Wednesday, May 30, 2012 – Spanish Winter, Mexican Spring – by Sinclair Noe

DOW – 160 = 12,419
SPX – 19 = 1313
NAS – 33 = 2837
10 YR YLD – 0.11 = 1.62%
OIL – 3.38 = 87.38
GOLD + 7.70 = 1563.50
SILV +.05 = 28.03
PLAT – 28.00 = 1406.00

Yesterday the Dow gained 125 and I said: “The reason du jour for today's market gains: positive news regarding Greece. Really? I'm not buying it. Make up your own reason for today's gains because we are just as likely to see declines tomorrow.”

And sure enough. The problem du jour was Spain and the Dow dropped 160. This economic stuff is easy. Remember when I told you a couple of months ago to get out in May? The S&P 500 has fallen nearly 6 percent in May, heading for its worst monthly performance since September. You're welcome. The Nasdaq is down 6.9% for the month. US Treasury benchmark yields fell to their lowest in at least 60 years. Oil dropped more than 3 percent to the lowest level in nearly six months; oil prices are down 16% in May. The dollar remains the cleanest shirt in the dirty laundry hamper, up 5.5% for the month. The euro dropped below $1.24 to a 23-month low. Spain's stock market hit a 9 year low. Yields on 10-year Spanish bonds topped 6.6%, which is close to levels at which Ireland and Greece sought international bail-outs.

The news from Europe was all Spanish overnight as the country struggles to find traction on any plan that will lead it away from the need for external help The Spanish Economy Ministry played down a report that the European Central Bank had rejected an initial plan to rescue Bankia, Spain's fourth biggest bank, by stuffing it with government bonds that could be used as collateral to borrow from the ECB. A ministry spokeswoman said: "Spain did not formulate any proposal to the ECB on funding the Bankia plan, so it was difficult for it to have an opinion."

Spanish Prime Minister Mariano Rajoy insisted the government has no intention of seeking an EU/IMF bailout either for its banks or for the state, but then a Governor for the Bank of Spain resigned, abruptly, a month before his term was due to end, adding to concerns about the handling of the Bankia crisis and relations with European institutions.

Highlighting Spain's difficulty in meeting fiscal targets while gripped by a worse-than-forecast recession, the outgoing central bank chief said tax revenue may fall short of government estimates and spending may be higher than expected. He recommended bringing forward a rise in value-added tax set for 2013 if the deficit objective goes off track this year.

Also, Spain announced its joint national-regional bond issuance scheme would go live within days:

Spain’s government said it would approve the issuing of joint bonds by the 17 regional governments next Friday, so as to make it cheaper for them to finance their debts. And so the blurry line between Spanish banks and national and regional governments gets a bit more out of focus. The problems of Spain’s economy all stem from the fact that the government sector is attempting to implement an austerity program at a time when the private sector is in deep retrenchment. Given the economic and political circumstances the country finds itself in it may have no choice, but that won’t change the outcome. Private sector demand is falling and economic circumstances continue to make it harder for the private sector to recover from the economic shock of the housing market collapse. The Bank of Spain says retail sales declined in April at a record rate and the economy will slow even more in the second quarter. It looks like Spain has entered the very nasty and possibly inescapable downward spiral.

Meanwhile, the National Bank of Greece is threatening that the Greeks face economic catastrophe if they leave the euro. Living standards would plummet, incomes would be slashed by more than half, and inflation and unemployment would skyrocket. The bank claims per capita income would collapse by at least 55 percent, the new national currency would depreciate by 65 percent against the euro and a recession (I hate to think what a depression would look like for Greece), now in its fifth year, would deepen by 22 percent, pushing unemployment and inflation through the roof.

Tomorrow the Irish vote in a referendum on a European budget discipline treaty which is seen as a precondition for receiving further EU/IMF aid.

So far, voters in Europe have sent an inescapable signal to the EU powers that be: no more austerity. In doing so, they showed that the average voter has a better understanding of economics than the technocrats in charge. So far, the all-austerity plan has not solved the debt crisis and has sent weaker economies into depression, with high unemployment, higher and higher costs to service debt, and strain that threatens the union. There is a case to be made that the problem with austerity is not the austerity itself, but the pace at which it is being imposed. Rather than a mad rush to meet euro-zone deficit limits, more flexibility is needed to allow governments to adjust over a longer period of time and benefit from economic recovery.

And there is another argument that says whatever the verdict at the ballot box, Euro-land can't avoid austerity. Its indebted governments can’t simply return to spending and borrowing as they had in the past. Financial markets just wouldn’t stand for it. And what we really have is a battle to see who will prevail in Europe, democracy or financial markets. Of course, a democratic union can suport financial markets, and indeed the vast majority of Europeans are in favor of keeping the Euro-union intact. However, the bigger question is whether the financial markets can live with a democracy, which can be messy at times. So far, there doesn't seem to be much flexibility.

