The Great Unwinding?

Dan Burrows of Daily Finance writes So much for the Dow's 2009 high. Good news on jobs is bad news for stocks:

It was silly season on Wall Street Friday. November's unemployment figure -- still a dismal 10% and subject to revision -- came in stunningly better than expected and the markets immediately soared to fresh 2009 highs. The Dow Jones Industrial Average ($INDU) alone shot up as much as 150 points in early trading.

And then, at about 11 a.m. Eastern, everybody decided to sell. "I don't know what happened," says David Wyss, chief economist at Standard & Poor's. "Some of it was probably just profit taking, but anybody who believes in rational markets hasn't looked at them very long."

On a Teeter-Totter

The Dow spiked, plunged and eventually finished with a wee gain. Welcome to the wacky world of equities, where good news is bad news and bad news is good news. It seems traders -- as fidgety as chipmunks but with shorter attention spans -- suddenly and collectively realized that an improving jobs picture could make their cheap-dollar-fueled bubbles blow up much sooner than expected.

Here's how: Stocks, gold and oil have all ballooned on the so-called reflation trade. That's where central banks and governments around the globe keep interests rates low (in the U.S.'s case, essentially at zero), while simultaneously flooding the world economy with stimulus spending. All that cheap liquidity has to flow somewhere, and it's been pouring into pretty much any asset class you can think of.

Magnifying this effect is that the weak dollar has become the vehicle of choice for the international carry trade. That's where traders borrow cheap currency (until recently, the yen for 16 years) to purchase higher-yielding assets such as stocks, bonds, oil, gold and commodities in general. Profit is made by pocketing the difference. As the dollar rises, borrowers of greenbacks find themselves in a short squeeze, which forces them to sell those higher-yielding assets in order to buy outright the dollars they've borrowed.

Dollar's Surprise Move

So if the economy is stabilizing faster than forecast -- as today's jobs report at first seemed to suggest -- the chipmunks figured the Fed will have to raise rates sooner than they expected. Why is that bad? Stocks and bonds drop on rate hikes even in the best of times. But in this case, it would hurt even more because a rising dollar will make all the assets it has reflated -- equities, debt, gold, oil, etc. -- fall even harder.

Which is exactly what the chipmunks did to these asset classes Friday. The dollar jumped and everything predicated on it being weak fell. Who saw that coming? Apparently no one. As Dennis Gartman, author of the well-regarded investment newsletter bearing his name, said Friday, punters who played the jobs report got what's coming to them.

"Anyone, anywhere who chooses to make material 'bets' in the world of trading/investing predicated upon the outcome of [the unemployment] report deserves the sound thrashing that he or she shall likely receive," Gartman told clients, noting that these reports are "notorious for revisions of 30% to 60%...in either direction!"

If there is some weirdly good news about Friday's market action, it's that at least the dollar/securities correlation remained intact, unlike the previous spooky session. On Thursday, small cap stocks, financials and oil fell even as the dollar sunk, too, notes Keith McCullough, CEO of ResearchEdge, a New Haven, Conn., strategy and research firm.

Rates Staying Put

"Dollar down equals stocks and commodities down?" McCullough wrote Friday. "Yes, this is new," the former hedge fund manager says. "It's called unwinding the reflation trade," says McCullough -- a situation that does not bode well for our bubbles.

Also adding to Friday's market mishegoss was that even though the employment report was a pleasant surprise when benchmarked against economists' and market expectations, "the overall labor market backdrop remains extremely fragile," wrote David Rosenberg, chief economist and strategist and Canada's Gluskin Sheff. In other words, at least some of the chipmunks took the time to actually digest the data -- and they didn't like what they ate.

But getting back to the idea that the Fed might hike rates anytime soon? Well, that's just goofy. "The Fed will need to see sustainable unemployment trends before they'll raise rates," says S&P's Wyss. "And then if the fragile recovery started to fall apart, they would just drop them again."

The bottom line for retail investors is that one day in the market (or in Friday's case, 90 minutes) does not make a trend. Every day is but a single data point -- and some points are noisier than others.

Now, I have to give you my read on Friday's stock market action. The surprise figure on the jobs report caused a big gap up at the opening and traders sold the news. The gap was filled by mid-day and stocks edged up by the close.

There is nothing sinister about this price action. Anyone with minimum trading experience has seen it a million times. Stocks gap up, traders sell the news, gap is filled and we move forward and grind higher. People love conspiracy theories but they should first learn to read the tape and understand market dynamics. The rally of a lifetime still has legs to run.

Having said this, we are witnessing the unwinding of the global reflation trade. On Thursday, Bloomberg reported that European Central Bank President Jean-Claude Trichet is withdrawing stimulus measures faster than economists anticipated, clearing obstacles to higher interest rates next year:

The ECB’s decision yesterday to end long-term emergency loans and tighten the terms of its final 12-month tender will give greater traction to any rate increases in 2010 should policy makers deem them necessary.

“The ECB chose a quicker exit path,” said Laurent Bilke, a former ECB economist now at Nomura International Plc in London. “It’s very difficult not to think it’s the beginning of a tightening process.”

The move to tie the rate on the 12-month loans to the ECB’s key rate rather than setting a fixed rate of 1 percent means any increase in the benchmark will also affect banks’ funding costs. While Trichet said the move doesn’t signal the ECB intends to raise rates, some officials are concerned that leaving borrowing costs at a record low for too long will fuel asset bubbles and faster inflation.

Trichet spoke as Federal Reserve Chairman Ben S. Bernanke promised a “smooth” withdrawal of stimulus in the U.S. as the world’s two biggest economies pull out of recession.

Yesterday’s announcements “put the ECB in a position where it can choose to raise rates if it wants to further down the line,” said David Page, an economist at Investec Securities in London. “We’re penciling in a rate rise in the second half of next year.”

Economic Recovery

The risk for the ECB is that any indication it could raise rates sooner than the Fed may fuel further gains in the euro and undermine the region’s economic recovery.

Further gain in the euro will definitely undermine Euroland's recovery. The article went on to quote an ECB council member:

ECB council member Axel Weber said yesterday it’s a “balancing act” for central banks to withdraw stimulus measures without threatening their economic recoveries.

“We’ve made it clear that we’ll gradually withdraw unconventional measures in the future,” Weber, who is also head of Germany’s Bundesbank, told ARD television. “But that doesn’t mean that we won’t use the necessary caution. There’s no need to send a signal on interest rates at the moment.”

The pace of withdrawing non-standard operations is a balancing act for all central banks that engaged in quantitative easing. If they proceed too quickly and too aggressively, they risk creating another global recession.

What does the removal of global liquidity mean in terms of global macro moves? Bloomberg reports that BNP Paribas sees the US dollar rallying in 2010 as the Fed cuts liquidity:

The dollar’s decline is in its final stages, heralding a rally in the next two years, as the Federal Reserve scales back stimulus measures, BNP Paribas SA said.

“The Fed has sent signals that it will stop expanding its balance sheet from March onwards,” a team led by Hans-Guenter Redeker, London-based global head of currency strategy, wrote in a report dated today. “Hence, dollar liquidity growth will start to shrink starting in March.”

“Markets tend to be forward looking and extreme dollar short positioning indicates to us that the dollar turnaround could come earlier,” they wrote.

The greenback's rally is not just based on covering of extreme short positions. Going forward, the USD will rally because the relative fundamentals will favor US growth over other regions. I agree with Stéfane Marion, chief economist and strategist at National Bank Financial and one of the few who correctly foresaw US payroll surprise, the next few employment reports will surprise to the upside as companies redeploy their cash flows and start hiring again to position themselves for the recovery. This will lend further support to the US dollar.

