Pension

ASIC climate change amateurs dictating terms to professionals

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The Australian Securities & Investments Commission (ASIC) is now seeking more oversight on corporates reporting on climate change. Since when did ASIC hold any sufficient expertise in climate science? Wouldn’t it be nice if ASIC placed more faith in capital markets to self-determine those risks instead of forcing ideologies into boardrooms via new regulations?

Don’t laugh. It is already happening. The Australian Prudential Regulation Authority (APRA) and ASIC  are “getting closer” to the action in boardrooms and the workplace. Already, boards have had visits from an organisational psychologist and company employees have received random calls from ASIC officers for “off-the-record” chats seeking “inside information” on the behaviour of their colleagues. APRA even want to sit in on board meetings to ensure governance oversight!

Climate change reporting is the next big thing ASIC is going after. Despite having no expertise in the field, ASIC wants to dictate terms. By its own admission, it has conducted studies with simplistic approaches which probably accurately assesses its amateur credentials.

Back in September 2018, ASIC released a report where it stated the following,

We undertook a high-level review of the prevalence of climate risk and climate-change-related content in annual reports for all listed companies for the calendar years 2011 to 2017 (inclusive). We searched approximately 15,000 reports and analysed the aggregated results across listed companies over time and by market capitalisation. We defined ‘climate change content’ as a reference to any of the following key terms: climate change, global warming, carbon emission, greenhouse gas, climate risk or carbon riskThis is a relatively simplistic approach which did not involve assessing the context within which our key terms were used. Our analysis was not designed to produce qualitative conclusions but rather to provide high-level insight into the prevalence of express disclosure on climate-change related topics in listed company annual reports.”

The unfortunate result for ASIC was the chart above. It fell from 22% to 14% over 5 years, during a time alarmists warned things were getting worse. Non-ASX300 companies reporting climate change fell from 18% to 10% of the total. How could that be? Maybe 90% of the ASX knows better than ASIC about the effects of climate change on their businesses?

Easier for ASIC to lean on a KPMG study that said 48% of CEOs surveyed saw climate change as a risk despite 58% being more worried about technological disruption and 54% concerned about territorialism. Or in other words, 52% of CEOs don’t see climate change is an issue and a whole band in the 48% that did probably felt pressured by their internal PR departments to comply with ESG malarkey, save getting caught out straying from the corporate realpolitik.

Will we see companies feel pressured to hire Chief Climate Change Officers (CCCOs) approved by the Climate Council run by Tim Flannery to appease ASIC? Will they determine the strategic direction of Harvey Norman? Or will shareholders prefer Gerry Harvey and Katie Page to lead that charge?

What constitutes compliance? How will ASIC aggregate the corporate climate change related information it garners in a way that produces qualitative results? Will the positioning of three new potplants in the boardroom be counted as sufficient reporting in climate abatement disclosure as affixing solar panels to the factory roof or switching the CEO’s car to an electric vehicle? Will the mere mentioning of the word “climate change” in an annual report suffice? Will ASIC get a warm fuzzy feeling if it conducts another 15,000 ‘CTRL F’ searches for words where 100% of corporates measure it? Job done? Will “name & shame” tables be produced to bash a mining company for having higher emissions than a tech start up?

It was only last week we were told that banks, insurers and super funds would be put through tough new climate change “stress tests” to be run by the  (APRA). We weren’t aware that APRA’s expertise extended to climate change either.

APRA should look at the 29% growth in assets within the 600,000 self-managed super funds (SMSF) which invest as much money as the very industry funds who lobby it to change the rules to force such disclosures as a guide. It probably says that more Aussies want to manage their own affairs instead of having nanny state rules that limit the scope of what they can invest in. Shouldn’t investors have a right to invest in tobacco, mining or gambling stocks if they see compelling value which assists the ultimate aim of putting more savings into retirement?

