Tuesday, April 15, 2014 - Yellen in the Lions' Den

Yellen in the Lions' Den
by Sinclair Noe

DOW + 89 = 16,262
SPX + 12 = 1842
NAS + 11 = 4034
10 YR YLD - .01 = 2.62%
OIL - .22 = 103.83
GOLD – 24.20 = 1303.40
SILV - .41 = 19.66

Stocks were all over the place today. We started with triple digit gains for the Dow Industrials, dipped to triple digit losses, then back into positive territory for the close with the major indices closing just below their morning highs. This kind of volatility does not engender confidence; it does warrant caution.

The utilities sector gained 1.3% and finished ahead of the other groups, extending its YTD gain to 11.8%; the biotech ETF added 1%, while the broader healthcare sector advanced 1.1%.Tech stocks have been beaten up quite a bit over the past couple of weeks. The Nasdaq 100 Tech Index (NDXT) is down 7% since April 1st. The Nasdaq Composite has exhibited weakness, but not to the point of meeting the definition of a correction; it would take a slide to 3,922 to mark a 10% fall from the March 5 closing high at 4,357; a 10% pullback from the March 6 intraday high of 4,371 would be achieved at 3,934.

The Labor Department’s Consumer Price Index, or CPI, increased 0.2% in March after posting a 0.1% increase in February. Excluding volatile food and energy prices, core prices ticked up 0.2%.Prices rose 1.5% for the 12 months ending in March. That is up from February’s year-over-year reading of 1.1%. Core prices moved up 1.7% over the 12 months, up from 1.6% in February.

A major factor in both headline and core CPI in March was a 0.3% increase in shelter costs. On an annual basis, housing costs were up 2.7%, the fastest pace in six years. The indexes for medical care, used cars and airline fares also increased in March. Apparel prices rose for the first time this year. Household furnishings and recreation prices dipped in the month. Real or inflation-adjusted hourly wages, meanwhile, fell 0.3% in March to $10.31. Real wages have risen 0.5% over the past 12 months. So, we’re not seeing wage-push inflation.

The big difference has been housing; shelter costs account for a full third of the basket of goods and services tracked in the consumer price index. In the past year, consumer prices excluding shelter have risen just 1%, an indication that inflation pressures are subdued outside of housing.

The old rule of thumb was that rents and utilities combined should not take up more than 30% of household income. A new study by Zillow finds 90 cities where the median rent, not including utilities, was more than 30 percent of the median gross income. A study by Harvard finds that nationally, half of all renters are now spending more than 30% of their income on housing, up from 38% of renters in 2000. Part of the reason for the squeeze on renters is simple demand; between 2007 and 2013 the United States added, on net, about 6.2 million tenants, compared with 208,000 homeowners.

For many middle and lower income people, high rents choke spending on other goods and services, impeding the economic recovery. Low-income families that spend more than half their income on housing spend about a third less on food, 50% less on clothing, and 80% less on medical care compared with low-income families with affordable rents.

Federal Reserve Chairwoman Janet Yellen is scheduled to go to the lion’s den tomorrow, making a speech before the Economic Club in New York. Today, Yellen took the show on the road, speaking to a banking conference in Atlanta, she said current rules on how much capital banks must hold to protect against losses don't address all threats. She said the Fed's staff is considering what further measures might be needed, and such measures would likely apply to only the largest and most complex banks. Yellen said the Fed would review the likely effects of imposing stricter rules on banks. That probably plays better in Atlanta than Manhattan.

At some point Yellen must press the case of the Fed as regulator and in control of the banks rather than vice versa. Now, any threat or hint of threat at tighter control is only likely to result in the big banks moving risky behavior into less regulated areas of the financial system. These areas are often called the shadow banking system.

One area of concern for Yellen and her Fed colleagues is the short-term debt markets. So, Yellen would like to see the banks hold more capital; the idea being that it would make them less susceptible to a run. Now, when you hear that the Fed Chair is concerned about a bank run, this is not the old fashioned bank run, with customers lined up at the door of Bedford Savings and Loan and Jimmy Stewart trying to persuade his neighbors that their long-term loans will provide sufficient liquidity to short-term needs.

The problem goes to an area of regulation overlooked, or perhaps neglected by Congress and the various regulators; specifically derivatives; and after the collapse in 2008 what the regulators did was to concentrate the risk of the derivatives among four major Wall Street banks; the big banks just got bigger.