Importantly, the drop in the US dollar allowed financial conditions to loosen as the US economy was trying to recover from a terrible recession. With interests rates at zero, the greenback's slide acted as an important buffer to further deterioration in economic conditions. Now that the economy is recovering, the greenback will reflect improving fundamentals.

So what does the global unwinding mean for other asset classes? Again, that all depends on how bold and how fast monetary authorities unwind all that stimulus they provided the financial system with.

In a recent comment, Reflation Trade or Recovery Trade?, Stéfane Marion and Pierre Lapointe of the National Bank Financial write that the "period between the end of recession and the first rate hike is a very profitable sweet spot" but they add that they "cannot exclude the possibility of short-term turbulence in equity markets" because the Fed will start removing liquidity.

On a sectoral basis, Mr. Lapointe recently shared his growth buys in 2010 with the FP Trading Desk:

For investors looking to take some risks in equities next year, the best bet is to keep it in North America, a new note from National Bank suggests.

"On a global basis, the sectors that are expected to show the best earnings growth in 2010 will not be the same as in 2009 ... consensus expects the strongest earnings improvements to be posted by the energy, materials, consumer discretionary and IT sectors," Pierre Lapointe, analyst with National Bank Financial Group, said in a note to clients.

And the best place for this is North America, with the U.S. having a 40% weighting and Canada 34% in these sectors.

Mr. Lapointe also expressed doubts about gold, which has been breaking price records on an almost daily basis in recent weeks.

"Since we think U.S. employment could start growing again soon and rates could start rising sooner than the market expects, we believe the U.S. dollar could gain support at the expense of bullion," he said.

I happen to agree that energy and IT will outperform in 2010 but my long-term portfolio remains almost exclusively weighted in Chinese solar stocks as this is the area where I see a long-term secular bull market developing.

[Warning: Solar stocks are not for the feint of heart as the sector is heavily manipulated by big hedge funds. I can tell you from personal experience that I endured swings of 40% or more in my portfolio but continued buying the dips and added to my long-term positions at very attractive levels.]

There are a few other sectors that show great promise. I continue to believe that in the investment environment we're heading in, you have to pick your spots, stay nimble and always remember that small is beautiful. Also, be very weary of those sharks on Wall Street spewing their nonsense, feeding off your insecurities.

Santa Rally or Rally of a Lifetime?

Let's have some fun for a change. Now that I bored you to death with all my relentless posts on the great pension plunder, let's talk markets.

John Heinzl of the Globe and Mail reports Santa arrives - right on schedule for a market rally:

Here at Investor Clinic, we're skeptical of axioms that purport to hold the secret to achieving great wealth in the stock market. We don't "sell in May and go away," for example. Nor do we time our buys and sells with the U.S. presidential election cycle.

Being fans of the buy-and-hold approach, we prefer to invest - and stay invested - in companies that increase their earnings and dividends. The problem with trying to time the market isn't only that you might guess wrong; you'll also face higher commissions and taxes.

But there is one seasonal pattern that intrigues us enough to dig a little deeper. We refer to the stock market's exceptionally strong performance in the month of December.

Is it just chance that the market almost always rises as the Christmas decorations are going up? Is it an excess of rum and eggnog? Should investors try to take advantage of this trend?

Before we try to answer these questions, let's look at the numbers.

In the past 25 Decembers, Canada's benchmark stock index has risen 23 times and fallen just two, including a 3-per-cent drop during last year's financial maelstrom. The only other losing December over that period was in 1996, when the index slipped 1.5 per cent.

The average gain in December over the last quarter-century was 2.37 per cent, which is more than three times higher than the roughly 0.7-per-cent average advance for all months. With yesterday's 260-point or 2.27-per-cent rise on the S&P/TSX composite index, this December is off to a flying start.

Sure, it could be random luck - but not likely. A few years ago, Thomson Financial crunched the December returns from 1969 through 2005 and found a 99-per-cent probability that something other than chance was behind the outsized gains.

So what factors might explain December's jolly performance?

Well, for starters, there's investor emotion. When the holidays are approaching, people are in a cheerful mood, and that optimism colours their perception of the market. December is also when year-end bonuses get handed out on Bay Street, and some of that cash may be plowed into stocks.

Tax-loss selling may be another factor. In the fall, investors sell their dogs to trigger capital losses for tax purposes, pushing the market down in October and November. But that downdraft attracts bargain hunters who lift prices back up in December, or so the theory goes.

Window-dressing may also come into play. Eager to make their books look pretty for year-end statements, fund managers buy winning stocks as the year draws to a close, giving prices a boost.

A final theory is that the Santa Claus rally is a self-fulfilling prophecy. Because everyone anticipates that the market will rise in December, they buy stocks, and sure enough, that's what happens.

So if December is such a great month, should investors place a big wager on the market on Nov. 30 and sell on Dec. 31, aiming to pocket a quick profit? Unfortunately, it's not that simple.

Although December has produced remarkably good results, on average, there is a lot of variability in the monthly returns, ranging from last year's 3-per-cent slide to an 11.8-per-cent gain during the tech mania of 1999. There have also been several Decembers when the market rose less than 1 per cent, which would barely cover the costs associated with buying and selling an index ETF (depending on the size of the trade and the commissions charged).

It's also important to remember that the December data are backward-looking. Whatever the cause of December's strong performance - it may be one factor, two factors, or a whole bunch of things - it's impossible to know whether the future will look like the past.

"The statistics prove December is a fairly reliable month for good performance in the market, and I can't dispute it," says Tim Burt, CEO of Cardinal Capital Management in Winnipeg. He predicts this December will continue that trend, as the end of the recession and improving corporate earnings give stocks a boost.

But he doesn't advocate trying to get in and out for a quick buck.

"That's a speculative trading strategy. We would never recommend people do that," he says. "We're buy-and-hold, long-term investors. So really what happens month to month is immaterial to us."

The nice thing about being a buy-and-hold investor is that you'll never miss out on big gains - whether they come in December or any other month. So instead of trying to time the market's ups and downs, just sit back and enjoy Santa Claus's generosity.

Just between you and me, in the markets we're heading in, buy and hold isn't going to help you one iota unless you're buying and holding the next big bubble, riding the wave up and hopefully getting out before the rest of the herd gets crushed.

As for the Santa rally, it arrived back in March thanks to Uncle Ben who gave the hedgies and prop trading desks at the major banks a green light to buy every risk asset out there. For those of you still pondering Dubai or do you sell, you're missing the rally of a lifetime:

Royal Bank of Canada says markets are returning to a more normal "performance environment." RBC Dominion Securities today set a 2010 target of 1,200 for the S&P 500 and 12,925 for the S&P/TSX composite index. Good news for investors from chief strategist Myles Zyblock: "The equity market has been on a blistering run since early March, with the large-cap indexes up by just over 60 per cent and bested by the small-cap benchmarks to the tune of a full 10 percentage points. These nine months most likely define the rally of a lifetime … While the embedded return expectations have turned more conservative with time, typical preconditions for a cyclical bear market such as policy tightening, a pending earnings recession or widespread investor optimism remain absent."

I worked with Myles back in my BCA Research days. Glad to see he's finally jumped on board to see that this rally still has ways to go.

I had lunch with Keith Porter on Thursday. Keith was an AVP at the Caisse, successfully managing emerging market equities for over ten years. He's a great guy with a great sense of humor and deep knowledge not just of emerging markets, but of markets in general. You can find his latest thoughts, along with those of others, on the Sceptical Market Observer blog.

