The Hutch Report

The joy of earning billions…and paying no taxes!

By | Finance, Politics

Our previous article focused on the ways in which companies are moving away from generally accepted accounting principles (GAAP) and towards non-GAAP adjustments in order to manipulate their balance sheets in a way that suits them best. 

These new methods of clever accounting have far ranging effects as we have seen, in spite of new tax laws set up by the Trump administration, corporate tax avoidance remains rampant. 

According to a new report by the “Institute on Taxation and Economic Policy,” it was found that 60 profitable Fortune 500 companies managed to avoid all Federal Income Taxes in 2018. The companies that managed to avoid paying the taxes were not distinct to one segment of the economy but represented a wide range of segments. 

Included in the report were examples such as computer maker International Business Machines (IBM) which earned $500 million in U.S. income and received a federal income tax rebate of $342 million. The retail giant Amazon reported $11 billion of U.S. income and claimed a federal income tax rebate of $129 million. The streaming service Netflix paid no federal income tax on $856 million of U.S. income. Beer maker Molson Coors enjoyed $1.3 billion of U.S. income in 2018 and received a federal income tax rebate of $22.9 million. Automaker General Motors reported a negative tax rate on $4.3 billion of income.

60 Companies Avoiding All Federal Income Taxes in 2018

U.S. Income and Federal Tax figures in millions of dollars.
Company U.S. Income Federal Tax Effective Tax Rate Industry
Activision Blizzard
Computers, office equip, software, data
AECOM Technology
Engineering & construction
Alaska Air Group
Retail & wholesale trade
Utilities, gas and electric
American Electric Power
Utilities, gas and electric
Miscellaneous services
Arrow Electronics
Retail & wholesale trade
Arthur Gallagher
Atmos Energy
Utilities, gas and electric
Avis Budget Group
Motor vehicles and parts
Oil, gas & pipelines
Cliffs Natural Resources
Oil, gas & pipelines
CMS Energy
Utilities, gas and electric
Industrial machinery
Delta Air Lines
Devon Energy
Oil, gas & pipelines
Dominion Resources
Utilities, gas and electric
DTE Energy
Utilities, gas and electric
Duke Energy
Utilities, gas and electric
Eli Lilly
Pharmaceuticals & medical products
EOG Resources
Oil, gas & pipelines
Utilities, gas and electric
Publishing, printing
General Motors
Motor vehicles and parts
Goodyear Tire & Rubber
Motor vehicles and parts
Oil, gas & pipelines
Honeywell International
Industrial machinery
International Business Machines
Computers, office equip, software, data
JetBlue Airways
Kinder Morgan
Oil, gas & pipelines
MDU Resources
Oil, gas & pipelines
MGM Resorts International
Miscellaneous services
Molson Coors
Food & beverages & tobacco
Retail & wholesale trade
Occidental Petroleum
Oil, gas & pipelines
Owens Corning
Miscellaneous manufacturing
Penske Automotive Group
Motor vehicles and parts
Performance Food Group
Retail & wholesale trade
Pioneer Natural Resources
Oil, gas & pipelines
Pitney Bowes
Computers, office equip, software, data
Utilities, gas and electric
Principal Financial
Prudential Financial
Public Service Enterprise Group
Utilities, gas and electric
Miscellaneous manufacturing
Miscellaneous services
Rockwell Collins
Aerospace & defense
Ryder System
Computers, office equip, software, data
Retail & wholesale trade
Industrial machinery
Tech Data
Retail & wholesale trade
Trinity Industries
Miscellaneous manufacturing
Utilities, gas and electric
United States Steel
Metals & metal products
Electronics, electrical equipment
Wisconsin Energy
Utilities, gas and electric
Xcel Energy
Utilities, gas and electric
Source: Institute on Taxation and Economic Policy analysis of SEC filings 

The loop holes and tax breaks used by these companies are varied and range from accelerated depreciation, stock options, and energy tax subsidies to name just a few. 

One of the most egregious loopholes in the tax code, known as the stock option loophole, allows companies to deduct millions or billions from their taxable income for compensating executives in the form of stock options. Corporations can take these deductions even though granting stock options costs them nothing. 

In a report produced in 2016, Citizens for Tax Justice (CTJ) reviewed five years of corporate filings and found this loophole allowed companies to annually avoid an average $13 billion in taxes. It should also be highlighted that the average sum corporations are currently avoiding could be understated because not all corporations report information about stock options.

The ITEP report also pointed this out as they stated, “In many cases, the company’s disclosures don’t fully clarify which tax breaks were used.“ Therefore, analysis of the balance sheet does not always lead to the true picture of a companies financial health. 

“All data cited in this report come from the 10-K annual financial filings published by these companies. In many cases, the company’s disclosures don’t fully clarify which tax breaks were used. For example, Chevron’s annual report for 2018 discloses that unspecified “tax credits” reduced the company’s income taxes by $163 million.”

They go on to say that despite these companies managing to avoid paying their share of taxes, there is nothing illegal about what they are doing. They are simply taking advantage of legal tax breaks that have been provided to them in order for them to shelter a large portion of their earnings from Federal taxes. There are, however, a number of moral and ethical questions that can be raised. 

If these companies are to be reigned in the only true change will come from sustainable tax reform which only the government can accomplish. The big problem facing the government as an institution is as the years pass, the debt and deficits grow, the working population pays a larger and larger portion of taxes as the public’s confidence in elected officials continues to weaken. 

The Hutch Report

Mind the GAAP!

By | Finance, Markets

With the earnings season upon us we now go through the same dog and pony show. Companies report earnings, then the success of those earnings are based mainly on whether or not they beat consensus analyst’s estimates. Curiously enough, many often beat by one penny. What methods do they possibly use to beat by a penny per share? 

Prior to earnings, analysts tend to be busy estimating what earnings they think will be reported. Their estimates are based on guidance from the company itself, economic conditions and their own independent models and valuation techniques.

Companies prepare their accounting using generally accepted accounting principles, also referred to as GAAP. GAAP, are a set of rules that encompass the details, complexities, and legalities of business and corporate accounting. GAAP are controlled by the Financial Accounting Standards Board (FASB), a non-governmental entity. The FASB creates specific guidelines that company accountants should follow when compiling and reporting information for financial statements or auditing purposes. GAAP is not law, and there is nothing illegal about violations of its rules unless those violations happen to coincide with other laws. Today, all 50 state governments prepare their financial reports according to GAAP. While a little less than half of them officially require local governments to adhere to GAAP.

