Wednesday, May 07, 2014 - On the Mend, Not Too Big, No Reason to Jail; Not Exactly

On the Mend, Not Too Big, No Reason to Jail; Not Exactly

by Sinclair Noe

DOW + 117 = 16,518
SPX + 10 = 1878
NAS – 13 = 4067
10 YR YLD un = 2.59%
OIL  + 1.35 = 100.85
GOLD – 18.00 = 1290.90
SILV - .25 = 19.40

Federal Reserve Chairwoman Janet Yellen testified before the congressional Joint Economic Committee today. Here’s the quick summary: taper from QE is on track, after the Fed exits QE asset purchases they will look at the possibility of raising interest rates – maybe 2015 or 2016, they will hold almost all of the mortgage backed securities they purchased on their books to maturity, the labor market is getting better but there are still some areas of concern such as long-term unemployment and underutilized workers and the participation rate, the housing market has flattened but she expects it will pick up again, it would be better if Congress was part of the solution rather than part of the problem, the economy paused in the first quarter but we’re on the mend.

That’s a couple of hours of testimony and Q&A in a nutshell. I just saved you a lot of time. You’re welcome.

There is a lot of talk about a stock market bubble, almost everywhere you hear someone with an opinion, but of course no one knows for sure. You could look at many indicators that seem bubbly: high margin debt, Shiller PE Index at the highest levels since 1929 and 2000, frothy M&A activity, IPO activity has been or was hot for a while, just like back in the dot.com days.

Just look at the recent bloodbath for Twitter, following the six-month lockup combined with a bad earnings report; high flying tech stocks plummet back to earth in 140 characters or less. If you want frothy, look at Tesla, which reported a $50 million dollar loss after the close of trade today; and even though revenue increased, share prices took a hit. It’s that kind of action that makes it feel like a bubble, but that doesn’t mean it is a bubble; not today anyway.

Venture capital certainly was one of the culprits driving up stock market prices in 1999 and 2000. Then, as now, low interest rates also played a part. In fact, the bursting of the bubble was related to the Federal Reserve raising interest rates six times between 1999 and 2000.

Maybe the Fed learned a lesson. While an overvalued stock market seems related to the Federal Reserve’s monetary policy and a chart of the S&P 500 is almost a mirror image of the Fed’s balance sheet, one of the goals of "Quantitative Easing," the Fed's program of buying treasuries to increase monetary supply and reduce the value of bonds, was to bolster other assets relative to bonds. With interest rates still so low, bonds are a lousy alternative to generate return, leaving more money in the stock market than if we were to have higher interest rates.

Fed Chair Yellen seems to be cautious with statements about interest rates and well aware that raising rates could reawaken the sleeping bear. Plus, we still have about $15 trillion in debt constantly rolling over, and if interest rates tick higher, that debt turns ugly fast. The stock markets know this and keep prices high. Of course, even with this knowledge, the business cycle hasn’t been repealed and the exit from QE and a Zero Interest Rate Policy remains fraught with peril.

Fed chairwoman Janet Yellen said, “many recent indicators suggest that a rebound in spending and production is already under way, putting the overall economy on track for solid growth in the current quarter.” The question is whether that pickup in output is being accomplished through better productivity or more hiring and longer workweeks. We got data on that issue this morning from a Labor Department report showing productivity fell at a 1.7% pace in the first quarter.

Some of the first-quarter drop reflects the drag on output caused by the harsh winter. But looking longer-term, productivity growth has slowed. Compared to a year ago, productivity is up a weak 1.4%. Of course, the demand for labor has not revved up much in recent quarters, so the growth in unit labor costs is also muted, up just 0.9% in the year ended in the first quarter. Part of the problem is that companies have been involved in relentless cost cutting, and after a while you can’t get any more water out of that well.

Of course, we haven’t recovered fully from the financial crisis. Ordinary Americans took huge balance sheet hits in the crisis: the loss of home equity, which only in some markets has come all the way back; job losses and pay and hours reductions, which led many to run down savings as they readjusted; declines in stock market portfolios; the flip side of ZIRP, the Zero Interest Rate Policy, is lower income thanks for retirees and other income-oriented investors.

