Arto Bendiken

Got money?

You might find it hard to hold onto. Americans with money are caught in a vise. On the one side is the de-leveraging economy. On the other is the government.

The depression squeezes everything – asset prices, businesses, earnings. And it’s going to be with us for years – no matter what the papers tell you. Get ready for a 20% decline in stock prices, says our old friend Marc Faber. Another analyst puts the current P/E at 22…also implying a loss of about 20% just to get down to ‘normal’ levels.

But “this isn’t a normal environment,” says a senior analyst at Ned Davis Research.

Well, it’s normal – for a depression. When word gets around, you’ll see stocks lose ground. Housing will probably go down in price too.

Meanwhile, over on the other side of the vise, Mr. Obama says he wants to raise taxes on the rich and on businesses by $1.9 trillion. Let’s see. We’ll make some guesstimates. There are about 100 million families in the US. Of those, about half are net taxpayers. And the top 10% are said to own half the wealth in the US and already pay 66% of its total taxes. Looks like they’re going to get whacked again. Each of the ‘rich’ families will pay nearly $200,000 more in taxes.

The idea is to make the tax system more ‘balanced,’ says the president, by taking more money from the people who pay the lion’s share of US taxes…and giving it to people who don’t pay anything.

Here’s a comment from Chris Edwards of the Cato Institute:

“President Obama has introduced his budget for next year. He proposes that the government spend $3.83 trillion in fiscal 2011. To put that number into context, let’s take a trip down memory lane.

“Pres. George W. Bush…came into office when annual federal spending was $1.86 trillion. He proposed to increase spending at a healthy clip, rising to $2.71 trillion by 2011.

“Bush and his team started blowing their budget almost immediately. They kept spending more and more – wars, a giant new homeland-security bureaucracy, a big-government response to Katrina, the prescription-drug bill, doubling K-12 education spending, big pay raises for federal workers, financial bailouts, and so on. I can’t think of a single crisis that occurred on President Bush’s watch that the Bush-Rove team didn’t have an interventionist and big-spending response to.

“In Bush’s last year, FY2009, the government spent $1 trillion more than the Bush-Rove team had originally planned. It is true that 2009 spending included $112 billion for the Obama stimulus bill, so let’s take that out. With that adjustment, the Bush-Rove team ended up spending $916 billion more annually by 2009 than they had originally planned. Note that the wars in Iraq and Afghanistan cost only about one-fifth of that 2009 excess spending amount.

“Then Obama comes into office and turns out to be Bush on steroids with respect to federal spending. Obama is calling for spending $3.83 trillion in 2011, or $1.1 trillion more than the federal budget nine years ago had promised. That’s a 41 percent forecasting error.

“The lesson from all this is that an administration’s promised spending beyond the first year is meaningless. Obama is proposing a freeze on a very small part of the budget, for example, but his budget plan next year will likely find reasons to break that promise. It scares the hell out of me that federal spending down the road could be 41 percent higher than even the huge increases projected by Obama…”

We understand the larceny of the tax increases. What we don’t understand is the economics.

The idea of a $3.8 trillion budget is to stimulate the economy. The Obama team knows as well as we do that this ‘recovery’ is mostly a mirage. Without jobs…and housing…you can’t expect real growth.

Monetary stimulus has failed. Mr. Bernanke supplies the banks with all the free money they want. All they do with it is pay themselves bonuses. What more can Bernanke do? Rates are already at zero; they can’t go lower.

That leaves fiscal stimulus. “Spend more money!” That’s what economists such as Nobel prize winner Paul Krugman, The Financial Times’ lead economist Martin Wolf, and Japan expert Richard Koo are whispering in Obama’s ear. Spending supposedly boosts sales and creates jobs.

But if you’re just taking money from one pocket and putting it another, what’s the point? There is no net increase in spending power. Still, economists argue that the rich don’t spend their money; they save it! And we know what an awful thing saving is…

Taking money from ‘the rich’ actually retards a real economic renaissance. The rich are the ones who consume the most…because they have the most to spend. More importantly, they’re the ones who fund the small businesses that do the hiring. Banks won’t take a chance. It’s the relatives…and ‘the rich’ themselves…who put their money on the line.

Either someone forgot to explain this to the Obama administration or they just don’t care. In Washington, politics trumps economics every time…

And now, both politics and economics are putting pressure on Americans with money.

Monetary Stimulus Produces Phony Recovery originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

The prospect of rising Treasury yields will pressure REIT valuations. “Yield instruments” like REITs are priced to yield a “spread” over Treasuries. So prices of yield instruments usually fall when Treasury yields rise. I am anticipating this exact scenario.

I’m a bear on Treasury bonds. Prices should go down and yields should go up as the creditworthiness of the US government deteriorates. Right now, with the 10-year yield at 3.64%, investors are assuming that the future direction of inflation and budget deficits will remain under control. Treasury bond bulls will argue the following points about inflation, federal deficits, and the existing stock of Treasuries. I’ve listed the bullish consensus view in bold type. My responses, listed as the alternative view, will follow each consensus view:

Consensus view on inflation: “High unemployment and low manufacturing capacity utilization will keep inflation fears in check. So those folks expecting inflation fears to push Treasury yields higher in 2010 are a few years early.”

Alternative view: Outside of the panic liquidation conditions of fall 2008 or the Great Depression, rising prices are hard-wired into the US economy. If investors panic once again and desperately seek to hold cash, the Fed can team up with spending addicts in Congress to create new US dollars in limitless quantities. The past two years have proven this out.

The issue isn’t whether the government can satisfy demands of investors looking to liquidate assets and hold dollars. As long as Treasury yields remain low, the government can create limitless amounts of new credit to satisfy investor demand for default-free government liabilities (Treasuries and paper money).

Instead, the real risk facing financial markets over the next few years is whether investors will remain willing to hold cash and Treasuries at low yields. Cash has no intrinsic value beyond the belief that it can be exchanged for goods and services. The value of Treasury securities depends on investors’ willingness to hold them, despite the near certainty that trillions in new Treasury securities will flood the market over the next decade.

The high unemployment/low capacity utilization argument is theoretical, antiquated, and based on a fairly closed, manufacturing-oriented economy. In this theoretical economy, unemployed workers continually bid the price of their labor lower until supply and demand for labor reach equilibrium at lower prices.

Today’s US labor market does not work that way. The work force is very specialized. A laid-off automotive engineer is not likely to underbid the salary of nursing graduates for an open nursing position. Instead, those who have left the labor pool are collecting unemployment benefits without contributing to the aggregate supply of goods and services. When the claims on goods and services grow faster than actual supply, prices rise. The conditions for hyperinflation arise when an economy’s productivity collapses and supply of government liabilities overwhelms demand (as confidence in the value of those paper government notes collapses).

The Federal Reserve promotes the “low capacity utilization” case for low inflation so it can keep subsidizing the wounded banks with easy money. But the market could lose confidence in the Fed’s theory if the CPI remains stubbornly high at the same time as unemployment remains high. The market would express this view by selling off long-duration Treasuries, which increases yields. If this happens, the Fed will have to tighten policy to restore the market’s confidence in the integrity of paper dollars. Fed tightening would lead to a reacceleration of the unwinding of the commercial real estate bubble.

Consensus view on Treasury supply required to fund budget deficits: “Even though US household savings may absorb just a few hundred billion in Treasuries in 2010, foreign investors and US banks will buy enough to keep yields from rising.”

Alternative view: Several sources estimate that the US Treasury must auction roughly $2.5 trillion in new securities in 2010. Some of the proceeds will retire maturing securities, while the balance will finance the budget deficit.

The majority of the Treasury securities auctioned in 2009 were bills with very short maturity. The average interest rate paid on the Treasury bills auctioned over the past year is roughly 1%. But recently, Treasury auctions have been weighted more toward the longer maturities. Supply could overwhelm demand, causing prices to fall and yields at auctions to rise.

Because banks are choosing to defend their souring bubble-vintage loans, and writing them off slowly over time, they won’t have the capacity in the “hold to maturity” section of their balance sheets to absorb as many Treasury securities as the market expects. If banks had flushed most of their bad loans off their balance sheets in 2009, they would have capacity to absorb perhaps hundreds of billions in Treasury securities in 2010. But they didn’t.

There is a scenario in which domestic demand for US Treasuries could exceed new supply in 2010: another stock market meltdown similar to the one in late 2008. If enough investors flee stocks in a panic and invest the proceeds into Treasuries, yields could go down.

But considering that the government has committed its balance sheet to bailing out the financial system, that scenario is unlikely. More likely is a scenario in which investors question the integrity of the US balance sheet. The way to do that is to sell Treasuries. This scenario would be negative for the stock market, likely sparking the next leg of the secular bear market – a leg that involves several years of the S&P 500 trending gently lower under a rising interest rate environment. But it wouldn’t likely involve a 2008-style panic liquidation of stocks.

Consensus view on the existing stock of Treasuries held by foreign investors: “Year after year, Treasury bears predict that foreign appetite for US Treasuries will weaken, but they keep buying. Foreign central banks will maintain their appetite for Treasuries because they have to keep their currencies cheap or pegged to the US dollar.”

Alternative view: Foreign investors must be willing to hold Treasuries at a yield that compensates them for the risk that inflation and interest rates might go up in the future. If these investors fear that future inflation, interest rates, and deficits will remain dangerous, they won’t buy more Treasuries until yields rise to higher levels.

A financial market that’s evolved to a state at which it requires a perpetually growing inflow of new money to remain stable is a Ponzi scheme. The market for tech stocks in 2000 and real estate in 2006 had evolved into a Ponzi.

