Thursday, September 26, 2013 - The Quotas Must Be Filled

The Quotas Must Be Filled

by Sinclair Noe

DOW + 55 = 15,328
SPX + 6 = 1698
NAS + 26 = 3787
10 YR YLD + .03 = 2.64%
OIL + .20 = 102.86
GOLD – 9.30 = 1324.80
SILV - .07 = 21.83

A couple of economic reports this morning with conflicting signals. The National Association of Realtors said its Pending Homes Sales Index, based on contracts signed last month, decreased 1.6 percent. At the same time, labor market data was more positive. Initial claims for state unemployment benefits dropped 5,000 last week to a seasonally adjusted 305,000.

And a little bit of research from the Atlanta Fed's macroblog that you probably didn't see; they report the pace of research and development (R&D) spending has slowed. The National Science Foundation defines R&D spending as “creative work undertaken on a systematic basis in order to increase the stock of knowledge” and application of this knowledge toward new applications.

R&D spending is often cited as an important source of productivity growth within a firm, especially in terms of product innovation. But R&D is also an inherently risky endeavor, since the outcome is quite uncertain. On top of that, the federal funding of R&D activity remains under significant budget pressure.

In the Countdown to the Shutdown, the Senate is expected to pass a government spending bill and send it back to the House of Representatives on Saturday, minus the defunding of Obamacare; the bill would be a so-called “clean” spending bill, dealing with spending and nothing else. House Speaker John Boehner says he doesn't like that and the House will try to tack on a measure to delay Obamacare for one year; they will also attach new spending cuts and other initiatives to a debt limit bill, something that Obama has said he would not tolerate.

If they can't figure this out, there could be a shutdown when we wake up on Tuesday morning. And despite near-universal acknowledgment that a shutdown is bad, it could happen. Investors have gone through such Washington brinkmanship before in 2011 and at the end of last year. There is a level of fatigue that has settled over the markets with regard to shutdowns and fiscal cliffs and political dysfunction. Last-minute deals emerged each time to kick the can down the road, and many investors believe this may play out again. Meanwhile, Treasuries have rallied from the expectation of taper to the fatigue of debt ceilings, and the only thing that seems to make sense is that the Fed wouldn't dare taper while Washington is in distress.

A new Bloomberg poll reveals most Americans say the country is on the wrong track: “Americans also are pessimistic about the course of the country, with 68 percent saying it’s headed in the wrong direction, the most in two years, according to the poll of 1,000 adults conducted Sept. 20-23.”

Note this is not a general malaise: “Americans’ negative feelings about Washington contrast with more optimistic views about their own prospects. Thirty-five percent of respondents expect their financial security to improve during the next year, up from 25 percent in December 2012.”

But for now, the circus is back in DC, and it's entertaining even if the act is stale. At least it would be fun if the whole thing didn't cost so much. So what has austerity cost us in the United States? The full price is hard to calculate, but the Congressional Budget Office figures that sequestration alone has cut GDP growth by about 0.8 percentage points. Since sequestration accounts for less than half of total belt-tightening over the past couple of years, a rough guess suggests that our austerity binge has cut economic growth by something like 2 percentage points—about half the total growth we might normally expect following a recession. Ironically, this means that we have indeed suffered the halving of economic growth that Reinhart and Rogoff estimated we’d get from running up the national debt above 90 percent. But we got it from not running up the debt. Go figure.

Jamie Dimon, the CEO of JPMorgan met with US Attorney General Eric Holder today, looking to cut a deal to end investigations into the bank's mortgage securities deals leading to the 2008 crisis. The talks might result in an $11 billion settlement; $7 billion cash and $4 billion in various forms of borrower relief; which is another way of saying it's really just a $7 billion dollar settlement, with some extra work for the accounting department on the side. Remember last year's multi-state, multi-bank $25 billion mortgage settlement? A new report shows the vast majority of the aid to borrowers came in the form of short sales and forgiveness of second mortgages. Just 20% of the aid doled out under the national settlement went to forgiveness of first-mortgage principal.