Before the crisis, if someone was hit with a financial emergency, like an accident or sudden job loss, those who had houses could often draw on home equity. Yesterday we reported that negative equity is falling; bit by bit over the years, homeowners have been climbing out of that hole, and new data from Black Knight Financial Services show that borrowers are approaching a threshold that will see only one in 10 US borrowers underwater on home loans.

Of course, the main reasons why negative equity has dipped is a combination of slightly higher prices, but also because foreclosures wiped away the mortgages of many of the most indebted. In January 2010, 10% of borrowers owed at least 50% more than their homes were worth. By January 2014, that number fell to 2% of borrowers.

With that home equity piggybank depleted or non-existent, the last-ditch financial fallback is accessing retirement savings; not complete liquidation, but just dipping in with an early withdrawal or a loan. Borrowing is limited to a maximum of half of plan assets or $50,000, whichever is lower. While the borrowing is interest free, the funds need to be repaid in five years. Early withdrawals typically carry a 10% penalty.

A Bloomberg story details how prevalent 401(k) withdrawals have become. For the latest year in which data is available, 2011, 4% of all households paid early withdrawal penalties. A Federal Reserve study found that 9.3% of taxpayers with retirement accounts paid early withdrawal penalties, an increase from 7.9% in 2004. Adjusted for inflation, the government collects 37% more money from early-withdrawal penalties than it did in 2003. Meanwhile, the amount of home equity loans outstanding was $704 billion in 2013, down 38% from the 2007 peak.

In addition to the lack of recovery from the financial crisis, we still haven’t fixed the underlying problems. Bank of America is holding its annual shareholder meeting. Not surprisingly, the hot topic dealt with some missing money; $4 billion, more or less; an accounting error that resulted in not enough capital to pass the Federal Reserve stress test, consequently dashing the buyback program and halting any dividend increases and sending share prices down 5% so far this year.  

The error, unearthed by a bank employee earlier this month, stemmed from how Bank of America calculated certain losses on bonds that it acquired when it bought Merrill Lynch in the depth of the financial crisis. The bank had been making the same mistake for several years. As a result of the error, Bank of America has $4 billion less capital than it had represented to the Federal Reserve on this year’s stress test.  The bank still faces billions of dollars of legal costs to settle cases with federal prosecutors over its mortgage lending practices. Executives have declined to detail how much they are reserving for those cases because it could hurt their negotiating position. Not surprisingly, many shareholders are opposed to increasing executive compensation packages this year.

Charles Holiday, the Chairman of BofA said: “I believe very strongly that this bank is not too big to manage.’’

James Gorman is CEO of Morgan Stanley; speaking at a conference in New York, Gorman said he didn’t believe more bankers should have gone to jail for the financial crisis. At first blush, Gorman makes a good argument, but there are some holes. Gorman said, “Bad judgment, incompetence, negligence, greed: these might be socially unacceptable… but they’re not criminal offenses.” And that’s true, and I don’t believe any Wall Street bankers  have been criminally charged with bad judgment or for being greedy; in fact, no major Wall Street banking executive has been criminally charged… with anything. However, fraud, conspiracy to commit fraud, aiding and abetting fraud, forgery (as in robo-signing), perjury (as in false documentation), intentional misrepresentation or lying publicly about securities (as in securities fraud), violation of Sarbanes-Oxley, and a few other things that took place – those are indeed criminal offenses.

Gorman also said Glass-Steagall should not have been repealed, even though he doesn’t think it played a role in the financial crisis. Again, not exactly correct. Glass-Steagall  was the depression-era law that kept securities underwriting and trading separate from commercial banking; in other words, investment banks could be involved in speculative trading, they just couldn’t use depositors money for their gambling. Glass-Steagall was repealed in 1999 in a sneaky bit of legislative legerdemain that was written by and allowed the merger of Travelers and Citicorp to create Citigroup. Since then, the US government has been forced to rescue Citigroup 3 times. The repeal of Glass-Steagall might not have caused the financial crisis but it certainly played a role.