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However, more and more, companies are finding that by following a standardized set of GAAP rules, their earnings often come out less than attractive. So, over the years corporate accountants have become more and more creative through the use of “non-GAAP” methods to improve their bottom lines. 

A study published by Audit Analytics noted that 96 percent of S&P 500 companies used non-GAAP measures in earnings releases during the fourth quarter of 2016. In addition, a study published by FactSet indicated that for the first quarter of 2017, 63 percent of the companies in the Dow Jones Industrial Average reported non-GAAP earnings per share and that, on average, the difference between the GAAP and non-GAAP earnings per share was approximately 54 percent. The most common adjustments were found to be restructuring charges, acquisition-related items, stock compensation costs, and, to a lesser extent, debt costs and legal costs. 

As companies battle to present themselves as profitable, non-GAAP measures are becoming the norm as the disparity between GAAP and non-GAAP results grows larger and larger. So if you think you are going to get the true story from a company’s statements or earnings reports, think again. 

Off-balance sheet financing is another method of non-GAAP financial engineering. A business tries to keep certain assets and liabilities off its balance sheet in order to present to the investment community a cleaner balance sheet than would otherwise be the case. It does so by engaging in transactions that are designed to shift the legal ownership of certain transactions to other entities. The transactions are designed to sidestep the reporting requirements of the applicable accounting framework, such as GAAP or IFRS. So, therefore, considered non-GAAP.

Off-balance sheet financing played an important role in the Lehman Brothers bankruptcy. Through the use of off-balance sheet entity ‘Repo 105’, Lehman was able to move $50 billion of debt off of their balance sheet, making them appear more financially stable before the end of the quarter. Since it was classified as a repurchase agreement, it was ‘bought back’ after the reporting period. When the debt was originally moved off-balance sheet, the bank recorded the debt as a ‘sale’ and booked the $50 billion as revenue. This type of accounting manipulation contributed to the largest bankruptcy in U.S. history, wiping out the life savings of thousands of employees of the bank. 

Adjusted EBITDA is another non-GAAP financial measure that has gained a lot of popularity. Speaking on Jim Grant’s Current Yield Podcast, Adam Cohen, founder of Covenant Review, stated, “Some version of adjusted EBITDA is quite common, but we are seeing things turn into absolute fantasy land.” He took a recent example using the company WeWork, currently valued at roughly $47 Billion, with a stated annualized revenue of $2.5 billion. Cohen explained that the WeWork 2017 income statement started with a net loss of $933 Million. Once they got themselves to adjusted EBITDA, they reduced that to a loss of $193 Million, however since they wanted to sell a bond yield, this wasn’t good enough, so they invented something called “adjusted EBITDA before growth investments” but that still wasn’t good enough, so they invented a third version called “Community adjusted EBITDA,” which at what point they achieved a positive $233 Million community adjusted EBITDA. That is a $1.1 Billion swing from net loss to profit, which is more than the amount of revenues they booked that year. 

As an update to this example, the Financial Times just reported on March 26th, 2019, “WeWork bond prices slipped on Tuesday after the provider of shared office space said that its losses had more than doubled from a year earlier, as the company ploughed money into a breakneck expansion that has captivated the real estate industry.”

So, as a word of caution to those investing in the next potential Lehman, as all these fairy tale companies go public, and as the earnings season takes off,  “MIND THE GAAP.”

The Hutch Report

The Fate of Blockchain

By | Cryptocurrency, Finance, Technology

Nasdaq reported today that they are investing in blockchain technology, and pushing for crypto and blockchain adoption. According to an official press release, Symbiont successfully closed a $20m Series B funding round. Nasdaq Ventures led the round which also included investors such as Mike Novogratz’s Galaxy Digital, Citi and Raptor Group among others.

Adena Friedman, President, and CEO of Nasdaq commented, “It is difficult to ignore the huge amount that investors, including some of the most sophisticated global investors, have poured into digital currencies in recent years. The invention itself is a tremendous demonstration of genius and creativity, and it deserves an opportunity to find a sustainable future in our economy …

At Nasdaq, we are working to help cryptocurrencies gain investors’ trust by offering our technology for trade matching, clearing, and trade integrity to start-up exchanges. We have also invested in ErisX, an institutional marketplace for cryptocurrency spot and futures. While this year will be another proving ground for cryptocurrencies, we believe digital currencies will have a role in the future. The extent of its impact will depend on the evolution of regulation and broader institutional adoption.”

The MIT Technology Review recently stated that the blockchain will become more useful, however, they also believe that blockchains will start to become boring this year. After the Great Crypto Bull Run of 2017 and the monumental crash of 2018, blockchain technology won’t make as much noise in 2019.

The blockchain enthusiasts are still working towards gaining world adoption for the technology, however as often cited, the level of investment into the technology should not be taken as a sign of its inevitable success. If that were the case the fate of so many grandiose startups in the 1999 – 2000 boom would have turned out quite different considering the level of investment that went into many of them. A leading venture capitalist told me once, “the graveyard is littered with many brilliant technologies.”

If google trends is any indication then interest in bitcoin and blockchain have been declining, or at least for the moment.

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On this past Wednesday, January 23, 2019, VanEck, the firm that had sought SEC’s approval to trade Bitcoin ETF on the CBOE exchange, withdrew its application. Analysts and crypto followers believed that the launch of a regulated Bitcoin ETF would attract billions of dollars in investments and saw these initial moves as a positive step towards global adoption. Yet, now that they have withdrawn their application, the news is being spun as something positive for the crypto industry, or at least according to NewsBTC

As the great baseball-playing philosopher, Yogi Berra once said, “It’s tough to make predictions, especially about the future.” Nassim Taleb views those trying to predict the future as simply “charlatans.” The problem is that almost all forecasters work within the parameters of the Gaussian bell curve, which ignores large deviations and thus fails to take account of “Black Swans”. Taleb defines a Black Swan as an event that is unexpected, has an extreme impact and is made to seem predictable by explanations concocted afterwards. It can be both positive and negative. 

