Wednesday, July 31, 2013 - GDP, FOMC, Swipes

GDP, FOMC, Swipes

by Sinclair Noe

DOW – 21 = 15,499
SPX – 0.23 = 1685
NAS + 9 = 3626
10 YR YLD - .03 = 2.58%
OIL + 2.24 = 105.32
GOLD – 3.50 = 1324.20
SILV + .08 = 19.91

Here's the scorecard as we wrap up the month of July. The Dow Jones Industrial Average is up 19.9% year to date, with about a 550 point gain for July. The S&P 500 is up 19.6% YTD, with a 70 point gain for the month. The Nasdaq Composite has a 20.9% YTD gain, with a 190 point gain for July. Ten year Treasury Yield is up about 10 basis points for the month and since the start of the year, yields have climbed from the 1.75% range to today's close at 2.58%. Oil prices jumped from 97.88 at the start of the month to the current 105.32. And August gold futures bounced from the 1200 level to the current 1325.

The stock market started today's session with gains but could not hold on as the Federal Reserve FOMC wrapped up its two-day meeting by announcing they will stay the course, and will keep buying $85 billion a month in bonds to help lower long-term interest rates. And it says it plans to hold its key short-term rate at a record low near zero at least as long as the unemployment rate stays above 6.5 percent and the inflation outlook remains mild. They say the economy is growing only modestly, a downgrade from its June assessment. The Fed expects growth will pick up in the second half of the year, but today's statement reflected a more cautious message. Chairman Ben Bernanke said after the June meeting that the Fed could slow the bond purchases later this year if the economy and job market continued to strengthen. But after Wednesday's meeting, the Fed described the economy as expanding only at a "modest pace" and there was no talk of taper.

The FOMC had little time to digest the latest economic data. The government announced earlier this morning that the economy expanded at an annual rate of 1.7% in the second quarter, better than economists had expected but below the pace that Fed officials regard as necessary to create enough jobs to bring down the unemployment rate. The Fed has predicted faster growth in the second half of the year.

The economy grew a bit faster than analysts had predicted, topping expectations of 1% growth, but still, it was sluggish, hardly indicative of an economic boom, let alone enough to bring down elevated levels of unemployment soon. It is also the third quarter in a row in which growth failed to top 2 percent, the average since the recession ended in 2009. And the slightly better than expected number was tempered by a downward revision to first quarter GDP, revised from 1.8% down to 1.1%. Today's number is also subject to a couple of future revisions.

There were some positives in the GDP report,  residential fixed investment increased by 13.4 percent, a sign the housing sector continues to recover. Personal consumption rose 1.8 percent, as consumers showed some resiliency, especially given the increase in payroll taxes at the beginning of 2013. Higher inventories added 0.41 percentage point to overall growth, but inventories are volatile. Meanwhile, military spending flattened out after falling 21.6 percent in the final quarter of 2012, and another 11.2 percent in the first quarter of 2013, military spending last quarter barely budged, sinking just 0.5 percent, so it looks like most of the military wind-down has been completed – maybe.

Every five years the Commerce Department's Bureau of Economic Analysis revises the data used to calculate GDP, including changes to definitions and classifications of some measures that update the data to better reflect the evolving economy. The results of that revision were released today, and it covers 83 years of data. There were some interesting results.

Dating back to 1929, the U.S. economy grew at a 3.3% annual pace, which is one-tenth of a percentage point higher than previously published estimates. From 2002 to 2012, the growth rate was 1.8%, up from a previously reported 1.6% pace.

The great recession was less severe than previously thought, with the economy shrinking at an average annual pace of 2.9%, revised from a 3.2% contraction. In 2012, the economy expanded at a 2.8% pace versus a previous estimate of 2.2%. But that performance was wildly uneven over the course of the year, with a strong 3.7% annualized pace in the first quarter after a big upward revision, followed by two middling quarters and finally an abysmal 0.1% growth rate in the final quarter of the year. In current dollar figures the revisions added nearly $560 billion to the overall figure 2012 GDP figure of $16.2 trillion. The current recovery, while revised to show stronger growth, is still the weakest since World War II. The economy expanded at an average 2.3% annual pace between the second quarter of 2009 and the fourth quarter of 2012, compared with a previously published 2.1% pace.

One of the interesting revisions to GDP includes recognition of the contributions from entertainment. Film, long-running television shows and some aspects of the literary world, which previously had not been counted, now will be included. Entertainment will need to possess three qualities to be counted: Ownership rights, a long life, and repeated use. So, something like a motion picture will be included as investment even after the movie has its initial run in theaters. It will have streaming, DVD sales, online sales, TV movie of the week. That future stream of production makes it an investment.

The economic value of a Harry Potter movie under the old method only showed up in GDP through the personal consumption expenditures on movie tickets or DVD sales in a given period.  Under the new definition, the cost of producing the film would also be part of GDP as an investment that contributes to the production process over decades. The economic value of a large swath of TV shows will remain worthless.

In addition to entertainment, the new calculations include research and development, transactions involving defined benefit pension plans, and nonfinancial ownership transfer costs in real estate, or the costs involved in sales beyond agent commissions.  R&D is currently considered a cost of doing business but with the new classification it will be defined as an investment no different than spending for a building, equipment or software.

I'm not sure how swipe fees are counted in GDP, but there might be some changes. Retailers battling banks over debit-card transaction costs were handed a victory by a US judge, who said merchants were overcharged billions of dollars under an unlawful swipe fee set by the Federal Reserve.

The judge ruled  that the Fed considered data it wasn’t allowed to use under the Dodd-Frank law in setting the cap on debit-card transaction fees, known as swipe fees, at 21 cents, and neglected to bolster competition in card networks.

The decision, unless overturned on appeal, will force regulators to revisit rules that bankers said would cost them 45 percent of their swipe-fee revenue. Lenders collected about $16 billion annually from those fees before the Fed’s regulation and responded by cutting back on perks such as rewards programs and free checking to soften the blow to their profits.

