Gleanings II ~ 497 ~ Compliments of Nick Rost van Tonningen Posted by John on February 11, 2013

Sub-prime 1.15 may be lurking in the financial reeds. At any given time 20 MM Americans are in attendance at US universities & colleges, 60% of them with student loans. At last report 37MM student loans were outstanding (incl. 2.2MM to people aged 60 or over), with 11% at least 90 days delinquent. In 2003 total student loans outstanding were US$250BN; today that’s US$1.066TR (implying 12+% compound annual growth). This exceeds by 20% or more each of credit card-, car-, & revolving home equity- loan outstandings. And while the latter three declined during the Great Recession as households deleveraged (although auto loan balances have started to creep up again), student loans kept growing; in fact their growth more than offset the decline in the balances of the other three combined (thereby suggesting that the household deleveraging phenomenon was a mirage perpetrated by those who didn’t look beyond the end of their noses; for this suggests that in the aggregate the household sector didn’t reduce its debt but merely altered its mix).

About 85% of all student loans outstanding are on the federal government’s tab and, as in the case of many sub-prime loans of yesteryear, were, & continue to be made, with little vetting of the creditworthiness of applicants &, more importantly, their earnings potential upon graduation (i.e. without regard for whether the applicant would study art, sociology, engineering or computer science) – it seems to have been largely a matter of ‘you are a student, you want money, here’s some, now go away’ . And not many of those taking out these loans had any inkling that student loans are very hard to get out from under, even in bankruptcy & are senior to all other consumer debt, and that collection can even be enforced by garnishees on Social Security payments.

This could have serious implications. Those with big student loan balances upon graduation may later experience difficulties accessing ‘normal’ consumer credit & car loans, saving up for their first house, & subsequently paying for it, even if they were able to. It may induce them to delay starting a family, or not to have one at all. And perhaps most important may be the consequences for universities & colleges, and public finance, and by implication  for America’s competitiveness in an increasingly ‘knowledge-based’ global economy. For this huge increase in student debt helped sustain the previous decades’ growth in university budgets at twice, or more, the compound rate of growth of the CPI (in part due to the escalating cost of employee non-salary benefits) despite drastic cutbacks in government funding support for them (thus the University of Virginia’s budget grew from US$678MM in 1990 to US$2.5BN in 2011 (i.e. at a 4.3% compound annual growth rate vs. 1.8% for the CPI), while the state’s share of its revenue base shrank from 26.2% to 5.6% thereof ( i.e. at a -0.77% compound annual ‘growth’ rate). And this may have the greatest impact on the top drawer universities due to the fact there is growing evidence that the incremental cost of attending them is not necessarily reflected in  the future incremental earnings capacity of their graduates. And with lower-than-expected earnings from their endowment funds they will have less money available to subsidize students from lower income families, thereby restricting their universe of potential incoming freshmen more & more to those from families of ‘independent means’.

According to The Economist Illinois is the epitome of state finances gone awry. Its unfunded pension liabilities are close to US$100BN & according to Democratic Governor Pat Quinn growing at US$17MM/day. And the State’s Commission on Government Forecasting and Accountability says its funding (assets/liabilities) ratio is 39%. This is the result of years of state underfunding & of overly optimistic assumptions of investment returns. So now in a budget in the US$30-US$35BN range, pension payments will account for US$5.1BN (almost triple the US$1.8BN in 2008) this-, &  rise to US$6.1BN next-,  year. While the Governor has for over a year been trying to get legislators to focus on this problem, the General Assembly adjourned on January 8^th, without addressed it – in all fairness, the accounting profession must share in the blame due to its idiotic insistence that pension funds with long term liabilities must apply the same “mark-to-market” valuation to their assets as short-term traders, as does the Fed, since in a 1-2% government bond yield environment the PV of far-off liabilities skyrockets.    

While retail investors have been piling into the stock market with abandon, causing it to have its best January in 16 years, corporate share buybacks have been faltering. Historically the latter have been a more dependable gauge of where the market may be headed in the short-to-medium term since corporate treasurers have insider knowledge as to the intrinsic value of their companies’ shares, and are number-, rather than emotion-, motivated in their decisions. On the other hand,  this may be a special case, since dividend payouts in the Fourth Quarter were greater than usual as a hedge against the possibility the fiscal cliff negotiations would alter their tax treatment.

Retail investors have also been piling into ETFs (Exchange-Traded Funds) marketed to them as a safer, lower cost alternative to mutual funds without being made fully aware of their possible pitfalls. Thus in Canada, of the  260 ETFs in existence, half have AUM < $25MM, and therefore will lack the degree of liquidity investors need to be able to sell at any time & get a ‘fair’ price.

The head of the Edmonton Police Union is upset because he says the force has far too many internal disciplinary hearings which, he claims, is causing low morale & undue staff turnover. But the facts speak for themselves. The details of two such disciplinary hearings to have recently become public knowledge. One dealt with an officer who, while out of town on a training exercise, came back to his temporary lodging after having spent some time at a bar, got into an argument with a colleague over the latter’s behaviour during the day & urinated all over the sleeping bag the other officer had retired into. And the other involved an officer who allegedly kicked a suspect in the head while the latter was laying on the ground with his hands handcuffed behind his back – methinks the head of the union is part of the problem rather than of the solution.

