Thursday, May 16, 2013 - What's Next For the Fed

What's Next For the Fed

by Sinclair Noe

DOW – 42 = 15,233
SPX – 8 = 1650
NAS – 6 = 3465
10 YR YLD - .08 = 1.87%
OIL + .95 = 95.25
GOLD – 6.60 = 1386.90
SILV + .10 = 22.79

The Labor Department reports the consumer price index dropped 0.4% in April from March, the biggest monthly drop since December 2008. The main reason the index fell was that gas prices plunged 8.1 percent. Excluding the drop in fuel costs, prices were largely unchanged. For the 12 months that ended in April, overall prices rose 1.1 percent — the smallest year-over-year increase in 2½ years. Excluding volatile energy and food costs, “core” prices ticked up 0.1 percent last month. Core prices have risen only 1.7 percent in the past 12 months. That’s below the Federal Reserve’s 2 percent inflation target. Yesterday, we reported that wholesale prices declined last month.

Inflation is not the problem right now; it might be a problem at some point down the road, but not now.

John Williams, the San Francisco Fed president gave a speech in Portland and he indicated that the Fed's Quantitative Easing program can be reduced soon, and that the whole program may be halted this year. He pointed out the pace of job growth has picked up since the program was launched in September, with an average pace of job growth of 200,000 over the last six months.

Williams said: “Assuming my economic forecast holds true and various labor-market indicators continue to register appreciable improvement in coming months, we could reduce somewhat the pace of our securities purchases, perhaps as early as this summer. Then, if all goes as hoped, we could end the purchase program sometime late this year.”

Williams was open to the idea of ramping up bond purchases if the economy slows down.

So, let's go back to the Federal Reserve's dual mandate of price stability and maximum employment. Right now, prices are stable; even a little bit of disinflation based upon this week's producer-price index and consumer-price index. No need to taper off.

On the maximum employment side of the mandate, the Fed set a target of 6.5% unemployment, which is still a long way from it's mandate of maximum employment. One of the reasons the unemployment rate has dropped to 7.5% is because the participation rate has dropped; fewer people are considered to be in the labor pool. The economy has been adding about 200,000 jobs per month, on average, over the last six months. We know that many of those jobs are temp jobs; many are part-time jobs; many are lower paying jobs. But they are net new jobs. The problem is that 200,000 jobs is not enough to lower the unemployment rate, unless a lot more people fall out of the labor market.

This morning, the Department of Labor reported initial claims for unemployment increased 32,000 to 360,000.

So, why do we have all this talk of tapering off from QE?

In order for QE to work, rather than just inflate asset prices, there needs to be viable investment opportunities that create productive jobs in the short, medium, and long term. Infrastructure would qualify as filling the bill, but not just building bridges to nowhere. And this is the flawed premise of QE, according to a recent speech by Dallas Federal Reserve President Richard Fisher: “by driving rates to historical lows along the entire length of the yield curve, investors will rebalance their portfolios and reach out to riskier assets, providing the financial wherewithal for businesses to increase capital expenditures and reengage workers, expand payrolls and regenerate consumption. Rising prices of bonds, stocks and other financial instruments will bolster consumer confidence. The CliffsNotes account of this play has the widely heralded “wealth effect” paving the way for economic expansion, thus saving the day.”

Fisher went on to add: “Until job creators are properly incentivized by fiscal and regulatory policy to harness the cheap and abundant money we at the Fed have engineered, these funds will predominantly benefit those with the means to speculate, tilling the fields of finance for returns that are enabled by historically low rates but do not readily result in job expansion.”

There are a few problems here. Cheap money does not encourage speculation. Cheap money encourages prudent lending. If you can only get a small rate on your loan, you are more likely to make certain that loan will be repaid. This is why triple-A rated corporate bonds pay less than junk bonds. This is also why the residential housing mortgages written in the past two years are a much better vintage than the mortgages written in 2005. High rates encourage speculation. The risk is not in the low rates, but rather that the low rates push prudent potential lenders to seek higher returns elsewhere, like in the stock market.

