How Does The Crisis Affect Me?

The crisis has affected each of us. We examine examples of how the financial crisis, and the associated economic, social and political instability may affect your life and wealth in ways you never considered

Selling the shale boom: lies, lies and more lies

Over a year ago, Netflix CEO Reed Hasting got into trouble with the SEC when Netflix stock price spiked 21 percent after Hasting boasted on his Facebook page that Netflix monthly viewing exceeded 1 billion hours 3 weeks before the company’s scheduled earnings release.  At the time, we opined that

Ever since the collapse of Enron and Lehman Brothers, corporate executive behavior and communication has been under the microscope with increasing regulatory scrutiny. There’s a good reason why almost all Fortune 500 C-Suite executives are very cautious and tight-lipped when speaking to the public about anything with stock price moving potential ….. It is irresponsible for a CEO to announce something without all the facts and figures.

Well, apparently we were too harsh on Hasting.  Bloomberg reported even more serious discrepancies rife in the U.S. shale industry (see also chart below from Bloomberg):

Sixty-two of 73 U.S. shale drillers reported one estimate [of oil and gas reserves] in mandatory filings with the Securities and Exchange Commission while citing higher potential figures to the public, according to data compiled by Bloomberg.

Shale Reserves

For example, Bloomberg cited Pioneer Natural Resources (PXD) Co.’s estimate was 13 times higher, while Goodrich Petroleum Corp. (GDP) was 19 times.  Bloomberg also noted the number PXD told to potential investors has increased by 2 billion barrels a year in each of the last five years — even as the proved reserves it files with the SEC have declined.   Similarly, the investor presentation by Rice Energy (RICE) shows 2.7 billion barrels. Rice, which went public in January, reported 100 million barrels to the SEC in March, that’s almost 27 times higher.

So in other words, these companies tell SEC one number, then can just turn around inflate that number to whatever ‘estimates’ companies believe to be ‘probable’ and/or ‘possible’.  If you think executives would be held responsible for this kind of ‘miscommunication’, you would be wrong. Apparently it is legal and a common operational procedure as Bloomberg explains:

The SEC requires drillers to provide an annual accounting of how much oil and gas their properties will produce, a measurement called proved reserves, and company executives must certify that the reports are accurate.

No such rules apply to appraisals that drillers pitch to the public, sometimes called resource potential. In public presentations, unregulated estimates included wells that would lose money, prospects that have never been drilled, acreage that won’t be tapped for decades and projects whose likelihood of success is less than 10 percent ……..

Many of the companies use their own variation of resource potential, often with little explanation of what the number includes, how long it will take to drill or how much it will cost. The average estimate of resource potential was 6.6 times higher than the proved reserves reported to the SEC, the data compiled by Bloomberg News show.

Meanwhile, Bloomberg quoted comments from two of the drillers.  From the Chairman and CEO of Pioneer Natural Resources (PXD):

“Experienced investors know the difference between the two numbers……..We’re owned 95 percent by institutions. Now the American public is going into the mutual funds, so they’re trusting what those institutions are doing in their homework.”

Here is the spokesperson of Marathon Oil chiming in:

Figures the company executives cite during presentations “are used in the capital allocation process, and are a standard tool the investment community understands and relies on in assessing a company’s performance and value,”

So this means Wall Street analysts model valuation, growth, and therefore stock recommendation based on ‘estimate’ that does not meet SEC reporting rules but thrown out by executives to tell a better story of their stocks to the potential investors?

Honestly, it seems even worse than Enron’s off-Balance Sheet Financing scheme.  Ultimately, in the Enron aftermath, CEO Jeff Skilling is serving 14 years of a 24-year original sentence for misleading investors.  Unfortunately, that precedent does not seem to have made as much impact you’d think at least within the onshore E&P industry.  In that regard, we totally agree with John Lee, a Petroleum Engineering professor at University of Houston:

If I were an ambulance-chasing lawyer, I’d get into this.

This ‘over-optimism’ also opens up a whole new can of worms as to the current projection of U.S. oil reserves and production.  Is the U.S. really on its way to become energy self-sufficient as some may believe based on “resource potential”?  We certainly hope U.S. government checks all supporting data and facts before lifting the crude oil export ban.