Gorman now joins some interesting company calling for the reinstatement of Glass-Steagall. Former CEO’s of Citigroup John Reed and Sandy Weill now regret the repeal and recognize the dangers. Politicians from both sides of the aisle have introduced legislation over the past few years to reinstate Glass-Steagll and effectively break up the big banks to protect taxpayers and restore confidence in the financial system.

Monday, August 19, 2013 - Not Attending Jackson Hole

Not Attending Jackson Hole

by Sinclair Noe

DOW – 70 = 15,010
SPX – 9 = 1646
NAS – 13 = 3589
10 YR YLD + .05 = 2.88%
OIL - .51 = 1365.20
GOLD – 11.60 = 1366.60
SILV - .07 = 23.29

It don't know where Ben Bernanke is. I know he is not scheduled to be in Jackson Hole, Wyoming this week. Most of the Federal Reserve policy makers will be at Jackson Hole for the annual economic get-together to debate whether the Fed should pull back from its $85 billion dollar per month asset purchase plan known as Quantitative Easing, also known as QE, also known as Stock Market Rocket Fuel. QE has lifted the markets to record highs this year, and talk of exiting QE has dropped the markets from highs the past couple of weeks.

Egypt continues to slip into a dark place as the military continues its bloody crackdown on civilian protesters. Just don't call it a coup; that specific designation would require an end to foreign aid. Egypt has been one of the biggest recipients of US foreign aid over the years. Egypt gets about $1.3 billion a year in aid. The money is not sent directly to Egypt; it goes to defense contractors who then send military equipment and expertise to the Egyptian military.

The biggest recipients of foreign aid to Egypt are Lockheed Martin, pulling in more than a quarter billion a year, followed by several others pulling in tens of millions, including DRS Technologies, L-3, Deloitte & Touche (apparently to keep track of everything), Boeing, Raytheon, and many more. The products include F-16s, surveillance equipment, Apache helicopters, Stinger missiles, motors, spare parts, and even teargas grenades.

The latest news out of Egypt is that a court has ordered the former dictator, Hosni Mubarak be released from custody. Mubarak has been detained on a variety of charges since his ouster in 2011. The courts say let him go. Not today, but maybe in a couple of weeks. Don't hold your breath. Actually, the court order means more volatility for Egypt; probably more protests; more protests means more teargas, so if you were in Cairo – hold your breath.

You may recall that when the Arab Spring began, Mubarak used some of the military equipment against protesters, including teargas grenades that proclaimed “Made in the USA”. This turned out to be a very bad marketing strategy. The Muslim Brotherhood then won the election and you have to wonder if the anti-US propaganda was a part of that. The Muslim Brotherhood turned out to be very bad at governing Egypt; the military, equipped with US made equipment, has now taken over the government. Just don't call it a coup.

You may also recall that one of the many factors in the Arab Spring was the release of Wikileaks diplomatic cables showing widespread political corruption. Wikileaks has just created its own “insurance” policy; sort of. Wikileaks is the website founded by Julian Assange; the site has released huge amounts of classified documents, also known as data dumps, detailing all sorts of governmental and diplomatic shenanigans. Assange has sought asylum at the Ecuadorian Embassy in London. WikiLeaks has released about 400 gigabytes' worth of mysterious data in a series of encrypted torrent files called "insurance." And no one can open it. File encryption means that the data is hidden and no one can see what's in the shared files without a key to unlock them, which hasn't been publicly released.

What is the meaning of calling it “insurance”? Is it meant to protect Bradley Manning (who has just been sentenced to 60 years), Edward Snowden, Julian Assange, or someone else? We don't know. The bigger question is what is in the “insurance” data dump? We don't know. It might be the identities of every secret agent working for the US around the world; it might be incriminating video; or everything that Edward Snowden had collected from his job with the NSA; it might be nothing more than a mumbo jumbo of code. It might even be the long anticipated data dump on the wrongdoing by the big banks.

For JPMorgan it appears bad habits, potentially illegal habits can't be broken. Last week, two junior level traders were criminally charged in connection with the London Whale losses. The bank is under investigation by eight agencies; add one more. The US Securities and Exchange Commission (SEC) is investigating whether JPMorgan's Hong Kong office hired the children of China's state-owned company executives with the express purpose of winning underwriting business and other contracts.

