Monday, August 04, 2014 - Giving Up the Ghost

Giving Up the Ghost
by Sinclair Noe

DOW + 75 = 16,569
SPX + 13 = 1938
NAS + 31 = 4383
10 YR YLD - .01 = 2.49%
OIL + .09 = 98.38
GOLD – 6.00 = 1289.20
SILV - .17 = 20.23

Let’s start with economic data; on Friday we had the monthly jobs report: 209,000 jobs and the unemployment rate ticked up to 6.2%. It was a decent jobs report but came in a little under expectations. Still the economy has been adding jobs at a strong clip this year. Early in 2014, the Conference Board’s employment trends index pointed to stronger job creation even though the economy temporarily contracted, and that’s exactly what happened. Hiring accelerated, the economy snapped back in the second quarter, and over the past six months the economy has added jobs at the fastest clip since 2006.

The Employment Trends Index increased in July to a reading of 120.31, up from 119.91; this represents a 6.6% increase from a year ago. The 6 month growth rate in the index is the strongest in over 2 years, and suggests solid job growth is likely to continue in the coming months. Job openings keep hitting post-recession highs. There were 4.64 million job openings in May, near an all-time high; and layoffs are extremely low, even compared to the prerecession period.

While there are some signs of strength in the jobs market, wages have been stagnant. Worker pay was a smaller piece of the US income pie than earlier estimated as some Americans collected significantly more in interest and dividend payments over the past two years.  According to revised data from the Commerce Department, employee compensation, including wages and benefits, was lower for each year from 2011 to 2013 than previously calculated. With the revisions, employee compensation was reduced by $9.5 billion in 2011, $5.1 billion in 2012 and $14.6 billion last year. It accounted for 52% of gross domestic income in the last quarter of 2013, down from a prior estimate of 52.2%.

More rank-and-file workers are participating in the recovery as companies report record profits and boost hiring. Compensation has accelerated this year, rising $134 billion after a $153 billion surge in the first quarter. It marked the biggest back-to-back gains since the six months ended in the first quarter of 2007. That’s because companies are hiring again and more people are returning to the workforce, not necessarily because paychecks are getting fatter. We’ve added millions of people to the payroll since the low point of the economy, but we haven’t added at all to the payouts that workers are receiving. Little has flowed to workers except as an increase in their employment rate.

The latest data on consumer credit is due out Thursday. It’s likely to show non-revolving debt like auto and student debt is continuing to grow rapidly. But credit-card debt has barely budged. Auto loans made up a big part of the growth in second quarter GDP. In the second quarter, motor vehicle and parts spending grew an annual 17.5% rate. Put another way, cars made up 3.7% of all consumer spending, the highest rate since the first quarter of 2008. Growth in subprime auto loans has climbed more than 130% in the past five years.

The New York Times recently reported that many subprime auto lenders are loosening credit standards and focusing on the riskiest borrowers, and then many of the subprime auto loans are bundled into complex bonds and sold as securities by banks to insurance companies, mutual funds and public pension funds, a process that creates ever-greater demand for loans. Subprime loans make up about a third of new car-sales and two-thirds of used cars; with many subprime loans carrying interest rates of 23% or more; the loans were typically at least twice the size of the value of the used cars purchased.

Now maybe you are thinking that there were financial reforms put in place following the downturn; reforms that would prevent subprime lending practices. The Dodd-Frank Act did create the CFPB, the Consumer Financial Protection Board, and you might imagine this would protect consumers from less- than scrupulous lenders. Auto loans were stripped out of the CFPB's jurisdiction by an amendment proposed by Representative John Campbell (R-CA), a former used car dealer. Ripping off poor people has become an art form, and one of the requirements is that the companies engaging in this performance art keep themselves outside regulation as much as possible.

General Motors Financial said today it was served with a subpoena from the Department of Justice directing it to turn over documents related to underwriting criteria on subprime auto loans. The Financial Institutions Reform, Recovery and Enforcement Act, allows the Justice Department to sue over fraud affecting a federally insured financial institution.

