Thursday, April 10, 2014 - Mr. Toad’s Wild Ride

Mr. Toad’s Wild Ride
by Sinclair Noe

DOW – 266 = 16,170
SPX – 39 = 1833 (-2.1%)
NAS – 129 = 4054 (- 3.1%)
10 YR YLD - .06 = 2.62%
OIL - .20 = 103.40
GOLD + 5.80 = 1319.10
SILV + .19 = 20.13

If you want to know why the stock market is up one day and down the next, and not just little moves but triple digit swings – I don’t know. If anybody says they know, they probably don’t. Maybe it’s the Fed, maybe it is earnings reporting season, maybe it’s a strong economy or a weak economy, or maybe the markets are just trying to imitate Mr. Toad’s Wild Ride. The one thing we know is that stock prices fluctuate, and over time a pattern or trend develops; right now things are wobbly.

In economic news, the Labor Department said that the number of people applying for unemployment benefits dropped to 300,000, the lowest level in nearly seven years.

The Treasury Department says the federal budget deficit for the first half of the 2014 fiscal year totaled $413 billion, down $187 billion from where it stood at this point last year, as tax revenue surged and spending sank.  In March, the Treasury collected $216 billion in taxes, up 16% from a year ago, helping reduce the deficit for March to $37 billion from $107 billion last year. 

Meanwhile, spending sank by 14%, or $40 billion; military spending has been cut, federal government jobs have been cut, and Fannie Mae and Freddie Mac are no longer a drain but rather a contributor to the Federal coffers. Tax receipts have been increasing as the stock market improved (not necessarily today but remember last year was strong). Also, the economy has been better, not great but better. 

The budget gap last month was the smallest deficit recorded for the month of March since 2000. Over all, the deficit is expected to equal 4.1% of gross domestic product in 2014, down from nearly 10% in 2009, during the depths of the recession. It is the fastest four-year reduction in deficits since the demobilization after World War II.

California is sinking. Scientists estimate that the Central Valley accounts for about 20% of the groundwater that is pumped in the nation. It's the lifeblood of the flourishing agriculture industry, producing crops from almonds to plums, nectarines and cotton. And the water to irrigate is pumped from aquifers that are not being replenished by rainfall.

The US Geological Survey published a study that found that 1,200 square miles of the Central Valley were sinking half-an-inch per year, but the rate is not consistent everywhere. The town of El Nido, just south of Merced sank almost a foot a year between 2008 and 2010. A foot a year is not sustainable. You can’t really mitigate against a foot a year.

Farmers are digging deeper wells, and as the water is pumped out of clay aquifers, the earth above falls to fill the void, and the clay compresses. It’s called subsidence. The land sinks and the compressed clay cannot hold as much water as it once did. Once subsidence happens there is no way to undo it.

About 30% of California’s water supply comes from underground supplies, more during droughts, and about 80% of state residents rely to some degree on groundwater. Some towns, cities and farming operations depend entirely on it. And it has been a problem for a long time. Three generations ago, so much groundwater was pumped from aquifers that half the valley sank like a giant pie crust, sagging 28 feet near Mendota and inflicting damage to irrigation canals, pipelines, bridges, roads and other infrastructure.

The sinking only stopped because of 2 massive government funded irrigation projects, the federal Central Valley project and the California State Water project, which flooded the region with water from distant mountains and relieved pressure on the natural underground water supply. Now, the drought and climate change have opened up a new era of groundwater pumping. The result is the ground is sinking and the land subsidence is perhaps the worst ever seen in California.

This causes multiple problems for infrastructure. Dams and irrigation canals rely on gravity to move water, but when the ground sinks, the water doesn’t always flow as expected.  Flood safety is another concern; flood control channels might not perform as expected as levees sink. Bridges sag; well casings fail; and then there is the issue of the state’s multi-billion dollar high-speed rail line plotted to run through an area that is sinking by about a foot a year.

While the San Joaquin Valley faces the worst problems of land subsidence, other regions of California are dealing with similar problems on a smaller scale. The USGS has been studying sinking ground in the Coachella Valley for years in conjunction with the local water district. In a 2007 USGS study, researchers determined that the ground had subsided up to 4 inches in parts of La Quinta, with smaller effects in parts of Palm Desert and Indian Wells, during a year-and-a-half period from 2003 to 2005.In the Coachella Valley, the ground has sunk in some places where groundwater levels have fallen. Uneven settling has cracked the foundations of houses and fractured walls, swimming pools and roads.

After years of drought, water tables are dropping fast. Well-drilling costs are soaring. The biggest problem is the gradual, irreversible compaction of the earth that occurs when aquifers are pumped to historic lows. It doesn’t make the aquifer unusable. It just reduces the amount of water that can be stored in it, now and in the future.

The Basel Committee on Banking Supervision released its final ruling on just how much derivatives traders have to hold in reserve to pay off on defaults. International regulators are trying to safeguard trades and bring more openness to a $700 trillion market, known for its secrecy.

Swaps are what investors use to help guard against risk (at least theoretically). They’re bought by pension plans and retirement funds to protect against fluctuations in interest rates, meaning they affect most people who own annuities. They’re used by the US government to limit exposure in the mortgage market and cut home-loan costs. Investors can also hedge an investment in a company by buying a swap that will pay them if a borrower stops paying its debts. They’re called swaps because investors and banks exchange, or swap, payments over time based on how interest rates move or how the creditworthiness of companies changes.

Think of it as a form of insurance, with a few major exceptions; swaps do not require an insurable interest. For example, you can buy life insurance for your spouse and your spouse can buy life insurance on you because you have an insurable interest in each other. Your doctor can’t buy a life insurance policy on your life because your doctor does not have an insurable interest. And when you think about it that is a good way to approach insurance. Otherwise, your doctor might buy an insurance policy on your life and then bet against you; which is essentially what many people did with swaps in the financial crisis; they bought insurance on mortgage debts betting mortgages would default.

