Tuesday, June 26, 2012 - Grapes of Wrath

Grapes of Wrath 
by Sinclair Noe


DOW + 32 = 12,534
SPX + 6 = 1319
NAS + 17 = 2854
10 YR YLD +.02 = 1.63%
OIL +.23 = 79.59
GOLD – 12.70 = 1573.60
SILV - .43 = 27.21
PLAT – 17.00 = 1433.00




The S&P/Case-Shiller reports shows home prices rose 1.3% in April.  The Conference boards Consumer Confidence Index fell for a fourth straight month; the index hit 62 last month, which is still above average and better than last year at this time. We are not officially in the Dog Days of Summer; it just feels like it. 


The European Union has released a road map outlining the path to tighter fiscal integration. Nothing too flashy and it might take a year or more to implement. German Chancellor Angela Merkel  had played down large moves such as the issuance of common debt until euro-area countries agree to broad oversight of their budgets.  Egan Jones downgraded Germany from A+ to AA-. 


Today, Reuters reported Merkel told politicians in her ruling coalition that Europe would not have shared total debt liability “as long as I live.” So, that pretty much kills any idea of a euro-bond. Mario Monti, the technocratic non-elected Prime Minister of Italy now denies he said: “Eurobonds or I resign.” 


Meanwhile, Spanish and Italian bonds aren't feeling healthy as yields rose again. Spain had to pay the highest yields since last November to sell 3.08 billion euros in short-term debt as demand from its ailing banks dwindled. Spain has officially requested a $125 billion dollar bank bailout. Details are being worked out. There are calls to just directly inject the money straight into the banks. Nobody is calling it theft. I don't know why not. Bondholders would be forced to take haircuts. 


Cyprus is bust and they need 10 billion euro but nobody is rushing in because it might set a bad example for those pushing the idea that suffering is good and mitigating pain might somehow be a bad thing. 


Another emergency Euro-summit starts on Thursday in Brussels. France will push a growth package. Germany will push for more pain. The United States will push for something, anything that looks like progress, and everyone will mildly disappointed except for the waffles and chocolates and beer. I'm not suggesting the players are taking this lightly. Deep economic collapses are dangerous. I think that is accepted. 




 In Europe, whether it’s Greece or Spain or Italy, they have insolvent banks that are in a deadly embrace with insolvent states. So, the states borrow money from the Euro-institutions in order to give to the banks and banks borrow to give to the state and both banks and states are sort of locked into a deadly embrace and they are sinking, unable to even tread water. 


So what can be done to break this  death bond  between insolvent banks and insolvent states? It will go one of two ways: either, to unify the banking system, and have it being funded directly not through national governments. Or, allow the banks to fail.  As for Greece, it has failed. Greece is in a depression. Think Oklahoma, circa 1931, Tom Joad- opoulous. Grapes of Wrath. 




The quote of the day: "An imbalance between rich and poor is the oldest and most fatal ailment of all republics." -Plutarch


A new book by Joe Stiglitz on Inequality. He wrote a piece for the Financial Times, and I'm sure the editors at the FT didn't quite comprehend the import. Here are the key ideas via Economist's View:


US inequality is at its highest point for nearly a century. ... One might feel better about inequality if there were a grain of truth in trickle-down economics. But the median income of Americans today is lower than it was a decade and a half ago... Meanwhile, those at the top have never had it so good. ...


Markets are shaped by the rules of the game. Our political system has written rules that benefit the rich at the expense of others. ... There is good news in this: by reducing rent-seeking ... and the distortions that give rise to so much of America’s inequality we can achieve a fairer society and a better-performing economy. …


America used to be thought of as the land of opportunity. Today, a child’s life chances are more dependent on the income of his or her parents than in Europe, or any other of the advanced industrial countries for which there are data. …


We can once again become a land of opportunity but it will not happen on its own... The country will have to make a choice: if it continues as it has in recent decades, the lack of opportunity will mean a more divided society, marked by lower growth and higher social, political and economic instability. Or it can recognize that the economy has lost its balance. The gilded age led to the progressive era, the excesses of the Roaring Twenties led to the Depression, which in turn led to the New Deal. Each time, the country saw the extremes to which it was going and pulled back. The question is, will it do so once again?


I promised I would follow up on a question from a listener on Friday. 


Hong Kong Exchanges and Clearing agreed on Friday to buy the London Metal Exchange for $2.14 billion, The deal will be presented to the London exchange’s shareholders by the end of July. The deal requires approval of at least 50 percent of the L.M.E.’s shareholders, who hold more than 75 percent of the firm’s stock. It also requires approval of British regulators.