JPMorgan has been trying to negotiate a smaller settlement of perhaps $3 billion, but that lowball offer was rejected. A settlement of the government mortgage cases in the $11 billion range would likely include claims from the regulator of Fannie Mae and Freddie Mac, which has sought some $6 billion from the bank over risky mortgage securities sold to the government-sponsored entities. There are also talks about which liabilities would be covered in the announced amount of a deal. There are still state investigations and various other probes. The Justice Department has a minimum of seven different probes into JPM and they're reportedly trying to settle as many as possible in rapid fashion.

JPMorgan's litigation costs totaled $17.3 billion over the last three calendar years, according to the company's annual report. Add another $11 billion and soon you're talking real money; and yet for all that, remarkably, unbelievably, no senior executives have criminally charged. It's a whole lot of money, completely detached from personal responsibility. JPM has a ton of money. Earnings estimates are pegged around $22 billion for 2013 and the company has a market cap of about $200 billion. Is $11 billion enough of a payoff to get the regulators to leave Jamie Dimon alone?

This is just the cost of doing business for these mega banks. There's the rub. Paying off regulators and settling criminal charges is only supposed to be the "cost of doing business" for criminals. When the FBI goes after the Mafia the stated goal was putting them out of business. There is no specific goal when it comes to cracking down on Wall Street. Only a portion of the settlements collected go to the actual victims. For the most part the money is used to fund more investigations. As long as JPM's income exceeds its legal fees they have no economic incentive to stop pushing the law at every opportunity. 

Most of JPMorgan's penalties did not include an admission of wrongdoing, but last week's $920 million dollar settlement of the London Whale trades did include an admission of wrongdoing. JPMorgan had to confess to Sarbanes Oxley violations.

The reason that this is a big deal is Sarbanes Oxley was designed expressly to get past the “I’m the CEO and I have no idea what happened” defense. Sarbanes Oxley requires corporate executives, which generally is at least the CEO and the CFO, to certify the adequacy of internal controls. And for a big bank, that includes risk controls. You can’t pretend to have adequate controls when, as the SEC describes, management is shocked to learn that their trading desk in London is involved in wildly reckless trades. But it isn’t just banks that have to now take Sarbanes Oxley seriously, although they are the most obvious targets. Everyone who signs Sarbox certifications is now at risk, as they were supposed to be all along. Jamie Dimon has met all the conditions for a criminal prosecution under Sarbanes Oxley, and the only reason why he hasn't been indicted is he heads a Too Big To Fail bank.

And so there was a meeting today between AG Holder and Dimon, arguing about price.

Meanwhile, on an only slightly related note, a new report from In the Public interest reveals that private prison companies are striking deals with states that contain clauses guaranteeing high prison occupancy rates. The report, "Criminal: How Lockup Quotas and 'Low-Crime Taxes' Guarantee Profits for Private Prison Corporations," documents the contracts exchanged between private prison companies and state and local governments that either guarantee prison occupancy rates (essentially creating inmate lockup quotas) or force taxpayers to pay for empty beds if the prison population decreases due to lower crime rates or other factors (essentially creating low-crime taxes).

Some of these contracts require 90 to 100 percent prison occupancy. In a letter to 48 state governors in 2012, the largest for-profit private prison company in the US, Corrections Corporation of America (CCA), offered to buy up and operate public state prisons. In exchange, states would have to sign a 20-year contract guaranteeing a 90 percent occupancy rate throughout the term.

While no state accepted CCA’s offer, a number of private prison companies have been inserting similar occupancy guarantee provisions into prison privatization contracts and requiring states to maintain high occupancy rates within their privately owned prisons. Three privately run prisons in Arizona have contracts that require 100 percent inmate occupancy, so the state is obligated to keep its prisons filled to capacity. Otherwise it has to pay the private company for any unused beds. The report notes that contract clauses like this incentivize criminalization, and do nothing to promote rehabilitation, crime reduction or community building.