Thursday, July 24, 2014 - Bankster Logic

Bankster Logic
by Sinclair Noe

DOW – 2 = 17,083
SPX + 0.97 = 1987
NAS – 1 = 4472
10 YR YLD + .05 = 2.51%
OIL - .03 = 102.04
GOLD – 10.10 = 1294.90
SILV - .54 = 20.47

An extremely flat day on Wall Street but good enough for another S&P 500 record high close.

In economic news: Initial claims for state unemployment benefits declined 19,000 to a seasonally adjusted 284,000 for the week ended July 19, the lowest level since February 2006. In the past six months, unemployment has fallen much faster than expected, from 6.7 to 6.1%. The labor market is still struggling with long term unemployment and part-time jobs instead of full-time work, but it seems to be making progress.

One area not showing progress is wages. The Labor Department released its latest report on median wages; on a year-over-year basis, median earnings were up just 0.8% in the second quarter, to $780 per week, not enough to keep pace with inflation. The median wage data is a bit different than the weekly earnings data that comes out of the Labor Department’s payrolls report. That one is the average earnings, and what’s likely happening is the growth for top earners is pulling that series up more. Average earnings are up 2.1% year-on-year. The report also showed that women earned 83.5% of what men did.

The Commerce Department said new home sales dropped 8.1% to a seasonally adjusted annual rate of 406,000 units in June. It was the biggest decline since July of last year. May and April sales were revised lower. So this was a very weak new home sales report, but earlier in the week we saw a fairly strong report on existing home sales.

Let’s move over to earnings reports:

Amazon.com can sell stuff, they just haven’t figured out how make a profit. Amazon is expanding grocery service, they introduced a new smartphone, and a set-top box for TV streaming, and they managed to increase revenue 23% to $19.34 billion from $15.7 billion in the earlier period. They also reported a loss of $126 million or 27 cents per share.

Caterpillar has the exact opposite problem; revenue fell but they posted a higher profit. Caterpillar’s revenue numbers have now fallen in six of its past eight quarters, with the quarterly year-over-year decline averaging 8.3%. In the last quarter, sales fell 3% from a year ago to $14.1 billion, while profit increased 4.1%.

Starbucks posted fiscal third-quarter profit of $512 million, or 67 cents a share, up from $417 million, or 55 cents a share a year ago. Revenue for the three months ended June 29 rose 11% to $4.1 billion from $3.7 billion.

Signaling a major turnaround in the airline industry’s fortunes, the nation’s three major legacy carriers; American Airlines, United Airlines and Delta Air Lines — all posted record profits in the past quarter. Delta reported net income for the second quarter of $801 million, up 17 percent from the year-earlier period. United Airlines, which had a loss in the first quarter and has struggled with its merger with Continental Airlines, posted a $919 million second-quarter profit. Douglas Parker, the chief executive of American Airlines, said today that the airline’s second-quarter profit, excluding special charges, of $1.5 billion was its best quarterly earnings performance ever.

General Motors posted second quarter earnings of $190 million on revenue of $39.6 billion, up from $39.1 billion in the same period a year ago. The problem for GM has been recalls for safety issues, which have killed 13 people. GM set up a compensation fund with $400 million; they have also paid $2 billion this year for the recalls, and they announced pretax charges of $874 million to cover future product recalls. GM is likely to feel the financial repercussions of the millions of cars it has recalled for years to come. The company has recalled 29 million vehicles this year, many of which haven’t yet been repaired. To give a sense of the pace, GM recalled around 15 million vehicles for ignition switch related issues so far this year, and repaired around 560,000 in the second quarter. It announced a recall of more than 700,000 vehicles for a separate issue just yesterday. The surprising part is the increase in revenue, which comes in part from pricing, but also the bad press hasn’t deterred buyers.

Businesses and individuals in the US have parked about $2.6 trillion in money market funds. It is generally considered a safe place to leave money short term, or that was the thinking until 2008, when money market funds broke the buck, dropping below par value of $1 per share. Turns out, the funds weren’t guaranteed. There is no government insurance on the safety of deposits, no regulator-required capital buffer to protect against losses, no central bank ready to stand as “lender of last resort” to keep a money market fund from suffering a short-term cash crunch. Of course, the Treasury and the Fed stepped in to bail out the funds and avoid a run on the funds, which would have been catastrophic.

And so, a mere 6 years later, the government has finally managed a few reforms, but they aren’t real reforms because the bankers fought reform tooth and nail.  The new reforms do not include capital buffers, but they will allow for a floating NAV, or net asset value. So your share in a money market fund may or may not be worth one dollar. And if you try to cash out, the funds can impose extra fees to slow down a potential run. That’s about it. After 6 years. I hope you feel safe and secure in the knowledge that nothing of any substance has changed in the last 6 years.

An examination by the Federal Reserve Bank of New York found that Deutsche Bank AG’s giant U.S. operations suffer from a litany of serious problems, including shoddy financial reporting, inadequate auditing and oversight and weak technology systems. In a letter to Deutsche Bank executives last December, a senior official with the New York Fed wrote that financial reports produced by some of the bank’s US arms “are of low quality, inaccurate and unreliable. The size and breadth of errors strongly suggest that the firm’s entire U.S. regulatory reporting structure requires wide-ranging remedial action.”

Deutsche Bank, one of Europe’s largest banks, was a forceful opponent of the Fed’s push to force foreign banks to comply with the same capital requirements as domestic banks. Officials from Deutsche Bank argued that the Fed’s requirement was too restrictive.  This year, the Fed went ahead with those tougher capital requirements for foreign banks. But it gave most of them until the middle of 2016 to comply. Yes, of course it’s theoretically possible that management could go through and fix everything that’s wrong with the firm’s US operations but, really, this is more of a tear down job.

Dark pools are where institutional investors can place large buy and sell orders without alerting the broader market. Prices and transactions are not reported; it is the furthest thing from a free and open marketplace.  Different financial institutions run a variety of dark pools. Barclays runs one of the biggest dark pools called Barclays LX. They’ve been sued by the state of New York for fraud; the suit alleges Barclays favored high frequency traders over other investors in the dark pool and they falsified marketing materials, inaccurately portraying the concentration of high-frequency traders in the market, and misrepresenting a service that purported to protect investors from predatory trading behavior.

