Monday, February 04, 2013 - Brouhaha As Excuse

Brouhaha As Excuse

by Sinclair Noe

DOW – 129 = 13,880
SPX – 17 = 1495
NAS – 47 = 3131
10 YR YLD - .04 = 1.97%
OIL – 1.61 = 96.16
GOLD + 6.80 = 1675.40
SILV - .08 = 31.86

With all the brouhaha over the fiscal cliff and the debt ceiling and the inauguration and the Super Blackout, it would be easy to forget the problems in Euro-land, but today, those problems have jumped back onto center stage, again. In Italy and Spain the prospects of stable government are slipping.

First in Italy, an election is scheduled for later in the month. The technocrat-slash-PM Mario Monti will exit, stage right, and the race is on. The second and third place contenders are a comedian named Beppe Grillo and another comedian, Silvio “Bunga-Bunga” Berlusconi; it appears unlikely either will win, but they are looking like they can splinter the vote for front-runner Pier Luigi Bersani. The running theme of the campaigns is anti-austerity and anti-German authoritarianism.

In Spain, the economy is contracting, again. Fourth quarter GDP shrank by 0.7%; the steepest decline in more than 3 years. Also, last week a new report showed unemployment at more than 26% in the fourth quarter. They are still calling it a recession but it is clearly a depression, and it is exacerbated by spending cuts and tax increases. Toss in a slush fund scandal involving the Prime Minister Rajoy, alleging kickbacks from construction firms; add in the Catalonian secessionist movement, and massive street protests.

Italian and Spanish bond yields jumped higher today. Implied default probabilities in Italy and Spain that were at 50 percent last July are still as high as 20 percent.

Toss in a $3 billion dollar fourth quarter loss for Deutsche Bank, and similar writedowns for Credit Agricole, the number 3 French bank; and last week the Dutch government nationalized the fourth largest bank in the Netherlands. The banks are still a weak link in any Euro-recovery. They haven't written off enough of their losses; they continue to hold toxic assets; they have tightened lending as capital gets swallowed up in the black hole of their impaired balance sheets.

Meanwhile, Royal Bank of Scottland is expected to announce tomorrow that has a settlement agreement with US and British authorities to pay $780 million in fines for manipulating Libor, the London Interbank Offered Rate, which is the key benchmark for interest rates.

Today, the British finance minister announced plans for what they are calling an electric ring fence around retail banks. The idea is to break up British banks that fail to guard their day-to-day banking from risky investment activity. The idea is that there would be repercussions to mixing deposits with the gambling money. We used to have a law that prevented those problems. It was called Glass-Steagall, and the Brits are slowly returning to the wisdom of that separation. And in announcing the new regulations, the British head of the Exchequer, George Osborne, (no relation to Ozzy), said: “America and elsewhere, banks found ways to undermine and get around the rules.” In the U.S., three out of the four biggest banks are bigger than they were before the financial crisis. Which is true, but he failed to mention that in the US and Europe, the big banks get bigger and bigger and operate with impunity from prosecution for things like Libor rate rigging or money laundering.

This is not to say that US banks have it easy. According to Brian Moynihan, the CEO of Bank of America, the acquisition of Countrywide was like climbing a mountain with a “250-pound backpack.” An article in the NY Times over the weekend says that so far, BofA has set aside some $40 billion to settle claims of mortgage misconduct that occurred before it acquired the fast and loose Countrywide. And to hear BofA tell it, all those bad mortgages sprang from the muddy waters of Countrywide. But according to documents from three Federal Home Loan Banks and a state Supreme Court in Manhattan, BofA continued shoddy mortgage practices well after the Countrywide acquisition.

Among the new details in the filing are those showing that Bank of America failed to buy back troubled mortgages in full once it had lowered the payments and principal on the loans — an apparent violation of its agreements with investors who bought the securities that held the mortgages.

