boom years.
CommentsSecond, in their efforts to combat the financial crisis, the major central banks have all brought down very short-term policy interest rates to close to zero, with no clear exit in sight. In normal times, any effort by a central bank to take short-term interest rates too low for too long will boomerang. Short-term market interest rates will fall, but, as investors begin to recognize the ultimate inflationary consequences of very loose monetary policy, longer-term interest rates will rise.
CommentsThis has not yet happened, as central banks have been careful to repeat their mantra of low long-term inflation. That has been sufficient to convince markets that any stimulus will be withdrawn before significant inflationary forces gather.
CommentsBut a third factor has become manifest recently. Investors are increasingly wary of a global financial meltdown, most likely emanating from Europe, but with the US fiscal cliff, political instability in the Middle East, and a slowdown in China all coming into play. Meltdown fears, even if remote, directly raise the premium that savers are willing to pay for bonds that they perceive as the most reliable, much as the premium for gold rises. These same fears are also restraining business investment, which has remained muted, despite extremely low interest rates for many companies.
CommentsIt is the combination of all three of these factors that has created a “perfect storm” for super low interest rates. But how long can the storm last? Although highly unpredictable, it is easy to imagine how the process could be reversed.
CommentsFor starters, the same forces that led to an upward shift in the global savings curve will soon enough begin operating in the other direction. Japan, for example, is starting to experience a huge retirement bulge, implying a sharp reduction in savings as the elderly start to draw down lifetime reserves. Japan’s past predilection toward saving has long implied a large trade and current-account surplus, but now these surpluses are starting to swing the other way.
CommentsGermany will soon be in the same situation. Meanwhile, new energy-extraction technologies, combined with a softer trajectory for global growth, are having a marked impact on commodity prices, cutting deeply into the surpluses of commodity exporters from Argentina to Saudi Arabia.
CommentsSecond, many (if not necessarily all) central banks will eventually figure out how to generate higher inflation expectations. They will be driven to tolerate higher inflation as a means of forcing investors into real assets, to accelerate deleveraging, and as a mechanism for facilitating downward adjustment in real wages and home prices.
CommentsIt is nonsense to argue that central banks are impotent and completely unable to raise inflation expectations, no matter how hard they try. In the extreme, governments can appoint central bank leaders who have a long-standing record of stating a tolerance for moderate inflation – an exact parallel to the idea of appointing “conservative” central bankers as a means of combating high inflation.
Third, eventually the clouds over Europe will be resolved, though I admit that this does not seem likely to happen anytime soon. Indeed, things will likely get worse before they get better, and it is not at all difficult to imagine a profound restructuring of the eurozone. Nevertheless, whichever direction the euro crisis takes, its ultimate resolution will end the extreme existential uncertainty that clouds the outlook today.
CommentsUltra-low interest rates may persist for some time. Certainly Japan’s rates have remained stable at an extraordinarily low level for a considerable period, at times falling further even as it seemed that they could only rise. But today’s low interest-rate dynamic is not an entirely stable one. It could unwind remarkably quickly.

Thursday, August 9, 2012

Who is getting Government Aid?

In spite of the fact that the old welfare program that was reformed in 1996 is now a mere shadow of its former self, government aid reaches more people than ever before.
More than one in three Americans lived in households that received Medicaid, food stamps or other means-based government assistance in mid-2010, according to a new report.
And when Social Security, Medicare and unemployment benefits are included, nearly half of the nation lived in a household that received a government check, according to the analysis of third-quarter 2010 Census data done by the Mercatus Center at George Mason University, a libertarian-leaning think tank. That's more than 148 million Americans.
Those numbers are on their way up thanks to the Great Recession and its aftermath, which have pushed record numbers of people onto public assistance programs. In particular, the stubbornly high unemployment rate has left millions of Americans in dire straits.
In 2008, one-quarter of people lived in households receiving a government lifeline and about 45 percent a government check, according to the Census Bureau. . . . 
. . . . The federal government sent a record $2 trillion to individuals in fiscal 2010, up nearly 75% from 10 years earlier. . . . 
. . . . Some 26% of Americans lived in households where someone received Medicaid, while the figure was 15% for food stamps. Those programs were by far the largest of the safety net.
Meanwhile, 16% of people lived in households collecting Social Security and 15% receiving Medicare benefits. These entitlements have been expanding as the Baby Boom generation retires.
The rapid growth of the nation's government assistance programs has concerned many on both sides of the political aisle.
"Whether we like it or not, we know it's not fiscally sustainable," said Veronique de Rugy, senior research fellow at Mercatus. "The bigger these programs, the bigger the voting block is against reform."
More than a third of Americans live in households receiving government assistance.

