Friday, April 11, 2014 - Corrupt or Incompetent, Take Your Pick

Corrupt or Incompetent, Take Your Pick

by Sinclair Noe

DOW – 143 = 16,026
SPX – 17 = 1815
NAS – 54 = 3999
10 YR YLD - .01 = 2.62%
OIL - .07 = 103.33
GOLD + .30 = 1319.40
SILV - .07 = 20.06

The S&P 500 closed at its lowest level in two months. The gauge slipped 2.7% this week, the biggest loss since 2012. The Dow Industrial are down 2.4% for the week. The Nasdaq Composite Index dropped 1.3% today, capping its biggest two-day retreat since 2011; and down 3.1% for the week; closing at its lowest level in 4 months. The major US indices are all back in the red year to date. Biotechs fell for the 7th week in a row; the worst run since 1998; and now down 21% from recent highs. About 7.4 billion shares changed hands on US exchanges, 5.8% higher than the three-month average.

We are entering a period that has historically been very poor for stocks. The idea is called “Sell in May” or the worst six months. According to the Ned Davis (NDR) database, had you invested $10,000 in the S&P 500 every May 1st starting in 1950 and sold October 31 of the same year, your initial position would only be worth $10,026. Put another way, by investing only from May through October, a $10,000 stake invested in 1950 would have only made $26.

The Labor Department reports the producer price index, gained 0.5% for March. Excluding the volatile categories of food and energy, core PPI prices rose 0.6% after falling 0.2% in February. The University of Michigan/ Thomson Reuters consumer sentiment rose to a preliminary April reading of 82.6, the highest reading since July, from a final March level of 80.

You’ve probably heard about the Heartbleed bug.  Heartbleed is a flaw in OpenSSL, a piece of code intended to create a secure connection between a server and Web browser; for example, between an online shop and customer. The bug allows an attacker to make the server surrender bits of information out of its memory that should not be accessible. What's more, the exploit leaves no trace. The fear is that the bug may expose credit card numbers, passwords, and more.

By some estimates the Heartbleed bug puts two-thirds of all websites at risk. Millions of smartphones and tablets running Google’s Android operating system have the Heartbleed bug. The government has issued a warning to businesses and banks to be on alert for hackers possibly stealing data.

The Federal Financial Institutions Examination Council, made up of representatives from the Federal Reserve Board of Governors, the Consumer Financial Protection Bureau and other regulators, said: “The vulnerability could allow an attacker to potentially access a server’s private cryptographic keys compromising the security of the server and its users. Attackers could potentially impersonate bank services or users, steal login credentials, access sensitive e-mail, or gain access to internal networks.”

And there’s not a lot you, as a consumer, can do until the websites fix the problem on their end. It may take some time. The Heartbleed bug has been found in the hardware connecting homes and businesses to the Internet. Cisco Systems and Juniper Networks said some of their networking products are susceptible to the encryption bug. Security experts say it might help to change passwords on sites you visit, but fixing the network equipment and software means the companies will rely on customers applying patches as they become available. Cisco said it would tell customers when software patches for its affected products are available.

Now for the scary part.

Bloomberg News reports the National Security Agency has known about the Heartbleed bug for 2 years, and rather than report it, or take steps to close it down, the NSA instead regularly used the encryption flaw to gather intelligence. Putting the Heartbleed bug in its arsenal, the NSA was able to obtain passwords and other basic data that are the building blocks of sophisticated hacking operations. The agency found the Heartbleed glitch shortly after its introduction, according to one of the people familiar with the matter, and it became a basic part of the agency’s toolkit for stealing account passwords and other common tasks.

The revelations have created a clearer picture of the two roles, sometimes contradictory, played by the US’s largest spy agency. The NSA protects the computers of the government and critical industry from cyberattacks, while gathering troves of intelligence attacking the computers of others, including terrorist organizations, nuclear smugglers and other governments.

Questions remain about whether anyone other than the US government might have exploited the flaw before the public disclosure. Sophisticated intelligence agencies in other countries are one possibility. If criminals found the flaw before a fix was published this week, they could have scooped up millions of passwords for online bank accounts, e-commerce sites, and e-mail accounts across the world.

If the reports are true, they would represent a serious breach of the NSA's mission.  There’s no excuse for leaving Americans and businesses vulnerable to breaches on this scale. They should be helping to shore up vulnerabilities, not exploiting them. The NSA has issued a statement denying prior knowledge of the Heartbleed bug; which is not a reassuring denial. This is one of the biggest breaches in the history of the internet, and the NSA, which is supposed to watch this stuff, claims they know nothing. For now, the NSA is sticking to their story that they are incompetent rather than corrupt.

Earnings reporting season is gearing up, with an epic miss from the biggest US bank. JPMorgan Chase said its first-quarter earnings fell 20%, driven by a decline in investment banking and mortgage lending. The bank reported net income of $4.9 billion for the first quarter, after stripping out payments to preferred stockholders. That was down from $6.1 billion in the same period a year earlier. On a per-share basis, the earnings amounted to $1.28, missing estimates of $1.39. Revenue, after stripping out the effect of an accounting charge for credit losses, was $23.8 billion, down 8 percent from $25.8 billion a year earlier. Revenues at the bank's fixed income trading business, part of its investment banking unit, slumped 21% to $3.8 billion. Mortgage originations plunged 68% to $6.7 billion, compared with the same period last year; the bank doesn't expect the trend to change anytime soon.

Wells Fargo posted a profit of $5.9 billion, up 14% from the same period in 2013. Still, the bank’s revenue for the quarter fell to $20.6 billion from $21.3 billion in the same period a year ago.

