Wednesday, June 25, 2014 - Use Your Library Card at a Copy Shop for a Horseback Ride to the Moon

Use Your Library Card at a Copy Shop for a Horseback Ride to the Moon
by Sinclair Noe

DOW + 49 = 16,867
SPX + 9 = 1959
NAS + 29 = 4379
10 YR YLD - .02 = 2.56%
OIL + .74 = 106.77
GOLD - .60 = 1319.40
SILV + .09 = 21.12

One of the jobs of the Commerce Department is to calculate the gross domestic product of the country; clearly it is a difficult task to figure out the value of all the goods and services produced, and so they tend to revise the numbers as they gather information. In April the Commerce Department figured the economy grew, just barely, 0.1% in the first quarter; last month they revised their GDP numbers to negative1.0%; today they revised GDP even lower. The economy shrank by 2.9%.

To understand the big move, you first have to realize that the GDP number is supposed to measure everything; construction and demolition, marriages and divorces, broccoli sales and cigarette sales, yoga classes and cancer treatments. One of the big reasons for the negative number is that the cost of healthcare dropped significantly.

The US spent $6.4 billion less on health care in the first quarter than in the last quarter of 2013. Government statisticians initially forecast a 9.9% increase in health-care spending, and what we got was a 1.4% decline. Considering all the millions of previously uninsured people who are gaining access to health insurance under the Affordable Care Act, how can they be shrinking so dramatically?

Health-care costs overall have been increasing more slowly in recent years compared with the pace before the 2007-09 recession. Slow growth in the price of health-care services combined with a decline in the amount of health care people consumed in the first quarter. Still, health-care spending is expected to accelerate again in coming quarters as the millions of people who gained health insurance coverage during the Affordable Care Act’s first open enrollment period begin to use their new coverage. Most people who got coverage at the start of the year, are just now figuring out how to use the coverage. So, the idea that people are spending less on health care may hurt the GDP number but that doesn’t mean it’s a bad thing. This also means that the economists don’t really understand how Obamacare is affecting the economic data; and that means they don’t really know how long it will distort data. This is new territory.  

A couple of other areas were also involved in shrinking the economy. Companies continue to hoard cash and shun investing in new equipment or new employees; and that will continue until demand picks up; we’ve been told demand will pick up, any day now…, it’ll pick up…., that’s what we’ve heard for a few years.

Another rough spot for GDP was in trade. The trade deficit widened in the first quarter, which would typically indicate growth, but in the first quarter both imports and exports dragged down growth. And then trade was disrupted by the weather, the excuse that keeps giving and giving.  And now that the winter has turned to spring and spring to summer, the economy will bounce back like a kangaroo on a trampoline. Maybe. Consider that when the economy shrank in the first quarter of 2009, the country lost 2.3 million jobs and the markets were in a free fall. Fast forward to first quarter 2014 and the markets are around record highs while the country added about 600,000 new jobs; hardly the stuff of gloom and doom.

Today’s GDP revision might give the Federal Reserve cause for pause, or more likely it will reinforce their dovish inclinations for monetary policy. On the fiscal side, if policymakers in Washington are concerned enough to give the economy a boost, they can consider straightforward measures that would promote growth and create jobs: invest in infrastructure, restore extended unemployment benefits, hire public-sector workers like teachers and first responders, and basically abandon austerity measures in general.

You may remember the gloom and doom days of 1973, when OPEC imposed an oil embargo; prices jumped, lines formed at gas stations to buy rationed gas. Lawmakers responded by limiting the export of oil from the US; we could still export gasoline and diesel but not oil. It didn’t make much common sense but that was the response to the embargo. Things have changed.

Now, oil drillers are tapping shale formations and so much oil is flooding out of the ground that prices for ultralight oil have dropped as much as $10 below the price of traditional crude oil. Which sounds good if you are a consumer, because you might think it would result in lower prices at the pump. But as you know, the price at the pump has been going up because of the crazies in Iraq, and Libya, and Ukraine. Rather than let the oil build up and let prices drop, the plan is to export that oil under a process known as a private ruling which would relax the export restrictions.

The private rulings by the Commerce Department define some ultralight oil as fuel after it has been minimally processed, making the oil eligible for sale outside the US. Export could start in August, and could increase to more than 700,000 barrels a day by next year. The Commerce Department has given permission to two companies to ship ultralight oil: Pioneer Natural Resources and Enterprise Products Partners.

