Wednesday, May 21, 2014 - Congratulations Graduates, Yada, Yada, Yada

Congratulations Graduates, Yada, Yada, Yada

by Sinclair Noe

DOW + 158 = 16,533
SPX + 15 = 1888
NAS + 34 = 4131
10 YR + .02 = 2.53%
OIL – .33 = 103.74
GOLD – 2.40 = 1292.90
SIL  un = 19.49

Earnings season is winding down; about 96% of S&P 500 companies have reported results, with profit growth this quarter of 5.5% and revenue up 2.8%. While more companies have topped earnings expectations than usual, fewer have beat on the revenue side. This has been an ongoing theme for corporate profits; bottom line growth without corresponding sales. If this formula sounds unsustainable, it is, unless there is some other factor pumping up the markets.

Follow-up from yesterday: China has signed a 30-year deal to buy Russian natural gas worth about $400 billion. The gas deal gives Moscow an economic boost at a time when Washington and the European Union have imposed visa bans and asset freezes on dozens of Russian officials and several companies over Ukraine. It allows Russia to diversify its markets for gas, which now goes mostly to Europe; essentially opening the door to Asia’s gas market and potentially closing the door on the petro-dollar.

The Federal Reserve today released the minutes of the most recent FOMC meeting. Fed policymakers considered several approaches to tightening monetary policy, but decided to remain flexible; which is another way of saying QE is a big experiment and they are just hoping nothing explodes in their face. By making no decisions, the Fed is making it difficult for Wall Street to be spooked by tightening talk, at least for now.

In the minutes, the Fed made no decisions on which tools to use. One great advantage of extending the debate about how to tighten is that it keeps the question of when stuck in background. If the Fed laid out a detailed exit strategy the markets would start to trade the strategy and essentially kill it in its tracks.

The minutes show the Fed still thinks the first quarter slowdown was weather related, and things will pick up, any day now. Fed officials still see slack in the labor force, but there wasn’t consensus on how much slack or what to do about it. Inflation is picking up just a little, but is regarded as stable and not a problem.

After the minutes were published, we heard from several Fed officials, starting with Janet Yellen delivering a commencement address to NYU grads. Yellen delivered what you might expect, and nothing to do with monetary policy: graduates, she said, should “tend the fires of curiosity,” listen to others, show grit in the face of failure, and the courage of her hero Ben Bernanke (yada, yada, yada).

Federal Reserve Bank of San Francisco President John Williams said he’s inclined to delay any action that would allow the central bank’s balance sheet to get smaller until after the Fed has lifted interest rates for the first time. Williams  believes the Fed needs to take into account the troubles it had last year when it first floated plans to wind down its bond-buying policy, and make sure markets understand what the central bank does with its bond holdings is entirely different than what it does with short-term rates.

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the Fed is still failing to deliver on its employment and inflation goals. Kocherlakota says the current unemployment rate of 6.3% overstates the nature of the improvement. He said the labor market is not healthy but he didn’t call for additional levels of stimulus, but he did say it was possible for the Fed to switch to a system where instead of targeting a specific level of inflation, it could shift to a regime where it allowed inflation to rise above target to make up for past shortfalls.

One area of agreement in the FOMC minutes is that officials are concerned about weakness in the housing market; citing factors like higher home prices, construction bottlenecks from a shortage of labor and harsh winter weather, as well as tight credit.

Former White House advisor Larry Summers thinks student debt is slowing the housing market, which in turn is slowing the broader economy. Since 2003, student loan balances have nearly quadrupled to $1.2 trillion, during a period when mortgage debt rose “only” 65% to $8.2 trillion and credit card debt actually declined by 4.2% to $660 billion. The burden of servicing that ever growing student loan debt is eating into other forms of borrowing and spending, such as the purchase of a home. And so the proportion of first-time buyers has been shrinking for years.

Over 70% of the students who are sitting through a commencement speech this spring have student loans. They will start their career, if any, with about $33,000 in debt. Even when adjusted for inflation, it’s about twice as much as 20 years ago. Back then, only 43% of students graduated with student loans. And as education costs have jumped, the idea of working your way through school just doesn’t work anymore.

One of the reasons why education costs have jumped is because of austerity. States cut back on funding for state universities; the schools raised tuition and they discovered they could charge whatever they want, or get away with, because the students just borrow the money. Once upon a time state governments held the reins of university budgets and they would tighten their grip occasionally; no more; and through the student loan programs, designed with whatever intentions, the government is simply aiding and abetting colleges in extracting ever more money from the future lives of their students.

And so for the Class of 2014, you now face the prospect of rising interest rates, a mountain of student loan debt, almost no chance of buying a home in the foreseeable future, and the prospects for a good job in your chosen field are not looking good. Congratulations, don’t despair, just have the grit and courage of Ben Bernanke (yada, yada, yada) and you’ll work your way out of your parents’ basement in 10 or 15 years.

Earlier this week, the Oregon Legislature approved a plan that could pave the way for college students to finance their education by selling equity stakes in their future income. It’s an interesting idea. With both unsubsidized and subsidized Federal loan rates now at 6.8%, and Grad PLUS rates even higher, the student loan burden that comes with an undergraduate degree, let alone further education can be daunting. Unfortunately, Federal loans are often the only option that a student has to pay for school nowadays.

Equity financing would allow these students to avoid debt in exchange for a portion of their future income for a set number of years. Proponents of the Oregon plan claim that 3% per year for 20 years would be enough to keep the program afloat. One concern is that students who expect to be high earners will not participate if it could mean they end up paying more in tuition when all is said and done. Equity financing would be costly for a medical student. A cap on repayment could help solve such a problem. The cap would still have to be higher than the average tuition rate charged by the school. Meanwhile, a equity financing might be a sweet deal for a student taking classes that don’t lead to a big paycheck; it might even encourage them to pursue higher education without regard to finance.

The best that can be said for the plan is that it is a tax on future earnings, the worst is that it is a newfangled name for indentured servitude.

