Tuesday, April 23, 2913 - A Tweet Day

A Tweet Day

by Sinclair Noe

DOW + 152 = 14719
SPX + 16 = 1578
NAS + 35 = 3269
10 YR YLD un 1.70%
OIL + .38 = 89.57
GOLD – 12.70 = 1414.60
SILV - .47 = 23.04

Some days you hear a bit of news and it's bad, really bad. And then some days, hackers hack into the Associated Press Twitter account and tweet that there are bombs at the White House, and the stock market goes into a freefall, and it's bad, but not really bad.

Yes, a false tweet sent stocks plummeting. The 143-point fall in the Dow industrial average came after hackers sent a message from the Twitter feed of the Associated Press saying the White House had been hit by two explosions and that Barack Obama was injured. The fake tweet, which was immediately corrected by Associated Press employees, caused a sensation on Twitter and in the stock market.

White House officials were unimpressed. An AP reporter apologized for the Twitter hacking at the start of the daily White House press briefing, saying the tweet had been deleted as soon as it was discovered. A stoney-faced Jay Carney, Obama's personal spokesman, thanked the reporter but did not look amused. "The president is fine. I was just with him," added Carney.

The market recovered within a few minutes of the misunderstanding, but the incident raised many questions. We still have a problem with high frequency trading algorithms that scan the news and trade quickly, causing flash crashes. And then there are people who set stop losses, who may be kicked out of a trade because someone's computer over-reacts. There's a substantial business by high-frequency trading hedge funds reading machine-readable news sold to them for big bucks by brand-name news organizations.

Fans of flash-trading robots say they make the market more "liquid," meaning stocks trade more easily. But they can also make liquidity vanish in an instant, making it harder for the few remaining human beings in the stock market to keep order when things go haywire. Remember the Flash Crash of May 2010? Remember the Facebook IPO? Remember yesterday?

Yep, yesterday. Google had a mini flash crash yesterday. And then it passed and nobody noticed much. It's actually happening all the time. And if you lose a little confidence in the markets, well you should. Now the market has almost become complacent of these errors.

And today's flash crash was a fairly simple prank hack; a one-hit wonder. Imagine if someone really wanted to be malicious. Imagine wave after wave of false news stories hitting the high frequency machines. We could one day be looking at not just a 150 point drop, but a thousand points, or maybe 10-thousand.

And if you still have some confidence in the markets, you'll love this next story. Standard & Poors, the credit rating agency is defending itself in a $5 billion civil fraud lawsuit. The government claims that S&P defrauded investors by telling them that its ratings on collateralized debt obligations were based on stuff like research and objective analysis. The government claims that, instead of objectively analyzing the CDOs, S&P analysts gave these CDOs the best possible ratings, in order to win more CDO-rating business from the banks that pay their salaries. 

The government seems to have a good case; many of the S&P analysts sent emails to each other and to their bosses explaining how bad the CDOs were and how the whole thing would end badly, and some referred to the ratings as “burning down the house”, and the whole email problem seems to indicate that the folks at S&P knew they were cheating; they really, really knew that what they were doing was wrong.

But S&P says that we should ignore those emails, that they were just part of the company's "robust internal debate." It says its ratings were just dumb and unreliable, not fraudulent. But then it also says we should go ahead and ignore its claims of objectivity and integrity, while we're at it. S&P is claiming that it's objectivity was mere puffery, which is a bit of a stretch for a legal defense, and even worse as a business model. It shouldn't come as a surprise. It has been painfully obvious that the credit rating agencies have a conflict of interests. They are paid by the banks whose products they rate.

This conflict was a problem before the crisis, and it remains a problem now. And though regulators have made loud noises about doing something about this problem, they have not done much in the way of solving it.

Which means that we could once again be in a situation in which a rating agency's ratings turn out to be woefully wrong. By that point, nobody will have any excuse for being surprised. S&P has all but told us to expect it. It is now part of the court records; their ratings are nothing more than puffery.

Speaking of puffery, it's earnings reporting season.

Apple reported fiscal second-quarter earnings of $10.09 a share on revenue of $43.60 billion versus $12.30 a share on $39.19 billion a year earlier. Better than expected. Apple is opening the doors to its bank vault, saying it will distribute $100 billion in cash to its shareholders over two years. Apple increased its dividend 15 percent to $3.05 a share and said it will expand its share repurchase program to $60 billion from the $10 billion level announced last year. 

KFC parent Yum Brands reported that quarterly profit fell less than Wall Street expected, despite a sharp drop in sales in its top market of China, and the company's shares jumped 6.5 percent. The fast-food operator reaps more than half of its overall sales in China. I did not know.

