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The American economy has looked pretty robust of late — unemployment just hit a 16-year low and stocks recently reached an all-time high.

This makes it all the more curious that Americans have suddenly stopped paying off their credit card bills at a rapid rate.

In the last two fiscal quarters, banks reported a steep rise in credit card charge-offs — debt that companies can’t collect from their customers — according to a report from Moody’s.

This chart from the report shows how each bank has fared on charge-offs, with Capital One, First National of Nebraska, and Synchrony showing the worst performance over the period:

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For centuries, cross-border trade has come with a currency problem. The expansion of globalisation has not made it any less pressing. The dilemma identified by the economist Robert Triffin is a powerful – and alarmingly current – reminder that a worldwide foreign exchange crisis is only one big mood change away.

The Scottish philosopher and economist David Hume identified the fundamental issue in 1752. While the sum of global exports always equals global imports, countries can run persistent trade deficits. In Hume’s time, the deficit country shipped gold to pay for overseas goods. Today, creditors have to accept large quantities of deficit countries’ currency.

Hume thought the free market would correct these imbalances, through what we now call currency devaluations. Exports would rise, imports would fall, and the gold would return. But it turns out that the economic patterns which lead to trade deficits are remarkably stubborn. They persist as long as importers can find a way to pay for their lifestyles.

When the gold runs out or the lenders finally give up, default is almost unavoidable. Usually, such national financial failures cause only small ripples in the world economy. But that is not always the case. As Triffin pointed out in 1960 the effects would be much more serious if creditors lose faith in the global reserve currency – the unit which is readily accepted for trade and commonly used for savings pretty much everywhere.

A flight from a reserve currency would throw the global trading system into disarray. As in Triffin’s day, the currency in question is the U.S. dollar. As the Belgian-American economist understood, the dollar will remain solid until the day of reckoning. Foreigners will be willing to accumulate more greenbacks because holdings of the global reserve currency help trade run smoothly. So they are more than happy to finance America’s trade deficit.

But the more the United States spreads dollars around the world, the more likely holders are to question America’s creditworthiness. Economists named the simultaneous desire for dollars and the danger involved in holding them the Triffin dilemma. Valéry Giscard d’Estaing, then the French finance minister, called it America’s “exorbitant privilege”.

The United States has exercised its privilege abundantly ever since. As the chart shows (, the net U.S. international investment position – basically the market value of dollars invested from America minus the value of dollars lent to it – first turned negative in 1988. After some gyrations, a firm trend has set in. By 2016, the deficit had reached around 11 percent of global GDP.

That is an awful lot of dollar value at risk. But the development is not surprising. Cross-border trade has increased from 17 percent of world GDP in 1960 to 45 percent today, according to the World Bank. The first horn of the Triffin dilemma explains that this growth leads to more expatriate dollars. The other horn points out that a currency crisis now would be very disruptive.

Suppose some American irresponsibility or arrogance exhausts the patience of the Chinese government, prompting it to sell some of its vast stock of dollar-denominated assets. Others would follow, rushing to currencies still perceived as relatively safe. That creates political discontent in countries such as Japan and Switzerland. Capital controls would come and cross-border trade would go.

Meanwhile, the U.S. Federal Reserve would probably raise interest rates to defend the dollar. Leveraged investors would be forced to sell, creating market mayhem. Big banks could topple over. Though they are better capitalised than a decade ago, they still rely extensively on the ready global availability of supposedly risk-free U.S. government debt.

The unity of that global quasi-government is fraying, though. Central bankers have tested politicians’ patience with years of ultra-low rates. And global politics are troubled. President Donald Trump does not generally behave like a believer in cross-border solidarity. The euro zone has become more inward looking. China has become larger but also more nationalistic. Japan has become smaller.

Ultimately, all profound financial problems must have political solutions, because only governments have enough authority to allocate damage and restore confidence. This explains why cross-border financial problems are especially hard to solve – there is no international government to intervene.

The U.S. dollar’s reserve status has withstood numerous shocks and a succession of profligate presidents. If the Triffin dilemma turns into a crisis, though, everyone will wonder why the dollar was allowed to underpin the global economy in a political near-vacuum.