The result, and it must be scaring the Fed, is that we are headed for a speculative bubble. If you always do what you've always done, you'll always get what you've always gotten. The Fed actually has some history with bubbles. The next time you read that a new era has dawned, that the old rules of economics don't apply, and that some asset class or other that’s been rising steadily for a while now is certain to keep on to infinity and beyond; that's just wrong. It really is that simple.  

The problem is that the Fed has been passing out cheap money to speculators and gamblers. And now they're shocked, shocked I tell you, to discover that the speculators are gambling with the cheap money. Speculation demands high rates as compensation for high risk, but the Fed has been passing out super-low rate money to the most high risk players.

And the banksters continue with their rotten ways. They take the zero-interest money from the Fed and they screw anybody and everybody they can. Today a case in point.

In 2006, Congress passed the Military Lending Act, which was designed to prevent predatory lenders from targeting men and women in uniform. But a new report from ProPublica and Marketplace entitled Beyond Payday Loans suggests aggressive lenders have merely shifted tactics and are still very actively going after military personnel.

Rather than a loophole, installment loan companies and so-called payday lenders have found huge gaps in the Military Lending Act. The Military Lending Act set a national interest rate cap of 36 percent APR (annual percentage rate) for loans to military members and their families (excluding mortgages and auto finance loans).

The Act covered three specific types of loans: payday loans (short-term, due in one lump sum after a borrower’s payroll check clears); car-title loans; and tax refund anticipation loans. Further, the loan-terms covered were restricted: 91 days or less for a payday loan, 181 days or less for a car-title loan.

As a result, lenders are offerings payday loans, which typically have annual percentage rates over 400%, with a duration of five months instead of three. Same is true of auto-title loans, which are secured by the vehicle’s title and typically have rates above 100%.

And yes it is the banksters that back the payday lenders, or in many cases the big banks are the payday lenders, through a different division of the company. QE and the other tools of the Fed have not cleaned up some of the worst abuses in the system.

Today, the International Monetary Fund weighed in, claiming the Quantitative Easing by the Fed, and the ECB, and the Bank of Japan had helped to stabilize financial markets and push asset prices higher. The IMF figured that: “While additional unconventional measures may be appropriate in some circumstances, there may be diminishing returns, and benefits will need to be balanced against potential costs.”

Maybe it is time to ask whether the Fed has been effective in its policy over the past five years. Yes, the Fed policy helped avert a global financial meltdown. Yes, the Fed policy prevented the collapse of the biggest banks. Yes, the Fed policy was a part in turning around massive job losses and helping bring down unemployment in a less-than-robust manner. No, the Fed hasn't done much to regulate the financial institutions that caused the problems in the first place. The Fed doesn't seem to believe in regulation; which is kind of like a Pope that doesn't believe in religion.

The Fed hasn't been particularly successful in its mandates. Perhaps the time is coming where they need to change the tools they're using. Maybe it is time to break away from Quantitative Easing, which mainly helps the banks, and maybe they need to start using tools that will promote a healthy economy, with maximum employment – not just a target of 6.5% unemployment – and help people find productive employment. And then they could use their regulatory tools to help ensure financial stability in what has become a casino market.

One of the better moves the Fed could consider is to open up low interest rates to entities other than the member banks; this probably exceeds the Feds generally accepted role, but not the technical limits of its tool box. Infrastructure investment still looks like the best, least speculative way to achieve the dual mandate. Imagine a country with a continental railroad - like what Lincoln did, or an nationwide highway system – like what Eisenhower did, or a country that develop science to the point we could fly to the moon – Kennedy and Johnson. Now imagine a country that is energy independent.

The time is coming for the Fed to move beyond Quantitative Easing, and this is why we've been hearing about tapering off. QE is not as effective as it once was, and it has never been as effective as it should have been. So, maybe a change is coming. The big question is where they go next.

