Friday, February 08, 2013 - The State of the Union is Contradictory

The State of the Union is Contradictory

by Sinclair Noe

DOW + 48 = 13,992
SPX + 8 = 1517
NAS + 28 = 3193
10 YR YLD un = 1.95%
OIL -.06 = 95.77
GOLD – 3.80 = 1668.20
SILV - .03 = 31.53

The State of the Union is...

Tuesday.

Do we have a solid economic recovery underway? The evidence will leave you whipsawed. Everywhere you turn, it seems, there is an economic contradiction.

Housing is up, but gross domestic product was sharply down in December, almost to recessionary territory. The economy has lost 3.2m jobs since 2007, but 5.2m have been created since 2009. Even so, the number of unemployed far outpaces the number of jobs. The Center on Budget and Policy Priorities says: "In November 2012, 12 million workers were unemployed but there were only 3.7m job openings. That is about 10 unemployed workers for every three available positions – in other words, even if every available job were filled by an unemployed individual, about seven of every 10 unemployed workers would still be unemployed."

The jobless rate keeps dropping, but the ratio of employed-to-unemployed people is about the same as last year. The economy gained 181,000 jobs a month last year, but the percentage of people who have been unemployed for more than 27 weeks has stayed relatively steady. People are working more hours, but productivity is falling. And economic output has almost ground to a halt, growing by 0.1% in December.

Households are becoming less indebted, which is a welcome development, but that's mostly because they are people are defaulting on debt. A side effect of the defaults is that disposable personal income is rising; when you default on debt you have more cash in pocket. Still, income inequality continues to climb and the middle class continues to shrink.

And whatever progress we've seen on the economy could grind to a halt at the end of the month with the possible implementation of the sequester. It is certainly a possibility, although it was not intended. The idea behind the sequester was that it was so draconian, it would be so lousy for the economy, that neither side would allow it to happen; the cuts would be so deep that no reasonable politician would permit them to pass. Of course, Diogenes could light his lantern and wander through the streets of Washington DC for years without locating a reasonable politician.

What happens if the sequester hits? The Congressional Budget Office estimates the economy would slow to a sluggish 1.4% this year. Job growth and job quality will lag, the housing market will languish. Everyone agrees that the sequester is terrible policy.

In fact, it was designed to be terrible policy. The sequester is a nondescript name for a poison pill, devised as a deterrent so unpalatable that Capitol Hill’s warring factions would be forced to make peace. That was back in the summer of 2011, when the artificial threat of a debt default loomed. So the White House and Congressional Republicans crafted the Budget Control Act, which appointed a bipartisan “super committee” to find $1.2 trillion in deficit reduction over 10 years. The super committee’s failure would trigger sequestration, a package of about $1 trillion in automatic cuts to domestic and security programs which would send the fragile economy into a tailspin. Self-inflicted austerity right now would be a really bad idea. The Federal Reserve in the past has been able to cut rates to cushion the effect of spending cuts. It can’t do anything like this now, because the Fed funds rate has already been cut more or less to zero in an attempt to fight the effects of financial crisis; the adverse effects on demand can’t be offset by cutting interest rates. And so, monetary policy just can't come to the rescue of fiscal policy.

Right now the central challenge is to reignite the economy; getting jobs back, improving wages, and restoring growth. Deficit reduction moves us in the opposite direction. That’s because most consumers (whose spending is 70 percent of economic activity) are still losing ground, and businesses won’t expand and hire without more consumers. 

The impasse has members of both parties warning, once again, that an unthinkable policy is becoming a very real possibility. House Speaker John Boehner has started using the phrase “the President’s sequester”. Back in 2011, Obama warned he would veto any attempt to sidestep the sequester; now he is trying to offer alternatives. For its part, the White House will blame Republicans for refusing to reduce tax breaks that benefit the wealthy. Democrats, who are seeking some $600 billion in new revenues, want to dump sweetheart provisions that protect owners of corporate jets or financiers who benefit from low carried-interest rates.

Obama also offered to revive dormant talks to reach a sweeping deal to slash the federal deficit and overhaul the U.S. tax code and entitlement systems. But it would be very tough to iron out a grand bargain in a couple of weeks.

If Republicans won’t give way on new revenues, it would become impossible. And there is no sense the GOP is prepared to cave, particularly because many of its members have sought the deep cuts the sequester would produce. What we’re left with yet another stalemate, and yet another countdown to a self-inflicted crisis.

The National Small Business Association, this week released its year-end survey of economic conditions. The outlook, as their press release stated, is “not so good”. The report says: “there are very few incentives to start or grow a small company” under prevailing conditions. Indeed, the survey shows that pessimism is rampant. Fifty-one percent of respondents say they anticipate a flat economy next year. Thirty-five percent foresee a recession, while just 14 percent anticipate that the economy will grow next year. By a 47-23 margin, surveyed small-business owners think the national economy is worse than it was one year ago. Particularly troubling to small business owners is “economic uncertainty,” which 69 percent of business owners cite as a significant challenge to the future growth and survival of their business.

So are we doomed? Not really. The history of NSBA reports paints a picture of small-business owners as a remarkably grumpy and pessimistic lot. The number of respondents foreseeing a recession next year is the highest since July 2009. It turns out that July ’09 was basically the low point of the recession, and output from July '09 to July 2010 expanded by $357 billion. In other words, small-business owners predicted a recession just as the recovery was starting. The 47-to-23 ratio of respondents saying the economy is worse off today than it was a year ago is alarming. But six months ago the ratio was an equally alarming 48-to-21. 

Perhaps the most interesting indicator in the survey is that small-business owners take a considerably rosier view of their own business prospects than those of the economy as a whole. A healthy 47 percent of respondents anticipate their own gross sales rising, while just 23 percent say they’ll decline. If growing businesses outnumber shrinking ones 2-to-1, then it’s hard to see how the economy is going to shrink.

And today, the major stock market indices climbed to multi-year highs. One headline I read credits optimism about the economy. Go figure.

Apple is sitting on a big pile of cash. David Einhorn, the hedge fund manager of Greenlight Capital wants Apple to issue preferred shares as a way to unlock shareholder value. His other ideas include increasing dividends and buying back its own shares. This is how a hedge fund manager thinks. For a man who's only tool is a hammer, the world looks like a nail. Apple became one of the biggest companies in the world because it invested in cutting edge technology; it spent time and money on design. Now, they can't figure out how to spend their money; they can't find new things to create. The inventors have become gentrified and cautious. They listen to hedge fund managers instead of inventors.