So, back to the housing market for a moment; you have a massive number of young adults living at home with very little financial means for purchasing a home. The recent argument was that as economies grew, this wealth would eventually lift the standard of living for all. There is new economic research showing that this isn’t always the case especially when a rentier class emerges. In fact, this wealth gap is being fully visualized through real estate. Some analysts have been scratching their heads wondering how housing prices could go up while homeownership is actually falling.

How do you have soaring home prices with household incomes dropping? The fact that investors are dominating in the housing market shows how large and powerful these big pools of money have become. The financial sector rarely had an interest in being actual property owners until the housing market imploded. But in the first quarter of this year, cash sales from investors reached an all-time high; that isn’t Mom and Pop buying a crib with cash and it certainly isn’t the first time buyer a few years removed from college.

Since 2005, we have increased the number of rental households by roughly 7 million (a 21 percent increase). Interestingly enough, we have a foreclosure graveyard of 7 million over this same period. Owner occupied housing has actually fallen over this period. We are looking at close to one decade of data and we have fewer individual homeowners today than we did in 2004.

In previous recoveries, you would also see home building picking steam up but that hasn’t happened. In better days, we would see more than 2 million housing starts per year. In this recovery, we’ve been doing our best to close in on 1 million.

And when the Fed last year floated the idea of taper, the markets responded with a taper tantrum, and rates increased, modestly, but an increase; and that was enough to slam the brakes on regular home buyers last year. Mortgage apps are now near an all-time generational low. Regular buyers are becoming a minority. Many of the “pent up demand” argument assumes first, that younger buyers have the means to buy. Second, it also assumes homes are affordable based on their income (which they are not). And so we have cash investors, spurred on by strong stock returns, but what happens if or when the inevitable stock market correction comes along?

Friday, October 18, 2013 - Biscuits on the Dark Side of the Moon

Biscuits on the Dark Side of the Moon

by Sinclair Noe

DOW + 28 = 15,399
SPX + 11 = 1744
NAS + 51 = 3914
10 YR YLD un = 2.59%
OIL + .28 = 101.15
GOLD – 2.70 = 1318.40
SILV + .07 = 22.06

There will be a lunar eclipse a little later this hour. In the West we won't see it, but you can phone your friends in the East. Maybe it explains something.

The S&P 500 index hit another all time record close.

Tobias Levkovich is the chief US equity strategist for Citigroup, and he may have had the best analysis of post-deal state of the markets: “Kicking the proverbial can down the street does not address the long-term fiscal imbalances. The twin decisions of a taper timing push out and the discord in Washington being swept under the rug until January and February roll in could keep P/E multiples more compressed as equity risk premiums stay elevated. Investors typically do not like uncertainty and it is hard to determine how these recent almost non-decisions can be seen as reinvigorating confidence aside from some relief that an imminent likely disaster has been avoided. Nonetheless, one cannot respectably believe that things truly have turned for the better as opposed to averting the worst. The long-term growth of non-discretionary government spending can still prove to be an overwhelming liability and it has not been the primary focus for legislators.”

Larry Summers will not be the next Federal Reserve Chairman, and maybe that gives him a little more time to reflect. In an interview with Charlie Rose, Summers addressed the core problem with the recent and upcoming budget battles: “ I don't know why the obsession should be with entitlements, like the test of a country is did we scale back entitlements? No, the test of the country is did we have a stronger economy for our children than we had for ourselves. That's what is in doubt and that's what we should be focusing on.”

The Iowa Electronic Markets is the only sportsbook in America allowed to bet on US elections. Next year’s midterm elections for Congress are now a tossup between the Republicans and the Democrats. Of course the odds will change over the next year. The attention span of the average voter is …, I'm sorry, what was that?

A Time magazine article published today suggests that Texas Senator Ted Cruz, leader of the conservative effort to tie a curtailment of Obamacare to funding the government, is coming under scrutiny for failing to disclose ties to a Caribbean-based private equity fund; a possible violation of ethics rules. Cruz told Time that the omission was inadvertent and that he is in the process of making corrections to his Senate financial disclosure form.

The government shutdown started on October 1^st; since then the top performing asset classes have been equities, specifically the stock markets in Japan, Spain, the US, and Italy. And of course, Google, which has now become an asset class all its own.

Google joined the $1,000 per share club today, following a better than expected earnings report last night. Google went public in 2004 at $85 a share. Google reported earnings of $10.74 per share, well ahead of consensus estimates of $10.34.

In other earnings news, both General Electric and Morgan Stanley topped Wall Street expectations for the third quarter. GE shares gained 3.6% and Morgan Stanley rose 2.6%.

Home price gains are slowing after a strong bounce off the bottom, potentially marking a new phase for the housing recovery. According to a report from Zillow, home values aren't rising as fast as they were and even dipped in a few hot markets in September. More homes are coming on the market, and Realtors report less competition among buyers.

A new report from PriceCoopersWaterhouse says funding for US startups rose in the third quarter from year-ago levels, as venture capitalists poured money into a growing number of fledging software companies. Total investments in startups rose 17% to $7.7 billion from $6.6 billion in the July-September quarter of 2012. The number of deals rose 7% to 1,005 from 937. The software industry pulled down the largest chunk of funding, nearly $3.6 billion.

The dollar fell to eight-and-a-half-month lows against the euro; down around 1 percent on the week. The Chinese economy grew at an annual rate of 7.8% in the third quarter, accelerating from the second quarter's 7.5% increase.

The 11th-hour agreement to raise the limit on US government borrowing and end a 16-day government shutdown also averted a default on Treasury bonds that had threatened the global financial system, and exposed the vulnerabilities of the economic revival plans of other countries, especially Japan and China. Perhaps no two economies outside the United States have more at stake in Washington's recurring drama than Japan and China. Not only are they the second- and third-largest economies, but they lend Washington more money than any other single nation. Both nations have adopted policies to revitalize their own economies that to some extent rely on the improving economic appetite, stable currency and increasing indebtedness of the US.

There are no bond markets large enough to give China and Japan an alternative to U.S. Treasuries for the dollars they accumulate selling exports. So the prospect of another U.S. default drama next year is likely to lend new urgency to China's preferred solution: conducting less trade in dollars and more in renminbi.

