Tuesday, December 10, 2013 - Impossible Until It Is Done

Impossible Until It Is Done

by Sinclair Noe

DOW – 52 = 15,973
SPX – 5 = 1802
NAS – 8 = 4060

10 YR YLD - .06 = 2.79%
OIL + 1.17 = 98.51
GOLD + 21.60 = 1263.00
SILV + .59 = 20.53

Today federal regulators voted to implement the Volcker Rule. It won't actually be implemented until 2015, but the vote was today. The Volker Rule will lay out specific activities that banks can and can't do.

The final rules would prohibit proprietary trading by banking entities. As required by the Dodd-Frank Act, the final rules would include exemptions for: Underwriting - this exemption would require that a bank act as an underwriter for a distribution of securities (including both public and private offerings) and that the trading desk’s underwriting position be related to that distribution. Market making-related activities - a market-making desk may hedge the risks of its market-making activity under this exemption. Risk-mitigating hedging - this exemption would require that hedging activity is identified specifically. Trading in certain government obligations banks could still trade in Treasuries and muni's, and what the heck, foreign sovereign debt or its political subdivisions.

The final Volker Rule would also clarify which activities are not considered proprietary trading, and it is looking like nothing is considered a proprietary trade with the possible exception of when a bank trader places a bet on the Yankees with his local bookie. You may recall that Jamie Dimon tried to claim that the London Whale was not involved in proprietary trading, rather hedging; of course this was after he claimed he didn't know what the London Whale was doing

The final rules would become effective (appropriately) April 1, 2014. The Federal Reserve Board has extended the conformance period until July 21, 2015. Turning the Volker Rule into regulations has been slowed by a lobbying onslaught. And it looks like the banking lobby has won. The banks met with regulators on a regular and constant basis, and basically rewrote the rules. There was a token appearance from bank reformers, but the odds were against them by about 99 to 1.

The Volker Rule won't be totally worthless. Already many banks have shut down or spun off the desks they used for trading that was clearly solely for their own account, what’s known as proprietary trading. Banks do other kinds of trading that can also make them money, or loses it. Figuring out which trades fall into which category isn’t always easy, and deciding how much risk is too much for which kind of transaction may be even harder. On these issues, how regulators decide to enforce the rules may be as important as the rules themselves. Some regulators may be concerned only with seeing that the markets operate smoothly, other regulators may actually try to prevent banks from trading that would blow up the bank and possibly the global financial system.

The banks say there is no way to distinguish between proprietary trading and hedging and market making. Paul Volker, the former Chairman of the Federal Reserve, the guy the rule was named for; Volker says the distinctions aren't tough: “It's like pornography, you know it when you see it.”

Bottom line is that the banks are going to try to skirt the rules, and whittle them down a bit more before implementation, but if this fails, the logical next step is to make it real simple and reinstate the Glass-Steagall Act.

And here is why it will likely fail: the banks wrote the rules, it's all way too complicated, too big to fail is still a problem – only bigger, and nobody cares. Admit it, your eyes are starting to glaze over. Your concern is whether the ATM will spit out cash, will the bank process your payment to the electric utility, and maybe they can pass out a few mortgages from time to time. So, nobody will say much until the next credit freeze, or the next international crisis when everything goes to hell in a handbasket and the banks come begging for bailouts. When that happens, we can all shout bloody murder.

Don't worry. What could go wrong?

Right now, politicians are gathering in Washington to craft and pass a budget deal and avert another government shutdown, which could happen January 15, unless they can put together a deal. And it looks like they might be close to a deal to de-fuse this fiscal time bomb they set themselves.

Any tentative budget deal might allow spending to rise from the scheduled $967 billion for fiscal 2014 to around $1 trillion. While that increase in outlays would be offset by raising some government fees and possibly cutting federal workers' retirement benefits. The plan does not purport to be any "grand bargain" that would slash the federal deficit. They may have a deal in the next few days, but for right now, there is no deal.

GM is once again General Motors, and no longer Government Motors. The US Treasury sold its last shares yesterday. Bailouts from the Bush and Obama administrations helped GM avoid liquidation and instead reorganized in 2009 bankruptcy. In return, the Treasury became a shareholder in GM. The US said it lost about $10.5 billion on its investment of $49.5 billion, but that's not the entire story.

GM was returned to investment-grade status by Moody’s Investors Service in September after losing it eight years ago; it's back in the S&P 500 index (it had been kicked out back when it was facing bankruptcy). Share price is up over 40% year to date. They're making good cars that are winning awards. And they have a new CEO, Mary Barra, the first female CEO of an automotive company.

According to a study by the Center for Automotive Research, a total automobile-industry shutdown from a liquidation of GM and Chrysler would have cut 2.63 million jobs from the US economy in 2009.  The bailout saved or avoided the loss of $105 billion in transfer payments and the loss of personal and social insurance tax collection in 2009 and 2010.

Eight major technology companies have joined forces to call for tighter controls on government surveillance, issuing an open letter to President Obama arguing for reforms in the way the US snoops on people.

