Friday, May 09, 2014 - Happy Mothers' Day

Happy Mothers’ Day
by Sinclair Noe

DOW + 32 = 16,583
SPX + 2 = 1878
NAS + 20 = 4071
10 YR YLD + .02 = 2.62%
OIL - .23 – 100.03
GOLD + .30 = 1291.10
SILV un = 19.26

Another up and down session on Wall Street but at the close it was a record high for the Dow Industrial Average. Whenever the Dow hits a record high close, we have a celebration with milk and cookies.

For the week, the Dow rose 0.4%, while the S&P 500 fell 0.1% and the Nasdaq lost 1.3%, for its worst weekly loss in a month. Small cap stocks moved higher today, but were still down on the week. The Russell 200 Index managed to close the week just a smidge above the 200-day moving average, and still well below the 50-day. According to SentimenTrader, Tuesday was only the third time in 35 years of market history that the NYSE Composite was sitting at a 52-week high one day before the Russell 2000 dropped below both its 50- and 200-day moving averages the next day. The last two occurrences were March 1999 and November 2007.

Fed Chairwoman Janet Yellen delivered testimony on Capitol Hill this week followed by questions from the lawmakers; she was even asked about the possible overvaluation in small caps. We covered Yellen’s testimony pretty extensively, but there were a few tidbits that didn’t make most newscasts, so we’ll put a wrap on this story with a couple of questions from lawmakers.

First, Joint Economic Committee Chairman Representative Kevin Brady(R-Texas) pushed Yellen for more clarity on when the FOMC would raise interest rates but Yellen would not pinpoint a date. Brady also displayed a slide showing the change in the S&P 500 total return since the end of the recession compared to the change in real disposable income per capita. Since the official end of the recession Main Street families have seen income increase 4.2% compared to Wall Street gains of 108.2%.

The other really interesting question came from Senator Bernie Sanders (I-Vermont). The senator began with the facts: “In the US today, the top 1 percent own about 38 percent of the financial wealth of America. The bottom 60 percent own 2.3 percent. One family, the Walton family, is worth over $140 billion; that’s more wealth than the bottom 40 percent of the American people. In recent years, we have seen a huge increase in the number of millionaires and billionaires, while we continue to have the highest rate of childhood poverty in the industrialized world. Despite, as many of my Republican friends talk about ‘the oppressive Obama economic policies,’ in the last year Charles and David Koch struggled under these policies and their wealth increased by $12 billion in one year. In terms of income, 95 percent of new income generated in this country in the last year went to the top 1 percent. “

Sanders then introduced an academic study that concludes, “The central point that emerges from our research is that economic elites and organized groups representing business interests have substantial independent impacts on US government policy, while mass-based interest groups and average citizens have little or no independent influence.”

That sounds like an oligarchy. So Sanders asked Yellen: “In your judgment, given the enormous power held by the billionaire class and their political representatives, are we still a capitalist democracy or have we gone over to an oligarchic form of society in which incredible enormous economic and political power now rests with the billionaire class?”

Yellen did not answer “yes.” But she did say, “There’s no question that we’ve had a trend toward growing inequality and I personally find it a very worrisome trend that deserves the attention of policy makers.” She also expressed concern that trends toward growing inequality “can shape [and] determine the ability of different groups to participate equally in a democracy and have grave effects on social stability over time.”

Also this week we had the White House released a report on climate change, the National Climate Assessment. The report basically says we need to make big changes. Today, speaking in California, President Obama said that he had ordered $2 billion in upgrades to federal buildings to increase their energy efficiency, adding that the Department of Energy would also be adopting new standards that would be the equivalent of taking 80 million cars off the road. Obama was speaking at a Wal-Mart, and it may be the first time a sitting president has visited a Wal-Mart; this after a multi-stop fundraising lalapalooza through the Golden State, and with a deaf ear to his own efforts to get a minimum wage deal past Congress. Meanwhile, the White House installed solar panels today.

There will undoubtedly be massive investments to combat climate change, but it isn’t always easy to spot the opportunities. According to a Bloomberg article, Wall Street’s idea of investing in climate change is to load up on natural gas, because it’s less dirty than other forms of fossil fuels. On the day the National Climate Assessment report was issued, the 44-company Standard & Poor’s Energy Index reached a record, and $322 million of cash flowed into exchange-traded funds that specialize in energy.

Here’s how Wall Street deals with climate change. The potential for hotter summers and colder winters will raise energy demand, and that suggests higher gas prices. Weather extremes are good for the energy business. More energy use, better for the earnings.

I can’t make this stuff up.

Next week’s economic calendar includes a Tuesday report on retail sales. Tuesday also brings a Commerce Department report on inventories, which was a major drag on first quarter GDP estimates. Also the CPI, or Consumer Price Index, which is expected to show tame inflation at the retail level with the possible exception of food prices. Next Friday we’ll get the April housing report and a chance to see if homebuilders are coming out of winter hibernation; an interesting subset will be whether starts on apartments are outpacing starts on single family residential; that reflects the shift toward renting rather than owning one’s home.

Over the weekend, we’ll follow the vote in Ukraine. There will be a referendum, I’m not sure what it will mean but it seems like a tipping point – maybe. The economic fallout from Ukraine moves at a slower pace but it apparently is having an effect as the slump in Russia's economy is taking its toll on sales and profits at businesses in the rest of Europe. The International Monetary Fund says Russia has already been dragged into a recession as investors flee the emerging market for fear of being caught up in the escalating conflict in eastern Ukraine. Trade and investment between Russia and Europe is worth about $500 billion a year. French bank Societe Generale cut first quarter net profit as they wrote down the value of their Russian banking activities. German factory orders in March fell by 2.8% compared to February, although it’s tough to say how much of that was related to tensions with Russia.

Meanwhile, Gazprom is threatening to cut off gas supplies to Ukraine. High quality global journalism requires investment. Russia’s energy minister said the state-controlled enterprise would move to a system of pre-payment for supplies to Ukraine from next month, bringing the simmering gas dispute between the countries a step closer to crisis.