Those who argue that foreign creditors will never sell Treasuries because it’s “not in their best interest” should explain why investors sold tech stocks or housing when they were in bubbles. Surely, it wasn’t in the best interest of tech bulls to sell. Selling meant prices would fall, thereby damaging the value of tech stock positions. But they sold aggressively, because they perceived it to be in their best interests.

The situation of foreign creditors holding an unpayable mountain of debt of a trading partner is a classic “prisoner’s dilemma.” A prisoner’s dilemma is a situation in game theory in which two parties might not cooperate even if cooperation is in their best interest. China and Japan might both conclude that buying more US Treasuries is not in their best interest. If they both stop buying at the same time, prices will fall and yields will rise.

This scenario, by the way, is the reason that the responsible American public is opposed to Keynesian deficits as far as the eye can see. Just because Keynesian pro-deficit policies plug a theoretical hole in “aggregate demand” doesn’t mean they are sustainable or wise. The public understands that Keynesian deficits are unsustainable. The cumulative effects of these deficits – which are never offset by surpluses during the good times – ultimately destroy confidence in both the government bond market and the currency.

When the Japanese government hits the debt wall in the next five years and Japanese bond yields spiral upward, it will prove the foolishness of Keynesian policy.

Here is where the existing stock of US Treasuries comes into play. Japan already owns $750 billion worth of Treasuries. When the Japanese government hits the debt wall and yields rise, the Bank of Japan will likely print new yen to fund the government. If so, the value of the yen could collapse, which would force the Japanese Ministry of Finance to sell some of its $750 billion in US Treasuries in order to defend its currency.

It remains to be seen how long the government and the central bank can keep savers involved in this Ponzi scheme. This scenario – if Japanese savers abruptly lose confidence in their government’s ability to service its massive debt load with taxes and bond market proceeds – is how Japan could shift quickly from deflationary conditions to hyperinflation.

Japan is several years ahead of the US in the transformation of its government bond market into a Ponzi scheme, so we should consider it a canary in the coal mine.

Aside from Japan, the appetites of two other huge Treasury investors are waning. The Chinese are rolling their maturing notes and bonds into buying shorter maturity bills. And the Social Security trust fund is not far from being in the position where it’s a net seller – rather than a net buyer – of Treasuries. With unemployment stubbornly high, less payroll taxes are flowing in. With lower payroll tax inflow in 2010, the trust fund has less of a surplus to invest into Treasuries. When demographics switch the trust into a deficit position, it will become a net seller, rather than a buyer, of Treasuries.

All of these factors argue convincingly for rising Treasury yields in 2010 and 2011. The consensus does not seem concerned about these factors. As of Jan. 20, the FTSE NAREIT Equity REIT Index yields 3.72%. This is roughly equal to the 3.64% benchmark 10-Year Treasury yield. Over the past 20 years, the average spread of the NAREIT index over Treasuries was 100 basis points, or 1%. Removing the influence of the 2005-2007 REIT bubble takes the historical average spread closer to 300 basis points over Treasuries.

So not only are REIT valuations at risk from rising Treasury yields, they’re also at risk from rising spreads over Treasuries. Considering that REITs are in a prolonged post-bubble environment, it’s reasonable to assume that REIT spreads over Treasuries will rise to 300 basis points or more. Assuming both factors – rising Treasury yields, a rising spread of REIT yields over Treasuries – the REIT index could easily fall 50% from current levels.

Regards,

Dan Amoss
for The Daily Reckoning

The Case for Higher Treasury Yields… And Lower REIT Prices originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

by Addison Wiggin & Ian Mathias

• Stocks up, gold up, but the dollar holds its ground… The 5 pokes the PIGS for an explanation
• Housing numbers, good and bad… including one metric that’s regressed 10 years
• The “good news” Patrick Cox sees from Obama’s State of the Union speech
• Is the mainstream catching on? Byron King’s rare earths warning in the Financial Times
• Plus, an obscure pro bono update from our favorite treasure hunters…
  
  

  Two days don’t constitute a trend. But sometimes, they indicate a potential turning point.

For much of 2009, U.S. stocks moved in inverse proportion to the U.S. dollar index. Likewise, gold rose as the dollar fell.

On Monday and Tuesday, the Dow charged forward a healthy 200 points. Gold ran up a solid $20 an ounce, to above $1110. And yes, the dollar index fell… but not much. It’s managed to hold above the 79 level, territory it hadn’t seen since last August.

So what’s going on? Well, the euro continues to look shaky. “Many still believe Greece will need financial support by EU members in order to pull themselves out of the debt hole they have dug,” says Chris Gaffney at EverBank today. And even if Greece can solve its own problems, there’s no guarantee the other PIGS can. The yen is looking pretty sluggish too, as Japan appears to be sliding back into recession (again).

That means among the “big three” currencies, the dollar wins by default. Again. The familiar patterns of 2009 -- stocks and gold up, dollar down -- might be history in 2010. In fact, we wouldn’t be surprised if the dollar index rose along with gold.

  The pending home sales figures from the National Association of Realtors have gotten stock traders all lathered up this week. December’s numbers improved 1% month over month. We have to concede any kind of improvement here is impressive. Recall in November buyers rushed to beat the deadline for the homebuyer tax credit -- unsure whether it would be extended. (It was.)

What the NAR is crowing about, however, is the year-over-year improvement of 10.9%. As if we’re supposed to forget the economy was practically frozen in amber in December 2008.

  Meanwhile, supply and demand in the housing market remain seriously out of whack. The Commerce Department reports housing vacancies remain near record levels. And a staggering 21% of housing units built since 2000 sit empty. That’s a whole lot of cheap drywall and expensive countertops.

  But it’s likely to be only half the story. "People focusing on the Multiple Listing Service (MLS) data for an accurate picture of the current housing market are missing the bigger picture,” writes the inimitable Dr. Housing Bubble. “This is like looking at Mercury and thinking you have a full picture of our solar system. This is the data that most in the public will be able to see without digging deeper into foreclosure and pre-foreclosure data, and this is what is now widely known as the shadow inventory."

In short, banks have been holding back on the shadow inventory, thus artificially lowering the supply of homes on the market.
 
Using Los Angeles as an example, a quick scan shows 6,901 homes for sale. Which seems like a small amount of inventory for a big area. But when you look at the shadow market -- those homes that are distressed, bank owned or scheduled for auction -- it's twice as big as the regular market.
 
In Los Angeles, an additional 6,583 notice of defaults have been filed, 4,264 home auctions are scheduled and 3,376 are now real estate owned.
 
“You can listen to the same dubious folks that missed the biggest collapse since the Great Depression,” the doctor says, “or you can spend a few minutes looking at the data above and putting 2 and 2 together.” The path ahead is not good for housing values.

   Nor will it get better anytime soon. This spring, the housing market still faces several key inflection points…

• The Fed keeps promising to end “quantitative easing” and thus stop buying crap mortgage paper as of March 31. As we said last week, there’s a boatload of wiggle room in that promise, but it’s still stated policy for now
  
• Buyers who want to snag the homebuyer tax credit must sign a contract by April 30. We haven’t heard rumblings about Congress extending the credit yet again, but nothing will surprise us
  
• More than 9% of borrowers whose mortgages are backed by the Federal Housing Administration are at least three months behind on their payments. Logically, that means another wave of foreclosures, but there’s a double incentive to engage in extend-and-pretend games here: The lenders wouldn’t have to write down the mortgages, and the FHA wouldn’t have to draw down its (pitiful) cash reserve.
  
  
  

  One more housing metric to chew on today… The U.S. Census Bureau says the homeownership rate is back to levels last seen 10 years ago.

Mainstream business Web sites characterize this as a “pre-bubble” level. We peg the start of the bubble earlier: Home prices began outpacing the consumer price index in 1996-97. The homeownership rate still has a long way to fall. In turn, select rental markets around the country should heat up.

  This morning, markets are taking additional cheer from the ADP employment report. It says employers cut 22,000 jobs in January, the fewest in two years. ADP’s numbers are about as reliable as, well, those from the Bureau of Labor Statistics, but markets react to them, so we pass them along.

The BLS reports its numbers on Friday, and there’s a wild card: This is the month the number massagers make their annual revision to the “birth-death model.” That’s the system by which they use entrails and a Ouija board to divine how many jobs were created or destroyed by small businesses. (Even then if the numbers don’t look good, it doesn’t hurt to move a decimal point a few spaces one way or the other.) 

   Buried within its fiscal 2011 budget proposal, we see the White House job projections. After the staggeringly bad forecast the administration made a year ago, these assumptions seem more believable, if optimistic still -- a 9.8% unemployment rate by year’s end, and 7.9% by the end of 2012.

On GDP, the projections are a little more giddy -- 3% this year, 4.3% each of the following two years. Guess that’s how this administration defines a “jobless recovery.”

  “The good news from the president's State of the Union speech is that he recognized that our federal deficit is a bad thing,” says Patrick Cox, accentuating the positive. Heh.

“His proposed spending freeze, starting next year, is only a symbolic gesture, but it is important. It proves that the administration learned a lesson from the Massachusetts Senate race. Specifically, that lesson is that you cannot criticize, even rightly, the previous administration's deficit spending and then triple the deficit without paying a price. I find this extremely encouraging.

“America has a lot to do before the potential of the economy is unleashed again, but the tide has turned.