Wednesday, May 15, 2013 - Have Another Cookie

Have Another Cookie

by Sinclair Noe

DOW + 60 = 15275
SPX + 8 = 1658
NAS + 9 = 3471
10 YR YLD - .01 = 1.94%
OIL + .18 = 94.39
GOLD – 33.30 = 1393.50
SILV - .82 = 22.69

More record highs on Wall Street. We celebrate with milk and cookies, and remembrances of the days of rice and beans and tins of tuna. Record highs are fleeting, almost ephemeral. I know the trend is your friend; don't fight the Fed; a rising tide lifts all boats; yada, yada. Why is this starting to feel like an asset bubble?

Stock Traders Daily did a comparison of quarter to quarter earnings and revenue growth rates for the S&P 500 and the Dow Industrials: “For the past two consecutive quarters, the Dow Jones Industrial Average has had zero growth. In fact, this quarter revenue growth declined by 2.65% (25 companies reporting thus far) and earnings have barely budged. Last quarter, there was negative earnings growth with revenue growth less than 1%, and since the third quarter of 2010, the EPS growth rate for the Dow has been declining steadily.”

So, the growth rate is at zero and the prices keep going higher. Don't worry, have another cookie; after 13 years in the market, you should be back to break even.

Meanwhile, the National Association of Home Builders/Wells Fargo housing-market index rose to 44 in May from 41 in April. The NAHB says builders are noting an increased sense of urgency among potential buyers as a result of thinning inventories of homes for sale, continuing affordable mortgage rates and strengthening local economies. Have another cookie.

Wholesale prices dropped in April. The producer-price index declined by a seasonally adjusted 0.7% to mark the biggest drop in more than three years. Wholesale prices over the past 12 months are up just 0.6%. In April, the cost of fuel fell 2.5%, led by a 6.0% drop in gasoline prices. Electricity and home-heating-fuel costs also eased, though natural-gas prices posted the biggest increase since mid-2008.

The price of food, meanwhile, fell 0.8% in April after jumping by the same amount in March. Vegetable prices plunged 10.6%, with the cost of squash, lettuce, celery and cucumbers all taking a dive. Meat prices also fell. Cookie prices were not included in the report.

The muted rate of inflation at both the producer and consumer levels gives the Federal Reserve more leeway to keep interest rates low and continue with QE. So, the talk about tapering off of QE might make more sense if the Fed was actually getting closer to its targets of 6.5% unemployment or 2.5% inflation. They aren't close.

The Federal Reserve Bank of New York reports households reduced debt during the first quarter by 1 percent to the lowest level since 2006. Household debt fell to $11.2 trillion in the first quarter compared with a peak burden of $12.7 trillion in the third quarter of 2008. Consumers reduced debt by $110 billion after increasing their borrowing by $31 billion in the fourth quarter of 2012, while delinquency rates fell across the board. Student debt bucked the trend, rising to a record $986 billion.

Households in the first quarter improved their debt payment patterns as delinquency rates on mortgages fell to 5.4 percent from 5.6 percent, on home equity loans to 3.2 percent from 3.5 percent, on credit cards to 10.2 percent from 10.6 percent and on student loans to 11.2 percent from 11.7 percent. One way to look at this is that reducing debt results in a better vintage of debt. Student lending has surpassed credit cards, auto loans, and home equity loans, and is now the largest form of consumer debt after mortgages.

Last week, Fed Chairman Ben Bernanke said “the Fed could push banks to maintain a higher leverage ratio, hold certain types of debt favored by regulators, or other steps to give the largest firms a ‘strong incentive to reduce their size, complexity, interconnectedness.’

“The Fed chairman acknowledged growing concerns that some financial companies remain so big and complex the government would have to step in to prevent their collapse and said more needs to be done to eliminate that risk.”

And Fed Governor Jeremy Stein said pretty much the same thing; and Fed Governor Daniel Tarullo also picked up on the talking point.

