Wednesday, April 11, 2012

Wednesday, April 11, 2012

DOW + 89 = 12,805
SPX + 10 = 1368
NAS + 25 = 3016
10 YR YLD +.04 = 2.03%
OIL - .13 = 102.57
GOLD - .90 = 1660.70
SILV -.23 = 31.71
PLAT – 14.00 = 1591.00

What changed between yesterday and today? What pushed the markets higher today? What pushed the markets lower yesterday? I hope I'm smart enough to not fall into that trap. The markets fluctuate. They don't go straight down and they don't go straight up. At the start of the month, I said you might want to think about taking profits off the table; I still think that's wise, but I'm not saying the market will crash; I don't think the sky is falling, at least not today.

There are twelve different regional banks in the Federal Reserve; each month the task of writing about the economy falls to a different bank; the results are published in a book format with a beige cover, hence the name “Beige Book”. It's a misnomer. Some months the book should be called “the lime green electrifying economic report” and other months it might be called the “Kind'a Blue Forecast”. This month, the report was prepared by the Cleveland Fed and the “Beige Book” title fits.

The Federal Reserve says the economy continued to grow at a "modest to moderate pace” over the last month. Manufacturers and retailers expressed some concern about rising oil prices, but the unusually warm weather helped retail sales. The report showed an economy chugging if not roaring along: manufacturing expanding, professional business services growing, freight volume increasing, strong new-car sales, growing tourism, favorable agricultural conditions, more mining and oil extraction, some improving loan demand, real estate activity was at low or lackluster levels but improving, hiring was steady, wage growth was constrained, and overall price inflation was modest. In a word – Beige.

About two weeks ago, the Dallas Fed issued a paper explaining how Too-Big-To-Fail must be allowed to fail. Today, Kansas City Fed President Esther George said the most important step in restoring market discipline to the financial system would be to eliminate too-big-to-fail policies, including taking advantage of a provision in the Gramm-Leach-Bliley Act that would force divestitures or termination of new activities within 180 days if a financial holding company isn't well managed or capitalized. Speaking at the 21st annual Hyman P. Minsky Conference in New York, she also said bank capital standards, in particular leverage requirements tied to equity capital, need to be strengthened She said she supported the implementation of the Volcker Rule and added there may be more financial activities that are incompatible with public safety nets.

By the way, do you know who Hyman Minsky was? He was an economist and part of what he did was to explain the characteristics of financial crises; he opposed deregulation in the 80's and he argued against the accumulation of debt. The debt argument came up in the subprime crisis. Minsky said there were three types of debtors, a hedge borrower, a speculative borrower, and a Ponzi borrower: a hedge borrower would have a traditional mortgage loan and would pay back both the principal and interest; the speculative borrower would have an interest only loan and would have to try to refinance later; and the Ponzi borrower would have a negative amortization loan that wouldn't cover the interest payments and the principal would actually increase.

I digress. Eric Rosengren, the President of the Federal Reserve Bank of Boston was also out on the Propaganda Tour. Rosengren said the money-market fund industry remains a significant source of risk for the U.S. economy, and is in need of major reform; a warning we also heard from Fed head Bernanke a few days back. And let us be aware that there is risk in money markets despite the perception they are safe places to park cash – remember they do not enjoy FDIC protection.

We have now seen two Fed presidents come out against too big to fail. A couple of months ago, President Obama said “no more bailouts”. I get the feeling that they're preparing us and maybe preparing the banks to take a hit. I suspect there's a bank, at least one major bank, major as in the top 19, that is “on the roof” and when it fails, the government will let it fail, and if it starts a cascade of failures, the government will allow some failure. Which would probably be a very good thing.

There is, I think a good argument to be made that the growth of the financial sector, and the increase in credit and debt is a form or wealth redistribution, and relative gains in the financial sector result in inequality. This is not a new concept; in the 13th Century, Thomas Aquinas said that “usury leads to inequality which is unjust in itself.”

It's not quite a zero sum game because the gains in the financial sector are not the result of productive output. It is worse than a simple shift of money from one pocket to another, it is malinvestment and the potential for improvement is lost. Still, if the share of income passing through the financial sector were to be reduced it might make room for expanded public services, improved social conditions, more productive private purpose, and reduced inequality. I'm not exactly sure how to accomplish this; there is no foolproof blueprint, but you could start by enforcing financial fraud laws – wouldn't that be a welcome change? And you could downsize the financial sector, or just allow it to fail on its own. Yesterday, the President gave a speech in which he demanded Congress raise taxes on millionaires as a way to recalibrate the nation's wealth distribution, but there might be a real need.

Income concentrations are relatively rare, and the conditions need to be just right; a perfect storm such as what we saw three years ago, followed by TARP, TALF, and massive bailouts that amounted to looting the Treasury. Helicopter Ben was blowing asset bubbles and enriching the bankers and related industries, because this is what the Fed does best - while the median household is living paycheck to paycheck and struggling with the price of gas and food. Monetary policy has been very influential on the income gap.

It should come as no surprise that a disproportionate share of income is going to the top 1%. For example, from 2002 to 2007, average real family incomes grew by 16.1% but 65% of that growth accrued to the top 1% while only 35% of that growth accrued to the bottom 99% of US families. From 2009 to 2010, average real family incomes increased by 2.3% and the top 1% captured 93% of those gains. The inequality has been growing at an unsustainable rate.

I'm not trying to say that the policy framework was better or worse in 2007 or 2010, only that it was cumulative. Moving forward, there are many policy battles to fight and it is an election year, which means nothing will get done. And that might be the best thing that could happen to a financial sector that is rife with toxicity. When it fails – do nothing. The financial sector has too much political clout to be regulated into downsizing but they are certainly capable of failing on their own; and we are being prepared for that probability.
Sinclair Noe

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