Thursday, December 1, 2016

"Granola Shotgun" and the Eventual U.S. Sovereign Debt Crisis

Some highlights from "Granola Shotgun", I think the entire blog is worth reading.

  • As I went through life I watched as another boom and bust cycle played out with the crash of October 1997 and then again in the crash of September 2008. The interesting thing to me is the way different generations interpreted these events. The older folks never adjusted their penny pinching when times were good. They reflexively saved against lean times regardless of the current abundance. Boomers never learned to restrain their enthusiasm no matter how often they screwed up. They held firm to their buy-now-pay-later ethos decade after decade. A dog doesn’t change its spots. -"The Lost World of the Solvent American"
  • The solution is always the same – work harder, earn more money, wait longer, take on more debt, buy something that someone else built, and feed the existing system regardless of how inefficient or pointless it might all be. - "Building Codes and the Self Built Mortgage Free Home"
He has a number of examples of how crushing regulatory burdens - at the county level - make it very difficult to build small, efficient commercial or residential properties. [See: 1, 2, 3, 4, 5 for examples.]

I've been looking quite a bit at the projected budget deficits over the coming two decades that will be caused by Social Security, Medicare, Medicaid and state pension obligations. State pensions are massively underfunded - to the tune of several trillions of dollars. Social security and Medicare represent liabilities of tens of trillions.

The federal budget deficit is now over a trillion dollars per year. Using accounting tricks, the government claims it's less than that, but look at the amount that the public debt grows every year. The increase in debt = expenses less revenue = true deficit. Simple check: the federal debt grew by $10 trillion in Obama's eight years. I think we can count on $1 trillion as the baseline going forward.

Using the government's own projections, Medicare will cause the deficit to increase by another $500 billion annually by 2026, Social Security will have the deficit increasing by a bit less but still several hundred billion, and Medicaid an extra couple hundred billion. (This assumes, of course, other federal expenditures and revenues held constant.) The total increase is a trillion dollars per year, which means eventually $2 trillion annual deficits for the federal government.

The current plan is just to borrow this. But these are enormous amounts of money. To put it in an individual perspective, there are fewer than 100 million federal income tax payers in the U.S. The current public debt of $19 trillion is $190,000 per taxpayer. Outspending revenue by $2 trillion annually is $20,000 per taxpayer.

If this sounds crazy, it is because you're looking at the endgame of a Ponzi scheme that ended when it caused the total fertility rate, and thus - eventually - the worker retiree ratio, to drop too much.

To put in a different perspective, the total equity value of the S&P 500 companies is less than $20 trillion. Imagine the federal government exhausting that much capital in ten years. I don't know when it will happen, but I think the bond market will choke. Occasional spikes in bond yields will be the signal that no more can be borrowed. (Ask James Carville.)

The alternative to borrowing is to get expenses back below revenues. There seem to be hard limits to the percentage of GDP that a government can collect (Laffer curve), although I'm sure it could collect more than it does now. If so, corporate taxes will be higher, not lower, and corporate profits will decline. Disposable income will fall significantly when income taxes rise. (Think: luxury cars, Starbucks, Amazon, Apple, cable TV bills, restaurants and breweries.)

In terms of cutting expenses, the federal government's largest expenses are these retirement Ponzi schemes. (And why would any baby boomer continue to support the federal government if these promises are not paid?) The only other expense that comes close is the military.

Interestingly, only a third of the military budget is for personnel. You could save maybe $200 billion a year if you stopped all materiel purchases and brought them back to bases in the U.S. to do pushups all day. If you want to get really clever, retrain them to do infrastructure repair of roads, bridges, water, sewer - another multi-trillion dollar can that has been kicked down the road and I am not even going to talk about in this post.

These cuts and tax increases are going to be very painful. I would imagine they will be the only political topic under discussion. No more neocon wars, no more gay marriage disputes. I would not bet on selling a new jet fighter or a 1,000 ship Navy. The Ponzi scheme disputes will have a racial identity politics dynamic because the older Ponzi participants are much whiter than the working age population.

Thus, my overall impression is that the U.S. is less rich than people currently believe or people's behavior currently implies. Stocks aren't worth their current multiple of earnings at peak profit margins; bonds shouldn't be yielding so little given that there is a recipe for a sovereign debt crisis. People's thinking right now is clearly delusional: Uber apparently subsidizes rides to the tune of 60% of the fare, so logically it is not worth the ~$100 billion that people think.