A federal judge has approved the city of Detroit’s latest attempt to extricate itself from some long-term derivatives contracts that have been costing it tens of millions of dollars a year, holding up a settlement as an example of “the very spirit of negotiation and compromise” that he hoped other creditors would follow. Judge Steven Rhodes of United States Bankruptcy Court ruled that Detroit could proceed with a plan to pay $85 million to UBS and Bank of America to terminate the financial contracts, known as interest-rate swaps, that were used to help finance pensions.

Under the terms of the settlement, the two banks agreed to back Detroit’s overall plan of adjustment, which is critical for the city’s push to resolve its bankruptcy by early fall. Municipal bankruptcy rules say that if one class of impaired creditors votes to approve the city’s plan of debt adjustment, the judge may be able to impose the terms forcibly on everybody else. The judge’s decision gives Detroit leverage for settlements with other creditors.

Earlier this year, Judge Rhodes had rejected a previous attempt to end the swaps that called for Detroit to pay the banks $165 million. He called that proposal “just too much money” and noted that Detroit would have a reasonable chance of success if it sued the banks outright, calling the swaps invalid and refusing to make any termination payments at all. The message was to re-engage in negotiations, and apparently it worked.

Detroit’s emergency manager, Kevyn Orr, and other officials have been calling for creditors to negotiate settlements quickly out of fear that Detroit’s case will become a hopeless quagmire if creditors keep fighting the city’s proposals for resolving their debts. The state law that put Detroit under emergency management is scheduled to expire in September.

Detroit entered into the swap contracts in 2005, when it tapped the municipal bond market for $1.4 billion to put into its workers’ pension funds. Much of the deal was structured with variable-rate debt, and the swaps were intended to work as a hedge, to protect Detroit if interest rates rose. But rates fell, and under those circumstances, the terms of the swaps called for Detroit to make regular payments to UBS and Bank of America. The swaps cost Detroit about $36 million a year.

The 2005 borrowing also required an unusual structure to avoid violating the city’s legal debt limit. In 2009, the debt was downgraded to junk, putting the city out of compliance with the terms of the swaps. So Detroit restructured the swap obligations, offering the two banks the tax revenue that it received from local casinos as a backstop.

When Detroit declared bankruptcy last summer, it estimated the cost of terminating its swaps at about $345 million. Days before filing its bankruptcy petition, Detroit said Bank of America and UBS had given it a break, so that it would have to pay only about $250 million to cancel the contracts. But other creditors, facing bigger relative losses, complained that the two banks were still getting way too much. They argued, among other things, that the interest-rate swaps were invalid from the beginning because the use of casino taxes for financial hedges is not allowed under state law. So, Detroit either got off cheap at $85 billion or the banks just stole $85 billion.

Tuesday, January 14, 2014 - The Day the Net Died (Maybe)

The Day the Net Died (Maybe)

by Sinclair Noe

DOW + 115 = 16,373
SPX + 19 = 1838
NAS + 69 = 4183
10 YR YLD + .04 = 2.87%
OIL + .83 = 92.63
GOLD – 7.40 = 1246.00
SILV - .15 = 20.36

A US appeals court has rejected federal rules that required Internet providers to treat all web traffic equally. The Federal Communications Commission's open Internet rules, also known as net neutrality rules, required Internet service providers to give consumers equal access to all lawful content without restrictions or varying charges. The US Court of Appeals for the District of Columbia Circuit struck down the regulation, which was passed in late 2010 and challenged in court by Verizon Communications. The decision that could allow mobile carriers and other broadband providers to charge content providers for faster access to websites and products, or block content, or slow down access.

One argument is that a video and Internet provider would have an incentive to bog down a video streaming service such as Netflix in favor of its own sites. Or it could charge a toll to those who want their content delivered at a higher speed, which media watchdogs say would stifle innovation and favor big and powerful companies.

The issue of companies playing favorites with their own content came to the forefront when Comcast announced plans to acquire NBCUniversal in 2009.  Comcast, the nation's largest cable and Internet distributor, said in a statement that the court ruling would not change the company's policies. At the time of the acquisition, the Comcast agreed to abide by the FCC's open Internet rules for 7 years, even if the courts changed them. After 7 years, the gloves would likely come off.

There is big money at stake, as we were reminded today. Charter Communications wants to buy Time Warner Cable in a deal valued at more than $37 billion. Time Warner Cable's board has rejected the offer.

The FCC had classified broadband providers as information service providers as opposed to telecommunications service providers, like telephone companies, and that distinction created a legal hurdle for the FCC's authority over them. This was the second time the court struck down the FCC's net neutrality rules. The FCC now could appeal the ruling to the full appeals court or to the US Supreme Court, something FCC Chairman Tom Wheeler said he is considering as he looked at "all available options" to ensure Internet networks remained free and open.

The regulators could also try to reclassify broadband providers so they fall in the same category as traditional phone companies, a step that would give the FCC more oversight power. With the agency taking its regulatory authority from the Telecommunications Act of 1996, it could go back to Congress and ask for new authority to regulate broadband. But the Republican majority in the House of Representatives has tried multiple times to repeal the FCC’s net-neutrality rules, and any legislation giving the FCC new authority over broadband providers would have little chance with lawmakers there.

One simple way, at least on its face, to get around the prohibition on applying common carrier rules to broadband would be for the FCC to reclassify broadband, subject to the common carrier rules that traditional voice service is subject to.

There will be serious push back from the phone and cable companies and their lobbyists. They will make threats, recycle all of their debunked myths about the Internet, they will claim that the internet belongs to them, and promise we can trust them not to do any of the bad things they've fought so hard to do.

Economic data today; the commerce department reported better-than-expected retail sales for December, up 0.2% versus estimates of 0.0%. Core sales, excluding the more volatile food and auto sectors, were up 0.7% for the biggest gain in almost a year. November sales numbers were revised slightly lower. These core sales correspond most closely with the consumer spending component of gross domestic product, and the increase suggested consumption accelerated in the fourth quarter from the third quarter's 2 percent annual pace.