One more thing this weekend. It’s Mothers’ Day. Don’t forget, and maybe take a little time to show your respect; respect for the work moms do, which is extremely undervalued, whether in the workplace or in the home. Acknowledge that the work moms do is what really makes everything else in the economy function. Admit it, society would collapse without the hard work of moms. I’m not saying you should forget the chocolates and flowers this weekend, which would be a mistake; just be sure they’re delivered with a heartfelt “thank you” and love.

Thursday, May 08, 2014 - Monetary Policy Is Not A Panacea

Monetary Policy Is Not A Panacea

by Sinclair Noe

DOW + 32 = 16550
SPX – 2 = 1875
NAS– 16 = 4051
10 YR YLD + .01 = 2.60
OIL – 01 = 100.24
GOLD - .10 = 1290.80
SILV - .15 = 19.25

Stocks were mostly lower today. The closing numbers looked quiet but it was a roller coaster ride with the Dow Industrials up about 150 points. The Nasdaq also squandered early gains to finish in negative territory. The Nasdaq ended lower for a third straight session, its longest losing streak since early April. A late selloff in utilities and energy, among the best performing sectors recently, dragged the S&P 500 lower. Of 445 companies in the S&P 500 that have reported earnings, 68.2% beat expectations, above the 66% beat rate for the past four quarters. Profits are expected to rise 5.3% this quarter.

The number of people who applied for new unemployment benefits last week fell to the lowest level in a month. Initial jobless claims dropped by 26,000 to a seasonally adjusted 319,000.

The federal government had a budget surplus of $114 billion in April. That is $1 billion more than a year ago and would be the biggest April surplus since 2008. For the fiscal year to date, CBO estimates the deficit to be $301 billion, down $187 billion compared to the same period in 2013.

Retailers posted modestly higher sales in April. Results from March and April are generally viewed together because of the shifting nature of Easter, which fell about three weeks later this year and moved into April from March last year. For the two-month period, retailers reported 3.4% growth, down from 3.5% a year earlier.

Consumer credit balances increased by $17.5 billion in March to a total of $3.141 trillion. The gain was a bigger increase than the $15.5 billion expected by economists. This was the biggest month-over-month growth rate since February 2013. Nonrevolving debt like college and auto loans grew by $16.4 billion. Revolving debt like credit cards increased by $1.1 billion.

At 4.21%, the 30-year fixed-rate mortgage is at its lowest since the week of November 7, 2013, so says Freddie Mac in their new weekly report on national mortgage rates. Last week, it averaged 4.29%. A year ago, it was 3.42%. Since the housing market crashed, the Federal Reserve has used extraordinarily easy monetary policy to keep interest rates like mortgage rates low in its effort to bolster the housing market and stimulate the economy.  Lately, various housing-market metrics such as existing-home sales, new-home sales, and mortgage applications have all been flagging. Last week, we learned that the US homeownership rate was at a 19-year low, and some experts think it'll never come back.

Yesterday, Fed Chair Janet Yellen said, "One cautionary note, though, is that readings on housing activity—a sector that has been recovering since 2011—have remained disappointing so far this year and will bear watching. The recent flattening out in housing activity could prove more protracted than currently expected rather than resuming its earlier pace of recovery." That was the big takeaway from Yellen’s Congressional testimony yesterday.

Fed Chair Janet Yellen was back on Capitol Hill today for a second day of testimony. She appeared before the Senate Budget Committee.  Yellen’s favorite new line is, “Monetary policy is not a panacea.” That pretty much says it all.

There are a couple of trends that concern Yellen; long term unemployment; there are about 3.5 million workers who haven’t found a job for at least 6 months. Also, income inequality is pulling down spending and slowing the economy. Yellen would like to do something about these disturbing trends, but you know, “Monetary policy is not a panacea.”

Meanwhile, the European Central Bank was meeting to determine monetary policy for the Euroland; they decided to leave interest rates unchanged at 0.25%. ECB President Mario Draghi’s favorite line is “whatever it takes” and he’s been saying it for a couple of years. Euroland is slogging along with persistently low inflation and high unemployment. Draghi says something should be done, but he did not say what; and the ECB might address stimulus of some sort or another next month or so.

Perhaps Draghi is waiting to see how the situation in Ukraine plays out; right now the picture is smoky and very gray. Rebels in eastern Ukraine say they will proceed with a referendum this weekend seeking autonomy even though Russian President Putin appeared to withdraw his support for the vote. Putin yesterday presided over nationwide army drills, a day after he softened his tone by promising to withdraw troops from the border. The government in Kiev says a referendum would be illegal. Putin also indicated he would pull Russian troops from the Ukrainian border, but satellite images show that probably isn’t happening. The situation involving the tug of war between the West and Russia regarding Ukraine has steadily worsened over time and now involves outright economic warfare; sanctions on one side and the threat of energy shortages on the other.

Even former Treasury Secretary Tim Geithner is coming out of exile to hawk a new book. Geithner says there had been talk about nationalizing banks back in the crisis days. On the legacy of the bailouts, Geithner rejects criticism that the Troubled Asset Relief Program benefited the rich rather than ordinary Americans. And yet he acknowledges that the too big to fail banks are bigger and more dangerous than ever.

Have you ever seen a boxer knocked out? The devastating blow is the one you don’t see coming. Mark Carney, governor of the Bank of England and head of the Financial Stability Board, an international watchdog set up to guard against future financial crises, was recently asked to identify the greatest danger to the world economy. He answered shadow banking. It is huge and growing fast, and little understood, and even less transparent. We don’t even know exactly what counts as shadow banking; basically, it refers to lending by non-bank institutions and it involves more than $70 trillion in assets, up from about $25 trillion ten years ago.

