My High Dividend Stocks Blog

My High Dividend Stocks
This is my high dividend stocks site where I help site members find high dividend stocks with earning power and strong balance sheets.

TIP OF THE WEEK - Avoid Bank Safe Deposit Boxes For Valuables

Avoid Bank Safe Deposit Boxes

Jason Brizic

August 17th, 2012

This story should concern you if you value your privacy and have a safe deposit box.

Your possessions such as precious metals and family heirlooms are not safe in a bank safe deposit box.

Bank officers can get into your safe deposit box for flimsy reasons.  They will also open your box if a government agent has some paperwork to open it.

Here is just one reason why you should avoid bank safe deposit boxes:

http://www.youtube.com/embed/ygG29W0DQno

For more tips, go here:

http://www.myhighdividendstocks.com/category/tip-of-the-week

TIP OF THE WEEK: An Open Letter to Warren Buffett

Warren Buffett is a genius investor but an economic ignoramus.  He has been paraded around by statists in government for his willingness to be taxed more.

This is a excellent article on why Warren Buffett should stop acting like a guilt ridden billionaire who wants the government to raise taxes on everyone.  It explains in very clear terms why Marx’s exploitation theory is complete wrong and why capitalism has improved all individuals standards of living.

http://mises.org/daily/6134/An-Open-Letter-to-Warren-Buffett

Be seeing you!

TIP OF THE WEEK: Read Mises on Money for free.

Avoid bad investments based on Keynesian economics.  Gary North explains Mises valuable contribution to Austrian economics.

Gary North's Tip of the Week - June 23, 2012 Money Book
                        =========================
                        My new book on money in now online. I am offering it to you for the price of toner
and paper.

                        The book presents what is known as the Austrian theory of the business cycle:
booms and busts. This theory was first presented a century ago by Ludwig von
Mises.

                        If you have never read what Mises wrote on money, but you really do want to know
what is going on today with the banking system, this book presents it in five
short chapters.

                        I am easier to read than Mises was. This will get you started.

                        http://www.garynorth.com/public/9689.cfm

                        Gary "Sound Money" North

TIP OF THE WEEK - What the Heck is Working Capital and Why Should You Care?

What the Heck is Working Capital and Why Should You Care?

Jason Brizic

April 20st, 2011

You need to know what working capital is because it is one of the indicators of balance sheet strength.

Follow Benjamin Graham’s advice on the importance of working capital.  The following passage comes from the 1937 book The Interpretation of Financial Statements Chapter XII:

            In studying what is called the “current position” of an enterprise, we never consider the current assets by themselves, but only in relation to the current liabilities.  The current position involves two important factors: (a) the excess of current assets over current liabilities – known as the Net Current Assets or the Working Capital, and (b) the ratio of current assets to current liabilities – known as the Current Ratio.

            The Working Capital is found by subtracting the current liabilities from the current assets.  Working Capital is a consideration of major importance in determining financial strength of an industrial enterprise, and it deserves attention also in the analysis of public utility and railroad securities.

            In the working capital is found the measure of the company’s ability to carry on its normal business comfortably and without financial stringency, to expand its operations without the need of new financing, and to meet emergencies and losses without disaster.  The investment in plant account (or fixed assets) is of little aid in meeting these demands.  Shortage of working capital, at its very least, results in slow payment of bills with attendant poor credit rating, in curtailment of operations and rejection of desirable business, and in a general inability to “turn around” and make progress.  Its more serious consequence is insolvency and the bankruptcy court.

            The proper amount of working capital required by a particular enterprise will depend upon both the amount and the character of its business.  The chief point of comparison is the amount of working capital per dollar of sales.  A company doing business for cash and enjoying a rapid turnover of inventory – for example, a chain grocery enterprise – needs a much lower working capital compared with sales than does the manufacturer of heavy machinery sold on long-term payments.

            The working capital is also studied in relation to fixed assets and to capitalization, especially the funded debt and preferred stock.  A good industrial bond or preferred stock is expected, in most cases, to be entirely covered in amount by the net current assets.  The working capital available for each share of common stock is an interesting figure in common stock analysis.  The growth or decline of the working capital position over a period of years is also worthy of the investor’s attention.

