Wednesday, August 20, 2014 - Sunlight is the Best of Disinfectants

Sunlight is the Best of Disinfectants

by Sinclair Noe

DOW + 59 = 16979
SPX + 4 = 1986
NAS – 1 = 4526
10 YR YLD + .02 = 2.42%
OIL + .63 = 93.49
GOLD – 3.80 = 1292.40
SILV + .04 = 19.55

No economic reports today, but the Federal Reserve released the minutes of the July 29-30 FOMC meeting. You will recall that the Fed left interest rates unchanged and continued the taper by reducing large scale asset purchases by $10 billion a month, with the plan to end purchases by October. The Fed had said in its policy statement following the July meeting that there was "significant" labor market slack, but the minutes showed many members of its policy-setting panel thought this characterization "might have to change before long."

Most Fed officials wanted further evidence the labor market and the economy were showing significant improvement before changing their view on raising rates, but they said, "Labor market conditions had moved noticeably closer to those viewed as normal in the longer run," and policymakers "generally agreed" the job market was healing faster than they had expected.

Most Fed policymakers felt any change in their view on when to start raising rates "would depend on further information on the trajectories of economic activity, the labor market and inflation." Well, we got more data yesterday showing that inflation is not a problem yet; so that leaves economic activity and the labor market. The economic trajectory has remained sluggish since the beginning of the recovery; GDP turned negative in the first quarter of this year and then showed a very strong bounce in the second quarter. Is the second quarter bounce sustainable? It seems most Fed officials think it could be. And the Fed minutes almost seem to gloss over this long-term sluggishness, or what the Center for Economic Policy Research callssecular stagnation. What is secular stagnation?

A persistent gap between actual and potential output. Because of an imbalance between saving and investment, the nominal interest rate required to maintain full employment falls to less than zero -- not just briefly, but persistently. Since the rate can't be cut to less than zero, monetary policy (as currently conceived) can't keep the economy running at full potential.

A slowdown in growth of potential output. This may happen because of demographic changes, or because innovation isn't what it used to be, or for other reasons.

An irreversible drop in the level of potential output. Even if the full-employment rate of interest is still positive and the growth in potential output hasn't slowed, the recession may have permanently cut its level -- for instance, by causing workers to leave the labor force and not come back. Even if the economy now grows as fast as it did before, it's on a lower track and won't ever converge with the path it was on pre-crash.

This all means that the Fed’s long awaited economic liftoff might not happen, at least for another 20 years or so. But the Fed doesn’t seem to be concerned with this problem, which means that if the US economy experiences secular stagnation, the condition will be self-inflicted.

That leaves the Fed with the question of the recovery in the labor market. So, it really boils down to jobs. More jobs, and specifically, the quality of the jobs. So far, the average wage is stuck at $24.25 an hour; too many jobs are part-time or temporary. If we start to see some movement on wages, and more full-time positions, that might be a sign for rate increases. One area of remaining slack is the low participation rate, the percentage of working age population that is still in the labor pool; many people got out of the pool. Last month the economy added 209,000 net new jobs. The unemployment rate moved up to 6.2% from 6.1%. The jobless rate can rise for both good reasons (more people looking for work) and bad reasons (fewer people having a job).  Even though the economy added jobs, more people joined the labor force, and that is why the unemployment rate moved higher.

There are many things that could derail the recovery in the labor market, but for now the Fed thinks things are on track, and that means a probable rate increase in the first half of 2015. Any rate increase is likely to be incremental. Right now the fed funds target rate is between zero and 0.25%. It would likely be increased by 25 basis points, with the lower range representing the rate on overnight reverse repurchase operations. In reverse repos, the Fed borrows funds overnight from banks to mop up excess cash in the financial system.

Market reaction to a slightly more hawkish Fed stance: well, the dollar index continued higher, Treasuries dropped but then settled down, precious metals were a little lower, oil was higher, stocks initially threw a little tantrum and then recovered. After all, there were no real surprises.