So if you were hoping that all that domestic oil drilling would lead to lower prices for America, yea, that’s not going to happen.

Have you ever been on the floor of one of the commodity exchanges, or maybe seen pictures of the commodities traders? Thirty years ago, the scene was a violent confrontation of traders battling it out in the pits. Nowadays, the trading is much more subdued. Traders walk around with a portable computer that calculates the price in real time. That formula that is on every commodity trader’s computer is a continuous time option pricing model known as the Black-Scholes-Merton formula. Robert Merton and Myron Scholes won the 1997 Nobel Prize in Economics for their formula; Fisher Black passed away in 1995.

Robert Merton went on to create computerized arbitrage trading formulas and he advised hedge funds for a while, including the Arbitrage Management Company and Long Term Capital Management. He then settled down to work as a professor at MIT, where his current academic include financial innovation, controlling macro financial risk, and managing sovereign risk.

Bob Merton says your 401K is dangerous. In an article published in the Harvard Business Review, Merton writes: "The only way to avoid a catastrophe is for plan participants, professionals, and regulators to shift the mind-set and metrics from asset value to income."

Instead of telling you how much you’ve accumulated in your 401K, the plan administrators should be telling you the amount of sustainable income an employee can expect to receive in retirement. The “risk is retirement income uncertainty, not portfolio value.” That's not to say that 401k money shouldn't be invested in stocks. In fact, Merton says, 401k investment managers should invest participants' savings in a mixture of "risky assets," including equities, and "risk-free assets," such as long-term US Treasurys and deferred annuities. Merton says the solution  for employees who want to lock in retirement income, “the obvious decision is to buy the annuity.”

By disclosing annual income, Merton says, employers would help employees quickly and easily calculate how much of their annual salary they can expect to replace in retirement, together with Social Security. As a result, employees would be better able to take action to ensure they are on track to retire as planned.

The Supremes are in session and handing down decisions on a daily basis. Let’s start with American Broadcasting Company v Aereo; the Supremes delivered a major victory to the nation’s television networks, ruling that an upstart Internet company was violating copyright laws by transmitting their programs without paying for them. It was a 6-3 vote; in the majority, Justice Breyer said Aereo’s use of modern technology to stream broadcast television was not much different than cable systems that must pay the networks for its content. Meanwhile, in the minority, Justice Scalia said that Aereo is a copy shop that gives its customers a library card. I’m not sure how you might use a library card at a copy shop, but anyway, Kinko’s is out of business and so is Aero.

Today the Supremes also ruled on a couple of fourth amendment cases. The Fourth reads, in part: “The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause…” and apparently your smartphone falls under the category of “papers and effects”.

 Riley v. California and United States v. Wurie featured similar facts. Defendants were detained validly, one for driving with expired tags and the other for a hand-to-hand drug sale. Police searched them, as they had every right to do, and seized their phones. Without getting a warrant, they looked at the contents of each phone and found evidence that led, eventually, to much more serious charges: gang-related attempted murder in the first case and drug distribution and weapons violations in the other.

California state courts refused to overturn Riley’s conviction when he appealed the attempted murder charge, but the 1st Circuit Court of Appeals reversed Wurie’s conviction and ordered a new trial on the grounds that the warrantless search violated the Fourth Amendment’s prohibition against “unreasonable searches and seizures.”

Police can search a suspect’s pockets, or briefcase, or car when making a valid arrest because there may be weapons nearby or evidence of crime that could be lost. In addition, officers can search when there are “exigent circumstances,” meaning when there is no time to lose, in order, say, to stop a crime in progress, prevent suspects from destroying evidence, or rescue a kidnap victim. Prosecutors in both cases argued that searching a cell phone is really just the same thing as the valid search of personal items. Chief Justice Roberts didn’t buy it, replying, “That is like saying a ride on horseback is materially indistinguishable from a flight to the moon.”

Roberts wrote the opinion for the unanimous decision and concluded: “We cannot deny that our decision today will have an impact on the ability of law enforcement to combat crime… Privacy comes at a cost.”

