“It’s Not Sustainable” – Sacramento Lashes Out At Calpers After Raising Pension Payments

In the latest sign that America’s looming pension crisis is inching closer to an all-our collapse that will inevitably end in a series of bailouts – or worse, the failure to pay out retiree’s coveted benefits – a handful of California cities are lashing out at CALPers after being forced to hike pension contributions to offset expectations for long-term returns that have been revised lower by the state pension system.

Ten of the largest local governments in the capital region can expect to pay a total of $216 million to CalPERS in fiscal 2018-19, an increase of $27 million over this year, according to the Sacramento Bee. And nearly half of that increase will be borne by one local government – the city of Sacramento.

The Sacramento region’s largest local governments will see pension costs go up by an estimated 14 percent next fiscal year, starting a series of annual increases that many city officials say are “unsustainable” and will force service cuts or tax hikes.

 

The increases come after CalPERS in December reduced the expected rate of return from investments, forcing local governments and other participants in the state’s retirement plan to pay more to cover the cost of pensions.

As one might expect, city officials are less than pleased. According to Leyne Milstein, the city of Sacramento’s finance director, said the city’s pension costs will double in seven years, and while city revenues have also increased in recent years, thanks in part to a strong real-estate market, the rise won’t be nearly enough to offset the increased cost.

“It’s not sustainable,” Milstein said. “These costs are going to make things incredibly challenging.”

In a report this month, Joe Nation, a researcher at the Stanford Institute for Economic Policy Research, wrote that “employer pension contributions are projected to roughly double between 2017 and 2030, resulting in the further crowd out of traditional government services.”

Nation said he supports tax increases to pay for pension obligations, although he adds that it would be extremely difficult to muster political support for such a tax.

In a futile exercise that resembles banging one’s head against a wall, local government officials from across the state, including West Sacramento, complained to CALPers board members, warning that they would need to cut services and raise taxes to put more money toward pensions.

“We don’t know how we’re going to operate,” said Oroville’s finance director, Ruth Wright, who suggested that a doubling of pension costs in five years could force the city into the nuclear option. “We’ve been saying the bankruptcy word.”

Of course, there’s little CALPers can do. If it doesn’t mandate the increases, it knows that will increase its culpability when the music stops and every asset has been liquidated.

To wit, Steve Maviglio of the labor-backed Californians for Retirement Security said officials have the means to address the increased costs. “If city officials are truly interested in meeting their obligations, they always have that opportunity at the bargaining table or providing more revenue thru measures on the ballot,” he said.

Of course, this exercise in cya isn’t nearly enough to stave off the inevitable collapse. Nation questions whether the new CalPERS return rate is too optimistic. In his report, he provides estimates for how much local governments can expect to pay if the fund’s investments don’t meet projections. In 12 years, the city of Sacramento would see pension costs go up $94 million a year under his alternative projection.

To afford these higher costs absent higher revenues, Sacramento would have to cut 25% of police and fire services after cutting other less essential services.

Milstein said she won’t estimate when or if the city will have to start cutting employees if the current financial forecast proves correct. In the city’s current budget, officials said, “Given the current revenue forecast, the city alone cannot absorb the increased costs of providing retirement benefits.”

Some groups, including the League of California Cities are lobbying CalPERS to consider funding options besides raising employer rates, including possibly suspending cost-of-living adjustments for pensioners and looking at working current workers into less generous plans.

As we’ve noted many times, defined benefit pension plans are, in many cases, a Ponzi scheme…

Current assets are used to pay current claims in full despite insufficient funding to pay future liabilities…but unlike Wall Street Ponzi schemers like Bernie Madoff, nobody goes to jail because everybody is complicit.

While California’s problem is certainly dire, pension costs directly triggered budget battles in state capitols across the US this year. Connecticut is still struggling to pass a budget that meaningfully reduces an expected $3.5 billion two-year deficit.

Indeed, as the chart below illustrates, underfunded pensions are an endemic problem.

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QE’s Untold Story: A Chart That Fed Correspondents Need To Investigate

Authord by Daniel Nevins via FFWiley.com,

We’ve produced some research over the years that we’d love to see the powers-that-be react to, but none more so than our look at financial flows during the QE programs.

By netting all lending by banks and brokers-dealers and then comparing it to the Fed’s lending, we stumbled upon a chart that seemed to show exactly what QE does or doesn’t do. But “doesn’t,” not “does,” was the story, and it couldn’t have been clearer. Or shown a more stimulating pattern. To geeks like us, our Excel click on “Insert, Line” was like stepping from a shady trail to a sunny vista.

