Mish's Global Economic Trend Analysis

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• Calpers Pension Plan Reports 1% Growth, Plan Assumes 7.5% Growth; Stunning "What If" Charts at Various Compounded Rates
• Still More on Credit-Worthiness of Bank Lending in Housing Bubble: Loan Originations vs. True Bank Lending
• Peugeot Has 51% Chance of Debt Default; Hollande Says France Will Not Let Peugeot Lay Off Workers

Calpers Pension Plan Reports 1% Growth, Plan Assumes 7.5% Growth; Stunning "What If" Charts at Various Compounded Rates Posted: 16 Jul 2012 11:32 PM PDT The California Public Employees' Retirement System (CalPERS) is an agency that manages pension and health benefits for more than 1.6 million California public employees, retirees, and their families. Its pension plan assumes 7.5% annual growth. For fiscal year ending 2012 CalPERS Reports Preliminary Performance of 1 Percent. How Underfunded is CalPERS? Bear in mind that CalPERS was massively underfunded before this report. How underfunded? Good question. Please consider CalPERS Lies About Equity Returns CalPERS is both corrupt and incompetent.  If it were a private firm, the lies about return on investments would send executives to jail and billions in lawsuits filed. "The California Public Employees' Retirement System (CalPERS) is the biggest public pension in the country. It is also deeply underfunded. Depending on the measure used, they have just 55-75% of money needed for future expenses while 80% is considered the minimum to be safe. Their return is currently less than 99% of big pension funds. On March 12, CalPERS voted to lower their expected return from 7.75% to 7.5%, ignoring the advice of their own chief actuary that it should be 7.25%. More than a few investment professionals consider a projected rate of 7.75% to be unrealistically high in these times and question whether 7.25% is realistic." Now we know that CalPERS is in the lowest 1% of all pension funds—what else would you expect from a California government agency? "What If" Charts at Various Compounded Rates Let's pretend that CalPERS is 100% funded. Already that is one hell of a pretend job, but assuming so, what will CalPERS underfunding look like at various compound plan performance rates? CalPERS currently has $233 billion in assets. It assumes 7.5% annual growth. What if it only returns 5%? or 2.5%? In the following charts the left scale is in billions of dollars. The bottom scale is in years. Base assumption is CalPERS is currently fully funded (which it clearly is not) CalPERS Assets Compounded at 7.5%, 5.0%, 2.5% CalPERS Underfunding at 5.0% and 2.5% I believe annualized returns for the next 10 years will be between 0% and 5% at most. I highly doubt they will be as good as 5%. With that in mind, lets take a closer look at projections for the next 10 years. CalPERS 10-Year Asset Growth Projections CalPERS 10-Year Projected Underfunding at 5.0% and 2.5% Once again the above charts assume pension plans are fully funded and they ignore effects of drawdowns if exceptionally low returns happen. Negative Returns for 10 Years? I have made the case that Negative Annualized Stock Market Returns for the Next 10 Years or Longer are Far More Likely Than You Think. For follow-up posts please consider Anatomy of Bubbles; Negative Returns for a Decade Revisited; Is Gold in a Bubble? Another "Lost Decade" Coming Up; Boomer Retirement Headwinds; P/E Expansion and Contraction Demographic Model Misty Water-Colored Memories, Dirt-Cheap Stocks, and Patient Opportunism Assume the Best Even if you assume negative or near-zero returns are impossible (ignoring Japan for the last 20 years and the S&P 500 since the 2000 peak) clearly cumulative annual returns over extended periods are possible. Given that pension plans are typically heavily invested in bonds, and the current 10-year treasury rate is 1.48%, it is going to be damn difficult for pension plans to come close to the annualized projection of 7.5% made by CalPERS and others. Moreover, the more risk pension plans take attempting to meet near-impossible goals, the more likely it is that they will blow sky high in taking that risk. I believe pension plans will not avoid the next huge drawdown and will be lucky to see 4% annualized growth. However, let's for the moment assume positive annual growth of 2.5% to 5%. Let's assume plans are not currently underfunded. Let's assume pension plans avoid the next big drawdown. Even with those optimistic assumptions (wildly optimistic as pertains to CalPERS being currently fully funded), CalPERS still rates to be deep in the hole 10 years from today. Lesson in Exponential Math If that still does not shock you, hopefully the following YouTube video on Exponential Math will. If you are not familiar with exponential functions such as 7.5% annualized growth assumed perpetually by CalPERS, please play the video above. Perhaps you should play it even if you are. Those in CalPERS counting on 7.5% annual growth are going to instead see clawbacks, reduced rates, or outright default. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Still More on Credit-Worthiness of Bank Lending in Housing Bubble: Loan Originations vs. True Bank Lending Posted: 16 Jul 2012 12:11 PM PDT In response to Reader Questions on "Credit-Worthiness": Did Banks Give Mortgages to Non-Creditworthy Borrowers? I received an email from reader David, who wanted to expand on point number 5 below from my post. This is what I stated, adding the words [banks thought]. The email from reader David follows this recap. Five Reasons Banks Extended Credit in Housing Bubble Years [Banks thought] People would pay mortgage loans because they always did [Banks thought] Housing prices would rise sufficiently to cover defaults [Banks thought] Mortgage interest rates to subprime borrowers were high enough to cover risk [Banks thought] Defaults would happen over a long period of time, not quickly concentrated Banks could pass the trash to Fannie Mae and Freddie Mac (without clawbacks for non-performance), and/or loans could be sliced and diced in tranches to investors If any of those conditions were true, then banks were indeed making loans to "credit-worthy" borrowers. Subprime borrowers did pay a huge penalty rate. Multiple combinations of the above five points are likely. Huge Mistakes Coupled With Greed Banks made huge mistakes because all five conditions above failed, far sooner than banks or the Fed expected. Recall that Bernanke did not believe there was a housing bubble at all! Thus, at the time, banks thought they were making creditworthy loans. They thought wrong, in a big way, and they were very greedy as well. Greed coupled with poor thinking is a very bad combination. What About Now? Banks are not lending now for three reasons Banks are capital impaired Banks are worried about being repaid The relatively small pool of credit-worthy borrowers who banks would lend to right now, do not want credit Stunning Change in Attitudes Another way of looking at the five points pertaining to the "housing bubble years" is there has been a stunning change in attitudes regarding how banks perceive "credit-worthiness" as well as a stunning change in willingness of consumers to go deeper in debt. Conclusion: Then as now, banks only lend to customers they think are credit-worthy. However, Attitudes on what it takes to be "credit-worthy" have changed. Attitudes are the key to understanding this apparent conundrum. Email Regarding Point Number Five Reader David wants to emphasize point number five ... Hello Mish Please emphasize that in the mortgage bubble, banks did not lend for the most part, they originated. Thus creditworthiness was not a factor since the agents who would face most of the losses were not banks, they were instead Fannie/Freddie, investors of MBS paper and especially investors of structured MBS paper and CDO's. The banks themselves only held inventory of super-senior paper which they expected had enough cushion to absorb any losses. Moreover, the banks held this paper off-balance sheet in SIV's and other conduits which technically were separate from the bank. Thus the loan-origination process asked not whether the borrower was credit-worthy, it asked only whether that loan could be sold on for a profit. David is clearly correct. So I wish to reiterate ... If banks think they will make enough profit to compensate for the risks they take, then they make loans. If they think they will make adequate profit on the loans, then by definition, they think they are making credit-worthy loans. Of course, as I pointed out, what banks thought would happen and what actually happened are two different things. Regardless of what did happen, banks thought they were making credit-worthy loans. Banks did originate tons of garbage (on purpose), but only with the intent to immediately pass the trash, not to hold the loan. The distinction is extremely important. Recall this discussion of "credit-worthy" lending is but a subpoint in the discussion of my original post regarding bank reserves: Can Bernanke Force Banks to Lend by Halting Interest on Excess Reserves?. Regardless of any discussion of credit-worthy lending, the answer is still the same: Bernanke cannot force banks to lend by lowering interest on excess reserves to zero. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Peugeot Has 51% Chance of Debt Default; Hollande Says France Will Not Let Peugeot Lay Off Workers Posted: 16 Jul 2012 10:00 AM PDT The incredibly inept policies of French president Francois Hollande are back in the news. Hollande is following up on his proposal to not let companies fire workers, starting right now with French car maker Peugeot's Plan to Cut 8,000 Jobs, Close Plant An article in El Pais has better details of Hollande's denial of reality than I have found elsewhere. My friend Bran who lives in Spain offers this translation key paragraphs of Hollande's "Moralization" of Political Life. Hollande says "Peugeot's plan is unacceptable and will be renegotiated." Hollande accused Peugeot owners of having delayed the restructuring plan with the excuse of not interfering in the election campaign and denied that the biggest problem are labor costs, as claimed. "There is also a strategy, a market and some shareholders who have distributed a dividends rather than reinvest them," he said. The solution? "Have an independent expert examine the company, find a way out of the plan to close the plants, and create a strategic plan for the automotive industry and encourage the purchase of French products in France." Peugeot Has 51% Chance of Debt Default Just to highlight how out of touch with reality Hollande is, please consider Peugeot Has 51% Chance of Debt Default, Credit Swaps Show PSA Peugeot Citroen (UG) bond-insurance costs surged to a record, trading as if the French automaker has a 51 percent chance of defaulting as it cuts thousands of jobs and closes a plant. Credit-default swaps on the carmaker's debt jumped 50 basis points to an all-time high of 800 basis points at 4:30 p.m. in London, Bloomberg swaps prices show. The contracts have doubled since March and now signal a 51 percent probability of default within five years. Caroline Brugier-Corbiere, a spokeswoman for Peugeot, declined to comment. Peugeot's cash reserves allow it to "survive for one to two years," said Xavier Caroen, a Zurich-based Kepler Capital Markets analyst who has a "hold" rating on the company. "We hope the French government lets them cut production and shut some sites in France, or they won't have any earnings in the future," Caroen said. Hollande Turns on the Heat The Financial Times reports Hollande turns heat on Peugeot François Hollande, France's Socialist president, has accused Peugeot's chief executive of ducking the blame for the crisis at the French carmaker, ratcheting up the pressure ahead of meetings this week about its plan to lay off 6,500 workers. Philippe Varin, the Peugeot chief, says the hefty social charges imposed on French employers are putting an impossible burden on his company as it tries to compete globally, calling on the new Socialist administration to make a "massive" cut to the charges. "It's too easy to blame labour costs," he said. "There were bad strategic choices. There were delays in taking difficult decisions and shareholders who were too hungry for dividends when investment should have been the priority." Dose of Reality It does not matter one iota whether or not Peugeot delayed firing workers attempting to influence the election. Whether or not Peugeot should have cut dividends earlier (yes they should have), is also irrelevant. What does matter is Peugeot is doomed to bankruptcy if it cannot fire workers. Expected Slowdown This slowdown in autos was not unexpected by me (but probably was unexpected by the bulk of economists). I wrote about it in advance in my article Global Collapse In Auto Sales Coming Up. The above article discusses a plunge in new manufacturing orders in the US, China, Europe, and Japan, with email anecdotes from forecasts from a worker at Bosch, the world's largest auto parts manufacturer who noted among other things "sales forecasts down again and more plant closure days coming up". In the midst of slumping demand, there is no other rational choice than reduce hours. Economically Insane Proposal On June 16, I wrote ... If socialists take control of both houses in French parliament as expected, president François Hollande would have free rein to carry out his stated policies such as hire more public workers, raise taxes on the rich, and Wreck France With Economically Insane Proposal: "Make Layoffs So Expensive For Companies That It's Not Worth It" Well, the socialists did take control of both houses of French parliament, and Hollande is following through. This is what I said previously .... Four Things, All of Them Bad Mass layoffs will occur before the law passes. Companies will move any jobs they can overseas.    Ongoing, if it's difficult to fire people, companies will not hire them in the first place.  Corporate profits will collapse along with the stock market should the need to fire people arise. The proposal to force companies to sell plants rather than fire workers as outlined by Industry Minister Arnaud Montebourg and Labour Minister Michel Sapin is nothing short of economic insanity. Peugeot is indeed attempting to fire workers before Hollande can pass changes that would "Make Layoffs So Expensive For Companies That It's Not Worth It" Results  Known in Advance The results are easy enough to predict in advance. Add to that list of four items... 5. Numerous bankruptcies 6. Massively rising unemployment - Exactly the opposite of what the law intends to happen. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Click Here To Scroll Thru My Recent Post List Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.