Monday, July 25, 2011

US Debt Default Will Punish Pensions

As America debates its debt, its debt ceiling, and the indebtedness of future generations, let’s make sure we all understand what we are talking about. Also, let’s look at an example of how the debt permeates through our society.  
Why does the US have debt?
Because the stewards of the country’s Treasury, Congress, spends more than it takes in in tax receipts.
What is the debt?
The US issues bonds, notes, and bills that promise to pay principal and interest at maturity of the issue. The principal is meaningless. A printing machine produces principal to infinity. The interest, on the other hand, is a problem. Almost all of the current debt will have to be rolled over (re-financed) before 2020 at interest rates that prevail at the time of re-issue.
How much is the debt?
Let’s refer to the following website: As of June, 2011, the official amount of Treasury debt issued is $14,343,088,000,000. In case we have trouble with all those commas, that figure represents ‘trillions’ of dollars in debt. 
How much interest expense does the country pay each year on the debt?
In 2011, the US will pay $385.8 billion in interest coupons. That’s down from $413.9 billion paid in 2010 because interest rates have been falling while debt has been rising. In the end, it is not the debt that crushes a nation but rather the interest coupon required to facilitate a growing debt. We now live in a completely artificial environment whereby the Federal Reserve works to orchestrate a contracting interest coupon so the debt can be perpetuated. Banks make money by lending. The Fed made $90 billion in 2010. That’s more than Exxon and Walmart combined! We can all see who really benefits from massive debt. One can read my article ‘Why US Treasuries Will Eventually Yield Nothing’ to learn more as to why interest coupons will continue to fall. 
Who owns the debt?
Here’s where it gets interesting. From the same website as previously referenced, the public owns $9,742,223,000,000 and roughly two-thirds of that is in the form of notes or intermediate term maturities. Another $4,600,864,000,000 in Treasury debt is listed as ‘Intragovernmental Holdings’. Nearly all of that $4.6 trillion is Treasury debt known as ‘Government Account Series’ (GAS) issue.
What’ the difference?
$4,580,584,000,000 of the $4,600,864,000,000 GAS debt is non-marketable. That means there is no market in which to sell this debt. In other words, if Treasuries should begin a bearish trend and sell off, investors that hold marketable Treasuries could sell their holdings to limit their losses. Holders of non-marketable Treasuries cannot. 
Who holds non-marketable Treasury debt?
Interestingly enough, US citizens do. The Social Security Trust Fund holds 57% of the non-marketable Treasuries. Federal government employees are tied to the non-marketable debt through their retirement plan with a 17% ownership. Take a look at the following chart.

