Friday, July 12, 2013 - Malala Day

Malala Day

by Sinclair Noe

DOW + 3 = 15,464
SPX + 5 = 1680
NAS + 21 = 3600
10 YR YLD + .02 = 2.60%
OIL + 1.34 = 106.25
GOLD - .80 = 1285.80
SILV - .23 = 20.02

So, let's recap. On Wednesday, Ben Bernanke said the Fed wasn't going to raise interest rates and really, nobody needs to worry about tapering. Or at least that's what the markets decided to hear this time, and so the S&P 500 managed its best week in 6 months, up 2.6%; treasuries rebounded with their best week in a year as the yield on the 10 year notes dropped 14 basis points; the dollar had its worst week in almost 2 years and gold had its best week in 8 months. And the price of oil jumped about 5%, and gas prices are up 9 cents in the past 4 days with today's increase the largest in 6 months, pushing the price of regular gas to its all-time high for this time of year.

If you were looking for inflation, we found it. The Producer Price Index, or PPI, measures inflation at the wholesale level and it was came in at 0.8% for June; the increase was mainly because of a nearly 3% increase in energy prices. The US economy has long been, and still remains very vulnerable to big swings in energy prices.

As you know, it is earnings reporting season, and today was the big day. JPMorgan and Wells Fargo reported earnings. Not only are these two of the biggest banks, but the big banks represent some of the strongest potential earnings of any sector in the economy for the past quarter. After the banks report, earnings season is all downhill.

Wells Fargo reported a 19% increase in 2Q profit, posting net invome of $5.5 billion or 98 cents per share. Revenue was flat at $21.4 billion. Wells Fargo is now the largest home mortgage lender and 2Q saw a drop-off in the mortgage market as rates increased, but that was late in the second quarter and did not significantly affect results. A bump in credit cards and commercial lending, and record origination of auto loans, further offset the home loan slowdown. So, with revenue flat, where did the extra profit come from? They cut expenses; specifically, they significantly reduced the amount they set aside in reserves for bad loans. What could go wrong?

JPMorgan reported a 31% increase in 2Q earnings, posting net income of $6.5 billion, or $1.60 a share. Revenue was $20 billion, compared with $26 billion in the period a year earlier. Two big sources of revenue increase came from the investment banking unit and from a 38% increase in fees, even as the mortgage banking business declined and net interest on loans dropped slightly. The record setting profit got a boost by setting aside $1.4 billion less for loan loss reserves, even as they set aside an additional $600 million for potential litigation. We don't know what litigation they're anticipating but that is enough for a pretty big legal battle.

There was also a nifty bit of accounting that somehow didn't show up in 2Q earnings and it deals with the increase we've seen in interest rates in the past month and a half. It falls under the category of Accumulated Other Comprehensive Income, and it dropped from $3.5 billion to $400 million. That little gem didn't make it into the headline earnings number, but when you start adding up some of the bad stuff, the headline numbers don't look so great. In fact, they start to cause some concerns.

Keep in mind that JPM is comparing 2Q earnings to a year ago, when the firm lost $3.4 billion as a part of the failed London Whale trade. As a side note JPM's total loans decreased slightly in the last quarter, while their excess reserves increased. You may also recall that the gambling money used by the London Whale came from excess reserves. And in a strange twist, the CIO, which is the London trading unit which included the London Whale, the CIO generated a negative $648 million in revenue in the last quarter. But the bigger question is what the bank is doing with the excess reserves; they aren't making loans with the money; so the indication is that they are trading with the money.

So, anyway the big profit announcements for 2Q earnings reporting season peaked today.

Of course, part of the JPMorgan conference call this morning dealt with the Senate Bill, introduced by Elizabeth Warren and John McCain to reinstate the Glass-Steagall law which would split investment and commercial banking, also some discussion about capital reserve requirements for banks.

Regarding a 21^st century version of Glass-Steagall, the bank seems to think the best reason why it is not needed is because they have lots of customers, and because they are customers they must like the business model, so why change?

And regarding the increased capital reserve requirements which call for the biggest banks to hold more reserves than smaller banks, well Jamie Dimon thinks that's unfair and creates an imbalanced competitive playing field. In other words, complete disregard for the concept of too big to fail. And it will come as no surprise they plan to lobby hard against Glass-Steagall, increased capital reserves, and don't forget reforms to the trading of credit derivatives.

The whole argument seems to be that the banks won't be able to compete and they won't be able to lend money if they actually have to observe sound business practices. This is boilerplate response from the banksters but it doesn't hold water. JPMorgan has enough money to make more loans right now, but they would rather trade through their investment banking business than make loans. As for the competitive disadvantage, well let's use JPM's own reasoning: a measurably healthier bank should have an easier time raising money and attracting customers.

And with regard to regulations on overseas trading in the $700 trillion derivatives market; first, it looks like the CFTC will move forward on imposing that part of the Dodd-Frank reforms. The CFTC voted on that this morning. The real reason they object to regulations on derivatives is because in an unregulated environment, they get to siphon off big profits with almost zero accountability.

Four Danish pension funds filed a lawsuit against twelve large banks, accusing them of increasing costs for investors trading in the $27 trillion credit default swap (CDS) market by stopping exchanges from entering the market.

The case, filed in the U.S. District Court in the Northern District of Illinois, follows a similar suit filed in May by an Ohio-based pension fund, the Sheet Metal Workers Local 33, and the Cleveland District Pension Plan in the same court.

The funds allege that dealers used their ownership and controls over clearing, data and other entities crucial to the market to block an independent clearinghouse from offering exchange-trading, deny market participants real-time price information and stop new participants from entering the market.

