March, Friday 16, 2012

DOW – 20 = 13,232
SPX + 1 = 1404
NAS – 1 = 3055
10 YR YLD +.02 = 2.30%
OIL + 2.04 = 107.15
GOLD + 2.80 = 1661.10
SILV + .02 = 32.66
PLAT – 13.00 = 1675.00

You look at the markets and you're confused. I know. The markets can be confusing. We heard that the Federal Reserve FOMC was feeling sanguine; the economic outlook was copacetic. And in the pretzel twist that passes for logic, that meant the Fed was not going to approve a new round of Quantitative Easing; the Fed would not shovel free money from a helicopter to rain down on Wall Street. Certainly, the markets would convulse and complain, they would twitch like a junkie past due for a fix. So far, no problem. Pretty much every asset class has been moving higher. Go figure.

It's pretty simple. The Fed will continue to provide free money to their Wall Street banking buddies; that's what the Fed does. There is no exit strategy from QE. In fact, not easing would be the equivalent to tightening. Really, it's just a matter of timing and deciding on a good name. It might not be called QE3; it might be called Operation Twist Some More, Maybe they'll call it the Sterilized Accommodation, or maybe just the New QE. Make no mistake, the Fed will have a purchase program that involves purchases of mortgage backed securities and Treasuries. The Fed's balance sheet will expand.

There are several reasons to expect more free money from the Fed: it's an election year, the unemployment situation is still grim, the increase in gasoline prices threatens to slow the economy, Europe still poses a threat, China poses a threat, everything poses a threat, and did I mention that it's a presidential election year.

Also, inflation is not a concern.

Stop snickering. The Labor Department reports the consumer price index, prices at the retail level, rose 0.4% last month on a seasonally adjusted basis, slightly below expectations of a 0.5% increase. Subtracting food and energy, the so-called core rate of inflation rose just 0.1%, slightly below expectations of a 0.2% increase. Not counting food and gas, because that just applies to people who eat and drive, prices were up for housing, autos, medical care, and household furnishings.

I know what you're thinking, in this debate about further economic stimulus, there might be a problem with inflation. Higher inflation might backfire by causing interest rates to rise and if that happens, you're not going to get any stimulus and you're going to make it much harder to restore price stability. Higher borrowing costs are a drag on economic activity. Housing is particularly vulnerable to higher rates. We've been saying that economic stimulus would be concentrated on the housing market, finally. This was the idea behind Operation Twist; this is why the Fed has been buying Mortgage Backed Securities, and this is why the Administration is rolling out the HARP 2.0 on Monday, which promises to be a huge round of refinancing, which means an enormous blast of supply, which equates to higher rates, and as homeowners lock in new rates, you just knew there would be a little spike. However, the Fed is not going to allow higher rates to stop a housing recovery. Housing is the soft spot of the recovery and Bernanke is not going to let borrowing costs move too far against him. One more reason why the Fed will step in as a buyer of even more Mortgage Backed Securities and even more US Treasuries.

Today, Charles Evans, president of the Federal Reserve bank of Chicago said: “Even with the large degree of accommodation already in place, monetary policy can and should take additional steps to facilitate a more robust economic expansion.” And this gets to the meat and potatoes. The Fed doesn't want to screw up this recovery. We're finally starting to see signs of recovery. The Fed knows they won't get musch help in the way of fiscal policy. There is no way they are going to tighten.

Sometimes I'm amazed that people think we have anything resembling a free market. The energy sector is thoroughly subsidized, from the biggest Big Oil to the smallest green innovator. If you think the transportation sector is a free market, just wander though any major airport, or get out on the highway and remember who built it and who controls it. Your healthcare is already run by government and I'm not just talking about Medicare. Doctors and nurses are licensed. Drugs are tested and inspected. The financial sector is addicted to Federal Reserve handouts and despite the recent Stress Tests, if  you take away the Fed's free money, every bank would fail. And yet no sector chafes against regulations more than the financial sector. Yesterday we talked about the abuses of the Goldman Sachs Trading company from the 1920's. The abuses in the financial sector weren't limited to Goldman. The House of Morgan paid no taxes. National City Bank repackaged bad foreign debt and sold it to their customers.

Eventually, all the malinvestment fell apart in 1929. And then the financial sector faced some regulations. The Securities Act of 1933 and 1934, and the Banking Act of 1933, also known as Glass-Steagall. The rules worked well for a long time, but they were eventually dismantled or disregarded. And now we have banks behaving badly, and they're too big, so big that they threaten the entire economy.

Capitalism depends upon honest, integrity, and trust. Without trust, there are no sensible economic risks. The economy freezes and crashes. Right now, Wall Street is controlled by greed. We had another lesson this week in the form of a resignation letter to Goldman Sachs. It was nothing new. Goldman has been behaving badly for generations. Wall Street has earned its notoriety. That might be the only thing Wall Street has earned.

The Street has only itself to blame. It should have welcomed new financial regulation as a means of restoring public trust. Instead, it lobbied intensely against the new Dodd-Frank Act and refused to resurrect Glass-Steagall. The Volker Rule has been shot full of holes, and Dodd-Frank has been gutted and will likely be gutted even more. Banks relentless search for profits has racked up immense "collateral damage". Investment banks have injured individuals and institutions of every stripe. Institutions include the Greece whose books Goldman cooked; Jefferson County, Alabama, and many European cities devastated by risky derivatives; colleges like the University of Virginia and Harvard who have held cut-rate sales on private equity; and pension funds and others who sued for fraudulent trades. Hurt individuals include veterans overcharged by JP Morgan Chase, and veterans wrongly evicted from their homes by Wells Fargo; millions abused in foreclosure and mortgage scams; and hundreds of millions globally impoverished by the crisis. Bank profits and bonuses hit all time highs, even after inflicting this widespread harm.

So, now we're faced with a financial sector that refuses to accept transparency, honesty, and integrity – all in the name of a free market, but still wants to have their risky derivatives trades covered by FDIC insurance. In a free market, you would have to be a complete idiot to do business with a lying, cheating, scumbag. In a free market, an invisible hand would come down and smite the greedy charlatans who treat their clients like Muppets. Or maybe we would all just wise up and realize we don't need banksters that repeatedly rip us off  and provide no value to the economy.