I don't mean to pick on Apple. It's happening to lots of corporations. Boeing started paying more attention to the bean counters than the engineers. The result was melting batteries and Dreamliners full of smoke. Stock buybacks are a sign of innovative constipation and scared management. I'm not advocating reckless behavior. I just don't like business cowardice.

We used to talk about Yankee ingenuity. Now companies are content to sit on cash. And they are sitting on a big bundle. And we know the story of the faithful servant who buried the talents in the yard to make sure they were secure. Nobody should be a shareholder in a company that buries its talents.

So, we have corporations sitting on cash, too stupid to use it; a middle class, or what's left of it, too weak to support the consumer spending that has historically driven economic growth; a middle class racked by debt and unable to invest in their future, too weak to educate themselves, too uncertain to take the quantum leap to entrepreneurship, and too weak to broaden out the tax base; and that in turn means we have a country too poor to invest in infrastructure (which might improve productivity and global competitiveness, education and research ( which might result in innovation), and are crucial for restoring long-term economic strength.

The Inaugural Address a couple of weeks ago was part one of a two part presentation; it focus on vision and philosophy. On Tuesday, February 12th, when the president gives his State of the Union address, he'll have an opportunity to make specific proposals, and build support to fix America's most challenging problem. That will be the nuts and bolts speech.

The state of the Union is...?

Thursday, February 07, 2013 -

Waiting for the Apocalypse

by Sinclair Noe

DOW – 42 = 13,944
SPX – 2 = 1509
NAS – 3 = 3165
10 YR YLD -.02 = 1.95%
OIL - .74 = 95.88
GOLD – 6.30 = 1672.00
SILV - .39 = 31.56

Some day this war will end. Some day we will have an apocalypse, not in the terrifying version of the word but in the original Greek definition of “apokalypsis”, meaning an “uncovering”, a “lifting of the veil”, or “the disclosure of something hidden”. One day we will wake up and realize that money is printed out of thin air and it is not a store of wealth but a vessel of debt; the veil will be lifted and we will see the debt masters for what they truly are. Until then we get little surprises in the form of troves of emails revealing the reality that the financial markets are not bastions of cool rationalism, nor are they temples to integrity; and the lubricant of commerce may be nothing more than a tar pit.

We have been reading the emails from Barclays, UBS, and S&P describing how they would rig rates or rate deals for a cow if only they could get their cut. Sometimes the language is clipped in an instant messaging style of prose, sometimes it is profane in a way that would make Tony Soprano blush, and it seems to be flowing forth in a never-ending stream of culpability. Some day this war will end. But not today.

Today we learn of the emails from JPMorgan Chase and they show that executives at the firm knew there were problems; an outside analysis discovered serious flaws with thousands of home loans; the executives responded by slapping lipstick on a pig. Rather than disclosing the full extent of problems like fraudulent home appraisals and overextended borrowers, the bank adjusted the critical reviews. As a result, the mortgages, which JPMorgan bundled into complex securities, appeared healthier, making the deals more appealing to investors.

We learn this because of a lawsuit against JPMorgan filed in Manhattan by the French-Belgian bank Dexia, which went belly up after buying into the lipstick slathered securities which of course, ultimately imploded. Documents filed in federal court include internal emails and employee interviews. After suffering significant losses, Dexia sued JPMorgan and its affiliates in 2012, claiming it had been duped into buying $1.6 billion of troubled mortgage-backed securities. The latest documents could provide a window into a $200 billion case that looms over the entire industry. In that lawsuit, the Federal Housing Finance Agency has accused 17 banks of selling dubious mortgage securities to the two housing giants, Fannie Mae and Freddie Mac. At least 20 of the securities are also highlighted in the Dexia case.

The Dexia lawsuit centers on mortgage-backed securities created by JPMorgan, Bear Stearns and Washington Mutual during the housing boom. As profits soared, the Wall Street firms scrambled to pump out more investments, even as questions emerged about their quality. JPMorgan scooped up mortgages from lenders with troubled records. In an internal "due diligence scorecard," JPMorgan ranked large mortgage originators, assigning Washington Mutual and American Home Mortgage the lowest grade of "poor" for their documentation. The loans were quickly sold to investors. One executive at Bear Stearns told employees "we are a moving company not a storage company." As they raced to produce mortgage-backed securities, Washington Mutual and Bear Stearns also scaled back their quality controls.

Washington Mutual cut its due diligence staff by 25 percent to prop up profit. A November 2007 email from a WaMu executive described the cutbacks as steps that "tore the heart out" of quality controls. The email said: executives who pushed back endured "harassment" when they tried to "keep our discipline and controls in place.” Even when flaws were flagged, JPMorgan and the other firms sometimes overlooked the warnings.

JPMorgan hired third-party firms to examine home loans before they were packed into investments. Combing through the mortgages, the firms searched for problems like borrowers who had vastly overstated their incomes or appraisals that inflated property values. An analysis for JPMorgan in September 2006 found that "nearly half of the sample pool" - or 214 loans - were "defective," meaning they did not meet the underwriting standards. The borrowers’ incomes, the firms found, were dangerously low relative to the size of their mortgages. Another troubling report in 2006 discovered that thousands of borrowers had already fallen behind on their payments.

And what did JPMorgan do when confronted with the defects? They ignored them or they whitewashed the findings or they just lied about them. Certain JPMorgan employees, including the bankers who assembled the mortgages and the due diligence managers, had the power to ignore or veto bad reviews. In other words, they knew the mortgage backed securities they were bundling and selling were full of garbage loans and they just didn't give a damn about it as long as they could sell it. Of course we all know that employees and analysts and due diligence directors say the darnedest things in emails, but if the emails reveal what the investigators think they reveal; then JP Morgan actually defrauded its clients, and the bank and its executives should obviously pay a big price for that.

Jamie Dimon, the CEO of JPMorgan has tried to differentiate his bank from the rest of Wall Street. He recently lashed out at what he called the “big dumb banks” that “virtually brought the country down to its knees.”