One of these so called deviations could be the advances of Quantum Computing, as we previously wrote about here, or it could be something not yet determined. 

The simple fact is that you have two groups — interested participants and non-interested participants. The interested participants will keep investing time and funds in order to realise the original objective of creating a decentralised peer-to-peer network where no single institution or person controls it. The non-interested participants will only adopt the technology once they believe it is in their advantage to do so and it becomes as simple as handing a friend a dollar bill.


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The New Economic Hitmen

By | Economics, Finance, Politics

John Perkins original book, “Confessions of an Economic Hitman” and his current book, “New Confessions of an Economic Hitman” brought to light some of the strategies the US has used over the years in order to gain control of foreign reserves that American companies may want to seize, such as oil. 

According to Perkins, the method of achieving this end was to use external consultants such as the one he worked for. They would arrange large loans for those countries via the World Bank and its partner organizations. However, the governments in question never received the money. Instead, the money would be transferred, directly or indirectly, to American companies, including construction firms like Halliburton or suppliers like General Electric. These American entities would then launch infrastructure projects which may have included power grids, or industrial parks and highways. These projects generated huge profits. However, not surprisingly, those profits went to the American companies and a few rich local familes. In the end, these countries that were already weighed down by huge debts just saw their debts grow larger, which in turn pressured the already poor and middle class. 

Typically, a developed country with a dictator that sits on a perch makes for a soft target. Dictators are often propped up by failed systems like corrupt police force and military. They are usually the most eager to redeem their images so if you can take photos with them signing agreements about huge infrastructure projects it will help soften their soily images.  Therefore, they are happy to stand on the podium and tell their ill-informed, semi-literate populace about the development the government is bringing to their country. 

As an example, in the 70s, large loans were provided to build a power grid in Panama. The real goal was to force the then Dictator Omar Torrijos into a situation where he owed the US a lot of money in order to have something to blackmail him with because at that point, his bankrupt country would be beholden to them. As Africans would say, you hold both the yam and the knife. In 1977, Torrijos signed a deal with the US, which guaranteed that the government of Panama would have full control of the Panama Canal starting 1999. In 1981, he was killed in a car crash.

Omar Torrijos

Looking at the situation today with the number of sanctions and tariffs being thrown around one has to wonder who the principle targets of the current administration are. Russia? The truth is, Russia and the US have been playing spy games on each other for years. The real targets are the emerging economies. “I have no doubt that there are economic hitmen targeting emerging economies like Turkey’s,” Perkins said in an interview to the Turkish based Anadolu Agency. But Turkey is not the only country where the US has imposed sanctions and tariffs. Currently, sanctioned countries include the Balkans, Belarus, Burma, Cote D’Ivoire (Ivory Coast), Cuba, Democratic Republic of Congo, Iran, Iraq, Liberia, North Korea, Sudan, Syria, and Zimbabwe.

In today’s globalised world economic hitmen are no longer only US based. Today they may come from any number of other countries, including Russia and China. Globalisation has created huge opportunities for economic hitmen around the planet.

Trump’s administration sees infrastructure as one of the key areas to boost US economy. However, the recently published Infrastructure plan has been criticised for lack of money and is highly dependent on private capital. The US is already running large deficits and the national debt now currently stands at $21.8 trillion. 

China, with its strong infrastructure achievements and the largest amount of foreign exchange reserves (China has by far the largest foreign currency reserves with over two and a half times more than the second largest reserve holder, Japan. When China and Hong Kong reserves are considered together, the total is $3.6 trillion), is constantly looking for low-risk long-term investment projects to achieve asset preservation and appreciation. By targeting the US, China could balance its foreign exchange levels while accelerating the rejuvenation of American infrastructure. This would also transform China into a job creator in the US. 

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The Hong Kong–Zhuhai–Macao Bridge, 55 kilometres long.

China is currently employing this strategy throughout Africa along with their One Belt, One Road initiative. China has been the largest trading partner of Tanzania for many years with some 350,000 Tanzanians doing jobs related to trade with China. Also Chinese companies have built a number of mega projects in Tanzania, including roads and bridges, creating about 150,000 jobs. 

Interestingly, on his last trip to the continent just before being replaced, Rex Tillerson said that African countries should be careful not to forfeit their sovereignty when they accept loans from China, the continent’s biggest trading partner.

Would Trump be open to outsourcing the development of the US infrastructure to Chinese firms? The short term boost to Trump’s reputation may blind him to the longer term complications. Could the US itself become a target of the economic hitmen?

The Hutch Report

The Deadly Market Sin – Complacency

By | Finance

What may go wrong if you are right?

The debate around the stock market’s performance continues to rage on. On one side the argument is that the market gains are justified because of explosive company earnings, Trump’s tax cuts or that the US markets are the only game in town. The competing view is that nothing has been fixed since 2007 and this is just all makeup on a pig. Low interest rates and company buybacks are fueling the drive for better returns. It is believed that it is all a slow motion train wreck ready to collapse. 

The purpose of this piece is not to add anything new to the debate but to highlight some issues that could arise in the event of the return of extreme volatility. Bear and Bull calls that appear initially correct could suddenly violently flip in a second as any number of unforseen events suddenly appear out of nowhere. Understanding historically how some of these events have been brought on may help dampen any future surprises.

The collapse of the Internet bubble, perhaps one of the largest financial fiascoes in U.S. history, came after a three-year period, starting in January 1997, when investors would buy almost anything even vaguely associated with the Internet, regardless of valuation. Investors ignored huge current company losses and were willing to pay 100 times expected earnings in fiscal 2002. They were provoked by bullish reports from sell-side securities analysts and market forecasts from IT research firms, such as IDC, Gartner and Forrester Research.

There are many of us who were around during the dot com bubble of 1999 to 2001 and lived the collapse of so many high flying overvalued stocks with huge cash burns and no profitability. The claim at the time was that it was a “new world.” Profitability did not matter. Eye balls mattered. As long as you had large traffic flows to your site you could worrry about profitability later.

All this activity did influence the economy and everything was firing on all cylinders. This held true for a while as long as investors kept throwing money at these wild west startups. The day the financing dried up, so did the company’s prospects of continuing as a going concern. The darlings of the day including,,, GeoCities,, or all but disappeared. This meant that these and thousands of companies like them ran out of cash and fired all their employees.  