Anyways, Keith and I enjoyed sushi and chatted a bit about the pension fund world and markets. He's not sure if he wants to get back into the big pension funds again and I don't blame him. These places are run by politicians and the people that survive are typically the sneaky, weasel politicians who know nothing about running and making money in the markets.

They're not all that terrible. Some are better than others but I told him to proceed cautiously and to look carefully at who is leading the fund. The last thing you want to do is end up working at a big pension fund run by an insecure fool who lusts power. You're better off doing your own thing if that's the only option available to you.

On the markets, we had an excellent discussion covering global banks, China, Brazil and the Fed. Keith thinks that the banks got gifts in the form of free money and the bailouts were a mistake. We both agreed that the UK economy is way too leveraged to the financial services industry.

But his comments on China were particularly interesting. Keith thinks that all this talk of excess capacity in China is missing the bigger picture. He told me that China is planning and preparing for the future so they have every reason to over-invest now and build up their infrastructure and stockpile the resources. It makes sense when you think about it; they saw all the mistakes the Western world made and decided it's best to be better prepared for the future.

There are still problems in China, most notably the disparities between the rural and urban population, but they're making leaps and bounds in almost every area, including clean energy where China is securing first mover advantage in the market for renewable energy.

On the markets, Keith remains sceptical of the rally and recently asked Am I Missing Something? He did, however, admit to me that the liquidity rally can go on for a lot longer than we think.

I told him this liquidity rally is only in third gear and will go to fourth and fifth gear, especially in the hot sectors. He agreed with me that some sectors are already bubbly and will likely get more bubbly as we move along.

And that's where I'll end my comment today. I know some of you got worried about Thursday's late day selloff or are worried about Friday's jobs report. Don't be scared, nothing has changed. Uncle Ben wants asset inflation and he's hoping that it will repair household and more importantly, banks' balance sheets.

And what Uncle Ben wants is what Uncle Ben gets, for now at least. So don't get too flustered or worked up about Friday's jobs report. Either way, the markets will continue to grind higher. Oh, and that major pullback that all the experts are waiting for? It won't happen because everyone is expecting it. The rally of a lifetime still has legs to run.

New York Takes a Bite Out of Pensions?

Quelle surprise! Bloomberg reports that N.Y. Raises Pension Requirements to Save $48 Billion:

New York state’s pension program will raise the retirement age and financial contributions for new workers to save the state and local governments about $48 billion over 30 years.

The change, affecting workers hired Jan. 1 or after, was approved by legislators today and is supported by Governor David Paterson. The two biggest public employee unions backed the change after Paterson agreed to drop proposals to eliminate a 3 percent pay increase this year and cut 8,700 state jobs.

“Savings will be achieved not only in state spending, but at the local level, which will help to reduce property taxes,” Paterson, 55, said in a statement. The state constitution bars reductions in pension benefits for existing workers.

New York’s pension fund, the third-largest in the U.S., covers 1 million current and retired workers, and had $126 billion in assets on Sept. 30, according to Comptroller Thomas DiNapoli, the sole trustee.

For new workers, the bill raises the age for retirement without penalty to 62 from 55, imposes a 38 percent penalty on non-uniformed workers who retire before 62 and increases the minimum years of service to draw a pension to 10 from 5, according to Paterson’s office.

Overtime payments included in calculating pension benefits will be capped at $15,000 a year for civilian workers, and 15 percent of wages for police and firefighters.

Savings Estimates

The Division of Budget estimated in December 2009 that a similar package of pension changes would save $30 million in its first year. In June, Paterson, a Democrat, said savings would be at least $48 billion over 30 years. Assembly Speaker Sheldon Silver, a Democrat from Manhattan, said today the changes would save state and local governments $48.5 billion.

For teachers outside New York City, whose pension fund covers 420,000 current and retired workers, the bill raises the minimum retirement age to 57 from 55 without penalty, and increases their pension contribution to 3.5 percent from 3 percent.

The bill changes New York City teacher pensions to save the city $19.1 million this year, rising to $64.1 million in 2019, according to a news release from the governor’s office.

The agreement with the United Federation of Teachers will save New York City $100 million over the next 20 years, Mayor Michael Bloomberg said in a statement.

“I look forward to working with our other partners in organized labor to begin creating the pension savings the city needs, while still providing deserved benefits to city workers,” Bloomberg said. The mayor is founder and majority owner of Bloomberg News parent Bloomberg LP.

Existing Teachers

Pension and health benefits for existing city teachers are unchanged, the mayor said. New hires will pay 4.85 percent of their pay to the pension plan for 27 years and 1.85 percent thereafter, up from current contributions of 4.85 percent for 10 years and 1.85 percent through 27 years, he said.

New teachers must have 10 years of service to collect a pension, up from five years now, and must work 15 years to collect health benefits after retirement, up from 10 years. The alterations require changes in city law.

The new category of pension benefits will do little to solve the state’s problem of growing retirement costs, said E.J. McMahon, director of the Empire Center for New York State Policy, an Albany-based group that advocates less government spending. Benefits promised current workers allow retirement at 50 percent of salary after 25 years.

“The legacy costs of our pension promises to current employees will remain a massive headache for decades,” McMahon said.

I urge you to read E.J McMahon's 2006 report, Defusing New York's Public Pension Bomb as well as his more recent comment, The Budget New York Needs, where he discussed New York's pension bomb:

New York’s public-pension system has become the epicenter of an influence-peddling scandal that has attracted the attention of the Securities and Exchange Commission and the state’s attorney general. But the millions in shady “placement fees” pocketed by a few politically connected middlemen are small change compared with the mushrooming cost of lavish pension benefits for state and local government retirees. Keeping these retirees in clover will demand billions more from New York’s sorely stressed taxpayers over the next few years. And the real scandal is that politicians are so reluctant to do anything about it.

In New York, as in almost every state, public employees are entitled to defined-benefit (DB) pensions—a guaranteed post-retirement income, based on peak salaries and career longevity. By private-sector standards, benefit levels are extraordinary. New York state and local government employees, as well as employees of public authorities, can retire earlier, with larger pensions, than the vast majority of the people who pay their salaries.

A New York teacher with 30 years on the job, for example, can stop working at 55 and start collecting an annual pension of roughly $55,000—entering retirement with the equivalent of a $1.2 million golden parachute, according to calculations by City Journal contributing editor Nicole Gelinas.

Taxpayers must shoulder the risks of covering these already-promised benefits. The pensions are paid out of gigantic pooled retirement funds, to which government employers contribute varying amounts, depending on actuarial assumptions and market fluctuations. During the Wall Street boom of the 1990s, pension-fund assets grew enough to reduce employer contributions to all-time lows as a percentage of salaries.

The downturn of 2001–03 had the opposite effect, rapidly driving pension contributions up. Since 2000, the combined annual pension costs for all governments in New York, including New York City, have risen from slightly under $1 billion to nearly $10 billion—reflecting both market conditions and benefit increases effective at the beginning of that period.

New York City’s annual pension contributions alone, up more than $3 billion over the last five years, are projected to rise by another $1 billion over the next three. Annual pension bills for the state and its local subdivisions, which now total about $3 billion, could double or triple by 2015. Rising pension costs also pose a considerable financial threat to the already-troubled Metropolitan Transportation Authority.

And these official numbers actually understate the problem because New York’s pension funds, like their counterparts throughout the country, calculate employer contributions based on government accounting standards that lowball their long-term liabilities. According to these skewed standards, the pension funds for New York State and New York City are technically at or near “fully funded” status. But Gotham’s actuary calculated in 2006 that New York City’s plans alone would be $45 billion in the hole if they employed the more sensible liability calculations that private-sector DB plans use.