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“The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the de facto dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy re-organization in American history at that time, Enron was attributed as the biggest audit failure.

Enron was formed in 1985 by Kenneth Lay after merging Houston Natural Gas and InterNorth. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that, by the use of accounting loopholes, special purpose entities, and poor financial reporting, were able to hide billions of dollars in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives not only misled Enron’s board of directors and audit committee on high-risk accounting practices, but also pressured Andersen to ignore the issues.

Enron shareholders filed a $40 billion lawsuit after the company’s stock price, which achieved a high of US$90.75 per share in mid-2000, plummeted to less than $1 by the end of November 2001. The U.S. Securities and Exchange Commission (SEC) began an investigation, and rival Houston competitor Dynegy offered to purchase the company at a very low price. The deal failed, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. Enron’s $63.4 billion in assets made it the largest corporate bankruptcy in U.S. history until WorldCom’s bankruptcy the next year.

Many executives at Enron were indicted for a variety of charges and were later sentenced to prison. Enron’s auditor, Arthur Andersen, was found guilty in a United States District Court, but by the time the ruling was overturned at the U.S. Supreme Court, the company had lost the majority of its customers and had ceased operating. Employees and shareholders received limited returns in lawsuits, despite losing billions in pensions and stock prices. As a consequence of the scandal, new regulations and legislation were enacted to expand the accuracy of financial reporting for public companies. One piece of legislation, the Sarbanes-Oxley Act, increased penalties for destroying, altering, or fabricating records in federal investigations or for attempting to defraud shareholders. The act also increased the accountability of auditing firms to remain unbiased and independent of their clients.” – Wikipedia

Smart Management?

Now check out Enron’s annual report for fiscal year 2000.

In the annual report Jeffrey K. Skilling (President and CEO) together with Kenneth L. Lay (Chairman) began the shareholder letter in the following (kind of pretty optimistic) way.

Below is an overview and discussion of Enron’s net income compared to a calculation of owner earnings.

You can see the big red warning flag of net income not syncing with owner earnings.

What I’ve heard is that many people will read the financial statements backwards. Start with the cash flow statement first and income statement last. It follows the mantra that cash is king. Follow the cash.

Wall Street fell in love with earnings, accruals, and backlog. Cash was for dummies.

Another simple rule of thumb is that bad companies rarely turn it around and stay consistent year over year. They may have a couple of good years, but expect to see down swings and frequent bad years.

A great book is Financial Shenanigans: How to Detect Financial Gimmicks & Fraud In Financial Reports. In the book the authors discuss the Enron scandal awarding Enron for “Most Outrageous Financial Shenanigans”, see image below.

The discussion of the Enron scandal in Financial Shenanigans and the financial shenanigans is summed up as follows.

The problem is that this is a ton of work for retail investors to dig up.

Doing a case study for education is insightful, but when you try to apply these techniques to every stock you are interested in, it easily gets overwhelming.

Few simple options.

  1. Invest in index funds as recommended by Warren Buffett and go on with your life
  2. Focus on simple businesses and don’t be afraid to throw 90% of companies you come across in the “too hard” pile
  3. Simplify your process by using systems and tools like Old School Value that helps you crunch numbers, identify red flags and makes financial analysis easier.

Recommended Books on Enron by Buffett

In his 2003 letter to shareholder Warren Buffett recommended the book The Smartest Guys In the Room. Here’s what he had to say.

Another book written about the Enron collapse is Power Failure: The Inside Story of the Collapse of Enron.

“Power Failure is the electrifying behind-the-scenes story of the collapse of Enron, the high-flying gas and energy company touted as the poster child of the New Economy that, in its hubris, had aspired to be “The World’s Leading Company,” and had briefly been the seventh largest corporation in America.

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I haven’t bothered with this chap for a while, but he has an article out currently that is just simply bad.

I’m not going to reproduce all of his post as it is mostly a waste of time: here is the article.

As I predicted back in 2008 and 2009 QE did not cause high inflation, surging interest rates, high growth, and was not really all that impactful given all the fuss about it. Yes, I have argued that QE1 was probably very effective because it shored up balance sheets at a very unusual time, however, the future iterations of QE and the aggregate impact has been fairly small given how expansive the policy was.