“The trend lines are extremely positive and will begin to yield real benefits soon. Our debt level is seriously awful, but not worse than it was at the end of World War II. America is going to suffer the consequences of an unnecessary excursion into California-style liberalism, but we'll come out stronger than ever. Moreover, we will be helped by a huge international market that did not exist in the late 1940s, when our economy was powering ahead.

“Shortly, investor fears are going to be calmed and the truly revolutionary technologies that will power the next period of economic super growth will accelerate further. In fact, some of you know our friend John Mauldin is predicting a full-fledged biotech bubble in the years to come. We've been working together on a few projects, and he's been buying some of our biotechs.”

We’re just two days away from a major development with one of Patrick’s picks. If I were to tell you what the company was working on, you wouldn’t believe me. Best to take a look at the research for yourself. You can get it here.

  “The future supply of rare earths is merely a problem. Eventually, it will become a crisis,” says Byron King, prominently featured on the Op-Ed page of today’s Financial Times.

Byron’s been beating the drum on rare earths for nearly two years; it’s good to see him finally get some mainstream attention. China controls at least 93% of total world output of these metals used in everything from hybrid cars to ballistic missiles. How did this happen?

“Rare earths processing is rarer than rare earths,” Byron explains. “Rare earths require a complex series of chemical extractive steps to bring the raw ores to the form of useable oxide, or final-stage metal. Processing rare earths is far more complex than, say, extracting gold or silver from ore. There are currently no processing facilities in the West for extracting the high-end rare earths in industrially useable quantities...

“In the past 30 years, the Chinese have strategically made the necessary investment in rare earths processing facilities. No one else outside China has done so.

“Why? Well, the Chinese made a conscious effort to drive foreign competition out of business along the way. Meanwhile the West, with its overwhelming belief in ‘free trade,’ has placed its faith -- and bet its farm -- on long-term Chinese willingness to sell rare earths to eager buyers outside the Middle Kingdom.”

You can find Byron’s piece here. If you can’t get past the Financial Times paywall, Google the terms “byron king financial times” and you’ll find it readily enough. To profit from the trend as the mainstream catches on, see Byron’s premium service, Energy & Scarcity Investor.

  “His objective should be obvious,” says a reader about Hank Paulson. “By taking the job as Treasury secretary, he was given a pass on at least $240,000 of taxes he would have owed on his Goldman Sachs stock gains had he not taken the job.

“Tax avoidance of this magnitude is sufficient incentive, or ‘objective,’ for anyone to suffer through a couple of years of government ‘service.’"

The 5:

Ian noticed the same thing. It’s one of many layers to the Paulson onion he’ll try to unpeel in his next piece for The Daily Reckoning. If it’s anything like his Ron Paul observations, you can expect lots of emotions spilled out on these pages.

  “I think you’re giving too much credit to the politicians running the White House and Congress,” writes a reader responding to why suddenly Washington, D.C., is focused on jobs. “I don’t believe they actually thought they had a handle on the unemployment issue; they may have wished for the lower unemployment numbers, but I truly don’t believe they had any clue.

“The reason they didn’t put stimulus money to work last year is because they saw what happened in China when it put its $500 billion-plus stimulus to work... the economy looked great for almost three quarters and then they hit a wall. There was no plan on how to keep the economy growing through private job creation. You can only go so far with stimulus money.

“I contend that the politicians in Washington knew this and decided to ‘keep their powder dry’ and use the funds this year to stimulate job growth. This stimulation will look and feel great -- right before the interim elections.”

The 5:

No doubt. Here’s another one that might have occurred to you already: The Census will create scads of new jobs in an election year. Sure, they will all go away in 2011, but that’s a problem to deal with in 2012.

  “It is really quite statist, anti-liberty and offensive of you to call Taiwan a ‘rogue state.’ The communists failed to conquer the nationalists in their last holdout on Taiwan. It is not and never was a ‘state’ of the communist government.

“You should honor their determination in holding out for their personal liberties against the all-encompassing, absolute state of communism. Screw China, no matter how much printed money it has. If it wants to integrate Taiwan, they should give Taiwanese good reasons for doing so.”

The 5:

It’s called sarcasm, dear reader.

Regards,
Addison Wiggin
The 5 Min. Forecast

P.S.:

Our friends at Odyssey Marine are on a different kind of mission than the usual searching for sunken treasure from ancient shipwrecks. At the request of Lebanon’s government, the Odyssey ship Ocean Alert is using sonar to locate wreckage -- including the black boxes -- from the crash of an Ethiopian Airlines jet off the Lebanese coast last week.

Understandably, this isn’t the sort of thing the folks at Odyssey issue press releases about, but we’re pretty impressed. It’s a wickedly complex undertaking. “The seabed in the area includes deep undersea canyons,” says Odyssey CEO Greg Stemm, “which adds a layer of complication and makes a search very difficult."

This isn’t a first for Greg’s team. One of its members located the solid rocket boosters from the space shuttle Challenger disaster in 1986. We’re working behind the scenes on a new project with Odyssey Marine. It’s going to be one of our most interesting projects to date. Once we cross a few of the “I’s” and dot a “T” or two, we’ll let you know more.

In yesterday’s edition of The Daily Reckoning, our resident short-selling specialist, Dan Amoss, explained why he believes REITs – and especially hotel REITs – offer a delectable short-selling opportunity.

Dan returns today to punctuate his bearish analysis of the REIT sector with an equally bearish analysis of Treasury bonds. “I’m a bear on Treasury bonds,” Dan says unapologetically. “Prices should go down and yields should go up as the creditworthiness of the US government deteriorates.”

If long-term interest rates were to rise as much as Dan expects, the REIT sector would suffer more than most other market sectors. REITs are interest-rate sensitive on at least two fronts. First, since most REITs used borrowed funds to amass their property portfolios, any increase in interest rates would increase their cost of capital, thereby squeezing profits. Secondly, most investors consider REITs “yield instruments.” As such, REITs, much like bonds, will rally when interest rates are falling and fall when interest rates are rising.

In the column below, Dan presents persuasive arguments for selling long-dated Treasury bonds. But first, please allow your California editor to perform a warm-up act by providing his own argument for selling Treasury bonds. Your editor’s argument is embarrassingly simple: Sell bonds because the US government is borrowing crazy amounts of money.

As the nearby chart illustrates in grisly detail, the US government has amassed $1.8 trillion of new indebtedness during the last 15 months. Astonishingly, each and every one of the last 15 months produced a deficit, including the tax-collection month of April, which had produced a surplus for 26 straight years.

So how much is $1.8 trillion, anyway?

Well, let’s see… It’s about 13% of US GDP. $1.8 trillion is also about double what the IRS collected from all individual taxpayers last year. In other words, if every American taxpayer had simply agreed to double his or her tax payments last year, the nation could have avoided this whole deficit mess.

For one final bit of perspective, $1.8 trillion is more than double the total debt America had accumulated during its first 200 years as a nation. America’s debt load did not crack the trillion-dollar level until after 1980. These days, we rack up 200 years worth of debt every six months or so.

Thus, from a purely mathematical standpoint, trillion-dollar annual deficits seem incongruous with 30-year Treasury bonds yielding less than 5%. Less than 20%, maybe.

The initiatives that are aggravating America’s runaway budget deficits are so mindless and uncoordinated they are, to paraphrase White House Chief of Staff, Rahm Emmanuel, “profanely moronic.” As these moronic initiatives pile trillion-dollar deficits atop one another, Treasury bond yields might go to 20% at some point…or the dollar might go to three euros…or both.

Treasury Bonds to Cower in Face of US Debt? originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

From AOCSDirect blog:

Executive Summary – Well this wasn’t hard to see coming. The states are scared of the Fed. The big threat is the Fed declares martial law and closes the state governments making them irrelevant. The states in fear for their own governments existence are passing states rights bills. These basically go back to the constitution reasserting that the states created the Federal Government. The constitution clearly lists the rights the Federal Government has and clearly states any other rights belong to the states. Unless specifically prohibited to the states.

Gold & Silver Money – The states doing this to date are as follows with the respective bill numbers which you can look up yourself:

Indiana S.B. 453 Colorado H.B. 09-1206 Missouri H.B. 0561 Georgia H.B. 430 Maryland H.J.R. 5

None of these bills has yet passed. They basically are saying the state has to operate based on gold and silver. They also say the banking system has to allow people to operate using gold or silver. I believe using a paper note backed 100% by gold or silver would be allowed.

Read the full story here.

Here’s a mystery: Homeowner defaults. Not that there are so many…the mystery is why there are so few…

In Nevada, for example. Two out of three homeowners are underwater…which is hard to do in the desert. Some of them owe hundreds of thousands of dollars on something that doesn’t exist anymore – the equity on their houses. Still, most of them continue making mortgage payments. What gives?

It’s a case of “asymmetrical ethics,” says The New York Times. Lenders don’t hesitate a minute to maximize their earnings – using every tool available to them and every trick in the book (including some tricks that have never been published). They default whenever it suits them.

But homeowners? They plod along. Maybe they think their house will come back in price. Maybe they think they’ll suffer some awful penalty if they default. Maybe they are just too proud and too honest to take advantage of the non-recourse mortgage provisions. So, they keep paying.

But for how long? Mortgage rates are based upon past behavior. In the past, people regarded mortgage payments as an inescapable, moral obligation. You paid as long as you were able.

It won’t be long before the ethics of Wall Street catch on all across the country. Gaming the mortgage system will become as common as signing up for food stamps. When people see that house prices won’t go back up…and when they see their neighbors shedding hundreds of thousands of dollars’ worth of mortgage debt – and getting away with it – they won’t be far behind.

