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.

Tuesday, July 22, 2014 - Curb Your Enthusiasm

Curb Your Enthusiasm

by Sinclair Noe

DOW + 61 = 17,113
SPX + 9 = 1983
NAS + 31 = 4456
10 YR YLD - .01 = 2.46%
OIL - .17 = 104.42
GOLD – 4.70 = 1308.50
SILV + .04 = 21.07

We start with a couple of economic reports. The National Association of Realtors reports existing home sales were up 2.6% in June to a seasonally adjusted rate of 5.04 million, compared to 4.91 million in May. Sales in June were 2.6% higher than last month, but were 2.3% below the June 2013 rate. Total inventory rose 2.2% in June to 2.3 million existing homes for sale; unsold inventory is up 6.5% from a year ago.

At June’s pace of sales, there was a 5.5 month supply of homes for sale. The Realtors’ group considers a 6-month supply to be a balanced market. Higher supplies favor buyers and lower supplies favor sellers. The Federal Housing Finance Agency says home prices in May rose 0.4% from the prior month and were 5.5% above their level of May 2013. Distressed sales accounted for just 11% of sales in June, down from 15% last year, 25% in 2012, and 30% in 2011. Fewer distressed sales probably explains why there were fewer sales than June of last year.

The Consumer Price Index, or CPI, measures inflation at the retail level; the CPI increased 0.3% in June. The core CPI looks at prices excluding food and energy, which is important for people who don’t eat food or drive cars or use electricity; core CPI was up 0.1% in June. On a year over year basis, CPI is up 2.1%, and the core CPI is up 1.9%. The big driver for the increase in June was higher prices for gasoline.

In earnings reports:

Quarterly profit at McDonald's fell more than expected. Second quarter net income fell almost 1% to $1.3 billion, or $1.40 per share. Sales at McDonald’s restaurants in the US dropped for a third straight quarter.

Coca Cola’s 2Q net income dropped to $2.6 billion from $2.68 billion a year earlier.

Verizon reported second quarter earnings nearly doubled, but it was a confusing report because Verizon paid for Vodaphone shareholders in the quarter, plus they sold some of their wireless spectrum to T-Mobile; cutting through the clutter, Verizon added 1.4 million devices; Verizon added three tablets for every new smartphone. Earnings were just a smidge above expectations.

Comcast reported net income of almost $2 billion for the second quarter, with total revenue of $16.8 billion, up 3.5% from the same period last year. The revenue increase came from high speed internet service. Comcast lost cable video customers, as more people bypass cable and satellite subscriptions in favor of cheaper streaming alternatives.

Credit Suisse reported a second quarter loss of $779 million, the largest loss since 2008; reflecting the charge of $2.6 billion related to the settlement with US law enforcement for a guilty plea to conspiring to aid tax evasion in helping American customers hide money in Swiss accounts. Or another way to look at it, they were one criminal conviction away from a $1 billion quarterly profit. Credit Suisse also announced it would exit the commodities trading business.

Meanwhile, it looks like bond traders are exiting the bond trading business. Trading in US government bonds has dropped 25% in the past few weeks compared to the same time period a year ago. Since the end of the second quarter, trading in investment grade bonds has dropped 17% and trading in junk bonds has dropped 8%.

Last week, Fed Chair Janet Yellen talked about overvaluation in the biotech and social media sectors. One of the most common measures of value is the P/E, or price to earnings ratio; there are certainly other measures of value, but PE is common. Generally, a low PE can point toward value, while a high PE might indicate overvaluation, or even an unprofitable company. Currently the S&P 500 trades at 16.1 times forward 12-month consensus earnings per share. So, you might think a PE of 165 would mean a stock was extremely overvalued, ready to crash; or not. In September 2003, Apple had a PE of 165; since then it has gained about 6,000%.

After the close of trade today, Apple posted fiscal third quarter results. Revenue came in at $37.4 billion versus $38 billion expected; EPS was $1.28 versus $1.23 expected; iPhone sales were on track; iPad sales were a little weak; Mac sales were a little better than expected. Apple posted profit of $7.75 billion, up from $6.9 billion in the year-ago period. Apple announced a new iPhone 6, not yet available, but ready to swamp stores before the end of the year; it will have a bigger screen. Curb your enthusiasm.

Also after the close, Microsoft posted profit of $4.6 billion, or 55 cents a share, on revenue of $23.4 billion. During the year-ago period, the world's largest software company earned $4.97 billion, or 59 cents a share, on $19.9 billion in sales. So, sales were up, profit was a slight miss, due to the Nokia acquisition. Bing search ad revenue is up 40%, and Bing now has about 20% of the market share for search engines. Microsoft is big in the cloud, where revenue is up almost 150%, topping 4 billion.

Hedge fund manager Bill Ackman went on CNBC yesterday and promised he would deliver the death blow against Herbalife. Ackman has been shorting the stock for about a year, a $1 billion bet the company will crash. Then he delivered a 3 hour diatribe with 250 slides in his PowerPoint presentation, alleging that Herbalife is not just a multi-level marketing nutritional club, it is a pyramid scheme preying on minorities, and the biggest fraud since Enron. Ackman didn’t present a great deal of evidence. Today the stock was up 15%, for no apparent reason, other than surviving an Ackman death blow.

There were two rulings from two federal appeals court panels on Obamacare today. The question was whether the government could subsidize health insurance premiums for people in states that use the federal insurance exchange; 36 states use the federal exchange, while the other states set up their own state exchanges. This goes back to wording in the original law that says subsidies can be applied to state exchanges.

 The United States Court of Appeals for the District of Columbia Circuit said that the government could not subsidize insurance for people in states that use the federal exchange. That decision could potentially cut off financial assistance for more than 4.5 million people who were found eligible for subsidized insurance in the federal exchange, or marketplace.

A couple of hours later, the United States Court of Appeals for the Fourth Circuit, in Richmond, upheld the subsidies, saying that a rule issued by the Internal Revenue Service was “a permissible exercise of the agency’s discretion.”

For now, nothing changes, with the exception that there will be many more billable hours for the attorneys.

Bloomberg reports that regulators are ready to label Metlife a potential threat to the financial system, subjecting the insurer to oversight by the Federal Reserve. MetLife, the biggest US life insurer, could be subjected to stricter capital, leverage and liquidity requirements as a result of Fed supervision. A decision by the Financial Stability Oversight Council may come as early as July 31, and MetLife would have 30 days to request a hearing before the FSOC to contest the decision.

The Dodd-Frank Wall Street Reform and Consumer Protection Act is now 4 years old, even though it isn’t really in effect; just 52% of the rules mandated under Dodd-Frank have been finalized by regulators; Another 23% have been proposed but they’re still working out details, and regulators haven’t even gotten around to 24% of the rules. A recent report by consumer watchdog Public Citizen called out the Securities and Exchange Commission as a particularly egregious delayer, noting that it had pushed back the deadlines for 13 of the 23 rules it was supposed to finalize this year.

