Wednesday, January 16, 2013 - Fuzzy Justice

Fuzzy Justice

by Sinclair Noe

DOW – 23 = 13,511
SPX +0.29 = 1472
NAS + 6 = 3117
10 YR YLD - .01 = 1.82%
OIL + .88 = 94.16
GOLD + .10 = 1681.00
SILV + .12 = 31.59

The National Association of Home Builders/Wells Fargo housing market index was flat at a seasonally adjusted level of 47 in January. This is a gauge of homebuilders' confidence. Conditions in the housing market look much better now than at the beginning of 2012 and an increasing number of housing markets are showing signs of recovery, which should bode well for future home sales later this year. The builder-confidence gauge is up 88% from the same period in the prior year, even though the number was essentially flat for the January reading.

Industrial production increased 0.3% in December and now stands at the highest level since the summer of 2008. Production is up for 2 months, indicating a recovery from Hurricane Sandy.

The House of Representatives finally passed a $51 billion aid package to provide emergency relief for Hurricane Sandy. It was a partisan vote, but 49 Republicans voted for the aid package, mainly representatives from the affected areas.

The Consumer Price index was flat in December. The core rate of inflation, excluding food and energy, rose 0.1%. Gasoline prices dropped last month. For all of 2012 consumer prices climbed 1.7%, the third lowest rate in the past 10 years. That’s also down from a 3% increase in the prior year. Core CPI was up 1.9% for the full year. You will recall the Federal Reserve has now set a target on inflation of 2.5% and a target on the unemployment rate at 6.5%; and they will buy about $85 billion in bonds until they get to their targets and spark some activity. So, there is still a lot of bond buying to go.

The Fed released its Beige Book today; that's the anecdotal survey of the economy by the 12 Fed regions. The survey says there is no real spark in the economy. Growth is lackluster. Manufacturing activity was mixed, with three of the 12 Fed regions reported a decline in factory output. The labor market was seen as mostly unchanged. Several districts reported delayed hiring, often in defense manufacturing, due to fiscal cliff uncertainties. Housing continued to be a bright spot. Existing home sales picked up in all but one of the Fed’s dozen regions with interest rates low. While consumer spending did grow during December, holiday sales were below expectations. High levels of energy production were reported across the country. In a word, the economy is beige.

The low interest rate environment fostered by the Fed tends to push savers to chase yield. The low interest rate environment also applies greater pressure on banks' loan margins, and likewise, they chase yield through their investment banking units. Today, we saw better than expected earnings from Goldman Sachs and JPMorgan Chase.

Goldman posted fourth-quarter earnings of $2.8 billion, or $5.60 per share, up from $978 million, or $1.84 per share, in the same period a year ago. Let's just say that analysts' expectations were well managed. The bank said it took in "significantly higher" revenues from credit products and mortgages in its bond-trading business. In other words, in a low interest rate environment, they took on additional risk.

JPMorgan Chase recorded fourth quarter net income of $5.7 billion, flat with the prior quarter, but up 52.7% from the prior year. Performance was supported by strong loan and deposit growth, record debt underwriting fees in the investment bank, and continued stabilization in credit, including a $700 million pre-tax benefit from lower mortgage reserves in real estate portfolios. In banking lingo, fewer reserves is considered stabilization. Chasing yield in a low interest rate environment can lead to things like the London Whale trading scandal. Today, JPMorgan announced it had reached an out of court settlement with Bruno Iksil, the whale. Details were not disclosed.

They did disclose some details of the $6.2 billion loss on trading positions taken by Bruno the Whale. Apparently there was a breakdown in management controls. The Whale got into credit derivatives and he couldn't get out. There were losses that carried into the fourth quarter. Regulators are still examining but don't hold your breath waiting for action. Jamie Dimon considers the Whale Trade to be a thing of the past; done and gone. Jamie Dimon's bonus was cut in half; the poor guy will only pull down about $10 million in bonuses. Bank insiders claim he will be able to survive, but he is accepting his punishment. In banker lingo a $10 million dollar bonus is considered punishment. Let's move on. Jamie has been punished enough.