            In the field of railroads and public utilities, the working capital item is not scrutinized as carefully as in the case of industrials.  The nature of these service enterprises is such as to require relatively little investment in receivables or inventory (supplies).  It has been customary to provide for expansion by means of new financing rather than out of surplus cash.  A prosperous utility may at times permit its current liabilities to exceed its current assets, replenishing the working capital position a little later as part of its financing program.

            The careful investor, however, will prefer utility and railroad companies that consistently show a comfortable working capital situation.

Let’s take a look at Safe Bulkers (SB) working capital situation from the past few years (Source: Morningstar.com).  Safe Bulkers financial strength has been eroding along with the dry bulk shipping market.

12/2007

12/2008

12/2009

12/2010

12/2011

Total Current Assets

$98,883,000

$88,086,000

$105,648,000

$104,276,000

$37,959,000

Total Current Liabilities

$43,984,000

$70,863,000

$65,551,000

$52,983,000

$51,673,000

Working Capital

$54,899,000

$17,223,000

$40,097,000

$51,293,000

($13,714,000)

Current Ratio

2.25

1.24

1.61

1.97

0.73

Revenues

$165,848,000

$200,772,000

$164,606,000

$157,020,000

$168,908,000

WC as % of Revenue

33.1%

8.6%

24.4%

32.7%

N/A

For more tips, go here:

http://www.myhighdividendstocks.com/category/tip-of-the-week

TIP OF THE WEEK - Book Value or Equity and How to Calculate Book Value per Share

Book Value or Equity and How to Calculate Book Value per Share

Jason Brizic

April 6th, 2012

Knowing the book value of a company helps the intelligent investor to buy low.

You want to buy assets that produce profits as cheap as possible.

The following comes from Benjamin Graham’s 1937 book The Interpretation of Financial Statements.

The book value of a security is in most cases a rather artificial value.  It is assumed that if the company were to liquidate, it would receive in cash the value at which its various tangible assets are carried on the books.  Then the amounts applicable to the various securities in their due order would be their book value.  (The word “equity” is frequently used instead of book value in this sense, but it is generally applied only to common stocks and to speculative senior securities.)

As a matter of fact, if the company were actually liquidated the value of the assets would most probably be much less than their book value as shown on the balance sheet.  An appreciable loss is likely to be realized on the sale of the inventory, and a very substantial shrinkage is almost certain to be suffered in the value of the fixed assets.  In practically every case the adverse conditions which would lead to a decision to liquidate the business would also make it impossible to obtain anywhere near cost or reproduction price for the plant and machinery.

The book value really measures, therefore, not what the stockholders could get out of their business (its liquidating value), but rather what they have put into the business, including undistributed earnings.  The book value is of some importance in analysis because a very rough relationship tends to exist between the amount invested in a business and its average earnings.  It is true that in many individual cases we find companies with small asset values earning large profits, while others with large asset values earn little or nothing.  Yet in these cases some attention must be given to the book value situation, for there is always a possibility that large earnings on the invested capital may attract competition and thus prove temporary; also that large assets, not now earning profits, may later be made more productive.

CALCULATING BOOK VALUE

As has already been said, in calculating book value it is assumed that the company’s assets are worth the figure shown on the balance sheet.  Indeed, book value simply means the value as shown by the books or balance sheet.

To take a simple example, a company’s balance sheet is as follows:

Fixed Property

$1,000,000

Capital Stock

$1,700,000

Good-will

500,000

Surplus

100,000

Current Assets

500,000

Current Liabilities

200,000

$2,000,000

$2,000,000

In this case the capital stock is represented by 17,000 shares of $100 par value common stock.  To find the book value of the common stock, add the $100,000 surplus to the $1,700,000 value shown for the stock, making a total of $1,800,000.  Then look on the asset side of the balance sheet for intangibles.  You will find $500,000 good-will.  This is then deducted from the $1,800,000, leaving $1,300,000 equity available for the 17,000 common shares.  Incidentally, the figure $1,300,000 is often referred to as the “net tangible assets” of the company.  Dividing this out, the net book value per share would be $76.47.

If you had not deducted the intangibles and had simply divided the $1,800,000 by the 17,000 shares you would have found the book value per share to be $105.88.  You will not that there is quite a difference between this book value and the net book value of $76.47 a share.  If only “book value” of the stock is mentioned, tangible or net book value is usually meant.  The larger figure may be termed: “Book value, including intangibles.”

