Monday, April 23, 2012 European Debate Austerity v. Growth, Walmart in Mexico, Apple in Seattle

DOW – 102 = 12,927
SPX – 11 = 1366
NAS – 30 = 2970
10 YR YLD - .04 = 1.93%
OIL +.03 = 103.14
GOLD – 4.10 = 1639.30
SILV - .84 = 30.86
PLAT – 22.00 = 1565.00

There is some uncertainty in Europe. Sarkozy is losing the election in France; the Dutch government has collapsed, and the debt continues to mount and the austerity plans aren't working and the natives are getting restless.

In France, Sarkozy came in second behind Francois Hollande, the Socialist candidate and a harsh critic of the spending cuts prescribed as a way to end the region's debt crisis. This was the first round of voting and there will be a runoff election on May 6^th. Hollande won 28.6 percent to Sarkozy’s 27.1 percent; Hollande has the momentum. Voter frustration with the status quo and with the E.U. fed a rise of support for extremes at both ends of the political scale, making potential kingmakers out of 11 million voters who supported candidates of the far right and left.

Sarkozy and Germany's Chancellor Angela Merkel have been the main architects of Europe's efforts to avoid a collapse of the region's shared currency. If Sarkozy loses, it means Merkel might not last. If both Sarkozy and Merkel lose power, we've got a whole new situation.

Figures reported by the European Union's statistics office confirmed the effects of budget-cutting programs on countries that use the euro currency. Even with widespread spending cuts, overall debt rose to 87.2 percent, the highest level since the euro was created. Separately, a survey of the euro zone's manufacturing and services sectors fell in April. Official data confirmed that Spain is in recession, after economic output fell 0.4 percent in the first three months of the year; that qualifies as a recession although I would categgorize it as a depression. Spain joins other European countries now officially in recession, including Italy, Belgium, the Netherlands and, outside the euro zone, the Czech Republic. Even Germany may have fallen into recession in the first quarter, though official data is not out yet.

The Dutch government resigned Monday after it couldn't reach agreement with an opposition party to bring its budget deficit within European Union rules. The budget dispute raised the prospect that the Netherlands could lose its top AAA credit rating. Euro zone unity is under strain as other Europeans resent what they perceive as Germany’s holier-than-thou attitude in insisting that all the other Euro-zone countries keep their promises to reduce government budget deficits to 3 percent or less of gross domestic product. The Dutch debate basically boils down to austerity versus growth.

Christine Lagarde, the president of the International Monetary Fund, speaking in Washington over the weekend, said: “A global, undifferentiated rush to austerity will ultimately prove self-defeating.” But Ms. Lagarde also acknowledged the quandary facing European leaders. Most of them simply do not have the resources to pay for public works projects or social programs that would ease the pain of rising unemployment and declining wages.

Last week, the International Monetary Fund called for Europe to begin issuing bonds backed by all members, so-called euro bonds, a measure that would take pressure off the most debt-burdened countries whose high borrowing costs are contributing to their economic woes. In Germany, there is little support for such measures. At weekend meetings the IMF announced an additional $430 billion in lending capacity by developed economies. The contributions came after IMF economists determined that countries around the world might require up to $1 trillion in new loans because of the combined effects of the sovereign debt crisis in Europe and sluggish global economic growth. 

There are also calls for the European Central Bank to issue another round of cheap three-year loans to banks, as it has already done twice since December. The bank should also cut the benchmark interest rate from 1 percent, or resume purchases of euro zone government bonds to hold down borrowing costs. Now, the ECB can't seem to enforce deficit reduction plans in exchange for bailing out the banks. The population is catching on to the idea that the banks are part of the problem and not the solution.

The IMF has three recommendations, as outlined in last week’s World Economic Outlook, which are somewhat at variance with current euro zone policy. First, it wants the region not to overdo short-term fiscal austerity while placing more emphasis on longer-term structural measures to improve budgets. Second, it wants the European Central Bank to continue very accommodative monetary policies. Finally, it wants the euro zone authorities to be prepared to inject capital directly into troubled banks and to accompany that with stronger European-wide supervision of lenders.