Some of the crown jewels of corporate America have reported declining revenues and earnings, and have lowered their forecasts, and in doing so, have unleashed a flood of obfuscation and excuses – from Easter falling on the wrong date to lazy sales reps. So when Caterpillar reported on Monday, it was almost refreshing in its unvarnished ugliness.

Sales plunged 17.7%, profits 44.6%. “A challenging first quarter,” Corporate Controller Mike DeWalt called it. Dealer sales had been less than expected, inventories had piled up on their lots, and they’d cut back their orders to bring down their inventories. End-user demand was down, along with sales of aftermarket parts. Everything was down. But manufacturing costs jumped, and profits sagged. The rest of 2013 would be tough, and revenue guidance was lowered by a chunk. Not a single excuse.

Then there’s IBM. Because it’s the world’s largest supplier of information technology, its earnings report is a harbinger of things to come… namely excuses. A technique it had picked up from Oracle last month. Oracle’s earnings call was a mess. Revenue dropped 1%, instead of being up. Revenues from new software licenses and cloud subscriptions dropped 2%, after the company had forecast an increase of 3% to 13%. Hardware sales were a disaster. Who did they blame? First, the government – the quarter “ended on the same day as the sequester deadline,” explained President and CFO Safra Catz – then the sales reps. Oracle had just hired 4,000 new reps around the world; that was the problem Catz and President Mark Hurd said in unison. They hadn’t been trained yet. It was just “sales execution.” Nothing else. Certainly not the economy, Catz pointed out.

“What we really saw was the lack of urgency we sometimes see in the sales force as Q3 deals fall into Q4,” Catz said. Those “new reps,” she said, “ran out of runway in Q3.” They just couldn’t close their deals. “The issue for us is simply conversion,” Hurd added. “Clearly we have work to do in training new reps on managing the sales processes,” Catz chimed in. What about the old reps? Where they all on vacation? They didn’t say. Not a good omen.

Thursday evening, it was IBM’s turn to report a first-quarter earnings shortfall and revenues that, instead of growing, had skidded 5% from a year ago. To get back on track, IBM would swing the axe, at a cost of $1 billion in the second quarter – “workforce rebalancing” was its newfangled term, “to better align our resources to opportunity.” There’d be a lot of “rebalancing.” The term was used 14 times during the call. And it would dump some businesses.  A few moments later he added that revenues in the Americas were down 3%

A scary thought that the three largest markets in the world could weaken simultaneously – despite the prodigious amounts of money that central banks have printed and handed out. That phenomenon must be hidden under layers of lazy sales reps, sequester deadlines, and badly timed holidays. Yet, at the very end, something did slip out: “We are clearly not immune from changes in the global economy,” Loughridge said during his wrap-up, the most revealing sentence of the entire earnings call.

Wednesday, February 06, 2013 - A Trend of Banks Behaving Badly

A Trend of Banks Behaving Badly

by Sinclair Noe

DOW + 7 = 13,986
SPX + 0.83 = 1512
NAS – 3 = 3168
10 YR YLD -.05 = 1.97%
OIL + .20 = 96.84
GOLD + 4.10 = 1678.30
SILV +.03 = 31.95

At last count, 282 companies in the S&P 500 index had reported quarterly earnings and 74% were beating analyst earnings projections. Gas prices are up 7% in the past week. The Federal Reserve confirmed that one of its internal Web sites was hacked into yesterday. You might think the Fed databases are pretty secure. Turns out nothing in cyberspace is secure; just see what happened to the New York Times, the Wall Street Journal and the Department of Energy; and that's just the past couple of weeks. The Congressional Budget office says the US budget deficit this year will hit $845 billion, which sounds like a lot of money, but for the first time in a long time, it won't hit a trillion.

The Justice Department filed a $5 billion civil complaint yesterday accusing McGraw-Hill and S&P of three types of fraud, the first federal case against a ratings company for ratings related to the credit crisis. No surprise.

The transcripts of the Federal Reserve's FOMC meeting in 2007 show the Fed didn't trust the ratings agencies. Fed Chairman Bernanke said: “There is an information fog” that “is very much associated with the loss of confidence in the credit-rating agencies.”And Fed Governor Kevin Warsh said: the firms’ “credibility has been shot” and “it is much harder to see that this market will unwind itself in a rather kind and comforting environment.”

At the Aug. 7, 2007 meeting William Dudley said “disturbing delinquency trajectories” had prompted ratings agencies to downgrade a significant number of assets and that losses had “led to a fundamental reevaluation of what a credit rating means and how much comfort an investor should take from a high credit rating.” Dudley’s remarks sparked an FOMC discussion on the risk to the economy from declining confidence in ratings companies. Five years later, a civil suit is brought, and I'm reminded of an old, forgotten saying about justice delayed.

