Tuesday, February 11, 2014 - Yellen: Far From Complete

Yellen: Far From Complete

by Sinclair Noe

DOW + 192 = 15,994
SPX + 19 = 1819
NAS + 42 = 4191
10 YR YLD + .04 = 2.71%
OIL + .36 = 100.42
GOLD + 15.90 = 1291.90
SILV + .16 = 20.34

Janet Yellen went to Capitol Hill this morning to deliver her first semi-annual Monetary Policy Report to Congress as Fed Chair; this is what we used to call the Humphrey-Hawkins testimony and it involves prepared remarks followed by a question and answer before the House Committee of Financial Services; tomorrow, she’ll repeat the process with senators.

With regard to monetary policy, Yellen said she expects a great deal of continuity in the FOMC's approach to monetary policy. No surprise; Yellen was the vice-chair, she served on the FOMC, she helped formulate the current monetary policy strategy, and she supports the strategy.

Yellen pointed to real gross domestic product growth which rose at an average annual rate of more than 3.5% in the third and fourth quarters, versus 1.75% in the first and second. She also said there has been “progress” in the labor market which has added 3.25 million jobs since the Fed began a new round of asset purchases in August 2012.

However the economy added just 113,000 jobs last month, and 75,000 jobs the month prior. While Yellen did not specifically reference these weaker than expected reports in her prepared remarks, she called the labor recovery “far from complete.”

And the Fed’s target of 6.5% unemployment as the line where they might pull back from their zero interest rate policy; turns out that 6.5% is more of a threshold than a trigger, and Yellen made clear that the FOMC is “considering more than the unemployment rate when evaluating the condition of the US labor market.” Yellen also said she was surprised by the most recent jobs reports from December and January although she thought weather might be a factor, and she admitted the recovery is far from complete.

In addition to the headline unemployment rate, the Fed is trying to figure out what to do with long-term unemployed workers and part-time-but-wannabe-full-time workers. The numbers may not reflect what people’s preferences are, but that the economy can’t absorb them yet.  In the Q&A, she said: "A significant part of the decline in labor force participation is structural and not cyclical. Baby boomers are moving into older ages where there is a dramatic drop off in labor force participation…” In other words, get used to the new normal.

And then she tossed the jobs issue back into Congress’ court: "For our part we are trying to do what we can, with monetary policy, to simulate a faster economic recovery to bring unemployment down nationally.... Monetary policy is not a panacea. I think it's absolutely appropriate for Congress to consider other measures that you might take in order to foster the same goals.... Certainly all the economists that I know of think that improving the skills of the workforce is one important step that we should be taking to address those issues."

The key moment in the Q&A session was probably when Yellen said a notable change in the outlook will be cause for a change or a pause in the tapering stance. Wall Street traders loved that line. And then she talked about what it would take for the Fed to jump back into more bond buying: “I think a significant deterioration in the outlook, either for the job market, or concerns, very serious concerns, that inflation would not be moving back up over time. But the committee has emphasized that purchases are not on a preset course, and we will continue to evaluate the evidence."

When Yellen was asked about the consequences of QE, specifically bubbles, she answered: “I think it's fair to say our monetary policy has had an effect of boosting asset prices. We have tried to look carefully at whether or not broad classes of asset prices suggest bubble-like activity. I have not seen that in stocks, generally speaking. Land prices (she was referring to farm land), I would say, suggest a greater degree of overvaluation."

And Yellen added: "We recognize that in an environment of low interest rates like we've had in the Unites States now for quite some time, there may be an incentive to reach for yield. We do have the potential to develop asset bubbles or a buildup in leverage or rapid credit growth or other threats to financial stability. Especially given that our monetary policy is so accommodative, we are highly focused on trying to identify those threats."

Of course, the Fed’s dual mandate is price stability and maximum employment, but they also work as bank regulators, and her answer about her role as a regulator was informative; you have to listen carefully to the nuanced role of the Fed as regulator: "To my mind, the regulatory agenda of trying to strengthen the financial system will bring important long-term benefits to the economy."

We talk about the big banks behaving badly, and so when we see what looks like recognition of the problems by an actual banker, well that’s noteworthy. Today in the Guardian, Ross McEwen, the CEO of RBS admitted the British megabank abused its customers during the financial crisis: "In the rush for growth and profit, RBS forgot what banking is about. The bank valued least the people it should have valued most: its customers. We sold them products like PPI which many didn't need, and in some cases didn't know they had. Our customers often felt confused by language they found difficult to understand. We wasted their time with needless bureaucracy. We literally and metaphorically put them at the back of the queue."

And if you’re wondering what the reference to PPI is about, PPI stands for Payment Protection Insurance. PPI was sold, often using misleading sales practices, alongside personal loans and other borrowing, including credit cards. The policies were meant to cover payments if customers were sick or unemployed, but often they did not pay out or the buyer did not qualify in the first place. The four biggest British banks, Lloyd’s, Barclays, Royal Bank of Scotland, and HSBC have set aside close to $35 billion in legal reserves to pay for abuses related to PPI.

McEwen took over as CEO of RBS in October. The letter is one that could serve as a template for bankers here in the US; Janet Yellen and her colleagues at the Fed should read it as well. Some of the other key points from McEwen include: “Openness breeds trust.” And, “RBS cannot start to claim to be a bank that always treats people fairly unless we stop doing those things that erode trust. We cannot start to claim we are renewing the bank unless we stop shirking our responsibilities to our shareholders – principally the British taxpayer.”

McEwen has announced a detailed plan within the next month. This will be fun to watch this story unfold. McEwen is not representative of all big bankers; just today, Barclays announced it would fire 12,000 employees over the next year and at the same time they are raising the bonuses for their investment bankers; and they also announced profits had dropped 13%.