Even if you are paying attention and think you understand the valuations you may be mistaken. The problem today is that companies and accountants are coming up with all kinds of clever ways to mask the true financial state of a company. This means that more and more professional and individual investors are not looking deeply enough into the details, as it takes more and more effort. Besides, it is not in reason to have to become an accounting forensic scientist just to figure out a company’s profitability. 

Jim Grant’s excellent “Current Yield Podcast” highlights the current environment of financial reporting in his show “Read the Footnotes,” and “Loan Sharks,” where for example they discuss how WeWork came up with different adjusted EBITA to suit their purpose. Fundamental analysis is usually how financial analysts make their judgements on a stock. If the company beats the analysts estimates it could rise considerably. If that analysis is flawed then the stocks are moving on false premises. Eventually stocks will always revert to their fundamental values, which indeed they did in 2001 to 2003.

What does this have to do with today’s market? A new report by the Wall Street Journal highlighted that a record number of IPOs, or 83% of US listed IPOs over the first three quarters of 2018, were companies that lost money in the 12 month prior to their going public. However, there are still many more that appear to have impressive balance sheets until their true financial state is exposed. Lurking within the financial statements and communications of public companies is a troubling trend. Alternative metrics, once used sparingly, have become increasingly ubiquitous and more detached from reality.

In 2011, Groupon Inc. announced plans for a highly anticipated initial public offering. But enthusiasm for the offering waned when the U.S. Securities and Exchange Commission (SEC) issued a comment letter questioning Groupon’s use of a profit metric it called “adjusted consolidated segment operating income.” It was believed that no company had ever used that metric before; it was intended to measure operating profit without including marketing expenses, stock-based compensation, and acquisition-related costs. Management argued that a $420 million loss from operations reported on its 2010 income statement should really be considered a $60 million gain.

The financial crisis of 2007-2008 that led to a decline in stocks was different. It began in 2007 with a crisis in the subprime mortgage market in the United States, fuelled by the Fed, and developed into a full-blown international banking crisis with the collapse of the investment bank Lehman Brothers on September 15, 2008. Excessive risk-taking by banks such as Lehman Brothers helped to magnify the financial impact globally.

When this crisis hit and volatiliy exploded so did trading volumes. We remember trading on a few different plaftorms during this period only to see them seize up from the volumes daily. You could be correct on a trade but find yourself not able to get out. 

Then this showed up:

SEC Halts Short Selling of Financial Stocks to Protect Investors and Markets

Commission Also Takes Steps to Increase Market Transparency and Liquidity



Washington, D.C., Sept. 19, 2008 — The Securities and Exchange Commission, acting in concert with the U.K. Financial Services Authority, took temporary emergency action to prohibit short selling in financial companies to protect the integrity and quality of the securities market and strengthen investor confidence. The U.K. FSA took similar action yesterday.

They changed the rules of the game. A large number of traders were caught holding short positions in financial stocks having to scramble to get out of them. A massive short squeeze erupted. 

Just when investors and traders had positioned themselves for larger gains on the short side, the Fed stepped in with extraordinary monetary policy adjustments which included never before seen bailouts. Investors that never fully understood the old adage “don’t fight the Fed” paid dearly. 

Readers may be aware of some of these facts but it is essential to highlight that even though you may be correct in your trading or investment decisions and thesis, you are working with a dynamic system that has the leverage to change the rules to its advantage. Many of these adjustements could put the trader and investor at an extreme disadvange. We advise you to listen to the RealVision interview with Marc Cohodes as his experience with Goldman Sachs during this time illustrates this perfectly. 

In 1971 the New York Stock exchange incorporated as a non-profit. The change to for profit status was organizational and the result of a transaction first approved in April 2005 by the New York Stock Exchange governing board. In March 2006 the New York Stock Exchange, a non-profit corporation, merged with Archipelago Holdings, Inc. into a new organization NYSE Group, Inc. as a publicly traded and for-profit company.  In April 2007 the company in a stock swap transaction combined with Euronext, the European stock exchange, becoming NYSE Euronext.

Interestingly enough, we began to see the advent of high frequency trading. One of the ways exchanges such as the NYSE make money are by allowing big-deal firms to install their computers closer to the actual exchange, so their electronic trade requests will arrive milliseconds earlier than competitors. High frequency and algorithmic trading now accounts for a very large percentage of total exchange trading volume.

The May 6, 2010, Flash Crash, also known as the Crash of 2:45, the 2010 Flash Crash or simply the Flash Crash, was a United States trillion-dollar stock market crash, which started at 2:32 p.m. EDT and lasted for approximately 36 minutes. 

The Chief Economist of the Commodity Futures Trading Commission and several academic economists published a working paper containing a review and empirical analysis of trade data from the Flash Crash. They concluded the following:

“Based on our analysis, we believe that High Frequency Traders exhibit trading patterns inconsistent with the traditional definition of market making. Specifically, High Frequency Traders aggressively trade in the direction of price changes. This activity comprises a large percentage of total trading volume, but does not result in a significant accumulation of inventory. As a result, whether under normal market conditions or during periods of high volatility, High Frequency Traders are not willing to accumulate large positions or absorb large losses. Moreover, their contribution to higher trading volumes may be mistaken for liquidity by Fundamental Traders. Finally, when rebalancing their positions, High Frequency Traders may compete for liquidity and amplify price volatility.”

Traders and investors that still believe that we have free markets may get a rude awakening. Aside from the famous flash crash, we are still not able to forecast how these algorithm trading bots will react in the case of a market event or Black Swan. 

So as an investor or trader you may be holding a short position or long position and be correct in your analysis only to find the profitable company you have been invested in has just declared bankruptcy, or have your trading platform seizes up under the massive volume hitting the markets due to a shock to the market, rendering you helpless, have your brokers suddenly adjust all margins putting you at a severe disadvantage, have the Fed step in with a nuclear option not yet known, have the SEC ban short selling or suddently watch in horror as prices tank as most of the market’s liquidity disappears because a number of large program trading algorithms have been turned off. Complacency in these markets in any form can be deadly. 

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The Ghostly Budget

By | Economics, Finance, Politics

It appears that the dark halls of the US Military Complex could teach Trump, Cohen and Manafort  a few things about shadow budgets and hiding money.