Explain how federal employees are affected?
Civilian federal employees hired before 1984 were covered by the Civil Service Retirement System (CSRS) and those hired after 1984 were covered by the Federal Employees Retirement System (FERS). Both plans had investible assets directed to the Civil Service Retirement and Disability Fund (CSRDF). This is a defined benefits retirement fund for retired Federal employees. This retirement benefit extended by the taxpayer is structured as an annuity. Like everything for our government employees, a defined benefit plan is the ‘Cadillac’ of retirement plans. According to the Office of Personnel Management (OPM), they estimate the cost of the FERS annuity to be 12.5% of employee pay. The federal employee pays .8% and you and I pay the other 11.7% of that contribution. The federal government makes supplemental payments into the CSRDF on behalf of employees covered by the CSRS because employee and agency contributions and interest earnings do not meet the full cost of the benefits earned by employees covered by that system. But, it is an annuity and it is totally controlled by the government. The government controls the payout. The government controls the allocation of the invested funds. And, the government controls the ownership of the funds. That means the employees have no rights to the money listed in the plan under their name.
What is in the CSRDF?
As the retirement fund of civilian Federal employees, the funds are 100% invested in special-issue Treasury securities that count against the national debt. Contributions to the fund can be, and are suspended when a debt ceiling prohibits further expansion of the national debt. Current investments in the fund are redeemed by the Treasury while contributions are suspended. If and when further governmental borrowing is allowed, by law, the fund is then made whole again. 
How much money is in the CSRDF?
According to an article authored by Katelin Isaacs at, the CSRDF reported a balance of $734 billion at the beginning of 2009. Here’a the part that I like. As with everything in our world today, the CSRDF is unfunded to the tune of $674 billion. It turns out that the CSRS was never funded while the newer and less generous FERS was and is funded. What we have is a dollar figure based on ‘imaginary value’ derived from Treasury note par value. 
How is the CSRDF funded?
According to the OMB, the fund will have an income of $98 billion (estimate) in 2010. A full $3 billion will come from employee contributions. The other $95 billion will come from interest ($40 billion) and well, essentially tax payers. Expenses, or payouts, are expected to be around $70 billion for the same year. Again, all investments are required to be in US Treasuries. Still, the fund has a lot of ground to make up. 
What if the US Treasury debt is capped or sells off?
We can see that civilian Federal employees and retirees could be hurt severely. If the debt can’t be expanded. the CSRDF will not get funding and retirement obligations will not be met. Should the Treasury notes and bills experience a loss in value due to selling pressure, the CSRDF will likely lose value and find itself more unfunded than originally thought. Even at best, the current Treasury Secretary has borrowed from the existing holdings of the fund to apply to the national debt to make it seem less threatening. Outright default on held Treasuries would surely diminish the value of the fund. 
How does the US government get away with this type of accounting?
I really like this part. What you are about to read explains our world and our fiscal predicament perfectly. Please read this next sentence very carefully. Quoting from the source listed below, ‘According to the U.S. Office of Management and Budget (OMB), balances in the trust fund are... available for future benefit payments and other trust fund expenditures, but only in a bookkeeping sense.’ That statement ought to engender confidence in the government.
But what about the part that is unfunded?
From the same source listed above, the fund is in no danger of insolvency because the unfunded gap will eventually close. Want to know how? This article that I am quoting from is from the Congressional Research Service written by Patrick Purcell in June of 2009. It says, ‘The decline in the ratio of CSRDF outlays to salary expense after 2020 will occur mainly because future retirees will receive smaller pension benefits under FERS than they would have received under CSRS.’ Does that sound like austerity? I suppose too, that actuaries could estimate rising taxes, rising interest rates, rising numbers of contributors (more government hires), and declining benefit recipients due to death. Or maybe, they are just dreaming!
What about Social Security?
Yep, the Social Security Trust Fund is required to own US Treasuries and as previously pointed out, the fund owns 57% of the non-marketable Treasury inventory. As with the CSRDF, if US Treasuries fail (default), so too will the Social Security Trust Fund. Also, as with civilian Federal employees and their retirement funds held by the CSRDF, a 1960 Supreme Court ruling established that contributors to Social Security do not have a right or an entitlement to receive benefits from the Social Security Trust Fund. The government can cut either off whenever it wants. The debt debate should be bringing the phony pension accounting to light in both Social Security and the CSRDF. Sadly, both now depend on ever expanding debt. 
Hopefully this little article will help with the understanding of the US debt and some of the ramifications of current, and probably ongoing debt debate. As we can see, our modern world is tentacled with pervasive debt. Putting a limit on that debt is not as easy as it might sound. Letting the debt continuously expand is clearly an exercise of surrender at the vault of the elite banks. Yes, Treasuries held in trust funds and pensions are valued at par. But if the Treasury is not allowed to borrow more money to pay the interest on currently issued Treasuries, default will occur rendering the paper worthless. On the other hand, if the Treasury is allowed to expand the debt unimpeded, the increased supply will erode the value of currently issued debt either through inflation or supply/demand dynamics. The government is now exposed as an irresponsible fiduciary as it requires certain retirement programs to hold only one security - the one that it issues. The US Treasury note might turn out to be one of the most risky securities on the market. To make matters even worse, the reported balances in some retirement programs like the CSRDF are only balances in a ‘bookkeeping sense’. Maybe we are playing musical chairs only all the chairs are make believe. Maybe what we should really take from the debt debate is the illusion of fiscal soundness. In other words, we are in an ocean of debt that threatens to drown us but fortunately we have a boat. However, the boat only exists in our minds through the power of imagination. The boat is not real. We just can’t afford to open our eyes and see that the boat is not real because the ocean will consume us. 
Disclaimer: The views discussed in this article are solely the opinion of the writer and have been presented for educational purposes. They are not meant to serve as individual investment advice and should not be taken as such. This is not a solicitation to buy or sell anything. Readers should consult their registered financial representative to determine the suitability of any investment strategies undertaken or implemented. BMF Investments, Inc. assumes no liability nor credit for any actions taken based on this article. Advisory services offered through BMF Investments, Inc.