If this sounds like yesterday's news or the news from 5 years ago; well, it is but it is also tomorrow's news. Some four years after the 2008 financial crisis, public trust in banks is as low as ever. Sophisticated investors describe big banks as “black boxes” that may still be concealing enormous risks, the sort that could again take down the economy. In the fall of 2008, when the meltdown hit, all the banks stopped, well they stopped pretty much everything, they stopped lending to each other; they stopped trading with other banks, and the reason they stopped was because after Lehman Brothers was allowed to collapse, no one understood the banks' risks. There was no way to look at a bank's disclosures and determine whether that bank might implode.

Was any given bank the next IndyMac, was it the next Northern Rock, the next Dexia? Did JPMorgan have toxic assets on their books or had they already dumped their trash on Dexia? JPMorgan was supposed to be one of the safest and best-managed corporations in America. Jamie Dimon, the firm’s charismatic CEO, can charm the cufflinks off journalist in New York or high rollers in Davos, and he had kept his institution upright throughout the financial crisis, and by early 2012, it appeared as stable and healthy as ever. And then the London Whale washed up on the banks of the River Thames.

The London Whale ran a little bit of a trading desk, and he had gambled away $6 billion, maybe more; investigators are still investigating; still the losses are not enough to destroy the House of Morgan, even though it wiped out one-third of the market capitalization. After all, JPMorgan is considered to have the best risk management operations in the industry.

And what this really tells us is that they haven't learned how to manage the risks; in part because the culture is corrupted. JPMorgan started reporting small losses, then they had to admit that its reported numbers were false. Federal prosecutors are now investigating whether traders lied about the value of the London Whale's trading positions as they were deteriorating. JPMorgan shareholders have filed numerous lawsuits alleging that the bank misled them in its financial statements; the bank itself is suing one of its former traders over the losses. Jamie Dimon didn’t understand or couldn’t adequately manage his risk, or maybe he knew and just slapped some lipstick on the pig. Investors are now left to doubt whether the bank is as stable as it seemed and whether any of its other disclosures are inaccurate.

And of course, it's not just JPMorgan; that is just the biggest player. Toss in Libor rate rigging from Barclays, UBS, and RBS. Toss in money laundering from HSBC and Standard Chartered, and don't forget robo-signing from a host of banks more concerned with being moving companies than storage companies; more concerned with their own profits than with pesky legal details like due process. And only after the fact do we see the emails that provide the colorful stories of how the banks misled clients, sold them garbage and then bet against them.

So, the question is: do you trust the banks? Chances are you answered “no”. Depending upon the survey, about 4 out of 5 people say they have no trust in our financial system; and I doubt the fifth person holds the banks in high regard. And four-and-a-half years after the meltdown, the Too Big To Fail banks are bigger than before, and because they've received get out of jail free cards they operate with impunity and disregard for the rule of law or requirements for transparency. The Geithner Policy insured the banks did not have to change their wicked ways; they were too big and too systemically important to be bothered.

Do you know what the banks have on their books? Are the assets vintage or toxic? You don't know because the banks are a black box of disclosure. And guess what? Jamie Dimon doesn't know how much risk JPMorgan is taking. And if he doesn't know how much risk his own bank has, then there is no way he knows about the garbage the other banks hold on their books. And here is the big problem. All it takes is a bump in the road and the financial institutions will freeze up once again.

Some day, the veil will be lifted. Some day the we will learn the secrets. Some day the war will be over.

Not today.

Last summer, Boeing's top management axed the engineer CEO who had been turning around BCA, [Boeing Commercial Airplanes, and making it better again. They replaced him with a non-engineer CEO. Then, management got into a confrontation with the engineer's union (which may also partly be the union's fault, but it's not a battle management can afford right now). Then the top management indefinitely postponed, in other words they killed off, the very promising 777X , new long-range, highly efficient model. These moves were on top of a 787 development model that de-emphasized in-house engineering and relied on industry partners for much of the development work. Since the 787 appeared to be out of the woods, there wasn't much need for R&D and engineers and new-fangled planes.

Then a 787 Dreamliner caught fire, and then another; batteries exploded and it was a bit of a problem. Back in Seattle, engineers, represented by a disgruntled union and forced to report to multiple layers of non-engineer management, are working overtime on the problem, but after several weeks, nobody appears to be close to a solution. And once they do find a solution, they will have to go through a process of re-certification. That process might take 6 months, maybe longer.

That is the background for Boeing's fourth quarter earnings report this month. The 787 problem wasn't discussed, except that the investigation was continuing and couldn't be discussed and 787 production was continuing full speed ahead, despite uncertainties about what needed to be done for the battery system, or any other aspects of the plane's design. If these planes being built need major retrofitwork in the future, well, that's for the engineers to worry about.  Apparently, the executives in Chicago didn't get the memo that the entire fleet of 787's has been grounded.

American Airlines' parent AMR Corp. and US Airways Group are within a week or two of finalizing a merger that would create the world's largest airline by traffic. The new company would be worth more than $10 billion, and the deal would be an all-stock transaction that would take place as part of the reorganization that would take American Airlines out of its Chapter 11 bankruptcy protection. The deal under discussion would give American Airlines creditors about 72% of the new entity and US Airways shareholders about 28%. There would be huge expenses with integrating the two companies and the merger process might cause some disruptions to customer service; and after a merger it's unclear if they will have a significant competitive advantage over the other big competitors, now whittled down to just three, but it would keep the new American-slash-US Air in the arena. And it would likely mean higher airfares for the rest of us.

For most of 2012, small-caps and large stocks slogged through the market ups and downs like white on rice. But since the market began to move off its November bottom, the Russell 2000 small-cap index has outpaced the Dow Jones Industrial Average by a wide margin. The Russell is up an impressive 18% since its November lows, while the Dow has risen about 11.5% during the same timeframe. Risk on.

Last month, 11 European countries, including France and Germany, moved forward on introducing a minuscule tax on trades in stocks, bonds and derivatives. The tax goes by many names. It's often called a Tobin tax, after the economist James Tobin. In Europe it goes by the more pedestrian financial transaction tax. In Britain, it goes by the wonderful Robin Hood tax.

A transaction tax could raise a huge amount of money here in the US and cause less pain than many alternatives. It could offset the need for cuts to the social safety net or tax increases that damage consumer demand. How huge a sum? An estimate from the bipartisan Joint Committee on Taxation, which scores tax plans estimates the tax could raise: $352 billion over 10 years.