The Fed’s rule, in effect since October 2011, will stay in place until the central bank drafts new regulations or interim standards. This is saying 21 cents may be too much. You’ll have to go back to the drawing board and figure out how much a debit-card transaction actually costs and is there going to be some kind of premium paid to that.

The Fed rule was called for by the 2010 financial overhaul law, which was enacted in response to the 2008 crisis. The ruling today finds that the Fed disregarded Congress's intent in passing the law by "inappropriately inflating all debit-card transaction fees by billions of dollars and failing to provide merchants with multiple unaffiliated networks for each debit-card transaction."

The retailers' lawsuit maintained that the cap is an "unreasonable interpretation" that exceeds the authority given to the Fed by the 2010 law. It also asserted that the Fed wrongly interpreted a provision of the law that requires that merchants have a choice of which bank network handles their transactions.

The retailers complained that the Fed had deviated from the law's intent by factoring expenses into the cap that the law didn't allow. They maintained that the Fed reversed its earlier view that the only costs that should be considered were those involved in the authorization, clearing and settlement of a transaction. Instead, the suit said, the Fed added costs such as losses from fraud that were outside the scope of the law.

The Fed in June 2011 formally set the cap for what banks can charge merchants at 21 cents for each debit-card transaction, plus an additional 0.05 percent of the purchase price to cover the cost of fraud protection.

Banks had lobbied hard against the cap, saying the lower fees wouldn't cover the cost of handling transactions, maintaining their networks and preventing fraud. Attempts by some big banks to compensate by charging consumers monthly fees for using debit cards sparked a nationwide furor in late 2011, leading the banks to drop their plans.

Monday, July 29, 2013 - Bees' Revenge

Bees' Revenge

by Sinclair Noe

DOW – 36 = 15,521
SPX – 6 = 1685
NAS – 14 = 3599
10 YR YLD + .04 = 2.60%
OIL - .13 = 104.57
GOLD – 6.60 = 1328.20
SILV - .14 = 19.95

Two big economic stories planned for this week. The Federal Reserve FOMC is meeting and they will issue a statement on Wednesday. Then we have the monthly jobs report on Friday.

September is the most likely time for the Fed to begin paring its $85 billion in monthly bond purchases. There are some concerns that big gains in jobs numbers could be enough of an economic pickup to prompt an early end to the Fed's bond buying, a program which has helped stocks rally for much of this year. So, from a Wall Street perspective, good news on the jobs front is bad news from the Fed, but of course signs of a stronger economy are more important in the long run. The S&P 500 is up 18.2 percent for the year so far, however that is not a good indicator of the broader economy.

The Fed may not cut back on bond buying. Remember the fact that Chairman Ben Bernanke has said that the decision to do so will be driven by the actual incoming data on the jobs and the economy rather than the Fed’s current expectations regarding that data. Despite the slow, steady job growth, unemployment has only moved about five-tenths of a percentage point down. This movement is barely enough for Bernanke to claim progress towards the Fed’s interim goals of 7% for the end of QE and 6.5% for the “beginning of thinking about” the end of ultra-low short term interest rates.

Moreover, despite the growth in jobs, the stock market indices and business profits, GDP for the three quarters following the inception of QE III looks like it will average about 1%, not 2%; and the first look at 2Q GDP might be even less than 1%, and that will be announced this week. We're still getting doses of sequestration blended into the GDP. And don't forget that the DC politicians could still

Monday's data was less than upbeat. Contracts to purchase previously owned US homes fell in June, retreating from a more than six-year high touched in May as rising mortgage rates were starting to dampen home sales.

We had a merger mania Monday.

US drugmaker Perrigo agreed to buy Irish drug company Elan for $8.6 billion. US-traded Elan shares rose 3.5 percent to $15.46. Perrigo was the S&P 500's worst percentage decliner, shedding 6.7 percent to $125.17.

Hudson's Bay Co , operator of department store chains Lord & Taylor in the United States and The Bay in Canada, said it would buy luxury retailer Saks for $16 per share. Saks shares rose 4.2 percent to $15.95.

Shares in advertising groups jumped after Publicis and Omnicom said they would merge. the deal might create an opening for rivals to poach defecting clients and potentially trigger more deals.

Omnicom shares were down 0.6 percent to $64.75 while smaller rival Interpublic Group gained 4.7 percent to $16.61.

Among the day's big gainers, shares of CF Industries Holdings, the world's second-largest maker of nitrogen fertilizer, jumped 11.8 percent to $202.30 after activist hedge fund Third Point LLC said it had acquired a stake.

Meanwhile, AMR Corp's American Airlines and US Airways will win EU approval for their $11 billion merger to become the world's largest carrier after agreeing to cede slots on a transatlantic route.

Treasury Secretary Jack Lew on TV yesterday, was asked "how come the Obama administration bailed out the banks but isn't talking about doing so for Detroit?"

The failure of large, major banks, two out the big three auto companies, the secondary market for housing finance-all of these posed unacceptably large risks to global financial markets, and thus the global economy, to a major industry, including its upstream and downstream suppliers, and to the national housing sector.

Detroit is not systemically connected in those ways, which is a sad commentary on the enormous power the banks wield over the economy. Still, Chapter 9 of the bankruptcy code might actually be a way to fix the problems with Detroit, short term. Of course, bankruptcy reorganization doesn't solve the longer term problem of deindustrialization. Detroit needs big investments along the lines of a Marshall Plan, and that probably won't happen unless there's an invasion.

And as we're hearing the news about Detroit, we are just now starting to hear about how the banksters helped to destroy the Motor City. Seems Detroit tried to buy derivatives to hedge against problems with their pension funds, but then there was a credit downgrade, and that squeezed the derivatives positions. Not enough in and of itself to destroy Detroit, just putting salt on the wounds. I'll try to get the full story in the next couple of days.