City workers and retired city workers in Detroit have agreed to pension cuts to help bailout the city from bankruptcy. General retirees would get a 4.5% pension cut and lose annual inflation adjustments. They accepted the changes with 73% of ballots in favor. Support for the pension changes triggers an extraordinary $816 million bailout from the state of Michigan, foundations and the Detroit Institute of Arts. The money would prevent the sale of city-owned art and avoid deeper pension cuts.

Most people travel to or from Israel by air, and the major airport, really the only airport is Ben Gurion in Tel Aviv; last year, 14 million people went through Ben Gurion Airport, in a country with a population of 8 million.  Yesterday a rocket from Gaza landed about one mile from the airport; we don’t have further details on that rocket; it didn’t hit the airport; it was a mile away. When news spread, Delta diverted a flight to Paris. United airlines cancelled flights. The Federal Aviation Administration banned all US passenger and cargo flights to and from Tel Aviv for at least the next 24 hours. European airlines cancelled flight to Israel. The possibility of a passenger jet being shot down over a war zone is a very realistic and fresh memory.

US and United Nations diplomats are in Israel, trying to broker a ceasefire of some sort. Israel continues to pound targets across the Gaza Strip. It does not appear a ceasefire is near. If there is any light at the end of the tunnel, the tunnel will be destroyed.

The European Union today threatened Russia with harsher sanctions if Russia doesn’t cooperate in the investigation of the downing of the Malaysian flight 17 and if Russia doesn’t stop sending weapons to Russian backed separatists in Ukraine. But it was just a threat, and they’ll get together later in the week to draft proposals for sanctions.

Thursday, January 09, 2014 - A World Of Central Bankers

A World Of Central Bankers

by Sinclair Noe

DOW – 17 = 16,444
SPX + 0.64 = 1838
NAS – 9 = 4156
10 YR YLD - .03 = 2.96%
OIL - .67 = 91.66
GOLD + 1.80 = 1228.70
SILV + .02 = 19.65

If it's not one central bank, it's another. Today the European Central Bank and the Bank of England met to determine monetary policy. Back in November, the ECB cut interest rates to 0.25%, so there were no expectations of further rate cuts in today's meeting. In Britain, which is outside the euro zone, the Bank of England left its benchmark interest rate unchanged at a record low of 0.5 percent.

As the US Federal Reserve has been creating new dollars at the rate of $85 billion a month under Quantitative Easing, the Fed's balance sheet has been growing, even as the ECB's balance sheet has been shrinking. And even though the Fed announced it would scale back those purchases by $10 billion a month, that just means the Fed balance sheet will continue growing, just not as fast. Or the bottom line; the Fed is creating money and the ECB is not.

Today, Mario Draghi, the president of the ECB said he wanted to “strongly emphasize” his earlier promise to keep monetary policy easy for as long as necessary. And Draghi said the ECB was “ready to consider all available instruments” to address either further weakness in consumer prices or increases in short-term money market rates that could put stress on banks. He did not, though, specify what tools he would use. The fear in Europe is that a nascent recovery could sputter and that low inflation (0.8% in December) could turn into deflation.

When asked if the euro crisis was over, Draghi said, “The recovery is there, but it’s fragile,” and it was too soon to declare victory. Even that might be a stretch. The unemployment problem for much of the euro-zone remains lousy; stuck at 12.1% for the past 9 months, and in some areas, youth unemployment is still around 50%, very dangerous levels. The problem for the ECB is essentially the same problem the Fed faces – how to improve aggregate demand. The ECB has been offering cheap money to the euro banks but the credit isn't getting through to companies and households. Lending to small businesses in the euro zone shrank 3.9% in November from a year ago, the biggest decline recorded by the ECB.

And with the Fed taper ready to kick in, the hope is that other countries and other central banks will pick up some slack in the world economy. Draghi has promised to do whatever it takes, and today he reiterated that promise, but that has been the promise for the past couple of years, and a couple of years can easily turn into a lost decade.

Here in the US, Ben Bernanke's farewell tour included a luncheon on Capitol Hill with Congress-folk, where he received a standing ovation and some of his past critics seemed to go soft. Bernanke offered an optimistic view of the economy, listing the country’s booming energy sector, stronger financial institutions and modest federal budget deficit reductions as positive signs.  Bernanke indicated he is more worried about the economic fate of middle-class families than the federal budget deficit going forward.

Meanwhile, the newly confirmed Federal Reserve Chairwoman, Janet Yellen has granted an interview to Time magazine and here's what she says about the economy: "I think we'll see stronger growth this year. Most of my colleagues on the Fed's policymaking committee and I are hopeful that the first digit [of GDP growth] could be 3 rather than 2... The recovery has been frustratingly slow, but were making progress in getting people back to work, and I anticipate that inflation will move back toward our longer-run goal of 2 percent." On the housing market, which had a brief lull this fall: "I expect it to pick back up and I do expect a further recovery."

Talking about the Fed's QE program, Yellen seems to believe that higher home prices and stock market stimulation is helping the average family. She is clearly a believer in the wealth effect, even though I have to question what data she might be looking at. RealtyTrac just released its Home Equity and Underwater Report for December 2013, which shows that 9.3 million US residential properties were deeply underwater, or about 1 in 5 of every property with a mortgage. "Deeply underwater" is defined as worth at least 25% less than the combined loans secured by the property. There are fewer homeowners who are deeply underwater, but there are still millions who are in serious trouble, and the longer these homeowners remain in a negative equity position without relief in the form of a principal loan balance reduction, the more likely that foreclosure will become the path of least resistance for them.

And on the jobs front, recent data from the Economic Policy Institute shows we're still about 1.3 million jobs below the pre-crisis peak – that's just to get back to break even, and then we would need about 6.6 million more jobs to get to where we need to be, in other words, how many jobs would be needed to employ all the people who would be actively looking for work if the economy were running at full steam.

The 7% unemployment rate is misleading because it is based partly on people dropping out of the work force and no longer being counted as unemployed. The economy is not strong enough to create jobs, so labor-force growth is not living up to its potential. If people who have dropped temporarily out of the labor force were still looking for jobs, the real unemployment rate would be 10.3%, not 7%. In other words, Dr. Yellen's confidence in the wealth effect never filtered down to the actual labor force.

If labor force participation drops, if for whatever reason, millions of people are no longer counted as part of the labor force, as is the case in the US, it’s a troublesome indicator for the economy and the real employment picture. It also makes the unemployment rate, now 7%, look a lot less awful: if you’re not counted in the labor force, and you don’t have a job, you’re not counted as unemployed. There are millions of people in that category. And their numbers are growing, not diminishing. The irony of the U-3 unemployment statistic is the fact that while unemployment has gone down 30% since its 2009 peak, we have the lowest labor force participation rate in over 3 decades.

People 55 to 64 years old, the first forget-about-retirement generation, are staying in the labor force to an ever greater degree. In 1992, only 56.2% were still in the labor force, in 2012, 64.5% were. Similar for older folks. The participation rate for people 65 to 74 years old jumped from 16.3% to 26.8%. Reality is this: fewer people can afford to retire. And the further reality is that the older workers are getting paid less.

