Monday, April 28, 2014 - But Our Bankers Aren’t Oligarchs

But Our Bankers Aren’t Oligarchs
by Sinclair Noe

DOW + 87 = 16448
SPX + 6 = 1869
NAS – 1 = 4074
10 YR YLD + .01 = 2.67%
OIL - .03 = 100.57
GOLD – 7.50 = 1297.30
SILV - .16 = 19.67

This should be an interesting week. On Wednesday, the Federal Reserve’s Federal Open Market Committee, the FOMC, will meet to determine monetary policy; a statement will be issued Wednesday. On Friday, we’ll have the monthly jobs report.

The market is jittery. The Dow fell 140 points on Friday, rose 139 on Monday morning, and gave it all back Monday afternoon, then recovered at little at the close. Investors are worried about the Ukraine crisis, the Fed’s tapering, peak earnings, high PEs, low GDP, inflation, deflation, and of course, their own shadows.

So far, the stock market has merely been sluggish to start the year; no big crash, no big gains. Last week, the big 3 indices were down a little, while the indices are in negative territory year to date, that could change with one good week of trading. After doubling or tripling since 2009, stocks aren’t cheap any more. Companies, meanwhile, are finding it harder to keep raising earnings in a period of soft economic growth. This makes investors more cautious, but because speculative excess still hasn’t reached the extremes of past bubbles, and because the Federal Reserve is determined to sustain the recovery, there is less fear of a big decline. The Fed has started slowly rolling back its quantitative easing, gradually ending the unprecedented bond-buying program that dumped more than $1 trillion into financial markets. Investors are trying to figure out how well corporate earnings will grow with less Fed aid.

A big complication is that many companies are reaching the limit of their ability to boost profits by cutting costs. More companies now need to focus on building revenues, which means higher costs for investment, hiring and wages. The days may be ending when Wall Street will reward companies for holding down wages and doing little investing; the focus is shifting to sustainable earnings.

Margin debt, a measure of the use of borrowed money to invest, is at a record high in dollar terms. But as a percentage of market value, it is 2.6%, still between the 2008 low of 2.3% and the 2007 high of 2.8%. Still, the markets haven’t yet shown enough excess to warrant a crash, and so people are still buying the dips; probably because they haven’t yet figured out where else they can go.

Money managers are turning on stocks that have delivered the best returns during the bull market: small caps. Large speculators such as hedge funds are betting $2.8 billion this month that the Russell 2000 Index will fall. That’s the most since 2012 and the highest versus average levels since 2004.

Today, the National Association of Realtors reported its Pending Home sales index increased 3.4% to 97.4. The index is based on contracts signed last month to purchase previously owned homes. These contracts usually become sales after a month or two, and March's rise suggested home resales could rebound in the months ahead. Existing home sales had fallen to their lowest levels in more than 18 months, with March sales down 7.9%; but today’s report suggests the possible end to the soft patch in sales.

Along with the economic news this week, we’re keeping an eye on geopolitical events, as Ukraine is crumbling under a constant barrage. Russian backed militants extended their hold on eastern Ukraine by seizing more public buildings in Donetsk region, breaking up rallies by supporters of the government in Kiev. The mayor of the second largest city in Ukraine was shot today. Russian gunmen are holding about 40 hostages, including 6 military observers from the Organization for Security and Cooperation in Europe, their interpreter and 4 Ukrainian army officers who were accompanying them.

Today, President Obama announce more sanctions against Russian oligarchs; imposing travel bans and asset freezes for 7 individuals and 17 companies. So far, most of the sanctions have been targeted toward energy companies or energy company executives and banks and bankers. Stop and think about that for a moment. Russian bankers are considered oligarchs fomenting geopolitical unrest and supporting the corrupt regime of Putin. And in the US we’re supposed to believe that our bankers are the beneficent titans of industry and pillars of commerce.

Last week we reported that the Department of Justice was in the early stages of negotiating a settlement with Bank of America. The government is reportedly seeking $13 billion in penalties, on top of $9.5 billion that BofA agreed last month to pay to the Federal Housing Finance Agency. The problem is that BofA sold mortgage backed bonds stuffed with shoddy mortgages that did not meet basic standards.

A big part of the settlement would go to the FHFA as compensation for selling the defective bonds to Fannie Mae and Freddie Mac. Another part of the settlement takes the form of consumer relief; requiring the bank to adjust mortgages to make them more affordable for borrowers; the problem is the bank probably doesn’t own the mortgages, so the bank wouldn’t really have that expense.

Also, digging deeper into the previously announced $9.5 billion settlement with FHFA, about $3.2 billion involved BofA buying back mortgage bonds, but they bought those securities for 20 cents on the dollar, and they still have value, probably a lot more than what BofA paid. When is a penalty a profit? When a big bank settles with the bank regulators.

The Supreme Court will hear a case that has some intriguing implications for mortgages; it involves the Truth in Lending Act. The case is Jesinoski v. Countrywide, the subsidiary of Bank of America. The Jesinoskis refinanced a mortgage in 2007; when their loan was closed, Countrywide did not provide all of the disclosures required by the Truth in Lending Act (TILA). Their suit states that they were not provided with two copies of a “Notice of Right to Cancel” and two copies of a “Truth in Lending Disclosure Statement.”