A broader definition, however, would include any bank-like activity undertaken by a firm not regulated as a bank: it could be bond trading platforms set up by technology firms, or payment systems offered by Paypal or financing offered by a retailer such as Sears, or peer-to-peer lending, or money market funds, or who knows what. At the core is the concept of credit and lending. Shadow banking fills a void left by traditional banks, which have become miserly with lending.

Yet shadow banking is poorly or non-regulated. Think of the structured investment vehicles, a legal entity created by banks to sell loans repackaged as bonds. These were notionally independent, but when they got into trouble they pulled in the banks that had set them up. Or money market funds, which seemed like a nice safe place to park cash as a stop-gap measure; they seemed conservative, nearly risk free, until they suffered a run.

Banks must now incorporate structured investment vehicles on their balance-sheets. Money-market funds must hold more liquid assets, to guard against runs. Limits on leverage have been imposed or are being considered for many forms of shadow banks. American regulators are still allowing some money-market funds to create the impression that an investor can never lose money in them. The problem for banks is that they are involved in shadow banking, either in the form of loans to shadow banks, or because the banks buy the products created by shadow banks.

One of the biggest paces for concern is China. Banks there are banned from expanding lending to certain industries, and from luring deposits by offering high returns. So they do both of these things indirectly, through shadow banks of various sorts. Some firms are setting themselves up as pseudo-banks. It is hard to imagine that all the shadowy loans to unprofitable steel mills and overextended property developers will pay off. At which point the Chinese government will likely step in a take control, but there will be a cost.

Nouriel Roubini, the New York University professor and chairman of Roubini Global Economics is known as something of an economic pessimist, and now he thinks we’re on the verge of a bubble, but not a collapse. Roubini says the Federal Reserve will keep its key lending rate low even after it lifts off from near zero, where it has rested for the few years. That slow process of normalization will keep the spigot of borrowing flowing, helping support the economy. But it will also lead to risky lending practices. Hence, a bubble is inflating that could eventually pop.

Roubini cited the return of some of the key characters associated with the period before the last financial collapse: Lots of low quality bond sales, debt without strong protections for bondholders. Roubini says: “All the risky things that were happening back in ’06 and ‘07 are back again to the same level, if not more. So we are in the beginning of a credit bubble, but just the beginning.”

Nonetheless, Roubini doesn’t see the reversal happening immediately, citing money that continues to rush into the market. For now, credit investors appear to be stuck in an uneasy equilibrium.

He’s by no means the first person to make this claim: the question of financial stability is one of the key criticisms of the Fed’s accommodative policies. Roubini didn’t criticize the central bank, so much as say that the Fed is damned-if-you-do, damned-if-you don’t.

Yeah, well, we’ve all learned that monetary policy is not a panacea.

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.

Tuesday, May 06, 2014 - Quickly Aging Here

Quickly Aging Here
by Sinclair Noe

DOW – 129 = 16,401
SPX – 16 = 1867
NAS – 57 = 4080
10 YR YLD  - .02 = 2.59%
OIL + .38 = 99.86
GOLD – 1.80 = 1308.90
SILV - .04 = 19.65

There was a pretty broad selloff on Wall Street today. AIG posted lousy earnings late yesterday, and today they dragged down most of the financials. Twitter proved a drag on the tech stocks. Twitter reached the 6 month expiration of a lock-up period that had restricted sale of about 82% of its outstanding stock. Share prices dropped about 18% today, but home prices in Silicon Valley are likely to move a bit higher in the next month. After the close, Disney posted better than expected earnings.

Let’s start with economic data; the trade deficit narrowed in March, down 3.6% to $40.4 billion. March exports came in at about $193 billion and imports were around $234 billion, resulting in a $40 billion shortfall. Exports are 17% above the pre-recession peak, while imports are about 1% above the pre-recession peak. Exports of capital goods, industrial supplies and materials, and automobiles increased in March. Exports of services hit a record high, while those of non-petroleum goods were also the highest on record. Exports to Canada, South Korea and Germany all touched all-time highs in March. Imports of food and non-petroleum products hit record highs in March.

Last week we saw the estimate for first quarter gross domestic product showing 0.1% growth; that estimate worked with an assumption that the trade deficit for March would come in at $38.9 billion, not the $40.4 billion reported today. So, this implies that the GDP number could be re-estimated by two-tenths, which would mean a negative -0.1% GDP for the first quarter, or maybe just a bit worse. There will be other data considered in the final GDP number, but it now looks like a negative number. And most economists are calling for a bounce back in the second quarter.

Corelogic reports home prices nationwide, including distressed sales, increased 11.1% in March 2014 compared to March 2013. This change represents 25 months of consecutive year-over-year increases in home prices nationally. On a month-over-month basis, home prices nationwide, including distressed sales, increased 1.4% in March 2014 compared to February 2014.

Excluding distressed sales, home prices nationally increased 9.5% in March 2014 compared to March 2013 and 0.9% month over month compared to February 2014. So, home price increases are slowing, and this might also prove a drag on GDP, but it doesn’t necessarily mean the housing market is in the dumps. One of the bright points in the report is that there are fewer distressed sales, that means there is also less inventory, and there is less negative equity.

A separate report from Black Knight Financial, a mortgage research firm finds the number of mortgages on which lenders initiated foreclosure in March fell to the lowest level in more than 7 years. Banks initiated foreclosure on 88,000 properties in March, down more than 27% from a year ago, and well below the high of more than 316,000 in March 2009.

Foreclosures should continue to trend down because the share of mortgages that are behind on their payments is also declining. Around 2.1% of all loans were in some stage of foreclosure in March, the lowest level since late 2008, and another 5.5% of all borrowers were 30 days or more past due on their loans but not yet in foreclosure, the lowest since late 2007. Both of those are still well above pre-crisis levels but they are down sharply from a few years ago.

Growth in the services sector accelerated in April, rising at the fastest pace in eight months as new orders jumped and overall activity quickened by the most since early 2008. The ISM said its services sector index rose to 55.2 in April from 53.1 in March, topping expectations for a read of 54.1. The data provides further evidence that economic activity is regaining momentum after lagging through much of the winter.

