Wednesday, September 11, 2013 - Twelve Years After

Twelve Years After

by Sinclair Noe

DOW + 135 = 15,326
SPX + 5 = 1689
NAS – 4 = 3725
10 YR YLD - .04 = 2.92%
OIL - .08 = 107.31
GOLD + 2.50 = 1366.80
SILV + .25 = 23.32

The war hasn't started..., yet.

The war with Syria hasn't started yet. We're still at war; troops still in Afghanistan, slowly exiting; but, we're still at war, 12 years after.

The Dow Industrials have climbed for 6 out of the last 7 sessions, which coincides with the announcement by Obama to seek a Congressional vote on Syria. The Dow has added over 500 points since then. The price of oil hit highs for the year in the buildup to war. We've grown averse to war. Even on Wall Street, the idea of not going to war is a good thing. Maybe that is something we've learned from the last 12 years. War is bad; not going to war is good.

And so last night we listened to the president trying to sell the necessity of more war, this time in Syria. He called it military intervention, but whenever you drop bombs on another country, it is war. I'm still not sure what the objective would be. I'm not sure what the cost would be, but the cost of the past 12 years has been much higher than anyone thought at the time. And then, halfway through the speech last night, we heard the possibility of a diplomatic solution. Today, diplomatic efforts intensified. France drafted a resolution for the UN Security Council to have Assad give up his chemical weapons. Secretary of State John Kerry meets with Russian foreign minister Sergei Lavrov tomorrow in Geneva

It will be very difficult to reach a diplomatic deal, and even if that happens it will be tougher to enforce and verify. The chemical weapons complex of Syria includes factories, bunkers, storage depots and thousands of munitions, all of which would have to be inspected and secured under a diplomatic initiative that President Obama says he is willing to explore. And there is a civil war in Syria, which makes things more difficult. We didn't hear many details last night but a confrontation has been postponed for a while. The Senate formally ended its consideration of a resolution authorizing military force against the Syrian government. We'll give peace a chance.

And if that doesn't work out, then we'll bomb the hell out of the place, and it won't be a little pinprick strike. A few senators have already started work on a bill that would authorize US military force in Syria if the Security Council can’t pass a workable resolution, or if Syria fails to comply with it.

So, that's where we stand, 12 years later.

The whole thing has a certain, as yet unidentified stench. The US and France are going to bomb Russia's only Middle East foothold? What are the odds? Russia was willing to start World War III over Syria? What are the odds? Someday we'll follow the money trail and it will all make more sense, or at least some sense. It's understandable that we are all very wary of warfare, but we shouldn't forget that such levels of wariness can be easily used to play with our minds, and to focus our attention away from other events.

So, today let's look at something that should be capturing our attention. There is a great article from Nobel prize winning economist Joseph Stiglitz. His argument involves a narrow issue, but it looks like a blueprint for future action. We’re seeing a lot of these attempts lately. In that vein, the way the Detroit bankruptcy is handled will in all likelihood have profound ramifications for other municipalities across the US. And this spring’s Cyprus bail-in model is the likely blueprint in Europe’s periphery. If it worked in Cyprus, it'll work in Greece, or Portugal, or Spain.  I've cross posted it on my blog:

We need a fair system for restructuring sovereign debt

A recent decision by a United States appeals court threatens to upend global sovereign debt markets. It may even lead to the US no longer being viewed as a good place to issue sovereign debt. At the very least, it renders non-viable all debt restructurings under the standard debt contracts. In the process, a basic principle of modern capitalism – that when debtors cannot pay back creditors, a fresh start is needed – has been overturned.

The trouble began a dozen years ago, when Argentina had no choice but to devalue its currency and default on its debt. Under the existing regime, the country had been on a rapid downward spiral of the kind that has now become familiar in Greece and elsewhere in Europe. Unemployment was soaring, and austerity, rather than restoring fiscal balance, simply exacerbated the economic downturn.

