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POSTS: Wednesday, 02-02-2011
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TIPPING POINTS

Process of Abstraction

Research Process

1- Sovereign Debt Crisis
2- EU Banking Crisis
3- Bond Bubble
4- State & Local Government
5 - Risk Reversal
 
6 - Residential Real Estate -
Phase II
7 - Commercial Real Estate
8 - Central & Eastern Europe
9 - Chronic Unemployment
10 - US Banking Crisis II
11 - Pension - Entitlement Crisis
12 - North & South Korea
 
13 - Public Policy MIscues
14 - Rising Interest Pressures
15 - Food Price Pressures
16 - US Stock Market Valuations
17- Finance & Insurance Balance Sheet Write-Offs
18 - Japan Debt Deflation Spiral
19 -Credit Contraction II
 
20 - US Reserve Currency
21 - US Fiscal, Trade and Account ImBalances
22 - China Bubble
23- Government Backstop Insurance
24 - Corporate Bankruptcies
25 - Slowing Retail & Consumer Sales
26 - Public Sentiment & Confidence
27 - Shrinking Revenue Growth Rate
28 - US Dollar Weakness
29 -Global Output Gap
30 - Oil Price Pressures
31 -Natural Disaster
32 - Pandemic
33 - Iran Nuclear Threat
34 - Crisis Programs Expiration
35 - Terrorist Event

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TIPPING POINTS

"The moment of critical mass, the threshold, the boiling point"

The tipping point is the critical point in an evolving situation that leads to a new and irreversible development. The term is said to have originated in the field of epidemiology when an infectious disease reaches a point beyond any local ability to control it from spreading more widely. A tipping point is often considered to be a turning point. The term is now used in many fields. Journalists apply it to social phenomena, demographic data, and almost any change that is likely to lead to additional consequences. Marketers see it as a threshold that, once reached, will result in additional sales. In some usage, a tipping point is simply an addition or increment that in itself might not seem extraordinary but that unexpectedly is just the amount of additional change that will lead to a big effect. In the butterfly effect of chaos theory , for example, the small flap of the butterfly's wings that in time leads to unexpected and unpredictable results could be considered a tipping point. However, more often, the effects of reaching a tipping point are more immediately evident. A tipping point may simply occur because a critical mass has been reached.

The Tipping Point: How Little Things Can Make a Big Difference is a book by Malcolm Gladwell, first published by Little Brown in 2000. Gladwell defines a tipping point as "the moment of critical mass, the threshold, the boiling point." The book seeks to explain and describe the "mysterious" sociological changes that mark everyday life. As Gladwell states, "Ideas and products and messages and behaviors spread like viruses do."

The three rules of epidemics

Gladwell describes the "three rules of epidemics" (or the three "agents of change") in the tipping points of epidemics.

  • Connectors are the people who "link us up with the world ... people with a special gift for bringing the world together." They are "a handful of people with a truly extraordinary knack [... for] making friends and acquaintances". He characterizes these individuals as having social networks of over one hundred people. To illustrate, Gladwell cites the following examples: the midnight ride of Paul Revere, Milgram's experiments in the small world problem, the "Six Degrees of Kevin Bacon" trivia game, Dallas businessman Roger Horchow, and Chicagoan Lois Weisberg, a person who understands the concept of the weak tie. Gladwell attributes the social success of Connectors to "their ability to span many different worlds [... as] a function of something intrinsic to their personality, some combination of curiosity, self-confidence, sociability, and energy."
  • Mavens are "information specialists", or "people we rely upon to connect us with new information." They accumulate knowledge, especially about the marketplace, and know how to share it with others. Gladwell cites Mark Alpert as a prototypical Maven who is "almost pathologically helpful", further adding, "he can't help himself". In this vein, Alpert himself concedes, "A Maven is someone who wants to solve other people's problems, generally by solving his own". According to Gladwell, Mavens start "word-of-mouth epidemics" due to their knowledge, social skills, and ability to communicate. As Gladwell states, "Mavens are really information brokers, sharing and trading what they know".
  • Salesmen are "persuaders", charismatic people with powerful negotiation skills. They tend to have an indefinable trait that goes beyond what they say, which makes others want to agree with them. Gladwell's examples include California businessman Tom Gau and news anchor Peter Jennings, and he cites several studies about the persuasive implications of non-verbal cues, including a headphone nod study (conducted by Gary Wells of the University of Alberta and Richard Petty of the University of Missouri) and William Condon's cultural microrhythms study.

