Friday, May 18, 2012 – Europe, Before the Flood – by Sinclair Noe

DOW – 73 = 12,369
SPX - 9 = 1295
NAS - 34 = 2778
10 YR YLD un = 1.70%
OIL - .57 = 93.41
GOLD + 17.80 = 1593.10
SILV +.67 = 28.82
PLAT + 2.00 = 1461.00

"He hath indeed better bettered expectation than you must expect of me to tell you how."

The Facebook Frenzy turned out to be a fairly orderly IPO. Share prices fluctuated but did not collapse nor did they soar; which means the price and quantity were about right; the underwriter was competent and reasonably accurate. The NASDAQ had some trouble executing trades but that was a relatively minor problem. Now, the new Facebook millionaires and billionaires have some heavy lifting to prove their value. Time will tell, and good luck to them in their efforts. FB +.23 = 38.23

I know its the biggest internet IPO ever, but in reality it's much ado about nothing.

The European economic crisis is expected to top the agenda at the G8 meeting tomorrow at Camp David. In Greece, voters will soon head to the polls for another round of elections which will be viewed by many as a referendum on the euro. The European Commission and the European Central Bank have been working on contingency plans in the event of a Greece exit from the 17-nation euro zone. Concern about whether Greece’s troubles would spread to other European nations hit the market last fall. It’s hard to imagine between what went on last fall and now, that a lot of preparations haven’t been made for this eventuality.

The first public declaration that preparations are in place came as economists at UBS said European taxpayers would have to swallow losses on Greece, whether or not it remains a member of the currency union. This is what you might expect from economists at UBS, or any other big bank - the taxpayers will have to pay.

Under a best case scenario, which would see Greece remain inside the euro but its colossal 274-billion-euro of outstanding debt put on a more sustainable path, UBS said European taxpayers would have to write-off 60-billion-euro of the 182-billion-euro of rescue loans they have provided.

If Greece was to leave the euro, however, the bill would jump to at least 225-billion-euro as the new currency would halve in value and 104-billion-euro of additional emergency funding by the ECB would be wiped out.

Contagion to the banking sector and across the eurozone, coupled with the economic damage that would cause, would lead to further unquantifiable costs. Other economists have estimated the final bill at nearly 800-billion-euro. UBS said the losses would cripple the ECB, which would need to be recapitalized.

So, the quick math is that keeping Greece in the Euro-union might cost 60 to 275-billion-euro; however a Greek exit might cost between 225 and 800-billion-euro – maybe more.

So, why is anybody talking about a Greek exit? The numbers don't add up. However, a currency union without Greece would be viewed as a stronger bloc by investors Greece has been a drag lately. Ultimately, a large part of the stay or go question is left to the Greeks. You can bet the ECB would not ease the path for a return to the drachma. If a return to the drachma proved to be a ruinous experience for the Greeks; it would mightily deter Portugal, Spain, and other from such temptation.

Global banks see a market rally on Greek exit. Major global banks are advising clients to prepare for a stock market rally and a resurgence of the euro if Greece is forced out of monetary union, betting that world authorities will flood the international system with liquidity. The ECB would cut interest rates, launch quantitative easing (QE), and back-stop Spain and Italy with mass bond purchases; the authorities would inject capital into the banks and create a pan-European system of deposit guarantees. The combined moves would be a major step towards EU fiscal union.

The Federal Reserve has been keeping its powder dry, waiting for the right time to provide more quantitative easing. For more than a year now, the central banks have said they know how to handle the problems in Europe; they've said they learned the lessons of the 2008 Lehman meltdown; the Federal Reserve has offered its playbook for responding to the European problem. The peripheral bond markets are ready to implode unless the ECB and the EU show they have deep pockets and are ready, willing, and able to start big time buying of debt in the secondary market. One trillion dollars in LTRO bailouts from last year are gone; Spain has already chewed up 55% of its debt schedule for the year and yields on Spanish bonds have been moving higher; and Moody's has cut its ratings on 16 Spanish banks by up to 3 notches – big banks like Santander. Greek banks have already experience a run; there was a small run on Bankia yesterday. I don't know if Greece will stay or go but it looks like the bet is for the central banks to respond with the biggest flood of liquidity the world has ever seen.

I'm thinking that is the game plan; executing the plan may still prove a challenge, and the whole thing could fall apart.

Meanwhile, we've had a chance to digest the JPMorgan mess. Time magazine wrote an article asking: “Is the Fed to Blame for JPMorgan's $ 2 Billion Blowup?”

They claim: “Initially, progressives pounced on the loss as reason to strengthen the yet-to-be-fully-implemented Dodd-Frank financial-reform law. Conservatives then pushed back on that conclusion, arguing that the loss was not a disaster for shareholders given the size and profitability of the bank overall and that policymakers shouldn’t overreact with more stringent regulation.

“However, there is another, smaller chorus of voices that is blaming neither government inaction nor banker recklessness but the policies of the Federal Reserve. These critics are arguing that excessive intervention by the central bank has distorted financial markets and forced big banks to resort to risky moves in order to maintain profits.

“....quantitative easing policies, under which the Fed has bought up “risk-free” assets like U.S. Treasury bonds, have caused there to be fewer safe assets to go around. In addition, the Fed’s decision to keep interest rates near zero since the height of the financial crisis in 2008 has reduced the profitability of banks’ usual business lines.”

While not blaming Bernanke, the idea is that the Fed fosters an environment that has encouraged investors (which includes banks) to take on risk due to their meager alternatives.

While it is true that the Fed has helped create the modern financial industry, they haven't forced anybody to gamble in the casino which is Wall Street; they didn't force JPMorgan to make stupid big bets in derivatives. While we might do well to be rid of the Fed, it just makes sense to implement the Volker Rule or better yet, to reinstate Glass-Steagall in the meantime.

Just how big a problem is this JPMorgan Blowup? Well, it has grown quickly from $2 billion to $3 billion and it could get worse. There are FBI, DOJ, and SEC investigations. The Senate Banking Committee Chair, Tim Johnson of South Dakota has announced his panel will call CEO Jamie Dimon to testify. That should give us some tough questions and some pertinent answers. For example, question: who is the largest the largest contributor to Senator Tim Johnson for the past 8 years – answer: JPMorgan Chase.

Freddie Mac reports average fixed mortgage rates again hitting new record lows. The 30-year fixed-rate mortgage at 3.79 percent continues to remain well below 4 percent and 15-year fixed-rate mortgages are also slightly down at 3.04 percent.

The only other economic report of the day was the BLS report on state by state unemployment. Thirty-seven states and the District of Columbia recorded unemployment rate decreases, five states posted rate increases, and eight states had no change. Forty-eight states and the District of Columbia registered unemployment rate decreases from a year earlier.

Nevada continued to record the highest unemployment rate among the states, 11.7 percent in April [down from 12.0 in March]. Rhode Island and California posted the next highest rates, 11.2 and 10.9 percent, respectively. North Dakota again registered the lowest jobless rate, 3.0 percent, followed by Nebraska, 3.9 percent, and South Dakota, 4.3 percent. Arizona at 8.1%

U.S. oil supplies grew last week by 2.1 million barrels. Storage levels are now the highest in nearly 22 years. Prices tend to decline when more oil is available. Prices have been moving lower, at one point today, dropping down to 91.81 a barrel, a 7 month low; down about 12% since the beginning of May.