Today, Barclays filed a motion to dismiss the lawsuit, and this is classic bankster logic; they argued that Barclays’ customers were sophisticated enough to understand that “glossy marketing brochures” about the dark pool, did not reflect its actual composition; their customers knew better than to rely solely on the marketing materials. So, they basically admitted they were lying in their marketing material, but their clients were smart enough to know that banks are liars.

President Obama called today for Congress to end a tax loophole that allows big corporations to designate a foreign country as their official address, in order to avoid US taxes. The corporation doesn’t have to actually move their headquarters, just set up an address overseas. Obama called on members of Congress to close the loophole even if they disagree with his broader calls for changes to the tax system that would lower corporate rates and close several loopholes, including that one. The legislative effort is unlikely to succeed in Congress.

Nine inversion deals have been reached this year by companies ranging from banana distributor Chiquita Brands to Medtronic. The whole idea is to pay less taxes while still enjoying the benefits of doing business in the US. Of course, the legal change of corporate headquarters is essentially a process of renouncing citizenship, and it just seems corporations should face the loss of citizenship the same way people do, which means they should pay an exit tax. There are other ways to put an end to this inversion tax evasion scheme. And if we don’t, you can count on executives whose companies were born of American ingenuity and which make their profits from American customers (including the government) will troll international waters for opportunities in low-cost tax havens. It’s a race to the bottom.

Thursday, July 18, 2013 - Those FERCing Energy Traders

Those FERCing Energy Traders

by Sinclair Noe

DOW + 78 = 15,548
SPX + 8 = 1689
NAS + 1 = 3611
10 YR YLD + .04 = 2.53%
OIL + 1.74 = 108.22
GOLD + 8.40 = 1284.00
SILV + .09 = 19.48

Record high closes for the the Dow & the S&P, along with record intra-day highs.

I know you're all wondering why we called this meeting; well, I'd like to report that the company is doing all right, we're managing to scrape by; but we'd be doing a lot better if the staff in the home office would get off their lazy butts and get some work done for a change.

Sounds a bit harsh, doesn't it?

Yet that is how Ben Bernanke started his testimony before the House of Representatives yesterday. Actually, what he said was: "The economic recovery has continued at a moderate pace in recent quarters despite the strong headwinds created by federal fiscal policy."

Bernanke has a point. Whatever motivation you assign to monetary policy, there are limits to the potential benefits, and those benefits are primarily limited to banks. Accommodative monetary policy is slow to flow to Main Street.

Wall Street has been very happy with QE, as we discussed yesterday. The bankers and hedge funds, and the shadow banks feel the future is assured as long as the economy remains weak and the Fed continues cash infusions into the banking system, and therefore most investments will succeed. In that kind of environment, the income earning ability of an asset is secondary to the capital gains potential. The Wall Street crowd pays higher and higher prices for assets and they finance their purchases with ever rising mountains of debt building up on the Fed's balance sheet. If you want to see the direction of the stock market, just look at a chart of the Fed's balance sheet.

Sure enough, Bernanke says he'll continue with easy money and the market hits another record today; just like clockwork. And that's all fine until some trader somewhere makes a bad mistake, and then everything freezes, and liquidity turns to block hard ice. Bernanke, as a student of the Great Depression, probably doesn't want to see that happen. And so on his Farewell Tour of Congress, Bernanke has pushed for fiscal policy to bridge the disconnect between the markets and Main Street.

Today Bernanke appeared before the Senate Finance Committee and the prepared remarks were the same as yesterday's and I haven't seen much of anything in the question and answer session to raise a flag: the future of monetary stimulus will be tied to the health of the economy, nothing is changing, and by the time it does change, Benny will be retired. Thank you and goodnight Mrs. Calabash, wherever you are.

Let's all jump in the Way Back Machine. You may remember that back in the 1990s, the US began deregulating electricity markets. States like California, New York, and Texas reorganized their “markets” to facilitate wholesale buying and selling, in other words, trading of electricity. You remember all that talk about free markets and such.

Now, let's set the Way Back Machine to the Summer of 2000; a typically warm California summer had people cranking up the AC, and Enron was cranking up the manipulation. Back in 2000, the Golden State had installed generating capacity of 45 gigawatts, and when everybody turned on the AC, the demand reached 28 gigawatts; energy traders took power plants offline for maintenance during peak demand. The result was rolling blackouts and power selling at a premium price, sometimes up to a factor of 20 times normal value.

Fast forward to March 2013; the Federal Energy Regulatory Commission, or FERC, alerted JPMorgan that it would recommend penalties against its power-trading unit. The notice said JPMorgan devised "manipulative schemes" that transformed "money-losing power plants into powerful profit centers." The alleged foul play stems from the bank's 2008 takeover of Bear Stearns, which was then at death's door due to its risky investments in the mortgage market. Turns out that Bear Stearns also had interests in out-of-date power plants, which JPMorgan acquired as part of the takeover.

Feeeling pressure to generate profits, the JPMorgan traders devised a scheme to take advantage of something called a “make whole” provision in energy markets. First, traders would offer a low bid to deliver a minimum amount of electricity from a plant the next day, ensuring that the plant would be turned on. And then the next day, traders would offer a much higher bid for the plant's electricity, virtually guaranteeing that no one would buy. The plant would thus operate well below capacity, and lose money.

But they didn't lose money because the make-whole provision requires plants to be repaid if their profits don't make up for the costs of getting the plant up and running. JPMorgan allegedly took advantage of that fact to squeeze money out of the states and make a profit. So they were trading solely to influence the price and not based upon normal supply and demand fundamentals.

On top of the allegations, investigators are accusing JPMorgan of systematically covering up documents that revealed the alleged trading strategy, including one that showed Blythe Masters, the global head of commodities for JPMorgan, demanding a "rewrite" of a document that questioned whether the bank was acting legally. FERC is also claiming that Masters gave "false and misleading statements" about trading practices under oath.

Well, now it appears that FERC and JPMorgan are on the verge of a $500 million settlement. Earlier this week FERC ordered Barclays to pay a $470 million penalty for suspected manipulation of energy markets in California and other Western states. Barclay's is fighting the charges.