The money would come from a tiny levy. A bill that might be introduced next month calls for a three-basis-point charge on most trades. A basis point is one-hundredth of a percentage point. So it amounts to 3 cents on every $100 traded. Critics claim the tax will harm our capital markets and won't raise that much money. They argue that such a tax cannot be enforced; that it will depress trading, leading to lower asset prices; and that it will ultimately be passed on to retail investors. If some kind of increase in taxes is inevitable, one that takes aim at high-frequency traders doesn't seem so bad.

Wednesday, February 06, 2013 - A Trend of Banks Behaving Badly

A Trend of Banks Behaving Badly

by Sinclair Noe

DOW + 7 = 13,986
SPX + 0.83 = 1512
NAS – 3 = 3168
10 YR YLD -.05 = 1.97%
OIL + .20 = 96.84
GOLD + 4.10 = 1678.30
SILV +.03 = 31.95

At last count, 282 companies in the S&P 500 index had reported quarterly earnings and 74% were beating analyst earnings projections. Gas prices are up 7% in the past week. The Federal Reserve confirmed that one of its internal Web sites was hacked into yesterday. You might think the Fed databases are pretty secure. Turns out nothing in cyberspace is secure; just see what happened to the New York Times, the Wall Street Journal and the Department of Energy; and that's just the past couple of weeks. The Congressional Budget office says the US budget deficit this year will hit $845 billion, which sounds like a lot of money, but for the first time in a long time, it won't hit a trillion.

The Justice Department filed a $5 billion civil complaint yesterday accusing McGraw-Hill and S&P of three types of fraud, the first federal case against a ratings company for ratings related to the credit crisis. No surprise.

The transcripts of the Federal Reserve's FOMC meeting in 2007 show the Fed didn't trust the ratings agencies. Fed Chairman Bernanke said: “There is an information fog” that “is very much associated with the loss of confidence in the credit-rating agencies.”And Fed Governor Kevin Warsh said: the firms’ “credibility has been shot” and “it is much harder to see that this market will unwind itself in a rather kind and comforting environment.”

At the Aug. 7, 2007 meeting William Dudley said “disturbing delinquency trajectories” had prompted ratings agencies to downgrade a significant number of assets and that losses had “led to a fundamental reevaluation of what a credit rating means and how much comfort an investor should take from a high credit rating.” Dudley’s remarks sparked an FOMC discussion on the risk to the economy from declining confidence in ratings companies. Five years later, a civil suit is brought, and I'm reminded of an old, forgotten saying about justice delayed.

The Royal Bank of Scotland has become the third global bank to reach a settlement with US and British authorities related to manipulation of Libor, the London interbank offered rate; the interest rates that affect trillions of dollars of, well almost everything. We now have some trends.

The Royal Bank of Scotland agreed to pay criminal fines of $150 million to the Justice Department, and a $325 million civil penalty to the Commodity Futures Trading Commission, the regulatory agency that has taken the lead in these cases. An additional penalty of $137 million, will be paid to the Financial Services Authority in Britain. So, it will pay a total of more than $600 million to resolve the case.

Well, some of this fine might actually be paid by British taxpayers. In 2008, the British government had to bail out the Royal Bank of Scotland after the firm led a consortium to buy ABN Amro for $97 billion. RBS contributed around $37 billion for the ill-advised deal. The government, which plowed roughly $71 billion into the bank in the bailout, now owns 82 percent of RBS.

To help pay for the overall settlement, RBS said it would claw back past and present bonuses totaling $471 million from both the traders implicated in the rate-rigging scandal and from employees in the bank’s operations. Still, this is going to make it tougher for the British government to sell its shares. Since the bailout in 2008, the bank’s shares have plummeted, and are currently trading around 32 percent below the initial purchase price.

The other two banks that settled were Barclays and UBS. Barclays paid about $450 million. UBS paid $1.5 billion. For other banks looking to settle, they should figure on at least $500 million to the Justice Department and Commodity Futures Trading Commission, and the total could easily reach $1 billion if the governments of several nations are involved and the conduct by its employees was particularly problematic.

Barclays and UBS were required to have their Japanese securities operations plead guilty to one count of wire fraud, but it left the parent company untarnished by a criminal conviction. This should largely avoid the so-called Arthur Andersen effect on the bank by limiting the chances a bank will lose its ability to continue in business in the United States because of the conviction. The parent company does have to acknowledge its violations by accepting a statement of facts that describes how it violated the law. For Barclays and UBS, this came as part of a nonprosecution agreement, which means no criminal charges were ever filed against the banks.

This admission does, however, subject the banks to additional legal liability in cases file by those that relied on Libor for everything from mortgage rates to derivatives. Plaintiffs in such cases will now be armed with plenty of evidence provided by the government.

In an interesting twist, the Royal Bank of Scotland accepted a deferred prosecution agreement under which federal prosecutors filed a wire fraud charge that will be held in abeyance as long as the bank continues to cooperate.

So a precedent is set; pay a fine; throw a foreign subsidiary under the bus; walk away with a slap on the wrist.

The US Postal Service is cutting back. Beginning in August, there will be no more Saturday delivery of mail. The Postal Service would continue to deliver packages on a six-day schedule, and post offices would continue to be open on Saturdays. Cutting back Saturday mail delivery is expected to save $2 billion per year. Since 2010, the agency has reduced hours at many small, rural post offices and cut staff, and also announced plans to reduce the number of its mail processing plants. Last April, the Senate passed a bill that provided retirement incentives to about 100,000 postal workers, or 18 percent of its employees, and allowed the Postal Service to recoup more than $11 billion it overpaid into an employee pension fund. But post office officials say the cuts and staff reductions are not enough. Last year, the Postal Service had a net loss of $15.9 billion.

The postal unions and some businesses say the move to 5-day delivery is bad; it could be tough for customers, especially those in rural areas, or the elderly, and for many small businesses. The Postal Service continues to suffer losses of $36 million a day and is headed for projected losses of about $21 billion a year by 2016. A major reason for the losses is a 2006 law that requires the agency to pay about $5.5 billion a year into a future retiree health benefit fund; literally paying for benefits for employees that haven't even started work yet.

US corporate profit margins have never been higher. Lately it has been popular to point out that higher corporate profits have come at the expense of falling employee compensation. This might change as the economy improves:  companies might invest more to satisfy greater demand, new intellectual property will spread to competition, and higher employment will increase labor's bargaining ability. 