We pointed out that the industry funds collect the highest fees from those socially responsible (SRI) portfolios, even though they chronically underperform the market. If we look at YTD, 1 or 10-year performance all of the SRI portfolios as indicated by published performance (listed on their websites) of local Australian Council of Superannuation Investors (ACSI) members, they have “underperformed” the benchmark index.

ACSI is behind this push for SRI. It even extends to pushing companies to have gender quotas, despite over half the members of ACSI failing to meet their own requirements. You can’t make this stuff up.

ASIC should promote free markets. It should rightly punish those companies that break laws. However, it should be up to shareholders to correctly assess risks. If climate change is a big deal then they can ask for their monies to be deposited into ACSI members’ SRI funds. The future growth of SMSFs will be a telling factor.  It will reveal those individuals looking to escape the grasp of limited investment options provided by rent-seeking industry funds looking to push their members into higher fee-paying products on the notion of saving the planet. Isn’t that just the type of red-flag the regulators should be looking to crack down on? Or does climate change grant get out of jail free cards? We all know the answer to that.

It is a disgrace. Amateurs dictating terms to professionals!

Add the Dutch to the $15.8tn pension shortfall

Negligence. No other word for it. Unrealistic assumptions coupled with a race to the bottom on interest products has meant the top 20 nations have a $15.8 trillion unfunded liability in pensions. CM wrote of the crisis awaiting US public pensions a while back.

It seems the Dutch are the latest bunch of pensioners to reach for the pitchforks at the prospect of having their retirement severely cut back. Shaktie Rambaran Mishre, chair of the Dutch pension federation (representing 197 pension funds and their members), said contributions might have to rise by up to 30% over the next few years to ward off the prospect of having to cut the pensions of 2 million retirees. That will go down a treat.

Zerohedge noted the lower Dutch risk-free rate is not low enough, and as a result about 70 employer-run pension funds with 12.1m members had funding ratios below the statutory minimum at the end of September, according to the Dutch central bank. And here lies the rub: if funds have ratios below the legal minimum for five consecutive years or have no prospect of recovering to a more healthy level, they must cut their payouts.

Can you imagine all of the Dutch who were looking forward to taking a round the world cruise to celebrate 40 years of hard work to face the reality that they’ll only be able to take a cruise down the Amsterdam canals.

This is an utter disgrace. You’d have to be asleep at the wheel as a regulator not to recognize expected returns on funds were so unrealistic as to beggar belief. Actuarial accounting lets you get away with it.

Yet the evil pensions funds will be the villains even though the supervisor left these children alone with a box of matches. Just watch them come home and act surprised that the house has burnt down.

We’re getting a taste of the remedy from the State of Illinois. It is issuing bonds specifically to help plug the gap. Rhode Island has gone the other way – take a 40% haircut or risk having nothing. Way to go!

It is worth factoring the longer term risk of the fall in consumption that this will ultimately have if even a slither or $16tn is no longer recycled into the economy.

This can only end in tears

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As Sweden’s economy slows to the worst economic growth rate in 5 years under a negative interest rate policy, one would think the Swedish Central Bank (Riksbank) would be seeking to prudently manage its asset book on the basis of appropriate risk/reward as opposed to lecturing Australia and Canada on their respective carbon footprints. What we are witnessing is yet another discrete move by authorities to manipulate markets based on fantasy rather than fact.  The hypocrisy is extreme as we shall discover.

While the Riksbank should have complete freedom in how it wishes to deploy capital, we should view this is a pathetic sop to the cabal at the European Central Bank (ECB). Since when did central bankers become experts on climate change? The RBA is no better. Deputy Governor, Guy Debelle, gave a speech in March 2019 on the risks posed by climate change which based prophecies on the data accident-prone IPCC and Bureau of Meteorology. Why not seek balance? Easier to fold to group think so as not to be outed as a pariah. Utterly gutless. Our own APRA is also pushing this ridiculous agenda on climate change reporting. It is willful negligence.

