Wednesday, February 15, 2012

February, Wednesday 15, 2012

DOW – 97 = 12,780
SPX – 7 = 1343
NAS – 16 = 2915
10 YR YLD +.01 = 1.93
OIL + 1.15 = 101.89
GOLD + 7.00 = 1729.10
SILV -.08 = 33.60
PLAT + 7.00 = 1637.00

The Greek debt crisis has not been resolved. Euro-zone finance officials have been meeting in Brussels and trying to figure out some deal that would avoid a disorderly default on Greek bonds, and at the same time they are trying to impose ever-harsher austerity measures on the Greek people, and the Greeks are finally growing a little backbone and telling their northern neighbors to ease up. And there is an election in Greece scheduled for April, and the Euro-zone finance officials would like to postpone everything until after the election because the mobs, err, the democratic process might yield unexpected results.

A new report released today shows the economy of the Euro-zone shrank by 0.3% in the fourth quarter of 2011. France eked out a smidgen of growth. The German economy contracted slightly. The Greek economy remains in shambles despite imposed austerity; five years of recession and the economy still contracting at a 7% annualized rate. The European economic plan isn't working.

One thing the Euro-debt crisis has done is remind us that bonds are not risk free. Granted, Greek and Italian bonds are in a different league than US Treasuries, but there is still a decent chance the United States could lose its Triple-A credit rating. Meanwhile, the big multi-national blue chip stocks have been solid performers. What would you rather own. A European bond that implodes, or a US Treasury bill that is losing value to inflation, or a global franchise that is expanding its brand in emerging markets and pays a dividend of about 3 percent? It is worth noting that many countries are struggling under debt while many corporations are thriving. The deleveraging process has already come and gone for corporations, and it has a long way to go for countries.

Iran now claims it has developed its nuclear program to the point where they can enrich uranium much faster. Israel says the Iranians have targeted Israeli diplomats around the world for assassination. The Iranians say the Israeli's have targeted nuclear scientists for assassination.  Iran has long refused to negotiate curbs on its nuclear program, saying it is intended to produce electricity for civilian uses.

The United States and Israel have not ruled out military action against Iran if diplomacy and sanctions fail, but today, Defense Secretary Leon Panetta said there are no plans for attacking Iran. Iran's Oil Ministry denied a state media report that it had cut off oil exports to six European Union states. The EU ban on Iranian crude is due to take effect in July. The top three importers of Iranian oil are India, China, and Japan.

 Here's the short-form on the Volker Rule, named after former Federal Reserve Chairman Paul Volker. The Dodd-Frank Act’s Volcker Rule would prohibit banking entities from engaging in proprietary trading of securities, derivatives and certain other financial instruments for the entity’s own account. The SEC has been accepting comments on the Volker Rule. A sub-group of the Occupy movement has come up with a 325-page letter to the SEC, and this may be the best thing to come out of the Occupy movement. Meanwhile, the big banks and their lobbyists have been claiming that if the rules become law, it will destroy liquidity in the markets and there will be significant costs to the economy.  Let's break down these two major arguments.

First, a bit of liquidity in the markets is a good thing; we want to match buyers and sellers in the market; too much liquidity is not   a particularly good thing; a proprietary trading desk may be nothing more than a high speed computer scalping pennies by front-running trades. There is no benefit to a flash crash. And does all that computerized trading really add anything? Or is it just gambling?

The second argument is that breaking up prop trading will come at a cost to the economy. I don't buy it. There may be some costs to the big banks, specifically Goldman Sachs, Bank of America, JP Morgan, Citigroup, and Morgan Stanley. So what? The big banks are not the economy. And the whole idea is to make these mega-banks a little smaller. And the problem is that the big banks keep the profits from prop trading but when they lose, they slough off the losses onto the taxpayers. The bank lobbyists don't consider those costs but the rest of us should. And if it means the big banks get smaller – all the better. I wrote a book “Eat the Bankers” and part of the premise is that the big banks must be cut into smaller banks, so that if they fail, they may still be easily digested without destroying the economy. What is the cost if they just ramp back up and crash the global financial economy?

Much of the debate about the Volker Rule has centered around the distinctions between market making and proprietary trading, and I believe this is the major problem with the Rule; it doesn't go far enough. Prop trading should not be allowed on the same balance sheet as depository banking. We used to have a rule for that – it was called the Glass-Steagall Act and it worked quite well.

The Federal Reserve released the minutes of their January 24th, and 25th FOMC meeting. The general idea is that the Fed is taking a wait and see approach to another round of bond buying, in other words, no official announcement of QE3, unless the economy starts to falter. Several members said they anticipated that unemployment would still be well above their estimates of its longer-term normal rate, and inflation would be at or below the Committee's longer-run objective, in late 2014. Even if we don't see a QE3 proclamation, make no mistake, the Fed is active, buying gobs and gobs of mortgage-backed securities.

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