Tuesday, December 03, 2013 - But Be Afraid

But Be Afraid

By Sinclair Noe

DOW – 94 = 15,914
SPX – 5 = 1795
NAS – 8 = 4037
10 YR YLD - .01 = 2.78%
OIL + 2.22 = 96.04
GOLD + 5.00 = 1225.30
SILV - .03 = 19.28

Stocks down again today for the third straight session, the first three-session losing streak since late September. It isn't a trend, yet; as we said yesterday, it's only a reason to stay cautious. I'm reading the rationale for today's decline:

“Traders blamed the slide on worries about the Federal Reserve winding down its economic stimulus program earlier than expected due to strong readings on November manufacturing and construction spending released Monday. Weaker-than-expected consumer spending for the kickoff to the holiday shopping season also has investors on edge.” (USA Today)

And now I'm more confused than ever. Traders claim the economy is too strong, then we hear that consumer spending is too weak, and the worry is the Fed will taper. Flip a coin – you'll be more accurate.

The bulls’ case appears increasingly strained. One argument is that there is enough talk of bubbles that there can’t possibly be one. But in fact, in the dot-com era, there was plenty of discussion of frothiness of the tech stocks. Remember irrational exuberance?

Similarly, contrary to popular perceptions, mortgage industry insiders were concerned about the subprime market starting in 2005, with every conference featuring a panel on whether that market was getting out of hand.

And at least those overdone bull markets were built on the back of solid fundamental growth. By contrast, the U.S. recovery is more technical than real, with headline unemployment failing fully to capture the dire state of labor conditions. Estimates that include underemployment at near Depression eara levels. College grads face an unprecedentedly hostile job market and many are also mired in student debt. Not surprisingly, consumer confidence has dropped over the past seven months. And the recovery in the housing market? We'll get to that in a moment.

The Fed’s policies of super-low interest rates and quantitative easing, which have lowered yields on Treasury and mortgage bonds, have sent investors scrambling for returns. And the Fed’s efforts have been compounded by similarly aggressive policies in Japan and China, and even a willingness to be more accommodative by the once austerity smitten European Central Bank. Market trading has been driven by anticipation of Fed action rather than economic fundamentals.

In a May 2013 testimony to the Joint Economic Council, Federal Reserve Chairman Bernanke stated that the FOMC has made it clear, "it is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes." Alongside additional answers he offered concerning the rationale and timing of such tapering, the financial markets immediately swooned.  A number of Federal Reserve officials had immediately and ever since come out to distort and negate some of the Chairman's communications, in an attempt to reduce the apparent runaway rise in borrowing costs, particularly on shorter-tenured bonds. we also do know that growth, revenue, and earnings, have all just been ok throughout the year. So,it makes sense that the Federal Reserve has had an outsized role in changing the trajectory of market performance, at least since June and probably into the New Year

Bill Gross, the head of bond giant Pimco, in his most recent investment outlook wrote: “Don't fight central banks, but be afraid.” Markets that have "excess liquidity" compliments of central banks become skewed toward the speculative end of the spectrum. Speculative markets can continue to rise much longer than rational people believe, or maybe the speculative market ended last Friday. Markets cannot rise forever based on printed money. At some point, the economy needs to carry more weight, but fear is not a valid investment strategy; discipline is.

Sales over the Thanksgiving weekend may have been a disappointment for the nation’s retailers, but they were a boon for the automakers, lifting their sales in the United States for November to the best rate since before the recession. Industrywide sales rose 8.9 percent in November to 1.25 million vehicles. At that pace, automakers predicted a seasonally adjusted annual rate of 16.3 million vehicles sold, the highest since May 2007. For the year, the industry is expected to sell 15.6 million new vehicles.

Corelogic released its report on home prices for October. The Corelogic Home Price Index is a 3 month weighted average, and it shows prices increased just 0.2% compared to September. Year over year, home prices, including distressed properties, nationwide increased 12.5%; this marked the 20^th consecutive monthly increase in home prices.

The housing market recovery is uneven, and home prices in 12 states remain at least 20% below local peak levels. Nevada’s home prices in October, including distressed sales, were 41% below a 2006 peak, the largest drop from bubble levels, despite explosive growth of 26% over the past year. Prices in Florida and Arizona in October were more than 30% below local peak levels. In California, home prices are still about 22% below the peak. In October, national home prices were down 17% from a bubble peak. Only 1.88 million homes were for sale at the end of October, down 2.1 percent from the previous month and the fewest since March. The shortage of inventory has slowed sales. Home re-sales fell in October for a second straight month to a seasonally adjusted annual pace of 5.12 million.

Michigan home sales were up 14% over the past year. That seems surprising in light of the news out of Detroit today, but Michigan is a big state. Detroit is in bad shape. Detroit is in far worse fiscal shape than other major American cities and cannot mount a sustainable recovery without a drastic overhaul that will certainly impose harsh sacrifices. The city of Detroit today officially became the largest municipality in U.S. history to enter Chapter 9 bankruptcy after US Bankruptcy Judge Steven Rhodes declared it met the specific legal criteria required to receive protection from its creditors. The landmark ruling ends more than four months of uncertainty over the fate of the case and sets the stage for a fierce clash over how to slash an estimated $18 billion in debt and long-term liabilities.

Whether Rhodes would deem the city insolvent wasn’t much of a question. If Detroit isn’t insolvent, what place is? Less clear was the status of pensions. The bankruptcy judge said he will allow pension cuts in Detroit's bankruptcy, even though pensions were protected under Michigan's constitution; but he also said he won't necessarily agree to pension cuts unless the entire reorganization plan is fair and equitable. The average Detroit General Retirement System pensioner nets less than $20,000 a year; for police and fire retirees, it’s about $34,000 annually.

Judge Rhodes said he will not issue a stay on the bankruptcy, meaning the case will proceed. And even though an appeal has already been filed, and more will come in the days ahead, the bankruptcy code provides for Chapter 9 to continue while appeals are pending that challenge. Rhodes also scolded the city for rushing through negotiations with its creditors, noting they only had 30 days to offer a counter-proposal. Saying that amount of time is “simply far too short,” Rhodes ruled the city did not satisfy good-faith requirements to try to negotiate with creditors outside of bankruptcy court. Bankruptcy protection limits the legal actions the city's 100,000 creditors can take to collect money owed to them. So, it looks like the Judge is pointing all parties back to the negotiating table.