The pattern among employers in a downturn in managing the non-executive/senior managerial workforce was to push out higher-cost older workers in favor of cheap, high energy, less set-in-their-ways new hires. Lots of people over 40 were given the heave-ho. Some eventually found work at much lower pay, some became self-employed (it’s a lot harder than the business press lets on; 9 out of every 10 new businesses fail in the first three years), and some retired, living more modestly than they had wanted to.

But who is not making it into the labor force? Young folks. The participation rate for those 16 to 19 has plunged from 51.3% in 1992 to 34.3% in 2012. OK, the BLS explains that by an increase in school attendance, and that would be a good thing. But the 25 to 54 year olds? Even among them, participation rates dropped from 83.3% in 2002 to 81.4% a decade later.

Among the 18 to 34 year old “Millennials,” those lucky ones who’re official counted in the labor force, unemployment has been a nightmare, with double digit unemployment rates, still, nearly 6 years after the financial crisis. It’s even worse for the 16 to 24 year olds, whose official unemployment rate is still 15%. In prior downturns, the employment rate for young adults nearly reached pre-recession levels within 5 years.

In the Great Recession, young adult employment had not even recovered halfway by the same point. A quarter of all job losses for young adults came after the Great Recession was officially over. The lack of jobs had driven many discouraged young people from the labor force altogether. A recent report by Opportunity Nation estimates that 5.8 million young adults are neither working nor in school.

And on the issue of banking reform Yellen says Dodd-Frank is a good road map but there may be a need for further steps. Which may be the biggest understatement of the new year. The Dodd-Frank reform legislation has been moving forward at a snail's pace, and the bank lobbyists are still in the process of re-writing bits and pieces and generally eviscerating key components. And even complete fulfillment of Dodd-Frank along current lines will not end the problem of “too big to fail.” 

Still, it's nice to see an incoming Fed head act like she'll pay attention to the Fed's role as a regulator. Under Alan Greenspan, the Fed was more of a deregulator than a regulator. Under Ben Bernanke, the Fed seemed to be more concerned with crisis control, and any thoughts of regulation were subservient to not letting the banking system implode, even if the bankers had lit the fuse. Now that there is some level of equilibrium, Yellen may actually feel emboldened to … ah hell, let's not get carried away; nothing will change.

Friday, August 23, 2013 - QE Giveth and QE Taketh

QE Giveth and QE Taketh

by Sinclair Noe

DOW + 46 = 15,010
SPX + 6 = 1663
NAS + 19 = 3657
10 YR YLD - .08 = 2.82%
OIL + 1.39 = 106.42
GOLD + 21.70 = 1398.80
SILV + .90 = 24.18


Yesterday, the Nasdaq crashed for about 3 hours; trading was halted; we still don't know why. It now has a snappy name, the Flash Freeze. It happened after shares of Apple got stuck at $498, then everything froze. In time we'll hear a good story about why it happened. My best guess for now is that it has to do with high frequency traders; the algo traders have a tendency to clog the trading pipes with all their bids, offers, and canceled orders as they try to scalp and front run trades. The market exchanges claim the high frequency traders provide liquidity, but I didn't see any liquidity for about 3 hours yesterday; zip, nada.

The markets had a pleasant and quiet day today, following a couple of weeks of fretting about Fed taper. America has created a whopping entitlement for the biggest Wall Street banks and their top executives, who, unlike most of the rest of us, are no longer allowed to fail. They can borrow from the Fed at almost no cost, then lend out the money at 3 percent to 6 percent or 30 percent; or they can take the money and gamble in markets they have rigged: derivatives, interest rates, energy, aluminum. It's all rigged; the big wheel spins round and round and the little ball always falls in the same spot. All told, Wall Street's entitlement is the biggest offered by the federal government, even though it doesn't show up in the budget. And it's not even a public good. It's just private gain.

And this whole idea of a taper, according to the primary dealers in the Federal Reserve banking system the taper is likely to start in September and wind down by the middle of 2014; well, it's not a done deal, and even if it is done there might be unintended consequences. Today, Christine Lagarde, the head of the International Monetary Fund, speaking at the Fed's Jackson Hole soiree, she noted that central bank policies “in one corner of the world can reach all corners.”

There’s little question that the Fed’s unprecedented flood of cash into the financial system since the financial crisis has rippled across the globe. Earlier that sometimes prompted complaints from developing nations that there was too much capital flowing into their markets, bringing inflationary pressures and hurting exports as their currencies rose in value. Now the concern for Lagarde and many others is on the other side and the increased risks of a sharp economic slowdown in emerging markets.

Bearish sentiment has gripped emerging markets in recent weeks. Cash is flowing out, pushing down the values of stocks, bonds, and currencies in India, Indonesia, and elsewhere; the Indian rupee has thrown itself off a cliff. Brazil's problems have been well documented and are boiling over. China's long guaranteed growth is unsure but likely quite a bit slower. Europe is starting to show signs of life but don't look for a V-shaped recovery; there are too many imbalances between the various economies of the Euro-zone. There's still too much debt, and too much bad debt, and the demographics are worse than in the US. Lagarde is correct on one point, the US economy doesn't operate in a vacuum.

And then there is the whole question of whether the Fed's QE has actually worked. There is little question that it has had an effect, but has it worked?

A secondary goal of QE is to accelerate the housing recovery. There are some signs that has happened. Home prices bottomed out in 2012 and have been rising by double-digits, year over year. Existing home sales are up 17% from last summer. But new home sales figures out this morning fell to a 9-month low. That might be a fluke, but it might also be the first tangible sign that rising mortgage rates are slowing the housing recovery before it gathers much momentum. It's hardly a ringing endorsement for tighter money.

The primary goal of QE is to prop up the banks, and to this end the Fed has done quite well. Refi's soared earlier in the year, and that is a big moneymaker for the banks. They write the refi's, extract the fees and dump the mortgages onto the lap of the government owned Fannie Mae and Freddie Mac. Refi's accounted for 70% of all mortgage lending in the first half of this year, but now they're drying up. Mortgage rates have jumped a full percentage point since early May. Wells Fargo Bank is the biggie in mortgage lending, and the refi business is down 50%, so they're firing 2,300 workers. QE giveth, and QE taketh away.

Elsewhere, retail sales aren't shining; even Wal-Mart is struggling. Car sales are up, but so are gas prices, and newer cars are more fuel efficient, so you buy a new car and cut your gas bill – it's a wash.For the Fed, the trick is to put the brakes on QE in the early stages of an economic rebound, because waiting too long could flood the economy with too much money, causing inflation, asset bubbles or worse. Yet it’s remarkably tricky to know in real time where the economy is headed, which is why the Fed and many other forecasters have misjudged the recovery during the past few years.

