Monday, December 09, 2013 - Corrupt Practices

Corrupt Practices

by Sinclair Noe

DOW + 5 = 16,025
SPX + 3 = 1808
NAS + 6 = 4068
10 YR YLD + .01 = 2.75%
OIL - .41 = 97.24
GOLD + 9.70 = 1241.40
SILV + .30 = 19.94

Next week the Fed FOMC will meet to determine policy. Today, three Fed big wigs gave speeches. We start with James Bullard, president of the St. Louis Federal Reserve Bank; Bullard says: “A small taper might recognize labor market improvement while still providing the [Fed] the opportunity to carefully monitor inflation during the first half of 2014,” and if inflation doesn't return to something approaching a target of 2%, well the Fed could pause the taper.

In separate remarks, Richmond Fed President Jeffrey Lacker said that the central bankers would discuss pulling back the pace of its asset purchase program but gave no indication of how the discussion could go.

 Dallas Fed President Richard Fisher said the central bank should begin to scale back its bond-buying “at the earliest opportunity,” because, “Money is cheap and liquidity is abundant. Indeed, it is coursing over the gunwales of the ship of our economy, placing us at risk of being submerged in financial shenanigans rather than in conducting business based on fundamentals.”

The taper talk spooked Wall Street traders but it's unlikely the Fed will taper at the December meeting. There is little harm in postponing the decision till the new year, particularly compared to the risks of pulling back too soon.

Meanwhile, the Federal Reserve reports that US net worth, a measure of household wealth, rose 2.6% to $77.3 trillion from July through September. Net worth reflects the value of homes, stocks, bank accounts and other assets minus mortgages, credit cards and other debts.

Net worth peaked at $69.1 trillion in Q3 2007, then dropped to $55.7 trillion in Q1 2009, for a loss of more than $13 trillion, and now it is up $21.6 trillion to $77.3 trillion. Adjusted for inflation, net worth is still about 1 percent below its pre-crisis peak, but both the stock market and home prices have continued to increase in the current October-December quarter.  Rising stock prices boosted Americans’ net worth $917 billion. Higher home values added another $428 billion.

The gains haven’t been equally distributed. The wealthiest 10 percent of households own about 80 percent of stocks. And home ownership has declined since the recession, particularly among lower-income Americans.

Total mortgage debt rose 0.9 percent from the previous quarter. Americans are also holding more consumer debt outside of mortgages, in the form of student loans, auto loans and credit cards. Consumer debt rose 6 percent from the previous quarter.

The flow of funds data from the Fed would indicate that QE has had an effect on the economy, it's still accurate to say it has been an unequal redistribution of wealth; with most of the gains going to Wall Street and little to none making it to Main Street. And then there is a question of the sustainability of the gains.

The other day, I talked about the fines in the JPMorgan $13 billion settlement and I raised the question of how the fines were calculated. Well it turns out they weren't really calculated as much as they were negotiated. It looks like the settlement agreement does not quantify the losses that form the basis for the civil penalty, or even provide an indication of how many violations the government determined occurred in connection with the issuance of the mortgage securities; according to the government, JPMorgan bankers regularly included loans in deals that did not meet the bank's underwriting guidelines and were "not otherwise appropriate for securitization." We just don't know the quantity and the actual losses associated with these toxic mortgages.

The breakdown of the $13 billion settlement with JPMorgan includes a $2 billion fine to prosecutors in Sacramento and $4 billion in relief to struggling homeowners in hard-hit areas like Detroit and certain neighborhoods in New York. The government earmarked the other $7 billion as compensation to federal agencies and state attorneys general across the country. In some settlements, the beneficiary of the fines is often the United States Treasury.

But the 8^th Amendment prohibits excessive fines; something the Supreme Court has defined as fines that would be grossly disproportional to the gravity of the offense. The government can look beyond the actual amount involved in the case and also consider the harm done to others, the need for deterrence, and such other matters as justice may require. And since the settlement was negotiated, JPMorgan could hardly argue now that the fines are excessive.