Homeowner Defaults: The Inevitable Truth Behind the Mystery originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

Today we offer thanks to Barry Ritholtz for sharing his views… literally. He’s moved into a new office in Manhattan where he can look out at the city in almost every direction.

From The Big Picture blog:

“Over the past few weeks, I have walked through the space with real estate people, contractors, building reps, etc., and noticed something rather amusing: Out of every single office, I could see the offices of at least one major bailout recipient — some offices, I could see four!“

Here’s his view of Bank of America:

The others include: Bear Stearns, Chrysler, CitiGroup, General Electric, Merrill Lynch, Morgan Stanley, and UBS.

You can see all of his original pictures, which are worth a look, in a post on his bailout skyline. Also, take note that Barry Ritholtz will be returning to speak this year at Agora Financial’s Investment Symposium in Vancouver, July 20-23, 2010. You can find more details about how to see him in person here. Don’t forget, Agora Financial Reserve members attend free of charge.

Barry Ritholtz on his new Bailout Skyline originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

James Delingpole, in Climategate: Time for the Tumbrils, noting the public collapse in credibility of AGW “science” utters a fine rant summed up in this wise (parochial references to British political figures and organizations omitted):

I’m in no mood for being magnanimous in victory. I want the lying, cheating, fraudulent scientists prosecuted and fined or imprisoned. I want warmist politicians booted out and I want fellow-travellers who are still pushing this green con trick to be punished at the polls for their culpable idiocy.

For years I’ve been made to feel a pariah for my views on AGW. Now it’s payback time and I take small satisfaction from seeing so many rats deserting their sinking ship. I don’t want them on my side. I want to see them in hell, reliving scenes from Hieronymus Bosch.

I too long to see the frauds and the fellow-travellers in the hell they’ve earned for themselves. But revenge, while it’s a tasty dish that long-time public “deniers” like Delingpole and myself are now thoroughly enjoying, isn’t the best reason to hound them and their enabling organizations out of public life. The best reason not to relent, to name and shame the fraudsters and shatter their reputations and humilate them — ideally, to the point where there’s a rash of prominent suicides as a result — is this:

If we don’t destroy them, they’ll surely ramp up yet another colossal, politicized eco-fraud to plague us all.

To explain why I’m sure this is so, let me start by reprising a comment I wrote in late November in response to someone who asked whether I bought conservative Senator James Inhofe’s theory that the climate scientists are all involved in a monolithic AGW conspiracy. Here’s what I said at the time:

If Inhofe actually believes that the entire scientific community is embroiled in monolithic AGW conspiracy, he’s an idiot; I agree with that. What I believe is actually going on is a lot more complicated and ambiguous than that. There are a lot of players in this dance. I’ll round up a few….

First, the scientists. Most are caught up in, or struggling against, an error cascade of humongous proportions. What’s an error cascade? Somebody gave one of the type examples upthread, over the mass of the electron. This is not conspiracy, it’s a result of a tendency to use seniority or authority as a shortcut when it’s technically difficult to evaluate evidence and socially difficult to be skeptical. All humans do this, even scientists.

Next, the Gaianists – term I made up for people in whom “Save the Earth!” has psychologically substituted for traditional religion (in more or less chiliastic forms). They mean well, they really do; they recycle as an act of virtue, they worry about composting and buying local produce — and they’re totally subject to being manipulated by the other players, which is important since most of the action is going on in democracies. They’re not usually manipulated directly by the scientists, except occasionally a very wealthy one (er, think dot.com millionaire) might get hit up for funding. The Gaianists aren’t a conspiracy; they’re not organized enough. There’s some overlap with the scientists at the non-chiliastic end of this group.

Next, the green-shirts. These are political hacks of all varieties who just love the ideas of more carbon taxes, more regulation, and the general expansion of state power, especially if they can posture as virtuous eco-saviors while they’re arranging this. They’re not a conspiracy either, just a bunch of careerists who compete for the Gaianists as a voting bloc. They sometimes behave a bit like a conspiracy, but only because their behavioral incentives tend to push them all in the same direction. Er, they’re not scientists. They’re Al Gore, or they’d like to be, only with political power too.

Any conspiracies in sight? Yes, actually…

Conspiracy #1: Most of the environmental movement is composed of innocent Gaianists, but not all of it. There’s a hard core that’s sort of a zombie remnant of Soviet psyops. Their goals are political: trash capitalism, resurrect socialism from the dustbin of history. They’re actually more like what I have elsewhere called a prospiracy, having lost their proper conspiratorial armature when KGB Department V folded up in 1992. There aren’t a lot of them, but they’re very, very good at co-opting others and they drive the Gaianists like sheep. I don’t think there’s significant overlap with the scientists here; the zombies are concentrated in universities, all right, but mostly in the humanities and grievance-studies departments.

Conspiracy #2: The hockey team itself. Read the emails. Small, tight-knit, cooperating through covert channels, very focused on destroying its enemies, using false fronts like realclimate.org. There’s your classic conspiracy profile.

My model of what’s been going on is basically this: The hockey team starts an error cascade that sweeps up a lot of scientists. The AGW meme awakens chiliastic emotional responses in a lot of Gaianists. The zombies and the green-shirts grab onto that quasi-religious wave as a political strategem (the difference is that the zombies actively want to trash capitalism, while the green-shirts just want to hobble and milk it). Pro-AGW scientists get more funding from the green-shirts within governments, which reinforces the error cascade — it’s easier not to question when your grant money would be at risk for doing so. After a few times around this cycle, the hockey team notices it’s riding a tiger and starts on the criminal-conspiracy stuff so it will never have to risk getting off.

Overall, is this conspiracy? No. Mostly it’s just people responding to short-term incentives, unaware that they’re caught up in an error cascade and/or being politically fucked around. Nobody involved is what you could reasonably call evil…well, except for the zombies. It would be pretty evil if the hockey team had planned all this, but I’m not cynical enough to believe that. Not yet, anyway, but I haven’t read all the emails either.

OK, now it’s months later and I’ve read enough of the emails to be fairly sure that the “team” did not in fact plan all this. Nor, I’m pretty sure, did the green-shirts or the zombies; they merely exploited an opportunity to do what they wanted to do anyway. The key point — and the reason the AGW frauds need to be shamed and punished — is that the political background conditions favoring this kind of fraud are still in place.

That is, the zombies and green-shirts still have a powerful interest in magnifying scientific errors that suit their agendas into politicized crusades that could produce error cascades just as huge. Somewhere out there, there are now-innocent scientific research groups who could become the next decade’s version of the “team”, degenerating into fraudulent conspiracies as careerism draws them in, the political villains cheer them on to rationalize the power-grab of the week, and the Gaianists gamely but stupidly try to do the right thing.

I’m even prepared to hazard a guess where the next fraud would be ginned up from: environmental toxicology and what are called “endocrine disruptors”.

The most effective way to prevent a recurrence is for there to be real penalties — political, social, and criminal — attached to playing the environmental-panic con game. It’s not a good outcome for any of us if the scientists who committed criminal data fraud and denied FOIA requests get a soft landing to positions elsewhere in academia. And the green-shirts who used that fraud as cover for their ambitions should absolutely be hounded out of public life so that politics in future will be a bit less toxic.

As for the zombies — well, hanging them all from lamp-posts would be ideal, but distinguishing them from their more-or-less innocent dupes is difficult. At least, by destroying the reputations of everyone who promoted this fraud, we might impair the zombies’ past ability to operate Gaianist organizations like so many sock puppets.

The most optimistic take on the long-term outcome is that the collapse of the AGW fraud might at least partially immunize us against future attacks of environmental junk science. I wish I were in fact that optimistic, but I’m not. In any case, a round of public excruciations of the villains in this one is certainly called for, pour encourager les autres.

UPDATE: I thought of killing myself, says climate scandal professor Phil Jones. Instead, this fraud and bully plays the tearful-victim card. The man truly has no shame.

The euro (EUR) moved back above the $1.40 handle overnight after it was announced the EU would back Greece’s plans to cut its budget deficit. European Commission President Jose Barroso said the EU is endorsing the Greek program and relayed confidence in the Greek authorities. The move came after the Greek government announced more measures to reduce the shortfall. The EU will demand monthly updates from Greece on its progress in cutting their deficit from the current 12.7% of GDP down to the EU’s 3% limit by 2012. The approval of the plan by the EU does not mean the union will be backing Greek debt with loans and does not insure against a default, but only allows Greece to continue to be part of the EU despite their large deficits.

The news seems to have calmed some of the speculators who were predicting a break-up of the euro. But many still believe Greece will need financial support by EU members in order to pull themselves out of the debt hole they have dug. One of my favorite economists, Nouriel Roubini, believes the EU or ECB will likely step in with loans or guarantees in order to quash the attacks of speculators on the euro. “I expect there is going to be eventually some financial support,” Roubini said on Bloomberg TV yesterday. He also suggested Greece should be going to the IMF to get a package of support.

Nobel laureate Joseph Stiglitz was also in the press yesterday suggesting that the EU should back Greece with financial support to end attacks on the euro. “If it made an announcement of support, then the hedge funds and speculators going after the euro would lose hope and they would just go away.” But the ECB seems to have drawn a line in the sand, and does not want to open the door for other week members of the EU to come to them for support. The IMF seems to be the best bet, but Greek Prime Minister George Papandreou has avoided going the IMF, and has instead pledged to freeze state wages and announced increases in a fuel tax. For now, the markets seem to be willing to give Greece some time to see if these measures can work.