Yesterday we told you House Republicans were going to meet to work out their strategy for raising the debt ceiling. They met last night. House Speaker John Boehner laid out a plan to link the debt ceiling increase to legislation that would have reversed a cut to veteran retirement benefits, but conservative Republicans opposed the plan because it did not include provisions to pay for the erasing the cuts in veterans retirement benefits and Republican leaders worried that Democrats would not go along, holding firm to President Obama’s demand that no policy attachments come with a debt ceiling increase.

The debt ceiling is the maximum amount the Treasury Department may borrow to pay for spending programs that Congress has already authorized. Up until the last several years, the majority party in each chamber had taken the responsibility of raising it. And then Speaker Boehner changed the protocol with something he called the “Boehner Rule”, which holds that any debt ceiling increase should be attached to spending cuts of equal size; that set off a series of standoffs resulting in a sequestration deal in 2011 and last year's government shutdown. Nobody wants that again, and so now Boehner has told the Democrats to bring the debt ceiling to a vote; a clean bill with no attachments; and he’ll muster a couple dozen Republican votes to assure passage.

And that takes us back round to Janet Yellen’s earlier comments about the economy; you will recall she said: “Monetary policy is not a panacea. I think it's absolutely appropriate for Congress to consider other measures that you might take in order to foster the same goals.” There is plenty Congress could do, but I think we all know that isn’t going to happen.

So where does that leave us when it comes to investing?  The economy is still weak, the recovery is fragile at best, payroll data missed expectations in December and January, you can only blame the weather for a part of the market reaction (an ice storm in Atlanta has nothing to do with Treasury notes that mature in 10 years), corporate profits continue to outpace corporate revenue, top line and bottom line don’t jibe, at some point the divergence will lead to a tipping point, at some point stocks need to pay attention to the reality on the ground. The recent four day rally just feels like a trap being set. QE failed to juice the economy because it  was stimulus misdirected to the banks and not to Main Street; Yellen will back away from QE because it isn’t working; it may have stabilized the  financial sector but it failed to stimulate inflation expectations or economic activity, and the whole experiment is getting too risky.

Yellen is right to say we need fiscal policy to guide the way but she is wrong to imply that monetary policy can’t do more and better; monetary policy could make a big positive change; unfortunately that’s not going to happen.   

Wednesday, October 16, 2013 - That Was Close

That Was Close

by Sinclair Noe

DOW + 205 = 15,373
SPX + 23 = 1721
NAS + 45 = 3839
10 YR YLD - .05 = 2.67%
OIL + .87 = 102.08
GOLD + 1.70 = 1283.70
SILV + .12 = 21.52

Wait, wait. Stop the countdown. There will be no debt-pocalypse. Not tonight. The politicians have worked out a deal. Whew, that was close. Under the agreement, the government would be funded through Jan. 15, and the debt ceiling would be raised until Feb. 7. So, if you stocked up on canned goods and cigarettes, well, they'll keep a few months and we can do this again to start the new year.

The government will re-open tomorrow. The government debt will be paid as usual. Life goes on.

Even as the shutdown of the United States government and the threat of a default appear to be coming to an end, the cost of Congress’s gridlock has already run well into the billions. Retail sales that weren't made, canceled vacations to national parks and other destinations, import inspections, export financing, and oil and gas permitting stalled; and the total will continue to grow after the shutdown ends. A full accounting will take months but this will likely have some adverse effect on 4^th quarter GDP.

Plus, tack on higher interest payments on short term debt, which have tripled from just a few weeks ago.  The World Bank has estimated that a similar standoff in 2011 raised borrowing costs in poor countries by about 0.75 percentage point, and that those costs remained elevated for months.

The Senate will take up a separate motion to instruct House and Senate negotiators to reach accord by Dec. 13 on a long-term blueprint for tax and spending policies over the next decade. So, at a time when fiscal dysfunction has done significant damage to the economy, the solution is to develop fiscal policy that will further put the brakes on the economy.

So, when you hear more news on this, you'll undoubtedly hear someone talk about the winners and losers in this political battle, and while there were certainly losers, and they are easy to spot; I still can't spot the winners.

So, it's back to business; we'll have a not quite so dramatic repeat in a few months, although the big losers in the battle will not be so reckless. It would be better to just end this game of debt ceiling.

The following article explains the debt ceiling; here's the link: Congress Shouldn't Raise the 'Debt Limit' -- It Should Repeal It by Scott Lilly.

The problem, however, is that the "debt-limit" resolution purports to be something that it clearly is not -- a tool for shaping and redefining the nation's fiscal policy -- and, in reality, plays a totally nonsensical role. It can't be explained to people in simple terms because it doesn't make any sense.

Back in 1917, President Woodrow Wilson needed a way to finance America's entry into World War I. The government's budgeting process was in shambles. Individual agencies went directly to Congress to seek appropriations without direction or even coordination from the White House. The War Department would put together their request and send it up to the Hill. The Department of the Navy and other departments would do the same.

But in many instances, Congress also had limited control over what the various pieces of the bureaucracy were up to, how they spent their money, or how much they spent. Despite an 1870 law that attempted to prohibit the creation of deficiencies -- obligations to pay tax dollars to individuals or businesses that have not been appropriated -- there was little real restraint on a department secretary who wanted to expand his budget by simply signing a contract to spend that money and then telling Congress that the United States owed the money and the good faith and credit of the American people would be damaged if Congress didn't appropriate the money and pay the bill.

So when President Wilson asked Congress for the authority to issue Liberty bonds -- the forerunner of modern-day Treasury bonds that were used to finance World War I -- many in Congress rightly wondered where the issuance of such debt could lead the country given the lack of any real budget process to make budgetary decisions. The debt limit was probably a useless tool for forcing budget choices even in those primitive days of developing the nation's fiscal policy. It had only one thing going for it -- a name that was hard to vote against.

