Friday, February 21, 2014 - Grab Tight and Hope for the Best

Grab Tight and Hope for the Best

by Sinclair Noe

DOW – 29 = 16,103
SPX – 3 = 1836
NAS – 4 = 4263
10 YR YLD -.02 = 2.73%
OIL - .50 = 102.25
GOLD + 3.10 = 1327.10
SILV + .03 = 21.95

Sometimes you just grab tight and hope for the best. There is a deal in the Ukraine. Ukraine's opposition leaders signed an EU-mediated peace deal with President Viktor Yanukovich. Under pressure to quit from mass demonstrations in Kiev, Russian-backed Yanukovich made a series of concessions, including a national unity government and constitutional change to reduce his powers, as well as announcing an early presidential election this year. The Ukrainian parliament then voted to revert to a previous constitution, which essentially stripped Yanukovich of some powers, sacked his interior minister blamed for this week's bloodshed, and amended the criminal code to pave the way to release his arch-rival, jailed opposition leader and former Prime Minister Yulia Tymoshenko.

The deal was mediated by the foreign ministers of Germany, Poland and France, and appears to have been a victory for Europe in its competition with Moscow for influence. The European envoys signed the document as witnesses, but a Russian envoy did not. And just because a deal has been signed it doesn’t mean it will be easy. Protesters remain encamped in Kiev's central Independence Square, where approximately 77 activists had been killed over the past week. There were some celebrations but many of the demonstrators were skeptical that Yanukovich could be trusted.

Ukraine still has problems. The country is deeply divided between Russian sympathizers and the opposition which supports the European Union. The country is broke and facing default. They are dependent on Moscow for energy imports. Putin promised $15 billion in aid after Yanukovich turned his back on a far-reaching economic deal with the EU in November, but now Russia is holding back to see how things play out. The devil is in the details but for this moment in time, they are trying to give peace a chance.

Meanwhile the city of Detroit is looking for a fresh start. You might hear that the city of Detroit officially filed for bankruptcy today; that’s not quite accurate. The state appointed emergency financial manager, Kevin Orr filed a bankruptcy plan with the courts. And that’s just the beginning of the strangeness that is Detroit.

To begin the process of restructuring and exiting Chapter 9 bankruptcy, the city of Detroit filed documents with the court outlining its restructuring plans; who might get what, and an idea of what the city might look like after it pays what it can.

Orr proposed 34% cuts to the pension checks of general city retirees and 10% to police and fire retirees, and they would lose cost of living adjustments, and it’s dependent on the city’s two independently controlled pension boards agreeing to support the plan of adjustment. The city has about 24,000 retirees. The city proposed paying about 20% to 30% of its retiree health care liabilities to a newly created trust fund.

The city proposed paying secured bondholders 100% of what they’re owed, while unsecured general obligation bondholders would receive 20%.The significant haircut for general obligation bonds now declared to be unsecured debt likely will upset participants in the $3.7 trillion municipal bond market, where general obligation bonds have traditionally been considered a safe bet for investors. A deal to end costly interest-rate hedges was not included in the plan, but there should be a plan for that within a few days.

The plan also calls for the city to invest about $1.5 billion over 10 years to improve public protection, restore services and reduce blight, including tearing down abandoned houses.

The judge overseeing the city’s bankruptcy, Steven Rhodes, must approve the restructuring plan before it can be finalized. This is likely to involve a fierce court battle with creditors over several months. Again, the devil is in the details, different parties will be upset; but the basic plan appears to be: fewer debt collectors, fewer murders, and fewer abandoned homes.

How will things work out for the Ukraine or for Detroit? We don’t know. In times of crisis, sometimes you just grab tight and hope you don’t get thrown off the horse. That appears to be the game plan of the Federal Reserve as the economy and financial markets collapsed around them in 2008. Today the Fed released transcripts of the Fed policy makers from 2008, when everything hit the fan. The one thing that becomes quickly apparent from the transcripts is that the Fed was not prepared for the meltdown and they were in no way certain about the best response.