Under the state’s constitution, pension benefits can’t be “diminished or impaired” for any current member of a public-retirement system in New York. So it will be difficult to stem the tide of mounting pension costs in the short term. The debate over pension reform is really about the appropriate mix of compensation for the next generation of government workers—and the impact they will have on state and local finances in the long term.

Far-fetched as it may seem, given the New York State Legislature’s shameless pandering to unions in recent years, there is precedent for pension reform. During the fiscal crisis of the 1970s, the legislature managed temporarily to scale back pension benefits for new public employees. However, the unions spent most of the next 25 years successfully clawing back much of what they had lost—and then some.

Governor David Paterson’s “Tier V” retirement plan, part of a June 5 deal with state employee unions, merely reset pension benefits to the levels of the early 1990s by raising the retirement age to 62; restoring a ten-year pension vesting period; and requiring employees to contribute to the pension fund throughout their careers. The governor also vetoed an extension of the existing “Tier II” retirement plan for police and firefighters, who can retire at half pay after 20 years, regardless of age. In its place, he proposed a plan that would set a minimum age of 50 for half-pay retirement after 25 years, which could produce significant savings for all New York municipalities, especially New York City.

Real pension reform, however, would go much further—by essentially throwing out the outmoded DB model for future employees. New York should follow the lead of a handful of other states, including Michigan, that have shifted non-uniformed government workers to defined-contribution (DC) accounts, like the 401(k) plans that have come to dominate the private sector.

Paterson has estimated that his proposal would save the state and local governments outside New York City a total of $32 billion over the next 30 years. By comparison, a DC plan like Michigan’s, with the annual employer contribution capped at 7 percent of payroll, might save at least $10 billion more. But the greatest benefit of a DC system is that taxpayers would no longer bear all the financial risks associated with providing guaranteed pension benefits. For the first time, public-pension costs would become both predictable and easily understandable, and the real costs of proposed benefit increases would be completely transparent. With normal turnover, between one-quarter and one-third of state and city employees would be in the new system within a decade.

Of course, if pension reform were subject to regular contract negotiations, public-employee unions would never accept a shift to a DC plan from the guaranteed, ultra-secure DB plan. But this is a rare case in which elected officials can alter a fringe benefit without the unions’ consent—because the state’s Taylor Law, which governs public-sector labor issues, specifically prohibits collective bargaining on pensions. Retirement benefits could be changed legislatively, ensuring that future generations of New Yorkers aren’t stuck with the same pension problem.

Unfortunately, as the legislature’s 2009 regular session wound toward its June adjournment, leading politicians continued to seek union permission to make any changes. New York City mayor Michael Bloomberg has repeatedly called for the state to revert to a system in which pension benefits are collectively bargained, and Paterson made a series of costly concessions to the unions in exchange for their agreement not to oppose his modest restructuring of pension benefits. It’s time for the governor, the mayor, and other elected officials to reassert their managerial prerogatives—to understand that government unions will never voluntarily relinquish the gold-standard pensions that taxpayers can no longer afford.

While I agree with Mr. McMahon that legacy costs of gold-plated pensions will remain a massive headache for decades, his solution is to basically pass the buck to individuals through DC plans.

As I've stated many times, cheaper DC plans are not the solution since they have been performing miserably. Also, what's wrong with providing a teacher, a police officer, a fireman some retirement security?

I say New York taxes the crooks on Wall Street to fund these public pensions. The investment bankers, private equity and hedge fund managers have to share the responsibility for the underfunded status of these pension plans.

***UPDATE***

E.J. McMahon criticized these reforms stating that Teachers clean up on "pension reform".

Are Public Sector Pensions Better?

The UK Press Association reports that public sector pensions are better:

Public sector workers have more generous pensions than those working in the private sector who belong to similar schemes, research has claimed.

The Institute for Fiscal Studies said not only did public sector workers have greater access to so-called gold-plated defined benefit schemes than those who worked for private companies, but the schemes themselves were typically more generous.

It said a combination of being able to claim their pension earlier, having longer job tenures and having their earnings peak at a lower age, meant the schemes were worth more as a percentage of public sector workers' salaries than they were for private sector workers.

The research calculated that on average one-year's worth of accruals in a defined benefit pension was worth the equivalent of 25.5% of earnings for someone in the public sector, compared with just 18.9% for some in the private sector.

The difference was even greater for women, with annual pension accruals worth around 26% of a female public sector worker's salary, compared with just 17.6% for a private sector counterpart.

The report said: "It is not just true that defined benefit pension coverage is higher in the public sector than the private sector, but those pensions are also worth more as a share of the total remuneration package."

Under defined benefit pensions, including final salary schemes, pensions are based on the number of years someone has belonged to a scheme and their pay.

But the majority of the schemes have now been closed to new entrants in the private sector, with companies instead offering less generous defined contribution schemes, under which the individual bears all the risk of investment volatility and increased life expectancy.

There is also a growing trend among firms to close their defined benefit schemes to existing members as well, as they have become increasingly expensive to offer in recent years.

Increasingly expensive is an understatement. Kathy Sandler of the WSJ reports that Ofcom to Look at BT's Pension Deficit, Charges:

The U.K.'s telecommunications regulator said Tuesday it will consult on whether BT Group PLC's substantial pension deficit, and the contributions it is making to it, should be taken into account when setting the amount the company can charge for wholesale services such as broadband and telephone lines.

Depending on the outcome of the consultation, BT could be allowed to charge up to 4% more to its Openreach customers -- including Carphone Warehouse Group PLC, British Sky Broadcasting Group PLC and even BT's own retail department -- which could then choose to pass on any increase to consumers.

BT's rivals lease its copper lines and offer their own competitive telephone and broadband services to U.K. households, and the price BT can charge them for using its telephone lines is set by Ofcom.

Currently, Ofcom takes into account the costs BT incurs from its continuing pension payments, but not from any of the top-ups it is required to make to plug any pension deficit gaps. BT agreed earlier this year to make top-up payments of £525 million ($863.7 million) a year to plug an as-yet unquantified deficit in its £40 billion pension scheme.

The U.K. telecommunications company is expected to conclude discussions with the pensions regulator and confirm the size of its pension deficit in the first half of 2010.

Amid market worries about the cost to BT of plugging a substantial hole in its pension fund, the company in May took the unusual step of announcing the £525 million top-up payments, which are set for the next three years, before it confirmed the actual size of its deficit.

Ofcom's consultation will look at whether deficit payments should also be included in Ofcom's calculations on how much BT's wholesale Openreach division can charge for its services. If Ofcom decides to include the payments, BT's charges could rise by up to 4%. But if the regulator decides not to include the payments and changes the way it estimates continuing pension costs, BT charges could fall by a small amount, Ofcom said.

BT welcomed Ofcom's consideration of the issue, and said it "considers it entirely reasonable that we should be able to recover an appropriate share of our pension deficit costs through regulated charges.

"There is good regulatory precedent for pension deficit costs to be recovered in this way in other regulated industries," BT added, although it cautioned that it is too early to come to any conclusions as to the outcome.

Collins Stewart analyst Morten Singleton said in a note to clients that although there are no current conclusions drawn, "we suspect the likely outcome will be a net minor positive for BT. We believe some of the pension deficit costs will be rechargeable in regulated charges ... however, we suspect that this will be partially countered by a minor change to the cost of capital."

The company inherited its pension liabilities, which are now around four times the company's market capitalization, from the generous final salary pension scheme provided before 1984 while it was under government control, and which the company continued to offer until BT closed the scheme in 2001.

