Friday, October 19. 2012 - Sometimes I Forget What I'm Supposed To Remember

Sometimes I Forget What I'm Supposed To Remember

by Sinclair Noe

DOW – 205 = 13,343
SPX – 24 = 1433
NAS – 67 = 3005
10 YR YLD -.06 = 1.77%

OIL – 1.96 = 90.14
GOLD – 21.10 = 1721.50
SILV - .75 = 32.17
PLAT – 29.00 = 1625.00

Today is the 25^th anniversary of Black Monday, and the markets paid homage with a 205 point drop, nothing close to the 508 point drop in 1987. On a percentage basis, 1987 was 16 times worse than today. The Crash of 1987 would be about a 3,100 point drop in today's markets. That would get your attention. Still, the more things change the more they stay the same.

Back in 1987, the Crash was blamed, at least in part, on program trading, based on portfolio insurance and a process called dynamic hedging. I remember computers back then that weren't fast enough to play Pong, much less cause a crash. Maybe the Wall Street crowd had really fast floppies. Today we have high frequency trading or HFT, and they can whip out trades in milliseconds; and if you're looking for a market crash in the future, don't be surprised if it comes from HFT. The whole idea of HFT is legalized theft and it doesn't add to market liquidity, stability or efficiency. They are not market-makers. They are market-manipulators. They have no obligation to make a market in any stock. The never have to post a market or ever honor the bids and offers they post. In fact, their game is to post fake bids and offers that they have no intention of honoring.

High-frequency traders send out tens of millions, if not billions, of orders to exchanges that are never meant to be executed. They are fake orders designed to manipulate prices on the nation's exchanges. And while other market participants are not actually forced to adjust their bids and offers or engage in any of these trades, allowing access to the exchanges to manipulate anybody in any way is something that ought to be outlawed. The main advantage of HFT is that the traders are fast and they are so fast they can jump in front of your trade and skim off a tiny fraction

The SEC allows exchanges to serve high frequency traders by leasing them co-location space next to the exchange's servers. It's kind of like allowing pickpockets to come into the bank and stand at the tellers' window and steal from the customers, as long as they only steal pocket change and not folding money. The problem is that all that pocket change adds up the real money. HFT activity is responsible for at least half of the daily 6.8 billion shares traded across America's exchanges, and may be as much as 80% by some measures. And when HFT accounts for more than 50% of trades it means the high frequency traders are playing with themselves. This means liquidity is an illusion.

Remember the Flash Crash of 2010? The Dow dropped 1,000 points in 10 minutes. Remember the Knight Capital fiasco a few months back? Remember Kraft Foods a few weeks ago? A computer algorithm has a minor glitch and in the blink of an eye tens of millions of dollars is wiped out; trillions could vanish in the time it takes to stir your coffee. So, do you trust the stock market?

The problem today was largely blamed on earnings. Of the 116 S&P 500 companies that have reported results so far, 58 percent have missed on revenue expectations. Note, we're not talking about bottom line profits, we're talking top line revenue; and in some ways that is far more frightening. Today it was GE, McDonald's and Microsoft. Yesterday it was Google, with premature earnings. Google is groping for ways to grow revenue. That puts Google in the same position as Microsoft, trying to find a way to extend its reach.

Google and Microsoft together have over $100 billion of cash on their balance sheets. Judging by the earnings misses that both turned in last night, Google and Microsoft are both willing to take a step back on earnings to invest in the "next big thing." The question for investors is whether or not either or both companies can find that elusive second act. The problem is not the prowess and expertise of these two high tech giants. They continue to create and refine. The problem is demand. We've seen it before.