The Royal Bank of Scotland has become the third global bank to reach a settlement with US and British authorities related to manipulation of Libor, the London interbank offered rate; the interest rates that affect trillions of dollars of, well almost everything. We now have some trends.

The Royal Bank of Scotland agreed to pay criminal fines of $150 million to the Justice Department, and a $325 million civil penalty to the Commodity Futures Trading Commission, the regulatory agency that has taken the lead in these cases. An additional penalty of $137 million, will be paid to the Financial Services Authority in Britain. So, it will pay a total of more than $600 million to resolve the case.

Well, some of this fine might actually be paid by British taxpayers. In 2008, the British government had to bail out the Royal Bank of Scotland after the firm led a consortium to buy ABN Amro for $97 billion. RBS contributed around $37 billion for the ill-advised deal. The government, which plowed roughly $71 billion into the bank in the bailout, now owns 82 percent of RBS.

To help pay for the overall settlement, RBS said it would claw back past and present bonuses totaling $471 million from both the traders implicated in the rate-rigging scandal and from employees in the bank’s operations. Still, this is going to make it tougher for the British government to sell its shares. Since the bailout in 2008, the bank’s shares have plummeted, and are currently trading around 32 percent below the initial purchase price.

The other two banks that settled were Barclays and UBS. Barclays paid about $450 million. UBS paid $1.5 billion. For other banks looking to settle, they should figure on at least $500 million to the Justice Department and Commodity Futures Trading Commission, and the total could easily reach $1 billion if the governments of several nations are involved and the conduct by its employees was particularly problematic.

Barclays and UBS were required to have their Japanese securities operations plead guilty to one count of wire fraud, but it left the parent company untarnished by a criminal conviction. This should largely avoid the so-called Arthur Andersen effect on the bank by limiting the chances a bank will lose its ability to continue in business in the United States because of the conviction. The parent company does have to acknowledge its violations by accepting a statement of facts that describes how it violated the law. For Barclays and UBS, this came as part of a nonprosecution agreement, which means no criminal charges were ever filed against the banks.

This admission does, however, subject the banks to additional legal liability in cases file by those that relied on Libor for everything from mortgage rates to derivatives. Plaintiffs in such cases will now be armed with plenty of evidence provided by the government.

In an interesting twist, the Royal Bank of Scotland accepted a deferred prosecution agreement under which federal prosecutors filed a wire fraud charge that will be held in abeyance as long as the bank continues to cooperate.

So a precedent is set; pay a fine; throw a foreign subsidiary under the bus; walk away with a slap on the wrist.

The US Postal Service is cutting back. Beginning in August, there will be no more Saturday delivery of mail. The Postal Service would continue to deliver packages on a six-day schedule, and post offices would continue to be open on Saturdays. Cutting back Saturday mail delivery is expected to save $2 billion per year. Since 2010, the agency has reduced hours at many small, rural post offices and cut staff, and also announced plans to reduce the number of its mail processing plants. Last April, the Senate passed a bill that provided retirement incentives to about 100,000 postal workers, or 18 percent of its employees, and allowed the Postal Service to recoup more than $11 billion it overpaid into an employee pension fund. But post office officials say the cuts and staff reductions are not enough. Last year, the Postal Service had a net loss of $15.9 billion.

The postal unions and some businesses say the move to 5-day delivery is bad; it could be tough for customers, especially those in rural areas, or the elderly, and for many small businesses. The Postal Service continues to suffer losses of $36 million a day and is headed for projected losses of about $21 billion a year by 2016. A major reason for the losses is a 2006 law that requires the agency to pay about $5.5 billion a year into a future retiree health benefit fund; literally paying for benefits for employees that haven't even started work yet.

US corporate profit margins have never been higher. Lately it has been popular to point out that higher corporate profits have come at the expense of falling employee compensation. This might change as the economy improves:  companies might invest more to satisfy greater demand, new intellectual property will spread to competition, and higher employment will increase labor's bargaining ability. 

But how do we speed this up? Corporate investments have become a place to store wealth, as opposed to growing the businesses. The problem with corporations storing wealth is that it isn't nearly as good for most of us as investing in innovation and hiring employees. Some of retained earnings are socked away for tax reasons, some are the collection of high-tech companies that are past their innovative prime, but a lot of earnings are being used to buy back company stock. These stock buy backs sound good to shareholders and corporate executives, but it is a short-term maneuver that doesn't yield any long-term gain in production or profit.