Remember about two weeks ago, when we heard that JPMorgan was close to reaching a settlement with the Federal Energy Regulatory Commission for manipulation of electricity prices? Well, no settlement as of yet. So, FERC is putting a little pressure on the process, issuing a statement claiming FERC staff "has preliminarily determined that JP Morgan Ventures Energy Corporation (JPMVEC) violated the Commission's Prohibition of Electric Energy Market Manipulation ... by engaging in eight manipulative bidding strategies.”

The Arctic sea ice is declining at a rapid pace. In 2013, it shrank to the smallest block ever recorded; it was just 40 percent of what it was in the 1970s. The North Pole now has a lake, an oversized puddle on top of the remaining sea ice. Although our climate experiences periods of warmer and cooler temperatures, this thawing could eventually lead to runaway melting as the ice becomes thinner and thinner over time.

As the Arctic thaws, it opens up areas for oil and gas exploitation. It's estimated that 30 percent of the world's undiscovered gas and 13 percent of its oil is located in the ice-locked region. While you'd think this would pave the way for profit, the reality is that costs will far outweigh the benefits; the possible economic benefits are probably in the billions of dollars however the possible costs and damage and extra impact is in the order of tens of trillions of dollars.

A newly released paper says that Arctic permafrost in the East Siberian Sea could be a global disaster in the making. Once this area thaws as much as 50 billion tons of methane could be released into the air.

Permafrost is soil that holds frozen moisture. It never thaws at any point in the year. One author of the new study says that this Arctic methane release is a massive economic time bomb.

Most attention is paid to the greenhouse gas carbon dioxide, or CO2. However, methane has been found to be at least 25 times better at trapping heat than CO2 gas. The Arctic region basically traps in methane gas in ice and frozen soil, like a large filter. The polar regions keep the atmosphere from having too much methane, but this is changing.

If the researchers are right, a 50 billion ton increase in methane in the atmosphere will speed global warming by 15 to 35 years, the date by which the world experiences a 2-degree-Celsius temperature rise above preindustrial levels.

Under a business-as-usual scenario of emissions, the researchers found the methane release would add $60 trillion in economic damage to the world's economy and would speed up the time by which the world experiences the 2-degree threshold by 15 years, to 2035. Sixty trillion dollars was the mean of the model, meaning some of the results produced much higher climate costs, more than $200 trillion. Under a slightly different scenario, in which emissions elsewhere were curbed, the methane cost would hit $37 trillion and temperatures would cross the 2-degree benchmark by 2040.

Go outside in the sun for about 15 minutes and tell me it isn't happening.

A swarm of about 30,000 bees attacked a North Texas couple as they exercised their miniature horses, stinging the animals so many times they died. The woman was stung about 200 times; her boyfriend was stung about 50 times. They survived. The two miniature horse died from the stings. The bees are being tested to see whether they are Africanized or "killer" bees. It is unclear what prompted them to leave the hive.

I have a theory. The bees are seeking revenge.

Bees are dying, or being killed off by the millions. According to professional beekeepers tens of millions of bees are dying. This is an ongoing problem; it's been a problem for a few years, and the problem is getting worse. And it matters, especially if you like to eat food.

There are about 100 crop species that provide 90 percent of food globally and, of these, 71 are pollinated by bees. In the US alone, a full one-third of the food supply depends on pollination from bees -- so if bee colonies continue to be devastated, major food shortages will inevitably result. I talked about this back in the Spring, the lack of bees threatened the almond crop in California.

Last month, an estimated 25,000 bumblebees were found dead in an Oregon parking lot as well, just a short time after 55 trees in the area had been sprayed with Safari, a neonicotinoid insecticide. These chemicals are typically applied to seeds before planting, allowing the pesticide to be taken up through the plant’s vascular system as it grows. As a result, the chemical is expressed in the pollen and nectar of the plant, and hence the danger to bees and other pollinating insects.

Oregon also followed up by restricting the use of 18 pesticides containing a type of neonicotinoid, but Oregon is the only state to put restrictions in place. Earlier this year the European Food Safety Authority (EFSA) released a report that ruled neonicotinoid insecticides are essentially “unacceptable” for many crops.

Friday, July 26, 2013 - Notes from the Favela

Notes from the Favela

by Sinclair Noe

DOW + 3 = 15,558
SPX + 1 = 1691
NAS + 7 = 3613

10 YR YLD - .01 = 2.56%
OIL - .82 = 104.67
GOLD - .30 = 1334.80
SILV - .26 = 20.09

Earlier in the week, the Dow and S&P hit record highs but the markets slipped; earlier today the Dow was down 150 points. For the week, the Dow rose 0.1 percent, the S&P 500 was flat (even as it hit a record) and the Nasdaq rose 0.7 percent.

It's Friday, and I have a bunch of notes and scraps that have been piling up, so we'll clean the desk, in no particular order.

The Thomson Reuters/University of Michigan's final reading on the overall index on consumer sentiment climbed to 85.1 from 84.1 in June, topping expectations for 84. It was the highest level since July 2007 and was also an improvement from July's initial reading of 83.9. Of course, if you paid a premium subscription, you could have had that information before the rest of the market.

Yesterday, I mentioned former Fed Chairman Paul Volker's remark that the only real financial innovation in the past 20 years was the ATM, which is actually about 30 years old now. And Volker wasn't quite right; the banks haven't done any real innovation but the hackers have. For nearly a decade, a band of cybercriminals rampaged through the servers of a global business who's who: Among the victims were 7-Eleven, Dow Jones, Nasdaq, JetBlue and JC Penney. Prosecutors say the hackers stole "conservatively" 160 million credit card numbers, and the dollar value of the crimes they helped facilitate is enormous; just four of the victims are out $300 million. The prosecutors say it's the largest data heist case ever and the suffering caused to identity theft victims was "immeasurable".