America is doing a lousy job of educating our kids. According to the latest results of a comprehensive set of international tests, America's teens have remained mid-pack among their peers worldwide and utterly stagnant in reading, math and science over the last 10 years.

America's 15-year-olds failed to improve on the Program for International Student Assessment; meanwhile, East Asian countries maintained their top slots, and other countries not generally known for their academic prowess have become breakout stars of a sort. Poland, Germany and Ireland showed tremendous growth, and Vietnam, which administered the exam for the first time in 2012, wound up among the top-performing countries, eclipsing the US in math and science. Yes, the US now trails Vietnam in our ability to educate our teenagers.

In fall 2012, the Organisation for Economic Co-Operation and Development tested 28 million students between ages 15 and 16 in 65 economies, including 34 OECD countries. Among those 34 countries, the US performed slightly below average in math, scoring 481, and ranked 26 (though the report notes that due to measurement error, the ranking could range from 23 to 29.) Shanghai, Singapore, Hong Kong, Chinese Taipei, Korea and Japan came out on top, followed by such European countries as Liechtenstein, Switzerland, Netherlands, Estonia, Finland and Poland. Peru, Indonesia, Qatar, Colombia and Jordan came in last.

In reading, the US performed around the OECD average of 496, ranking 17 (or between 14 and 20) with an average score of 498. Again, Shanghai, Hong Kong, Singapore, Japan, Korea, Finland, Ireland, Taipei, Poland and Estonia came out on top, with Argentina, Albania, Kazakhstan, Qatar and Peru filling out the bottom.

The US also came in around the OECD science average of 501, ranking 21 (between 17 and 25) with an average score of 497. Top scorers included Shanghai, Hong Kong, Singapore, Japan, Finland, Estonia, Korea, Vietnam, Poland and Canada. The lowest performers include Peru, Indonesia, Qatar, Albania and Tunisia.

We've tried to chronicle the misdeeds of Wall Street banksters leading up to and following the financial crisis, so it might surprise you to learn that, according to a survey from the Economist Intelligence Unit, 60% of those surveyed said they had a positive view of Wall Street's reputation for ethical conduct; of course those surveyed were Wall Street financial industry executives. A separate survey by Edleman interviewed 31,000 regular people, and they concluded that the financial services industry was the least trusted of 18 industries to do the right thing by the general public.

The quote of the day goes to Goldman Sachs CEO Lloyd Blankfein, speaking at an industry conference today, saying “This country does a great job of creating wealth, but not a great job of distributing it.”

Thursday, October 31, 2013 - Halloween Miracles

Halloween Miracles

by Sinclair Noe

DOW – 73 = 15,545
SPX – 6 = 1756
NAS – 10= 3919
10 YR YLD + .02 = 2.54%
OIL - .53 = 96.24
GOLD – 20.20 = 1323.70
SILV - .83 = 22.01

The S&P closed near its intraday low, but it's been a good October. For the month, the Dow gained 2.8 percent, the S&P 500 added 4.5 percent and the Nasdaq rose 3.9 percent. The S&P 500 is up 23.2 percent for the year so far.

The S&P/Case-Shiller index showed that home prices in 20 large metro areas rose 1.3% from July and 12.8% from August 2012. Prices haven't risen this fast year over year since Feb. 2006. Still, there are signs of a cooling. The rate of monthly increases in the 20 large cities peaked in April. Since then home prices continued to rise, but at a slower pace each month. This month 16 cities reported smaller gains in August compared to July. Las Vegas saw the largest annual increases, with prices soaring from a year earlier  29.2%. In San Francisco prices jumped 25.4%; in Los Angeles 21.7%; in San Diego 21.5%.

The Chicago purchasing managers index jumped to a reading of 65.9 in October, up from 55.7 and well ahead of the consensus of 54.5. Readings above 50 indicate expansion.

The number of Americans filing first-time claims for unemployment insurance fell by 10,000 last week, to 340,000 from 350,000 the week before. Though it's the third straight week that claims have dropped, the number of applications is still within a range that signals a sluggish labor market. The unemployment rate at 7.2% is almost certain to climb in October because of the government shutdown. The jobless rate includes workers who are temporarily laid off from their jobs, even if they eventually get paid for time missed. As a result, the unemployment rate in October will include furloughed government workers as well as private-sector employees laid off by companies that rely heavily on federal contracts. The unemployment rate could jump up to 7.5%. The number of net jobs created, however, might not be affected nearly as much. That number is derived from a separate Labor Department survey of businesses about how many people they hired in a month.

The unemployment rate in the 17-nation eurozone remained unchanged in September at a record high of 12.2 percent. The number of unemployed rose by 60,000 to 19.45 million. The jobless rate for those aged under 25 edged up to 24.1 percent from 24 percent in August. The unemployment rate for the wider 28-nation European Union remained unchanged at 11 percent.

 Figures on government spending and debt were released today. The government's fiscal year runs Oct. 1 through Sept. 30. Total public debt subject to limit was $17.043 Trillion. The deficit through August dropped to $755 billion.

Settlement talks between the Justice Department and JPMorgan are in danger of breaking down over the bank’s demands that it avoid future criminal charges and that another government agency pay some of the $13 billion price tag.

Federal prosecutors have been working with JPMorgan for months to resolve allegations that the bank knowingly sold securities made up of low-quality mortgages in the lead-up to the financial crisis. As of last week, the nation’s largest bank had agreed to a tentaive $13 billion settlement that would expunge multiple government probes. Details of the agreement were being hashed out, but now the sides have reached an impasse.

Attorneys for JPMorgan proposed a deal that would give the bank protection from future criminal investigation. Federal prosecutors assumed that aspect of the deal was settled and were bothered when attorneys asked that the bank be released from future criminal prosecution. There also remains a standoff over whether JPMorgan or the Federal Deposit Insurance Corp. is responsible for losses on mortgage securities issued by Washington Mutual, the failed bank that JPMorgan bought out of receivership for $1.9 billion in 2008. Some of those securities are a part of the complaints that JPMorgan is trying to resolve in its settlement with the Justice Department.