Devaluation and debt restructuring worked. In subsequent years, until the global financial crisis erupted in 2008, Argentina's annual GDP growth was 8% or higher, one of the fastest rates in the world.

Even former creditors benefited from this rebound. In a highly innovative move, Argentina exchanged old debt for new debt – at about 30 cents on the dollar or a little more – plus a GDP-indexed bond. The more Argentina grew, the more it paid to its former creditors.

Argentina's interests and those of its creditors were thus aligned: both wanted growth. It was the equivalent of a "Chapter 11" restructuring of American corporate debt, in which debt is swapped for equity, with bondholders becoming new shareholders.

Debt restructurings often entail conflicts among different claimants. That is why, for domestic debt disputes, countries have bankruptcy laws and courts. But there is no such mechanism to adjudicate international debt disputes.

Once upon a time, such contracts were enforced by armed intervention, as Mexico, Venezuela, Egypt, and a host of other countries learned at great cost in the nineteenth and early twentieth centuries. After the Argentine crisis, President George W. Bush's administration vetoed proposals to create a mechanism for sovereign-debt restructuring. As a result, there is not even the pretence of attempting fair and efficient restructurings.

Poor countries are typically at a huge disadvantage in bargaining with big multinational lenders, which are usually backed by powerful home-country governments. Often, debtor countries are squeezed so hard for payment that they are bankrupt again after a few years.

Economists applauded Argentina's attempt to avoid this outcome through a deep restructuring accompanied by the GDP-linked bonds. But a few "vulture" funds – most notoriously the hedge fund Elliott Management, headed by the billionaire Paul E. Singer – saw Argentina's travails as an opportunity to make huge profits at the expense of the Argentine people. They bought the old bonds at a fraction of their face value, and then used litigation to try to force Argentina to pay 100 cents on the dollar.

Americans have seen how financial firms put their own interests ahead of those of the country – and the world. The vulture funds have raised greed to a new level.

Their litigation strategy took advantage of a standard contractual clause (called pari passu) intended to ensure that all claimants are treated equally. Incredibly, the US Court of Appeals for the Second Circuit in New York decided that this meant that if Argentina paid in full what it owed those who had accepted debt restructuring, it had to pay in full what it owed to the vultures.

If this principle prevails, no one would ever accept debt restructuring. There would never be a fresh start – with all of the unpleasant consequences that this implies.

In debt crises, blame tends to fall on the debtors. They borrowed too much. But the creditors are equally to blame – they lent too much and imprudently. Indeed, lenders are supposed to be experts on risk management and assessment, and in that sense, the onus should be on them. The risk of default or debt restructuring induces creditors to be more careful in their lending decisions.

The repercussions of this miscarriage of justice may be felt for a long time. After all, what developing country with its citizens' long-term interests in mind will be prepared to issue bonds through the US financial system, when America's courts – as so many other parts of its political system – seem to allow financial interests to trump the public interest?

Countries would be well advised not to include pari passu clauses in future debt contracts, at least without specifying more fully what is intended. Such contracts should also include collective-action clauses, which make it impossible for vulture funds to hold up debt restructuring. When a sufficient proportion of creditors agree to a restructuring plan (in the case of Argentina, the holders of more than 90% of the country's debt did), the others can be forced to go along.

The fact that the International Monetary Fund, the US Department of Justice, and anti-poverty NGOs all joined in opposing the vulture funds is revealing. But so, too, is the court's decision, which evidently assigned little weight to their arguments.

For those in developing and emerging-market countries who harbor grievances against the advanced countries, there is now one more reason for discontent with a brand of globalization that has been managed to serve rich countries' interests (especially their financial sectors' interests).

In the aftermath of the global financial crisis, the United Nations Commission of Experts on Reforms of the International Monetary and Financial System urged that we design an efficient and fair system for the restructuring of sovereign debt. The US court's tendentious, economically dangerous ruling shows why we need such a system now.

