Tuesday, November 27, 2007

Updates - SIVs, Citi, Social Security, Subprime, and Taxes

First thing to update is the status of this blog. I started it on October 2, not quite two months ago. Since then I have written 26 pieces for publication, but nothing substantial in the past week. The reason is that maintaining the level of publication I started out with has proved difficult as evidenced by the late payment notices I have been receiving (I have forgotten to pay the bills!). So I took some time off to catch up on the other pieces of life not reflected in the blog (bills, family, work, exercise, etc.). I will continue to post so long as I continue to have visitors, although there will be periods of quiet.

There have been some very interesting developments in the interim, and I am writing today to update the issues I have been writing about in November. If you have been following my blog (thank you) then these should be of interest to you. You can click on any of the topics below to go directly to that topic, or just read from the top.

Citigroup Subprime SIVs Social Security and Taxes Short Rant on policy and responsibility

On Citigroup:
It has been interesting watching this unfold. Citi announced today that it will receive a $7.5 billion capital investment from the Abu Dhabi Investment Authority. According to the press release

Each Equity Unit is mandatorily convertible into Citi shares at prices ranging from $31.83 to $37.24 per share. The Equity Units convert to Citi common shares on dates ranging from March 15, 2010, to September 15, 2011, subject to adjustment. Each Equity Unit will pay a fixed annual payment rate of 11%, payable quarterly.

11% seems high to me, about the same as Ford Motor Credit and GMAC high yield bonds give or take a point, and these are convertibles. Abu Dhabi ends up with a 4.9% interest in Citi post conversion.

Now the layoffs are coming in force, and there is a lot of speculation in the media about how many jobs. I heard today on MSNBC anywhere from 15,000 to 45,000. That could be a lot of layoffs and of course it comes just before the holidays.

The investment by Abu Dhabi reinforces the fact that America is currently on sale, as I wrote about in my first piece in November. Interestingly, this purchase is with dollars so the exchange rate is not the issue. Rather it is the price of oil.

Since I wrote that piece, the Fed chairman testified before Congress and released its (now quarterly) report on the economy. The report was pretty much as expected, as was the testimony. Of course some of the dialog during the testimony was simply amazing in that it will likely lead to a proposal by Congress to federally guarantee jumbo mortgages (just what we need – more obfuscation of the “market”). I believe I heard warnings of stagflation in the testimony as well. If you would like more detail on this you can find it here.

While on the subject of the overall economy, I have some anecdotal evidence of a slowdown. Each year my family drives 230 miles to visit relatives for Thanksgiving. Last year the trip took about 6 hours with traffic, each way being a very long drive. This year it took just over four hours each way with almost no traffic. I believe gas prices are beginning to have an impact.

On Subprime:
What is happening there? Well, for one thing the Federal Home Loan Banks have vastly increased their exposure over the past quarter to provide liquidity to the mortgage market. Freddie and Fannie did their part as well, although they have since disclosed problems of their own relating to poorly underwritten mortgages. I wrote abut these increased exposures here. In a pleasant surprise, Senator Schumer is onto this scheme and posted a letter to the Federal Home Loan Bank today. Details here. Other than that there have been increased calls for taxpayer help to bail out homeowners so as to avoid a real economic problem. I don't believe there should be any bailout, and you can read about my reasons for this here and here and here.

We now know that Citi has taken substantial assets onto its balance sheet relating to the SIVs, and HSBC announced that it is moving approximately $45 billion in SIV assets onto its balance sheet. I believe this is a blow to Citi and the whole MLEC plan because HSBC has taken the matter into its own hands and consolidated the problem. We should ask why Citi does not do the same, but the answer is likely to be one we don’t want to hear. Perhaps Citi does not have the equity to absorb such a move at this point. Whether Citi must consolidate these off-balance sheet entities is the subject of ongoing debate. According to a WSJ Online Edition article there MAY be a requirement to consolidate since Citi has taken over $32 billion in assets onto its balance sheet as of September 30 (as I discussed here). Sounds to me like a lot of intellectual wrangling over a pretty simple issue – if ultimately Citi will be forced to bail out these entities, whether for “reputational” or any other reasons, then they should be on the balance sheet. Of course that’s just my opinion.