 

RESEARCH METHODOLOGY

 

PROCESS OF ABSTRACTION

 

 

SOVEREIGN DEBT & CREDIT CRISIS

 

Inverted chart of 30-year Treasury yields courtesy of Doug Short and Chris Kimble. As you can see, yields are at a "support" area that's held for 17 years.

If it breaks down (i.e., yields break out) watch out!

The state budget crisis will continue next year, and it could be worse than ever. That's part of what's freaking out muni investors, who last week dumped them like they haven't in ages.

States face a $112.3 billion gap for next year, according to the Center on Budget and Policy Priorities. If the shortfall grows during the year -- as it does in most years -- FY2012 will approach the record $191 billion gap of 2010. Remember, with each successive shortfall state budgets have become more bare.

Things could be especially bad if House Republicans push through a plan to cut off non-security discretionary funding for states, opening an additional $32 billion gap. 

MUNI BOND OUTFLOWS

RISK REVERSAL

 

RESIDENTIAL REAL ESTATE - PHASE II

 

COMMERCIAL REAL ESTATE

2011 will see the largest magnitude of US bank commercial real estate mortgage maturities on record.

2012 should be a top tick record setter for bank CRE maturities looking both backward and forward over the half decade ahead at least.

Will this be an issue for an industry that has been supporting reported earnings growth in part by reduced loan loss reserves over the recent past? In 2010, approximately $250 billion in commercial real estate mortgage maturities occurred. In the next three years we have four times that much paper coming due.

Will CRE woes, (published or unpublished) further restrain private sector credit creation ahead via the commercial banking conduit?

Wiil the regulators force the large banks to show any increase in loan impairment. Again, given the incredible political clout of the financial sector, I doubt it.

We have experienced one of the most robust corporate profit recoveries on record over the last half century. We know reported financial sector earnings are questionable at best, but the regulators will do absolutely nothing to change that.

So once again we find ourselves in a period of Fed sponsored asset appreciation. The thought, of course, being that if stock prices levitate so will consumer confidence. Which, according to Mr. Bernanke will lead to increased spending and a virtuous circle of economic growth. Oh really? The final chart below tells us consumer confidence is not driven by higher stock prices, but by job growth.

9 - CHRONIC UNEMPLOYMENT

There are 3 major inflationary drivers underway.

1- Negative Real Interest Rates Worldwide - with policy makers' reluctant to let their currencies appreciate to market levels. If no-one can devalue against competing currencies then they must devalue against something else. That something is goods, services and assets.

2- Structural Shift by China- to a) Hike Real Wages, b) Slowly appreciate the Currency and c) Increase Interest Rates.

3- Ongoing Corporate Restructuring and Consolidation - placing pricing power increasingly back in the hands of companies as opposed to the consumer.

FOOD PRICE PRESSURES

RICE: Abdolreza Abbassian, at the FAO in Rome, says the price of rice, one of the two most critical staples for global food security, remains below the peaks of 2007-08, providing breathing space for 3bn people in poor countries. Rice prices hit $1,050 a tonne in May 2008, but now trade at about $550 a tonne.

WHEAT: The cost of wheat, the other staple critical for global food security, is rising, but has not yet surpassed the highs of 2007-08. US wheat prices peaked at about $450 a tonne in early 2008. They are now trading just under $300 a tonne.

The surge in the FAO food index is principally on the back of rising costs for corn, sugar, vegetable oil and meat, which are less important than rice and wheat for food-insecure countries such as Ethiopia, Bangladesh and Haiti. At the same time, local prices in poor countries have been subdued by good harvests in Africa and Asia.

 

- In India, January food prices reflected a year-on-year increase of 18%t.

- Buyers must now pay 80%t more in global markets for wheat, a key commodity in the world's food supply, than they did last summer. The poor are especially hard-hit. "We will be dealing with the issue of food inflation for quite a while," analysts with Frankfurt investment firm Lupus Alpha predict.

- Within a year, the price of sugar on the world market has gone up by 25%.