While it is true that on a per capita basis, Australia and Canada’s emissions are higher than the global average, why doesn’t the Riksbank give us credit for lowering that amount 11.4% since 2000? Even Canada has reduced its carbon emissions by 7.3% over the last 18 years. Admittedly Sweden’s emissions per capita have fallen 21.9% according to the IEA. Greta will be happy.

Why hasn’t the Riksbank taken China or India to task for their 169.9% or 94.7% growth in CO2 emissions respectively? There are plenty of oil-producing nations – Qatar, UAE, Bahrain, Saudi Arabia and Oman that have worse per capita outcomes than Australia or Canada. Do these countries get special dispensation from the wrath of the Riksbank? Clearly.

The US has pulled out of the Paris Climate Accord. If the US has marginally lower emissions per capita (15.74t/CO2-e) than Australia (16.45t/CO2-e), isn’t a double standard to write,

The conditions for active climate consideration are slightly better in our work with the foreign exchange reserves. To ensure that the foreign exchange reserves fulfil their purpose, they need to consist of assets that can be rapidly converted to money even when the markets are not functioning properly. Our assessment is that the foreign exchange reserves best correspond to this need if they consist of 75 per cent US government bonds, 20 per cent German and 5 per cent British, Danish and Norwegian government bonds.

Essentially Riksbank commitment to climate change is conditional. The US which is responsible for 13.8% of global emissions can be 75% of holdings. Australia at 1.3% can’t. No doubt sacrificing Queensland Treasury Corp, WA Treasury Corp and Albertan bonds from a Riksbank balance sheet perspective will have little impact on the total. In short, it looks to be pure tokenism. The Riksbank has invested around 8% of its foreign exchange reserves in Australian and Canadian central and federal government bonds. So perhaps at the moment, it is nothing but substitution from state to federal. Why not punish NSW TCorp for being part of a state that has 85%+ coal-fired power generation?

At the very least the Riksbank admits its own hypocrisy.

The Riksbank needs to develop its work on how to take climate change into consideration in asset management. For instance, we need a broader and deeper analysis of the issuers’ climate footprint. At the same time, one must remember that the foreign exchange reserves are unavoidably dominated by US and German government bonds. The Riksbank’s contribution to a better development of the climate will, therefore, remain small. This is entirely natural. The important decisions on how climate change should be counteracted in Sweden are political and should be taken by the government and the Riksdag (parliament).

Still, what hope have we got when Benoît Cœuré, member of the Executive Board of the ECB, lecturing those on “Scaling up Green Finance: The Role of Central Banks.” He noted,

2018 has seen one of the hottest summers in Europe since weather records began. Increasing weather extremes, rising sea levels and the Arctic melting are now clearly visible consequences of human-induced warming. Climate change is not a theory. It is a fact.

Reading more of this report only confirms the commitment of the ECB to follow the UN’s lead and deliberately look to misallocate capital based on unfounded claims of falling crop yields and rising prices (the opposite is occurring) and rising hurricane and drought activity (claims that even the IPCC has admitted there is little or no evidence by climate change). Sweden is merely being a well-behaved schoolboy.

Cœuré made the explicit claim, “The ECB, together with other national central banks of the Eurosystem, is actively supporting the European Commission’s sustainable finance agenda.

CM thinks the biggest problem with this “agenda” is that it risks even further misallocation of capital within global markets already drowning in poorly directed investment. It isn’t hard to see what is going on here. It is nothing short of deliberate market manipulation by trying to increase the cost of funding to conventional energy using farcical concocted “climate risks” to regulate them out of existence.

Cœuré made this clear in his speech,

once markets and credit risk agencies price climate risks properly, the amount of collateralised borrowing counterparties can obtain from the ECB will be adjusted accordingly.

What do you know? On cue, Seeking Alpha notes,

Cutting €2bn of yearly investments, the European Union will stop funding oil, natural gas and coal projects at the end of 2021 as it aims to become the first climate-neutral continent.