You may be wondering what JPMorgan, or Bear Stearns, or Barclays were they doing in the energy business? JP Morgan is a major player in all facets of the energy markets, not only electricity, but also oil, oil storage, petroleum derivatives such as gasoline and heating oil, diesel and more. They don't produce electricity or oil or gas; they trade these commodities. The big banks are players of particular significance, with virtual limitless funding available to them as 'banks' at the Fed window. They then trade, or gamble, or manipulate energy prices in the field of oil and gas and electricity; and their trading has an important bearing on the formation of prices of these commodities. If their actions in the electricity markets are an example of how they play the game, then one could well surmise that it is not only utility customers that are paying manipulated prices for their energy needs.

So, you can see that JPMorgan might be keen to settle this FERC accusation and move on. For you and me, $500 million sounds like a lot of money, but it's not like it would come out of Jamie Dimon's wallet; it's a write-down and the accountants will deduct it from taxes; and it's less than 7% of the losses attributed to the London Whale; and you recall that was, according to Dimon, nothing more than a “tempest in a teapot.”

Which means that the overall deterrent value of the FERC settlement is zero, and it's just a matter of time until the next Enron, or Barclays, or JPMorgan manipulates the energy markets in a way that is deemed egregious and illegal. Meanwhile, they continue to legally trade in the energy markets casino.

Just look at the earnings results from the most recent reports: Goldman’s quarterly profits doubled, with debt underwriting up 40% to a record, and fixed income currency and commodities (trading) up 12%. Bank of America’s Q2 profit rose 63% based on “global markets” fixed income, currency, commodities, and equity trading up a reported 93%. Citicorp’s Q2 profits were up 42%, with profits up 63% from trading stuff. And JPMorgan’s profits in the quarter rose 31%, with a 38% rise in investment banking fees, a 19% rise to $2.8 billion from investment and corporate banking, a 50% rise in debt underwriting and an 83% increase in equity business line.

So you know, nobody really knows how things like investment banking “fees” are calculated, or debt underwriting, or whether or not they include “market-making,” otherwise known a “trading,” that happens on the other side of underwriting and investment banking deals. And in America, no banker goes to jail because we believe in free markets. So everything is good because they're trading, and they're making money. Where does that money come from? You know the answer.

Monday, May 06, 2013 - Wall Street Loves the Mushy Jobs Report

Wall Street Loves the Mushy Jobs Report

by Sinclair Noe

DOW – 5= 14968
SPX + 3 = 1617
NAS + 14 = 3392
10 YR YLD + .02 = 1.77%
OIL + .18 = 95.79
GOLD - .40 = 1471.30
SILV - .09 = 24.14

Friday's jobs report was great for Wall Street. The Dow Industrials briefly topped 15,000 and managed to close at a record high. The S&P 500 hits new records as well. The actual jobs report was only semi-good. The economy added 165,000 net new jobs in April. The February and March reports were revised higher. That's certainly better than losing 700,000 jobs, but it wasn't enough to get the economy up to cruising speed. Wall Street loved it; just enough job growth to avoid recession; not enough job growth to cause the Fed to exit QE to infinity.

Wages are still basically flat. Since the financial collapse of 2008, 9.5 million Americans have simply left the workforce. Once you leave the workforce, you stop being counted, you become invisible. About 22 million Americans are unemployed or under-employed or working part-time because they can't find full-time work. The Federal Reserve last week told us they are pretty well tapped out as far as their ability to fix things; they said: “fiscal policy is restraining economic growth.”

A new report from the Brookings Institute puts numbers on fiscal policy. In the 46 months since the official end of the Great Recession, state, local and federal governments have cut about 500,000 jobs. In contrast, in every other U.S. recession since 1970, the government hired approximately 1.7 million people, on average. That means the U.S. is an estimated 2.2 million jobs in the hole. An extra 2.2 million jobs added to the labor force would mean the unemployment rate would be about 6.1% instead of 7.5%.

President Obama set a goal of 1 million new manufacturing jobs in his second term. Last month we added zero. Not one. Nada. Zip. We did add low-wage jobs, though. Maybe we can talk about a national manufacturing strategy now?

In the 2012 campaign President Obama set a goal of creating 1 million new manufacturing jobs. (This goal comes after the country lost 5.5 million manufacturing jobs between 2000 and 2009.) Manufacturing jobs bring money into the economy. Manufacturing jobs also bring along with them many jobs in other sectors that support manufacturing, from the supply chain to the maintenance to the marketing and sales of the goods. This is what the president understood when he set this goal. But with the March jobs numbers the economy has created a total of only 39,000 manufacturing jobs this year -- zero in March. That leaves the country with 961,000 manufacturing jobs to go in the time remaining.

So, today, President Obama headed out on a jobs tour, touting who knows what, trying to build suport for who knows what. He's going to Austin Texas. He'll visit a high school and a technology company, and will talk with entrepreneurs and workers about proposals he made earlier this year to boost jobs and training. In February, Obama said he wanted to invest in manufacturing "hubs" around the country, spend $50 billion on roads, bridges and other infrastructure, and raise the minimum wage to $9 per hour from the current $7.25. Most of the proposals require Congressional approval, but that's not going to happen.

And for now, Wall Street loves the slightly mushy, slightly tepid jobs reports. One hallmark of a bull market is that the money doesn't leave the market. Over the past seven weeks or so, there were ample opportunities for the market to correct. It didn’t, and now it has broken higher once more.

All the indexes have broken higher at this juncture. It will correct at some point, but a lack of selling dooms those looking for a correction. Until that fact changes, it is more of the same.

Bull markets rotate, especially as they age. What was outcast becomes vogue and that which was hot becomes cold. The past couple of months has seen this process at work, with the safety sectors of health care, consumer durables, and utilities beginning consolidations while technology became hot once more.

Remember the National Mortgage Settlement? A little over a year ago, 5 major US banks worked out a deal with 49 state attorneys general to cut mortgage debt amounts and restructure troubled loans; it was a $25 billion dollar deal, although the banks were allowed to count things like short sales as part of their penalties. The banks were supposed to improve their services and not leave people in limbo when requesting loan mods or other services. So, how are they doing?