More frequently, swaps dealers sold swaps to people or entities who didn’t need the swaps or didn’t understand the swaps; for example the city of Detroit or the nation of Greece; they bet interest rates would go one way, and then they took on more debt than was prudent and when rates turned, they lost everything. Swaps made bankers billions of dollars before helping to blow up the global economy in 2008.

The other significant difference between swaps and insurance is that insurance companies must have reserves to pay claims. Swaps dealers, not so much; and so when defaults happen, the swaps contracts have a nasty history of not covering the risks they are supposed to cover. In other words, they never paid their claims.

After the crash, regulators set to work to make them less dangerous, through changes that in the process would make them less profitable. Where swaps had been one-on-one deals before, now they would be backstopped by third parties in clearinghouses that ensure everyone can pay, with the aim of avoiding emergency bailouts and panic. And the new Basel Rules now applies a minimum 20% risk weighting to money deposited at clearinghouses, which are third parties that guarantee the transactions. Note that is not a 20% in actual reserves, just a 20% risk weighting on money deposited at clearinghouses; big difference.

Today’s edition of “Banks Behaving Badly” features a hedge fund, SAC Capital Advisors, run by Steven A. Cohen. A judge has accepted a guilty plea from the hedge fund firm as part of a $1.2 billion criminal settlement for insider trading. In total, SAC Capital has agreed to pay $1.8 billion to resolve criminal and civil probes into insider trading. The Department of Justice said that payout is the largest insider trading settlement in history. The judge said: "These crimes clearly were motivated by greed, and these breaches of the public trust require serious penalties."

Now here is the peculiar part; if these breaches of the public trust require serious penalties why would they not include prison time? The answer is that you can avoid prison if you can pay enough money. SAC Capital has lots of money. Manhattan U.S. Attorney Preet Bharara said: "Today marks the day of reckoning for a fund that was riddled with criminal conduct." Not exactly. Today marks the day SAC Capital writes a check and continues on; that does not constitute a day of reckoning.

Friday, December 27, 2013 - Fooled Again

Fooled Again

by Sinclair Noe

And now we present the curious case of Michael Steinberg. Not familiar? That's understandable; Michael Steinberg is a convicted felon, securities fraud and conspiracy, specifically insider trading. Steinberg is a close personal friend and former trader with Steven A. Cohen. You've likely heard that name. Cohen is the billionaire, stock picker who runs SAC Capital hedge fund; recently fined $1.2 billion by the SEC for insider trading and not maintaining adequate supervision of his employees. Cohen has not been charged as an individual.

Eight SAC employees have been criminally charged; six have pleaded guilty and are cooperating with the government; one faces trial in January; Steinberg just lost his trial, and when the verdict was announced, the fellow fainted. The other guy who faces trial in January fainted when he was arrested. It's a bit funny, a bit pathetic. Steinberg faces a maximum of 85 years but that won't happen. Still, it looks like a potential case against Cohen could gain traction.

The US Attorney's Office in Manhattan has secured 77 insider trading convictions since 2009, without losing a single case. Jurors are capable of understanding insider trading. It's a fairly simple form of cheating. Jurors are also capable of understanding more complex forms of cheating. The markets are rigged by cheaters, in the form of insider trading and other, more complex scams. There are many honest people who earn god livings in the markets, but there are plenty of cheaters. The prosecutors aren't even going after the folks on the other side of the insider trades; someone supplied information on Weight Watchers, Gymboree, Dell, Nvidia, and Intermune (and others). At some point, those people expected something for their information. There is an old saying: if you can't identify the “mark” at a poker table, it's you.

No need to actually sit at the table with big time hedge fund types – you're still the “mark”. Just look at what's happening in Detroit. I knew it was just a matter of time until we started hearing more about how the big banks bet against Detroit; slowly but surely the information is oozing out as the vultures fight over the carrion.

Detroit, of course, has many problems, long standing problems. Back in 2005, Detroit's pensions were underfunded to the tune of $1.44 billion. Then-mayor Kwame Kilpatrick and other city officials set up nonprofit entities and corporations to issue the debt, and bought interest rate swaps as a hedge against rising interest rates (more precisely, they were sold interest rate swaps). Interest rates then dropped to the lowest levels in history; they lost the bet. Detroit owes the holders of the swaps the difference between the interest rates, adding to the pensions' underfunding by as much as $770 million over the next 22 years. Essentially, the politicians and banks gambled with the city's debt, and that bet may have exceeded legal limits on the debt; raising the question of whether the illegal bet is valid. There will probably be lawsuits.

And now that Detroit is in bankruptcy, the unelected emergency manager of Detroit, Kevin Orr, worked out a tentative deal to pay the UBS AG and Bank of America Merrill Lynch Capital Services more than $300 million in “secured debt”. Those banks are considered secured creditors because Detroit put up revenue from three casinos as collateral for the loan; which is now the only stable source of revenue for Detroit. The initial settlement would given the banks about 80 cents on the dollar of what they are owed, compared to 16 cents on the dollar that Orr has offered to retirees for their pensions. The judge told attorneys for Orr’s team to renegotiate the casino money deal because every deal the city has made relating to the swaps “has been made with a gun to its head”.

And so they went back to the table, and they have come up with a new deal, an incrementally better settlement that leaves much of the original structure intact. If the deal is approved by federal bankruptcy Judge Steven Rhodes, Detroit would get out of the swaps deal for about 56 cents on the dollar, get $120 million in cash to bolster city services and free up casino revenues, crucial to the city’s ongoing operations, that were used to secure a previous renegotiation of the swaps deal in 2009. Detroit might be smart to argue that the two major issues with the swaps in the bankruptcy proceeding: whether the swaps are secured debt, and whether the deal was legal in the first place. A favorable ruling for the city on either matter could result in a far better outcome than what has been agreed to.

Over the past five years Detroit has reduced its salary expenses by 30 percent. More than 2,350 public jobs have been cut, accelerating the city’s already notable pace of deterioration. Far from uncontrollable, the cost of health benefits for the city’s public workers and retirees has risen more slowly than the national rate of 4 percent a year. Since 2008, Detroit has reduced its spending by more than $400 million. In the same period, city revenues have fallen by nearly $260 million, with a steep decline after 2011. This decline, rather than its pension obligations, more than accounts for the city’s projected deficit this year of $198 million.