Remember back in the 80's when Japan was known for its electronic prowess? In 1990 Japanese products represented nearly 30% of the world's total export value. Now that figure is closer to 14%. Remember back in the 80's when the Japanese started an aggressive expansion, buying up all things American. Now, they're on the hunt for growth anywhere they can find it and in any sector that grows. For example: Talkeda Pharmaceuticals has been on a $15 billion buying binge, scooping up Swiss, Brazilian, and a couple of US companies. Daikin Industries just spent nearly $4billion to buy the US airconditioning manufacturer, Goodman. In the financial services sector, Mitsubishi UFJ Lease and Finance is purchasing Jackson Square Aviation for $1.3 billion.  Tokio Marine & Nichido Fire Insurance bought Delphi Financial Group last year for $2.7 billion. And earlier this week, Softbank said it would purchase a 70% stake in Sprint Nextel for $20 billion. That's the biggest M&A deal of the year.

Japanese companies have more than $2 trillion in cash on their balance sheets and some very powerful motivation. The Japanese economy is lousy; the demographics are old; private, corporate, and government debt is 500% of Japanese GDP; and Japanese companies just can't seem to drum up business in Japan.

Of course, back in 1987, the economy recovered pretty quick after the Crash. I don't think that would happen today. The main reason is that the financial sector has changed. Back then we had traditional banks and there were investment banks; and there was a brick wall between them. Back then we had Glass-Steagall. We should resurrect it. It was good policy.

Five years ago Wall Street’s excesses almost ruined the economy. Bankers, hedge-fund managers, and private-equity traders speculated on the upside, then shorted on the downside — in a vast zero-sum game that resulted in the largest transfer of wealth from average Americans to financial elites ever witnessed in this nation’s history.

Average Americans lost big; including over $7 trillion of home values, a $700-billion-dollar bailout of Wall Street, and continuing high unemployment. The top one-percent, the financial elites made out fine. The rich get richer and the poor get poorer; maybe some things never change. The stock market has about caught up to where it was before the crash of 2008; this time it was a far different rebound than the rebound following the Crash of 87. The pay and bonuses on the Street are once again sky-high. So are the pay and perks of top corporate executives. This country has had a hard row to hoe, but some folks have made out like bandits. The problem is that there just aren't enough of them to increase demand. That should be one of the lessons we learned from the Japanese.

In the 1980s the ten biggest banks had less than 30 percent of bank depositary assets. Now they have 54 percent. And the four biggest now dominate the Street almost completely. Because lenders and investors know they’re too big to fail, the four biggest banks have a competitive advantage over smaller rivals that pose larger financial risks. That means they’ll only get bigger.

Breaking up the biggest banks and capping the size of all banks is hardly a radical suggestion these days. There's a long list who think we should. We need to restore trust to Wall Street, and that means we should outlaw the High Frequency Trading bandits; that's one of the lessons we should have learned back in 1987. We need to break up the biggest banks and resurrect Glass-Steagall. That's one of the lesson we actually learned back in 1929. And then we forgot it. "Those who cannot remember the past are condemned to repeat it.”

Wednesday, August 15, 2012 - I've Never Been to Spain and I've Never Seen a Flash Flamenco

I've Never Been to Spain and I've Never Seen a Flash Flamenco
- by Sinclair Noe

DOW – 7 = 13,164
SPX  + 1 = 1405
NAS + 13 = 3030
10 YR YLD +.08 = 1.80%
OIL -.07 = 94.26
GOLD + 4.10 = 1604.10
SILV un = 27.93
PLAT un = 1400.00

JPMorgan Chase, Barclays, UBS,  Deutsche Bank, Royal Bank of Scotland, HSBC Holdings, and Lloyd's are the seven banks subpoenaed in the past week in New York and Connecticut’s investigation into alleged manipulation of Libor. Citigroup and UBS received subpoenas earlier this year as part of the investigation. New York Attorney General Eric Schneiderman and Connecticut Attorney General George Jepsen are jointly investigating alleged manipulation of the London interbank offered rate, or Libor. 

Meanwhile, HSBC has handed over details of current and former employees to the US authorities as part of a tax probe that almost sank rival bank UBS in 2009. As a result, the bank may be sued by the former employees claiming banks infringed the criminal code and Swiss privacy laws. HSBC claims it has avoided breaching strict Swiss banking secrecy laws by redacting from the documents any information that could lead to the identification of clients.