But how do we speed this up? Corporate investments have become a place to store wealth, as opposed to growing the businesses. The problem with corporations storing wealth is that it isn't nearly as good for most of us as investing in innovation and hiring employees. Some of retained earnings are socked away for tax reasons, some are the collection of high-tech companies that are past their innovative prime, but a lot of earnings are being used to buy back company stock. These stock buy backs sound good to shareholders and corporate executives, but it is a short-term maneuver that doesn't yield any long-term gain in production or profit.

A new report by the Corporation for Enterprise Development shows nearly half of US households  (132.1 million people) don't have enough savings to weather emergencies, or finance long-term needs like college tuition, health care and housing. According to the Assets & Opportunity Scorecard, these people wouldn't last three months if their income was suddenly depleted. More than 30 percent don't even have a savings account, and another 8 percent don't bank at all. 

We're not just talking about people who living people the poverty line, either. Plenty of the middle class have joined the ranks of the "working poor," struggling right alongside families scraping by on food stamps and other forms of public assistance. More than one-quarter of households earning $55,465-$90,000 annually have less than three months of savings. And another quarter of households are considered   net worth asset poor, " meaning that the few assets they have, such as a savings account or durable assets like a home, business or car, are overwhelmed by their debts."

The report shows household median  net worth  declined by over $27,000 from its peak in 2006 to $68,948 in 2010, and at the same time, the cost of  basic necessities like housing, food, and education have soared. Part of the problem is fixed cost, the things that are difficult to "cut back" on. Housing, health care, and education cost the average family 75 percent of their discretionary income in the 2000s. The comparable figure in 1973: 50 percent.

When consumers can't keep up with the costs, they fall into a debt trap. The average borrower carries more than $10,700 in credit card debt, one in five households still rely on high-risk financial services that target low-income and under-banked consumers. 

Tuesday, February 05, 2013 - Cutting to Spite Ourselves

Cutting to Spite Ourselves

by Sinclair Noe

DOW + 99 = 13,979
SPX + 15 = 1511
NAS + 40 = 3171
10 YR YLD +.04 = 2.02%
OIL + .47 = 96.64
GOLD – 1.40 = 1674.00
SILV +.06 = 31.92

The Congressional Budget Office released revised budget projections that show the federal deficit will drop to $845 billion this year, the first time during Obama's presidency that the red ink would fall below $1 trillion. The budget office also said the economy will grow slowly in 2013. The reason for the slowdown is a tax increase in January and spending cuts coming in the next couple of months.

A few minutes after the CBO report, President Obama spoke to the press and said those spending cuts would damage the economy and must be avoided. He asked Congress for a short-term deficit reduction package that will delay deeper cuts past the automatic start date of March 1, also known as the sequester.

The automatic cuts are part of a 10-year, $1 trillion deficit reduction plan that was supposed to spur Congress and the administration to act on long-term fiscal policies that would stabilize the nation's debt. Though Congress and the White House have agreed on about $2.6 trillion in cuts and higher taxes since the beginning of 2011, they have been unable to close the deal on their ultimate goal of reducing deficits by about $4 trillion over a decade.

If the automatic cuts are allowed to kick in, they would reduce Pentagon spending by 7.9 percent and domestic programs by 5.3 percent. Food stamps and Medicaid would be exempt, but Medicare could take up to a 2 percent reduction, under the plan.

White House aides say the president's plan for long-term deficit reduction would increase tax revenue by about $600 billion to $700 billion over 10 years as well as reduce mandatory health care spending, primarily in Medicare, by about $400 billion over the next decade. It would also change an inflation formula that would reduce cost-of-living adjustments for beneficiaries of government programs, including Social Security. Republicans have called for a more comprehensive overhaul of government entitlement programs.

For now, the President is asking for a short-term deficit reduction package of spending cuts and tax revenue that will delay the sequester, and give Congress time to chip away at the problem.

Part of what we should have learned is that austerity is not the answer. Europe has shown that. When economists talk about the role of government in economic recovery, they often focus on the question of whether or not we need more economic stimulus. Government participation in the economy does not just stimulate private sector activity.  Government is itself a large, diverse and important sphere of economic enterprise.  Our federal, state and local governments produce and deliver important goods and service, things that people want and need, and that they have asked their representatives to create and maintain.   And governments employ millions of people in income-earning positions to carry out all of this production.  Ordinarily, we would expect that as a society grows, government will grow commensurately along with everything else.  As our population grows and private enterprises proliferate, we need more schools and teachers, more courthouses and police stations, more public parks, more inspectors and regulators, more paved roads and street lights, and more government clerical workers.  So while it is true that government spending also stimulates additional economic activity in the private sector – just as any economic enterprise stimulates economic activity in the other enterprises it touches and affects – it is also true that the public enterprises governments oversee and the tasks governments perform are all by themselves an important component of overall economic activity.

The part of government spending that is devoted to purchases made in the production of goods and services is called “consumption and gross investment” , or CGI, and it amounts to about 15% to 20% of GDP.  Government consumption and gross investment (CGI) can be contrasted with other forms of government spending that do not contribute to GDP, such as transfer payments to the public under social insurance programs like Social Security and unemployment insurance programs.

CGI started to dry up after the stimulus package started to wear off in 2011, and public enterprise also started to decline. Paul Krugman asked: “How big a deal is this? Government consumption and investment is about $3 trillion; if it had grown as fast this time as it did in the Bush years, it would be 12 percent, or $360 billion, higher. Given a multiplier of more than one, which is what the IMF among others now thinks reasonable under current conditions, that ends up meaning GDP something like $450 billion higher, which is 3 percent — and an unemployment rate 1.5 points lower. So fiscal austerity is the difference between where we are now and an unemployment rate not much above 6 percent.”

For the past couple of years we've heard bipartisan talk about grand bargains, fiscal cliffs, sequestration, and debt ceilings, with different strategies granted, but with a common theme to shrink government.

 Obama actually told us government must shrink because we are “out of money”.  But notice how absurd it would be if the leaders of private sector industry were to say that the private sector economy has to shrink because it is out of money.  Everybody recognizes that if our economy is to grow and progress, private enterprise needs to spend and invest, and that the means of financing are created along with the initiatives that are financed.   In the case of government, the financial constraint is even less relevant, I mean they print the currency, so there are no real constraints due to a lack of money.