US law does not stop companies from hiring politically connected executives, but hiring people in order to win business from relatives can be bribery, and the SEC is investigating JPMorgan's actions under the US Foreign Corrupt Practices Act. If it's not one thing it's another.

The big banks seem to get away with..., everything. That's not always the case with the hedge fund managers; they tend to be viewed in a slightly different light; they are not considered systemically important; Bernie Madoff was sent to the big gray house. Steven Cohen saw his hedge fund charged, although Cohen wasn't personally charged. Today, the SEC announced a deal against Phil Falcone which includes an $18 million penalty, and Falcone must admit wrongdoing, and he will be banned from the securities industry for at least 5 years.

In June 2012, federal regulators had accused Falcone of manipulating the market by improperly using $113 million in fund assets to pay his own taxes and to favor some customer redemption requests secretly over others, among other things. His actions, “read like the final exam in a graduate school course in how to operate a hedge fund unlawfully.”

Falcone and his Harbinger hedge fund entities engaged in serious misconduct that harmed investors, and the SEC says their admissions leave no doubt that they violated the federal securities laws. For Falcone, who is currently engaged in two battles over LightSquared, a broadband company in bankruptcy he is fighting to maintain control over, the settlement appeared to be a positive turn of events. He struck a more upbeat note than the regulator saying he was, “pleased that we were able to reach a settlement to resolve these matters with the S.E.C.”

Following the financial crisis, the Federal Reserve, which is actually a regulator of banks; we forget that some times; the Fed, in addition to its other mandates of price stability and maximum employment, the Fed regulates banks, even though they don't really have their heart in it. The Fed in the role of regulator is kind of like a Pope who doesn't believe in religion. Anyway, following the financial crisis, the Fed started conducting stress tests on the big banks. They graded on a curve.

These annual financial health checkups continue and today the Fed described some significant shortcomings in the banks’ responses to the so-called stress tests. Despite the severity of the recent housing bust, the Fed said some banks weren’t taking into account the possibility of falling house prices when valuing certain mortgage-related assets for the tests. In other cases, banks assumed they would be strong enough to take business away from competitors in stressed times.

The Fed appeared most concerned that banks were applying the tests too generally. In other words, such banks didn’t pay enough attention to the risks that were particular to their assets and operations. Banks excluded material that was relevant to the bank’s “idiosyncratic vulnerabilities.” Under the tests, the banks have to assume weakness in the economy and turmoil in the markets, and then calculate the losses they would suffer under such conditions. The banks then subtract those losses from capital, the financial buffer they maintain to absorb losses. If the assumed losses cause capital to fall below a regulatory threshold, the banks effectively fail the test.

As part of the stress tests, banks have to carefully lay out capital plans to show regulators that they would have the strength to operate through tough times. The Fed says the banks are, in essence just trying to pass the test without really addressing the problems.

The stress tests have created tension between the Fed and the banks. One reason is that the tests can determine how much a bank is allowed to pay out in dividends or spend on stock buybacks.

President Obama is meeting with regulators today to get a status report on the progress of the Dodd-Frank reform act, the financial reform legislation that appears to have stalled after three years. This fall, the president will face a host of renewed efforts for financial reform, including housing finance reform. Just a reminder that September will mark the 5 year anniversary of the bankruptcy of Lehman Brothers, and so maybe it's time to get around to some reforms to prevent another Lehman Brothers collapse.

The Dodd-Frank law, which Congress passed in response to the meltdown, called for hundreds of new rules, including new oversight of the massive swaps market, mortgages and consumer financial products, and large nonbank financial firms. Regulators have missed deadlines on many of the most controversial requirements. The rules are about 40 percent complete. For example, the so-called Volcker rule to forbid banks from making risky trades with their own money is more than a year behind schedule, as five different agencies struggle to agree on a single rule. Despite that, the Dodd Frank act has grown while shrinking; grown from 848 pages of statutory text to 13,789 pages – more than 15 million words of regulation.

The White House meeting features the heads of major financial regulatory agencies, including the Treasury, Comptroller of the Currency, Securities and Exchange Commission, Commodity Futures Trading Commission, and the Consumer Financial Protection Bureau, among others.