Very Serious People are warning that China might lose confidence in America and start dumping our bonds. That might not be such a bad thing. China selling our bonds wouldn’t drive up short-term interest rates, which are set by the Fed. It’s not clear why it would drive up long-term rates, either, since these mainly reflect expected short-term rates. And even if Chinese sales somehow put a squeeze on longer maturities, the Fed could just engage in more quantitative easing and buy those bonds up. China could, possibly, depress the value of the dollar. But that would be good for America; a boon for American exporters.

And a US default would be very bad indeed for Japan, which is attempting to revive domestic consumption and investment, in part, by weakening the yen as part of the policy known as Abenomics. A US default would likely prompt investors to buy yen.

Bottom line is that there will be more talk about an alternative to the dollar as a reserve currency, but there is no place to run. At least not at this time.

The Murdoch Street Journal reports JPMorgan Chase has reached a tentative $4 billion deal with the Federal Housing Finance Agency to settle claims that the bank misled government-sponsored mortgage agencies about the quality of mortgages it sold to them during the housing boom. The deal is for less than the $6 billion the agency initially sought.

HSBC Group just lost, again; this time a $2.46 billion judgment in a long-running securities fraud lawsuit. The shareholder lawsuit alleged that Household International, now known as the HSBC Finance Corporation, misled investors about its lending practices, the quality of its loans and its accounting between 1999 and 2002. The lawsuit has wound its way through United States courts for 11 years and has been regularly noted in HSBC’s corporate filings. A federal jury in 2009 in Chicago found partially in favor of the shareholders, but HSBC and the other defendants have repeatedly challenged that verdict. Yesterday, the $2.46 billion dollar decision was announced in Federal District Court in Chicago. HSBC says it will appeal.

How much does a hamburger on the Dollar Menu cost?

Wrong, it costs much more. The fast-food industry costs US taxpayers about $7 billion a year, according to a report released this week. Researchers at the University of California at Berkeley and the University of Illinois said this subsidy comes about because 52% of fast-food workers are paid so poorly that they must rely on public assistance programs such as Medicaid and earned income tax credits. The fast food industry earns profits, pays dividends to shareholders, and pretty good wages to CEO's, but they stick the low wage costs on taxpayers, whether you eat their food or not.

Taco Bell and McDonald's are welfare queens. There is no free lunch. There is not even, really, a Dollar Menu.

 In 1965, CEOs at big companies earned, on average, about twenty times as much as their typical employee. These days, CEOs earn about two hundred and seventy times as much. That huge gap between the top and the middle is the result of a boom in executive compensation, which rose eight hundred and seventy-six per cent between 1978 and 2011. Last month, the SEC unveiled a rule to require companies to disclose the ratio of the CEOs pay to that of the median worker. The drive for transparency has actually helped fuel the spiralling salaries. For one thing, it gives executives a good idea of how much they can get away with asking for. The idea behind transparency is that full disclosure would embarrass companies enough to restrain executive pay, but the reality is that people who can ask to be paid a hundred million dollars are beyond embarrassment. A more crucial reason, though, has to do with the way boards of directors set salaries.

Boards tend to be comprised of members from peer companies that are bigger and tend to pay their own CEOs more. Also, boards tend to look at the CEO salaries of peer group firms and then peg their CEO's pay to the fiftieth, or seventy-fifth, or ninetieth percentile of the peer group; never lower. With all the companies following the same protocol, salaries ratchet higher, regardless of performance. It's known as the Lake Wobegone effect, where all the CEOs are above average.

Today's program has been brought to you in part by Powdermilk Biscuits. Heavens they're tasty and expeditious. 

Tuesday, September 17, 2013 - Everything is on Hold at a Bad Level

Everything is on Hold at a Bad Level

by Sinclair Noe

DOW + 34 = 15,529
SPX + 7 = 1704
NAS + 27 = 3745
10 YR YLD - .02 = 2.84%
OIL + .22 = 105.64
GOLD – 3.90 = 1311.00
SILV- .08 = 21.84

Market players are focusing on the Fed right now. Yesterday, Larry Summers withdrew his name from consideration to be the next Fed Chairman; maybe it doesn't matter who the next Fed chair is, they are likely to continue on the same path. Today, Jim Rogers said the role of Fed Chair is nothing more than a lapdog for the establishment. Harsh, but not necessarily inaccurate. Still, the Fed Chair is a powerful role and it looks like a woman almost nobody knows will soon take over. Give yourself 3 points if you know her name and her current job title. (Janet Yellen, Fed Vice Chair)

The Federal Open Market Committee, the FOMC, was meeting today; they'll continue meeting tomorrow to determine monetary policy. It's widely expected the FOMC will announce taper, in part because of logistics. The FOMC meets tomorrow, another meeting in October, another meeting in December, and then Bernanke retires. Market participants are expecting taper, and the Fed usually avoids surprises. September and December are the two most likely times for an announcement, in part because the October FOMC meeting does not include a scheduled press conference to explain any significant changes; also October will be right in line with budget battles If there is a negative market reaction to taper, it's probably better to have it in September rather than December, heading into the holidays.

The decision to QE or not QE doesn't seem to be based upon economic progress; the economy has improved but it is still a long, long, long, long way from healthy, especially in the labor markets. A new report from the Census Bureau today confirms the economic weakness. Last year, for the first time in half a decade, median household income did not fall and poverty did not rise. The report depicts an economy that has failed to improve the lot of most households and left about 46.5 million Americans living in poverty in 2012.

Median household income, adjusted for inflation, fell slightly for the fifth straight year to $51,017, the lowest level since 1995. That is down about 9 percent from an inflation-adjusted peak of $56,080 in 1999, though the economy has grown by about 28 percent since then. Income is also down about 8.3 percent since 2007, when the economy started to contract. The census data shows that the top 5 percent of earners — households making more than about $191,000 a year — have recovered most of their losses and took in about as much in 2012 as they did before the downturn. But those in the bottom 80 percent of the income distribution are, on average, making considerably less.

