Wednesday, October 3, 2012 - Happy Anniversary

Happy Anniversary

by Sinclair Noe

DOW + 12 = 13,494
SPX + 5 = 1450
NAS + 15 = 3135
10 YR YLD +.01 = 1.62%
OIL – 3.86 = 88.03
GOLD + 4.60 = 1780.00
SILV +.02 = 34.74
PLAT + 10.00 = 1692.00

So, how are we doing?

Well, we're seeing some stronger employment figures, a surge in refinancing applications, and expansion in the services sector.

The Institute for Supply Management’s service sector index rose to 55.1 from 53.7 last month – well ahead of expectations for a small decline.

The Mortgage Bankers Association’s latest weekly survey showed mortgage applications jumped 20 per cent over the previous seven days to the highest level since April 2009. The average interest rate on a 30-year fixed-rate mortgage fell to 3.53 per cent from 3.63 per cent last week, a new historic low. The increase in mortgage applications comes on top of already strong refinancing activity. We've seen 10 months of improving existing home sales and prices. The Federal Reserve stepped in with QE to Infinity and Beyond; maybe the Fed is leading this parade; maybe the Fed just jumped on the bandwagon; we'll see in a couple of months.

The big monthly jobs report is Friday. Economists are expecting an increase in payrolls in the neighborhood of 115,000 to 130,000 but also a rise in the overall unemployment rate to 8.2 per cent. Today, the payroll processing company ADP reported private companies added 162,000 jobs in September. That sounds good but the ADP numbers are not a good predictor for the official monthly jobs report. We would probably need a surprising number, up or down, to shift sentiment in the election.

So rather than wait for the debate tonight or the jobs report on Friday, the markets are trying to figure out the elections, and maybe trying to price in results. An outfit called LPL Financial is contrasting the performance of 16 different industry groups; eight that are perceived to be beneficiaries if President Obama is re-elected, and eight that would likely do better under Republican rule. Now, this is not scientific, but here are the lists. On the Democratic side: Health Care facilities, Food and Staples Retailing, Gas Utilities, Health Care Services, Life Sciences Tools and Services, Construction Materials, Homebuilding, Construction and Farm Machinery. On the Republican side: Coal and consumable Fuels, Diversified Financial Services, Oil & Gas Exploration, Oil and Gas Drilling, Managed Care, Electric Utilities, Specialty Retail, Telecommunications Services.

I'm not real sure why gas utilities would do better under Democrats and electric utilities would be better under Republicans. And I'm not sure why oil and gas industries would do better under Republicans. Oil fell to a two-month low after a report this morning that US crude production climbed to the highest level in more than 15 years and fuel consumption decreased.

Futures dropped 4.1 percent after the Energy Department said crude output rose 11,000 barrels a day to 6.52 million last week, the most since December 1996. Total fuel demand fell 0.3 percent to 18.3 million barrels a day in the four weeks ended Sept. 28, the lowest level since April. Crude and distillate stockpiles declined as gasoline supplies rose.

So, anyway they looked at the performance of the industries and Democrat's industries have far outperformed the Republican's.

So, the Economist magazine conducted a survey of 384 economists (appropriately). About half of the economists surveyed said that Obama understands economics better than Romney, in contrast to the 28 percent of respondents who believed that Romney had a better grasp of the discipline. In addition, the number of economists that said the economy would grow more quickly under Obama was nearly double the number that said it would grow more quickly under Romney.

I guess we'll just have to watch the debates and the jobs report and maybe we just have to wait until people actually vote. And then we can start talking about the questions that weren't asked and the issues that were avoided.

Today is an anniversary of sorts. Four years ago today, President George W. Bush signed into law the biggest corporate rescue in American history. Even as unemployment has remained above 8 percent for 43 months, the country’s biggest banks are making almost as much as they ever have. The six largest banks in the US posted combined profit of $63 billion over the past 4 quarters through June. The $63 billion profit for the 12 months ended June 30 was exceeded only in calendar years 2005 and 2006, when combined net income was $68 billion and $83 billion. The six financial firms will have combined profits of $9.9 billion in the third quarter, $17.4 billion in the last three months of the year and $75.8 billion in 2013, according to current earnings estimates. The firms report third-quarter results later this month.

The Federal Reserve, for its part, has traveled through the looking glass to find increasingly exotic ways to provide more stimulus, recently saying that it is just going to keep buying bonds and pumping cash into the economy until we sink or until we see a real recovery, whichever comes first. So, the Fed has been propping up the banks but the money hasn't made its way to Main Street. And now the bankers complain they can't pump out loans fast enough; they say there is a capacity problem. The very low interest-rate environment that bailed these guys out was also a curse, to hear them tell. The bankers claim revenue is being squeezed by low interest rates and the 2010 Dodd-Frank Act, which includes caps on debit-card fees that have cost the biggest US lenders about $8 billion a year. Of course, most of the Dodd-Frank Act has been emasculated by the bankers' lobbyists. The bankers haven't talked much about the problems of excessive risk from their own prop trading desks, you know, like the problem with the London Whale.

