Monday, August 12, 2013 - The End of Mandatory Draconian Punishment

The End of Mandatory Draconian Punishment

by Sinclair Noe

DOW – 5 = 15,419
SPX – 1 = 1689
NAS + 9 = 3669
10 YR YLD + .02 = 2.60%
OIL+ .19 = 106.16
GOLD + 22.60 = 1338.30
SILV + .87 = 21.53

This week's economic calendar includes retails sales reports tomorrow, plus a look at inflation on the wholesale level tomorrow, and inflation at the retail level on Wednesday; also reports from the Philly Fed, plus a look at industrial production, housing starts, and consumer sentiment. The over-riding question is whether the economy is seriously showing strength or if we are just grinding along. Most of the expectations for this week's data suggest more of the same old, same old. It's doubtful we will see anything that could sway the Federal Reserve to change policy, and that means the stock and bond markets may have gotten ahead of themselves in pricing in an improving economy.

The Treasury Department reported this morning that the US government spent $98 billion more than it took in last month, with the deficit driven by spending on healthcare programs, pensions for the elderly and the military. So far in the current fiscal year, which began in October, the federal government has run $607 billion into the red, a narrowing from the $974 billion deficit chalked up in the same 10 months of fiscal year 2012.

A major change today from the Justice Department; Attorney General Eric Holder is calling for sweeping and systemic changes to the American judicial system. Holder made the announcement today during a speech to the American Bar Association, outlining a reform plan he calls “Smart on Crime”.

Holder says the Justice Department would direct federal prosecutors to charge defendants in certain low-level drug cases in such a way that they would not be eligible for mandatory sentences now on the books. Prosecutors would do this by omitting from official charging documents the amount of drugs involved in a case. By doing so, prosecutors would ensure that nonviolent defendants without significant criminal history would not get long sentences.

The Smart on Crime reforms also include allowing for the early release of non-violent elderly federal defendants who had served significant portions of their sentences, thereby helping to reduce the overall federal prison population. Holder also called for greater use of incarceration alternatives and renewed focus on prevention, pointing out reforms in typically conservative states that have steered funding towards treatment and supervision, rather than funneling more money into prisons.

Holder said: “The bottom line is that, while the aggressive enforcement of federal criminal statutes remains necessary, we cannot simply prosecute or incarcerate our way to becoming a safer nation. To be effective, federal efforts must also focus on prevention and reentry. We must never stop being tough on crime. But we must also be smart and efficient when battling crime and the conditions and the individual choices that breed it."

He also noted that sentences are often racially disproportionate, referencing a February report indicating that, in recent years, black male offenders have received sentences nearly 20 percent longer than white offenders convicted of similar crimes.

Since Richard Nixon declared the "war on drugs" in 1971, US prison numbers have soared to account for 25% of all the world's prisoners even though it has only 5% of the world's population. Drug-related offenses drive the vast majority of the increased prison population.

Some of the proposals unveiled by Holder, such as giving federal judges the leeway to depart from mandatory minimum sentences for some drug offenses, require congressional approval,and getting any consensus in Washington DC is tough, even though this should be an issue that attracts bi-partisan support.

Forty years of a failed war on drugs has destroyed communities and families all across our land. Hard earned tax-payer dollars have been wasted on ineffective policies that have resulted in over-incarceration, pushing state and federal budgets to the brink of bankruptcy.

The attorney general said 17 states have directed money away from prison construction and toward programs and services such as treatment and supervision that are designed to reduce the problem of repeat offenders.

In Kentucky, legislation has reserved prison beds for the most serious offenders and refocused resources on community supervision. The state, Holder said, is projected to reduce its prison population by more than 3,000 over the next 10 years, saving more than $400m.

Holder also cited investments in drug treatment in Texas for non-violent offenders and changes to parole policies which he said brought about a reduction in the prison population of more than 5,000 inmates last year. He said similar efforts helped Arkansas reduce its prison population by more than 1,400. He also pointed to Georgia, North Carolina, Ohio, Pennsylvania and Hawaii as states that have improved public safety while preserving limited resources.

Five years after Wall Street's malfeasance nearly caused a global financial metldown, and after four years of hearing Jamie Dimon whine about how regulations would hurt his bonus, and long after tens of billions of dollars have been lost to bankster fraud, we're about to see the first arrests of Wall Street bank employees. What's more, the suspects work at JPMorgan Chase, a bank which, ironically enough, politicians and pundits insisted was the "good bank" after the financial crisis hit in 2008. This in connection with the London Whale case.

Despite the overwhelming evidence of criminal behavior in a large number of cases, this will have been the first time since the financial crisis that a banker's been arrested on criminal charges, assuming the arrests take place as planned, of course.