A new report by the Corporation for Enterprise Development shows nearly half of US households  (132.1 million people) don't have enough savings to weather emergencies, or finance long-term needs like college tuition, health care and housing. According to the Assets & Opportunity Scorecard, these people wouldn't last three months if their income was suddenly depleted. More than 30 percent don't even have a savings account, and another 8 percent don't bank at all. 

We're not just talking about people who living people the poverty line, either. Plenty of the middle class have joined the ranks of the "working poor," struggling right alongside families scraping by on food stamps and other forms of public assistance. More than one-quarter of households earning $55,465-$90,000 annually have less than three months of savings. And another quarter of households are considered   net worth asset poor, " meaning that the few assets they have, such as a savings account or durable assets like a home, business or car, are overwhelmed by their debts."

The report shows household median  net worth  declined by over $27,000 from its peak in 2006 to $68,948 in 2010, and at the same time, the cost of  basic necessities like housing, food, and education have soared. Part of the problem is fixed cost, the things that are difficult to "cut back" on. Housing, health care, and education cost the average family 75 percent of their discretionary income in the 2000s. The comparable figure in 1973: 50 percent.

When consumers can't keep up with the costs, they fall into a debt trap. The average borrower carries more than $10,700 in credit card debt, one in five households still rely on high-risk financial services that target low-income and under-banked consumers. 

Tuesday, February 05, 2013 - Cutting to Spite Ourselves

Cutting to Spite Ourselves

by Sinclair Noe

DOW + 99 = 13,979
SPX + 15 = 1511
NAS + 40 = 3171
10 YR YLD +.04 = 2.02%
OIL + .47 = 96.64
GOLD – 1.40 = 1674.00
SILV +.06 = 31.92

The Congressional Budget Office released revised budget projections that show the federal deficit will drop to $845 billion this year, the first time during Obama's presidency that the red ink would fall below $1 trillion. The budget office also said the economy will grow slowly in 2013. The reason for the slowdown is a tax increase in January and spending cuts coming in the next couple of months.

A few minutes after the CBO report, President Obama spoke to the press and said those spending cuts would damage the economy and must be avoided. He asked Congress for a short-term deficit reduction package that will delay deeper cuts past the automatic start date of March 1, also known as the sequester.

The automatic cuts are part of a 10-year, $1 trillion deficit reduction plan that was supposed to spur Congress and the administration to act on long-term fiscal policies that would stabilize the nation's debt. Though Congress and the White House have agreed on about $2.6 trillion in cuts and higher taxes since the beginning of 2011, they have been unable to close the deal on their ultimate goal of reducing deficits by about $4 trillion over a decade.

If the automatic cuts are allowed to kick in, they would reduce Pentagon spending by 7.9 percent and domestic programs by 5.3 percent. Food stamps and Medicaid would be exempt, but Medicare could take up to a 2 percent reduction, under the plan.

White House aides say the president's plan for long-term deficit reduction would increase tax revenue by about $600 billion to $700 billion over 10 years as well as reduce mandatory health care spending, primarily in Medicare, by about $400 billion over the next decade. It would also change an inflation formula that would reduce cost-of-living adjustments for beneficiaries of government programs, including Social Security. Republicans have called for a more comprehensive overhaul of government entitlement programs.

For now, the President is asking for a short-term deficit reduction package of spending cuts and tax revenue that will delay the sequester, and give Congress time to chip away at the problem.

Part of what we should have learned is that austerity is not the answer. Europe has shown that. When economists talk about the role of government in economic recovery, they often focus on the question of whether or not we need more economic stimulus. Government participation in the economy does not just stimulate private sector activity.  Government is itself a large, diverse and important sphere of economic enterprise.  Our federal, state and local governments produce and deliver important goods and service, things that people want and need, and that they have asked their representatives to create and maintain.   And governments employ millions of people in income-earning positions to carry out all of this production.  Ordinarily, we would expect that as a society grows, government will grow commensurately along with everything else.  As our population grows and private enterprises proliferate, we need more schools and teachers, more courthouses and police stations, more public parks, more inspectors and regulators, more paved roads and street lights, and more government clerical workers.  So while it is true that government spending also stimulates additional economic activity in the private sector – just as any economic enterprise stimulates economic activity in the other enterprises it touches and affects – it is also true that the public enterprises governments oversee and the tasks governments perform are all by themselves an important component of overall economic activity.

The part of government spending that is devoted to purchases made in the production of goods and services is called “consumption and gross investment” , or CGI, and it amounts to about 15% to 20% of GDP.  Government consumption and gross investment (CGI) can be contrasted with other forms of government spending that do not contribute to GDP, such as transfer payments to the public under social insurance programs like Social Security and unemployment insurance programs.

