Tuesday, August 27, 2013 - The Drums of War

The Drums of War

by Sinclair Noe

DOW – 170 = 14,776
SPX – 26 = 1630
NAS – 79 = 3578
10 YR YLD - .07 = 2.71%
OIL + 3.34 = 109.55
GOLD + 11.00 = 1417.00
SILV + .19 = 24.62

Yesterday Secretary of State Kerry laid out the case against Syria. Today we learned the US could be ready to take military action as soon as Thursday. Defense Secretary Hagel today said: "We have moved assets in place to be able to fulfil and comply with whatever option the president wishes to take."

This follows last Wednesday's suspected chemical attack near the Syrian capital, Damascus, which reportedly killed more than 300 people; more than 3,600 people were treated for nerve agents, and by some estimates the death toll is now approaching 500. You've surely seen the grisly videos. They are compelling, but in light of the faulty intelligence that preceded the war in Iraq, there is a call for stronger proof. White House spokesman Jay Carney says a report on chemical weapons use being compiled by the US intelligence community and will be published this week.

There is not a requirement for Congressional approval for the president to initiate military action including strikes; rather the War Powers Act requires congressional notification, and that has been happening; of course questions of legality will be debated. The UK Parliament is to be recalled on Thursday to discuss possible responses. Prime Minister David Cameron said the world could not stand idly by after seeing appalling scenes of death and suffering caused by suspected chemical weapons attacks. French President Francois Hollande said France was "ready to punish" whoever was behind the attack. The Arab League said it held Syrian President Bashar al-Assad responsible for the attacks and called for UN action.

Russia, China, and Iran - allies of the Syrian government - have stepped up their warnings against military intervention, with Moscow saying any such action would have "catastrophic consequences" for the region.

After almost 12 years of war, the public is not keen on new battles; the latest polls show only 9% support for military intervention. And an almost irresistible feeling that something needs to be done is running head-on with the reality that there is no course of action that is attractive and that does not carry significant risks. A diplomatic response seems unlikely at this point. A minimalist response of stepping up support for Syrian opposition forces has so far proven ineffective. A more likely response is strategic missile and air strikes, perhaps similar to the Bosnian campaign of 1999 or the more recent campaign against Libyan dictator Kaddafi. Regime change is explicitly not the goal of military action, and administration officials have suggested any airstrikes will be limited.

Or the whole damn thing could explode into World War III. At the very least, Syria will be a mess for quite some time; we don't know who or what will replace the Assad regime, and even a fairly smooth transition of power can prove challenging as we've learned in Egypt; the situation in Syria will be an even bigger challenge. The outlook for military action is stark.

Warships are on the move. The impending conflict is rippling across financial markets. Europe and Asia moved lower. Equity markets in the Middle East were down significantly. Syria is not considered a major player in oil, but the region is vital, and so oil prices spiked this morning, up 2.95 at 108.87 a barrel. We've seen oil prices top out at 108.00 a couple of times this summer, so a breakout above 108 is important. We're at six month highs. Post-financial crisis highs for crude sit just below $114. We're not that far off.

Gold loves fear. Yesterday, gold closed above $1400, and today it kept running, hitting an intraday high of 1425; there is a major level of resistance at 1420, and it is being challenged. We're not that far off. After that the big levels of resistance are around 1520; that is still pretty far off.

Emerging markets could absorb the brunt of the selling as this crisis continues to unfold. Money has been flowing out. Although this is more likely a result of other factors not associated with military moves in the Middle East. Many are now dubbing the BRIC countries (the grouping of Brazil, Russia, India and China) down and out, but the lower prices also make valuations more enticing. Maybe periods of pessimism are good times to buy, but only if you have a constitution suited to catching falling knives. For investors bracing for an end of cheap dollars from the Federal Reserve, emerging market currencies are getting hit hard.

Meanwhile, I went to the New York Times website today, and it was down; hacked by the Syrian Electronic Army, a group which supports Syrian president Bashar al-Assad. So I guess the war has already started.