And in a period of rising property taxes, income taxes, and interest rates, people are going to find out that residential housing is not an investment. Depending on state law, it may be possible for retired municipal employees to expropriate significant amounts of home equity to maintain their pensions.

What do people say to this? I find that the rebuttal is that the Fed will print money and buy the government bonds to fund the deficit. That is what is going to look really delusional in the history books!

I realize that people have been talking about this for decades. I guess the mistake then was thinking that this would matter as long as interest rates were still falling. But I think it will be a mistake to assume it will never matter.

Finally, note the scary conclusion from the Granola Shotgun blog is that, at least at first, people are not going to be allowed (allow each other, really) to do a lot of the belt-tightening that will be needed to cope with the loss of illusory wealth. Can't build a little accessory dwelling in the backyard for your parents to live in.

Wim Hof, The Iceman Cometh

Peabody Energy Requests Extension, Gives Updates

Update in the extension request that was just filed:

The Debtors and their advisors have also dedicated significant time and resources to, among other things the following:

a)Negotiating the Plan with various creditor groups, including the Debtors' lenders party to the First Lien Credit Agreement or their successors or assigns (the "First Lien Lenders"), and an ad hoc group of senior unsecured noteholders (the "Ad Hoc Noteholders"), an ad hoc group of noteholders for the Debtors' 10.00% senior secured notes due March 2022 (the "Second Lien Noteholders' Group"), and the committee for the unsecured creditors (the "Creditors' Committee");
Notice they don't mention any negotiation with the subordinated noteholders or the equity!
"Against this backdrop of achievement, and in recognition of the complex issues still facing the Debtors, the Debtors request an order further extending the Exclusive Periods. The Debtors are engaged in active and ongoing negotiations with, among others, the Debtors' First Lien Lenders, Ad Hoc Noteholders, the Second Lien Noteholders' Group and the Creditors' Committee. The Debtors have made considerable progress in negotiating the Plan and currently intend to file the Plan by December 14, 2016. However, in an abundance of caution and in case unanticipated delays arise, the Debtors hereby seek an extension of their Exclusive Periods."
I suspect that the plan will be leaving unsecured creditors significantly impaired, and so will not provide for any distributions to the subordinated notes (currently trading at 20!) or the equity.

Tuesday, November 29, 2016

Prechter on Dividends

"[T]he greater investors' pessimism, the more dividend payout matters to them, and the greater their optimism, the less relevant or necessary it is deemed. In today's market environment, dividends are actually considered a detriment to stock ownership, the theory being that it is better for management to put the money back into the company to make it grow faster. As far as I can determine, this attitude is unprecedented."
- The Wave Principle of Human Social Behavior and the New Science of Socionomics

Monday, November 28, 2016

In Today's EXXI Docket...

It is an unfortunate reality that the legacy shareholders of Energy XXI Ltd are billions of dollars out of the money. Faced with this reality, the Equity Committee—knowing that its valuation arguments will fail and that shareholders are entitled to nothing—has filed the above-described motions designed to transform worthless equity interests into a variety of potential unsecured tort claims, with the goal of having those purported claims certified as a class, estimated at an astronomical value, and voted against the plan in sufficient magnitude to control the general unsecured claims class at EXXI, the Bermuda parent company from which public equity was issued. This creative approach aimed at thwarting an otherwise-consensual reorganization is contrary to the Bankruptcy Code and must be rejected.

Saturday, November 26, 2016

"Peabody debt dispute fizzles as coal prices rise" $BTU $BTUUQ

Story:

On Wednesday, Peabody said the company was working to resolve the dispute that pitted its secured lenders against unsecured creditors, including distressed debt hedge funds Aurelius and Elliott, who were seeking a larger share of Peabody's assets in the reorganization.

"The parties are working to settle the (debt) issue as part of broader negotiations regarding the plan of reorganization," Peabody spokesman Vic Svec said in an emailed statement.

Peabody expects to file its reorganization plan by mid-December and hopes to exit bankruptcy within a year of its April 2016 filing, Svec said.
The unsecured debt is still trading in the high 50s. That's a substantial valuation hole to make up (don't forget accrued interest) before even the subordinated notes will be in the money.

Friday, November 18, 2016

Energy XXI Confirmation Hearing Set for December 13

"The Confirmation Hearing will commence before the Honorable David R. Jones, Chief Bankruptcy Judge for the Southern District of Texas, Houston Division at the United States Courthouse, Room 400, 515 Rusk Street, Houston Texas 77002 on December 13, 2016 at 9:00 a.m. (Central Time) and will continue from day-to-day thereafter on dates that are convenient for the Court."