Let's be clear: These arrests are a good thing. Justice demands that anyone, no matter who they are, be made to answer for their deeds. What's more, bankers at "too big to fail" institutions have the power to shatter, and even bring down, the global economy. The lack of arrests up to this point means there's been no deterrent effect, no reason for them not to keep committing fraud. And when you compare and contrast the banksters antics, compared to the kid who smokes a joint and goes to jail under mandatory sentencing laws, well it makes a mockery of justice. But even if arrests are made, it is expected to be junior level traders, it won't be Bruno Iksil, the trader known as the London Whale; he's worked out some sort of deal and he's cooperating with investigators. It won't be the Whale's boss, or anybody higher up the corporate food chain. It'll be low-level guys.

There is good reason to look up the corporate chain. Senior management was either complicit or asleep at the switch. The bank's own risk management rules and guidelines were violated 330 times. JPMorgan Chase stonewalled their regulator and as losses grew, Chase provided less and less information to the OCC. Dimon ordered the bank to omit critical data from its standard reports to the OCC.

Now sometimes the Department of Justice arrests low-level workers in an attempt to get them to provide information against upper level management; they use them to build a case. Sometimes, the low-level guys are nothing more than sacrificial lambs. We'll see.

News out of Mexico today that could have a big impact on the energy sector. Mexican President Enrique Peña Nieto proposing to end a ban on foreign firms taking part in the state-run oil industry. Now, this is not a new idea, and in the past it has not been well received.

The proposal would allow state-oil agency Petróleos Mexicanos, or Pemex, to partner with foreign firms and share profits, a practice prohibited by the Mexico constitution. It would also allow more private participation in electricity generation in an attempt to drive down prices that the government says are 25% higher than in the United States.

Peña Nieto says the oil and electricity industries would remain under government control and that private companies could not claim petroleum reserves as their own even as opponents railed against changes they say run contrary to the national interest and risk handing over the country's greatest treasure to foreigners. Pemex has not been employing new technologies, and the thinking is that bringing in foreign firms might modernize practices. Oil output has dropped from nearly 3.4 million barrels per day in 2004 to 2.5 million barrels per day in 2012. The flip side is the fear that foreign firms will do more than modernize, they will claim Mexican reserves as their own, or employ environmentally harmful drilling techniques.

Meanwhile, north of the border, Texas has been employing modern techniques for quite some time; the result is a boom in exploration and production; the oil is flowing, but the water supply is running dry. Three years of drought, decades of overuse, coupled with the oil industry's demands on water for fracking are drying up reservoirs and underground aquifers. The Texas Commission on Environmental Quality says 30 communities could run out of water by the end of the year. And while most of those communities are small rural towns, there are nearly 15 million people living under some form of water rationing, barred from freely watering their lawns or refilling their swimming pools or in the case of the small town of Barnhart Texas, they've just run out of water; turn the faucet and nothing happens.

Fracking is a powerful drain on water supplies. In adjacent Crockett county, fracking accounts for up to 25% of water use. Fracking isn't the only reason for water shortages. Big cities soak up plenty of water, agriculture takes its share, climate change and the drought have added to the problem, but fracking seems to be the straw that might break the camel's back. Last week, heavy rains hit much of Texas, but it wasn't enough to recharge the aquifers.

Thursday, August 08, 2013 - Shining Light on the Bright Economy

Shining Light on the Bright Economy

by Sinclair Noe

DOW + 27 = 15,498
SPX + 6 = 1697

NAS + 15 = 3669

10 YR YLD - .01 = 2.58%
OIL -.59 = 103.78
GOLD + 25.10 = 1313.40
SILV + .66 = 20.35

After three down days and a negative start to today's trading, the major market indices finished in positive territory. Three day losing streaks have been rare for the past nine months. You have to go back to December last year where we had more than a three day losing streak and any kind of decline that caused a scare; that was the fiscal cliff brouhaha, you'll recall.

This certainly is not a market for short sellers, it has been about eight months since the bears have been able to put any real fear on the table. The market may go down for three days, but then it pops back up; the down days are apparently nothing more than a pause that refreshes, and then the buyers rush back in.

Despite taper talk, the Fed has not committed to taper, just a bit of jawboning, and they are still pumping $85 billion a month into mortgage backed securities and treasuries, and then the cherry on top is that $40 billion managed to flow into equity funds in July. Earnings growth is decent even if revenue growth is underwhelming. There is still cash on the sidelines. Maybe too much cash on the sidelines.

Wealthy Americans put away about 37 cents for every dollar they earned, which is more than triple their savings rate in 2007. In addition, a Bank of America study cited in the CNBC report found that more than half of millionaires have a "substantial" amount of cash on hand and of that group, about 60 percent said they didn't plan to invest it in the next two years.

As the recovery struggles to gain solid ground, the findings indicate that even while America's wealthiest households are getting an ever larger share of the income pie, they're doing little to put that money to productive use in the economy. Over the last few decades, the incomes of the top 1 percent of earners grew by about 275 percent, according to a 2011 report from the Congressional Budget Office. During the same period, the bottom fifth of earners saw their incomes grow by just 20 percent. That increased concentration of wealth in the hands of a few, combined with the effects of the Financial Crisis and the slow recovery, has meant less money in the hands of low- and middle-income Americans -- who are more likely to spend it -- decreasing demand for goods and services. The lack of demand in the economy makes wealthier Americans more hesitant to spend, keeping the cash concentrated in a few hands. Call it a vicious cycle instead of the virtuous cycle.

While it has indeed been enjoyable to ride the bull train for the majority of this year, history suggests that it is probably a good idea to keep an eye on the exits these days, and the biggest known threats are the taper tantrum and upcoming budget battles; I'll get to the budget in a bit. We know about the taper tantrum; any hint of taper can send the markets into a hissy fit, so imagine if or when the Fed actually cuts back on QE. Yes, we all know it will happen eventually but Wall Street will still have a tantrum. Already the Fed is setting us up with the idea that the economy has improved enough and is strong enough to handle less monetary stimulus. Don't be surprised to see more news stories and articles on how bright the economy is these days.

A Labor Department report today showed initial jobless claims rose less than expected in the most recent week. The day's report dropped the four-week average of claims to the lowest level since 2007, before the start of the recent recession.

Yes, too many Americans are out of work and have been that way for too long. And yes, household incomes, adjusted for inflation, are still below 2007 levels. Yes, job number one is more jobs and better jobs and better pay. The economy needs growth in order to make that happen, and that's where the news is good. Confounding so many skeptics, the economy is actually shifting into higher gear. Growth for this year's second quarter was reported at 1.7%, beating expectations. Yes, that's the good news; 1.7%

The Federal Reserve Board, not known for going out on a limb or for accurate prognostication, recently raised its 2014 forecast for real growth to the 3%-to-3.5% range. And the country will likely see two to three more years of good growth, which would produce millions of new jobs and begin to raise incomes. This is one reason the stock market recently reached all-time highs. Yea, that's it. Happy days are here again. Happy days, happy days.

The US is the only developed country with a story like this to tell. Europe, unfortunately, is facing a long period of economic stagnation. Its financial crisis came later, and southern Europe is laboring under the burdens of sick banks and weak competitiveness. Meanwhile, Japan, where the population is falling, hasn't seen meaningful growth in years and isn't likely to see it now. In a global economy, it isn't exactly encouraging when your global partners struggle.

There are a number of factors that could slow any growth we're seeing and send the markets into a tailspin, and the taper tantrum is just one. The other is the budget battle. Right now, Congress is on its 5 week money collecting tour of the home districts, also known as summer recess. The good news is that with Congress out of Washington for the remainder of the summer, they can't do much damage to the economy, but in September they'll try to make up for lost time. There is a very real possibility of a government shutdown, and just getting close is enough to damage things. Remember the fiscal cliff scare.

But for now, don't bet against the markets, and don't lose sight of the exits.

Of course a taper tantrum and budget battles aren't the only things that could rattle markets. There were three drone strikes in Yemen today; so we are now engaged in a remote control war in the Middle East. And of course the banksters could always throw a monkey wrench in the works at any given moment.

In the last few days, the Department of Justice, along with the SEC, filed a case against Bank of America over a 2008 prime mortgage securitization that breaks some new ground in fraud allegations and is also saber-rattling in the form of launching a criminal investigation into JP Morgan’s sale of mortgage backed securities.

We've been down this road before, but at a certain point you have to think it could be problematic for the banksters, just because it is coming at them fast and furious. JPMorgan is being poked and prodded by at least eight different federal regulators for alleged misdeeds ranging from mortgage shenanigans to interest-rate manipulation. The latest addition to this long list of troubles did appear to gently rattle JPMorgan's stock price, which was down less than one percent, on a day when the broader stock market was slightly higher. Just a blip; and allegations of wrongdoing are just business as usual.

JPMorgan has suffered $16 billion in legal costs since 2009. But the bank has earned $71 billion in profit during that time. JPMorgan on Wednesday raised its estimate for future legal costs to $6.8 billion, up an extra $800 million, to account for the new probes. But it could pay off that entire bill with just the second quarter's $6.5 billion in profits.