Anybody reading this may have come across a story that grazed a few pages a year ago. However, surprisingly it didn’t seem to make more noise among the public than it did at the time. The story involved some unsupported adjustments, or spending by the US army that amounted to roughly $21 trillion. That number is not a typo. If true, it would mean that the US army had spent an unauthorized amount that would equal the current sum of the national debt. Even though the story may not have created a very large public disturbance, it did put a few people in the Pentagon into action. We wanted to find out where the trail was leading. 

For those not familiar with the case, it all started when Dr. Mark Skidmore, a PH.D. in economics and Professor and Morris Chair in State and Local Government Finance and Policy at the Michigan State University, was listening to an interview with Catherine Austin Fitts, former assistant secretary of Housing and Urban Development. In the interview as Skidmore explained “Fitts refered to a report that had come out in 2016 by the Office of the Inspector General (responsible for providing some accountability and tracking of financial activity of the Federal Government).” The report indicated that in fiscal 2015, the US army (with a budget of roughly $122 billion) had adjustments of $6.5 trillion. Because of Dr. Skidmore’s experience and knowledge base, he had some serious doubts about the quoted figure and assumed they must have meant $6.5 billion. He looked at the report himself and to his surprise found that it was not an error. 

This prompted Dr. Skidmore to suggest to Fitts to investigate the issue further.  So during the summer, two MSU graduate students searched government websites, especially the website of the Office of Inspector General (OIG), looking for similar documents dating to 1998. What they found was far beyond what they expected to find. They found documents indicating a total $21 trillion in undocumented adjustments over the 1998-2015 period, of which $11 trillion were directly linked to the US Army.

Dr. Skidmore’s work was able to show that there was something very broken within the budget process. By October 5, 2017 they suddenly discovered that the link to the original OIG report “Army General Fund Adjustments Not Adequately Documented or Supported” of July 26, 2016 had been disabled. Within several days, the links to other OIG documents that had been identified in their search were also disabled. However, Dr. Skidmore and his team had the foresight to copy the July 2016 report and all other relevant OIG-reports in advance and re-post them (The original government documents and a report describing the issue can be found here).

On December 7, 2017, Pentagon officials announced that the Defence Department was beginning the first agency wide financial audit in its history, 

By June 2018, Dr. Skidmore wrote the following update:

“In late May 2018, a graduate student at Michigan State University found on the OIG website the most recent report for the DoD, which summarizes unsupported adjustments for fiscal year 2017. However, this document differs from all previous reports in that all the numbers relating to the unsupported adjustments were redacted. That is, all the relevant information was blacked out.”

So is this situation just over exaggerated with hyperbole and blacked out documents for more dramatic effect? Governmental departments are extraordinarily inefficient organizations. It often requires a number of documents to be signed off before one can order some additional pencils. 

Could such an inefficient department have the smarts and tools to be able to disguise such a massive amount of money from the taxpayers eyes? Well here are some other incidents which shows they never stop short of giving it their best try. 

December 5, 2016, The Washington Post reported that the Pentagon had buried an internal study that exposed $125 billion in administrative waste in its business operations amid fears Congress would use the findings as an excuse to slash the defence budget.

February 5, 2018, a leading accounting firm said in an internal audit obtained by POLITICO, that one of the Pentagon’s largest agencies couldn’t account for hundreds of millions of dollars’ worth of spending, (curiously just as President Donald Trump was proposing a boost in the military budget.)

On August 13, 2018, President Donald Trump signed a military budget boosting the Pentagon’s spending by $82 billion in the next year—a spending increase that dwarfs the entire military budgets of most other nations on Earth. (Russia, for example, will spend an estimated $61 billion on its military this year). With the increased spending included in this year’s National Defense Authorization Act (NDAA), the Pentagon will get to spend more than $700 billion next year. The budget hike was a priority for Trump and was approved by Congress as part of a March spending deal that saw spending on both defense and domestic programs hiked by about $165 billion—smashing through Obama-era spending caps.

On September 17, 2018, it was reported that the Pentagon had massively overestimated, for the second fiscal year in a row, how much its new retirement system would cost.

All that is required is a quick search of the Pentagon and their funding requirements to discover that this is a game that has gone on for a long time. There seems to be a budget for some and a black budget for others in the government.  In the end, it is the taxpayers that are flipping the bill for all the spending. In a Dec. 8 Forbes column that he co-authored with Laurence Kotlikoff, Skidmore said the “gargantuan nature” of the undocumented federal spending “should be a great concern to all taxpayers.”

The fact that these previous reports along with the revelations of Dr. Skidmore and Catherine Austin Fitts have not caused people to become enraged is surprising. This just seems to show that the general public view towards the current levels of greed and corruption are still complacent.  Although the US dollar as a reserve currency may allow the government to get away with many of their spending habits and shadow budget operations for the moment, the day it’s removed will cause some serious repercussions. 

We can already see many signs of the international community getting frustrated with strong arm tactics by the US and adjusting appropriately in order not to be held hostage anymore by the US dollar reserve status.

Reuters recently reported, 

“The U.S. dollar’s share of currency reserves reported to the International Monetary Fund fell in first quarter of 2018 to a fresh four-year low, while euro, yuan and sterling’s shares of reserves increased.” 

It is no longer a matter of if, but when.

The Payments War: Who will the winner be?

By | Economics, Finance, Technology

When mentioning Payments War, some people think of Shopping Wars and fist fights at Walmart on Black Friday. This article is not about that. The Payments Wars are actually multiple wars. A war on cash. A war for your shopping behavior and data. A war for your wallet. These wars are raging both online in the digital world as well as offline in the analog world and the two worlds are converging as combatants vie for cashless digital transactions for offline payments. Why should you care? Every time you buy something, whether you like it or not, it is over you and your data for which the battle is being fought. Your payment behavior and your payment data is what they are after. How will you pay and which platforms will be used? Will that be cash, credit card, debit, PayPal/Venmo, Square, Bitcoin and other cryptocurrencies, Apple Pay, Samsung Pay, Amazon one-click payments, Visa, Mastercard, Discover, Amex or even a credit line offered at the time of checkout?