The CME Group (CME), the world's largest derivatives exchange and Chicago-based hedge fund Citadel Group, planned to offer CDS exchange trading in 2008 before dropping the plan the following year. The banks threatened to withdraw their business from the CME if it went through with it CDS exchange venture, the funds allege.

The banks used their control over the International Swaps and Derivatives Association (ISDA), a trade group, and Markit, a data provider and owner of benchmark indexes, to deny or delay licenses the exchanges needed to offer CDS trading, according to the complaint. The funds also accuse the banks of controlling a CDS clearinghouse, which is now owned by IntercontinentalExchange (ICE), to keep trading off exchanges and restricting membership to the clearinghouse to the largest banks. Markit and ISDA are defendants in the suit and ICE is named as a co-conspirator.

The House of Representatives defied a White House veto threat and passed a farm bill on Thursday that expands the taxpayer-subsidized crop insurance system but omitted food stamps. Lawmakers passed the 608-page bill, unveiled by Republican leaders late on Wednesday night, on a 216-208, party-line vote after two hours of debate in which no amendments were allowed.

Republican leaders said food stamps, traditionally part of the farm bill, would be handled later and that, for now, they needed a way to start negotiations with the Senate over a compromise bill. Democrats said the real intent of the action was to isolate food stamps for large cuts in funding. House Speaker John Boehner declined to say if leaders would allow a vote on a farm bill with larger food stamp spending than his party liked. "We'll get to that later."

Just a reminder; there are now more than 47 million Americans using food stamps for their daily bread. The House passed a version of the bill that includes $195 billion in subsidies to farmers or for agribusiness over 10 years, but it eliminates food stamps and nutrition programs. Now, they are expected to get around to it sooner rather than later, but this just seems to be a dangerous political game.

Do you remember the story of Malala Yousafzai? She's the Pakistani schoolgirl who was shot in the head last year by extremists for speaking out about her right to education. She survived and today is her 16^th birthday. The United Nations declared today “Malala Day” and she spoke before the UN in New York. This is an amazing young girl. Here is the link to the speech, and it is very worthwhile to take the time to watch this.

Let me share a few of her quotes:

First of all she said: "'Malala Day' is not my day. Today is the day of every woman, every boy and every girl who have raised their voice for their rights."

Also, “ We realize the importance of our voice when we are silenced.”

“Today we call upon the world leaders to change their strategic policies in favor of peace and prosperity.”

“We realize the importance of pens and books when we saw the guns. The extremists are afraid of books and pens.”

“One child, one teacher, one book and one pen can change the world. Education is the only solution. Education first.”

Hamlet Dies

by Sinclair Noe

Record Highs for Dow and S&P.

DOW + 169 = 15,460
SPX + 22 = 1675
NAS + 57 = 3578
10 YR YLD - .10 = 2.57%
OIL – 1.92 = 104.60
GOLD + 22.70 = 1286.60
SILV + .69 = 20.25

To taper or not to taper? That is the question.

Whether 'tis nobler in the mind

to suffer the slings and arrows of outrageous bond market feral hogs

or to feed the savage beasts with unending securities purchases.

Or to tighten against a Sea of non-existent inflationary troubles

And by opposing end them: to die, to sleep,

to slaughter the feral hogs at the Discount Window trough;

and end the thousand Natural shocks that markets are heir to?

Is that all? To taper, to tighten, perchance to Dream;

Aye, there's the rub.

For one is QE and the other is accommodative monetary policy,

while fiscal policy and structural reforms

are nothing more than ephemeral motions,

the stuff of what dreams may come,

When we have shuffled off this mortal coil.

Well, that's enough of our literary mosh pit for today. As I recall, Hamlet died.

The FOMC minutes released by the Fed yesterday, were much ado about nothing... sorry. There was a bunch of talk that boiled down to the basic idea that Quantitative Easing and interest rates are two separate policies. The FOMC bigwigs have no intention of raising the interest rate target; that is off limits. The securities purchases under QE will taper off at some point, but there were more in favor of continuing than quitting. And even when they do quit, it will be slow, or it will be a variation on the theme. For now, it just makes sense that they will continue, if for no other reason it is a way to structurally reform the capital reserves of the big banks; a job the politicians and the courts have been unwilling to undertake.

So, the big theme from the FOMC minutes is we can get the taper without higher rates. But the bond market may have something to say about that. After all, the Fed has been the biggest buyer in the bond market; remove the biggest buyer, and prices drop and rates go up. If or when the Fed tapers that just signals for a flood of money to exit bonds. Indeed we've seen massive redemptions in bond funds at the biggies: Pimco and Vanguard.

Then, if you look over at the Dollar Index you might think there has never been talk of taper. The greenback jumped off a cliff the past two days, although it did firm up in afternoon trading.

And thus the Native hue of Resolution
Is sicklied o'er, with the pale cast of Thought,
And enterprises of great pitch and moment,
With this regard their Currents turn awry,
And lose the name of Action.

The Fed is driving the markets. Make no mistake about it. If you are still inclined to fundamentals, you might be wondering what is driving the valuations. As we begin with the second-quarter earnings season, analyst expectations are calling for companies in the S&P 500 to see earnings growth in the neighborhood of 0.8%. Revenue growth, or lack thereof, will be another point of weakness but operating margins should remain supportive.

