Wednesday, May 30, 2012 – Spanish Winter, Mexican Spring – by Sinclair Noe

DOW – 160 = 12,419
SPX – 19 = 1313
NAS – 33 = 2837
10 YR YLD – 0.11 = 1.62%
OIL – 3.38 = 87.38
GOLD + 7.70 = 1563.50
SILV +.05 = 28.03
PLAT – 28.00 = 1406.00

Yesterday the Dow gained 125 and I said: “The reason du jour for today's market gains: positive news regarding Greece. Really? I'm not buying it. Make up your own reason for today's gains because we are just as likely to see declines tomorrow.”

And sure enough. The problem du jour was Spain and the Dow dropped 160. This economic stuff is easy. Remember when I told you a couple of months ago to get out in May? The S&P 500 has fallen nearly 6 percent in May, heading for its worst monthly performance since September. You're welcome. The Nasdaq is down 6.9% for the month. US Treasury benchmark yields fell to their lowest in at least 60 years. Oil dropped more than 3 percent to the lowest level in nearly six months; oil prices are down 16% in May. The dollar remains the cleanest shirt in the dirty laundry hamper, up 5.5% for the month. The euro dropped below $1.24 to a 23-month low. Spain's stock market hit a 9 year low. Yields on 10-year Spanish bonds topped 6.6%, which is close to levels at which Ireland and Greece sought international bail-outs.

The news from Europe was all Spanish overnight as the country struggles to find traction on any plan that will lead it away from the need for external help The Spanish Economy Ministry played down a report that the European Central Bank had rejected an initial plan to rescue Bankia, Spain's fourth biggest bank, by stuffing it with government bonds that could be used as collateral to borrow from the ECB. A ministry spokeswoman said: "Spain did not formulate any proposal to the ECB on funding the Bankia plan, so it was difficult for it to have an opinion."

Spanish Prime Minister Mariano Rajoy insisted the government has no intention of seeking an EU/IMF bailout either for its banks or for the state, but then a Governor for the Bank of Spain resigned, abruptly, a month before his term was due to end, adding to concerns about the handling of the Bankia crisis and relations with European institutions.

Highlighting Spain's difficulty in meeting fiscal targets while gripped by a worse-than-forecast recession, the outgoing central bank chief said tax revenue may fall short of government estimates and spending may be higher than expected. He recommended bringing forward a rise in value-added tax set for 2013 if the deficit objective goes off track this year.

Also, Spain announced its joint national-regional bond issuance scheme would go live within days:

Spain’s government said it would approve the issuing of joint bonds by the 17 regional governments next Friday, so as to make it cheaper for them to finance their debts. And so the blurry line between Spanish banks and national and regional governments gets a bit more out of focus. The problems of Spain’s economy all stem from the fact that the government sector is attempting to implement an austerity program at a time when the private sector is in deep retrenchment. Given the economic and political circumstances the country finds itself in it may have no choice, but that won’t change the outcome. Private sector demand is falling and economic circumstances continue to make it harder for the private sector to recover from the economic shock of the housing market collapse. The Bank of Spain says retail sales declined in April at a record rate and the economy will slow even more in the second quarter. It looks like Spain has entered the very nasty and possibly inescapable downward spiral.

Meanwhile, the National Bank of Greece is threatening that the Greeks face economic catastrophe if they leave the euro. Living standards would plummet, incomes would be slashed by more than half, and inflation and unemployment would skyrocket. The bank claims per capita income would collapse by at least 55 percent, the new national currency would depreciate by 65 percent against the euro and a recession (I hate to think what a depression would look like for Greece), now in its fifth year, would deepen by 22 percent, pushing unemployment and inflation through the roof.

Tomorrow the Irish vote in a referendum on a European budget discipline treaty which is seen as a precondition for receiving further EU/IMF aid.

So far, voters in Europe have sent an inescapable signal to the EU powers that be: no more austerity. In doing so, they showed that the average voter has a better understanding of economics than the technocrats in charge. So far, the all-austerity plan has not solved the debt crisis and has sent weaker economies into depression, with high unemployment, higher and higher costs to service debt, and strain that threatens the union. There is a case to be made that the problem with austerity is not the austerity itself, but the pace at which it is being imposed. Rather than a mad rush to meet euro-zone deficit limits, more flexibility is needed to allow governments to adjust over a longer period of time and benefit from economic recovery.

And there is another argument that says whatever the verdict at the ballot box, Euro-land can't avoid austerity. Its indebted governments can’t simply return to spending and borrowing as they had in the past. Financial markets just wouldn’t stand for it. And what we really have is a battle to see who will prevail in Europe, democracy or financial markets. Of course, a democratic union can suport financial markets, and indeed the vast majority of Europeans are in favor of keeping the Euro-union intact. However, the bigger question is whether the financial markets can live with a democracy, which can be messy at times. So far, there doesn't seem to be much flexibility.

The world is a dangerous place; the Muslim Brotherhood has been elected to lead Egypt past the Arab Spring. Syria is being butchered by a madman. UN nuclear inspectors showed new satellite imagery indicating that Iran may be conducting clean-up work at the military site where inspectors suspect tests relevant to developing nuclear weapons have been carried out. 