Tuesday, September 10, 2011 - Infinite Monkey Diplomacy Theorem

Infinite Monkey Diplomacy Theorem

by Sinclair Noe

DOW + 127 = 15,191
SPX + 12 = 1683
NAS + 22 = 3729
10 YR YLD + .06 = 2.96%
OIL – 2.29 = 107.23
GOLD – 23.20 = 1364.30
SILV - .75 = 23.07

The war hasn't started..., yet.

We had an off the cuff comment from Secretary of State John Kerry that set off a new peace plan. Kerry told reporters in London that President Bashar al-Assad of Syria could avert a strike if he turned over his chemical weapons stockpile within a week, adding that such an outcome was unlikely. This is apparently a new diplomatic policy based upon the infinite monkey theorem; which postulates that if you had a roomful of monkeys with typewriters, the monkeys would almost surely, eventually type out the complete works of William Shakespeare.

In this context, the monkey is not an actual monkey but a metaphor for an abstract device or perhaps a Secretary of State, and given enough time to talk he would almost surely, eventually stumble across a peace plan. Last night his apparently off-the-cuff proposal had gained broad support, including a warm welcome from both Syria and Russia, which said it would bring Syria’s chemical weapons under international control. France has introduced a proposal with the UN. Kerry has denied the whole thing, calling the remark nothing more than a rhetorical exercise. Methinks he doth protest too much; for what is politics but a rhetorical exercise?

If you don't like the infinite monkey theorem, then perhaps we are seeing an extremely impressive 3D chess match, and the Grand Masters are trying to pass it off as a game of checkers. Remember that Obama just returned from the G20 meeting in Russia, and there was a private meeting between Obama and Putin. We don't know the details but it is fairly certain the Syrian situation was discussed. We will know more in the richness of time.

Or, more precisely at about 6PM Pacific time. President Obama delivers a State of the Strike Speech from the Oval Office. White House speechwriters have been revising their drafts. Obama is now expected to say that the threat of military action has led to the diplomatic opening, and to urge Congress to keep the pressure on Syria even as his administration examines whether the Russian proposal is serious or a way to obstruct military action. Negotiations are more effective with the threat of cruise missiles. And this leaves fewer excuses for Congress to vote against granted the president authority for military intervention, if Assad were to reneg on the peace proposal. And all this may come to naught; calls for peace so rarely silence the drums of war; but there seems to be a moment here where sanity might prevail.

It has been a blast to watch. On cable news, everything is breaking; breaking news; breaking updates; breaking coverage; breaking developments; huge developments; breaking huge developments.

While all attention is focused on Syria, we almost forgot that this week five years ago there was a meltdown on Wall Street. Lehman Brothers went bankrupt. The biggest banks were so terrifyingly big that they had to be bailed out by the US government in order to survive a financial crisis, lest they obliterate the global financial system. Today, the big banks are even bigger.

The four biggest US banks (JPMorgan Chase, Bank of America, Citigroup and Wells Fargo) today have about $7.8 trillion in assets, or about 47 percent of U.S. gross domestic product, up from $6.4 trillion, or 43 percent of GDP, at the time of the crisis in 2008. The six biggest banks, a group that now includes Goldman Sachs and Morgan Stanley, now have $9.6 trillion in assets, or nearly 58 percent of GDP.

The Dodd-Frank rules designed to stop banks from betting with the insured deposits of ordinary savers are still on the drawing boards, courtesy of the banks' lobbying prowess. The Volcker Rule has yet to see the light of day.

JPMorgan Chase is the biggest of the banksters, and may well be the baddest. Last year it lost $6.2 billion by betting on credit default swaps tied to corporate debt - and then lied about it. Evidence shows the bank paid bribes to get certain counties to buy the swaps. The Justice Department is investigating the bank over improper energy trading. That follows the news that the anti-bribery unit of the Security and Exchange Commission is looking into whether JPMorgan hired the children of Chinese officials to help win business. The bank has also allegedly committed fraud in collecting credit card debt, used false and misleading means of foreclosing on mortgages, and misled credit-card customers in seeking to sell them identity-theft products.