A study on Québec sovereignty conducted by a Québec independence group but partly funded by the Provincial government, based on input from 1,200 people in 13 regions across the province, purports to have found 92 ways in which being part of Canada constitutes ‘soft ethnocide’, i.e. hinders the Province’s development as Québecers want it (to develop) – possibly the loopiest of the 92 is that, following the latest census 27 new ridings were created outside-, but only three within-, Québec. This is a self-inflicted wound; for decennial adjustment is based on the rate of population growth elsewhere in the country compared Québec’s; so obviously Québecers aren’t procreating enough and attracting enough new immigrants to their province (while immigration policy in its case is a hard fought-for provincial jurisdiction). So rather than being hard done by, Québec actually got an undeserved bonus since the deal made years ago fixed Québec’s number of seats in the House of Commons at 75, with the number of seats for the other provincesto be prorated off that number – so much for gratitude & for the idea that ‘a deal is a deal.!        

For those interested, Philip Aldrick had a long, but very informative, article in the Sunday Telegraph entitled Mark Carney Plots Assault on the Bank of England that is unfortunately too lengthy to do justice to here in a few lines.

Last year the aggregate profits of China’s steel companies were down 98% YoY, & almost one in three actually lost money. The China Iron and Steel Association on January 25^th blamed the high prices charged by foreign iron ore producers. This is disingenuous at best, & an outright lie at worst. For iron ore prices were actually lower in 2012 (a high of US$150 & an average of US$125 respectively) while the corresponding numbers for 2011 had been US$185 & US$ 170.

Yum Brand Inc’s KFC sales in China were down 6% in the Fourth Quarter, after having been up 9% in the first three quarters, on stories in its media & blogosphere that two of its suppliers got their chickens up to killing weight in just 45 days by pumping them full of dangerous hormones – anyone who saw the movie Food Inc. will remember the sequence in which chickens raised to a killing weight at a similar age towards the end of their life had to sort of drag themselves on their bellies to the feed trough when they were hungry because their bodies were too heavy for their still soft leg bones to support them (although it didn’t make the same chemical link claim, presumably upon the advice from the same lawyers who didn’t permit the inclusion of footage from the California strawberry fields where workers wear space-type suits to avoid getting sick from the chemicals used there). There have been a number of major tainted food scandals in China in recent years, involving, among others, dangerously adulterated cooking oil, baby formula laced with compounds dangerous to their health, & “exploding” water melons, that have sensitized the hoi polloi there to food quality issues to an extent that cases of mad cow disease & periodic salmonella-, e-coli-, & listeriosis poisonings have been unable to do in North America.

Next June the next round of the much-feared ‘gakao’ exams will take place in China that the BBC calls “the world’s toughest”.  Officially known as the National Higher Education Entrance Exams they are written each year by 9+MM students, most of them high school seniors. In one form or another they predate the Communist regime, although over time their nature has been changed in various ways. Spread over two days they basically determine students’ career paths; so for two days the entire country suffers from ‘Gakao Fever”, with streets blocked & construction halted near exam sites so as not to distract those taking them. One market letter quotes the lifestyle of the 17 year-old daughter of a friend who in preparation for them attends school from 0730 – 2200 hrs, with a two hour lunch break and  … usually … Saturday afternoons & Sunday morning off, & a news paper that of another girl who attends school from 0730 – 1700 hrs & then goes home to do six hours of homework – so, many parents who can afford it send their kids to universities abroad to eliminate the risk that, if they wrote a bad exam, they might be stigmatized for the rest of their lives.

On February 2^nd Japanese Coast Guard vessels arrested the captain & 13-men crew of a Chinese fishing vessel for illegally fishing in Okinawa’s 200 mile ‘exclusive economic zone’ (not the Senkaku /Diaoyu islands). This was the first such event since September 2010 when the Japanese arrested the crew of another Chinese fishing vessel, detained them for a number of days & proposed prosecuting them, until Beijing retaliated by cutting of rare earth metal exports to Japan (which quickly made Tokyo realize which side their bread was buttered on). While this time they were released after just a few hours, this cannot help but have a negative impact on Japanese-Chinese relations, especially if Beijing were to interpret their early release as a sign of weakness.

In London house prices today are as much as 50% over their 2008 level, while elsewhere in the country they are still below it. This is due to every foreign Tom, Dick & Harry with cash to spare wanting to buy a London pied a terre. And a provision enabling foreigners to get a residency permit in a hurry if they invest a million pounds in Britain has helped to fuel this London house buying mania (last year alone thousands of Russians, & several thousand Americans, took advantage of it to establish a foothold in what still is one of the world’s most liveable & centrally-located cities).