On Thursday, five of the gang's members were indicted. One is in custody in the US, a second is awaiting extradition in the Netherlands, and three more are still at large. Maybe if the banks paid more attention to providing a safe place to store money and a safe way to facilitate digital transactions, and if they spent less time trying to trade derivatives; maybe there could have been some financial innovation that actually was innovative.

The Federal Housing Finance Agency says the Swiss bank UBS has reached a settlement and will pay $415 million to the government-sponsored housing enterprises Fannie Mae and $470 million to Freddie Mac to resolve claims of misrepresenting the quality of collateral backing securities sold to Fannie and Freddie between 2004 and 2007.

The bank has already paid out $612 million to settle allegations of manipulating interest rates. UBS is now the third bank to settle with the FHFA after Citigroup and General Electric did so for undisclosed sums. UBS is just one of 18 banks the FHFA pursued in 2011 for allegedly lying about the quality of the collateral backing securities; essentially packaging subprime loans and selling them as a better quality.

 Home Affordable Modification Program or HAMP has been something of a disappointment nearly from its inception. After loudly touting the program’s ability to help 4 million borrowers, the administration was forced to concede it had barely helped a fraction of that number, or roughly 1.2 million mortgage modifications; and some advocates and administrators in the program actually came right out and declared the thing a failure. However, in recent months, we’ve been hearing a lot about how HAMP is finally getting going and hundreds of thousands of borrowers are getting the loan modifications that they need. What we haven’t heard until now, though, is just how many of them are re-defaulting on those loan modifications just months or years later; the number is now at 306,000.

I can see why many people think the HAMP program is a dud, but just to maintain perspective the Hope For Homeowners plan initiated by President Bush set aside $300 billion to refinance toxic loans and in 3 years time it managed to modify 71 loans; and the FHA-Secure plan managed to refinance 4,100 mortgages over a 3 year span. As far as the high number of re-defaults, the modification programs never dealt with the underlying problems, and for many, relief was just too little, too late.

One year ago today, Mario Draghi, the president of the European Central Bank spoke at an investment conference and he said:  "the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough." The speech seemed to revive markets and stave off what looked like an impending collapse. A few weeks later, Draghi introduced OMT, or Outright Monetary Transactions, a conditional bond buying program. Spanish and Italian bond yields stabilized, even though the ECB hasn't actually used OMT to actually buy bonds. Germany’s constitutional court is due to rule later this year on OMT’s legality under German law. The ECB hasn't exactly managed to forge a solid plan, and so the financial improvement has not been accompanied by a meaningful change in what matters most: namely, the ability to generate economic growth, create jobs and arrest excessive income and wealth inequalities.

Earlier this week we marked the 3 year anniversary of the Dodd-Frank Act. Which is to say it was passed onto law, although less than half of the Act has been enacted. Mainly, it's been a battleground for bank lobbyists trying to tear out the entrails.

A federal grand jury indicted Steven A. Cohen's hedge fund SAC Capital Advisors on fraud charges. The hedge fund was charged with wire fraud as well as four counts of securities fraud, and the government is seeking to force SAC to surrender any fraud-related profits. According to the indictment from roughly 1999 to 2010, SAC obtained and traded on inside information to boost returns and fees and that the scheme involved a number of portfolio managers, research analysts and dozens of publicly traded companies.

The government has also filed civil money-laundering charges against the firm, which call for fines and penalties to be determined at a trial, the date of which hasn’t been set. Those civil charges pose the greatest threat to Cohen’s fortune because prosecutors allege that if the fund reinvested the proceeds of illegal insider trading into its capital pool, then the entire pool is tainted and subject to forfeiture, but it's expected that prosecutors won't try to go after the entire amount.

SAC oversaw $6 billion for outsiders at the start of this year, but have since withdrawn about $5 billion. The big question for those folks is whether they will face clawbacks. SAC is almost like Cohen's personal hedge fund; he has about $7.5 billion in SAC’s funds and employees account for $1.5 billion of assets. And the fund is conducting business as normal, or somewhat normal. Cohen wasn't named in the criminal indictment and faces no threat of prison time. In the corporate criminal world, avoiding indictment is the key battleground.

What does it take to be considered wealthy? A new survey finds the majority of people with a net worth of between one and five million dollars do not consider themselves wealthy; 28 percent of people worth between $1 million and $5 million call themselves wealthy. For people worth more than $5 million, just 60 percent of them say they’re rich. Of those surveyed, 50 percent said they’d consider themselves rich if they had no financial constraints on activities. So, it's not really a number.

Tell that to Eike Batista; he's the Brazilian oil tycoon who started 2012 as the eighth richest person in the world; net worth estimated at $34 billion; now that has dropped to $200 million. You might think that $200 million is a lot; if you had that money, you might think you were wealthy, but I'm not sure if that's how Batista feels. So, it's not really a number.

A few months ago, a Senate committee grilled Apple CEO Tim Cook over the company’s creative accounting strategies, accusing it of cheating the U.S. Treasury by stashing away billions of dollars that live in no tax jurisdiction at all. The company didn’t dispute the truth of the accusations, but blamed the United States for building a tax system that makes bringing overseas earnings back to the United States very expensive, and proposed simplified rules that would make it cheaper to do so.

The Organization for Economic Cooperation and Development has been working on the problem; in February they issued a report. The G20 held a meeting last weekend and they said they want a more globally uniform tax system, and they want the OECD to finish up a a concrete plan to crack down on tax cheats, and they want that plan within the next 2 years.

More problems for Boeing's troubled 787 Dreamliner today; one was grounded, an oven overheated in another and damage was found in wiring on two other planes. It's turning out to be like a flying cruise ship.