Under the Truth in Lending Act, a borrower has the right to rescind the loan by midnight of the third business day following the closing of the loan, or until the lender has provided the borrower with all the legally required loan documents. The Act also creates a three-year time limit to exercise the right to rescind the loan, even if the required disclosures have not been delivered to the borrower. Three years to the day, the Jesinoskis sent a letter to Bank of America rescinding the loan. BofA said the letter meant nothing. The Jesinoskis sued to enforce their rescission request, saying that their letter should have been sufficient.

The case has made its way through appellate courts, which denied their appeal, but other District Courts have been split on whether a letter is an allowable form of notification in instances such as the Jesinoskis’ case. The Supreme Court merely said they would hear the case; any actual decision is a long way off.

A more pressing matter for Bank of America is capital levels required by the Federal Reserve. You may remember the Fed recently conducted stress tests for big banks and it turns out that, following further review, Bank of America flunked the test; seems they miscounted  the treatment of structured notes assumed in its acquisition of Merrill Lynch in 2009. The bank notified the Fed of its mistake and the Fed is now “requiring the Bank of America Corporation to resubmit its capital plan and to suspend planned increases in capital distributions.” Or in plain English, no stock buybacks, and no dividend increases.

Particularly concerning for regulators and shareholders, the bank had been making the accounting error for more than four years, potentially inflating its true level of capital during that period. This basically goes to the practice of booking gains or losses based on changes in the value of a firm’s own debt, which led to BofA’s regulatory capital problem. Essentially, accounting rules mean that, in some cases, the worse off a firm is from a credit standpoint, the more it may gain in terms of earnings. That is because the value of its own debt would be falling during a stressed time. This would lead to a smaller liability. And a decline in a liability results in a gain to income.

This didn’t used to be much of an issue since the value of bank debt didn’t change all that much. Then came the financial crisis. And as bank debt remained volatile in its wake, firms were left with big counterintuitive gains or losses in their income based on fluctuations in the value of some of their liabilities. Banks started to exclude the impact of such changes from their results. Investors couldn’t make heads nor tails of the mess, and so they ignored it, at least until it affects buybacks and dividends. The important part to remember is that BofA flunked its stress test, and nearly 6 years after the financial meltdown they still have toxic junk on their books and they haven’t figured out how to count it.

Meanwhile, regulators in Britain announced they’ve begun criminal proceedings against 3 former Barclays employees suspected of manipulating the Libor. The new criminal proceedings are the latest development in a broad investigation into the manipulation of major interest rates by some of the largest global banks, including Barclays, UBS, Royal Bank of Scotland, and others. Twelve people in total are now facing criminal charges in Britain. All 12 are mid-level traders. Barclays, RBS, UBS, the Dutch lender Rabobank and ICAP have combined to pay more than $3 billion in fines to British and American authorities in the investigation of manipulation of various Libor-linked interest rates, but so far regulators have not been able to figure out whether higher level execs at these institutions knew anything about manipulation in a multi-trillion dollar market; which seems remarkably unlikely.

Wednesday, August 14, 2013 - Gripped by Euphoria

Gripped by Euphoria

by Sinclair Noe

DOW – 113 = 15,337
SPX – 8 = 1685
NAS – 15 = 3669
10 YR YLD - .03 = 2.71%
OIL + .11 = 106.94
GOLD + 15.10 = 1337.50
SILV + .41 = 21.88

Egypt's military was accused of pushing the country towards civil war after hundreds of protesters were believed to have been killed in a “massacre” at two Muslim Brotherhood protest camps.Security forces used machine guns, snipers, tear gas and armoured bulldozers during a full scale assault to clear the camps in Cairo. The operation left a scene of carnage on the capital’s streets and Egypt embroiled in its worst turmoil since the start of the Arab Spring.

With clashes breaking out across the country, the military declared a month-long state of national emergency and imposed a sweeping curfew in major cities.

Wednesday’s operation was the culmination of a six-week stand-off between Egypt’s security forces and the Muslim Brotherhood which followed the military’s decision to remove Mohammed Morsi as president. He had been the country’s first Islamist leader and its first to be democratically elected.

Mr Morsi’s supporters had vowed to occupy two protest camps,in Cairo until he was reinstated. That ended when the military moved into both camps with decisive force.

The Muslim Brotherhood put the number of dead at more than 500, and said that those killed in the “massacre” included unarmed civilians, women and children. Egypt’s health ministry gave an official death toll of 149, with more than 1,400 injured, although those figures were expected to rise.

The eurozone grew by 0.3% in the quarter to June, according to Eurostat, ending a recession – defined as two or more consecutive quarters of negative growth – that had dragged on for 18 months. Economists had forecast more modest growth of 0.2%, following a downwardly revised contraction of 0.3% in the first quarter. The data also showed growth in the wider European Union rose by 0.3%, after shrinking by 0.1% in the first three months of the year.