US STOCK MARKET VALUATIONS

 

WORLD ECONOMIC FORUM

Potential credit demand to meet forecast economic growth to 2020


The study forecast the global stock of loans outstanding from 2010 to 2020, assuming a consensus projection of global
economic growth at 6.3% (nominal) per annum. Three scenarios of credit growth for 2009-2020 were modelled:


• Global leverage decrease. Global credit stock would grow at 5.5% per annum, reaching US$ 196 trillion in 2020. To
meet consensus economic growth under this scenario, equity would need to grow almost twice as fast as GDP.
• Global leverage increase. Global credit stock would grow at 6.6% per annum, reaching US$ 220 trillion in 2020.
Likely deleveraging in currently overheated segments militates against this scenario.
• Flat global leverage. Global credit stock would grow at 6.3% per annum to 2020, tracking GDP growth and reaching
US$ 213 trillion in 2020 – almost double the total in 2009. This scenario, which assumes that modest
deleveraging in developed markets will be offset by credit growth in developing markets, provides the primary credit
growth forecast used in this report.

Will credit growth be sufficient to meet demand?


Rapid growth of both capital markets and bank lending will be required to meet the increased demand for credit – and it is
not assured that either has the required capacity. There are four main challenges.


Low levels of financial development in countries with rapid credit demand growth. Future coldspots may result from the
fact that the highest expected credit demand growth is among countries with relatively low levels of financial access. In
many of these countries, a high proportion of the population is unbanked, and capital markets are relatively undeveloped.


Challenges in meeting new demand for bank lending. By 2020, some US$ 28 trillion of new bank lending will be
required in Asia, excluding Japan (a 265% increase from 2009 lending volumes) – nearly US$ 19 trillion of it in China
alone. The 27 EU countries will require US$ 13 trillion in new bank lending over this period, and the US close to US$
10 trillion. Increased bank lending will grow banks’ balance sheets, and regulators are likely to impose additional capital
requirements on both new and existing assets, creating an additional global capital requirement of around US$ 9 trillion
(Exhibit vi). While large parts of this additional requirement can be satisfied by retained earnings, a significant capital gap in
the system will remain, particularly in Europe.

The need to revitalize securitization markets. Without a revitalization of securitization markets in key markets, it is doubtful
that forecast credit growth is realizable. There is potential for securitization to recover: market participants surveyed by
McKinsey in 2009 expected the securitization market to return to around 50% of its pre-crisis volume within three years.
But to rebuild investor confidence, there will need to be increased price transparency, better data on collateral pools, and
better quality ratings.


The importance of cross-border financing. Asian savers will continue to fund Western consumers and governments:
China and Japan will have large net funding surpluses in 2020 (of US$ 8.5 trillion and US$ 5.7 trillion respectively), while
the US and other Western countries will have significant funding gaps. The implication is that financial systems must
remain global for economies to obtain the required refinancing; “financial protectionism” would lock up liquidity and stifle
growth.

 

US$ RESERVE CURRENCY

SocGen crafts strategy for China hard-landing

Société Générale fears China has lost control over its red-hot economy and risks lurching from boom to bust over the next year, with major ramifications for the rest of the world.

Société Générale said China's overheating may reach 'peak frenzy' in mid-2011

- The French bank has told clients to hedge against the danger of a blow-off spike in Chinese growth over coming months that will push commodity prices much higher, followed by a sudden reversal as China slams on the brakes. In a report entitled The Dragon which played with Fire, the bank's global team said China had carried out its own version of "quantitative easing", cranking up credit by 20 trillion (£1.9 trillion) or 50pc of GDP over the past two years.

- It has waited too long to drain excess stimulus. "Policy makers are already behind the curve. According to our Taylor Rule analysis, the tightening needed is about 250 basis points," said the report, by Alain Bokobza, Glenn Maguire and Wei Yao.

- The Politiburo may be tempted to put off hard decisions until the leadership transition in 2012 is safe. "The skew of risks is very much for an extended period of overheating, and therefore uncontained inflation," it said. Under the bank's "risk scenario" - a 30pc probability - inflation will hit 10pc by the summer. "This would cause tremendous pain and fuel widespread social discontent," and risks a "pernicious wage-price spiral".