But just four years later, President Warren G. Harding signed the Budget and Accounting Act of 1921 and instituted the beginning of modern federal budgeting. The act was largely based on the recommendations of a commission established by President William H. Taft a decade earlier, and did a number of important things.

First, the act established the Bureau of the Budget, which reviewed and could revise the budget requests of all departments and agencies of the federal government. The Bureau was obliged to add all of the spending up into one total and propose changes in revenue to ensure that deficits were kept to a minimum.

Second, the act created the General Accounting Office to have professional auditors go over the agencies' books and examine whether expenditures were made in conformance with the laws under which they were authorized. Congress also reorganized itself so that all spending requests were under the jurisdiction of a single committee.

Finally, the legislation established strict procedures by which any employee of the government could sign a contract obligating the federal government to make any kind of payment. Any employee who did so without appropriated dollars to pay the cost of that contract was guilty of a felony and subject to criminal prosecution.

The increased control and accountability provided by the 1921 act went a long way toward addressing the concerns that had sparked the Liberty bond amendment, but Congress continued the process of passing legislation to increase the debt limit as it was needed. However, Congress finally dealt directly and comprehensively with establishing a process to determine all of the issues related to the growth of the public debt in 1974 with the adoption of the Congressional Budget and Impoundment Control Act.

This act, among other things, required each house of Congress to adopt a resolution each year setting forth a blueprint for future spending decisions as well as changes in the level of revenues collected, and expressly requiring a vote on the level of the deficit that would result from the decisions about spending and revenues. This not only gave Congress the opportunity to vote on deficits before they were created, but it also made the "debt ceiling" completely irrelevant except for one purpose: whether or not we should default on paying the bills on purchases we had previously decided to make.

But the House did not move to suspend the legislative charade of deciding whether or not to pay the bills they had already voted to ring up for several years after the congressional budget process was implemented in 1977. There were probably several reasons for that. One was that some members of Congress never seem to tire of hearing themselves drone on about the evils of rising debt. All too often, those members are only covering their tracks for supporting more spending and big tax giveaways. Another group saw the regular process of bargaining with the White House over whether or not to push the country into default as a useful opportunity to get concessions of various types. This was more popular in the House than in the Senate, because the Senate already had a wealth of executive branch appointments on which to bargain over, and what could be demanded and obtained was usually small enough that the White House and congressional leaders were willing to play the game.

But in 1979, former House Speaker Tip O'Neill (D-MA) assigned a rapidly rising young member of the House Democratic caucus -- then-Rep. Dick Gephardt (D-MO) -- to head up the effort of passing the debt limit. 

Gephardt figured out how to translate the obvious solution for dealing with the debt ceiling from the standpoint of logic into a change in the House rules. Under the Gephardt rule, as the change became known, when a budget resolution conference report was adopted, a House Joint Resolution was automatically deemed as passed by the House and sent to the Senate. Put in place in 1979, the new rule was first used in 1980 and remained in place until House Speaker Newt Gingrich (R-GA) jettisoned the procedure in 1995. While Speakers O'Neill, Jim Wright (D-TX), and Tom Foley (D-WA) were willing to let the will of the House on the annual budget resolution represent the will of the House on the debt limit with no further demands on either President Ronald Reagan or George H.W. Bush, Speaker Gingrich saw it as a potential pressure point in his dealings with President Bill Clinton.

On a number of occasions, the House had to act on legislation to prevent default despite the Gephardt rule. This was either the result of amendments added in the Senate, or because the budget resolution anticipated growth in the public debt that was slower than the demands on the Treasury turned out to be because the economy grew at a slower pace than the Congressional Budget Office had forecast. But most of the time, the budget resolution provided the basis for House action on the debt limit.

So we are again at the 11th hour with continued uncertainty as to whether the Congress will force the country into default. Consumer confidence has dropped 12 points in the past week, the most since the collapse of the Lehman Brothers investment bank five years ago. House Republican leaders insist that their disagreement over raising the debt limit is a matter of deep philosophical differences with the president over how much the federal government should be borrowing. But if you look at their position in terms of the legislation they have passed -- the so-called Ryan budget resolution, H. Con. Res. 15 -- you find in section 101 on page 6, line 6: "DEBT SUBJECT TO LIMIT.--The appropriate levels of the public debt are as follows: Fiscal year 2014: $17,776,278,000,000." That is exactly $1.077 trillion above the current debt limit that House leaders refuse to raise. It is also $184 billion above the level of debt that the Congressional Budget Office projects the country will have at the end of this fiscal year in October 2014. All but four House Republican leaders who were in the chamber at the time of passage voted for that resolution.

The reason the public debt is rising under the House-passed budget is that the $2.82 trillion in spending contained in the budget resolution passed this spring greatly exceeds the $2.27 trillion in revenues contained in that proposal. Very simply, they have voted to spend the money, but they don't want to pay the bill.

Monday, October 14, 2013 - Canned Goods and Cigarettes

Canned Goods and Cigarettes

by Sinclair Noe

DOW + 64 = 15,301
SPX + 6 = 1710
NAS + 23 = 3815
10 YR YLD + .01 = 2.69%
OIL + .12 = 102.14
GOLD + .10 = 1274.30
SILV - .07 = 21.37

Earlier today President Obama warned that if the standoff is not resolved by Thursday’s deadline to raise the debt ceiling, “we stand a good chance of defaulting.” And then he postponed a scheduled meeting with congressional leaders. That's the good news.

No, seriously, that's the good news; Senate leaders were closing in on a deal to raise the federal debt ceiling and end the 2 week old government shutdown, so the president stepped aside to let the legislators work a deal.

Senate Majority Leader Harry Reid said on the floor that he was “very optimistic” about what he called the “constructive, good-faith negotiations” aimed at avoiding the nation’s first default on its debt. Senate Minority Leader Mitch McConnell said he expected that “we’re going to get a result that will be acceptable to both sides.”