James Kwak raised a vital question about these talking points: Too-big-to-fail banks enjoy implicit subsidies and impose externalities on the rest of us; therefore those subsidies and externalities should be priced; and then those banks can decide whether they want to absorb those costs or make themselves smaller. 

Here’s what they are saying: Too-big-to-fail banks are too big and complex and pose a systemic risk to all of us; therefore they need to become smaller and less complex; and the Fed will tweak the regulations until they become smaller and less complex.

What’s remarkable about this? These three men—probably the three most important on the Board of Governors when it comes to systemic risk regulation (as opposed to monetary policy, for example)—all say that they know that the megabanks are too big and complex. They all say that accurate pricing of subsidies and externalities is not an end in itself.* They all say that the goal is smaller, less complex banks.

If the goal is smaller, less complex banks, why not just mandate smaller, less complex banks? Why beat around the bush with capital requirements and minimum long-term debt levels? Those tools might be appropriate if you think huge, complex banks should exist but you want to make them safer. But if you’ve already concluded that banks need to be smaller and less complex, then they’re just a waste of time.

They also betray a frightening naivete regarding corporate governance. The theory is that higher capital requirements, for example, will lower banks’ profits, which will upset shareholders, who will eventually force the board of directors to eventually convince the CEO to break up his empire. This scenario, unfortunately, depends on the premise that American corporations are run for the benefit of their shareholders, which is only roughly true, and even that often requires long, expensive, and messy shareholder activist campaigns.

Instead, there’s an obvious solution: rules that limit the size and scope of financial institutions. But Bernanke has ruled out “arbitrary” size caps in favor of his cute regulatory dial-tweaking.

Again, Bernanke’s position might be defensible if he wasn’t already sure that today’s banks are too big and complex. Then it might make sense to tweak the incentives and see how the market reacts. But if he knows they are too big and complex, he should eliminate that risk in the simplest, most direct way possible. If he’s not sure how much smaller and simpler banks need to be, he can do it in steps: set one set of size and scope limits, see what he thinks about the outcome, and then set another set of limits if he’s still unhappy.

To use a crude analogy, let’s say we’re concerned about guns on airplanes. Ben Bernanke thinks, like I do, that guns on planes present an unacceptable risk to the safety of air travel. But his approach is to charge a $100 fee for anyone who wants to bring a gun onto a plane. If people keep bringing guns on board, he’ll raise the fee to $200, then $300, and so on until people stop. The sensible, obvious solution is to just ban guns on planes. But that would be “arbitrary.”

It is theoretically plausible that one should simply price the subsidies and externalities and then let the market determine whether big banks provide enough societal benefit to offset the costs they impose on the rest of us. But that is not what Stein, Tarullo, and Bernanke are saying.

Meanwhile, Attorney General Eric Holder was speaking before the House Judiciary Committee hearing today on another subject, but he was asked about comments he made back in March about the idea that the big banks are too big to jail. He said his comments were misconstrued and he added that there is “no bank, there’s no institution, there’s no individual who cannot be investigated and prosecuted by the United States Department of Justice.”

And that was the straightest answer he gave in testimony today. Have another cookie.

Meanwhile, a few years ago, I wrote a book about breaking up the too big to fail banks; Eat The Bankers: The Case Against Usury: The Root Cause of the Economic Crisis and the Fix

Tuesday, January 15, 2013 - It's Better Than Nothing

It's Better Than Nothing

by Sinclair Noe

DOW + 27 = 13,534
SPX + 1 = 1472
NAS – 6 = 3110
10 YR YLD - .03 = 1.83%
OIL - .71 = 93.43
GOLD + 12.10 = 1680.90
SILV + .29 = 31.47

Let's start with some economic reports. Consumer spending rose 0.5% in December and sales for October and November were revised slightly higher. It was a pretty good holiday shopping season, but the pace of spending in 2012 failed to equal the gain in the previous year. Retail spending rose an unadjusted 5.2%, down from 7.9% in 2011. And the pace of spending might slow as workers adjust to lower take-home pay as a result of a 2% hike in the payroll tax.