When the ECB give the banks cheap money, the banks take the money and gamble – why not? It is cheap money. The banks buy the sovereign bonds and then they bet against the same with Credit Default Swaps. For the banks, the best bet is that the economy will shudder and shake and quake and maybe default. And to aid in the bet, the banks are not lending out the cheap money they received from the ECB.

Just a reminder that the Greeks hold an election on May 6, the same day as the runoff in France. Surely the Greeks are looking at the Dutch indignation regarding austerity. The same Dutch that demanded Greek leaders submit to EU demands for punitive austerity measures or forget about getting any help to avoid bankruptcy.

From Reuters: A former chief executive of Calpers, the biggest U.S. public pension fund, and a former board member were charged by federal regulators on Monday with scheming to defraud Apollo Global Management, a private equity firm, of more than $20 million in placement fees.

The U.S. Securities and Exchange Commission said that Federico Buenrostro, a former chief executive of the California Public Employees' Retirement system, and Alfred Villalobos, a friend and former board member who became a placement agent, fabricated documents as part of the fraud. Villalobos is also a former deputy mayor of Los Angeles.

Investment firms hire placement agents to help them land business at pension funds. According to the SEC, Buenrostro and Villalobos, gave Apollo Global the impression that Calpers, which has $235 billion in assets, had reviewed and signed placement-agent fee disclosure letters in accordance with its procedures.

"In fact, Buenrostro and Villalobos intentionally bypassed those procedures to induce Apollo to pay placement agent fees to Villalobos's firms," the SEC said in a statement. "The false letters bearing a fake Calpers logo and Buenrostro's signature were provided to Apollo, which then went ahead with the payments."

Villalobos generated more than $70 million in placement agent fees over approximately a 10-year period, at least $58 million of which was related to Calpers' investments, according to the SEC.

Buenrostro served as Calpers' CEO from 2002 to 2008.

From the Murdoch Street Journal: In a letter set to be sent to regulators and lawmakers on Monday, an MF Global customer group calls for J.P. Morgan to “return hundreds of millions of dollars in MF Global customer funds transferred” to J.P. Morgan in late October. The group, called the Commodity Customer Coalition, urged U.S. officials to “demand” that the New York bank “disgorge all MF Global customer property immediately.” J.P. Morgan is cooperating with the ongoing investigation, has said it did nothing wrong and lost some of its own money in the Oct. 31 bankruptcy because it was a creditor of MF Global.

Next up, we have two tales of corporations performing badly. We start with Walmart. Walmart, has just been caught in a massive bribery scandal that extends to the highest levels of the organization. Just as bad, Walmart's senior management appears to have long known about the scandal and has deliberately tried to cover it up. About 20% of all Walmart stores worldwide are in Mexico.

Walmart de Mexico apparently bribed Mexican officials for years; the bribes may have totaled more than $24 million and they were paid to win permission to open new stores without having to go through regular legal channels. The bribes were initially hidden from Walmart's global headquarters in Bentonville, Arkansas, by disguising them as normal legal bills, which would be accounting fraud. One of the key executives in charge of the bribery payments quit the company in 2005 after being passed over for promotion. He then detailed his behavior to some of Walmart's lawyers, implicating many senior Walmart executives in the process. The CEO of Walmart de Mexico is said to have personally approved the bribes. Walmart's global headquarters launched an investigation of the bribes but despite finding evidence of suspicious behavior and possbly clear violations of law, they shut down the investiagtion. Walmart's then-CEO, H. Lee Scott, Jr., was briefed on the investigation. He reportedly rebuked the company's investigators for being too aggressive.Walmart's current CEO, Michael Duke, was chairman of Walmart International at the time of the scandal. He received frequent briefings about the bribery allegations and progress of the investigation.

The Foreign Corrupt Practices Act makes it illegal to bribe officials in countries in which American companies do business, which is what Wal-Mart is accused of doing here. And don't forget the accounting fraud.

Our next example of a corporation behaving badly is Apple. A guy from Seattle named Rex sued Apple and won. He kept a blog of his battle. Here is the quick version. In 2008, Rex bought an Apple laptop was part of a batch that contained a defective chip. Apple acknowledged the defect and said it would replace it when it burned out. When the chip burned out three years later, Apple flaked out; they claimed his computer was a slightly different version than the model for which it had agreed to replace the chip. So, this guy, Rex, goes to the Apple store, he mails letters, he makes phone calls and he keeps meticulous records of everything, and he writes a blog about his experience. And finally, in March he ends up in small claims court and he wins. David beats Goliath.

If it sounds like a heck of a lot of work and hassle for a computer repair – it is. And that is what Apple was counting on. They thought they could just wear the guy down and eventually he would quit. Most people would give up. Who could blame them? In the past, wronged customers could band together and file a class-action lawsuit. The whole reason why class actions were set up is because most Americans don’t have time or money to go to court over a small item. But today, most companies have added clauses to their customer contracts that prohibit class-action suits. Instead of class action, the corporations now have contracts that mandate arbitration. The problem with arbitration is that customers lose 95% of the time. Coincidentally, the arbitrators are selected by the companies.

So, Rex sued Apple and took them to small claims and Apple fought back. They sent two attorneys to fight the battle, even though it was pretty clear they were liable for the defective chip. They probably thought they could wear the guy down, that he might not show up, or that he might slip up and not be prepared. Maybe Apple was just trying to be a bully. Now the guy is entitled to a new computer and Apple has to pay their attorneys. Once upon a time, Apple was the scrappy underdog, throwing a hammer through the window of conformity. Those days are gone. Apple is now a monolith that thinks the legal system is there to serve them; and customers are meant to be beaten into submission. And they do it for the worst possible reason: because they can. It is only a matter of degrees between screwing one guy in Seattle, screwing the Mexicans who live near a Walmart, screwing the clients of MF Global, screwing the pensioners in California, screwing Europe. And everybody is doing it.

Sinclair Noe

Eat the Bankers

Thursday, April 19, 2012 - Say on Pay Just Says No to Citigroup, BofA Loses by Winning, and the Risky World of Derivatives

DOW – 68 = 12,964
SPX – 8 = 1376
NAS – 23 = 3007
10 YR YLD -.03 = 1.95%
OIL -.01 = 102.66
GOLD +.60 = 1643.60
SILV + .17 = 31.90
PLAT + 3.00 = 1587.00

Vikram Pandit, the CEO of Citigroup was “this close” to a $15 million dollar payday. And then shareholders slammed on the brakes and demanded the amount be toned down. It might be a trend. Wells Fargo and Bank of America will ask shareholders to vote on executive pay in coming weeks, and the results at Citi might influence the voting at Wells and BofA. Yesterday, shareholders rejected the compensation plan of regional bank FirstMerit Corp., of Akron, Ohio. The bank gave its CEO a pay raise to $6.4 million last year from $5.5 million, while its stock fell 20 percent.

“Say-on-Pay” votes by shareholders were a requirement of the Dodd-Frank financial reform Act, and it looks like 90% of the compensation packages are winning approval, but the margin is slim. The Occupy movement plans to protest at 36 shareholder meetings this spring and the investment community seems to be waking up from a long nap of disengagement. The California Public Employees Retirement System, or CalPERS, voted no on the Citigroup pay measure because Citi “has not anchored rewards to performance.”

Unfortunately, the only reason CalPERS voted against the pay package was because Pandit's performance was beyond incompetent. What is the appropriate role for CalPERS? Shouldn't they stand up for their members? Chief executives at some of the nation's largest companies earned an average of $12.9 million in total pay last year -- 380 times more than a typical American worker. Average CEO pay rose 14% compared to 2010, when they earned $11.4 million on average. Disparity is one thing, under-performance is another.

Pandit raked Citigroup shareholders over the coals. He sold his hedge fund and pocketed $165 million, then he took a $37 million dollar signing bonus, then he lost hundreds of millions of Citi's money, and he presided over some of the worst possible performance you can imagine for a shareholder. On a split adjusted basis, one share of Citigroup stock was valued at $536 five years ago; today it is worth $34. Last month, Citigroup failed the Federal Reserve's Stress Test – that means no dividends for shareholders. The vote against Pandit's pay package was not about income inequality, it was only about the truly terrible job Pandit has done, driving share price into a ditch, failing to achieve regulatory minimums, pushing one of the biggest banks in the world to the very edge of insolvency. Citi would be insolvent right now if not for ongoing government support.

Bank of America issued a first quarter earnings report today. The report included this gem: “Results Include Negative Valuation Adjustments of $4.8 Billion Pretax, or $0.28 Per Share, From the Narrowing of the Company’s Credit Spreads.” I'll try to explain: If a bank’s own debt securities are falling in price, it effectively means its liabilities – the amount it owes — are worth less. Accounting rules say that’s positive for the balance sheet, and the decline in liabilities can therefore show up as a gain in the income statement. But in the first quarter, certain Bank of America debt securities were worth more, which means those liabilities increased in value, and that therefore produced a loss, of $4.8 billion, in earnings.

Not all of a bank’s debt gets adjusted in this way. And, yes, it seems absurd that falling debt prices – a sign that investors think a bank is less creditworthy – should lead to a gain in profit. In theory, if Bank of America defaulted on its corporate bonds, they could post a huge profit and the CEO would probably get a bonus.

At some point, there will be another major bank failure; we can't continue to allow such insane accounting to continue at the banks; we've gone from sublime to absurd to just downright stupid. And even worse, it's really dangerous. A listener passed along an article from Seeking Alpha that looks at the risk we are really exposed to.

The entire US GDP is less than $15 trillion each year. The gross notional amount of derivatives issued in the USA is more than $291 trillion. Now people say you can’t use the “notional” value, that it's misleading. Another number is the "net current credit exposure" (NCCE) which is only about $370 billion (only); this number is supposed to represent risk imposed by derivatives, but it doesn't provide the ultimate exposure to loss, it just measures the cost of unwinding the contracts. Then there are “value at risk” calculations; those are very inconsistent; the banks tried to use “value at risk” about 4 years ago to measure the fallout from the subprime mortgage market. That didn't work.

In reality, it is impossible to know the true risk of $291 trillion in New York issued derivatives. And there is more than $400 trillion more in London based derivatives. And even if nobody knows the true risk, it is highly likely that a fairly large increase in interest rates would be enough to trigger trillions of dollars in payments. And that means the Federal Reserve can’t raise interest rates. Even if the dollar comes under relentless selling pressure, the Fed can't raise rates. Even if inflation jumps, the Fed can't raise rates.

And part of the problem is where the banks hold their derivatives. All the too-big-to-fail banks are using FDIC-insured depository divisions to house derivatives, with the exception of Morgan Stanley (which uses its SIPC-insured division). That provides them with lower collateral requirements because FDIC depositary units usually have higher credit ratings than investment banks or bank holding companies. Insolvency laws provides priority to derivatives counter-parties over the FDIC. If and when a bank is liquidated, the FDIC will be on the hook to repay depositors, but the failing bank will be stripped of all assets.

Now imagine there is some event that triggers a 1 percent loss in derivatives, or about $3 trillion. The FDIC has about $40 billion in readily available funds, plus a $500 billion dollar line of credit with the Treasury, and ultimately the full faith and credit of the US government. OK, it is highly unlikely that there will be an event that would trigger that big of a problem, what about 0.1% in losses. Still plenty big enough to effectively destroy the FDIC and tip the dominoes in a long, cascading line of defaults.

And don't forget there are more than $400 trillion in derivatives written in London; those are unregulated; good luck trying to find out details on that paper, but you can bet that the US taxpayer is ultimately on the hook for those bets. Part of the exposure is held on the balance sheets of foreign, mostly European banks, including Deutsche Bank, PNB Paribas, Credit Suisse, UBS, and the other usual suspects. But, a large number of seemingly foreign derivatives is also hidden inside bank divisions, owned by American institutions, who do business in London. Such derivatives are not reported to the Fed, the OCC or the FDIC. Lenient British banking laws insure that these opaque obligations are not subject to public scrutiny.

What could go wrong?

Today, french government officials said the rumor of a credit downgrade is unfounded. There is no new information from any rating agency that would point in this direction. French bond yields jumped on the downgrade talk before recovering. The downgrade speculation comes just days ahead of the first round of voting in France's presidential elections. Standard & Poor's stripped France of its triple-A rating in January. Moody's put a negative outlook on France's triple-A rating in February. Spain's debt problems aren't going away any time soon. It just takes a small glitch to create a big problem.