Of course, if they don't reach a deal by tomorrow, you might want to stock up on canned goods and cigarettes; there's a good chance cigarettes will be more valuable than gold in the debt-pocalypse. And the meltdown could start prior to the actual deadline of Thursday; folks will wait it out tomorrow, but before the close of the markets on Wednesday, if there is no deal, it could get ugly. So stock up on the canned goods and cigarettes tomorrow.

If this whole mess seems surreal, it is, but that doesn't mean you know how it works. So, allow me to provide the Readers' Digest version of everything you need to know about the federal deficit.

When the government spends more than it collects in tax revenue it must borrow to finance the difference. The national debt now stands at $16.7 trillion dollars; that's the total amount the federal government has borrowed throughout the years to finance cumulative cash deficits; plus the money it owes to itself, primarily the Social Security Trust Fund. The publicly held debt is owed to a wide variety of investors, including international investors, domestic private investors, the Federal Reserve, and state and local governments. The federal government has carried debt throughout its history. Typically the nation has run up deficits during wars and recessions, but then paid down the deficit when the war ended or the economy recovered. In recent years however, sharp increases in deficits have driven the debt to historic levels even as government spending was poised to explode to care for an aging population.

The debt ceiling sets a legal limit on borrowing by the federal government. Legislation to raise the debt limit usually leads to some partisan political posturing but little real drama. The past few years have been different. The United States hit its 16.7 trillion debt ceiling in mid-May. Treasury Secretary Jack Lew started to borrow from retirement funds from federal workers, a move that has bought a few months before he hits a point where he will be unable to borrow more to continue to pay the nation's bills. If Congress does not vote by Thursday to raise the limit, Secretary Lew says the government will default on its obligations.

House Republicans have demanded a number of concessions in exchange for granting the Treasury an additional year of borrowing authority. Among their concessions demanded for not shutting down the government was the repeal of the Affordable Care Act, also known as Obamacare; they then merged the shutdown concessions into the debt ceiling concessions, only to slowly but surely abandon those concessions as they realized they were running into a brick wall; The next concession to fall was a one year delay in implementation of Obamacare; which they have now abandoned as impossible; then a demand for repeal of the medical device tax which was a part of Obamacare, and nobody quite understands it or care about it unless you happen to sell medical devices. President Obama says he will not negotiate over the debt limit. Congress passed the spending measures that racked up the debt and now they have to pay the bills.

In its effort to extract concessions from Democrats in exchange for opening the government, the GOP has faced a fundamental strategic obstacle: They don't have the votes. A majority of the members of the House have gone on record saying that if they were given the opportunity to vote, they would support what's known as a "clean" continuing resolution to fund the government, in other words a resolution that deals only with the debt ceiling and doesn't have all sorts of concessions tacked on.

But a funny thing happened right as the government was shutting down; on September 30, the House Republicans passed a measure that prevents anyone other than the Speaker of the House from bringing the clean CR to a vote. Which means Speaker John Boehner is the only person who can bring this mess to a vote in the House of Representatives, and Boehner is still holding out for something; nobody knows exactly what, but it might involve cigarettes.

Now, you might think there is no rational reason to shut down the government to preclude what is essentially a Republican-designed health law, first pitched by Newt Gingrich in response to HillaryCare, the original version of ObamaCare was actually created by the Heritage Foundation, and then implemented by a Republican governor in Massachusetts, only to be abandoned in pursuit of a White House run, which ironically resulted in a less than winning 47% of the vote. The conservative health care plan that would create the conditions for finally attaining universal health coverage in the United States, a goal that all the other advanced nations have achieved decades ago. In particular, the alternative to “Obamacare” proposed by the GOP is nonexistent, and basically means leaving millions of Americans without proper medical care.

On top of that, the shutdown, together with the previous sequestration, and the overall contractionary fiscal stance, will most likely make the very slow recovery even slower, maintaining an unnecessarily large portion of the labor force unemployed.

The debt ceiling, which we are still approaching, even if at a slower pace because of the shutdown, will make matters even worse. How much worse? Nobody knows; somewhere between bad and debt-pocalypse.

And then this afternoon, came word of progress, maybe, sort of. Wall Street traders were optimistic that a deal might be reached; there was a quick round of buying that pushed the major indices into positive territory. We may get a deal, maybe not, but again, if nothing is worked out by tomorrow afternoon, it's probably a good idea to load up on canned goods and cigarettes, and maybe some single malt Scotch.

Three Americans were awarded the Nobel prize in economics Monday for work that helped answer this crucial question: What determines the prices of an asset, whether a stock, bond or a house?

The winners of the $1.23 million prize were Eugene Fama and Lars Peter Hansen of the University of Chicago and Robert Shiller of Yale. Their work has led to everything from low-fee index mutual funds to a deeper understanding of why home prices can become irrationally high, as they did in the last decade.

Fama and Shiller are considered direct opposites in their views of how markets sort out the prices of financial assets. Fama is a father of the "efficient markets hypothesis," the idea that because markets are very good at incorporating all known information about the value of an asset, it can be a fool's errand to try to predict in what direction the price of a stock or bond will go. Shiller is a leading proponent of the idea that markets, driven as they are by human psychology, can create large and sustained mispricings, such as in the late 1990s when excessive optimism drove the stock market into bubble territory. He is a student of "behavioral economics," the study of how quirks in human psychology can create results that traditional economic theory would not predict.

Fama's "efficient markets hypothesis" holds that investors can do just as well or better by investing in stock index funds as they can by trying to time the market and pick individual stocks. Anything they think they know about the future prospect of a company, in other words, is almost certainly already reflected in its share price.

Shiller challenges some key aspects of the efficient markets hypothesis. In a 1981 paper, for example, he demonstrated that stock prices are much more volatile than the underlying trends in the dividends they pay would suggest. He went on to show that periods when stock prices are high relative to corporate earnings tend to be followed by periods of below-par returns, and vice versa.