All CM will say is best of luck with this decision. Just watch how this kneeling at the altar of the pagan god of climate change will completely ruin the EU economy. The long term ramifications are already being felt. The EU can’t escape the fact that 118mn of its citizens (up from 78m in 2007) are below the poverty line. That is 22% of the population. So why then does Cœuré mention, in spite of such alarming poverty, that taking actions (that will likely increase unemployment) will be helped by “migration [which] has contributed to dampening wage growth…in recent years, thereby further complicating our efforts to bring inflation back to levels closer to 2%.

Closer to home, the National Australia Bank (NAB) has joined in the groupthink by looking to phase out lending to thermal coal companies by 2035. The $760 million exposure will be cut in half by 2028. If climate change is such a huge issue why not look to end it ASAP? This is terrible governance.

Why not assess thermal coal companies on the merits of the industry’s future rather than have the acting-CEO Philip Chronican make a limp-wristed excuse that it is merely getting in line with the government commitment to Paris? If lending to thermal coal is good for shareholders in 2036, who cares what our emissions targets are (which continue to fall per capita)? Maybe this is industry and regulator working hand-in-hand?

The market has always been the best weighing mechanism for risk. Unfortunately, for the last two decades, global central bank policy has gone out of its way to prevent the market from clearing. Now it seems that the authorities are taking actions that look like collusion to bully the ratings agencies into marking down legitimate businesses that are being punished for heresy.

This will ironically only make them even better investments down the track when reality dawns, just as CM pointed out with anti-ESG stocks. Just expect the entry points to these stocks to be exceedingly cheap. Buy what the market hates. It looks as though the bureaucrats are set to make fossil fuel companies penny stocks.

The irresponsibility of socially responsible investing

United Nations Sustainable Development Logo

Socially Responsible Investment (SRI) has been heavily pushed by members of the Australian Council of Superannuation Investors (ACSI) for a while now. Apart from cynically cashing in on the generally higher fees generated by these “woke” funds, the returns have been nothing much to write home about. As Milton Friedman once said, “One of the great mistakes is to judge policies and programs by their intentions rather than their results.

If we look at YTD, 1 or 10-year performance all of the SRI portfolios as indicated by published performance (listed on their websites) of local ACSI members, they have “underperformed” the benchmark index. One outperformed in the 5-year category. Hardly anything to crow about. So as much as they might feel warm and fuzzy for turning these funds into virtue-signalling investment vehicles, the outcomes for the monies entrusted to them is far from ideal. While investors should bear ultimate responsibility for where they deploy retirement funds, do they realise how much money they are torching by believing in this nonsense?

So why do these funds try to bully top-performing companies to conform to their irrelevant ideals which on the face of it do not appear to be working? If one reads through the fine print, many superannuation administrators pat themselves on the back that they are aligning portfolios to the United Nations Sustainable Development Goals (SDGs). If one wants to champion best in class ethics, the UN is the last place anyone should look. Just look at the unethical scandal that occurred at UNAIDS. 

It doesn’t take a rocket scientist to work out what these SDGs are – eliminating hunger, wiping out poverty, promoting gender equality, good health, clean water and sanitation, affordable clean energy etc. All wonderful things in and of themselves, but surely if the market agrees with them,  shouldn’t share prices reflect that?

Friedman spoke of free-market economics, “Well, first of all, tell me: Is there some society you know that doesn’t run on greed? You think Russia doesn’t run on greed? You think China doesn’t run on greed? What is greed? Of course, none of us are greedy, it’s only the other fellow who’s greedy. The world runs on individuals pursuing their separate interests. The great achievements of civilization have not come from government bureaus [including the UN]. Einstein didn’t construct his theory under order from a bureaucrat. Henry Ford didn’t revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty you’re talking about, the only cases in recorded history, are where they have had capitalism and largely free trade. If you want to know where the masses are worse off, worst off, it’s exactly in the kinds of societies that depart from that. So that the record of history is absolutely crystal clear, that there is no alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by the free-enterprise system.