Of course, the regulations are difficult for the bankers, mainly because they were never held accountable for their wrongdoing. The five big banks that agreed in a $25 billion mortgage settlement to reform foreclosure practices have continued to "dual-track" homeowners, an abusive technique that pushes families out of homes they thought their bank was trying to help them save. A new report looks at the progress the banks have made in complying with the terms of the deal, reached in March after federal and state investigations. Bank of America, JPMorgan Chase, Citigroup, Wells Fargo and Ally Financial have until Wednesday to implement hundreds of "servicing" reforms mandated by the settlement, or face penalties of up to $1 million per occurrence.

And now we hear the New York AG has filed a fraud lawsuit against the nation’s biggest banks claiming tens of billions of dollars in damages tied to investor losses on mortgage bonds. The allegation is that the Bear Stearns business that JPMorgan took over in 2008 deceived mortgage-bond investors about defective loans backing securities they bought. Bear Stearns “systematically failed” to evaluate loans, ignored defects uncovered and “kept investors in the dark” about review procedures and problems with the loans.

The Bear Stearns mortgage unit packaged $212 billion in mortgage bonds from 2003 through 2006, according to the state’s complaint. Losses on $87 billion of those bonds packaged during just two of those years total $22.5 billion so far.

This is what happens when there is no accountability.

That's not exactly accurate. The banks have accountability, it's just that they count different than the rest of the world. JPMorgan's retail division that cut $555 million in the second quarter from an allowance covering future loan losses. That translates into a gain in pretax earnings. In the same period the previous year, the bank added about $1 billion to that sum, an addition treated as an expense. The $1.55 billion swing was more than one-fifth of the company’s pretax income for the three months.

JPMorgan wasn’t alone in profiting from loan-loss accounting. A $1.48 billion decline from a year earlier in Bank of America’s provision amounted to more than 40 percent of the firm’s $3.4 billion second-quarter pretax income.

I keep getting the uneasy feeling that the big banks are just pretending to be solvent, even as the numbers paint a different picture. Maybe that's why all of the Federal Reserve's actions have centered on Wall Street stimulus rather than Main Street stimulus.

Iceland didn't follow the rest of the world by bailing out bankers. Surprisingly, they arrested them instead. Now their economy is recovering faster than the EU and the United States.

Remember when the United States government told the American people that action was required to save the banks? Four years ago today. Action in the form of Billions of dollars of debt. Hard to forget that. Hundreds of billions of dollars in national debt later and we're still digging our way out of the hole.

At the start of the world wide 2008 economic collapse, Iceland was in worse shape than almost any other country in the world. Imagine what America would be like today if we bailed out the victims of poor banking practices, while punishing the bankers who were responsible instead of bailing them out. Is Iceland merely being a rebel desperate for revenge against a powerful industry, or on to something that America should have done as well?

Wednesday, April 18, 2012 - Euro Debt, Iceland, the IMF, and Forgiveness

DOW – 82 = 13,032
SPX – 5 = 1385
NAS – 11 = 3031
10 YR YLD -.03 = 1.98%

OIL – 1.43 = 102.77
GOLD – 8.00 = 1643.00
SILV - .08 = 31.73
PLAT – 5.00 = 1581.00

Spain's non-performing loans as a proportion of total lending jumped to 8.16% in February, up from 7.91% in January and the highest level in 18 years. Data from the Bank of Spain show that Spanish banks are burdened with about 176 billion euros of "troubled" real estate assets and that 21% of the 298 billion euros of loans linked to property developers are non-performing. Despite the increase in the country's bad loans, the yield on Spain's 10-year bond fell to a 1-1/2 week low of 5.72% on optimism over tomorrows auctions of 2-year and 10-year Spanish securities.

Will Europe and its increasingly ugly currency, the euro, get out of the crisis in one piece? This is probably the biggest question for the global economy right now. There is increasing concern that Spain and Italy will eventually default. Maybe the euro will survive but nobody seems confident of that right now. And it appears Europe is facing an economic depression which will diminish living standards and create social unrest and take years to work though. A best case scenario is years of stagnation. Actually there is another solution and we'll get to that in a few moments.

The fate of the euro has global consequences. Europe is the largest marketplace in the world. When Euro-countries and companies and the general population pull back and stop spending and investing and buying, it won't take long for the effect to be felt in the United States.