So what’s with the new-found enforcement religion? Is Attorney General Holder trying to rebuild what little he has left in the way of a reputation after essentially admitting back in March that the big bad banks were too big and too bad to be bothered by things like laws.

Testifying before the Senate Judiciary Committee, Holder told lawmakers that he is concerned that some institutions have become so massive and influential that bringing criminal charges against them could imperil the financial system and the broader economy. His remarks came as a growing number of lawmakers have suggested that big banks are, effectively, “too big to jail.”

Holder said: “I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy,” he said. “And I think that is a function of the fact that some of these institutions have become too large.”

There was some uproar and signing of petitions, and then we didn't hear much for a while, and now BofA is charged and JPMorgan is under investigation. Don't get too excited. It’s inconceivable that the DoJ would indict JP Morgan at a corporate level. Not only would Holder not risk destabilizing the bank, there’s simply no way the Treasury would let him go there. If any actual criminal charges are contemplated (remember, this is just an investigation), expect a rerun of the UBS Libor strategy, where UBS paid a large fine for Libor rigging and admitted to criminal conduct…in its Japanese unit. I’d be delighted to be proven wrong, but there’s no reason to expect anything other than new and better optics from the Obama Administration at this late date.

And then this tidbit; the trader at the center of JPMorgan Chase's $6.2 billion trading loss last year will not face charges related to the incident. Bruno Iksil, who worked in JPMorgan's chief investment office in London and incurred losses on oversized positions in a derivatives market, is reportedly cooperating with government investigators.

The Federal Bureau of Investigation in New York and the Securities and Exchange Commission, along with regulators in the UK, opened probes last year into the activity surrounding the costly bets, which earned Iksil the nickname "the London Whale" from his fellow Wall Street traders.

The case is still open, but according to a New York Times report on Thursday, JPMorgan is close to a deal with the SEC and British regulators, which is expected to be announced in the fall. The fate of a potential criminal case against JPMorgan or individuals who worked for the bank during the incident remains unclear.

Friday, May 11, 2012 - JPMorgan Moving On

DOW – 34 = 12,820
SPX – 4 = 1353
NAS +0.18 = 2933
10 YR YLD -.04 = 1.84%
OIL – 1.51 = 95.57
GOLD – 13.00 = 1581.40
SILV - .15 = 28.99
PLAT – 21.00 = 1471.00

So, let's break down the problems at JP Morgan Chase. The bank lost net $800 million, on a $2 billion dollar trading loss in synthetic credit derivatives. They won't go broke today. JPM made $5.4 billion in profit in the first quarter. Still, a couple of billion dollars is significant, and it raises questions about the regulation of banks, the valuation and suitability of derivatives, the size of the world's largest firms and the systemic risk they may pose to the financial system. For the past few years, JPM has been increasing the size and importance of its proprietary trading desk based in London. Theoretically, a proprietary trading desk trades stocks, bonds, currencies, commodities, derivatives and other financial instruments with the firm's own money – as opposed to using customers' money. If the bank makes money, they keep it and Jamie Dimon gets a big bonus. If they lose big, Jamie Dimon could lose his job, but he gets to keep the bonus. If the proprietary trading department screws up royally and the trades implode and pose a possible systemic threat, then the taxpayers cover the losses, and Jamie Dimon gets to keep his bonus.

Once upon a time, the proprietary trading department of a bank was not the major part of the banks' profits. The bankers made money by traditional banking. Over time, they realized they could play the markets with the banks money, and so the prop trading morphed into something like an internal hedge fund, which accounts for the lion's share of the banks' profits. JP Morgan's internal hedge fund was known as the chief investment office, or CIO. In theory, the CIO was in charge of hedging risk, at least that's what Jamie Dimon has been claiming. That's a load of bull. The CIO had the highest value at risk of any part of the bank's operations. Value at risk is another way of measuring how much the prop trading desk could lose on any given day. Yesterday, during the quickie news conference, Jamie Dimon revealed that JP Morgan had restated its value at risk of the CIO in the first quarter, from $67 million to $129 million. And as fast as you can say WTF, JPMorgan's risk doubled. Risk did not go up 5% or 10%. Their bets were twice as risky as they had claimed.

Now, this is the same industry that argues that they have too much regulation. Either Jamie Dimon has lied to the public about his knowledge of risk, or he is a blithering incompetent dolt who doesn't know what the most risky part of his company is doing. It would be hard not to know. Reporters have been talking about the CIO for a couple of years and the reports have been more intense in the past few months. Several weeks ago there were reports about a London-based Morgan trader making huge high-stakes bets, causing excessive volatility in derivatives markets. When asked about it then, Dimon called it “a complete tempest in a teapot.”