One consequence of these cuts is that public services like transportation, infrastructure maintenance and education are barely functioning. And yet there is one expense that has, so far, been spared: service fees on derivatives that were sold to the city by banks backed by UBS and Bank of America. In fact, these fees are the only significant increase in spending over the past five years. There have been many numbers tossed about in the Detroit bankruptcy, including the claim that the pensions are underfunded by $3.5 billion, but by some calculations, if you strip out the wheeling and dealing, the actual underfunded amount may be closer to $800 million. The public sector pays for the mistakes of the financial sector, and observers are led to believe that the basic promise of retirement is the city’s problem.

This isn't the first time the “swaps” problem has hurt municipalities, we also have examples from Montgomery County, Alabama and San Bernardino, California, and at the core is the question of whether pensions, secured by 20, 30, or 40 years of work are more or less secure than bets by banks. A new report by the Center for Retirement Research at Boston College indicates that costly pension promises are not the major cause of municipalities weak financial conditions. The researchers compared 32 cities that have recently made headlines as they struggle with serious budget problems to a list of 149 other cities that are in relatively good financial shape. "When identifying the source of the problems, fiscal mismanagement leads the list," the study's authors found. "Economic problems, in large part a response to the financial crisis and ensuing recession, come in second." And, "In many cases pension were a contributing factor, but they weren't the driving factor in the fiscal challenges these cities are facing."

Our next story takes us to Switzerland, where 300 Swiss banks are working to meet Department of Justice year-end deadline to put a stop to tax evasion by American clients. Banks with reason to believe they violated tax laws can ask the DOJ to waive prosecution if the banks disclose how they helped Americans hide assets, and the banks will be required to hand over data on undeclared accounts, and pay penalties. If the banks don't apply for waivers and cooperate, then the banks and their customers could face criminal probes.

To gain the non-prosecution deals the banks must pay 20% of the value of accounts not disclosed by August 2008, 30% for accounts opened between August 2008 and February 2009, and 50% for accounts opened afterward. Fourteen Swiss banks are already part of criminal investigations. The crackdown on tax cheats really took off back in 2009, when the US charged UBS, the biggest Swiss bank, with aiding Americans in hiding some $20 billion in assets. UBS admitted it fostered tax evasion; they paid $780 million in fines; they avoided prosecution.

The banks are complaining, whining really, that the penalties are too high. Some Swiss banks may decide to opt-out of the non-prosecution deal, but that comes with a risk. Nearly 40,000 clients told the IRS all about their offshore accounts so that they might avoid prosecution. If it is later learned that some of those clients had accounts with banks that skipped the non-prosecution deal, it would seem like a slam dunk case against the bank. One area that still seems confusing is how to treat multinational corporations with headquarters in the US but offices in Switzerland.

You might think the decision to opt-in to the non-prosecution deal would be simple because the banks aren't really paying a penalty; the money comes from client accounts; it isn't really the banks' money; it is the clients' money. Of course this is not how banksters think. Once the money is in the banks' account, it becomes their money; it is capital they can leverage, and then use to trade.

Just a reminder, we're talking about tax evasion, the same crime that brought down Al Capone. Imagine some petty thief robs the local liquor store and steals a case of beer; he won't get a non-prosecution deal by just handing over a few beers to the cops. Meanwhile, two Swiss banks, Wegelin and Bank Frey, have already gone out of business; and UBS estimates several more will likely close in the coming year. Tax evasion is the business model of the Swiss banks; without it they really can't function. The practice has become institutionalized over time. There is a much older model for taxation: render unto Caesar.

We “celebrated” the Federal Reserve's 100^th anniversary on December 23. Of course, we could probably eliminate taxes if we could just come up with a better central bank. The government, if it and not the Fed was in control of its money supply, could spend as needed to meet its budget, drawing on credit issued by its own central bank (not the Fed); it could do this until price inflation indicated a weakened purchasing power of the currency. Then and only then, could the government need to levy taxes; and the need for taxes would not be to fund the budget but to counteract inflation by contracting the money supply.

In 1977, Congress gave the Fed a dual mandate, not only to maintain the stability of the currency but to promote full employment. The Fed also has another job, as a regulator of the banking system; and as a regulator, it is an abysmal failure; worse than an atheist priest.

There is a discipline in economics known as the “theory of repeated games” and the basic idea is that if you repeatedly cheat at a game, then it increases the likelihood that I will retaliate by trying to cheat you. Of course that is just a theoretical game. In the real world, I might just stop playing your game. When corruption and cheating permeates a society, everything starts to break down, fairness and trust turn to dust and the vacant, crumbling buildings of Detroit.

You have probably invested through Wall Street at some time or another, and yet we know that insiders rig the game; they cheat to fatten their own wallet at your expense. We know that the banks change the laws to make their wagers more “secure” than the pensions of retired cops and firefighters. Even the new deal for Detroit values banks bets at 56 cents on the dollar but pensioners would only get 20 cents on the dollar. Ah, but you might not have a public pension, so you are not concerned. Do you have a private retirement account? A 401k or IRA? The banksters have no more respect for private accounts than public accounts.

Political and economic inequality go hand in hand with a two-tiered justice system, and at the root of the rot are the banksters, cheating the system, lying on a grand scale, and doing it all with impunity. Maybe 2014 could be the year when we won't be fooled again. Best wishes for the New Year.

Thursday, October 17, 2013 - No Winners, No Free Lunch

No Winners, No Free Lunch

by Sinclair Noe

DOW – 2 = 15,371
SPX + 11 = 1733
NAS + 23 = 3863
10 YR YLD - .08 = 2.58%
OIL – 1.59 = 100.70
GOLD + 37.40 = 1321.10
SILV + .47 = 21.99

The S&P 500 closed at a record high. We don't celebrate a record high on the S&P. When the Dow hits a record high we have milk and cookies. No particular reason, we just don't celebrate.