More than 20% of homes headed by a college grad and 24 percent of Americans working full-time can't make ends meet. Those statistics indicate that economic insecurity extends beyond the unemployed or little-educated. It also indicates that poverty is a much bigger problem than you probably think. The good news is that everything’s on hold, but at a bad level. Don’t expect things to change until the American economy begins to generate more jobs. And tomorrow the Fed is probably going to whistle past that graveyard.

Instead the Fed, according to their minutes, is afraid of asset bubbles and frothy markets. Also, the FOMC recognizes that the efficacy of QE is fading; $85 billion a month in asset purchases just doesn't have the same punch it once delivered. One more consideration is that the deficit is shrinking. That means the Treasury issues less and less debt to cover government spending. Right now, purchases of government debt by way of QE account for the majority of new debt issued by the Treasury, and if the Fed continues buying at the current pace they could reduce the supply of Treasuries available to other market participants. This could be a problem because Treasuries are one of the few remaining Triple-A rated financial instruments, which is sometimes a requirement for collateral; and without that collateral a whole bunch of deals never get done. So, if the Fed keeps up QE they risk choking out the financial system's ability to lend and create possible destabilization in the Treasury market..

We'll see what happens tomorrow.

If you can give a reasonably simple definition of QE, congratulations. You are a very smart person. Slap a gold star on your forehead. A new Reuters Ipsos poll finds  just 27 percent of US adults could pick the correct definition of quantitative easing from among five possible answers. Quantitative easing, or QE for short, is when the Fed buys bonds in order to push down interest rates and boost the economy.

Fed officials have stressed how important it is that the public does not equate a reduction in quantitative easing with a rise in interest rates. Even though the Fed's well telegraphed intention to pare back its bond buying has raised interest rates over the last five months. Two conclusions: The Fed at times has not done a very good job of explaining what it is up to. Also, it's also fair to say that the state of financial literacy in the United States has room for improvement.

The other big news this week was the mass shooting at the Navy Yard in Washington D.C.; you've heard all about it and it is another tragic story and the only thing I can add is that nothing will change.

The other big news this week has been the flooding in Colorado; there are a few little sidebar stories here that you probably haven't heard. The rain and flooding washed out roads and bridges. To assess the damage a Colorado company that makes drones started flying the drones to photograph the damage, making maps. Within a couple of hours they were delivering high resolution, georeferenced maps; that's very helpful for emergency responders. Very helpful, especially because the drones can fly even when manned airplanes and helicopters can't fly because of bad weather. Or at least the drones could fly until last Saturday, when FEMA showed up and closed the drones down.

The other thing you haven't heard about from the Colorado floods is the natural gas rigs that were flooded. Some gas wells were submerged, some tanks were ripped from their stands. Leaking tanks have been spotted floating down rivers. There is a huge amount of toxic gas leaking into the water. I haven't heard anything about it on mainstream media.

The inflation adjusted U.S. gross national product, the most comprehensive measure of U.S. economic activity, grew by 2.5 percent in 2012, according to the Commerce Department. We're now getting some breakout by city. San Francisco had the fastest growing economy in the country, up 7.4%, and Houston grew at a 5.3% clip, followed by LA at 3.1% growth.

JPMorgan Chase has agreed to pay about $800 million to a host of government agencies in Washington and London — and make a groundbreaking admission of wrongdoing — to settle allegations stemming from a multibillion-dollar trading loss. This is technically accurate and shows some refreshing tough-mindedness among regulators in how they are negotiating with JP Morgan over its London Whale trades. JP Morgan had risk controls that were way way short of industry standards, and bank executives, including Dimon himself, lied flagrantly to the media about the nature and severity of the case for a troublingly long time after it became public. And we learned later that the bank was exceptionally high-handed and dishonest in its dealings with regulators.

The FBI and the Manhattan prosecutor’s office are still investigating criminal charges and the CFTC is continuing with its own probe. Unlike the SEC, the trading commission has examined whether JPMorgan amassed a position so large that it “manipulated” the market for financial contracts known as derivatives. And the proposed settlement opens the door for private litigation. But the big win for JPMorgan is that senior executives are avoiding charges despite blatant and well-recorded lies. Martha Stewart is probably foaming at the mouth.

A grand jury has indicted two former JPMorgan traders at the center of the bank's "London Whale" scandal. Javier Martin-Artajo and Julien Grout were accused of hiding hundreds of millions of dollars of losses within JPMorgan's chief investment office in London by marking positions in a credit derivatives portfolio at inflated prices. The two men were charged by prosecutors last month. Eventually, if the regulators maintain backbone, they will eventually find employees willing to cut a deal and roll-over on senior executives, but for now the code of “omerta” is alive and well in the banking industry.

Even with the settlements in the trading loss case, the bank’s regulatory problems are far from resolved. JPMorgan faces inquiries from at least seven federal agencies and two European nations. The authorities have cast a wide net, examining everything from the bank’s hiring practices in China to mortgage loans it sold to investors in the financial crisis. Prosecutors and the F.B.I. in Manhattan are also examining whether JPMorgan did not alert authorities to suspicions about Bernie Madoff's ponzi scheme. Then there's the probe by the Federal Housing Finance Agency, which has accused JPMorgan of selling shoddy mortgage securities to Fannie Mae and Freddie Mac. Then there is the comptroller's office and the Consumer Financial Protection Bureau's investigation into the way the bank collected credit card debt from customers. I'm sure there's something I'm forgetting, but that's enough for now.

Monday, September 16, 2013 - Do It Again

Do it Again

by Sinclair Noe

DOW + 118 = 15,494
SPX + 9 = 1697
NAS – 4 = 3717
10 YR YLD - .02 = 2.86%
OIL - .53 = 106.06
GOLD – 14.00 = 1314,90
SILV - .45 = 21.92

The Bank of International Settlements is a Swiss based central bank for the central banks, kind of a global clearing house. The BIS has just issued its quarterly economic review. The conclusion: it's 2007 all over again, but even worse. All the previous imbalances are still there, but total public and private debt has grown to more than 30% of GDP in advanced economies, and bubbles are forming in emerging markets. Subordinated debt has in Europe and the US has ballooned. Leveraged loans are at an all time high. The BIS said interbank credit to emerging markets has reached the highest level on record while the value of bonds issued in off-shore centers by private companies from developing nations exceeds total issuance by firms from rich economies for the first time.