Well, New York State Attorney General Eric Schneiderman says that Bank of America and Wells Fargo “have flagrantly violated those obligations, putting hundreds of homeowners across New York at greater risk of foreclosure," and he intends to sue them for violating the terms of the settlement. Schneiderman said he would seek injunctive relief and an order requiring the two banks to comply with the settlement. His statement did not say he was seeking damages or penalties. No word on how the other banks (JPMorgan Chase, Citi, and Ally) were performing.

There was a monitor assigned to track the banks' performance or lack thereof, and they are expected to issue a report in the next couple of months; then attorneys general have a chance to file enforcement claims following a 21-day notice to the monitoring committee.

Meanwhile, there was a New York Times report over the weekend that said there was a 70-page government document that the Federal Energy Regulatory Committee, or FERC, sent to JPMorgan in March, alleging the bank manipulated the power market in California and Michigan in 2010 and 2011. FERC investigators found JPMorgan devised "manipulative schemes" that transformed "money-losing power plants into powerful profit centers." The Times report indicates the bank has until mid-May to respond.

FERC has already put together a case against Barclays which includes $470 million in proposed penalties.FERC has jurisdiction over physical power and trading in natural gas, but several of its recent cases - including the one against Barclays - hinge on demonstrating that traders may have manipulated physical prices in order to profit on derivatives. Barclays has disputed the FERC allegations and said it will defend itself in court if FERC issues a final order seeking to impose the fine. To date, FERC has not issued a final order.

FERC has not moved publicly to charge JPMorgan, but it looks more and more likely. FERC normally does not disclose investigations but last summer they subpoenaed internal emails and other documents as part of an ongoing investigation focused on bidding practices that may have raised electricity prices about $73 million in California and Midwestern power markets.

In November, FERC imposed a temporary ban on JPMorgan's ability to trade physical power at market-based rates for six months, starting in April, for failing to disclose information to the FERC and the California ISO in a market manipulation investigation.

The 70-page document took aim at Blythe Masters, a top executive who is known on Wall Street for helping expand the boundaries of finance. The document cites her supposed “knowledge and approval of schemes” carried out by energy traders in Houston. The investigators claimed she had “falsely” denied under oath her awareness of the problems. 

In addition, the bank faces showdowns with other agencies, like the Office of the Comptroller of the Currency, which is considering new enforcement actions against JPMorgan over how it collected credit card debt and that the bank relied on faulty documents when pursuing lawsuits against delinquent customers; who may or may not have been delinquent.

In a recent report examining a $6 billion trading loss at the bank, Senate investigators faulted JPMorgan for briefly withholding documents from regulators. The trading loss has spawned several law enforcement investigations into the traders who created the faulty wager.

Also under investigation is the bank's possible failure to alert authorities to suspicions about Bernard L. Madoff. The Times reports at least eight federal agencies are investigating the bank.

Meanwhile, Bank of America has reached a settlement with MBIA. Here is the basic situation at the heart of the dispute; prior ot the meltdown in 2008, MBIA wrote insurance on many mortgage securitizations and credit default swaps that ultimately went bad, including obligations that seemed likely to force it to pay as much as $3 billion toMerril Lynch. The insurer claimed that it had been misled by Countrywide Financial regarding the quality of mortgages it was insuring, and sought as much as $5 billion from Countrywide.

The settlement calls for BofA to pay $1.6 billion in cash and return about $100 million in bonds.

In an interview on CNBC, Charlie Munger, Warren Buffet's right hand man, said that Cyprus demonstrates, “an old truth, you can’t trust bankers to govern themselves. A banker who’s allowed to borrow money at X and loan it out at X plus Y will just go crazy and do too much of it, if the civilization doesn’t have rules that prevent it.” Munger added, “What happened in Cyprus was very similar to what happened in Iceland, it was stark raving mad in both cases. And the bankers, they’d be doing even more if the thing hadn’t blown up. I do not think you can trust bankers to control themselves. They’re like heroin addicts.” 

Thursday, February 07, 2013 -

Waiting for the Apocalypse

by Sinclair Noe

DOW – 42 = 13,944
SPX – 2 = 1509
NAS – 3 = 3165
10 YR YLD -.02 = 1.95%
OIL - .74 = 95.88
GOLD – 6.30 = 1672.00
SILV - .39 = 31.56

Some day this war will end. Some day we will have an apocalypse, not in the terrifying version of the word but in the original Greek definition of “apokalypsis”, meaning an “uncovering”, a “lifting of the veil”, or “the disclosure of something hidden”. One day we will wake up and realize that money is printed out of thin air and it is not a store of wealth but a vessel of debt; the veil will be lifted and we will see the debt masters for what they truly are. Until then we get little surprises in the form of troves of emails revealing the reality that the financial markets are not bastions of cool rationalism, nor are they temples to integrity; and the lubricant of commerce may be nothing more than a tar pit.

We have been reading the emails from Barclays, UBS, and S&P describing how they would rig rates or rate deals for a cow if only they could get their cut. Sometimes the language is clipped in an instant messaging style of prose, sometimes it is profane in a way that would make Tony Soprano blush, and it seems to be flowing forth in a never-ending stream of culpability. Some day this war will end. But not today.

Today we learn of the emails from JPMorgan Chase and they show that executives at the firm knew there were problems; an outside analysis discovered serious flaws with thousands of home loans; the executives responded by slapping lipstick on a pig. Rather than disclosing the full extent of problems like fraudulent home appraisals and overextended borrowers, the bank adjusted the critical reviews. As a result, the mortgages, which JPMorgan bundled into complex securities, appeared healthier, making the deals more appealing to investors.

We learn this because of a lawsuit against JPMorgan filed in Manhattan by the French-Belgian bank Dexia, which went belly up after buying into the lipstick slathered securities which of course, ultimately imploded. Documents filed in federal court include internal emails and employee interviews. After suffering significant losses, Dexia sued JPMorgan and its affiliates in 2012, claiming it had been duped into buying $1.6 billion of troubled mortgage-backed securities. The latest documents could provide a window into a $200 billion case that looms over the entire industry. In that lawsuit, the Federal Housing Finance Agency has accused 17 banks of selling dubious mortgage securities to the two housing giants, Fannie Mae and Freddie Mac. At least 20 of the securities are also highlighted in the Dexia case.