Friday, March 08, 2013 - Jobs Report and Bad Banks

Mark your Calendar, April 5 & 6 and make your reservations for the 2013 Wealth Protection Conference in Tempe, AZ. For conference information visit www.buysilvernow.com or click here or call 480-820-5877.

Jobs Report and Bad Banks

DOW + 67 = 14, 397
SPX + 6 = 1551
NAS + 12 = 3244
10 YR YLD +.07 = 2.06%
OIL + .29 = 91.85
GOLD + .60 = 1580.20
SILV + .12 = 29.10

The Dow Industrial hit their fourth consecutive record high close. The S&P 500 is within 1% of record highs. The S&P is up for 6 straight days, and 9 out of the past 10 weeks. Year to date, the Dow is up 9.9 percent, while the S&P 500 is up 8.8 percent and the Nasdaq is up about 7.5 percent.

The economy added 236,000 jobs in February. The unemployment rate fell from 7.9% to 7.7%. The number of jobs gained beat expectations by about 76,000. The unemployment rate is now at its lowest level since December of 2008. Part of the reason for the drop in the unemployment rate is that fewer people are counted as being in the labor pool, looking for a job; this is known as the participation rate and it dropped to 63.5%, matching a 32 year low.

Still, this was a much stronger jobs report than we've seen in a while. There was improvement, but not enough. We haven't yet seen the dramatic upswing that leads to a virtuous cycle of growth and truly low unemployment.

The report showed that virtually every sector added jobs with the exception of government. The public-sector workforce has been shrinking for four years, and last month another 10,000 jobs were lost. Most of the state and local government layoffs are over, however state and local government employment is still trending down. Of course, the Federal government layoffs are ongoing with many more layoffs expected due to the sequestration spending cuts.

Construction added 48,000 jobs; similar ongoing gains in construction are not likely. The biggest increases in hiring occurred in professional services, with 73,000 new jobs, health care added 32,000 and retail added 24,000 jobs. The economy has added an average of 205,000 jobs over the past four months, up from 154,000 in late summer.

The U-6 unemployment rate is an even higher 14.3%; U-6 includes people who have gotten too discouraged to look for a job or who can only find part-time work; by that measure; 22.6 million Americans remain out of work or underutilized, including 8 million people working part-time and nearly 5 million who have been without a job for at least six months. About 40% of unemployed people have been out of work longer than six months, far more than at any time since the Great Depression. Many of those people will not work again. For statistical purposes the long-term unemployed stop getting counted. Some of those people are retiring as the boomer generation grays; sometimes the retirement is voluntary, more likely not.

The 55- to 64 age group is the fastest growing group of entrepreneurs. The 20 to 34 age group has the lowest level of entrepreneurship. There are a couple of factors at work here. First, there is a tendency to hire younger workers; they cost less; and so younger workers find it easier to take a traditional job. For a young worker, with a mountain load of student loan debt, the traditional job might make sense. We know that boomers have been opting for or forced into self-employment. Older workers have experience and some have managed to save enough to launch a self-employed career. Further, some have reached the age where they are eligible for Medicare, and no longer have to worry about being tied to the company store's health care plan.

Some people equate innovation and creativity with youth. Bill Gates would probably have a hard time getting a regular job in Silicon Valley today. But with age comes experience and competency, and perhaps a confidence to think outside the box. Of course, if the labor pool gets shallow, many self-employed would jump back in.

Back to the jobs report; while it looked like a solid report, we are still not seeing enough new jobs. The population growth suggests we need 165,000 new jobs per month just to stand still. That means the improvement in the unemployment rate is largely the result of people leaving the workforce. Average hourly earnings, meanwhile, climbed 4 cents, or 0.2%, to $23.82 in February. They are up 2.1% over the past 12 months, just slightly faster than the pace of inflation. The workweek edged up 0.1 hour to 34.5; it usually rises when the economy gets stronger.

So, the headline numbers: 236,000 new jobs; unemployment drops to 7.7%; that is good news, but we still have a bad labor market.

Now, I refer you to Federal Reserve Chairman Bernanke's recent testimony before Congress. After talking about the threat of deflation, Bernanke said: “our accommodative monetary policy has not really traded off one of [the FOMC’s mandated goals] against the other, and it has supported both real growth and employment and kept inflation close to our target.”