- The bank said overheating may reach "peak frenzy" in mid-2011. Markets will then start to anticipate a hard-landing, which would see non-perfoming loans rise to 20pc (as in early 1990s) and a fall in bank shares of 50pc to 75pc over the following 12 months. "We think growth could slow to 5pc by early 2012, which would be a drama for China. It would be the first hard-landing since 1994 and would destabilise the global economy. It is not our central scenario, but if it happens: commodities won't like it; Asian equities won't like it; and emerging markets won't like it," said Mr Bokobza, head of global asset allocation. However, it may bring down bond yields and lead to better growth in Europe and the US, a mirror image of the recent outperformance by the BRICs (Brazil, Russia, India and China).

- Diana Choyleva from Lombard Street Research said the drop in headline inflation from 5.1pc to 4.6pc in December is meaningless because the regime has resorted to price controls on energy, water, food and other essentials. The regulators pick off those goods rising fastest. The index itself is rejigged, without disclosure. She said inflation is running at 7.6pc on a six-month annualised basis, and the sheer force of money creation will push it higher. "Until China engineers a more substantial tightening, core inflation is set to accelerate.

- The longer growth stays above trend, the worse the necessary downswing. China's violent cycle could be highly destabilising for the world." Charles Dumas, Lombard's global strategist, said the Chinese and emerging market boom may end the same way as the bubble in the 1990s. "The basic strategy of the go-go funds is wrong: they risk losing half their money like last time."

- Société Générale said runaway inflation in China will push gold higher yet, but "take profits before year end".

- The picture is more nuanced for food and industrial commodities. China accounts for 35pc of global use of base metals, 21pc of grains, and 10pc of crude oil. Prices will keep climbing under a soft-landing, a 70pc probability. A hard-landing will set off a "substantial reversal". Copper is "particularly exposed", and might slump from $9,600 a tonne to its average production cost near $4,000. Chinese real estate and energy equities will prosper under a soft-landing,

- The bank likes regional exposure through the Tokyo bourse, which is undervalued but poised to recover as Japan comes out of its deflation trap. If you fear a hard landing, avoid the whole gamut of Chinese equities. It will be clear enough by June which of these two outcomes is baked in the pie.

SocGen crafts strategy for China hard-landing Pritchard

PUBLIC SENTIMENT & CONFIDENCE

 

 

SHRINKING REVENUE GROWTH RATES

PIMCO'S NEW NORMAL: According to PIMCO, the coiners of the term, the new normal is also explained as an environment wherein “the snapshot for ‘consensus expectations’ has shifted: from traditional bell-shaped curves – with a high likelihood mean and thin tails (indicating most economists have similar expectations) – to a much flatter distribution of outcomes with fatter tails (where opinion is divided and expectations vary considerably).” That is to say, the distribution of forecasts has become more uniform (as per Exhibit 1).

* EGYPT:

-- More than 130 people have been killed in violent unrest since a Jan. 25 "day of wrath". Mubarak, a close U.S. ally for three decades, has responded by sacking his government, appointing a vice-president for the first time and offering economic reform to address public anger at rising prices.

-- Security, which disintegrated on Saturday and Sunday when police withdrew from the streets, has slowly been restored. Extra troops sent into cities across Egypt have helped to calm panicked residents and stop looting. Protesters have called for a million people to take to the streets on Tuesday.

* JORDAN:

-- Islamists, leftists and trade unionists gathered in central Amman on Jan. 28 in the latest protest to demand political change and wider freedoms. A crowd of at least 3,000 chanted: "We want change."

-- Banners showed a wider range of grievances than the high food prices that fuelled earlier protests two weeks ago, and included demands for free elections, the dismissal of Prime Minister Samir al-Rifai's government and a representative parliament.

-- Demonstrations have taken place across Jordan calling for the reversal of free-market reforms which many blame for a widening gap between rich and poor.

-- Jordan announced a $225 million package of cuts in the prices of some types of fuel and of staple products including sugar and rice.  

* SUDAN:

-- Students have held protests in the universities of Khartoum and Gezira against proposed cuts in subsidies in petroleum products and sugar, a strategic commodity in Sudan. Prices of other goods have already risen due to a surge in global food prices and a devaluation of the local currency.