Hansen built on Shiller's work in important ways by using new statistical methods to test what exactly was driving all that stock price volatility. Hansen's work established more strongly the idea that the mispricings Shiller identified had to do with fluctuations in how much appetite for risk people had. When times are good more investors are willing to pay high prices for assets, and when times are bad, investors become more cautious. Today Shiller said the Federal Reserve's economic stimulus and growing market speculation were creating a “bubbly” property boom.

So, it just seems like a prudent thing to load up on canned goods and cigarettes and Scotch. Better safe than sorry.

Tuesday, October 08, 2013 - Low Probability High Consequence

10082013 Script

Low Probability High Consequence

by Sinclair Noe

DOW – 159 = 14,776
SPX – 20 = 1655
NAS – 75 = 3694
10 YR YLD un = 2.63%
OIL + .53 = 103.56
GOLD – 3.50 – 1319.90
SILV - .06 = 22.39

The Dow Industrials are down for 11 of the past 14 sessions, posting a loss of nearly 900 points. It's not exactly a crash; Wall Street is still expecting a resolution to the debt ceiling and the shutdown. The debt ceiling will likely be resolved with some short-term band-aid, but there is a chance that the idiots will mess it up and there will be a default. There is a low probability of default but a high consequence; that's a nasty mix and the reason I don't play Russian Roulette.

Most financial markets are only slowly getting worried about the possibility of a debt default, but in one tiny corner of the bond market things are starting to look a little panicky.

Today, investors dumped one-month Treasury bills due for payment after October 17, the date the Treasury Department has warned it will no longer have the cash to pay all of its obligations unless Congress raises its borrowing limit, known as the debt ceiling. Every day that passes after that date raises the risk the government will default on some of its debt. These short-term bills will probably be the first to go unpaid. Interest rates and bond prices move in opposite directions; so as prices dropped today, rates spiked, which means the government is paying more to borrow for one month than it does to pay for one year, a freak occurrence. Yep, everything is going exactly according to plan.

President Obama held a news conference today, calling on Republicans to both fund and reopen the government and to raise the nation’s borrowing limit as the federal shutdown entered a second week. President Obama phoned Speaker Boehner earlier this morning to urge him to allow a House vote on a budget bill without conditions, as Mr. Boehner called on the president to come to the negotiating table to resolve a spending standoff that has shuttered the government for eight days.

So far this whole shutdown hasn't been working out. What has been accomplished? Damage the livelihood of millions of Americans? Check. Government secretaries, food-truck operators, cleaners who work in motels near national parks: They’re all hurting. Waste billions of taxpayer dollars? Check. It costs a lot to shut agencies, Web sites and parks, and it will cost a lot to reopen them. Meanwhile, the House has voted to pay the salaries, eventually, of hundreds of thousands of employees whom it has ordered not to work.

And the lack of accomplishment just reinforces intransigence. In private, it appears Speaker Boehner has told his allies that he won’t bring up a clean CR, and he’s hopeful that as the deadline nears, President Obama will deal. It'd be nice to read that in private, there was some more conciliatory language, but at the moment, all of the private rhetoric is about hardening people's positions and convincing the team that the other side will cave.

In 1860, Abraham Lincoln had some choice words for Southerners who charged that he, not they, would be to blame for secession if Lincoln refused to compromise on the extension of slavery. Lincoln said: “A highwayman holds a pistol to my ear, and mutters through his teeth, ‘Stand and deliver, or I shall kill you, and then you will be a murderer!’ ”

So, while there may be a low probability of default, you still have to consider who's got a finger on the trigger. The debt ceiling is considered leverage, not a bullet to the skull.

And even if there is a stop-gap resolution to the debt ceiling and the shutdown, we still have other issues to deal with. The international Monetary Fund today issued a warning to central banks to move with extreme caution as they wind down emergency stimulus, warning that a botched exits risk setting off an asset crash in emerging markets and worldwide contagion.

The report said a witches’ brew of sliding currencies and excess credit could spin out of control. “Thin markets could amplify price movements and kick off sale spirals. Contagion effects could both amplify and broaden asset price movements and capital outflows as investors flock out of emerging market economies.”

Oh yeah, the taper!

The Supreme Court is in session again. I'm not sure how that works in a government shutdown. Maybe they pay the stenographer with an IOU, or a gift card to Wal-Mart. Today they heard arguments in a very important case,  McCutcheon v. Federal Election Commission, a case that maybe you could call Citizens United 2.0. 

 Here's the background. During the 2012 election season, Shaun McCutcheon, an electrical engineer who lives in Alabama, started making donations to all the candidates he supported. He made many donations, always staying under the donation limit of $2,500. Eventually, though, McCutcheon went over a different limit: the cap on the overall amount of money a single donor can dole out. Political donors can give no more than $123,200 during the two-year election cycle—$48,600 to federal candidates and $74,600 to political parties and related committees. McCutcheon believed the aggregate limit was unreasonable and unconstitutional, and so, with the backing of the Republican National Committee, a coplaintiff in his case, he sued his way to the Supreme Court.

At stake in McCutcheon is whether it's constitutional for the government to cap overall donations made by a single political donor. McCutcheon, his lawyers, and their conservative allies say the limit curbs First Amendment rights and does little to guard against corruption or the appearance of corruption, the court's justification for placing limits on political giving and spending. On the other side, campaign finance watchdogs and their lawyers say ending the aggregate limit would create a system in which wealthy donors could cut multimillion-dollar checks to candidates and parties, making Republicans and Democrats alike even more beholden to wealthy contributors.

The Supreme Court's landmark 1976 case Buckley v. Valeo upheld the overall contribution limit, at the time set at $25,000 for every two-year cycle. The court held that limiting the amount of contributions imposed only a marginal restriction on speech since the important thing was the act of contributing, not the amount). And the court said the government's interest in preventing corruption and the appearance of corruption justified that marginal restriction.