Monday, August 6, 2012

What is the Fiscal Cliff - Part 3

Looks like the concern about the "Fiscal Cliff" is gaining some momentum.  Below is another article on the subject from  The links to the other blogs on the "Fiscal Cliff" are  as follows:

 If lawmakers cannot agree on how to address the pending "fiscal cliff," $7 trillion worth of tax increases and spending cuts will begin to go into effect in January.
The smart money says Congress won't come close to an agreement before the November election, and that lawmakers may not even be able to reach one until early next year. At that point, of course, they'd need to undo at least some of the tax increases and spending cuts that went into effect.
In the meantime, uncertainty about just what Congress will do will weigh on the economy.
Here's a rundown of what happens if lawmakers fail to act before Jan. 1, 2013.
Automatic spending cuts
Since Congress has failed to reach a bipartisan debt-reduction deal, the Budget Control Act requires automatic spending cuts to commence on Jan. 2 that will amount to $1.2 trillion in deficit reduction over 10 years.
Defense: $55 billion will be cut in 2013 from projected levels of discretionary defense spending. That translates into at least a 10% cut to every program, project and activity that's not explicitly exempt.
Nondefense: $55 billion will be cut from projected levels of nondefense spending, which includes things like education, food inspections and air travel safety. Budget experts estimate the cuts will result in at least an 8% cut to programs, projects and activities.
Bush tax cuts
The Bush tax cuts, the eternal partisan trip-wire, are all set to expire Dec. 31. As a result:
Income tax rates: Rise to 15%, 28%, 31%, 36% and 39.6%, up from 10%, 15%, 25%, 28%, 33% and 35%.
Capital gains rate: Rises to 20% from 15% for most filers.
Qualified dividend rate: Rises to one's top income tax rate, up from 15% for most filers.
PEP/Pease limitations: Restored. High-income households may not be able to take some itemized deductions and personal exemptions in full.
Child tax credit: Falls to $500 per child from $1,000. The refundable portion also reduced.
American Opportunity Tax Credit: Expires. The lesser value HOPE tax credit for college tuition is reinstated. Several smaller education tax benefits also expire.
Earned Income Tax Credit: Expansion of eligibility for the credit expires.
Marriage penalty relief: Expires. Effectively that means a low- or middle-income two-earner couple will owe more to the IRS than they would if they were single making the same income.
Estate tax:Parameters revert to pre-2001 levels. The exemption level falls to $1 million from $5 million; and the top tax rate on taxable estates rises to 55%, up from 35%.
AMT patch
Won't be renewed. Income exempt from the Alternative Minimum Tax in 2012 -- for which taxpayers will file returns next year -- falls to $33,750 for individuals and $45,000 for married couples. That's down from $50,600 and $78,750, respectively, if the exemption amounts had been adjusted for inflation.
As a result more than 30 million people will be hit by the so-called "wealth" tax, up from 4 million to date. 
A bipartisan bill from the Senate Finance Committee proposes a patch for 2012 and 2013 but it has not passed the Senate or House yet.
Payroll tax holiday
Expires. The Social Security tax rate reverts to 6.2%, up from 4.2%, on the first $110,100 in wages. Effectively, someone making $50,000 will pay another $1,000 in payroll taxes next year.
Unemployment benefits extension
The federal extension expires. That means workers who lose their jobs after July 1, 2012, will only receive up to 26 weeks in state unemployment benefits, down from as many as 99 weeks in state and federal benefits that had been available until recently.
Tax extenders
A host of smaller individual and business tax breaks will have expired. A bipartisan bill from the Senate Finance Committee proposes to extend many of them, but it has not passed the Senate or House yet.
Medicare doc fix
Expires. Medicare payment rates for physician services drops by 27%.
Some budget experts count as part of the fiscal cliff the onset of a new Medicare surtax on high-income households under health reform.
But unlike the other fiscal cliff tax provisions, the new tax was not written into law as a wink-wink "temporary" provision. It is, however, included to reflect the magnitude of tax increases set to take effect simultaneously in 2013.
A 0.9% surtax will apply to wages on earned income over $200,000 ($250,000 if married). That's on top of the 1.45% Medicare currently owed on all wages. Those making between $200,000 and $500,000, for instance, will only pay about $633 extra while households making $1 million or more would pay another $11,242.
A 3.8% Medicare surtax will also apply for the first time to at least a portion of high-income households' investment income.