Halliburton Co has agreed to plead guilty to destroying evidence related to the 2010 Deepwater Horizon oil spill in the Gulf of Mexico, which killed 11 workers and left a horrific mess. The guilty plea is the third by a company over the spill, and requires the world's second-largest oilfield services company to pay a maximum $200,000 statutory fine; that's about how much Halliburton earns every 23 seconds, based on 2012 revenue numbers. Halliburton also made a separate, voluntary $55 million payment to the National Fish and Wildlife Foundation, plus 3 year probation.

Meanwhile, another Gulf of Mexico drilling rig caught fire this week off the coast of Louisiana. The blaze broke out Monday on a natural gas platform. The rig partially collapsed, but then sand and sediment covered up the spill and the fire is out or nearly out; and because it is natural gas it dissipated quickly in the ocean water. No one was injured.

Meanwhile, TEPCO, the Tokyo Electric Power Company finally admitted today, what had been suspected for quite some time; the Fukushima Dai-ichi nuclear power plant, the one damaged in the 2011 eathquake and tsunami, has been leaking contaminated water into the ocean. They don't know how much damage has been done by the leaks; they don't have a plan to clean it up and they don't seem to have a plan to stop it.

The northeast of Brazil is largely poor and rural. Years ago, there was a migration to the South, to the major cities of Rio de Janiero and Sao Paolo. The migrants were looking for jobs, industrial jobs. There were more people looking than getting. The migrants camped out. In Rio, they camped out in the hills surrounding the city. Eventually the encampments turned into shacks, the shacks turned into homes, but the entire process was haphazard. The homes lacked modern conveniences, and so the residents strung up illegal lines, they built illegal plumbing. The shacks turned into homes turned into small cities; slum cities known as favelas. The houses were built close together, the roads often not more than a tight alleyway, difficult for police to patrol. Poverty and unemployment were high. Gangs soon became a stronger authority figure than police; crime was pervasive; hope was not.

The favelas grew over time. In Rio, a city of more than 11 million people, it is estimated that more than 4 million live in favelas, or slums. The largest favela, Rocinha, is home to more than 500,000. Last year, the government sent in police with machine guns and armored vehicles to clean up the favelas in advance of the World Cup Soccer tournament next year, and the Olympic Games in 2016. You would probably not feel safe walking through a favela.

There is a favela in the north part of Rio, known as Varginha; it is very poor and violence is common. Built on swampland, Varginha is one of several favelas that have been "pacified," meaning the drug lords who once ran the place have been ejected or subdued by authorities. The government has allocated money for community centers, libraries and a train station. But residents say they have received more broken promises than actual help, and basic services such as sanitation remain woefully unavailable. They also complain that police are abusive and treat everyone like a criminal.

Pope Francis is visiting Brazil. He is not meeting with Brazil's president; the Pope instead headed to Varginha, telling residents of the notorious slum that their leaders must do a better job of helping them. The Pope said public authorities and "those in possession of greater resources" must "never tire of working for a more just world, marked by greater solidarity!" He told the crowds that "No one can remain insensitive to the inequalities that persist in the world!"

It was the most political message yet in the pope's pilgrimage to Brazil, and for many it echoed the enormous protests that erupted last month among Brazilians angry over government corruption, excessive state spending on upcoming international sports events, and lack of basic services such as education and healthcare.

And then after visiting the favela, he went to another favela, known as the City of God and he visited with recovering drug addicts, saying , “It is necessary to confront the problems underlying the use of these drugs, by promoting greater justice, educating young people in the values that build up life in society, accompanying those in difficulty and giving them hope for the future.”

And along the way, the Pope opened the windows of the Popemobile and even got out to walk with the crowds of people and kiss babies and give hugs and blessings to the crowds of people; he visited a little speck of a Catholic chapel; he just walked up to the modest home of a local family and was welcomed like a long lost brother. The security detail must have freaked out, but even in the most dangerous and violent slums of South America, there was not even the hint of a problem.

He stressed to the people of the favelas that he is on their side, saying: “The church offers its collaboration on all initiatives that lead to the development of all people. The church is with you. The pope is with you.”

Hours later, speaking under a rainy sky at the beach in Copacabana, the pope’s message to the more than one-million faithful was to shake up the church and make a “mess” in their dioceses by going out into the streets to spread the faith. He was less political and more centered on the importance of believing in Jesus. “He is a friend who does not defraud. ”

There has been revolution in the Middle East – the Arab Spring, and the n the Arab Spring-Part2. And throughout much of Europe there have been protests, especially in the periphery. It seems that we have forgotten what is important. How much real-world difference the papal visit might make remains to be seen. John Paul II visited the favelas of Rio in 1980, and obviously the underlying problems hardly disappeared in the intervening 33 years, but the Pope is the spiritual leader of more than one billion souls. And even if he can't change the reality on the ground, maybe he can make us consider how we keep score. He said, "The measure of the greatness of a society is found in the way it treats those most in need, those who have nothing apart from their poverty."

Thursday, July 25, 2013 - Big Finance Crushes Innovation

07252013 Script

Big Finance Crushes Innovation

DOW + 13 = 15,555
SPX + 4 = 1690
NAS + 25 = 3605
10 YR YLD + .02 = 2.60%
OIL + .22 = 105.61
GOLD + 12.50 = 1335.10
SILV + .10 = 20.35

Usually I write a daily post, based upon various sources, but today I ran across an article that seemed to express the idea of financialization quite well. I made minor changes for time for my daily broadcast, see Moneyradio.com, but I am including the full cross-post below, and if you go to the link, there are several good cross-links. - Sinclair

How Big Finance Crushes Innovation and Holds Back Our Economy

Bold economic thinkers warn that it's time to tame the financialization monster.

By Lynn Stuart Parramore

Whatever happened to innovation in America? President Obama told us that our future depends on it. Across the political spectrum, everyone pretty much agrees that innovation is vital to prosperity.