A Federal Reserve survey of 75 domestic and 23 foreign banks shows that banks are seeing solid demand for loans, but the banks aren’t making it easy for borrowers. Banks reported stronger demand for prime residential mortgages for the first time since last summer and for home equity lines for the first time since October 2013. Credit standards on prime mortgage loans have eased somewhat, but mortgage standards still remain tighter than in 2005. The July survey also shows that new qualified mortgage rules has reduced approval rates on applications for prime jumbo home-purchase loans and nontraditional mortgages but have not impacted prime mortgages. Banks were somewhat more willing to make consumer-installment loans than they were in the April survey.

New research from the Federal Reserve and Northwestern University finds that expanding unemployment insurance benefits reduces the likelihood of mortgage delinquency. About 5 million foreclosures were completed between 2008 and 2012, but it could have been much worse. The survey says unemployment benefits prevented about 1.4 million foreclosures between 2008 and 2012.  

The researchers discovered there were other side benefits from jobless benefits. Banks who saw a lower default risk expanded credit access. Mortgage investors lost less than they otherwise would have. Local governments took a smaller hit. Also, more owners hanging onto their properties meant that homes stood a better chance of not falling into disrepair, which in turn would have sunk property values in their neighborhoods. And here’s one key finding for housing-policy wonks: Fewer troubled properties cut the government’s costs for expanding jobless benefits by narrowing the number of bad loans that would have been covered by federally controlled mortgage-finance giants Fannie Mae and Freddie Mac. Savings related to Fannie and Freddie decreased net costs for the federal government’s jobless-benefits expansion by about one-fifth.

Today’s bank failure comes from Portugal, and it was a big one. Banco Espirito Santo gave up the ghost; the bank will be shut down, and its healthy businesses transferred to a new bank. Portuguese officials were unable to find private investors to prop up the bank, and so the government will use 4.9 billion euro, or about $6.6 billion of its own funds to bail out the bank, or at least part of it. The bank will be spit in two, with the healthy part going to Novo Bank; the healthy part will include deposits and viable assets; so for now, the depositors and senior bondholders are safe.

Regulators are investigating possible accounting fraud and abuse of privileged information by the Espírito Santo family. Toxic loans, mainly to the Espirito Santo corporate parent and various subsidiaries, will be quarantined in a separate bad bank, which will be owned by shareholders and junior bondholders. Eventually, the new bank, or Novo Bank, will be sold in an attempt to recover the taxpayer loan. It is not clear whether even a sanitized version of Banco Espírito Santo will be worth enough to repay the loan.

Banco Espírito Santo provides something of a preview of what may happen in October when the European Central Bank discloses the results of an exhaustive review of bank holdings in the eurozone. The review is intended to uncover precisely the kind of hidden problems that have undone Banco Espírito Santo.

The central bank review is expected to expose an unknown number of other banks with problem loans or other woes that they have failed to disclose to regulators or shareholders. There has been concern that the central bank’s findings could destabilize the eurozone financial system. The European Union still lacks a comprehensive system for dealing with troubled banks, meaning countries must finance their own bailouts.

There is a new study taking a look at the state of banks in the US, the limits of Dodd-Frank reform, and what should be done with banks that are too big to manage. The study was requested by Democratic Senator Sherrod Brown and Republican Senator David Vitter, and the study finds that some institutions remain too complex and interconnected to be unwound quickly and efficiently if they get into trouble. That means that banks still would be able to force a taxpayer bailout in some form, and the banks are essentially receiving value in that implied guarantee. And the new study had the Government Accounting Office look at the value of that implied bailout. Turns out it was a tough calculation as the value of the implied guarantee varies, skyrocketing with economic stress (such as in 2008) and settling back down in periods of calm. If we were to return to panic mode, the value of the implied taxpayer backing would rocket. In other words, the threat of high-cost taxpayer bailouts remains very much with us.

Friday, March 21, 2014 - Friday Wrap-up

Friday Wrap-up

by Sinclair Noe

DOW – 28 = 16,302
SPX – 5 = 1866
NAS – 42 = 4276
10 YR YLD - .02 = 2.75%
OIL + .69 = 99.59
GOLD + 6.20 = 1335.70
SILV un = 20.38

The S&P 500 briefly climbed to a record high of 1,883.97, just over its previous record of 1,883.57. We hit resistance and didn’t break through. For the week, the Dow is up 1.8%, the S&P is up 1.6% and the Nasdaq is up 0.9%.

The European Union has added a few more sanctions against Russia, adding 12 names to their list of Russians and Ukrainians facing asset freezes and travel bans. One EU commissioner said the goal is not sanctions, the goal is to get Putin to the negotiating table. The EU doesn’t want anything to rattle their already weak financial situation. In Europe they consider the Spanish “recovery” to be one of their success stories. GDP is projected at 1% growth, double last year’s 0.5% pace, and youth unemployment is still 55%; and this is considered good news. Spain, and several other EU nations are in no condition to fight a sanctions battle with Russia.

A separate order signed by President Obama yesterday expanded sanctions and authorized potential future penalties. Yesterday’s sanction expansion included Bank Rossiya, not one of the largest Russian banks, but it starts to pull the financial sector into the equation. The EU cancelled a summit in Russia planned for June. US bankers are now considering whether they participate in a scheduled May investor’s conference in Russia.

Several US banks have a presence in Russia; Citigroup has about 1 million Russian customers. Goldman Sachs has made at least $1 billion in investments in Russian companies and won a three-year contract last year to advise the Kremlin on improving the nation’s image overseas and to help the country attract more investors. Seriously, I can’t make this stuff up.

Euro leaders also vowed to wean the EU off oil and gas imports from Russia; you may recall a similar pledge made in 2008 after Russia invaded Georgia. And the EU did cut back on oil and gas imports, a little, but they still rely on Russia for nearly a third of oil and gas imports. This time, the leaders set a deadline for mid-year to come up with a comprehensive plan. A summer time plan is quite different than actual gas in the tank to heat the kitchen in winter.

Any cutbacks in Euro-zone energy imports will likely push Russia to export energy to the East, and as we mentioned a few days ago, they have a pipeline to the Pacific. Putin is scheduled to visit China in May, apparently for final negotiations on a natural gas supply deal. The next logical question is, why would the world’s largest oil exporter and the world’s most populous nation need Western banks when they have each other?

On Wednesday the Federal Reserve FOMC wrapped up a policy session and Chairwoman Janet Yellen was asked when the Fed might consider raising rates and she said it would be after asset purchases were completed and then she said a “considerable” time and then she was pressed to explain and she said a considerable time was about 6 months. And Wall Street traders did the math and computed that rates would start to go up in May of 2015, and they had a minor freak out. That was Wednesday, and the question was whether Yellen and her Fed colleagues would walk back that timeline. Today, the answer is no, they will stick with it.

St. Louis Fed President James Bullard today said Yellen was simply echoing prevailing market expectations when she said made the reference to 6 months. Dallas Federal Reserve President Richard Fisher echoed the idea that asset purchases would end around October and interest rate policy would come under consideration soon thereafter, describing the timeline as “sound”. So, Yellen didn’t have a slip of the tongue, she did make a fairly concrete policy signal.

This does not mean there is unanimity among Fed policy makers. Today, Minneapolis Fed President Narayana Kocherlakota said that raising interest rates to head off a potential financial crisis is simply not worth it, and he thinks the odds of a crisis are low, so there is little benefit to trying to reduce the probability of a crisis with tighter monetary policy.

Of course, the Fed is already in the process of tightening monetary policy, that’s what the taper is. This will cause long-term interest rates to rise -- and the worst is still to come. For instance, the yield on the 10-Year note jumped to 2.77%, from 2.68% on the same day of FOMC's decision to reduce asset purchases by another $10 billion. And short-term rates are rising to an even greater extent, despite the fact that the Fed is still posting a bid of $55 billion each month for these debt instruments. The Fed’s quantitative easing asset purchase plan was the only reason the yield on the 10-year note has been so low for so long. Well, not the only reason; the weak economy was part; but QE was the primary reason.

The Fed and the markets are generally acting like exit from QE and the Zero Interest Rate Policy will be easy. It won’t, but QE and ZIRP have mainly been a benefit for the bankers and the wealthy. Loose monetary policy is just another policy benefiting the rich… bringing undesirable consequences.

This is a moment where you might hear the phrase: “Well, don’t throw the baby out with the bath water.” Meaning we would still need loose monetary policy while we deal with other policies that directly benefit the rich. Well, loose monetary policy not only directly benefits the rich, it reinforces the other policies being criticized; and if you look closely, that isn’t a baby in the bath, it is a rich person acting like a baby.

And that brings us to today’s edition of Banks Behaving Badly, again. The banking industry was already bludgeoned by accusations that it “robo-signed” its way through mortgage default paperwork, shuttling struggling homeowners closer to foreclosure without giving them their due process. Now, fresh accusations that banks engaged in similar practices with credit card customers.

The latest development comes in the form of a lawsuit filed last week by Miami resident Ruth Moya against JPMorgan Chase.  According to her, she fell behind on her credit card payments after her husband’s business failed in late 2008. So the following year, JPMorgan filed two collection lawsuits against her.

The problem, Moya says, is that her paperwork, and that of thousands of other customers, got hurried through JPMorgan by bank employees who were less-than-concerned about getting things correct. Her lawsuit alleges that the bank’s collection lawsuits against credit card customers have contained numerous errors and are often missing relevant information, such as bankruptcies or consumer disputes. It describes an office of nine or 10 employees in San Antonio, Texas, who were FedExed paperwork for 50 to 100 collection actions per state per day. The employees, the lawsuit says, signed affidavits attributing to the papers’ accuracy without reading through them.

The lawsuit claims the “affidavits were executed by Chase employees en masse, often thousands at a time, one-after-the-other, without the affiant reviewing or verifying the information attested to in the affidavits.”

California and Mississippi have sued the bank over the way it collects credit-card debt.  The Mississippi lawsuit accused the bank of pursuing consumers for debts that had already been paid. The California lawsuit said that JPMorgan had committed “debt-collection abuses” against some 100,000 California credit-card borrowers over about three years.

Yesterday, the Consumer Financial Protection Bureau released a report on debt collection complaints. Consumers told the agency they had been hounded for debts they did not owe, or told they would be arrested or thrown in jail if they did not pay. The CFPB received more than 30,300 complaints about debt collectors in the second half of last year alone.

Fitch Ratings today upgraded its outlook for the US AAA credit rating, removing the nation from a downgrade watch after politicians put off another debt limit battle until next year. The company, one of three major credit rating firms, changed the outlook for the rating to stable from a negative watch put in place in October. Fitch said at that time political brinkmanship over raising the debt limit had increased the risk of a government default, raising the probability of a rating downgrade.

Last month's debt limit deal was a key reason for upgrading the outlook.  Fitch also cited the improved federal fiscal situation, including the shrinking budget deficit and brightening economic picture.

When you hear claims that government spending is out of control, you might want to consider that there has been a big shift, including 4 major pieces of deficit-reduction legislation enacted since the fall of 2010 were the Budget Control Act of 2011, the American Taxpayer Relief Act of 2012, the Bipartisan Budget Act of 2013, and this year’s farm bill.

Altogether, they cut projected deficits over 2015-2024 by $4.1 trillion: about $3.2 trillion from program cuts, including the associated interest savings; and $950 billion from higher revenues, including the interest savings. Program cuts outweigh revenue increases by 77% to 23%, or about 3 to 1. In fact, total federal spending has already fallen from 23.9% of gross domestic product (GDP) in 2009, at the bottom of the recession, to a projected 20.2% of GDP in 2013.  While total federal spending will remain high throughout the coming decade under current policies, that’s mostly because of a marked increase in interest payments.  In particular, as the economy recovers, interest rates will also rise, simultaneously increasing the interest we must pay on any given amount of debt.