Here’s the updated chart, which we dubbed the “argyle effect” and looks even sharper than it did when we first produced it in 2014:

We like the chart because we’re just as confirmation-biased as the average human – anything that confirms our QE skepticism is cognitively satisfying. And the chart appears to show that QE was largely irrelevant. It merely replaced growth in privately financed credit with growth financed by the Fed. The Fed grabbed the credit-growth baton for QE laps and returned it to the private sector for QE pauses, and whoever didn’t have the baton more or less stood still.

As we concluded in 2014, QE is a substitution story, not an addition story.

Many pundits told the addition story as QE was underway. They expected banks to “multiply up” reserves by aggressively expanding their loan books. But reserves never significantly multiplied.

We think there are five reasons why the “money multiplier theory” failed:

  1. High-quality borrowers don’t emerge mysteriously from cracks in the Eccles Building and parade zombie-like to bank loan desks. In other words, credit demand was probably about the same with or without QE.
  2. QE’s effects on bank balance sheets aren’t quite as distorting as they’re often depicted. Consider that new reserves are typically matched by new deposits, because dealers offering bonds to the Fed get paid for those bonds through their accounts at commercial banks. In other words, QE adds a similar item to both sides of bank balance sheets, which you might not appreciate if your information comes from those who call for banks to “lend out” reserves. That’s impossible—reserves can’t be “lent out”—and it often leads to exaggerated statements about the implications of excess reserves.
  3. To a significant degree, banks can neutralize excess reserves (and the corresponding “excess” deposits) with financial derivatives and other balance sheet adjustments. They can rearrange exposures to mimic a balance sheet of equal risk that’s not stuffed with reserves.
  4. Just as importantly, excess reserves flow naturally from banks that don’t want them to banks that don’t mind them nearly as much. Consider that Fed data shows a disproportionate amount of QE’s extra reserves landing at U.S. branches of foreign banks. Those foreign banks might have sound reasons for holding excess reserves.
  5. The money multiplier theory is inconsistent with real-world reserve management practices. The Bank of England has called it “reverse” to how bank lending and reserve management work in the real world. And the gap between theory and reality is so large that you don’t even need the four reasons above to reject the money multiplier—you just need a healthy skepticism about mainstream theory.

According to our chart, even QE’s wealth effects appear to be poorly understood. If credit growth is the same with or without QE, any effects on bond and stock prices might be more psychological than commonly believed.

Or, those effects might transmit mainly through financial derivatives (see #3 above). Or, I hear at least a few readers asking, “What wealth effects?” We’ll never know for certain if QE boosted asset prices at all. Maybe the bull market only needed low interest rates, a slowly growing economy, the knowledge that our policy honchos wanted asset prices higher, and a soothing narrative that they have the tools to make that happen?

Think of it this way: New borrowers know approximately how many calories they can consume, and after the Fed starts delivering three meals a day, private banks find that their contributions are no longer needed. By necessity, private banks shut down their kitchens, and almost nothing changes economically. We get substitution, not addition.

Getting to the Bottom of the Burberry Backlash

To be sure, the argyle effect might not be surprising to the Fed’s policy makers. They might have already looked at the data in the same way we did. They might also believe that QE increased the overall lending trend (referring to the entire period’s lending growth), irrespective of the pattern from one QE to the next. All that said, we’d like to know their reaction.

We’d like to know: Would the Fed’s heads explain the chart pattern differently to our interpretation above? If our interpretation is on the central-bank-printed money, how do they justify their policies? How do they expect the pattern to change as QE unwinds? Or, do they not know what to expect—are they as confused as anyone else about what QE really does? The last possibility matches public statements by both current and former FOMC members. (See, for example, Bill Dudley here, Kevin Warsh here, or just about anything from Richard Fisher.)

So, we’re asking Fed correspondents to lend a hand. Nearly nine years after QE began, you’re tired of having the same discussions, right? Here’s a chance to make the discussions more interesting—a chance to drop a Burberry bombshell on your most insightful Fed contact. Inquiring minds would like to see the bomb’s impact, or at least to know how policy makers would go about defusing it. More bluntly, inquiring minds deserve to know. It’s our economy, too, and public officials should be held accountable for the results of their actions.

And if the public interest isn’t enough to persuade Fed correspondents to investigate the argyle effect, we’ll offer other incentives. In return for a report that includes the insights of any FOMC member or senior Fed researcher, we’ll send a complimentary copy of Economics for Independent Thinkers, which is filled with similar research. Or, if our book isn’t mainstream enough for you, we’ll send a thank you with a big smiley face on it. Either way, we look forward to your report on our simple—yet oddly revealing—chart.