As far as the deterrence factor, the government failed horribly on that front. JPMorgan CEO Jamie Dimon probably had little to no direct involvement in the troubled mortgage deals, even if he did preside over the company and set policies. He did sign off on the annual reports, and under Sarbanes Oxley, he should have had, at the very least, some awareness. Dimon walks scot-free.

But what about the investment bankers who were involved in underwriting and selling the dubious mortgage deals that led to the massive penalty? They appear to be doing just fine as well. Indeed, until last month, three of the top bankers responsible for the deals still worked at JPMorgan. And one of them, the guy in charge of managing risk for the securitization group, is now in charge of the division that monitors risk for the entire bank.

JPMorgan claims that many of the toxic mortgages originated through Bear Stearns and Washington Mutual, the two failed financial institutions that JPMorgan scooped up in the financial crisis. What about the investment bankers who were involved in underwriting and selling the dubious mortgage deals at Bear and WaMu? Well, the head of Bear Stearns' mortgage division (also named in the suit) is now a partner at Goldman Sachs and he's the global head of the bank's mortgage trading division. Another head from Bear's bond business (also named in the suit) is now the head of Deutsche Bank's corporate banking and securities division. Another mortgage chief from Bear ended up as a chief of mortgage products for Bank of America. Other bankers involved in the mortgage scam have retired, but there doesn't seem to be anything in the settlement that would prevent them from continuing in the industry.

So, the bottom line is that there was no individual accountability in the settlement, there was not full disclosure of crimes committed, or any significant attempt to quantify the actual losses, and of course there was no admission of wrongdoing; absent those factors, settlements like these continue to reward and incentivize illegal conduct.

Meanwhile, you'll recall that in August JPMorgan disclosed that the SEC was investigating the bank's hiring practices in China; specifically that the bank favored hiring people from prominent Chinese families in order to win investment banking business. Over the weekend, the New York Times reported that emails uncovered in that investigation appear to clearly indicate that they knew they were crossing the line. In one email, an executive said that hiring sons and daughters of powerful people in China "almost has a linear relationship" with winning assignments. The documents even include spreadsheets that list the bank's "track record" for converting hires into business deals. And the email goes on: “You all know I have always been a big believer of the Sons and Daughters program."

So, the program even had a name, and everybody knew it, except apparently for the upper level executives back in New York, who remarkably remained clueless about the Sons and Daughters program, or the types of trades executed by the London Whale, or the toxicity of the mortgage loans by the mortgage department, or anything else.

Anyway, JPMorgan could be indicted under the Foreign Corrupt Practices Act which prohibits American companies from paying money or offering anything of value to foreign officials for the purpose of "securing any improper advantage."  Under the Act, the gift doesn't have to be linked to any particular benefit to the American firm as long as it's intended to generate an advantage its competitors don't enjoy. Of course, JPMorgan has spreadsheets to prove they got a big bang for their bribery buck. But the point is that the Foreign Corrupt Practices Act is strict.

By comparison, we don't even require that American corporations disclose to their own shareholders the payments they make to American politicians. If a Wall Street bank wants to hire the child of a prominent politician – go ahead. And of course the politicians and the technocrats regularly enjoy the revolving door between Washington DC politics and Wall Street corporate offices.

The list of public officials with past or present ties to Wall Street reads like a government phone book: Treasury Secretary Tim Geithner is now head of Warburg Pincus; budget director Peter Orszag works for Citigroup; Don Regan (Merril Lynch); Robert Rubin (Goldman, Citigroup); Phil Gramm (UBS); Alan Greenspan (Pimco); and that's just a quick sample.

In the Citizens United case, Justice Anthony Kennedy wrote for the majority: “if the First Amendment has any force it prohibits Congress from fining or jailing citizens, or associations of citizens, for simply engaging in political speech.”

Of course, we all know that money talks. JPMorgan has the spreadsheets that prove that money talks in China. And we have to Foreign Corrupt Practices Act to punish bribery. But in the US, we don't have a strict Corrupt Practices Act because the people that write the laws sold us out. Sorry, but you know it's true.