The world is a dangerous place; the Muslim Brotherhood has been elected to lead Egypt past the Arab Spring. Syria is being butchered by a madman. UN nuclear inspectors showed new satellite imagery indicating that Iran may be conducting clean-up work at the military site where inspectors suspect tests relevant to developing nuclear weapons have been carried out. 

Meanwhile, just one state to the south, in case you hadn't noticed, is another exercise in flexibility, or lack thereof. I found this report on the situation in Mexico. On May 6th, the four candidates for the Presidency debated. In a nation where the internet reaches only 30%, and few can afford cable, the debate was not carried on broadcast television. The Federal Electoral Institute (IFE) chose to have a former porn star host the debate. She was clad in a thin, revealing white dress.

On May 11th, the PRI's candidate, Pena Nieto, attempted to speak at Mexico's elite Iberoamericana University. Student protests prevented him from speaking.

As governor of the State of Mexico, Nieto had repeatedly used police force to prevent student protests. In the wake of the Iberoamericana protests, thousands marched through Mexico City, and then other cities, against Pena Nieto. Their demands were simple: above all, clean elections. An end to corruption and manipulation in the IFE. Fair and equal access to the media-- an end to the unfair, biased and deceptive coverage by Party-controlled media.

In the weeks that have followed, this youth movement has come to be known as "YoSoy132," or "I Am 132." It takes some of its inspiration from the Occupy and Anonymous movements. It remains independent, its primary focus on organizing to observe the polls and, if possible, ensure their integrity.

Much and serious talk has arisen, of a "Mexican Spring." What this would mean, remains unclear. In both Eastern Europe and the Middle East, it entailed replacing authoritarian governments with democratic regimes. In Mexico, the loudest criticisms of the democracy movement remain focused on "stability." These same critics argue loudest that Mexico today is a democracy, with a three-party system and a limited Presidency. All experience from the past twelve years, says something different. Mexico's youth today, say something different.

The question is-- what would a Mexican Spring consist of?

We're coming up on the 2 year anniversary of the Dodd-Frank financial reform law. This was the response to the abuses of the financial industry that resulted in the near meltdown of the global financial system in 2008. Two years after the law was passed and it hasn't made any real difference. I can say that with some certainty because only a small portion fo the law has been enacted; the rest is under consideration and review; and every line in the law is being beaten back by the banks. This means the big part of the law; like bringing transparency to the trading of derivatives and the Volker Rule, which would theoretically eliminate banks making risky trades through their proprietary trading desks, those parts have not been enacted.

And even if Dodd-Frank survives the attacks of the banking lobbyists, there are doubts about its potential efficacy. Recently, there have been complaints that the law is overly complex. This is a good argument because the law runs about 2,000 pages and damn near nobody has read the whole thing, much less figured out the implications. Banking has become incredibly complex. The recent multi-billion dollar trading flop by JPMorgan just underscores how complex banking has become; and their trading activity has become so complex that they don’t' even understand the ramifications of their own actions; the regulators certainly lack awareness and the banks' own efforts at self regulation are laughable. On top of all that we don't know if Dodd-Frank regulations will be effective and we don't know if they will ever be implemented. So, that leaves us facing the same problems we faced in 2008.

You might have noticed there is a strong anti-regulatory sentiment this election year. Maybe you've heard about the “regulatory tsunami of unprecedented force” issuing from Washington. Maybe you've heard about the “vast edifice of regulations” or the “regulatory jihad”. The truth is that the Obama administration has issued slightly fewer rules than George W. Bush did at the same point in his tenure. And the cost benefit analysis has shown fewer costs to business than the previous administration. That restraint means that two-thirds of the rules proposed in Dodd-Frank have not been implemented; four years after the near collapse of the financial world as we know it and we haven't done anything to correct the problem. I understand that nobody likes the burdens of regulations but I also don't like salmonella in my spinach; I don't like cars that have exploding gas tanks; I don't like factories that spew toxic waste into the air or into rivers; I don't like businesses that force children to work on their assembly lines; I don't like businesses that discriminate against people because of the color, religion, gender, or other orientation; and I don't like banks that gamble with deposits and threaten to destroy the economy unless taxpayers bail them out.

What is going to prevent a repeat of 2008? Whether we are ready to admit it or not, Dodd-Frank is dead on the vine. The Senate Banking Committee's ranking Republican, Senator Richard Shelby of Alabama, has vowed to repeal Dodd-Frank altogether. The panel’s chairman, Senator Tim Johnson of South Dakota, and Senator Charles Schumer, a Democrat of New York, have called for looser rules on banks’ international derivatives trades. After JPMorgan’s losses came to light, Senator Johnson said it shows“why opponents of Wall Street reform must not be allowed to gut important protections for the financial system and taxpayers.” He is right. Now he and other committee members, and the regulators, need to show what they have learned. Don't hold your breath. Senator Johnson's biggest campaign contributor – JPMorgan. What is needed are requirements for derivatives to be traded on transparent exchanges — which would have prevented the trades from piling up without notice. Banks should also be required to move any derivatives deals into separately capitalized bank affiliates, which would protect taxpayers, and the banks, from disastrously large losses. Banks fought hard to keep those provisions out of Dodd-Frank, and, even now, they are still pressing to scale them back. The derivatives marketplace has grown to more than $700 trillion in size. It is the wild wild west of finance, and it is ground ripe for tax evasion and other abuses.