Over the past 4 years, improved earnings, and their accompanying stock market rallies, have been driven by cost cuts rather than strong profit growth. That can't last forever. Companies have been keeping the fire stoked by burning the furniture, then the doors, and now they're ripping the roof off the joint to keep the fires burning. There just isn't a lot more cost cutting that remains. Because of this, it is unlikely we will see many surprises in performance results in earnings this season.

So, the next question is whether valuations are enough to drive further rallies. Not really, but that's the wrong question because we know that this market is being driven by the Fed. Of course, valuations could lead to a long grind up even if we don't see a big rally. Some are already saying that today's record high close is nothing more than short covering; that's where traders who were shorting the market, betting it would go down, got caught and now have to buy back in to cover their positions.

Of course we can speculate on what is driving the market at any given moment but if you really want to make money like the pros, the trick is to be fast and early.

You've heard of the Consumer Confidence Index. The highly respected gauge of consumer sentiment is compiled by the University of Michigan and Thomson Reuters and released each month. And you can get it 2 seconds before the rest of the world, if you're willing to pay an extra $6,000 per month. The 2 second advantage really only has value to high frequency traders who can jump in ahead of the rest of the world and scalp a bit of profit. If that sounds like insider trading, it is.

New York Attorney General Eric Schneiderman has opened an investigation, saying: “The securities market should be a level playing field for all investors and the early release of market moving survey data undermines the fair play in the markets.”

The Institute for Supply Management teamed up with Thomson Reuters to also sell a kind of enhanced access to the results to a monthly survey of purchasing managers. For a price, they send out a special version of the report designed to be digested by computers and thus quickly trade-able. The Duetsche Borse sells a 3 minute early version of the Chicago Business Barometer for 2,000 euros a year.

Thomson Reuters says they sell the Consumer Confidence Index 2 seconds early version to help their customers make better informed trading and investment decisions. Seriously, that was their response.

Did you ever see the old Paul Newman and Robert Redford movie, “The Sting”? The basic idea was that they set up a guy to think he was hearing the real-time results of a horse race, when in fact, the results were a few minutes old. The guy bet on the race and lost. There's a sucker born every minute. Thank you Thomson Reuters, for helping make us all better educated suckers, or, I mean …, investors.

And finally, an idea whose time has come, or is actually long overdue, and probably has very little chance of success, but we have to talk about it. A bipartisan group of 4 senators that includes Elizabeth Warren and John McCain introduced an updated version of the Glass-Steagall Act today.

The new bill, which is also cosponsored by Sens. Maria Cantwell (D-Wash.) and Angus King (I-Maine), would require banks that accept federally insured deposits to focus on traditional lending and would bar them from engaging in risky securities trading. The separation between lending and trading was originally imposed in 1933 by the Glass-Steagall Act. The legislation introduced today would also bar banks that accept insured deposits from dealing swaps or operating hedge funds and private equity enterprises.

McCain voted for the 1999 Gramm-Leach-Bliley Act, which repealed Glass-Steagall, but he's come to his senses. Good for him. Even the folks who wrote the 1999 act have come to regret it. Not Phil Gramm, but the folks who wrote it from Citigroup. Quick history; in 1998 Citibank merged with Travelers. The new company combined commercial banking and insurance and investing in a one-stop shop. It was the largest merger in history at the time. One problem – it was illegal under the Glass Steagall Act of 1933. So, the folks at Citigroup lobbied and they lobbied hard, and they re-wrote the rules to suit their pocketbooks.

Last Summer, former CEO Sandy Weill said he had a change of heart about repealing Glass-Steagal.

In 2009, John Reed, the co-founder of Citigroup issued his regrets, saying: “ I would compartmentalize the banking industry for the same reason you compartmentalize ships. If you have a leak, the leak doesn't spread and sink the whole vessel. So generally speaking you'd have consumer banking separate trading bonds and equity.”

And then, 10 years after his treasonous deal, Reed tried to justify his greed, saying: “When you're running a company, you do what you think is right for stockholders. Right now I'm looking at this as a citizen.”

Apparently Citigroup management was forced to renounce citizenship as a requisite for employment.

Senator McCain issued a written statement today, saying: "Since core provisions of the Glass-Steagall Act were repealed in 1999, shattering the wall dividing commercial banks and investment banks, a culture of dangerous greed and excessive risk-taking has taken root in the banking world. Big Wall Street institutions should be free to engage in transactions with significant risk, but not with federally insured deposits."

He's absolutely correct. Gamble all you want, just don't make me pay for your gambling losses. Unfortunately, the bill introduced today probably doesn't have much chance, because frankly the banks are still running Washington. They control the place.

Wednesday, July 03, 2013 - Independence Day

Independence Day

by Sinclair Noe

DOW + 56 = 14,988
SPX + 1 = 1615
NAS + 10 = 3443

10 YR YLD + .03 = 2.50%
OIL + 1.64 = 101.24
GOLD + 10.10 = 1253.50
SILV + .34 = 19.82

Today is Independence Day. I know; the Fourth of July is tomorrow, but it is Independence Day in Egypt, or Coup Day, or something. They had huge crowds in Tahrir Square and they celebrated with fireworks, so let's called it Independence Day. We're not really sure what it is, but we know a few things. There has been a revolution. The Egyptian army has overthrown President Mohamed Morsi, announcing a roadmap for the country’s political future that will be implemented by a national reconciliation committee.

The head of Egypt's armed forces issued a declaration today suspending the constitution and appointing the head of the constitutional court as interim head of state. Morsi's presidential Facebook page quoted the disposed president as saying he rejected the army statement as a military coup. Morsi was the head of the Muslim Brotherhood and he had served for one year as president, after being democratically elected, following the revolution that overthrew the sort-of democratically elected dictator Hosni Mubarak. Democracy can be messy. And these are messy, noisy, uncertain and unpredictable days for Egypt.