Friday, July 15, 2011

Default Doubt

For all the talk this week of a potential US sovereign debt default, the market seem to be convinced otherwise. All the King’s politicians were out pronouncing a default to be ‘cataclysmic’ or ‘unthinkable’. Yes, the US Congress has been consumed with the debt ceiling in the US. It seems $14.3 trillion is not enough to borrow. The politicians want more. Citizens are once again threatened with the idea of not taking on more debt as a bad thing. Really? I thought it was good to minimize debt and pay it off if possible. Anyway, the equity markets dipped a bit this week but the most interesting thing was the behavior of the bond market.
Staring a default threat in the face, the bond market rallied. That’s right, the US Treasury bond market rallied. The chart below is the US 10-year Treasury note and we can see from the chart that it rallied about 2% this week. The message is there is great doubt about a default. It is just not going to happen. See the chart below.

3 months: UST
Chart courtesy

Disclaimer: The views discussed in this article are solely the opinion of the writer and have been presented for educational purposes. They are not meant to serve as individual investment advice and should not be taken as such. This is not a solicitation to buy or sell anything. Readers should consult their registered financial representative to determine the suitability of any investment strategies undertaken or implemented. BMF Investments, Inc. assumes no liability nor credit for any actions taken based on this article. Advisory services offered through BMF Investments, Inc.

Friday, July 8, 2011

A Fools Viagra

Readers of my newsletter this month know it was titled, ‘Central Bank Viagra’. This article is a continuation of that theme. To get right to the point, Dow 12,000 seems to be the central bank Viagra line. In other words, whenever the Dow seems to be in danger of losing the 12,000 level, central bankers and other market manipulating shills get really active to boost the Dow higher. I won’t bore readers with a bunch of statistics that try to prove a point. Certainly the market indices are capable of rallying on their own. Certainly investors can push a rally. But good Lord, people! Most major economies are completely dependent upon central banking lifelines. Most major governments are insolvent. There are riots all over the world in response to the complete ineptitude of government. Economic data (what real data is allowed to escape the propagandist governments that compile such information) continues to imply weakness rather than strength. Yet, all bad news is quickly spun to be broadcast on financial teevee as either great news, good news, or not as bad as it could have been news. It’s all great. Pile on. There is a bull market in stocks and it is all based on fundamentals. Yeah sure!
Let us turn to a few charts. But first, we should now view charts with a disclaimer. Charts have always been the picture that investors draw with their buys and sells. We are now in this strange new land where the power elite artificially run everything. It’s like when Richard Nixon thought he could arbitrarily assign wage and price controls to impose government will on economics. Of course, that idiocy led to a horrible recession. Today, the elite know that no one pays attention to fundamentals anymore. We know they are all made up, massaged, and contorted to match a fantasy viewpoint. But charts have always been the revelation of truth. They simply show the daily activity of investors. Investment decisions are made based on charts. Aahh! Our market manipulators are on to us and now they, the manipulators, draw the charts. It appears that they now visualize how they want a chart to look over the course of the next few weeks and they simply draw upon central bank programs for ammunition. Thus, charts are now ‘drawn’ rather than reflect. 
June of 2011 was an interesting month. Thrice we flirted with the central bank Viagra line of 12,000 and thrice the central bank came charging to the rescue with massive buy programs. Housing foreclosures and loan defaults be damned. Double digit unemployment on the horizon for the next generation be damned. Government leaders debating on whether or not to raise a supposed sovereign nation’s borrowing ceiling above $14,300,000,000,000 dollars be damned. The Plunge Protection Team wanted us to be privy to a stock rally. It seems that the PPT now believes that a stock rally can only be procreated as long as the Dow keeps its head above 12,000. Okay, fellows - I think we all got the point! Geeez! The last week of June was the best week in two years, already! Chart 1 below shows the intervention process as marked by the little blue lines. 