Until last year, BT had been topping up its pension fund with £280 million a year, on a 10-year payment scheme, based on the deficit at its last actuarial pension review in 2006 of £3.4 billion. Analysts have estimated the deficit could have ballooned to as much as £6 billion to £8 billion based on the value of equities and bonds at the end of 2008, when its latest actuarial valuation started.

Ofcom will publish a further consultation on BT's pension costs in spring 2010, with a statement to follow later in that year.

Shares of BT rose 1.4% to 142 pence in a broadly higher London market. The stock has risen almost 5% in the year to date.

BT is not the only company topping up its pension plan. Here in Canada, CP Rail announced it will voluntarily prepay C$500 mln into its pension plan:

Canadian Pacific Railway Ltd said on Tuesday it plans to accelerate funding of future pension obligations through a voluntary prepayment in December of about C$500 million ($476 million), a move an analyst said was disappointing although not unexpected.

The prepayment into its Canadian defined benefit pension plan will be made using cash on hand and help to reduce volatility in future pension funding requirements and make cash flows more predictable, the railroad company said in a statement.

The contribution is "certainly not a positive development as we believe it would have been more constructive to see that cash put to better use in the business," RBC Capital Markets analyst Walter Spracklin said in a research note to clients.

He added, however, that the payment was expected after CP raised the C$500 million in an equity issue earlier this year.

It will have a minimal impact on earnings, Spracklin said.

Calgary-based CP, Canada's No. 2 railway, now estimates its 2010 pension contributions to be between C$150 million and C$200 million after application of a portion of the prepayment. It had previously forecast that pension contributions would range between C$250 million and C$300 million.

CP's shares ended up 93 Canadian cents, or 1.8 percent, at C$51.90 on the Toronto Stock Exchange on Tuesday.

I like the analyst who was quoted as saying that this was not a positive development since that cash could be "put to better use in the business." I guess solidifying the pension plan is not considered good use of a company's capital among financial analysts.

Of course, unlike public sector pensions that are fully backstopped by the government, private sector pensions can easily experience severe deficits that if left unchecked, will jeopardize the pensions of workers.

So are public sector pensions better? You bet they are but their day of reckoning will also come and when it does, public and private sector workers will all be in the same sinking ship.

Pension Tension on the Rise?

Colin Barr, senior writer at CNN Money reports that Pension tension is on the rise:

Retirement plans are on the mend, but the healing process is going to be long and painful.

In addition to taking a big chunk out of individuals' 401(k)s, last fall's market meltdown left 92% of corporate pension plans underfunded at year's end, according to a study by investment consultant Wilshire Associates.

As bad as that sounds, it pales in comparison to the shortfalls in public pension plans. At the end of 2006, public pension plans were already underfunded by $361 billion, according to the Pew Charitable Trusts. That was before the stock market collapse, soaring unemployment rates and tumbling tax revenues dealt municipal finances another blow.

The federal insurer of corporate pensions, the Pension Benefit Guaranty Corp., reported this month that it was $22 billion in the red in the most recent fiscal year. The PBGC takes over pensions when they are underfunded or when their sponsors go into bankruptcy, and makes up some of the payments due.

While the bounce in the stock market this year has helped the situation, observers say more pain is ahead.

Strapped municipalities will face pressure to cut back on promised benefits. Hard-hit companies will be forced to choose whether to invest in their businesses or to beef up their pension plans.

"We're going to face increasing stresses in the pension world over the next three to five years," said Leo Kolivakis, a pension industry consultant who writes the Pension Pulse blog. "People are hoping and praying the stock market will bail them out, but they're going to be disappointed."

There are several forces that account for the current pressure on pensions.

One problem was that companies didn't contribute enough to their pension plans. The reason: They were counting on high returns to pick up the slack, a scenario that didn't pan out in the stock market's lost decade.

Another was that many pension funds made bad investments, embracing so-called alternative investment classes, such as hedge funds and private equity, which have performed poorly in the market unwind.

At the same time, companies are now stuck having to pony up more. That's because of the weak economy, which has led the government to commit to low interest rates for the foreseeable future.

It's also because of the 2006 Pension Protection Act, which started taking effect last year. It includes a long overdue increase in the premiums charged by the PBGC and forces companies to be fully funded by 2015.

Congress moved late last year to ease some of the requirements and may yet stretch them out again. But in the meantime, numerous companies are facing higher funding requirements.

It all adds up to a continuing squeeze on pension funds' financial position.

"There are no good solutions in an economic downturn," said Alan Glickstein, senior retirement consultant at Watson Wyatt. "Everyone's got difficult choices right now."

The bills are starting to come due in state capitols. The West Virginia legislature recently passed a bill approving the sale of $225 million of bonds to help stressed local governments close their pension gaps. The city of Huntington in the state's southwestern corner had warned that a $125 million pension shortfall could force it into bankruptcy.

The situation is less dire for big companies. But they aren't out of the woods.

Among the companies with underfunded pension plans is oil giant Exxon, whose U.S. pension plan assets were worth $6.6 billion less than the plan's liabilities at the end of 2008. The firm has contributed $4.1 billion to its plans so far this year. And Exxon made $45 billion in profits last year and retains its triple-A credit rating, so there is more where that came from.

Less certain is the fate of workers and retirees tied to companies in troubled industries such as airlines, retail and manufacturing.

Goodyear, the Akron, Ohio, tiremaker that has cut thousands of jobs in the past year, said in its annual report that its U.S. pension funds were underfunded by $2.1 billion at the end of 2008. The company, which froze its U.S. salaried pension plan last December, warned that the underfunded status would "significantly increase our required contributions and pension expenses, which could impair our ability to achieve or sustain future profitability."

Goodyear says it expects to contribute at least $300 million to its pension plans this year, including $260 million it contributed in the first nine months.

OfficeMax, the Naperville, Ill., office retailer, last month contributed $100 million of its stock to a plan that was $435 million underfunded at the end of 2008.

Delta Airlines, the Atlanta-based operator of the Delta and Northwest airlines, said in its 2008 annual report it expects to spend $420 million this year on pension benefits. Its pension plans' liabilities exceeded their assets by $8.6 billion at the end of 2008.

While companies are surely hoping that the market rally that started in the spring will take the edge of some of those problems, pension watchers note that the past decade should have taught all of us a lesson about banking on big market gains.

"Companies are in the same place as individuals," said Steve Foresti, managing director at Wilshire Consulting. "Everyone needs to save more. The markets aren't going to bring these balances back."

I meant what I told Mr. Barr, if plan sponsors are hoping for stock market gains to lead them out of their pension woes, they'll be very disappointed. Why? Because the next 20 years will look nothing like the last 20 years. Given the historic low levels of bond yields, it's simply a pipe dream to think that asset appreciation will lead you out of this mess.

Pension deficits are a long-term structural problem that will require difficult choices ahead. I've been writing about global pension tension for over a year and unfortunately I have not seen governments take this issue seriously. Perhaps they're too scared to face the music (watch video below).

Global Trade Indicating V-Recovery?

Jonathan Lynn of Thompson Reuters reports that global trade volumes rise sharply in third quarter:

World trade volumes grew sharply in the third quarter of this year, data from the Dutch CPB research institute showed on Friday, in a further sign that the global economy is pulling out of crisis.

CPB said trade volumes in the third quarter were 4.3 percent higher than in the second -- the second biggest quarter-on-quarter increase since it started tracking trade flows in 1991, and contrasting with a record 12.3 percent drop in the three months ended February.

The turning point appears to have been this summer, when trade in the three months ended July turned positive on a quarter-on-quarter basis for the first time since May last year, the institute said in its latest World Trade Monitor.