Yesterday, I told you that Standard Chartered had reached a settlement with New York State regulators. There will be no criminal prosecutions as a result of the settlement, mainly because the New York state regulator doesn't have prosecutorial powers. You may also recall that when this story broke last week, one of the first things Standard Chartered did was to hire PR firms that tried to say most of the Iranian transactions were before the sanctions, and it wasn't really $250 billion in money laundering, it was at the most maybe a paltry $14 million. 

Part of the settlement with the New York State Department of Financial Services is that both parties agree the conduct involved transactions of at least $250 billion. Not that it matters. SCB still gets off with a slap on the wrist, just a $340 million dollar fine, not even one percent of the business done. And you will note the language did not say, “the conduct at issue involved FRAUDULENT transactions of at least $250 billion.” Still, they face investigations from the federal regulators, the Treasury, the Federal Reserve, and the Department of Justice; all are notorious for cutting sweetheart deals with the banksters. Whatever deal they reach will now be based on $250 billion not $14 million. 

Meanwhile, Reuters reports the estates of the victims of the 1983 bombing of the US Marine barracks in Beirut sued Standard Chartered seeking compensation over the bank's concealment of Iran-linked transactions. The civil lawsuit, filed in US district court in Manhattan, said the bombing victims obtained a $2.6 billion judgment in compensatory damages against Iran in 2007. The court document said the plaintiffs include representatives of the estates of the 241 US servicemen killed in the attack in the Lebanese capital, relatives and heirs and bombing survivors. The  lawsuit on behalf of the bombing victims claims "those unlawful actions are part and parcel of Iran's longstanding, determined efforts to evade collection of the judgment, and other judgments."

Treasury prices fell, sending 10-year yields toward the highest in almost three months. Ten-year yields have climbed from the record low of 1.38 percent on July 25. We've been getting some fairly positive economic reports and that weighs on bonds. We've seen a slightly better than expected July jobs report; it wasn't great but it was better than expected. The July retail sales report was pretty solid. Today, a report showed that industrial production in the US increased more than forecast in July; manufacturers are turning out more cars and computers. 

On the flip side, we've seen inflation is flat. The BLS reported that the seasonally adjusted Consumer Price Index, a measure of inflation at the retail level, was virtually flat at 0.0%  in July, or just 0.6% annualized rate. The CPI less food and energy increased 0.1% (1.1% annualized rate) on a seasonally adjusted basis. There is a different calculation, the CPI-W, used for figuring the cost of living adjustment for Social Security and other programs – not a big jump but positive. 

The Fed is focused on the future, because monetary policy influences the economy only gradually, so what officials really care about is what the data will show in the coming months. Their most recent guesses, published in June, pegged core inflation between 1.2 and 1.7 percent this year, which is well below their target. All in all, inflation is below target for the Federal Reserve calculations, which means they have some room to be a little looser with monetary policy, but the slightly positive economic reports mean that another round of QE is not in the immediate future. You may recall that in 2010, Fed Head Bernanke gave a speech at the Jackson Hole Economic Symposium and signaled a second round of quantitative easing or QE2. There is another Jackson hole Symposium on August 31st, but don't expect QE3. This  doesn't mean the Fed is not loose with money – they are; just that they likely won't be announcing QE3. 

Last week, for a brief time, the machines took over the stock markets; tens of thousands of trades took place of some of the major stocks; trades done by what they are now calling rogue algorithms. This created instability in prices; trading was halted, but not before Knight Capital lost about $400 million on rogue trades. This instability is troubling for anyone trading or investing in stocks.