So why aren’t we getting the job done? Clearly, we’re in desperate need of clean technology that won’t poison us. Our information and communications systems are not up to snuff. Our infrastructure is outdated and crumbling before our eyes. We’re not investing enough in these areas, and it shows. Yet they’re necessary not only for America’s economic health, but for stability and prosperity around the globe.

The U.S. used to be the envy of the world when it came to innovation, making things that dazzled the world and enhanced the lives of millions. But the Information Technology & Innovation Foundation, a bipartisan think-tank that ranks 36 countries according to innovation-based competitiveness, tells us we’re getting pushed aside on the global innovation stage. In 2009, to the surprise of those conducting the study, the U.S. ranked #4 in innovation, behind Finland, Sweden and Singapore. In 2011, the U.S. ranking was unchanged. Worse, the U.S. ranked second to last in terms of progress over the last decade.

Research by the Organization for Economic Cooperation and Development (OECD) also shows that the U.S. is not making as many cutting-edge products as it used to, and that other countries with strong investment in the foundations of innovation, like education and research and development, and fewer of the things that hinder it, like income inequality, are making greater strides than we are.

What went wrong?

William Lazonick, an expert on the history of the American business corporation, points out that the U.S has enjoyed, over its history, an extremely productive economy. We still have important productive assets, but we’re now taking money out of our productive economy instead of investing in it. The shift has happened over time, but the mechanisms of extraction have become dangerously efficient. A giant financial sector and wealthy class are sucking money, vampire-like, out of the productive sector, where the goods, technologies and services that we want are created.

Financiers may appear to be simply “making money out of money,” but if you look closely, you can see that they are really getting rich on the backs of people producing useful things, like consumer electronics, and capital goods like factories and equipment. Good jobs, the health of the overall economy and society, growing incomes for the poor and middle class—all of these things have been put aside in the quest for more financial profits. The game is unsustainable. And it’s turning out badly.

To get the economy humming, argues Lazonick, you want to fuel the kind of growth that allows people to enjoy higher living standards. You want an economy that is stable and allows everyone to share in prosperity. But nowadays, the executives who are running large industrial corporations like GE, Dupont, Cisco and Microsoft are focused on making as much money as they can in the short-term for shareholders, and more importantly, themselves.

Unsurprisingly, they support the policies that allow them to do this: things like low taxes, risky speculation, sky-high executive pay, and pulling investment out of education and infrastructure. What happens to our economy in the long-term is not really their concern. There’s a motto on Wall Street: “I.B.G.-Y.B.G.” or “I’ll Be Gone, You’ll Be Gone.” As long as you’re making money right now, what happens tomorrow is not your problem.

It’s everyone else’s problem. Witness the decline in the number and quality of jobs, the middle class evaporating, and the financial instability that brought about the Great Recession.

A look back

It wasn’t always like this, as Lazonick and Damon Silvers have pointed out. It used to be that Wall Street made its money issuing long-term bonds that governments and corporations could then use to invest in America’s productive assets. Sure, there was trading in stocks and bonds, but you didn’t get huge increases in wealth funneled to Wall Street as a result. There was some speculation involved, but it was expensive for individuals to trade and such trading wasn’t designed to get huge amounts of volume.

The commercial banking system was well regulated, and household savings could be channeled to businesses at fairly good rates of return. Financial institutions were relatively stable and they could help industry to produce technological advances and economic development. Up until the 1960s, most Americans understood and accepted the importance of the federal government in helping to jumpstart innovation through things like defense and aerospace spending. Some of that money got channeled through universities, and some of it was directed to large corporations, which, like GE, could “bring good things to life.”

But in recent decades, several monkey wrenches got thrown into this system, starting in the 1960s with the trend of conglomeration, in which corporate titans built empires that gobbled up scores and even hundreds of companies. In the 1970s, as inflation grew and the Japanese economy took off, Wall Street shifted from investing to trading, and later, in the 1980s, executives came to adopt a harmful ideology known as “shareholder value,” which held that shareholders are the only people who deserve returns from corporations — forget about the taxpayers and the employees without whose support, sweat and risk such companies would not exist. Corporations started focusing on manipulating stock prices to realize short-term gains, and conducting stock buybacks to enrich executives at the expense of research and development or investing in the skills of workers.

Wall Street banks started moving into higher margin businesses. They were no longer regulated utilities, but high-risk, high-return institutions. This destabilized their basic credit intermediation function. Up to the 1970s the productive system dominated the financial system. But from the 1980s on, the balance of power was reversed.

The financialization monster

Think about it: what GE product did you recently purchase that enhanced your life? In the era of financialization, big companies like GE have turned their attention to making quick Wall Street profits instead of fabulous products. In the 1980s, for example, GE’s Jack Welch rapidly expanded the company’s business into issuing credit cards, mortgage lending and other financial activities. It wouldn’t be long before financial operations accounted for almost half of the company's profit.

Eventually we ended up with a situation in which, as my colleague Joshua Holland has noted, a corporate executive will starve the company of needed resources and hinder its ability to be productive in the interest of short-term gains. In his book The Speculation Economy, Lawrence Mitchell of George Washington University points out that a recent survey of CEOs of major American corporations revealed that nearly 80 percent would have "at least moderately mutilated their businesses in order to meet [financial] analysts’ quarterly profit estimates."

Silvers notes that as financialization fever took over, the U.S. developed a dangerous imbalance between private and public finance, and we promoted public policy founded on the strange idea that there really is no such thing as a public good. We embraced the idea that capital markets are more efficient if regulators step aside, and we subscribed to the faulty notion that deregulation of financial institutions would help the economy prosper.

Without regulation and strong unions to ensure that the U.S. kept steadily and thoughtfully channeling money into productive investments like training workers and creating stable jobs with reasonable incomes, the economy essentially became a casino and the gap between the rich and the rest grew wider. We became known less for innovation that enriched people’s lives than for creating complicated financial instruments that are designed to rip people off. From 2004-2008, for example, when other advanced economies were pouring money into clean technology, the U.S. financial markets were rapidly innovating new financial products that served to extract yet more wealth from the productive parts of our economy.