Fast forward to Citizens United, which overturned a couple of previous decisions that argued that some donation limits are constitutional. What happens if the overall cap is eliminated? A single donor could give nearly $3.7 million by maxing out his or her donations to every candidate of a preferred party, plus the state committee, the national party and its affiliated committees. With the overall limit scrapped party operatives could create mega-fundraising committees that can solicit seven-figure checks and then spread the money far and wide within their party at the federal and state level.

But wait, there's more! The Supreme Court has agreed to let a lawyer for the Kentucky Republican Seantor Mitch McConnell argue before the court. McConnell, the Senate minority leader is a vehement foe of campaign finance regulations; he led the fight to overturn the 2002 McCain-Feingold law with his suit, McConnell v. FEC, which he lost, and he has repeatedly filibustered Senate bills to beef up disclosure of dark money spending in our elections.

This time, McConnell wants to go even farther than McCutcheon;today the attorney for McConnell argued that the court should revisit the underlying legal principle that justifies whether there should be any limits on contributions to candidates. The aggregate contribution limits, he said, force candidates and political parties to compete for an "artificially limited pool of money." That seems a strange argument in light of Citizens United which allows an individual, like Mr. McCutcheon, to say whatever he wants and spend as much as he wants on independent, campaign related messages.

The FEC will have a tough row to hoe before the Roberts Court. The FEC seems to be arguing against an overall cap, but if an individual can give a few thousand to 23 different candidates, why not give the same amount to a 24^th candidate? Based upon today's arguments, that is probably what will decide the issue, but it misses the point. This is not a case about freedom of speech. One thing the Court has not truly explained is how spending a boatload of money is considered free speech. Of course, one should be free to speak about the government and politics, but I don't think that should include the ability to buy politicians and then bribe them to look after one's special interests.

James Madison wrote that government should be dependent on the great body of the people and not an inconsiderable proportion, or a favored class of it. There was a time, in the late 19th Century I believe, when business moguls actually put bags of cash on the desks of politicians to buy favors. Money has always been involved in this country's electoral politics, but many of the most blatently corrupt practices were reigned in during the 20th Century. Now, we seem to have returned to the age of the robber barons and to politicians who are for sale to the highest bidder. At every level, bottom to top, campaign contributions are a bribe. And what the Supreme Court is deciding is the difference between a democracy and an oligarchy; unfortunately that is not what they will consider, and that is part of the shame.

The justices will issue their opinion in McCutcheon before the end of June.

Monday, October 07, 2013 - Already Bankrupt

Already Bankrupt

by Sinclair Noe

DOW – 136 = 14, 936

SPX – 14 = 1676
NAS – 37 = 3770
10 YR YLD - .02 = 2.63%
OIL - .67 = 103.17
GOLD + 11.20 = 1323.40
SILV + .61 = 22.45

The markets gave up Friday's gains. The political dysfunction is hurting; right now it's just the economic uncertainty; that's a phrase I hate because businesses always face uncertainty but the shutdown and the looming debt ceiling are significant uncertainties. Let's start with the debt ceiling. Businessweek is describing it as “an economic calamity like none the world has ever seen.”

Here's the not so rosy scenario: “Failure by the world’s largest borrower to pay its debt -- unprecedented in modern history -- will devastate stock markets from Brazil to Zurich, halt a $5 trillion lending mechanism for investors who rely on Treasuries, blow up borrowing costs for billions of people and companies, ravage the dollar and throw the U.S. and world economies into a recession that probably would become a depression. Among the dozens of money managers, economists, bankers, traders and former government officials interviewed for this story, few view a U.S. default as anything but a financial apocalypse. “

Sure, if the US misses a payment it would be much bigger than 2008 because the US government is so much bigger and more interconnected than Lehman Brothers; and after the collapse of Lehman, the government stepped in to clean up the mess. Who cleans up the mess when the mess is the US government?

Warren Buffett says the politicians should not use the debt limit as a weapon in policy debates. From a Fortune magazine article last week, Buffett said: “It should be like nuclear bombs, basically too horrible to use.” Or as Senator Ted Cruz calls them: “Half measures.”

Just a reminder that in 2011, back when there was just a little talk about default without an actual default, just a hint, it wiped out $6 trillion of value from global stocks. Investors, structured vehicles, collateral agreements, derivatives contracts and other trading covenants have ratings-based rules that could force the replacement of Treasuries in a trade or portfolio.

Some people speculate it would push interest rates higher, others guess it might push rates down, but nobody knows for sure. The scarier scenario is that everything just freezes; it wouldn't matter whether rates are up or down because nobody can make a deal. Once the system starts to break down related to settlement and payments, then liquidity disappears.

Treasury Secretary Jack Lew has said the government will have only $30 billion of cash left by Oct. 17 to meet its commitments. Those can run as high as $60 billion a day, which means the Treasury will need to borrow more to meet its liabilities. The Treasury has $120 billion of short-term bonds coming due on Oct. 17.

About half of the US debt is held by foreign governments, central banks and other overseas investors. China is the largest holder of US Treasuries, with about $1.3 trilllion; they are not happy. A new idea is taking hold among House Republicans that perhaps breaching the debt ceiling isn't such a terrible idea after all. One form this takes is the patently absurd remarks of Rep. Ted Yoho (R-Fla.) who muses that "I think, personally, it would bring stability to the world markets." So, that's one politician who just certified he is insane.

A slightly less insane idea is to prioritize payments, but there are some problems with that: Treasury is not authorized to unilaterally decide to pay certain bills and not others. If it were, the constitutional order would completely collapse. Obama could just not cut the checks for farm subsidies or missile defense programs he opposes.  Because payment prioritization is illegal, Treasury's payment system is not designed to allow prioritization to happen. The systems "are designed to make each payment in the order it comes due." Of course systems could always be changed. But they can't just whip up an entirely new computer system in the next two weeks.