Thursday, December 6, 2012 - Dude, Watch Out for That Cliff

Dude, Watch Out for That Cliff

by Sinclair Noe

DOW + 39 = 13,074
SPX + 4 = 1413
NAS + 15 = 2989
10 YR YLD -.01 = 1.58%
OIL – 1.44 = 86.44
GOLD + 5.70 = 1701.00
SILV + .12 = 33.13

So, Barack Obama and John Boehner have figured out a way to deal with this whole fiscal cliff, man. There going to go to Seattle, Washington and they're gonna smoker reefers and drink coffee until they come up with, like a really great idea, dude.

Why not? It wouldn't be any worse than what they're doing now.

In economic news:

New applications for unemployment benefits dropped for the third straight week, but we're still not back to the levels before Hurricane Sandy. Initial jobless claims declined by 25,000 to a seasonally adjusted 370,000 in the week ended Dec. 1. Tomorrow is the monthly jobs report; don't expect it to reveal any long term trend; it will be distorted by the Hurricane and also by the holiday shopping season. The guess is for about 75,000 new jobs in November, well below the average for the past few months.

The Federal Reserve issues a quarterly flow of funds report; the most recent volume shows households trying to cut back on debt in the third quarter; or at least cutting mortgage debt, while student loan debt and car loan debt piled up. When factoring in inflation, American households have deleveraged by about 13% since the meltdown of 2008.

In the third quarter, a 3% drop in mortgages more than offset the 4.3% increase in consumer credit, namely student and car loans. Household net worth, the difference between assets and liabilities, rose $1.7 trillion to $64.8 trillion.

Companies again built up debt, with non-financial debt leaping 4.4% as firms hit the corporate bond market with interest rates so low. Corporate stockpiles of cash hit a record $1.74 trillion, up 2.6% from the second quarter. After rising for the first time in a year and a half in the second quarter, state and local government debt slipped 0.1%. Federal government debt climbed 6.2%, which marked the smallest rise since the second quarter of 2008. All told, households, businesses and governments saw debt expand by 2.4% in the third quarter, which is the smallest increase since the fourth quarter of 2009.At $39.28 trillion, that’s just less than 2.5 times the nation’s annualized output in the third quarter.

Debt may well be one of the biggest drags on economic growth: 35-40% of everything we buy goes to interest; 29% of business profits go to the financial industry; 21-32 trillion are hidden in offshore tax havens.

You don't have to be paying interest on anything directly to be paying interest. Interest is built into the product; 40% of public projects, on average, goes to interest;12% interest for garbage collection; 38% interest on water processing; 70+% interest as part of public housing costs. US debt has not been paid off since 1835. In past 24 years US has paid $8.2 trillion in interest on $15 trillion in debt.

And Now – Banks Behaving Badly:

The British bank, Standard Chartered say it expects to pay $330 million to settle claims by United States government agencies that it had moved hundreds of billions of dollars on behalf of Iran, in violation of American sanctions against Iran. The estimated settlement payment would come in addition to a $340 million settlement the bank reached in August with the New York State Department of Financial Services, which charged Standard Chartered with scheming with Iranian companies and banks for nearly a decade to hide 60,000 transactions worth $250 billion from regulators.

Last Month, HSBC Holdings, another major British bank, set aside an additional $800 million to cover potential fines stemming from a money laundering investigation, bringing its total provisions for the case to $1.5 billion. HSBC is still negotiating a settlement. Last summer, ING Bank, reached a $619 million dollar settlement with the Treasury Department over claims the bank violated American sanctions against Iran, Libya, and other countries.