If you’ve ever stood in a teller’s line at the bank, you may have noticed the FDIC sticker, which reads, “Backed by the full faith and credit of the United States Government.” Effectively, that means, if the assessments the FDIC charges the banks to meet the needs of the Deposit Insurance Fund run short, the taxpayer must prop up the fund to make insured depositors whole. On top of that promise, the National Depositor Preference statute came into being in the US in 1993, making all deposit liabilities at insured depository banks preferred over the claims of other creditors.

The serious wrinkle in the plan is that if one of the four largest banks in terms of derivative exposure was put into receivership by the FDIC, its derivative counterparties have the legal right to assert a super-priority claim on the liquid assets of the bank, jumping in front of depositors. Typically, the counterparties start grabbing their collateral before the public is even aware of the problem.

The Deposit Insurance Fund probably has about $40 billion in assets. With the Dodd-Frank prohibition against further taxpayer bailouts of banks, where would the FDIC turn to stem a run on one of the largest banks?

Under the Federal Deposit Insurance Act, the FDIC, acting as a conservator or receiver for an insured depository institution, has the right to “disaffirm or repudiate any contract or lease.” But here again, Wall Street has the FDIC between a rock and a hard place. Let’s say there was a reenactment of 2008 and Citigroup was sliding toward insolvency. If the FDIC repudiated Citigroup’s derivative contracts, it would set off a panic and contagion at the other three largest banks holding trillions in derivatives, creating an even larger financial tab for the Deposit Insurance Fund to meet. Banks taking deposits of public funds are required to pledge collateral against any funds exceeding the deposit insurance limit of $250,000. But derivative claims are also secured with collateral, and they have super-priority over all other claimants, including other secured creditors. The money is gone before you get to the teller’s window.

But before you lose any sleep over the prospects of another, potentially far worse global financial meltdown, take solace that the economy is recovering. There are a few more jobs, and consumers are spending, and the housing market is improving, and the Fed has been pumping money into the economy to foster this growth of credit. Right?

Well, one of the lessons we’ve learned in the recovery is that there is a difference between credit growth and economic growth. And absent real and sustainable economic growth a gap eventually forms as credit growth expands. The more one spends on a place of shelter the less one has to spend on other things, and overall demand is reduced. Bank lending finances the purchase of existing assets, particularly with reference to real estate. Such existing asset finance does not directly stimulate investment or consumption, but it drives up asset prices, and that leads lenders and borrowers to believe that even more credit is both safe and desirable. The expansion is like a rubber band that can only stretch so far.

So, it seems the greatest danger to the current economy are the very mechanisms that are still used to “fix” the last financial crisis: money-printing and asset-purchases by major central banks around the world that unleashed a global flood of liquidity for over five years. Most of this massively huge pile of cash has landed in the laps of banks, institutional investors, hedge funds, private equity firms, and other speculators has not been used to boost lending to the private, and thus has not contributed to the recovery of the real economy. Instead, it has been poured into financial assets and has artificially goosed their valuations.

This money sloshing through the system and the persistence of zero-interest-rate policies have driven desperate investors ever further out into “all risky asset classes,” including emerging assets, junk-rated corporate credit, Eurozone peripheral debt, and equities. That buying pressure has inflated their valuations even further. And in the emerging markets, it led to an appreciation of exchange rates.

And when the rubber band breaks, there will be a derivatives bet on it. When the derivatives default, the counterparties, operating in an unregulated shadow banking world of their own design, do not have sufficient capital to pay off the derivatives bet, and so the first thing they’ll do is raid the bank vaults, and when that dries up, the short-term credit markets freeze, because none of the counterparties have faith that the other party has any more in capital reserves than they have.

Tuesday, March 19, 2013 - First, They Came for the Bank Deposits

Mark your Calendar, April 5 & 6 and make your reservations for the 2013 Wealth Protection Conference in Tempe, AZ. For conference information visit www.buysilvernow.com or click here or call 480-820-5877. This year's conference features Roger Weigand, Nathan Liles, David Smith, Mark Liebovit, Arch Crawford, Ian McAvity, Bill Tatro, and I will speak on Friday. There is an expanded Q&A session with all speakers on Saturday. I hope you can attend.