The wrong kind of innovation

Paul Volcker once famously quipped that the ATM is the only useful financial innovation he’s seen in the last 20 years. It seems that while we haven’t gotten around to things like clean technology, we’ve created lots of innovative ways for ordinary people to lose money—things like lines of credits on homes that tend to thrust people into debt more quickly and force them to bear the burden of Wall Street’s obsession with making bigger returns at any cost.

Jan Kregel and Leonardo Burlamaqui have examined how as the financial sector has grown larger, the U.S. has ceased to be a center for developing new knowledge. Finance is no longer playing the role of the “handmaiden of creative destruction” that allows industry to produce technological advance and economic development.

Kregel and Burlamaqui also observe that the financial services industry has special features which create economic instability in a variety of ways, for example, using things like derivatives packages to shift risk from financial firms onto those less able to bear that risk. Bubbles followed by catastrophic crashes become inevitable: eventually, the weight of financial speculation becomes so great that it overwhelms the system, as we saw in the late 1920s, and in the 2007-08 financial crisis. When these crises occur, speculation decreases for a time, but as we can see now, the financial sector is hell-bent on restoring profits— not for the sake of the economy and jobs, but for the sake of their incomes.

Damon Silvers has also pointed out that the costs of financial bubbles include the effects of the failure to productively invest capital, including the decline of government investment in research and development. Income inequality keeps growing, and Wall Street types push the false idea that any money they make is made fairly and that the government should never intervene. Wages are pressed down and yet wealth keeps on building— but only for the very few.

What to do?

Bottom line: the U.S. financial sector no longer serves the productive sector—in fact, it may be killing it. But can it be stopped?

Taming the financialization monster won’t happen through volunteerism. Through our increasingly corrupt political system, the titans of the financial sector pull more of the strings in Washington, and they’re not likely to speak out against things like skyrocketing executive pay, one of the forces driving income inequality, vaporizing jobs, and diverting money from more productive channels. According to a report by the Economic Policy Institute, American CEOs now earn 273 times the average worker’s salary. Thirty years ago, the average chief executive of a large public company took in less than 30 times the pay of the typical worker. Have CEOs really become that much more valuable?

As Lazonick points out, social norms have to change. In Japan, stratospheric executive pay is considered unacceptable because there’s an understanding that making a company work is a collective endeavor. That’s an important social value. In Europe, there’s a movement to curb executive pay at bailed-out banks. Senior staff at banks that enjoy state funding would only be able to earn 15 times the national average salary or 10 times the wages of the average worker at the bank. Bonuses would be capped at twice fixed salary.

That’s a good idea, and something we need to be discussing in the U.S., where executive pay is not only extremely high compared to the rest of the world, but often arbitrary and shockingly detached from performance.

Lazonick thinks what we really need is a whole new mindset about the economy. He recommends several things that would help get us back on track:

• Understand that markets don’t create value, but that organizations investing in productive capabilities, like business, governments, and households do.

• Ban stock repurchases by U.S. corporations so corporate financial resources can be channeled to innovation and job creation instead of wasted for the purpose of jacking up companies’ stock prices.

• Realize that the shareholder value ideology is destructive and will cause us to lag behind other countries that don’t subscribe to it.

• Regulate employment contracts to ensure that workers who contribute to the innovation process get to share in the gains from innovation.

• Create work programs that make use of and enhance the productive capabilities of educated and experienced workers whose human capital would otherwise deteriorate through lack of other relevant employment.

• Move toward a tax system that channels some of the money made on the gains from innovation toward government agencies that can invest in the public knowledge base needed for the next round of innovation.

We’ve still got plenty of innovation left in us, but we have to change our priorities and make the financial economy subordinate to the productive economy. That would go a long way toward getting Wall Street off our backs and allowing America to once again be a place where energetic people thrive and work together to produce great things.

Wednesday, July 24, 2013 - The Showdown

The Showdown

by Sinclair Noe

DOW – 25 = 15,542
SPX – 6 = 1685
NAS + 0.33 = 3579

10 YR YLD + .07 = 2.58%
OIL + .09 = 107.00
GOLD – 26.10 = 1322.60
SILV - .34 = 20.25

No new records today. No milk and cookies, just the crumbs.

 A federal bankruptcy judge has cleared the way for Detroit’s bankruptcy case to go forward without legal challenges. The decision by Judge Steven Rhodes of United States Bankruptcy Court freezes all litigation against the city during the bankruptcy process and consolidates state-level legal challenges to Detroit’s Chapter 9 filing into the federal bankruptcy case.

The federal bankruptcy court has “exclusive jurisdiction” over the case, he said, adding, “There is no case law that holds otherwise.”

The judge was attempting to put to rest a legal spat that began almost immediately after Detroit filed for BK last week. On Friday a state judge ruled that the filing violated the state Constitution, which protects the pensions of retired public employees. The city has been expected to seek reductions in pensions in bankruptcy court as part of its broader efforts to reduce Detroit’s estimated $18 billion in debts and other obligations.

Today, Judge Rhodes approved a motion by the city’s emergency financial manager, Kevyn Orr, to freeze all litigation against the city during the bankruptcy process. The move effectively gives Judge Rhodes the authority to rule on the issues raised by retired public employees regarding their pensions.

Remember Meredith Whitney? She's the financial analyst who correctly predicted that Citigroup was in trouble, right before the financial crisis. In an op-ed in the Financial Times she says, "The aftershocks of the largest municipal bankruptcy in US history will be staggering, and Detroit will set important precedents."

Whitney thinks this is the first in that many many municipal defaults she's been predicting for the past 3 years. She went on 60 Minutes in 2010 and said the muni market was going to hell in a handbasket, and she caused a minor freakout, which never came to pass. She is right when she points out that many municipalities are struggling to balance their obligations to current and former employees, bondholders and public services and that something will have to give. And if Detroit can wipe out underfunded pensions, there will be other cities that will consider similar action, but it's not so easy.