The trader responsible for placing the bets is Bruno Iksil, who also earned several nicknames: the London Whale and Voldemort. Iksil's credit default positions were so large that they caused unusual market movements. Iksil could move markets on his own. The market traders knew it. The Federal Reserve knew it. The SEC knew it. The ECB knew it. Are we supposed to believe Jamie Dimon was the only man on Wall Street who didn't know about the London Whale? He looked the other way. Even after a $2 billion dollar loss, the net loss is only $800 million because the CIO office was making money in other trades. And this is where we get to Dimon's level of awareness. As long as the CIO was making money, there was nothing egregious, there were no errors, there was no risk, there was no bad judgment.

The banks never do anything wrong until they lose money. The banks never need to be regulated until they implode. The banks never need bailouts until they need bailouts. The biggest banks are still so large, so complex, and their desire for profits so great that they remain a systemic risk to the global financial system. So, why do we have proprietary trading departments in banks? Why does – or now we can say why did - JPMorgan pay the London Whale $100 million per year to make risky bets? Because Jamie Dimon didn't consider it to be a big risk. The Whale made money and if the Whale lost too much, he'll go begging for bailouts. Privatized profits and socialized losses. Yes, the same Jamie Dimon that didn't understand the amount of risk, or the one who lied about the risk (it is either one or the other) is the same Jamie Dimon who has been leading the battle against regulation of the banks, and now says: “We will admit it, we will fix it and move on.” Just like nothing ever happened. What the heck, it worked in 2008. There has probably never been a greater reminder that we need to separate the gambling side of banking from the traditional banking. We used to do this in America. It was part of the Glass-Steagall Act. It worked. It didn't stop the big banks from gambling but it didn't support their gambling habit. If the banks gambled and failed, they went bankrupt. With real life consequences, the banks were not quite so reckless.

Maybe, if we separated the traditional bank from the casino, we could actually see banks do something that provides some benefit for the countries that have issued charters which allow the banks the privilege to exist. Maybe then, when people come to the bank and say they want to borrow money to buy a house or a car or a truck or to build a factory, JPMorgan might say yes. Now they look at these crazy schemes and say “no”, and it's not because the ideas are so bad, it's just that they can make so much more money by taking excess deposits and gambling on synthetic credit derivatives. And the more people deposit with the bank and the bank doesn't loan that money out, the more excess deposits they can use for gambling.

The losses here had been mounting for at least six weeks, according to Morgan. Why didn't this come out in the first quarter earnings? Well, it's not the end of the world. Fitch Ratings downgraded JPM this afternoon, and JPM will probably need to post an additional billion dollars in collateral to adjust for the downgrade, but they're still rate AA-. And yes, today's price hit lopped about $13 billion off of market cap. And yes, further losses are likely to occur as the firm unwinds some of its positions. And yes, there are ongoing concerns about the volatility and viability of these synthetic credit positions.

We don't really know exactly how or where the money was lost but there is a chance it disappeared down the same wormhole as Jon Corzine. There is some guesses that the CIO was investing in something called a Credit Default Index, specifically the CDX. IG.NA.9, which would expire in December 2012, right about the end of the world according to the Mayan calendar. The point is there is plenty of time to lose a plenty big amount of money. And the more fun thing to remember is that most of these derivatives are written between the same 20 biggest banks in the world, so if one goes belly up, they all get vaporized.

Actually, there are some fun guesses and one of the most entertaining is that the JPMorgan short squeeze on the silver market is finally coming to bite them in the butt. And there is a good chance the losses could continue. And there is a good chance that some powerful players were propping up the share price today. There was a multimillion dollar stock purchase just before the closing bell.But they can't just keep on keeping on based upon size alone. In fact, too big to fail may have been one of the major reasons for the failure of the London Whale. When Bruno Iksil got so big he was moving markets, people figured out it was him, and they started picking him off, making it more expensive for him to do his trades, forcing him to show mark-to-market losses, and eventually forcing him to unwind his position, which would make them money, which it apparently did.

Of course, the big concern is that the London Whale-dermort was really just involved in simple trading and hedging and we don't know squat about the really dangerous and really complex stuff which will all implode on 12-21-2012. So, don't worry.

That's the simplified version of what happened. If you don't want another global financial meltdown then we should look at changing things. The banks need to stop doing all this incredibly complex gambling which benefits no one. We, the people allow banks to have charters, and there is no good reason to charter this kind of activity. It does no good for our economy – just the opposite. At the very least, we might allow the charter but at least demand that if they are going to gamble, they use their own money.