Friday, April 12, 2014 - Trade Secrets

Trade Secrets

by Sinclair Noe

DOW – 0.08 = 14,865
SPX – 4 = 1588
NAS – 5 = 3294
10 YR YLD - .07 = 1.72%
OIL – 2.85 = 90.66
GOLD – 84.00 = 1478.00
SILV – 1.81 = 25.95

The S&P 500 is up about 2.4 percent for the week, and the Dow up about 1.8 percent and Nasdaq up about 2.4 percent. The S&P has only had two weeks in 2013 with bigger gains. For the year, the Dow has gained more than 13 percent and the Nasdaq is up 8.7 percent.

Retail sales fell in March for the second time in three months and consumer confidence dropped in April. Sales fell 0.4 percent in March. Consumer spending was considerably weaker in the first quarter than estimated. Core sales, which strip out cars, gasoline and building materials, fell 0.2 percent last month. This measure corresponds closely with the consumer spending component of the government's measure of gross domestic product. It is widely believed that the end of the payroll tax holiday is related to the drop in consumer spending. Going a step further, growth is expected to slow sharply in the second quarter largely because fiscal policy tightened further in March.

A separate report from Thomson Reuters/University of Michigan shows the consumer sentiment index dropping ot 72.3 in April, the lowest level since last summer.

Producer prices, or prices at the wholesale level, fell 0.6 percent in March, their biggest drop in 10 months, as gasoline prices tumbled. In the 12 months through March, wholesale prices were up 1.1 percent, the smallest rise since July. Prices had increased 1.7 percent in February.

It's earnings season, and today a couple of the biggest banks posted results. Wells Fargo reported earnings of $5.2 billion, up from $4.2 billion a year ago. Revenue was slightly lower. The bank’s mortgage banking income slipped 3 percent; mortgage originations dropped by 16%. Corporate lending increased.

The nation's largest bank, JPMorgan Chase, reported a 33% increase in first quarter earnings. Net earnings came in at $6.5 billion, even as revenue dipped by $1 billion. JPMorgan reported strength in mortgage lending and investment banking. Within the investment banking unit, assets grew to $19 trillion for the first quarter. At least that's what it looks like. And it looks like they had about $2.3 trillion in derivatives on the balance sheet, and $1.6 trillion in derivatives “off balance sheet”. The notional amount of assets associated with these derivatives is somewhere around $70 trillion; again just kind of guessing.

What are these derivatives assets being used for? How do they contribute to JPMorgan’s record earnings? What risks are being run by having such large items “off balance sheet”? Is it gambling in derivatives that is enabling JPMorgan to make record profits in a depressed marketplace? The public has no information and no way of finding out.

JPMorgan and various counterparties operate in what is basically a hidden casino, and when one of the players loses, the entire global derivatives casino tends to freeze; that's what happened in 2008 with the collapse of Lehman; everything froze because nobody had enough information to assess the damage to their own balance sheets and “off-balance sheet” holdings, and that means they were totally clueless about the counterparties in the derivatives casino.

Jamie Dimon, the CEO of JPMorgan, talked about the growth in tangible book value, but he did not include the off balance sheet derivatives, which would clearly push book value below one. Which means that all the analysts who cover JPMorgan can't figure out value. And the reason is they don't know how much risk the bank is taking. And an even better question is why are they taking all the risk? How does this benefit the economy? The answer is that it provides no benefit to the economy, beyond enriching a few executives and traders in the firm.

While the banks are still reporting big profits, they are also cutting jobs. So, something doesn't add up. Why would a business that grows earnings 33% need to fire tens of thousands of workers? Regulation will force changes in their business model. The big question is what the banks will look like in a year.