They've set aside $6.8 billion for legal; which sounds like a lot; it is a lot. But for JPMorgan it is just the cost of doing business; they weigh the probability of getting caught; they weigh the probability of being prosecuted; they weigh the cost of fighting regulators; they don't even worry about the possibility of criminal charges; they tally the cost of penalties; and they still have a hefty profit. That's all that matters.

And the guys running the banks five years ago, well they got while the getting was good. Richard Fuld presided over the collapse of Lehman. and sent a tidal wave of panic through the global financial system, Fuld is living comfortably.

He has a mansion in Greenwich, Conn., a 40-plus-acre ranch in Sun Valley, Idaho, as well as a five-bedroom home in Jupiter Island, Fla. He no longer has a place in Manhattan, since he sold his Park Avenue apartment in 2009 for $25.87 million. Other bankers such as Jimmy Cayne (Bear Stearns), Stanley O’Neal (Merrill Lynch), Chuck Prince (Citigroup) and Ken Lewis (Bank of America) are also living in quiet luxury. The five ultra-rich former Wall Street chieftains have simultaneously faded into luxurious obscurity while the survivors — Jamie Dimon of JPMorgan and Lloyd Blankfein of Goldman Sachs — have only consolidated their power.

Last year a federal judge approved a $90 million settlement of a class action suit brought by Lehman investors against Fuld and several other company executives and directors. The judge, Lewis Kaplan, questioned whether the settlement, which will be paid entirely by Lehman’s insurers, was fair given that none of the individuals would pay out of pocket. He agreed to the deal, however, because litigation expenses for a trial were likely to deplete the funds available for compensating the investors. The cost of doing business.

Five years and the situation is more dangerous than ever. The big banks are bigger than ever, more ungovernable than ever; and the economy still hasn't recovered. Now, think about what might happen if we had a repeat of five years ago; or Act II if you prefer. What happens if there is another bank failure and we are again presented with the option of bailing out the banks or watching our 401ks slip away like sand through the hourglass. The big banks are ungovernable - too big to fail, too big to jail, too big to curtail. They should be split up, and their size capped. They should be chopped into small pieces, easily digestible pieces. When a small bank fails, we don't even burp. Chop them up into bite size morsels. There's no need to wait for Congress to do it; the nation's antitrust laws are adequate to the job. There is ample precedent. In 1911 we split up Standard Oil. In 1982 we split up Ma Bell. The Federal Reserve has authority to do it on its own in any event. 

We could do it. Things change. Happens all the time.

Today, the Dow Industrial Average announced a change. In the biggest shake-up of the Dow Jones industrial average in nearly a decade, Goldman Sachs, Visa and Nike will join the 30-stock index, with Bank of America, which just two years ago was the largest US bank by assets, one of the names exiting the Dow. Also leaving the Dow, Hewlett-Packard, and Alcoa. The changes will take effect at the opening of trading September 23.

Bank of America's run in the Dow was not one for the history books. The stock joined the index in February 2008. The stock is down more than 65 percent since it joined the Dow. The company was engulfed by the financial and housing crisis after it acquired sub-prime mortgage originator Countrywide Financial in January 2008. The bank said being removed from the index "has no impact on our business or our strategy for providing solid returns to shareholders." True enough, the moves don't affect the bottom line of the companies. With a market value of about $157 billion, BofA becomes the biggest US company not included in the average, other than Apple and Google

Monday, September 09, 2013 - The Problem Is We Do Get It

The Problem Is We Do Get It

by Sinclair Noe

DOW + 140 = 15,063
SPX + 16 = 1671
NAS + 46 = 3706
10 YR YLD - .04 = 2.90%
OIL – 1.56 = 108.97
GOLD – 2.30 = 1387.50
SILV - .13 = 23.82

The war hasn't started..., yet.