The other big news out of Europe will come later this morning, as the Norges bank will be announcing their latest rate decision. Everyone, including Chuck and I, believe they will keep rates steady, but they have surprised the markets in the past. The Norges bank was the first in Europe to raise interest rates back in October and increased them again at the end of the quarter. Norway’s economy is doing well, and a recent jump in home prices gives them reason to come back to the rate table. But with the Greek situation keeping the value of the euro down, they fear a big jump in the value of the krone if they do surprise the markets with a rate increase. Currency traders will be analyzing the statement that usually accompanies their rate decision, to see how soon we should expect another move up. Hopefully I will have the rate decision by the time I get this done, and will include it in my wrap-up. No matter what the Norges bank does today, they continue to maintain a hawkish stance, and their economy continues to be strong; both of which should keep the Norwegian krone (NOK) underpinned.

The pound sterling (GBP) moved higher versus both the euro and the US dollar after data showed that UK consumer confidence rose in January. The reading of 73 was nearly double the 39 measured one year ago. As Chuck pointed out earlier this year, Britain returned to growth in the fourth quarter, ending a long recession. But like the US recovery, the UK recovery is still questionable. The BOE has said they would announce a pause in their quantitative easing program later this week after spending 200 billion pounds on emergency bond purchases. Like the US’s Fed, the BOE has pumped billions of pounds into the markets in order to try and stimulate them, but the inflationary impact of these moves has yet to be felt. I believe these quantitative easing policies were reckless, and applaud their end.

But without government support, the bond markets will be a bit thinner, and interest rates will likely be bid up putting the fragile recoveries in the UK and US at risk. And with both countries heading toward elections later this year, will the central banks be able to fight off political calls for additional stimulus measures? I doubt it! I expect both to come back to get another hit of the ‘stimulus drug’ which will only add to their deficits, and make the job of kicking the stimulus habit even harder down the road. The longer we remain on the easy money path, the harder we will be hit by the inflation train that is coming down the tracks. This isn’t good news for the US dollar or the pound sterling.

But back to what is happening today. The dollar drifted lower overnight as investor confidence continued to strengthen and they moved funds back into riskier assets and away from the ‘safe haven’ of the dollar. Data released yesterday morning in the US showed December pending home sales moved up 1% after falling 16% in November. Compared with a year earlier, pending sales rose 10.5%, with the $8,000 government incentive for first time homebuyers being credited for driving many of these sales. Today we will get the Challenger Job data and ADP employment numbers, along with the ISM non-manufacturing number. The employment numbers are expected to be disappointing, but many are expecting to see a slight increase in the ISM number.

Tomorrow will be a much bigger data day, as we will get the weekly jobs data along with the factory orders and nonfarm productivity numbers. And the week will close out with another big round of data with the first monthly jobs numbers for 2010. The recent dollar strength could turn on a dime if this data shows a big jump in the unemployment sector and a decrease in factory orders. Investors have begun to buy back into the ‘feel good’ story of a US economy that is well on its way to recovery. These numbers could give the markets a cold slap of reality, bringing risk aversion back into vogue.

But for now, investors are looking for yield, and the benefactors yesterday were the South African rand (ZAR) and the Brazilian real (BRL), both of which posted nice gains overnight. Brazil’s SWF was not in the market, and the real was allowed to appreciate over 1% versus the US dollar. The real was helped by the announcement that industrial output had a record gain in December from a year earlier. Brazilian industrial production jumped 18.9% in December after having contracted 14.7% a year ago.

As I am wrapping this up, the dollar is moving dramatically higher, but I can’t figure out what is driving it higher. The numbers released are right in line with expectations. I’ll have to try and figure out what is going on and will give Chuck my analysis to include with tomorrow’s Pfennig.

Greek Debt Won’t Kill the Euro originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

Portrait of a Chinese Mandarin.

man·da·rin (mnd-rn)
n.
1. A member of any of the nine ranks of high public officials in the Chinese Empire.
2. A high government official or bureaucrat.
3. A member of an elite group, especially a person having influence or high status in intellectual or cultural circles.

Well, OK, if we're talking about the current ATF Mandarins, I'm not sure how big a swath they cut through "intellectual and cultural circles," but they personify the "elite group" having "influence or high status."

I recently forwarded to the ATF Ombudsman (Marianne Kettels) an "open letter" that had been posted on this website. That letter offered suggestions about how ATF's senior management could genuinely close the currently enormous communications gap between them and our field personnel. I viewed the letter as direct, professional and constructive, and asked Ms. Kettels to forward it to Acting Director Ken Melson for review. After all, it was Melson who, in an bureau-wide posting, demanded that we "speak up". Furthermore, according to its stated charter, the Ombudsman office is a perfectly appropriate place to send such information.

However, Ms. Kettels forwarded the letter not to Director Melson as requested, but to the Chief Counsel's Office! That's right…constructive information sent in good faith to the Ombudsman was immediately provided to, and only to, the very pack of attack dog lawyers who are directly responsible for many of our current corruption and ethics problems. Kettels could have simply responded that she could not forward the information to the Director (for whatever strange reason), or have offered suggestions or alternatives. But no…she sent it to the Bureau's professional Hit Team, so they could swing into action and do what they do best (cover senior management ass by any means and at any cost).

Folks,

I received this link forwarded by CPT Jonathan Tuttle with this comment:

This is what happened to one agent who tried to go through the ATF Ombudsman to pass constructive suggestions to top ATF management. Documents attached, also posted at the below, along with SA Cefalu's take on the gobsmack.

http://cleanupatf.org/forums/index.php?/topic/62-speak-up-eh-lets-see-how-that-works-in-the-real-world/

I have taken the time to post the attached pdf documents so that the whole world can see them, here and here.

"Attack dogs" is a perfectly apt description of the professional liars of the ATF Chief Counsel's Office. Their leashes are held by the anti-gun politicians of the Congress who feed them in return for enforcing their agenda and NOT, rest assured, by AD Melson or even AG Eric Holder. It is evident that neither of these people holds any sway over the Mandarin lawyers.

Mike
III

ATF Chief Counsel's Office lawyer.

OK, I'm sorry, that's an insult to HONEST attack dogs everywhere.

As I was standing in line at the grocery store, I was generously donating my Precious Mogambo Time (PMT) to educate all within earshot that they are idiots if they are not buying gold, silver and oil, and they were telling me that I was the idiot, and then I told them, no, they were the idiots, and they responded that, no, I was the idiot, and then there was a spontaneous lopsided debate (me against all the them) about who was the most idiotic.

My argument was simple: buy gold, silver and oil to protect themselves against the incredible fiscal insanity of the federal government, which is proposing a budget for fiscal year 2010 for a whopping, I-can’t-believe-my-freaking eyes, $3.8 trillion (in a $14 trillion US economy!), of which a slightly-less-than-whopping, but still in the “I-can’t-believe-my-freaking-eyes” zone, $1.6 trillion would be deficit-spending!!

The astute Junior Mogambo Ranger (JMR) has made note of the two exclamation points as being redundant for them, as they immediately comprehend and shudder in horror at the knowledge that $1.6 trillion in deficit spending means that the always-repellent, usually slimy, mostly corrupt, sometimes idiotic and sometimes actually insane federal government will have to borrow the aforementioned slightly-less-than-whopping, but still in the “I-can’t-believe-my-freaking-eyes” zone, $1.6 trillion from somebody.

In the old days, the government would have to borrow their deficit-spending money from, like everyone else, people who have saved up some money, and this competition for funds would drive interest rates up, which caused a big problem, people rioted in the streets and hung deficit-spending elected officials from lampposts. Thus the federal government was, as you would expect, not prone to borrowing money, and prices did not go up, which pleased everybody, especially the poor, who actually get poorer when prices go up.

Then (and you might want to note that the soundtrack has turned all gloomy, best described as “discordant horns over muted kettle drums played with an irregular beat, accompanied by the howling wolves of inflation that will soon be eating you alive”), the Federal Reserve stepped into the scene, now with the horrid Alan Greenspan at the helm, and who began a deliberate campaign, beginning with his appointment in 1987, to creating monstrous amounts of credit in the banks, which was, literally, a free gift from the Federal Reserve.

And so, with all this credit just sitting there on the books at the banks, the banks could drop interest rates to almost nothing, and still make a profit by loaning money, which was again created by the banks literally out of thin air, to people and businesses!

The money supply boomed! Naturally, with all this new money floating around, prices zoomed, and the prices of stocks, bonds, houses and size of government also grew, and grew, and grew, matched only by the desperate wailing of The Mogambo, whose despair is to be seemingly marooned on this stupid planet of stupid people who actually believe that you can borrow yourself into prosperity, and that banks can increase the money supply without any ill effects whatsoever like inflation which is the thing that destroys people and destroys currency and destroys countries.

And – even worse! – the dimwitted denizens of this planet actually believe that their governments can borrow ridiculous amounts of money – ad infinitum! – to provide more and more money, and more and more benefits, to more and more people, with not only no, not only zero, not only nada, nil, and el squat-o adverse effects of any kind, but will that some fabulous benefit would be permanently achieved! Hahahaha!

Thus, I thought I would easily win the debate with my fellow shoppers, proving conclusively that they were, just like I said, idiots for not buying gold, silver and oil in response to such governmental deficit-spending insanity, since their only line of argument was in the boring “Shut up and go away!” and “We hate you!” category, whilst I had the entire history of the last 4,500 years of what happens when one idiot country after another deficit-spends themselves into bankruptcy, and especially the truly-stupid countries that tried using a fiat currency to finance deficit-spending!

Alas, my dreams of victory were not to be, and instead of saying “Thanks, Wise And Wonderful Mogambo (WAWM) for showing us how stupid we are!” they laughed at me! Laughed!

