Agree to Disagree
by Sinclair Noe
DOW – 216 = 14,960
SPX – 22 = 1608
NAS - 43 = 3401
SPX – 22 = 1608
NAS - 43 = 3401
10 YR YLD 0 .03 = 2.10%
OIL + .38 = 93.69
GOLD + 2.70 = 1403.70
SILV unch = 22.65
OIL + .38 = 93.69
GOLD + 2.70 = 1403.70
SILV unch = 22.65
The big economic news this week will be the Friday morning jobs
report. ADP, the payroll processing company does its own jobs report, and today
they estimated the economy added 119,000 new jobs in May. The ADP report is not
a good indicator of Friday's report, but taken on its own, today's analysis
shows a softening labor market, dragged down by the sequester.
Then, this afternoon we read the Federal Reserve Beige Book;
here's how they described things:
“Overall economic activity increased at a
modest to moderate pace since the previous report across all Federal Reserve Districts except
the Dallas District, which reported strong economic growth. The
manufacturing sector expanded in most Districts since the previous Beige
Book. Most Districts noted slight to moderate gains in consumer spending and a
moderate increase in vehicle sales. Tourism showed signs of strength in
several Districts. A wide variety of business services expanded, and
transportation traffic increased for producer, consumer, and trade goods.
Residential real estate and construction
activity increased at a moderate to strong pace in all Districts. Commercial
real estate and construction activity grew at a modest to moderate pace
in most Districts.”
And fade to beige, actually a modest to moderate shade of beige.
After reading the Beige Book, I know what you're probably thinking; yes, it is
properly titled. I really don't think we need to spend more time on that report
because it's pretty obvious the Fed didn't spend much time on the report. Yes,
we should all pitch in to send them a thesaurus.
You'll notice that the Federal Reserve did not use words like:
fantastic, robust, overheated, exuberant, or even copacetic. I've been trying
to tell you that there is a disconnect between the economy and the stock
market.
Part of the problem is the Fed lives in a land of make believe and
isolation. This week, Federal Reserve Governor Sarah Bloom Raskin was speaking
on a panel at a conference on joblessness. Seems she left her ivory tower and
went to a job fair in her hometown and she was shocked to find that most of the
jobs were for security guards, restaurant workers and even life guards.
So, she investigated the type of jobs that have been gained
since the economy emerged from recession. She found half of all those hired
received low pay jobs, but two-thirds of the jobs lost in the recession were
middle income jobs like factory and construction workers. Ms. Raskin said she
is concerned about “the quality of jobs available.”
The low quality of jobs added in the
recovery explains why wages have mostly stagnated even while unemployment has
declined in recent years. Ms. Raskin said the phenomenon suggests there is a
disconnect between education and the skills employers need; which may be
partially true, but also demonstrates the need for Ms. Raskin to get out a
little more.
She also said the current unemployment
rate, which still remains high despite its gradual improvement, underestimates
the true scope of the unemployment problem. And she said the “real risk” of
long-term unemployment is that the longer a worker stays unemployed, the more
unemployable they grow. Firms are increasingly reluctant to hire people who
have been out of the workforce for long stretches, which leads to those workers
losing skills and ultimately the ability to ever reenter the workforce.
She didn't talk about monetary policy.
The SEC has come up with a proposal to
make sure the money market fund industry doesn't “break the buck” again. The
funds would be required to fundamentally change how it prices its shares in an
effort to reduce the risk of abrupt withdrawals, also know as a run. You'll
love this; the idea to stop a run on the funds is to charge withdrawal fees and
delay the return of funds to customers in times of financial distress.
In other words, once the money market
funds get their hands on your money, it's not really your money anymore, it's
their money and you don't have much say.
In 2008, the Reserve Primary Fund, one
of the largest money funds, suffered losses on Lehman Brothers debt and could
not maintain its $1 per share price, known as "breaking the buck." That ignited a run by investors across the money fund
industry, cutting off a major source of overnight funding for many
corporations. I remember talking about that with you, and telling you back then
that there was a real problem.