The simple solution would be to reinstate Glass-Steagall, the old depression era response to the problem of Too Big to Fail Banks. Split the banks into a traditional bank and an investment bank. The traditional bank takes deposits and makes loans; safe, conservative, and boring. The investment bank can make trades and if they win they keep the profits and if they lose, the depositors accounts would not be affected, and the investment banks could sink or swim based on their own performances. No wonder the bankers are opposed.

Tuesday, May 29, 2012 - Dithering About Europe - by Sinclair Noe

DOW + 125 = 12,580
SPX + 14 = 1332
NAS + 33 = 2870
10 YR YLD -.01 = 1.73%
OIL +.08 = 90.84
GOLD – 18.90 = 1555.80
SILV -.55 = 27.98
PLAT – 9.00 = 1432.00

The reason du jour for today's market gains: positive news regarding Greece. Really? I'm not buying it. Make up your own reason for today's gains because we are just as likely to see declines tomorrow. Still, Europe is important.

Philadelphia Federal Reserve Bank President Charles Plosser said Monday that people in the United States have no need “to get all in a dither” over Europe’s debt crisis. Plosser feels that Europe’s economic problems could even benefit the US in the short term. It is “not an unreasonable argument,” he said, that low US interest rates and gas prices in response to the uncertainty in Europe’s financial situation could offset any potential difficulties for the American economy. Plosser said Europe “is just throwing a lot of noise into the system right now. It makes reading the tea leaves particularly difficult right now.” He noted, however, that a “flood of liquidity” into the US seems much more likely than investors running from US financial institutions. But, he added, the Fed will be able to deal with any fallout from Europe’s economic troubles. He believes the Fed has the necessary tools to deal with the situation, no matter what the situation.

So, how is the Euro situation likely to be resolved? Well, the Greek election is June 16, so the Euro probably won't implode before the election, however there will be significant posturing. Most Greeks want to stay in the euro-union; by a wide majority of over 80%. The last election was an opportunity to express anger with the mainstream centrist parties that had made such a mess. The reality is that most Greeks don't like the extreme right wing and left wing parties. Look for a return to the center, maybe the center-left.

Once Greece actually has a government, the most likely solution is for Germany and France to reset interest on Greek debt to zero, and possibly some partial defaults on debt. The Greeks are not likely to accept more austerity without seeing the banksters take a haircut. And this might be the only way for the Greeks to get out of debt, depending on the terms. And there's the rub. The terms of any deal will likely be punitive; in which case, the deal never gets done, or the deal goes sour within a year or so.

The latest plan is actually a plan floated last year by Germany’s opposition parties that involves joint European liability for nations’ sovereign debt. It’s called the European Redemption Pact (PDF). Since fresh thinking on the European debt crisis is badly needed, it’s worth taking a look. Here’s the plan in a nutshell: The debt of the 17 countries belonging to the single-currency euro zone is split into two parts. The portion up to 60 percent of each nation’s gross domestic product stays on the books, unchanged.

The portion of nations’ debt exceeding 60 percent of GDP is transferred into something called the European Redemption Fund. The 17 countries are still liable for the portion of their debt that’s transferred in the fund. They have 20 or 25 years to pay it off.

Legally, however, all 17 nations are jointly liable for the debt placed in the fund. This is a way for low-debt nations such as Germany to backstop high-debt nations like Greece, giving peace of mind to their creditors and lowering interest rates. To make sure countries pay off their debt in the European Redemption Fund, some of their national tax revenue would be earmarked for repayments. They would also have to commit to fixing national finances to free up money for debt service. Having gotten the rest of their debt down to 60 percent of GDP, countries wouldn’t be allowed to run it back up. There would be automatic “debt brakes”.

If this is the best tool to deal with the Euro-debt problem then there is reason to get your dither up; there is reason for the Greeks to spit on such a deal; there is no way they could repay the Redemption Fund while containing debt to GDP ratios.

If the Germans really want redemption, the solution is really quite simple, eliminate usury against the Greeks; cut interest rates to zero; wipe out some of the existing debt; take the hit now and make the future better; give them a fighting chance; treat them with some dignity and stop treating them as lazy thugs.

And this brings us back to the comments from Philly Fed Prez Plosser; he claims there is no reason to get all in a dither over the euro-debt crisis. He may be right but it would require more compassion and more common sense than the ECB, the IMF, and the euro-banksters have demonstrated to date.

Meanwhile, here is another example of why the Greeks voted for the extreme fringe. The Greeks don't have a governmetn, they don't have bandages in their hospitals, and the bailout money from the Euro-union, well that goes to the banks; $22.6 billion for Greeks four biggest banks — via bonds from the EFSF, the European Fubar Slush Fund. The Hellenic Financial Stability Facility was set up to funnel funds from Greece’s bailout program to recapitalize its banks. As long as this is the priority, it is understandable why the Greeks are voting angry.