A German newspaper summed it up quite nicely: "At the moment, Washington is fighting over the budget and nobody knows if the county will still be solvent in three weeks," the paper concludes. "What is clear, though, is that America is already politically bankrupt."

As for the government shutdown, over the weekend the House voted to retroactively pay the roughly 800,000 furloughed federal workers; the measure still requires a Senate vote. So, the shutdown is no longer about expense because all the workers will be paid eventually; this just means that the government is not going to receive revenue, and that there will still be pain for the furloughed workers and the communities they live in. This has broken down to nothing but stupidity, plain and simple, with a side order of cruelty.

On Sunday, Speaker John Boehner’s talk hardened. He insisted he does not have the votes to get anything through unless the Democrats make concessions to get those measures passed. Obama has refused to do so. More worrisome, Boehner is changing his demands. Earlier, it was to delay implementation of Obamacare a year. Yesterday, there was no mention of Obamacare; the bone of contention was now out of control spending and debt. I’m not sure this is an actual change in position but in messaging, with the fight now moving to the debt ceiling.

And so today, President Obama made an unscheduled visit to the Federal Emergency Management Agency in his latest bid to draw attention to the effects of the government shutdown and to challenge Speaker John Boehner’s claim that he does not have enough votes to pass a measure to finance the government.

“The House should hold that vote today,” Mr. Obama said. “If Republicans and Speaker Boehner are saying there are not enough votes, then they should prove it. Let the bill go to the floor and let’s see what happens. Just vote. Let every member of Congress vote their conscience and they can determine whether or not they want to shut the government down. My suspicion is, my very strong suspicion is, that there are enough votes there.”

Turning up the pressure, Mr. Obama added, “The reason that Speaker Boehner hasn’t called a vote on it is because he doesn’t apparently want to see the government shutdown end at the moment, unless he’s able to extract concessions that don’t have anything to do with the budget.”

Chief Justice John Roberts and the Supremes will take the bench as scheduled today, ignoring the shutdown of much of the rest of the federal government. The Supreme Court has agreed to hear an array of cases of interest to employers and workers, manufacturers and financiers, and anyone else concerned about the intersection of commerce, law, and society.

The court today will hear arguments on whether federal securities law precludes certain class actions filed by investors who invoke state law. The case has added sizzle because it involves investors suing various defendants for losses related to R. Allen Stanford’s $8 billion Ponzi scheme. A lower court said that a federal statute, the Securities Litigation Uniform Standards Act, did not forbid state-law class actions in this context. 

Separately, the justices will resolve whether the corporate target of a state’s consumer-protection lawsuit can get the dispute moved from state court to federal court. The question sounds hyper-technical, but it matters. Defendants in consumer-protection cases prefer to litigate in federal courts, which are widely perceived as less plaintiff-friendly. This case involves Mississippi’s suit challenging alleged price fixing by manufacturers of flat-screen display panels. 

In recent years, the federal appeals court in Washington DC has issued a series of rulings making it difficult for the Environmental Protection Agency to curb power plant pollution that crosses state lines. The EPA is asking the Supreme Court to overturn a 2012 decision by the US Court of Appeals that struck down an agency rule that required upwind states in the East, Midwest, and South to reduce emissions of nitrogen oxides and sulfur dioxide to help downwind states meet national ambient air quality standards.

The Supreme Court refused to hear Argentina’s appeal of a lower court’s decision in favor of hedge funds that held bonds on which the country had defaulted. As is their custom, the justices offered no reasons for turning down the appeal. The appeal was from an interim decision last year from the United States Court of Appeals for the Second Circuit, in New York, and the justices may yet have an opportunity to consider whether to hear a separate appeal from the lower court’s final decision, issued in August. The case was brought by bondholders who were owed more than $1.3 billion and who refused to accept reduced payments after Argentina’s default in 2001. Most of the nation’s other creditors accepted such payments in later debt swaps. The Second Circuit ruled that Argentina had violated a contractual promise to treat all bondholders equally.

This case may actually set a precedent for US. 

Friday, October 04, 2013 - This Is Not A Game

This Is Not A Game

by Sinclair Noe

DOW + 76 = 15,072
SPX +11 = 1690
NAS + 33 = 3807
10 YR YLD + .04 = 2.65%
OIL + .39 = 103.70
GOLD – 5.50 = 1312.20
SILV + .04 = 21.84

The government showdown continues. So, there isn't much actually happening. We don't have a jobs report to analyze. The next jobs report will be so screwed up by the shutdown that it won't be possible to make heads or tails of it, whenever it is reported. We don't need a functioning government to tell us that the job market is lousy. But we do need one to help make the job market better.

It's the first Friday of the month, usually the day we get a bunch of random numbers from the government telling us what we already knew: Good jobs are scarce. This month, the government is too busy being held hostage by House Republicans to give us those random numbers. But there's plenty of evidence already that September was grimly similar to many of the months that came before it in this grinding recovery. With sagging consumer confidence and hiring surveys, September may even have been worse than August.

Whenever Bureau of Labor Statistics workers stop being furloughed by a government shutdown, economists, on average, expect it to report 185,000 new jobs on nonfarm payrolls in September and an unemployment rate holding at 7.3 percent. And if we look at this week's ADP report and the ISM hiring survey, we see diminished expectations; maybe around 170,000 new jobs.

And then the longer this shutdown continues, the worse the labor market will manage. For example, today Lockheed Martin says it will furlough 3,000 employees on Monday due to the government shutdown, and they say the number of employees put on furlough will increase weekly if the shutdown continues.

Earlier this week, United Technologies Corp. announced that it will furlough 2,000 employees by Monday and more than 5,000 if the shutdown continues into next month.