I will perform this calculation on one of my favorite high dividend stocks – Safe Bulkers (SB)

Fixed Property

$777,663,000

Capital Stock

$71,000

Intangibles

0

Additional Paid-in Capital

114,918,000

Current Assets

37,959,000

Retained Earnings

216,853,000

Other Investments

11,649,000

Current Liabilities

51,673,000

Other Long Term Assets

50,000,000

Non-current Liabilities

493,756,000

$877,271,000

$877,271,000

All of this balance sheet information is as of 4Q 2011.  Safe Bulkers has since added another 5,750,000 shares and $37,375,000 in additional paid-in capital since the 4Q 2011 report.  Safe Bulkers had 70,896,924 shares at the time of the 4Q 2011 financials report.

Safe Bulkers had $331,842,000 in book value at the end of 4Q 2011 (equity values – intangibles; highlighted in yellow above).  Divided that by 70,896,924 shares and you get a book value per share of $4.68.  That would be a very nice, low price to buy Safe Bulkers at.  Safe Bulkers sold for $3.00 - $2.50 per share at the depths of the 2009 recession.

Safe Bulkers book value per share rises to $4.82 if you include the additional paid-in capital the company raised after 4Q 2011.  This also assumes they didn’t incur any new liabilities in the meantime either.

For more tips, go here:

http://www.myhighdividendstocks.com/category/tip-of-the-week

TIP OF THE WEEK: Have you ever wondered how much things cost in gold? PricedInGold.com does it for you.

Have you ever wondered how much things cost in gold?  PricedInGold.com does it for you.

Jason Brizic

March 2nd, 2012

Prices can be expressed many ways.  In a barter economy the price of fish can be expressed in terms of any other good.  “I’ll give you 12 eggs for 1 fish.”  The price of the fish is 12 eggs.  It can be said another way: the price of one egg is 1/12th of a fish.   Barter is tedious because both owners of goods have to want what the other guy is willing to part with.  This is called double coincidence of wants.  Money solves this problem.  It acts as a medium of exchange.  Mr. A has eggs.  He trades them to Mr. B for some silver coins.  Mr. A has silver now.  He wants fish.  He trades Mr. C some silver coins for fish.  Everyone is happy.  Money is the most marketable commodity.  It make exchange of goods easier than barter.

All prices in the US are expressed in dollars because of immoral legal tender laws.  There is a website that allow you to see many interesting prices expressed in weights of gold.  Not only does it show the current price, but it shows the historical price going back over a hundred years.  Prices can be measured in troy ounces of gold or gold grams.  Gold grams are a good measurement for smaller goods such as barrels of oil or food.  Here is the conversion formula for troy ounces to grams:

one troy ounce = 31.1034768 grams

As you can see in the long term chart below, oil is a volatile commodity, with it's price swinging wildly in a range from less than 1 gram per barrel to almost 5 grams per barrel. But this chart also shows that these oscillations are part of a sideways price movement centered around 2.5 grams per barrel. Crude's current price around 2 grams is a bit below it's long term average.

Of course, the fluctuating value of the dollar makes it very hard to gauge whether oil prices themselves are rising or falling… Oil today at 2 grams, is about the same as it was in the early 1950s; but if you measure the price in US dollars, you would get the impression that it is about 30 times more expensive today!

Crude Oil, West Texas Intermediate From 1950:

To see dozens of more prices expressed in gold go to www.pricedingold.com

For more tips, go here:

http://www.myhighdividendstocks.com/category/tip-of-the-week

TIP OF THE WEEK - Why you should purchase rolls of nickels from your bank.

Why you should purchase rolls of nickels from your bank.

Jason Brizic

February 17th, 2012

Gresham’s law states that “When a government compulsorily overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation.”  This is what happened to the 90% pre-1963 silver dimes and quarters in the US.  It has happened to copper pennies.  And it is about to happen nickels.

http://en.wikipedia.org/wiki/Gresham%27s_law

Americans had the opportunity to buy and hold 90% silver coins before 1963 cheaply.  Those that did so were smart.  Gresham’s law took effect.  You will almost never happen upon a 90% silver dime or quarter anymore.  Most of them have been picked out of circulation.  Today, the 90% silver coins are valued for their metal content and not their face value anymore.  You have an opportunity to buy nickel at less than spot market price.  You can resell them later at a profit. 