First, They Came for the Bank Deposits

by Sinclair Noe

DOW + 3 = 14,455
SPX – 3 = 1548
NAS – 8 = 3229
10 YR YLD - .05 = 1.91
OIL – 1.72 = 92.39
GOLD + 7.00 = 1613.80
SILV + .01 = 29.01

The best quote I've seen on the Cyprus Bank Heist; and I wish I had thought of this; “First, they came for the bank deposits.”

Actually, they are still in the planning and scheming stages of stealing bank deposits from the Cypriots; some say it's really an attack on Russian mob money. And so one new scheme being floated is to only expropriate accounts above 100 thousand-euros. The Cyprus banks are still on holiday. We should note that at least half the Cyprus bank bailout capital needs come from the restructuring of Greek debt held by Cyprus banks that Cyprus government agreed to as part of 'EU solidarity'. You remember the haircut on Greek bonds? You didn't expect the bankers to really take a hit on that did you? No, eventually it worked its way back to the bank depositors, some goat herder in Nicosia has to pay for the bankers' gambling debts.

But surely those Cypriots were fiscally irresponsible, free-loading from the government trough? Nope, not the case. Prior to the 2008 crisis, Cyprus had high growth, low unemployment and sound public finances. And then the next point being tossed about is that surely those crazy Cypriots had it coming to them for living in a tax haven. Of course, I'm not sure how different tax evaders like GE and Exxon Mobil and Apple and Honeywell are compared to the tax evading Russian oligarchs. Maybe we should expropriate all the bank deposits of those businesses formed in that little tax haven known as Delaware. Maybe the next time a US bank comes crying for a bailout, we can just tell them to raid all the bank accounts in the Cayman Islands.

Anyway, this whole Cyprus thing is falling apart before it happens. Plan A was for the Euro Commission to steal money from all the Cypriot depositors, then use than money as a down payment for a bailout of the Cyprus banks. Plan B calls for leaving the Cypriot goat herders alone, and not raiding accounts under 100 thousand-euros, but hitting the bigger 100 thousand-euro-plus accounts. Plan C is developing and it has the Cyprus legislators rejecting the whole scheme, because Cyprus is a small island, and people actually know their politicians and where they live.

The whole idea that Cyprus would be destroyed by bad banks apparently doesn't resonate the way Hank Paulson's speech on how a bank default would result in a global financial meltdown which would cost much, much more than a simple bailout. Instead, the Cypriots are not falling in line like the Americans and the Greeks and the Portuguese and the Spanish.

And a side note for today's Cyprus update; you may recall that there were some big discoveries of oil and gas deposits near Cyprus. No, I don't know how it all fits into the scheme, but I think someone should make a movie; I can't wait to see the ending.

Now, the big problem with the Cyprus Bank Heist is that bank deposits are supposed to be senior, meaning everyone else who gives money to the banks gets wiped out before the depositors. The equity holders get wiped out, followed by junior debt, followed by senior debt (which is usually sovereign or central bank debt), and the last to lose is the depositor, that goat herder form Nicosia. And I know what you're thinking: I'm not a goat herder from Cyprus. How does this apply to me?

In the US, depositors have actually been put in a worse position than Cyprus deposit-holders, at least if they are at the big banks that play in the derivatives casino. The regulators have turned a blind eye as banks use their depositaries to fund derivatives exposures. And as bad as that is, the depositors, unlike the Cypriot depositors, aren’t even senior creditors. Remember Lehman? When the investment bank failed, unsecured creditors (and remember, depositors are unsecured creditors) got eight cents on the dollar. One big reason was that derivatives counterparties require collateral for any exposures, meaning they are secured creditors. The 2005 bankruptcy reforms made derivatives counterparties senior to unsecured lenders. Lehman was an investment bank and didn't have retail deposits. What about banks with retail deposits?

Remember when Bank of America, the parent of both the retail bank and the Merrill Lynch securities unit moved derivatives from the Merrill Lynch unit over to the bank holding company? It was the autumn of 2011. Moody's downgraded BofA's long term credit ratings. The Moody’s downgrade spurred some of Merrill’s partners to ask that contracts be moved to the retail unit, which had a higher credit rating. Why did it have a higher credit rating? Because it is FDIC insured. Bank of America’s holding company -- the parent of both the retail bank and the Merrill Lynch securities unit -- held almost $75 trillion of derivatives back in 2011. About $53 trillion, or 71 percent, were within Bank of America NA.