Wait a moment. The Office of the Comptroller of the Currency issued a couple of orders to JPMorgan, one related to the London Whale, and another related to the BSA/AML, which stands for Bank Secrecy Act and Anti-Money Laundering compliance. Seems the bank wasn't up to snuff on compliance and they failed to correct previously identified weaknesses in their compliance program. The previously identified problems included 22 pages of specific things the OCC said JPMorgan must do to be in compliance, and it turns out the bank did nothing to correct the problems. Now, we don't know if the bank did any actual money laundering in direct relation to these orders, but we do know that 18 months ago, JPMorgan got caught sending a ton of gold to Iran in violation of sanctions. And then fast forward to today, and JPMorgan still refuses to comply with the Bank Secrecy and Anti-Money Laundering orders, and the punishment is exactly … nothing.

Now compare that with a guy in Los Angeles named Karen Gasparian, who runs a check cashing company (and I'm no fan of check cashing firms) and he was actually prosecuted for failure to comply with BSA/AML law – the very same failure to comply as Jamie Dimon and JPMorgan Chase. Mr. Gasparian apparently cashed checks for more than the $10,000 limit without properly reporting the transactions. There are reports of ties with Armenian and Russian gangs. I'm certainly not trying to defend this guy running the check cashing store. Today, Mr. Gasparian was sentenced to five years in prison. Today, Jamie Dimon received a $10 million dollar bonus.

This week’s bold warning on infrastructure comes weighted with the sort of price tag that seems abstract to many taxpayers in a nation where a financial bailout costs $500 billion, a war is $113 billion a year, the annual deficit runs to $1 trillion and recent spending cuts amount to $110 billion.

The cost of deficit reduction became real when people got their first paycheck this year and realized the payroll tax holiday was over. But experts said the reality of a failure to invest $1.1 trillion more in infrastructure by 2020 will creep up on them.

If the problem is not addressed, power outages will become more frequent, prices at the supermarket and department store will inch up, traffic will detour around bad bridges, household incomes will drop and millions of people will lose their jobs.

There's been plenty of documentation of the challenge of rebuilding a post-World War II infrastructure at the end of its natural life, including: roads, bridges, the electrical grid, water and sewer systems, ports. One of the most meticulous accounts has come in a series of reports by the American Society of Civil Engineers (ASCE), which delved into each failing system to calculate not just the cost of restoration but the economic and personal price of doing too little or nothing at all.

The exclamation point on the “Failure to Act” reports came Tuesday in an ASCE paper: An investment of $2.7 trillion is needed by 2020; likely funding available, $1.6 trillion. The Congressional Budget Office says combined federal, state, and local spending for roads and bridges now amounts to about $160 billion.

No, the numbers don't add up, and the result, according to the report is: “Job losses will mount annually, and by 2020 it is predicted that there will be 3.5 million fewer jobs throughout the country. The expected impact for every household in the U.S. will be an average loss of more than $3,000 per year through 2020 in disposable personal income . . . due to job cutbacks and declining business productivity.” After that, it gets worse: “Expected loss of disposable personal income is estimated to exceed $6,000 annually from 2021 to 2040.”

And finally, Germany's central bank will repatriate some $200 billion worth of gold reserves it has stored in the United States and in France. The Bundesbank plans to bring back to Germany some of its 674 tons of gold stored in the vaults of the Federal Reserve in New York, and the Bank of France in Paris.

After the end of World War II, Germany had no gold reserves, but as its economy recovered and Germany became the export powerhouse it is today, the country accepted gold as well as dollars from the central banks of its trading partners to cover the financial imbalance created by German trade surpluses.

During the Cold War, West Germany followed a policy of storing its gold as far west as possible in case of a Soviet invasion.

But the central bank came under pressure last year when Germany's independent Federal Auditors' Office last year concluded it failed to properly oversee its gold reserves. The auditor suggested the central bank should carry out regular inspections of the gold held abroad to verify its book value or change the reserves' management.

Why bring the gold back now? Don't the Germans trust the central bankers? Even after Germany completes the transfer at the end of 2020, half of its gold will remain abroad — about 37 percent in New York. The Bundesbank does not plan to move any gold out of the Bank of England, which will continue to store 13 percent of the total.

The New York Fed stores the German gold without cost on the theory that the presence of foreign gold supports the dollar’s status as the global reserve currency. I'm not sure that is a public position but it is an interesting idea. The Bank of England, by contrast, charges about €550,000 a year for storage, so storage costs are part of the reason. But there is also an emotional attachment. The Bundesbank has continually rejected periodic attempts by political leaders to convert the reserves to cash, and has not sold any gold on world markets.