Tuesday, February 26, 2013 - Send in the Clowns

I will be speaking at the Wealth Protection Conference 2013, April 5 & 6 in Tempe. It's a great conference. Click here to find out more and make a reservation.

Send in the Clowns

by Sinclair Noe

DOW + 115 = 13900
SPX + 9 = 1496
NAS + 13 = 3129
10 YR YLD -.02 = 1,88%
OIL - .42 = 92.69
GOLD + 21.10 = 1615.70
SILV + .44 = 29.53

Twice a year the Fed Chairman visits Capitol Hill. He talks to senators and the next day he talks to the House of Representatives. Today, Bernanke told lawmakers that he had done a good job and he tried to take his bows. Bernanke said Fed policymakers are cognizant of potential risks from their extraordinary support for the economy, including the possibility that it might fuel unwanted inflation or stoke asset bubbles. But, he said the risks did not seem material at the moment, adding the central bank has all the tools it needs to retreat from its monetary support in a timely fashion.

Bernanke said: "To this point, we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more rapid job creation."

When asked pointedly by Republican Senator Bob Corker about whether the Fed's easy monetary policy was contributing to competitive currency devaluations globally and laying the groundwork for inflation, Bernanke was unequivocal. He said: "My inflation record is the best of any Federal Reserve chairman in the post-war period. We are not engaged in a currency war."

 Elizabeth Warren, a Democrat, pressed Bernanke on what she said is an implicit subsidy that large banks receive in the form of lower borrowing costs from being perceived as too big to fail. Warren asked:"We've now understood this problem for nearly five years, so when are we gonna get rid of 'too big to fail?'"

Warren also asked whether big banks should repay taxpayers for the billions of dollars they save in borrowing costs because of the credit market's belief that they won't be allowed to fail, repeatedly citing a recent Bloomberg View study estimating that the biggest banks essentially get a government subsidy of $83 billion a year, nearly matching their annual profits.

Bernanke countered that Dodd-Frank financial reform rules had given regulators more power to wind down failing financial institutions, making the issue less of a concern. Bernanke said: "The subsidy is coming because of market expectations that the government would bail out these firms if they fail. Those expectations are incorrect. "

Bernanke warned the near-term spending cuts known as the sequester, which are set to take hold later this week, would threaten an already challenged economic expansion: "The Congress and the administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration, with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run."

Bernanke also addressed the labor market:"High unemployment has substantial costs, including not only the hardship faced by the unemployed and their families, but also the harm done to the vitality and productive potential of our economy as a whole."

Here is a link to video of Warren questioning Bernanke.

The main takeaway from the testimony is Bernanke downplayed the risks from the Fed’s economic stimulus campaign, describing it as necessary and effective and making clear it is likely to continue for some time. And then he told the lawmakers they need to do their part, saying: “Although monetary policy is working to promote a more robust recovery, it cannot carry the entire burden of ensuring a speedier return to economic health.”

Speaking of which: The economy is going to hell in a hand basket! The sky is falling, or airplanes will fall from the sky! The sequester is coming, the sequester is coming!

Yeah well. While President Obama warns of the dire economic impact from across-the-board budget cuts, the nation may face more serious fiscal debates in the months ahead on a potential government shutdown and renegotiation of the debt ceiling.

With just three days before the $85 billion in reductions for this year are scheduled to start, Obama and Republicans led by House Speaker John Boehner yesterday traded blame again for the impasse. The president and his Cabinet officers drew a landscape of lost jobs, long lines at airports, delays at ports and cutbacks at national parks.

There’s been no public sign of negotiations between Obama and congressional Republicans. As the administration continued laying out details of how programs used by many Americans would be curtailed, Republican governors joined their congressional delegations in accusing Obama of overplaying his hand. And it will probably take about a month before most people really start to notice the cuts. Obama said they were no less a threat to the world’s largest economy, which stalled in the fourth quarter. “The uncertainty is already having an effect,” Obama said. “Companies are preparing layoff notices. Families are preparing to cut back on expenses. The longer these cuts are in place, the bigger the impact will become.”