There is nothing in today's jobs report to indicate the Fed would step away from QE. Bernanke and Fed Vice Chair Janet Yellen have gone to pains to persuade investors that they want to see the economy attain “escape velocity” before they move toward tighter policy. And most of the Fed's monetary actions take time to be felt, but any hint of an exit from free money would likely trigger a negative and immediate reaction. So, the Fed will sit back and stay quite on this report.

Yesterday, we learned the results of the first part of a two part stress test for the 18 biggest US banks. Only one bank failed the test: Ally only had 1.5% in capital set aside under a measure known as Tier 1 common ratio, which compares the bank’s common equity to its risk-weighted assets. That is significantly below the generally accepted standard of 5%. In other words, they didn't have a cash cushion for tough times. So, Ally Financial, which by the way is still 74% owned by us taxpayers, was the only bank to fail. The other 17 institutions fared better, but many experienced major mortgage, securities and loan losses under the recession scenario.

Of course, the results are based on the banks' reported figures, which don't always jibe with the Federal Reserve's numbers. For example, Wells Fargo reported much higher reserves. Goldman Sachs could theoretically lose $25 billion in trading losses under the stress test; no problem; they passed. JPMorgan reported higher numbers than the Fed figured. Goldman Sachs gave itself enough reserves to pass the test; the Fed's numbers would have resulted in a failing score. What this really tells us is that the banks still have a fair amount of toxic assets on the books.

Of course, there are quite a few people who are arguing the stress tests were way too lenient; they underestimated the potential losses, and the effects of a global financial meltdown which can paralyze the entire system, as Hank Paulson would say. And even under the test, the worst case scenario is that the banks would lose $462 billion, but nobody would panic. Everything would just roll merrily along. And the test didn't look at a possible increase in interest rates, which might represent a much bigger risk to the banks.

It's kind of like preparing for crossing Death Valley in July. You have a nice cold can of Coca-Cola, you're good to go; you pass the preparedness test.. Actually, the test is really about the ability of banks to pay dividends and buyback stock in order to prop up share price, in order to boost executive bonuses.

Next week, the Fed will release another series of stress test results which will determine whether the banks can pay dividends to shareholders of can buyback shares. Citigroup has already announced a share $1.2 billion in buybacks. Last year, the Fed passed most of the big banks and let them pay out billions. Bank of America, sensing a request would be unwelcome, didn’t even ask. This year, however, Bank of America will likely get the green light. BofA passed yesterday's stress test, despite having set aside very little for legal reserves. And BofA is facing some lawsuits that could cost tens of billions.

The dispute involves a 2011 settlement that BofA reached with some very big investors. The settlement was for $8.5 billion to cover up to $100 billion in losses on bad Countrywide loans. In other words, they settled for pennies on the dollar. Now, there is a suit alleging a breach of fiduciary duty by the trustee that accepted the settlement; if that is found to be the case, the settlement could easily rise to more than $25 billion.

A look at Bank of America’s estimates for how much it will have to pay for its mortgage liability is telling. It has gone up steadily each year. In 2009, the bank had a reserve of $3.5 billion. By last year, it had jumped to $19 billion, with an estimate of additional loss of up to another $4 billion. And so Bank of America seems to have been consistently underestimating its legal exposure. In keeping the reserves low, Bank of America has already won. If it turns out that the bank loses its cases and has to pay much more money, it nevertheless has managed to make its books look that much better for years. It's a risky move, and for now, the regulators are giving them a pass. Time will tell what the courts will do.

Also, next week we are scheduled to read the Senate Permanent Subcommittee on Investigations report on the London Whale. We expect the report will show senior executives at JPMorgan were very much aware of the Whale's trades and played a role in allowing the CIO trading desk to build bets without fully warning regulators and investors.

A BBC article exposed another risk in the banking sector: technology. We've heard lots of stories about financial innovation over the years but it turns out the banks don't have much respect for technology. The problem grows when there have been acquisitions. The transition from two systems to one system can take years, and can result in significant overlap; multiple mortgage systems, 50 or more, when one or two would get the job done.