The acquisition could provide a windfall for JPMorgan Chase and Goldman Sachs, which collectively own a 20 percent stake in the London-based exchange. The banks could pocket a combined $436 million through the transaction. This seemed to be the focus of the Financial Times' reporting on the story; they seemed entirely focused  on the sale as a liquidity event for the shareholder-members of the LME; indeed, they will have a nifty payday. They will collect their lucre and be long gone before there are any consequences. 


For the Asian investors, there is a longer term view. This represents another sign of Asia’s importance to the world’s commodities industry. The Asian bourse, one of the world’s biggest financial exchanges based on market capitalization, outbid several American rivals for control of the 135-year-old London firm.


Despite concerns that the Chinese economy may be slowing down, the country and other emerging markets in the region now are the largest buyers of a number of commodities, such as iron ore and coal, as their domestic markets continue to report high levels of growth. The latest acquisition will help the Asian bourse take advantage of this demand. 




The Fed last week decided to extend through the end of the year a bond maturity-extension program called Operation Twist, in which the central bank replaces short-term debt it holds with longer-term securities. Operation Twist had been due to end this week. Dallas Federal Reserve Bank President Richard Fisher says:
"My suspicion is Operation Twist is having a very minor effect and I have argued that the benefits do not exceed the costs; the costs exceed the benefits, and that's why I personally didn't support the program. But I was in a minority." 


I’m not sure what the costs are because it is basically a wash. Sell short buy long.


Fisher, an inflation hawk, has been a staunch opponent of further Fed easing. Though he does not have a vote on the Fed's policy-setting panel this year, he participates in the committee's deliberations. All but one voting member on the panel supported last week's extension of Operation Twist.


"In practical terms, there's a limit to what we can do without distorting the marketplace," he said. "And that's a subject of much debate at the committee."

Jeffrey Lacker, the president of the Richmond Federal Reserve Bank says it is doubtful that another round of bond buying would boost economic growth. "The impediments to growth are things that monetary policy is really not that capable of offsetting," Lacker was the one dissenting vote against the extension of Operation Twist. 


Lacker said he expects inflation to stay close to the Fed's 2% target despite the recent softness in oil prices. Lacker said he favors steady policy and now sees the first rate hike coming in "late" 2013 due to the recent slowdown, later than the "mid" 2013 projection he made last month.

So, we have a couple of Fed heads saying they’ve hit the 2% inflation target actually, the core number is below 2%, and they are impotent to use monetary policy to boost growth, or they just don’t give a damn about their mandate to achieve maximum employment. 


What does the Fed propose doing about the situation? Almost nothing. Last week the Fed announced some actions that would supposedly boost the economy, extending the Twist. This helps a little with housing and mortgage rates but it does nothing for employment; it was the bare minimum the Fed could do to deflect accusations that it is doing nothing at all.


Why won’t the Fed act? The Fed, like the European Central Bank, like the U.S. Congress, like the government of Germany, has decided that avoiding economic disaster is somebody else's responsibility.  The fundamentals of the world economy aren’t, in themselves, all that scary; the building blocks for providing food and jobs and housing and care for the world's population – that's all within our reach – we can do it; but there has been a shift from those in positions to make a difference and those in positions of power that don’t want things to change for the better. It’s the almost universal abdication of responsibility that should scare the beejeesus out of you. 

Tuesday, June 12, 2012 - Cleaning Off My Desk on an Off Day - by Sinclair Noe

Did you notice that the Non-bailout Spanish Bank Bailout grew over the weekend?  Last Friday, the International Monetary Fund said Spain's banks would need to raise at least $46 billion dollars as a buffer against a sharper economic contraction and to stabilize the Spanish financial system and prevent contagion to the rest of the Euro-zone. Before the weekend finished, the bailout had grown to more than $125 billion and we were already hearing warnings that it wasn't enough. 


The bailout has almost no chance of success and it seems just a matter of time until the Euro-powers that be impose harsh conditions on Spain. The Euro-zone leaders seem unwilling or unable to change from their austerity policies, even as Greece and Spain fall apart and the core euro-zone economies contract. Four years after the financial crisis began, many rich capitalist economies have not recovered their pre-crisis output levels. There are 60 million fewer people employed worldwide than if the pre-crisis trend had continued. In countries like Spain and Greece, overall jobless rates are approaching 25%, with youth unemployment over 50%. Even in countries experiencing "milder" unemployment problems, like the US and the UK, between 8% and 10% are out of work. If we include those who have given up looking for jobs or those who are forced to work part-time for want of fulltime opportunities, "real" unemployment could be easily over 15% even in these countries.