A second report from the Commerce Department showing retail inventories, excluding autos, increased 0.6 percent in November after increasing 0.3 percent in October. The economy grew at a 4.1 percent rate in the third quarter, which was the fastest pace in almost two years. Fourth-quarter GDP growth estimates range as high as a 3.9 percent rate.

It's earnings reporting season and this week features the big banks; today featured JPMorgan and Wells Fargo. Wells reported an 11% jump in profits, thanks in large part to cost cutting, which is to say they fired people. Wells Fargo says their mortgage business is doing just about what it would be expected to do at this point in the economic cycle. The nation's biggest mortgage lender, Wells Fargo, said its mortgage volume tumbled to $50 billion in the quarter, down 60 percent from $125 billion a year ago. The second-biggest lender, JPMorgan Chase, said its mortgage originations, that includes new home purchases and refinancings, fell 54 percent to $23.3 billion from $51.2 billion a year ago.

A jump in interest rates has had a big impact on the housing market. That should be a warning sign for a Federal Reserve seemingly bound and determined to withdraw stimulus from a still-shaky economy. Higher rates have hurt demand. The average interest rate for a 30-year fixed-rate mortgage has jumped to 4.5 percent from a record low of 3.3 percent in early 2013. Fed Chairman Ben Bernanke and others argued they weren't kicking the props out from under the bond market, but that's sort of what happened: Bond prices fell, and interest rates jumped. Of course, rates are still relatively low, and the housing market is not exactly in a panic, though sales are slowing.

The specifics of bank earnings are increasingly unimportant because nobody believes the numbers anymore; the numbers are massaged and manipulated to such a degree that they are of no value. Wells Fargo closed near an all time high. Still, the reports are fun reading, even if much is fictional.

JPMorgan met earnings expectations if you overlook the legal costs, and Wall Street seemed willing too overlook the legal costs today. Investment banking fee revenue dropped 3 percent. The bank had $1.1 billion of legal expenses in the fourth quarter, about $850 million of which was linked to a recent settlement for failing to report its suspicions of fraud at its client Bernard Madoff's fund.

The bank agreed to some $20 billion of legal settlements in 2013; almost equal to a typical year's profit. CEO Jamie Dimon indicated some investigations into JPMorgan are just beginning, so the idea is that they just treat the legal problems as the cost of doing business.

One bit of info from JPMorgan today, a key lending metric, the ratio of the bank's loans-to-deposits, hit a new low. In 2013, JPMorgan on average lent out just 57% of its deposits. That's down from 61% a year ago and the lowest that ratio has been in at least a decade. Back in 2004, JPMorgan's loan-to-deposit percentage was as high as 88%. It's also down at rivals. But not as much. The industry average is just under 70%.Traditionally, banks have lent out 80 to 90% of their deposits.

So, why isn't JPMorgan making loans? One reason is that they can make as much money, about $300 million by just buying short term, low interest rate Treasury bonds. Dimon should send a thank you note to Bernanke. The other possible explanation is that there isn't much demand for loans. Either way, this would seem to be an indicator of sluggish growth.

The bank earnings season actually kicked off on Friday when the Federal Reserve released a statement saying it made an estimated $79 billion in net interest income, driven by its $90 billion in interest income on its portfolio of Treasuries, mortgage bonds, and other securities. The Fed sent $77 billion to the US Treasury. The Federal Reserve, after operational costs, is earning double the profits of Exxon Mobil ($44 billion) and Apple ($41 billion), and those two companies are doing a combined $600 billion in global revenues. The Fed doesn't have to drill oil wells or hire Chinese kids to glue together phones, they basically print money, buy mostly risk-free bond investments and do a little research to determine what the interest payments are going to be. The Fed has built up a $4 trillion dollar portfolio, and they have sent more than $350 billion to the Treasury since 2009. By the way, the Fed sent $88 billion to the Treasury in 2012, so they were down last year. No, I don't know what that indicates.

Standard & Poor's Ratings Services revised its outlook on California's credit ratings to positive from stable, citing the governor's budget plan. S&P foresees raising the state's rating one notch within two years, if California follows the $107 billion budget Brown proposed last week. S&P said it is also encouraged by the proposal's emphasis on repaying debt and building reserves. While Brown did not suggest specific action for making the teachers' underfunded retirement system whole, he did highlight that the pension "is in need of a long-term funding strategy.”

In a letter issued through the Economic Policy Institute, including seven Nobel Laureates, argue that the government should hike the federal minimum wage from $7.25 to $10.10 an hour by 2016 and then peg future increases to inflation.

The effect of a minimum wage hike is one of the most hotly debated issues in economic research. Some argue that a boost in the wage floor would hurt low wage earners because employers would be hesitant to hire if they had to pay their workers more. In the letter, the economists, argue that the "weight" of the evidence indicates past minimum wage hikes haven’t hurt the job market.

However, the letter reads: "Research suggests that a minimum-wage increase could have a small stimulative effect on the economy as low-wage workers spend their additional earnings, raising demand and job growth, and providing some help on the jobs front."

Thursday, October 03, 2013 - Don't Underestimate the Idiocy

Don't Underestimate the Idiocy

by Sinclair Noe

DOW – 136 = 14,996
SPX – 15 = 1678
NAS – 40 = 3774
10 YR YLD - .02 = 2.61%
OIL – 1.22 = 102.88
GOLD + .40 = 1317.70
SILV - .04 = 21.80

Well, we won't be able to sift through the jobs report tomorrow, due to the government shutdown. There are lots of things that won't happen tomorrow, but next week, the International Monetary Fund and the World Bank will meet in Washington. Ahead of the meeting, Christing Lagarde, the IMF Director delivered an assessment of the global economy. It's subdued. Lagarde says “In many of the advanced economies, however, we are finally seeing signs of hope. Growth is looking up, financial stability is returning, and fiscal accounts are looking healthier.”