According to Bloomberg, investors poured $16.3 billion in the first seven months of the year into mutual funds and exchange-traded funds focused on energy companies.  Our advise to retail investors –  Do your homework and double fact-checking, if something sounds too good to be true, it usually is.

Submitted by EconMatters

Housing and the real CPI

With housing prices still rising, albeit more slowly, inquiring minds might be wondering about "Real" interest rates and the "Real" CPI?

CPI Distortions

We believe the federal government’s reported CPI is distorted, but not for the same reasons as most others. Home prices used to be in the CPI but the BLS now uses OER (Owners’ Equivalent Rent). OER is a measure of actual rental prices. It is also fiction.

The BLS determines OER from a measure of rental prices and also by asking the question “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?

If you find that preposterous, You are not the only one. Regardless, rental prices are simply not a valid measure of home prices.

OER Weighting in CPI

OER has the single largest weight of any component in the CPI, at 23.957 percent.
CPI Components
Let’s play "What If?" Specifically, "What if the BLS used actual home prices instead of OER in calculating the CPI?"


Periodically, Black Knight Financial Services provides the actual data behind their HPI (Home Price Index), a measure of actual prices.

We can use that data to see what the CPI would look like if we put actual home prices in the CPI instead of OER.

We call this the "HPI-CPI".


  • Click on any chart to see a sharper image
  • Data as of June 2014

Let’s start with a look at the rate of increase in home prices vs. the rate of increases in OER.

Comparative Growth in HPI vs. OER

From 1994 until 1999 there was little difference in the rate of change of rent vs. housing prices. That changed in 2000 with the crash and accelerated when Greenspan started cutting rates.
The bubble is clearly visible but neither the Greenspan nor the Bernanke Fed spotted it. The Fed was more concerned with rents as a measure of inflation rather than speculative housing prices.

Two Inflation Indexes Year-over-Year

The above chart shows the effect when housing prices replace OER in the CPI. In mid-2004, the CPI was 3.27%, the HPI-CPI was 5.93% and the Fed Funds Rate was a mere 1%. By my preferred measure of price inflation, real interest rates were -4.93%. Speculation in the housing bubble was rampant.

In mid-2008 when everyone was concerned about "inflation" because oil prices had soared over $140, I suggested record low interest rates across the entire yield curve. At that time the CPI was close to 6% but the HPI-CPI was close to 0% (and plunging fast).

As measured by HPI-CPI real interest rates were positive from mid-2006 all the way to 2010, even when the Fed Funds rate crashed to .25%. That shows the power of the housing crash and how badly the Fed misplayed the housing bubble.

Real rates went positive again in mid-2010 until early 2011.

CPI and HPI-CPI Variance From Fed Funds Rate

The above chart shows two measures of "Real" interest rates. The Blue line is the Fed Funds Rate minus the CPI. The Red line is the Fed Funds Rate minus the HPI-CPI.
Both measures show how the Fed has pushed real rates into negative territory.

However, the rate of growth in home prices is slowing. If home prices actually start to decline, which I believe likely, HPI-CPI will show outright deflation.

And even with the Fed Funds rate at 0.25%, real rates will again be positive as measured by HPI-CPI, but perhaps not by the Fed who uses the CPI as its measure of price inflation.

US Interest Rates Can Never Rise

It’s not just the public who has to worry about rising interest rates, the Federal government might soon get a taste of its own medicine.

With the Federal Reserve doing all it can to stimulate inflation, increases to interest rates are taking a front seat amongst borrowers’ fears. From the admittedly partisan Republican Senate Committee on the Budget comes this report outlining how federal interest outlays will dovetail with other expenses in the future.

To summarize:

The U.S. gross federal debt currently stands at $17.548 trillion, and net interest payments to our creditors are the fastest-growing item in the budget. In 2014, the Congressional Budget Office projects that the nation will spend $233 billion on interest payments. By the end of the budget window in 2024, however, CBO forecasts that interest payments will nearly quadruple to an astonishing $880 billion. Every dollar spent paying our creditors is a dollar wasted—money for which we get nothing in return. Interest payments threaten to crowd out every other budget item.