The country is in unchartered territory. The economy is under severe pressure. Most institutions are weak. A credible leader is yet to emerge with widespread support. And, to make things worse, there is no play book. The mood on the street may look joyful but the situation could easily turn violent.

Nobody really knows what will happen next, but the Egyptian people took to the streets to say that what had been happening was not acceptable. They are no longer fearful or ambivalent about their government. With a little luck, maybe something good will come from all this.

Yesterday we talked about the doubling of interest rates on student debt. It shot up to 6.8% from 3.4% for new loans. So, the next time you go to a college graduation, look past the caps and gowns and make sure you notice the ball and chain most graduates are wearing as they march onstage to receive their diplomas. That's student loan debt, which at over $1 trillion tops credit card debt in the U.S. today. The average burden is $28,000, but add in their credit cards and they're graduating with an average of $35,000 in debt. It's no wonder that people who've paid off their student loan debt are 36 percent more likely to own homes than those who haven't.

A growing number of voices, including the Fed, are pointing to the way this debt burden is a drag not just on the borrowers but the wider economy. One survey found that student debt reduces average aggregate car purchasing by $6.4 billion a year. Young people are leaving school with the kind of debt that was once only incurred by the purchase of a first home; not surprisingly, it's depressing home buying too.

According to the Federal Reserve Bank, two-thirds of college graduates leave with some debt, and 37 million Americans are repaying a student loan right now. And the grads who graduate with no debt are the really lucky ones. The grads who graduate with debt are semi-lucky – they get a degree and a chance at emplyment. Lots of students don't graduate but still have debt. And then, about one-third of high school graduates aren't luck enough to go to college.

We shouldn't even call them student "loans," because you can't refinance them, and you can't get out from under them by declaring bankruptcy. It's more like indenture. Thanks to the Bankruptcy Reform act of 2005, there's no statute of limitation on collecting student loans, and lenders can garnish wages, tax refunds and even Social Security checks. Back in 2007, now-Sen. Elizabeth Warren asked: "Why should students who are trying to finance an education be treated more harshly than someone … who racked up tens of thousands of dollars gambling?" Nothing's changed, although Warren is part of a limited number of people in Congress who are trying. Now, Warren has proposed that student loans should get the same interest rates as banksters. You know, the Fed should offer money for education at the same ¼% that they give money to the big banks.

Following World War II, GI's returned home and went to school, and it was financed through the GI Bill. That one thing created more wealth than any other single thing in our nation's history. In theory and to a significant extent in practice, any GI could, if they worked hard enough, get a bachelor's degree from one of the best universities in the country (and, therefore, in the world), almost free of charge. The pronounced social and economic mobility of the postwar period would have been unthinkable without institutions of mass higher education, provided at public expense. The result was a highly educated population, relative to the pre-war years, that went on to productive work. And that in turn led to the greatest expansion of the middle class that we've ever seen.

Once upon a time, states competed to expand their public university systems - and many were free, or close to it. The stellar University of California system was tuition free (though there were fees) until the late 60's; so was the City University of New York system for a long time, and Arizona universities, and plenty of other states. Now, California is one of at least 10 states that now spends more on prison than higher education. I haven't seen any studies that make a direct link, but I'm pretty sure the two are connected.

A federal judge has approved HSBC's $1.9 billion settlement for money laundering. While noting "heavy public criticism" of the settlement, which enabled HSBC to escape criminal prosecution, US District Judge John Gleeson, New York, called the decision to approve the accord "easy, for it accomplishes a great deal."

The settlement was announced last December, but it required approval. The settlement includes $1.25 billion in forfeitures and $665 million in civil fines. The settlement is part of a deferred prosecution agreement, or DPA, that runs for 5 years. That means that the bank has to avoid doing the bad things they did, or they could be indicted. I've never heard of a major bank operating under a DPA that actually has been indicted for violating the DPA, but that's the theory.

And what are the bad things HSBC is accused of doing? Well for years they laundered money on behalf of Colombian and Mexican drug cartels. They laundered money for customers in Burma, Cuba, Sudan, Libya, and Iran, which were all subject to US sanctions. They dealt with drug dealers, murderers, terrorists, and other unsavory types and they made sure the bad guys had money to do bad things. But don't worry, it's not criminal; it's just a civil case.

Judge Gleeson said he had received requests from the public to reject the agreement because it did not hold HSBC criminally liable. He also read numerous editorials and columns suggesting, as one put it, that HSBC was "too big to indict." Gleeson, nonetheless, said "significant deference" was owed to the Obama administration in deciding not to press an indictment. Gleeson said "much of what might have been accomplished by a criminal conviction has been agreed to in the DPA," whose administration he will supervise.

This is not true. The settlement does not accomplish much. What the judge has done is to shred the justice system once again; it seems to be common practice these days. Judgments such as this just create a two-tiered justice system. And we accept it out of ambivalence and fear. One set of laws for the rich and powerful, another set of laws for everyone else. Maybe we should require that judge to recite the Pledge of Allegiance every morning to start the court day. Maybe he could read that segment about “justice for all”; not just punishment for the poor folk; not just an agreement to tie executive bonuses to meeting compliance standards; not just coddling the bag men for murderers and drug dealers and terrorists; not just a slap on the wrist if you hold a wad of money in your hand. Justice for all. What a joke.