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Inflation is high, very high and it was [and is] caused by the expansion of the money supply by the Federal Reserve and other Central Banks around the world. As this plot is of ‘everything’, clearly inflation is widespread throughout the economy. There are obvious ‘bubbles’ again in real estate around the world. So Mr Roche is incorrect with regard to ‘inflation’ and his prediction.

The entire purpose of the Fed expansion was to create inflation. This is because with MBS losing value as the real housing market collapsed due to rising defaults, MBS securities were going to ‘zero value’ very quickly.

Who owned this trash? Banks, Hedge Funds, Pension Funds, worldwide. Suddenly everyone was demanding cash….There wasn’t enough in the system, thus the massive and very fast deflation that occurred. QE has been an exercise in [re] inflation.

Importantly, what this process was not akin to was “money printing”. This is due to the fact that operations like QE do not actually expand the quantity of net financial assets in the private sector. In other words, the Fed created reserves and traded them to the private sector, but the Fed also removed a T-bond or MBS at the same time. So you could say that they printed a super short-term instrument into the private sector and unprinted a long-term instrument from the private sector.

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So again, pure nonsense.

The ‘money supply’ increased and has continued to increase as a result of QE. QE and the expansion of the money supply is what has caused the increase in the inflation data.

So the concern of market commentators about the ‘shrinkage’ in the Fed’s Balance Sheet is a very real concern, as, the commercial banks capital reserves are largely composed of Fed assets. We saw in 2008 what happens when the commercial banks become illiquid. Apparently, once again MBS securities are expanded. So all of the ingredients are again present for problems, particularly if the Fed’s shrinkage is too fast or too far. The castles are once again built on sand and people are worried what happens if the tide comes in.


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Get ready to step over some landmines, investors. The number of companies defaulting on their debt is hitting levels not seen since the financial crisis, and it’s not just a problem for bondholders.

So far this year, 46 companies have defaulted on their debt, the highest level since 2009, according to S&P Ratings Services. Five companies defaulted this week, based on the latest data available from S&P Ratings Services. That includes New Jersey-based specialty chemical company Vertellus Specialties and Ohio-based iron ore producer Cliffs Natural. Of the world’s defaults this year, 37 are of companies based in the U.S.

Meanwhile, coal producer Peabody Energy (BTU) and surfwear seller Pacific Sunwear (PSUN) this week filed plans for bankruptcy protection. Shares of Peabody have dropped 97% over the past year to $2 a share and Pacific Sunwear stock is off 98% to 4 cents a share.

The implosion of oil prices is the top reason for the rise in defaults as it makes it harder for energy companies to repay debt. The Federal Reserve’s decision to hike short-term interest rates last year along with slowing global growth are also putting pressure on companies’ ability to service their debt.

Defaults are clearly an issue for bondholders, since these events mean they no longer receive payments on money lent to these companies. But the situations can be brutal for stock investors, too, as restructuring after a default can leave shares essentially worthless as the bondholders often become the new owners of the company. The rise of defaults hold several lessons for stock investors, including:

* Beware speculating on energy stocks. Brave investors have been trying to call a bottom in energy companies’ profits for several quarters now. But the sector’s pain continues as interest payments get all that more onerous given the massive drop in energy prices. Of the 46 global defaults this year, 13 are in the oil and gas sector, says Diane Vazza, head of global fixed income research at S&P Ratings Services. The surge in defaults is largely “fallout from multi-year lows in commodity prices,” she says. Energy profits keep falling. Energy sector profits are expected to drop another 107% in the first quarter of 2016 – even worse than the 55% drop in the first quarter of 2015, says S&P Global Market Intelligence.

* Cut losses. “It will come back” are famous last words for investors. When investing in individual stocks, especially some that could be even remotely flirting with default, it’s best to cut losses short. Investors in coal producer Peabody Energy defaulted on March 18, leading to the company to file for bankruptcy protection in April. Don’t think it’s just a problem for investors holding the company’s debt. Stock investors watched $1.3 billion in shareholder wealth burn up in just a year as the stock dropped from $73 a share to roughly $2 a share now. Had investors cut their losses at 10% of what they paid, they could have avoided this catastrophe.