Today is the anniversary of one of the scariest days in market history. On May 6, 2010, the Dow plunged nearly 1,000 points in a matter of minutes in what became known as the flash crash. The crash wiped out $1 trillion in wealth in the blink of an eye, only to recover, kinda, sorta. High-frequency computerized trading was believed to at least be part of the cause of the technical breakdown. And the regulators have not figured it out to this day, and yes it could happen again.  

Last week, SEC Chair Mary Jo White testified before Congress that the markets were not rigged. Today, the SEC announced they have sent out subpoenas demanding records from brokerage companies to try and figure out how customers’ orders are routed, and how firms are being paid for order flow. The good news is the SEC is investigating; the bad news is that dark pool and high frequency trading has been going on for years and the SEC appears totally clueless.

Institutional Investor released its Rich List, a list of the 25 top income generating hedge fund managers. David Tepper of Appaloosa Management topped the list with $3.5 billion in earnings. Second on the list was Steven Cohen of SAC Capital, who might have fared better if his firm hadn’t been guilty of insider trading. Just for reference, $3.5 billion works out to $400,000 an hour.

I also ran across an article that puts the Fed’s QE into perspective. The Federal Reserve has spent approximately $3.2 trillion in the post-Crisis era, with most of the money being dropped from helicopters hovering over Wall Street banks. The Fed mainly bought Treasuries and mortgage backed securities, but they could have mailed a check for $10,223 to every person in the US; they could have bought back all the US debt owned by China, Japan, and Belgium; they could have created 12.8 million jobs in 2009, each paying $50k a year, and still be making payroll for them today – which actually would have met their mandate. And that’s just based upon large scale asset purchases under QE; by some estimates the Fed has dished out my than $17 trillion to prop up the financial order. A trillion here, a trillion there, pretty soon it adds up to real money.

The Census Bureau released a report on the demographic makeup of the US; the population is aging rapidly; about 1 in 5 Americans (21%) will be 65 years old and up by 2050, compared with just 13% in 2010 and less than 10% in 1970. It sounds like a lot of old people, but it seems less so when compared with other countries. In 2050, around 40% of Japan’s population will be 65-plus, up from 24% in 2012. In Germany, Italy, Spain, and Poland over 30% will be 65 plus. China will have about 26% of its population over the age of 65, which amounts to more old people in China than the entire population of the US.

The concern with an aging population is that there will be a much slower economy: less spending, less saving, lower economic output, and slower growth; fewer working age people paying taxes, less money going into social programs like Social  Security and Medicare, and more money coming out of those programs. But the Census report also finds that the working age population will increase, mainly due to immigration.

The White House today released the 2014 National Climate Assessment, written by 300 climate experts and reviewed by the National Academy of Sciences. The full report, at more than 800 pages, is the most comprehensive look at the effects of climate change in the US to date. Don’t worry, they also provided a Cliff Notes version that weighs in at a mere 137 pages, thereby killing fewer trees. The short and sweet is that we’re all going to fry; it’s too late, climate change is here and now, and it will just get worse and worse.

Average temperatures in the US have increased 1.3 degrees to 1.9 degrees Fahrenheit (depending on the part of the country) since people began keeping records in 1895, and about 80% of that warming has come in the past 20 years. The period from 2001 to 2012 was warmer than any previous decade on record, across all regions of the country. And it will keep getting hotter. If we really get very serious about cutting emissions, temperatures will rise by 3 to 5 degrees, depending on location, over the next 80 years; if we keep going the way we’re going, temperatures will rise 5 to 10 degrees, and maybe by 15 degrees in some places. That means 115 degree days in the desert southwest could be 125 to 130 degrees.

In addition to extreme heat, you can add wildfires, and drought, and hurricanes, and extreme downpours – real gulley washers, plus rising sea levels. The report says that in much of the US, especially the Midwest and Northeast, more rain is falling in short-duration, heavy bursts, leading to more flooding. The Northeast and Midwest may continue to get wetter, while the Southwest becomes even more parched, raising water supply and energy concerns there.

The report warns the Southwest to prepare for major disruptions ahead due to climate change: "Increased heat and changes to rain and snowpack will send ripple effects throughout the region’s critical agriculture sector, affecting the lives and economies of 56 million people –- a population that is expected to increase 68% by 2050, to 94 million. Severe and sustained drought will stress water sources, already over-utilized in many areas, forcing increasing competition among farmers, energy producers, urban dwellers, and plant and animal life for the region’s most precious resource."

The report says the Southwest will be plagued by drought, which is not really uncommon, but the droughts will be hotter and drier and longer and will lead to a big increase in wildfire activity, which has already started to take place.

The report notes that American society and its infrastructure were built for the past climate, not the future. It highlights examples of the kinds of changes that state and local governments can make to become more resilient. One of the main takeaways is that you don't want to look at the weather records of yesteryear to determine how to set up your infrastructure.

Monday, May 05, 2014 - Riggers’ Propaganda

Riggers’ Propaganda

by Sinclair Noe

DOW + 17 = 16,530
SPX + 3 = 1884
NAS + 14 = 4138
10 YR YLD + .02 = 2.61%
OIL - .38 = 99.38
GOLD + 9.10 = 1310.70
SILV + .13 = 19.69

Last week we told you about prosecutors and regulators preparing to criminally prosecute Credit Suisse and maybe BNP Paribas, and the slap on the wrist enforcement efforts of the past decade, and especially under the mis-guidance of Attorney General Eric Holder’s “Too Big to Jail” policy. The Swiss finance minister met Holder on Friday to discuss a US probe into Swiss banks that allegedly helped Americans evade US taxes, which includes Credit Suisse. Today, Holder posted a video on the Justice Department website saying that the DOJ is pursuing criminal investigations of financial institutions that could result in action in the coming weeks and months, and adding that no company was “too big to jail.”