-- Sudanese protesters said on Monday a student had died after being beaten by security forces who brutally broke up demonstrations inspired by protests in neighbouring Egypt.

-- On Jan. 30, students in Khartoum University were teargassed in their dormitories, with at least five injured, activists said.

* GABON:

-- Riot police in Gabon fired tear gas to break up a protest by around 5,000 opposition supporters on Jan. 29, with witnesses saying that up to 20 people were wounded in the clashes.

-- It was the second such protest since opposition leader Andre Mba Obame declared himself president on Jan. 25. The oil exporter has been troubled since the 2009 election won by Ali Bongo Odimba, but which the main opposition group is insisting was rigged.

* TUNISIA: -- Tunisia's uprising empowered Arabs across the Middle East and North Africa, where many countries share the complaints of poor living standards and authoritarian rule. Weeks of violent protests over poverty, repression and corruption forced President Zine al-Abidine Ben Ali out on Jan. 14 after 23 years in power. The United Nations has said 117 people died during the unrest, including 70 killed by gunfire.  

* ALGERIA:

-- Several Algerian towns including the capital experienced days of rioting in January, provoked by a jump in food prices. Two people died and hundreds were injured during the clashes, officials said. At least four men set themselves on fire in provincial towns.

-- To calm the situation, Algeria has decided to cut the cost of some foodstuffs and to increase by 18 percent the amount of soft wheat it supplies to the local market each month.

* OMAN:

-- About 200 people protested this month near the civil ministries in Muscat asking the government to stop corruption and address rising prices. (For full Reuters Africa coverage and to have your say on the top issues, visit: africa.reuters.com/) (Writing by David Cutler, London Editorial Reference Unit;

Nearly 11 Percent of US Houses Empty

HOME OWNERSHIP

- America's home ownership rate, after holding steady for a while, took a pretty big plunge in Q4, from 66.9 percent to 66.5 percent.

- That's down from the 2004 peak of 69.2 percent and the lowest level since 1998.

- Homeownership is falling at an alarming pace, despite the fact that home prices have fallen, affordability is much improved and inventories of new and existing homes are still running quite high.

- Bargains abound, but few are interested or eligible to take advantage.

OCCUPANCY RATE

- Of the nearly 131 million housing units in this country:

- 112.5 million are occupied.

- 74.8 million are owned - only dropped by about 30 thousand in the past year.

- 38 million are rented, but that's up by over a million year over year.

- That means more new households are choosing to rent.

VACANCY RATE

- More concerning than the home ownership rate is the vacancy rate.

- There were 18.4 million vacant homes in the U.S. in Q4 '10 (11 percent of all housing units vacant all year round), which is actually an improvement of 427,000 from a year ago, but not for the reasons you'd think.

- The number of vacant homes for rent fell by 493 thousand, as rental demand rose.

- 471,000 homes are listed as "Held off Market" about half for temporary use, but the other half are likely foreclosures. And no, the shadow inventory isn't just 200,000, it's far higher than that.

So think about it. Eleven percent of the houses in America are empty. This as builders start to get more bullish, and renting apartments becomes ever more popular. Vacancies in the apartment sector have been falling steadily and dramatically, why? Because we're still recovering emotionally from the toll of the housing crash.

Younger Americans have seen what home ownership has done to their friends and families, and many want no part of it. Credit has become very nearly elitist. Home prices, whatever your particular data provider preference might be, are still falling.

Banks still holding 70% of REO from market

RealtyTrac Senior Vice President Rick Sharga said major banks:

- currently hold roughly 1 million REO, or homes repossessed through foreclosure,

- only 30% have actually made it onto the market.

- foreclosure filings reached a new high in 2010 and should climb even higher this year, possibly surpassing 4 million filings.

- that's not counting the more than 5 million delinquent loans that have yet to enter the initial stages of the foreclosure process

"I think you're looking at a 2011 that will be worse than 2010, then some stabilization through 2012. In 2013, you'll see a more manageable number of REO,"

Sharga told HousingWire Saturday at the REO CON default industry education summit in Fort Worth, Texas.

The major kink in the housing market's recovery, and for the macro economy overall, is the work left to be done on homes currently in the foreclosure process, those about to enter it and the amount of repossessed homes the banks must shed. Striking a proper balance on how to mange this shadow inventory of foreclosures is vital for the banks to show a healthy balance sheet while not dumping too many distressed properties onto the market, further dragging down home prices and values.