The problems with the Euro are structural; a currency union without an accompanying political union. Seventeen individual states all share the same money, but still chart their own budgetary courses. Over the past few years that meant the global marketplace was expected to treat Greece and Germany as equals. The idea was that the risks were the same because the currency was the same. The currency masked the fundamental differences that distinguished the fiscal soundness of individual member states, giving less-disciplined governments access to too much credit. And now the PIIGS, (Portugal, Ireland, Italy, Greece, and Spain) are buried in debt.

One solution is to allow the European Central Bank to issue bonds for the entire Union backed by all members. Germany doesn't like the idea of putting its credit on the line. Maybe the Germans have a fear of inflation built on the hyper-inflationary past of the Weimar Republic. Maybe the Germans have some moralistic reason to think they are financially superior, more economically worthy. Whatever the reason, the response is to impose austerity. Tighten the belt. Put the brakes on the economy. Unfortunately the prescription for starvation is not a diet. Austerity ensures that Europe cannot grow robustly, enhancing the debt burdens of weaker states. The cure is as bad as the disease. Europe will not shrink its way to prosperity.

Italy’s prime minister has abandoned the notion that Italy can balance its budget during a deepening recession. Slow growth, not profligate public spending, is the No. 1 problem in Italy. And in Spain, where a recession is causing a wave of loan delinquencies and defaults. Investors are bailing out of Spanish government bonds for fear the government will be overstretched trying to save Spanish banks.

Italian Prime Minister Mario Monti is the technocrat who is supposed to get Italy’s finances back on the straight and narrow. After meeting in Rome today, his cabinet announced that it’s now projecting the federal budget to show a deficit equal to 0.5 percent of gross domestic product in 2013, worse than a previous forecast of a 0.1 percent deficit. Prices of Italian bonds dropped on the news.

The International Monetary Fund is starting to catch on. They realize that it is one thing to throw money at the wayward banks, but it is another matter to get the money moving through the economy. And they have come to realize that households burdened by debt will not go out and spend. Last week, the IMF targeted household debt reduction policies. You probably haven't heard much about it because it involve debt forgiveness and mortgage write-downs. The IMF issued a report using Iceland as an example. Iceland defaulted and they have recently forced banks to accept reductions in mortgage interest payments of up to 40% and many distressed households had a portion of the debt written off. The economy there has now recovered remarkably since its bank-led collapse in 2008.

It found that countries, like Ireland, that saw house prices and household borrowing skyrocket, saw a longer than average period of recession after the bursting of the housing bubble. A large part of this protracted recession it said is due to households trying to reduce their debt levels, which in turn leads to less spending in the economy, driving the recession deeper and further. In the case of Iceland the situation was more difficult, due in part to the much bigger proportion of the population that was affected, and to the wide presence of foreign currency mortgages.

The government and the newly constructed Icelandic banks developed a template to be used in case by case restructuring discussions between borrowers and lenders. The templates facilitated substantial debt write-downs designed to align secured debt with the supporting collateral (that is, bring the loan into line with the value of the house) and align debt service with the ability to repay.

The IMF found that such case by case negotiations safeguard property rights and reduce moral hazard, but they take time. As of January of this year, only 35% of the case by case restructuring applications had been processed. To speed things up, Iceland has introduced a debt forgiveness plan which writes down deeply underwater mortgages to 110% of the households' pledgeable assets.

It noted that only when a comprehensive framework was put in place and a clear expiration date for relief measures announced that debt write-downs finally took off. As of January 2012, 15 to 20% of all Icelandic mortgages have been or are in the process of being written down.

In the US in the 1930's the Roosevelt administration introduced the Home Owners Loan Corporation, which bought distressed mortgages from banks with government bonds, with federal guarantees on principal and interest. It then restructured these mortgages to make them more affordable to borrowers.

80% of the restructured loans (some 800,000) were protected from repossession by the measure, and the mortgages were subsequently sold on over time for a nominal profit at the time the program was brought to an end in 1951. The mortgage purchases amounted to 8.4% of 1933's GDP in the US.

The IMF said "a key feature of the HOLC was the effective transfer of funds to credit constrained households with distressed balance sheets and a high marginal propensity to consume, which mitigated the negative effects on aggregate demand" caused by the recession and need for household deleveraging.

The main mechanism to make loans more affordable was to extend the term of the mortgage - sometimes doubling the term - and converting it from a variable to a fixed rate. In a number of cases the HOLC also wrote off part of the principal to ensure that no loans exceeded 80% of the appraised value of the house.

Austerity is not the solution. Increasing debt to pay for unsustainable debt is not the answer. When debt is unsustainable you can't grow your way out of it and you certainly can't shrink your way out of it.

I've told you for a long time that when debt becomes unsustainable there are three outcomes: slow default, quick default, or default due to war or catastrophe. There is actually one more outcome – debt forgiveness. It is rare, but it might actually be the answer.