Of course, the euro-crisis is no longer contained in Greece. Spain is standing on the edge of the financial cliff. Last week, Spain nationalized their fourth largest bank, Bankia. Late today, we learned the European Central Bank has rejected Spain's proposed plan to recapitalize Bankia with government bonds. Spain had proposed putting $24 billion in sovereign bonds into Bankia's parent company, which would then get swapped out for cash at the ECB's three-month refinancing window. The ECB reportedly rejected the plan on the grounds it violated EU rules against central bank funding of governments. Apparently, consistency is not one of the tools in the central bankers' tool belt.

In the latest symptom of Europe’s financial turmoil, the region’s riskier companies are bypassing banks and investors at home and turning to the US for loans. European companies borrowed about $18 billion in the US leveraged-loan market this year, more than double the amount for all of 2011

The S&P/Case-Shiller home price index was unchanged in March; the good news is that it didn't go down; the bad news is that it remains at post-crash lows. Phoenix continues to lead the recovery, up 2.2% in the first quarter. San Diego was up 0.4% for the quarter. LA gained 0.1%. The worst performers in the first quarter: Detroit and Chicago.

The Conference Boards, consumer-confidence index declined to 64.9 in May, the lowest level since January and the third monthly decline. Consumers were less positive about current business and labor-market conditions, and they were more pessimistic about the short-term outlook. To assess how consumers view the employment environment, economists follow a labor-market statistic derived from the Conference Board’s report. The labor differential subtracts the percentage of respondents who said jobs are “hard to get” from the percentage who said jobs are “plentiful.” The labor differential hasn’t been positive since January 2008, near the beginning of the Great Recession. In May the labor differential reached negative 33.1% — the lowest since January — compared with negative 29.7% in April.

On Friday, the Labor Department will report on employment for May, and nonfarm payrolls are generally guesstimated to rise to 168,000, compared with 115,000 in April. Hundreds of thousands of out-of-work Americans are receiving their final unemployment checks sooner than they expected, even though Congress renewed extended benefits until the end of the year.

In February, when the program was set to expire, Congress renewed it, but also phased in a reduction of the number of weeks of extended aid and effectively made it more difficult for states to qualify for the maximum aid. Since then, the jobless in 23 states have lost up to five months’ worth of benefits.

Next month, an additional 70,000 people will lose benefits earlier than they presumed, bringing the number of people cut off prematurely this year to close to half a million.

Some states are making it harder to qualify for the first few months of benefits, which are covered by taxes on employers. Florida, where the jobless rate is 8.7 percent, has cut the number of weeks it will pay and changed its application procedures, with more than half of all applicants now being denied.

Most states offer 26 weeks of unemployment benefits, plus the federal extensions that kicked in after the financial crash. The number of extra weeks available by state is determined by several factors, including the state’s unemployment rate and whether it is higher than three years earlier. So states like California have had benefits cut even though the unemployment rate there is still almost 11 percent. Benefits have ended not because economic conditions have improved, but because they have not significantly deteriorated in the past three years. In May, an estimated 95,000 people lost benefits in California.

Friday, May 25, 2012 – It's Better Than It Looks, Striving For Happiness Amidst the Cow Pies - by Sinclair Noe

DOW – 74 = 12,454
SPX – 2= 1317
NAS – 1 = 2837
10 YR YLD - .01 = 1.75%
OIL -.06 = 90.60
GOLD + 15.90 = 1574.70
SILV +.21 = 28.63
PLAT + 14.00 = 1436.00

For the week, the S&P 500 rose 1.7 percent.  I'm of the opinion that life is better than it appears. We look around sometimes and the world can seem scary. Sometimes we have to look a little deeper to find the good, the decent, the delightful and the potentially pluperfect.

And that brings us to today's topic on the possibility of the Federal Reserve pumping money into the banking system through asset purchases, in other words, Quantitative Easing Part 3. Inflation expectations are falling, if you consider Treasury bonds as a gauge of inflation. The lower outlook for inflation gives the Fed wiggle room to stimulate the economy. Although, right now the Dow looks like a better QE indicator, and it is not indicating QE. The banks can always make a case for QE, but what about the Fed officials who make the actual decisions?

St. Louis Federal Reserve President James Bullard says he expects the U.S. economy to perform better than many forecasters anticipate and that the Fed will therefore need to raise interest rates in late 2013, not late 2014 as its policy committee is currently indicating.

Minneapolis Federal Reserve President Narayana Kocherlakota thinks the current labor market performance is much closer to maximum employment than the data alone would suggest. A few weeks back, Kocherlakota said the Fed should start looking at tightening monetary policy in the next six to nine months. He said he saw inflation at around 2% this year and 2.3% in 2013, numbers that signal the need to start exiting the central bank’s current ultra-easy policy.