Which brings us to our next segment: “Where in the world is Edward Snowden?” We now know he was not on Evo Morales' presidential jet. The president of Bolivia had flown to Russia to meet with Russian President Vlad Putin. President Morales then tried to fly back to Bolivia. Someone, somewhere suspected that he was trying to sneak out with Snowden on board. Portugal, Spain, France, and Italy refused to allow the presidential jet to fly over their airspace. The plane circled around for a few hours and eventually landed in Austria. The plane was searched and they did not find Snowden.

Now, normally a presidential jet, like Air Force One, is considered to be something like an embassy; there is an issue of national sovereignty. So, there is more than a little outrage over a pretty serious diplomatic transgression. Bolivia's ambassador to the United Nations said "the orders came from the United States." From a diplomacy standpoint, one does not normally interfere with diplomats and high-ranking public officials in transit. It is extraordinary to prohibit passage through one's state air space en route to another state. Almost all the nations in South America have condemned the intervention.

So, we spend billions of dollars on high tech intelligence and spy stuff and we still can't figure out whether Snowden is in the Moscow airport or on the Bolivian presidential jet or who-knows-where.

What we have learned about Snowden is that he doesn't have $1.9 billion to pay a civil fine.

Thursday, May 09, 2013 - First We Start With A Military Bank

First We Start With A Military Bank

by Sinclair Noe

DOW – 22 = 15,082
SPX – 6 = 1626
NAS – 4 = 3409
10 YR YLD + .05 = 1.81%
OIL - .71 = 95.91

Initial claims for state unemployment benefits fell 4,000 to a seasonally adjusted 323,000, the lowest level since January 2008; that's January 2008, not December 2008. The weekly report from the Department of Labor shows layoffs remained contained even as other parts of the economy such as manufacturing show strain from budget cuts in Washington. The improvement in employment contrasts sharply with other data, including retail sales and manufacturing, that have suggested a cooling in the economy at the end of the first quarter. Two possible explanations come to mind; either companies think any economic slowdown is temporary, and so they are not cutting, or companies have already done so much cutting that there just aren't any more easy cuts. If it proves to be the latter, then it would be a challenge to maintain profit margins without finding additional demand.

Meanwhile, productivity gains are flagging, which could be a sign of economic weakness. Bloomberg reports employee output per hour grew at an average 0.7 percent annual rate over the past 12 quarters, which is a pace so slow it’s rarely seen outside of recessions. Gains since the recovery began in June 2009 have averaged 1.5 percent, the weakest of the nine postwar expansions that lasted as long. The two sources of growth are population growth - more people requiring more - and productivity gains – the same number of people producing more in the same amount of time. There are two ways to increase productivity; work harder or work smarter; working smarter usually means an investment in technology.

The pace at which an economy can grow without stoking inflation reflects the rate of growth of the labor force plus how much each worker can produce; it's sometimes called the speed limit for the economy. Smaller gains in productivity therefore mean advances in gross domestic product will also be restrained. Coincident with a sluggish economy, there has been a slump in business investment in equipment and software.

Companies have been slow to boost spending on more sophisticated machinery and time-saving devices such as faster computers -- a driver of the late 1990s boom in productivity. Without bigger gains in efficiency, it will be difficult for economic growth to gain momentum, and worker pay may suffer even as businesses are spurred to boost hiring in the short term.

The idea that technology has been the driver of productivity gains made sense in the 1990s, but over the past five years there is considerable evidence that productivity gains have come from squeezing workers; making workers do more for the same pay or for less pay. This means working with old or outdated equipment and also working harder. Many people who are still employed are doing the work of 2 jobs ten years ago.

There are, of course, limits to how much a company can cut without degrading their product or service to the point where they start losing sales or create a dangerous workplace. If you've noticed poor customer service, this is one possible explanation.

It's interesting that the Murdoch Street Journal just ran an article quoting a VP at McDonald's, the fast food giant, saying that “service is broken.” The number one complaint: “rude or unprofessional employees.”

For McDonald’s, a company that spends an estimated $2 billion annually on advertising to attract customers, having counter personnel who alienate them in the final moments of a transaction is a disaster. Fixing customer service will require more than admonishing hundreds of thousands of employees to smile.

That article has spawned other articles offering ideas on how McDonald's can improve the customer experience. Suggestions include: creating a shared emotion around delivering a great customer experience, invest more in training employees, simplify work processes, encourage employees to share stories of customer satisfaction, and give employees a reason to smile. I have a suggestion for McDonald's: hire more workers and pay them better.

Speaking of more jobs at McDonald's, today or sometime very soon, is graduation day at many universities. And that means that there will be thousands of graduating students hitting the pavement in search of jobs, and that means that in a few short months they will become delinquent on their student loans. It's a big problem.

The New York Fed provided analysis from 2012: ... as many as 47 percent of student loan borrowers appear to be in deferral or forbearance periods, and thus did not have to make payments as of third-quarter 2011. Specifically, 17.6 percent of borrowers had exactly the same balance in the third quarter as in the second quarter of this year, and 29.1 percent increased their overall student loan balance by taking on new originations or accruing interest to the balance. We then recalculate the proportion of borrowers with a past due balance excluding this group of borrowers. We find that 27 percent of the borrowers have past due balances, while the adjusted proportion of outstanding student loan balances that is delinquent is 21 percent.

A few years ago, I wrote a book entitled “Eat the Bankers” and one of my ideas was to create a Military Bank. Any person who is good enough to stand in harm's way and possibly shed blood for their country is good enough to be given a good deal. All active military would be entitled to the best possible terms on legitimate credit that our country has to offer. The Federal Reserve has been lending money to banks at 0.25% to zero percent, therefore the Military Bank could offer credit to active military personnel at a rate not to exceed 0.25%. If it's good enough for the bankers, it's good enough for America's greatest heroes that defend our freedom.