Another factor that can mess up IT integration is a difference in cultures. For instance, believe it or not, Countrywide’s prize asset was its servicing platform, software it had developed internally. But Bank of America didn’t like or do custom, it relied as much as possible on vendor-provided software. It proceeded to upload its customer data and integrate stray systems into the Countrywide platform, and then manage it like a BofA installation, which resulted in it losing the specialists who knew the systems

Most IT applications carry around dead code – which lies dormant because none of the live modules are using it. When Knight Capital ran an update in its systems, some of the dead code was brought back to life, causing the system to spit out incorrect trades.

By the way, the BBC article was in response to an IT crash at a British bank, NatWest, which left customers unable to withdraw cash, pay for goods or services, or carry out online banking. But don't worry, it can't happen here.

Wednesday, October 10, 2012 - Great Fun and Very Entertaining

Great Fun and Very Entertaining

-by Sinclair Noe

DOW – 128 = 13,344
SPX – 8 = 1432
NAS – 13 = 3051
10 YR YLD - .03 = 1.69%

OIL – 1.04 = 91.35

GOLD – 1.30 = 1763.60
SILV +.08 = 34.08

PLAT – 13.00 = 1678.00

(to listen to audio visit Financial Review at MoneyRadio.com)

It's earnings season. Chevron took a hit after announcing third quarter earnings would be substantially lower. Alcoa took a hit because law suits and remediation costs are part of their business model and not one time exclusions. FedEx announced it will fire workers and park planes to cut $1.7 in expenses. S&P cut Spain's sovereign credit rating to BBB-minus, just a notch above junk status.

Less than 4 weeks to the election. Tomorrow we can watch the vice-presidential debate. It's all great fun and very entertaining. Last week, the first presidential debate produced a bump in the polls for Romney. The latest Pew Research Center poll shows Mitt Romney ahead of President Barack Obama among likely voters, 49% to 45%. But the latest Gallup poll shows President Obama leading Romney among likely voters, 50% to 45%.

If you're wondering about the discrepancy, the reason is simple. The Pew poll covered the days immediately following last Wednesday's presidential debate, but it didn't include last weekend. The Gallup poll, included the weekend and that means it also included Friday's September's jobs report which showed unemployment down to 7.8 percent for the first time in more than three years. Romney got a bump from the debate. Obama got a bump from the jobs report. So, really the poll numbers are pretty accurate and indicate a very close race. It's all great fun and very entertaining and that is exactly what corporate media is hoping for; a horse race.

Part of the problem with the influence of money in elections is that all players in the game are affected by it, the corporate media included. Presidential elections are big money. Ratings, readership and advertising rates all soar, particularly when it's a close race in the home stretch. But not if it's a blowout. If one candidate has a comfortable lead, it is in the best interest of news reporting organizations, driven by the bottom line, to depict a tightening race.

The November 3, 1948 edition of the Chicago Tribune can sell for as much as $500. You know the paper; the one that had the big headline: “Dewey Defeats Truman”. Accuracy is not the point. The Las Vegas bookies still have Obama as the favorite by about 70% to 30%; those are the betting odds, not the anticipated vote tally. I think the bookies are more concerned with accuracy than the media; and that says more about the media than the bookies.

Two weeks ago the Republicans complained the polls were skewed. Now the Democrats complain the polls are skewed. Of course, the polls are incredibly misleading. When you hear numbers like 50% to 45% you naturally think that it applies to 95% of the entire citizenry. The truth is that Democrats and Republicans are outnumbered by citizens who don't vote. Maybe they have good reasons for not voting, but nature and democracy abhor a vacuum.

In contrast to the fun and entertainment of politics, the Federal Reserve is boring and dismal; this is not to say they are apolitical, they just lack excitement. Nothing says boring like the Beige Book, the Fed's anecdotal assessment of the economy from its 12 regional banking districts. 

The mid-August through September Beige Book shows stronger housing markets helped boost economic activity at the end of the summer in nearly every region of the country. Rising home sales helped lift home prices in most districts. Auto sales increased in most parts of the country. Consumer spending was flat or up only slightly in most districts. Manufacturing was mixed; half the districts reporting a slight improvement. Hiring was unchanged in most districts. Oil production hit a record high in South Dakota. The drought continued to weigh on farm activity in the Midwest. The central bank's outlook represents a subtle shift from gradual growth to moderate growth.