“There are no winners here,” that was the declaration from President Obama this morning. He then cited the damage done: families going without paychecks, home buyers and small businesses unable to get loans, consumers cutting back on spending, businesses pushing back hiring plans, and increased borrowing costs which add to the deficit.

Washington’s budget battle could result in a $24 billion hit to the US economy. That estimate comes courtesy of ratings firm Standard & Poor’s; they say the 16-day government shutdown and the wrangling over the debt limit shaved at least 0.6%, maybe a full point, off fourth quarter GDP growth. They had been estimating 3% annualized growth in the fourth quarter; now they peg it at 2%. The $24 billion loss is substantial, especially for a self inflicted wound.

But wait, there's more. Macroeconomic Advisers says the whole fiasco likely cost 900,000 jobs and possibly more in the months ahead. And one of the little noticed side stories is that the fiscal cliff inspired sequestration cuts, inspired by the debt ceiling debates of 2011, which cut the country's credit rating, and instituted on the edge of the fiscal cliff from earlier this year; those cuts are still in place. Along with an improving economy, those steps helped U.S. budget deficits fall from 8.7 percent of GDP in the 2011 fiscal year to an anticipated 3.9 percent of GDP for the fiscal year that ended on September 30. But this has all come at a steep cost.

The Congressional Budget Office estimates that the economic benefits of eliminating sequestration “would increase the level of real (inflation-adjusted) gross domestic product (GDP) by 0.7 percent and increase the level of employment by 0.9 million in the third quarter of calendar year 2014 (the end of fiscal year 2014) relative to the levels projected under current law.”

Spending cuts and tax increases since 2011 have cut the deficit by about $3.9 trillion over the next ten years. The sequester accounts for $1.2 trillion of that, about a third of the total. So a rough horseback guess suggests that the total effect of our austerity binge has been a GDP reduction of 2 percent and an employment reduction of nearly 3 million.

If the economy were running at full capacity, deficit slashing wouldn't have this effect. It would be perfectly appropriate policy. Unfortunately, Republicans don't believe in cutting spending during good times and increasing it during bad times. They believe in cutting it during Democratic presidencies and increasing it during Republican presidencies.

Mark Zandi, chief economist at Moody's says: "Increasingly I'm of the view that the reason why our economy can't kick into a higher gear is because of the uncertainty created by Washington." Zandi estimates the fiscal austerity has cost 2.25 million jobs. Without those measures, the unemployment rate would stand at 6.3 percent now rather than 7.7 percent.

"Reckless", that's the word from Richard Fisher; “reckless” fiscal policy will likely force the Federal Reserve to stand pat on monetary policy this month. Richard Fisher, the hawkish president of the Federal Reserve Bank of Dallas, said that the fiscal standoff means even he would find it difficult to make a case for scaling back bond purchases at the Fed's policy meeting on October 29-30. Fisher said taper is not in play because, "This is just too tender a moment."

There are a number of factors the Fed would need to consider in deciding when to pare its $85 billion in monthly purchases of Treasuries and mortgage bonds. The government will release the September jobs report on Tuesday; you'll recall it was postponed due to the shutdown. The Fed will have to digest a great deal of data in a short time before their FOMC meeting on the 29^th; and it will be impossible to assess the full damage of the Fiscal Fiasco, without allowing more time to let everything settle. Then the Fed is scheduled to meet in December; maybe the Fed could taper by then, but they will likely wait to see if lawmakers squander the opportunity presented by the December budget conference committee to agree on measures that enhance short-term growth prospects and longer-term fiscal reforms, while simultaneously removing a recurrent threat of government shutdown and default.

Meanwhile, and notwithstanding the earlier taper talk, the Fed may now have no choice but to stay longer in its intense policy experimental mode; due both to the likelihood of weaker data and to a perceived need to take out insurance for the economy against future political dysfunction. It appears individuals and companies are postponing important decisions, and this will likely lead to lower consumption, less buoyant hiring, and fewer investments in capital expenditures like equipment and buildings, and all that ahead of the economically vital holiday season. Call it self insurance, or merely erring on the side of caution.

It's earnings reporting season. While companies are generally reporting healthy earnings for the third quarter, an unusual number have been warning that the fourth quarter is not going to look as good, in part because of the political turmoil. Of the 105 companies in the S&P 500 that have reported earnings so far, 68 have provided negative guidance.

Today, IBM reported third quarter earnings with a revenue miss of nearly $1 billion, sparking a sell-off in after-hours trading. The company blamed most of the revenue shortfall on a 40% drop in hardware sales in China, as the country gets ready to implement a new economic plan in November.

Google reported a third-quarter profit of $2.97 billion, or $8.75 a share, compared with a profit of $2.18 billion, or $6.53 a share, for the year-earlier period.

JPMorgan has agreed to pay $100 million in fines and make a groundbreaking admission of wrongdoing to settle an investigation into market manipulation involving the bank’s multibillion-dollar trading loss in London, underscoring how far the bank was willing to go to put the blunder behind it. The fine is nothing; the admission of guilt is significant. The trading commission charged the bank with recklessly “employing a manipulative device” in the market for swaps, financial contracts that allowed the bank to bet on the health of companies. The swaps are similar to insurance, but anyone can buy, you don't have to have an insurable interest. Think about your doctor buying a life insurance policy on your life. Not comforting is it?

Steven A. Cohen's SAC Capital Advisors and prosecutors have agreed in principle on a penalty of at least $1 billion to settle a criminal insider trading investigation against the hedge fund. The potential settlement would give Cohen's firm credit for agreeing to pay more than $600 million to settle a civil lawsuit filed earlier this year against the firm by the Securities and Exchange Commission. The hedge fund and prosecutors have yet to resolve other issues such as whether the firm will admit any wrongdoing and whether Cohen may be prohibited from managing money for outside investors.

SAC Capital is in the process of returning much of the $5 billion in outside money it manages for others. About $6 billion of the firm's money belongs to Cohen and his employees.