But like the scheming little vengeful rat that I am, I am soon back to pleasantly dreaming and plotting sweet revenge against a long list of people – now a little longer! – all of them guilty of a whole host of insults against me, both real and imagined, for which they must pay.

But as for laughing, it will be I who will have the last laugh, as gold, silver and oil zoom in the raging inflation in prices that is sure to befall us from such insane increases in the money supply, and my laugh will be both cold and chilling, perhaps echoing eerily hollow with a subtle undertone of crushing doom and despair, and it will sound a little like this: “Hahahahahahahaha!”

2010 US Budget Strains the Printing Press originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

A Coastie with a Remington 870 SBS. (Which, when you think of it. what sort of sense does THAT make? Are they still fond of blunderbusses for "repelling boarders?")

(DISCLAIMER: KIDS, DO NOT TRY THIS AT HOME. IF YOU ARE NOT AN 'ONLY ONE,' THAT MISSING FEW INCHES ON YOUR SHOTGUN BARREL CAN BRING THE U.S. MARSHALS AND FBI SNIPERS TO YOUR HOUSE TO SHOOT YOUR KID IN THE BACK AND DRILL YOUR WIFE THROUGH THE HEAD WHILE SHE'S HOLDING HER BABY. JUST ASK RANDY WEAVER.)

So, it seems the Internal Revenue Service is buying itself some new toys -- short-barreled shotguns for home-invasion work, just like the free-lance criminals use. Of course, independent felons not acting under color of law (and there's something refreshing about their honesty compared to the IRS) do not have the taxpayers to fund their logistics -- they just saw the barrels off some garden-variety stolen twelve-gauge, but then, hey, nothing but the best for the King's revenue agents.

Here's the money paragraph:

The Internal Revenue Service (IRS) intends to purchase sixty Remington Model 870 Police RAMAC #24587 12 gauge pump-action shotguns for the Criminal Investigation Division. The Remington parkerized shotguns, with fourteen inch barrel, modified choke, Wilson Combat Ghost Ring rear sight and XS4 Contour Bead front sight, Knoxx Reduced Recoil Adjustable Stock, and Speedfeed ribbed black forend, are designated as the only shotguns authorized for IRS duty based on compatibility with IRS existing shotgun inventory, certified armorer and combat training and protocol, maintenance, and parts.

Submit quotes including 11% Firearms and Ammunition Excise Tax (FAET) and shipping to Washington DC.

I shared this with Robert "Mad Bob" REDACTED, commanding officer of the Dogtown Rangers. His reaction?

"Only sixty?" he asked in wonderment. "Ain't gonna be enough. Ain't gonna be NEARLY enough, the dumb sonsabitches."

Universal identification is portrayed by some as the holy grail of Internet security. Anonymity is bad, the argument goes; and if we abolish it, we can ensure only the proper people have access to their own information. We'll know who is sending us spam and who is trying to hack into corporate networks. And when there are massive denial-of-service attacks, such as those against Estonia or Georgia or South Korea, we'll know who was responsible and take action accordingly.

The problem is that it won't work. Any design of the Internet must allow for anonymity. Universal identification is impossible. Even attribution -- knowing who is responsible for particular Internet packets -- is impossible. Attempting to build such a system is futile, and will only give criminals and hackers new ways to hide.

Imagine a magic world in which every Internet packet could be traced to its origin. Even in this world, our Internet security problems wouldn't be solved. There's a huge gap between proving that a packet came from a particular computer and that a packet was directed by a particular person. This is the exact problem we have with botnets, or pedophiles storing child porn on innocents' computers. In these cases, we know the origins of the DDoS packets and the spam; they're from legitimate machines that have been hacked. Attribution isn't as valuable as you might think.

Implementing an Internet without anonymity is very difficult, and causes its own problems. In order to have perfect attribution, we'd need agencies -- real-world organizations -- to provide Internet identity credentials based on other identification systems: passports, national identity cards, driver's licenses, whatever. Sloppier identification systems, based on things such as credit cards, are simply too easy to subvert. We have nothing that comes close to this global identification infrastructure. Moreover, centralizing information like this actually hurts security because it makes identity theft that much more profitable a crime.

And realistically, any theoretical ideal Internet would need to allow people access even without their magic credentials. People would still use the Internet at public kiosks and at friends' houses. People would lose their magic Internet tokens just like they lose their driver's licenses and passports today. The legitimate bypass mechanisms would allow even more ways for criminals and hackers to subvert the system.

On top of all this, the magic attribution technology doesn't exist. Bits are bits; they don't come with identity information attached to them. Every software system we've ever invented has been successfully hacked, repeatedly. We simply don't have anywhere near the expertise to build an airtight attribution system.

Not that it really matters. Even if everyone could trace all packets perfectly, to the person or origin and not just the computer, anonymity would still be possible. It would just take one person to set up an anonymity server. If I wanted to send a packet anonymously to someone else, I'd just route it through that server. For even greater anonymity, I could route it through multiple servers. This is called onion routing and, with appropriate cryptography and enough users, it adds anonymity back to any communications system that prohibits it.

Attempts to banish anonymity from the Internet won't affect those savvy enough to bypass it, would cost billions, and would have only a negligible effect on security. What such attempts would do is affect the average user's access to free speech, including those who use the Internet's anonymity to survive: dissidents in Iran, China, and elsewhere.

Mandating universal identity and attribution is the wrong goal. Accept that there will always be anonymous speech on the Internet. Accept that you'll never truly know where a packet came from. Work on the problems you can solve: software that's secure in the face of whatever packet it receives, identification systems that are secure enough in the face of the risks. We can do far better at these things than we're doing, and they'll do more to improve security than trying to fix insoluble problems.

The whole attribution problem is very similar to the copy-protection/digital-rights-management problem. Just as it's impossible to make specific bits not copyable, it's impossible to know where specific bits came from. Bits are bits. They don't naturally come with restrictions on their use attached to them, and they don't naturally come with author information attached to them. Any attempts to circumvent this limitation will fail, and will increasingly need to be backed up by the sort of real-world police-state measures that the entertainment industry is demanding in order to make copy-protection work. That's how China does it: police, informants, and fear.

Just as the music industry needs to learn that the world of bits requires a different business model, law enforcement and others need to understand that the old ideas of identification don't work on the Internet. For good or for bad, whether you like it or not, there's always going to be anonymity on the Internet.

This essay originally appeared in Information Security, as part of a point/counterpoint with Marcus Ranum. You can read Marcus's response below my essay.

Taken with my Panasonic GF1 and the Lumix 20mm f1.7 pancake lens while I was waiting in our car for my wife to buy some ham and cheese. Handheld, no flash, but edited in Adobe Lightroom. I love the camera's shallow depth of field.

It’s a textbook case of when doing less is more. If the Obama administration had better kept its powder dry, instead of spending so profligately, it perhaps wouldn’t be stuck doing so much backpedaling.

Now the federal budget’s in pieces and it seems too late to be begging from the too big to fail banks.

 

Too Late to Beg From the Too Big to Fail originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

What a marvelous recovery! But there are so many unresolved mysteries! GDP growth over 5%…but, mysteriously, no jobs…and no rally in the housing market.

And now, to compound the mystery, Mr. Obama has come forward with a $3.8 trillion budget.

The markets like it. Stocks rose 118 points on the Dow yesterday. Gold went up $21. Investors see more hot money on its way…a Vesuvius of it…

The amount of the budget itself is staggering. That’s a lot of money. But even more staggering is the glaring omission: the Obama administration is planning to spend $1.6 trillion it doesn’t have. And that’s on top of the $1.35 trillion it didn’t have, but nevertheless spent, last year. Where is all this money coming from? Another mystery…

Let’s see…put those two deficits together and you’ve got a budget hole as big as the Milky Way… Nearly $3 trillion, or more than 20% of GDP.

Another thing that is mysterious about this galaxy of debt is that it comes just as the economy is supposed to be recovering. If you thought the economy were recovering, why would you risk such a huge, record-shattering deficit?

Nothing quite adds up. The GDP is expanding at a healthy pace – according to the numbers handed out by the feds. But people have few jobs and little income.

“Wage and benefit growth hits historic low,” reports The Wall Street Journal.

Employers aren’t employing. Workers aren’t working. And houses are no longer throwing off cash. That leaves more and more people with empty pockets.

Apparently, not even the feds themselves believe the economy is really out of the ditch. We are already rolling along on the recovery road – supposedly. Still, the feds send out the most expensive tow truck in history!

And now The Financial Times draws the obvious conclusion:

“US Deflation No Longer Seen as a Risk.”

You wanna bet?

The world’s number one economy is running huge deficits. But the world’s number two economy is running even bigger ones. Not much bigger…but slightly bigger.

In Japan, deficits are a bit larger than tax receipts. In America, they are a bit smaller. In both cases they are enormous…and growing.

For all its colossal deficits, Japan has not bought its way out of depression…or out of deflation either. Au contraire, the more it spends fighting deflation the further prices fall.

How could this be? Another mystery. How could government be so inept as to shoot itself in the foot whenever it pulls a trigger? How could it be so near-sighted as to aim for one thing and hit the thing it was meant to protect? How could it be so lame-brained as to do exactly the wrong thing at exactly the wrong time?

We can’t answer those questions…at least, not this minute.

So, let’s turn to the evidence. There it is in yesterday’s news report from Bloomberg:

“Consumer prices in Japan in record fall.”