Elsewhere, we’ve been waiting for the Department of Justice announcement on a settlement with Bank of America. Bank of America has reportedly reached a record $17 billion settlement to resolve an investigation into its role in the sale of mortgage-backed securities before the 2008 financial crisis. The official announcement will come tomorrow. The deal works out to $10 billion in cash, and $7 billion in soft dollar consumer relief - which is really a gift to the bank involving credits for various forms of consumer aid that the bank would or should be doing anyway. So, if you have a BofA mortgage and you’ve been having trouble with a loan mod or a refinance – try again. And by the way, the bank will make money on consumer aid.

The deal requires Bank of America to acknowledge making serious misrepresentations about the quality of its residential mortgage-backed securities issued by itself and by Countrywide Financial and Merrill Lynch. In exchange, BofA will probably not have to actually admit wrongdoing, and they get a free “get out of jail” card.  

Usually these settlements include a statement of facts which is most notable for its absence of facts and details. That silence means the Department of Justice is essentially protecting the banks from private lawsuits by deliberately withholding evidence which could result in even further disclosure of really bad behavior and even bigger damages and other unexpected outcomes. The biggest unexpected outcome would be that the public finally says to hell with the bankster criminals and we all see through the flimsy apologists in the media and the cronies in politics.

Most people know the banksters got away with murder; and I use the word literally, not figuratively. Most people want to see bankster executives prosecuted. Most people understand that the fines in these settlements are just a slap on the wrist, cost of business paid by shareholders, and taxpayers. Yep, the fines are typically considered tax deductible.

Tomorrow, the DOJ will announce the biggest settlement ever against a bank: $17 billion. But we know, it’s really a little under $10 billion in cash, with all kinds of little gifts to the banksters to soften the blow. And we know this will do nothing to deter future wrongdoing. You can place a huge derivative bet that they’re still committing those same crimes and new ones (such as subprime auto), so the prosecution clock resets daily.

And the crazy part is that the Department of Justice and BofA think we’re all too stupid to understand the cronyism. They will portray the settlement as a get tough stance on the bankers. Hogwash, I know it, you know it.

About 100 years ago, Supreme Court Justice Louis Brandeis wrote his famous statement that "sunlight is said to be the best of disinfectants" in a 1913 Harper's Weekly article. He went on to say that transparency is “justly commended as a remedy for social and industrial diseases.” Brandeis actually wrote privately about the idea of transparency 20 years earlier, writing, “about the wickedness of people shielding wrongdoers and passing them off (or at least allowing them to pass themselves off) as honest men."

About 100 years ago, the country was struggling with what was known as the Money Trust, the rough equivalent of today’s systemically important financial institutions, or too big to fail banks. Brandeis asked how the great wealth of his day had been accumulated, and he concluded: “power breeds wealth as wealth breeds power. But a main cause of these large fortunes is the huge tolls taken by those who control the avenues to capital and to investors. There has been exacted as toll literally ‘all that the traffic will bear.’”

Just a reminder, some of the mortgage problems of Bank of America date back to their acquisition of Countrywide; BofA had their own illegal mortgage problems. The guy who started Countrywide and nearly ran it into the ground is Angelo Mozillo. Until now, the harshest penalty imposed on Mozilo has been a $67 million settlement with the SEC from 2010 to resolve allegations that he misled Countrywide investors. Actually, Mozilo was forced to disgorge about $45 million from the sale of stocks, some of which may have been based on insider information; and then Bank of America paid for most of the other penalties; which is to say shareholders and consumers paid for Mozilo’s penalties.

The US attorney’s office in Los Angeles is now preparing a civil lawsuit against Mozilo and as many as 10 other former Countrywide employees. Government attorneys plan to sue Mozilo, Countrywide’s former chairman and chief executive officer, and other individuals using the Financial Institutions Reform, Recovery and Enforcement Act. The law, approved by Congress in 1989 in response to savings-and-loan scandals, gives prosecutors 10 years to bring cases and has less stringent liability requirements than criminal charges.