The remedies on offer are well known. Reduce budget deficits by cutting spending – especially "unproductive" social welfare spending that reduces growth by making poor people less willing to work. Cut taxes at the top and deregulate business cut red tape, provide tax incentives to invest and generate growth; and make hiring and firing easier. Except it isn't working.


And there is also plenty of historical evidence showing that austerity remedies have never worked. The same happened during the 1982 developing world debt crisis, the 1994 Mexican crisis, the1997 Asian crisis, the Brazilian and the Russian crises in 1998, and the Argentinian crisis of 2002. All the crisis-stricken countries were forced (usually by the IMF) to cut spending and run budget surpluses, only to see their economies sink deeper into recession. Going back a bit further, the Great Depression also showed that cutting budget deficits too far and too quickly in the middle of a recession only makes things worse.


As for the need to cut social spending to revive growth, there is no historical evidence to support it either. From 1945 to 1990, per capita income in Europe grew considerably faster than in the US, despite its countries having welfare states on average a third larger than that of the US. Even after 1990, when European growth slowed down, countries like Sweden and Finland, with much larger welfare spending, grew faster than the US.


Also there is no historical evidence to support tax cuts and deregulation as a remedy resulting in  investment and growth; this was tried in many countries after 1980, with very poor results. Unemployment rates in the major capitalist economies were between 0% (some years in Switzerland) and 4% from 1945-80, despite increasing labor market regulation. There were more jobless people during the 19th century, when there was effectively no regulation on hiring and firing.


In Spain, 50% of young people are unemployed while the priority is to to bring the deficit down from 9% of GDP to 3% in three years? And there are several major American cities that also have massive unemployment, especially among young people. A society in which the rich have to be made richer to work harder while the poor have to be made poorer in order to work harder. Where there is shared sacrifice, shouldn't there be shared prosperity? 




Sheila Bair, the former Chairwoman of the FDIC says efforts to increase and improve regulation of Wall Street have bogged down. She has formed a new group, the Systemic Risk Council, that will monitor and encourage regulatory reform. 


Bair says: “The great challenge is to devise a system to identify risks that threaten market stability before they become a danger to the general public. We need a more effective and efficient early-warning system to detect issues that jeopardize the functioning of U.S. financial markets before they disrupt credit flows to the real economy. And two of the most critical tasks are how to impose greater market discipline on excess risk-taking and effectively end the doctrine ‘too big to fail.’”


The Dodd-Frank act passed in 2010 provided for numerous steps, including the creation of an Office of Financial Research that was supposed to help the newly created Financial Stability Oversight Council in identifying threats to financial stability and deciding which financial firms were systemically important and how much additional regulation they should receive. That council is composed of all the major regulatory bodies, and so far it has accomplished little. So far, regulators had so far missed two-thirds of the 221 deadlines for adopting regulations set forth in the law.


The main reason for the delays in implementing reform? The banks have been fighting reform. Senator Dick Durbin said it best about 3 years ago: "the banks -- hard to believe in a time when we're facing a banking crisis that many of the banks created -- are still the most powerful lobby on Capitol Hill. And they frankly own the place," 


Have you been following the story about the Stuxnet cyber weapon? This is the software virus that was widely believed to have been used by the United States and Israel to attack Iran's nuclear program. Turns out some of the software code used in Stuxnet may be the same code used in the Flame virus, which was a cyber weapon used back in 2009 in the Middle East. Flame is a highly sophisticated computer virus that disguises itself as common business software. It was deployed at least five years ago and can eavesdrop on conversations on the computers it infects and steal data. If the United States is proven to be a force behind Flame, it would confirm the country that invented the Internet is involved in cyber espionage -- something for which it has criticized China, Russia and other nations. Instead of issuing denials, authorities in Washington recently launched investigations into leaks about the highly classified project. Two years ago at the Wealth Protection conference I said Cyber-war would be a major trend in the years to come. Most people thought that was a little crazy. A Pentagon report last year that outlined the still-evolving U.S. cyber strategy said economic espionage could prove the greatest threat to long-term U.S. interests, pointing to thefts of industrial and defense secrets via Internet spyware. 