Knight Capital's business is these quick in and out trades. They've established computer rooms in close proximity to the exchanges, and they get a split second advantage, just enough for the computers to jump in front of a trade, and manipulate the bids and offers in such a way as to scalp a tiny amount from thousands or even millions of trades. The federal commodities trading commission reports that something like 500 to 600 people at Goldman Sachs are employed doing nothing but working on these kinds of quick in-and-out algorithm tradings, although I don't think Goldman's algorithm is to blame for this particular incident. But it's a very widespread thing that's happening, and last week it went out of control.  So, now there is talk about the need for regulation; there has been talk about regulating these kinds of flash trades for a few years. There was supposed to be something in Dodd-Frank. Nothing has been regulated. 

One possible solution is a financial transaction tax, just a small tax on each share traded, the tax might even increase as volume increases. That would probably eliminate the flash traders, who are really nothing but middle men, skimming from each trade while adding nothing of value. Rightfully, isn't that the role of government? New York state actually has stock transaction tax and it's been on the books for more than 100 years, and it rebates the tax to the Wall Street traders for some inexplicable reason. The tax doesn't cover flash trades. 

Don't confuse flash trades with flash mobs; that is apparently the latest thing in Spain. The Spanish government gave in to demands to bailout the Spanish banks and imposed harsh austerity measures on the Spanish people. So the people are having flash mobs in grocery stores and then they steal food and give it to the poor. Other flash mobs dance the flamenco in bank lobbies and they sing songs about how they dislike the bankers. I've never been to Spain but I would like to go. 

According to regulatory filings late yesterday, some well-known money managers reported significantly reduced stakes in big banks, including JP Morgan Chase and Goldman Sachs, as well as food companies such as Kraft Foods Inc. in the second quarter. Billionaire investor George Soros’s Soros Fund eliminated positions in JPMorgan Chase, Goldman, and Citigroup. The investment company also reported a new stake in Wal-Mart and a big stake in Facebook. 

Warren Buffet's Berkshire Hathaway reduced positions in Procter&Gamble, Johnson and Johnson, Intel, and Visa.  Berkshire increased its existing positions in Wells Fargo and IBM. Buffet bought National Oilwell Varco, an oilfield equipment company, and Phillips 66. 

And John Paulson, the guy who made a fortune bundling subprime junk through Goldman Sachs and then betting against it; Paulson was selling stock in the second quarter and buying GLD, the exchange-traded fund that tracks the price of gold.  Paulson's $21 billion hedge fund now has more than 44 percent of its US traded equities tied to bullion.

Monday, August 6, 2012 - Front Running and Money Laudering - All in a Day's Work

Front Running and Money Laundering - All in a Day's Work

- by Sinclair Noe

DOW + 21 = 13,117
SPX + 3 = 1394
NAS + 22 = 2989
10 YR YLD -.02 = 1.55%
OIL -.10 = 93.86
GOLD + 8.00 = 1612.60
SILV +.08 = 27.98
PLAT – 5.00 = 1407.00

A couple of weeks ago I said we had entered the Dog Days of Summer; technically that was correct, however the Economic Dog Days officially start this week; there is almost nothing on the calendar, trading volume has dried up; today was the lightest volume of the year, excluding holidays. Knight Capital was trading again but not with the same vigor of last week. Knight managed to find a consortium of investors to pony up $400 million to allow the company to continue to scalp trades. High-frequency trading algorithms have flourished in the past few years, as under-regulation made way for non-regulation.  The mega banksters and their attendant trading firms figured out a way to  make huge trading profits virtually every day, off of their customers, by front-running, which means  they inserted themselves as middle-men into every trade.

The high frequency traders set up computer rooms right next to the exchanges to assure they get super fast trade information, just a few milliseconds is enough. The high frequency trade algorithms submit bids-to-buy and offers-to-sell hundreds of times per second, and the computer programs determine exactly what price sellers and buyers are willing to accept. The bids and offers would be near-immediately canceled, because the investment banks had no interest in actually following through with them — for all intents and purposes, these were fake bids and offers, or a type of quote-stuffing.  The brokerage firms would then run-in-front of the buyers, hence “front-running”, to buy the stock first, then immediately turn around and sell it to the other buyers for just a bit more.