A funny thing happened today; for a few moments the constant drumbeats for war were quieted, and there was talk of a diplomatic solution; fleeting, nothing concrete, hypothetical, could disintegrate in the flicker of a butterfly's wing.

Russia jumped on a remark by Secretary of State John Kerry, who said Syria should save itself by handing over its chemical weapons. Kerry was quick to dismiss as hypothetical his own comment that Syrian President Bashar al-Assad could avert U.S. strikes by surrendering his chemical arsenal to international control. But Assad's ally Russia quickly turned it into a firm proposal that was "welcomed" by Damascus and echoed by the UN chief Ban Ki-moon. The White House said it was "seriously skeptical" but would take a "hard look" at the proposal.

Russia's foreign minister said he would push Assad to place Syria’s stockpile of nerve gases, blister agents and other chemical agents under UN supervision for eventual destruction. He said Russia also would push Syria to sign the Chemical Weapons Convention, the international treaty that prohibits use of poison gas. The Syrian government quickly put out a statement saying it would cooperate.

Can you trust Russia to broker a peace deal? Hell no. Over the last weeks, since the inception of the demonstrations in Egypt for president Morsi's ouster, to the sarin gassing of innocents in Syria these past days, the price of oil has skyrocketed more than 15 percent for WTI crude from near $95/bbl in June to over $110/bbl and Brent crude closing this past week at over $116/bbl.

After Saudi Arabia, the most immediate beneficiary of this spiking of oil prices is Russia -- now, together with the Saudis, the world's largest oil producer, with 7 million barrels/day being shipped into the export market. In no other big economy do oil and gas play such a vital role as in Russia. They account for two-thirds of its exports, half its budget revenue and nearly one-third of economic output. In a real sense, the history of Russia's oil industry since the collapse of communism is the history of the country itself. Clearly the higher the price of oil, the greater the benefit to Russia and the largesse of the Putin government, whose domestic economic policies and well being are principally funded by oil revenues.

To keep the pot boiling in the Middle East, the Russians have been the long-standing and grievously irresponsible defenders of Iran and its nuclear program, while freely arming Syria's Assad government with a full array of weaponry including highly advanced anti-aircraft weapons system. This while forever rendering meaningful UN action moot through threat of a Security Council veto. Clearly the price of oil has become a strategic imperative of Russian foreign policy. But it's also important to know when to ease off the gas and tap the brakes; like maybe right before you go flying off a cliff.

The fast-moving events presented at least the possibility of a diplomatic and political solution, even if everybody seems to have just stumbled on the idea. And the whole idea of a peaceful resolution could fall apart very quickly. We'll find out more over the next two evenings as President Obama hits the airwaves; tonight he'll speak with six major American news networks as part of his sales pitch to build support and he'll go directly to the people Tuesday.

In the background, his aides have been heavily lobbying Congress while seeking support from other nations; so far, some countries , such as Germany, have said they support the idea of military action, but they want no part of it.  Senate Democratic Leader Harry Reid set a test vote for later this week, but it was unclear whether the measure would attract enough backing to clear anticipated procedural roadblocks. Most counts show that the Congress is reluctant to back force, and constituents have been vocal in opposition. In town hall meetings during the congressional recess and in polls, most Americans don’t accept that the humanitarian argument is sufficient to justify a military strike.

According to a CNN poll, nearly 6 in 10 Americans think Congress should not authorize limited military action in Syria, with roughly 7 in 10 saying that airstrikes against Syria would not achieve any significant goals for the United States and that the US does not have any national interest in Syria.

Obama’s upcoming media blitz, to include interviews on six television networks and a primetime Oval Office address, is not going to rally the public to support military action. The president faces strong competition for the public’s attention, and most people are not attentive to him. Barely a tenth of the population watched Obama’s 2013 State of the Union address. Moreover, many people who do pay attention miss the president’s points, and the less people know, the more confidence they have in their pre-existing beliefs and resist factual information.