Have your ever heard of the push-out provision? It's a little known provision in the Dodd Frank reforms, and the bank lobbyists have killed it, and lawmakers came together in bipartisan unity to bury it. The idea behind the push-out provision is that the banks would have to separate their swaps trading units from the main bank, where funds are FDIC insured. So, now that the lobbyists have killed the push-out provision, they can gamble in derivatives trading using insured deposits.

Now, if you're wondering why or if this is significant, just look at Cyprus, or if you want to get a bit closer, look at Detroit. Both pensioners and bond holders argue they should have priority in claiming a stake in the city's assets in the bankruptcy process. However, a different class of creditor has legally senior status. Holders of financial derivatives enjoy super-priority in bankruptcy, thank to changes in the bankruptcy law of 2005; they are not subject to the ‘automatic stay’ provision intended to prevent a disorderly grab for collateral by competing creditors. They can press their claim immediately, prior to bankruptcy proceedings and therefore before claims by competing creditors are considered. This may potentially leave nothing for other creditors to divide during subsequent proceedings.

The latest court proceeding in Detroit was to determine if retired city workers might get 16 cents on the dollar, even though the Michigan constitution contains a provision which bans any action to cut pension benefits of public employees, or whether the federal bankruptcy code trumps the state constitution. And if you think Detroit is the only city with these kinds of problems, think again. And if you think it only applies to retirement plans, remember what I just told you about the push-out provision. That's right, the super-priority position of financial derivatives also applies to your FDIC insured bank account.

Bill Gross, the billionaire founder and chief investment officer of Pacific Investment Management Co., also known as PIMCO, writes an investment outlook; kind of a regular newsletter that he posts on the website. The latest from Bill Gross is a bit of a surprise. He says wealthy people need to stop whining about the taxes they pay, realize their success is mostly dumb luck and pay even higher taxes to help the less fortunate. Gross writes in his latest monthly missive, entitled "Scrooge McDucks,": "Having gotten rich at the expense of labor, the guilt sets in and I begin to feel sorry for the less well-off." It's a Halloween miracle. 

And he continues: “Admit that you, and I and others in the magnificent '1%' grew up in a gilded age of credit, where those who borrowed money or charged fees on expanding financial assets had a much better chance of making it to the big tent than those who used their hands for a living.”

And Gross suggests the soaring income inequality of the past few decades is a serious problem for the entire US economy: “Developed economies work best when inequality of incomes are at a minimum. Right now, the U.S. ranks 16th on a Gini coefficient for developed countries, barely ahead of Spain and Greece. By reducing the 20% of national income that “golden scrooges” now earn, by implementing more equitable tax reform that equalizes capital gains, carried interest and nominal income tax rates, we might move up the list to challenge more productive economies such as Germany and Canada.

“I would ask the Scrooge McDucks of the world who so vehemently criticize what they consider to be counterproductive, even crippling taxation of the wealthy in the midst of historically high corporate profits and personal income, to consider this: Instead of approaching the tax reform argument from the standpoint of what an enormous percentage of the overall income taxes the top 1% pay, consider how much of the national income you’ve been privileged to make.”

Gross notes that the 1 percent now take up 20 percent of U.S. income, up from 10 percent in the 1970s -- a fact he attributes at least partly to the massive tax cuts for the wealthy enacted by Presidents Ronald Reagan and George W. Bush.

Gross also points out that the wealthy have gotten all of the benefit of the explosive rise of the financial sector over the past several decades, along with a 30-year decline in interest rates. Together, these two factors lined the pockets of the wealthy, but left everybody else behind. And Gross offered a policy prescription: “If you’re in the privileged 1%, you should be paddling right alongside and willing to support higher taxes on carried interest, and certainly capital gains readjusted to existing marginal income tax rates. Stanley Druckenmiller and Warren Buffett have recently advocated similar proposals. The era of taxing ‘capital’ at lower rates than ‘labor’ should now end.”

And then Gross takes a shot at Carl Icahn, and probably quite a few other captains of industry by adding: “If X can’t grow revenues any more, if X company’s stock has only gone up because of expense cutting and stock buybacks, what does that say about the U.S. or many other global economies? Has our prosperity been based on money printing, credit expansion and cost cutting, instead of honest-to-goodness investment in the real economy?”

Thursday, September 05, 2013 - Mustering Support

Mustering Support

by Sinclair Noe

DOW + 6 = 14,937
SPX + 2 = 1655
NAS + 9 = 3658
10 YR YLD + .08 = 2.98%
OIL + 1.23 = 108.46
GOLD – 23.90 = 1368.70
SILV - .25 = 23.31

The war hasn't started, yet.

President Obama is in St. Petersburg Russia for the G-20 summit, he received a cordial but cool greeting from Russian President Vlad Putin, however Putin had harsh words for Secretary of State John Kerry, calling him flat out a “liar”, referring to his testimony regarding Syria, a close ally of Russia.The United States has given up trying to work with the U.N. Security Council on Syria, accusing Russia of holding the council hostage. Russia, backed by China, has used its veto power three times to block council resolutions condemning Assad's government and threatening it with sanctions. 

Yesterday, a Senate panel authorized military action in a “limited and specified manner”. A full vote is expected next week. Syria is dominating a summit with an official agenda focused on economic growth, monetary policy and global banking and tax rules. Obama began meeting with other leaders of the Group of 20 nations, trying to persuade allies to give the US a measure of political cover even if they withhold military support. Obama has already met with Shinzo Abe of Japan, Francois Hollande of France – who may be the only US ally taking part in a strike against Syria, and also a meeting with Dilma Rousseff of Brazil.

Brazil won't be part of any military action, and Rousseff might even cancel a planned trip to the White House in October 23^rd; the reason has nothing to do with Syria. Rather the Brazilian President is a bit ticked off about information leaked by Edward Snowden that shows the US spied on communications between Rousseff and her top aides. Brazil’s Senate is creating a committee to probe the spying allegations and seek federal police protection for Glenn Greenwald, the journalist who revealed the documents from Snowden. Brazil's foreign minister said: “This represents an inadmissible and unacceptable violation of Brazilian sovereignty. This kind of practice doesn’t live up to the type of trust needed to have a strategic partnership.”

Indeed, the pressure for military action in Syria will find reluctance from several countries as it follows in the footsteps of the Snowden allegations. And if Obama can't muster international support for military intervention in Syria, it will make the job of Congressional support more difficult. Various handicappers believe the resolution would go down to defeat if the vote were held today. So far, the Administration has been unable to make much of a case, beyond moral outrage. In a post Iraq world, people are actually asking pertinent questions like: how long will it last? What is the objective? How much will it cost? So far these are unanswered or inadequately answered questions. It's interesting that they can always find money for military action isn't it?