The impact of a slowdown on US Federal Reserve asset purchases had been expected to dominate this year’s annual meetings but the Fed’s decision to hold off on tapering has removed that focus. And attention will now turn to the spectacle of a government shutdown and impending debt ceiling default. Lagarde called the debt ceiling “mission critical”, because “the normalization of monetary policy affects so many markets and people across the globe, the US has a special responsibility: to implement it in an orderly way, linking it to the pace of recovery and employment; to communicate it clearly; and to conduct a dialogue with others.”

Late yesterday, President Obama was interviewed by CNBC and he warned that investors should be worried, saying “This time's different. I think they should be concerned.”

It was a pretty clear message to political opponents that even their Wall Street benefactors are growing weary of this mess, saying “I think Wall Street can have an influence. CEOs around the country can have an influence. This is going to have a profound impact on our economy, their bottom line, employees and shareholders unless we start seeing a different attitude around that faction of Congress.”

Today, the Treasury Department released a report warning of catastrophic damiage if Congress fails to raise the debt ceiling. The report states: "A default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse."

The Treasury report mentioned that even the prospect of default can cause economic problems, including lower consumer confidence, stock market volatility and higher interest rates on business loans and mortgages. An actual default could have consequences for years to come. The US has never defaulted on its debt, but the cost of insuring one-year Treasury bonds against default has quintupled in the past 10 days.

So, the president says there is cause for concern; the Treasury warns of a catastrophe; and the IMF says the debt ceiling is mission critical, and Wall Street slips a little, but apparently they haven't yet figured out how to turn this into a full fledged panic. There is an air of complacency that might linger until the last minute. Warren Buffett says, “We will go right up to the point of extreme idiocy, but we won’t cross it.” Maybe, but I think Warren underestimates the idiots.

If the debt-limit isn’t lifted, the Treasury will face the prospect of violating one of three laws: The World War I-era statute that created the debt limit, the ban on direct lending to the Treasury from the Federal Reserve, or the 14th Amendment declaring that the legitimacy of U.S. debt must go unquestioned.

There may be some ways to circumvent default, but those options are all “iffy”, at best. The most widely discussed strategy would be for President Obama to invoke authority under the 14th Amendment and essentially order the federal government to keep borrowing, an option that was endorsed by former President Bill Clinton during an earlier debt standoff in 2011. Other potential October surprises range from the logistically forbidding, like prioritizing payments, issuing i.o.u.’s or selling off gold and other assets, to more fanciful ideas, like minting a trillion-dollar platinum coin.

President Obama will not invoke a constitutional amendment to unilaterally increase the nation’s debt limit if  an  impasse with House Republicans causes that ceiling to be breached in two weeks. White House press secretary, Jay Carney, said: “We do not believe that the 14th amendment provides that authority to the president.” The president, he added, “completely” agrees with his advisers’ legal reasoning. More specifically, this removes the idea of an impeachable offense. Of course, that doesn't mean the debt-ceiling will be lifted; again, we should not underestimate the idiots.

But it all goes back to the complacency of Wall Street, which hasn't hit panic stage but has been drifting lower. The Dow Industrials have quietly dropped 9 of the last 11 sessions, shedding 720 points along the way, to close under 15,000. Wall Street is concerned but not yet convinced of a catastrophic default, but also cognizant that the possibility of default forces the Federal Reserve to avoid the taper.

Earnings estimates have been slow in coming down. And the stock market, supposedly forward looking and focused on corporate revenues and earnings, has been completely blind to them. Fundamentals no longer matter. All that matters is the Fed. A shift that has become the Fed’s most glorious accomplishment. And the Fed continues to feed Wall Street with $85 billion a month. Step right up and gorge.

Yet in this infinite QE environment where there is no gravity for stocks and even junk bonds, the smart money is selling hand over fist, unloading whatever they can, however they can. Record junk bond issuance is just one aspect. Another aspect: IPOs. They have gone haywire.There were 23 IPOs in May, 20 in June, 17 in July, 19 in August, and 21 in September. But last week alone, there were 12 IPOs – more than two per day. And today, with all the dire warnings, Twitter announced its IPO. Generally, IPOs are scheduled apart to avoid overloading the market. But now the smart money is scrambling to issue paper while it still can and stuff it into the portfolios of retail investors at current “out of whack” valuations, stocks and bonds alike, before the Fed turns off its crazy money spigot, and before investors will finally open their eyes to the grim earnings reality.

Meanwhile, junk bond issuance hit a record high in September, at more than $47 billion. Year to date, issuance amounted to $255 billion, blowing away last year’s volume for this period of $243 billion. The year 2012, already in a bubble, set an all-time record with $346 billion. This year, if the Fed keeps the money flowing and forgets about that taper business, junk bond issuance will beat that record handily.

Junk-bond funds got clobbered in July and August as retail investors briefly opened their eyes and realized what they had on their hands and fled, and they went looking for yield elsewhere, but there was still no yield in reasonable places, and so they held their noses and picked up these reeking junk-bond funds again. Cash inflow doubled over the last week to $3.1 billion, the most in ten weeks.

These retail investors were fired up by the Fed’s refusal to taper even a little bit, giving rise to the hope that it might actually never taper, that this is truly QE to Infinity, Wall Street’s dream come true. 

The theory is that the Fed is mortally afraid that any taper would pop the asset bubble it has inflated over the last five years. Toss in the threat of a debt default and the Fed must have felt like a porcupine in a room full of balloons. Functionally, the Fed believes that the only cure for a burst bubble is a bigger bubble, so this comes as no surprise. They appear to be willfully blind that, in an era of plutocratic concentration of wealth, the old supply-side nostrums don’t work.