The Hutch Report

Many may not realize this war going on right before their eyes each and every day as they buy their coffee, their lunch, their gas, groceries, electronics and anything else. And it has been going on for a long time. The winner wants to be the master of how consumers pay for things. As hinted above, the reasons are several-fold. One is, that at scale, there is money to be made processing payments and slicing a few cents or more off of each transaction which amounts to massive amounts at scale. To put this in some context here were the quarterly revenue volumes reported by a few of the combatants in the summer of 2018

A 2017 report by Statista estimates that total payments revenues, which were 1.6 trillion US dollars in 2016 will reach 2.2 trillion US dollars by 2021. That is what the processors are earning on payments. The overall payments volume, what PayPal calls TPV or Total Payment Volume, is a much higher amount.

These massive volumes of payments occur each day online, in stores around the world, at market places, peer to peer, travel and transportation, domestic services, credit payments, business to business payments, cross border and international payments… in other words, there is a lot. We were unable to find exact figures for the total value and number of transactions comprising annual payment volumes including cash and non-cash world-wide, but you can easily see that this number is easily in the trillions. Effectively it would probably be very close to the sum of the GDP (gross domestic product) of all countries – in other words the Gross World Product which is currently near $80 Trillion dollars a year.




Alibaba, the world’s largest (454M buyers) online market place processed $547 Billion of payments in China alone in 2017. So while $547B is large, it is a small fraction, less than 1% of world GDP … or total world payment volume.










Secondly and some may argue even more valuable than the processing fees, generating revenues for payments companies such as the ones mentioned above, is the data that can be collected on consumer and merchant behavior.  The Hutch Report recently chronicled how data is quickly becoming the new biological nerve gas. The credit card associations assign a merchant category code to each merchant and this code corresponds to the type of business or service the company offers. But this is just the tip of the iceberg, data is collected for each transaction on the amount, the location, the date and time, the type of transaction (purchase, refund, withdrawal, deposit, etc), the type of account, card number, identity of the card acceptor (eg. merchant), information on the terminal used for payment, and much more. Apple already has over 450 million credit cards on file related to iTunes, the iOS Appstore, and Apple TV. In addition to knowing what media you consume, with Apple Pay, they will know even more about you. In addition to advertisers and the merchants themselves, payments data is also super interesting to investors and market speculators. Investors and speculators will go to great lengths to collect data in order to build an edge for themselves. There are now even companies such as RSMetrics that produce and sell aerial imagery of retail outlet parking lots and production facilities. Payment data is much more granular and refined. In addition, the Government also loves digital data, particularly digital cash because then they can completely monitor it, control it, and even charge negative interest rates quite easily if they so choose.

Given the size of the battlefield, a fragmented regulatory landscape and the existence of a plethora of consumer segments, consumers and consumption types … these wars for how you pay and how your payments data is collected will continue to rage for some time.

The Hutch Report

The Debt Jubilee – “There ain’t no such thing as a free lunch”

By | Economics, Finance

It should be no surprise to anybody who has been reasonably informed about what has gone on in the last 15 or so years that debt is becoming a burden. This has become an issue not only in the US but pretty much everywhere all over the world. The debt has come in many forms such as student loan debt, credit card debt, medical debts, personal loans, and on a national scale you have the national debt, underfunded pension liabilities, medicare etc. 

The big issue is how to manage it. A few are talking about it but only in the form of a warning, “someday soon we will have to deal with it.” They keep pushing it off. However the longer you push off a problem like the one we face, the more pressing the problem becomes and that tends to eliminate the bulk of your options to deal with it when it really comes due. 

There has been a potential solution that has been bantered about for the past few years. However, it has been presented as the only solution that will be left when it becomes too late to entertain any others. The solution is known as the “Debt Jubilee,” or debt forgiveness. It means what its name implies, that if someone owes you money you just forgive the debt. The debtor is no longer required to pay back the money he/she owes.

This idea has in fact been around for a long time. Historians have counted around thirty episodes of general debt cancellations from 2400 to 1400 BC, noting they were occasions of great festivity which often involved the physical destruction of the tablets on which liabilities were recorded. One of the most famous episodes of debt forgiveness comes from ancient Babylon (modern-day Iraq). In 1792 BC, the self-proclaimed King Hammurabi of Babylon forgave all citizens’ debts owed to the government, high-ranking officials, and dignitaries (read more from our post about Hammurabi here). The Code of Hammurabi, which currently sits in the Louvre in Paris, declared:

“If any one owe a debt for a loan, and a storm prostrates the grain, or the harvest fail, or the grain does not growth for lack of water, in that year he need not give his creditor any grain, he washes his debt-tablet in water and pays no rent for this year.” 

The main thing to remember is that at that time the main creditor in most cases was the King himself, and/or institutions closely aligned with the monarch. It was relatively easy for the King to abolish debts owed directly to himself or the royal institutions, or even to a substantial proportion of wealthy creditors.

Debt forgiveness was also practiced during the time of the Old Testament. In Jewish Mosaic Law, every seventh Sabbath year saw the wiping away of all debts, where creditors cancelled all the obligations of their fellow Israelites. Every 49th year (seven Sabbath years) was the ‘Year of the Jubilee’ when freedom from all debt and servitude was proclaimed throughout the land.

This practice of debt forgiveness was not purely altruistic on the part of the creditors and ruling class. History has shown that if debtors become too enslaved to their creditors and ruling class, too disenfranchised, it opens the door for opposers or competing rulers to recruit the debtors in revolts to overthrow the ruling class. In current times, protests such as those led by the Occupy Movement show that these issues are still prevalent today and are never too far from boiling over.

At the end of World War I, Europe emerged mired in debt and in a depression. By the mid-1930s, many countries began to abandon the Gold Standard in an attempt to reflate their economies without the burden of an exchange-rate system. As part of this process, most of Europe’s governments had a significant portion of their liabilities written-off for good.

As recent as World War II the practice of debt forgiveness has been exercised. Following the end of WWII, the London Debt Agreement of 1953 saw the abolition of all of Germany’s external debt. The total forgiveness amounted to around 280% of GDP from 1947-53. This last episode is important because it is central to why a debt jubilee may not be the panacea that many believe. 