The Dexia lawsuit centers on mortgage-backed securities created by JPMorgan, Bear Stearns and Washington Mutual during the housing boom. As profits soared, the Wall Street firms scrambled to pump out more investments, even as questions emerged about their quality. JPMorgan scooped up mortgages from lenders with troubled records. In an internal "due diligence scorecard," JPMorgan ranked large mortgage originators, assigning Washington Mutual and American Home Mortgage the lowest grade of "poor" for their documentation. The loans were quickly sold to investors. One executive at Bear Stearns told employees "we are a moving company not a storage company." As they raced to produce mortgage-backed securities, Washington Mutual and Bear Stearns also scaled back their quality controls.

Washington Mutual cut its due diligence staff by 25 percent to prop up profit. A November 2007 email from a WaMu executive described the cutbacks as steps that "tore the heart out" of quality controls. The email said: executives who pushed back endured "harassment" when they tried to "keep our discipline and controls in place.” Even when flaws were flagged, JPMorgan and the other firms sometimes overlooked the warnings.

JPMorgan hired third-party firms to examine home loans before they were packed into investments. Combing through the mortgages, the firms searched for problems like borrowers who had vastly overstated their incomes or appraisals that inflated property values. An analysis for JPMorgan in September 2006 found that "nearly half of the sample pool" - or 214 loans - were "defective," meaning they did not meet the underwriting standards. The borrowers’ incomes, the firms found, were dangerously low relative to the size of their mortgages. Another troubling report in 2006 discovered that thousands of borrowers had already fallen behind on their payments.

And what did JPMorgan do when confronted with the defects? They ignored them or they whitewashed the findings or they just lied about them. Certain JPMorgan employees, including the bankers who assembled the mortgages and the due diligence managers, had the power to ignore or veto bad reviews. In other words, they knew the mortgage backed securities they were bundling and selling were full of garbage loans and they just didn't give a damn about it as long as they could sell it. Of course we all know that employees and analysts and due diligence directors say the darnedest things in emails, but if the emails reveal what the investigators think they reveal; then JP Morgan actually defrauded its clients, and the bank and its executives should obviously pay a big price for that.

Jamie Dimon, the CEO of JPMorgan has tried to differentiate his bank from the rest of Wall Street. He recently lashed out at what he called the “big dumb banks” that “virtually brought the country down to its knees.”

If this sounds like yesterday's news or the news from 5 years ago; well, it is but it is also tomorrow's news. Some four years after the 2008 financial crisis, public trust in banks is as low as ever. Sophisticated investors describe big banks as “black boxes” that may still be concealing enormous risks, the sort that could again take down the economy. In the fall of 2008, when the meltdown hit, all the banks stopped, well they stopped pretty much everything, they stopped lending to each other; they stopped trading with other banks, and the reason they stopped was because after Lehman Brothers was allowed to collapse, no one understood the banks' risks. There was no way to look at a bank's disclosures and determine whether that bank might implode.

Was any given bank the next IndyMac, was it the next Northern Rock, the next Dexia? Did JPMorgan have toxic assets on their books or had they already dumped their trash on Dexia? JPMorgan was supposed to be one of the safest and best-managed corporations in America. Jamie Dimon, the firm’s charismatic CEO, can charm the cufflinks off journalist in New York or high rollers in Davos, and he had kept his institution upright throughout the financial crisis, and by early 2012, it appeared as stable and healthy as ever. And then the London Whale washed up on the banks of the River Thames.

The London Whale ran a little bit of a trading desk, and he had gambled away $6 billion, maybe more; investigators are still investigating; still the losses are not enough to destroy the House of Morgan, even though it wiped out one-third of the market capitalization. After all, JPMorgan is considered to have the best risk management operations in the industry.

And what this really tells us is that they haven't learned how to manage the risks; in part because the culture is corrupted. JPMorgan started reporting small losses, then they had to admit that its reported numbers were false. Federal prosecutors are now investigating whether traders lied about the value of the London Whale's trading positions as they were deteriorating. JPMorgan shareholders have filed numerous lawsuits alleging that the bank misled them in its financial statements; the bank itself is suing one of its former traders over the losses. Jamie Dimon didn’t understand or couldn’t adequately manage his risk, or maybe he knew and just slapped some lipstick on the pig. Investors are now left to doubt whether the bank is as stable as it seemed and whether any of its other disclosures are inaccurate.

And of course, it's not just JPMorgan; that is just the biggest player. Toss in Libor rate rigging from Barclays, UBS, and RBS. Toss in money laundering from HSBC and Standard Chartered, and don't forget robo-signing from a host of banks more concerned with being moving companies than storage companies; more concerned with their own profits than with pesky legal details like due process. And only after the fact do we see the emails that provide the colorful stories of how the banks misled clients, sold them garbage and then bet against them.

So, the question is: do you trust the banks? Chances are you answered “no”. Depending upon the survey, about 4 out of 5 people say they have no trust in our financial system; and I doubt the fifth person holds the banks in high regard. And four-and-a-half years after the meltdown, the Too Big To Fail banks are bigger than before, and because they've received get out of jail free cards they operate with impunity and disregard for the rule of law or requirements for transparency. The Geithner Policy insured the banks did not have to change their wicked ways; they were too big and too systemically important to be bothered.

Do you know what the banks have on their books? Are the assets vintage or toxic? You don't know because the banks are a black box of disclosure. And guess what? Jamie Dimon doesn't know how much risk JPMorgan is taking. And if he doesn't know how much risk his own bank has, then there is no way he knows about the garbage the other banks hold on their books. And here is the big problem. All it takes is a bump in the road and the financial institutions will freeze up once again.

Some day, the veil will be lifted. Some day the we will learn the secrets. Some day the war will be over.

Not today.

Last summer, Boeing's top management axed the engineer CEO who had been turning around BCA, [Boeing Commercial Airplanes, and making it better again. They replaced him with a non-engineer CEO. Then, management got into a confrontation with the engineer's union (which may also partly be the union's fault, but it's not a battle management can afford right now). Then the top management indefinitely postponed, in other words they killed off, the very promising 777X , new long-range, highly efficient model. These moves were on top of a 787 development model that de-emphasized in-house engineering and relied on industry partners for much of the development work. Since the 787 appeared to be out of the woods, there wasn't much need for R&D and engineers and new-fangled planes.