A criminal conviction of an entity regulated in the United States could lead authorities to potentially revoke a charter, essentially a death sentence for a bank. In his video, Holder said prosecutors are working closely with regulators to address the issues before taking action, "Rather than wall off banks from prosecution, the potential for such severe consequences simply means that federal prosecutors conducting these investigations must go the extra mile to coordinate closely with the regulators that oversee these institutions' day-to-day operations."

It’s starting to sound like Holder is going after criminal charges without the consequences of criminal charges; maybe he can collect a slightly bigger fine, but still leave the bank charter in place. Otherwise, this is a big pile of baloney. And the proof will be in the putting. Until we see a banker jailed and a charter revoked, AG Holder is just spouting propaganda.

The propaganda mill is spinning fast in Washington DC these days. Securities and Exchange Commission Chair Mary Jo White flatly rejected claims that retail investors are being fleeced by high-frequency traders who can use their speed to jump ahead with buy and sell orders that fetch better prices.

White told a US House of Representatives panel last week, "The markets are not rigged." White reiterated that her agency's investigators are actively pursuing probes into high-speed traders and dark pools, or anonymous trading venues, but she also sought to dispel the notion that using high-speed technologies to trade ahead of others using stock quotes disseminated on public data feeds could meet the legal definition of "unlawful insider trading." She acknowledged at one point that the market is not "perfect" and told lawmakers that the agency's "data-driven" review of market structure issues surrounding areas such as order types, dark pool trading and data feeds was still ongoing. Even though the SEC has not concluded or barely even launched the investigation, White already knows the facts, saying: "I want to be very clear that the market metrics suggest that the retail investor is very well-served by the current market structure."

The rather unusual reason why SEC Chair White and Congress are suddenly concerned about rigged markets is because of Michael Lewis' latest book Flash Boys and HFT (high-frequency trading) and whether the markets are manipulated. What they're not talking about is how the markets have been set up for institutionalized rigging. And they are rigged; have been for a long time.

It goes back to the time when the NYSE was the only game in town, and prices were quoted in fractions: a half, a quarter, an eighth. Buyers and sellers of listed shares used brokers to send orders to the NYSE Floor for execution. On the Floor, "specialists" are in charge of every stock. Their job was, and still is, to match up buyers and sellers and "keep a fair and orderly market" as they facilitate "price discovery."

The specialist used to see all orders for the stocks they were in charge of because all orders had to come to them. Besides matching up buyers and sellers, specialists can also trade for their own account. That means they can try and make money trading the stocks where they are specialists. Here's how the specialist makes real money, besides getting paid a small fee for matching up orders.

The key to being the specialist is seeing all the order flow. Because specialists have knowledge of who is buying, who wants to buy and how much and at what prices, and the same is true for knowing the sell side, the specialist essentially gets to trade on inside information. The specialist could raise the bid if he wanted to buy stock because he knew there were more buy orders coming into his book, and if he was right and the stock moved higher, he could sell his position for a nice profit.

And that is pretty much how the system works today. Eventually, investors grew weary of having the specialists slice off profits on insider information. Even though we got rid of the fractional system, we still have the insiders slicing off small profits on each trade. Now the Nasdaq doesn’t have a specialist system because there is no central trading floor where dealers meet and call out prices, but in the automated, cyberspace world, each dealer is his own specialist.

Eventually, electronic communications networks (ECNs) sprang up. ECNs were and still are networks where dealers who weren't part of Nasdaq could place their quotes and buy and sell with each other. From there it wasn't long before Nasdaq dealers wanted to get onto all the ECNs and demands were made to trade NYSE and AMEX stocks on the computer networks. That's how technology changed the old specialist system into a mass of different trading venues that now includes entirely new exchanges like BATS, and dark pools where banks and crossing services trade for clients demanding anonymity.

The problem now is that there is no longer any one central place where all orders go to be executed. Orders are spread around based on cost, and services, and, most importantly, "payment for order flow." So, now the online brokerage firms like Schwabb, and Etrade, and whoever, don’t have their own traders to execute trades and they don’t have their own trading desks, so they have to route those orders to an exchange or a couple of exchanges to match up buyers and sellers. In order for exchanges and networks that offer execution of orders to be successful, they have to have orders coming in so they can match up buyers and sellers. Otherwise, if there aren't enough orders to allow matching of buyers and sellers at prices where customers want to transact, that exchange would have no "liquidity" and it would lose business.

So how do all these competing exchanges get orders? They pay for them. They pay Schwab, and Ameritrade and Scottrade for their "order flow." That's right; your order at your discount brokerage is sold to someone so it can be traded on their exchange. Who gets paid for your order? Not you. Your brokerage gets paid.

So, after the switch to decimalization in 2001, we had the rise of the market makers. Market makers are the same as specialists, except they are mini-specialists in the stocks they trade electronically for their broker-dealer or bank trading desk who trade on Nasdaq or on the ECNs or anywhere where an intermediary can interpose himself into a trade, and they will impose their trade ahead of your trade. That’s why they buy order flow, so they can create an internal “book” so they can have their own inside information on the order flow, so they can trade against it, or sell it to other traders.

HFT operators are looking at all the order flow going into all the different exchanges and trading venues they can peer into. They look into the total flow of orders, which no single exchange can see, and with their empirically modeled time sequencing of orders, spreads, and depth that they run through reinforcement learning algorithms, they come up with a trade that steps in to buy or sell shares before someone who intended to transact there gets a chance to.

Speed is critical to high-frequency trading. Exchanges rent HFT shops space next to their servers (co-location) so they get their data faster than everyone else. That's legal. They couldn't do it if there weren't so many exchanges and trading venues competing for orders. You can thank the SEC for making that a reality without sensible limits. They couldn't do it if there was no such thing as payment for order flow; yes, they get paid for their order flow too. You can thank the SEC for allowing that neat little scheme.  HFT shops can buy and sell at the same price (that's a zero profit or loss), but because they provided some venue "liquidity" by sending their super-fast order there to be executed, they get paid. That's not arbitrage in the traditional sense; that's just playing the game. They couldn't do it if they didn't have all the information at the speed they get it at from the exchanges the SEC regulates.