Looking at volatile monthly figures, trade in September grew by a record 5.3 percent after falling 1.5 percent in August, reflecting higher exports and imports in all regions, said the CPB Netherlands Bureau for Economic Policy and Analysis, whose data are used by the European Commission and World Bank.

But the long-term trend remains negative, with average volumes in the 12 months ended August showing a record 14.4 percent drop compared with the previous 12 months.

The World Trade Organisation has forecast that trade will contract by more than 10 percent this year -- the biggest drop since the Great Depression.

The CPB Netherlands Bureau for Economic Policy and Analysis publishes its World Trade Monitor every month. You can read it by clicking here.

Here are the key points:

• Third quarter: world trade up by 4.3%, the first quarterly increase since the first quarter of 2008.
• September: world trade up by 5.3% month on month, after a revised decline of 1.5% in August.
• September: world trade still 14% below its peak of April 2008.
  

Yanick Desnoyers, Assistant Chief Economist at the National Bank of Canada wrote a Hot Chart, Global Trade Flows Surge in September that was used in the New$ to (Us)e blog:

A key concern in recent months has been that the run-up in markets and commodities was speculative in nature. Fortunately, it is accompanied by a strong resumption in global trade flows. According to data just released by the CPB Bureau of Economic Policy, global volume trade surged 5.3% in September, the biggest increase on record.

Interestingly, the resumption in global trade flows was widespread across regions covered by the CPB. In particular, imports from industrialized countries increased 4% in September and are up a whopping 20% on a quarterly annualized basis.

As today’s Hot Chart shows, this was the first quarterly rise in six quarters. This development is a confirmation that demand from industrialized countries is firming up. With such an improvement in global trade, we believe that global growth will be above trend in 2010, as also suggested by the unprecedented growth of the OECD leading indicator.

We must be wary of these YoY rates of change, considering the hugely depressed comps last year. For example, the Port of LA’s total October traffic was down 8.3% YoY, a big improvement from previous months’ 15-25% drops. Yet at 647,000 TEUs, it compares poorly with October 2007 (735k) or October 2006 (800k).

Also, the US is obviously an important part of the global trade flow. Since the Ports of LA and Long Beach combined handle 40% of the US container traffic, I fail to see where the global recovery comes from given that port traffic remains weak.

My take is that the massive fiscal and monetary stimulus is starting to be felt in the real economy and that in the next few months, economic indicators will likely surprise to the upside, especially in the US. Stay tuned but it's definitely looking like a stronger than anticipated recovery is on its way. Friday's employment report should confirm this.

Bankers Want to Continue Protecting Us?

Diane Urquhart sent me this Toronto Star article by James Daw stating that bankers' group wants to continue to protect you:

Canada's bankers have woken up. Hearing the cries for a supplement to the Canada Pension Plan or other larger-scale plan, they decided to use some gang-style protection tactics to guard and expand their turf.

Don't let the government suck money into a single, quasi-public, one-size-fits-all plan, their Canadian Bankers Association warns in a report released Friday. Let us continue to protect you.

"Requiring younger people to belong to a new contributory public retirement plan could have the effect of diverting income they need for other purposes such as near-term savings objectives and also may not result in actual increases in overall savings rates."

The report has several ideas for improving private-sector offerings – described in words familiar to careful readers of a 2008 paper by Toronto pension lawyer James Pierlot, A Pension in Every Pot: Better Pensions for More Canadians.

Governments should offer relief from taxes and rules, the banks argue.

Yet they make no mention of the drain on retirement income caused once banks and insurers receive our meagre savings.

Canada has the highest investment fund fees in the world, enough on average to bleed 40 per cent of future retirement income from the most diligent savers.

Most of these funds lag market and pension returns. There's also the occasional bad advice and outright larceny by employees of banks and associated securities dealers.

Yet the banks' solution for stretching dollars in retirement is to keep more of our money. They ask to be able to sell life annuities from their branches.

Jean-Pierre Laporte, another Toronto pension lawyer, called as early as 2006 for an idea the banks dismiss: letting employees and employers take advantage of the efficiencies and lower cost of the CPP.

So, naturally, he dismisses the bankers' suggestion that Canada's retirement savings system is working – and would work better if only the tax incentives were more attractive.

"For anyone to argue our system works is ridiculous," Laporte said after reading the report.

"It only works for employees of government and large enterprises. They don't really tell us why (allowing Canadians to contribute to a large-scale pension like the CPP) would be a bad thing. They are saying the current system works – for us – so don't fix it."

Pierlot agrees with the bankers that Canadians should have more choice of ways to save, including private-sector pensions that could serve multiple workplaces, the self-employed, members of associations and individuals. He proposed this a year ago.

Yet he asks: "If choice is a good thing, why not have the reforms the paper proposes as well as new government options?"

The bankers have put their weight behind other proposals included in Pierlot's paper for the C.D. Howe Institute, which is a good thing.

We should let everyone have as much tax-deferred retirement savings room as government employees, plus top-up room after breaks in employment or fluctuations in income. We should harmonize pension legislation across the country.

But Pierlot chides the bankers for treating statistics on retirement savings as though members of public- and private-sector pension plans are all the same. "The difference between the two sectors matters because one has a problem, the other doesn't," he says.

The bankers suggest things would be so much better for workers who rarely have a pension or save much before age 35 if they had more tax-assisted savings room later in life.

More saving room later in life would help, but it's hard to catch up even if you have the room. So starting early and having investment returns compound over many years is better, if you can do it.

I agree with Mr. Laporte, to claim that our pension system is working is simply ridiculous. The bankers, like the insurers, will vigorously defend the private sector solution for our ailing pension system but the reality is that they're charging outrageous fees and leave far too many people scrambling for retirement security. In short, the bankers will defend their profits but they're not delivering the goods at a reasonable cost.

***UPDATE***

Ken Georgetti, president of the Canadian Labout Congress, writes that improving CPP is answer to pension woes:

Re:Bankers' group wants to continue
to protect you, Nov. 28

The Canadian Bankers Association, as you report, thinks there's nothing wrong with our retirement security system that their products can't fix. Their suggestion to meet growing poverty among seniors and the severe holes in our patchwork system of pensions is, not surprisingly, a better tax regime to encourage more investment in what they have to sell.

Even some bankers, however, acknowledge that our decades-long experiment with RRSPs has failed. Don Drummond, chief economist of TD Bank, has called RRSPs into question and suggested that we need stronger public pensions, such as higher benefits through the Canada Pension Plan.

Despite what the bankers association says, the wheels have fallen off. The value of RRSPs has tanked and Canadian financial firms charge some of the highest administrative fees in the world, contributing to the industry's hefty profits.

I say that the CPP is a dependable vehicle – a model of efficiency, portability and stability covering 93 per cent of workers in Canada. Improving CPP benefits, even doubling them over time, is achievable and affordable. A growing number of economists and actuaries are coming to the same conclusion, which clearly frightens the Canadian Bankers Association.

One caveat: we need to improve transparency and accountability at the CPPIB.

Putin for Pensions?

Greg Bryanski of Thomson Reuters reports that Russia's Putin sees economy boost from higher pensions:

Russian pensioners who will have 46 percent more money in 2010 than this year will provide a much needed boost for the flagging economy as they spend, Prime Minister Vladimir Putin said on Wednesday.

'Our decision to increase pensions may contradict (the goal of maintaining macro stability). But at the same time it is a stimulus. It is consumption,' Putin told a pensions conference in Moscow.

Putin said the pensioners, who spend 80 percent of their meagre income on consumption, shun expensive imported goods and tend to buy domestically produced ones.