In Australia,  it would seem that many high performing companies, that aren’t ‘compliant as they should be‘, are being pressured to increase diversity, women on boards and all manner of meaningless benchmarks preached by the ACSI and its members.

Take the 30% Club which pushes to have 30% women on boards. While this started in the UK in 2010, it has spread across multiple jurisdictions including Australia. The 30% Club emphatically quotes from a McKinsey study,  “Companies in the top quartile for gender diversity on their executive teams are 21% more likely to experience above-average profitability than companies in the fourth quartile.” What this study doesn’t say is that the bottom quartile of companies maybe just poorly run, in spite of the genitalia of the board.

Don’t mistake the most important point to be made. If a board is best served by all women, you won’t hear a peep from investors if they can produce the best results. As soon as we start to try to enforce gender quotas, performance becomes predicated on chromosomes rather than capability. What next? Ensure fair representation of LGBT on boards? Religions? Races? Disabilities? Where does it stop when all that matters is ability that produces performance?

Take a look at the disaster that has befallen PG&E in recent times. In the interests of pandering to all these irrelevant SDGs, it can tell you the exact breakdown of the diversity of its workforce but can’t tell you the status of much of its infrastructure, some which have been directly responsible for the devastating wildfires in California. The company was forced into Chapter 11 bankruptcy. Did diversity help shareholders? If one’s house is on fire, do we worry about identity? Or who has the skillsets to put out the blaze the fastest? QED.

Yet our woke investors keep pushing these trends. IFM Investors waxes lyrical about its climate change, 30% Club and carbon disclosure project. Good for it. It has a choice. It should live by the sword and die by it. If that is what it wishes to focus on why not allow the free market to; a) decide whether superannuation holders want to deploy funds in such a manner and b) let corporates decide if SRI is good for their businesses.

Yet, the latest push by these socialist fund administrators is to ensure that companies conform to the ‘Modern Slavery Act.’ Are these people for real? Who are they to try to enforce federal law? Talk about self-imposed authority. It is a safe bet that 99%+ corporates listed on the ASX behave are compliant in this regard because if not the punitive outcomes will be severe.

Moreover, if some of these funds own stocks like Tesla in their international portfolios, perhaps they might consider such a hip and trendy investment has an indirect connection to child-slave labour in DR Congo where 70% of the world’s cobalt is mined to go into the Li-ion batteries.

There is one absolute truth in finance. In good times, any mug CEO can be successful. It is only when markets turn sour that the “quality” of decent management is truly appreciated in how they successfully manage to mitigate risk in an ugly downturn. In a difficult market climate, only the fittest survive and if companies have strayed off the reservation to appeal to investors, it will soon become self-evident in the results.

As we stare at the precipice of a potentially deep global recession, the previous paragraph will be all that matters. Because those corporates too busy hitting diversity targets, installing genderless bathrooms and ensuring they have double-checked all employees have complied with Earth Hour will be slaughtered when markets take a pounding.

These SDG focused funds will soon see that they are part of one giant herd and as performance starts to suffer in this crowded trade, the stampede toward the exit will reveal just how irresponsible the push to ram through such irrelevant metrics at the very companies who caved in was.

As a contrarian investor, the best investments will be in exactly those companies that shun(ned) this foolhardy exercise and forged a path in the spirit of Milton Friedman. Afterall they understood what it really means to be “free to choose.” So back up the truck in tobacco, mining and fossil fuel stocks on any pullback. After all, mean reversion will see these stocks outperform if nothing else.

Don’t forget Harvey Norman (HVN). How could it be that the company is worth 4x the combined value of Myer and David Jones, the latter two businesses focused on pleasing the United Nations rather than customers?  Hmmm.

Isn’t that the ultimate ready reckoner for these SDG funds? The market is always right. If the performance of the funds deployed isn’t making the grade, don’t attempt to force the best of breed to comply to your self imposed standards. Embrace companies that follow their lead. Not the other way around. It begs the question, what on earth are people who should believe in free markets doing to thwart it functioning efficiently?