And then don't forget the Fed's dual mandates of price stability and maximum employment. We do not have maximum employment; not even close. Maybe it's too much to expect the Fed to deliver jobs; certainly it is too much to expect the Fed to deliver jobs with the tools of QE. Maybe it would be easier if the Fed just waits until they hit their target of 6.5% unemployment; clear, clean, and unambiguous

 It’s understandable that everybody wants more clarity, especially as we approach the end of the Bernanke era. But the Fed itself probably doesn’t know what it’s going to do, given the conflicting picture painted by all the data it looks at. And when the Fed finally does change policy, it will probably be incremental, and I'm not confident it has been priced in, not yet; that cake hasn't been baked yet.

Speaking of half-baked; financial reform has been on a back burner for years. Earlier this week President Obama called the regulators to the White House for a progress report, something, anything that might provide assurances that there won't be a repeat of 2008. Administration officials and some lawmakers have expressed frustration that the Dodd-Frank act, remain unenforced as an alphabet soup of federal agencies wrangle over how to adopt it, and the bank lobbyists constantly try to rewrite it.

Last month, Treasury Secretary Jack Lew complained in a speech that the regulators were moving too slowly to confront the dangers of banks that are so large that governments cannot allow them to fail for fear of bringing down the economy. The administration has said it wants to end the era of Too Big To Fail; they have stated flatly that there will be no more bank bailouts, but they still don't have the actual reforms in place. For too long, financial watchdogs were asleep on the job, allowing Wall Street megabanks to become too complex to manage and regulate and ‘too big to fail. As the banks have returned to profitability there has been growing impatience with the pace of bank regulation.

The banks have been feeding at the trough of QE, and now the Fed is talking about removing QE. This means the banks had damn well better be strong enough, they had better set aside enough reserves to weather problems. It wouldn't look good to pull away QE, have a big bank fail, and then have to go through this whole bailout process all over again. And make no mistake, QE1, QE2, and QE3 have all been an ongoing, drawn out bailout for the banks.

If we could ever get past the fear of another global financial meltdown scenario, maybe we could take all the trillions of dollars that have been funneled to the banskters, and instead funnel that money onto Main Street. Theoretically of course.

Speaking of half-baked; Congress is in recess, so they haven't been messing things up. Actually, this Congress hasn't done anything even when they are in session. This has been the most gridlocked Congress in decades. When they get back from recess they might actually do something; and that is not necessarily a good thing. There is a decent chance Congress might close down government. Yesterday,  about a third of the Republican caucus sent a letter to House Speaker John Boehner and Majority Leader Eric Cantor urging them to oppose any annual spending bills that include funding for Obamacare.

Today Boehner responded by saying that when Congress reconvenes on September 9 after the summer break, “Our intent is to move quickly on a short-term continuing resolution that keeps the government running and maintains current sequester spending levels."

This weekend you'll likely hear quite a bit about the 50^th Anniversary of the March on Washington; it was August 28, 1963, and it was actually called the “March on Washington for Jobs and Freedom”. The march was intended to raise awareness of civil rights and economic issues, because social and economic justice are just branches of the same tree.

Monday, August 19, 2013 - Not Attending Jackson Hole

Not Attending Jackson Hole

by Sinclair Noe

DOW – 70 = 15,010
SPX – 9 = 1646
NAS – 13 = 3589
10 YR YLD + .05 = 2.88%
OIL - .51 = 1365.20
GOLD – 11.60 = 1366.60
SILV - .07 = 23.29

It don't know where Ben Bernanke is. I know he is not scheduled to be in Jackson Hole, Wyoming this week. Most of the Federal Reserve policy makers will be at Jackson Hole for the annual economic get-together to debate whether the Fed should pull back from its $85 billion dollar per month asset purchase plan known as Quantitative Easing, also known as QE, also known as Stock Market Rocket Fuel. QE has lifted the markets to record highs this year, and talk of exiting QE has dropped the markets from highs the past couple of weeks.

Egypt continues to slip into a dark place as the military continues its bloody crackdown on civilian protesters. Just don't call it a coup; that specific designation would require an end to foreign aid. Egypt has been one of the biggest recipients of US foreign aid over the years. Egypt gets about $1.3 billion a year in aid. The money is not sent directly to Egypt; it goes to defense contractors who then send military equipment and expertise to the Egyptian military.

The biggest recipients of foreign aid to Egypt are Lockheed Martin, pulling in more than a quarter billion a year, followed by several others pulling in tens of millions, including DRS Technologies, L-3, Deloitte & Touche (apparently to keep track of everything), Boeing, Raytheon, and many more. The products include F-16s, surveillance equipment, Apache helicopters, Stinger missiles, motors, spare parts, and even teargas grenades.

The latest news out of Egypt is that a court has ordered the former dictator, Hosni Mubarak be released from custody. Mubarak has been detained on a variety of charges since his ouster in 2011. The courts say let him go. Not today, but maybe in a couple of weeks. Don't hold your breath. Actually, the court order means more volatility for Egypt; probably more protests; more protests means more teargas, so if you were in Cairo – hold your breath.

You may recall that when the Arab Spring began, Mubarak used some of the military equipment against protesters, including teargas grenades that proclaimed “Made in the USA”. This turned out to be a very bad marketing strategy. The Muslim Brotherhood then won the election and you have to wonder if the anti-US propaganda was a part of that. The Muslim Brotherhood turned out to be very bad at governing Egypt; the military, equipped with US made equipment, has now taken over the government. Just don't call it a coup.

You may also recall that one of the many factors in the Arab Spring was the release of Wikileaks diplomatic cables showing widespread political corruption. Wikileaks has just created its own “insurance” policy; sort of. Wikileaks is the website founded by Julian Assange; the site has released huge amounts of classified documents, also known as data dumps, detailing all sorts of governmental and diplomatic shenanigans. Assange has sought asylum at the Ecuadorian Embassy in London. WikiLeaks has released about 400 gigabytes' worth of mysterious data in a series of encrypted torrent files called "insurance." And no one can open it. File encryption means that the data is hidden and no one can see what's in the shared files without a key to unlock them, which hasn't been publicly released.

What is the meaning of calling it “insurance”? Is it meant to protect Bradley Manning (who has just been sentenced to 60 years), Edward Snowden, Julian Assange, or someone else? We don't know. The bigger question is what is in the “insurance” data dump? We don't know. It might be the identities of every secret agent working for the US around the world; it might be incriminating video; or everything that Edward Snowden had collected from his job with the NSA; it might be nothing more than a mumbo jumbo of code. It might even be the long anticipated data dump on the wrongdoing by the big banks.

For JPMorgan it appears bad habits, potentially illegal habits can't be broken. Last week, two junior level traders were criminally charged in connection with the London Whale losses. The bank is under investigation by eight agencies; add one more. The US Securities and Exchange Commission (SEC) is investigating whether JPMorgan's Hong Kong office hired the children of China's state-owned company executives with the express purpose of winning underwriting business and other contracts.

US law does not stop companies from hiring politically connected executives, but hiring people in order to win business from relatives can be bribery, and the SEC is investigating JPMorgan's actions under the US Foreign Corrupt Practices Act. If it's not one thing it's another.