It is entirely possible that we could soon witness the amazing spectacle of Congress defeating a war resolution backed by the president and every top elected leader.

Of course, a resolution can be defeated and not killed outright. Remember TARP? The first vote for TARP was defeated and it took a market swan dive, a second TARP vote, and the addition of lots of pork to reverse the initial vote. But also bear in mind that the reason TARP was initially voted down was the barrage of voter phone calls and e-mails against it, reportedly 99% opposed until financial services firms started getting employees to call in favor of the bill, which shifted the tally to a mere 80% or so of callers opposed.

Even if the President musters enough votes to strike Syria, at what political cost? Any president has a limited amount of political capital to mobilize support for his agenda, in Congress and, more fundamentally, with the American people. Time and again we have seen domestic agendas succumb to military adventures abroad — both because the military-industrial-congressional complex drains money that might otherwise be used for domestic goals, and because the public’s attention is diverted from urgent problems at home to exigencies elsewhere around the globe.

We've mentioned before that Syria is a minor player in the oil markets, but geographically any action there would have an affect on oil prices. The rarely noticed reason is that Syria is closely allied with Iran, and indeed this whole Syria thing may have more to do with Iran than Syria. Anyway, if something happens, we'll likely see a spike in oil prices. We've been seeing oil over $100 a barrel and gasoline above $3.40 a gallon for much of the last 3 years. Those prices would have shocked many Americans a few years ago, but have now become the new normal.

What changed? Well, Americans are breaking their addiction to driving, at least a little. We own fewer cars per household than just a few years ago. Unfortunately, some of the reduction in motor gasoline consumption directly relates to massive under-employment, especially among those under 25, as well as lower wages among the employed. And the cars we own are more fuel efficient. The average fuel efficiency for new cars sold in the US just six years ago was only 20.8 miles per gallon; today it's 24.8 MPG. That may not sound like much, but it's about a 20% improvement.

Higher domestic production and lower American consumption have meant declining imports of crude oil and petroleum products-- a reversal of another once seemingly inexorable trend. The economic burden of imported oil is represented not by the number of barrels, but instead by the real value of the resources we must surrender in order to obtain the oil. The dollar value of petroleum imports as a share of GDP has come down a little as a result of recent gains in production and conservation, but still remains significantly elevated relative to the levels of a decade ago.

Let's get back to economic news.

Tomorrow we'll see the monthly jobs report for August. We got some clues today. Jobless claims declined by 9,000 to 323,000 in the week ended Aug. 3. Employers seem to be holding the line on dismissals. Meanwhile, ADP, the private payroll processing firm issued their monthly report which showed companies increasing employment by 176,000 workers in August. The ADP report does not always match with the government report, but folks like to use it for guesstimates anyway. It's widely expected the economy added 175,000 to 180,000 jobs last month, up from July's gain of just 162,000. Anything over 200,000 would tilt the odds heavily in favor of the Fed beginning to taper QE security purchases at the FOMC meeting in two weeks.

 

Bill Gross, the head of PIMCO, in his September letter to investors says that central banks' easy money policies have become less effective in generating economic stability, and that zero-bound interest rates have threatened finance and investment in the "real economy."

Gross writes: "Why invest in financial or real assets if bond prices could only go down, and/or stock prices could no longer be pumped up via the artificial steroids of QE?"

Gross added that liquidity will be "challenged" when policymakers start to tighten easy money policies and stocks may also be "at risk" when the Fed ends its bond-buying program. In other words, the Fed's exit from QE might not be baked into the cake just yet.

If you've been listening to the Financial Review for more than a day or two, you know that I think the banking system poses a systemic threat to the economy. A few years ago I wrote a book called “Eat theBankers”, and you can follow these daily broadcasts at the website EattheBankers.com. So, it is reassuring for me when I hear others jumping on the bandwagon. I'm not going to go into detail, but Simon Johnson, the former chief economist for the International Monetary Fund, recently wrote an article for Bloomberg, and I'm posting the link: The title is: Bank Leverage is the DefiningDebate of Our Time.

The basic idea of the article is that excessive leverage could bring down the world economy again. And the next financial collapse could be even worse than what we experienced in the fall of 2008. The debate is between the Too Big to Fail Banks that want to take more risks precisely because they can draw on implicit or explicit government guarantees, and on the other side are sane people who realize that the banks could destroy the economy.

The banks don't want to set aside safe, reserves, they'd rather take that money and gamble. Letting banks calculate their own risk weights or develop their own methodologies makes no sense -- conflicts of interest predominate when you are too big to fail. But asking rating companies or government officials to come up with meaningful risk weights also is doomed to fail. They lack the information, motivation and compensation incentives to do this right.

We've had this debate before; at the beginning of the 20^th century Teddy Roosevelt brought a case against JPMorgan's Northern Securities Company as part of the anti-trust movement. The case was ultimately decided by the Supreme Court in the government's favor. Had the monopolists won, instead of enjoying a vibrant competitive economy and a century of unprecedented growth that made the U.S. the world’s greatest power, we would have likely ended up like other unfortunate countries where a few oligarchs rule to the disservice of the broader public and the greater good of the economy. 

Tuesday, June 04, 2013 - Systemically Dangerous

Systemically Dangerous

by Sinclair Noe

DOW – 76 = 15,177
SPX – 9 = 1631
NAS – 20 = 3445
10 YR YLD un = 2.13%
OIL + .38 = 93.83
GOLD – 11.20 = 1401.00
SILV - .20 = 22.65

Tuesday?? What happened? For 20 consecutive weeks, Tuesday was an up day on Wall Street; going back to January, every Tuesday was a winner. I don't know why. Maybe there was something going on in the shadows and dark corners of Wall Street, maybe it was just a fluke of nature; maybe it was a trend that started and continued as the algorithmic traders took notice.

The first rule of trends is that a trend in place is more likely to continue than it is to reverse, until it reverses. That sounds simple, but it isn't. Behind that concept is the idea that you follow the market rather than trying to impose your will, or your pre-conceived notions, or your bias on the market. Today, the trend reversed.

