Wednesday, August 8, 2012 - Rogue Regulators, Central Bank Enablers, and a Jolt of Profit for Morgan Stanley

Rogue Regulators, Central Bank Enablers, and a Jolt of Profit for Morgan Stanley
-by Sinclair Noe

DOW + 7 = 13,175
SPX + 0.87 = 1402
NAS – 4 = 3011
10 YR YLD +.01 = 1.64%
OIL +.07 = 93.42
GOLD + .30 = 1613.60
SILV - .06 = 28.14
PLAT + 3.00 = 1414.00

The Dog Days Rally on Wall Street extended to day 4 but the dog is looking tired. The S&P 500 closed above 1400. The Nasdaq Composite closed above 3000 but finished slightly lower on the day. The volume was very light, so it's hard to find strong conviction in the rally; still it is a rally, or it was. The main driver seems to be the idea that the ECB will, in fact, do whatever it takes to prop up the Euro-union. Today, the Bank of England gave little indication that it would rush to pour in further stimulus even as it cut its forecast for medium-term economic growth in Britain. France's central bank forecast a contraction in growth going into the third quarter, citing weak demand from the periphery and Britain.


The strange case of Standard Chartered Bank just keeps getting stranger. The British bank has been accused by a regulator from New York state of doing business with Iran in violation of sanctions. The regulator has threatened the bank's charter in New York. The bank denies it did the dirty with the Iranians, or at least they deny they did as much as accused, maybe just a few million in deals but certainly not the billions they are accused of. So, now they have gone on the offensive, accusing the regulator of being a “rogue”. SBC chief executive Peters Sands said the accusations and possible revocation was "disproportionate" and came as a "complete surprise". One British lawmaker said the affair was part of a "political onslaught" in the United States against British banks; others described it as an anti London bias and a form of banking sector protectionism. 

This is actually a very bizarre case. You do have to wonder why the New York regulators would be so cruel as to single out Standard Chartered. Why SCB? Why now? Is there some darker, more nefarious reason for enforcing the law? I don't know what the reason might be; I can only recognize that any regulatory enforcement against a bank is an aberration. Maybe the New York regulator didn't get the memo; maybe the regulator didn't get the bribe. Any regulator that actually tries to enforce existing laws has undoubtedly gone “rogue”.  Yea, that's it, the regulator is the problem. There are many other banks that have done much worse and there has been no punishment whatsoever. So, you can see why the bankers at SCB are whining for being singled out. 

So, this is a pretty clear example of government over-reach and the assault on free market principles. Now let's get back to the reasons for the 4-day rally on Wall Street; there are problems in Europe and that threatens the US, and so the ECB and the Fed have indicated they will be standing by to provide accommodative policy, or maybe quantitative easing, and if there is one thing Wall Street loves, it is free money. Over the past few weeks, whenever the economy, either in Europe or here, seems to be showing signs of weakness, there are calls for free money from the central banks, a boost from the Fed, an injection from the ECB. The President of the Boston Federal Reserve Bank says he favors a bond buying program, and Wall Street rallies with the predictability of Pavlov's dog. ECB President Mario Draghi says he will do whatever it takes and the bankers can almost feel the free money being injected directly into their veins. Does this really help?

You might make the argument that the central bankers actions have helped avert a meltdown, but it really hasn't helped to correct the underlying, systemic problems with the economy. This is evidenced by the Fed's failure to achieve its dual mandate which includes maximum employment. Maybe the Fed passing out free money to Wall Street can't resolve what really ails America. All the free money tossed out of the helicopter didn't clean up the housing collapse; it didn't reform the tax code; it didn't maximize employment; it didn't raise the standard of living over the past 30 years; it didn't keep jobs from being outsourced; it didn't boost American competitiveness.

In Europe, the troika hasn't been able to create confidence in the monetary union, they haven't been able to improve growth prospects, they haven't been able to avoid a downturn that has destroyed Greece and threatens Spain and Italy, they haven't been able to quell the crisis. They have thrown trillions of euros at the problem and they have managed to staunch the bleeding but the fiscal problems of Spain and Italy are not resolved and will probably demand full blown bailouts, and there really isn't enough cash to buy the bonds needed to suppress a meltdown. Draghi promises to do  whatever it takes, but it will take at least a few more weeks. And that is part of the problem. The interventions have only served to drag out the problems, eliminating the sense of urgency, and so there has been precious little action on the fiscal side. The ECB is not the governments of the sovereign Euro-nations.

Likewise, the Fed is not the US government, and has proven itself to be a poor regulator to boot. With no threat of impending regulation and no enforcement of existing laws and regulations, the financial sector has wallowed in its own cesspool. The Libor rigging scandal and the London Whale trading losses and the Standard Chartered sanction skirting just show the bankers are still cheating, and gambling and taking excessive risks with other peoples' money, just like back in 2008, maybe worse. So why do we still think the proscribed course of action is for the Fed to shower more free money on Wall Street?

We will almost certainly see a form of Quantitative Easing in Europe in September; we'll see QE from the Fed before or after the election. It might result in another rally on Wall Street but it won't solve the underlying problems with the economy. Maybe Bernanke should follow the advice of Nancy Reagan and just say no. It would likely be a painful move. The banksters would whine, but it might go a long way to stop the Fed from serving as the enabler to Wall Street. And it might even push the politicians in Washington to do their jobs. 

Fat chance. 

And for those of you that think banks provide no value to the economy, I present the case of Morgan Stanley's contribution to the electric grid. KeySpan, an electric generator wanted to increase capacity but realized more capacity would lower prices and they couldn't cut capacity without losing market share to the competition, a company called Astoria Generating; and they couldn't buy Astoria without raising some anti-trust issues. This is where Morgan Stanley comes in. Keyspan entered into a swap with Morgan Stanley that effectively purchased the capacity of Astoria at $7.57 a kilowatt-month. Morgan Stanley then turned around and hedged that trade by entering into a swap that bought the capacity from Astoria for $7.07 a kilowatt-month. Morgan Stanley pocketed the difference, which worked out to about $22 million over three years. 

The deal allowed KeySpan to push up the price of electricity in New York, costing consumers an extra $300 million. Yesterday, a federal judge approved a $4.8 million settlement between the Justice Department and Morgan Stanley over accusations of price fixing in the electricity market. This means Morgan Stanley only profits by about $16 million, not including legal fees. You can see how this is a deterrent. 


The National Oceanic and Atmospheric Administration (NOAA) says July was the hottest month ever in the US, breaking the record that had stood since the Dust Bowl summer of 1936. The January-to-July period was also the warmest since modern record-keeping began in 1895, and the warmest 12-month period, eclipsing the last record set just a month ago. It was the fourth time in as many months that temperatures broke the hottest-12-months record.

The drought is the worst since 1956 and it will yield the smallest corn crop in six years, which has fed record-high prices and tight supplies. It would be the third year of declining corn production despite large plantings. The heat and drought feed off each other. You can deny global warming if you want but you might want to hedge that position.