So, there is more debt than ever, and a greater appetite for risk. And if the Fed raises interest rates this week there will almost certainly be a spill-over effect; global borrowing costs will rise. The international financial system is more unbalanced than 5 years ago, and there is a concern that markets can remain liquid under stress. If there is a problem with liquidity, the BIS figures there are fewer lifelines than before. The global markets, including the US, have become addicted to easy money and the

QE is essentially morphine for bankers. And while it may have been necessary as a post-crisis measure, the patient is now hooked and withdrawal could prove disorderly. Some folks consider QE as nothing more than mind-boggling fiscal profligacy, even though the national debt is shrinking, year over year. The real problem is that the money has been largely stuck with the banks, and the banks have grown bigger and more dangerously leveraged than before the crisis; yes the debt is growing slower but the stimulus didn't spread out to the rest of the economy.

And so the Federal Reserve meets this week and they are widely expected to announce the taper, or slow and steady reduction of securities purchases. Already, rates are up more than 100 basis points on the 10 year note since the mention of a possible taper. It isn't a done deal; the Fed might not taper; maybe the timing just isn't right. Fannie Mae and Freddie Mac are set to auction as much as $17 billion in mortgage bonds; that might be dumping too much supply on the markets if the Fed steps away as the primary buyer.

And to justify the taper, the FOMC will need to claim the economy is improving and doesn't really need special help. We all know better. The economy isn't dead but it isn't healthy; GDP is charging ahead like a sloth on barbiturates; the unemployment rate has dipped down to 7.3% because so many have fallen out of the labor force.

And an even nastier reality about the labor market; rates of unemployment for the lowest-income families, those earning less than $20,000, have topped 21 percent, approaching Great Depression numbers. And households with income of more than $150,000 a year have an unemployment rate of 3.2 percent, a level traditionally defined as full employment. At the same time, middle-income workers are increasingly pushed into lower-wage jobs. Many of them in turn are displacing lower-skilled, low-income workers, who become unemployed or are forced to work fewer hours.

Among households making less than $20,000 a year, the share of underutilized workers jumps to about 40 percent. For those in the $20,000-to-$39,999 category, it's just over 21 percent and about 15 percent for those earning $40,000 to $59,999. At the top of the scale, underutilization affects just 7.2 percent of those in households earning more than $150,000.

In addition to the 5^th anniversary of the Lehman Brothers collapse, this is also the second anniversary of Occupy Wall Street. You'll remember that one of the issues the protesters protested was economic inequality. One remnant of the Occupy movement is the phrase “99 percent” - that stuck. And when you combined the 99% with the 47%, that might have determined the election of 2012. The Occupy movement isn't dead; it is spreading out in smaller and more local groups, and it doesn't get much media coverage, but it left a very lasting impression, seared on the minds of the national conscience; the idea that extreme levels of inequality exist, are not acceptable, and eventually the 99% storm the gates.

To the long list of problems linked to income inequality, we can now add political gridlock. According to a new study in the Journal of Economic Perspectives, the rise and fall of income inequality is closely correlated to political polarization in the House of Representatives. Of course, correlation isn't causation—we can't say whether inequality fuels political polarization or vice versa. What we know is that income inequality is at the highest levels since the late 1920s, and the distance between the political parties is at the highest level in more than 100 years.

The president spoke at a White House event this morning pegged to the fifth anniversary of the bankruptcy of Lehman Brothers. Obama reiterated his refusal to negotiate with Republicans over the debt ceiling. And he called on Congress to “pass a budget without drama.” Saying, “I cannot remember a time when one faction of one party promises economic chaos if it can’t get 100 percent of what it wants. That’s never happened before.”

So, we have the Federal Reserve meeting this week to determine the possibility of tapering the easy money morphine from the Wall Street junkies, and the most dysfunctional Congress since the Civil War at odds with the president over whether the nation will pay its bills. And the markets started the morning with the Dow Industrials up about 170 points. And for this we can thank Larry Summers. (I never thought I would say that.) Yes, thank you Larry Summers for dropping out of the race to be the next Federal Reserve Chairman.

Past performance is not a guarantee of future results, so Summers might not have hurt the economy as Fed Chairman. Fortunately, we'll never know. But the mere threat of his becoming Fed Chairman was hurting the economy lately, by hurting stocks and bonds. His withdrawal from the race is a boon. Equity markets around the globe cheered his withdrawal this morning. Maybe Summers could keep withdrawing from Fed chair consideration until the economy recovers.

The most likely candidate to replace Bernanke is Fed Vice Chair, Janet Yellen. Also mentioned is Donald Kohn, the former Fed Vice Chair. Timmy Geithner has been part of the team reviewing the candidates; maybe he likes his own resume. There are other possibilities, and we would be well served to look beyond the usual suspects.

Speaking of the withdrawal of Larry Summers today, President Obama said: “Larry was a critical member of my team as we faced down the worst economic crisis since the Great Depression, and it was in no small part because of his expertise, wisdom, and leadership that we wrestled the economy back to growth and made the kind of progress we are seeing today.”

And in that statement there is a certain delusional innocence that is both sad and scary.

“Liquidate labor, liquidate stocks, liquidate real estate,” Treasury Secretary Andrew Mellon may or may not have told Herbert Hoover in the early years of the Great Depression. “It will purge the rottenness out of of the system.” This is what has since become known as the “Austrian” view (although most of its modern proselytizers are American): economic actors need to learn from their mistakes, “malinvestment” must be punished, busts are needed to wring out the excesses created during boom times.

Within the economic mainstream, there is some sympathy for the idea that crisis interventions can create “moral hazard” by bailing out the irresponsible. But the argument that financial crises should be allowed to wreak their havoc unchecked has few if any adherents. 