With all the talk about war, it would be easy to overlook the banks behaving badly, but don't worry, I've got it covered. Let's start with JPMorgan; the Federal Housing Finance Agency wants JPMorgan to pay more than $6 billion to settle claims that it knowingly sold bad mortgages to Fannie Mae and Freddie Mac ahead of the financial crisis. Such a settlement would be the biggest single penalty paid by any bank for actions ahead of the crisis. It would also roughly match the $6.2 billion JPMorgan lost in the "London Whale" trading debacle in early 2012.

The FHFA regulates Fannie Mae and Freddie Mac, and they claim JPMorgan misled the mortgage agencies about the value of $33 billion in mortgage backed securities. JPMorgan expects to settle the case, but they're balking at the price.

Meanwhile, a former JPMorgan trader wanted by the United States for allegedly falsifying bank records to cover up $6 billion in trading losses was arrested in Madrid. Javier Martin-Artajo was arrested after he presented himself to police in Madrid and was later released on bail. Now there will be extradition hearings.

For years I've been saying the biggest banks should be broken up, chopped into smaller pieces, more easily digestible. It would be the best thing for the economy, and according to a new research report from the investment bank Keefe, Bruyette and Woods, it would be good for the banks' shareholders. The report says  JPMorgan's value might be 30 percent higher if it were broken into pieces. If JPMorgan were broken into four units -- traditional banking, investment banking, asset management and private equity -- the market value of those segments could total $255.7 billion -- a 29.9 percent premium over Thursday’s market valuation of $196.9 billion. The move also would unlock some $19.5 billion that the bank is setting aside to satisfy capital reserve requirements for so-called too big to fail banks. That's money the bank might make available for lending.

The report also looked at JPMorgan's legal problems, which include 13 investigations by federal regulators, not to mention some overseas legal problems on charges ranging from manipulation of energy markets to hiding large losses during the “London Whale” debacle in early 2012. The bank also faces a barrage of lawsuits from individuals and its trading counterparties. The legal uncertainties have taken their toll on JPMorgan's stock, with shares trading at 8.65 times the bank's earnings over the past 12 months. Similar institutions trade at multiples that are 25 percent to 40 percent higher. The report says the legal problems aren't enough to bring the bank down.

Ah, we can't let this one pass without notice. The New York Attorney General has sued Donald Trump for his Trump University. Attorney General Eric Schneiderman says many of the 5,000 students who paid up to $35,000 thought they would at least meet Trump but instead all they got was their picture taken in front of a life-size picture of “The Apprentice” TV star.

“Trump University engaged in deception at every stage of consumers’ advancement through costly programs and caused real financial harm,” Schneiderman said. “Trump University, with Donald Trump’s knowledge and participation, relied on Trump’s name recognition and celebrity status to take advantage of consumers who believed in the Trump brand.”

Schneiderman is suing the program, Trump as the university chairman, and the former president of the university in a case to be handled in state Supreme Court in Manhattan. He accuses them of engaging in persistent fraud, illegal and deceptive conduct and violating federal consumer protection law. The $40 million he seeks is mostly to pay restitution to consumers.

And honestly,… I’m not saying there shouldn’t be consumer protections, and fraudulent activity should certainly be punished, but if you’re paying $35,000 to go to something called Trump University the words caveat and emptor do leap to mind.

In economic data today, the Case-Shiller Home price index showed price gains of about 1% for the month and 12% year over year, roughly inline with previous gains as well as expectations. However, this is a June report for home sale closings from late spring and early summer (meaning the sales contract was signed even earlier). It contains virtually no information about how home prices are reacting to the sharp jump in interest rates this summer. That said, some details: All 20 cities posted monthly and annual gains, but prices rose faster this month than last in just 6 cities as opposed to 10 in May. Dallas and Denver hit new all-time highs. San Francisco is up 47% from its March 2009 low. Phoenix is up 37% from its September 2011 low. Las Vegas prices are up 24.9% Y/Y, San Francisco +24.5%, Phoenix up 19.8%, Los Angeles +19.9%. On the lower end, Cleveland +3.5%, D.C. +5.7%, Chicago +7.3%, New York +3.3%.