What else? Well, you'll remember that in 2012, a coalition of 49 states and the US reached a settlement with five of the country’s largest mortgage servicers, Wells Fargo, Bank of America, JPMorgan, Citi, and Ally in an effort to stop abuses such as “robosigning” of documents used in foreclosure proceedings and to lower barriers to modifications of loans. 

Now hold onto you hat; the banks are still behaving badly. Wells Fargo was sued by New York state over claims the bank failed to uphold terms of a $25 billion mortgage-servicing settlement aimed at helping distressed homeowners avoid foreclosure. Wells and BofA were accused by New York Attorney General Eric Schneiderman of violating the provisions of the national accord by continuing to impose unnecessary delays on borrowers seeking to modify the terms of their loans. BofA has agreed to mend its evil ways, but Wells Fargo just couldn't get their act together.

Wells Fargo is one of the most difficult banks for distressed homeowners to deal with, Schneiderman said at the press conference. The bank sends “incomprehensible communications” to borrowers; he even read a letter from the bank to a homeowner; it was pure goobledygook. After months of discussions with both banks, Wells Fargo “refused to acknowledge there’s a problem.” 

Friday, July 12, 2013 - Malala Day

Malala Day

by Sinclair Noe

DOW + 3 = 15,464
SPX + 5 = 1680
NAS + 21 = 3600
10 YR YLD + .02 = 2.60%
OIL + 1.34 = 106.25
GOLD - .80 = 1285.80
SILV - .23 = 20.02

So, let's recap. On Wednesday, Ben Bernanke said the Fed wasn't going to raise interest rates and really, nobody needs to worry about tapering. Or at least that's what the markets decided to hear this time, and so the S&P 500 managed its best week in 6 months, up 2.6%; treasuries rebounded with their best week in a year as the yield on the 10 year notes dropped 14 basis points; the dollar had its worst week in almost 2 years and gold had its best week in 8 months. And the price of oil jumped about 5%, and gas prices are up 9 cents in the past 4 days with today's increase the largest in 6 months, pushing the price of regular gas to its all-time high for this time of year.

If you were looking for inflation, we found it. The Producer Price Index, or PPI, measures inflation at the wholesale level and it was came in at 0.8% for June; the increase was mainly because of a nearly 3% increase in energy prices. The US economy has long been, and still remains very vulnerable to big swings in energy prices.

As you know, it is earnings reporting season, and today was the big day. JPMorgan and Wells Fargo reported earnings. Not only are these two of the biggest banks, but the big banks represent some of the strongest potential earnings of any sector in the economy for the past quarter. After the banks report, earnings season is all downhill.

Wells Fargo reported a 19% increase in 2Q profit, posting net invome of $5.5 billion or 98 cents per share. Revenue was flat at $21.4 billion. Wells Fargo is now the largest home mortgage lender and 2Q saw a drop-off in the mortgage market as rates increased, but that was late in the second quarter and did not significantly affect results. A bump in credit cards and commercial lending, and record origination of auto loans, further offset the home loan slowdown. So, with revenue flat, where did the extra profit come from? They cut expenses; specifically, they significantly reduced the amount they set aside in reserves for bad loans. What could go wrong?

JPMorgan reported a 31% increase in 2Q earnings, posting net income of $6.5 billion, or $1.60 a share. Revenue was $20 billion, compared with $26 billion in the period a year earlier. Two big sources of revenue increase came from the investment banking unit and from a 38% increase in fees, even as the mortgage banking business declined and net interest on loans dropped slightly. The record setting profit got a boost by setting aside $1.4 billion less for loan loss reserves, even as they set aside an additional $600 million for potential litigation. We don't know what litigation they're anticipating but that is enough for a pretty big legal battle.

There was also a nifty bit of accounting that somehow didn't show up in 2Q earnings and it deals with the increase we've seen in interest rates in the past month and a half. It falls under the category of Accumulated Other Comprehensive Income, and it dropped from $3.5 billion to $400 million. That little gem didn't make it into the headline earnings number, but when you start adding up some of the bad stuff, the headline numbers don't look so great. In fact, they start to cause some concerns.

Keep in mind that JPM is comparing 2Q earnings to a year ago, when the firm lost $3.4 billion as a part of the failed London Whale trade. As a side note JPM's total loans decreased slightly in the last quarter, while their excess reserves increased. You may also recall that the gambling money used by the London Whale came from excess reserves. And in a strange twist, the CIO, which is the London trading unit which included the London Whale, the CIO generated a negative $648 million in revenue in the last quarter. But the bigger question is what the bank is doing with the excess reserves; they aren't making loans with the money; so the indication is that they are trading with the money.

So, anyway the big profit announcements for 2Q earnings reporting season peaked today.

Of course, part of the JPMorgan conference call this morning dealt with the Senate Bill, introduced by Elizabeth Warren and John McCain to reinstate the Glass-Steagall law which would split investment and commercial banking, also some discussion about capital reserve requirements for banks.

Regarding a 21^st century version of Glass-Steagall, the bank seems to think the best reason why it is not needed is because they have lots of customers, and because they are customers they must like the business model, so why change?

And regarding the increased capital reserve requirements which call for the biggest banks to hold more reserves than smaller banks, well Jamie Dimon thinks that's unfair and creates an imbalanced competitive playing field. In other words, complete disregard for the concept of too big to fail. And it will come as no surprise they plan to lobby hard against Glass-Steagall, increased capital reserves, and don't forget reforms to the trading of credit derivatives.

The whole argument seems to be that the banks won't be able to compete and they won't be able to lend money if they actually have to observe sound business practices. This is boilerplate response from the banksters but it doesn't hold water. JPMorgan has enough money to make more loans right now, but they would rather trade through their investment banking business than make loans. As for the competitive disadvantage, well let's use JPM's own reasoning: a measurably healthier bank should have an easier time raising money and attracting customers.