Perhaps investors have the clearest indication of socialist activism by the very requirement to join the club. “ACSI drives strong ESG performance in companies in which our members invest because ESG creates long-term value…We use our collective impact to influence companies and financial markets in the interests of our members as long-term investors…Commitment to these beliefs is a pre-requisite for membership of ACSI.

Never has it been a more sound decision to set up an SMSF.

Westpac reported a 40% increase in home repossessions

Mortgages Westpac

Don’t get CM wrong – this is still the law of small numbers.  Westpac reported this week that it repossessed another 162 properties in the latest fiscal year.  That is a 40% increase. While it is but a dribble compared to the 100,000s of total loans outstanding it is none-the-less a harbinger of things to come. Westpac made clear, “the main driver of the increase has been the softening economic conditions and low wages growth.”

The current status of 90-day+ delinquencies has been rising over time. As have 30-day +. While nothing alarming, the current economic backdrop should give absolutely no confidence that an improvement in conditions is around the corner. We are not at the beginning of the end, but at the end of the beginning.

Former President Ronald Reagan once said of the three phases of government, “if it moves, tax it. If it keeps moving regulate it. If it stops moving, subsidize it.” How is that relevant to the banks?

We have already had the government fold and attach a special bank tax on the Big 4. Phase 1 done. Now we are in the middle of phase 2 which is where knee-jerk responses to the Hayne Banking Royal Commission (HBRC) where banks will be on the hook for the loans they make. That is a recipe for disaster that could bring on phase 3 – bailouts.

Sound extreme? How is a bank supposed to make a proper risk assessment of a customer’s employability in years to come? Can they predict with any degree of accuracy on the stability of candidates who come for loans? The only outcome is to cut the loan amount to such conservative levels that the underlying purpose gets diluted in the process and prospective home buyers have to lower expectations. Not many banks will look positively at taking several loans on the same property with different institutions. That won’t work. SO loan growth will shrink, putting pressure on the property market.

What is the flip side? Given property prices in Sydney hover at 13x income (by the way, Tokyo Metro was 15x income at the peak of its property bubble), restrictions on further lending against loan books that are on average 63% stuffed with mortgages (Japan was 41.2% at the peak) won’t be helpful. A property slowdown is the last thing mortgage holders and banks need.

While equity continues to rise at Aussie banks, the equity to outstanding mortgages has gone down since 2007 i.e. leverage is up. If banks saw their average property portfolios drop by more than 20% many would be staring at a negative equity scenario. Yet, it won’t be just mortgage owners that we need to worry about. Business loans could well go pear-shaped as the onset of higher unemployment could see a sharp increase in delinquencies through a business slowdown. A concertina effect occurs. More people lose their job and a vicious circle ensues. It isn’t rocket science.

Of course, Australia possesses the ‘boy who cried wolf‘ mentality over the housing market. Yet it is exactly this type of complacency that paves a dangerous path to poor policy prescriptions.

In Japan’s property bubble aftermath, 40% of the value of loans went bang. 17% of GDP. $1.1 trillion went up in smoke. It took more than 10 years to clean up the mess and the aftershocks remain. Accounting trickery around the real value of loans on the balance sheet can hide the problems for a period but revenue tends to unravel such tales. 181 banks and building societies went bust. The rest were forced into mergers, received bailouts or were nationalised. Now the Japanese government is a perpetual debt slave, having to raise $400bn per annum in debt just to fill the portion of the $1 trillion budget that tax collections can’t fill.

The problem  Japan’s banks faced was simple.  If a neighbour’s $2m home was repossessed through mortgage stress and the bank fire sold it for $1.4m, the bank needed to mark to market the value of the loan portfolio for that area by similar amounts. In doing so, a once healthy balance sheet started to look anything but. Extrapolate that across multiple suburbs and things look nauseating quickly.