So, should you bother paying any attention to the media blitz? In decisions of war, bravery is needed in knowing when to be humble, in listening for one’s biases and evaluating new evidence. Or as Winston Churchill once said: “Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen.”

Most people distrust government, especially on issues of war, especially when they are complex and their consequences are uncertain; and this certain qualifies as uncertain. But it's not that this situation is too complex for simple-minded voters to grasp the significance. The population is not stupid. We get it. We understand that the complexity is often just a cloak against honesty. We understand that the path to peace can be more than bombing people. The problem isn't that we don't get it. The problem is that we do get it.

More than four years after the recession officially ended, 11.5 million Americans are unemployed, many of them for years. Nearly 4 million have given up looking for work altogether. If they were actively looking, today's unemployment rate would be 9.5 percentinstead of 7.3 percent. The participation rate is at the lowest level in 35 years. It's now pretty well understood that of the two ways you can reduce unemployment, we got the bad one Friday. That is, the jobless rate can fall because more jobseekers land jobs -- good; or because they give up looking -- bad. Some of that decline is demographic -- our workforce is comprised of a growing share of workers on the cusp of retirement. But most of it -- I'd say about two-thirds based on the analysis I've seen -- is due to weak labor demand. People have given up and dropped out of the labor pool.

The median wage keeps dropping, adjusted for inflation, and incomes for all but the top 1 percent are below where they were at the start of the economic recovery in 2009.

Deficit hawks in both parties don't want you to know this but the federal deficit as a proportion of the total economy is shrinking fast: It's on track to be only 4 percent by the end of September, when the fiscal year ends. The non-partisan Congressional Budget Office predicts it will be only 3.4 percent in the fiscal year starting October 1. To put this into perspective, consider that the average ratio of the deficit to the GDP over the past 30 years has been 3.3 percent. So the deficit is barely a problem at all. Still, it's amazing how politicians can justify spending billions of dollars to drop bombs, but we can't afford to spend money to build a bridge, or make sure a hungry kid, right here in America, has food for the school day. A decent society would put people to work, even if this required more government spending on roads, bridges, ports, pipelines, parks and schools. War, however is not the answer.

Friday, September 06, 2013 - Fed Policy Creates Inequality

Fed Policy Creates Inequality

by Sinclair Noe

DOW – 14 = 14,922
SPX + .09 = 1655
NAS + 1 = 3660
10 YR YLD - .04 = 2.93%
OIL+ 1.86 = 110.23
GOLD + 21.10 = 1389.80
SILV + .63 = 23.94

The war hasn't started ..., yet.

This morning we got the big monthly jobs report. Nonfarm payrolls increased by 169,000 jobs last month falling short of the 175,000 to 180,000 Wall Street had expected. Not only did hiring miss expectations last month, but the job count for June and July was revised to show 74,000 fewer positions added than previously reported.

While the unemployment rate fell a tenth of a percentage point to 7.3 percent, its lowest level since December 2008, the decline reflected a drop in the share of working-age Americans who either have a job or are looking for one. That participation measure reached its lowest point since August 1978, a further sign of underlying economic weakness. The rate for men touched a record low.

U-6, a measure of underemployment that includes people who want a job but who have given up searching and those working part time because they cannot find full-time jobs fell three tenths of a percentage point to a 4-1/2-year low of 13.7 percent.

The private sector accounted for the bulk of the job gains last month, but government payrolls increased 17,000 as local governments hired teachers for the new school year. Factory employment rebounded after falling in July. Construction payrolls were flat as both residential and nonresidential construction jobs fell. There was another month of strong job gains in the retail sector. Leisure and hospitality employment also posted solid increases as did health care and social assistance.

So, a generally weak jobs report; there was still growth; we posted a positive number; not a negative, but it was weak growth. That got people wondering if the Federal Reserve would still taper this month. It's widely expected the Fed will cut back or taper its purchases of Treasuries and Mortgage backed securities; currently the Fed is purchasing $85 billion per month; the idea is to reduce purchases to just $70 billion, as they try to slowly get away from the QE purchases. Did today's jobs numbers change anything? Probably not. Certainly nothing that made an overwhelming case. It can be argued how much impact QE has had on jobs in the first place.