The companies said that while they sympathize with national security concerns, recent revelations make it clear that laws should be carefully tailored to balance them against individual rights. The letter reads in part: "The balance in many countries has tipped too far in favor of the state and away from the rights of the individual — rights that are enshrined in our Constitution... This undermines the freedoms we all cherish. It's time for a change."

The companies signing off on the letter include: AOL, Apple, Facebook, Google, LinkedIn, Microsoft, Twitter, and Yahoo. It sure would have been nice if the tech companies had been loudly supporting intelligence reform before Snowden's disclosures.

And today, more than 500 authors delivered a petition urging the United Nations to create an international bill of digital rights that would enshrine the protection of civil rights in the internet age. The signatories say the capacity of intelligence agencies to spy on millions of people's digital communications is turning everyone into potential suspects, with worrying implications for the way societies work.

The petition says the extent of surveillance revealed by Snowden has challenged and undermined the right of all humans to "remain unobserved and unmolested" in their thoughts, personal environments and communications. "This fundamental human right has been rendered null and void through abuse of technological developments by states and corporations for mass surveillance purposes."

The statement adds: "A person under surveillance is no longer free; a society under surveillance is no longer a democracy. To maintain any validity, our democratic rights must apply in virtual as in real space."

Demanding the right "for all people to determine to what extent their personal data may be legally collected, stored and processed", the writers call for a digital rights convention that states will sign up to and adhere to. "Surveillance is theft. This data is not public property, it belongs to us. When it is used to predict our behaviour, we are robbed of something else – the principle of free will crucial to democratic liberty."

Have you heard about the Doomsday File. Edward Snowden claims he didn't bring a single NSA document into Russia, but as journalist Glenn Greenwald has hinted, he may have access to a trove of pilfered documents stored on a data cloud. British and US intelligence officials tell Reuters they think he may have a "doomsday" cache containing highly classified material to ensure he won't be arrested or physically harmed. He's believed to have enough data to keep the bombshell reports coming for the next two years. It's unclear if intelligence agencies know where the data is stored, but somehow they're aware that at least three people have the passwords, which are only valid at certain times each day.

Of course today also the memorial service for Nelson Mandela. More than 100 current and former heads of state plus tens of thousands of others, attended the service at a soccer stadium in Soweto. Jacob Zuma, the current president of South Africa was booed. President Obama shook hands with Cuban President Raul Castro. It was a peculiar service, rambling and punctuated by high winds and a harsh rain. I think the best quote of the day goes to President Obama, who said: "Nelson Mandela reminds us that it always seems impossible until it is done." And while there were many dignitaries, it was a day for the people, not the powerful.

Thursday, December 05, 2013 - 46664

46664

by Sinclair Noe

DOW – 68 = 15,821
SPX – 7 = 1785
NAS – 4 = 4033
10 YR YLD + .03 = 2.87%
OIL + .18 = 97.38
GOLD – 18.20 = 1226.10
SILV - .28 = 19.54

Nelson Mandela is dead. News reports say the former South African President died peacefully at his home. He was 95. Nelson Mandela will be remembered as the person who, more than any other, brought an end to apartheid, the heartless policy of “separate development” in which white, black and South Asian South Africans were obliged to live apart. It is part of his towering achievement that the very notion of racial segregation is anathema throughout the civilized world.

Yes, the stock market was down again today but the economy is doing better than you thought. Third quarter gross domestic product grew at a 3.6% pace, revised up from earlier estimates of 2.8%. Wow, sounds great, until you dig into the numbers. A large part of the revision, almost half, comes from an increase in inventories. Businesses were stocking the shelves. Were they predicting a gang-buster holiday shopping season or were they caught flat-footed by a lack of demand? We won't know with certainty until we get through the fourth quarter, but most indications are that the economy is still slogging forward, and there doesn't seem to be a need for such a large inventory buildup. We know businesses accumulated more than $116 billion in inventories in the quarter, the most since the first quarter of 1998.

Growth in consumer spending, which accounts for more than two-thirds of US economic activity, was revised down to a 1.4% rate, the lowest since the fourth quarter of 2009. That line about consumer spending is a bit misleading, and I always have to issue a caveat, because the economy is about much more than consumers, but still. Consumer spending had previously been estimated to have increased at a 1.5% pace. A sluggish start to the holiday shopping season offered another reason for caution on the economy's near-term prospects. Several big retailers reported disappointing November sales, with some relying on bargains to lure shoppers. And so, there is a strong possibility businesses will still have inventory on the shelves after the holidays, and there will be no need for new orders to replenish the stocks, and that will likely weigh down GDP growth in the fourth quarter and into the New Year.

Consumers are holding onto the purse strings. Some companies that reported sales gains had to offer more bargains to attract shoppers. The need to keep discounting, which stems from sagging consumer confidence and shoppers trained to wait for bargains, will persist through the remainder of the season. Retailers have created this expectation; just check your inbox; I'll bet you're getting more and more promotional e-mails from national chains. Why rush when there might be a better deal next week.