So, for example, if your pension fund tried to buy a million shares of company XYZ, they put in a bid, the HFT companies like Knight Capital get that info a few hundreds of a second before the public; their computers come up with fake bids and offers, and then they front run the sale and it ends up costing your pension fund an extra half penny per share. It adds up over time.

And so it's no surprise, that a consortium of Wall Street investment banks would want a piece of this High Frequency action. It is almost like a transaction tax that the investment bankers can impose on customers, you know, the same kind of transaction tax that the investment bankers claim they can't be forced to pay.

Stocks closed at 3 months highs. Spanish and Italian bond markets recovered a little. European Central Bank President Mario Draghi has said the ECB may buy short-dated bonds to lower borrowing costs to help Europe. Draghi will have to wait for the Germans to determine if they want to participate and if they think Draghi's plan is legal, and the whole deal will take at least a few weeks, and most of Europe goes on vacation in August and nothing, really nothing gets done. Nothing has been fixed in Europe, but things seem to be getting better or at least not worse, and it seems unlikely that there will be any kind of real blow-up, and that is problematic for the market bears, so there is a bit of a short squeeze. Why fight it? Go on vacation.  European shares closed at 4 month highs.

The New York Stock Exchange has confirmed it is in talks with securities regulators to settle allegations that the exchange violated rules intended to promote fair competition. The SEC is investigating whether the NYSE is violating the regulation that prohibits an exchange from sending out data on a private feed to certain clients faster than on public data feeds. The SEC ramped up its focus on market structure issues like the one at the heart of the NYSE probe in the wake of the May 6, 2010, "flash crash" in which the Dow Jones Industrials plunged about 700 points in several minutes, but there is no indication the current investigation deals with the flash crash. Earlier this year, the SEC's market abuse specialized unit disclosed it was conducting roughly 20 different inquiries, ranging from order types to how exchanges police their markets.

Standard Chartered Bank reaped hundreds of millions of dollars of fees by scheming with Iran's government to hide roughly 60,000 transactions over nearly a decade. The bank violated anti-money laundering laws by scheming with Iran to hide more than $250 billion of transactions, New York state bank regulators say Standard Chartered may lose its license to operate in New York State.

The bank was "apparently aided" by its consultant Deloitte & Touche LLP, which hid details from regulators, and despite being under formal supervision by regulators including the Federal Reserve Bank of New York for other compliance failures involving the Bank Secrecy Act and money laundering.

According to regulators, the bank's actions "left the U.S. financial system vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes, and deprived law enforcement investigators of crucial information used to track all manner of criminal activity."

So, five years ago the banking industry imploded, and over the past few weeks we've seen example after example of how the problems with the finance industry have not been fixed. We've had the frightening risk management at JPMorgan, where the London Whale lost $5.8 billion and counting, we had the complete breakdown of PFGBest; we still don't have any response to the vaporization of more than a billion dollars of MFGlobal accounts; the misuse of insider information at Nomura, the Libor scandal at Barclays, which is growing daily and just involves the global standard for anything with an interest rate; the software glitch at Knight Capital that led to a miniature flash crash, so their traders can scalp a few pennies on everything; money laundering at HSBC; and now money laundering at Standard Chartered. This latest deal was more than just trying to avoid taxes, it was literally aiding Iran.

According to Reuters, the regulator described how Standard Chartered officials debated whether to continue Iranian dealings. In October 2006, the top official for business in the Americas, whom the regulator did not name, warned in a "panicked message" that the Iranian dealings could cause "catastrophic reputational damage" and "serious criminal liability."  A top executive in London shot back: "You f---ing Americans. Who are you to tell us, the rest of the world, that we're not going to deal with Iranians." The reply showed "obvious contempt for U.S. banking regulations," the regulator said.

Standard Chartered allegedly moved money through its New York branch on behalf of Iranian financial clients, including the Central Bank of Iran and state-owned Bank Saderat and Bank Melli, that were subject to U.S. Sanctions. Such transactions were permissible until November 2008, when the Treasury Department prohibited them on concerns that they were being used to evade sanctions, and that Iran was using banks to fund nuclear and missile development programs.