Federal regulators have proposed a group of firms that aren't banks to be deemed potential threats to the financial system that need stricter government oversight. The Financial Stability Oversight Council, which includes Treasury Secretary Jacob Lew and Federal Reserve Chairman Ben Bernanke, was created to help prevent another meltdown.

Nonbank financial firms include insurers, hedge funds, mutual fund companies and private equity firms. Those deemed "systemically important" would have to increase their cushion against losses, limit their use of borrowed money and submit to inspections by Fed examiners. These firms would have 30 days to notify the council that they're contesting the designation. The council would have to vote again to finalize each designation. The regulators didn't name the firms or say how many it wants to designate as so big and interconnected that their potential troubles could imperil the financial system.

Some of the usual suspects include the insurance firms, AIG and Prudential, they might include names like Pimco; we'll get to them in a moment. I'm not sure how much credence we lend to the regulators, especially considering they haven't been able to regulate the systemically dangerous banks. If they want to be taken seriously, the first step is to reinstate Glass-Steagall.

We don't know the firms on the list of nonbank, potentially dangerous financial firms, but it would seem that Pimco is pretty big – about $2 trillion, and before they could be labeled dangerous, bond guru Bill Gross has taken aim at the Federal Reserve and Ben Bernanke, charging that the Fed's super-easy monetary policies are dangerous to an economic recovery.

Gross is the founder and co-chief investment officer of Pimco and he writes a regular letter to investors which he posts on the firm's website. The latest letter is entitled “Wounded Heart” and he warns investors to reduce risk assets as a result of the weak rewards to be gained. Gross characterized the Fed's zero interest rate policy and quantitative easing as distorting markets by keeping interest rates artificially low and creating an insatiable demand for riskier, higher yielding assets.

Gross wrote: "Our global financial system at the zero-bound is beginning to resemble a leukemia patient with New Age chemotherapy, desperately attempting to cure an economy that requires structural as opposed to monetary solutions.”

Gross also wrote: “Central banks — including today’s superquant, Kuroda, leading the Bank of Japan — seem to believe that higher and higher asset prices produced necessarily by more and more QE check writing will inevitably stimulate real economic growth via the spillover wealth effect into consumption and real investment. That theory requires challenge if only because it doesn’t seem to be working very well.”

The quick version of Gross' thesis is that financial markets require “carry” to pump oxygen to the real economy; “Carry” is compressed – yields, spreads and volatility are near or at historical lows; the Fed's QE plan assumes higher asset prices will reinvigorate growth; it doesn't seem to be working; therefore reduce risk/carry related assets.

Gross may have a point, but then he missed his mark claiming that low rates create less incentive to take risk; and while that may be true, it is the wrong answer. Gross seems stuck in his supply-side world. The answer is not creating more credit, but creating more demand. Short-term the Fed has been able to re-inflate the stock market, and Bernanke makes no bones about that, but it is a dangerous game to inflate asset bubbles, and it doesn't really do much to create jobs. If the Fed really wants to lower the unemployment rate, they will have to change their tactics, and that seems to be what the Fed is priming the markets for right now.

Today,  Esther George, president and CEO of the Federal Reserve Bank of Kansas City and a member of the Federal Open Market Committee, which determines central bank monetary policy gave a speech and she said she is in support of "slowing the pace of asset purchases as an appropriate next step for monetary policy." While she acknowledged her views are not shared by the "majority" of the voting members of the FOMC, it created fresh uncertainty about when the Fed will start dialing down its stimulus. This is the dangerous gamble part of the Fed's asset bubble policy

George went on to say: "History suggests that waiting too long to acknowledge the economy's progress and prepare markets for more normal policy settings carries no less risk than tightening too soon," and "A slowing in the pace of purchases could be viewed as applying less pressure to the gas pedal, rather than stepping on the brake. Adjustments today can take a measured pace as the economy's progress unfolds." It's not so much a matter of applying the brakes, as it is that the Fed is in the wrong vehicle.

Back to those systemically dangerous, too big to fail institutions. Back in 1999, then deputy US attorney general Eric Holder wrote a memo entitled  “Bringing Criminal Charges Against Corporations,”  in which he argued that government officials could take into account “collateral consequences" when prosecuting corporate crimes.

That memo has resurfaced at a time when Holder, now U.S. attorney general, faces increasing criticism for the Department of Justice's reluctance to bring charges against white-collar criminals. Although it brought only a modest change in the way prosecutors evaluate whether to bring criminal charges against corporations, Holder's memo laid the groundwork for subsequent policies that allowed for more leeway when going after large firms.

In 1999, Holder highlighted the possibility of deferred prosecution -- an arrangement now common in the wake of the financial crisis -- whereby prosecutors essentially give defendants amnesty in exchange for paying a fine, enacting reforms and cooperating with investigators. Later, officials published further memos, turning the option into more of a recommendation. The policy was strengthened in response to the Arthur Andersen scandal of the early 2000s. After the government brought criminal charges against the consulting firm, the company failed, causing 28,000 workers -- many of whom likely had no role in any wrongdoing -- to lose their jobs. A court later overturned the charges.

Holder told the Wall Street Journal in 2006 that he drafted the memo in response to complaints that there seemed to be no uniform rules for deciding whether to bring charges in corporate cases: "[I] didn’t expect these issues would become as big as they were," Holder told the WSJ at the time. Indeed, they've only grown larger in the seven years since that interview.

The government has yet to prosecute any big banks or major executives for their role in the meltdown, and critics have derided Holder and his Justice Department for using the collateral damage argument as an excuse for not doing enough to hold those institutions accountable. The DOJ came under fire last year after declining to prosecute HSBC for years of money laundering violations, saying that to do so would bring too much damage to the global economy.

The government just backed down. Maybe there were reasons in 2008 to say maybe we shouldn’t indict any bank we can because it will just add to the systemic risk. But we were in 2012 to 2013 with HSBC -- that risk wasn’t there and we weren’t dealing with something that was relating to the activities that produced the 2008 crisis.

And finally today, we have a follow-up to the London Whale. Bloomberg Markets will report in its July Issue that Bruno Iksil, a Frenchman who would soon become known as the London Whale because of the size of his trades, knew that the trades were going very badly. On March 23, 2012 he wrote a message to an assoicate saying, “We are dead I tell you.”