The composition of the US nickel has been unchanged since the end of WWII.  The nickel is 75% copper and 25% nickel.  It costs the US government 11.2 cents to produce the 5 cent nickel.  They are broke and they need to cut government costs wherever it is easiest.  The voters don’t care about the composition of the coinage.  So, the US government is proposing changes to the composition of the nickel.

http://money.cnn.com/2012/02/15/news/economy/pennies_nickels/

The website www.coinflation.com calculates the daily metal value of all US coins.  The metal inside a nickel is worth 5.6 cents.  Nickel is selling for $9.07 per pound and copper is selling for $3.78 per pound in commodity markets today.  Buy low at 5 cents and sell high at 5.6 cents.  That is a 12.68% return on invested capital at today’s prices.  However, there is no market for coinage nickels right now because there is only one type of nickel.  You will have to wait to make any money off Gresham’s law.

The potential return on investment (ROI) is much higher.  About a year ago when nickel was selling for over $10.00 per pound and copper was over $4.00 per pound the metal in a single nickel was worth 6.2 cents.  That is a ROI of 24%.

The long term prospects for the price of copper and nickel are up.  Central bank monetary inflation will continue to erode the purchasing power of the dollar.  The price of nickel and copper expressed in dollars will continue to increase with monetary inflation.  A relapse of the world economy into recession will have the opposite effect on the price on copper and nickel.  So, in the short term the price of nickel and copper will go down, but long term the price will go up.

Buy nickels in two dollar rolls from you local bank.  You don’t have to sort nickels since there is only one composition of nickels in circulation.  The pre-1982 copper pennies are worth 2.5 cents (150% ROI), but you have to find them and separate them from all the zinc pennies.  That is a very labor intensive process.  I performed a test.  It took me one hour to sort through $10.00 of pennies.  Only about 15% were copper pennies (Gresham’s law again).  1 hour of labor yielded $1.50 in copper pennies worth $3.75 in metal.  Time is money.  I could have bought $100 in nickels in five minutes at a bank and been done with it.  No sorting necessary.  The best part is that your nickels are always worth their face value.  It is a guaranteed investment so long as you are patient.

For more tips, go here:

http://www.myhighdividendstocks.com/category/tip-of-the-week

TIP OF THE WEEK: The Federal Reserve Is Not Holding Down the FED Funds Rate, But I Know Who Is.

The Federal Reserve Is Not Holding Down the FED Funds Rate, But I Know Who Is.

Jason Brizic

February 10th, 2011

The Federal Reserve pretends to control interest rates through the use the FED funds rate.  http://www.federalreserve.gov/monetarypolicy/openmarket.htm

I see this all the time in financial articles.  Pick any of these articles (http://tinyurl.com/7vurwdx) and you will see moronic language like this:

“Federal Reserve officials said they expect short-term interest rates to stay close to zero "at least through late 2014." The Fed has been trying to give more explicit guidance on what it expects in the future as part of a broader move to greater transparency.”

The FED claims that it is holding this key interest rate low until at least 2014 using the federal funds target rate.  Here is the definition of the FED funds rate from its Wikipedia entry:

In the United States, the federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralized basis. Institutions with surplus balances in their accounts lend those balances to institutions in need of larger balances. The federal funds rate is an important benchmark in financial markets.[1][2]

The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate.

The federal funds target rate is determined by a meeting of the members of the Federal Open Market Committee which normally occurs eight times a year about seven weeks apart. The committee may also hold additional meetings and implement target rate changes outside of its normal schedule.

The commercial bankers (aka depository institutions) have decided not to loan out all the money the FED created for them during the bailouts of 2008-2009.  They are holding over $1.5 trillion dollars in excess reserves.

Therefore, they don’t need to make overnight loans to one another to satisfy the legal reserve requirements. These bankers are scared to make loans in this horrible economic environment.  I don’t blame them for being scared.  They have decided to park the money back at the FED and the FED is paying them 0.25% interest to store it for them.  This has caused the federal funds effective rate to drop to 0%. 

The FED could get the banks to lend the $1.5 trillion dollars into the economy by imposing a fee on excess reserves.  But that would create hyperinflation in the money supply and prices would rise over 100% in a few months.  The FED doesn’t want that to happen, so they pretend to be in control of the federal funds effective rate when the terrified bankers really are.  The bottom line is that there will be no economic recovery until bankers increase their lending.  That means we will experience a double-dip recession regardless of what happens in Europe or China.  I’m waiting for much lower stock prices to buy high dividend stocks with earning power and strong balance sheets.