Russia, hit harder by the economic crisis than most other major emerging economy, is very slow to recover due to the very weak domestic demand and Putin has vowed to continue stimulus policies, helping the demand recover.

Russia is raising pensions by 35 percent in 2009 and plans to raise them further in 2010, envisaging to spend a staggering 10 percent of GDP on pensions and other social benefits.

As a result of the increase, the average pension will rise to 8,000 roubles ($277.4), breaching the minimum subsistence level and achieving a replacement ratio of 39.7 percent on the average post-crisis salary.

The pensions increase will also bring an eight percentage points hike in social security taxes to 34 percent of income from 2011, a move generally opposed by businessmen.

So what gives? Did the Christmas spirit strike Vladi early this year? Or could it be that polls are showing support for Putin and Medvedev is falling:

Prime Minister Vladimir Putin's approval rating has fallen to an eight-month low, a poll said on Wednesday, as faith in Russia's leaders is tested by an economic crisis that has put more than one million people out of work.

Despite a sharp deterioration in the economy, Putin and ally President Dmitry Medvedev have enjoyed high ratings since they took up their posts last year. But polls have shown their public approval fall steadily in recent months.

Public trust in the work of Putin fell from a peak of 72 percent in mid-October to 65 percent on November 22, the lowest point since March, according to weekly poll figures posted on the site of the Public Opinion Foundation on Wednesday.

Medvedev's rating stood at 54 percent, down from 62 percent in October.

"This is extremely serious for the government," Moscow Carnegie Centre analyst Nikolai Petrov said. "In the absence of any stable political institutions, Putin's popularity is the foundation of the country's political stability."

He said the fall was clearly caused by the economic crisis, and government decisions to raise pensions and scrap a controversial transport tax were efforts to stem the fall.

Russia remains mired in a deep economic crisis, with GDP contracting 8.9 pct in the third quarter from a year earlier. Unemployment has climbed by more than a third, from 4.1 million in May last year to 5.8 million in October.

Trust in the prime minister's office fell from 80 percent in August to 73 percent in November, according to rival pollster VtSIOM. A third poll from the Levada centre registered a fall in trust in Putin from 66 percent in August to 60 in November.

"Putin and Medvedev's ratings are not directly dependent on what they do and say, they reflect the general situation in the country," Levada Centre analyst Denis Volkov said. "We have seen a steady fall, but no collapse."

Public trust in Medvedev fell from 58 percent in August to 51 percent in October, according to the Levada Centre. The

Kremlin-aligned analyst Sergei Markov warned against reading too much into the poll ratings, saying ratings always fell as Russia's long, grey winter.

"They'll get better again in May when the sun comes out," he said.

Regardless of the reasons, I think Putin is onto something. Now, if only we can figure out a way to redistribute income from Wall Street crooks back into the pensions they keep plundering.

Is Dubai's Sovereign Risk Overblown?

Laura Cochrane and Tal Barak Harif of Bloomberg report that Dubai Debt Delay Rattles Confidence in Gulf Borrowers:

Dubai shook investor confidence across the Persian Gulf after its proposal to delay debt payments risked triggering the biggest sovereign default since Argentina in 2001.

The cost of protecting government notes from Abu Dhabi to Bahrain rose, extending the steepest increase since February as Dubai World, with $59 billion of liabilities, sought a “standstill” agreement from creditors. Its debt includes $3.52 billion of bonds due Dec. 14 from property unit Nakheel PJSC. Dubai credit-default swaps climbed 90 basis points to 530 after yesterday increasing the most since they began trading in January, CMA Datavision prices showed.

“There is nothing investors dislike more than this kind of event,” said Norval Loftus, the head of convertible bonds and Islamic debt at Matrix Group Ltd. in London, which manages $2.5 billion of assets including Dubai credits. “The worst-case scenario will, of course, be involuntary restructuring on the Nakheel security that brings into question the entire nature of the sovereign support for various borrowers in the region.”

Dubai World’s assets range from stakes in Las Vegas casino company MGM Mirage to London-traded bank Standard Chartered Plc and luxury retailer Barneys New York through asset-management firm Istithmar PJSC. The Dubai government’s attempt to reschedule debt triggered declines in stocks worldwide that had been rebounding from the worst financial crisis since the Great Depression.

Many investors didn't foresee the scale of Dubai's debt problems. I spoke to a consultant today who told me that lawyers and accountants he knew working in Dubai kept telling him how Dubai's investment authorities are aggressively financing their purchases of global assets.

So will Dubai's debt problems plunge global markets to new lows? I strongly doubt it. Jan Randolph, head of the sovereign risk group at IHS Global Insight, talked with Bloomberg's Mark Barton about Dubai's proposal to delay debt payments and the role neighboring emirate Abu Dhabi may play in easing the crisis.

Mr. Randolph thinks Dubai's sovereign risk is overblown and I agree. He says this is essentially a liquidity problem and the debt represents 20% of GDP. He mentioned that Abu Dhabi which is the real cash cow, can easily bail out Dubai. Abu Dhabi's sovereign wealth fund is the world's largest, with over $600 billion in assets. It can easily support Dubai's debt problems.

What does all this mean for global investors in the next few days? Nothing much except that you'll have another opportunity to buy a dip, which is what you'll do if you're intelligent (that's what Goldman and JP Morgan will be doing). Nothing has fundamentally changed. The Fed is staying on the sidelines for the foreseeable future and they'll let this bubble blow. The global liquidity rally has legs to run, so don't get too flustered by Dubai's debt woes.

Another interesting trend is what's going on in China. Kevin Hamlin of Bloomberg reports that China Overcapacity Wreaks Global Harm, EU Group Says:

China’s excess industrial capacity is “wreaking far-reaching damage on the global economy,” stoking trade tensions and raising the risk of bad loans, the European Union Chamber of Commerce in China said.

A 4 trillion yuan ($586 billion) stimulus package is worsening overcapacity, especially in the steel, aluminum, cement, chemical, refining and wind-power equipment industries, according to a study by the chamber and Roland Berger Strategy Consultants, released in Beijing today.

The world’s third-biggest economy has rebounded this year on stimulus spending and a $1.3 trillion credit boom. China is adding capacity when global demand is yet to recover from the financial crisis, increasing the risk of trade frictions undermining commerce and making the threat of non-performing loans within the nation “ever larger,” the EU Chamber said.

“The Chinese stimulus package has poured credit into increasingly questionable projects,” the business group said, without identifying specific ventures. “The global impact already can be felt in the form of growing trade tensions.”

U.S. President Barack Obama and Chinese President Hu Jintao pledged this month to work to ease frictions, exacerbated by U.S. duties on Chinese tires.

The chamber recommended 30 measures to cut overcapacity, including letting an undervalued yuan gradually appreciate, reducing a “subsidy” for Chinese manufacturers.

Energy Prices

It also proposed lowering energy-price subsidies, raising interest rates to reduce easy credit, increasing dividend payments by state-owned enterprises, and spending more on health care and social security to encourage consumption and cut precautionary savings.

No comment was immediately available today from China’s commerce ministry.

In September, China’s State Council approved plans to curb expansion in industries including steel, cement, glass, coke, wind turbines and shipbuilding. The government has also introduced measures to limit land supply to sectors with excess capacity. So far, the government’s efforts have been ineffective, the chamber said.

China’s excess capacity is an “international concern” as goods that can’t be sold locally may be sent to markets that shrank because of the global slump, European Union Trade Commissioner Catherine Ashton said in Beijing Sept. 9. Ashton has since been named the EU’s top diplomat.