When a financial crisis hit in 2008 that was probably worse than anything the world had seen since the early 1930s, the bailout of the big banks in late 2008, was hugely unpopular. Now, the feeling is that it was necessary at the time. The Federal Reserve’s subsequent (and continuing) bailout of banks has been somewhat more controversial, but still meets widespread approval among economists. The dangerous financial-sector practices that precipitated the crisis have mostly been left in place. Far from being tamed, the financial beast has gotten its mojo back — and is winning. The people have forgotten — and are losing. Of course the reason that people so easily forget is because we averted endless waves of bank failures and a complete meltdown of the global financial system. We also didn't learn much because we were spared the full consequences. And maybe that is why we still haven't done the things necessary to achieve actual growth; maybe that's why the president still thinks Larry Summers did a great job. Maybe that's why the 99% are still important.

Friday, August 09, 2013 - May All Your Wishes Come True

May All Your Wishes Come True

by Sinclair Noe

DOW – 72 = 15,425
SPX – 6 = 1691
NAS – 9 = 3660

10 YR YLD - .01 = 2.57%
OIL + 2.57 = 105.97
GOLD + 2.30 = 1315.70
SILV + .31 = 20.66

As we started the week, I warned that August can be fairly volatile in the stock market; it seems like the lazy days of summer and volume is usually lackluster, as it was today, but sometimes that just intensifies price swings. The markets were down again today, the fourth decline in the week, and the first weekly decline on the heels of six weeks of gains. The Dow was down 1.5% for the week. The S&P pushed back to 1700 a few times but couldn't break through. This week's declines don't seem to tell us much; we could go either way next week. Yes, I know the rally is long in the tooth; going back to March 2009, the rally is 4.4 years old, longer than the average rally, but it really is too early to start catching falling knives.

There wasn't much in the way of economic reports this week; earnings reporting season is winding down, Congress is away on Summer recess. I guess it's been about a week since we saw the guesstimates on second quarter GDP, and you'll recall that the guesstimates included revisions that go back 83 years. The government is recalculating the numbers to try to get a more accurate picture. One of the revisions was to how research and development is counted; now it will be considered an investment, and that adds to GDP, and makes GDP bigger than we thought. Meanwhile, another revision shows they've been overestimating the amount of income not reported by taxpayers; this could include restaurant workers under-reporting tips, or people who work for cash and don't report it. The result is that it looks like wage earners make less than we thought.

Before the figures were revised, it appeared that wages and salary income in 2012 amounted to 44 percent of GDP, the lowest at any time since 1929, which is as far back as the data goes. But the revisions cut that to 42.6 percent, which matched the revised 2010 figure as the lowest ever. The flip side of that is that corporate profits after taxes amounted to a record 9.7 percent of GDP. Each of the last three years has been higher than the earlier record high, of 9.1 percent, which was set in 1929. So, the new data shows what you probably suspected; corporations are getting richer and workers aren't.

Even in the Dog Days, we've had some interesting news. Tesla makes a very good car and their earnings are reflecting that. Priceline, the name-your-price online hotel booking place is up around $1,000 per share and we're feeling deja vu from 1999 all over again. And Jeff Bezos, the Amazon.com guy is buying the Washington Post newspaper; admittedly, that doesn't sound like much. I bought a newspaper the other day along with an iced tea and I sat down and read it and got ink on my hands and it was very satisfying. Bezos is buying the whole company.

The biggest economic news this week came from Federal Reserve officials talking about the need to eventually taper the Fed's bond buying program, or more specifically slowing down the rate at which they acquire new assets. The Fed may actually be able to slow down the volume of purchases and still increase the share that they take out of the market. The Fed would have a difficult time just changing course; they recognize that sudden change is problematic. And so they are taking very, very small steps; actually right now, they only talking about the possibility of taking small steps. And if it starts to hurt; they will stop. And they will huddle back in their corner.

Eventually the huddle in the corner will not include Ben Bernanke, he's planning on hanging up his lasso and riding into the sunset, or at least into a cushy job with some humongous private financial firm. Today, President Obama held a press conference and while most of the talk was on how the government is spying on everybody, including me and you; and by the way, Mr. Obama feels this is justified; there was also a question on his pick to replace Bernanke. He hasn't decided yet, but he says he has a “range of outstanding candidates” including Larry Summers and Janet Yellen; and whomever it is, they should remember the Fed has a dual mandate to maintain price stability and avoid inflation, and also to achieve full employment.

The press conference covered a wide range of issues, including Republican opposition to Obamacare, which Mr. Obama described as an “ideological fixation.” A key part of the law begins on Oct. 1, when insurance exchanges start. Under that provision, the 15 percent of Americans still without health insurance will, for the first time, be able to sign up for coverage at a significantly cheaper rate than what they can buy on the individual market. Those who still can't afford insurance at those reduced rates can get a tax credit under Obamacare.

The Oct. 1 start date for the exchanges coincides with the date that Congress needs to pass a temporary spending bill to keep the government running. Tea party Republicans have vowed not to pass that spending measure, and shut down the government in the process, if the bill includes any funds for Obamacare.

So, what's the biggest crisis facing the country right now? A CBS poll asked Americans which issue they feel Congress should focus on, and the answers included the economy, followed by the budget deficit, health care and education. What's interesting here is what didn't make the top responses. Fill in the blanks for yourself.

Meanwhile, we keep getting hints of a spine in financial regulators. The SEC is now trying to get JPMorgan to admit to wrongdoing in connection with an investigation of the multi-billion dollar trading losses by the London Whale. For decades, the big banks have settled suits and the SEC has allowed them to “neither admit nor deny wrongdoing”. And even now, the SEC is looking at a civil suit, not criminal charges, and there does not appear to be any threat of charges against JPMorgan senior management.

The losses in the case have now grown to more than $6 billion, stemming from derivatives bets made by JPMorgan's Chief Investment Office in London. The top trader at the CIO office was Bruno Iksil, also known as the London Whale. Iksil is said to be cooperating with US and UK regulators. And the bank is expected to be fined by the British regulators. Meanwhile the FBI and federal prosecutors in Manhattan are uncovering emails and phone records to see who knew what and when, regarding the size of the losses. The bank initially told investors that the losses would maybe be $2 billion. Jamie Dimon, the CEO, described the losses as a “tempest in a teapot”. Dimon is not personally suspected of wrongdoing in the investigation. But it appears the traders in London breached the bank's risk limits in making their derivatives trades, and that points to a lack of internal controls.