Of course, Jamie Dimon couldn't let the earnings report pass without begging for some relief from regulators. Dimon argued  that banks are safer than ever, that JPMorgan’s size and scale and universality provides services that clients want and is good for the world, and that “I hope at one point we declare victory and stop eating our young.”

of course yesterday, JPMorgan research released a 328 page report arguing that global tier 1 investment banks were “un-investable” and the mega banks need to spin-off their businesses to provide capital return to shareholders. So, there's a bit of a disconnect there. Also, there was a Wells Fargo report this week saying the biggest banks trade at 20-30% discounts to their sum-of-the-parts values.

A follow-up to the mortgage abuse settlement. Recall the PR barrage in the wake of the robosigning scandal: its was “sloppiness,” “paperwork errors”. Servicers kept claiming, despite overwhelming evidence of bad faith and the institutionalization of impermissible practices, that there was really nothing wrong with how they were operating. Remember it was important for them to take that position, because if they were to admit that the bank knew it was engaging in widespread abuses with management knowledge and approval, it would be admitting to fraud.

The Fed and the OCC told the big 14 mortgage servicers to conduct reviews of all mortgages; the mortgage servicers hired consultants to scour the mortgage files; the consultants charged $2 billion but couldn't get through many files; the Fed and the OCC threw up their hands and worked out a deal for the servicers to send out checks to abused homeowners, $3.6 billion for 4.4 million homeowners; most check are for $300 or less. Now, you may be wondering how the mortgage servicers and banks and regulators knew how much to send to abused homeowners, and which homeowners should get checks, seeing as how they didn't finish the investigation; well, they let the banks tell them how much they felt was a good amount to pay, and that settled it. Senators are now looking into the mess and demanding information from the regulators, but the Fed is stonewalling the Senate investigation.

At the meeting yesterday, Federal Reserve staff argued that the documents relating to widespread legal violations are the “trade secrets” of mortgage servicing companies. In addition, staff from the Office of the Comptroller of the Currency (OCC) argued that these documents should be withheld from Members of Congress because producing them could be interpreted as a waiver of their authority to prevent disclosure to the public of confidential supervisory bank examination information.

Widespread legal violations are the trade secrets of mortgages servicing companies. I can’t make this stuff up.

Lots of people have been discussing how negative investor sentiment is. Markets are making new all time highs as expectations that markets will be higher six months hence is at a mere 19% 

While the stock market has been climbing to record highs, the rally has highlighted the disconnect from the broader economy; however, the market does not appear disconnected from earnings. Record high stock indices are matching record high levels in corporate earnings. S&P 500 companies are on track to generate north of $25 per share in collective profits this quarter. That's better than it sounds; earnings for S&P 500 companies are expected to grow at a modest 1.2 percent in the first quarter. What's very unusual about this particular new high in earnings is that it doesn't come along with a new high in economic activity around the world. If we have record earnings in a relatively lousy economic environment, what if the economy improves? Or the flip side of that question is whether we can maintain corporate earnings without improvement in the economy?

As the U.S. Commerce Department released a report late last month showing corporate profits at a 60-year high, suddenly the big news was about how cheating surely must be rampant in Social Security disability.

Wait, what?

Also late last month, a Washington Post investigation showed that the 30 companies that make up the Dow Jones industrial average pay a dramatically smaller portion of their profits in taxes than they did a half century ago. Instead of discussing how that impacts government services, all of Washington is talking about slashing Social Security and Medicare.

It’s bait and switch.

The Commerce Department says corporate profits increased to 25.6 percent in 2012, the highest in any year since 1950 and far higher than the 19.9 percent level common in the years just before the economic collapse.  Citizens for Tax Justice and the Institute on Taxation and Economic Policy evaluated 280 of the Fortune 500 companies and found that 30 paid no federal income taxes at all from 2008 through 2010. The following year, 26 paid no income taxes. None. Zip. Zero. Some corporations pay. But not much. A Washington Post analysis found that about 50 years ago, corporations included in the current Dow Jones industrial average routinely listed federal tax expenses as 25 to 50 percent of worldwide profits. Now, the Post found, they report less than half that.