Mark Cuban was cleared by a Texas jury of using a private tip to avoid a big loss on his 2004 sale of Internet company shares. Cuban, 55, the owner of the Dallas Mavericks basketball team, lashed out at the U.S. government and lead prosecutor Jan Folena after the verdict, saying the government had tried to bully him. The SEC brought the insider trading civil lawsuit against Cuban in November 2008. A judge dismissed the suit in 2009 but an appeals court revived the case the following year. Cuban refused to settle the case and went to trial, even though he said on Wednesday that he had spent more on fees for lawyers than the possible fines for admitting to insider trading. He could have faced up to $2 million in fines.

Taco Bell and McDonald's are welfare queens. They force taxpayers to pay for what they are unwilling to pay their workers. 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 theUniversity 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.

There is no free lunch. There is not even, really, a Dollar Menu.

Thursday, August 01, 2013 - From Russia With Love

From Russia With Love

by Sinclair Noe

DOW + 128 = 15,628
SPX + 21 = 1706
NAS + 49 = 3675
10 YR YLD + .13 = 2.72%
OIL - .08 = 107.81
GOLD – 14.30 = 1309.90
SILV - .18 = 19.73

Record highs for the Dow and the S&P 500 indices.

Economic data today from the Institute for Supply Management; its index of national factory activity rose to 55.4 last month from 50.9 in June, with increases in new orders and production. A reading above 50 indicates expansion in the sector, which hit a soft patch in the spring.

The pick-up in manufacturing was also corroborated by financial data firm Markit, which said its U.S. Manufacturing Purchasing Managers Index rose to a four-month high in its final July reading. Measures of factory jobs rose in both reports, with the ISM employment index reaching its highest since June last year.

The improvement in employment is in line with a separate report from the Labor Department showing initial claims for state unemployment benefits dropped 19,000 to a seasonally adjusted 326,000 last week, the lowest since January 2008. In another report, consultants Challenger, Gray & Christmas said planned layoffs at U.S. firms fell 4.2 percent in July.

Tomorrow morning we'll get the government's monthly jobs report. The government is expected to report nonfarm payrolls increased 185,000 last month after rising 195,000 in June. And the unemployment rate might inch down to 7.5%. Overall job gains in the second quarter averaged 196,300 per month.

A federal court ruling on Wednesday paves the way for a further reduction in the interchange fees (also known as “swipe” fees) that banks levy on merchants for debit cards. It is a victory for retailers, who protested that the 2010 Dodd-Frank financial law, which lowered the fees from 44 cents to 21 cents per transaction, didn’t go far enough. Now, U.S. District Court Judge Richard Leon has essentially scrapped the 21-cent limit and set the stage for an even lower amount, though it may be months, if not years, before any changes are made to the existing cap.

But if changes are indeed made, it could be consumers who ultimately pay the price for banks’ potential loss of billions of dollars in “swipe” fees. As banking industry experts note, the revenue has to be replaced, so higher overdraft penalties and account maintenance charges are all possible. And ultimately, the very existence of debit cards could be in doubt, even if consumers still embrace them as a way to instantly tap into their checking accounts when they reach the cash register.

Russia has granted American fugitive Edward Snowden asylum for a year, allowing the former US spy agency contractor to slip quietly out of Moscow's airport after more than five weeks in limbo.

The White House, which wants Snowden sent home to face trial for leaking details of government surveillance programs, signaled that President Barack Obama might boycott a summit with President Vladimir Putin in Moscow in September and one official said high-level talks next week were "up in the air".

White House spokesman Jay Carney said: "We see this as an unfortunate development and we are extremely disappointed by it. We are evaluating the utility of the summit."

Snowden has avoided the hordes of reporters trying to find him since he landed from Hong Kong on June 23, and gave them the slip again as he left the transit area where he had been holed up. Almost unnoticed, he was driven away from the airport by car.

Snowden, whose first leaks were published two months ago, was quoted as saying by the WikiLeaks anti-secrecy group which has assisted him, that: "Over the past eight weeks we have seen the Obama administration show no respect for international or domestic law but in the end the law is winning," And he thanked the Russians for granting asylum.

A Russian lawyer assisting Snowden said he had gone to a safe location which would remain secret, and that he could now work and travel freely in the country of 142 million.

State television showed a picture of Snowden getting into a grey car at the airport accompanied by Sarah Harrison, a WikiLeaks legal researcher. Wikileaks release a statement saying, “We have won the battle – now the war.”

Meanwhile, Glenn Greenwald, the reporter with the British newspaper, the Guardian, is out with another story compliments of Snowden; this one is titled “Xkeyscore: NSA tool collects nearly everything a user does on the internet”

A top secret National Security Agency program allows analysts to search with no prior authorization through vast databases containing emails, online chats and the browsing histories of millions of individuals. The NSA boasts in training materials that the program, called XKeyscore, is its "widest-reaching" system for developing intelligence from the internet.

The files shed light on one of Snowden's most controversial statements, made in his first video interview published by the Guardian on June 10.

"I, sitting at my desk," said Snowden, could "wiretap anyone, from you or your accountant, to a federal judge or even the president, if I had a personal email".

US officials vehemently denied this specific claim. Mike Rogers, the Republican chairman of the House intelligence committee, said of Snowden's assertion: "He's lying. It's impossible for him to do what he was saying he could do."

But training materials for XKeyscore detail how analysts can use it and other systems to mine enormous agency databases by filling in a simple on-screen form giving only a broad justification for the search. The request is not reviewed by a court or any NSA personnel before it is processed.

Under US law, the NSA is required to obtain an individualized Fisa warrant only if the target of their surveillance is a 'US person', though no such warrant is required for intercepting the communications of Americans with foreign targets. But XKeyscore provides the technological capability, if not the legal authority, to target even US persons for extensive electronic surveillance without a warrant provided that some identifying information, such as their email or IP address, is known to the analyst.

Meanwhile, three US senators announced bills today that proposed the most sweeping structural changes to the secret court that oversees the legal basis for surveillance activities since it was set up 35 years ago.