Iksil had lost $44 million on corporate-credit bets three days earlier and was down more than $500 million for the year. He and junior trader Julien Grout, under pressure from their manager, had tried to hide the extent of losses that would swell to more than $6.2 billion, the bank’s biggest trading blunder ever.

“They are going to destroy us,” Iksil wrote to Grout that Friday in one of hundreds of e-mails, instant messages, transcripts of recorded conversations and other documents released in March by the U.S. Senate’s Permanent Subcommittee on Investigations after a nine-month probe.

In a 301-page report and at a hearing, the panel accused the largest and most profitable U.S. bank of hiding losses, deceiving regulators and misinforming investors.

The report, the bank’s own 129-page account and interviews with traders and current and former executives offer evidence of a widening spiral of panic as the losses became known beyond a small circle of traders and the extent of the damage reached top management, including Chief Executive OfficerJamie Dimon.

What the documents show is that Dimon presided over a company whose traders amassed growing positions in complex derivatives and whose executives offered rosy forecasts, withheld information from regulators and ignored risk limits that were breached 330 times in the first four months of 2012.

The records reveal how little has changed to prevent even the best-managed banks from speculating their way into trouble five years after the collapse of Lehman Brothers and three years after passage of the Dodd-Frank Act.

Monday, April 22, 2013 - Airplanes, Austerity, and Flying Bulls

Airplanes, Austerity, and Flying Bulls

by Sinclair Noe

DOW + 19 = 14,567
SPX + 7= 1562
NAS + 27 = 3233
10 YR YLD - .01 = 1.70%
OIL + .80 = 88.81
GOLD + 19.80 = 1427.30
SILV + .12 = 23.51

It's Monday but it's a better Monday than last Monday. No bombings to report today, at least not in our country.

Over the weekend, the cover story on Barron's magazine featured a cartoon drawing of a bull on a pogo stick, leaping through the air. You may recall that 6 months ago, Barron's poll of big money, institutional investors were bearish on the market; that was about 1,000 points ago. Now they're bullish. This would be a contrary indicator. But not today. Today, the bulls were buying the dips. The market started negative but finished positive. It’s all about momentum. Many fundamentally-oriented investors have been licking their wounds. And the nature of momentum-driven investing is that it can work longer than more sober-minded souls would think possible.

An open question is the odd continued rise of stock prices even as corporate earnings weaken. Why are investors paying more for companies whose earnings are declining in aggregate? In normal bull markets, you see a new leadership group emerge, and late in cycle, investors increasingly favor conservative stocks. This time the leaders are defensive plays, high quality companies that pay healthy dividends. While bulls say that this is predictable given ZIPR, we’ve had ZIPR for years now.
When this disconnect ends is anyone’s guess. But markets like this suggest that even more caution than usual is warranted.

The National Association of Realtors reported existing home sales slipped 0.6 percent last month to a seasonally adjusted annual rate of 4.92 million units. The supply of existing homes on the market for sale rose 1.6 percent during the month to 1.93 million, which represented 4.7 months' supply at March's sales pace, up from 4.6 in February.

That's is way below the 6 months' worth normally considered as an ideal balance between demand and supply. A year earlier, the inventory of unsold homes was 2.32 million, a 6.2 months' supply. More homes are expected to go on the market next month ahead of the summer buying season, so it might just be seasonal or it might signal that tight inventory is crimping demand, or it might signal that there is a real drag on housing.

It's earnings reporting season. Caterpillar reported this morning, with earnings of $1.31 per share; they missed estimates. In a statement the company expressed optimism on domestic housing, but said a 50% reduction in mining related businesses and little to no inventory build going into summer planting season will hurt results. For 2013, Caterpillar lowered its forecasts for both earnings and revenue to the low-end of the previous range.

Netflix posted better than expected earnings, and jumped about 20% in price.

Tomorrow, we'll get the Apple earnings. Over the past six months, Wall Street has gone from thinking that Apple can do no wrong to thinking that there's no way Apple will ever again do anything right. The stock has collapsed from a high of $702 to a recent low of $390 last week. Apple's results in the December quarter disappointed many analysts, and the company's outlook for the first quarter was muted. After a steady flow of news reports suggesting that first-quarter sales have not gone well, as well as Apple's failure to release any new products so far this year, many on Wall Street think that Apple will miss even its low guidance for the quarter.

The government is expected to report Friday that the economy expanded at a relatively healthy 3% clip in the first three months of 2013 after an anemic 0.4% gain in the fourth quarter. But don’t put too much stock into the mostly backward-looking report on gross domestic product. The signs of another midyear slowdown are already evident in softer consumer spending, a barely growing manufacturing industry and a slower pace of private-sector hiring. The same seesaw pattern also occurred in 2012 and 2011; and this year we can add in the effects of the fiscal cliff and the sequester. Consumers are finally feeling the bite from an increase in taxes earlier in the year and a round of federal budget cuts should pinch harder. The cuts only started to take effect in mid-March, and the biggest impact is likely to be felt in the next few months. Best case is for a continuation of an uneven recovery.

Today was the first day of the sequester hitting airports, as the nation's largest airports dealt with the onset of furloughs for FAA air-traffic controllers. Reports of late takeoffs at O’Hare, Atlanta’s Hartsfield-Jackson Atlanta International, New York’s LaGuardia, Los Angeles International and Charlotte-Douglas International in Charlotte, N.C., were widespread. In many cases, planes left the gate, only to sit on the tarmac for extended periods of time, while many flights were cancelled. Flights into cities such as Washington and New York were delayed by more than two hours as a result of the furloughs. Flight delays and cancellations at one airport can have a ricochet effect throughout the rest of the country, messing up arrivals and connections.

Pimco’s Bill Gross, the manager of the world’s largest bond fund, is the latest to trash a focus on austerity by British and euro-zone officials, telling the Financial Times that moving to cut debt too fast instead risks wrecking an economic recovery rather than righting the fiscal ship.

“The U.K. and almost all of Europe have erred in terms of believing that austerity, fiscal austerity in the short term, is the way to produce real growth. It is not,” Gross said. “You’ve got to spend money.”

 Gross says it was a mistake to think bond markets were calling on governments to embark on a round of severe fiscal belt-tightening. “In the long term it is important to be fiscal and austere,” Gross said. “It is important to have a relatively average or low rate of debt to GDP. The question in terms of the long term and the short term is how quickly to do it.”