One area QE has had a big impact is in the mortgage market; 10-year Treasuries hit 3% briefly yesterday, and the 5% mortgage is likely not too far behind. Oddly enough, jumbo loans are actually now cheaper than conforming loans for the first time in anyone’s memory. The Federal Reserve has essentiallly subsidized the housing market with its mortgage backed securities purchases. And as QE maybe starts to unwind, we ask who won and who lost?

According to a new report from mortgage-backed securities analysts at Bank of America Merrill Lynch, “the cost burdens are disproportionately impacting low-income groups and renters.” Not exactly earth-shattering news unless you consider the source. (I've been saying it for years, but now BofA admits it.)

One important insight here is that “easy monetary policy,” as evidenced by QE, is correlated with the rise in income inequality over the past 35 years. The two periods over this time where inequality really shot up came right after recessions in 1991-93 and 2007-11. These two periods were characterized by aggressive monetary policy, including quantitative easing. Since the primary credit channel in the successive rounds of QE targeted assets for either the rich or near-rich, this stands to reason.

But the primary focus of the paper is housing, and the primary focus of the Fed's QE policy also appears to have been housing. The Fed basically created the conditions for a rise in home prices, thinking that would have great positive effects for the economy. BofA/Merrill cites a Harvard State of the Nation Housing report.

The report starts with comments on the benefits associated with housing’s revival, such as home equity accumulation, but it quickly turns to a starker reality, which is that “the number of households with severe housing cost burdens has set a new record.” This language would be more consistent with the view of housing expressed in gold terms – housing is not a good news story. Moreover, the report shows that the hardest hit in the population are renters and those at the low end of the income distribution. The share of renters in the population, now at 35%, has been rising in recent years, as the homeownership rate has steadily declined from the bubble peak in 2004. So not only are renters disproportionately sharing in increased housing costs, the percent of households in this category is increasing in the wake of the financial crisis.

The Harvard report defines two categories of households with respect to housing costs as a share of income: moderately burdened and severely burdened. Moderately burdened households pay 30%-50% of pre-tax income for housing; severely burdened households pay more than 50%. Rising home prices laid the burden primarily on owners between 2001 and 2007, but as home prices declined and credit tightened, the burden shifted to renters. Most importantly, in aggregate, between 2001 and 2011, there was a 35% increase in the number of burdened households, for a net addition of 11 million households to the burdened category. The percent of burdened households grew from 29.4% to 36.8%.

Even with mortgage rates plummeting from 7% to 4% from 2001 to 2011, 42 million households experienced moderate or severe housing costs. And the report doesn't take into account negative equity. Renters took the brunt of this stress in the later period; by 2011, an incredible 50% of all renters were burdened by high housing costs.

This impacts quality of life. If you spend most of your income just to keep a roof over your head, it means you spend less for other things like food, health care, transportation, and education. And that lead the banking analysts to conclude that the Fed was adding to inequality. Specifically, the report says:

If monetary policy is in fact responsible for increasing housing cost burdens through policies that have inflated home values, then it is also responsible for limiting the available dollars that lower income families have to spend on education. If unequal access to education is indeed a key driver of growing income inequality, then it appears as if the vicious cycle of rising home prices, higher housing costs, less money to spend on education and greater income inequality is poised to continue.

So today, when the jobs numbers came out weaker than expected, the speculation centered on whether the Fed would cut back on QE. When you consider that QE in reality is lip service and happy talk about full employment and stable prices, and the actual outcome is greater inequality, well, maybe something other than Fed monetary policy would be better.

