News that Moves 1st addition '09: German "Failed" Auction, Cram Down Legislation, MER & Gold Bars, China/U.S. Debt, Money Flows, Califonia IOUs

RCM Comment: To start off the new year we have put together a list of essential stories. These stories are a microcosm of the world we live in and the challenges we face. This is a reality check. Beware the main stream financial media as it constantly belches out positive spin. Don't be seduced by the calls for a rally and the oft elusive market bottom. In our experience there is no need to guess at bottoms. The majority of money is made after the bottom is clearly in place and the next bull market is underway. Until then we must remain vigilant, protect principal, and as my highschool ice hockey coach used to say, "Read and react son, read and react."

Fleckenstein Jan. 8th:

...the German Bund market experienced a "failed" auction as investors bid for fewer bonds than the German government wanted to sell. Since all the world's governments are increasing their budget deficits, led by us, this development is one that we might want to take note of, especially since Germany is one of the best government credits on the planet.

The Pitfalls of Cram Down Legislation: In the next few months, we're probably going to hear a lot more about the subject of mortgage cram downs. Congress would like to wave a magic wand in a manner that's perceived to help homeowners and one of the concepts being bandied about is allowing judges to reduce mortgages for folks who are underwater. In an email to me this morning, the Lord of the Dark Matter weighed in on that subject. He succinctly explained the problems and the pitfalls, as he so often does. Thus, I'd like to reprise them here:
"Yesterday Senators Dodd, Schumer and Durbin announced a deal with Citigroup on what is known as mortgage cram down legislation. The revised bill Citigroup endorsed would give judges the ability to adjust principle payments or interest rates on existing loans, and could extend the term on the loan, according to the language of the bill. The legislation would be limited to existing mortgages, rather than future loans. Senator Durbin brokered the deal with Citigroup and is seeking similar support from other lenders. This proposed legislation will be wonderful for irresponsible borrowers, will annoy responsible borrowers who did nothing wrong over the past five years, and is an absolute disaster for lenders. Do not be fooled by Citigroup's participation: If you had your arm twisted behind your back by a three hundred and six billion dollar gorilla, your negotiating position wouldn't be terribly strong, either. "The proposed legislation will have a significant negative impact on the valuation and performance of all non-agency MBS and whole loans, and thus greatly reduce the chances that non-agency mortgage markets return anytime soon: I assume of course -- perhaps naively -- that some people actually want a non-agency MBS market to return. The proposed legislation will also negatively impact credit card and auto lending markets due to the increased likelihood of bankruptcy filings. Why would any investor again purchase a non-government guaranteed security issued by a notionally bankruptcy-remote trust when the government can simply change the rules after the fact?
"On the one hand, we have the Fed courageously and innovatively trying to reinvigorate the consumer credit market via a new non-recourse facility to provide financing for investors in new securitizations of auto and student loans. On the other hand, we get this proposed legislation which lowers the incentives for investors who want to buy and hold that type of paper. Any systemically important financial institution with a large portion of credit card, auto loan and second-lien paper on their balance sheet is going to be impacted. One of them was off 3.10% yesterday. "In sum, the cost of the bailout of the U.S. financial system is inevitably going to rise, the delta on more capital being required for U.S. banks is now 100, and it is my personal view that this proposed legislation substantially increases the probability that the U.S. banking system is going to have to be fully nationalized."

Merrill Lynch says rich turning to gold bars for safety
Merrill Lynch has revealed that some of its richest clients are so alarmed by the state of the financial system and signs of political instability around the world that they are now insisting on the purchase of gold bars, shunning derivatives or "paper" proxies. By Ambrose Evans-Pritchard Last Updated: 10:32AM GMT 09 Jan 2009
Gary Dugan, the chief investment officer for the US bank, said there has been a remarkable change in sentiment. "People are genuinely worried about what the world is going to look like in 2009. It is amazing how many clients want physical gold, not ETFs," he said, referring to exchange trade funds listed in London, New York, and other bourses.
"They are so worried they want a portable asset in their house. I never thought I would be getting calls from clients saying they want a box of krugerrands," he said.
Merrill predicted that gold would soon blast through its all time-high of $1,030 an ounce, and would hit $1,150 by June. The metal should do well whatever happens. If deflation sets in and rocks the economic system it will serve as a safe-haven, but if massive monetary stimulus gains traction and sets off inflation once again it will also come into its own as a store of value. "It’s win-win either way," said Mr Dugan. He added that deflation may prove the greater risk in coming months. "It’s very difficult to get the deflation psychology out of the human brain once prices start falling. People stop buying things because they think it will be cheaper if they wait."
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China Is Losing Its Taste for U.S. Debt By KEITH BRADSHER Published: January 7, '09 HONG KONG — China has bought more than $1 trillion of American debt, but as the global downturn has intensified, Beijing is starting to keep more of its money at home, a move that could have painful effects for American borrowers.
The declining Chinese appetite for United States debt, apparent in a series of hints from Chinese policy makers over the last two weeks, with official statistics due for release in the next few days, comes at an inconvenient time. On Tuesday, President-elect Barack Obama predicted the possibility of trillion-dollar deficits “for years to come,” even after an $800 billion stimulus package. Normally, China would be the most avid taker of the debt required to pay for those deficits, mainly short-term Treasuries, which are government i.o.u.’s. In the last five years, China has spent as much as one-seventh of its entire economic output buying foreign debt, mostly American. In September, it surpassed Japan as the largest overseas holder of Treasuries.
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Money Flows Out of Hedge Funds At Record Rate – Financial Times
Investors pulled a net $32B from hedge funds last month, making 2008 the first year in their recorded history that the funds have had significant outflows and ending the industry’s 18 years of asset growth.
Mike Morgan – It is important to note that the main wave of redemptions did not start hitting until this past September. And here’s the kicker. It is estimated that there are $60B of redemptions in place now that are not in the $32B number referenced in the article.

California may delay tax refunds amid budget impasse With Gov. Arnold Schwarzenegger’s veto of Democrats’ $18-billion package of tax hikes and cuts, the state could begin issuing IOUs as soon as Feb. 1. GOP legislators join a suit against the package.
By Jordan Rau and Evan Halper January 7, 2009
Reporting from Sacramento — State officials on Tuesday braced for the possibility of delaying tax refunds to millions of Californians, along with student grants and payments to vendors, as the latest round of budget negotiations between Gov. Arnold Schwarzenegger and Democratic legislators collapsed. With little more than a month’s worth of cash left in the state treasury, the governor and lawmakers have been unable to agree on how to erase a budget gap projected to reach $41.6 billion by the middle of next year. Democrats announced Tuesday that two weeks of discussions had ended in an impasse and sent Schwarzenegger the $18-billion fiscal package they passed last month. The governor vetoed it, as he had promised to do.
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