January, Tuesday 24, 2012

DOW – 33 = 12,675
SPX – 1 = 1314
NAS + 2 = 2786
10 YR YLD unch = 2.06%
OIL -.37 = 99.21
GOLD -9.90 =1666.40
SILV -.30 = 32.15
PLAT -11.00 = 1554.00

Greece's private creditors are negotiating how much of a discount they will take on Greek bonds. Under the agreement drawn up in October, bondholders would take a 50 percent write-down on the notional value of their Greek holdings; in other words, they would swap their bonds for new bonds worth 50 cents on the dollar. Last week the two sides were converging on an agreement that would see private creditors accepting a real loss of 65 to 70 percent and new bonds with 30-year maturity. This week the negotiations seem stuck on the interest rate the new bonds would pay – 4% or 3.5%. Private creditors say a 4% coupon is their final offer; the Greeks say they can only go 3.5%.

The idea is that the bond swap would allow Greece to cut its debt from around 160% of GDP to 120% of GDP over the next 8 years. The clock is ticking on a deal because Greece has more than 14-billion Euro in bond redemptions that come due in March. Without a deal, Greece would be forced into a hard default, which would freak out the Eurozone. If they can come to a deal, then Greece is looking at a selective default, meaning they swap the bonds and nobody freaks out. A deal needs to be struck soon. Everything must be in place by March 5^th, and then there will be an April 8^th deadline for elections. All the negotiating is really what you might expect, so why the big worry? Well, the stock market has been up for about 5 days, so it was due for a pullback. Also, the longer the negotiations drag out, the greater the possibility the Greek people might figure out that getting screwed by the technocrats and the bankers, and they might just say “no” to the whole mess. It probably won't happen, but it could.

And then came news that the International Monetary Fund was concerned the Eurozone debt crisis might spread beyond Europe. Three months ago, the IMF forecast 2012 global growth at 4%; now they say it will be just 3.3%, and warned it could drop as low as 1.3 percent if Europe lets the crisis fester for much longer.  The IMF's chief economist warned, “There is an even greater danger, namely that the European crisis intensifies, and in this case the world could be plunged into another recession. With the right set of measures, the worst can definitively be avoided and the recovery can be put back on track," he said. "These measures can be taken, need to be taken, and need to be taken urgently."

So, the idea is that the IMF and the ECB and the Fed and the technocrats know how to avoid a collapse but they're losing patience and they're getting a little annoyed. The IMF's Global Financial Stability Report also pointedly warned against complacency by the US, they say our economy is susceptible to a range of shocks from the euro-zone crisis, including attacks on the financial sector. The IMF is concerned deleveraging could cause a credit crunch in Europe that would reverberate around the globe, pulling trade and investment out of emerging and developing economies, and squeezing the US. The IMF report said, the “potential spillovers could include direct exposures of U.S. banks to euro-area banks, or the sale of U.S. assets by European banks.”

Meanwhile, the Federal Reserve is meeting. Tomorrow, the FOMC will issue a statement on interest rates and for the first time, Fed officials will release forecasts for their best guess of the path of short-term rates for coming years. They will also provide the likely time of the first rate hike and will also disclose qualitative assessments of the role of the balance sheet ahead. We'll see how this works out. If nothing else, it will give us a written forecast, and in a year or two, we can look back and laugh, or maybe cry. Anyway, don't expect too much transparency.

For example, don't expect the Fed to come out and announce that QE3 is underway, even though it probably is. The central bank has purchased somewhere in the neighborhood of $2.3 trillion of mortgage and government bonds in two rounds of Quantitative Easing, or QE. In September, they announced Operation Twist, the plan to sell $400 billion of short-term debt and use the proceeds to buy an equal amount of longer-maturity securities. And Operation Twist has worked, sort of, as long-term rates have dropped and mortgage rates have moved to historic lows. Now, it is widely expected the Fed will be buying up more home loan debt, maybe $500 billion to $600 billion during the first half of the year. Such a move might allow greater chance for success for programs such as HARP, or even for principal reduction plans, but unfortunately, it doesn't do much to build demand.

Fed Chairman Bernanke says that as of the end of the second quarter of 2011, there were 2 million vacant homes for sale, with about 500,000 units owned by banks or by the mortgage giants Fannie Mae and Freddie Mac; some estimates of shadow inventory are twice as high and some estimates go as high as 8 to 10 million. One thing is certain, the number of foreclosed properties is big and growing. There is a large chunk of money, billions of dollars, sitting on the sidelines waiting to see what kind of program the government comes up with. Even if we don't hear details from the Fed tomorrow, we might get a hint tonight in President Obama's State of the Union Address.