New York Federal Reserve President Wiliam Dudley says:“My view is that, if we continue to see improvement in the economy, in terms of using up the slack in available resources, then I think it’s hard to argue that we absolutely must do something more in terms of the monetary policy front.” Dudley thinks economic growth at around 2.4%, is sufficient to keep the central bank from easing monetary policy.

Overall, the chatter from the Fed-heads seems sanguine. That could change before the June FOMC meeting. The monthly jobs report always carries the potential to shake a Fed governor to the core. The next FOMC meeting is June 19. The Greeks vote on June 17. Anything that can happen in 2 days would be addressed with liquidity programs, not easing, and liquidity programs have not needed FOMC meetings to be put into effect in the past. Fed officials know the timing of the Greek vote, and typically want to see the impact of events over time before responding with monetary policy tools.

Still, the Euro-leaders seem determined to impose austerity on the peripheral countries with pure cut off your nose to spite your face sensibility. Things in Euro-land could get nasty fast. The whole Lehman Brothers collapse was nasty fast; it could happen again. The Spanish word for Lehman is Bankia; the fourth largest bank in Spain has been nationalized; trading has been halted; they will be receiving a $24 billion dollar injection of cash recapitalization. And the recent JPMorgan bungle was a vivid reminder that Too Big to Fail banks still pose a very real systemic threat. Plus, it might shut up Jamie Dimon from whining about financial reform. Maybe Dodd-Frank and Glass-Steagall wouldn't have prevented multi-billion dollar losses, and still growing but now Dimon's argument sounds like someone debating we shouldn't have seat belts because they wouldn't have prevented Hurricane Katrina.

Still, absent a big dose of nasty, the situation is fairly good for us. We head into the Memorial Day Holiday with an improving jobs picture, low inflation, plenty of softness in the economy but not enough to warrant QE3 at this precise moment. And with global turmoil, strife, and trouble, money is looking for a safe haven and that not only props up the US economy but also QE3 would spoil the illusion and send money looking for safety elsewhere; that kind of a hit would be worse than the jolt of stimulus from QE3. Of course, the Fed is still accommodative and they still have an implied put in place and they're still printing money at a prodigious clip; but we're not spending with the recklessness of the recent past.

There’s a confused and confusing debate going on over whether President Obama has presided over a “spending binge,” as Republicans claim, or whether, under Obama, “federal spending is rising at the slowest pace since Dwight Eisenhower brought the Korean War to an end in the 1950s.”

The key is fiscal year 2009 -- and who you blame for it. By any measure, spending popped that year. If you’re looking at raw dollars, it rose by $535 billion. And “the 2009 fiscal year,” writes Market Watch’s Rex Nutting, “which Republicans count as part of Obama’s legacy, began four months before Obama moved into the White House.”

That’s true: The federal fiscal year stretches, somewhat weirdly, from October to September. So fiscal year 2009 began in October 2008.

And that’s the point of Nutting’s analysis: if you attribute most of fiscal year 2009 to George W. Bush then, after adjusting for inflation, federal spending under Obama has actually dropped by 0.1 percent. Politifact checked the numbers and agreed: “Using raw dollars, Obama did oversee the lowest annual increases in spending of any president in 60 years,” they write. “Using inflation-adjusted dollars, Obama had the second-lowest increase -- in fact, he actually presided over a decrease.”

The real issue is that 2009 is an anomaly driven by crisis. The Bush Administration screwed it up and drove the spending much higher. Obama stayed the course.

The question is where should spending be now? The Obama administration wanted it to be higher. After all, unemployment rose through 2010, and remains high today. It has proposed a raft of additional stimulus bills since 2009. Republicans in Congress, however, refused to pass most of their plans, and NOT because they had an epiphany on fiscal discipline; past action refutes any non-politicized argument. The lower spending numbers are due to Republican obstructionism but they're afraid to acknowledge the lower numbers, much less take credit for them – which would be an admission of responsibility for failed policy. Instead the Democrats are touting the lower spending numbers when in fact it is numeric proof they've had their legislative agenda and economic plans hoisted on a petard. Washington is so full of cow pies, they are unavoidable. And so the Fed is sitting back waiting to whitewash the lack of fiscal policy. It isn't exactly the checks and balances envisioned by our founding fathers but so far the tapestry is only slightly raveled.

And still, we head into the weekend with the price of oil in a nifty decline, and I don't know who to thank for that but I'll take it. The price at the pump is almost bearable except my long-term memory hasn't faltered completely, and for this I find comfort. The weather looks good for a barbeque. Speaking of long-term memory, this is the first Memorial Day in 10 years that the US hasn't been at war in Iraq. There are approximately 23.4 million US veterans, 1.7 million of whom served in Iraq or Afghanistan. And because of everything they gave, we have the freedom to do whatever we want, more or less. And now our Iraq War vets can spend the holiday at home. That's good. We have the choice to get buried under the negatives or we have the choice to strive for happiness. I'm pretty sure there is empirical evidence that the standard of living is improving. I'll look it up some day but for now I'm of the opinion that life is better than it appears. That's my story and I'm sticking to it. 