As then-Fed Chairman Ben Bernanke said during an emergency conference call on Jan. 21, 2008: "We were seriously behind the curve in terms of economic growth and the financial situation." And so at that meeting, they cut the Fed Funds discount rate target by three-quarters of a percent. Twelve days earlier they had called another emergency meeting and made no change to interest rates. Nine days later, on January 30, they cut rates another 50 basis points.

Then at their September 16, 2008 meeting the Fed left interest rates unchanged, even though Lehman Brothers had just collapsed and insurance giant AIG was in the grips of a crisis that threatened to bring down the whole financial system. By the end of 2008, the Fed had made eight rate cuts, leaving its benchmark short-term rate on Dec. 16 at a record low near zero. It remains there today.

At the September meeting, many Fed officials were far more worried about inflation risks than about the risk of an economic collapse and depression. The word "inflation" occurs 129 times in the Sept. 16 transcript; the word "recession" was uttered just five times. ("Laughter" is noted in the transcript 22 times.)

Lehman fallout was unclear. The day after Lehman declared bankruptcy, Fed officials still didn't have a handle on what the long-term effect would be on the economy. Dave Stockton said: "I don't think we've seen a significant change in the basic outlook. We're still expecting a very gradual pickup in GDP growth over the next year."

Several Fed officials congratulated themselves on the controversial decision to deny funding for a potential acquisition of bankrupt Lehman Bros. The move, however, significantly worsened the crisis. Former Kansas City Fed chief Thomas Hoenig said: "I think what we did with Lehman was the right thing because we did have a market beginning to play the Treasury and us, and that has some pretty negative consequences as well.” And St. Louis Fed chief James Bullard said: "By denying funding to Lehman suitors, the Fed has begun to reestablish the idea that markets should not expect help at each difficult juncture."

And if they were unsure of the effect of the Lehman collapse, they totally misread the failure of Bear Stearns. In April, just after the collapse of Bear, Bernanke seemed to think the worst had passed, saying: “I think we ought to at least modestly congratulate ourselves that we have made some progress," he said. "Our policy actions, including both rate cuts and the liquidity measures, have seemed to have had some benefit. I think the fear has moderated. The markets have improved somewhat." Actually, it was just the calm before the storm. Then at the September 16 meeting, Bernnake made the mistake of self-congratulation once again, saying: “I think that our policy is looking actually pretty good.”

Janet Yellen, the new Fed Chairperson, seemed to grasp the gravity of the situation more than most of her colleagues. At an Oct. 28-29 Fed meeting, Yellen noted the dire events that had occurred that fall. With a nod to Halloween, she said the Fed had received “witch’s brew of news.” Yellen went on to say: “The downward trajectory of economic data has been hair-raising, with employment, consumer sentiment, spending and orders for capital goods, and homebuilding all contracting.” Market conditions had “taken a ghastly turn for the worse,” she said. “It is becoming abundantly clear that we are in the midst of a serious global meltdown.” Yellen had downgraded her economic outlook and was predicting a recession, with four straight quarters of declining growth. She was right about that, even if no one was sure what to do about it.

Maybe they were just tilting at windmills, as Philly Fed President Charles Plosser suggested, saying: “I don’t think that anything that we do today — cutting the funds rate 50 basis points or whatever — is going to make the next couple of months in terms of the overall economy any less painful.”

They thought they should get more regulatory powers in return for bailing out the banks. Richard Fisher, head of the Federal Reserve Bank of Dallas, said in a March 2008 conference call:  "I am just a little worried about being taken advantage of here. The question is, what do we get in return, and how do we make sure that, since we are not the regulator of these dealers, there is indeed discipline?" Of course it turns out there was no discipline. The big banks are now bigger and riskier than ever.

At times they were overwhelmed. At the September 16 meeting a Fed economist said: "We did receive a great deal of macroeconomic data since ... last Wednesday. We didn't seem to get any of it right, but it all netted out to just about nothing."  And everybody had a good laugh.

Eventually, Bernanke seemed resigned to his limitations. In October of 2008, he was asked about the future direction of rates and he answered: “I feel rather unconfident about predicting the path of rates six months in the future, because I’m not quite sure what is going to happen tomorrow at this point.”

To be fair, even though they made a bunch of mistakes, the global financial system did not collapse. Sometimes you just grab tight and hope for the best.