The Rescue of Knight Capital
To complete the saga about Knight Capital I have added the article on the rescue of Knight Capital by a number of investment firms.  From
Knight Capital Group will live to see another trading day, but its investors are not pleased.
After suffering a massive loss from a trading glitch last week, Knight Capital  struck a deal with a group of investors who purchased a majority stake in the trading firm for $400 million.
Knight Capital's stock dropped nearly 25% Monday to hover around $3 following the announcement of the deal. The new investment will severely cut into the value of existing shareholders' stakes.
Knight said the group of new investors includes TD Ameritrade, Blackstone Group, Getco, Stifel Nicolaus, Jefferies Group, and Stephens Inc.
These investors will receive 267 million shares of Knight, according to a document filed with the Securities and Exchange Commission on Monday. Ahead of this deal, Knight had roughly 90 million shares outstanding.
Knight lost about 60% of its value over a three-day period last week, despite a huge rally on Friday.
"I feel very confident and the board feels confident we made the right choice for this firm," CEO Thomas Joyce told CNBC Monday morning.
The firm lost $440 million after a trading software snafu on Aug. 1 that sent numerous erroneous orders in NYSE-listed securities into the market. Some 150 companies listed on the NYSE were affected.
Knight Capital plays a key role on Wall Street by acting as a middleman in the markets, completing investors' orders to buy and sell stocks.
Last week, several clients of Knight suspended trading activity with the firm. But by Friday afternoon, several of those clients, including TD Ameritrade and Scottrade, had resumed trading with Knight. That helped lift shares of Knight by nearly 60% on Friday.
On Monday morning, E*Trade said it had also resumed trading with Knight.
Still Roger Freeman, an analyst at Barclays Capital that follows Knight, said he still questions just how much of the firm's overall trading volume will return.
The New York Stock Exchange also announced Monday morning that it temporarily reassigned custodial duties over nearly 700 stocks to Getco, another high speed trading firm.
Once the rescue deal is officially completed and approved, the New York Stock Exchange said it will hand these stocks back to Knight. 

Saturday, August 4, 2012

What is the Fiscal Cliff?  Part 2

The Committee for a Responsible Federal Budget (CRFB) has put together a very well-written report on the Fiscal Cliff entitled Between a Mountain of Debt and a Fiscal Cliff:  Finding a Smart Path Forward.  Below is an excerpt from the report that gives the major tax and spending issues involved in the "Fiscal Cliff".  I encourage you to go to the website and look at the reports.  They are usually well-written and relatively easy to understand.

The excerpt is in italics.  From the CRFB:

As Federal Reserve Chairman Ben Bernanke has explained, at the end of the year “there’s going to be a massive fiscal cliff of large spending cuts and tax increases.” Although some combination of spending cuts and new revenue are desperately needed to put the country on a sustainable path, Chairman Bernanke has rightly pointed out that “it is important to achieve sustainability over a longer day is a pretty short time frame.”