The story of the West is a story of water; droughts, floods, the development of water infrastructure. But the story of water in the West is also being told, every day, in the growing crisis facing communities, watersheds, ecosystems, and economies. This isn’t a crisis of for tomorrow. It is a crisis today. What is, perhaps, a surprise, is that it has taken this long for the entire crazy quilt of western water management and use to finally unravel. But it is now unraveling.

The old adage of the blind men describing an elephant based on their experience touching different parts of it applies to western water. In the past few years, we’ve seen bits and pieces of the puzzle: a well, and then two wells, and then a town goes dry. A farmer has to shift from water-intensive crops to something else, or let land go fallow. Vast man-made reservoirs start to go dry. Groundwater levels plummet, yet the response is to try to drill new and deeper wells and pump harder, or build another dam, or move water from an ever-more-distant river basin. Competition between industry and farming increases. And politicians run back to old, tired, half-solutions rather than face up to the fact that we live in a changed and changing world.

Here are a few pieces of the puzzle that we had better start to put together into a coherent picture if we hope to change our direction.

In January 2012, the Texas town of Spicewood Beach ran out of water. Then Magdalena, New Mexico ran out. More recently, Barnhart, Texas. Now Texas publishes a list of towns either out or running out of freshwater. In some parts of Texas, demands for water for fracking are now competing directly with municipal demands.


Because of a severe, multi-year drought (described as “the worst 14-year drought period in the last hundred years”) and excessive water demands, the US Bureau of Reclamation, this week,announced it will cut water released from Lake Powell on the Colorado River to the lowest level since the massive reservoir was filled in the 1960s. Water levels in Lake Mead have already dropped more than 100 feet since the current drought began in 2000, but even in an average year, there is simply more demand than supply.


Las Vegas is so desperate for new supplies they have proposed a series of massive and controversial ideas, including: a $15+ billion pipeline to tap into groundwater aquifers in other parts of the state, diverting the Missouri River to the west, and building desalination plants in Southern California or Mexico so they can take a bigger share of the Colorado.


Governor Jerry Brown is pushing a $25+ billion water tunnel project to try to improve water quality and reliability for southern California farmers and cities and improve the deteriorating ecosystems of the Sacramento-San Joaquin Delta, with no guarantees that it will do any of those things at a price users are willing and able to pay.


San Luis Reservoir in California, which serves the Silicon Valley and other urban users, has fallen to 17 percent because of severe drought, making business, communities, and water managers nervous. Other major California reservoirs are also far below average, though massive deliveries of water continue on the assumption that next year will be wet.


Praying for rain has become an official water strategy for some politicians in Texas, Georgia,Florida, Oklahoma, and elsewhere.


Another popular water strategy seems to be to sue your neighboring state. Here are some examples: Texas v. Oklahoma and Kansas v. Nebraska and Colorado, and outside of the west,Florida v. Georgia (and Alabama too)


Groundwater is disappearing in California, the Great Plains, Texas and elsewhere in the West, because our laws and policies ignore the fact that surface and groundwater are connected. Contributing the problem, water managers and legislators typically put no restrictions on groundwater pumping, leading to inevitable, and inexorable, groundwater declines.

There is more and more and more evidence of declining snowpack in the western US as the climate warms.

These are just a few recent examples of the growing water-related dislocations in the western US. Writ large, the entire region is at risk. Oh, one more, the Colroado River, at Lake Mead, backed up by the Hoover Dam, the lake is receding; it's estimated that in four years there won't be enough water to cover the turbines to produce the elctricity for Las Vegas. You can replace a power plant. I'm not sure how you replace a river