Michael Hudson highlighted why jubilee, debt cancellations, cannot now be replicated exactly:

“……the main credit/debt transactions initially were undertaken directly between the (ultimate) creditor and (ultimate) debtor. The largest credit relationship was between the government and taxpayers. Nowadays a very large proportion of all financial transactions are intermediated via financial institutions. Any attempt to cancel some category of debt, say government debt or personal mortgages, would immediately drive those financial intermediaries holding such assets, e.g. banks, pension funds, investment trusts, into insolvency.”

There are many economic and ethical problems with the debt jubilee concept. It would essentially amount to the government stealing wealth from all lenders and giving it to all borrowers. The more nefarious or corrupt you were prior to the jubilee, the more you would make out like a bandit as a result of the jubilee. A debt jubilee would paral­yse the finan­cial sec­tor by destroy­ing bank assets. In an era of secu­ri­tized finance, the own­er­ship of debt is engrained in society in the form of asset based secu­ri­ties (ABS) that gen­er­ate income streams on which a mul­ti­tude of non-bank recip­i­ents depend. Debt forgiveness would eventually destroy both the assets and the income streams of own­ers of ABSs, most of whom are inno­cent bystanders. 

As we mentioned earlier, the example of Germany’s debt foregiveness after World War II is an important one. LSE Professor of Economic History Albrecht Ritschl conducted research into how Germany was able to pay off its debts after the two World Wars:

“In a telling comparison Ritschl showed that the debts racked up by the struggling Eurozone economies – Portugal, Italy, Ireland, Greece and Spain – were equal in size to Germany’s current gross domestic product. In other words, debt cancellation for the Eurozone would be equivalent to the debts that were cancelled by the Allies after World War II.”

When polled whether or not Greece should be the recipient of some form of debt cancellation from the eurozone, only 16% of polled Germans agreed. The irony may have been lost on some.

The world’s financial system is more interconnected than ever. Debt forgiveness would take on an unimaginable complexity. There are a large number of counter-party risks as shown by the Deutsche Bank example below:

The Hutch Report

This would no longer be a one to one abolishment of debt as in the days of Hammurabi. Any debt forgiveness of one party would affect a number of other parties. As free market economist Milton Friedman once said, “There ain’t no such thing as a free lunch.” It may be time to devise another plan, and quickly. 

The Hutch Report

Is Hammurabi’s Code the key to fixing the banks?

By | Finance, Law

Over the years there have been a chain of events that have led us to where we are now. This is true not only for the US but for the rest of the world. In a previous article we tried to determine when the US was at its strongest, to maybe shed some light on where the US went off track. It seemed clear that when the US middle class was the largest portion of the population domestic production was also at its greatest. Simply put, people were working and had money to spend. More demand created more production and more jobs.

Looking at the non-farm payroll reports you would think that everything is booming yet we see from a number of sources that low unemployment numbers do not tell the whole story. There are a large number of facts and arguments that support that point of view. Things are not well and getting worse but the subject of this article is what to do about it?

We know from the financial crisis of 2007 that very little was done. The New York Times highlighted the differences between the Savings and Loans Crisis of 1983 and the Financial Crisis of 2007 where following the S&L crisis there were 1,100 prosecutions, compared to 2007 where only one banker went to jail.

The population that was affected by the crisis tried to vent their frustration in anyway they could. So the protest movement, Occupy Wall Street was born The main issues raised by Occupy Wall Street were social and economic inequality, greed, corruption and the perceived undue influence of corporations on government—particularly from the financial services sector. The OWS slogan, “We are the 99%,” referred to income inequality and wealth distribution in the US between the wealthiest 1% and the rest of the population. That was 2007 and now it is worst.

How did the financial media cover this?

“SERIOUSLY?” CNN’s Erin Burnett asked mockingly after finding one protester who didn’t know the government made money on the Wall Street bailout.

Fox News largely mocked them as “whackos” and “communists,” and took pains to compare Occupy Wall Street unfavourably to the Tea Party.

At the time, CNBC’s Lawrence Kudlow suggested the protests were unpatriotic (currently President Trump’s chief economic adviser).

Most financial media criticised the protests for not supplying any concrete solutions and to stop playing the “Blame Game,” and here lies one of the main issues. The levels of greed and corruption are through the roof yet fewer and fewer are being punished, in spite of the fact that these so called white collar crimes have had serious repercussions in the greater economy and do affect peoples lives indirectly. Today the motivation behind greed to steal and harm others seems to be stronger than the deterrents from the risks involved. We should therefore be playing the blame game even more and bring people to justice. Here we look to the Code of Hammurabi for some insight.

The Code of Hammurabi is a well preserved Babylonian law code of ancient Mesopotamia, dating back to about 1754 BC. It is one of the oldest deciphered writings of significant length in the world. The sixth Babylonian king, Hammurabi, enacted the code, and partial copies exist on a man sized stone stele and various clay tablets. The Code consists of 282 laws, with scaled punishments, adjusting an eye for an eye, tooth for a tooth as graded depending on social status, or slave versus free man. Nearly one half of the Code deals with matters of contract, establishing, for example the wages to be paid to an ox driver or a surgeon. Other provisions set the terms of a transaction, establishing the liability of a builder for a house that collapses.

If an architect was hired to construct a bridge, he and his family would be forced to sleep under the bridge. If a captain was hired to sail a ship and he was responsible for wrecking it, he would be personally liable for the damages. If a builder built a house for someone and did not build it properly, and the house that he built fell and killed the owner of the house, then the builder would be put to death. These are examples of clear and direct irresponsibility. If the builder purchased crappy materials at a cut rate, he would still be responsible. The principle concept is to hold people responsible for their actions.

If an accuser brought an accusation of a crime but could not prove it, the accuser would be put to death. Or, thieves would have their fingers cut off. We are supposed to be living in a more civilised society and are not advocating such exaggerated drastic measures, although one of the closest allies to the US employs them.

The main idea here is holding those in power accountable for their actions to the point where should their actions harm others, they would be “personally” liable, or as Nassim Taleb advocates having “skin in the game.”

How could the code be applied to today’s incidents? Think about how many investment manager market forecasters would change their tune if what they pushed their clients into was taken out of their personal accounts. You would most likely begin to see the most conservative portfolios you have ever seen. It would probably cut Goldman Sachs business by 60%. How would Jim Cramer react if his “Buy Buy Buy” rants held him personally liable for any losses he may incur?