Monday, June 23, 2014 - Calm Before the Storm

Calm Before the Storm
by Sinclair Noe

DOW – 9 = 16,937
SPX – 0.26 = 1962
NAS + 0.64 = 4368
10 YR YLD un = 2.62%
OIL  - .13 = 106.04
GOLD + 3.60 = 1319.30
SILV + .02 = 21.00

The economic data today from the National Association of Realtors shows existing home sales picked up in May. Total sales rose 4.9% to 4.89 million units from an upwardly revised 4.66 million in April. While that marks a month to month increase, sales are down from the 5.15 million level of May one year ago.  Total housing inventory increased 2.2% in May. Unsold inventory is 6% higher than a year ago.

Meanwhile, Markit's US Flash manufacturing PMI report for June, increased to 57.5 from 56.4 in May.

The stock market has drifted slightly higher over the past couple of months. Yes we hit record highs last week, but the movement has been very slow, volume has been light, and volatility is almost non-existent. Volume is down about 50% since 2008. The VIX, or volatility index, sometimes known as the fear index, is down below 12, which means that the only people in the options market are all maxxed out on Ambien, or Valium. The S&P 500 hasn’t had a daily move of 1% in more than 2 months. Russia invades Ukraine – wake me when it’s over. Radical militants threaten to tear apart Iraq – we’ve seen this story before. The US economy is weak right now but growth is right around the corner – rinse, lather, repeat. The US plays Portugal in the World Cup and it’s a tie, of course.

The Federal Reserve looked at monetary policy and cranked up the old Xerox to publish their statement. Maybe this is the result of all that Federal Reserve fiddling; maybe they have created the boring stock market, which lulls everyone into a false sense of complacency. Of course, that’s not how markets work, no matter how much central bank finesse is applied. Markets are risky, always have been, always will be. I think it’s safe to say this is the calm before the storm, because there is always a storm in the markets.

There was some merger activity today. General Electric struck a deal to acquire France-based Alstom's power business for $16.9 billion after a lengthy pursuit. There was another utility deal, Wisconsin Energy announced a deal to acquire Integrys Energy for $9.1 billion. Oracle also announced a deal to acquire MICROS Systems for $4.6 billion.

The price of oil has been one of the few markets to show movement, which is not good news for drivers. Rising oil prices translate to rising gasoline prices, but there is lag of several weeks. Given the recent jump in oil prices, gasoline prices are poised to increase in coming weeks. Higher prices at the pump serve as a tax on consumers, whose purchasing power is still questionable. It’s estimated that an increase of $10 a barrel subtracts 0.4% from real GDP growth. Of course, for that to apply, the price increase has to stick.

The Supreme Court is in session and today they ruled on limiting the Environmental Protection Agency’s power to regulate facilities that emit carbon dioxide. The decision would reduce the number of carbon-emitting facilities the EPA can regulate, but it is a limited ruling, and even Justice Scalia said: "It bears mention that EPA is getting almost everything it wanted in this case."

Meanwhile a statement from the EPA claims victory, "The Supreme Court’s decision is a win for our efforts to reduce carbon pollution because it allows EPA, states and other permitting authorities to continue to require carbon pollution limits in permits for the largest pollution sources." Industry groups, such as the American Petroleum Institute, also claimed victory. The group said in a statement that the decision was a "stark reminder that the EPA's power is not unlimited."

The decision won't have a huge impact on US climate policy, as the decision only modestly changed the number of large facilities subject to certain permitting requirements. It also won't affect the Obama administration’s proposal to reduce emissions from power plants, which is a separate program.

When the EPA classifies something (like carbon dioxide) as a harmful pollutant, it triggers a number of legal requirements under the Clean Air Act. One of them, known as a "prevention of significant deterioration" (PSD) rule, requires factories, power plants, and other large facilities to get the EPA's approval before they make changes that would lead to higher pollution. These facilities also must use the "best available control technology" to reduce the effects of pollution they emit. Another provision requires any facility that is a "major source" of pollution to get a permit from the EPA.

Under the Clean Air Act, facilities become subject to these regulations if they emit more than 250 tons (or in some cases as little as 100 tons) of pollution per year. Traditional pollutants such as sulfur dioxide or lead can be harmful even if they are only emitted in trace amounts, so a relatively low threshold makes sense. Only large factories and power plants emit that much of these conventional pollutants.