Meanwhile, the Commerce Department reported that after-tax corporate profits in the third quarter increased at a 2.6 percent pace in the third quarter, slowing from the prior quarter's 3.5 percent pace. So profits are still growing, quite nicely, but they are growing slower. Dividends decreased $179 billion in the third quarter, in contrast to an increase of $273 billion in the second; part of that decrease is from dividends paid by Fannie Mae to the federal government in the second quarter.

The knee jerk reaction on Wall Street was that the GDP number was stronger than estimates and Wall Street looks at good news as bad news, based upon the idea that the Fed will taper from Quantitative Easing; that speculation was enough to push treasury yields to 3-month highs, but a closer examination of the numbers shows the GDP numbers to be a little less than robust. Atlanta Federal Reserve Bank President Dennis Lockhart summed it up by saying: "I am not prepared to interpret the revised third quarter number as an indication that the economy is on a much stronger track."

Another number in the report was the price index for gross domestic purchases, which came in at 1.8%, up 0.2% from the second quarter. These measures of inflation are important because the Fed has repeatedly promised not to raise the so-called fed funds rate, now at nearly zero, until the jobless rate falls below 6.5% or inflation rises above 2.5%; those are the thresholds, rather than the targets. The Fed has targeted an inflation rate of 2%; that would be the sweet spot. And as long as inflation remains below target, that provides justification to keep the fed funds target rates in the zero range.

Why is that important? Markets are jittery about the Fed starting the process of ending some $85 billion in bond purchases each month. The purchases of Treasurys and mortgage-backed securities are meant to keep interest rates low and stimulate the economy. The tapering of bond purchases, however, is likely to trigger an increase in interest rates of all kinds and that could dampen economic growth. When the Federal Reserve first hinted during the summer that it would soon scale back, mortgage rates surged and interest rates also rose in many developing countries.

A new research report by the Cleveland Fed indicates that when the inflation rate remains low, it would be justification for the Fed to maintain its Zero Interest Rate Policy. In other words, the Fed will try a balancing act; keeping the fed funds rate lower for longer, to ease the worries of investors and let the economy more gradually acclimate to a future that at some point, might include higher interest rates.

An interesting point to ponder is that inflation remains tame, perhaps even disinflationary, even as the stock market has moved to record highs. Now you might suspect that a rising stock market, even a frothy stock market, even a bubblicious stock market might have an inflationary impact on the economy; then again, maybe not. Here we are in a stock market boom, and deflation is a greater concern, and apparently a guide for Fed policy. Go figure.

Today, the European Central Bank and the Bank of England left interest rates unchanged. Deflation is a big concern in the Eurozone. Producer price inflation (PPI) fell to -1.4% in the eurozone in October. This is how deflation becomes lodged in the price chain. Prices are sticky for a while as you approach zero inflation, but once you break through the ice into deflation things can move fast; an example would be Greece.

We seem to have a glut of things, and you know the old story about supply and demand. China's fixed capital investment over the past year has been $4 trillion; that represents an 8 fold increase in the past 10 years, and it compare with $3 trillion for the entire EU and $3 trillion for the US. China is a vast new source of supply for a saturated global economy. Meanwhile, today's data on GDP suggests US businesses are a bit saturated as well. Europe's slide towards deflation is replicating what happened in Japan in the 1990s at the onset of its lost decade.

Japan is now fighting back with a strong monetary stimulus program called Abenomics, an easy money policy after the abject failure of a tight money policy. The result of tight money was that fiscal policy had to carry the entire burden instead. Budget deficits exploded as Japan battled the slump. Public debt ballooned to 245% of GDP. ECB President Mario Draghi says the central bankers are fully aware of downside risks of protracted low inflation. The ECB has been behind the curve for most of the past three years, needlessly causing a double-dip recession that caused havoc to public finances; so I guess its no surprise they took no action today.

In other economic news, the Department of Labor released its weekly jobless claims report this morning, and these results were also better-than-expected. Seasonally-adjusted claims fell by 23,000 to 298,000, significantly beating the 320,000 claims economists had predicted. Combined with yesterday's ADP payroll report, this would seem to bode well for tomorrow's monthly jobs report, but this weekly claims report was over the Thanksgiving holiday week, and the results might be slightly distorted. Still, it was the third straight weekly drop in initial claims. Not bad.

Look for 180,000 new jobs and the unemployment rate to go from 7.3% to 7.2%.

Regulators are reportedly ready to approve a tough version of what is known as the "Volcker Rule," part of the Dodd-Frank financial-reform act, which prohibits banks from proprietary trading, which is fancy talk for "gambling with their own money." Regulators were originally planning to leave a big loophole in the Volcker Rule by letting banks do what's known as "portfolio hedging”. This is basically proprietary trading by another name, because it lets banks claim that any kind of trading they do is hedging against losses somewhere in their massive, multi-trillion-dollar portfolios.

One reason why the Volker Rule might actually have teeth is the London Whale. Remember the $6 billion loss that was, according to Jamie Dimon, a portfolio hedge? Not exactly. Bankers warn that this version of the Volcker Rule means mega-banks will not be able to protect themselves from future economic calamities, which means they have no choice but to get smaller and take fewer risks.

Sounds about right.