Where NOT to Collect Investment Income

Posted On Apr 26, 2016 By Dave Gonigam

  • Wall Street’s newest innovation: Securities backed by cellphone contracts!
  • As investors “reach for yield,” we unveil a once-in-seven-years income strategy
  • Object lesson: Valeant Pharmaceuticals and the “magic” of financial engineering
  • Cops driving small-business owners out of business and onto welfare
  • A fragile “durables” number … the mechanics of the cashless society… The 5 begins its 10th year… and more!

The Bizarro World of ZIRP — zero interest rate policy — has just served up its biggest absurdity yet.

Wall Street is about to begin securitizing… cellphone contracts.

“Securitization,” as a reminder, is the process by which smallish debt instruments — like mortgages or auto loans — get packaged up into a bigger debt instrument and sold off to investors seeking a yield.

You’ll recall securities backed by mortgages whose borrowers couldn’t keep up payments were the catalyst for the Panic of 2008.

For the last three years, we’ve been documenting how growing numbers of auto loans are likewise going bad. The auto loan market isn’t big enough to blow up the whole financial system again… but it can certainly blow up in the faces of investors (maybe you, if these securities wind up in a bond fund you own).

So back to cellphones: Verizon is on the verge of issuing debt securities backed by cellphone contracts.

Why? Much of it has to do with the way Americans buy phones nowadays. Used to be the carriers like Verizon and AT&T subsidized the purchase. That’s how people got a $450 base-model iPhone for “free” as long as they stuck to a two-year contract.

Nowadays, people buy on an installment plan. On the consumer end, it looks much the same — no money upfront for a base-model iPhone as long as you stick to a two-year contract.

But for the carrier, it’s completely different now. On the one hand, they face higher costs for the handsets upfront. At the same time, however, “the popularity of zero-rate, no-money-down offers has given carriers a new cash stream that can be securitized,” reports Bloomberg.

Ain’t financial wizardry grand?

“Already significant in Japan,” says the Financial Times, “analysts estimate the securitization of mobile phone payments in the U.S. could quickly grow to be the third-largest consumer finance market, behind car loans and credit cards.”

Japan? Securitized cellphone contracts are hot in Japan? Where they’ve had ZIRP for eons and recently entered into NIRP — negative interest rate policy? You don’t say!

Anything for yield, right? Ten-year Japanese government bonds have yielded less than 2% since 1998… less than 1% since 2012… and yields went negative a few weeks ago. Complain all you want about “the punishment of savers” in America, but we’ve got nothing on the poor Japanese.

Securitized cellphone contracts in the United States could be a $50 billion market. Presumably they’d be low-risk, too — at least compared with securities backed by a mortgage or car loan.

“But should a consumer default on payment or not pay their bill in full,” says the FT, “it is unclear who gets paid first — the mobile phone provider for the wireless service or the investor for the handset loan, because both are bundled up together in the same contract.”

Neither the Bloomberg nor the FT story indicates what sort of yield investors would get from these securitized cellphone contracts. Verizon’s probably still figuring it out.

But the whole thing already strikes us as dodgy. So what can you do these days to get a respectable yield without stepping too far out on the risk curve?

Enter an instrument our income specialist Zach Scheidt calls “Chicago Income Rights.” We’re taking the wraps off them today.

(No, they have nothing to do with the municipal debt of the city of Chicago — that’s way too risky at this time!)

Instead, we’re talking about a strategy under which contract law “locks in” your income payments. You collect these payments while sidestepping all the ups and downs of the stock market. And the returns can be unusually lucrative — doubling or even tripling your money.

“According to dozens of examples I personally investigated,” says Zach, “you could have pocketed a steady stream of extra annual payments, including some ranging from $4,697–6,364 a year.”

We caution: Chicago Income Rights are not risk-free. They’re not for everyone. But Zach says now’s the best time to jump into them in seven years… and the window of opportunity won’t stay open forever.

Zach’s prepared a full introduction for you — no long video to watch, either — at this link.

To the markets… where aside from crude, it’s a quiet day. As we write, the S&P 500 has added three points to yesterday’s gains, resting at 2,091. Gold is stable at $1,242. Treasury yields are moving up, the 10-year note at 1.93%.

It’s crude that’s again the big mover — up 3.5% at last check, to $44.13.

But in a world of sub-$50 oil, Standard & Poor’s has seen fit to downgrade the corporate debt of Exxon Mobil from AAA. That leaves only two companies standing with a lofty AAA bond rating — Microsoft and Johnson & Johnson.

The one economic number of note this morning is a dud: Durable goods orders rose 0.8% in March, way off the “expert consensus” looking for a 1.6% increase. If you throw out transportation (because aircraft orders are notoriously volatile), the numbers are an even bigger disappointment. The lower dollar of late isn’t helping the factory sector — not yet, anyway.

Valeant was a standard Wall Street scam,” says David Stockman — reflecting on one of the week’s big newsmaking firms.

Execs from Valeant Pharmaceuticals (VRX) will be hauled before Congress tomorrow to be lectured about high drug prices. Those execs do not include the new CEO, Joe Papa, who was named to the gig yesterday.

For our purposes, however, Valeant’s fall from grace is more interesting as an object lesson in how the “Wall Street casino” sucks in the unsuspecting investor with stories of epic growth.