For more tips, go here:

http://www.myhighdividendstocks.com/category/tip-of-the-week

TIP OF THE WEEK - Register your stocks in your own name

Register your stocks in your own name

Jason Brizic

January 20th, 2011

The MF Global bankruptcy proved one very important thing.  It proved that your assets are not your assets if you allow your broker to register them in their street name.  In fact, your brokerage can use your assets as their own to make risky derivative bets.  And when they go bust due to bad leveraged bets, then your assets can go to their creditors instead of to you.  This is what just happened in the MF Global bankruptcy.

Protect yourself by registering the stocks you own in your name.

Call your broker and tell them that you want all your stocks registered in your name.  Tell them you don’t want them in street name anymore.  There is a cost to this.  It will cost you time and some money each time you sell your stock certificates, but this is the price you must pay to secure your assets from brokerage theft.  If you are not willing to do this, then you probably should not own stocks.

This will make life very difficult for day traders, but much safer if you are a high dividend stock investor.  The high dividend stock investor buys when companies with earning power and strong balance sheets are priced at a deep discount.  He sells the stocks he owns when the company is not likely to deliver high dividend yields and when earning power and balance sheet strength diminishes.  This usually doesn’t happen overnight, so you can afford to register your stocks in your own name.

Here is an article by Gary North that summarizes the problem nicely.

* * * * * * * * * *

A lot of Americans do not know how ownership of stocks is handled. They think they personally own the stocks in their portfolios. They don’t.

There were investors in MF Global who thought they owned commodities. They didn’t.

Consider this.

Do you own gold and silver mining stocks? Or any stocks for that matter? Even if you say, “yes”, chances are you don’t really own them.

It is one of the dirtiest little secrets in the brokerage business. And 99.9% of people have no idea it is even being done to them. It’s called “street name registration” and it’s how the brokerage where you hold your stocks “registers” your shares. To save money and time, and to allow your shares to be included as assets that they can use to do what they want with, your brokerage never actually registers you as an owner of the shares.

Street name registration allows your broker to lend your shares to short sellers, thereby driving down the price of your own stocks. Additionally, this method allows your broker to “re-hypothecate” your assets–meaning it allows your broker to borrow money against your shares and speculate in the derivatives market.

These hidden risks are planting the seeds of tomorrow’s ultimate collapse – In which there may be a system-wide collapse of broker dealers, taking down millions of investors, and ensuring permanent non-recoverable losses to an entire generation!

Too extreme? Maybe. But consider this:

MF Global investors found out first hand just how secure their funds were. Most don’t realize it, but MF Global was a clearing house for both stocks and futures. Like many/most brokerages, they “invest” their own funds, often on a highly leveraged basis, to earn income. But, with the recent collapse of Greek government bonds and with MF Global’s highly leveraged position in them, MF Global was bankrupted in an instant.

The problem is, they tried to cover their losses with their customer’s own funds. You see, unless your shares are registered in your own name – a process that isn’t that difficult or costly – your brokerage considers it as assets they can use for their own needs.

Plus, once a brokerage goes bankrupt (which is something we expect to happen very often over the coming years) if you hadn’t personally registered your shares then your shares go down as assets of the brokerage and are used to pay off their creditors.

In normal times, this does not happen. We are heading into abnormal times.

Some believe their stocks will be protected by the Securities Investor Protection Corporation (SIPC), which insures stocks accounts from broker collapse up to $500k for securities, and account cash balances up to $250k. But what if you have more than $250k in cash and/or more than $500k of securities in your account? What if one of the largest broker dealers in the country went bust, bringing down thousands of accounts and depleting the entire reserves of the SIPC? What if the SIPC itself goes bankrupt? What few people are aware of, is that the SIPC only carries about $1 billion in funds to cover investors! This means only one or two high profile broker dealer bankruptcies will be enough to completely wipe out the SIPC.

Some may claim the US government will bail out the SIPC to whatever extent needed. But what if two major broker dealers went bust while at the same time the US government suffers a major Treasury bond auction failure? This is all but a certainty in the coming years.

And the same thing applies in Canada to Canadian brokerages and Canadian stocks. The Canadian economy is intricately tied to the US. In fact, not many people are aware, but all that backs the Canadian dollar is the US dollar. The Canadian Government sold all its gold decades ago.

There’s lots more to learn here. Read the full article.