Then a 787 Dreamliner caught fire, and then another; batteries exploded and it was a bit of a problem. Back in Seattle, engineers, represented by a disgruntled union and forced to report to multiple layers of non-engineer management, are working overtime on the problem, but after several weeks, nobody appears to be close to a solution. And once they do find a solution, they will have to go through a process of re-certification. That process might take 6 months, maybe longer.

That is the background for Boeing's fourth quarter earnings report this month. The 787 problem wasn't discussed, except that the investigation was continuing and couldn't be discussed and 787 production was continuing full speed ahead, despite uncertainties about what needed to be done for the battery system, or any other aspects of the plane's design. If these planes being built need major retrofitwork in the future, well, that's for the engineers to worry about.  Apparently, the executives in Chicago didn't get the memo that the entire fleet of 787's has been grounded.

American Airlines' parent AMR Corp. and US Airways Group are within a week or two of finalizing a merger that would create the world's largest airline by traffic. The new company would be worth more than $10 billion, and the deal would be an all-stock transaction that would take place as part of the reorganization that would take American Airlines out of its Chapter 11 bankruptcy protection. The deal under discussion would give American Airlines creditors about 72% of the new entity and US Airways shareholders about 28%. There would be huge expenses with integrating the two companies and the merger process might cause some disruptions to customer service; and after a merger it's unclear if they will have a significant competitive advantage over the other big competitors, now whittled down to just three, but it would keep the new American-slash-US Air in the arena. And it would likely mean higher airfares for the rest of us.

For most of 2012, small-caps and large stocks slogged through the market ups and downs like white on rice. But since the market began to move off its November bottom, the Russell 2000 small-cap index has outpaced the Dow Jones Industrial Average by a wide margin. The Russell is up an impressive 18% since its November lows, while the Dow has risen about 11.5% during the same timeframe. Risk on.

Last month, 11 European countries, including France and Germany, moved forward on introducing a minuscule tax on trades in stocks, bonds and derivatives. The tax goes by many names. It's often called a Tobin tax, after the economist James Tobin. In Europe it goes by the more pedestrian financial transaction tax. In Britain, it goes by the wonderful Robin Hood tax.

A transaction tax could raise a huge amount of money here in the US and cause less pain than many alternatives. It could offset the need for cuts to the social safety net or tax increases that damage consumer demand. How huge a sum? An estimate from the bipartisan Joint Committee on Taxation, which scores tax plans estimates the tax could raise: $352 billion over 10 years.

The money would come from a tiny levy. A bill that might be introduced next month calls for a three-basis-point charge on most trades. A basis point is one-hundredth of a percentage point. So it amounts to 3 cents on every $100 traded. Critics claim the tax will harm our capital markets and won't raise that much money. They argue that such a tax cannot be enforced; that it will depress trading, leading to lower asset prices; and that it will ultimately be passed on to retail investors. If some kind of increase in taxes is inevitable, one that takes aim at high-frequency traders doesn't seem so bad.

Tuesday, February 05, 2013 - Cutting to Spite Ourselves

Cutting to Spite Ourselves

by Sinclair Noe

DOW + 99 = 13,979
SPX + 15 = 1511
NAS + 40 = 3171
10 YR YLD +.04 = 2.02%
OIL + .47 = 96.64
GOLD – 1.40 = 1674.00
SILV +.06 = 31.92

The Congressional Budget Office released revised budget projections that show the federal deficit will drop to $845 billion this year, the first time during Obama's presidency that the red ink would fall below $1 trillion. The budget office also said the economy will grow slowly in 2013. The reason for the slowdown is a tax increase in January and spending cuts coming in the next couple of months.

A few minutes after the CBO report, President Obama spoke to the press and said those spending cuts would damage the economy and must be avoided. He asked Congress for a short-term deficit reduction package that will delay deeper cuts past the automatic start date of March 1, also known as the sequester.

The automatic cuts are part of a 10-year, $1 trillion deficit reduction plan that was supposed to spur Congress and the administration to act on long-term fiscal policies that would stabilize the nation's debt. Though Congress and the White House have agreed on about $2.6 trillion in cuts and higher taxes since the beginning of 2011, they have been unable to close the deal on their ultimate goal of reducing deficits by about $4 trillion over a decade.

If the automatic cuts are allowed to kick in, they would reduce Pentagon spending by 7.9 percent and domestic programs by 5.3 percent. Food stamps and Medicaid would be exempt, but Medicare could take up to a 2 percent reduction, under the plan.

White House aides say the president's plan for long-term deficit reduction would increase tax revenue by about $600 billion to $700 billion over 10 years as well as reduce mandatory health care spending, primarily in Medicare, by about $400 billion over the next decade. It would also change an inflation formula that would reduce cost-of-living adjustments for beneficiaries of government programs, including Social Security. Republicans have called for a more comprehensive overhaul of government entitlement programs.

For now, the President is asking for a short-term deficit reduction package of spending cuts and tax revenue that will delay the sequester, and give Congress time to chip away at the problem.

Part of what we should have learned is that austerity is not the answer. Europe has shown that. When economists talk about the role of government in economic recovery, they often focus on the question of whether or not we need more economic stimulus. Government participation in the economy does not just stimulate private sector activity.  Government is itself a large, diverse and important sphere of economic enterprise.  Our federal, state and local governments produce and deliver important goods and service, things that people want and need, and that they have asked their representatives to create and maintain.   And governments employ millions of people in income-earning positions to carry out all of this production.  Ordinarily, we would expect that as a society grows, government will grow commensurately along with everything else.  As our population grows and private enterprises proliferate, we need more schools and teachers, more courthouses and police stations, more public parks, more inspectors and regulators, more paved roads and street lights, and more government clerical workers.  So while it is true that government spending also stimulates additional economic activity in the private sector – just as any economic enterprise stimulates economic activity in the other enterprises it touches and affects – it is also true that the public enterprises governments oversee and the tasks governments perform are all by themselves an important component of overall economic activity.