Senators Richard Blumenthal of Connecticut, Ron Wyden of Oregon and Tom Udall of New Mexico, all Democrats, want a special advocate for Americans' privacy to argue before the Fisa court when the government seeks extraordinary surveillance requests. They also propose to diversify the powerful secret court ideologically and geographically.

A separate measure from the three senators would still allow the chief justice of the US supreme court to select the Fisa court judges, but would require him to pick them from nominations brought by the chief judges of the US federal circuit courts. The court's membership would expand to 13 judges, essentially representing each of the federal courts nationwide, from the current 11.  Currently, the Fisa court has only one petitioner: the government. In its 35-year history, it has rejected 11 out of more than 34,000 surveillance requests.

Yesterday, Private Bradley Manning was convicted on multiple counts of violating the Espionage Act (which could result in 136 years of prison) but was found not guilty of the most serious charge against him, "aiding the enemy."

Manning was found guilty of leaking - which he admitted to and will not get anything like 136 years for - but that he was found not guilty of "aiding the enemy." That "not guilty" is a good thing, it means Manning is not guilty of treason. The fact that the government would even pursue it is chilling to a free press. Under the prosecution's Orwellian logic, essentially any classified information given by a whistle-blower to a journalistic outlet (whether WikiLeaks or the Times, which published Manning-WikiLeaks revelations) amounts to treason if "the enemy" can read it. Well, the enemy, whomever it may be at any given moment, can read anything it wants on the Internet, the government can (and does) stamp its every embarrassing action "classified," and so almost any revelatory investigative reporting on national security (the Pentagon Papers, the Abu Ghraib revelations, you name it) could in principle lead to the death penalty. It makes you wonder what the government is hiding.

It also makes you think about investigative journalism. Compare the coverage of the Bradley Manning trial to the trial of Jodi Arias or George Zimmerman. What passes as news is pathetic.

So, I leave you with these words from Thomas Jefferson: "Our liberty cannot be guarded but by the freedom of the press, nor that be limited without danger of losing it."

Let's go to the police blotter.

A jury found former Goldman Sachs Group Inc vice president Fabrice Tourre liable for fraud for his role in a failed mortgage deal that cost investors $1 billion. The SEC had accused Tourre in a civil lawsuit with misleading investors in a product known as Abacus 2007-AC1 by failing to disclose that hedge fund billionaire John Paulson helped choose, and intended to bet against, mortgage securities underlying the 2007 deal.

It also alleged that Tourre misled ACA Capital Holdings Inc, a company also involved in selecting assets for Abacus, into believing Paulson & Co would be an equity investor in the synthetic collateralized debt obligation.Paulson went on to make billions of dollars in 2007 betting against the U.S. housing market.

The SEC said he made about $1 billion from his short position on Abacus, while investors including ACA and IKB Deutsche Industriebank lost about the same amount.

Goldman agreed in July 2010 to pay $550 million to settle with the SEC over Abacus, without admitting or denying wrongdoing. Tourre parted ways with Goldman in 2012, but the bank paid for his legal defense. So, the headline will read that the “SEC scores a conviction in an important case dealing with fraud on Wall Street”, but it really should read “Goldman throws a Junior Staffer Under the Bus to Appease Regulators”.

Meanwhile, a federal judge gave final approval to a $590 million settlement by Citigroup that resolves a shareholder lawsuit accusing the bank of hiding tens of billions of dollars of toxic mortgage assets.

In the written opinion the judge wrote: "Although the $590 million recovery is a fraction of the damages that might have been won at trial, it is substantial and reasonable in light of the risks faced if the action proceeded to trial."

The settlement resolves claims by shareholders who purchased Citigroup shares from February 2007 to April 2008 that the New York-based bank misrepresented its exposure to securities known as collateralized debt obligations that were tied to mortgage investments. Citigroup lost $27.68 billion in 2008. The lawsuit cited the plunge in the company's stock price from $47.89 at the start of the fourth quarter of 2007 to $2.80 by January 2009.

The settlement was announced last August, but the judge had questioned the fairness of the settlement, and eventually awarded substantially lower fees and expenses than what was sought by the plaintiffs' lawyers.

And let's briefly check in on Wall Street's most infamous insider trader, Steve Cohen of SAC Capital. Earlier this year, when the SEC extracted $616 million from Cohen's fund in two regulatory settlements, he expressed his deep remorse by buying, within weeks, a $155 million Picasso and a $60 million beach house in the Hamptons, right down the road from his other Hamptons beach house, worth $18 million. Then in late July, Cohen was hit with two new major blows: a civil charge from the SEC and criminal charges filed by federal prosecutors against his firm, SAC Capital Advisors. The SEC charge, "failure to supervise," looked at first like a relatively tame thing to lay on a suspected criminal mastermind, with a lifetime ban from the securities business being the worst possible outcome. It looked like Cohen would skate without a criminal charge, which most would consider a huge victory, but the story is still unfolding because  the SEC filed its case through an administrative proceeding, not in civil court, Cohen will have limited rights to discovery, which would have helped him prepare his defense in any potential criminal cases. That's assuming the SEC actually pursues a criminal case. So far the SEC has been pretty spineless in its efforts to find justice on Wall Street.

The reason for the lack of serious efforts to prosecute wrong-doing are simple; the regulators don't want to upset their future bosses. The New York Times reports that the revolving door has been spinning fast, pushing former powerful regulators like Robert Khuzami (former SEC enforcement chief), Mary Schapiro (former SEC chief) and Lanny Breuer (former head of the Justice Department's Criminal Division) all the way from the halls of justice to the corner office in Fat City. All three are now out of government and in private practice representing those very Wall Street interests they once regulated - earning a combined annual income of more than $9 million. 