The big banks seem to get away with..., everything. That's not always the case with the hedge fund managers; they tend to be viewed in a slightly different light; they are not considered systemically important; Bernie Madoff was sent to the big gray house. Steven Cohen saw his hedge fund charged, although Cohen wasn't personally charged. Today, the SEC announced a deal against Phil Falcone which includes an $18 million penalty, and Falcone must admit wrongdoing, and he will be banned from the securities industry for at least 5 years.

In June 2012, federal regulators had accused Falcone of manipulating the market by improperly using $113 million in fund assets to pay his own taxes and to favor some customer redemption requests secretly over others, among other things. His actions, “read like the final exam in a graduate school course in how to operate a hedge fund unlawfully.”

Falcone and his Harbinger hedge fund entities engaged in serious misconduct that harmed investors, and the SEC says their admissions leave no doubt that they violated the federal securities laws. For Falcone, who is currently engaged in two battles over LightSquared, a broadband company in bankruptcy he is fighting to maintain control over, the settlement appeared to be a positive turn of events. He struck a more upbeat note than the regulator saying he was, “pleased that we were able to reach a settlement to resolve these matters with the S.E.C.”

Following the financial crisis, the Federal Reserve, which is actually a regulator of banks; we forget that some times; the Fed, in addition to its other mandates of price stability and maximum employment, the Fed regulates banks, even though they don't really have their heart in it. The Fed in the role of regulator is kind of like a Pope who doesn't believe in religion. Anyway, following the financial crisis, the Fed started conducting stress tests on the big banks. They graded on a curve.

These annual financial health checkups continue and today the Fed described some significant shortcomings in the banks’ responses to the so-called stress tests. Despite the severity of the recent housing bust, the Fed said some banks weren’t taking into account the possibility of falling house prices when valuing certain mortgage-related assets for the tests. In other cases, banks assumed they would be strong enough to take business away from competitors in stressed times.

The Fed appeared most concerned that banks were applying the tests too generally. In other words, such banks didn’t pay enough attention to the risks that were particular to their assets and operations. Banks excluded material that was relevant to the bank’s “idiosyncratic vulnerabilities.” Under the tests, the banks have to assume weakness in the economy and turmoil in the markets, and then calculate the losses they would suffer under such conditions. The banks then subtract those losses from capital, the financial buffer they maintain to absorb losses. If the assumed losses cause capital to fall below a regulatory threshold, the banks effectively fail the test.

As part of the stress tests, banks have to carefully lay out capital plans to show regulators that they would have the strength to operate through tough times. The Fed says the banks are, in essence just trying to pass the test without really addressing the problems.

The stress tests have created tension between the Fed and the banks. One reason is that the tests can determine how much a bank is allowed to pay out in dividends or spend on stock buybacks.

President Obama is meeting with regulators today to get a status report on the progress of the Dodd-Frank reform act, the financial reform legislation that appears to have stalled after three years. This fall, the president will face a host of renewed efforts for financial reform, including housing finance reform. Just a reminder that September will mark the 5 year anniversary of the bankruptcy of Lehman Brothers, and so maybe it's time to get around to some reforms to prevent another Lehman Brothers collapse.

The Dodd-Frank law, which Congress passed in response to the meltdown, called for hundreds of new rules, including new oversight of the massive swaps market, mortgages and consumer financial products, and large nonbank financial firms. Regulators have missed deadlines on many of the most controversial requirements. The rules are about 40 percent complete. For example, the so-called Volcker rule to forbid banks from making risky trades with their own money is more than a year behind schedule, as five different agencies struggle to agree on a single rule. Despite that, the Dodd Frank act has grown while shrinking; grown from 848 pages of statutory text to 13,789 pages – more than 15 million words of regulation.

The White House meeting features the heads of major financial regulatory agencies, including the Treasury, Comptroller of the Currency, Securities and Exchange Commission, Commodity Futures Trading Commission, and the Consumer Financial Protection Bureau, among others.

Thursday, April 25, 2013 - Austerians v. Keynesians

Austerians v. Keynesians

by Sinclair Noe

DOW + 24 = 14,700
SPX + 6 = 1585
NAS + 20 = 3289
10 YR YLD + .01 = 1.71%
OIL + 1.79 = 93.22
GOLD + 36.70 = 1469.20
SILV + 1.24 = 24.50

Five years ago the banking system nearly imploded and almost resulted in a meltdown of the global financial system. Three years ago Congress passed the Dodd-Frank financial reforms, aimed at correcting some of the problems of 2008. Dodd-Frank may have included some good ideas, but you had to wade through 2,000 pages to find anything worthwhile. Much of the legislation has still not been implemented, and on the issue of averting another banking system implosion, it really didn't do much; it basically called on regulators to do a better job of catching problems and nipping them in the bud. We all know that's not going to happen.

And so, the biggest banks have been getting bigger than before the financial crisis and it's widely believed that if a big bank were to fail, they would be bailed out.., again. The government considers these banks to be Systemically Important Financial Institutions, which means they are Too Big to Fail. That implied backing has given firms a green light to engage in risky activities that pose a threat to the financial system.

Yesterday, Senators David Vitter and Sherrod Brown introduced legislation that aims to end the implicit guarantee of a government bailout. Brown and Vitter are calling for big banks with more than $500 billion in assets to have capital equal to 15 percent of their assets. Banks with at least $50 billion would have to set aside 8 percent. Community banks, those below the $50 billion threshold, would be exempt because they typically have large reserves.

There are global capital requirements for big banks; known as the Basel III requirements, but that is a risk-weighted measure; the banks can still count very risky assets, although less-risky assets get a higher ranking.

The legislation presents Wall Street megabanks with a clear choice: either have enough of your own capital to cover your own losses or downsize until you are no longer a risk to taxpayers. The banks are opposed to the idea. Shocking, right? The banks claim that if they have to hold enough capital to cover their losses, that means they would have to cut back on lending. This would probably be a better argument if the banks were actively expanding their lending as opposed to actively expanding their proprietary trading.

This is proposed legislation at this time. And even though it has strong populist support, it probably has a snowballs chance in Blythe, in July. However, it should prove a valuable fundraising tool for the politicians willing to oppose it. Brown and Vitter may have honorable intentions, but this is how Congress really makes its pocket and re-election money.

So, five years down the road; no solutions.

For the past five years there has also been a debate about how to lift the economy out of the hole left by the near financial meltdown. One one side were the Keynesians and on the other side, the austerians. The Keynesians, following the ideas of the British economist John Maynard Keynes, wanted to increase government spending to offset weakness in the private sector. The idea is that this stimulus spending would reduce unemployment, create demand, and prop up economic growth. The austerity crowd wanted to cut spending to reduce deficits and restore confidence. The austerians were following the ideas of economists Kenneth Rogoff and Carmen Reinhart, among others, who claimed that if  governments did not cut spending, countries would soon cross a deadly 90% debt-to-GDP threshold, after which growth would be permanently impaired.