Wells Fargo used improper accounting techniques to hide losses in order to borrow money from the Federal Reserve at lower interest rates — effectively defrauding the government by hiding the true scope of the bank’s financial problems. According to Hammurabi’s code, if the line of management responsible for such actions were forced to pay damages, not under the guise of an incorporated company, but from their personal net worth it is doubtful that those responsible would have ever authorised such actions. The result of the present judicial system is that the bank continues to replicate such actions and at worst the CEO is dismissed with a massive bonus.

Before economic activity can be developed to where the middle class becomes stronger once again, putting the greater economy on a stable footing for all, regulations have to be enforced and more crimes need to be punished. Crimes need to be punished accordingly. To do this requires political will, but those politicians need to be also held personally accountable. However, we need to start somewhere so the financial industry seems like a good place to start. As Billy Ray Valentine said in the movie Trading Places, “You know, it occurs to me that the best way you hurt rich people is by turning them into poor people.” The movie Trading Places was essentially an example of an eye for an eye. You may remember that the Winthorp’s bet was for $1, no skin in the game.

Getting 5 years in prison for stealing a few packs of gum compared with ripping off billions from tax payers and getting a slap on the wrist is an economy on the edge of chaos, not stability. As trend forecaster Gerald Celente likes to say, “When people lose everything, they lose it.”

The Hutch Report

Will Turkey be the first domino to fall?

By | Finance

There has been many financial crises over the past century, yet few of those provided much of a warning that they were about to hit.  It only becomes clear after the fact. We then begin to hear speeches on what there was to learn and how to avert any future crisis, until the next crisis arrives in a slightly different form. Philosopher George Santayana, once wrote, “Those who cannot remember the past are condemned to repeat it.” History has proven this to be true. 

We now have a situation brewing in Turkey, yet there are many in the financial media who are already quick to write off the current collapse in the Turkish Lira as contained to Turkey and that the size of Turkey’s GDP makes it less of a threat. Yet, Turkey’s GDP is double the size of what Thailand’s was during the Asian crisis. Therefore, in order to understand the current crisis in Turkey, it is worth looking back at the Asian crisis of 1997.

In 1997, just before the crisis hit, Thailand’s economy was booming. Banks were lending freely. The resulting large quantities of credit that became available generated a highly leveraged economic climate, which led to excessive real estate speculation, and pushed up asset prices to an unsustainable level. An economic expansion, that nobody wanted to end, was in full force. In fact, the Thai central bank kept the currency artificially high, fuelling the speculative bubble. 

I guess you could say that there were signs of a brewing crisis if you choose to focus on them. Banks began lending against the security of the buildings that didn’t have too much of a chance at being filled. Muang Thong Thani was a housing estate built for 700,000 people and became a victim of the coming crash.  At the time of the mid-1990s, Thailand, Indonesia and South Korea had large private current account deficits and the maintenance of fixed exchange rates encouraged external borrowing and led to excessive exposure to foreign exchange risk in both the financial and corporate sectors. Capital controls were being reduced and there was a lack of transparency. 

In 1995 the US dollar began to strengthen. For the Southeast Asian nations which had currencies pegged to the US dollar, the higher US dollar caused their own exports to become more expensive and less competitive in the global markets. Southeast Asia’s export growth slowed dramatically in the spring of 1996, deteriorating their current account position. Once the financial markets sensed that the Thai foreign currency reserves were dwindling, they started shorting the Thai Baht. The asymmetric information in the financial markets led to a “herd mentality” among investors. Their actions helped to magnify the underlying weaknesses and hence, make the first domino fall.

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The economy ground to a halt, salaries were cut and the price of everything began to go up. The IMF stepped in with a loan but that didn’t help so they went to the US for help but they refused. The US was hardly worried that a small country like Thailand could cause any significant damage beyond its own borders. 

Once Thailand began to unravel, speculators and traders began to get worried about other South Asian countries, such as Malaysia, Indonesia and South Korea. Like a classic run on the bank, investors began to dump their positions in those countries, and at the same time speculators were quick to short the currencies, putting more downward pressure on them. Current Prime Minister of Malaysia, and also Prime Minister at the time, Dr. Mahathir bin Mohamed,  stated, “As the currency and the stock market went down, we felt totally helpless.” Once the contagion hit Indonesia, the Government and economy collapsed and from that fallout, the social fabric began to collapse. The IMF had to step in and provide huge loans, but with those loans came conditions. These countries were then subjected to acute economic austerity.

The contagion then spread to South Korea but by the time the IMF got to their central bank the money was all gone. In spite of the fact that the South Koreans had convinced everyone their financial foundation was stable. In order to avoid a default, South Korea received a bailout of $55 billion in new loans and credits. In the end roughly $116 billion flowed out of Southeast Asian Markets.  

At the time, US hedge fund LTCM, controlled $100 billion in global assets and $1 trillion indirectly. The Asian financial crisis was not factored into their complex mathematical risk equations and therefore took Long Term Capital Management completely by surprise. Contagion came to America.

Looking back, one important point here is that this contagion was not set off by anything fundamental beyond Thailand. If Thailand had been contained, the other economies may have adjusted and set stricter controls in order to avoid a Thai scenario. It was fear of the unknown and a loss of confidence that forced the financial markets to make the moves they made. The corruption, overbuilding, and foolish loans were just kerosene for the fire once the match was lit. Today’s world financial markets and economies are so interlinked that events impacting one region will have an emotional behavioural impact on another. One domino falling sparks fear in the markets that others are sure to follow. 

So the question is looking at today’s markets, who will be the first domino to fall? Some thought Cyprus but that was contained. Then there was Greece but that was contained. There was talk of Italy being the first. Then last week we had Turkey. If the Turkish situation deteriorates you can bet that the financial markets will, like during the Asian crisis, become nervous regarding areas beyond Turkey bringing considerable risks of financial contagion. We already saw investors dumping stocks such as Italian bank UniCredit last week, for fear that they are over exposed to risks in Turkey. According to the Bank for International Settlements, international banks had outstanding loans of $224 billion to Turkish borrowers, including $83 billion from banks in Spain, $35 billion from banks in France, $18 billion from banks in Italy, $17 billion each from banks in the United States and in the United Kingdom, and $13 billion from banks in Germany. So what happens next is anybody’s guess but to believe that it couldn’t happen again is probably not the most prudent view to take.