Tuesday, August 06, 2013 - Dog Days

Dog Days

by Sinclair Noe

DOW – 93 = 15,518
SPX – 9 = 1697
NAS – 27 = 3665
10 YR YLD + .02 2.63%
OIL - .86 = 105.70
GOLD – 21.20 = 1283.60
SILV - .23 = 19.58

If the markets are boring you this summer, you just aren't paying attention. August trading in this post-financial crisis landscape has been anything but boring. For the past four years, the market has offered tremendous gains and harrowing losses during the month of August. The boring, flat market many of us have grown to expect just hasn't materialized.

Investors were treated to big gains in August 2009 and August 2012. But in August 2010 and 2011, the broad market coughed up about 5%. In 2010, August ended up marking the final lows of a summer correction. In 2011, the eurozone crisis pulled stocks underwater by as much as 12% during the month of August, only to claw their way back from the brink of a new bear market. So much for the dog days of summer. This time around, nothing should surprise you. 

The US trade deficit declined in June to its lowest level in more than 3-1/2 years as imports fell and exports touched a record high. The Commerce Department says the trade gap fell 22.4 percent to $34.2 billion, the smallest since October 2009. The percentage decline was the largest since February 2009.

May's shortfall on the trade balance was revised to $44.1 billion from the previously reported $45.0 billion. Exports of goods and services increased 2.2 percent to a record $191 billion. The gain in exports was broad based, with food, industrial supplies, capital goods and consumer goods rising. Motor vehicle exports, however, fell in June. The increase in export growth may point toward slightly stronger second half GDP growth for the economy.

I mentioned yesterday that we were expecting some Federal Reserve officials to give some speeches this week. Yesterday, Dallas Fed President Richard Fisher called for an end to QE; no surprise because it's well known that Fisher opposes ongoing QE. Today, Dennis Lockhart, President of the Federal Reserve Bank of Atlanta spoke as part of a panel discussion; and Charles Evans, President of the Chicago Fed Bank spoke to reporters.

Lockhart said continued improvement in the labor market would be key: "If we see the growth pick up in the second half and if we see a continuation of the job gains that we - not (the) 162,000 number that we saw last month but at a higher range, say 180-200,000 - I think with other fundamentals improving we probably are in a position to remove ... the extraordinary policy program over the medium term - that being the asset purchase program." Lockhart also said that if the economy deteriorates then the exit from QE is not a foregone conclusion.

Chicago Fed President Charles Evans said much of the same: "We are quite likely to reduce the flow of purchases rate starting later this year - I couldn't tell you exactly which month that will be - and it's likely to wind down over time in a couple or few stages."

Both Fed officials think the Fed will stick to a Zero Interest Rate Policy for quite some time. Evans said he expects the economy to grow about 2.5 percent in the second half of this year, and more than 3 percent next year. That rate of growth should generate about 175,000 to 200,000 jobs a month and will probably bring the unemployment rate down to about 7.2-7.3 percent by the end of the year. So, the outlook is rosy, the current conditions, not so much. The Fed doesn't always nail economic forecasts.

All told, Evans said, the Fed's third round of quantitative easing, or QE3, will likely total at least $1.2 trillion since January 2013, double the size of the Fed's prior round of purchases. So, we might question whether we got our money's worth and also if the economic forecasts are good enough. Even if the economy starts averaging 200,000 net new jobs per month, is that good enough, considering the quality of jobs? Is 6.5% unemployment good enough? Remember, the Fed hasn't seen much in the way of fiscal policy to improve the situation.

Another regional Fed policymaker, Narayana Kocherlakota, president of the Minneapolis Fed, has called for the Fed to spur the economy further by lowering its threshold for considering a hike in rates to 5.5 percent unemployment, near the economy's long-term normal rate.

So, the markets were down today, even with good news on the trade deficit because the market is focused on free money from the Fed and fearful they will take away the punch bowl, or the Bernanke “put”, or whatever you want to call it; the Fed has been pumping $85 billion a month into the markets and they would hate to see it go. For the rest of us, that money doesn't seem to filter down from Wall Street to Main Street, but it is turning into the lifeblood of Wall Street, and when it's gone Wall Street will likely respond poorly, and today was just a small indication.