But carbon dioxide is different. Factories produce vastly more carbon dioxide than other pollutants regulated by the EPA. Under existing rules, about 15,000 facilities are required to get permits under the Clean Air Act based on their emissions of non-carbon pollutants. If the EPA had used the same 250-ton threshold for carbon dioxide emissions, 6.1 million facilities would suddenly have needed permits. The agency estimated it would cost $21 billion per year just to process all that paperwork.

So the agency effectively re-wrote the law, exempting facilities that emitted less than 100,000 tons of carbon dioxide from getting a permit. Several states and business groups challenged this decision, arguing that the EPA had no authority to unilaterally re-write the law.

Almost everyone agrees that a literal reading of the Clean Air Act would lead to madness. The EPA has warned that "decade-long delays in issuing permits would become common, causing construction projects to grind to a halt nationwide." The Supreme Court didn't want that to happen.

But a majority of the court, led by Justice Scalia, also didn't like the EPA's approach. The court said that if Congress set a threshold of 250 tons, the EPA can't just unilaterally change it to 100,000 tons. Instead, the court's majority held that the term "air pollutant" can have different meanings in different parts of the Clean Air Act. While the "Act-wide definition" of air pollutant includes carbon dioxide, Scalia wrote, "EPA has routinely given it a narrower, context-appropriate meaning" in certain parts of the Clean Air Act. Scalia used the same trick to avoid subjecting millions of facilities to burdensome permitting requirements. He held that the definition of "air pollutant" didn't include carbon dioxide in sections of the Clean Air Act where including it would lead to a vast expansion in regulation.

The court's four liberals, led by Justice Stephen Breyer, preferred a different approach. Rather than selectively interpreting "any air pollutant" to exclude carbon dioxide, Breyer would instead have interpreted another phrase in the same section of the law, "any source" to exclude power plants that produce only modest amounts of carbon dioxide.

Two of the court's conservatives, Samuel Alito and Clarence Thomas, wrote a separate opinion arguing that the Supreme Court had been wrong to push the EPA into regulating carbon dioxide in the first place in 2007.

While the EPA can't impose regulations on new power plants based on their carbon dioxide emissions, the court ruled that the courts can regulate the carbon dioxide emissions of facilities that are already subject to regulations based on their emissions of conventional pollutants. So the EPA will still do what the EPA does; it’s estimated that 83% of greenhouse gas emissions that could potentially be regulated under the Environmental Protection Agency's interpretation of the law would still be covered as a result of the ruling, compared with the 86% of emissions that the EPA says it wants to regulate.

What today’s ruling really shows is that Congress has been out of touch and dysfunctional in dealing with pollution and climate change; rather than deal with issues, they stick their heads in the sand and hope the problem goes away, but it doesn’t; it simply shifts to another part of government that may or may not manage to resolve the problem, but in either case, is not held accountable to the voters; and then finally, if the problem persists, it goes to the courts. It’s a bad way to make and enforce laws.

A couple of other cases today: in Loughrin v. US; the court declined to reduce the scope of a federal criminal law against bank fraud, ruling that prosecutors do not need to prove that defendants intended to defraud a bank. The decision came in an appeal brought by Kevin Loughrin, who was convicted of six counts of bank fraud for stealing checks that he then altered so he could buy merchandise at Target stores.

Loughrin told police he meant to buy the items using the checks, then return the items for cash refunds. He was charged with using altered checks totaling $1,184.  Loughrin appealed his conviction. He argued that the bank fraud statute required prosecutors to prove that he intended to defraud the banks on which the checks were drawn. He said his intent was only to deceive Target. In other words, this was run of the mill fraud, and the use of a check was incidental. Loughrin did not appeal his related convictions for identity theft and possession of stolen mail. Between 2006 and 2010, the government sought to prosecute nearly 3,000 cases using the statute. Meanwhile, no major bankers have gone to jail for the crimes associated with the financial crisis; I’m just saying.

One more decision today: New Jersey wanted to institute legalized gambling on football, passing a law that the NFL and other sports leagues quickly fought in court.  The NFL won (as it often seems to do in court) at the federal appellate level, forcing New Jersey to take the case to the Supreme Court. The Supremes declined to review the case, so if you are in New Jersey, or any other state except Nevada, you’ll have to continue to call your bookie, or you can play fantasy football in a league set up through the NFL’s website.