Instead, policymakers should enact a comprehensive plan to replace much of the approaching fiscal cliff with a combination of tax reform, entitlement reform, and spending reductions which could phase in gradually and thoughtfully to put the debt on a clear downward path.  Absent such action, however, this deficit reduction would occur all at once in a blunt and ultimately anti-growth manner. The following is set to take place at the end of 2012

The Expiration of the 2001/2003/2010 Tax Cuts

On December 31st, the set of tax cuts enacted in 2001, expanded in 2003, and extended in 2010 will expire. As a result, the top rate will rise from 35 percent to 39.6 percent and other rates will rise in kind. The 10 percent bracket will disappear, and the child tax credit will be cut in half and no longer be refundable. The estate tax will return to the 2001 parameters of a $1 million exemption and a 55 percent top rate. Capital gains will be taxed at a top rate of 20 percent and dividends will be taxed as ordinary income. Finally, marriage penalties will increase, and various tax benefits for education, retirement savings, and low-income individuals will disappear.

The End of AMT Patches

Congress generally “patches” the AMT every year to help it keep pace with inaction. As a result, just over four million tax returns currently pay the AMT. If a new patch is not enacted retroactively for 2012, that number will increase to above 30 million for that year and would exceed 40 million by the end of the decade.

The End of Jobs Measures

In February, the President signed an extension of a two percent payroll tax holiday and extended unemployment benefits through year’s end. Under current law, both will disappear at the end of the year, causing employee payroll taxes to increase from 4.2 percent to 6.2 percent, and reducing the number of weeks individuals can collect unemployment insurance.

The End of Doc Fixes

The Sustainable Growth Rate formula calls for a substantial reduction in Medicare payments to physicians – a reduction lawmakers have deferred through continued “doc fixes” since the early 2000s. At the end of the year, the current doc x will end, leading to a nearly 30 percent immediate reduction in Medicare physician payments.

The Activation of the Sequester

Beginning on January 1, 2013, an across-the-board $1.2 trillion spending sequester over ten years will go into effect as a result of the failure of the Super Committee. The sequester will immediately cut defense spending across the board by about ten percent, will cut non-defense discretionary spending by about eight percent, and will reduce Medicare provider payments by two percent. In total, this will result in an immediate $110 billion single-year reduction in budget authority.

The Expiration of Various “Tax Extenders”

Various normal “extenders,” such as the research and experimentation tax credit and the state and local sales tax deduction, expired at the end of 2011. Some of these extenders are likely to be reinstated retroactively at the end of this year, but will disappear under current law.

The Implementation of New Taxes from PPACA

The Patient Protection and Affordable Care Act (PPACA) included several revenue measures set to go into effect in 2013. The largest of these measures is a 0.9 percent increase in the Medicare HI (hospital insurance)payroll tax for higher earners and an effective 3.8 percent tax increase on investment income. The law also calls for an increase in the floor for unreimbursed medical expense deduction, a 2.3 percent excise tax on medical devices, limits on annual contributions to Flexible Spending Accounts (FSAs), and elimination of the employer deduction for Medicare Part D retiree subsidy payments.

Reaching the Debt Ceiling

The debt ceiling agreement reached last summer is likely to allow continued borrowing through the 2012 election – particularly given that the Treasury Department has a number of “extraordinary measures” at their disposal to delay hitting the ceiling. However, the debt ceiling may need to be increased again at year’s end in order to avoid a potential default

Roubini on the State of the US Economy into 2013

Always interesting to read an uncompromising view of the US economy made by Dr. Roubini.  You may not like it, but it is hard to disagree and even harder to refute.  If you like this sort of straight forward view about economics and a variety of other issues I strongly recommend that you visit

The article is in italics and the bold is my emphasis.  From

While the risk of a disorderly crisis in the eurozone is well recognized, a more sanguine view of the United States has prevailed. For the last three years, the consensus has been that the US economy was on the verge of a robust and self-sustaining recovery that would restore above-potential growth. That turned out to be wrong, as a painful process of balance-sheet deleveraging – reflecting excessive private-sector debt, and then its carryover to the public sector – implies that the recovery will remain, at best, below-trend for many years to come.