Thursday, May 17, 2012 – Banks Start to Run – by Sinclair Noe

DOW – 156 = 12,442
SPX – 19 = 1304
NAS – 60 = 2813
10 YR YLD -.06 = 1.70%
OIL +.17 = 92.73
GOLD + 34.00 = 1575.30
SILV +.78 = 28.15
PLAT + 19.00 = 1459.00

The Dow Industrials have now dropped for 11 out of the past 12 trading sessions, giving back all the gains going back to the start of the year.

Greece's caretaker Cabinet was sworn in this morning and they'll hold power at least until next month's election.  The European Central Bank has stopped providing funds to Greek banks. People have been pulling euros out of the Greek banks, concerned about a possible exit from the Euro-zone common currency and a return to the Drachma, which would be an effective devaluation. So Greek citizens take their money out the front door of the bank and the ECB refuses to replenish supplies, and something has to give. There will be an election in about one month. There will be attempts to find a resolution. German Chancellor Merkel is even considering lifting the jackboot of austerity from the necks of the Greeks. It is one thing to demand fealty, it is another to consider the very real possibility of a Greek exit from the Euro-union. Germans are starting to realize that a Greek exit from the Euro-union will be very expensive. Everybody is now doing a study to determine how much a Greek exit might cost; the numbers seem to run in the trillions. So, why not find a cheaper solution?

Which takes us to Spain. Bankia, one of the largest banks in Spain, has already been taken over by the government. Today, a rumor started that depositors were pulling money out; a classic bank run; Spain's top economic offical announced this was not a Greek-style bank run. Shares of Bankia slipped 29%, and closed down 14%. Bankia was clobbered by bad real estate loans. The problem in Spain goes straight back to a real estate bubble. We are constantly told the problem in Europe is profligate spending by the crisis countries. Fans of arithmetic know that Italy’s debt to GDP ratio, although high, was actually declining in the years just before the crisis. Spain and Ireland were both running budget surpluses. What did happen was that these countries, especially Spain and Ireland, had unsustainable housing bubbles that were fueled by foolish bankers in Germany and elsewhere in northern Europe. 

The drama served to drive up interest rates on bonds auctioned in Madrid. The situation in Spain is tenuous and the threat of financial contagion is palpable. Unemployment is around 25% and it's estimated that the black market now accounts for about 20% of all economic activity. The underground economy is a double edged sword; it robs the government of revenue but it keeps otherwise unemployed people afloat. Without the underground economy Spain would probably have violent social unrest.

Meanwhile, JPMorgan is having a hard time moving on. Earlier this week, they announced a $2 billion dollar loss in proprietary trades in the derivatives market. The loss has now grown to $3 billion. The trade involved credit default indexes or basically long positions in investment grade corporate bonds and short positions in high yield or junk bonds. This kind of trade is now very illiquid, and now that other traders know JPMorgan needs to unwind their position, they can apply the screws. It is becoming clear that the Value at Risk assessments were wrong, they are losing money faster than they thought possible. How much more will they lose? Nobody seems to know the potential liability, but it seems fair to say things are getting worse, at least for now.

Meanwhile, there are a few investigations into what is going on. The FBI, the DOJ, and the SEC are trying to figure out if any laws have been violated. We don't know what they're investigating. The unregulated world of derivatives would seem to be fertile ground for money laundering and tax evasion but a better guess is something more mundane, such as failure to certify internal controls or improper disclosures. The things CEO Jamie Dimon has said about Value at Risk just aren't adding up. And we learn the Chief Investment Office, the unit responsible for the loss had a separate VaR system. It used a less stringent calculation that gave a lower risk assessment of its trades. The unit also reported directly to Dimon, a factor which allowed it to maintain a separate risk monitoring set-up to other parts of the investment bank. Despite repeated warnings from executives inside the firm as long ago as 2005, the CIO unit remained notably free from oversight. And if there were indeed repeated warnings, then Dimon had a legal obligation to make that information public. He didn't.

The descriptions of the trades as hedges, not speculative trades, don't make sense. They had about $15 billion in distressed European debt. Europe has been in trouble, so those investments were losing value. Their story, which does not make sense, is that they decided to hedge this position with a derivative of a derivative. In this case, it was an index of credit default swaps, which is the form of derivative that blew up AIG. JP Morgan's story is that instead of offsetting the risk, the hedge increased the losses dramatically. They woke up one morning, and they had a $2 billion loss; and 4 days later it grew to $3 billion. If you have distressed European debt, you are supposed to have already reserved against the losses in it. So why hedge the position at all? Just sell it. Get rid of these incredibly risky assets before they can suffer any additional losses. If you already have losses, it is not necessary to recognize a loss, because you have already reserved for it. So, you should not have had to hedge, period.

You may recall that after the Enron debacle, there were laws written to require that financial statements contained truthful information. There are civil penalties for filing false certifications and criminal penalties for fraudulent filings. The law is known as Sarbanes-Oxley, but the reality is that nobody gets prosecuted. Still, if you were investigating Jamie Dimon, it might be a consideration. The problems at JPMorgan appear to be more than a mistake, it looks more like a material breakdown of internal controls and misrepresentations. And it just might be illegal. Not that it will matter much.