And so you pay whenever you make a trade; you lose about a penny per share, sometimes more, and you’re expected to accept this little slice in the name of liquidity, but it isn’t really liquidity, it’s really just volume. High-frequency trading has nothing to do with what liquidity is, what liquidity means to the market. Volume is not liquidity.

Everything is usually fine when markets are moving up or are relatively stable. We won't really notice HFT. But, in a wicked downdraft, when HFT players turn off their computers, we will see that there are no bids on any specialists' books or parked with market makers. There will be no stopping stocks from falling for that reason. We saw it in the May 2010 flash crash. That's what HFT has done to the market. It has made it a dark pool, and a dark pool is not required to yell out a price like the old-school specialists; instead prices come in at a more leisurely pace, when it suits the ECNs, after they scalped their share. What this means is that we don’t really know what the price is, and you can’t have a market without prices, which means one day we could have a catastrophic market failure; despite the propaganda otherwise. 

Friday, May 02, 2015 - April Jobs Report

April Jobs Report

by Sinclair Noe

DOW – 45 = 16,512
SPX – 2 = 1881
NAS – 3 = 4123
10 YR YLD - .01 = 2.59%
OIL + .57 = 99.99
GOLD + 15.70 = 1301.60
SILV + .44 = 19.56

Today is another Jobs Report Friday. We will go into quite a bit of detail here because really, most everything we talk about in regard to economics begins with work and jobs. It is my hope that you will join us here on the first Friday of each month to get your comprehensive, fact based coverage of the jobs report.

Last month the economy added 288,000 net new jobs, and the unemployment rate dropped to 6.3%. April marked the biggest monthly gain in jobs since January 2012, when the economy added 360,000 jobs. Employment gains for February and March were revised higher by a combined 36,000; that raised the monthly average to 214,000 jobs a month since the start of the year. Through the first 4 months of 2014, the economy has added 857,000 payroll jobs, slightly better than the first 4 months of 2013, despite the harsh winter this year.

In the current 58 month expansion, employers have added more than 200,000 jobs per month in 38% of the months. Current job creation performance is stronger than it was in the business-cycle expansion that occurred during the recovery in the early 2000s, even when a real estate construction bubble fueled growth.  Today’s job creation pace lags well behind previous recent economic recoveries, such as 1970, or 1975 that saw job creation above 200,000 in about 60% of months. Needless to say, 200,000 jobs a month means a lot less today with a population that is more than 100 million people larger than it was in 1970. Total employment is now only 113,000 below the previous peak, so we should top that next month; however, the overall population has increased in the past 6 years, so there are still millions of people without jobs.

The report came in far above expectations. The consensus estimates called for 210,000 new jobs and the unemployment rate inching down to 6.6%, however there was a wide range of estimates.

The drop in the unemployment rate to 6.3% was the biggest monthly drop in 31 years and the unemployment rate is at the lowest level since 2008, but the drop in the headline rate was for the wrong reasons; the participation rate declined to 62.8% from 63.2%, meaning the labor pool fell by 806,000 workers. The unemployment rate is measured against a labor pool of people who are considered actively looking for work or working. When someone stops looking for work, they stop being counted, although it doesn’t necessarily mean they wouldn’t like work.

There are 2 major reasons why the participation rate has dropped: the first reason is demographics, and the second is the economic downturn.

Looking at demographics, the baby boomers are retiring in massive numbers, and not always voluntarily. However, many boomers are re-entering the workforce in a stealthy manner; the highest rate of entrepreneurship activity belongs to the 55-64 age group. It turns out the recession spurred new-business formation. In a "necessity is the mother of invention" scenario, it appears that many people who lost jobs started their own businesses. Of course, it might take some time for a new venture to be profitable and in the meantime, those people might not be counted as actively seeking jobs.

Meanwhile, younger people are staying in school, either going back to school for training or re-training, or dragging out school because of the high cost of education. An interesting point here is that unemployment for young adults age 20-24 dropped from 12.2% to 10.6% in April. Millennials getting jobs; or dropping out of workforce. We don’t know for certain, but one possible explanation is that graduates from the Class of 2013, that have been biding their time looking for a job or just unable to find a job, suddenly got very serious about taking any kind of job as the Class of 2014 prepares to enter the workforce.

Another age group we watch is the 25 to 54 year olds; they’re in their prime working years, too young to retire and unlikely to be in school. The 25 to 54 participation rate declined in April to 80.8% from 81.2% in March, and the 25 to 54 employment population ratio decreased to 76.5% from 76.7%. The participation rate for this age group should increase as the economy improves.

The other reason is the economic downturn, many people lost jobs and have had a very difficult time finding work, driving long term unemployment to unacceptable levels. The recent loss of unemployment benefits for the long-term unemployed is another way in which people fell from the ranks; in order to receive unemployment benefits, one has to actively look for work. As the benefits were cut, people still unemployed were cut from the ranks. Extended benefits were cut off beginning in late December. If the expiration of benefits was causing hundreds of thousands of people to drop out of the labor force, it should have showed up in the data in January, or February. It didn’t. Maybe the unemployment rate fell because of 806k drop in labor force, a lagged effect from expiration of unemployment insurance, or maybe there is just some statistical noise. We won’t know for sure until we see a few more months data.

What’s also odd about the decline in the labor force is how it happened. The number of so-called re-entrants, unemployed workers who have started looking for jobs again, fell by 417,000. That’s the biggest drop since the government began keeping records in 1967.  And new entrants into the labor force, such as graduates or immigrants, fell by 126,000. That’s the biggest decline in more than five years. Put another way, two-thirds of the drop in the labor force stemmed from people choosing not to enter in the first place. Normally a decline takes place when workers exit the labor force.

According to the BLS, there are 3.452 million workers who have been unemployed for more than 26 weeks and still want a job. This was down from 3.739 in March. This is trending down, but is still very high. And it does not mean that 300,000 long term unemployed workers found jobs; they just stopped being counted.