And with regard to regulations on overseas trading in the $700 trillion derivatives market; first, it looks like the CFTC will move forward on imposing that part of the Dodd-Frank reforms. The CFTC voted on that this morning. The real reason they object to regulations on derivatives is because in an unregulated environment, they get to siphon off big profits with almost zero accountability.

Four Danish pension funds filed a lawsuit against twelve large banks, accusing them of increasing costs for investors trading in the $27 trillion credit default swap (CDS) market by stopping exchanges from entering the market.

The case, filed in the U.S. District Court in the Northern District of Illinois, follows a similar suit filed in May by an Ohio-based pension fund, the Sheet Metal Workers Local 33, and the Cleveland District Pension Plan in the same court.

The funds allege that dealers used their ownership and controls over clearing, data and other entities crucial to the market to block an independent clearinghouse from offering exchange-trading, deny market participants real-time price information and stop new participants from entering the market.

The CME Group (CME), the world's largest derivatives exchange and Chicago-based hedge fund Citadel Group, planned to offer CDS exchange trading in 2008 before dropping the plan the following year. The banks threatened to withdraw their business from the CME if it went through with it CDS exchange venture, the funds allege.

The banks used their control over the International Swaps and Derivatives Association (ISDA), a trade group, and Markit, a data provider and owner of benchmark indexes, to deny or delay licenses the exchanges needed to offer CDS trading, according to the complaint. The funds also accuse the banks of controlling a CDS clearinghouse, which is now owned by IntercontinentalExchange (ICE), to keep trading off exchanges and restricting membership to the clearinghouse to the largest banks. Markit and ISDA are defendants in the suit and ICE is named as a co-conspirator.

The House of Representatives defied a White House veto threat and passed a farm bill on Thursday that expands the taxpayer-subsidized crop insurance system but omitted food stamps. Lawmakers passed the 608-page bill, unveiled by Republican leaders late on Wednesday night, on a 216-208, party-line vote after two hours of debate in which no amendments were allowed.

Republican leaders said food stamps, traditionally part of the farm bill, would be handled later and that, for now, they needed a way to start negotiations with the Senate over a compromise bill. Democrats said the real intent of the action was to isolate food stamps for large cuts in funding. House Speaker John Boehner declined to say if leaders would allow a vote on a farm bill with larger food stamp spending than his party liked. "We'll get to that later."

Just a reminder; there are now more than 47 million Americans using food stamps for their daily bread. The House passed a version of the bill that includes $195 billion in subsidies to farmers or for agribusiness over 10 years, but it eliminates food stamps and nutrition programs. Now, they are expected to get around to it sooner rather than later, but this just seems to be a dangerous political game.

Do you remember the story of Malala Yousafzai? She's the Pakistani schoolgirl who was shot in the head last year by extremists for speaking out about her right to education. She survived and today is her 16^th birthday. The United Nations declared today “Malala Day” and she spoke before the UN in New York. This is an amazing young girl. Here is the link to the speech, and it is very worthwhile to take the time to watch this.

Let me share a few of her quotes:

First of all she said: "'Malala Day' is not my day. Today is the day of every woman, every boy and every girl who have raised their voice for their rights."

Also, “ We realize the importance of our voice when we are silenced.”

“Today we call upon the world leaders to change their strategic policies in favor of peace and prosperity.”

“We realize the importance of pens and books when we saw the guns. The extremists are afraid of books and pens.”

“One child, one teacher, one book and one pen can change the world. Education is the only solution. Education first.”

Tuesday, May 07, 2013 - Good Times Roll

Good Times Roll

by Sinclair Noe

DOW + 87 = 15,056
SPX + 8 = 1625
NAS + 3 = 3396
10 YR YLD + .01 = 1.78%
OIL - .64 = 95.52
GOLD – 17.70 = 1453.60
SILV - .08 = 24.06

The fun started in Asia as a weak yen sent Tokyo stocks to their highest level in almost five years while Australian shares closed lower after briefly erasing declines following the Reserve Bank of Australia's to cut key interest rates. The yen has now lost one percent since Thursday; the result is a rally in the Nikkei, supported by upward revisions in earnings expectations for Japanese companies. Japan's Nikkei 225 is up more than 50% in the past six months and overnight breached 14,000 for the first time since 2008. This is known as Abenomics, named after Shinzo Abe, the Japanese prime minister who has instituted a very aggressive form of monetary easing, much more aggressive than what the Federal Reserve is doing in the US; the plan will double Japan's monetary base by the end of 2014.

Later in the week, we'll see if Abenomics is gaining traction as Japanese automakers report earnings; of course, it may still be too early to see Abenomics result in stronger earnings, but over time, a weaker yen should result in more car sales for the likes of Toyota and Honda. The world has done OK while Japan has stagnated. If Japan were to go back to something like a 3% growth rate, that would make a big difference to the global economy. This might be a potentially serious opportunity to improve the pace of global growth.

Then the fun spread to Europe. ECB President Mario Draghi has said he'll do whatever it takes to push the euro zone economy forwards. Last week the ECB cut rates, keeping downward pressure on the euro although the stronger German data pushed it back above $1.31 against an easing dollar. Germany, the region's largest economy, reported a rise in industrial orders in March, confounding expectations for a drop. The German DAX Index finally topped the highs of 2007. For the first time in a couple of years, Portugal completed a sale of 10-year bonds. The bond sale puts Portugal on course to exit its bailout on time, and qualifies it for a ECB debt support program. The 10-year note yields 5.6%, safely below the 6% level that is considered a danger zone. The MSCI Global Index edged past its June 2008 high.

The good times then spread to the US, where Wall Street saw new record highs. There isn't much economic news to move the markets this week. The economic news last week wasn't great but it was better than expected, and so everything is moving higher. Small caps moved to new highs; Dow Transports are confirming with new highs; even emerging markets are pulling out of a skid; the S&P 500 has been up 11 out of the past 13 sessions; we've seen 10 record highs this year. It has been an impressive run. Will it last forever? Of course not. Will it continue longer than you think? Probably, or it could end tomorrow.