Prosecutors dropped a criminal probe of Mozilo in early 2011. The Citizens for Responsibility and Ethics in Washington, a watchdog group, sued the Justice Department in June to try to obtain its records detailing investigations of Mozilo and Countrywide. The group faulted the government for failing to prosecute either Mozilo or the company “despite substantial evidence of wrongdoing.”

Wednesday, October 24, 2012 - Do the Hustle

Do the Hustle

by Sinclair Noe

DOW – 25 = 13,077

SPX – 4 = 1408

NAS – 8 = 2981
10 YR YLD +.01 = 1.77%
OIL - .43 = 88.30
GOLD – 6.20 = 1702.50
SILV + .06 = 31.83
PLAT – 12.00 = 1566.00

Someday, we'll get through a whole week without having to report on the never-ending string of bad behavior by the big banks. I thought this might be the week. There were other things in the news; the Presidential debate on Monday; the Federal Reserve FOMC meeting today. We even had a proxy for the bad banks; the giant insurance company AIG reached a settlement with 39 states for creating a death list, where they would stop paying on annuities when someone died but they wouldn't look for beneficiaries of a life insurance policy. Then to top it off the CEO, Robert Benmosche, said he was indignant that nobody in the government had thanked him for paying back the bailout money that kept the company from total collapse 4 years ago. And over the past couple of weeks, Chase and Wells Fargo were sued for shoddy and virtually non-existent underwriting of mortgages that failed. Who was left?

You might think the big bad banks would take the week off from the news cycle. Yes, someday, we'll break the bonds of this gruesome litany of dirty deeds; someday this war will end. But not today.

The latest federal lawsuit over alleged mortgage fraud paints an unflattering picture of a doomed lender: Executives at Countrywide Financial urged workers to churn out loans, accepted fudged applications and tried to hide ballooning defaults. The prosecutor described Countrywide's reckless lending practices as “spectacularly brazen in scope.”

The suit claims Countrywide introduced a program called the “Hustle” or “High Speed Swim Lane” (lousy acronym)to churn out mortgage loans. No income, no problem. If the computer program raised a red flag, just change the numbers. Bonuses were based on quantity not quality; and later, bonuses were paid on the ability to hide the high number of defaults. We've seen this story before:everyone was incompetent, nobody verified income in the no-income-verification loans, when they found defects they hid them, and there were sleazy changes in procedures and compensation practices whereby Countrywide went from “try to originate lots of good mortgages” to “try to originate even more lots of mortgages with no quality standards whatsoever and also there’s a bonus for steamrolling quality-control checks.” Also it’s got a terrible name – the “Hustle”; one of these days there’s going to be a lawsuit about a mortgage lender called the Fast Underwriting Basis Alternate Rate program. Figure out the acronym for yourself, or make up your own; it's fun.

And after Countrywide wrote the loans and lied about the quality of the loans, they sold the loans to Fannie Mae and Freddie Mac; that's where we all get involved. Taxpayers have spent $170 billion to keep Fannie and Freddie afloat, and it could cost $260 billion more to support the companies through 2014. The lawsuit says that Fannie and Freddie suffered $1 billion in losses because they had to pay for Countrywide's defaulted loans. The lawsuit also complains that Bank of America is refusing to buy back mortgages "even where the loans admittedly contained material defects or even fraudulent misrepresentations."

Bank of America bought Countrywide Financial in 2008 and it’s fair to say it hasn't been a happy marriage; the Murdoch Street Journal totaled up the Countrywide losses at approximately $40 billion, as of last summer. If you held stock in BofA, be sure to thank Hank Paulson and Angelo Mozilo. If you were trying to figure out the maximum past and future losses you might start with the fact that Countrywide Financial originated about $2.25 trillion of mortgages between 2003 and 2007.

The fun fact about today's lawsuit is that it is originating from the Department of Justice; meanwhile, Fannie and Freddie are independently trying to get back money from BofA. Now I don't know if these are overlapping bad mortgages, or a different batch of bad mortgages.