The part of government spending that is devoted to purchases made in the production of goods and services is called “consumption and gross investment” , or CGI, and it amounts to about 15% to 20% of GDP.  Government consumption and gross investment (CGI) can be contrasted with other forms of government spending that do not contribute to GDP, such as transfer payments to the public under social insurance programs like Social Security and unemployment insurance programs.

CGI started to dry up after the stimulus package started to wear off in 2011, and public enterprise also started to decline. Paul Krugman asked: “How big a deal is this? Government consumption and investment is about $3 trillion; if it had grown as fast this time as it did in the Bush years, it would be 12 percent, or $360 billion, higher. Given a multiplier of more than one, which is what the IMF among others now thinks reasonable under current conditions, that ends up meaning GDP something like $450 billion higher, which is 3 percent — and an unemployment rate 1.5 points lower. So fiscal austerity is the difference between where we are now and an unemployment rate not much above 6 percent.”

For the past couple of years we've heard bipartisan talk about grand bargains, fiscal cliffs, sequestration, and debt ceilings, with different strategies granted, but with a common theme to shrink government.

 Obama actually told us government must shrink because we are “out of money”.  But notice how absurd it would be if the leaders of private sector industry were to say that the private sector economy has to shrink because it is out of money.  Everybody recognizes that if our economy is to grow and progress, private enterprise needs to spend and invest, and that the means of financing are created along with the initiatives that are financed.   In the case of government, the financial constraint is even less relevant, I mean they print the currency, so there are no real constraints due to a lack of money.

Yesterday I told you to look for a lawsuit against S&P. As expected, the government is seeking more than $5 billion in a civil lawsuit against Standard & Poor's and parent company McGraw-Hill over mortgage-bond ratings, marking the first federal enforcement action against a credit rating agency over alleged illegal behavior tied to the recent financial crisis. S&P reportedly had a chance to settle for about $1 billion, but they felt the price was too high. Attorney General Eric Holder said at a news conference that S&P misled investors, causing them to lose billions, and that its ratings were affected by "significant conflicts of interests." He said that while analysts raised red flags as early as 2003, S&P executives ignored questions about ratings.

In the filing Monday, the government said: "Considerations regarding fees, market share, profits, and relationships with issuers improperly influenced S&P's rating criteria and models." In other words, they sold their ratings to the highest bidder and didn't give a damn about honesty. So, the question is why did it take so long to bring civil charges against the ratings agency?

Well, the lawyer defending S&P says the government intensified its investigation after S&P downgraded the government's credit rating in 2011, following the debt ceiling dysfunction. I'll give the lawyer credit for misdirection, if nothing else. S&P will likely use the same defense the industry has been using for years to explain the seemingly misguided ratings -- their right to free speech. S&P and other credit rating agencies have claimed that their ratings were merely free speech and are therefore protected under the First Amendment. 

There is a paper trail of damaging emails. You've heard about this before. And when those emails are read aloud in court, the best hope will be to make jurors think that maybe it's just a government vendetta. But listen to some of the emails:

In an April 2007 email, an analyst quoted in the lawsuit told an investment banking client that the priorities inside S&P were not centered on providing accurate ratings, but rather were focused on not “p*ssing off too many clients and jumping the gun ahead of [competitors] Fitch and Moody’s.”

The banker emailed back: “I mean come on we pay you to rate our deals, and the better the rating the more money we make?!?! What’s up with that? How are you possibly supposed to be impartial????”

Another S&P analyst wrote: "We rate every deal … it could be structured by cows and we would rate it.”

The email complaints about the integrity of the ratings were so numerous that S&P management directed analysts to stop sending complaints via email. But the emails continued. They wrote about allowing bankers to have greater input into the ratings process; let the bankers help make the grades for the products they were selling; and all designed to increase revenue for S&P. One email that seems particularly damaging came from a director in charge of rating CDOs in late 2006. He wrote: “this market is a wildly spinning top which is going to end badly.”

The paper trail is long and extremely damaging. So, what does it take to come up with criminal charges against a large financial institution? Seriously, what does it take to get a criminal charge started?

Today, Barclays, the British bank, announced it is provisioning another $1.3 billion in its Q4 results to settle claims it mis-sold financial products, bringing total provisions to about $3.5 billion. And UBS, the Swiss banking giant, announced a a $2.1 billion dollar fourth quarter loss, with $1.5 billion of that coming from fines for manipulating Libor interest rates. The Libor rate affects the prices of hundreds of trillions of dollars of financial products; everything from credit cards to mortgages to municipal bonds. Basically, the price of everything in the world the price is somehow connected to Libor. And these guys were monkeying around with this for individual profit. But nothing illegal happened.

And finally, Dell Computer will be taken private by founder Michael Dell and Silver Lake Partners in a $24.4 billion dollar deal. It works out to about $13.60 per share, roughly one-quarter Dell's all-time high 12 years ago. Still, it's the biggest buy out in years. 

Wednesday, December 19, 2012 - You Can't Kill a Bank, Even With a Bushmaster

You Can't Kill a Bank, Even With a Bushmaster

by Sinclair Noe

DOW – 98 = 13,251
SPX – 10 = 1435
NAS – 10 = 3044
10 YR YLD -.03 = 1.80%
OIL + 1.49 = 89.42
GOLD – 5.00 = 1666.90
SILV - .66 = 31.08

All right, let's start with a refresher course; Libor stands for the London Interbank Offered Rate. It’s the rate at which banks are able to borrow money from each other. The lower a bank’s rate (banks submit their own rates) the healthier it’s deemed to be. If you're balance sheet is healthy, you get a low rate when you borrow. If your balance sheet is known to contain toxic assets, you have to pay a higher rate to borrow. The rates were especially indicative of banks’ health during the peak of the financial crisis when the markets were all but frozen and access to funds were limited.

The Libor rate is determined daily; sixteen banks submit their rates to an agency; the four highest rates are wiped out and the four lowest rates are wiped out. The result is averaged and the daily Libor rate is published. It would take more than one bank to manipulate the rates. But once the rate is published it affects trillions of dollars of financial instruments around the globe.