The concern is that there is a temptation for the banksters to dump losing derivatives onto the insured institutions. And you might think we have some fairly tight restrictions on that sort of thing. But when BofA dumped derivatives from Merrill Lynch onto the FDIC insured banking side of the business, the Federal Reserve seemed to think this was perfectly fine. The FDIC, which would have to pay off depositors in the event of a bank failure, thought it was a bad idea, but it happened anyway.

And so, the pecking order in the US is that derivatives counterparties are first in line. If there is a problem, they get to grab the assets first and leave everyone else to fight over the crumbs, if there are any. And in theory, the FDIC will make sure there are crumbs, but in reality, if the derivatives counterparties get paid first, there are no crumbs. The FDIC doesn't have enough money to pay trillions on derivatives plus deposit holders.

Wait a minute; we're not really talking about trillions of dollars in losses; that's just the notional amount, and that just Bank of America. But BofA is not alone. JPMorgan’s deposit-taking entity, JPMorgan Chase Bank NA, as of the fourth quarter 2011, contained 99 percent of the New York-based firm’s $79 trillion of notional derivatives. Maybe you remember the story of the London Whale, Bruno Iksil, the derivatives trader who lost $6.2 billion or maybe $8 billion, part of which included insured deposits.

After outcry from the people of Cyprus and anyone who cares about financial markets and worries about the implications of a government suddenly seizing a chunk of the money people kept in supposedly safe bank accounts, the terms of the rescue deal were being renegotiated.  Europe has spent the past three years trying to persuade global investors and ordinary citizens that their money is safe in European banks. They had finally succeeded in the last several months. And then they pull this stunt.

The modest declines in financial markets the past couple of days are a sign that global investors are betting  that the losses being forced upon Cypriot bank deposits will be a one-off situation, and not form a precedent for future aid to banks in Greece, Spain, Portugal and beyond. This is not to say that the Cyprus Bank Heist will spread. The greater likelihood is that there will be resolution, but this is not yet certain.

For a measly $5.8 billion euros, the EU has now put the entire Eurozone on edge-not to mention the entire global economy. It revolves around something as simple as trust. After all, if governments can just seize deposits by means of a "tax" then deposit insurance is worth absolutely zip.

Meanwhile in Cyprus, there were a number of alternatives to breaking this underlying bond of trust. The banks have some bond debts outstanding, which certainly should have been written down before the deposits were attacked.  In fact, the tax is an attempt to avoid this, and should be resisted on that ground alone.

What the Cyprus Bank heist does is to expose the nasty little banking secret; the banksters can't be trusted.

And if you think it can't happen here, think again; the mechanisms are already in place.

First, they came for the bank deposits.

The Federal Reserve is meeting today and tomorrow. Each time the Fed has tried over the past few years to ease off efforts to stimulate the economy, each time they've made the slightest move to turn off the free money spigot, it has come to regret the decision as premature. Its leading officials say the recovery has been slower as a consequence of those pauses. It is a mistake they do not want to repeat.

The central bank is buying $85 billion a month in Treasury and mortgage-backed securities because it wants unemployment to fall more quickly. While recent economic data suggests that growth is quickening, Mr. Bernanke has said that the situation remains unacceptable and that the pace of progress is uncertain.

Mr. Bernanke and the Fed’s vice chairwoman, Janet L. Yellen, have been abundantly clear in recent commentary that the improvement in the labor market to date falls far short of what they will need to see before reducing monetary policy accommodation.

Also, the federal government has just embarked on another round of spending cuts, known as sequestration, and the extent of the resulting drag on the economy may not be evident for several months. The Fed will not take overt steps to scale back its asset purchases any time soon. The Fed is not going to take any chances until it is sure that we have avoided another spring/summer swoon.

The Federal Reserve has increased its assets from $900 billion in 2007 to over $3,150 billion and still climbing today. On the liabilities side of the Fed's balance sheet, reserve balances held by banks have gone from $10 B in 2007 to $1,750 B and climbing today.  Expect the Fed to continue to buy long-term assets at its current pace through the end of 2013. Then at the beginning of next year you might expect the Fed would buy new assets only to the extent necessary to replace maturing holdings so as to keep total assets steady through 2014, and then..., well nobody knows for certain what happens. Maybe they sell, maybe they hold to maturity, likely a mix of selling and holding.