A recent study from Morgan Stanley showed the shadow inventory, those properties facing imminent default, evolving from mostly subprime and Alt-A loans to containing more prime loans as elevated unemployment levels have pushed more homeowners behind on their mortgage.

Analysts said that some 8 million repossessions would need to be liquidated over the next five years before the market stabilizes.

Adding to the problem are recent issues the banks are having processing the paperwork. In October, the banks had to hold up foreclosures to refile affidavits signed improperly in many states, pushing more than 250,000 foreclosure cases into 2011. Reports recently showed that the problem may have spread to the notices of default as well.

As RealtyTrac employees have found, notices of default "dropped off a cliff" late last year and are still off in January, Sharga said.

And in the 23 states where lenders must foreclose on a homeowner through the court system, backlogs of cases have formed month-long delays. Sharga said a court clerk in Florida, one of the states with the longest traffic jams, told him between 500,000 and 600,000 cases are yet to be heard.

Sharga said he's encouraged by the uptick in demand for REO. "We've seen more traffic on our site, and even more buyers raising their hand asking for help from a Realtor," he said. "This means they're getting serious about buying again." He also said that the most traffic comes from Southwestern states and Florida.But Sharga said there is plenty of work to be done, and that any further delays in the process will only set back an already postponed recovery. "It won't feel normal again until about 2013," Sharga said.

 

Boom's Home-Ownership Gains Lost

The meltdown of the U.S. mortgage market and rising foreclosures have wiped out more homeowners than were created in the 2000-07 housing boom, some industry watchers say, the latest indication of the severity of the housing bust.

In the fourth quarter of 2010, 66.5% of Americans owned homes, down from 67.2% a year earlier and the lowest rate since the end of 1998, according the Census Bureau. During the boom, when easy credit made mortgages available with less regard for income or ability to pay, the ownership rate surged to a record 69.2% in 2004's second and fourth quarters and stayed near that level until the recession deepened.

Some industry watchers expect the rate to slip below 65% as the housing market meltdown forces millions more Americans to give up their homes.

That "shows how big the bubble was and how catastrophic the bursting has been," said Paul Dales, senior U.S. economist with Capital Economics. "We have pretty much reversed all of the increases in the home-owner rate generated by the housing boom."

The nation's homeownership rate gained 0.8 percentage points from 2000 to 2007, but has lost 1.3 percentage points since 2007, erasing the boom's gains, said Stephen East, a Ticonderoga Securities housing analyst.

The first wave of trouble struck several years ago as borrowers took out so-called subprime mortgages with low interest rates that later reset, often with much higher payments that they couldn't afford. The problem spread as the recession led to high unemployment. Now, as declining real-estate values leave many borrowers owning more than their homes are worth, more Americans are simply walking away.

The changes in the market are taking a toll on minority ownership. Just 44.8% of black-only households were homeowners in the fourth quarter of 2010, down from 46% a year earlier. The rate for Hispanics also fell, to 46.8% from 48.4%, the Census showed. The rate for white, non-Hispanic households slipped to 74.2%, from 74.5%.

The downturn is most pronounced in the West, which was dramatically overbuilt during the market boom and continues to see high foreclosure rates. It registered the nation's lowest ownership rate, at 61%, down from 62.3% a year earlier. The Midwest had the highest percentage of homeowners among regions, but it also saw a year-over-year decline, to 70.5% from 71.3%.

The vacancy rate for rental housing fell to 9.4%, from 10.7% a year earlier. Housing experts say each 1% decline in the home-ownership rate represents the movement of one million households to rentals.

With demand expected to surge, developers are ramping up apartment construction. CoStar Group, a commercial real-estate data and analysis provider, expects about 23,000 multifamily units to be completed this year, followed by nearly 95,000 in 2012 and more than 109,000 in 2013.

"Americans are going through a fundamental transition in the way they look at rental housing," said Greg Kraus, senior director of acquisitions with Invesco Real Estate, which has spent more than $1 billion on apartment communities in the last 15 months. "Historically, there's almost been a subtle disdain in many markets if you're a renter. That stigma is going to go away."