The impact of all of this on the money markets is still uncertain. According to this WSJ article:

Efforts by HSBC to protect its SIVs are being watched closely by analysts and managers of money-market mutual funds, some of which have invested in debt issued by the two SIVs, called Cullinan Finance Ltd. and Asscher Finance Ltd. Janus Capital Group Inc. is estimated to have held about $606 million, or 2.7% of its money-market assets, in Cullinan and Asscher through the end of October, which has since been reduced. Federated Investors Inc. holds about $350 million in Asscher in its five largest money funds.

In other words, the mutual funds are still waiting to see whether they will be taking a hit on these. So far it appears they are winding down their exposure, but still have substantial assets tied to SIV structures.

On Social Security and Taxes:
I have been debating with people all week about my stance on Social Security, including the latest proposal by Fred Thompson to address the “crisis” we have. This Fox News Article reports his tax and Social Security plan as follows:

Thompson's proposal, announced on "Fox News Sunday," would allow filers to remain under the current, complex tax code or use the flat tax rates.
Asked whether the plan would cut too deeply into federal revenues, the former Tennessee senator and actor said experts "always overestimate the losses to the government" when taxes are cut.

"We've known for years any time we have lowered taxes and any time we've lowered tax rates, we've seen growth in the economy," Thompson said.

Thompson added that money would be saved by his Social Security reform plan. He proposed that workers younger than 58 receive smaller monthly Social Security checks than they are now promised. Individuals could contribute 2 percent of their paycheck to a personal retirement account, an amount that would be matched by the Social Security trust fund.

The retirement plan "faces up to the fact that Social Security is going bankrupt and we're going to have to do something about it," he said.

Well, first of all Social Security is only going bankrupt if the Federal Government decides not to honor its promise to repay what it borrowed from the Trust Fund (see my article on this topic here). If it does not, then it may be time to sell any treasury securities you have because they would no longer be “risk free”. (The Trust Fund does not own treasury securities, rather special IOUs from the federal government that are backed by the full faith and credit of The United States of America).

Next problem with this statement is the same old crap about the Laffer curve and taxes – if we can decrease taxes to grow the economy it will raise tax revenue. If this is true then why worry about Social Security? We can just cut taxes to pay for it! Ridiculous indeed. Now, to be fair, the article does not actually say that he believes a tax cut will result in higher tax revenue, but this is the argument we consistently hear from Republicans on this issue. I have yet to see any actual proof that the Bush tax cuts CAUSED tax revenues to increase. I have seen plenty of evidence that tax revenues have increased, but never any cause and effect proof. In other words, we do not know if it is the Bush tax cuts, fiscal stimulus from excessive borrowing, or normal economic growth from population growth and global growth that has caused tax revenues to increase. What we do know is that since the Bush tax cuts we are in a lot more debt and that is becoming a problem, especially when no one wants a tax increase to pay it down.

Finally, a flat tax has the potential to be regressive and could be another gift to the high-income population. In any event, a reduction in tax revenue is a problem at a time when we are at war (two wars, actually), and facing the need to begin repaying what has been borrowed from Social Security (not to mention the health care issues). At the end of the day, this boils down to paying for the Bush tax cuts and maybe even more tax cuts by reducing promised Social Security benefits relied on and paid for by lower- and middle-income retirees. It is a transfer of wealth from those with less to those with more. It is a sham. Again, that is just my (somewhat informed) opinion.

A short rant on policy and responsibility.
I think it’s about time we begin taxing to pay for our wars. Until now, we have fought this war in Iraq by borrowing the money and paying civilian warriors so as to avoid a draft and any tax increase. I wonder how long we would be in Iraq if we instituted a draft to get the soldiers we need and raised taxes to pay for it. I see uprisings on college campuses. I hear the cries of the high-income earners writing checks to the Treasury. My guess is we would already be gone. Isn’t this irresponsible? What happened to the party of personal responsibility? Isn’t keeping promises to taxpayers such as Social Security an act of personal responsibility? Isn’t managing the country in a fiscally sound manner an act of personal responsibility? How is it we get lectured on the values of personal responsibility by those who seem to ignore theirs? I shall continue to object.

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