In
2010, the SEC adopted rules that bolstered fund transparency, tightened credit
quality standards, shortened the maturities of fund investments and imposed a
new liquidity requirement. For years, proponents of further reform have
raised concerns that money market funds, mutual funds that invest in short-term
debt securities, can be considered as safe as bank deposits even though they do
not have a government guarantee.
In a compromise move, the SEC's plan
mostly focuses on prime funds for institutional investors, which are seen as
more prone to runs because those investors are more sophisticated and more
likely to pull large blocks of money first if there is a panic.
The
SEC estimated that institutional funds represent 37 percent of the market with
$1 trillion in assets. The SEC's plan calls for two
alternative proposals that it said could be adopted alone or in combination.
The
first piece would require prime funds used by institutional investors to
transition from a stable, $1 per share, to a floating net asset value (NAV) - a
move designed to reduce the risk of runs like those during the financial
crisis. The SEC said that retail and government
funds, which are not considered to be at the same risk for runs, would not have
to move to a floating NAV. That one dollar price seems appealing even if it is
not an accurate price of the net asset value. It's smoke and mirrors and a big
pile of garbage, but it gives the illusion of stability.
The second proposal, meanwhile, would
give fund boards for institutional and retail funds the authority to impose
so-called "liquidity fees and redemption gates" during times of
stress. That would give funds the power to stop an
outflow of investor money.
Goldman Sachs wants you to believe
that Too Big To Fail banks do not actually enjoy a funding advantage. Goldman
put out a paper with the mild title of "Measuring the TBTF effect on bond pricing." It argues that the commonly-held
view that TBTF banks can borrow cheaply because bond investors expect the
government will support them used to be a little bit correct. Then it became
very correct during the financial crisis. But now is totally incorrect.
The study argues
that that six banks with more than $500 billion in assets paid interest rates
on their bonds that were an average six basis-points lower than smaller banks
from 1999 to mid-2007. When the financial crisis struck, the funding advantage
grew far wider. But beginning in 2011, the funding difference reversed, with
the biggest banks now paying an average of 10 basis points more than smaller
banks.
It sounds like a
good argument but it isn't exactly true. The TBTF funding has never been about
absolute funding levels of big banks or even the funding levels of big banks
relative to smaller banks, rather it is that the big banks get government
support that lowers the cost of funds compared to what they should be.
Goldman has much
lower capital reserves, or a cushion to protect against bad bets, and they tend
to bet much bigger, therefore they should be paying a significant premium for
capital. They don't. So, there is a TBTF subsidy. It's not as large as it once
was, probably because the financial crisis made it clear that the largest
financial institutions are far more fragile than almost anyone suspected prior
to 2008. But it's there and plain enough to see.
It's a bit
disturbing that Goldman doesn't seem to understand this. Their misperception
means that they are likely to misread or ignore market signals about the risks
they take. Goldman—and the other TBTF banks—seem to still be blind to their own
vulnerability—which is what got us in the financial crisis mess in the first
place.
Tomorrow, the
International Monetary Fund is expected to issue a report on Greece, a mea
culpa, or as they describe it: In an internal document marked “strictly
confidential,” the IMF said it badly underestimated the damage that its
prescriptions of austerity would do to Greece’s economy, which has been mired
in recession for years.
Seems the IMF
ignored its own criteria for qualification, then maybe decided Greece should
not have been eligible for assistance, then they thought Greek debt was
sustainable, then they thought the Greeks would cut all government spending,
then they realized that couldn't happen, but then they decided to hold the
Greeks for ransom until they cut more than they could, then they wondered why
the economy didn't respond like they hoped, then they postponed the restructuring
for 2 years because they were worried the Greeks couldn't be trusted with a new
credit card, then that made everything more expensive for the Greeks, then they
didn't count very well, then they failed to identify growth enhancing
structural reforms, and all the IMF mistakes didn't help Greece, but it did
help the wider Eurozone and especially the Euro-banks, and the whole country
just went down the toilet and it's a crying shame, and oopsie, the IMF is sorry
about that, but now they conducted a study and determined that despite all
those things that might seem on the surface to be IMF mistakes, in the end, it
was the Greek government that is to blame.