The government filed two civil lawsuits against Bank of America for what the Justice Department and securities regulators said was a fraud on investors involving $850 million of residential mortgage-backed securities.

The Justice Department and the Securities and Exchange Commission filed the parallel suits in US District Court in Charlotte.

The securities date to about January 2008, putting them just at the beginning of the global financial crisis.

Bank of America responded to the lawsuits with a statement: "These were prime mortgages sold to sophisticated investors who had ample access to the underlying data, and we will demonstrate that.

Bank of America had warned in a securities filing on Thursday about possible new civil charges linked to a sale of one or two mortgage bonds.

The two suits accuse Bank of America of making misleading statements and failing to disclose important facts about the mortgages underlying a securitization named BOAMS 2008-A.

"These misstatements and omissions concerned the quality and safety of the mortgages collateralizing the BOAMS 2008-A securitization, how it originated those mortgages and the likelihood that the 'prime' loans would perform as expected," the Justice Department said in its statement. A "material number" of mortgages in the pool "failed to materially adhere to Bank of America's underwriting standards."

Bank of America has announced a series of settlements with investors and the government, including an $8.5 billion settlement with investors in mortgage-backed securities and a $1.6 billion deal with bond insurer MBIA Inc.

Last week, a jury in New York City convicted former Goldman Sachs trader Fabrice Tourre on six civil counts of securities fraud, for selling a toxic mortgage-backed bond to investors without disclosing that an architect of the deal, hedge fund Paulson & Co., also bet on its failure. This victory for the Securities and Exchange Commission signifies a long-awaited measure of justice for the unbridled greed and dirty dealing that sparked the financial crisis, but an exceedingly small one. Tourre was a young, mid-level employee, listed as a “vice president,” but so are hundreds of people at Goldman, not a decision-maker in executive suites throughout Wall Street. The conviction means he’ll pay a fine and probably get barred from the securities industry, an industry he’s already left to pursue a doctorate. This is hardly the level of accountability that practically the entire country demanded to see, especially when you consider that it represents the sum total of legitimate crisis-related convictions, and a non-criminal one at that. The SEC must stop chasing minnows while letting the whales of Wall Street go free.

Despite this, the Tourre case matters. It should lead Washington to rethink the conventional wisdom that financial regulators and Justice Department officials have spread about these cases: that they’re impossible to prosecute. It’s not just critical for how we remember the last crisis; it also shapes how we should think about the next one, whenever it comes to pass.

If you look at all the excuses for the total absence of prosecutions of major bank executives for their roles in nearly crashing the global economy, you find two major themes. First, the financial industry’s conduct was perhaps unethical but not technically illegal, especially since the peculiarities of securities law ensure that well-heeled bank executives will find some loophole to exculpate themselves from guilt. Second, juries will not be able to understand the hopelessly complex intricacies of the law, and will simply punt before agreeing beyond a reasonable doubt on the guilt of the bankers.

The Tourre case proves these both wrong. To say the case discredits a silly argument gives that argument too much weight. There were numerous convictions of accounting fraud in the Enron and WorldCom era, in cases that were at least as complex as the 2008 crisis. Ultimately fraud is fraud. Juries are more sophisticated than people give them credit for. They take their job seriously.

That appears to be the result of the trial of Fabrice Tourre. The jury, which has been interviewed extensively, fully understood that Tourre was something of a scapegoat and not the central decision-maker at the firm. They recognized that senior executives at Goldman Sachs approved the deal, known as Abacus. And they generally discounted the damning emails from Tourre, bragging about selling the toxic bonds to “widows and orphans.”

Instead, they bore down into the details, asking simple questions about whether Tourre’s lack of disclosure to investors about the designed-to-fail quality of Abacus represented securities fraud. They saw through the allegation that the industry generally did not disclose the participation of hedge funds like Paulson in derivatives deals, and focused on whether that constituted a material misrepresentation. And Tourre’s participation in the scheme, not his place on the totem pole at Goldman, was the determinative factor. One juror summed it up this way: “They portrayed him as a cog, but in the end a machine is made up of cogs and he was a willing part of that.” While Toure faced civil charges with a lower burden of proof, these core insights from the jury could have been employed even in criminal financial fraud cases.