The opening ceremonies at the 2014 Olympic Winter Games in Sochi will take place a year from today, on February 7^th, 2014. Originally budgeted to cost about US$11BN, they are about to set a record for cost overruns; for so far US$37BN has been spent & the final cost is now expected to be close to 5x the original estimate. This is said to have ‘angered’ President Putin (and so it should since it does not reflect well on his managerial ability) – by comparison the cost to China of hosting the 2008 Summer Olympics, a far bigger event & also a huge national showcase ‘marquee’ extravaganza , is said to have been US$40BN and that  to Canada/Vancouver of hosting the 2010 Winter Games less than US$7BN. And to top it all off, Sochi is an even more illogical a place than  Vancouver was to hold Winter Games since the average winter daytime high is 11° C/50°F &  night time low 4°c/39°F (which is far above that required to make artificial snow). So, when the Olympic Committee was there to inspect progress, it noticed the virtual absence of snow but was assured by the organizers that they will “store” this year’s snow under insulating cover until next year (at what cost in a place where summer time temperatures are in the 25°C+/77°F+ range?).

GLEANINGS II – 497

Thursday February 7^th, 2013

Carbon pricing is a ‘third rail issue’ in North America. Many Americans still feel entitled to cheap energy (largely a “want”) while happily forking over more than the price of gasoline for a bottle of water (a “need”) that comes from someone else’s tap & that they could have gotten for next to noting from their own (tap). As to climate change, despite growing numbers of climatic disasters, most Americans still suffer from the ‘boiling frog syndrome’ or, worse still, have a cynical it-will-last-out-my-lifetime attitude. So, just as America’s shortsightedness caused the US to lose the first round in the space race to the Soviet Union almost 55½ years ago, it now seems destined to lose the environmental remediation race to China, because environmental degradation there has now reached levels where it is become too visible to the hoi polloi to be ignored &, more importantly, has begun to affect the quality of life of its leaders.

CANADA’S AFRICAN ADVENTURE TAKES A COLONIAL TURN (G&M, Doug Saunders

–Few people realize that Canada is now the largest mining operator in Africa, bigger even than China. A few years ago the Harper government shifted its foreign aid focus away from Africa. But it has now done a 180 & reverted back to a large scale aid strategy for Africa, albeit one with a difference; for it seeks to piggy-back onto the presence of Canada-based resource companies to aid the “social and environmental issues of extractive development”. In theory, this makes sense; but in practice the downside of this policy is that this risks becoming, as is starting to happen to China, the face of ‘neocolonialism’ for the locals.

An old adage holds that “a man is known by the company he keeps”, and Western resource companies generally speaking, often deservedly so, don’t have a great reputation in the developing world, in part because they take advantage of the often lax environmental standards & in part because their single-minded pursuit of short-term profit maximization often collides with what the locals perceive to be their best interests. And the sad part of this is that Canada has long had a (totally underutilized) pool of goodwill in sub-Sahara Africa, in part because it does not have a colonial past. But since Mr. Harper became Prime Minister Canada’s foreign policy has been ‘Amateur Hour’ personified, as in the US under Bush 43, only more so, & for the same reason : neither man ever had a passport before they became their nation’s leader. So right now his personal priority is what might be called Free Trade 2.0, securing a free trade agreement with low growth Europe while his time & attention would have been more fruitfully spent in Canada’s long-term interest promoting  trade agreements with African countries that want to diversify away from their former colonial overlords, don’t particularly care for the “Ugly America” aspects of a closer relationship with the US, and have begun to get concerned about the neo-colonialist aspects of China’s intentions.

CANADIAN EXTREMISTS LIKELY CITIZENS (G&M, Colin Freeze)

-CSIS (the Canadian Security Intelligence Service) provided under the Access to Information Act, a 21-page study entitled  A Study of Radicalization : The Making of Islamist Extremists in Canada. It says, among others, that the reasons why people want to become terrorists defy explanation, but notes that, contrary to the CW, Canadian-born radicals, not immigrants,  “constitute a plurality” of those identified as violent extremists, none of whom could be “assessed to be poorly integrated into Canadian society”.

This issue has been in the limelight ever since the Prime Minister of Algeria claimed that two men with Canadian passports had been among those killed after the recent attack on a gas plant in his country (although his government has yet to validate that claim & Canadian police officers there to investigate it have complained about a lack of cooperation). Canadian passports have long been the fake personal identification document of choice among evil doers, incl. Israel’s Mossad.

A LOW PROFIT FUTURE FOR BANKS (Reuters, Olaf Storbeck)

-Commerzbank, Germany’s second-largest, this week announced it will write off 560MM Euros-worth of deferred tax accruals (that therefore won’t be available anymore to offset future profits). This is part of the “new normality” CEO Martin Blessing has talked about in describing the bank’s prospects, when tougher regulation, low interest rates & more risk-averse customers will put paid to the banks’ recent, gloriously profitable past. At least it is not dithering in adjusting its business model & internal procedures : last November, it launched a cost-cutting cum reorganization plan to strengthen its domestic retail operation that, after having cut 9,000 jobs following its 2009 merger with Dresdner Bank, will see  6,000 more jobs cut by 2016, reducing its domestic staff 15%. While painful in the short run, it is expected to help the bank prosper in an era of low profits & even lower expectations