* Mind companies on the bubble. Companies don’t usually just default without warning. Ratings agencies routinely rate companies’ credit worthiness and sound an alarm when the financials deteriorate. S&P Ratings keeps a list of the companies with the very lowest credit ratings at risk of a downgrade. The number of such “Weakest Links” jumped to 242 in March from 235 in February.

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Shares in Slater and Gordon, the law firm now talking with its banks about reorganising its debt, took another beating today.

At the close, they had lost more than 45% to $0.315. At that price, the market capitalisation is about $110 million, down about $90 million on yesterday’s close of 58 cents.

Last year the shares hit a high of $8.07, valuing the company at $2.8 billion, but have been on steep slide because of its underperforming business in the UK and the British’s government plans to limit compensation for road accidents.

Slater and Gordon on Monday marked down the value of that UK business and reported a $958.3 million loss for the six months to December.

The company is reorganising and cutting costs, meaning likely redundancies in the UK where it has 3950 of its 5350 staff.

The other priority is to bring down debt. Net debt was $741.4 million at the end of December, up 18.9% or $118 million since June.

The company has agreed to deliver an operating plan and restructure proposal to its banking syndicate and its financial advisers this month.

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Covers a number of issues and topics that we are currently studying.

A report by administrators FTI Consulting into the solvency of Clive Palmer’s Queensland Nickel refinery near Townsville has recommended the company be liquidated, ahead of a creditors meeting next Friday.

The creditors will meet on April 22 to decide whether to place the company into liquidation with debts in excess of $100 million, including more than $73 million owed to around 800 employees who lost their jobs last month.

The FTI report says the business does not have enough cash to pay the workers.

With unsecured creditors likely to receive no more than 50 cents in the dollar, responsibility for some of the unpaid redundancy entitlements of workers will fall to taxpayers under a federal government scheme.

The refinery’s owner, federal MP Clive Palmer, who is already being investigated by the Australian Securities and Investments Commission (ASIC) over his role in the business, which he bought in 2009.

Palmer said he “retired” from the business in 2013, when he entered federal politics, but last night the ABC’s “Four Corners” aired allegations that Palmer acted as a “shadow director”approving all expenditure at the refinery, using a pseudonymous email account under the name “Terry Smith”.

If Palmer is found to have acted in that capacity, he becomes legally liable in the same manner as an actual director.

Palmer has denied he approved spending at the refinery as a shadow director prior to it being placed in voluntary administration in January.

One the ABC’s “Lateline” program, shortly after the “Four Corners” story, Palmer attempted to explain that he was not responsible for the current state of Queensland Nickel, which during 2014-15, donated $5.9 million to the Palmer United Party.

Queensland Nickel donated another $288,516 to the PUP in the six months to December 2015.

Four weeks ago, Palmer created a joint venture using two of his companies to take control of Queensland Nickel while it was under administration. The refinery shut and workers lost their jobs just a few days later, contrary to claims by the MP that he had “saved” the refinery for a second time.

On “Lateline” he said any expenditure he oversaw was for the joint venture.

“My role was set out in the joint venture agreement as a member of the joint venture committee to direct Queensland Nickel to make sure they complied with the terms of the agreement as a manager,” he said.

The administrator’s report also identifies potential breaches of the Corporations Act by Palmer and his nephew, Queensland Nickel managing director Clive Mensink.

“Our investigations indicate certain persons appointed as a director, or who may have acted in the capacity of a director may have contravened [several sections of the Corporations Act] as well as their fiduciary and common law duties,” the report says.

“Our observations indicate Mr Palmer, a former director of the company, appears to have acted as a shadow/de facto director of QN at all material times from February 2012 up to the date of our appointment on 18 January 2016.”

The administrators have also honed in on payments made to Palmer-related entities, saying: “We have identified significant transactions in value and quantum entered into by QN that appear to be both uncommercial and director-related transactions. These transactions could be recovered in a liquidation scenario.”

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