‘Unfounded’ Criticism

Yu Yongding, a former adviser to the Chinese central bank, said yesterday in Melbourne that that the “worrying” long-term effects of China’s expansionary policies include overcapacity, bad loans, and inefficient investment.

Not everyone agrees with the EU Chamber’s assessment. Isaac Meng, a senior economist at BNP Paribas SA in Beijing, said industries including steel and cement are not big exporters and claims of damage to the global economy are “unfounded.”

“In sectors where China is a massive exporter, like electronics, there’s no overcapacity because when exports collapse factories just close,” he added.

Increasing trade tensions between China and the U.S. are the result of high unemployment in the U.S., which is creating “political pressure to reduce China’s exports,” Meng said.

China as ‘Victim’

China’s own economy is the main “victim” of excess capacity, the chamber said. Lower profits mean companies lack cash to invest in research and development and develop more valued-added goods, it said. Businesses are also forced to cut costs, contributing to slower wage growth and less consumption, the report added.

“This is a major obstacle on the government’s path to become both an innovative and sustainable economy,” the report said.

China’s lending surge this year focused mainly on expanding production at state-owned enterprises, the report said. This led growth in fixed-asset investment by manufacturing companies to jump to 50 percent by mid-year from 25 percent in January and February, the chamber said.

Companies in industries with overcapacity will struggle to repay credit, increasing the risk of a repeat of the 1990s surge in non-performing loans, the chamber said.

China’s five largest banks have submitted plans to regulators for raising money after unprecedented lending eroded their capital, according to four people with knowledge of the matter.

It’s “particularly troubling” that more than 140 billion yuan was invested in the steel industry in the first half of this year and that 58 million tons of capacity are under construction when global demand may decline 14.9 percent in 2009, the report said. The chamber also warned of “a looming deluge” of extra cement capacity in the nation.

On the one hand you have the Fed flushing the financial system with liquidity and on the other you have massive Chinese stimulus leading to huge excess capacity in some sectors. Will China export inflation or will it once again export another wave of goods deflation? It sure looks like the latter.

Finally all this talk of sovereign risk, Dubai debt, China overcapacity, and global financial nervousness is really trivial. For a second year in a row, I watched CNN's Heroes. If you want to know the real meaning of life, stick your nose out your Bloomberg screen and read up on these remarkable individuals who through their selfless actions make a real difference in people's lives.

California Rumblings?

Jim Christie of Reuters reports that Los Angeles' budget gaps may force dramatic change:

Los Angeles must take dramatic steps in coming months to bring its budget back into balance, including measures to slim the size of its government and reduce how much it spends on pensions for retired employees, the city's top budget official said on Wednesday.

Los Angeles, California's biggest city, is seeing a steep drop in revenues fueled by the state's 12.5 percent unemployment rate, a slump in consumer spending, an uncertain housing market and a weakening commercial real estate sector.

Fitch Ratings has grown so concerned about Los Angeles' budget woes that on Tuesday it downgraded the city's general obligation debt to AA-minus from AA.

Fitch said it expects the city's economic decline to impede financial recovery. Among problems it cited were high unemployment, sales tax weakness, assessed value losses, high home foreclosure and negative amortization mortgage exposure.

Miguel Santana, the city's administrative officer, said he was not surprised by the downgrade. He is intimately aware of how the city's finances are faring, and they're in dire shape, he told Reuters in a telephone interview after briefing the city council on options for balancing the city's books.

Officials must close a nearly $100 million gap in the city's current-year budget, and are likely to use reserve funds to do so, Santana said.

"Next year we're expecting a $400 million deficit," he said.

"We really need to prioritize our programs," he added, noting that tapping reserve funds next year would be imprudent.

Instead, difficult choices about the size of Los Angeles government should be made. "Next year we'll have to find some real structural adjustments," Santana said.

Those adjustments may include layoffs and shifting some work done by the city to the private sector to shave costs.

They may also include a new pension benefit structure for city employees -- the so-called "two tier" system that many local officials around California are mulling.

The system would basically have new public employees hired after a certain date receive fewer pension benefits than current employees.

New public workers may also have to contribute more from their paychecks to their retirement accounts.

"We're looking at everything," Santana said.

Fitch in its statement underscored its concern about how much Los Angeles may be spending on pension benefits.

"As rising pension costs contribute significantly to the future financial needs, the city cites pension reform as necessary to achieve fiscal balance and has already begun discussions with some labor groups. However, Fitch views the ability to achieve savings in this expense as uncertain in both amount and timing, especially since any change to the police and fire retirement systems requires voter approval," the credit rating agency said.

What's going on in Los Angeles will soon be going on across the US and developed world. Don't think for a second that tough fiscal measures won't be taken to shore up public finances. And this will certainly mean curtailing pension benefits for new and existing public sector employees.

Elsewhere in California, Reuters reports that Calpers may dump Blackrock as an adviser:

Calpers, the biggest U.S. public pension fund, is considering dumping asset manager giant BlackRock Inc as one of its real estate investment advisers, a person familiar with the matter said.

The California Public Employees' Retirement System is also investigating why two outside pension advisors were managing its $6.8 billion hedge fund portfolio two years after their contracts had lapsed, the Los Angeles Times reported on Wednesday.

Calpers, which has suffered major losses on private equity and real estate during the credit crisis, recently informed BlackRock and other advisers that it was reviewing the relationships and would decide whether to continue or sever ties.

BlackRock, one of the world's largest money managers and a company that has thrived during the crisis, nonetheless steered Calpers into investing $500 million into Peter Cooper Village and Stuyvesant Town, a sprawling 11,000-apartment Manhattan apartment complex.

That investment, inked near the height of the real estate boom, is now widely considered worthless, the Wall Street Journal said on Wednesday, citing unidentified sources. The housing complex is owned by Tishman Speyer Props LLC and BlackRock.

BlackRock declined to comment on the Calpers review, citing a policy against discussing client activity. Calpers paid BlackRock $12.6 million in real estate advisory fees last year, the Journal said.

The real-estate review began several months ago and could be completed during a meeting next month. Real estate advisers are expected to learn the results of the review in January, said the person briefed on the situation, who was not authorized to speak publicly about it.

Calpers spokesman Brad Pacheco told the Journal the $200 billion pension fund would not "speculate on the future of our real-estate relationships until the review is complete."

Calpers officials in Sacramento, California, could not be reached for comment.

BlackRock shares were up 0.4 percent at $230 in early trading.

The pension fund voted last week to reduce its exposure to fixed-income investments managed by AllianceBernstein and PIMCO, a unit of Allianz . Still, the pension granted one-year contract extensions with the two firms.

HEDGE FUND ADVISERS

In related news, Calpers placed an official who oversees its $5.8 billion of hedge fund stakes on leave, the Los Angeles Times said, citing people briefed on the matter.

The advisers have been working with the pension fund since 2003, but their contracts lapsed two years ago, the newspaper said. Calpers officials found these advisers were paid $36 million.

A Calpers' spokesman told the paper that it was investigating dealings with outside advisers, but declined to discuss the disciplinary action further.

"We recently discovered that certain Calpers controls and procedures were not followed in the last two years," Pacheco told the Times.

Certain Calpers controls and procedures were not followed? Damn, what a shocker! I have seen or heard about lax internal controls countless times. From front-running currencies in personal accounts to shady side dealings with investment managers. You name it and I've seen or heard about it.

I will repeat this again, these large public pension funds need a thorough performance, operational and fraud audit conducted once a year by independent experts and the results should be publicly posted on their websites. Let's put some teeth into the meaning of fiduciary duty or else we can expect one disaster after another.

Happy Thanksgiving to my US readers.