We already know that the expiration of the payroll tax cuts was an especially damaging outcome of the fiscal cliff negotiations. It will total approximately $125bn less in wage-earners’ pockets, and is showing up immediately in reduced paychecks. Average weekly earnings of all employees on private nonfarm payrolls: $818.69 in December. The 2% payroll tax increase clips $16.37 a week from take-home pay. And if weekly earnings held steady in January, at the December level, workers would feel like they earned $802.32 instead. That’s the equivalent of losing all the 2012 gain in weekly earnings in one month.” As a percentage of income it hits the middle class hardest because it applies only to the first roughly $113,000 in wages, effectively a regressive measure that takes money from the people most likely to spend it.

Meanwhile, producer prices, or prices at the wholesale level fell 0.2% on a seasonally adjusted basis. Core producer prices, which exclude the volatile categories of food and energy, rose 0.1% last month, led by cigarettes. So, if you smoke, quit. Food prices at the wholesale level fell 0.9% in December after a 1.3% gain in the prior month that was due, in part, to a severe drought. December’s decline in producer prices for food is the first decrease since May. Meanwhile, energy prices fell 0.3% in December, led lower by gasoline. For all of 2012, wholesale prices increased 1.3%, the smallest growth in a calendar year since 2008. Tomorrow, we'll find out how that equates to prices at the consumer or retail level.

The Census Bureau reports more working families are slipping into poverty; 200,000 more working families, or the working poor, fell into poverty in 2011 compared to 2010. Although many people are returning to work, they are often taking jobs with lower wages and less job security. This means that nearly a third of all working families may not have enough money to meet basic needs. Now, you'll recall that the recession officially ended in the second half of 2009. Maybe we need a better way to measure recessions because the reality that we weren't in a recession, we have been in a small “d” depression, and we haven't really pulled out of it. For many Americans, there hasn't been a real recovery. And for people who have experienced the recovery, it has been concentrated; the top 20 percent received 48 percent of all income while those in the bottom 20 percent got less than 5 percent.

States in the South, such as Georgia and South Carolina, and those in the West, such as Arizona and Nevada, had the greatest increase in the number of working poor. The increase was slower in the Mid-Atlantic and Northeast. In 2011, roughly 23.5 million, or 37 percent, of U.S. children lived in working poor families compared with about 21 million, or 33 percent, in 2007. About 10.4 million such families - or 47.5 million Americans - now live near poverty, defined as earning less than 200 percent of the official poverty rate, which is $22,811 for a family of four. Again, these are working families; people who have jobs but for many families, working hard just isn't enough. They are cashiers and clerks, nursing assistants and lab technicians, truck drivers and waiters. Either they are unable to find good, full-time jobs, or their incomes are inadequate and their prospects for advancement are poor. In many cases, low-wage workers are involuntarily working part-time – often in multiple, temporary jobs. If it remains unaddressed, the trend is likely to continue, pushing more families into economic uncertainty, fueling greater income inequality and dampening national economic growth.

Work is better than not working, a fact that has hit home hard for many veterans. The unemployment rate for veterans of the recent wars has remained stubbornly above that for nonveterans, though it has been falling steadily, dropping to just below 10 percent for all of 2012. That was down from 12.1 percent the year before. The year-end unemployment rate for nonveterans was 7.9 percent in 2012. Today, some good news from Wal-Mart. They will hire veterans, any veteran who wants a job, provided the veterans have left the military in the previous year and did not receive a dishonorable discharge. This represents the largest hiring commitment for veterans in history.

About 100,000 of Wal-Mart’s 1.4 million employees in the United States are veterans. It's pretty simple, Wal-Mart realizes that hiring veterans is a smart move. Veterans are leaders with discipline, training, a dedication to service, a sense of hierarchy, and a willingness to make a commitment to the organization they are in.