There would have to be some common sense limits; a Private First Class earns a little over $20,000 a year and would not be eligible to borrow a billion dollars from the Military Bank. All lending would be based on legitimate need and legitimate ability to repay. But if the Private First Class needed a loan to buy a car or housing or to pay for education or training – they should get the same rate as the bankers.

I thought that it was a good idea, and it could even be expanded to veterans, and then expanded to first responders, law enforcement, and other people who are certainly as deserving or more deserving than bankers. I thought it was a good idea, and the general concept seems to be gaining some favor.

Elizabeth Warren introduced her first standalone piece of legislation yesterday, calling for the government to give student borrowers the same deal it gives big banks when they need a loan. The measure would allow students who are eligible for federally subsidized Stafford loans to borrow at the same rate that banks get from the Federal Reserve when they need a short-term infusion of cash from the central bank’s discount window.

Speaking on the floor of the Senate, Warren said: "If the Federal Reserve can float trillions of dollars to large financial institutions at low interest rates to grow the economy, surely they can float the Department of Education the money to fund our students, keep us competitive, and grow our middle class."

The proposal drew some blowback from the banking industry. Patrick Sims, a director in policy research at Hamilton Place Strategies, argued a short-term loan from the discount window during a time of crisis is not at all comparable to a long-term student loan.

Sims said that while some people have called for higher rates or penalty rates for banks that access the discount window, the point of the funding is to prevent a liquidity crisis and is not how banks fund themselves over time.

"Using something completely unrelated and feeding into populist animosity toward large banks to increase the sympathy for the student loan body or students in general, it just kind of sounds like a weird way to legislate," Sims said. "I don’t know if it necessarily helps our student loan situation in the United States today."

Under Warren’s proposal, the Fed would make funds available to the Education Department for one year to make loans to students at the same rate offered to large banks. Warren says the bill would give students relief from high interest rates while giving Congress time to find a long-term solution to the increasing costs of Stafford loans.

Warren noted that large banks can currently borrow from the Fed’s discount window at a rate of about 0.75 percent, but if the rate for new Stafford loans increases — as it is set to do on July 1 — a student borrower seeking a loan this summer will pay almost 7 percent.

"In other words, the federal government is going to charge students interest rates that are nine times higher than the rates for the biggest banks — the same banks that destroyed millions of jobs and nearly broke this economy," she said. "That isn’t right."

Student loan debt had topped $1 trillion, and it has warned about the ripple effects on the economy if those borrowers are unable to buy a home or save for retirement. Warren also noted the "serious risk to the recovery" that student debt poses, and said students are just as important to economic growth as big banks. Warren dismissed the idea that the bill would be too expensive. The federal government earns 36 cents in profit on every dollar it lends to students, she said, which will bring in a total of $34 billion next year.

Warren said: "We shouldn’t be profiting from our students who are drowning in debt while we’re giving great deals to big banks."

I think it's a good idea. Either that or the students go get a job at McDonald's; just don't complain about the service.

Tuesday, February 26, 2013 - Send in the Clowns

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

Send in the Clowns

by Sinclair Noe

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

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

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

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

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

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

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

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

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

Here is a link to video of Warren questioning Bernanke.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Thursday, February 21, 2013 - the Big Coincidence

Note: I will be a speaker at the upcoming 2013 Wealth Protection Conference in Tempe, AZ on April 4^th and 5^th. Click here for details and registration information. Hope to see you there.

The Big Coincidence

by Sinclair Noe

DOW – 46 = 13,880
SPX – 9 = 1502
NAS - 32 = 3131

10 YR YLD + .04 = 1.98%
OIL – 2.23 = 92.99
GOLD + 12.10 = 1577.40
SILV + .12 = 28.78

We had a bundle of economic reports to start the day. Let's run through them. First, the CPI report, which measures inflation at the retail level, shows prices were unchanged in January for the second month. Consumer prices are up just 1.6% in the past 12 months. One striking subset of the CPI report showed energy prices dropping 1.7% in January on a seasonally adjusted basis. Of course we all know that gas prices were climbing almost every day through the month; most likely, we'll see a significant bump in the February report.

A couple of manufacturing reports showed weakness. The Philly Fed's  gauge of regional manufacturing activity fell to negative 12.5 in February from negative 5.8 in January with declines in overall activity and new orders. And Markit, a financial information services company, said its gauge of manufacturing activity dropped to 55.2 in February from 55.8. Any reading above 50 indicates expansion but the purchasing managers index showed a slower expansion, with weaker new orders and employment.

Initial jobless claims rose 20,000 to a seasonally adjusted 362,000 in the week ended Feb.16^th. The number was a smidge worse than expectations.

The Conference Board's Leading Economic Index, or LEI, rose 0.2% in January. The LEI is a forward looking weighted gauge of 10 indicators designed to signal business cycle peaks and troughs. Positive contributions came from stock prices, a leading credit index, jobless claims, building permits, and manufacturers’ new orders for consumer goods and materials. Negative contribution came from consumers’ expectations, manufacturing hours, a manufacturers’ new orders index and manufacturers’ new orders for core capital goods.

Overall, the leading indicators, and for that matter, the other economic reports, point to a relatively sound but sluggish economy.