The filings show that Bank of America had modified more than 134,000 loans in such securities with a total principal balance of $32 billion. Even as the bank’s loan modifications imposed heavy losses on investors in these securities, Bank of America did not reduce the principal on second mortgages it owned on the same properties. The owner of a home equity line of credit is typically required to take a loss before the holder of a first mortgage. By slashing the amount the borrower owes on the first mortgage, Bank of America increases the potential for full repayment of its home equity line. Bank of America carried $116 billion in its home equity loans on its books at the end of the third quarter of 2012.

This new information is part of a suit that alleges BofA's $8.5 billion dollar settlement of shady mortgage practices back in the summer of 2011, that settlement was letting BofA off far too easy (about 2 cents on the dollar), and it was made without proper analysis of all the wrongdoing by BofA. So, the acquisition of Countrywide offered BofA a scape goat, an excuse for nasty behavior. The only problem is that they kept running things the same way as Countrywide.

Meanwhile, the Justice Department, along with state prosecutors, plans to file civil charges against Standard & Poor's Ratings Service, accusing the firm of fraudulently rating mortgage bonds that led to the financial crisis. A suit against S&P would be the first the government has brought against the credit ratings agencies related to the financial crisis. Up until last last week, the Justice Department had been in settlement talks with S&P, but negotiations broke down after the Justice Department said it would seek a settlement in excess of “10 figures,” or at least $1 billion, essentially wiping out a full year of profits for the S&P parent company, McGraw Hill.

During settlement negotiations, the Justice Department held out the threat of a criminal case against S&P. Ultimately, the government plans to bring a civil suit, which has a lower burden of proof than a criminal case. And we all know the Justice Department hates to work hard to insure fair and equal justice under the law.

So you're probably saying: “Hey, this whole Euro-zone dysfunction is nothing new. So what if another Euro-bank gets fined for being sleazy scum bags? So what if there's a corruption scandal in Spain? So what if I haven't even mentioned Greece or Cyprus? So what if the austerity measures are grinding the life out of the Euro-economy like a jack-boot on the throat? What does all that have to do with a downturn in the US stock market?

And the answer is – it's a good excuse.

We have a couple of big, juicy round numbers serving as resistance; the Dow is staring down 14,000 and the S&P is pushing 1500. And then we have record highs to consider. And then we have to pause and consider that the move in January looked nearly parabolic. And that forces us to ask some questions. Has the economy actually improved? Can the average investor continue to ignore stocks or can the markets find greater fools to step up to the plate and donate their money?

Why worry; the markets always go up; except when they don't.

With the stock market up more than 100 percent from those scary days in early 2009, it seems we’re in danger of repeating the same old cycle of swearing off stocks forever during scary markets, missing a huge rally and then deciding it’s time to buy when stocks are high again. Or maybe it's time to sell. Actually, the thing to do right now is to make sure you have a plan in place which covers scenarios such as February 2013, and probably the first question to be answered when creating a plan is: Why are you investing this money in the first place?

And what this really tells us is that the US and Euro-zone economies are a bit stronger and more resilient than than we imagine. And when black swan events are predicted and discussed, they rarely happen; they are instead avoided.

The Energy Information Administration says Americans spent a record amount on gasoline last year, with more of their income going toward motor fuel costs than at any time since the 1980s. The average household expenditure on gasoline hit $2,912 in 2012, or just under 4 percent of pre-tax income, as higher prices at the pump canceled out the effect of more efficient vehicles.

This was the highest estimated percentage of household income spent on gasoline in nearly three decades, with the exception of 2008. The previous record amount was just below $2,750 in 2008, as crude oil prices spiked toward $150 a barrel in the first half of 2012. Global crude oil prices averaged around $111 in 2011 and 2012. The average cost of a gallon of gasoline in U.S. cities was $3.70 last year, up more than 30 percent since 2010. And although prices are down from 12 months ago, prices are moving higher; up 4 cents last Friday alone.

On February 3, 1913, the 16th Amendment to the Constitution was ratified; the reason that's important is because it marks 100 years of federal income tax.

And finally, there's one thing I think we all learned from yesterday's Super Bowl: don't forget to pay your electric bill on time.