Chart 1: 2 months - DJIA
Chart courtesy
But with all this manipulation and intervention, there was something that seemed to be very curious. Yes, I know a lot of people doubt the existence of the PPT and they also deny the dark powers of stock manipulation. But, we can see from the chart that the volume of trading in June was nothing special. It was barely even average. The question always comes up with the PPT of ‘how do they do it’? Of course, no market manipulator would be willing to admit to their criminal deeds. That leaves us with an examination of the evidence. Since we all know that the markets are famous for vanishing trails and underhanded activity, proof is hard.
Let’s bring in another chart. Chart 2 below is a chart of the CBOE Put/ Call ratio. Generally, we could all agree that in times of rising risks, investors are more inclined to buy put options that of course appreciate when their associated underlying asset declines in value. Options have always been, and I believe they still are, the investment for the more sophisticated and wealthy investors. I also believe they are the product of choice for those inclined to manipulate the market with house money. We know the Federal Reserve has ownership in the DTCC where stock trades are cleared. We know the Fed has a printing press. We know the Fed, as Mr. Bernanke is on record, can invent money at no cost to them. So, if the Fed wanted to goose the Dow every time it dipped to 12,000, it would seem logical that they could stampede the options exchange with call options on everything. If the options never strike, it was never the Fed’s money anyway. If they pump enough money into calls, it forces traders to buy stocks and indexes so they can build up their inventory to meet the tsunami of demand from impending executions. 
Our second chart shows the Put/ Call ratio year-to-date on a daily basis. By mid-June of this year, the Dow was in a rapid decline. As expected, the Put/ Call ratio went above 1. That means that there were more puts being bought than calls. Once the Dow dipped below the Viagra line, the PPT struck and the ratio plunged back to .5. That means there were twice as many call options being bought as opposed to put options. Really? As the Dow dropped below 12,000, more calls were bought than puts. I wonder who put the word out that the PPT was coming to the rescue? Here is the real kicker. While actual trading volume on the NYSE was average to light through June, the CBOE (the exchange where options are traded) reported its best month ever! Again, for the month of June equity trading volume was about average and options volume was the best ever! Again, who bought all these options contracts? Again, who had the money to buy voluminous contracts? Who was willing to step in and buy almost nothing but call options? Study Chart 2.

Chart 2: Year-to-date daily CPCE
Chart courtesy
To summarize, it seems that we have now entered into a world in which our governments and elite investment bankers want to draw charts so they can convince us to continue to work more for less pay while we extend our debt and spend our brains out. Most nations have complied as debt owed to big banks has done nothing but grow. The Put/ Call ratio has been very low for the entire year. It seems our politicians have a story they want to sell us and they are using the stock market as a salty snack to make us drink more of their beer. Who are these people? Do they really think they can set arbitrary lines for the market indices and that strategy will work over time? Well, it’s good to know how they think. Maybe the put/call ratio should be something we watch closely for clues on market direction. Should the ration push back to 1 again, we should infer less intervention and more market weakness. If the ratio holds low, we should infer that the call buying will underpin a market rally. Should the Dow fall back to the 12,000 level, maybe we should anticipate another rally. Can this kind of artificiality be sustained? Only a fool would fill a prescription for this form of Viagra and expect it to work. 
Disclaimer: The views discussed in this article are solely the opinion of the writer and have been presented for educational purposes. They are not meant to serve as individual investment advice and should not be taken as such. This is not a solicitation to buy or sell anything. Readers should consult their registered financial representative to determine the suitability of any investment strategies undertaken or implemented. BMF Investments, Inc. assumes no liability nor credit for any actions taken based on this article. Advisory services offered through BMF Investments, Inc.