Author’s Note: We separated QE and non-QE periods according to the credit the Fed added to the financial system through all of its activities, not just open market operations. Because we included loans, repos, and various emergency facilities enacted during the financial crisis, our time periods are slightly different than the announced start and end dates for QE alone. (For more details, see this note from 2014, although replicators should be aware that the Fed recently replaced its “credit market instruments” category with a few subcategories.) In other words, the line showing the Fed’s net lending is jagged by design. By separating periods of high versus low Fed-sourced credit, we could test whether the private sector’s net lending would show a reverse correlation to the Fed’s activities. As you can see, it did.

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“You Get Nothing” – World’s Largest Insurer Warns US Stocks Offer “No Returns” For The Next Decade

There will be "almost no prospective returns" from U.S. stocks over the next decade because the market is fully valued following years of gains, according to the global strategist at Allianz Global Investors, which manages $569 billion.

As Bloomberg reports, low interest rates and bond purchases by central banks have left cash and many other asset classes "significantly mispriced," Neil Dwane said Monday as part of a panel discussion on long-term investing at the Toronto Global Forum.

"The U.S. is fully valued," said Dwane, whose firm is owned by Munich-based insurance giant Allianz SE.

 

"There’s almost no prospective returns for the next 10 years from the U.S. equity market, and therefore investors have to look into Asia or Europe where valuations are significantly lower."

 

With interest rates close to zero around the world and bond markets "manipulated by central banks," it’s difficult to assess risk and return, he added.

 

Many investors have turned to high-yield bonds or emerging markets for income, which raises risks.

Dwane is not alone of course in this ominous view, as Bloomberg notes, Jim Keohane, chief executive officer of the Healthcare of Ontario Pension Plan, agreed that it’s not a good time to be buying assets of nearly any stripe.

"Right now assets are very expensive," said Keohane, whose firm manages more than C$70 billion ($54 billion).

 

"We need to be patient, to wait for better opportunities. Whenever the next crisis comes, assets are going to be on sale. You can buy them a lot cheaper than you can buy them today, but you have to have patience to be able to do that."

And finally, John Hussman, of Hussman Funds, warned that a century of reliable valuation evidence indicates that the S&P 500 is likely to experience an outright loss, including dividends, over the coming 10-12 year horizon, and we presently estimate likely interim losses on the order of -60% or more.

A rate of return of even 1% in cash is a much more desirable option than investors may imagine.

For a while, Bernie Madoff’s investors felt great about their impressive “returns.” For a while, investors in dot-com stocks felt the same. For a while, investors in mortgage bonds felt the same. But when investors focus on returns rather than the very long-term structure, stability, and even existence of the underlying cash flows, terrible things can happen.

All that’s required to get the snowball rolling is the creeping recognition that there’s no “there” there.

In response to the delusion that low interest rates “justify” virtually any level of market valuation, regardless of the growth rate of the underlying cash flows, the speculation of recent years has created a situation where there is effectively no way out for investors in aggregate. Every security that is issued must be held by someone until it is retired.

When one investor sells a share, it simply means that another investor buys it. The only question is who will hold the bag.

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Nixing NAFTA: Trump Might Not Have as Much Power as He Thinks

President Donald Trump has made it clear he’s willing to terminate the North American Free Trade Agreement, but legal experts aren’t sure he has the authority to do so.

Under the U.S. Constitution, Congress is given the power to “regulate commerce with foreign nations,” suggesting it has the a final decision on NAFTA. Article II of the Constitution, however, grants the president the power to conduct foreign policy.

Is NAFTA is a foreign or commerce treaty? Most legal academics believe the power should reside with Congress, according to Scott Lincicome, adjunct scholar at the Cato Institute, a free market think tank based in Washington, D.C.

NAFTA is technically a congressional-executive agreement and not a treaty, leading some to believe that it falls under congressional power to regulate foreign commerce.

“The thinking on this is, look, this isn’t a standard treaty that falls far more clearly under the foreign affairs powers of the president and constitutional provisions on treaties,” Lincicome said at a recent Cato event.

To justify his potential executive action, Trump has pointed to NAFTA’s Article 2205, which says the country can withdraw from the trade agreement in six months after providing written notice.

Yet Bill Reinsch, a distinguished fellow at the Stimson Center, expressed skepticism in remarks made at Cato recently that Trump alone can trigger Article 2205.