CGI started to dry up after the stimulus package started to wear off in 2011, and public enterprise also started to decline. Paul Krugman asked: “How big a deal is this? Government consumption and investment is about $3 trillion; if it had grown as fast this time as it did in the Bush years, it would be 12 percent, or $360 billion, higher. Given a multiplier of more than one, which is what the IMF among others now thinks reasonable under current conditions, that ends up meaning GDP something like $450 billion higher, which is 3 percent — and an unemployment rate 1.5 points lower. So fiscal austerity is the difference between where we are now and an unemployment rate not much above 6 percent.”

For the past couple of years we've heard bipartisan talk about grand bargains, fiscal cliffs, sequestration, and debt ceilings, with different strategies granted, but with a common theme to shrink government.

 Obama actually told us government must shrink because we are “out of money”.  But notice how absurd it would be if the leaders of private sector industry were to say that the private sector economy has to shrink because it is out of money.  Everybody recognizes that if our economy is to grow and progress, private enterprise needs to spend and invest, and that the means of financing are created along with the initiatives that are financed.   In the case of government, the financial constraint is even less relevant, I mean they print the currency, so there are no real constraints due to a lack of money.

Yesterday I told you to look for a lawsuit against S&P. As expected, the government is seeking more than $5 billion in a civil lawsuit against Standard & Poor's and parent company McGraw-Hill over mortgage-bond ratings, marking the first federal enforcement action against a credit rating agency over alleged illegal behavior tied to the recent financial crisis. S&P reportedly had a chance to settle for about $1 billion, but they felt the price was too high. Attorney General Eric Holder said at a news conference that S&P misled investors, causing them to lose billions, and that its ratings were affected by "significant conflicts of interests." He said that while analysts raised red flags as early as 2003, S&P executives ignored questions about ratings.

In the filing Monday, the government said: "Considerations regarding fees, market share, profits, and relationships with issuers improperly influenced S&P's rating criteria and models." In other words, they sold their ratings to the highest bidder and didn't give a damn about honesty. So, the question is why did it take so long to bring civil charges against the ratings agency?

Well, the lawyer defending S&P says the government intensified its investigation after S&P downgraded the government's credit rating in 2011, following the debt ceiling dysfunction. I'll give the lawyer credit for misdirection, if nothing else. S&P will likely use the same defense the industry has been using for years to explain the seemingly misguided ratings -- their right to free speech. S&P and other credit rating agencies have claimed that their ratings were merely free speech and are therefore protected under the First Amendment. 

There is a paper trail of damaging emails. You've heard about this before. And when those emails are read aloud in court, the best hope will be to make jurors think that maybe it's just a government vendetta. But listen to some of the emails:

In an April 2007 email, an analyst quoted in the lawsuit told an investment banking client that the priorities inside S&P were not centered on providing accurate ratings, but rather were focused on not “p*ssing off too many clients and jumping the gun ahead of [competitors] Fitch and Moody’s.”

The banker emailed back: “I mean come on we pay you to rate our deals, and the better the rating the more money we make?!?! What’s up with that? How are you possibly supposed to be impartial????”

Another S&P analyst wrote: "We rate every deal … it could be structured by cows and we would rate it.”

The email complaints about the integrity of the ratings were so numerous that S&P management directed analysts to stop sending complaints via email. But the emails continued. They wrote about allowing bankers to have greater input into the ratings process; let the bankers help make the grades for the products they were selling; and all designed to increase revenue for S&P. One email that seems particularly damaging came from a director in charge of rating CDOs in late 2006. He wrote: “this market is a wildly spinning top which is going to end badly.”

The paper trail is long and extremely damaging. So, what does it take to come up with criminal charges against a large financial institution? Seriously, what does it take to get a criminal charge started?

Today, Barclays, the British bank, announced it is provisioning another $1.3 billion in its Q4 results to settle claims it mis-sold financial products, bringing total provisions to about $3.5 billion. And UBS, the Swiss banking giant, announced a a $2.1 billion dollar fourth quarter loss, with $1.5 billion of that coming from fines for manipulating Libor interest rates. The Libor rate affects the prices of hundreds of trillions of dollars of financial products; everything from credit cards to mortgages to municipal bonds. Basically, the price of everything in the world the price is somehow connected to Libor. And these guys were monkeying around with this for individual profit. But nothing illegal happened.

And finally, Dell Computer will be taken private by founder Michael Dell and Silver Lake Partners in a $24.4 billion dollar deal. It works out to about $13.60 per share, roughly one-quarter Dell's all-time high 12 years ago. Still, it's the biggest buy out in years.