This was more than just an academic debate. Japan embraced austerity and its economy stagnated for two decades. Europe embraced austerity and its economy has been battling rolling waves of recessions, and in some countries, economic depression. The most recent numbers out of the Euro-zone show new highs in unemployment for Greece, Spain, and France. Distrust of the Union is at all time highs. On Monday, José Manuel Barroso, the European commission president said the austerity policies being applied, mainly under pressure from Berlin, had reached the "limits of political and social acceptance" and were "unsustainable" in their current form.

Here in the US, we have seen a mix of austerity and stimulus and the results have been mixed as well. We cut back on government jobs; we had the fiscal cliff; we are now facing the sequester. If you don't like the idea of long delays at the airport, sorry but that's just the beginning. The sequester is throwing around 600,000 people out of work according to the Congressional Budget Office. These are people who have the necessary skills to fill jobs in the economy but who will not be working because people in Washington lack the skills to design policies to keep the economy near full employment. It just makes sense that the government needs to address budget issues and eliminate waste and fraud and unproductive programs. Meanwhile, the Federal Reserve has been pumping money into the financial system, but not into the broader economy. The results have been sluggish growth, unsustainable growth. So, QE doesn't seem to be successful, either.

And then last week we learned that the Rogoff-Reinhart paper was based on bad arithmetic. Once the error was corrected, the "90% debt-to-GDP threshold" instantly disappeared. The discovery of this simple math error eliminated one of the key "facts" upon which the austerity movement was based. So, you might think the debate is over; the Keynesians have defeated the austerians; stimulus beats sequesters. Not so fast.

Excessive debt is still problematic, just that the specific levels of 90% debt to GDP is not a precise level. And stimulus, at least in the form of Quantitative Easing, hasn't been nearly as effective as we would like. So, what's wrong? The biggest problem is that the stimulus has been coming from the Federal Reserve in the form of monetary policy and not from the government in the form of fiscal policy. The Fed has been stimulating the banks by adding more debt to the financial system; this is the equivalent of putting out fire with gasoline.

And, all the money the Fed has been pumping into the banks, has not trickled into the broader economy.  QE does not actually increase the circulating money supply. It merely cleans up the toxic balance sheets of banks. Ben Bernanke is infamous for suggesting that the Fed could crank up the printing press, or to follow the idea of Milton Friedman, deflation could be cured by simply dropping money from helicopters. A real “helicopter drop” that puts money into the pockets of consumers and businesses has not yet been tried. Why not?

It seemed logical enough. If the money supply were insufficient for the needs of trade, the solution was to add money to it. Most of the circulating money supply consists of “bank credit” created by banks when they make loans. When old loans are paid off faster than new loans are taken out (as is happening today), the money supply shrinks. The purpose of QE is to reverse this contraction.

But QE isn't really a matter of the Fed cranking up the printing press; it is actually an asset swap. The Fed exchanges dollars for the banks' toxic assets. It's a way to clean up the banks' balance sheets; it probably keeps the banks from going bankrupt and creating another financial meltdown, but it does nothing for the balance sheets of federal or local government, or most businesses, or consumers.

Quantitative easing as practiced today is not designed to serve the real economy. It is designed to serve bankers who create money as debt and rent it out for a fee, or use it for trading. Bernanke has long claimed that he needs the help of fiscal stimulus to really stimulate the economy. Maybe, but it doesn't really seem the Fed has done it's part to stimulate the broader economy, rather it has decided that the broader economy takes a backseat to resuscitating the zombie banks. And at the same instance that Bernanke calls for fiscal assistance, the Fed proclaims it's independence from the government. Bernanke has proclaimed this independence on several occasions. The unanswered question is that if the Fed doesn't serve the government, then who do they serve?

For the austerian crowd, their debt limits have been debunked, but even worse, their timing sucks. Cutting budgets while simultaneously propping up the balance sheets of the banksters is a double whammy that drains the life blood of economic growth. The QE stimulus doesn't send money to Main Street and the budget cuts take money away from Main Street. It shouldn't surprise you to learn that this combination isn't working. Money has not been circulating. The velocity of money has now slowed to a near standstill; a mere ratio of 1.54, the lowest in more than 60 years.

So, now that the austerian arguments are in shatters, it would seem a good time to revisit stimulus; not stimulus for the big banks, but direct stimulus. And one of the questions that must be asked is what is the definition of public debt? We know there are big differences in household debts. We know that if we accumulate debt for consumer purchases, we can quickly dig a hole. But if we accumulate debt to start a business or to educate our family so we can get a better job, that debt might be worthwhile. In short, there is a difference between debt and investment.

And one lesson we should have learned from the financial crisis is that we can't count on the banks to facilitate investment in the broader economy. We have a choice to support the banks' toxic balance sheets and their gambling addiction or support investment in the local economy. Of course that would require some legislative and executive backbone; so don't hold your breath. 

Tuesday, June 12, 2012 - Cleaning Off My Desk on an Off Day - by Sinclair Noe

Did you notice that the Non-bailout Spanish Bank Bailout grew over the weekend?  Last Friday, the International Monetary Fund said Spain's banks would need to raise at least $46 billion dollars as a buffer against a sharper economic contraction and to stabilize the Spanish financial system and prevent contagion to the rest of the Euro-zone. Before the weekend finished, the bailout had grown to more than $125 billion and we were already hearing warnings that it wasn't enough. 


The bailout has almost no chance of success and it seems just a matter of time until the Euro-powers that be impose harsh conditions on Spain. The Euro-zone leaders seem unwilling or unable to change from their austerity policies, even as Greece and Spain fall apart and the core euro-zone economies contract. Four years after the financial crisis began, many rich capitalist economies have not recovered their pre-crisis output levels. There are 60 million fewer people employed worldwide than if the pre-crisis trend had continued. In countries like Spain and Greece, overall jobless rates are approaching 25%, with youth unemployment over 50%. Even in countries experiencing "milder" unemployment problems, like the US and the UK, between 8% and 10% are out of work. If we include those who have given up looking for jobs or those who are forced to work part-time for want of fulltime opportunities, "real" unemployment could be easily over 15% even in these countries.


The remedies on offer are well known. Reduce budget deficits by cutting spending – especially "unproductive" social welfare spending that reduces growth by making poor people less willing to work. Cut taxes at the top and deregulate business cut red tape, provide tax incentives to invest and generate growth; and make hiring and firing easier. Except it isn't working.


And there is also plenty of historical evidence showing that austerity remedies have never worked. The same happened during the 1982 developing world debt crisis, the 1994 Mexican crisis, the1997 Asian crisis, the Brazilian and the Russian crises in 1998, and the Argentinian crisis of 2002. All the crisis-stricken countries were forced (usually by the IMF) to cut spending and run budget surpluses, only to see their economies sink deeper into recession. Going back a bit further, the Great Depression also showed that cutting budget deficits too far and too quickly in the middle of a recession only makes things worse.


As for the need to cut social spending to revive growth, there is no historical evidence to support it either. From 1945 to 1990, per capita income in Europe grew considerably faster than in the US, despite its countries having welfare states on average a third larger than that of the US. Even after 1990, when European growth slowed down, countries like Sweden and Finland, with much larger welfare spending, grew faster than the US.


