Juggling Dynamite

Jim Chanos did an interview on Charlie Rose April 8. Youtube has a highlight clip:

You can view the entire 30 min discussion here.
Gary Shilling was discussing similar themes on Bloomberg April 13:

Debt “repos”, “swaps” and other clever lies have been the most insidious financial fraud tool of our times. It turns out many countries used some version of the hide-your-debt two-step to qualify for entry into the Euro in 1999. ENRON used similar techniques to perpetrate massive fraud and go bust in 2001. (If you have not seen the documentary on this, watch it now. It will help you understand a lot about what has happened since. You can rent the DVD or see it on line here: Enron, the smartest guys in the room.
This Wall Street Journal chart shows how at the end of each of the past five quarters, large banks temporarily flipped their net short-term borrowings in the repo market to lower the appearance of their risk profiles at quarter end when they release reports to the public. After quarter end, they flip it back on. See: WSJ: Managing Risk:

“Excessive borrowing by banks was one of the major causes of the financial crisis, leading to catastrophic bank runs in 2008 at firms including Bear Stearns Cos. and Lehman Brothers. Since then, banks have become more sensitive about showing high levels of debt and risk, worried that their stocks and credit ratings could be punished.
That practice, while legal, can give investors a skewed impression of the level of risk that financial firms are taking the vast majority of the time.”

Read more: WSJ: Big Banks mask risk levels And rest assured, this was not only in America…
All the while corporate insiders: executives and directors are selling their shares at an epic clip before earnings season begins to ramp up. The ratio of the total amount of stock sales versus stock purchases in the last week was almost 5-to-1, according to the Vickers Weekly Insider newsletter. The 8-week moving average of this ratio is more than 4-to-1, according to Vickers. Vickers considers any ratio below 2 sales for every one purchase to be bullish. Above 2.5-to-1 is bearish. A reading of 5-1 is “clearly bearish: See CNBC: Corporate Insider Selling picks up before earnings.
Meanwhile back on Main Street, today’s Lender Processing Services “Mortgage Monitor Report,” declared a new US record of 7.9 million first-lien and REO mortgages now in default:

The nation's foreclosure inventories reached record highs. February's foreclosure rate of 3.31 percent represented a 51.1 percent year-over-year increase. The percentage of new problem loans also remains at a five-year high. The total number of non-current first-lien mortgages and REO properties is now more than 7.9 million loans. Furthermore, the percentage of new problem loans is also at its highest level in five years. More than 1.1 million loans that were current at the beginning of January 2010 were already at least 30 days delinquent or in foreclosure by February 2010 month-end.

The upside of this data is that due to the staggering number of defaults, it is now taking borrowers well over a year, in some cases nearly two years, to go from missing a payment to being kicked out of their home. Rent free in between, this is providing some fleeting capital to support a recent surge in consumer spending. Sound like sustainable growth??

I did a series of interviews with the Moneyshow network last week. The first is available here: Price Risk High.
Yesterday John Hussman's weekly letter elaborates nicely on some of the concerns I have mentioned in recent interviews and the key hurdles haunting risk markets and bullish hopes from here.

“The real concern from my perspective remains the potential for a second wave of delinquencies beginning in data as of the first quarter of 2010 and extending well into 2011. While we've seen some suggestions that many Alt-A and Option-ARM loans have already been modified, the premise of this argument is problematic since it is also true that about three-quarters of modified mortgages go on to default a second time, and few of these modifications result in substantial alterations in principal or interest payments beyond 12 months.
In short, my impression is that investors are deluding themselves about the solvency of the banking system. People learned in the 1930's that when you don't require the reported value of assets to have a clear and tangible link to the value that the assets would have in liquidation, bad things happen. Yet this is what regulatory and accounting rules are allowing for the banking system at present. While I do believe that bank depositors are safe to the extent of FDIC guarantees, my impression is that the banking system is still quietly insolvent.”

The bad debts being glossed over in the banking systems (and governments) of the world today are a major systemic risk. But even if we set this issue aside and assume a miracle solution will allow the system to gradually hobble back to health without any further blow ups, the point remains that stock valuations today promise to be as stubbournly unrewarding to investors over the next 7-10 years as they have been over the last 10 years:

“Presently, a normalization of valuations, not to extreme undervaluation but simply a reversion to post-war, non-bubble norms, would imply an average annual return for the S&P 500 of just 2.97% over the coming 5 year period.
This outcome is not dependent on whether or not we observe a second set of credit strains, but is instead baked into the cake as a predictable result of prevailing valuations. The risk of further credit strains simply adds an additional layer of concern here. Investors have chased risky securities over the past year to the point where the risk premium for default risk has eroded to the levels we saw at the peak of the credit bubble in 2007. My sense is that this is a mistake that will be painfully corrected. Investors now rely on a sustained economic recovery and the absence of any additional credit strains – and even then would be likely to achieve only tepid long-term returns from these levels.”

See Extend and Pretend: