Monday, August 04, 2014 - Giving Up the Ghost

Giving Up the Ghost
by Sinclair Noe

DOW + 75 = 16,569
SPX + 13 = 1938
NAS + 31 = 4383
10 YR YLD - .01 = 2.49%
OIL + .09 = 98.38
GOLD – 6.00 = 1289.20
SILV - .17 = 20.23

Let’s start with economic data; on Friday we had the monthly jobs report: 209,000 jobs and the unemployment rate ticked up to 6.2%. It was a decent jobs report but came in a little under expectations. Still the economy has been adding jobs at a strong clip this year. Early in 2014, the Conference Board’s employment trends index pointed to stronger job creation even though the economy temporarily contracted, and that’s exactly what happened. Hiring accelerated, the economy snapped back in the second quarter, and over the past six months the economy has added jobs at the fastest clip since 2006.

The Employment Trends Index increased in July to a reading of 120.31, up from 119.91; this represents a 6.6% increase from a year ago. The 6 month growth rate in the index is the strongest in over 2 years, and suggests solid job growth is likely to continue in the coming months. Job openings keep hitting post-recession highs. There were 4.64 million job openings in May, near an all-time high; and layoffs are extremely low, even compared to the prerecession period.

While there are some signs of strength in the jobs market, wages have been stagnant. Worker pay was a smaller piece of the US income pie than earlier estimated as some Americans collected significantly more in interest and dividend payments over the past two years.  According to revised data from the Commerce Department, employee compensation, including wages and benefits, was lower for each year from 2011 to 2013 than previously calculated. With the revisions, employee compensation was reduced by $9.5 billion in 2011, $5.1 billion in 2012 and $14.6 billion last year. It accounted for 52% of gross domestic income in the last quarter of 2013, down from a prior estimate of 52.2%.

More rank-and-file workers are participating in the recovery as companies report record profits and boost hiring. Compensation has accelerated this year, rising $134 billion after a $153 billion surge in the first quarter. It marked the biggest back-to-back gains since the six months ended in the first quarter of 2007. That’s because companies are hiring again and more people are returning to the workforce, not necessarily because paychecks are getting fatter. We’ve added millions of people to the payroll since the low point of the economy, but we haven’t added at all to the payouts that workers are receiving. Little has flowed to workers except as an increase in their employment rate.

The latest data on consumer credit is due out Thursday. It’s likely to show non-revolving debt like auto and student debt is continuing to grow rapidly. But credit-card debt has barely budged. Auto loans made up a big part of the growth in second quarter GDP. In the second quarter, motor vehicle and parts spending grew an annual 17.5% rate. Put another way, cars made up 3.7% of all consumer spending, the highest rate since the first quarter of 2008. Growth in subprime auto loans has climbed more than 130% in the past five years.

The New York Times recently reported that many subprime auto lenders are loosening credit standards and focusing on the riskiest borrowers, and then many of the subprime auto loans are bundled into complex bonds and sold as securities by banks to insurance companies, mutual funds and public pension funds, a process that creates ever-greater demand for loans. Subprime loans make up about a third of new car-sales and two-thirds of used cars; with many subprime loans carrying interest rates of 23% or more; the loans were typically at least twice the size of the value of the used cars purchased.

Now maybe you are thinking that there were financial reforms put in place following the downturn; reforms that would prevent subprime lending practices. The Dodd-Frank Act did create the CFPB, the Consumer Financial Protection Board, and you might imagine this would protect consumers from less- than scrupulous lenders. Auto loans were stripped out of the CFPB's jurisdiction by an amendment proposed by Representative John Campbell (R-CA), a former used car dealer. Ripping off poor people has become an art form, and one of the requirements is that the companies engaging in this performance art keep themselves outside regulation as much as possible.

General Motors Financial said today it was served with a subpoena from the Department of Justice directing it to turn over documents related to underwriting criteria on subprime auto loans. The Financial Institutions Reform, Recovery and Enforcement Act, allows the Justice Department to sue over fraud affecting a federally insured financial institution.

A Federal Reserve survey of 75 domestic and 23 foreign banks shows that banks are seeing solid demand for loans, but the banks aren’t making it easy for borrowers. Banks reported stronger demand for prime residential mortgages for the first time since last summer and for home equity lines for the first time since October 2013. Credit standards on prime mortgage loans have eased somewhat, but mortgage standards still remain tighter than in 2005. The July survey also shows that new qualified mortgage rules has reduced approval rates on applications for prime jumbo home-purchase loans and nontraditional mortgages but have not impacted prime mortgages. Banks were somewhat more willing to make consumer-installment loans than they were in the April survey.

New research from the Federal Reserve and Northwestern University finds that expanding unemployment insurance benefits reduces the likelihood of mortgage delinquency. About 5 million foreclosures were completed between 2008 and 2012, but it could have been much worse. The survey says unemployment benefits prevented about 1.4 million foreclosures between 2008 and 2012.  

The researchers discovered there were other side benefits from jobless benefits. Banks who saw a lower default risk expanded credit access. Mortgage investors lost less than they otherwise would have. Local governments took a smaller hit. Also, more owners hanging onto their properties meant that homes stood a better chance of not falling into disrepair, which in turn would have sunk property values in their neighborhoods. And here’s one key finding for housing-policy wonks: Fewer troubled properties cut the government’s costs for expanding jobless benefits by narrowing the number of bad loans that would have been covered by federally controlled mortgage-finance giants Fannie Mae and Freddie Mac. Savings related to Fannie and Freddie decreased net costs for the federal government’s jobless-benefits expansion by about one-fifth.

Today’s bank failure comes from Portugal, and it was a big one. Banco Espirito Santo gave up the ghost; the bank will be shut down, and its healthy businesses transferred to a new bank. Portuguese officials were unable to find private investors to prop up the bank, and so the government will use 4.9 billion euro, or about $6.6 billion of its own funds to bail out the bank, or at least part of it. The bank will be spit in two, with the healthy part going to Novo Bank; the healthy part will include deposits and viable assets; so for now, the depositors and senior bondholders are safe.

Regulators are investigating possible accounting fraud and abuse of privileged information by the Espírito Santo family. Toxic loans, mainly to the Espirito Santo corporate parent and various subsidiaries, will be quarantined in a separate bad bank, which will be owned by shareholders and junior bondholders. Eventually, the new bank, or Novo Bank, will be sold in an attempt to recover the taxpayer loan. It is not clear whether even a sanitized version of Banco Espírito Santo will be worth enough to repay the loan.

Banco Espírito Santo provides something of a preview of what may happen in October when the European Central Bank discloses the results of an exhaustive review of bank holdings in the eurozone. The review is intended to uncover precisely the kind of hidden problems that have undone Banco Espírito Santo.

The central bank review is expected to expose an unknown number of other banks with problem loans or other woes that they have failed to disclose to regulators or shareholders. There has been concern that the central bank’s findings could destabilize the eurozone financial system. The European Union still lacks a comprehensive system for dealing with troubled banks, meaning countries must finance their own bailouts.

There is a new study taking a look at the state of banks in the US, the limits of Dodd-Frank reform, and what should be done with banks that are too big to manage. The study was requested by Democratic Senator Sherrod Brown and Republican Senator David Vitter, and the study finds that some institutions remain too complex and interconnected to be unwound quickly and efficiently if they get into trouble. That means that banks still would be able to force a taxpayer bailout in some form, and the banks are essentially receiving value in that implied guarantee. And the new study had the Government Accounting Office look at the value of that implied bailout. Turns out it was a tough calculation as the value of the implied guarantee varies, skyrocketing with economic stress (such as in 2008) and settling back down in periods of calm. If we were to return to panic mode, the value of the implied taxpayer backing would rocket. In other words, the threat of high-cost taxpayer bailouts remains very much with us.

Thursday, July 24, 2014 - Bankster Logic

Bankster Logic
by Sinclair Noe

DOW – 2 = 17,083
SPX + 0.97 = 1987
NAS – 1 = 4472
10 YR YLD + .05 = 2.51%
OIL - .03 = 102.04
GOLD – 10.10 = 1294.90
SILV - .54 = 20.47

An extremely flat day on Wall Street but good enough for another S&P 500 record high close.

In economic news: Initial claims for state unemployment benefits declined 19,000 to a seasonally adjusted 284,000 for the week ended July 19, the lowest level since February 2006. In the past six months, unemployment has fallen much faster than expected, from 6.7 to 6.1%. The labor market is still struggling with long term unemployment and part-time jobs instead of full-time work, but it seems to be making progress.

One area not showing progress is wages. The Labor Department released its latest report on median wages; on a year-over-year basis, median earnings were up just 0.8% in the second quarter, to $780 per week, not enough to keep pace with inflation. The median wage data is a bit different than the weekly earnings data that comes out of the Labor Department’s payrolls report. That one is the average earnings, and what’s likely happening is the growth for top earners is pulling that series up more. Average earnings are up 2.1% year-on-year. The report also showed that women earned 83.5% of what men did.

The Commerce Department said new home sales dropped 8.1% to a seasonally adjusted annual rate of 406,000 units in June. It was the biggest decline since July of last year. May and April sales were revised lower. So this was a very weak new home sales report, but earlier in the week we saw a fairly strong report on existing home sales.

Let’s move over to earnings reports:

Amazon.com can sell stuff, they just haven’t figured out how make a profit. Amazon is expanding grocery service, they introduced a new smartphone, and a set-top box for TV streaming, and they managed to increase revenue 23% to $19.34 billion from $15.7 billion in the earlier period. They also reported a loss of $126 million or 27 cents per share.

Caterpillar has the exact opposite problem; revenue fell but they posted a higher profit. Caterpillar’s revenue numbers have now fallen in six of its past eight quarters, with the quarterly year-over-year decline averaging 8.3%. In the last quarter, sales fell 3% from a year ago to $14.1 billion, while profit increased 4.1%.

Starbucks posted fiscal third-quarter profit of $512 million, or 67 cents a share, up from $417 million, or 55 cents a share a year ago. Revenue for the three months ended June 29 rose 11% to $4.1 billion from $3.7 billion.

Signaling a major turnaround in the airline industry’s fortunes, the nation’s three major legacy carriers; American Airlines, United Airlines and Delta Air Lines — all posted record profits in the past quarter. Delta reported net income for the second quarter of $801 million, up 17 percent from the year-earlier period. United Airlines, which had a loss in the first quarter and has struggled with its merger with Continental Airlines, posted a $919 million second-quarter profit. Douglas Parker, the chief executive of American Airlines, said today that the airline’s second-quarter profit, excluding special charges, of $1.5 billion was its best quarterly earnings performance ever.

General Motors posted second quarter earnings of $190 million on revenue of $39.6 billion, up from $39.1 billion in the same period a year ago. The problem for GM has been recalls for safety issues, which have killed 13 people. GM set up a compensation fund with $400 million; they have also paid $2 billion this year for the recalls, and they announced pretax charges of $874 million to cover future product recalls. GM is likely to feel the financial repercussions of the millions of cars it has recalled for years to come. The company has recalled 29 million vehicles this year, many of which haven’t yet been repaired. To give a sense of the pace, GM recalled around 15 million vehicles for ignition switch related issues so far this year, and repaired around 560,000 in the second quarter. It announced a recall of more than 700,000 vehicles for a separate issue just yesterday. The surprising part is the increase in revenue, which comes in part from pricing, but also the bad press hasn’t deterred buyers.

Businesses and individuals in the US have parked about $2.6 trillion in money market funds. It is generally considered a safe place to leave money short term, or that was the thinking until 2008, when money market funds broke the buck, dropping below par value of $1 per share. Turns out, the funds weren’t guaranteed. There is no government insurance on the safety of deposits, no regulator-required capital buffer to protect against losses, no central bank ready to stand as “lender of last resort” to keep a money market fund from suffering a short-term cash crunch. Of course, the Treasury and the Fed stepped in to bail out the funds and avoid a run on the funds, which would have been catastrophic.

And so, a mere 6 years later, the government has finally managed a few reforms, but they aren’t real reforms because the bankers fought reform tooth and nail.  The new reforms do not include capital buffers, but they will allow for a floating NAV, or net asset value. So your share in a money market fund may or may not be worth one dollar. And if you try to cash out, the funds can impose extra fees to slow down a potential run. That’s about it. After 6 years. I hope you feel safe and secure in the knowledge that nothing of any substance has changed in the last 6 years.

An examination by the Federal Reserve Bank of New York found that Deutsche Bank AG’s giant U.S. operations suffer from a litany of serious problems, including shoddy financial reporting, inadequate auditing and oversight and weak technology systems. In a letter to Deutsche Bank executives last December, a senior official with the New York Fed wrote that financial reports produced by some of the bank’s US arms “are of low quality, inaccurate and unreliable. The size and breadth of errors strongly suggest that the firm’s entire U.S. regulatory reporting structure requires wide-ranging remedial action.”

Deutsche Bank, one of Europe’s largest banks, was a forceful opponent of the Fed’s push to force foreign banks to comply with the same capital requirements as domestic banks. Officials from Deutsche Bank argued that the Fed’s requirement was too restrictive.  This year, the Fed went ahead with those tougher capital requirements for foreign banks. But it gave most of them until the middle of 2016 to comply. Yes, of course it’s theoretically possible that management could go through and fix everything that’s wrong with the firm’s US operations but, really, this is more of a tear down job.

Dark pools are where institutional investors can place large buy and sell orders without alerting the broader market. Prices and transactions are not reported; it is the furthest thing from a free and open marketplace.  Different financial institutions run a variety of dark pools. Barclays runs one of the biggest dark pools called Barclays LX. They’ve been sued by the state of New York for fraud; the suit alleges Barclays favored high frequency traders over other investors in the dark pool and they falsified marketing materials, inaccurately portraying the concentration of high-frequency traders in the market, and misrepresenting a service that purported to protect investors from predatory trading behavior.

Today, Barclays filed a motion to dismiss the lawsuit, and this is classic bankster logic; they argued that Barclays’ customers were sophisticated enough to understand that “glossy marketing brochures” about the dark pool, did not reflect its actual composition; their customers knew better than to rely solely on the marketing materials. So, they basically admitted they were lying in their marketing material, but their clients were smart enough to know that banks are liars.

President Obama called today for Congress to end a tax loophole that allows big corporations to designate a foreign country as their official address, in order to avoid US taxes. The corporation doesn’t have to actually move their headquarters, just set up an address overseas. Obama called on members of Congress to close the loophole even if they disagree with his broader calls for changes to the tax system that would lower corporate rates and close several loopholes, including that one. The legislative effort is unlikely to succeed in Congress.

Nine inversion deals have been reached this year by companies ranging from banana distributor Chiquita Brands to Medtronic. The whole idea is to pay less taxes while still enjoying the benefits of doing business in the US. Of course, the legal change of corporate headquarters is essentially a process of renouncing citizenship, and it just seems corporations should face the loss of citizenship the same way people do, which means they should pay an exit tax. There are other ways to put an end to this inversion tax evasion scheme. And if we don’t, you can count on executives whose companies were born of American ingenuity and which make their profits from American customers (including the government) will troll international waters for opportunities in low-cost tax havens. It’s a race to the bottom.

Wednesday, July 23, 2014 - Another Day Another Dollar

Another Day Another Dollar

by Sinclair Noe

DOW – 26 = 17,086
SPX + 3 = 1987
NAS + 17 = 4473
10 YR YLD un = 2.46%
OIL = 103.12
GOLD – 3.50 = 1305.00
SILV - .06 = 21.01

The Standard & Poor’s 500 index rose to an all-time high, as Apple boosted technology companies and health-care shares rallied through another busy day of earnings reports. The Dow was lower, mainly due to Boeing – we’ll get to that in a moment. Apple hit its highest level since 2012, based on earnings reported after the close yesterday.

Profits at S&P 500 members probably rose 6.2 percent in the second quarter, while sales gained 3.3 percent. Let’s knock out a few earnings reports:

Facebook posted $791 million in net income, or 30 cents a share, compared with $333 million or 13 cents a share in the second quarter of 2013; revenue totaled $2.9 billion compared to $1.8 billion in the year ago period. Mobile advertising represented 62% of its ad revenue; they have figured out Facebook on a smartphone. Facebook now claims 1.32 billion monthly users.

AT&T was once the telephone company, now it’s the second largest US mobile provider; they earned  $3.6 billion or 68 cents per share in the second quarter, down from $3.8 billion or 71 cents per share a year ago; even as revenue increase from $32.1 billion to $32.6 billion.

Biogen Idec rallied 11 percent after raising its full-year forecast, while Intuitive Surgical jumped 18 percent as results topped estimates.

At first blush, Boeing’s numbers looked good; the aerospace giant earned $2.40 per share, easily beating estimates of $2 per share; the company lifted its earnings outlook for the rest of the year. Shares dropped about 2%. Revenue growth disappointed. Commercial airline sales were up less than expected; there was a substantial charge for a military tanker. Boeing is one of the dogs of the Dow – down 7% year to date.

Delta Air Lines said its second-quarter earnings were up 17%, driven by higher passenger and operating revenue as traffic increased. Delta has said it plans to reinvest about 50% of its operating cash flow back into the business, resulting in $2 billion to $3 billion of capital expenditures annually through 2018, with $2.3 billion planned for 2014.

Another day, another General Motors recall; the only difference is that today’s recall does not involve ignition switches; it’s a problem with the seats. Today’s recalls total 717,950 vehicles covering six models; bring the total for the year to about 29 million. If you own a GM vehicle, call the dealer. The problem with ignition switches hasn’t gone away, just that today, it moved to Jeep-Chrysler, which announced nearly 800,000 vehicles will be recalled for ignition switch problems.

Another month, another downward revision from the IMF. In June, the International Monetary Fund forecast US economic growth would be about 3% to 3.5% for the rest of this year, and then they revised forecasts down to 2%. Today, the IMF said US economic growth would be about 1.7%. The IMF says lower growth expectations should contribute to continued slack in the labor market for the next three to four years, with the United States remaining below full employment until 2018.

The IMF says the Federal Reserve could keep its benchmark interest rates at zero beyond the middle of 2015, the date implied by policymaker forecasts, as long as inflation and financial stability concerns remain subdued. Future US growth could be disappointing if interest rates rise too quickly, or if there is a broader and concerted slowdown in emerging markets, or if increasing geopolitical tensions in Iraq and Ukraine prompt higher energy prices and severe financial and trade disruptions. The IMF also warned that an aging US population meant the economy would not be able to grow above 2% long term without significant reforms, including tax and immigration changes, more investment in infrastructure and job training, and the provision of childcare assistance, which could help lure more Americans into the workforce. Even without these measures, the IMF said there is "a strong case" for more government spending to support the economic recovery in the near-term, as long as there is a plan to deal with high entitlement spending later on.

Meanwhile, the IIF, the Institute of International Finance says investors have been willing to take on more risk, pushing borrowing costs down and stock prices higher, based in part on strengthening confidence in the US and global recoveries, but with perhaps too much exuberance. Investors don’t seem to be taking adequate account of the uncertainties around economic growth and monetary policy, and that points to a pull-back in markets. With uncertainty likely to increase on both fronts, a correction from current ultra-low levels of volatility could continue, accompanied by a correction in asset valuation. The IIF’s concerns echo those of some Federal Reserve officials, who said at their June meeting that low volatility levels and increased risk-taking signaled “market participants were not factoring in sufficient uncertainty about the path of the economy and monetary policy.”

Another day and the fighting continues in the Middle East. The latest count has 687 Palestinians killed in the conflict. Ben Gurion Airport in Tel Aviv remains closed to US airlines, and many other global carriers. Secretary of State John Kerry is trying to negotiate a ceasefire but it looks unlikely.

In the Netherlands, a day of mourning as the bodies of the victims were returned for identification. Most of the passengers were Dutch. Two military planes, one Dutch and the other Australian, carrying the first 40 coffins landed at Eindhoven air base. They were met by members of the Dutch royal family, the Prime Minister and hundreds of victims' relatives. In Kiev, the Ukrainian government reports two Ukrainian military jets were shot down within 20 miles of the crash scene.

The downing of a civilian jetliner might turn out to be the Lusitania moment that could draw the US and Russia into a new world war, but for now, it doesn’t seem likely. The more likely reaction will be an increase in sanctions against Russia, which the US has already done; the EU is more reticent. The European Commission, the EU’s executive arm, will put forward its proposals to a committee of the 28 EU member governments in Brussels tomorrow. The bloc’s foreign ministers this week called for plans for measures that could hit “access to capital markets, defense, dual-use goods, and sensitive technologies, including in the energy sector.” Russia supplies 30% of the natural gas to Europe, and it is a major trade partner. Yesterday, France delivered a $1 billion dollar warship to Russia, saying the Russians had paid for it and it was scheduled for delivery. Business drives the truck, coffins are placed in the back.

Events in Gaza and Ukraine have, for the time being, taken global attention away from the Syrian civil war and the ISIS’s advance through Iraq. Last Thursday and Friday were the two bloodiest days yet in Syria’s civil war, with more than 700 people killed in fighting between the Syrian government and ISIS, the Sunni militant group. An ISIS suicide bombing killed 31 people, mainly civilians, in Baghdad yesterday. ISIS appears to be consolidating its newly acquired territories. The government in Baghdad appears to be struggling to cobble together something that would actually pass as a government. The civil wars in Syria and Iraq are growing increasingly chaotic and there doesn’t seem to be much hope for resolution.

The Gaza and Ukraine conflicts are not likely to draw greater powers into a major conflict. And one reason is because Gaza and Ukraine are not major oil producers. The conflict that represents the largest potential threat to markets is still the ISIS invasion of Iraq; there oil supply could be severed and the jockeying among regional middle powers could possibly lead to a wider scale conflagration between Sunni and Shia sponsor states.

So, one of the indicators that things are getting better or worse will be reflected in the price of energy. Think of it this way: Everything you did this morning involved energy consumption: Waking up to your smart phone (charging overnight), putting on the coffee, pouring the cold milk from the fridge, taking a shower, driving the car to work and walking into your air-conditioned office. Likewise, the rest of your day will be one big consumption of energy. Anything that disrupts that supply of energy disrupts the work you do.

Right now there is probably a $5 to $10 fear premium built into the price of oil, and that seems to be acceptable. The signal from the energy market about the demand of energy and the risk of getting enough of it is clear: Prepare for less growth, less certainty and more geopolitical risk. The market, however, maintains a steady hand: Israel will be contained more or less, Russia and Ukraine will find a solution or just fade away. The non-acceptance of Black Swans is clear for everyone to see. The market is “perfect” in its information, zero interest rates will save us and we have all been fooled into believing that the real world no longer matters. Unemployment, social inequality, wars, innocents being killed, and TV images of people fighting to live another day are not relevant. Maybe, after 13 years of war, the US is just weary of any threat.

At some point the fear premium could pop and oil prices could jump to $150 or $200 a barrel, and if that happens the IMF forecast is way too high; if that happens the economy comes to a grinding halt; if that happens, everybody in the US and Europe will wake up and scream bloody murder, but for now, it’s just another day, another dollar.

Tuesday, May 20, 2014 - Protected Species

Protected Species
by Sinclair Noe

DOW – 137 = 16,374
SPX -12 = 1872
NAS – 28 = 4096
10 YR YLD - .02 = 2.51%
OIL + .87 = 102.98
GOLD + 1.70 = 1295.30
SILV + .05 = 19.49

Today is Tuesday and that means that General Motors has announced another recall; this time 2.6 million more cars. Last week, GM recalled 3 million vehicles. So far this year, GM has announced 29 recalls affecting more than 15 million cars globally. The list of recalled vehicles is long. It’s easier to list the vehicles that haven’t been recalled; they have recalled 58 versions of Chevrolet and GMC pickups.

Last week the Dow hit a record high; since then it has been floundering. For the fourth straight session, the Nasdaq Composite has posted more 52-week lows than 52-week highs; 55 lows versus 38 highs. The Russell 2000 Index of small and mid-cap stocks hit a high on March 4^th and since then it has dropped almost 10%.

Meanwhile, interest rates have been moving steadily lower despite winding down of large scale asset purchases under the Fed’s quantitative easing, and the talk about raising interest rates at some point down the road. With yields on the 10-yr Treasury note dipping down around 2.5%, that means somebody is buying Treasuries, but if not the Fed, then who?

Well, it’s certainly not Russia. Putin sold off more than $100 billion in Treasuries in March; he was probably expecting Treasury prices to tumble, but that didn’t happen. The most likely buyer is Belgium; from November of last year through January 2014, Belgium bought approximately $142 billion in US Treasuries, which is quite a bit considering the Belgian GDP is about $480 billion; so their bond buys were equal to about 30% of GDP.

As a member of the Eurozone, Belgium can’t just print new money. So, something is rotten. Or maybe the Fed has opened up a branch office in Antwerp.

Anyway, Putin is in China today to talk up the virtues of Russian natural gas. Putin met with Chinese President Xi Jinping at a start of a two-day meeting on Asian security with leaders from Iran and Central Asia. Putin is hoping to extend his country's dealings with Asia and diversify markets for its gas, which now goes mostly to Europe. Russia has been negotiating for more than a decade on a proposed 30-year deal to supply gas to China. Officials said they hoped to complete work in time to sign a contract while Putin is in Shanghai, but they have not yet announced a signed agreement. Putin told Chinese reporters ahead of his visit that China-Russia cooperation had reached an all-time high.

Russia is worried about its European gas market, seeing lackluster European demand and political efforts, intensified since the Ukrainian crisis, to diversify away from Russian gas constraining future sales to the West. At the same time, the shale gas phenomenon, with possible US and Canadian liquid natural gas exports to come, has Moscow concerned about what prices it can hope to attain from the European market. Developing new, potentially lucrative markets in the east seems to be the answer to Russia’s European gas concerns.

China also feels a new impetus for a deal. Despite a slowing of the domestic economy, future demand for energy, the key to both growth and political stability, will be robust. Efforts to develop China’s domestic shale resources are promising, but are unlikely to produce consequential volumes until the next decade. Meanwhile, China has been meeting growing energy consumption with coal powered plants, and they are literally choking on that decision, as the air quality has been nearly destroyed.

Tomorrow we will get the minutes of the last Federal Reserve FOMC meeting. Today we had Fed heads giving speeches. William Dudley, the president of the New York Fed is saying the Fed will take its time raising interest rates.  Noting both market and Fed expectations that the first hike will come some time near the middle of 2015, Dudley said, “if the economy is stronger than expected, causing the excess slack in the labor market to be absorbed sooner and inflation to rise more quickly than forecasted, then lift-off is likely to be pulled forward in time. If, instead, economic growth disappoints, inflation stays unusually low and the labor market continues to exhibit evidence of considerable excess slack, then lift-off will likely be pushed back in time.”

As for the over $4 trillion worth of bonds on its balance sheet, Dudley expects them to be reduced via “automatic pilot”; in other words, as Treasury securities mature and mortgages are repaid. Dudley offered his two cents on why the housing sector’s contribution to the economy has “stalled out” over the past few quarters.  While he said some decline in activity was to be expected following the jump in mortgage rates last year, “the extent of the slowdown has surprised me given that the recent pace of housing starts, roughly 1 million per year, is far below what is consistent with the economy’s underlying demographics.”

Dudley said mortgage credit is still unavailable to borrowers with lower credit scores. Also, student debt has delayed the entry of new first-time home buyers; that could make it harder even for existing homeowners to sell their homes and trade up, slowing the traditional turnover of the housing market. Dudley said he expects the housing recovery to continue, “the pace will likely be slow, especially relative to past economic recoveries.”

The online real estate site, Zillow reports 18.8% of US homeowners with a mortgage, or 9.7 million households, were underwater on their mortgages at the end of the first quarter. That's an improvement from the end of last year when this figure was 19.4%, and it's a large improvement from a peak of 31.4% in 2012, but it shows that negative equity is still an issue in the housing market.

What's more, there is an additional 10 million households that have 20% or less equity in their homes. For those homeowners, it would be difficult to sell without coming up with some money to cover the broker fees, closing costs and the down payment for the next home.

European Union regulators have charged banks JPMorgan, HSBC and Credit Agricole with colluding to manipulate the price of financial products linked to interest rates.

The European Commission's regulator said the banks will now have a chance to respond to the preliminary findings. If the Commission ultimately concludes they have broken the law, it can impose a fine of up to 10% of their annual revenue. In December 2013, the Commission levied fines totaling $1.4 billion on Barclays, Deutsche Bank, RBS and Societe Generale as part of the same case, which covers financial derivatives linked to a benchmark interest rate called Euribor in the period 2005-2008. Barclays escaped fines for having notified the Commission of the existence of the cartel, and the others were granted a reduction in their fine for cooperating in a settlement.

Late yesterday, Credit Suisse entered a guilty plea for conspiring to help US customers evade taxes, the first such guilty plea by a major financial institution in years. Today Credit Suisse shares rose almost 1%. Apparently a felony conviction is a good thing. And why not? Top bank executives will get to keep their jobs, the bank can pin the whole thing on a handful of underlings, and it won't have to give up a list of client names to the government. Credit Suisse will have to let an independent monitor keep an eye on it, but that's a minor inconvenience at worst. The guilty plea could cost the bank some clients here and there, but investors and analysts are betting there won't be much impact. The most painful part of the deal, the $2.6 billion in fines, is manageable, less than one quarter's revenue.

For the most part, the mainstream media is dutifully accepting the spin of the Department of Justice, that this case is significant by virtue of being the first plea of this sort made by a bank in over two decades. The fact that those intervening years saw regulators generally take a very hands off approach to banks, and that we had a global financial crisis with no measures of this sort taken against the perps somehow escapes mention.

Let me return to one critical issue: why no individuals were prosecuted or even fined. This case, like so many we have discussed, seems ideally made for at least a civil action under Sarbanes Oxley against the CEO and CFO, since they must certify the adequacy of internal controls. The most charitable coloration you can put on what looks an awful lot like obstruction of justice (although Credit Suisse was not charged with that) was that it was a failure of internal controls. And Sarbanes Oxley is designed so that a civil action can easily tee up a criminal case on the same control deficiencies.

Credit Suisse was in many ways the perfect major financial institution from which to demand a guilty plea. Although its investment banking and wealth management operations are global, the commercial banking operation in the United States is largely confined to its New York branch. It does not own a subsidiary in this country providing bank services to local customers, so it really only had to negotiate with the New York authorities and the federal government to resolve the case. That meant the effort to mitigate potential collateral consequences of a guilty plea was confined to just a few agencies. So, if you think the Credit Suisse case will become the template to go after American banks, well, yeah, that’s not going to happen. The banking class remains a protected species. 

Monday, January 28, 2013 - What's Going On

What's Going On

by Sinclair Noe

DOW – 14 = 13,881
SPX – 2 = 1500
NAS + 4 = 3154
10 YR YLD + .03 = 1.97%
OIL + .69 = 96.57
GOLD – 4.80 = 1655.50
SILV - .34 = 30.94

This will be a big week of economic reports, including: the Federal Reserve concludes its first policy meeting of 2013 on Wednesday; the monthly jobs report on Friday (look for a gain of 165,000 jobs and the unemployment rate to hold steady at 7.8%); earnings reporting season continues according to expectations; tomorrow brings an update on fourth quarter GDP; later in the week we'll see reports on incomes, spending, and sentiment.

Today we learned orders for durable goods, the big-ticket items made in the US, increased 4.6% in December, fanned by a big batch of bookings for military and commercial aircraft. Demand also improved for most other makers of long-lasting goods, suggesting that US manufacturers could be poised for a modest rebound in 2013. Then Caterpillar issued a less than bright outlook for 2013, which put a damper on the sector.

Toyota Motors retook the title of world's largest auto maker, posting a 23% gain in global sales to a record 9.75 million vehicles in 2012. General Motors moved to second place in global sales at 9.29 million; Volkswagen was in third place with 9.07 million sales.

The National Association of Realtors reports pending home sales fell 4.3% in December, with low inventory cutting results. The trade group's pending-home-sales index declined to 101.7 in December from 106.3 in November.

No policy changes are expected from the Fed this week, but investors will be on the lookout for further clues to policy makers’ assessment of the economic recovery. Last year, the Fed said it was committed to holding interest rates near zero as long as unemployment remained above 6.5% and inflation remained below 2.5%.

It‘s less clear, however, what it would take to get the Fed to end its open-ended third round of quantitative easing, because the analysts still don't quite believe the Fed targets for inflation and employment. Minutes of previous Fed meetings have highlighted a wide divergence of opinion over the potential time frame for the program. Beyond the targets and the time frame, nobody is quite sure how the Fed can possibly back away from juicing the economy. And an equally intriguing thought is what the Fed might do if all their stimulus continues to disappoint. Don't expect big surprises from this week's Fed meeting. The Fed will continue to pass out money for their buds on Wall Street; they will continue their $85 billion per month bond-buying program and keep short-term interest rates near historic lows. Esther George, president of the Kansas City Federal Reserve, has said that the Fed’s willingness to give away easy money could undermine the stability of the financial system in the future.

Not surprising then to hear a new elite consensus on the US budget deficit. One of the functions of the World Economic Forum in Davos – decide for yourself whether this is a virtue or a vice – is to give the plutocrats a venue for figuring out their party line. For a long time, the conventional wisdom among this crew has been that the deficit and the debt were the United States’ chief economic problems. Not only was the deficit the United States’ most important economic woe, it was the most important economic issue in the entire world. But, then the rich guys figured out that if austerity is actually imposed, it might deter the Fed from loading bags of money into their helicopters and dumping it on their buds on Wall Street. So the new idea out of Davos is that deficits don't really matter.

The fact that deficit cutting was the right prescription in the 1990s doesn’t necessarily make it the priority today. So, the rich guys in Davos are abandoning the deficit fighting dogma in favor of economic policy that is more like medical treatment than religion. It isn’t a dogma that should be cleaved to under every circumstance. Instead, it is a doctor’s black bag, whose particular instrument depends on the specific patient.

Viewed in that way, there is no contradiction between supporting a hawkish approach to U.S. government spending in the 1990s and a more expansionary bias today. The world has changed, so the right policy needs to be different, too .Today, the long-term interest rate is negligible, the constraint on investment is lack of demand, productivity has vastly outstripped wage growth, and the oft-repeated mantra that reduced deficits spur investments and you’ll get more middle-class wages doesn’t work in the same way,

In other words, deficit reduction does not constitute the basis for satisfactory growth strategy. Instead, to get growth, particularly for the beleaguered middle class, you need “investment,” a category a budget hawk might simply term “spending.” Let's all remain flexible.

Of course, there is still the Machiavellian intrigue of DC politics, but today, a surprise as a bipartisan group of senators. Four Republicans and Four Democratic senators agreed on an immigration reform plan they hope to move quickly with legislation giving 11 million illegal immigrants a chance to eventually become American citizens. The senators released the outline of a comprehensive immigration reform effort - one with plenty of details missing - that still must be turned into legislation.

A funny thing happened on the way to the bank. Bloomberg reports: More than $114 billion exited the biggest U.S. banks this month, and nobody’s quite sure why.

The Federal Reserve releases data on the assets and liabilities of commercial banks every Friday. The most current figures, covering the first full week of 2013, show the largest one-week withdrawals since the Sept. 11, 2001, attacks. Even when seasonally adjusted, the level drops to $52.8 billion—still the third-highest amount on record, and one for which bank experts and analysts were reluctant to give a definitive explanation.

The most obvious culprit is the expiration of the Transaction Account Guarantee program, the extraordinary federal effort to shore up the country’s non-gigantic banks during the 2008 financial crisis. Big banks were considered “too big to fail,” while smaller ones were vulnerable to runs. The TAG program backstopped their deposit bases by temporarily offering unlimited insurance on money kept in non-interest-bearing accounts. That guarantee ended on Dec. 31, so a decrease in deposits would be expected first thing in January.

But hold on: The Fed data show $114 billion leaving the 25 biggest banks—about 2 percent of their deposit base. Only $26.9 billion left all the others, equivalent to 0.9 percent of their deposit base. Experts had predicted that the end of TAG would hurt the nation’s small banks because the big ones are still considered too big to fail.

So if the missing $114 billion is not the result of the TAG program expiration—or at least not all related to TAG—what’s going on? The first quarter is always a wacky quarter. And January 2013 has seen an incredible amount of change. First, the fiscal cliff drama had companies shifting dividends and had bank clients guessing what their tax liabilities would be, which might explain the $60.4 billion pumped into the largest banks during the week ending Dec. 26. (Seasonally adjusted, it was the sixth-highest level on record.) Second, the payroll tax just went up, sticking most wage earners with paychecks that are 2 percent smaller.

Third, ordinary investors may be ready to move out of federally guaranteed accounts and into investments. Stocks did very well in 2012. Equity mutual funds saw their second-highest inflows on recordin the first week of the year. Market exuberance is high, with one measure of risk aversion at a three-decade low.

If deposits are really trending down—and at the end of the month, we’ll be smarter than we are now—if that’s the case, it can tell us a few things. It could tell us is that the law of elasticity is finally catching up with deposits. In other words, contrary to what economic theory predicts, deposits have been piling up at banks ever since the crisis, even though they offer pitiful yields. That may finally be ending, but it is a little too early to tell. One week does not make a trend. Still, $114 billion is a big figure, and it’s one to keep an eye on.

ABC News reported:

Activists from the hacker collective known as Anonymous assumed control over the homepage of a federal judicial agency Sunday morning. In a manifesto left on the defaced page, the group demanded reform to the American justice system and what the activists said are threats to the free flow of information.

The lengthy essay largely mirrors previous demands from Anonymous, but this time the group also cited the recent suicide of Reddit co-founder and activist Aaron Swartz as has having "crossed a line" for their organization. Swartz was facing up to 35 years in prison on computer fraud charges. Prosecutors said he had stolen thousands of digital scientific and academic journal articles from the Massachusetts Institute of Technology with the goal of disseminating them for free.

Anonymous says Swartz was "killed because he was forced into playing a game he could not win - a twisted and distorted perversion of justice - a game where the only winning move was not to play."

"There must be a return to proportionality of punishment with respect to actual harm caused," it reads, also mentioning recent arrests of Anonymous associates by the FBI. In their statement, the hackers say they targeted the homepage of the Federal Sentencing Commission for "symbolic" reasons.

The group claimed that if their demands were not met they would release a trove of embarrassing internal Justice Department documents to media outlets. Anonymous named the files after Supreme Court justices and provided hyperlinks to them from the defaced page. I've heard about efforts to follow the links, which don't seem to link to anything, but this could get interesting.

Tuesday, December 11, 2012 - If Banks Could Kill They Probably Will

If Banks Could Kill They Probably Will

by Sinclair Noe

DOW + 78 = 13,248
SPX + 9 = 1427
NAS + 35 = 3022
10YR YLD +.03 = 1.65%
OIL +.09 = 85.65
GOLD – 2.20 = 1711.40
SILV - .27 = 33.10

If all goes according to plan, in about 13 days, a star will rise in the east somewhere over Washington DC, signaling the birth of a new budget deal. If you're waiting for three wise men, don't hold your breath, because they couldn't find them in our nation's capitol. With just days to go before the nation slides down the fiscal Cliff Clavin of tax increases and spending cuts mandated by our confederacy of dunces to take effect with the passing of the arbitrary date on a calendar, there are signs that a deal to avoid the slide is near.

Pert' near every reporter in Washington says a deal is imminent. Just this Sunday, Obama and Boehner met in secret, well, not exactly a secret, and they did something, maybe they came up with a deal, maybe they barbequed some brats and watched some football, but their silence on the subject speaks volumes. Their silence almost provides proof positive that a bipartisan deal must be something that might have possibly been a part of the silent conversation, or not; but hey, it looks like a deal, except for all those pesky details. And it only took two years, possibly, of unnecessary uncertainty and sovereign debt downgrades to hammer out an agreement to whup the economy upside the head with a two by four without totally destroying it, rather than figuring out a way to grow the economy. Hallelujah, we have something that might be close to a deal, but nobody is saying anything.

Meanwhile, the Fed is meeting to consider monetary policy; and you never know what those wild and crazy guys will come up with. Meanwhile, the Treasury Department is dusting off its book of magic monetary incantations which includes “extraordinary measures” in the event the politicians do a lemming imitation and run off the cliff, and fail to come to a consensus on the debt ceiling, which means paying the bill for money already spent. The extraordinary measures would allow the Treasury to continue to send out checks for things like Social Security, military salaries and other payments. The U.S. was about $67 billion under the $16.394 trillion debt ceiling as of Friday. That’s small change in a world of trillion-dollar deficits and billions in monthly borrowing.

Treasury expects to bump up against the cap, which is set by Congress, very near the end of this month. Lawmakers may not raise it before then — the debt limit has become entangled in fiscal cliff talks. The White House wants to be able to raise the debt ceiling without political drama, though Republicans see their authority over the cap as a crucial bargaining chip. So, the Treasury could play with the numbers and some bonds and keep the government open for a few weeks. After that, who knows? Maybe the government will have to force PBS to fire Big Bird. Maybe the government could shorten the workweek for the Coast Guard; you know, an unpaid furlough. Maybe, they could raise the cost of a fishing license to $50,000. I know some people who would pay. Maybe they could get a loan from a big insurance company.

The Treasury Department says it plans to sell its last remaining shares in AIG, the insurance giant that would have toppled in 2008 without a federal takeover. Washington essentially nationalized AIG in a fit of financial panic, out of fear that AIG's collapse would have taken much of the financial system with it. Instead, the government committed $182 billion to AIG, making it the largest bailout of any single company. The General Motors bailout, at about $52 billion, cost less than one-third what the feds provided to AIG. Treasury expects the government to earn a net profit of $22.7 billion on the AIG bailout, once it sells its remaining shares. That amounts to roughly a 3 percent annual return

The ugliest part of the AIG bailout was the discovery in 2009 that $62 billion in taxpayer funds disbursed to AIG ultimately went to big banks that had contracts with AIG, including Goldman Sachs, Merrill Lynch, Bank of America and even a few foreign firms. They paid off AIG trading partners at 100 cents on the dollar, when those same partners would have gotten a fraction of that amount if AIG had declared bankruptcy. This is when we learned the great untold secret about AIG; it isn't really an insurance company; no self-respecting insurance company would ever pay 100 cents on the dollar for any claims. Instead, we learned that AIG was just a conduit to funnel taxpayer money from Washington to Wall Street.

But, hey, the deal was done, and now the Treasury can sell a few more shares and turn a profit. All's well that ends well.

Not exactly.

Nearly one-third of the AIG stock that the Treasury is selling came from the Federal Reserve, not from the Treasury's bailout program. Plus, there was a little side deal that was a part of the bailout that gives AIG a waiver on billions in future tax payments. I'm not saying I wanted to see AIG destroyed, but it was painful to see the bailout and then the lavish bonuses, and to never see anybody from AIG go to jail for anything. We shoulda had at least one perp walk for our money. But, a global financial meltdown was averted and it won't happen again..., because, umm...., because maybe we'll get lucky next time?

Right now, the Federal Reserve is regulating AIG because AIG owns a small bank, but AIG is planning to sell the bank, and when that is done there will be no government regulator of AIG's non-insurance financial activities, which was the problem that almost destroyed AIG. There may be one option; if the Fed declares AIG to be a systemically important financial institution, then they would continue to be regulated, presumably.

Of course, systemically important financial institution is just another way of saying too big to fail, which is another way of saying too big to jail. Case in point; HSBC. The Treasury Department notes that HSBC allowed “hundreds of millions of dollars” from Mexican drug trafficking organizations to flow though accounts in the U.S” even though the bank had “substantial resources” to limit money-laundering risks.

Specifically, $881 million in drug trafficking proceeds by the Sinaloa Cartel in Mexico and the Norte del Valle Cartel in Columbia were laundered through HSBC’s U.S. unit without being detected by the bank. The British banking giant had to pay a $1.9 billion dollar fine for money laundering with Iranians, Mexican drug cartels and such; it sounds like a lot of money, but it's really like a traffic ticket for you or me.

Today, the NY Times quotes anonymous government officials who say they were skittish about indicting HSBC because formal charges would amount to a "death penalty" for the bank, potentially roiling the financial system. Which reminds me of a quaint old saying: “With liberty and justice for all,” or maybe it was “equal protection under the law,” or some such nonsense because if you are a big bank, the law does not apply.

Not a single HSBC individual faces criminal prosecution. Nor have any individuals been charged at the five other big European banks that have also managed to dodge formal money-laundering charges in recent years, including British bank Standard Chartered, which entered its own deferred prosecution agreement on Monday. Apparently, all of this constant money laundering was done by robots.

The message is clear, if you are going to launder money to terrorists and drug cartels, do it under the protective umbrella of a large bank, because apparently the government is afraid of the big bad banks. And that means that if you are a bank and you're big enough, you're basically going to get away with creating and selling toxic securities while also betting against them and trigger a global depression without having to worry about doing any jail time. If you are part of a big bank you can get away with everything short of murder. Bankers can't actually murder people, all they can do is launder dirty money for terrorists and drug cartels which do the actual murdering. It's a technicality, but it is worth noting.

Meanwhile, Italy is still Italy. Over the weekend, Italian Prime Minister-slash-technocrat-slash-commisar, decided to resign. There was great wringing of hands and gnashing of teeth; how could Italy survive? Worse still, would former Italian Prime Minister Silvio Berlusconi rise up from his bunga bunga bed to make a run at the post? Would Monti's resignation usher in an era of instability in Europe's third largest economy? Which is a little crazy considering the unemployment, and protests, and riots, and instability throughout much of Euro-land, including Italy.

New figures out this week showed Italy’s gross domestic product down 2.4% from the year-ago period — the fifth quarterly decline in a row; and industrial production off 1.1% in October from the previous month, the 14th consecutive monthly decline. Under Monti, unemployment in Italy has risen to more than 11% and youth unemployment tops 36%, with countless more young Italians leaving the country for better opportunities elsewhere.

The austerity policies, designed to reduce the deficit by raising taxes and reducing government spending, are having trouble reaching their deficit targets because the GDP keeps falling, and so the debt to GDP ratio grows, even as spending is cut to the bone. Italy’s debt-to-GDP ratio has swollen to an estimated 126% this year. So, most of the politicians that are thinking about running for Prime Minister have pretty much fallen in line with the Euro-powers-that-be in Brussels. And Italian voters who have lived with an unelected government for the past year will soon have a choice of pre-approved candidates. Let's hope they choose wisely.

According to the Public Company Accounting Oversight Board, the nation's top accounting regulator, accounting firms have a problem with actual accounting. The PCAOB report released yesterday "said the eight biggest accounting firms failed in 22% of the audits it reviewed last year to gather enough evidence to support opinions issued by the firms that claimed a company's internal controls were effective."

Actually, that explains a lot.