Also there is no historical evidence to support tax cuts and deregulation as a remedy resulting in  investment and growth; this was tried in many countries after 1980, with very poor results. Unemployment rates in the major capitalist economies were between 0% (some years in Switzerland) and 4% from 1945-80, despite increasing labor market regulation. There were more jobless people during the 19th century, when there was effectively no regulation on hiring and firing.


In Spain, 50% of young people are unemployed while the priority is to to bring the deficit down from 9% of GDP to 3% in three years? And there are several major American cities that also have massive unemployment, especially among young people. A society in which the rich have to be made richer to work harder while the poor have to be made poorer in order to work harder. Where there is shared sacrifice, shouldn't there be shared prosperity? 




Sheila Bair, the former Chairwoman of the FDIC says efforts to increase and improve regulation of Wall Street have bogged down. She has formed a new group, the Systemic Risk Council, that will monitor and encourage regulatory reform. 


Bair says: “The great challenge is to devise a system to identify risks that threaten market stability before they become a danger to the general public. We need a more effective and efficient early-warning system to detect issues that jeopardize the functioning of U.S. financial markets before they disrupt credit flows to the real economy. And two of the most critical tasks are how to impose greater market discipline on excess risk-taking and effectively end the doctrine ‘too big to fail.’”


The Dodd-Frank act passed in 2010 provided for numerous steps, including the creation of an Office of Financial Research that was supposed to help the newly created Financial Stability Oversight Council in identifying threats to financial stability and deciding which financial firms were systemically important and how much additional regulation they should receive. That council is composed of all the major regulatory bodies, and so far it has accomplished little. So far, regulators had so far missed two-thirds of the 221 deadlines for adopting regulations set forth in the law.


The main reason for the delays in implementing reform? The banks have been fighting reform. Senator Dick Durbin said it best about 3 years ago: "the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place," 


Have you been following the story about the Stuxnet cyber weapon? This is the software virus that was widely believed to have been used by the United States and Israel to attack Iran's nuclear program. Turns out some of the software code used in Stuxnet may be the same code used in the Flame virus, which was a cyber weapon used back in 2009 in the Middle East. Flame is a highly sophisticated computer virus that disguises itself as common business software. It was deployed at least five years ago and can eavesdrop on conversations on the computers it infects and steal data. If the United States is proven to be a force behind Flame, it would confirm the country that invented the Internet is involved in cyber espionage -- something for which it has criticized China, Russia and other nations. Instead of issuing denials, authorities in Washington recently launched investigations into leaks about the highly classified project. Two years ago at the Wealth Protection conference I said Cyber-war would be a major trend in the years to come. Most people thought that was a little crazy. A Pentagon report last year that outlined the still-evolving U.S. cyber strategy said economic espionage could prove the greatest threat to long-term U.S. interests, pointing to thefts of industrial and defense secrets via Internet spyware. 


You may have noticed that the price of a gallon of gas has dropped about 30 cents since late April, while the price of crude oil has dropped more than $25 a barrel; there seems to be a lag. We have been so preoccupied with oil prices that you probably didn't notice a report a few months ago from the National Intelligence Council (don't even ask me who they are); they claim that water shortages will likely lead to political disruptions and many more violent wars in strategically important regions over the next decade. We could live without oil. We can't live without potable water. 

Wednesday, May 30, 2012 – Spanish Winter, Mexican Spring – by Sinclair Noe

DOW – 160 = 12,419
SPX – 19 = 1313
NAS – 33 = 2837
10 YR YLD – 0.11 = 1.62%
OIL – 3.38 = 87.38
GOLD + 7.70 = 1563.50
SILV +.05 = 28.03
PLAT – 28.00 = 1406.00

Yesterday the Dow gained 125 and I said: “The reason du jour for today's market gains: positive news regarding Greece. Really? I'm not buying it. Make up your own reason for today's gains because we are just as likely to see declines tomorrow.”

And sure enough. The problem du jour was Spain and the Dow dropped 160. This economic stuff is easy. Remember when I told you a couple of months ago to get out in May? The S&P 500 has fallen nearly 6 percent in May, heading for its worst monthly performance since September. You're welcome. The Nasdaq is down 6.9% for the month. US Treasury benchmark yields fell to their lowest in at least 60 years. Oil dropped more than 3 percent to the lowest level in nearly six months; oil prices are down 16% in May. The dollar remains the cleanest shirt in the dirty laundry hamper, up 5.5% for the month. The euro dropped below $1.24 to a 23-month low. Spain's stock market hit a 9 year low. Yields on 10-year Spanish bonds topped 6.6%, which is close to levels at which Ireland and Greece sought international bail-outs.

The news from Europe was all Spanish overnight as the country struggles to find traction on any plan that will lead it away from the need for external help The Spanish Economy Ministry played down a report that the European Central Bank had rejected an initial plan to rescue Bankia, Spain's fourth biggest bank, by stuffing it with government bonds that could be used as collateral to borrow from the ECB. A ministry spokeswoman said: "Spain did not formulate any proposal to the ECB on funding the Bankia plan, so it was difficult for it to have an opinion."

Spanish Prime Minister Mariano Rajoy insisted the government has no intention of seeking an EU/IMF bailout either for its banks or for the state, but then a Governor for the Bank of Spain resigned, abruptly, a month before his term was due to end, adding to concerns about the handling of the Bankia crisis and relations with European institutions.

Highlighting Spain's difficulty in meeting fiscal targets while gripped by a worse-than-forecast recession, the outgoing central bank chief said tax revenue may fall short of government estimates and spending may be higher than expected. He recommended bringing forward a rise in value-added tax set for 2013 if the deficit objective goes off track this year.

Also, Spain announced its joint national-regional bond issuance scheme would go live within days:

Spain’s government said it would approve the issuing of joint bonds by the 17 regional governments next Friday, so as to make it cheaper for them to finance their debts. And so the blurry line between Spanish banks and national and regional governments gets a bit more out of focus. The problems of Spain’s economy all stem from the fact that the government sector is attempting to implement an austerity program at a time when the private sector is in deep retrenchment. Given the economic and political circumstances the country finds itself in it may have no choice, but that won’t change the outcome. Private sector demand is falling and economic circumstances continue to make it harder for the private sector to recover from the economic shock of the housing market collapse. The Bank of Spain says retail sales declined in April at a record rate and the economy will slow even more in the second quarter. It looks like Spain has entered the very nasty and possibly inescapable downward spiral.

Meanwhile, the National Bank of Greece is threatening that the Greeks face economic catastrophe if they leave the euro. Living standards would plummet, incomes would be slashed by more than half, and inflation and unemployment would skyrocket. The bank claims per capita income would collapse by at least 55 percent, the new national currency would depreciate by 65 percent against the euro and a recession (I hate to think what a depression would look like for Greece), now in its fifth year, would deepen by 22 percent, pushing unemployment and inflation through the roof.