The Fed is also charged with regulating banks; they have finally approved the new stress test rules under the purview of the Dodd-Frank Act. The new rules apply to banks with consolidated assets of more than $10 billion. The new set of rules was jointly approved by the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board and the Office of the Comptroller of the Currency (OCC). The regulation requires stress tests based on three scenarios - a baseline scenario, an adverse scenario and a severely adverse scenario. When they did the first stress tests a few years ago, they really underestimated the severely adverse scenario. Now, the banks are opposed to reporting the baseline, so they'll only have to report severely adverse scenario.

The effect is that the banks don't have to reveal how much loss-absorbing capital can be paid out through stock repurchases and dividends; better for shareholders and executive; worse for taxpayers in the event of failure and bailout. Of course, we've been told repeatedly there will be no bailouts in the future, not even for the chronically underfunded big banks. The idea behind the stress tests is that the Fed can head off such a failure. One little problem, the Fed backed off the requirement that CFOs of the banks confirm that the numbers they're providing are accurate.

The banks argued, and the Fed apparently agreed, that providing data about what's going on in the banks is simply too "confusing for any CFO to be able to be sure his bank had gotten it right." I'm not making this up. The CFOs of the big banks will be allowed to make up whatever numbers suit them. This leaves me just a tad leery of the stress tests and more than leery of the banks. Why would you ever put your investment dollars into a bank that is so complex that they can't figure out where the money is?

Dear Federal Reserve,

I thinks there is some money in this heah bank. I cain't figure out where it 'tis, but I ain't gonna stress about it, so we pass the test.

Sincerely,

CFO

If you've been worrying about the fiscal cliff, and by the way it is a fiscal, not physical, cliff; worry no more. After the election the bankers will get back to running things in Washington. Politico reports the plan is to get a big budget deal that provides stability for investors by eliminating the threats of government shutdowns, credit-rating downgrades, debt ceiling disasters and wide fluctuations in spending and tax policy. Some on Wall Street believe the circumstances are so dire they are ready to pressure Republicans to abandon orthodoxy for a more important goal: to prove that Washington won't hold the economy hostage to its own partisan dysfunction.

Jamie Dimon, Lloyd Blankfein and others have signed onto a multimillion dollar ad campaign to build public support for a deal. And CEOs are also lobbying senior lawmakers and their aides to find a solution. The executives say they’re willing to consider ponying up more money in tax revenue to the government, a move they hope will give cover to Republicans that want to sign onto a grand bargain. And those who support a deficit deal believe both presidential candidates have given strong signals that they will work for one once the election is over.

Both Romney and Obama are widely viewed in corporate America as likely to support a deal roughly along the lines of the Bowles-Simpson commission recommendations that will include trims to Social Security and Medicare and new revenues beyond just increased taxes for the wealthy. Corporate America would also like to see such a deal include a lower overall corporate rate and changes to the taxation of overseas profits. I repeat; Social Security and Medicare get cut, taxes increase for everybody – except the corporations.

While many on the Hill are skeptical that even the clout of the Wall Street could force a deal, optimists believe that the outside help would pressure lawmakers to sign onto a deal, or at least to give them political cover if they do. The logic: If business says a deal will help jump-start the economy, how could Congress and the president be against it?

The bank executive say that if a deal is made, the largest single roadblock to a stronger US recovery, widespread and damaging corporate uncertainty on taxes and the ability of the US government to execute basic functions, would be lifted, unleashing a much stronger recovery that would benefit whoever is in the Oval Office and members of Congress who supported such an agreement.

And while the fiscal cliff is a problem, it is not the biggest problem we face in America – not by a long stretch.

Lloyd Blankfein, the CEO of Goldman Sachs, summed it up without a trace of irony or understanding: “Where else in the world are the problems so clearly solvable as they are here?”

No sooner had Blankfein uttered the words than I saw a vision of a possum walking through the great Okefenokee Swamp: Yep, son, we have met the enemy and he is us.