More than 400 earnings reports from S&P 500 companies are now in the books, with 47% beating estimates on sales, 72% beat on earnings per share; the aggregate earnings per share beat is 5.4%, and year to year earnings per share grew by 2.5%. Annual sales growth is negative 1.4%; that indicates companies are still cutting costs; there are limits to this strategy.

Of course, it's difficult to make sense of earnings reports these days. A new report from Ernst and Young surveyed 3,500 staff in 36 countries; 20% said they had seen financial manipulation in their companies in the last 12 months. In addition 42 percent of board directors and top managers surveyed said they were aware of "some type of irregular financial reporting".

And despite scandals and regulatory failures in the wake of the credit crunch, almost a quarter of top financial services staff surveyed said they were aware of manipulation and almost 10 percent of all staff said their companies had understated costs, overstated revenues or used unprincipled sales tactics.

At some point demand has to increase or the fun stops. Consumer credit expanded at a slower pace in March. Non-revolving debt led the way; things like auto loans and student loans. Credit card debt fell by 2.4%.

In a follow-up to last Friday's jobs report, today the Bureau of Labor Statistics released its Job Openings and Labor Turnover Summary, also known as the JOLTS report. There are about 3.8 million job openings in the country; there are about 12 million unemployed people looking to fill those jobs. Employers aren't firing people any more, but they're not hiring people, either. Employers still see demand as too weak to justify ramping up hiring. Consumers have been too busy picking through the wreckage of their finances to spend a lot of money.

So the stock market is flying high even as customers are pulling in their wings. What's keeping the markets at these highs? Central banks keep pumping up the bubble. This year is a year where all market behavior is basically nonsense. In an environment where you have the central banks pushing down all yield levels on whatever is supposed to be a fixed-income investment. With key economies like the United States seeing a patchy recovery but others struggling to maintain growth, major central banks around the world have shown over the last few weeks they intend to keep stimulus flowing freely for the time being. Let the good times roll.

A follow-up to reports that New York Attorney General Eric Schneiderman will sue Bank of America and Wells Fargo for violating terms of the National Mortgage Settlement; this was the $25 billion dollar settlement for allowing banks to overcharge people, use fake documents and otherwise abuse customers; and it wasn't really $25 billion because the banks could write off full amounts of short sales and loan mods; and this will shock you – most of the write-offs are short sales. Part of the deal would require the banks to actually respond to loan modification requests and to stop losing paperwork and stop abusing customers. This has proved to be too much for Bank of America and Wells Fargo, so the New York AG has said he'll sue; not for money; apparently he'll sue for equitable relief.

What is equitable relief? Apparently it would be an injunction to force BofA and Wells to comply with the servicing standards in the Settlement. Now, they didn't comply with the original settlement, so why would they comply with an injunction? Who knows.

“I'm going to put if very bluntly. I regard the moral environment as pathological...these people are out to make billions of dollars and nothing should stop them from that. They have no responsibility to pay taxes. They have no responsibility to their clients... to counter-parties in transactions. They are tough greedy aggressive and feel absolutely out of control...and they have gamed the system to a remarkable extent.”

That's a quote from a recent speech by economist Jeffrey Sachs. It's only remarkable because Sachs is considered part of the establishment; a former economic advisor for the IMF and the United Nations. But the abuses by the banksters have become so blatant that they can't be overlooked. The Too Big To Fail Banks have admitted to money laundering to the worst drug cartels and terrorist organizations. No indictments. The banksters admit to millions of separate counts of perjury in the robo-signing scandal. No indictments, instead they reach a settlement and then violate the settlement. Again, no indictments. 

And if the Big Banks don't comply with the injunction to make them comply with the settlement..., well, I'm not sure but I'm guessing there won't be any indictments, just another limp wet noodle lashing.

Friday, April 12, 2014 - Trade Secrets

Trade Secrets

by Sinclair Noe

DOW – 0.08 = 14,865
SPX – 4 = 1588
NAS – 5 = 3294
10 YR YLD - .07 = 1.72%
OIL – 2.85 = 90.66
GOLD – 84.00 = 1478.00
SILV – 1.81 = 25.95

The S&P 500 is up about 2.4 percent for the week, and the Dow up about 1.8 percent and Nasdaq up about 2.4 percent. The S&P has only had two weeks in 2013 with bigger gains. For the year, the Dow has gained more than 13 percent and the Nasdaq is up 8.7 percent.

Retail sales fell in March for the second time in three months and consumer confidence dropped in April. Sales fell 0.4 percent in March. Consumer spending was considerably weaker in the first quarter than estimated. Core sales, which strip out cars, gasoline and building materials, fell 0.2 percent last month. This measure corresponds closely with the consumer spending component of the government's measure of gross domestic product. It is widely believed that the end of the payroll tax holiday is related to the drop in consumer spending. Going a step further, growth is expected to slow sharply in the second quarter largely because fiscal policy tightened further in March.

A separate report from Thomson Reuters/University of Michigan shows the consumer sentiment index dropping ot 72.3 in April, the lowest level since last summer.

Producer prices, or prices at the wholesale level, fell 0.6 percent in March, their biggest drop in 10 months, as gasoline prices tumbled. In the 12 months through March, wholesale prices were up 1.1 percent, the smallest rise since July. Prices had increased 1.7 percent in February.

It's earnings season, and today a couple of the biggest banks posted results. Wells Fargo reported earnings of $5.2 billion, up from $4.2 billion a year ago. Revenue was slightly lower. The bank’s mortgage banking income slipped 3 percent; mortgage originations dropped by 16%. Corporate lending increased.