For now, the Federal Reserve is running the economy. There are limits to their monetary policy powers, but absent any signs of intelligent life forms in Washington DC, the Fed is in charge. Yesterday, we had a glimpse into the Fed policymakers' brains. The markets were a bit rattled to learn that the masters of the economic universe were nervous about QE to infinity and beyond. QE is the Fed's experiment in buying $85 billion a month in Treasury bonds and mortgage backed securities, and flooding Wall Street with cash, in the unrealistic hope that the Wall Street crowd might spread some of the cash through the broader economy. . At the Fed's January policy meeting, some policymakers started to grouse that all those bonds were piling up on the balance sheet and the vaults were getting full, and they would have to stop buying at some point.

Wall Street's response was something like a junkie going cold turkey; shaking, trembling, and wide-eyed paranoia that the Fed would take away their free-money-fix. Of course, that's not what the Fed said; a few of them just posited the idea that maybe, someday, there might come a time when the Fed is no longer involved in the undeclared nationalization of the bond market. Then they looked around and recognized that unemployment is still high, inflation is still tame, growth is still sluggish, and the Congress likes to take razor blades and self-inflict wounds just to test their ability to feel anything.

The next self-inflicted cutting takes place March 1^st. They call it the sequester. The sequester was a result of the wrangling over the debt ceiling in the summer of 2011, when Republican leaders — who had previously passed clean debt increases 19 times under President Bush — demanded spending cuts as the price for averting a default. On the brink of default, Congress passed the Budget Control Act, which enacted immediate spending cuts and created a supercommittee tasked with striking a “grand bargain” to reduce the deficit. The Budget Control Act (BCA) of 2011, passed the House with 269 “yea” votes – 174 Republicans and 95 Democrats. In the 100-seat Senate, Democrats made up most of the 74 "yea" votes, but there were 28 Republicans in that majority, as well. Quite simply, this was both parties. Republicans walked away from the committee after refusing to consider tax increases on the wealthy, setting sequestration into motion. The sequester, which cuts from both domestic and defense spending, was designed to be painful enough that both sides would negotiate to avert it.

Congress is currently on recess until next Monday, leaving just five legislative days until the automatic cuts, known as sequestration, will take effect. The fact that Congress didn't get anything done in 1 ½ years might make you think they won't get anything done in five days. Ever since Senate Democrats unveiled their plan to avert the sequester with a mix of new revenues and spending cuts, there has been no negotiations between the Democratic and Republican leadership offices in the Senate. No discussions about any potential compromises. 

So, here's what happens if or when the sequester kicks in. Because its cuts are across-the-board, the sequester will affect most domestic programs. Jobless workers will lose access to unemployment benefits, while safety net programs for women and children and early childhood education programs will face deep cuts. The sequester will cut funding for law enforcement and border security, food safety, airline travel security, Head Start, disaster relief, and health research. Defense programs will also see reductions. These cuts will have broad ramifications for the country’s recovering economy, pushing it down the austere path Europe has followed into second recessions. Independent reports predict that sequestration would reduce economic growth by 0.6 percent over the year while also leading to the loss of 700,000 jobs. The debt limit fight that created the sequester already pummeled the recovery, and allowing these spending cuts to take effect would cause even bigger problems.

Democrats believe the real action on the sequester has yet to come, and will ramp up in earnest in March. Which means, of course, that the cuts will kick in. Democrats no longer see the sequester as sufficient to force Republicans to cave on new revenues; rather, they increasingly see the looming government shutdown deadline of March 27th as the real means for them to force a GOP surrender.

The idea is that the sequester isn’t as dramatic a deadline as the fiscal cliff and debt ceiling deadlines were. The sequester doesn’t have that immediate shock value. It’s not the kind of thing where people wake up on March 1st and realize it happened. It doesn’t have the sort of acute impact that the fiscal cliff or debt ceiling.

But a government shutdown will get your attention. So the month of March is when negotiations heat up, and right now it appears to be advantage Dems, because there is no other formulation of the sequester that is more appealing than the current formulation. The hit in defense spending is not worse than the hits from agreeing to non-defense discretionary cuts. The House Republican plan would not include any new taxes but it would gut Dodd-Frank Financial reform, and take away funding for Obamacare, and pretty much wipe out the first four years of the Obama administration. So, at the end of the day, the Dems like sequester better than the House Republican alternative, which offers no quarter, and so the Dems will stick to their demands for more revenue. Or maybe both sides will just sit back and see if the other side slices the razor blade too deep and bleeds to death.

And that brings us back to the masters of the economy, the Federal Reserve; they're watching the politicians make a royal mess of fiscal policy and they're thinking about how they will be forced to clean up the mess; especially when they've got a bit of a mess themselves. The cash spigot is flowing and gushing money over Wall Street banks while the Fed's own balance sheet is backed up. And the differential is getting a tad inconvenient.

Bloomberg ran an article yesterday which basically says the Fed is paying the big banks to be big and unwieldy. The larger they are, the more disastrous their failure would be and the more certain they can be of a government bailout in an emergency. The result is an implicit subsidy: The banks that are potentially the most dangerous can borrow at lower rates, because creditors perceive them as too big to fail. How much lower are the big banks borrowing costs?

A couple of economists put the number at about 0.8 percentage point. The discount applies to all their liabilities, including bonds and customer deposits. Small as it might sound, 0.8 percentage point makes a big difference. Multiplied by the total liabilities of the 10 largest U.S. banks by assets, it amounts to a taxpayer subsidy of $83 billion a year. To put the figure in perspective, it’s tantamount to the government giving the banks about 3 cents of every tax dollar collected. It's also the same amount the Fed is spending on QE 3; it's also the same amount of cuts required by the sequester. But I'm sure that's all mere coincidence.