Continue Reading on www.resourceinvestor.com

* * * * * * * * * *

For more tips, go here:

http://www.myhighdividendstocks.com/category/tip-of-the-week

TIP OF THE WEEK - Why MF Global went down and how you can protect your life's savings

December 16th, 2011

Jason Brizic

Investment institutions (like MF Global) can legally steal your assets and use your property for their own purposes.  They can do this because you have agreed to let them do this by consenting to their customer agreements.  Read the article below by Austrian economist, Doug French, for a devastatingly clear explanation of what killed MF Global and it customer’s [victims] savings.

Your savings and investments may not be safe in your brokerage accounts depending on the fine print in the agreements you consented to.  Some financial corporations have agreements that allows them to use your assets as their collateral in their bets in the derivatives markets.  Other financial corporation’s only claim to do this with your margin accounts; therefore, standard brokerage accounts and retirement accounts would remain untouched in that situation.

This means that an investor who had $100,000 in a money market account with MF Global could still be wiped out by the MF Global bankruptcy.  Most people think that their brokerage money is safe in money markets, but that is not necessarily the case depending on the customer agreements you entered into.

Action steps:

1)    Go to Google and perform a search using the name of your financial institution plus the word rehypothecation.  The results might scare you.

a.    For example Fidelity rehypothecation yields the following results: http://www.google.com/search?q=fidelity+rehypothecation&rls=com.microsoft:*&ie=UTF-8&oe=UTF-8&startIndex=&startPage=1

b.    Click through a couple of the results until you find someone who dug out the applicable fine print from the customer agreements

2)    If the fine print says anything like what MF Global’s fine print said, then you have a decision to make soon.  You can keep the account or close the account.

“7. Consent To Loan Or Pledge You hereby grant us the right, in accordance with Applicable Law, to borrow, pledge, repledge, transfer, hypothecate, rehypothecate, loan, or invest any of the Collateral, including, without limitation, utilizing the Collateral to purchase or sell securities pursuant to repurchase agreements [repos] or reverse repurchase agreements with any party, in each case without notice to you, and we shall have no obligation to retain a like amount of similar Collateral in our possession and control.”

It isn’t clear to me at this time how the MF Global bankruptcy will be handled by the FDIC and the SIPC (http://en.wikipedia.org/wiki/Sipc).  There are proposals in congress to change what is covered and by how much.  Regardless of the actions of congress, ultimately the FDIC and SIPC are empty promises because they don’t have enough money to insure the assets they claim to insure.  The Federal Reserve would have to hyper inflate the money supply to back their insurance claims.  Doug French addresses this at the end of his article below.

* * * * * * * * * *

MF Global's Fractional Reserves

by Doug French

Recently by Doug French: Who Serves During Disaster?

 

 

 

Jon Corzine told the House Agriculture Committee, "I simply do not know where the money is, or why the accounts have not been reconciled to date." The public is outraged that the former CEO of bankrupt global financial-derivatives broker and prime dealer in US Treasury securities MF Global doesn't know where the missing $1.2 billion in client funds went.

Corzine is the member a few exclusive clubs: he is a Goldman Sachs alum, former US senator, and former New Jersey governor. After the incumbent Corzine was beat by Chris Christie in the 2009 New Jersey gubernatorial race, the MF board probably rejoiced, believing the guy to fix their problems was suddenly available. Now he's in the club of taking a mere 20 months to create the eighth largest bankruptcy in history.

As a stand-alone entity, MF Global was born in 2007 when it was spun off from UK hedge-fund giant, Man Group. MF booked revenues of $4 billion that year from interest earned by using its customers' funds, an operation that sounds like fractionized banking: short-term embezzlement used to make profits.

For banks, the practice was sealed in English common law in 1811 in the court case of Carr vs. Carr, where Master of the Rolls Sir William Grant ruled that debts mentioned in a will included bank accounts since the money had been deposited into the bank and wasn't earmarked in a sealed bag. The deposit was thus a loan rather than a bailment.

The same Judge Grant ruled the same way five years later in Devaynes vs. Noble, despite an attorney's argument that "a banker is rather a bailee of his customer's funds than his debtor … because the money in … [his] hands is rather a deposit than a debt, and may therefore be instantly demanded and taken up."

In 1848, in Foley vs. Hill and Others, Lord Cottenham ruled,

"Money, when paid into a bank, ceases altogether to be the money of the principal; it is then the money of the banker, who is bound to an equivalent by paying a similar sum to that deposited with him when he is asked for it.… The money placed in the custody of a banker to do with it as he pleases."