The foreclosure crisis is impeding a housing recovery and holding back the entire economy. Obama is expected to suggest more incentives to encourage lenders to help homeowners refinance. It remains to be seen if the nation will return to historical patterns of home-ownership. There is still a demand problem, and this goes directly to the high rate of joblessness. The depressed economy leaves many people who would normally be buying homes either unable to afford them or too worried about job prospects to take the risk; still others that might typically move from one house to another find they're stuck, effectively locked into their home. The economy is depressed, in part because of the housing bust. The converse is that an improving economy will lead to an increase in home purchases, and more purchases will lead to more home starts, and that strengthens the economy, and the circle is unbroken; by and by Lord, by and by. And there may be a better world awaiting as unemployment claims are down and the economy is growing (even if modestly) and home sales are inching higher, and builder confidence is getting off the floor.

We are very likely to see a push from the Federal Reserve and the administration to stimulate the economy through the housing market; this will be the conduit for QE3, this will be the pipeline for election year stimulus.

According to a new global survey from the Edelman Group, and the survey covered 1000 people in 25 countries, and further included at least 200 people considered “highly informed”: of all industries, and for the second year in a row, banks and financial services are the least trusted and trusted even less than last year. Banks went from 50% favorable response to 47%; financial services from 48% to 45%. CEOs are slightly more credible than politicians and regulators (in a reversal from the year before) but overall, still not credible. Only 38% of respondents thought that they could trust the CEO as a source of information on a given company. Last year this stood at 50%. Technology remained the most credible sector, with a 79% favorable response. The most credible source of information on a company were seen as academics and experts (68%) and also technical experts (66%). The “average employee” was chosen as the most credible source of info on a company. Who else is credible? Why, you are. The category “People like yourself”shot up in favorable response among the “informed public” by 22 percentage points to 65%.

When asked, “How much do you trust government leaders to tell you the truth, regardless of how complex or unpopular it is?” 46% of respondents said that they did not trust them at all. Only 29% of the informed public saw government officials and regulators as a credible source of information on a given company (vs. 43% in 2011). And yet… Almost half of respondents (49%) believed that government did not regulate business closely enough. When asked what the government’s most important role in business is 31% said consumer protection and 25% said to ensure responsible corporate behavior. Only 4% said that government should not play a role in business.

The public’s disgust with Congress has been confirmed in poll after poll; the only consensus is that the 11% of Americans who think Congress is doing a good job need therapy. A headline in the congressional newspaper The Hill announces, “K Street Headhunters Enamored with Upcoming Class of Retiring Lawmakers.” Lobby shops and law firms in DC are scouting the talent and formulating their “mock draft” as at least 25 representatives and senators have announced their plans to leave office at the end of their current terms. Former senators could expect to earn somewhere between $800,000 and $1.5 million in annual salary next year at lobby firms, while ex-House members could earn between $300,000 and $600,000, headhunters estimated.

Tonight, you'll hear both parties talking about the economy and jobs but you won't hear this story mentioned in polite company. But remember, it's not just the lawmakers, it is the corporations that are paying the K Street legal firms and the retired politicians. The corporations expect a return on their money, and they get it. Companies can hire armies of high-paid lawyers and accountants to mold the tax code in their favor. Once upon a time, this type of activity was called graft and corruption. Now it's just par for the course.

The headline jobless rate is 8.5% for December, down form 8.7% in November. Today we got a few additional details on the December jobs report. The jobless rate fell in 37 states and Washington, D.C. States hit hardest by the housing crisis continue to suffer the most. Nevada again notched the highest jobless rate at 12.6%, followed by California at 11.1%. States with abundant natural resources performed the best, including North Dakota at 3.3%, Nebraska at 4.1% and South Dakota at 4.2%. In Arizona, the rate is 8.7%.

The FOMC tomorrow will tell us at what level they want to price fix the short term cost of money and for how long. This forecast from each individual member will be based on their economic forecasts. While these forecasts will be useful from a market perspective as the Fed’s words alone can influence rates, relying on Fed forecasts as something close to ultimately being accurate has historically proven to be dangerous.

For a quick instant replay check over the past 10 years, the Fed believed the US economy was on the cusp of deflation in ’02 thru ’04 and it’s why they lowered the fed funds rate to 1% and kept them there for a full year. This forecast of deflation of course was wrong as one of the great commodity bull markets of all time began in early 1999. We also know this cheap money below the rate of inflation enabled the credit bubble. The other Fed forecast of major consequence was said by Ben Bernanke to Congress on March 28th 2007, “At this juncture…the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained.” My point is that the extra transparency the Fed will give us today is irrelevant if they get the underlying policy wrong and the chances are they will.

There's a paradox to economic policy. The more it succeeds at prolonging short-term prosperity, the more it inspires long-run destabilizing behavior by businesses, banks, consumers, investors, and government. If they think basic stability is assured, they will assume greater risks – loosen credit standards, borrow more, engage in more speculation, relax wages and price behavior that ultimately make the economy less stable. Long booms threaten deep busts.