Of course, last week, there was a major brouhaha about the academic research of Rogoff and Reinhart, who in 2010 put forth the idea that when a country reaches 90% debt to GDP it willl inevitably result in economic contraction. Last week, three economists presented a follow-up which showed Rogoff and Reinhart had flawed assumptions and basic math errors in their research. The idea that there’s a debt-to-GDP threshold that is true for every country, falls apart.

The “moral of this story is that it is an illusion to expect that the complicated relationship between public debt and GDP growth will always and everywhere be the same.” The idea that there is a stable relationship between debt and growth across time and places, independent of weak economies, is now behind us.

The timing of these developments is interesting. Right now there’s a serious effort to rethink the move to austerity. Between the developments in Japan and the IMF’s efforts in Europe and England, the common wisdom will soon be that austerity as a solution was oversold, with all the toxic side effects hidden. The question next will be how to turn that into political power.

France and Spain fell short of their budget deficit goals last year and rather than imposing even more draconian measures, the European Commission signals an end to sharp spending cuts.

The EU's statistics office Eurostat said France posted a deficit of 4.8 percent of economic output, higher than its 4.5 percent target. Spain's shortfall was the largest in the EU. Despite cuts and tax increases, Spain's budget shortfall was 7.1 percent, excluding bank recapitalization, higher than the government's 6.98 percent official year-end reading and well above Madrid's original target of 6.3 percent.

With budget cuts blamed for a second straight year of recession, the EU's top economics official Olli Rehn indicated over the weekend that more flexibility on tough economic targets was needed. European Commission President Jose Manuel Barroso, said today that austerity had reached its natural limits of popular support, saying: "A policy to be successful not only has to be properly designed, it has to have the minimum of political and social support."

Budget cuts have been at the center of the euro zone's strategy to overcome a three-year public debt crisis but they are also blamed for a damaging cycle where governments cut back, companies lay off staff, Europeans buy less and young people have little hope of finding a job. Crippling levels of unemployment and outbreaks of violence in southern Europe are now forcing a rethink, with the focus shifting to economic growth strategies.

It is not yet clear just how big a policy shift EU policymakers are planning.

From the Wall Street Journal:

Troubles overseas are threatening the US recovery for the fourth year in a row. This time it’s weakening economies abroad, rather than tumbling financial markets, signaling turbulence ahead.

US exports of goods to the European Union are declining outright. Growth in overall US exports has been sputtering for months, after a three-year postrecession surge. And major US companies are reporting increasingly disappointing overseas outlooks tied to the recession-plagued euro zone and slowing growth in other leading economies such as China.

The renewed fears of a global slowdown come after months of hope that a stronger recovery was finally taking shape.

Monday, September 10, 2012 - When the Crack Pipe Fails to Satisfy

When the Crack Pipe Fails to Satisfy

-by Sinclair Noe

DOW – 52 = 13,254
SPX – 8 = 1429
NAS – 32 = 3104
10 YR YLD +.02 = 1.68%
OIL -.30 = 96.24
GOLD – 10.50 = 1725.80
SILV - .34 = 33.44
PLAT + 2.00 = 1599.00

Consumer credit shrank by $3.28 billion in July; this marked the first declines in consumer credit in nearly a year as Americans reduced credit card debt. Now for the scary part; I read a couple of stories on this today and they described the news as worrisome for the economy. I disagree. It might be worrisome for the credit card companies; it might be worrisome for the payday loan companies; it might be worrisome for the banks and other loan sharks, but I consider it good news for consumers and the economy in general. Consumer debt does not add to productivity; it doesn't manufacture things. It's debt. It's inflationary. It's takes resources which could be applied to greater purpose elsewhere. It doesn't really matter because the Federal Reserve says they revised their earlier estimates for June, and it is likely we'll all be paying with plastic again in August – you maybe, not me.

Credit has been expanding almost continuously since mid-2010 as the country recovered from the 2007-2009 meltdown. The decline in July was the first drop since August of last year. In July, revolving credit, which includes credit cards, shrank by $4.82 billion. The data looks at declining credit as a negative because it is closely correlated to consumer spending. Of course, there is the possibility that people are buying things with something we used to call money; I know that is a farfetched notion, but I'm holding out hope.

The concept of stopping the continuous compounding of debt upon more debt upon more debt; the very idea of someone in a hole, stopping digging – this notion is completely and totally alien to the Federal Reserve. And so the Federal Reserve will almost certainly announce QE3 at the end of the week, or some version of QE3, or some new catchy name for tossing out free money to the banks, while creating mountains of fresh, new debt.

The only surprise would be if the Fed did not announce QE3 and QE to infinity; in which case the market would throw a tantrum and break things, like your 401k. The Wall Street bookies, or analysts, are putting the odds of QE3 at 99%. And then you have to believe that since the market believes the Fed will deliver QE to infinity, they have already baked it into the cake. Accommodative policy is already priced into equity and bond valuations.

We know the markets love free money, but what if the Fed announced QE and the markets were flat or even worse, their response is negative because it's already priced in. And even though the Wall Street types love free money from the Fed, businesses on Main Street aren't making investment or hiring decisions based on the idea that the Fed is holding interest rates near zero. In fact, if you want to spur capital expenditures, you might want to hint that rates will go up in the future and now is the time to make your move. At some point, the Fed's action won't be enough to make a major difference in markets; I don't think we're there yet.

Yale University professor Stephen Roach and Bill Gross, the manager of the world’s biggest bond fund at Pimco say central bank money printing is losing its effectiveness in spurring growth.

Roach says: “I’ve been negative about the U.S. ever since the Fed went to their unconventional monetary policy.”

Gross, who oversees Pimco’s $270 billion Total Return Fund, wrote in the monthly commentary posted on Pimco’s website last week: “Our credit-based financial system is burdened by excessive fat and interest rates that are too low.”

After the Fed’s first round of quantitative easing, the Bank of England announced 75 billion pounds ($120 billion) of asset purchases in March 2009, and the ECB provided 442 billion euros ($565 billion) in one-year loans to the region’s lenders in its Long Term Refinancing Operation, or LTRO, three months later. The Bank of Japan said in October 2010 it would buy 5 trillion yen ($64 billion) of government and corporate debt.