Yesterday I told you to look for a lawsuit against S&P. As expected, the government is seeking more than $5 billion in a civil lawsuit against Standard & Poor's and parent company McGraw-Hill over mortgage-bond ratings, marking the first federal enforcement action against a credit rating agency over alleged illegal behavior tied to the recent financial crisis. S&P reportedly had a chance to settle for about $1 billion, but they felt the price was too high. Attorney General Eric Holder said at a news conference that S&P misled investors, causing them to lose billions, and that its ratings were affected by "significant conflicts of interests." He said that while analysts raised red flags as early as 2003, S&P executives ignored questions about ratings.

In the filing Monday, the government said: "Considerations regarding fees, market share, profits, and relationships with issuers improperly influenced S&P's rating criteria and models." In other words, they sold their ratings to the highest bidder and didn't give a damn about honesty. So, the question is why did it take so long to bring civil charges against the ratings agency?

Well, the lawyer defending S&P says the government intensified its investigation after S&P downgraded the government's credit rating in 2011, following the debt ceiling dysfunction. I'll give the lawyer credit for misdirection, if nothing else. S&P will likely use the same defense the industry has been using for years to explain the seemingly misguided ratings -- their right to free speech. S&P and other credit rating agencies have claimed that their ratings were merely free speech and are therefore protected under the First Amendment. 

There is a paper trail of damaging emails. You've heard about this before. And when those emails are read aloud in court, the best hope will be to make jurors think that maybe it's just a government vendetta. But listen to some of the emails:

In an April 2007 email, an analyst quoted in the lawsuit told an investment banking client that the priorities inside S&P were not centered on providing accurate ratings, but rather were focused on not “p*ssing off too many clients and jumping the gun ahead of [competitors] Fitch and Moody’s.”

The banker emailed back: “I mean come on we pay you to rate our deals, and the better the rating the more money we make?!?! What’s up with that? How are you possibly supposed to be impartial????”

Another S&P analyst wrote: "We rate every deal … it could be structured by cows and we would rate it.”

The email complaints about the integrity of the ratings were so numerous that S&P management directed analysts to stop sending complaints via email. But the emails continued. They wrote about allowing bankers to have greater input into the ratings process; let the bankers help make the grades for the products they were selling; and all designed to increase revenue for S&P. One email that seems particularly damaging came from a director in charge of rating CDOs in late 2006. He wrote: “this market is a wildly spinning top which is going to end badly.”

The paper trail is long and extremely damaging. So, what does it take to come up with criminal charges against a large financial institution? Seriously, what does it take to get a criminal charge started?

Today, Barclays, the British bank, announced it is provisioning another $1.3 billion in its Q4 results to settle claims it mis-sold financial products, bringing total provisions to about $3.5 billion. And UBS, the Swiss banking giant, announced a a $2.1 billion dollar fourth quarter loss, with $1.5 billion of that coming from fines for manipulating Libor interest rates. The Libor rate affects the prices of hundreds of trillions of dollars of financial products; everything from credit cards to mortgages to municipal bonds. Basically, the price of everything in the world the price is somehow connected to Libor. And these guys were monkeying around with this for individual profit. But nothing illegal happened.

And finally, Dell Computer will be taken private by founder Michael Dell and Silver Lake Partners in a $24.4 billion dollar deal. It works out to about $13.60 per share, roughly one-quarter Dell's all-time high 12 years ago. Still, it's the biggest buy out in years. 

Monday, February 04, 2013 - Brouhaha As Excuse

Brouhaha As Excuse

by Sinclair Noe

DOW – 129 = 13,880
SPX – 17 = 1495
NAS – 47 = 3131
10 YR YLD - .04 = 1.97%
OIL – 1.61 = 96.16
GOLD + 6.80 = 1675.40
SILV - .08 = 31.86

With all the brouhaha over the fiscal cliff and the debt ceiling and the inauguration and the Super Blackout, it would be easy to forget the problems in Euro-land, but today, those problems have jumped back onto center stage, again. In Italy and Spain the prospects of stable government are slipping.

First in Italy, an election is scheduled for later in the month. The technocrat-slash-PM Mario Monti will exit, stage right, and the race is on. The second and third place contenders are a comedian named Beppe Grillo and another comedian, Silvio “Bunga-Bunga” Berlusconi; it appears unlikely either will win, but they are looking like they can splinter the vote for front-runner Pier Luigi Bersani. The running theme of the campaigns is anti-austerity and anti-German authoritarianism.

In Spain, the economy is contracting, again. Fourth quarter GDP shrank by 0.7%; the steepest decline in more than 3 years. Also, last week a new report showed unemployment at more than 26% in the fourth quarter. They are still calling it a recession but it is clearly a depression, and it is exacerbated by spending cuts and tax increases. Toss in a slush fund scandal involving the Prime Minister Rajoy, alleging kickbacks from construction firms; add in the Catalonian secessionist movement, and massive street protests.

Italian and Spanish bond yields jumped higher today. Implied default probabilities in Italy and Spain that were at 50 percent last July are still as high as 20 percent.

Toss in a $3 billion dollar fourth quarter loss for Deutsche Bank, and similar writedowns for Credit Agricole, the number 3 French bank; and last week the Dutch government nationalized the fourth largest bank in the Netherlands. The banks are still a weak link in any Euro-recovery. They haven't written off enough of their losses; they continue to hold toxic assets; they have tightened lending as capital gets swallowed up in the black hole of their impaired balance sheets.

Meanwhile, Royal Bank of Scottland is expected to announce tomorrow that has a settlement agreement with US and British authorities to pay $780 million in fines for manipulating Libor, the London Interbank Offered Rate, which is the key benchmark for interest rates.

Today, the British finance minister announced plans for what they are calling an electric ring fence around retail banks. The idea is to break up British banks that fail to guard their day-to-day banking from risky investment activity. The idea is that there would be repercussions to mixing deposits with the gambling money. We used to have a law that prevented those problems. It was called Glass-Steagall, and the Brits are slowly returning to the wisdom of that separation. And in announcing the new regulations, the British head of the Exchequer, George Osborne, (no relation to Ozzy), said: “America and elsewhere, banks found ways to undermine and get around the rules.” In the U.S., three out of the four biggest banks are bigger than they were before the financial crisis. Which is true, but he failed to mention that in the US and Europe, the big banks get bigger and bigger and operate with impunity from prosecution for things like Libor rate rigging or money laundering.