To put the $880 billion, single-year interest payment in perspective, here is what we currently spend on other budget items:

    • Federal Courts – $7.4 billion
    • Department of Education – $56.7 billion
    • Secret Service – $1.8 billion
    • Food Inspection – $2.3 billion
    • Census Bureau – $1.0 billion
    • Border Patrol – $12.3 billion
    • National Parks – $3.0 billion
    • NASA – $17.6 billion
    • Centers for Disease Control – $7.1 billion
    • Federal Prison System – $6.9 billion
    • Workplace Safety Inspections – $0.9 billion
    • Immigration and Customs Enforcement – $5.6 billion
    • FDA – $2.6 billion
    • Federal Highway Budget – $40.4 billion
    • Coast Guard – $10.0 billion
    • Small Business Loans – $0.9 billion
    • Veterans’ Health Care – $55.3 billion
    • FBI – $8.3 billion

Every debt incurred today must be paid off in the future. The graph above may be shocking to some, but it’s only a very small part of the picture. This is just interest on debt, and doesn’t even include the costs of repaying the principal. Of course, the principal never really gets repaid as the government just borrows anew to paper over its old debts, but the interest must be covered or savers will stop lending money to the government.

Nor is this only a concern for the future. Last year the government spent more on interest payments (c. $700 bn.) than it did on Medicare (a little under $600 bn.).

Rise of the fatty

For all the talk about QE this, HFT that, crony capitalism, cold war 2.0, hyperinflation, deflation, social inequality, Keynesian dead end, global financial meltdown, perhaps the one more tangible threats to mankind as a whole (and to the future underfunded healthcare costs) is something far simpler: the rise of the fatty. Obesity is growing right here in the U.S. A new study indicates that the obesity rate exceeds 20 percent in every state in the union!


Below via Nature is a look at why is it that those cuddly, jovial fat people, who seem to be growing exponentially in recent years, present a great danger not only to themselves, but to exponentially growing welfare costs as well, in a world which already is, for all intents and purposes, insolvent.

They are everywhere.

fatty 1

They don’t fit on the scale.

fatty 2

A lot of their problems can be explained by the surge in cheap, hollow calories.

fatty 3

The bottom line is they are a danger: to themselves, and to those others who will be tasked to pay for their care.

fatty 4

Source: Nature

Most pension funds will fail in next 30 years

Bridgewater Associates did an analysis of pension funds recently and concluded 85 percent of them will fail if returns average 4 percent annually.

Bridgewater notes that public pensions have just $3 trillion in assets to invest to cover future retirement payments of $10 trillion over the next many decades. It would take an investment return of roughly 9 percent a year to meet those obligations.

With the 30-Year long bond yielding a mere 3.1 percent and with stock valuation through the roof, we expect negative returns for 7-10 years.

Stretched out over 30 years, 4 percent seems about right. 9 percent will not happen.

CNBC has additional analysis.

Influential and well-regarded hedge fund Bridgewater Associates Wednesday warns public pensions are likely to achieve 4% returns on their assets, or worse. If Bridgewater is right, that means 85% of public pension funds will be going bankrupt in three decades.

Bridgewater came to these conclusions by stress testing the nation’s public pension plans, much the way banks need to be evaluated on what could happen given a wide range out outcomes.

Many pension observers make the claim pensions will achieve 7% to 8% returns. But even if that assumption is correct, which is unlikely, public pensions are looking at a 20% shortfall, Bridgewater says. A 4% return is much more likely, the firm says.

Bridgewater set up a sophisticated model to simulate many of the possible market environments to see how they would affect public pension’s resources. In 20% of those scenarios, public pensions run out of money in 20 years. And in 80% of the scenarios, public pensions run out of money within 50 years, Bridgewater says.

Massive Number of Municipal Bankruptcies on Horizon

We wonder what Bridgewater’s model would predict starting with losses for the next seven to ten years. That is what we think is highly likely.

Given the only way to shed  pension obligations is bankruptcy, one hell of a lot of municipal bankruptcies are on the horizon unless some other legal maneuver is found.