This is where Aussie banks are headed. This time there is no China to save us like in 2009. Unemployment rates in Australia never went above 6% after the GFC in 2008/9, unlike the US which went to 10%. We weathered that storm thanks to a monster surplus left by the Howard government, which we no longer have.

Sadly China has had 18 months of consecutive double-digit car sales decline. Two regional Chinese banks have folded in the last 3-4 months. China isn’t a saviour.

Nor is the US. While the S&P500 might celebrate new highs, aggregate corporate profitability hasn’t risen since 2012. The market has been fuelled by debt-driven buybacks. We now have 50% of US corporates rated BBB because of the distortions created by crazed central bank monetary policy, up from 30%. Parker Hannifin’s latest order book shows that customer activity is falling at a faster pace.

Nor is Europe. German industrial production is at 10-year lows. The prospects for any EU recovery is looking glib. Risk mispricing is insane with Greek bond spreads only 1.8% higher than German bunds.

What this means is that 28 years of unfettered economic growth in Australia is coming to an end and the excesses built in an economy that believes its own BS is going to leave a lot of people naked when the tide goes out.

The Australian government needs to focus on more deregulation, tax and structural reforms. Our record-high energy prices, ridiculous labour costs and overbearing red-tape are absolutely none of the ingredients that will help us in a downturn. We need to be competitive and we simply aren’t. Virtue signalling won’t help voters when the whole edifice crumbles.

All a low-interest rate environment has done is pull forward consumption. It seems the RBA only possesses a hammer in the tool kit which is why it treats everything as a nail. It is time to come to terms with the fact that further cuts to the official cash rate and the prospect of QE will do nothing to ward off the inevitable.

Pain is coming, but the prospects of an orderly exit are so far off the mark they are in another postcode. Roll your eyes at the stress tests. Stress tests are put together on the presumption that all of the stars align. Sadly, in times of panic, human nature causes knee-jerk responses which put even more pressure.

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The Aussie banks have passed their best period. While short term news flow, such as a China trade deal, might give a short term boost, the structural time bomb sits on the balance sheet and while we may not get a carbon copy of the Japanese crisis, our Big 4 should start to look far more like the rest of the global banks – truly sick. The HBRC will see that it becomes way worse than it ever needed to be.

Complacency kills.

Japanese consumer confidence waning as consumption tax hike starts tomorrow

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As the 10% consumption tax rate kicks in from October 1 in Japan from the current 8%, it is worth reflecting on the sorry state of consumer confidence. We are back below 2014 levels. While the sales of Japanese rugby jerseys and huge consumption of beer by gaijin at the Rugby World Cup may provide a brief respite, the trend remains distinctly negative.

Note that consumption tax has been the biggest portion of government revenue since 2014 and is on track to be 37% of the total in 2019, followed by individuals and the lazy corporate sector. Japan’s small-medium enterprises (SMEs) are the backbone of employment, comprising 70% of the labour force and 97% of all corporations. Yet 70% of SMEs pay no tax at all.

From an individual level, the top 0.7% of earners in Japan pay 30% of the tax bill, up from 20% in 1974. The bottom 50% have seen their tax contribution fall from 10% to around 2.8%. The top 8% pay around three-quarters of the total.

With Japan running a ¥100 trillion (US$1tn) national budget, the Ministry of Finance needs to sell ¥40 trillion (US$400bn) every year to plug the budget deficit.  The hope is that the consumption tax will lower the dependence on having to debt finance to such extremes.

More public pension roadkill ahead

CM has been writing about the public pensions crisis in the US for years. This chart only serves to highlight that the problem doesn’t seem to be getting any better. It seems in Illinois, 200 of the 650 public pension funds out there have more beneficiaries than active workers contributing to the fund. By 2021 this is expected to be half of all public pension funds in Illinois.

ZeroHedge noted,

The value of all future pension promises to be paid out to public safety workers totalled just $320 million in 2005. By 2017, that number had jumped to nearly $600 million. That’s a jump of over 80% or more than three times the pace of inflation.