Now, we have another example of why corporations are not people. While several big banks set aside hundreds of millions of dollars, while neither admitting nor denying guilt, we present the strange tale of Gustl Mollath, a German man, who seven years ago, may the accusation that staff at the Hypo Vereinsbank (HVB) – including his wife, then an assets consultant at HVB – had been illegally smuggling large sums of money into Switzerland. Mr. Mollath was committed to a high-security psychiatric hospital after being accused of fabricating a story of money-laundering activities. He remains in that hospital to this day, against his will. But recent evidence brought to the attention of state prosecutors shows that money-laundering activities were indeed practiced over several years by members of staff at the Munich-based bank, the sixth-largest private financial institute in Germany, as detailed in an internal audit report carried out by the bank in 2003. The report, which has now been posted online, detailed illegal activities including money-laundering and aiding tax evasion. A number of employees, including Mollath's wife, were subsequently fired following the bank's investigation.

Asked why the bank kept the report to itself and did not approach the authorities, a bank spokeswoman said: "In 2003 HVB initiated extensive investigations via internal audits in response to information provided by Mr Mollath on transactions that had taken place a long time before … It was determined that employees had acted contrary to their instructions regarding Swiss banking transactions". While the findings did result in some firings, the audit "did not produce sufficient evidence indicating criminal conduct … that would have made a criminal charge seem appropriate". There are now calls for the judiciary to reassess Mr. Mollath's case, but nothing yet.

And that brings us to Argentina. You may recall that Argentina suffered a major financial crisis in 2001; the country successfully managed an external debt restructuring; they said no to the standard austerity package, and the result was a fairly remarkable economic recovery. But they're not out of the woods just yet. Elliott Capital Management, a vulture fund based in the tax haven Cayman Islands refused to accept the terms of the debt restructuring that was accepted by more than 92% of bondholders in 2005 and 2010. It has demanded payment in full, and has actively pursued its case in different courts across the world. A few months ago, Elliott Capital got a judge in Ghana to seize an Argentine navy ship. Then a judge in a district court in New York ruled that the Argentinian government must pay $1.3 billion to the same vulture fund, the full face value of their holdings plus accumulated interest starting in late 2001.

Elliott and other vulture funds are not conventional investors. They buy bonds at discount rates during a crisis with the explicit intention of taking the distressed countries to court in foreign jurisdictions, while also holding out for payment in full with no renegotiation of the debt. Obviously vulture funds are not concerned with niceties such as how the debt was accumulated, the principle that debts should be served according to the debtor's capacity to pay or how the enforced payments will affect the well-being of the most vulnerable. They represent global finance in its most nakedly aggressive and exploitative form.

The New York ruling also contained an injunction that prohibited third parties from "aiding and abetting" any violation of his order, thereby preventing Argentina from being able to continue payments to the creditors that had accepted the restructuring. This has far-reaching implications beyond this case, because it calls into question all debt restructuring deals that are not just likely, but also necessary to preserve international finance. For example; why would those holding Greek bonds accept a debt restructuring plan that might be necessary for a solution and beneficial to all, if they know that vulture funds can hold out and receive judicial support in international courts?

The ruling also contradicts US internal bankruptcy laws, which force minority creditors to confirm to deals accepted by 70% of creditors. If this ruling is supported in the higher courts (both Argentina and other creditors have already appealed) it will create an unviable situation for global bond markets. Creditors will only be making one-way bets if no possibility of restructuring is accepted, making the only options all (full payment) or nothing (complete default).

And then the credit rating agencies stepped in this week and cut Argentina's rating to slightly above junk status. Is Argentina at risk of default? Well, the current account is in balance, international reserves are above $46bn and the ratio of debt service payments to exports is less than 20%. Unemployment has gone from a high of around 22% to about 7%. Argentina has been one of the fastest growing economies in the world.

After 2002, Argentina reversed the austerity measures promoted by the IMF, renationalized key productive sectors like aviation, pensions and most recently oil, increased social protection and income transfers to the poor, and reduced poverty substantially. Real wages have increased, and wage inequalities have been reduced. In other words, Argentina is a dangerously successful story. It shows that there is life after a default, and that austerity is not the best way out of a crisis. These are two lessons that clearly frighten financial markets and their allies within the judicial system, and obviously there is concern that other countries in financial distress could seek to emulate this example. Remember Iceland? It's a safe bet that the Greeks, and Spaniards, and Italians remember.