And for now, the markets are freaked out, traders and analysts still think there will be a compromise within the next 30 days or so.

Looming even larger than the March 1 start of the automatic spending cuts is a potential government shutdown if Democrats and Republicans can’t agree on a stopgap funding measure by March 27, the date that current government funding expires. Without a deal in Congress that Obama would sign, government spending would halt.

In the battle over the sequester, Boehner has maintained his pledge not to entertain any new tax revenues. President Barack Obama and Democrats have called for a resolution that consists of both spending cuts and increased revenue, such as closing corporate tax loopholes and implementing the Buffet rule to raise taxes on billionaires.

During a news conference, Boehner showed no signs of hedging. "The president says we have to have another tax increase in order to avoid the sequester,” he said. "Well, Mr. President, you got your tax increase. It’s time to cut spending here in Washington."

So, don't expect a sequester deal. Sen. Ron Johnson (R-Wis.) said House Speaker John Boehner (R-Ohio) would lose his speakership if he agrees to new tax revenues to avert the across-the-board spending cuts that are set to kick in on March 1.

Much of the motivation for deficit reduction, a goal shared by policy makers across the political spectrum, is the belief that deficits consume the nation’s seed corn. That is, deficits represent negative saving. Because saving is presumed to be the key determinant of long-term real economic growth, deficits deplete the supply of saving and thus reduce growth. There are many problems with this analysis. One is that it assumes that all government spending is consumption. In fact, much of it consists of investment. the federal government will invest $550 billion this year in physical capital (buildings, equipment), research and development and human capital (education). This includes grants to state and local governments for these purposes.

It is perfectly reasonable to finance long-lived capital projects with borrowing. Because the benefits will accrue over many years, it would be silly to treat things like highways as if they were consumed within a single year for budget purposes.

Unfortunately, the federal budget is silly in this respect. It treats investment spending the same way every other budgetary item is treated – as if it were consumption with no long-lasting benefits for the nation.

An unfortunate consequence of this budgetary convention is that reducing federal investment is viewed as beneficial if it reduces the deficit. Moreover, it is often easier to cut investment spending than consumption, just as homeowners suffering from an income loss may find that deferring maintenance or planned improvements is the easiest way to conserve cash.

Many economists say they believe that the best thing the federal government can do to raise the long-term economic growth rate is increase infrastructure spending. It would have the double benefit of mobilizing idle resources, especially unemployed workers, while low interest rates permit capital projects to be financed very cheaply. One main barrier to achieving this double benefit is the confusion between investment spending and consumption spending, which is distorted by the way the budget is presented and the way we calculate saving.

Meanwhile, Italy's politics have almost literally become a clown show. The front-runner, who had teamed with the former European Central bank technocrat, did not do well in yesterday's election. Go figure. Beppe Grillo, the clown comedian did well, his movement was the top vote getter, even though he didn't win, and even though or perhaps because he is not a politician, he is not particularly wise, he does not have a permanent tan, he does not own the entire telecommunications industry in Italy, he is no a shameless unrehabilitated whoremonger, and he is not a Goldman Sachs puppet, (which may be a bit redundant). The Italians failed to do the responsible thing and vote for austerity. Go figure.

Italy is doing what Greece was (quite understandably) too small, too afraid and too vulnerable to do which is to say, collectively, “up yours” to austerity, technocracy and cronyism. And yes, they probably won't get away with it. Italian party chiefs began jockeying to forge a coalition of rivals and head off a second vote as a political vacuum of at least a month loomed.

The Five Star protest movement of comedian Beppe Grillo looked likely to emerge as the biggest single party in the lower house. The scourge of bankers and corrupt elites, Mr Grillo has campaigned for a return to the lira and a restructuring of Italy’s $2 trillion public debt.

The conservative bloc of ex-premier Silvio Berlusconi looked poised to win the senate, coming back from the political grave with vows to rip up the EU’s austerity plans and push through tax cuts to pull Italy out of deep slump. The majority of Italians have clearly voted against the Brussels consensus. That is a damning indictment. But if they can't come up with a coalition, look for another technocrat to be installed to run things until they figure it out. 