Maybe treason is too harsh a word.

And then there is the case of Capital One, just a small problem, hardly worth a mention. The Justice Department says Capital One has agreed to pay $12 million to resolve allegations the bank violated special consumer protections in federal law for members of the military. Capital One wrongfully foreclosed on some homes and improperly repossessed some cars,  the bank obtained wrongful court judgments against some service members, and improperly denied interest rate relief on some credit card and car loans.

In a settlement under the Servicemembers Civil Relief Act, Capital One will pay $7 million in damages, including at least $125,000 to each service member whose home was unlawfully foreclosed upon and at least $10,000 to each service member whose vehicle was unlawfully repossessed. The Act basically says you can't foreclose on a service member while they are on active duty. Some guy in the mountains of Afghanistan really should not be worrying about his family, back in the states, being kicked to the street while he's trying to fight Taliban armed with the latest rocket launcher purchased by the ayatollahs in Iran and financed by Standard Chartered and audited by Deloitte and Touche.



Earlier today at a conference in Massachusetts, Fed Chairman Ben Bernanke said:
“ ..aggregate statistics can sometimes mask important information.  For example, even though some key aggregate metrics--including consumer spending, disposable income, household net worth, and debt service payments--have moved in the direction of recovery, it is clear that many individuals and households continue to struggle with difficult economic and financial conditions. Exclusive attention to aggregate numbers is likely to paint an incomplete picture of what many individuals are experiencing. One implication is that we should increase the attention paid to microeconomic data, which better capture the diversity of experience across households and firms. ...”

Another implication is that policymakers such as Ben Bernanke should do more to help individuals and households who "continue to struggle with difficult economic and financial conditions." So why isn't he pushing the Fed to do more at every opportunity?


Banks are also stockpiling cash; they're sitting on more than $1.5tn in excess reserves in the US. Corporations are sitting on much more cash than that. Many are not even rewarding investors or accelerating their growth with the money, thereby causing harm to themselves, according to a recent survey by Ernst & Young. Economists also say that cash hoarding is blocking a recovery in Europe.Another study by the Political Economy Research Institute at the University of Massachusetts found that if corporations and banks invested $1.4bn in cash into productive investments and job creation, unemployment would fall below 5% by the end of 2014.

To be sure, the purpose of these companies - and of capitalism itself - is to create profits, not jobs. But as the Great Depression and the Great Recession have demonstrated - and as a famous philosopher-economist once said - capitalism sows the seeds of its own destruction. Sometimes it makes sense to take a long term view, and invest in your customers.

Of course, the question will arise: how can we make quarterly profits-obsessed corporations tap their vast reserves to invest and create jobs to serve their long-term interests? I don't know. But we do know where the money is.

And then we hear the story of the geniuses in San Diego. San Diego's Poway school district is paying $1 billion to borrow $105 million. According to a story in the Voice of San Diego, the city really had no choice. It was either raise taxes or float what appeared to be just another bond to fix its schools.

"Without increasing taxes, the district couldn't afford to borrow money in the conventional way. So, instead of borrowing from investors over 20 or 30 years and paying the debt down each year, like a mortgage, the district got creative. With advice from an Orange County financial consultant, the district borrowed the money over 40 years in a controversial loan called a capital appreciation bond. The key point for the district: It won't make any payments on the debt for 20 years."

Never mind the irony of the advice coming from a consultant in Orange County, which once hailed as being the home of the biggest US bankrupt county. This 40-year capital appreciation bond is really a zero-coupon bond that doesn't require any payments for the first 20 years.

"And that means the district's debt will keep getting bigger and bigger as interest on the loan piles up. The bottom line: For borrowing $105 million in 2011, taxpayers will end up paying investors more than $981 million by 2051, or almost 10 times what the district borrowed. That's wildly more expensive than a typical school bond, in which a district pays back two or maybe three times what it borrowed."