The Fed cut its overnight bank lending rate to between zero and 0.25 percent in December 2008 and has indicated it may keep it there through 2014. The ECB has reduced borrowing costs to 0.75 percent and the BOE to 0.5 percent. The BOJ lowered its target rate to about zero from 0.5 percent.

Fed stimulus has typically debased the currency. The Dollar Index tracks the greenback against six US trading partners; the index dropped 13 percent between the Fed’s announcement of $2.3 trillion in easing in November 2008 through the end of the bond buying in June 2011. That might not happen this time. The index is trading around 80.5, a fairly strong level of support. Also, we’re seeing clearer signs of diminishing returns from success quantitative-easing programs. Also, it's pretty clear that the US recovery is less than robust, you might call it tepid, you might call it a non-recovery, or you might call it something we can't call it on the radio. But the rest of the world isn't in much better shape.

The Euro-zone economies contracted 0.5 percent in the second quarter from a year earlier. Japan is struggling to overcome more than a decade of deflation and the effects of last year’s record earthquake. Bill Gross wrote on the Pimco website that central banks are agog in disbelief that the endless stream of QEs and LTROs have not produced the desired result. Yep, and junkies are amazed when the crack pipe fails to satisfy; why should the debt junkies be any different.

Gross also says new regulations requiring banks to hold more capital and increased saving by households has prevented record low interest rates from sparking the recovery central bankers anticipated. As if banks having enough money to back up their bets is a bad thing, as if households not digging a deeper and deeper hole to finance day to day consumption is a bad thing. Gross is a pretty smart guy but when a man makes his living with a hammer, the whole world looks like a nail.

In addition to the Federal Reserve FOMC meeting we'll be watching the news out of Europe. Stocks declined earlier today as Greek Prime Minister Antonis Samaras was meeting officials from the nation’s creditors after failing to secure agreement from coalition partners on spending cuts. Meanwhile, Greece’s Democratic Left leader said that no decision had been made on the cuts required to obtain further aid for the country’s bailout, and that poorer citizens must be protected from austerity measures.

The German Constitutional Court will rule on the legality of the Euro-bailout fund. Also, Mario Draghi, the president of the European Central Bank still has to sort out exactly what the next steps are for the Euro-zone under his whatever it takes, unlimited conditional support, bond-buying scheme. If nothing else, Draghi has kicked the can into the politicians' court; he can claim he did his part and now it is up to the politicians and the German courts.

George Soros made his fortune betting on currencies in the midst of economic crisis in the UK; Soros says: “Lead or leave: this is a legitimate decision for Germany to make. Either throw in your fate with the rest of Europe, take the risk of sinking or swimming together, or leave the euro, because if you have left, the problems of the eurozone would get better.”

And while the Germans deliver their verdict, the Dutch will also take to the polls for national elections. The Netherlands economy is fairly strong but it has been slowing and the Netherlands is not an island, despite all the canals, it is feeling the slowing effects of the Euro-crisis.

The Dutch and the Germans have been part of the northern countries demanding austerity by the southern or peripheral countries, but now that the Dutch are feeling the slowdown, the idea of austerity becomes less appealing. While the Dutch generally still see the benefit of fiscal responsibility and financial sustainability, more and more people doubt that now is the best time to try to reign in the deficit as it is becoming clear that the cutbacks deepen the crisis rather than solving it.

Since 2008, the internet collective known as Anonymous has hacked the CIA, the Sun newspaper, the Church of Scientology, the FBI, the Arizona Department of Economic Security, Visa, Mastercard, and a host of other large corporations, sparking a global police crackdown last year. For a period in 2011, LulzSec – an offshoot of Anonymous, the internet"hacktivist" collective who came to prominence around the time of the Wikileaks affair – wreaked a trail of chaos across the web. Their actions ranged from the transgressive – they had taken down the CIA's website and hacked into Sony's database and released more than a million user names and passwords. Then they hacked PBS television after they aired a negative documentary about Julian Assange. LulzSec hacked into their website and replaced the homepage with an article about Tupac Shakur, "Tupac Still Alive in New Zealand" (I have long suspected Tupac was living in New Zealand). Then, during the Arab spring, members of the group hacked and defaced Tunisian and Egyptian government sites. One hacker (later discovered to be a 16-year-old London schoolboy), allegedly wrote a webscript that enabled activists to circumvent government snooping.

Thousands and possibly millions of websites hosted by GoDaddy.com went down today, causing trouble for up to 5 million small businesses. A Twitter feed that claimed to be affiliated with Anonymous said it was behind the outage, but this couldn't be confirmed. Another Twitter account, known to be associated with Anonymous, suggested the first one was just taking advantage of an outage it had nothing to do with. Maybe they were hacked, maybe GoDaddy just screwed up on their own. GoDaddy was a target for hacktivists early this year, when it supported a copyright bill, the Stop Online Piracy Act. Movie and music studios had backed the changes, but opponents say they would result in censorship and discourage Internet innovation. And GoDaddy sided with the censors.

The US Treasury Department said it will sell $18 billion of American International Group Inc., slashing its stake in the New York company by more than half and making the government a minority shareholder for the first time since the financial crisis was roaring in September 2008.

At JPMorgan directors are considering lower 2012 bonuses for Chief Executive Jamie Dimon and other top executives in the wake of a multibillion-dollar trading disaster. But they also are grappling with the question of how to do that without drastically reducing the executives’ take-home pay. More than 93% of Mr. Dimon’s $23 million in compensation last year came from either stock- or cash-based bonuses. Citigroup’s board, meanwhile, is expected to decide this fall how to fine-tune next year’s compensation plan to win broader support among investors. One thought is if an executive loses billions of dollars in reckless trades, maybe they don't deserve a bonus.

Transocean Ltd. and the Justice Department have discussed a $1.5 billion settlement that would resolve federal claims over the company's role in the 2010 rig explosion that led to the nation's worst offshore oil spill.

Transocean said in a regulatory filing that several issues, including the possible time period for payment, must be resolved before a deal can be completed. A Justice Department spokesman declined to comment. Transocean owned the Deepwater Horizon drilling rig, where 11 workers died in an April 2010 explosion triggered by a blowout of BP's Macondo well. Transocean also says it rejected settlement offers earlier this year from BP and a group of private attorneys for Gulf Coast residents and businesses.

Transocean was once a US company, but now they're headquartered in Switzerland. They are involved in deep-water ocean oil drilling and apparently Switzerland offered, easy coastal access.