It's been clear sailing for bankers ever since. No questions asked.

At the same time, people are surprised that a commodity brokerage firm would misplace client assets. As Christopher Elias explains for Thomson Reuters,

"MF Global's bankruptcy revelations concerning missing client money suggest that funds were not inadvertently misplaced or gobbled up in MF's dying hours, but were instead appropriated as part of a mass Wall St manipulation of brokerage rules that allowed for the wholesale acquisition and sale of client funds through re-hypothecation. A loophole appears to have allowed MF Global, and many others, to use its own clients' funds to finance an enormous $6.2 billion Eurozone repo bet."

Free bankers are always insisting that fractional-reserve banking is A-OK, as long as bankers inform depositors up front that the bank will be using their customers' money to make loans and investments.

That is exactly the case with MF Global. The company's customer agreements included the following clause:

7. Consent To Loan Or Pledge You hereby grant us the right, in accordance with Applicable Law, to borrow, pledge, repledge, transfer, hypothecate, rehypothecate, loan, or invest any of the Collateral, including, without limitation, utilizing the Collateral to purchase or sell securities pursuant to repurchase agreements [repos] or reverse repurchase agreements with any party, in each case without notice to you, and we shall have no obligation to retain a like amount of similar Collateral in our possession and control.

Back in 2007, customer funds held by MF as collateral against commodities trades could be invested in two-year Treasuries earning north of 4.5 percent. But in the wake of the '08 meltdown, the Bernanke Fed has flattened yields to be counted in basis points. With these low rates MF Global revenues fell to $517 million in 2010.

The old bond trader Corzine thought he could juice up MF's earnings with a little financial razzle-dazzle. Thinking outside the box (and off the balance sheet), Corzine moved $16.5 billion in assets into repos. A repo involves putting up assets as collateral, assets to be repurchased later, and borrowing money against those assets. MF used an off-balance-sheet repo called a "repo-to-maturity" where the loan and the collateral in the transaction have the same maturity. US accounting rules consider the transaction a sale and the assets can be moved off the balance sheet.

Most of these assets were bonds from Italy, Spain, Belgium, Portugal, and Ireland, all paying healthy coupon rates that would easily cover the repo interest rate and provide a nice profit. MF Global would have virtually no skin in the game (their customers provided it) and be earning a nice interest-rate spread.

Although things have been rocky in euroland, the collateral value of the short-term bonds appeared safe with the guarantee provided by the European Financial Stability Facility (EFSF).

With the $16.5 billion in assets moved off its balance sheet, MF Global then ramped up a net-long sovereign-debt position of $6.2 billion on its balance sheet – exposure that was five times the company's net worth.

While the EFSF guarantee would insure against the default of the sovereign debt if the bonds were held to maturity, MF was still at risk to make margin calls, if the bonds dropped in price day-to-day. Elias writes,

"Like Wall Street cocaine, leveraging amplifies the ups and downs of an investment; increasing the returns but also amplifying the costs. With MF Global's leverage reaching 40 to 1 by the time of its collapse, it didn't need a Eurozone default to trigger its downfall – all it needed was for these amplified costs to outstrip its asset base."

So while MF Global's eurozone bets had not defaulted, the company's liquidity was drained making margin calls and trying to meet short-term-debt obligations as the euro-crisis news flow out of Europe vacillated.

MF Global was able to leverage up its euroland bets by way of the rehypothecation of their clients' collateral. Hypothecation is pledging collateral for a loan. Like the mortgage on your house.

Customers of MF posted cash, gold, or securities as collateral to backstop their commodity futures and derivatives trading. MF would then take those customer assets to back its own trades and borrowing. Mr. Elias explains, "The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations much to the chagrin of hedge funds."

Under US rules, a prime broker is allowed to rehypothecate assets to the value of 140 percent of the client's liability to the broker. The rules are more liberal in the United Kingdom, where there is no limit and in many cases UK brokers rehypothecate 100 percent of collateral value placed in their custody.

Elias writes that by 2007, rehypothecation was half the shadow banking system.

"Prior to Lehman Brothers' collapse, the International Monetary Fund (IMF) calculated that U.S. banks were receiving $4 trillion worth of funding by re-hypothecation, much of which was sourced from the UK. With assets being re-hypothecated many times over (known as 'churn'), the original collateral being used may have been as little as $1 trillion – a quarter of the financial footprint created through re-hypothecation."