Who knows? There is a good chance the Fed doesn't even know. And so tomorrow, when the FOMC wraps up its 2 day meeting, they will issue a statement saying nothing has really changed and they will remain vigilent, which is Fedspeak for: we've painted ourselves into a corner and we hope you don't notice.

The new pope, Francis, spoke today, the first official day of his pontificate Tuesday by setting out a vision for the Roman Catholic Church of mutual caring and of concern for the environment, urging followers to pay special attention to society's poor and neglected.

Before tens of thousands of pilgrims and dignitaries gathered for his inauguration in St. Peter's Square, the pontiff made clear that his papacy would reflect the themes of service and love of nature so closely identified with the saint after whom he named himself, Francis of Assisi.

"Let us be protectors of creation, protectors of God's plan inscribed in nature, protectors of one another and of the environment," the pope said. "Let us not allow omens of destruction and death to accompany the advance of this world!"

He called on government leaders, and himself, to "protect all of God's people and embrace with tender affection the whole of humanity, especially the poorest, the weakest, the least important."

Where were you ten years ago today. I'll give you a hint; it was the start of the Iraq war. Ten years later, here we are: 4,488 US deaths in Iraq, more than 32,000 significant injuries. Suicide rates of soldiers are so high it is impossible to ignore -- some while in Iraq and others after returning home. Traumatic brain injuries, grieving families, moral injury and multiple limb loss are just a few of the constant reminders of the tremendous costs of war.  More than 100,000 Iraqis died, we didn't keep accurate records; about 3 million Iraqis were displaced. These figures cannot be ignored. And they are the results of war.

The cost to the economy has been high. Estimates range from about $1 trillion to more than $3 trillion. It's hard to count, but those estimates are probably low. We're still paying for Vietnam. Some pay more than others. The waiting time for a first time claim with the VA is more than 600 days for some claims. One cost that has just begun to accumulate is Iraq veterans' medical care and disability payments, which could top out in yearly spending around 2050 and total in the hundreds of billions of dollars. This is not surprising, even though there is no special fund set aside to help us meet the towering commitment. A look at previous wars shows that VA spending continues to climb for decades after a conflict is over then falls off as veterans die in old age.

When we go to war, the most sacred commitment is to never leave anyone behind, even after they return home. The deal has always been that if you fight for your country, your country will take care of you. That has always been the deal. U.S. troops invaded Iraq 10 years ago this week, and our obligations to veterans of the post-9/11 wars have just begun. We're aren't living up to that commitment.

Tuesday, March 12, 2013 - Smoke Signals

Mark your calendar - April 5 & 6 - and make your reservations for the 2013 Wealth Protection Conference in Tempe, AZ. For conference information visit www.buysilvernow.com or click here or call 480-820-5877. This year's conference features Roger Weigand, Nathan Liles, David Smith, Mark Liebovit, Arch Crawford, Ian McAvity, Bill Tatro, and I will speak on Friday. There is an expanded Q&A session with all speakers on Saturday. I hope you can attend.

Smoke Signals

by Sinclair Noe

DOW + 2 = 14,450
SPX – 3 = 1552
NAS – 10 = 3242
10 YR YLD -.03 = 2.02
OIL – 1.84 = 90.22
GOLD + 10.90 = 1593.70
SILV + .16 = 29.25

Today we will communicate with smoke signals, the same as the Vatican, which started its conclave to elect a new Pope with black smoke. Wall Street was blowing black smoke out of its chimneys for most of the day, and then near the end of trading, a little wisp of white smoke pushed the Dow iIndustrial Average into positive territory, and another record high close.

President Obama travels to Capitol Hill to try to sell his grand bargain on the deficit. GOP blows black smoke from its chimney. Anyway, it appears that no one wants to listen to the president, meaning a grand bargain may be no easier to strike now than it was in 2011 or 2012 or any other time Obama has failed to do it. Paul Ryan responds by trotting out the Ryan Plan, which we've seen before; but this one was updated and slightly more regressive. Ryan's budget is presented as nothing but a sober-minded effort to make "tough choices" and solve practical problems. It turns Medicare into a voucher plan, slashes spending on Medicaid and food stamps, repeals Obamacare, and cuts taxes for the wealthy.  In response, the White House blows black smoke from its chimney.

The National Federation of Independent Business says its small business optimism index improved slightly in February; up 1.9 points to 90.8. Apparently, that is still a pretty low level on the scale of optimism indices; on Main Street, earnings are depressed, sales are down quarter over quarter, and there's not much to lift spending, don't look for a boost in hiring, and small business owners report that lending options remain closed. Black smoke on Main Street.

A new Reuters/Ipsos poll finds two-thirds of Americans say they are cutting their monthly spending and almost all of the rest say their spending is little changed

The biggest reason given by those who said they are cutting spending - 72 percent of those polled - was increasing savings and paying off debts. The second biggest was higher gas prices, cited by 63 percent.

Of those cutting back specifically because of gas prices or tax increases, 81 percent said they are cutting down on meals at restaurants, 73 percent are reducing entertainment costs such as movies and concerts and 62 percent are spending less on travel and vacations.

At the same time, affluent consumers are showing signs of increased confidence, according to at least one recent survey. This bifurcation may play into concerns about income inequality and could add to pressure in Congress to resist any budget deficit cutting deal that reduces spending on the social safety net and doesn't include further taxes on the wealthy.

Mohamed El-Erian, Pimco CEO says the Fed will not tolerate a big selloff in risk assets; two, the Fed has been forcing other central banks to be more aggressive; and third, investors can shrug off political issues. El-Erian says the Fed has been "artificially altering prices" and changing investor behavior; but he doesn't think the Fed's winding down from $85 billion a month in bond purchases, aggressive forward guidance, and near zero interest rates will "come for quite a while." But when it does happen: "It's going to be incredibly complex." With the Dow at record highs, El-Erian says he doesn't see a “great rotation” from bonds to stocks, rather the money is flowing into stocks from cash and money markets. White smoke from the chimney of Pimco.

The advance to new highs on the Dow is a direct result of never-before-seen manipulation by the Federal Reserve. The next question is whether the Fed can engineer a new era of prosperity in America. Bernanke has long claimed that he can't do it alone, so we might be looking at an example of where the stock market will not predict the nation's economic future. It seems that way, but more likely, we're just seeing a lag in the smoke signals.

Historically the stock market tends to act three to six months ahead of the economy in both directions. That pattern has not gone away. The 2007-2009 bear market bottomed in March 2009 when the current bull market began. The 2008-2009 recession was proclaimed to be officially ended three months later in June, 2009.

The stock market has been factoring in the economic recovery since, and has already recovered to its pre-crisis levels, the Dow and S&P 500 now back to their peaks of 2007. Meanwhile, the economy is merely catching up to what the stock market has been predicting for it.

But as the economy catches up to the market's expectation, the market will continue to focus on what lies ahead, and at this point it may not be a continuation of what it has anticipated for the last four years. Through those years the economy has been fueled by extreme easy money policies, record low interest rates, and massive government fiscal and monetary stimulus.

The government already began reversing the fiscal stimulus last year with cutbacks in federal payrolls, and is significantly stepping up that reversal this year, with the 2% payroll tax increase in January, and now the upcoming automatic "sequester" cuts in government spending, or some negotiated form of the automatic cuts.

Meanwhile, the Federal Reserve has promised to keep its easy money policies and QE programs, including record low interest rates, going well into 2014 - unless the economy improves faster than expected or inflation heats up.

And already we're hearing hints that the Fed may also begin to remove the QE punchbowl sooner than currently expected. I don't mean to scare you. The Fed won't be taking away the punch bowl because they're scared of screwing up everything. But the politicians act like it's their job to screw things up; they roll around in dysfunction like pigs in mud. And the stronger the stock market the more they are encouraged to take away the punch bowl. Then, we head into April and May, which marks the end of the markets' best six months. It's amazing how things synch up. However, there is a chance that sly investors will try to step in front of the “Sell in May” strategy, and sell a bit early.

Consider: The quality of the recent rally seems dubious; it's based on the Fed's loose money policy. Money market and savings accounts earn next to nothing, and that is forcing investors to accept the risks of stock ownership or get paid almost nothing. This is dangerous.

The quality of the "recovery" also seems dubious. Despite a good jobs report on Friday, the economy is fragile. The housing market has shown signs of strength, but again much of the rally can be traced back to the Fed, which now controls the market for mortgage backed securities.

And there are still major risks outside the US. The Euro-zone appears to have stabilized, but it is still in a downward glide due to austerity. And the Eurobeatings will continue until morale improves. That is the consensus of the IMF and the European Council, and almost everyone in a position of power, except Beppe Grillo.