“The [NAFTA] statute is quite clear that the United States could withdraw, but the statute doesn’t go beyond saying who the United States is.” Reinsch said.

The issue of withdrawal is written ambiguously into NAFTA. It does not speak to whether the legislative or the executive branch has the power to take that first step.

Even if Congress has the final authority on pulling out, the president has significant control over other aspects of the treaty, and could do significant damage to the deal, Jon R. Johnson, a senior fellow at the CD Howe Institute, a Canadian policy think tank, wrote in January.

Johnson, an advisor on international trade to the Canadian government during the original NAFTA negotiations, said that when Congress approved NAFTA in 1993, it left enforcement of tariffs to then-President Bill Clinton. Johnson believes that given the track record of Congress in delegating authority to the executive branch, Trump could raise tariffs.

“Congress has delegated powers to the president to act unilaterally to address national emergencies and balance-of-payments and national security situations. These powers include the ability to raise tariffs and to adopt other border measures.” Johnson wrote.

Ultimately, Trump may have to settle for halfway measures, and not because the legal arguments could prove difficult. Terminating NAFTA would be controversial. According to a Gallup Poll, 48 percent of Americans support the trade agreement. Only six percent favor outright withdrawal.

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WTI/RBOB Jump After Major Inventory Draws Across Entire Energy Complex

WTI posted a 5.2% gain in October, the first back-to-back monthly advance this year, and held up near the highs of the day into the API print. WTI/RBOB kneejerked higher as the data hit showing large inventory draws across everything…

 

API

  • Crude -5.087mm (-1.3mm exp)
  • Cushing -263k
  • Gasoline -7.697mm (-1.55mm exp)
  • Distillates -3.106mm

Big product draws in the previous week – and a modest crude build – bucked the recent trend but tonight's API data shows huge draws across everything…

Expectations that OPEC’s cuts are “tightening the market supply-demand fundamentals continues to drive prices higher,” Gene McGillian, a market research manager at Tradition Energy, told Bloomberg.

There is “a little bit of profit-taking and that’s why the rally seems to have kind of stalled. But, I don’t think we have any indications that the rebalance has completely been priced into the market”

The reaction was an immediate algo-buying panic then modest fade…

Jay Hatfield, portfolio manager at the InfraCap MLP exchange-traded fund, told Bloomberg, "inventories are in good shape. Demand is quite positive globally. We’ve been appropriately bullish."

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Is Hillary Clinton’s Halloween Costume Culturally Insensitive?

The lucky students at Texas A&M University got a costume-sensitivity-flowchart for Halloween this year from the GLBT Resource Center.

We thought it might help you when you choose your out for for tonight.

Wondering about your Halloween costume? Here are some things to keep in mind…

But, we wonder if Hillary Clinton has checked the chart because her choice of costume – to some – may be highly offensive…

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Trump Promises Tax Cuts for Christmas, White House Defends John Kelly’s Civil War Comments, and Ex-Catalan President Flees to Brussels: P.M. Links

  • John KellyNetflix halts ‘House of Cards’ Season 6 production in wake of Kevin Spacey accusation.
  • Trump promises tax reform for Christmas.
  • White House defends Chief of Staff John Kelly’s Civil War comments, calls criticism ‘disgraceful’.
  • Former Catalan President Carles Puigdemont flees to Brussels.
  • The Portland Mercury has a pretty cool collection of spooky, and cringe-inducing, stories of dental-related horror for Halloween.

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If Industry-Funded Scientists Can Be Conflicted, Surely Government-Funded Scientists Can Be Too

EPALogoEnvironmental Protection Agency administrator Scott Pruitt has declared that researchers who receive funding from his agency cannot serve on its scientific advisory committees. “It is very, very important to ensure independence, to ensure that we’re getting advice and counsel independent of the EPA,” Pruitt told reporters Tuesday, according to The Washington Post.

Nearly 10 years ago, I researched the issue of research conflicts of interest for the American Council on Science and Health. My report concluded that

there is very little evidence that alleged conflicts of interests are significantly distorting scientific research, harming consumers and patients or misleading public policy. Most conflicts of interest activists clearly have prior strong ideological commitments against markets and corporations. They view the conflicts of interest campaign as another tool to attack an enterprise which they already despise on other grounds.

Interestingly, in my review of the voluminous conflicts-of-interest literature 10 years ago, I could find no published studies that even attempted to see whether government funding might skew research results in the direction favored by the agency that supported such research.