Friday, July 26, 2013 - Notes from the Favela

Notes from the Favela

by Sinclair Noe

DOW + 3 = 15,558
SPX + 1 = 1691
NAS + 7 = 3613

10 YR YLD - .01 = 2.56%
OIL - .82 = 104.67
GOLD - .30 = 1334.80
SILV - .26 = 20.09

Earlier in the week, the Dow and S&P hit record highs but the markets slipped; earlier today the Dow was down 150 points. For the week, the Dow rose 0.1 percent, the S&P 500 was flat (even as it hit a record) and the Nasdaq rose 0.7 percent.

It's Friday, and I have a bunch of notes and scraps that have been piling up, so we'll clean the desk, in no particular order.

The Thomson Reuters/University of Michigan's final reading on the overall index on consumer sentiment climbed to 85.1 from 84.1 in June, topping expectations for 84. It was the highest level since July 2007 and was also an improvement from July's initial reading of 83.9. Of course, if you paid a premium subscription, you could have had that information before the rest of the market.

Yesterday, I mentioned former Fed Chairman Paul Volker's remark that the only real financial innovation in the past 20 years was the ATM, which is actually about 30 years old now. And Volker wasn't quite right; the banks haven't done any real innovation but the hackers have. For nearly a decade, a band of cybercriminals rampaged through the servers of a global business who's who: Among the victims were 7-Eleven, Dow Jones, Nasdaq, JetBlue and JC Penney. Prosecutors say the hackers stole "conservatively" 160 million credit card numbers, and the dollar value of the crimes they helped facilitate is enormous; just four of the victims are out $300 million. The prosecutors say it's the largest data heist case ever and the suffering caused to identity theft victims was "immeasurable".

On Thursday, five of the gang's members were indicted. One is in custody in the US, a second is awaiting extradition in the Netherlands, and three more are still at large. Maybe if the banks paid more attention to providing a safe place to store money and a safe way to facilitate digital transactions, and if they spent less time trying to trade derivatives; maybe there could have been some financial innovation that actually was innovative.

The Federal Housing Finance Agency says the Swiss bank UBS has reached a settlement and will pay $415 million to the government-sponsored housing enterprises Fannie Mae and $470 million to Freddie Mac to resolve claims of misrepresenting the quality of collateral backing securities sold to Fannie and Freddie between 2004 and 2007.

The bank has already paid out $612 million to settle allegations of manipulating interest rates. UBS is now the third bank to settle with the FHFA after Citigroup and General Electric did so for undisclosed sums. UBS is just one of 18 banks the FHFA pursued in 2011 for allegedly lying about the quality of the collateral backing securities; essentially packaging subprime loans and selling them as a better quality.

 Home Affordable Modification Program or HAMP has been something of a disappointment nearly from its inception. After loudly touting the program’s ability to help 4 million borrowers, the administration was forced to concede it had barely helped a fraction of that number, or roughly 1.2 million mortgage modifications; and some advocates and administrators in the program actually came right out and declared the thing a failure. However, in recent months, we’ve been hearing a lot about how HAMP is finally getting going and hundreds of thousands of borrowers are getting the loan modifications that they need. What we haven’t heard until now, though, is just how many of them are re-defaulting on those loan modifications just months or years later; the number is now at 306,000.

I can see why many people think the HAMP program is a dud, but just to maintain perspective the Hope For Homeowners plan initiated by President Bush set aside $300 billion to refinance toxic loans and in 3 years time it managed to modify 71 loans; and the FHA-Secure plan managed to refinance 4,100 mortgages over a 3 year span. As far as the high number of re-defaults, the modification programs never dealt with the underlying problems, and for many, relief was just too little, too late.

One year ago today, Mario Draghi, the president of the European Central Bank spoke at an investment conference and he said:  "the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough." The speech seemed to revive markets and stave off what looked like an impending collapse. A few weeks later, Draghi introduced OMT, or Outright Monetary Transactions, a conditional bond buying program. Spanish and Italian bond yields stabilized, even though the ECB hasn't actually used OMT to actually buy bonds. Germany’s constitutional court is due to rule later this year on OMT’s legality under German law. The ECB hasn't exactly managed to forge a solid plan, and so the financial improvement has not been accompanied by a meaningful change in what matters most: namely, the ability to generate economic growth, create jobs and arrest excessive income and wealth inequalities.

Earlier this week we marked the 3 year anniversary of the Dodd-Frank Act. Which is to say it was passed onto law, although less than half of the Act has been enacted. Mainly, it's been a battleground for bank lobbyists trying to tear out the entrails.

A federal grand jury indicted Steven A. Cohen's hedge fund SAC Capital Advisors on fraud charges. The hedge fund was charged with wire fraud as well as four counts of securities fraud, and the government is seeking to force SAC to surrender any fraud-related profits. According to the indictment from roughly 1999 to 2010, SAC obtained and traded on inside information to boost returns and fees and that the scheme involved a number of portfolio managers, research analysts and dozens of publicly traded companies.

The government has also filed civil money-laundering charges against the firm, which call for fines and penalties to be determined at a trial, the date of which hasn’t been set. Those civil charges pose the greatest threat to Cohen’s fortune because prosecutors allege that if the fund reinvested the proceeds of illegal insider trading into its capital pool, then the entire pool is tainted and subject to forfeiture, but it's expected that prosecutors won't try to go after the entire amount.

SAC oversaw $6 billion for outsiders at the start of this year, but have since withdrawn about $5 billion. The big question for those folks is whether they will face clawbacks. SAC is almost like Cohen's personal hedge fund; he has about $7.5 billion in SAC’s funds and employees account for $1.5 billion of assets. And the fund is conducting business as normal, or somewhat normal. Cohen wasn't named in the criminal indictment and faces no threat of prison time. In the corporate criminal world, avoiding indictment is the key battleground.

What does it take to be considered wealthy? A new survey finds the majority of people with a net worth of between one and five million dollars do not consider themselves wealthy; 28 percent of people worth between $1 million and $5 million call themselves wealthy. For people worth more than $5 million, just 60 percent of them say they’re rich. Of those surveyed, 50 percent said they’d consider themselves rich if they had no financial constraints on activities. So, it's not really a number.