And there is still quite a bit of slack in the labor market, with approximately 7.5 million workers employed part-time for economic reasons; people who have had their hours cut back or people working part-time because they can’t find full-time work. When you add in those under-utilized workers, you get a different measurement known as U-6, which dropped to 12.3% from 12.7% in March. The number of people holding multiple jobs jumped by 133,000 from April 2013 to April 2014. Women almost entirely led this statistic, with the number of employed single mothers increased 1.4% over the past year.

Hiring was widespread and it doesn’t look like there was any one industry or sector that had an unusual jump. Professional services added 75,000 jobs, but about one-third were temporary positions. Employment and temporary help services added 28,000 jobs. Retailers added 35,000 jobs, bars and restaurants added 33,000 and the construction industry hired 32,000 workers. Industries where minimum-wage employment is most prevalent in the economy, accounted for 40% of total new private-sector job creation in April, excluding health care. Manufacturers generated 12,000 jobs, but this was disappointing in light of recent economic data pointing to increased manufacturing activity; yesterday, the ISM reported it manufacturing index had increased to 54.9 last month, up from 53.7 in March. Government also added 15,000 jobs, with state and local governments adding 18,000 jobs and federal cutting 3,000 positions.

Average hourly wages were unchanged at $24.31, reducing the year-over-year gain to just 1.9%. Consumer spending has been outpacing income growth, resulting in low saving rates, meaning workers have less discretionary funds, meaning a dwindling likelihood they will go out and spend at an increasing rate. Paychecks have actually become leaner since the recession officially ended. Real median weekly earnings for full-time wage and salary workers during the first three months of this year were down 3% from the end of the recession.

Looking at the types of jobs making up employment also provides a cause for concern. Among 13 industries that make up total US private-sector employment, the 5 with the lowest nominal average weekly earnings represented about 52% of private-sector employment gains over the past year. Leisure and hospitality employment showed the strongest growth among low-earning industries, added 412,000 jobs over the year through April, representing about 17% of total private-sector job gains.

Middle-earning industries, professional and business services, construction and manufacturing, represented about 40% of annual job gains. While higher-earning industries made up about 8% of added employment. Among the five industries with the highest weekly earnings, private-sector employers added about 194,000 of these jobs over the past year. Longer-term trends show lopsided jobs growth, with lower-wage employment ramping up in recent years. During the recession, lower-wage industries made up 22% of job losses. But over the past four years, these jobs made up 44% of employment growth, according to a recently released report from the National Employment Law Project. One indication that workers aren’t particularly confident is that quitting is below pre-recession levels, signaling that many workers are unwilling to trade some job stability and security to advance their careers.

Today’s jobs report was good, one of the best months we’ve seen in a long time, and we have a 58 month trend of job gains, which is a heck of a lot better than bleeding jobs, but the trend is still not strong enough. Nearly five years since the economy began expanding, the labor market continues improving, but at a frustrating pace for the 10 million unemployed workers and 3 million people not counted as unemployed who still currently want a job. Ongoing elevated unemployment is not only a serious drag for those families enduring it, but it will continue to drag on the overall economy until lawmakers get serious about full employment and creating quality jobs that deepen and secure the middle class. 

Thursday, May 01, 2014 - If the Cops Never Arrest the Killer, Nobody Really Died

If the Cops Never Arrest the Killer, Nobody Really Died

by Sinclair Noe

DOW – 21 = 16,558
SPX – 0.27 = 1883
NAS + 12 = 4127
10 YR YLD - .04 = 2.60%
OIL - .39 = 99.35
GOLD – 6.40 = 1285.90
SILV - .13 = 19.12

No record high for the Dow today. The Industrial Average was up and down, up and down throughout the day, but couldn’t hold positive territory. Today’s economic reports showed consumer spending increased, as did manufacturing activity, and unemployment claims.

Consumer spending increased 0.9 percent in March after rising by 0.5 percent in February, the largest gain in more than 4-1/2 years. The top 6 automakers backed up the spending report by reporting year over year gains in sales. The spending report supports the notion that cold weather just paused consumer activity and there is pent up demand that will lead to more economic activity in the second quarter. Income increased 0.5 percent in March, the biggest gain since last summer, but with spending outpacing income growth, the saving rate, which is the percentage of disposable income households are socking away, hit a 14-month low.

The Institute for Supply Management said its manufacturing index of national factory activity rose to 54.9 last month, up from 53.7 in March. A reading above 50 indicates expansion in the nation's factories. Manufacturing activity has now accelerated for 3 consecutive months and last month's gains were driven by a pickup in employment, export orders and inventories; although new orders were unchanged.

The Labor Department reports initial claims for state unemployment benefits increased 14,000 to a seasonally adjusted 344,000. Tomorrow morning we’ll get the monthly nonfarm payrolls report; look for 210,000 net new jobs in April and the unemployment rate to dip to 6.6%. That wouldn’t be enough to lift the labor market out of the doldrums but it would be another small step in the right direction.

A couple of news articles caught my attention, one from the Murdoch Street Journal and the other from the NY Times. You are forgiven if you missed them; they deal with banksters, and fraud, and regulators who look the other way, hoping for a post-government job with a golden parachute, and prosecutors without spines.

The Journal story deals with the Swiss units of Goldman Sachs and Morgan Stanley, and how they’ve agreed to hand over potentially incriminating details about how they helped Americans evade taxes; in return the banks won’t face prosecution.  Goldman's Swiss private bank had about $12 billion in assets under supervision as of the end of last year. Morgan Stanley's Swiss private bank had $50.7 billion in assets under management as of last year. The other big US banks likely did the same things, but they haven’t worked out a deal just yet.