“The casino doesn’t see that these ‘growth’ stories are really nothing more than financial engineering scams,” says Mr. Stockman. “That is, until some hard-to-predict catalyst triggers the sell-off — as happened last fall with revelations about accounting irregularities and fake sales at a tiny specialty pharmacy affiliate of VRX called Philidor.”

The growth was achieved not by bringing innovative new drugs to market… but by merger and acquisition deals under the former CEO, Michael Pearson.

“During his tenure,” David writes, “Valeant spent about $40 billion on some 150 acquisitions. And exactly what common expertise and value-added leverage did these far-flung acquisitions in contact lenses, ophthalmological therapies, dermatology, cosmeceuticals, anti-aging creams, Botox equivalents, acne fighters, toenail fungus ointments and much more bring to the table?

“Well, what they brought was an opportunity to slash thousands of jobs, eliminate R&D and fund massive amounts of goodwill and intangible assets with cheap debt. Most especially, these deals enabled Valeant to fill its purchase accounting ‘cookie jars’ with fulsome amounts of reserves that could thereafter be used to cause inconvenient integration costs to disappear, as needed.

“It was all good as long as VRX could jack up prices of the drugs it acquired. But even in crony-capitalist Big Pharma, there’s an upper limit to price increases. Raise the price of drugs radically enough,” says David, “and you will eventually attract competitors into the market with new formulations that circumvent the patent; get greedy enough and generics will swamp you on the patent’s expiration.”

Key point: There are other Valeants out there whose prices haven’t yet tumbled down the elevator shaft. David has spotted a couple in the last month, just ripe for the put-option picking in David Stockman’s Bubble Finance Trader.

The war on small business, NYPD edition: New York’s finest have been busy harassing owners of mom and pop groceries, laundromats and other businesses.

The Washington Post’s Radley Balko summarizes how it works. “They claim the businesses aren’t doing enough to prevent criminal activity, aren’t doing enough to prevent the sale of alcohol to minors or are guilty of some other inaction. They then threaten to shut the place down unless the owner gives police carte blanche to co-opt their surveillance cameras, search their stores and spy on their customers.”

ProPublica and the New York Daily News did the heavy lifting on this story. In a typical instance, an undercover cop will prowl a laundromat selling what he says are stolen electronics. A guy buys. The owner doesn’t even know there’s a problem until months later.

“The police begin nearly every case with a secret application to a judge requesting an order closing the business while the case is being decided,” says the Daily News, “and before the owner has had the opportunity to appear in court. Judges approved the closure requests 70% of the time…

“Most cases resulted in settlements, 333 of which allow the NYPD to conduct warrantless searches. In 102 cases, the owner agreed to install cameras that the NYPD can access upon request. Another 127 settlements require storeowners to use electronic card readers that store customers’ ID information, also available to the NYPD upon request.”

“Legal harassment and coercion,” is what New York’s public advocate Letitia James calls it. Not that she’s in a position to do anything.

The owner of one store where an employee sold a can of beer to a minor without asking for ID says the next time he’s subject to this legal harassment and coercion, he won’t pay a fine. “I will just close the store. And after that, if I close the store, I’m going to apply for welfare. I’m going to apply for everything. So they gonna pay me now, right?”

“Here’s a problem for you,” begins today’s mailbag, dragging our attention back to the war on cash.

“If we do end up going cashless, how will people, private individuals, carry on the daily ‘business’ of selling things privately? I mean big-dollar items like automobiles, boats, etc. Will we have to have devices that accept credit/debit cards?

“To replace and/or augment the barter system, first, it was silver and gold that were accepted in exchange for items of purchase. Then cash was invented for more convenience. Then checking added more convenience. Then credit cards came and morphed into debit cards.

“The states that have sales taxes (and those that don’t will get them!) will benefit greatly, as no one will be able to cheat on the sales prices of these large-ticket items (not that anyone does that now). Will we revert back to bartering to beat the system? Or is this why the pundits are pushing everyone to have some gold and silver? Hmmmm.”

The 5: Huh? Which pundits?

Anyway, one answer came to us earlier this year when we had a story about a homeless guy in Detroit who accepts credit cards. Seriously. He has a Square reader attached to his cellphone.

Really, it’s an ingenious way to rope in the 7.7% of Americans who have no bank account — give ’em Obamaphones and Square readers.

“Wow — got a shock when I read my comments and questions quoted in The 5,” a new reader writes.

He’s new not only to us but to many financial matters. At his behest, we took a crack at the simplest explanation we could summon of the relationship between a bond’s price and its yield.

Apparently, we succeeded. “That’s the explanation that has so far done the best at getting through my apparently thick cranial bone and not making my gray matter shout, ‘Lalalalalalalala… I’m not listening!…’ 🙂

“And thanks for your kind words about us newbies. Much appreciated.”

The 5: You’re welcome. Happy to oblige.

Best regards,

Dave Gonigam
The 5 Min. Forecast

P.S. Allow us a moment of self-indulgence: It was on this day in 2007 that The 5 Min. Forecast published its first issue.

The first few years, our fearless leader Addison Wiggin penned these daily missives — curating our analysts’ best ideas on your behalf.

In a moment of perhaps questionable judgment, he asked me in 2010 to begin collaborating with him. By 2012, he threw all caution to the wind, handing me solo responsibility for The 5. Just a little background, in case you’re a newer reader.

I extend my thanks to Addison for entrusting me with his creation… and together we extend our thanks to you for coming back to The 5 each day. As our virtual mailbag proves over and over, we have the most passionate, informed, engaged readership anywhere!


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