This is not to say that US banks have it easy. According to Brian Moynihan, the CEO of Bank of America, the acquisition of Countrywide was like climbing a mountain with a “250-pound backpack.” An article in the NY Times over the weekend says that so far, BofA has set aside some $40 billion to settle claims of mortgage misconduct that occurred before it acquired the fast and loose Countrywide. And to hear BofA tell it, all those bad mortgages sprang from the muddy waters of Countrywide. But according to documents from three Federal Home Loan Banks and a state Supreme Court in Manhattan, BofA continued shoddy mortgage practices well after the Countrywide acquisition.

Among the new details in the filing are those showing that Bank of America failed to buy back troubled mortgages in full once it had lowered the payments and principal on the loans — an apparent violation of its agreements with investors who bought the securities that held the mortgages.

The filings show that Bank of America had modified more than 134,000 loans in such securities with a total principal balance of $32 billion. Even as the bank’s loan modifications imposed heavy losses on investors in these securities, Bank of America did not reduce the principal on second mortgages it owned on the same properties. The owner of a home equity line of credit is typically required to take a loss before the holder of a first mortgage. By slashing the amount the borrower owes on the first mortgage, Bank of America increases the potential for full repayment of its home equity line. Bank of America carried $116 billion in its home equity loans on its books at the end of the third quarter of 2012.

This new information is part of a suit that alleges BofA's $8.5 billion dollar settlement of shady mortgage practices back in the summer of 2011, that settlement was letting BofA off far too easy (about 2 cents on the dollar), and it was made without proper analysis of all the wrongdoing by BofA. So, the acquisition of Countrywide offered BofA a scape goat, an excuse for nasty behavior. The only problem is that they kept running things the same way as Countrywide.

Meanwhile, the Justice Department, along with state prosecutors, plans to file civil charges against Standard & Poor's Ratings Service, accusing the firm of fraudulently rating mortgage bonds that led to the financial crisis. A suit against S&P would be the first the government has brought against the credit ratings agencies related to the financial crisis. Up until last last week, the Justice Department had been in settlement talks with S&P, but negotiations broke down after the Justice Department said it would seek a settlement in excess of “10 figures,” or at least $1 billion, essentially wiping out a full year of profits for the S&P parent company, McGraw Hill.

During settlement negotiations, the Justice Department held out the threat of a criminal case against S&P. Ultimately, the government plans to bring a civil suit, which has a lower burden of proof than a criminal case. And we all know the Justice Department hates to work hard to insure fair and equal justice under the law.

So you're probably saying: “Hey, this whole Euro-zone dysfunction is nothing new. So what if another Euro-bank gets fined for being sleazy scum bags? So what if there's a corruption scandal in Spain? So what if I haven't even mentioned Greece or Cyprus? So what if the austerity measures are grinding the life out of the Euro-economy like a jack-boot on the throat? What does all that have to do with a downturn in the US stock market?

And the answer is – it's a good excuse.

We have a couple of big, juicy round numbers serving as resistance; the Dow is staring down 14,000 and the S&P is pushing 1500. And then we have record highs to consider. And then we have to pause and consider that the move in January looked nearly parabolic. And that forces us to ask some questions. Has the economy actually improved? Can the average investor continue to ignore stocks or can the markets find greater fools to step up to the plate and donate their money?

Why worry; the markets always go up; except when they don't.

With the stock market up more than 100 percent from those scary days in early 2009, it seems we’re in danger of repeating the same old cycle of swearing off stocks forever during scary markets, missing a huge rally and then deciding it’s time to buy when stocks are high again. Or maybe it's time to sell. Actually, the thing to do right now is to make sure you have a plan in place which covers scenarios such as February 2013, and probably the first question to be answered when creating a plan is: Why are you investing this money in the first place?

And what this really tells us is that the US and Euro-zone economies are a bit stronger and more resilient than than we imagine. And when black swan events are predicted and discussed, they rarely happen; they are instead avoided.

The Energy Information Administration says Americans spent a record amount on gasoline last year, with more of their income going toward motor fuel costs than at any time since the 1980s. The average household expenditure on gasoline hit $2,912 in 2012, or just under 4 percent of pre-tax income, as higher prices at the pump canceled out the effect of more efficient vehicles.

This was the highest estimated percentage of household income spent on gasoline in nearly three decades, with the exception of 2008. The previous record amount was just below $2,750 in 2008, as crude oil prices spiked toward $150 a barrel in the first half of 2012. Global crude oil prices averaged around $111 in 2011 and 2012. The average cost of a gallon of gasoline in U.S. cities was $3.70 last year, up more than 30 percent since 2010. And although prices are down from 12 months ago, prices are moving higher; up 4 cents last Friday alone.

On February 3, 1913, the 16th Amendment to the Constitution was ratified; the reason that's important is because it marks 100 years of federal income tax.

And finally, there's one thing I think we all learned from yesterday's Super Bowl: don't forget to pay your electric bill on time. 

Friday, February 01, 2013 - Jobs Report Friday

Jobs Report Friday

by Sinclair Noe

DOW + 149 = 14,009
SPX + 15 = 1513
NAS + 36 = 3179
10 YR YLD + .02 = 2.01%
OIL + .12 = 97.61
GOLD + 3.80 = 1668.60
SILV + .37 = 31.94

Today is a Jobs Report Friday. Total nonfarm payroll employment increased by 157,000 in January, and the unemployment rate inched higher to 7.9%. The headline number was below expectations, which had been running from 170,000 to 185,000 new jobs. However, employment figures for November and December were revised up sharply. November was revised from 161,000 to 247,000, a gain of 86,000; so it turns out that job growth immediately before the election was actually under-estimated; December was revised from 155,000 to 196,000, a gain of 41,000.

In January, job gains occurred in retail trade, construction, health care, and wholesale trade, while employment edged down in transportation and warehousing. Exactly what this pace of job growth means for the unemployment rate depends on whether many of the workers sitting on the sidelines decide to join, or rejoin, or can find a place in the labor force. Right now, labor force participation rates, the share of people of working age who are either working or looking for jobs, is hovering around 30-year lows. Only those who are actively looking for work are counted as unemployed, so if the labor force participation stays low, even modest job growth can cause the unemployment rate to fall quite a bit.