In one phone call last year, the London Whale, Mr. Iksil, told a colleague that the bank’s estimated losses were “getting idiotic.” Mr. Iksil added that “I can’t keep this going” and that he did not know where his boss in London “wants to stop.” Investigators suspect the traders' concerns were not relayed to upper management of the bank in keeping with industry standards. Of course, the investigation might get even more interesting if those concerns were relayed to management.

Even if JPMorgan moves beyond this investigation, they still have eight other federal agencies investigating their practices, including possible criminal and civil violations, plus at least one state regulator, and two European nations. The SEC calling for an admission of wrongdoing represents a major shift in attitude by the new SEC Commissioner Mary Jo White. Ms. White won't be involved in prosecuting JPMorgan because she has recused herself because she used to represent the bank back when she was in private practice. Still, if the SEC wins, it represents one of the toughest penalties faced by the banksters; they have to say out loud that they did a bad, bad thing, and Ms. White might even force them to write on the blackboard 100 times: “I'm sorry I lied to investors.”

Yep, that'll teach 'em.

The Silver Fire grew overnight to more than 16,000 acres, or about 25 square miles, with winds pushing the fire east towards Palm Springs. Firefighters say they have reached 25% containment but the fire is still growing. We wish them the best in their fight.

And finally, the Perseid Meteor shower can be seen this weekend; best times will be Sunday and Monday nights. Try to stay away from city lights, hope for clear skies, and enjoy nature's free show, and may all your wishes come true. 

Friday, August 02, 2013 - Jobs and Side Bets

Jobs and Side Bets

by Sinclair Noe

DOW + 30 = 15,684
SPX + 2 = 1709
NAS + 13 = 3689
10 YR YLD - .11 = 2.60%
OIL - .95 = 106.94
GOLD + 4.60 = 1314.50
SILV + .26 = 19.99

The stock market started lower, with tepid news on the jobs front, but managed to claw back into positive territory, confirming the perverse Wall Street logic that bad is good. The weakness in the jobs market was seen as proof positive the Fed will continue with QE to infinity and beyond, and talk of taper can be set aside for the next Fed Chairman, whoever he or she may be.

The economy added 162,000 jobs last month; that was less than the estimates of 185,000 and less than the recent averages of about 192,000. Also, May and June payroll gains were revised down by 26,000.

The unemployment rate dropped to 7.4% down from 7.6%. This is the lowest level for the unemployment rate since November 2008. Most of the decline in unemployment was due to more people getting jobs but part of it was due to a slight fall off in the labor force, a signal of not-too-strong labor demand, as 37,000 workers dropped out of the labor market. In July, the number of unemployed fell by 263,000 but the number of employed increased by only 227,000. 

The participation rate ticked down one-tenth, to 63.4%, lower than it was a year ago at 63.7 %. The participation rate is at its lowest levels in 35 years and well below the 66% to 67% rate that was normal over the past 20 years. The workforce can shrink when more workers retire or go to school, but it also contracts when people give up the job hunt. The lower participation rate is partly demographics, as the baby boom generation moves into retirement, whether they want it or not. So, if we look at the participation rate for working age population, generally ages 25 to 59, we see the participation rate unchanged at 75.9%. Also, it's estimated that many people slip into the underground economy, which is not as sinister as it sounds; it simply means many people are working in an unreported cash economy.

Most industries added jobs last month; manufacturing added 6,000 jobs in July, after declining slightly in the prior two months. Over the past year, factory employment is up only 18,000.  Construction was off 6,000 last month. Professional and technical services added 21,100 jobs, almost exactly in line with its 20,000 average over the last year. Wholesale trade added 13,700 jobs, somewhat above its 7,000 average for the last year.  Health care added just 2,500 jobs, the smallest gain in a decade. 

Retailers added 47,000 jobs and restaurants and bars added 38,000. So, the composition of jobs is not great; retail and restaurants are generally lower-paying sectors, and they accounted for more than half of all job growth last month. In a weak job market, workers will be more likely to take even lower paying jobs. A recent paper by Canadian researchers suggests that many of the people taking these jobs are relatively over-educated. The authors argue that, since 2000, globalization and technological advancement have reduced the demand for "high-skilled" workers. Desperate for employment, these workers ended up pushing the "lower-skilled" out of the job market entirely. This may help explain why the share of people aged 25 to 54 counted as being in the labor force has declined by 3.5% since 2000.

Government employment was flat overall last month, but state and local governments have slowly started adding jobs in recent months, up 42,000 since January; this might be misleading because many government jobs have experience fewer hours because of furloughs brought on by sequestration.

Weekly hours ticked down 0.1% in July, and weekly earnings are up in nominal terms by 1.9 percent over the past year, about the rate of inflation; this means that most wages are not growing in terms of buying power.

The number of part-time workers increased slightly in July to 8,245 million. Those workers are included in the alternate measure of labor under-utilization, known as U-6, which decreased from 14.3% in June to 14% in July. By that measure, roughly 22 million people are unemployed or underemployed. There are about 4.2 million workers who have been unemployed for more than 26 weeks and still want a job; this is down form 4.3 million in June and is at the lowest level since May 2009. Long-term unemployment is trending down but is still very high; this number should be closer to 2 million in a healthier economy.

The economy has been adding jobs for the past 41 consecutive months, adding 7.3 million jobs since February 2010; it's just not enough. Despite 41 months of private-sector job growth, there were still 2.0 million fewer jobs on nonfarm payrolls and 1.5 million fewer jobs on private payrolls in July than when the recession began in December 2007. The analogy is that we are stuck in second gear, which is better than reverse, or better than driving into a ditch, but at this rate we'll never get to the destination of a strong jobs market.