It’s the main reason why taxpayer contributions can’t keep up with pension costs. Pols are doing nothing to control the growth of promises to be paid, sticking taxpayers with ever-increasing costs and ratcheting up the likelihood the pension plans will fail…

… In 1987, municipalities owed a total of $2.6 billion in benefits earned to active and retired public safety workers across the state. Today, that number has jumped to more than $23 billion. That’s a jump of nearly nine times.”

Don’t forget what the Illinois Police Dept did several years back. IN June 2017 CM wrote,

“Sadly the Illinois Police Pension is rapidly approaching the point of being unable to service its pension members and a taxpayer bailout looks unlikely given the State of Illinois’ mulling bankruptcy. Local Government Information Services (LGIS) wroteAt the end of 2020, LGIS estimates that the Policemen’s Annuity and Benefit Fund of Chicago will have less than $150 million in assets to pay $928 million promised to 14,133 retirees the following year…Fund assets will fall from $3.2 billion at the end of 2015 to $1.4 billion at the end of 2018, $751 million at the end of 2019, and $143 million at the end of 2020, according to LGIS…LGIS analyzed 12 years of the fund’s mandated financial filings with the Illinois Department of Insurance (DOI), which regulates public pension funds. It found that– without taxpayer subsidies and the ability to use active employee contributions to pay current retirees, a practice that is illegal in the private sector– the fund would have already run completely dry, in 2015…The Chicago police pension fund held $3.2 billion in assets in 2003. It shelled out $3.8 billion more in benefits to retired police officers than it generated in investment returns between 2003 and 2015…Over that span, the fund paid out $6.9 billion and earned $3.0 billion, paying an additional $134 million in fees to investment managers.”

What have the police been doing? Retiring early and cashing in their pensions to avoid the inevitable.

The problem for Illinois is that a taxpayer-funded bailout is all but impossible. The State of Illinois ranked worst in the Fed study on unfunded liabilities.  The unfunded pension liability is around 24% of state GDP. In 2000 the unfunded gap to state revenue was 30% and in 2013 was 124% in 2013. Chicago City Wire adds that the police fund isn’t the only one in trouble.

“Chicago’s Teachers Union Pension Fund is $10.1 billion in debt. Its two municipal worker funds owe $11.2 billion and its fire department fund owes $3.5 billion…All will require taxpayer bailouts if they are going to pay retirees going into the next decade…Put in perspective, the City of Chicago’s property tax levy was $1.36 billion in 2017…Paying for retirees “as we go,” which will prove the only option once funds run dry, will require almost quadrupling city property tax bills…Last year, it would have required more than $4 billion in revenue– including $1 billion for City of Chicago workers, $1.5 billion for teachers, and $1.5 billion for retired police officers and firefighters.”

This problem is going to get catastrophically worse with the state of bloated asset markets with puny returns. Looking at how it has been handled in the past Detroit, Michigan gives some flavour. It declared bankruptcy around this time three years ago. Its pension and healthcare obligations total north of US$10bn or 4x its annual budget. Accumulated deficits are 7x larger than collections. Dr. Wayne Winegarden of George Mason University wrote that in 2011 half of those occupying the city’s 305,000 properties didn’t pay tax. Almost 80,000 were unoccupied meaning no revenue in the door. Over the three years post the GFC Detroit’s population plunged from 1.8mn to 700,000 putting even more pressure on the shrinking tax base.

In order for states and local municipalities to overcome such gaps, they must reorganise the terms. It could be a simple task of telling retiree John Smith that his $75,000 annuity promised decades ago is now $25,000 as the alternative could be even worse if the terms are not accepted. Think of all the consumption knock-on effects of this. I doubt many Americans will accept that hands down, leading to class actions and even more turmoil.

Did CM mention gold?

Joe Nation’s Pension Tracker is a really good website to look at the actuarial setting of pensions against the marked-to-market unfunded liabilities. Have a stiff drink handy before you open up.