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Farrell: Good for Portugal. What Are They Thinking in Illinois?

Thursday, 13 Jan 2011 | 10:41 AM ET

Portugal had a very successful bond offeringon Wednesday.

There was a little hiccup with the sale of some three year notes that wound up being sold at a yield to maturity of 5.4%. The prior three year sale of Portuguese paper was at 4.06% yield, so the jump was wide.

But it got sold.

The good news was in the auction of ten year paper. The fact it got sold at all is good. The yield was a surprising 6.72% and it was oversubscribed by three times. Just the day before ten year paper was trading well north of 7%. I have mentioned that 7% level a couple of times. Dr. Ed Yardeni researched it and found that when Greece pierced 7% it was on the EU's doorstep for a bailout within 16 days. When Ireland's ten year paper reached 7% it was at that same doorstep within 21 days. 7% is not an affordable interest rate and marks the 'magic' point where it all hits the fan.

Maybe Portugal has bought some time.

The Illinois House of Representatives passed a bill that raises the state income taxfrom a maximum rate of 3% to 5%. An allegedly non-partisan tax review board said that would cost a family of three making $60,000 a year another $1,080 in taxes.

That is hard to believe and would be a killer for such a family.

They also raised the corporate income tax to 7% from 4.8% and said, this is the best part, annual spending increases would be held to 2% a year. California just announced $12 billion in spending cuts.

As painful as they are, we are in the position of having no choice.

Illinois is projecting a $13 billion deficit on a budget of $26 billion and they promise not to increase it by more than 2%! No cuts? What are they thinking? And people and companies are going to react to higher taxes. They always do. These tax increases will not raise the expected amounts.

Meredith Whitney, famed financial analyst who predicted the housing collapse, was on CNBC Wednesday morning and seemed a little less worried about municipal debt. She now thinks there will be municipal defaults, but not state defaults. But the Financial Times of London ran a story that predicted the US municipal market is on the verge of a crisis that will rival Europe's sovereign debt problems.

Great.

Back overseas for a moment to Germany. Their GDP rose 3.6% last year, the best showing in two decades. Reunification was painful and expensive. Germany also had a bond sale yesterday. Five year notes were auctioned at a 2% yield which looks great compared to the rest of Europe. But the last auction only a month ago was at 1.73%, so the Euro issues are costing Germany since it is obvious any rescue will be mostly at their expense.

It is thought the EU is mulling over an attempt for a comprehensive answer to all ills. Rumors of a large loan to Portugal are working their way around. As is a potential debt buyback by the central bank, or guarantees by the bank. Ministers meet next week but the heads of State don't get together until February 4th. It's doubtful any earth shaking news will come out until then.

Some economists in China worry in a New York Times articlethat the most recent stated inflation rate of 5.1% is wrong by half. Who knows? But if directionally correct, the fact that loans made in the first week of January equaled all the loans made in December could indicate a still hot economy that needs sharply higher rates to cool off.

The US housing market is just the opposite.

Zillow.com, a real estate research house, said the month of November was the 53rd consecutive month house prices in the US fell on a year over year comparison. November 2010 was off 5% from the November a year earlier. Zillow.com says the total decline from the June, 2006 peak to November, 2010 is 26%, which is a larger decline that the one from 1928 to 1933.

Wow! Not a record you want to break.

Vincent Farrell, Jr. is chief investment officer at Soleil Securities Group and a regular contributor to CNBC.

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