Tell that to Eike Batista; he's the Brazilian oil tycoon who started 2012 as the eighth richest person in the world; net worth estimated at $34 billion; now that has dropped to $200 million. You might think that $200 million is a lot; if you had that money, you might think you were wealthy, but I'm not sure if that's how Batista feels. So, it's not really a number.

A few months ago, a Senate committee grilled Apple CEO Tim Cook over the company’s creative accounting strategies, accusing it of cheating the U.S. Treasury by stashing away billions of dollars that live in no tax jurisdiction at all. The company didn’t dispute the truth of the accusations, but blamed the United States for building a tax system that makes bringing overseas earnings back to the United States very expensive, and proposed simplified rules that would make it cheaper to do so.

The Organization for Economic Cooperation and Development has been working on the problem; in February they issued a report. The G20 held a meeting last weekend and they said they want a more globally uniform tax system, and they want the OECD to finish up a a concrete plan to crack down on tax cheats, and they want that plan within the next 2 years.

More problems for Boeing's troubled 787 Dreamliner today; one was grounded, an oven overheated in another and damage was found in wiring on two other planes. It's turning out to be like a flying cruise ship.

Halliburton Co has agreed to plead guilty to destroying evidence related to the 2010 Deepwater Horizon oil spill in the Gulf of Mexico, which killed 11 workers and left a horrific mess. The guilty plea is the third by a company over the spill, and requires the world's second-largest oilfield services company to pay a maximum $200,000 statutory fine; that's about how much Halliburton earns every 23 seconds, based on 2012 revenue numbers. Halliburton also made a separate, voluntary $55 million payment to the National Fish and Wildlife Foundation, plus 3 year probation.

Meanwhile, another Gulf of Mexico drilling rig caught fire this week off the coast of Louisiana. The blaze broke out Monday on a natural gas platform. The rig partially collapsed, but then sand and sediment covered up the spill and the fire is out or nearly out; and because it is natural gas it dissipated quickly in the ocean water. No one was injured.

Meanwhile, TEPCO, the Tokyo Electric Power Company finally admitted today, what had been suspected for quite some time; the Fukushima Dai-ichi nuclear power plant, the one damaged in the 2011 eathquake and tsunami, has been leaking contaminated water into the ocean. They don't know how much damage has been done by the leaks; they don't have a plan to clean it up and they don't seem to have a plan to stop it.

The northeast of Brazil is largely poor and rural. Years ago, there was a migration to the South, to the major cities of Rio de Janiero and Sao Paolo. The migrants were looking for jobs, industrial jobs. There were more people looking than getting. The migrants camped out. In Rio, they camped out in the hills surrounding the city. Eventually the encampments turned into shacks, the shacks turned into homes, but the entire process was haphazard. The homes lacked modern conveniences, and so the residents strung up illegal lines, they built illegal plumbing. The shacks turned into homes turned into small cities; slum cities known as favelas. The houses were built close together, the roads often not more than a tight alleyway, difficult for police to patrol. Poverty and unemployment were high. Gangs soon became a stronger authority figure than police; crime was pervasive; hope was not.

The favelas grew over time. In Rio, a city of more than 11 million people, it is estimated that more than 4 million live in favelas, or slums. The largest favela, Rocinha, is home to more than 500,000. Last year, the government sent in police with machine guns and armored vehicles to clean up the favelas in advance of the World Cup Soccer tournament next year, and the Olympic Games in 2016. You would probably not feel safe walking through a favela.

There is a favela in the north part of Rio, known as Varginha; it is very poor and violence is common. Built on swampland, Varginha is one of several favelas that have been "pacified," meaning the drug lords who once ran the place have been ejected or subdued by authorities. The government has allocated money for community centers, libraries and a train station. But residents say they have received more broken promises than actual help, and basic services such as sanitation remain woefully unavailable. They also complain that police are abusive and treat everyone like a criminal.

Pope Francis is visiting Brazil. He is not meeting with Brazil's president; the Pope instead headed to Varginha, telling residents of the notorious slum that their leaders must do a better job of helping them. The Pope said public authorities and "those in possession of greater resources" must "never tire of working for a more just world, marked by greater solidarity!" He told the crowds that "No one can remain insensitive to the inequalities that persist in the world!"

It was the most political message yet in the pope's pilgrimage to Brazil, and for many it echoed the enormous protests that erupted last month among Brazilians angry over government corruption, excessive state spending on upcoming international sports events, and lack of basic services such as education and healthcare.

And then after visiting the favela, he went to another favela, known as the City of God and he visited with recovering drug addicts, saying , “It is necessary to confront the problems underlying the use of these drugs, by promoting greater justice, educating young people in the values that build up life in society, accompanying those in difficulty and giving them hope for the future.”

And along the way, the Pope opened the windows of the Popemobile and even got out to walk with the crowds of people and kiss babies and give hugs and blessings to the crowds of people; he visited a little speck of a Catholic chapel; he just walked up to the modest home of a local family and was welcomed like a long lost brother. The security detail must have freaked out, but even in the most dangerous and violent slums of South America, there was not even the hint of a problem.

He stressed to the people of the favelas that he is on their side, saying: “The church offers its collaboration on all initiatives that lead to the development of all people. The church is with you. The pope is with you.”

Hours later, speaking under a rainy sky at the beach in Copacabana, the pope’s message to the more than one-million faithful was to shake up the church and make a “mess” in their dioceses by going out into the streets to spread the faith. He was less political and more centered on the importance of believing in Jesus. “He is a friend who does not defraud. ”

There has been revolution in the Middle East – the Arab Spring, and the n the Arab Spring-Part2. And throughout much of Europe there have been protests, especially in the periphery. It seems that we have forgotten what is important. How much real-world difference the papal visit might make remains to be seen. John Paul II visited the favelas of Rio in 1980, and obviously the underlying problems hardly disappeared in the intervening 33 years, but the Pope is the spiritual leader of more than one billion souls. And even if he can't change the reality on the ground, maybe he can make us consider how we keep score. He said, "The measure of the greatness of a society is found in the way it treats those most in need, those who have nothing apart from their poverty."