Meanwhile, just one state to the south, in case you hadn't noticed, is another exercise in flexibility, or lack thereof. I found this report on the situation in Mexico. On May 6th, the four candidates for the Presidency debated. In a nation where the internet reaches only 30%, and few can afford cable, the debate was not carried on broadcast television. The Federal Electoral Institute (IFE) chose to have a former porn star host the debate. She was clad in a thin, revealing white dress.

On May 11th, the PRI's candidate, Pena Nieto, attempted to speak at Mexico's elite Iberoamericana University. Student protests prevented him from speaking.

As governor of the State of Mexico, Nieto had repeatedly used police force to prevent student protests. In the wake of the Iberoamericana protests, thousands marched through Mexico City, and then other cities, against Pena Nieto. Their demands were simple: above all, clean elections. An end to corruption and manipulation in the IFE. Fair and equal access to the media-- an end to the unfair, biased and deceptive coverage by Party-controlled media.

In the weeks that have followed, this youth movement has come to be known as "YoSoy132," or "I Am 132." It takes some of its inspiration from the Occupy and Anonymous movements. It remains independent, its primary focus on organizing to observe the polls and, if possible, ensure their integrity.

Much and serious talk has arisen, of a "Mexican Spring." What this would mean, remains unclear. In both Eastern Europe and the Middle East, it entailed replacing authoritarian governments with democratic regimes. In Mexico, the loudest criticisms of the democracy movement remain focused on "stability." These same critics argue loudest that Mexico today is a democracy, with a three-party system and a limited Presidency. All experience from the past twelve years, says something different. Mexico's youth today, say something different.

The question is-- what would a Mexican Spring consist of?

We're coming up on the 2 year anniversary of the Dodd-Frank financial reform law. This was the response to the abuses of the financial industry that resulted in the near meltdown of the global financial system in 2008. Two years after the law was passed and it hasn't made any real difference. I can say that with some certainty because only a small portion fo the law has been enacted; the rest is under consideration and review; and every line in the law is being beaten back by the banks. This means the big part of the law; like bringing transparency to the trading of derivatives and the Volker Rule, which would theoretically eliminate banks making risky trades through their proprietary trading desks, those parts have not been enacted.

And even if Dodd-Frank survives the attacks of the banking lobbyists, there are doubts about its potential efficacy. Recently, there have been complaints that the law is overly complex. This is a good argument because the law runs about 2,000 pages and damn near nobody has read the whole thing, much less figured out the implications. Banking has become incredibly complex. The recent multi-billion dollar trading flop by JPMorgan just underscores how complex banking has become; and their trading activity has become so complex that they don’t' even understand the ramifications of their own actions; the regulators certainly lack awareness and the banks' own efforts at self regulation are laughable. On top of all that we don't know if Dodd-Frank regulations will be effective and we don't know if they will ever be implemented. So, that leaves us facing the same problems we faced in 2008.

You might have noticed there is a strong anti-regulatory sentiment this election year. Maybe you've heard about the “regulatory tsunami of unprecedented force” issuing from Washington. Maybe you've heard about the “vast edifice of regulations” or the “regulatory jihad”. The truth is that the Obama administration has issued slightly fewer rules than George W. Bush did at the same point in his tenure. And the cost benefit analysis has shown fewer costs to business than the previous administration. That restraint means that two-thirds of the rules proposed in Dodd-Frank have not been implemented; four years after the near collapse of the financial world as we know it and we haven't done anything to correct the problem. I understand that nobody likes the burdens of regulations but I also don't like salmonella in my spinach; I don't like cars that have exploding gas tanks; I don't like factories that spew toxic waste into the air or into rivers; I don't like businesses that force children to work on their assembly lines; I don't like businesses that discriminate against people because of the color, religion, gender, or other orientation; and I don't like banks that gamble with deposits and threaten to destroy the economy unless taxpayers bail them out.

What is going to prevent a repeat of 2008? Whether we are ready to admit it or not, Dodd-Frank is dead on the vine. The Senate Banking Committee's ranking Republican, Senator Richard Shelby of Alabama, has vowed to repeal Dodd-Frank altogether. The panel’s chairman, Senator Tim Johnson of South Dakota, and Senator Charles Schumer, a Democrat of New York, have called for looser rules on banks’ international derivatives trades. After JPMorgan’s losses came to light, Senator Johnson said it shows“why opponents of Wall Street reform must not be allowed to gut important protections for the financial system and taxpayers.” He is right. Now he and other committee members, and the regulators, need to show what they have learned. Don't hold your breath. Senator Johnson's biggest campaign contributor – JPMorgan. What is needed are requirements for derivatives to be traded on transparent exchanges — which would have prevented the trades from piling up without notice. Banks should also be required to move any derivatives deals into separately capitalized bank affiliates, which would protect taxpayers, and the banks, from disastrously large losses. Banks fought hard to keep those provisions out of Dodd-Frank, and, even now, they are still pressing to scale them back. The derivatives marketplace has grown to more than $700 trillion in size. It is the wild wild west of finance, and it is ground ripe for tax evasion and other abuses.

The simple solution would be to reinstate Glass-Steagall, the old depression era response to the problem of Too Big to Fail Banks. Split the banks into a traditional bank and an investment bank. The traditional bank takes deposits and makes loans; safe, conservative, and boring. The investment bank can make trades and if they win they keep the profits and if they lose, the depositors accounts would not be affected, and the investment banks could sink or swim based on their own performances. No wonder the bankers are opposed.