Many states prohibit municipalities from going the BK route; they must be truly insolvent; they need to exhaust other ways to pay off debt. And then there is the simple idea that the economy is getting better. It's not getting great, but it hasn't fallen into the abyss, and that means state and local revenues are getting better.

And besides, Detroit could solve this whole problem in a heartbeat, if they could just get the profits from Goldman Sachs' aluminum warehousing operations. Hmmm. Detroit's problems surely run deep. But beneath its fiscal problems, and all the hemming and hawing about them, lie the seeds of rebirth for the city and the broader metro region. Since the economic crisis, and perhaps somewhat before it, the first signs of recovery and revitalization, modest as they may be, are finally starting to surface. And housing is so cheap, we could all just go up there and buy a former auto plant and convert it into a summer cottage; snowbirds in reverse.

A NBC/Murdoch Street Journal poll released today finds that Americans disapprove of Congress. We really, really don't like Congress; 83% disapprove of the job Congress is doing; that's a record level. Just 12% approve of the job Congress is doing, and 57% say they would replace every member of Congress if they could. The poll also finds that the president's approval rating has dropped to 45 percent, down from 48 percent last month.

I don't get it; I don't understand. Who are these 12% who approve of Congress? Does that 12% represent the “Friends and Family Plan” or is it the lobbyists who have already paid for their Congress person?

What's behind this dissatisfaction? Let's keep it simple; it's the economy. That's not everything but it is the 800 pound gorilla. And so today, President Obama started talking about the economy. You'll hear more in coming days and weeks. There will be a debate to define an economic policy. And the debate started in Galesburg, Illinois at Knox College. Galesburg is a small town with a little over 30,000 residents and a median income of just over $17,000. In 2004, the Maytag plant closed down; the unemployment rate is still a little above 8%.

Obama went on the offensive, well aware that it is just a matter of time before Congress re-emerges from it's summer slowdown and slips into full-fledged dysfunctional overdrive. He took credit for helping strengthen the economy, while acknowledging that “we're not there yet”; and he went on the attack against Republicans in the House of Representatives for engaging in “an endless parade of distractions, political posturing and phony scandals.” He said, “Washington has taken its eye off the ball,” and it needs to stop.

And then he addressed two issues that will dominate the debate in Washington in coming months – the debt ceiling and funding the government. Obama said: “We’ve seen a sizable group of Republican lawmakers suggest they wouldn’t vote to pay the very bills that Congress rang up — a fiasco that harmed a fragile recovery in 2011, and one we can’t afford to repeat.”

Over in the House, meanwhile, Speaker John Boehner has said that he will not "raise the debt ceiling without real cuts in spending," a mantra that preceded a similar showdown in 2011. Boehner has alternatively said he would not allow the country to default -- making it hard to gauge how serious a threat this truly is -- but there are loads of lawmakers who are perfectly willing to gamble with default.

Obama clearly learned from earlier missteps, when the administration declared victory on the recovery prematurely. He focused his address not on acknowledging a modest recovery but trying to argue for why his policies on spending, health care, immigration and even raising the minimum wage would help drive a more broadly shared recovery.

He spent a lot of time talking about how wages have grown for top earners but not the middle class, and rising stock prices do not translate to widely shared prosperity. And this is really where the economic debate is headed, an attempt to define the true origins of prosperity. And the debate will be between the trickle down theory and the middle out economics.

Economic policy choices may seem complex but they boil down to a simple question: whether what's best for a capitalist economy is an ever-increasing concentration of wealth at the top or a thriving and growing middle class. That's why arguments about the debt, sequestration, trade policy, tax reform, and fiscal stimulus are really distractions – along with a lot of what passes for news on any given day.

A modern understanding of economics leads to the conclusion that prosperity is the result of ongoing interaction between consumers and businesses. The middle-out theory tries to improve the interaction by creating conditions that allow both middle class consumers and the businesses that depend on them to prosper and to provide mutual benefit in a kind of virtuous cycle. This means that a prosperous economy revolves not around a tiny number of the very rich but around a great and growing number of middle-class consumers and small businesspeople.

Middle-out economics has several important advantages over trickle-down. One is reality: This is how complex, adaptive systems like economies in fact thrive. A second is politics: Middle-class voters will naturally prefer a story that puts them in the center, rather than at the margins. And the third is intuition: We know in our gut that we're all better off when we're all better off. We have seen how inequality does not lift all boats. We don't seek equal results, just equality of opportunity.

The implication of trickle down is that prosperity trickles down form the top and so it's only the people at the top who matter; but most people realize that people in the middle and bottom also matter. We are connected on many different levels, indivisible.

And while it is tempting for businesses to only court the top, the reality is that they need the middle and the bottom; they need more customers, not just a couple of wealthy customers. We need more Americans who have purchasing power, education, health security, and access to capital participating in the economy; whether as consumers or as innovators, which is actually just another way of saying small business people. In other words, we need the economy operating at full capacity. If we hope to achieve our full economic potential we need to get everyone involved.

We need more consumers, yes, because that drives demand and when we have demand, business people will respond to demand, and that in turn, will encourage more innovators, more ideas, more competition, and of course, more jobs. Economic growth happens when together we invest in the education and health care and infrastructure and research that provide the foundation for the entrepreneurial energy of the private sector.

Obama plans to expound on his ideas in speeches across the country in the weeks ahead. His address today in Galesburg did not include major new policy proposals, but new ideas are expected to be sprinkled in future remarks. Already, the Republicans are denouncing the speech for a lack of specifics, and today the president denounced them for a lack of specifics, saying: “You can't just be against something. You've got to be for something.”

But the specifics are not the real story; the real story is the showdown between trickle down and middle out.