Now, it might surprise you to learn that Wal-Mart is taking some flack for this announcement. After all, most of these jobs will not be high paying and Wal-Mart is not known for a great benefits package; some of these veterans will end up among the working poor. Still, a job at Wal-Mart is better than no job; maybe they would like to extend the job offers to veterans who didn't leave the military within the past year. What about the longer-term unemployed vets? Wal-Mart is far from perfect but today I think Wal-Mart should be commended. That doesn't mean we should skip over the concerns, especially while there's a debate raging in Washington about spending. How about making sure the GI Bill is used to educate our veterans and prepare them for better jobs and a better way of life? Since when is the motto of America "it's better than nothing?"

The debt ceiling debate rages, despite the fact that it is an artificial construct. Republicans see the debt-ceiling vote as a way to extract some spending cuts out of Obama. Yesterday, Obama said he would not play that game. Assisting Obama was Fed Chairman Ben Bernanke, who compared refusal to raise the debt ceiling to a family refusing to pay its credit card bill. Bernanke warned: “Default would increase our borrowing costs and damage economic growth and therefore add to future budget deficits, not decrease them.” Republicans probably won't listen to Obama or Bernanke or Tim Geithner, for that matter; yes, Geithner issued his own debt ceiling warning. They might listen to corporate leaders who are growing weary of the political contention following the fiscal cliff fight. The Chamber of Commerce is warning Republicans not to push their luck with the debt ceiling.

Bernanke's analogy of a family not paying its credit card bill might not be the best comparison. Americans have been defaulting at record rates. During the last five years, U.S. individuals have walked away from a staggering $585 billion in mortgages, credit card debts and other personal loans. That works out at about $6,000 per household.

And if the numbers are to be believed, there is probably a lot more to come.

Turn on any news program devoted to the economy and you will doubtless hear some Wall Street blowhard telling you that American households have been “repairing their balance sheets” and paying down their debts. They make it sound so virtuous, and they often then segue into sneering remarks about those degenerate Greeks and other Europeans who don’t behave in the same responsible way.

The truth is very different. According to the Federal Reserve, U.S. household debts peaked five years ago at a gigantic $13.8 trillion. Since then it has declined to $12.9 trillion – a decline of about 7%. To put that in context, household debts today still exceed those seen at the end of 2006, near the peak of the bubble. They are three times what they were in 1998. The total debt reduction from the peak, says the Fed, is $954 billion. Loan write-offs, at $585 billion, account for 60% of that. In other words,  in the last five years Americans have walked away from $3 in debt for every $2 they’ve paid off.In the first quarter of 2010 alone about 13% of all credit card debt was just written off. Households weren’t alone. Corporations have defaulted on $35 billion to $40 billion in debt per year in recent years. It seems individuals have learned a valuable lesson from corporations.

The number of American homeowners who are underwater fell from 12 million to just 7 million; and by underwater, we don't mean Hurricane Sandy underwater, rather they owe more than their house is worth; and when we say just 7 million – well, yes, that is still an absurd number. And that number could fall to just 4 million in a couple of years. According to an analyst with Blackstone: "The housing market is rebounding faster than anyone thought possible," then again, Blackstone would say that: It is aggressively buying single-family houses to try and profit on a housing rebound.

Meanwhile, Facebook CEO Mark Zuckerberg announce something today; the company's first major product launch since it's IPO last Spring. It's a graph search; which basically would allow Facebook users to tailor their searches, such as by specifying music and restaurants that their friends like, or their favorite dentist. The reverse is also possible, such as discovering friends who have an interest in a particular topic. As always, there are privacy concerns. The world's largest online social network, with more than one billion users, Facebook is moving to regain Wall Street's confidence in the wake of a rocky IPO and concerns about its long-term money-making prospects. Central to its efforts is devising new ways to make money from users who are migrating to mobile devices. Unfortunately, they haven't figured out how the graph search will raise revenue.