And there you have another mystery, don’t you? Japan inflates the money supply with its zero rates over more than a decade…and its Godzilla budget deficits. And what happens? Its economy sinks and its consumer prices go down!

And so here comes the US of A following the Japanese lead…in the sincerest form of flattery…

Will it not get the same results?

We don’t know. But we wouldn’t be surprised.

We have a lot more to say about this…

…about how the economic theories behind these moves are corrupt, linear and superficial (if not downright stupid)…

…and about how the real driving force behind these deficits is politics, not economics. Economists are just useful idiots. The politicians are using them to grab more money and power for themselves and their friends…

…but let’s go directly to the denouement of this mystery story. Here’s what is really going on:

First, the GDP growth story is one part statistical noise, one part counterfeit, and one part damned lie. We’re in a depression. It will take years to resolve itself.

That’s why unemployment remains high…and why there will be no recovery in housing prices. They may go up. They may go down. They won’t ever get back to the bubble highs of 2006 – not in real terms. Not in our lifetimes.

Second, the mystery of the $1.8 trillion deficit – it too is a mixture of mendacity, audacity, and intellectual laxity. In short, the feds are spending so much money for one reason only: because they think they can get away with it.

Can they?

Of course not…not really. Here’s what is going to happen…

The reality of the non-recovery is going to catch up with this market. Stocks were down in January. Most likely, they’ll sink for the rest of the year too.

The economy will slide as the de-leveraging process continues. It won’t be straight down. But by fits and starts, the mistakes will be corrected…

…but that brings us back to this $3.8 trillion government budget. Its purpose, in large part, is to prevent the corrections from occurring. The feds will try to turn the US into Zombieland, just like the Japanese feds did. You’ll see massive federal spending taking up some of the slack from the private sector – but essentially wasting money on useless projects. And you’ll see major zombie corporations – GM…AIG…etc – propped up with taxpayer’s money.

Speaking of AIG, special agent Neil Barofsky is on the case. He’s ‘probing’ 25 cases of possible fraud involving TARP funds. The AIG bailout is one of them. The original price tag for saving Goldman’s speculative positions with AIG was $85 billion. The whole tab later came to $182 billion.

The flatfoot Barofsky wants to know where the money went. To tell you the truth, we’re curious too – although we doubt there will be any surprises.

But back on our beat…how the mysteries get resolved…

…we know why the economy is winding down…and we know why the feds are running such huge deficits…

…but big deficits aren’t pushing up prices in Tokyo; they’re having the opposite effect. They’re pushing them down. Does that mean US deficits will get the same results – the economy and prices lower instead of higher?

We don’t know…but our guess is that ‘yes’ is the right answer.

Economic Recovery: The Unresolved Mysteries originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

RDFcache is a content-addressable storage system for RDF data.

Earlier today we looked at how the housing market is teetering atop artificially created price levels engineered through bailout and stimulus. Now, we turn our attention to the official evidence of it. In its latest Quarterly Report to Congress (pdf), the Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) documents how, “Supporting home prices is an explicit policy goal of the Government.”

According to Tracy Alloway at the Financial Times:

“…propping up house prices is now an explicit goal of the US government… So explicit in fact, that the Special Inspector General for the Troubled Asset Relief Program has knocked up this little chart to show how various policy programmes (Hamp, MHA, etc.) lead to higher houseprices:”

Alloway goes on to cite the SIGTARP report:

“Supporting home prices is an explicit policy goal of the Government. As the White House stated in the announcement of HAMP for example, ‘President Obama’s programs to prevent foreclosures will help bolster home prices.’”

It’s pretty tough to see how the housing market can reach the kind of equilibrium price levels that will support a sustainable recovery with this unabashed government intervention. When the policy support goes away, which because of its cost it eventually must, the second leg down in housing is likely to follow in short order.

See Alloway’s complete post in Financial Times Alphaville coverage of the US housing bubble v2.0.

Chart: How the US Gov’t is Guaranteeing a Second Housing Bubble originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

Folks,

CPT Jonathan Tuttle of the Beltway Commandos forwards this post from the ATF agent "Microscope" on the CleanUpATF.org website.

I have taken the liberty of posting the pdf of the judge's order in this case here. You may be suspicious of "Microscope's" analysis until you read the order.

Once again we see how the street agents are being screwed by the senior executives, especially the professional liars of the Chief Counsel's Office.

Mike
III

Posted Today, 02:25 AM

Ridiculous Part I

Between September 2004 and August 2007 ATF Agent Jay Dobyns and his family received verified death and violence threats on a dozen separate occasions from crime suspects Agent Dobyns investigated.

The threat sources ranged from a home invasion suspect, to a murder-for-hire suspect through various members and associates of the Aryan Brotherhood, the MS-13 and the Hells Angels. The threats and actions moved beyond plots to kill Agent Dobyns and extended to proven and credible plans to capture and torture his then 14-year-old daughter and video tape the gang rape of his wife.

ATF did next to nothing and fluffed off the situations. Agent Dobyns internally grieved the mismanagement to then Deputy Director Edgar Domenech who requested a “fact finder” investigation to be conducted "in house" by ATF’s internal affairs.

The IA investigation was embarrassingly one-sided, unprofessional and incomplete. IA intentionally set out to protect ATF with a predetermined exoneration and did so by concluding the accused ATF managers did nothing wrong. ATF thought Dobyns' complaint would end with their whitewash.

Domenech used IA’s flawed report to advise Dobyns in writing, “I do not believe that any ATF officer deliberately set out to mishandle any of the various matters at issue, nor do I believe that a hostile work environment was intentionally created. Therefore, the personal relief that you seek must be and is hereby denied.” (Agents, remember those words next time you are accused by ATF of wrongdoing. According to the Deputy Directors own assessment if your error was not “deliberate” or “intentional” then you have done nothing to be punished for. Agents, this is a gift that Domenech gave us and it will keep on giving forever, i.e. ATF must prove that your transgression was deliberate and intentional. The precedent has been set but I digress. Allow me to return to point.)

The Office of Special Counsel and the Office of the Inspector General investigated the very allegations that ATF IA examined. The independent investigation arrived at an exact 180 degree opposite conclusion than ATF’s IA. The OSC found ATF managements handling of the situations to be inept at best.

Agents, how can two independent investigations conducted by government trained and experienced investigators and relying on the exact same facts and circumstance arrive at entirely opposite conclusions? The “how?” is because ATF will avoid accountability and protect their executives at any and all costs to include doctoring their own internal reviews.

In OSC's letter to President Obama on this matter they wrote, "Notably absent is any statement from ATF regarding action taken to address their failures to adequately investigate the threats made against Special Agent Dobyns. Threats against agents must be pursued aggressively and officials at all levels must cooperate in any investigation. The protection of its own agents is critical to the success of ATF’s mission."

When new DD Ronnie Carter and his new Assistant Director for Field Operations Billy Hoover came to power they met with Agent Dobyns and settled the dispute out of court. In that settlement Carter and Hoover "guaranteed" to personally put an end to the hostile work environment and whistleblower reprisals Dobyns had been subjected to under the previous regime. Carter went so far as to state to Agent Dobyns, "The people in this agency will do exactly what I tell them to do."

Ridiculous Part II

Approximately 7 months after the settlement agreement was signed Agent Dobyns requested the assistance of ATF’s Special Operations Division to backstop a personal vehicle being driven by his now 16-year-old daughter (the prior target of unaddressed kidnapping and torture threats).

Carter, Hoover and SOD Chief Marino Vidoli decided to deny the backstopping request, but, took it one step further. With no explanation or justification they recalled all of the previously issued backstopping mechanisms put in place to assist Agent Dobyns in obtaining and maintaining security for himself and his family. All of the backstopping that Agent Dobyns had been able to create for himself and his family were removed and thus that personal security was intentionally exposed and compromised by ATF's actions.

Four months later in August 2008, the Dobyns family home was burned to the ground in an arson fire. With Carter and Hoover now in charge of their own regime, ATF dropped the ball again, only this time to a much worse and more malicious level than Domenech and Bouchard ever dreamed of.

Agent Dobyns sued ATF in the United States Court of Claims for violating the settlement agreement contract and for the reprisals he was continuing to receive.

ATF brought in attorneys from the Department of Justice to defend their actions. The DOJ and ATF attorneys teamed up in motioning the court to enact a “death sentence” on the Dobyns lawsuit seeking a total and universal dismissal of Agent Dobyns’ complaint.

If the government’s motion were granted ATF would be home free and never have to face ANY accountability for their bad acts. A classic David vs. Goliath battle.

Agent Dobyns and his pro-bono attorney (our David) going toe-to-toe against the best team of DOJ and ATF legal minds that the government could assemble (Goliath).

On January 15, 2010, United States Court of Claims Judge Francis Allegra issued his written ruling. Judge Allegra cited dozens of legal precedents, to include Supreme Court rulings that support the continuance of Agent Dobyns lawsuit in Federal court. The only element the government succeeded in winning was a FOIA dispute which would have proven to be inconsequential as the case moved forward. David won.

In their failed argument against Dobyns the government attorneys attempted to fluff off the legitimacy of his lawsuit when they argued to Judge Allegra that the Dobyns lawsuit was, “nothing more than an unadorned, ‘the-defendant (ATF)-unlawfully-harmed-me accusation’.”

Judge Allegra humorously ruled that the government’s flawed view of the Dobyns lawsuit, “revolve(s) around the notion that despite its 147 counts and 43 typed pages the plaintiff’s complaint somehow lacks specificity.”

Judge Allegra further cited the previous Office of Inspector General investigation writing, “The OIG opined that ATF should have taken threats against Dobyns and his family more seriously and its responses to threats were inadequate, incomplete, and unnecessarily or needlessly delayed.”