The revival was led by Germany, which grew by 0.7% in the second quarter. And for many Europeans there's not much cause for celebration just yet. More than 19.2 million people are currently unemployed in the euro area, according to Eurostat, with more than one in four Spaniards and Greeks out of work. It takes two quarters of economic contraction to call a recession, and only one quarter of growth to call the end of the recession. One quarter is not a trend.

It's an oft-used rule of thumb, but it's not really the official definition. That's why the National Bureau of Economic Research, the official arbiter of U.S. recessions, defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales." Most everybody agrees that the U.S. was officially in a recession in 2001, even though we never had two straight quarters of negative GDP in that recession.

Second-quarter Eurozone GDP was pulled higher by strong growth in some countries, including Germany, France and Portugal. But France and Portugal are still touch-and-go, and several other countries, including Spain, Italy and the Netherlands, are still in recession. All it would take is a credit crisis in one of those countries to spark another debt panic and slam economic growth once again. Greece and Cyprus are still in a Depression.

One more reason to be less than exuberant about the end of the Euro-Recession is that they haven't really solved the problems. They are still trying to enforce austerity on the periphery, and it still isn't working; there's been a little relief when they take the boots off the necks, but otherwise, not much has changed. The financial sector is still a big problem; they still have banks to break up, and they might, starting with RBS, but that will be slow, and painful

Fund managers around the world are exuberant, convinced that America is in full recovery and Europe has overcome its debt crisis. Maybe not so much today, but that's the general feel. Bank of America’s monthly survey of investors showed a dramatic rise in confidence in August, with a net 72% expecting growth to accelerate over the next year. It is the highest in reading since 2009. This would be considered a contrary indicator. When everybody is happy, they've already put their money in the markets, and there is nothing left to do but sell.

Survey says almost everybody expects bond yields to rise as deflation fears evaporate, with just 3% still worried about the risk of an economic relapse. Managers have slashed their bond allocation to a 28-month low. The exuberant mood comes as margin debt on Wall Street hovers near $377 billion, just below its all-time high and well above peaks before the dotcom crash and the Lehman crisis. Margin debt is a form of debt as “a tool used by stock speculators to borrow money from brokerages to buy more stock than they could otherwise afford on their own. If the stock rises, they end up making far more money. If the stock crashes, you could lose your shirt and more. Brokers can force the sales of certain positions to cover losses.

Forced sales of stocks can set off panic and a rush for exits, snowballing into a crash, as happened in 1929. The current market may have further legs but there are some “astonishing similarities” between the latest patterns and events preceding prior market crises. Profits have been ticking along at stall speed just as in 2006 and 2007, and just like then people are resorting to leverage to squeeze out the last dime.

The rise in margin debt is matched by leveraged excess across the system, with debt-driven buy-backs of corporate shares running at a $400 billion annual rate. Leveraged buy-outs are back in vogue. IPOs are all the rage again. Junk bond yields are near record lows.

Investors are betting the US Federal Reserve is about to taper bond purchases for healthy reasons, because the US economy is strong enough to stand on its own feet. The counter-view is that the Fed is tightening for “unhealthy” reasons, because it has taken to heart warnings from the Bank of International Settlements about the dangers of excess leverage and a fresh asset bubble.

The Bank of America survey said there has been a dramatic divergence between “Main Street” and “Wall Street”. While the US economy has grown by $1.3 trillion since 2009, the US stock market has added $12 trillion.

The bank said nominal GDP growth over the past four quarters has been the slowest ever recorded outside a recession. This would not normally be circumstances when the Fed took away the punchbowl and tightened credit.

Two former JPMorgan Chase employees are facing criminal charges related to the trading scandal that cost the bank $6.2 billion last year. The two lower level employees are charged with wire fraud, and conspiracy to falsify books and records related to the trading losses. The trader who traded the losses, Bruno Iksil, also known as the London Whale, is cooperating with investigators. The two guys who have been charged have not been arrested.

Preet Bharara is the prosecutor and he tried to sound tough today. "This was not a tempest in a teapot, but rather a perfect storm of individual misconduct and inadequate internal controls," he said, directing his remarks squarely at Jamie Dimon.

He also said, "The difficulty inherent in precisely valuing certain kinds of financial positions does not give people a license to mislead or cover up losses. That goes double for handsomely paid executives at public companies whose actions can roil markets and upend an economy." So, it sounds tough, but it's not like we've seen them going after senior management.

You probably think you are entitled to some modicum of privacy in your emails. You would be wrong. Google, said so, publicly today. The internet giant argued in a US lawsuit that people who send messages via email should not “be surprised” if those messages are intercepted by the recipient’s email provider, in the same way that someone sending a letter to a business associate might expect it to be opened by a secretary.

"People who use web-based email today cannot be surprised if their emails are processed,” Google said. “Indeed, 'a person has no legitimate expectation of privacy in information he voluntarily turns over to third parties,” it added, citing a Supreme Court judgment handed down over electronic communications in 1979 – long before Google existed.

If you have a question or a subject you would like to bring to my attention, you can send me an email. …... sinclair@moneyradio.com

That should work.