Even this year, the consensus got it wrong, expecting a recovery to above-trend  annual GDP growth – faster than 3%. But the first-half growth rate looks set to come in closer to 1.5% at best, even below 2011’s dismal 1.7%. And now, after getting the first half of 2012 wrong, many are repeating the fairy tale that a combination of lower oil prices, rising auto sales, recovering house prices, and a resurgence of US manufacturing will boost growth in the second half of the year and fuel above-potential growth by 2013.
The reality is the opposite: for several reasons, growth will slow further in the second half of 2012 and be even lower in 2013 – close to stall speed. First, growth in the second quarter has decelerated from a mediocre 1.8% in January-March, as job creation – averaging 70,000 a month – fell sharply.
CommentsSecond, expectations of the “fiscal cliff” – automatic tax increases and spending cuts set for the end of this year – will keep spending and growth lower through the second half of 2012. So will uncertainty about who will be President in 2013; about tax rates and spending levels; about the threat of another government shutdown over the debt ceiling; and about the risk of another sovereign rating downgrade should political gridlock continue to block a plan for medium-term fiscal consolidation. In such conditions, most firms and consumers will be cautious about spending – an option value of waiting – thus further weakening the economy.
CommentsThird, the fiscal cliff would amount to a 4.5%-of-GDP drag on growth in 2013 if all tax cuts and transfer payments were allowed to expire and draconian spending cuts were triggered. Of course, the drag will be much smaller, as tax increases and spending cuts will be much milder. But, even if the fiscal cliff turns out to be a mild growth bump – a mere 0.5% of GDP – and annual growth at the end of the year is just 1.5%, as seems likely, the fiscal drag will suffice to slow the economy to stall speed: a growth rate of barely 1%.
CommentsFourth, private consumption growth in the last few quarters does not reflect growth in real wages (which are actually falling). Rather, growth in disposable income (and thus in consumption) has been sustained since last year by another $1.4 trillion in tax cuts and extended transfer payments, implying another $1.4 trillion of public debt. Unlike the eurozone and the United Kingdom, where a double-dip recession is already under way, owing to front-loaded fiscal austerity, the US has prevented some household deleveraging through even more public-sector releveraging – that is, by stealing some growth from the future.
CommentsIn 2013, as transfer payments are phased out, however gradually, and as some tax cuts are allowed to expire, disposable income growth and consumption growth will slow. The US will then face not only the direct effects of a fiscal drag, but also its indirect effect on private spending.
CommentsFifth, four external forces will further impede US growth: a worsening eurozone crisis; an increasingly hard landing for China; a generalized slowdown of emerging-market economies, owing to cyclical factors (weak advanced-country growth) and structural causes (a state-capitalist model that reduces potential growth); and the risk of higher oil prices in 2013 as negotiations and sanctions fail to convince Iran to abandon its nuclear program.
CommentsPolicy responses will have very limited effect in stemming the US economy’s deceleration toward stall speed: even with only a mild fiscal drag on growth, the US dollar is likely to strengthen as the eurozone crisis weakens the euro and as global risk aversion returns. The US Federal Reserve will carry out more quantitative easing this year, but it will be ineffective: long-term interest rates are already very low, and lowering them further would not boost spending. Indeed, the credit channel is frozen and velocity has collapsed, with banks hoarding increases in base money in the form of excess reserves. Moreover, the dollar is unlikely to weaken as other countries also carry out quantitative easing.
CommentsSimilarly, the gravity of weaker growth will most likely overcome the levitational effect on equity prices from more quantitative easing, particularly given that equity valuations today are not as depressed as they were in 2009 or 2010. Indeed, growth in earnings and profits is now running out of steam, as the effect of weak demand on top-line revenues takes a toll on bottom-line margins and profitability.
CommentsA significant equity-price correction could, in fact, be the force that in 2013 tips the US economy into outright contraction. And if the US (still the world’s largest economy) starts to sneeze again, the rest of the world – its immunity already weakened by Europe’s malaise and emerging countries’ slowdown – will catch pneumonia.