Treasury Secretary Tim Geithner said the trading loss by JPMorgan “helps make the case” for tougher rules on financial institutions, as regulators continue to think about the possibility of implementing the Dodd-Frank Reforms and the Volker Rule aimed at policing Wall Street. This would be funny except it isn't. It's dangerous. Geithner made the remarks after it was revealed the White House has been putting pressure on the Treasury Department to push for tougher rules on banks, which would be funny except, earlier this week President Obama was interviewed on the View and he talked about how: “JP Morgan is one of the best-managed banks there is. Jamie Dimon, the head of it, is one of the smartest bankers we got and they still lost $2 billion.” Which would be funny except it isn't. I guess the idea is to force JPMorgan to act responsibly by complimenting them excessively. It's an interesting strategy.

Wednesday, May 9, 2012 - Greek Government, Spanish Banks, Gold Prices - It's All Messy

DOW – 97 = 12,835
SPX – 9 = 1354
NAS – 11 = 2934
10 YR YLD unch = 1.84%

OIL - .56 = 96.45
GOLD – 15.40 = 1590.40
SILV - .20 = 29.37
PLAT – 12.00 = 1505.00

The Greek tragedy continues; no success so far in negotiations to form a coalition government after weekend elections resulted in a deadlock. It looks like there might be another election in June. The Greeks accepted another $5 billion dollar bailout payment today, so they keep the government afloat for a few more weeks. Now, the chatter is shifting to the very real idea that Greece will exit the Euro, and trying to figure out the implications. The concern is that exiting the Eurozone is going to be impossible and possibly will trigger a cascade of bad economic consequences. Absolutely right, but only because it might be done in an uncontrolled manner.

The Federal Reserve and the ECB and the IMF and all the others have been saying that the Euro-crisis is under control. If, or when Greece exits the Euro, nobody should be surprised; this train has been rolling down the track for a couple of years, and the Germans and ECB and IMF and Fed all had plenty of time to come up with solutions. And they didn't. So, now the Greek voters have come up with a solution. They didn't come up with a unanimous decision, not even a plurality. The whole thing was a crazy mish-mash of votes, ranging from communists to neo-nazis. Sometimes democracy is messy, but it looks like it has produced a solution in Greece.

Spain took over Bankia, the country's fourth biggest lender. In a deal that will give the state a 45 percent indirect stake in Bankia, the government will take control of its parent company BFA by converting into equity a 4.5 billion euro loan it had given the financial group previously. The economy ministry pledged to do all it takes to clean up Bankia, which has more than 30 billion euros of exposure to troubled loans to property developers and repossessed land and buildings. The government is expected to lend or give Bankia up to 10 billion euros in additional aid and it is widely expected that the bank will need more.

Since the banking crisis began, Spain has bailed out seven smaller savings banks, but the Bankia rescue is by far the biggest and it comes after a string of other banking reform plans revealed over the past week. These include moving toxic assets out of some banks and demanding that banks set aside 35 billion euros against loans to the building sector, on top of 54 billion euros the banks are already provisioning.

Prime Minister Mariano Rajoy had promised not to use state funds to rescue the banks, but mounting doubts over Bankia had shaken the euro zone and he did a U-turn. And if you're wondering why voters in France voted the way they voted, or why the voters in Greece went to such extremes. Here is the answer. Spain demands austerity from its citizens and then bails out the banks. The politicians promise they won't bail out the banks and it's just a lie. Where does all the money go? To the banks.

As concerns about Spanish banks grow, there are warning that Europe's banking system urgently needs to be overhauled, otherwise the entire monetary union could be in jeopardy. The continent's leaders missed their chance to reform the system in the wake of the 2008 financial crisis, and are now paying the price. At a press conference last week, ECB President Mario Draghi admitted the temporary European Financial Stability Facility (EFSF, also known as the Euro Fubar Slush Fund), the rescue fund for cash-strapped euro-zone countries, has not been very successful Draghi said: "Its functioning fell short of both expectations and needs.” He did not say exactly what is wrong with the fund and what needs to be changed. He failed to mention that the ECB has long been exploring ways of expanding the scope of the EFSF, or its permanent successor, the European Stability Mechanism (ESM, also known as the Euro Slush Mechanism), to give the bailout mechanism more firepower.

Spanish banks are particularly unsteady. They are sitting on roughly 1 trillion-euro ($1.3 trillion) in shaky loans related to the ailing real estate sector. The estimates for the cash shortfall range from 50 billion-euro to 200 billion-euro. The German government wants to prevent the bailing out of Spanish banks from setting a precedent. Bailing out German banks at the taxpayers' expense has already not been particularly popular. What's more, it would hardly end with bailouts for Spanish banks. Ireland, which only had to be bailed out by the rescue fund because of its banks, and thus has a much higher level of government debt than Spain, could insist on equal treatment.

So, after all this time, nobody wants to bailout the banks, and yet, nobody has a better idea. Well, nobody but the Greeks.