Tomorrow the Irish vote in a referendum on a European budget discipline treaty which is seen as a precondition for receiving further EU/IMF aid.

So far, voters in Europe have sent an inescapable signal to the EU powers that be: no more austerity. In doing so, they showed that the average voter has a better understanding of economics than the technocrats in charge. So far, the all-austerity plan has not solved the debt crisis and has sent weaker economies into depression, with high unemployment, higher and higher costs to service debt, and strain that threatens the union. There is a case to be made that the problem with austerity is not the austerity itself, but the pace at which it is being imposed. Rather than a mad rush to meet euro-zone deficit limits, more flexibility is needed to allow governments to adjust over a longer period of time and benefit from economic recovery.

And there is another argument that says whatever the verdict at the ballot box, Euro-land can't avoid austerity. Its indebted governments can’t simply return to spending and borrowing as they had in the past. Financial markets just wouldn’t stand for it. And what we really have is a battle to see who will prevail in Europe, democracy or financial markets. Of course, a democratic union can suport financial markets, and indeed the vast majority of Europeans are in favor of keeping the Euro-union intact. However, the bigger question is whether the financial markets can live with a democracy, which can be messy at times. So far, there doesn't seem to be much flexibility.

The world is a dangerous place; the Muslim Brotherhood has been elected to lead Egypt past the Arab Spring. Syria is being butchered by a madman. UN nuclear inspectors showed new satellite imagery indicating that Iran may be conducting clean-up work at the military site where inspectors suspect tests relevant to developing nuclear weapons have been carried out. 

Meanwhile, just one state to the south, in case you hadn't noticed, is another exercise in flexibility, or lack thereof. I found this report on the situation in Mexico. On May 6th, the four candidates for the Presidency debated. In a nation where the internet reaches only 30%, and few can afford cable, the debate was not carried on broadcast television. The Federal Electoral Institute (IFE) chose to have a former porn star host the debate. She was clad in a thin, revealing white dress.

On May 11th, the PRI's candidate, Pena Nieto, attempted to speak at Mexico's elite Iberoamericana University. Student protests prevented him from speaking.

As governor of the State of Mexico, Nieto had repeatedly used police force to prevent student protests. In the wake of the Iberoamericana protests, thousands marched through Mexico City, and then other cities, against Pena Nieto. Their demands were simple: above all, clean elections. An end to corruption and manipulation in the IFE. Fair and equal access to the media-- an end to the unfair, biased and deceptive coverage by Party-controlled media.

In the weeks that have followed, this youth movement has come to be known as "YoSoy132," or "I Am 132." It takes some of its inspiration from the Occupy and Anonymous movements. It remains independent, its primary focus on organizing to observe the polls and, if possible, ensure their integrity.

Much and serious talk has arisen, of a "Mexican Spring." What this would mean, remains unclear. In both Eastern Europe and the Middle East, it entailed replacing authoritarian governments with democratic regimes. In Mexico, the loudest criticisms of the democracy movement remain focused on "stability." These same critics argue loudest that Mexico today is a democracy, with a three-party system and a limited Presidency. All experience from the past twelve years, says something different. Mexico's youth today, say something different.

The question is-- what would a Mexican Spring consist of?

We're coming up on the 2 year anniversary of the Dodd-Frank financial reform law. This was the response to the abuses of the financial industry that resulted in the near meltdown of the global financial system in 2008. Two years after the law was passed and it hasn't made any real difference. I can say that with some certainty because only a small portion fo the law has been enacted; the rest is under consideration and review; and every line in the law is being beaten back by the banks. This means the big part of the law; like bringing transparency to the trading of derivatives and the Volker Rule, which would theoretically eliminate banks making risky trades through their proprietary trading desks, those parts have not been enacted.

And even if Dodd-Frank survives the attacks of the banking lobbyists, there are doubts about its potential efficacy. Recently, there have been complaints that the law is overly complex. This is a good argument because the law runs about 2,000 pages and damn near nobody has read the whole thing, much less figured out the implications. Banking has become incredibly complex. The recent multi-billion dollar trading flop by JPMorgan just underscores how complex banking has become; and their trading activity has become so complex that they don’t' even understand the ramifications of their own actions; the regulators certainly lack awareness and the banks' own efforts at self regulation are laughable. On top of all that we don't know if Dodd-Frank regulations will be effective and we don't know if they will ever be implemented. So, that leaves us facing the same problems we faced in 2008.

You might have noticed there is a strong anti-regulatory sentiment this election year. Maybe you've heard about the “regulatory tsunami of unprecedented force” issuing from Washington. Maybe you've heard about the “vast edifice of regulations” or the “regulatory jihad”. The truth is that the Obama administration has issued slightly fewer rules than George W. Bush did at the same point in his tenure. And the cost benefit analysis has shown fewer costs to business than the previous administration. That restraint means that two-thirds of the rules proposed in Dodd-Frank have not been implemented; four years after the near collapse of the financial world as we know it and we haven't done anything to correct the problem. I understand that nobody likes the burdens of regulations but I also don't like salmonella in my spinach; I don't like cars that have exploding gas tanks; I don't like factories that spew toxic waste into the air or into rivers; I don't like businesses that force children to work on their assembly lines; I don't like businesses that discriminate against people because of the color, religion, gender, or other orientation; and I don't like banks that gamble with deposits and threaten to destroy the economy unless taxpayers bail them out.

What is going to prevent a repeat of 2008? Whether we are ready to admit it or not, Dodd-Frank is dead on the vine. The Senate Banking Committee's ranking Republican, Senator Richard Shelby of Alabama, has vowed to repeal Dodd-Frank altogether. The panel’s chairman, Senator Tim Johnson of South Dakota, and Senator Charles Schumer, a Democrat of New York, have called for looser rules on banks’ international derivatives trades. After JPMorgan’s losses came to light, Senator Johnson said it shows“why opponents of Wall Street reform must not be allowed to gut important protections for the financial system and taxpayers.” He is right. Now he and other committee members, and the regulators, need to show what they have learned. Don't hold your breath. Senator Johnson's biggest campaign contributor – JPMorgan. What is needed are requirements for derivatives to be traded on transparent exchanges — which would have prevented the trades from piling up without notice. Banks should also be required to move any derivatives deals into separately capitalized bank affiliates, which would protect taxpayers, and the banks, from disastrously large losses. Banks fought hard to keep those provisions out of Dodd-Frank, and, even now, they are still pressing to scale them back. The derivatives marketplace has grown to more than $700 trillion in size. It is the wild wild west of finance, and it is ground ripe for tax evasion and other abuses.

The simple solution would be to reinstate Glass-Steagall, the old depression era response to the problem of Too Big to Fail Banks. Split the banks into a traditional bank and an investment bank. The traditional bank takes deposits and makes loans; safe, conservative, and boring. The investment bank can make trades and if they win they keep the profits and if they lose, the depositors accounts would not be affected, and the investment banks could sink or swim based on their own performances. No wonder the bankers are opposed.