Goldman and Morgan Stanley figured out the playbook, and it appears to go something like this: Senior officers of the banks aid and abet tax fraud by wealthy American clients, fail to make legally required criminal referrals, fail to comply with subpoenas, and then demand immunity from prosecution. Department of Justice prosecutors pee their pants and cave in to a slap on the wrist deal. No senior banker or bank was prosecuted. No banker was sued civilly by the government. No banker had to pay back his bonus that he “earned” through fraud. And the tax cheats that they aided and abetted have plenty of time to cover their tracks and might get away scot free, because the banksters aren’t required to turn over the client lists.

Then I read a New York Times story that claims federal prosecutors are getting close to criminal charges against at least a couple of major banks: Credit Suisse, for offering tax shelters to Americans, and BNP Paribas for doing business with countries like Sudan and Iran that the US has placed under sanctions. Prosecutors in New York and Washington have apparently held talks with BNP about a guilty plea from the bank’s parent company. Ben Lawsky, New York’s top regulator reportedly plans to impose steep penalties against BNP and its employees but would not revoke the bank’s license. Prosecutors have secured similar assurances from the New York Fed.

The discussions between regulators and prosecutors and lawyers was obtained under the Freedom of Information Act, and they demonstrate that defense lawyers were pushing prosecutors not to act without assurances that regulators will keep a bank in business. The question of culpability seems fairly straightforward; BNP conducted its own internal investigation that identified significant volume of transactions that could be considered impermissible under sanctions in place between 2002 and 2009, including improperly routing money through its New York branches.

There doesn’t seem to be a big concern at BNP about the possibility of criminal convictions that might result in loss of the bank’s charter, much less worry over executives facing jail time. It’s as if the criminal acts were performed by ghosts or phantasms.  BNP has set aside $1.1 billion in legal reserves; they expect a fine; it’s the cost of doing business.

Of course this is nothing new; two years ago, HSBC escaped criminal charges for violating economic sanctions and what appeared to be clear cut money laundering. JPMorgan recently paid a $2 billion dollar fine for its role in assisting Bernie Madoff’s Ponzi scheme, without having to admit guilt. Of course no one goes to jail. Almost no one. In January, Kareem Serageldin, a mid-to-upper level executive for Credit Suisse (not a CEO or CFO) was sentenced to 30 months in prison for concealing hundreds of millions in losses in the bank’s mortgage backed securities portfolio. Why this guy ended up going to prison and not somebody from Lehman, Bear Stearns, AIG, Countrywide, Bank of America, Merrill Lynch, Citigroup, HSBC – go figure; there is no rhyme or reason beyond the notion that regulators and prosecutors are simpering little cowards.

It didn’t used to be this way. After the crash of 1929, the Pecora Hearings seized upon public outrage, and the head of the New York Stock Exchange landed in prison. When FDR took office he immediately announced a banking holiday and the bankers snapped to attention. After the savings-and-loan scandals of the 1980s, 1,100 people were prosecuted, including top executives at many of the largest failed banks and S&Ls. In the late 90s and the turn of the century, when the tech bubble burst and revealed widespread corporate accounting scandals, top executives from WorldCom, Enron, Qwest and Tyco, among others, went to prison. And the accounting firm of Arthur Andersen was criminally convicted for its complicity in the fraudulent steaming scam that was Enron; Andersen went out of business in 2002; delivering pink slips to many good and decent accountants along with the pond scum. Since then prosecutors have walked lightly for fear of collateral damage.

Since then, the bankers realized they could act with impunity, and they have. There has been no crackdown following the meltdown of 2008. From 2004 to 2012, the Justice Department reached 242 deferred and nonprosecution agreements with corporations, compared with 26 in the previous 12 years. The idea behind a deferred prosecution agreement, or DPA, is that the banksters stop doing the illegal stuff and if they do any other illegal stuff, the deal is off the table, and prosecutors can come down with full weight for past and current wrongdoing. Instead, there is no follow-up. It’s like a criminal is released on parole, violates parole, violates parole again, and again, and again; and the courts turn a blind eye.

So, now, with the BNP and Credit Suisse cases, the prosecutors goal seems to be criminal prosecution without making the banks actually suffer the consequences of criminal charges. Prosecutors consider them test cases; BNP and Credit Suisse aren’t the biggest banks; prosecutors aren’t sure what would happen with criminal charges; they don’t really know what to expect if they actually get a criminal guilty plea. If they start small, it might mean the end of the BNP tennis tournament or it might mean 200-thousand pink slips for bank employees, or it might be the spark that ignites a financial panic. They overlook the slow, insidious, systemic rot of the foundations of all global financial transactions – trust. In the long run, that seems far more dangerous.

Attorney General Eric Holder has testified before the Senate “that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if we do prosecute, if we do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy.”

The bank lawyers play on this fear; they claim bank clients -- including trustees, fiduciaries and pension funds -- could be forced to cut ties with a financial institution labeled a criminal enterprise.  Counterparties also might think twice before entering into billion-dollar transactions with such firms. Damaging a bank’s business could lead to broader fallout across the financial industry, just as Lehman’s collapse in 2008 prompted investors to withdraw from other firms on concern its exit would set off a wave of losses. Even the threat of criminal action must be handled in such a way as to not spook customers.  

It seems to be a spurious argument; akin to a doctor telling you that surgery to remove a cancerous tumor is dangerous and painful, so there is nothing to do but let the cancer overwhelm the host, curl up and wait to die. And then there is the more absurd part of the defense; the idea that pension funds would be forced to cut ties with criminal banksters; as if it is perfectly fine to have pension funds and trustees doing business with bankers involved in criminal activity, just so long as there are no official criminal charges. A complete denial of wrongdoing based upon a lack of enforcement. If the cops never arrest the killer, nobody really died. Yea, that’s it, pay no attention to the bloody corpse, pay no attention to the wreckage and devastation of the global financial meltdown; whistle past the graveyard.

You know the meltdown involved criminal wrongdoing; the regulators know it; the prosecutors know it. What they don’t seem to know is the collateral damage from non-enforcement and non-prosecution. Every action has a consequence, and non-action is a form of action.