If a bank is forced to pay $54 million to regulators over bad loans should the public be made aware of it?

Probably. If for nothing else than for the sake of transparency in the post-2008 world. But since 2007, the independent US agency responsible for maintaining public confidence in the US financial system has preferred to settle wrong-doing by banks outside of court while also keeping news of settlements private.

That’s according to a report in the Los Angeles Times which obtained more than 1,600 pages of FDIC settlements from 2007 with banks and individuals accused of wrongdoing. The cases involve reckless loans to homeowners, falsified documents and among other things inflated appraisals, according to the report.

Instead of pursuing the cases in court the FDIC has been settling with defendants for a fraction of the losses incurred. But perhaps the more controversial finding is that the FDIC has agreed in “scores of settlements” to a so-called “no press release” clause that would prevent it from voluntarily making the agreements public. In other words, the agency would apparently avoid issuing news around settlements.

Restoring trust frequently requires symbolic, as well as merely effective, change to take place. One insight from the tradition of penitence and forgiveness is that it is often not enough to put matters back to where they were before things went wrong; some demonstration of a change of heart by means of restitution and a visibly robust refusal to let the same failings occur again, is necessary before a bad situation can be made good. Exactly what kind of action by the banks, or by the government, would be necessary to restore trust in this way would probably emerge if the debate about banking ethics were to take place openly in the public realm. To achieve this is not just a matter of technical “fixes” but may require public, corporate, contrition for past failings, demonstrably robust structures to ensure that old mistakes are not repeated, and possibly some symbolic steps to assure the public that the corporate culture has changed.

And from the FDIC and the banks, black smoke. And for systemic corrections and trust in public institutions - black smoke.  

Wednesday, November 14, 2012 - How I Learned to Stop Worrying and Love the Bomb

How I Learned to Stop Worrying and Love the Bomb

by Sinclair Noe

DOW – 185 = 12,570
SPX – 19 = 1355
NAS – 37 = 2846
10 YR YLD un = 1.59%
OIL + 1.10 = 86.48
GOLD + 2.70 = 1728.60
SILV + .24 = 32.84

President Obama held his first post-election news conference today. I was a little surprised when he announced the presidential pardon for Big Bird.

Then he moved on to the more serious issues, like the sex life of generals.

In addition to addressing the Petraeus scandal, Mr. Obama used the opportunity to broach a far more expected crisis; the looming "fiscal cliff." He stressed that unless Congress acts to avert the "fiscal cliff" all Americans could see their taxes could go up and the economy could fall back into a recession, and he insisted that the top 2% of income earners see a tax increase.

So, that's where it stands. Both sides digging in their heels.

Everyone is afraid of falling off the fiscal cliff, but there's another dangerous countdown clock about hit to zero and no one is talking about it, even though it will spell even more financial problems for us all.

At midnight on December 31, 2012, we'll get tagged; the Transaction Account Guarantee (TAG) program will expire. The TAG program was initiated at the height of the crisis when depositors were fleeing banks for fear they would go under. So, the FDIC upped regular deposit insurance from $100,000 to $250,000 and under the TAG banner initiated unlimited insurance for all non-interest bearing transaction accounts.

If or when the unlimited insurance expires, corporations, businesses and depositors will be looking for a safe place to park their cash, and there is quite a bit of parking; those soon-to-be-uninsured deposits total some $1.4 trillion. Where will the money go? Likely to the biggest banks, money market funds and the safety of short-term U.S. Treasuries. This will create serious negative repercussions.

First, the too-big-to-fail (TBTF) banks that created the credit crisis and spawned the Great Recession are much bigger now than they were in 2008, and are about to get even bigger.

Because the failure of any one of America's big five banks would implode the global financial system, they will never be allowed to fail. That makes them a fortress for depositors, regardless of expiring guarantees. The same isn't true for the smaller banks that will start disappearing.

The problem for the economy is that TBTF banks are going to have to make bigger and bigger loans and orchestrate far-reaching lending schemes that encompass wide swaths of the population (as they did with mortgages) to accommodate the greater economies of scale their huge size demands. That's going to lead to massive concentrations of risk, which the TBTF banks have proven has been, and will be, their downfall. The counterparties on these deals are the other TBTF banks. And for the average consumer that means less competition, higher fees and transaction costs, and less access to credit at the local level, or at least a big risk premium for stooping down to deal with a small local business.