The company said Wednesday that its Sikorsky division, which makes Black Hawk helicopters, would be hit first. It expects nearly 2,000 employees, including those employed at facilities in Connecticut, Florida and Alabama, will be furloughed on Monday.

There are numerous reports that House Speaker John Boehner has told Republican House members that he would cave on the debt ceiling fight. He'll agree to use a combination of Democratic and establishment GOP votes to hike the debt ceiling and avoid damaging America's credit and the economy, and perhaps creating a global financial meltdown.

We don't know it that is true, but if it is, that means the worst case scenario in the current self inflicted financial crisis won't come to pass and the US won't default on its debts in the midst of a government shutdown. Let's be clear about this; the shutdown is continuing. The debt limit problem is separate from the fiscal dispute that’s shut down the government.

The government is shut down because the appropriations that pay for its activities expired at the end of the fiscal year which was Sept. 30, and Congress hasn’t passed a funding bill to keep that money flowing. The debt limit arrives around Oct. 17, when the US hits a legal limit on the amount of money it can borrow, meaning the Treasury can’t pay many debts already incurred. Similar but different; a breach of the debt limit would likely result in a total freakout for financial markets and result in worldwide chaos. That's just a guess because it's never actually happened.

What exactly is the strategy heading into the debt ceiling? That's the funny thing. There is no strategy, other than the fear factor; you know, pass it or there will be a loud explosion. This whole debt ceiling thing is a sort of grand, metaphorical legislative ceremony. Congresses, past and present, have passed all sorts of bills that are now law, those laws dictate that a certain amount of money needs to get spent, and from time to time, in order to make good on what are already ironclad obligations, the "debt ceiling" has to be "raised," in order to maintain the full faith and credit of the United States, and the U.S. Treasury bonds, which the world has essentially agreed to observe as the magical linchpin of what is colloquially known as "the global economy."

This whole process of raising the debt ceiling is really nothing more than an incantation; a loud chant in which our lawmakers profess the desire to honor our sovereign credit. So, Boehner might cave on the debt ceiling. The stories appear to be based on the word of some Republican moderates reporting what Boehner has told them in private. That could be wishful thinking on their part. It could reflect Boehner just telling them what they want to hear. There could still be some partisan fights on the issue, and Boehner might not be able to control certain elements in the GOP. In other words, it's not a done deal.

But Boehner seemed anything but conciliatory when he and other senior Republican lawmakers appeared before reporters this morning denouncing comments from an anonymous White House official who was quoted as saying the Democrats were “winning” in the funding impasse. Boehner said, “This isn't some damn game.”

Meanwhile, not much going on, so President Obama gets together with Joe Biden and they head out for sandwiches with a side of damage control. Obama told reporters that “No one is winning.” and then he ordered a hoagie, and he went on to say the whole shutdown could be over today, if there was a clean CR presented to the House. Yeah, that's not going to happen.

Meanwhile, you heard about the story of the woman who drove her car into the blockades around the White House the other day; she was shot and killed by police. The Capitol Hill Police have been on the job since the government shut down on midnight on Tuesday without any idea of when their next paycheck will come. In the aftermath of Thursday's shooting though, the Democratic and Republican lawmakers they protect joined together to compensate with something even better than money: applause and a big thank you. The police force is largely excepted from the shutdown, meaning they still go to work, they just won't be paid until Congress passes a budget.

Now, if you really want to end this shutdown fast, I mean lightning fast, the Capitol Hill Police could just decide that they stand by their fellow federal employees, and they could refuse to go to work. No police protection for the politicians on Capitol Hill until they resolve the shutdown. The shutdown would be over in a New York minute.

Instead, House Democrats announced this afternoon that they will try to force the House to vote on a measure to fully fund the government -- and end the shutdown -- with a procedural motion known as a discharge petition. Their resolution would fund the government through Nov. 15 at the same levels as the Senate-passed continuing resolution. And, like the Senate bill, there would be no strings attached related to delaying or defunding Obamacare. Yeah, that's not gonna happen.

Anyway, banks  are totally not worried about the U.S. government defaulting, sparking a nightmarish financial panic. Yes, they're stocking extra cash in ATMs to satisfy cash-hungry zombie hordes. But they're sure they won't need it. Bank executives are adding 20 to 30 percent more cash to their ATMs just as a hedge against debt ceiling mayhem. This is all just in case House Republicans pull the trigger on the gun they're holding to the head of the U.S. economy by refusing to raise the federal government's borrowing limit, or debt ceiling. That could cause the government to default on its debts, triggering a crisis that would be make 2008 look like a blip.

At the same time, these banks are telling their clients they think there is a "zero percent" chance of such a crisis happening. Bank strategists and economists all remember the last time we came close to disaster, in August 2011, and politicians managed to pull out a deal at the last minute that time. So of course they expect the same thing to happen again. After all, past performance is a gold-plated guarantee of future results, right?

We've been keeping you up to date on the JPMorgan giant settlement with regulators which some report could top $11 billion, one of the biggest Wall Street deals in history; except of course that it would be $7 billion cash and $4 billion in accounting tomfoolery, and then JPMorgan could write off more than $3.8 billion in tax breaks.

Last week Dimon met with Attorney General Eric Holder to discuss the settlement after his bank’s offer to settle was reportedly rejected. If this sounds unusual, it is; and AG Holder is not instituting a new policy of personal consultations with everybody under investigation by the Department of Justice, but Dimon gets special treatment. And the latest twist in the story is that Dimon will step down as Chairman of the banking unit of JPMorgan Chase. This is a bit of a surprise because there was a recent push by shareholders to split the chairman and CEO roles. Shareholders voted against the measure however and Dimon was able to retain the dual roles.

What does it all mean? We don't know, but Jamie Dimon's halo is tarnished, and he might not carry as much clout as in the past. Most likely he will be spending a little less time in the spotlight, but he could just as easily be spending time in handcuffs for pretty blatant violations of Sarbanes Oxley.