More than a dozen banks in the U.S. and Europe are under investigation for Libor rate rigging. Even though it is not really surprising, the sheer scope and audacity of the market manipulation involved in the latest bank scandal still manages to inspire a sense of awe and nauseum.

In July, Barclays reached a settlement on manipulating the Libor rate, and they paid a $450 million fine. Today, as expected, UBS, the Swiss bank agreed to a settlement of $1.5 billion for its role in manipulating Libor. The charges made against UBS show the bank not only manipulated the Libor rate to make itself look healthier to outsiders but also to make money by colluding with other banks. From a regulator’s perspective that’s a lot worse than lying a bit to appear in better condition.

According to the regulators, at least 45 different managers and traders were involved in a scheme to manipulate Libor. The manipulation was so pervasive that the U.K.'s Financial Services Authority says every single trade in which UBS was involved over five years was suspect. Regulators found at least 2,000 instances of certain manipulation. Where did they find this damning evidence? Emails. And the dumbest email is credited to an eager young trader trying to entice a banker to submit a fraudulent Libor rate. How do you entice a banker to commit a fraudulent act? Apparently bribery works.

“I will f***ing do one humongous deal with you ... I’ll pay you, you know, 50,000 dollars, 100,000 dollars ... whatever you want."

There is strong evidence to suggest that the UBS traders were incredibly stupid, including this exchange over IM: “dude don’t IM about all the Libor manipulating you’re doing.” Or, one way to read a lot of these exchanges is that many UBS Libor manipulators genuinely didn’t know that it wasn’t okay to lie about Libor, they had no sense of morality or right and wrong, and they felt not a twinge to ask other banks to lie about Libor, and offer bribes to interdealer brokers to get them to get other banks to lie about Libor. Libor was a number, and someone made it up, and so why wouldn’t you make it up to suit you, as opposed to otherwise?

The important thing about this settlement is not the fine, which UBS should have no trouble paying, even though it is going to cause the bank to take a loss in this quarter. The bank's share price was up 1 percent this morning, if that tells you anything about how much financial damage the settlement is going to do. What matters is that criminal charges are finally starting to be filed. Three former UBS traders have already been arrested in the U.K., and more arrests are coming in the U.S. So far, all the arrests are lower level traders, not the executives who clearly authorized and perhaps encouraged the collusion.

On top of that, prosecutors broke a taboo and actually filed a criminal charge against UBS itself, something they are typically too terrified to do. Of course, this charge was designed to do minimal damage; it was limited to UBS's unit in Japan, which pleaded guilty to one count of fraud, and it doesn't affect the rest of the bank. Still, a criminal charge is a criminal charge. Authorities are loath to prosecute big banks criminally because they consider it a "death sentence" for banks. Something we're not sure is completely accurate because, well, these banks never get killed off do they?

But prosecutors don't dare take the chance, because toppling these behemoths might crush the financial system. Of course, given that UBS and other big banks are constantly getting themselves into massive amounts of trouble, a death sentence might leave us all better off in the long run.

Still, the policy is to be nice to banks, even if they are evil. We need look no further than the money laundering bank HSBC. Bank regulators and Treasury opposed having HSBC admit the truth – that it violated the money-laundering statutes; that it was in business with drug cartels and terrorists. Not only would the truth lay bare the hypocrisy of the War on Drugs but it might not be nice to the money laundering bank. They warned that such a guilty plea could cause a systemic crisis because HSBC was too big to fail; it is systemically important. When Treasury warns DOJ that a prosecution could cause a global crisis there is no chance that the AG will override Treasury’s warning on his own initiative. That is why line prosecutors urged AG Holder to meet personally with Secretary Geithner to urge him to withdraw his objections to the proposed prosecution, but Holder apparently declined to seek a meeting. Instead, the DOJ accepted Treasury’s warning that HSBC was too big to prosecute because doing so would cause a global systemic crisis.

Libor manipulation cost Fannie Mae and Freddie Mac more than $3 billion, according to an estimate by a government watchdog, who recommends the government-owned mortgage giants sue the big banks.

That estimate and legal advice were made in a private report by Steve Linick, the inspector general for the Federal Housing Finance Agency, the regulator for Fannie and Freddie, which were taken over by the U.S. government during the financial crisis. Now, $3 billion isn't enough to keep us from going over the fiscal bunny hill, but it's nothing to sneeze at.

And yes, if you have a mortgage through Fannie or Freddie, it means that you are a victim of the Libor rate rigging scandal.

If you still think Libor fraud is a victimless crime, the muni-bond market has 6 billion reasons it begs to differ. States, cities and other municipal borrowers have lost at least $6 billion as a result of banks manipulating Libor.

This $6 billion in losses would come on top of the $4 billion that muni borrowers have already paid big banks to close out derivatives trades that went bad, partly because of Libor manipulation. This is all part of a study released in October.

The Libor investigations have implications for states and cities that are still contending with the fiscal legacy of the recession, which left them grappling with falling tax revenue and rising costs. States have had to deal with combined deficits of more than $500 billion since fiscal 2009, according to the Washington-based Center on Budget & Policy Priorities.

The losses came not because Libor manipulation affected borrowing costs, but because these bond issuers entered some $500 billion in interest-rate swaps with banks, according to some estimates. These swaps were a type of derivative, essentially an insurance policy the muni-bond issuers bought to protect themselves against interest rates rising. When interest rates -- Libor specifically -- fell instead, the muni-bond issuers lost a boatload of money on the swaps.

In other words, in the eyes of the muni-bond issuers, these banks tricked them into betting that interest rates were going to rise and then sold them derivatives to insure against rising rates, and then they colluded to manipulate the rates lower.

States and cities have been lawyering up, preparing to sue the banks over Libor manipulation, lawsuits that could ultimately cost the banks billions of dollars.

And finally,

Walmart sells almost everything inside its stores, including guns and ammunition and assault rifles. But some things are too dangerous to be sold in WalMart, including: a pregnant Barbie doll, a book by George Carlin, and the debut album by Sheryl Crow (because it includes lyrics about buying a gun at WalMart and shooting children). Proving once again that ideas are still more dangerous than the sword, or the Bushmaster assault rifle. I'm not sure how they measure up against an RPG, and it is my understanding that drones do not discriminate.