The nation's largest bank, JPMorgan Chase, reported a 33% increase in first quarter earnings. Net earnings came in at $6.5 billion, even as revenue dipped by $1 billion. JPMorgan reported strength in mortgage lending and investment banking. Within the investment banking unit, assets grew to $19 trillion for the first quarter. At least that's what it looks like. And it looks like they had about $2.3 trillion in derivatives on the balance sheet, and $1.6 trillion in derivatives “off balance sheet”. The notional amount of assets associated with these derivatives is somewhere around $70 trillion; again just kind of guessing.

What are these derivatives assets being used for? How do they contribute to JPMorgan’s record earnings? What risks are being run by having such large items “off balance sheet”? Is it gambling in derivatives that is enabling JPMorgan to make record profits in a depressed marketplace? The public has no information and no way of finding out.

JPMorgan and various counterparties operate in what is basically a hidden casino, and when one of the players loses, the entire global derivatives casino tends to freeze; that's what happened in 2008 with the collapse of Lehman; everything froze because nobody had enough information to assess the damage to their own balance sheets and “off-balance sheet” holdings, and that means they were totally clueless about the counterparties in the derivatives casino.

Jamie Dimon, the CEO of JPMorgan, talked about the growth in tangible book value, but he did not include the off balance sheet derivatives, which would clearly push book value below one. Which means that all the analysts who cover JPMorgan can't figure out value. And the reason is they don't know how much risk the bank is taking. And an even better question is why are they taking all the risk? How does this benefit the economy? The answer is that it provides no benefit to the economy, beyond enriching a few executives and traders in the firm.

While the banks are still reporting big profits, they are also cutting jobs. So, something doesn't add up. Why would a business that grows earnings 33% need to fire tens of thousands of workers? Regulation will force changes in their business model. The big question is what the banks will look like in a year.

Of course, Jamie Dimon couldn't let the earnings report pass without begging for some relief from regulators. Dimon argued  that banks are safer than ever, that JPMorgan’s size and scale and universality provides services that clients want and is good for the world, and that “I hope at one point we declare victory and stop eating our young.”

of course yesterday, JPMorgan research released a 328 page report arguing that global tier 1 investment banks were “un-investable” and the mega banks need to spin-off their businesses to provide capital return to shareholders. So, there's a bit of a disconnect there. Also, there was a Wells Fargo report this week saying the biggest banks trade at 20-30% discounts to their sum-of-the-parts values.

A follow-up to the mortgage abuse settlement. Recall the PR barrage in the wake of the robosigning scandal: its was “sloppiness,” “paperwork errors”. Servicers kept claiming, despite overwhelming evidence of bad faith and the institutionalization of impermissible practices, that there was really nothing wrong with how they were operating. Remember it was important for them to take that position, because if they were to admit that the bank knew it was engaging in widespread abuses with management knowledge and approval, it would be admitting to fraud.

The Fed and the OCC told the big 14 mortgage servicers to conduct reviews of all mortgages; the mortgage servicers hired consultants to scour the mortgage files; the consultants charged $2 billion but couldn't get through many files; the Fed and the OCC threw up their hands and worked out a deal for the servicers to send out checks to abused homeowners, $3.6 billion for 4.4 million homeowners; most check are for $300 or less. Now, you may be wondering how the mortgage servicers and banks and regulators knew how much to send to abused homeowners, and which homeowners should get checks, seeing as how they didn't finish the investigation; well, they let the banks tell them how much they felt was a good amount to pay, and that settled it. Senators are now looking into the mess and demanding information from the regulators, but the Fed is stonewalling the Senate investigation.

At the meeting yesterday, Federal Reserve staff argued that the documents relating to widespread legal violations are the “trade secrets” of mortgage servicing companies. In addition, staff from the Office of the Comptroller of the Currency (OCC) argued that these documents should be withheld from Members of Congress because producing them could be interpreted as a waiver of their authority to prevent disclosure to the public of confidential supervisory bank examination information.

Widespread legal violations are the trade secrets of mortgages servicing companies. I can’t make this stuff up.

Lots of people have been discussing how negative investor sentiment is. Markets are making new all time highs as expectations that markets will be higher six months hence is at a mere 19% 

While the stock market has been climbing to record highs, the rally has highlighted the disconnect from the broader economy; however, the market does not appear disconnected from earnings. Record high stock indices are matching record high levels in corporate earnings. S&P 500 companies are on track to generate north of $25 per share in collective profits this quarter. That's better than it sounds; earnings for S&P 500 companies are expected to grow at a modest 1.2 percent in the first quarter. What's very unusual about this particular new high in earnings is that it doesn't come along with a new high in economic activity around the world. If we have record earnings in a relatively lousy economic environment, what if the economy improves? Or the flip side of that question is whether we can maintain corporate earnings without improvement in the economy?

As the U.S. Commerce Department released a report late last month showing corporate profits at a 60-year high, suddenly the big news was about how cheating surely must be rampant in Social Security disability.

Wait, what?

Also late last month, a Washington Post investigation showed that the 30 companies that make up the Dow Jones industrial average pay a dramatically smaller portion of their profits in taxes than they did a half century ago. Instead of discussing how that impacts government services, all of Washington is talking about slashing Social Security and Medicare.

It’s bait and switch.

The Commerce Department says corporate profits increased to 25.6 percent in 2012, the highest in any year since 1950 and far higher than the 19.9 percent level common in the years just before the economic collapse.  Citizens for Tax Justice and the Institute on Taxation and Economic Policy evaluated 280 of the Fortune 500 companies and found that 30 paid no federal income taxes at all from 2008 through 2010. The following year, 26 paid no income taxes. None. Zip. Zero. Some corporations pay. But not much. A Washington Post analysis found that about 50 years ago, corporations included in the current Dow Jones industrial average routinely listed federal tax expenses as 25 to 50 percent of worldwide profits. Now, the Post found, they report less than half that.