Moody’s Investors Service will this month start cutting the credit ratings of more than 100 banks, a move that risks pushing up their funding costs and probably curbing lending. BNP Paribas, France’s biggest lender, Deutsche Bank, Germany’s largest, and New York-based Morgan Stanley are among firms that face having their short- and long-term debt downgraded to their lowest-ever levels by Moody’s.

The cuts follow downgrades by Standard & Poor’s and Fitch Ratings last year; and the fear is the cuts could erode profits, trigger margin calls and leave some firms unable to borrow from money market funds that have strict rules on who they can lend to. Without access to funding from private sources, banks have had to sell assets and reduce lending. I’d like to say the views of the rating agencies don’t matter anymore but, unfortunately, they do.

The Federal Reserve has for the first time given approval for a large Chinese bank to purchase a US bank. It also gave approval to two other large Chinese banks to expand their operations in the United States.

The Fed approved the application of the Industrial and Commerce Bank of China Limited, China’s largest bank, and two other Chinese firms to purchase The Bank of East Asia U.S.A., located in New York City. The Fed also approved an application by the Bank of China to set up a branch in Chicago and an application by the Agricultural Bank of China Limited to establish a branch in New York City.

It's tough to beat the kind of year Exxon Mobil had in 2011. Shares rose by 20% and profits surged by 35% to $41.1 billion. Revenues jumped 28% to $452.9 billion, helping Exxon reclaim the top spot in the Fortune 500. Wal-Mart slipped to No. 2 in the Fortune 500 in 2011 after holding onto the top spot for two years in a row. The retailer was forced to aggressively cut prices to reverse its declining same store sales in the U.S. That helped push revenues up by 6% during 2011, to $447 billion, but it hurt Wal-Mart's bottom line -- profits declined by 4.6% during the year, to $15.7 billion.

Gold prices have been trading lower this week and futures prices hit a 17 week low this morning before recovering through the trading session. It is becoming apparent that Greece will have a difficult time remaining in the Euro-Union. And many people are more worried about Spain than Greece. The US dollar index has benefited recently on safe-haven demand due to the EU situation. The dollar may have problems but it is the cleanest shirt in a hamper full of dirty laundry. The lower prices have spread through the commodities markets, not just precious metals; it appears to be part of a risk-off response to the European Union debt and financial crisis. Crude oil hit a four and a half month low on Monday, and traded lower today; over the past five sessions, oil is down about 10%. As recently as last month, ever higher crude oil prices and $5 a gallon gas were still regarded as possible. Since then gas prices have dropped to levels much lower than they were a year ago.

Back to the metals; why isn't gold performing as a safe-haven investment? Consider that the metals are a measure of how well the currency is being managed. Right now the US dollar is being reasonably well managed compared to other currencies; the cleanest shirt theory. With all the problems in Europe, it is fairly obvious that central banks are printing a whole bunch of currency in order to bail out banks and countries. The ECB and the IMF have already dished out about $2 trillion dollars in bailouts over the past six months, and there is almost certainly going to be more. And so, you're probably wondering why gold isn't selling for about $10,000 an ounce. And the answer is that gold and silver prices are manipulated. I'm not big into conspiracies, but seriously, if you were printing a currency would you want to see gold prices jump up to $5,000? And if gold hit $10,000 we would all be talking about the collapse of the dollar; we would all be talking about how Federal Reserve notes are nothing but counterfeit paper. We would all be crying about the failure of the Fed. And considering the relatively small market for gold and silver, it shouldn't surprise anybody that the markets are manipulated. You should remember that the investment market for gold is quite small. Wal-Mart has a bigger market valuation than the entire market for gold.

Seriously, I'm not a conspiracy theorist. This is what the Fed does. They manipulate the amount of money in circulation. The M1 through whatever M amount; they have a printing press. They manipulate interest rates; every few weeks they have a meeting and then they announce how they decided to manipulate rates. In turn, they manipulate bonds and mortgages and all manner of debts. They manipulate stocks. We used to call it the Plunge Protection Team until we learned the real name, “The President's Working Group on Financial Markets”. The price of oil is manipulated by use of the strategic reserves and cafe requirements on one side to out and out war on the other end of the scale. The government pays farmers to grow or not grow certain crops – which sounds like they manipulate the price of food. From time to time, the CME will change margins on the precious metal futures – that manipulates the price.

If you were going to have a major monetary easing in the near future, (like maybe if Greece exits the EU, or maybe at the June 19 FOMC meeting) if you were planning something that would devalue the dollar and run the risk of inflation – you would come out and say inflation is under control and you remain vigilant – you would suppress gold prices – and you wouldn’t tell people your real plans.

Why would you want to buy gold and silver if you know the prices are artificially low? Back to basic supply and demand. Think of it like a balloon being held under water. The price is being pushed down. And think of demand as the air that fills that balloon. Demand is currently expanding. Admittedly, the technical levels for gold are making holders nervous, but long term holders are probably looking at these prices as a chance to buy the dip.