Judge Allegra cited from Agent Dobyns complaint in his ruling that, “ATF allowed ATF managers to perpetuate a hostile work environment characterized by individual and institutional reprisals - harassment, discrimination, slander, defamation, whistle blower retaliation and misuse of internal affair mechanisms; ATF failed to take adequate steps to protect plaintiff (Dobyns) and his family; ATF failed to provide essential security backstopping and protective documents necessary to obtain and maintain a covert residency and safe daily existence; ATF failed to take a variety of steps to investigate properly the arson fire and manipulated official investigative findings.”

Judge Allegra’s final words were clear. “The court believes that his case should proceed.”

Agents – 1, ATF – 0.

NOTE: Pay special attention to the Appendix at very end of the ruling. There you will find a list of ATF transgressions; bad acts that ATF attempted to convince the court they should not be held accountable for. This is shameful.

Ridiculous Part III

Immediately after learning of their loss ATF and DOJ attorneys filed a countersuit against Dobyns. The government claims that the United States has been damaged by the release of Agent Dobyns’ book No Angel and is seeking monetary compensation from Dobyns for their alleged damages.

ATF Agents let me run this scenario by you: An Agent commits a damaging crime against ATF. He does so to such an extreme level that ATF and DOJ attorneys file a federal lawsuit against the agent seeking damages compensation. So we ask…

When did ATF determine they were damaged? The book has been on bookshelves for one year and ATF knew about the publication of it 11 months before that, so let’s say for roughly two years ATF was aware of their damages.

Did ATF investigate the alleged crime? Yes. Did the Professional Review Board confer on this crime and the investigation of it? Yes. So if the investigation revealed a crime would the PRB impose discipline, especially one so heinous to ultimately result in a lawsuit? Yes. Did the PRB propose discipline? No. Did the PRB put as much as an adverse letter in the agents personnel file? No.

So let me get this straight. ATF feels that they are severely damaged by a crime committed by a currently employed agent. ATF bypasses the entire internal discipline process and jumps straight to a lawsuit. But, ATF does so two years after investigating the alleged “crime” against them and files their suit just days after learning their own motion to legally bury the agent is overturned?

Who is ATF’s Chief Counsel and where did he get is law degree? In my Cracker Jack box I only got a lousy comic book. Ken Melson, hello, are you out there? Are you monitoring anything that your attorney’s are doing?

The ATF/DOJ countersuit is a blatant example of malicious prosecution and one that will go down at the bottom, or at least near the all-time low for ATF. If I were Agent Dobyns whatever it was I was asking the courts to consider for my monetary compensation, as of today I would add another zero to the end of that total.

Rest assured ATF Agents, the truth never changes and it never goes away. ATF can attempt to morph it, disguise it, mitigate it, cover it up, re-invent it, fabricate it, lie about it, and use their best attorneys and the courts to avoid it, but, the truth will always remain the truth and very quickly in this case it will begin to reveal itself to full public view.

Then you will be able to form your own conclusions, pro or con, with ALL of the facts, evidence and testimony available to help you decide who is right and who is wrong.

The totality of this case is a single example of how ATF Chief Counsels Office enacts their blind loyalty, true believer, no-act-to-low approach to defend against their managers failures and how our executives hatred for an employee can skew their reasoning.

Government attorneys are mandated by Congress maintain the very highest levels of ethics and integrity in seeking truth and justice for the American people. I don’t believe Congress left a loophole in that standard to exclude ATF agents.

The elements of Agent Dobyns case may be unique but ATF’s actions against him are not. They demonstrate a common example of how ATF executives loath working agents, and most especially the ones who have the courage to take a stand against them.

Sir, _____________ (fill in the blank as needed with Sullivan, Melson, Carter, Hoover, Carroll, Loos, Vidoli, Newell, Gillette, Higman, Domenech, Bouchard, Webb, Dobyns) please raise your right hand. Do you swear to tell the truth, the whole truth and nothing but the truth, so help you God? Are you aware of the penalties for perjury against the United States? Please be seated and state your name for the court…

The commercial real estate crisis may be the most anticipated crisis in history. But just because it’s widely anticipated doesn’t mean that the crisis won’t be destructive for REIT shares. Since most REITs are richly valued, the slow-moving commercial real estate crisis will ensure that future returns disappoint.

Consider the valuation of REITs versus the S&P 500, which itself is overvalued. Despite being 25% below its late 2007 peak, the US stock market – measured by the S&P 500 index – is very expensive. The “Shiller P/E ratio,” developed by Yale professor Robert Shiller, measures the S&P 500 against the average S&P 500 earnings over the previous 10 years, adjusted for inflation. It’s a much more robust measure of valuation, considering the fluctuation of corporate earnings, and the fact that after bubbles, much of the earnings booked during the boom are written off during the bust. Consider that the earnings booked by Citigroup and other big banks near the peak of the bubble were largely written off during the bust. Therefore, a 10-year average of earnings is a better indicator of true earnings.

The Shiller P/E ratio for the S&P 500 Index is now 21 – up dramatically from 13 at the March 2009 lows. This 21 P/E is higher than at almost any point in stock market history, outside of the late 1920s bubble, the late 1990s bubble, and the market peak in 2007. The S&P 500 is overvalued based on the Shiller P/E, but corporate earnings are supposedly going to soar in 2010, right? Well, even if you believe the optimistic 2010 estimates, the market is still more than fully valued on that metric.

Ditto REITs.

Commercial real estate – and the REITs that hold commercial properties – began to deflate rapidly in late 2008. But the Fed stepped in with bailout funds and easy money to halt the deflation…and even pumped the bubble back up a bit. The nearby chart shows the results of the Fed’s handwork. REITs of all shapes and sizes more than doubled off the stock market lows of last March, while the Bloomberg Hotel REIT Index more than tripled. (We’ll come back to this chart a little later).

This rally has the look and feel of a dead-cat bounce, which means that it provides an attractive short-selling entry point.

REITs soared as the bubble inflated from 2000-2007, then crashed when the bubble popped in 2008 and early 2009, and then launched a dead cat bounce when the Fed flooded the system in mid-2009 with massive injections of liquidity and cheap credit. Now REITs are priced at bubble valuations – valuations that bear little resemblance to economic reality.

This bounce has postponed a healthy purge of assets in which old capital invested by foolish speculators during the bubble would have been wiped out – clearing the way for new owners to assume title to real estate at reasonable prices. When central banks prop up deflating bubbles with super-easy bailout cash, the bubble investors don’t liquidate their overly inflated assets. They hang on and hope for a turnaround.

But bubbles always deflate…always. Government intervention merely muffles the hissing sound for a while. This story played out in the Japanese real estate bubble that peaked in 1990, and it’s happening with the US commercial real estate bubble that peaked in 2007. Capital becomes trapped in a dead asset class, thereby stretching the bubble’s resolution out over decades.

Toward the end of 2009, it became clear that “extend and pretend” had become the official policy at most banks that hold commercial mortgages. We won’t see a cleansing flush of hundreds of billions in underwater properties changing hands to new owners. Instead, properties will be dribbled out of the foreclosure pipeline at a slow pace. This measured pace of foreclosures will add to the chronic glut of property that will be quickly listed for sale into any bounce in demand.

Some of the best short-selling opportunities in the REIT sector may be in the hotel REIT sub-sector.

It’s not a stretch to expect the hotel business will be ugly for a long time. Corporate and leisure travel is in the midst of a depression. And leveraged hotel owners built or acquired too many hotels near the peak of the commercial real estate bubble.

Now many hotel owners are desperate to generate cash in order to pay down debt and retain titles to properties. Some are slashing nightly room rates below break-even levels. You know from the growth of Internet hotel booking services just how much more competitive and transparent hotel pricing has become over the past decade. Unless competitors are willing to match the pricing of the most desperate hotel owners, healthier competitors will suffer lower occupancy.

Some levered hotel owners, like Sunstone Hotel Investors, are abandoning their equity in some properties to salvage others. In the fourth quarter of 2009, Sunstone defaulted on several nonrecourse mortgages held against 13 of its properties and turned the title over to its lenders. Sunstone calls this a “deed-back,” but it’s really a strategic default.

Sunstone’s lenders will probably keep and operate the hotels, rather than dump them at a distressed price. The behavior of Sunstone and its lenders shows how many hotel owners and lenders are putting off the necessary liquidation of underwater properties with bloated cost structures. The industry still needs to make more progress on downsizing, slashing operating costs, shrinking mortgage sizes, and lowering room rates to match demand. Until it does, the industry’s returns on capital will not consistently exceed its cost of capital.

Hotel REITs are highly sensitive to perceptions about the near-term health of the hotel business. Trends in occupancy and room rates shape perceptions about earnings. Hotel REITs own portfolios of hotels and outsource the management to companies like Marriott for a fee.

Because of the relatively fixed costs of paying management companies a fee for operating hotels, Hotel REITs operate with high operating leverage: A 20–30% decline in revenues can translate into a 50–75% decline in operating income. Also, unlike offices or retail REITs with sticky long-term leases, the cash flow for hotel REITs adjusts quickly to changing conditions on a day-by-day basis.

Over the past nine months, hotel REITs have soared on the perception that corporate and leisure travel will rebound strongly in 2010 and 2011. Analysts have forecast a sharp rebound in earnings.

But I’m not buying it. In fact, I’m selling it.

Regards,

Dan Amoss
for The Daily Reckoning

REITs… A Thing to Avoid originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.