You may have noticed that the price of a gallon of gas has dropped about 30 cents since late April, while the price of crude oil has dropped more than $25 a barrel; there seems to be a lag. We have been so preoccupied with oil prices that you probably didn't notice a report a few months ago from the National Intelligence Council (don't even ask me who they are); they claim that water shortages will likely lead to political disruptions and many more violent wars in strategically important regions over the next decade. We could live without oil. We can't live without potable water. 

Monday, June 11, 2012 - The Non-Bailout Spanish Bank Bailout - by Sinclair Noe

DOW – 142 = 12,411 

SPX – 16 = 1308
NAS – 48 = 2809
10 YR YLD -.04 = 1.60%
OIL – 1.50 = 81.20
GOLD + 1.40 = 1597.10
SILV + .05 = 28.58
PLAT + 13.00 = 1450.00

So, here's the headline from the Murdoch Street Journal: “US Stocks Tumble as Spain Bank Bailout Optimism Fades”. And my question is how many phones did they have to hack before they found someone who was optimistic about the Spanish Bank Bailout?

Over the weekend, Spain requested a bailout of up to 100 billion euros ($125 billion) in loans from the European Union to assist its banks. Statements about the deal left several open questions, including the exact amount of aid the country will need and how the funds will be distributed. What exactly is there to be optimistic about? Oh, the Euro did not explode over the weekend – that's a relief but not a reason to be a big time buyer of equities.

It's not like the Spanish Bank Bailout makes anything better, except for the specific Spanish Banks being Bailed-Out. Europe still has a nasty circle of slow or no growth and increasing debt burdens. Greece's first bailout in 2010 sparked a healthy 1.3 percent rally in the S&P 500 stock index on the following day, but subsequent rescues fostered more muted responses.

The reaction after Spain's bank bailout has been the most downbeat of the lot. The four prior bailouts – for Greece and Ireland in 2010, Portugal in 2011 and Greece again in 2012 -- showed the euro's rallies fade within a month, while stocks were mixed, based on various factors.

In the credit default swaps market, where investors take out insurance against the risk of sovereign default, the pattern has been similar. The cost of buying insurance against Greek, Irish or Portuguese default tended to drop after the first two weeks as investors took the bailout news as a sign of relief, only to rise back to pre-bailout levels or higher within a month. After initially falling, the cost of insuring $10 million of Spanish government debt against default rose to 595 basis points, or $595,000 per year for five years. That is just off a record high.

For the Spanish economy as a whole, there has been no debt relief. This is what happened to Ireland. The banks are in healthier shape today, but the country is still in real trouble. In fact, a report by Spain's central bank showed Spanish banks were the main buyers of Spanish sovereign debt last year, essentially making the government dependent on the banks it is now trying to help. The Spanish government bails out Spanish banks, and Spanish banks bail out the Spanish government. And the longer this insanity persists the more likely people are to realize that the entire solution is a big game played on a closed course.

Bloomberg reports Wall Street bankers and traders, given hope by a market rebound in the first quarter, are now seeing earnings and paychecks threatened by turmoil in Greece. Yep it's all about the bankers and their profits and their bonuses. People in Spain have lost their homes, they have lost their jobs, and so clearly the concern here is the paychecks of Wall Street bankers. The government and the banks have forgotten why we have an economy in the first place; we do not have an economy to serve the banks and the government, which are morphing into one and the same. The reason for a bailout is not to make the banks whole. We've seen this game before. It is losing its effectiveness because we can all see through the scam.

Wait just one minute; just a week ago, Spain was saying they didn't want a bailout, they didn't need a bailout. What's going on here? Well, technically it is not a bailout, it is a line of credit to Spanish Banks. What's in a name? A rose by any other name would smell as sweet.

So, maybe the better question is whether the bailout that isn't a bailout will work. And the answer is probably not. Spain's access to capital markets and its cost of debt is not being addressed. The last auction of Spanish government bonds saw yield around 6.50% with the bulk of bonds being purchased by local banks. Spain and its banks also face pressure on their own ratings, which are now perilously close to becoming non-investment grade. The bailout may actually adversely affect the ability of Spain and its banks to funds. Commercial lenders are now subordinated to official lenders. Based on the precedent of Greece, this increases the risk significantly, discouraging investment.

The amount – 100 billion euro or more depending on the independent assessment of the needs of Spanish banks- may not be enough. The capital requirements of Spanish banks may turn out to much higher – as much as 200-300 billion euro. And since the money is going to rebuild the banks instead of rebuilding the economy, you will have banks that won't make loans to people who don't have jobs, and the nasty downward circle continues to swirl. The bailout will be provided with no conditions, which creates its own problems. The lack of conditions may lead to Greece, Ireland and Portugal seeking relaxation of the terms of their assistance packages.