Another way of looking at it; the top five US banks, with assets of $9 trillion, more than half the size of the US economy, aren't really making any money; the profits they report are essentially transfers from taxpayers to their shareholders.  The result is a bloated financial sector and recurring credit gluts. Left unchecked, the superbanks could ultimately require bailouts that exceed the government’s resources. Picture a meltdown in which the Treasury is helpless to step in as it did in 2008 and 2009.

Regulators can change the game by paring down the subsidy. One option is to make banks fund their activities with more equity from shareholders, a measure that would make them less likely to need bailouts. Another idea is to shock creditors out of complacency by making some of them take losses when banks run into trouble. A third is to prevent banks from using the subsidy to finance speculative trading, the aim of the Volcker rule in the US and financial ring-fencing in the UK. Another idea is to take the banks off Federal Reserve induced life support and instead use the money to pay down the deficit without draconian, meat-cleaver cuts to spending and without significant tax increases; and use the savings to grow the economy for everybody, except, of course, the five big banks.

I saw the video of Elizabeth Warren grilling regulators but this article from Time tells the rest of the story:

It's hard to find a serious critic of big banks in Washington. Senator Dick Durbin explained a few years ago that the big banks “own the place.” But there is a new kid in town. Massachusetts Senator Elizabeth Warren was sworn in in January and given a seat on the Senate Banking Committee. Warren is extremely well versed in finance. And last week, the committee held its first hearing of the new year to question regulators about the stability of the nation’s financial system, and to get a progress report on the implementation of post-crisis financial reform.

Warren stole the show, pointedly asking each member of the panel when the last time they had taken a large Wall Street bank to trial, where their misdeeds would be aired publicly. The regulators seemed completely stymied by the thought of actually going to trial and they couldn't give the senator a straight answer. You can see the video online; it's quite enlightening. The implication was, of course, that regulators are either unwilling or unable to take big banks to trial, that they rely too much on mutually agreed upon settlements as penalties for misbehavior, a slap on the wrist, and that this reluctance has created a dangerous culture of impunity on Wall Street.

But Warren’s second point is equally interesting, and perhaps more important to understanding what remains broken about the American banking system. She indicated that the majority of the nation’s big banks are “trading below book value.” The book value of a company is simply the total value of all the company’s listed assets minus its liabilities — in theory, that is, what shareholders would get by selling their company off for parts.

But most companies are worth more than book value. That’s because most firms are more than just a sum of their parts — they possess institutional knowledge, for example, that enables them to turn their employees, equipment, and intellectual property into profits. But lately, the stock market is actually valuing large banks like Citigroup, Bank of America, and JPMorgan, below the value of the company’s stated assets minus liabilities. 

Let’s take the example of Citigroup, which has a market capitalization of $135 billion. In other words, if you had $135 billion, you could buy up all the outstanding shares of Citigroup. But here’s the rub: If you actually add up the stated value of Citigroup’s assets minus liabilities, the bank should be worth at least $190 billion. Theoretically, you could buy up Citi, chop it up, and sell it for parts, and make a tidy $55 billion in profit.

Of course, in a competitive market, this shouldn’t be. Something is amiss, and Senator Warren thinks there can only be two reasons: 1) Banks aren’t being honest about the value of their assets; or 2) The market believes that large banks are too big to manage effectively. In his response, Federal Reserve Board Governor Daniel Tarullo added that regulatory uncertainty may play a role in pushing down the values of bank stocks. But are these the correct explanations?

It would appear that a lack of trust in bank accounting is one culprit for the discrepancy. In a recent cover story for The Atlantic magazine, Frank Partnoy and Jesse Eisenger examined Wells Fargo’s annual report. They found that the vast majority of the assets on Wells Fargo’s books are securities like derivatives and mortgage-backed securities which aren’t traded often or on public markets. These securities are difficult to value, and therefore banks must use estimates when putting together their financial reports. But Partnoy and Eisenger claim the complexity and incentives to hide risk, causes big-bank financial statements to be effectively useless.

Barry Rithotz, CEO and director of equity research at Fusion IQ, commenting upon the article summed up investor’s skepticism in the banking sector succinctly:

Banks are essentially opaque black boxes; banks have purposefully concealed what’s on their balance sheets . . . they are not merely complex, but actually deceptive; investors have no idea what they are buying when they own one of the behemoth money centers like Citigroup, Bank of America, Wells Fargo, or JP Morgan.

So it would seem Senator Warren is on to something when she accuses large banks of being dishonest about the value of their investments. Warren isn’t accusing large financial institutions of outright fraud. These institutions are following the letter of law, and complying with accounting rules from the Financial Accounting Standards Board. But accounting isn’t an exact science, and given enough resources, firms can avoid conforming to the spirit of these rules while still technically being in compliance.

You don’t need to take Warren’s word for it. Just take a look at the bank’s stock prices and decide for yourself. Bank representatives may argue that the $55 billion discrepancy between Citigroup’s market capitalization and book value are due completely to the fear that regulators will increase capital requirements, but does this explanation really pass the smell test?

Regulatory uncertainty may be a factor, but ultimately investors don’t understand what these banks have on their books — and don’t want to be holding the bag when we eventually find out. Remember when we almost had a global financial meltdown in 2008; financial institutions froze, in part because they didn't know the counterparty risk, what the other bankers had on their books. They still don't know, and you don't know, and the regulators don't know.

In a scenario like that, what could go right?