All of this churning has created rivers of liquidity, much of it with no asset backing. And what assets do provide backing aren't the quality they used to be. The repo rules were liberalized in the Clinton era. So instead of AAA government paper being required, AA sovereign debt works just fine; after all, as James B. Stewart writes for the New York Times:

"The law also allows commodities firms like MF Global to use segregated customer funds as a source of low-cost financing for their own operations, but they are required to replace any customer assets taken from segregated accounts with supposedly ultrasafe collateral of the same value, typically United States Treasuries, municipal obligations and obligations whose payments of principal and interest are guaranteed by the government." [emphasis added]

Of course all this rehypothecating creates mountains of counterparty risk, all dependent on dubious collateral that has been pledged multiple times. The equivalent of having four mortgages on a house, each having been sold to other parties who have been told their mortgage is in first position. When the property value starts dropping or the borrower doesn't pay, only one lender will get there first and legal fistfights ensue.

This rehypothecation activity may be the biggest credit bubble of all time, according to Elias. J.P. Morgan alone has rehypothecated over half a trillion dollars in 2011, Morgan Stanley $410 billion, Goldman Sachs $28 billion, and the list goes on.

Americans have been told US banks have little exposure to European sovereign debt, but according to the Bank for International Settlements (BIS), US banks hold $181 billion in the sovereign debt of Greece, Ireland, Italy, Portugal, and Spain. And while Germany is considered the belle of the Continental ball, Grant's Interest Rate Observer reports that Deutsche Bank is levered at 43:1 and the Bundesbank has doubled its leverage since 2007 when it was geared at 75:1 – these days the central bank is levered at 153:1.

Extreme leverage is a problem if the slightest thing goes wrong – anywhere. When the cost of swapping euros for dollars soared at the end of last month, a coordinated central-bank cavalry charged out of nowhere, cutting swap rates and establishing temporary bilateral-liquidity swap arrangements. Nobody but financial news junkies seemed to know or care.

The truth about the financial crash wasn't known until Bloomberg chased its request for information all the way to the Supreme Court to obtain documents that shed light on how much dough the Federal Reserve really provided the banks during the 2008 meltdown.

For instance, it turns out Wachovia shareholders got lucky as the bank was floated a secret loan from the Fed of $50 billion to keep the doors open while a sale could be arranged with Wells Fargo for $7 a share rather than shareholders having to take the buck-a-share offer from the wounded Citibank.

"This deal enables us to keep Wachovia intact and preserve the value of an integrated company, without government support," Wachovia's chief executive Robert Steel said at the time.

Right, no government support at all.

Instead of being among the bailed out, Corzine and MF Global are now joining Lehman, IndyMac, Colonial, and all the small-fry banks lacking the friends in high places needed to keep them afloat. In the fractional-reserve world, markets don't decide the winners and losers; government does.

Stewart writes for the NYT, "SIPC will replace up to $500,000 of securities and cash (but not futures contracts) missing from customer accounts at member firms," and the notion of even covering futures accounts has been floated on CNBC by Senator Debbie Stabenow, just as the FDIC replaces deposits up to $250,000. But covering the losses of clients and depositors is hardly the reflection of sound capitalism and the honoring of property rights.

Murray Rothbard wrote,

"If no business firm can be insured, then an industry consisting of hundreds of insolvent firms is surely the last institution about which anyone can mention 'insurance' with a straight face. 'Deposit insurance' is simply a fraudulent racket, and a cruel one at that, since it may plunder the life savings and the money stock of the entire public."

So it's unlikely Jon Corzine knows where the $1.2 billion in customer money went any more than the president of a failed bank would know exactly where the customer deposits went.

The bigger issue is that, day by day, Mr. Corzine looks to be merely a canary in the fractional-reserve coal mine.

Reprinted from Mises.org.

December 15, 2011

Doug French [send him mail] is president of the Ludwig von Mises Institute and the author of Early Speculative Bubbles & Increases in the Money Supply. He received the Murray N. Rothbard Award from the Center for Libertarian Studies. See his tribute to Murray Rothbard.

* * * * * * * * * *

Link to the article on LewRockwell.com: http://lewrockwell.com/french/french143.html

For more tips of the week click here: www.myhighdividendstocks.com/tip-of-the-week