Monday, February 04, 2013 - Brouhaha As Excuse

Brouhaha As Excuse

by Sinclair Noe

DOW – 129 = 13,880
SPX – 17 = 1495
NAS – 47 = 3131
10 YR YLD - .04 = 1.97%
OIL – 1.61 = 96.16
GOLD + 6.80 = 1675.40
SILV - .08 = 31.86

With all the brouhaha over the fiscal cliff and the debt ceiling and the inauguration and the Super Blackout, it would be easy to forget the problems in Euro-land, but today, those problems have jumped back onto center stage, again. In Italy and Spain the prospects of stable government are slipping.

First in Italy, an election is scheduled for later in the month. The technocrat-slash-PM Mario Monti will exit, stage right, and the race is on. The second and third place contenders are a comedian named Beppe Grillo and another comedian, Silvio “Bunga-Bunga” Berlusconi; it appears unlikely either will win, but they are looking like they can splinter the vote for front-runner Pier Luigi Bersani. The running theme of the campaigns is anti-austerity and anti-German authoritarianism.

In Spain, the economy is contracting, again. Fourth quarter GDP shrank by 0.7%; the steepest decline in more than 3 years. Also, last week a new report showed unemployment at more than 26% in the fourth quarter. They are still calling it a recession but it is clearly a depression, and it is exacerbated by spending cuts and tax increases. Toss in a slush fund scandal involving the Prime Minister Rajoy, alleging kickbacks from construction firms; add in the Catalonian secessionist movement, and massive street protests.

Italian and Spanish bond yields jumped higher today. Implied default probabilities in Italy and Spain that were at 50 percent last July are still as high as 20 percent.

Toss in a $3 billion dollar fourth quarter loss for Deutsche Bank, and similar writedowns for Credit Agricole, the number 3 French bank; and last week the Dutch government nationalized the fourth largest bank in the Netherlands. The banks are still a weak link in any Euro-recovery. They haven't written off enough of their losses; they continue to hold toxic assets; they have tightened lending as capital gets swallowed up in the black hole of their impaired balance sheets.

Meanwhile, Royal Bank of Scottland is expected to announce tomorrow that has a settlement agreement with US and British authorities to pay $780 million in fines for manipulating Libor, the London Interbank Offered Rate, which is the key benchmark for interest rates.

Today, the British finance minister announced plans for what they are calling an electric ring fence around retail banks. The idea is to break up British banks that fail to guard their day-to-day banking from risky investment activity. The idea is that there would be repercussions to mixing deposits with the gambling money. We used to have a law that prevented those problems. It was called Glass-Steagall, and the Brits are slowly returning to the wisdom of that separation. And in announcing the new regulations, the British head of the Exchequer, George Osborne, (no relation to Ozzy), said: “America and elsewhere, banks found ways to undermine and get around the rules.” In the U.S., three out of the four biggest banks are bigger than they were before the financial crisis. Which is true, but he failed to mention that in the US and Europe, the big banks get bigger and bigger and operate with impunity from prosecution for things like Libor rate rigging or money laundering.

This is not to say that US banks have it easy. According to Brian Moynihan, the CEO of Bank of America, the acquisition of Countrywide was like climbing a mountain with a “250-pound backpack.” An article in the NY Times over the weekend says that so far, BofA has set aside some $40 billion to settle claims of mortgage misconduct that occurred before it acquired the fast and loose Countrywide. And to hear BofA tell it, all those bad mortgages sprang from the muddy waters of Countrywide. But according to documents from three Federal Home Loan Banks and a state Supreme Court in Manhattan, BofA continued shoddy mortgage practices well after the Countrywide acquisition.

Among the new details in the filing are those showing that Bank of America failed to buy back troubled mortgages in full once it had lowered the payments and principal on the loans — an apparent violation of its agreements with investors who bought the securities that held the mortgages.