The relief in Rome was short-lived. Italian bonds rallied early but within hours, Italian borrowing costs were creeping back up again, reflecting persistent market fears that the Continent’s third-largest economy could be the next to falter. Contagion into Italy and other countries is a reality. There seems to be little Italy can do to protect itself. Technocratic Prime Minister Mario Monti, appointed last November to succeed Silvio Berlusconi, has tried to shore up finances, overhaul the pension system, and implement regulatory reforms. The country is on track to bring its budget deficit within 3 percent of GDP this year. Italian banks are relatively healthy, and unemployment is less than half the 24 percent in Spain. Spain’s fundamentals are much worse than Italy’s.

Italy’s situation is hardly rosy. Its debt burden—120 percent of GDP—is the highest of any European country except Greece. Its economy slid into recession during the fourth quarter of 2011 and is expected to contract 1.7 percent this year. Monti’s reform agenda is stalling, unemployment at 10.2 percent is the highest in a decade, and consumer confidence is the lowest in 15 years. Italy is positioned to be the next lightning rod in the euro area. For now, yields on Italian debt are at 5.84 percent, less than they were when Monti took over last year.

Apparently the idea of the non-bailout, no pre-conditions Spanish Bank Bailout was that it would appear as if Spain itself is not paying for the bailout. In other words, it was a gamble by the Spanish government to avoid a general government bailout. The gamble failed; the Spanish government will now own this bailout and they will soon be stuck with the same kind of conditions imposed on the Greeks, and this will continue until it ends badly.

So much for a firewall.

The Federal Reserve has release a new study that shows the average American family lost 38.8 percent of its wealth from 2007 to 2010, with the biggest losses concentrated among households with the most assets tied to their homes. Fed economists conduct the surveys every three years to produce a snapshot of household balance sheets, pensions, income, and demographics that’s more detailed than broader reports about the economy. The surveys allow comparisons over time, with a consistent methodology since 1989.

Median net worth declined to $77,300 in 2010, an 18-year low, from $126,400 in 2007, the central bank said in its Survey of Consumer Finances. Mean net worth fell 14.7 percent to a nine-year low of $498,800 from $584,600. Just a reminder, the “mean” is the average while the “median” is more like the midway point.

The impact has been a massive destruction of wealth all across the board and especially for the broader middle class, or what once was the middle class. The decreases in median net worth appear to have been driven most strongly by a broad collapse in house prices.

The housing slump and financial crisis also boosted the dependence on wages as a percentile of net worth for the wealthiest 10 percent. The top 10 percent by wealth got 55.8 percent of their pre-tax family income from wages in 2010, up from 46.2 percent in 2007, the survey found. The portion earned from capital gains plunged to 2.3 percent from 14.4 percent. Once upon a time it was a widely held belief that the wealthiest would be able to pull the economy out of a downturn, but the uber-wealthy are a small proportion of the overall population and they can only account for a tiny fraction of the consumer spending you might expect from hundreds of millions of consumers who have been forced to tighten their belts.

Debt as a share of family assets rose to 16.4 percent from 14.8 percent as asset values declined. For those households with debt in 2010, the median value of debt was unchanged from 2007, while the share of families having debt fell to about 75 percent from 77 percent. Debt payments more than 60 days overdue were reported by 10.8 percent of families in 2010, up from 7.1 percent in the prior survey. Measures of debt payments relative to income might have been expected to increase. In fact, total payments relative to total income increased only slightly, and the median of payments relative to income among families with debt fell after having risen between 2004 and 2007. The share of families with high payments relative to their incomes also fell after rising substantially between 2001 and 2007. If there is any one thing that makes sense during these difficult economic times, it is to cut or eliminate debt.

Fed policy makers meet next week to consider whether the central bank needs to add to its record stimulus after employment grew at the slowest pace in a year in May.

The Fed has already cut its key interest rate almost to zero and injected hundreds of billions to bailout banks and purchased a few trillion in debt to lower long-term borrowing costs. Even so, the jobless rate has stayed above 8 percent since February 2009, compared with the central bank’s long-range goal of 4.9 percent to 6 percent. Why? Because the actions taken by the Fed were more consistent with saving the banking and financial sector than with fulfilling its mandate of maximum employment. I don't know if it is impossible for the Fed to bring down unemployment with monetary policy alone, only that their policy has not done the job even though it has benefited the banksters, you know, just like what's happening right now over in Europe.