Let's compare, and I'll try to keep it non-partisan. If we combine the Bush and Obama administrations, we can go back over the past 151 monthly jobs reports and the economy has added 3.46 million jobs in that time; that works out to about 23,000 jobs per month on average. Just to keep up with population growth, we needed to create about 135,000 jobs per month, or a little over 20 million. By way of contrast, under 8 years of the Clinton administration, the economy added just over 23 million jobs in 96 months, for an average monthly gain of 241,000.

According to analysis from  the Federal Reserve Bank of Chicago, at the current pace it would take another five years to return to full employment. This estimate includes aggressive assumptions about aging, immigration and the birthrate that make the "employment gap" smaller than many others believe. The return to full employment could take even longer if those assumptions are wrong, or if growth slows down sometime over the next five years.

With this kind of jobs shortfall, we should be able to put the idea of the Fed taper to rest for a while, and indeed, after its FOMC policy meeting earlier this week, the Fed slightly downgraded its economic view and didn’t offer any signals as to when it would start tapering asset purchases, currently set at $85 billion a month.

Still, today we heard from St. Louis Fed President James Bullard saying he believed the Fed should be careful about basing its decisions on forecasts and that policymakers should wait to see more data before deciding to taper bond purchases.

Other data today showed a slight gathering of inflationary pressure, with the 12-month reading of the Commerce Department's gauge of core inflation rising to 1.2 percent in June from 1.1 percent a month earlier. So, inflation is still nowhere near the Fed's target.

Earlier in the week, the GDP report showed Gross domestic product, a measure of the nation's economic output, grew at a mere 1.4 percent annual rate in the first half of the year, down from 2.5 percent in the same period of 2012. Most economists expect GDP will accelerate in the second half of this year, which would make it more plausible for the current hiring trend to continue, but the fact that the jobless rate has fallen steadily despite weak output might point to a frightening possibility: perhaps the economy's growth potential has fallen. Maybe this is the new normal, a structural shift to slower growth, where less output is needed to create jobs, but also slower income growth over time.

Absent significantly stronger economic data in the next few weeks, we can forget the misconceptions that the Fed will look to taper in September.

Meanwhile, fiscal policymakers should be screaming for jobs, but they aren't and it looks like the best we can hope for on the fiscal side is that they don't drive the car into the ditch. Don't forget, there will be a battle over the debt ceiling, expected to hit by around November. So, on the monetary policy side, the Fed has little economic data to support a taper, and on the fiscal side, there seems little that would encourage taper.

The new, fun parlor game for the summer is to pick the next head of the Fed; pick a candidate and place your bets. Topping the list of contenders to replace Bernanke we have Larry Summers and Janet Yellen, but there are some other names to consider as well, the dark horse candidates. Larry Summers is the front runner; he is President Obama's former chief economic advisor, but he also goes back to the days of Clinton, and Summers actually was a proponent of deregulation and Gramm-Leach-Bliley, which ended up gutting Glass-Steagall; so there is some baggage. Janet Yellen is the current vice chair at the Fed; considered very intelligent and steeped in both the practice and theory of central banking, but some think she might be soft on inflation fighting.

There are indications that Mr. Summers and Ms. Yellen disagree on a pressing issue before the Fed:  how much longer and how much harder to push for economic growth.” They share a conviction that the Fed can and should seek to stimulate the economy during periods of slack demand. Summers appears to have less confidence in the tools available to the Fed at the moment, and greater concern about the potential consequences. Yellen defends the Fed's policies as safe and effective.

The dark horse candidates to replace Bernanke include Donald Kohn, a former Fed vice chair. Then, don't forget that former Treasury Secretary Tim Geithner is helping in the selection process, so there's a slim chance he might toss his hat in the ring. Longer shots include Robert Reich or Joseph Stiglitz; interesting, but yea, that's not going to happen.

Fabulous Fab, or more precisely Fabrice Tourre, the junior level Goldman Sachs trader was convicted yesterday of misleading investors on a derivative called Abacus, which was set up to gamble on the mortgages behind the housing market run-up, but turned out to be rigged full of sub-prime. Confused?

The important thing to understand is that the securitization at issue in no way helped to create capital for anything. It was a pure gamble. One side bet that the mortgage market would collapse. The other bet it would not. 

Consider the mortgage securitization market. First, there are mortgages, which help people buy homes. Those mortgages are packaged in a securitization and sold to investors. Some investors buy tranches that give them low yields with little chance of loss. Others get tranches with higher yields, but will lose their principal if enough borrowers default. The money put up by the investors helped to finance home buyers, which is the kind of thing a financial system should do. (It did it badly, but that is not the issue here.)

The next level of security packaged a bunch of tranches from different deals and sold securities based on those assets. By raising money to finance tranches in the first level of securitizations, it indirectly helped to finance home buyers.

Note that nobody needed to bet against either of those securitizations. The money put up by the buyers was going to homeowners, or at least to those who had previously lent to those buyers.

But the securitization that Mr. Tourre helped to create was “synthetic.” It did not raise money that went, directly or indirectly, to homeowners or to those who had lent money to them. Instead, it picked a bunch of tranches from previous securitizations — tranches that no one involved in this deal had to own — and fashioned a new securitization in which one set of investors bet those securities would work out and another set bet they would not.

Goldman Sachs was the bookie.

And this is why we need Glass-Steagall. There is no reason for the banks to be bookies. Restore the separation between commercial and investment banking, let the investment banks play bookie with partners' capital, and put the commercial banks back into the lending business. After the dust settles, put the banks not only in the lending business but make mortgages "make and hold" loans that stay in the banks' loan portfolios rather than being securitized and sold off to investors.

It is then that we will see what all of the property in the country is worth. Long after we get the government out of the mortgage market and investment bankers out of the government-guaranteed market where they issue securities on the securitized property.

If you want to gamble, you're welcome to do so, but banks that have access to insured deposits and get bailed out if they get into trouble, should not be using those insured deposits to put together a betting book and taking the bookie's cut.

And so that's the main reason why I oppose Larry Summers as the next chairman of the Federal Reserve, but I wouldn't bet on it.