The filings show that Bank of America had modified more than 134,000 loans in such securities with a total principal balance of $32 billion. Even as the bank’s loan modifications imposed heavy losses on investors in these securities, Bank of America did not reduce the principal on second mortgages it owned on the same properties. The owner of a home equity line of credit is typically required to take a loss before the holder of a first mortgage. By slashing the amount the borrower owes on the first mortgage, Bank of America increases the potential for full repayment of its home equity line. Bank of America carried $116 billion in its home equity loans on its books at the end of the third quarter of 2012.

This new information is part of a suit that alleges BofA's $8.5 billion dollar settlement of shady mortgage practices back in the summer of 2011, that settlement was letting BofA off far too easy (about 2 cents on the dollar), and it was made without proper analysis of all the wrongdoing by BofA. So, the acquisition of Countrywide offered BofA a scape goat, an excuse for nasty behavior. The only problem is that they kept running things the same way as Countrywide.

Meanwhile, the Justice Department, along with state prosecutors, plans to file civil charges against Standard & Poor's Ratings Service, accusing the firm of fraudulently rating mortgage bonds that led to the financial crisis. A suit against S&P would be the first the government has brought against the credit ratings agencies related to the financial crisis. Up until last last week, the Justice Department had been in settlement talks with S&P, but negotiations broke down after the Justice Department said it would seek a settlement in excess of “10 figures,” or at least $1 billion, essentially wiping out a full year of profits for the S&P parent company, McGraw Hill.

During settlement negotiations, the Justice Department held out the threat of a criminal case against S&P. Ultimately, the government plans to bring a civil suit, which has a lower burden of proof than a criminal case. And we all know the Justice Department hates to work hard to insure fair and equal justice under the law.

So you're probably saying: “Hey, this whole Euro-zone dysfunction is nothing new. So what if another Euro-bank gets fined for being sleazy scum bags? So what if there's a corruption scandal in Spain? So what if I haven't even mentioned Greece or Cyprus? So what if the austerity measures are grinding the life out of the Euro-economy like a jack-boot on the throat? What does all that have to do with a downturn in the US stock market?

And the answer is – it's a good excuse.

We have a couple of big, juicy round numbers serving as resistance; the Dow is staring down 14,000 and the S&P is pushing 1500. And then we have record highs to consider. And then we have to pause and consider that the move in January looked nearly parabolic. And that forces us to ask some questions. Has the economy actually improved? Can the average investor continue to ignore stocks or can the markets find greater fools to step up to the plate and donate their money?

Why worry; the markets always go up; except when they don't.

With the stock market up more than 100 percent from those scary days in early 2009, it seems we’re in danger of repeating the same old cycle of swearing off stocks forever during scary markets, missing a huge rally and then deciding it’s time to buy when stocks are high again. Or maybe it's time to sell. Actually, the thing to do right now is to make sure you have a plan in place which covers scenarios such as February 2013, and probably the first question to be answered when creating a plan is: Why are you investing this money in the first place?

And what this really tells us is that the US and Euro-zone economies are a bit stronger and more resilient than than we imagine. And when black swan events are predicted and discussed, they rarely happen; they are instead avoided.

The Energy Information Administration says Americans spent a record amount on gasoline last year, with more of their income going toward motor fuel costs than at any time since the 1980s. The average household expenditure on gasoline hit $2,912 in 2012, or just under 4 percent of pre-tax income, as higher prices at the pump canceled out the effect of more efficient vehicles.

This was the highest estimated percentage of household income spent on gasoline in nearly three decades, with the exception of 2008. The previous record amount was just below $2,750 in 2008, as crude oil prices spiked toward $150 a barrel in the first half of 2012. Global crude oil prices averaged around $111 in 2011 and 2012. The average cost of a gallon of gasoline in U.S. cities was $3.70 last year, up more than 30 percent since 2010. And although prices are down from 12 months ago, prices are moving higher; up 4 cents last Friday alone.

On February 3, 1913, the 16th Amendment to the Constitution was ratified; the reason that's important is because it marks 100 years of federal income tax.

And finally, there's one thing I think we all learned from yesterday's Super Bowl: don't forget to pay your electric bill on time.