The decline in the labor force participation rate brought the unemployment rate down much faster than anyone would have thought. The aging of America accounts for a little bit of it, but you’d still expect that job searches would go up and participation would rise as opportunities are opening up. For the long-term unemployed, who now represent 40 percent of all jobless workers, the opportunities still seem few and far between. Millions have exhausted their unemployment benefits and many more will fall off the government’s system in the coming months , and once the fall off, they seem to disappear.

The BLS report shows the number of unemployed persons, at 12.3 million, was little changed in January. In January, the number of long-term unemployed (those jobless for 27 weeks or more) was about unchanged at 4.7 million and accounted for 38.1 percent of the unemployed. Both the employment-population ratio (58.6 percent) and the civilian labor force

participation rate (63.6 percent) were unchanged in January. The number of persons employed part time for economic reasons, at 8.0 million, changed little in January. These individuals were working part time because their hours had been cut back or because they were unable to find a full-time job. The alternate measure of unemployment, or U6, which includes under-utilized workers was unchanged at 14.4%. That means the number of people working part-time who want to work full-time and the people who want work but are no longer counted as looking for work; that number is now 21.4 million. 

In January, the average workweek for all employees on private nonfarm payrolls was unchanged at 34.4 hours. Average hourly earnings for all employees on private nonfarm payrolls rose by 4 cents to $23.78. Over the year, average hourly earnings have risen by 2.1 percent. 

State and local governments lost 129,000 jobs in 2009, 262,000 in 2010, and 239,000 in 2011. In 2012, state and local government employment declined by 32,000 jobs. In January 2013, state and local governments lost another 4,000 jobs. It appears most of the state and local government layoffs are over, however state and local government employment is still trending down slightly. Of course. the Federal government layoffs are ongoing with another 5,000 jobs lost in January.

With the November/December revisions, there were 200,000 new jobs, on average over the past three months.The new numbers are based on far more reliable — but slower to arrive — counts of the the number of workers for whom unemployment insurance premiums were paid. In 2012, employment growth averaged 181,000 per month. A month ago, we were told the average for the year was only 153,000, basically the same as in 2011. With the revisions, we are told that the 2011 average was really 175,000. At the end of last year, the official figures showed employment had risen 3.7 percent from the bottom in February 2010 to the end of 2012. Now that figure is 4.1 percent. A year from now we will get benchmark revisions for the last nine months of 2012. It is quite possible the 2012 annual average will then rise further, to more than 200,000.

The economy has added jobs for 28 straight months; just not fast enough. Since the downturn began in December 2007, the economy has had a net decline of about 2.3 percent in its nonfarm payroll jobs. And that does not account for the fact that the working-age population has continued to grow, meaning that if the economy were healthy we should have more jobs today than we had before the downturn.

Getting the economy to 5 percent unemployment within two years, a return to the rate that prevailed when the downturn, would require job growth of closer to 285,000.

So, we slog along. The Federal Reserves QE to Infinity and Beyond just isn't enough to get the jobs numbers improving. Maybe monetary policy could do something, but the current efforts are misdirected. Fiscal policy isn't helping. The Social Security Payroll Tax hike only shrinks paychecks. States are looking to raise sales taxes. Military spending fell 22.2% in the fourth quarter; eventually we should see a Peace Dividend but right now it's just spending cuts. Spending cuts won't add jobs.

The only reason for employers too hire more workers is if they have more customers. Where do customers come from? Well, you know the answer. For exporting companies, the customers come from Europe, Asia and South America. Not much growth from those areas. The government can be a customer, but the battle in Washington these days is about spending cuts and tax hikes. That leaves consumers; 70% of all economic activity. And consumers have seen their purchasing power decline. Median wages, adjusted for inflation, have been on the decline. Many consumers are still trying to pay down debts, and continue to keep a tight grip on dollars that do make it into their purse. Consumer confidence hit a 12 month low. The focus should be on moving money through the economy, in turn creating demand, and in turn creating jobs.

Once we get more jobs, if we get more jobs. Then everything gets easier.

The jobs news was good enough to push the major market indices higher. The Dow tops 14,000. The S&P 500 climbs above 1500. It was the best January of the new century. All this market news is great, especially if you already have a big chunk of change in the markets. The fear is that the average investor, who isn't in the market, who hasn't participated in the rally, will finally jump in when the rubber band has stretched fully. Yes, stocks have become more widely held over the past two decades. And roughly half of Americans own some stocks through mutual funds and pension funds. But only about a third of all Americans hold more than $10,000 in stock. So while more Americans hold stock, they don't hold much. Wealth for most families comes from their homes and jobs , which have not not recovered as quickly or as strongly as stocks.

And if you think the S&P climbed too quickly, check out Italy and Spain. After posting modest gains during the first week of the new year, both these markets exploded to the upside, quickly outpacing the S&P. But both Italian and Spanish shares are rolling over a bit. Nationalization of a Dutch bank today provided a stark reminder that Europe is still struggling to shake off the legacy of the financial crisis and find a way to let banks fail without loading up governments with debt. The Dutch government was forced to rescue SNS REALL to protect savers' deposits after the banking and insurance group racked up huge losses on real estate lending. Attempts to find a private buyer or investor failed.

A couple of economic reports: the automakers posted strong sales for January. GM sales were up 16% compared to a year ago. Ford up 22%, Toyota up 27%, and Chrysler with a 16% gain.

The Institute for Supply Managements manufacturing index climbed to 53.1 last month from December’s 50.2. Readings above 50 signal expansion.

Exxon Mobil and Chevron, the largest U.S. energy producers, are boosting profits with oil refineries that some analysts and investors urged them to divest as recently as last year. Earnings from processing crude into fuels such as gasoline and diesel more than made up for lagging returns from oil and natural gas exploration during the final three months of 2012, Exxon and Chevron reported today. Fuel refining helped propel fourth-quarter net income to a five-year high of almost $9.95 billion for Exxon and a record $7.25 billion for Chevron.

Those stories have a common thread. The price of oil has been climbing; good news for Exxon and Chevron; drivers have been buying new cars, which are generally more fuel efficient. For some folks the math is simple. Say you spend $300 a month on gas, and you're driving a vehicle that get 15 to 20 MPG. Switch that for a new car that gets 35 to 40 miles per gallon, and in many cases you pay the cost of a new car with the gas savings. As sales of new cars increase, it ripples through the economy.