If there are any such studies out there, please direct my attention toward them now. The topic is certainly worth addressing. As the economists William N. Butos and Thomas J. McQuade argued in 2005,

Scientists’ success in securing funding testifies to their submission of proposals that receive a favorable hearing by the funding agencies. Thus, scientists have an incentive to develop and nurture professional relationships with agency members, advisors, and consultants. Finally, government funding of science, including that associated with military R&D, unavoidably establishes linkages between the funding agencies’ preferences (or legislative charge) and the scientific activity that university and industry researchers perform. These linkages relate to the purposes for which funds are made available, thereby affecting the direction and regulation of scientific research as well as specific protocols for military R&D.

In a column published just when the anti-fracking hysteria was peaking, I asked, “Is Regulatory Science an Oxymoron?” At the conclusion I posed a couple of questions:

Why is it that environmentalists and environmental agency bureaucrats can always gin up studies that show that any activity they oppose and/or want to regulate is dangerous to the environment? On the other hand, why is it that energy producers and energy agency bureaucrats can gin up studies that suggest that the benefits of any activity they favor outweigh the costs?

My tentative answer: Regulatory science is an oxymoron.

In any case, the foregoing is not meant endorse any of the candidates nominated by Pruitt to serve on the EPA’s scientific advisory board. Each will need a case-by-case evaluation; avoiding both government shills and industry shills is a good idea. But Pruitt’s ruling that researchers dependent on agency funding should not serve on EPA advisory committees is not self-evidently wrong.

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Stocks Advance For 7th Straight Month As Yield Curve Crashes To 10 Year Lows

Well that was easy…

When does this mouth snap shut?

 

Japan wins October… with only two down days all month (the first -0.4% and the 2nd last night -0.003%!)…NKY's best month since Oct 2015

S&P, Dow, and Nasdaq's best month since February, Trannies were the only major index red with Small Caps bouncing back green today…

 

This is the 7th straight monthly advance for the S&P 500 (and Dow) (Last 7 mth, May 2013. Last 8 mth, Jan 2007. Last 9, Mar 1983).. and 11th of the last 12 months up…

h/t @JohnKicklighter

Tech, Utes, and Financials outperformed in October… Retailers lagged…

 

FANG Stocks surged almost 8% in October – 2nd best month ever…

TSLA ended the month -3%… AMZN up 15%

 

Another ugly day for Under Armour… to the lowest since April 2013…

 

It was a big month for other assets too…

  • Dollar Index rose 1.7% in October – best month since Nov 2016
  • Bitcoin surged 52% in October to a new record high
  • 2Y Treasury yield rose 11bps in Oct, 2nd monthly rise in a row to highest monthly close since Sept 2008
  • TSY 5s30s curve flattened for 3rd month in a row to flattest monthly close since Oct 2007
  • WTI Crude's highest monthly close since June 2015 (up 2 months in a row)
  • Gold's first consecutive monthly drop since Dec 2016

Stocks bounced back from yesterday's dip with Small Caps outperforming today and Nasdaq since Friday

 

VIX hit a 9 handle early on… bounced… then was pushed back down a 9 handle in the last hour…before rising once again…

 

Treasury yields were mixed today (long-end outperforming), echoing the month of October (2Y +11bps, 30Y +1bps)

 

With the yield curve starting to re-accelerate flatter…

 

The Dollar Index surge in October but has fallen the last 3 days…

 

Driven by slump in CAD (offset by strength in CNY)…

 

Bitcoin hit a new record high today after news of a Bitcoin Futures contract broke…

 

Copper and Crude ended October up 5.3% – oddly the same – with silver and gold stuck at the flatline…

 

Just one last thing… While US equity markets had a big October run… all the major US equity indices implied vols rose on the month… led by Small Caps…

 

And remember – October was all about China…

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There Are No Cheap Stocks Anymore… Literally

The S&P is substantially overvalued on 18 of 20 valuation metrics, with the only exceptions being free cash flow (helped again by depressed capex), and relative to small caps/bonds – the Fed's favorite indicator –  where yields remain depressed thanks to the Fed's failure to stimulate wage inflation for nearly 9 years.

 

But as the relative collapse of the equal-weight S&P relative to the market-cap-weighted S&P, all the gains have gone to the biggest names…

 

And longer-term, share prices have drifted – some might say 'inflated' – to the point that there are no cheap stocks anymore… literally.

 

Perhaps this chart will highlight the 'inflation' better

It now takes the average American worker almost 95 hours to earn enoough to buy one S&P 500 index 'unit'…30% higher than at the peak in 2007 and almost triple its cost at the lows in 2009…

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