Another day another bad bank story. The Royal Bank of Scotland agreed to pay $42.5 million late Tuesday in a settlement with the Nevada attorney general that ends an 18-month investigation into the deep ties between the bank and two mortgage lenders during the housing boom. Most of the money paid by R.B.S. — $36 million — will be used to help distressed borrowers throughout Nevada. In addition, R.B.S. agreed to finance or purchase subprime loans in the future only if they comply with state laws and are not deceptive. The settlement between the bank and Catherine Cortez Masto, Nevada’s attorney general, relates to conduct at Greenwich Capital, the R.B.S. unit that bundled mortgages into securities and sold them to investors. Nevada found that R.B.S. worked closely with Countrywide Financial and Option One.

International Paper has agreed to pay the FDIC to settle a year-old lawsuit stemming from the 2009 collapse of Guaranty Financial Group, an Austin, Texas, company that ranks as the fifth-biggest U.S. bank failure. As part of the agreement, the failed bank’s creditors will get an added $38 million, bringing the total settlement to $80 million. Although International Paper didn’t have any direct connection until this year to the banking industry or to the failed Texas bank, its involvement in the case demonstrates the long tentacles of the financial crisis. International Paper was pulled into the case in February when it bought packaging firm Temple-Inland, which had owned Guaranty for nearly two decades before spinning it off into an independent company in 2007. Guaranty failed less than two years later, weighed down by toxic securities that were backed by adjustable-rate mortgages. It had 162 branches and $13.5 billion in assets. The failure cost the FDIC’s deposit-insurance fund $1.29 billion

Meanwhile, with a splash of irony that would make even Socrates cringe, the Federal Reserve concluded its FOMC meeting today and announced they will keep interest rates at zero and they will stimulate the economy by purchasing $40 billion a month in mortgage backed securities until the economy improves or the cows come home. The Fed went on to say that inflation is not a problem, consumer spending isn't strong but it isn't weak and the economy continues to expand as it is stumbling along and they really didn't say much with two weeks to go before an election. The FOMC meets again in December, just in time to preview the fiscal cliff. For now, job growth has been slow and the unemployment rate remains elevated, so pass the MBS.

Fed Chairman Bernanke is seeking to spur the economy with a third round of quantitative easing, and he says his stimulus works by lowering borrowing costs and encouraging investors to seek higher-yielding assets. Boosting home and equity prices through bond buying will encourage consumers and businesses to spend more. Since these are the same assets that plummeted during the financial crisis after reaching record highs, “is there some risk you could start a new bubble and repeat the whole cycle?

While Federal Reserve Bank of New York President William Dudley acknowledged that current policy “could distort asset allocations and lead to renewed financial-asset bubbles,” this isn’t a risk now, he said in an Oct. 15 speech. Dudley says: “There is little evidence of problems or excesses, but this could change.” Dudley said the Fed’s policies are affecting yields in the bond market though “to say that’s a bubble, I don’t think that’s quite right.” He added that the debt market is a “lever of policy” for the central bank. And we should pay no attention to the man behind the curtain, pulling the levers.

The Standard & Poor’s 500 Index reached 1,465.77, the highest since 2007, on Sept. 14, the day after the FOMC said it would buy $40 billion of mortgage-backed bonds a month without limiting the total or duration of purchases. QE1, QE2, Operation Twist, and the ECB-led Long-term Refinancing Operation which a year ago was a really big deal in unleashing a massive global risk-on trade. But this time around the laws of diminishing returns are setting in. Six weeks after the unveiling of QE3, the market is down 2%. This hasn't happened before. Every economic-sensitive sector is in the red, and even Financials, the one sector that should benefit, have made no money for anybody.

Home prices also have begun to rise, jumping in the second quarter by the most in more than six years. The real question is how does the Fed know whether or not these prices will prove to be justified in the long run? The Fed doesn’t have perfect knowledge about what constitutes a sound long-term price for equities or housing, but this is a risk the Fed is willing to take. I know you don't want to fight the Fed, just be careful when they send you out to hunt high yield.