Next, when businesses and corporations can't justify the risk of parking money in cash, they'll start chasing yield. Money market funds will be the preferred parking place for a lot of that cash. Even though money market funds don't pay much, they allow quick withdrawals and are considered a good substitute for non-interest bearing checking accounts at banks, but there's a problem with money market funds. They aren't guaranteed. They were back when the Federal government was guarantying all financial parking lots at the time of the crisis, but no more. 

What's potentially problematic is that if billions of dollars of cash goes seeking some yield in money market funds, fund managers are going to have to put those new monies to work. And where do a lot of money market funds go to buy short-term interest bearing instruments so they can offer the best yields to potential billion-dollar customers? Too often they turn to European banks issuing short-term paper.

And then a lot of the cash coming out of bank checking accounts is going to go into short-term Treasury bills and notes. Right now the Treasury issues about $30 billion of one-month T-Bills every week. If the majority of the $1.4 trillion sitting in banks in soon to be uninsured accounts heads into these most liquid instruments it would take a year of issuance to satisfy that demand. Now, don't forget, the Federal Reserve is buying some $45 billion a month of Treasuries and agency paper. And, what about money market funds? If they get flooded with cash, they too will be buying the short- term issues spit out by the Treasury. What happens if there is actually some deal on the fiscal cliff that results in smaller deficits? The Treasury wouldn't have to issue as much new debt as it does now. The demand for short-term Treasuries could very conceivably turn their yields negative.

What happens then? As if corporations, pension funds, and people aren't yield starved enough. Will the further implosion of yields and the continuing destruction of fixed income cause everyone to reach further and further out on the risk curve? It's already happening. Junk bond funds are seeing record inflows as investors are clamoring for yield.

And the TAG is just a very small part of the fiscal cliff.

Meanwhile, we saw the minutes of the Federal Reserve's October 23 & 24 FOMC meeting. The Fed has been selling $45 billion a month in short-term Treasurys and using the proceeds to buy an equal amount of longer-term securities. When Operation Twist ends after December, the Fed will run out of short-term investments to sell. The minutes show support among “a number of” Fed policymakers to replace Twist with another program of long-term bond purchases. The Fed heads also confirmed they plan to keep interest rates near zero for a few more years, and there was some talk of establishing numerical targets for the economy. Nothing earth-shattering here, but I'm willing to wager there were some off the record discussions about the fiscal cliff.

The economy has been hooked up to the anesthetic drip of low interest rates and cheap money. Cheap money that caused the crisis has been replaced by even cheaper money to prevent a worse one. The chances of a rapid recovery are a good deal less than anyone wants, and a fair chunk of that is due to the global economic situation. Today, the Bank of England issued its most pessimistic outlook since the financial crisis. The economy will not recover its pre-recession peak for another three years as Britain faces a “period of persistently low growth” and sticky inflation.

In Euro-land, a popular backlash is building against cuts to public services and the “internal devaluation” policies that have targeted wages and Europe’s high levels of social protection with the aim of restoring competitiveness to the EU’s highly indebted economies. This year unemployment is expected to reach record levels of more than 11% in the eurozone and 10.5% in the EU. Taking a step away from the statistics, it means that more than 25m Europeans will be unemployed this Christmas. It is going to get worse. EU forecasts predict that joblessness rates will climb even further.

In Spain, once an EU pin-up for growth and a country that was not in debt before the banking crisis, youth unemployment has hit 55% and the recession is still deepening. There have been general strikes across Europe; hundreds of thousands participated. Tens of thousands took to the streets in Madrid. Protesters burned things; police fired rubber bullets.

Tens of millions of Europeans blame austerity for suppressing demand and acting as a dampener on growth at a time of economic recession triggered by the financial crisis. The deadly combination of slowdown plus austerity, compounded by economic imbalances built into the EU’s single currency, has pushed countries, especially the southern European economies at the heart of the eurozone debt storm, into what looks like a deep and protracted slump; and it is bad enough to drag down even the most powerful Euro-economies, and don't think it won't affect the US economy.

Europe has had much more austerity in aggregate than we have and it isn't working for them. And for all the people who are so scared about the fiscal cliff, what they're are really arguing is that slashing spending and raising taxes on ordinary workers is destructive in a depressed economy, and that we should actually be doing the opposite.