The G20 wrapped up its summit in Russia. The summary was that the situation in the global economy looks better now than it did five years ago. Economic growth is recovering, but there are still risks, and saying it was too early to ease off government stimulus spending, in spite of recent positive economic news. The G20 now faces a multi-speed recovery with the US economy pushing ahead, Europe maybe finding a floor and developing economies facing blowback from the looming 'taper' by the Fed. Collateral damage from the Fed's easy monetary policies can be found in emerging market economies that enjoyed rapid growth with a flood of cheap dollars, only to see those easy dollars dry up with talk of taper.

The G20 Summit was designed to deal with economic issues, but this one got caught up in the Syrian situation. Obama persuaded nine other G20 nations plus Spain to join the United States in signing a statement calling for a strong international response, although it fell short of supporting military strikes. Obama and Putin talked but could not find agreement. Unable to win Security Council backing because of the opposition by veto-wielding Russia and China, Obama is seeking the support of Congress instead. He declined to speculate whether he would go ahead with a military strike in Syria if Congress opposed it but said most G20 leaders condemned the use of chemical weapons even if they disagreed whether to use force without going through the U.N..

Looking ahead to Monday, Congress reconvenes. This is the first day that both the Senate and the House are back in session after the long summer recess. There are many urgent issues waiting to be resolved — including the continuing resolution that will keep the US government open for business, and this thing with Syria. Sept. 17 & 18 is the next Fed FOMC meeting. And then as we wrap up September, Congress must pass a continuing resolution by Sept. 30 or the government will shut down Oct. 1. There is no chance that a complete 2014 budget can be passed before Oct.1, the start of 2014 fiscal year. A short-term, extension-type continuing resolution for government funding must be passed instead, before Oct. 1. The duration of the continuing resolution will likely be pretty short — say, a couple of months -- so that the Congress does not have to make tough decisions on issues such as sequesters for the 2014 fiscal year.

The war hasn't started..., yet.

Thursday, September 05, 2013 - Mustering Support

Mustering Support

by Sinclair Noe

DOW + 6 = 14,937
SPX + 2 = 1655
NAS + 9 = 3658
10 YR YLD + .08 = 2.98%
OIL + 1.23 = 108.46
GOLD – 23.90 = 1368.70
SILV - .25 = 23.31

The war hasn't started, yet.

President Obama is in St. Petersburg Russia for the G-20 summit, he received a cordial but cool greeting from Russian President Vlad Putin, however Putin had harsh words for Secretary of State John Kerry, calling him flat out a “liar”, referring to his testimony regarding Syria, a close ally of Russia.The United States has given up trying to work with the U.N. Security Council on Syria, accusing Russia of holding the council hostage. Russia, backed by China, has used its veto power three times to block council resolutions condemning Assad's government and threatening it with sanctions. 

Yesterday, a Senate panel authorized military action in a “limited and specified manner”. A full vote is expected next week. Syria is dominating a summit with an official agenda focused on economic growth, monetary policy and global banking and tax rules. Obama began meeting with other leaders of the Group of 20 nations, trying to persuade allies to give the US a measure of political cover even if they withhold military support. Obama has already met with Shinzo Abe of Japan, Francois Hollande of France – who may be the only US ally taking part in a strike against Syria, and also a meeting with Dilma Rousseff of Brazil.

Brazil won't be part of any military action, and Rousseff might even cancel a planned trip to the White House in October 23^rd; the reason has nothing to do with Syria. Rather the Brazilian President is a bit ticked off about information leaked by Edward Snowden that shows the US spied on communications between Rousseff and her top aides. Brazil’s Senate is creating a committee to probe the spying allegations and seek federal police protection for Glenn Greenwald, the journalist who revealed the documents from Snowden. Brazil's foreign minister said: “This represents an inadmissible and unacceptable violation of Brazilian sovereignty. This kind of practice doesn’t live up to the type of trust needed to have a strategic partnership.”

Indeed, the pressure for military action in Syria will find reluctance from several countries as it follows in the footsteps of the Snowden allegations. And if Obama can't muster international support for military intervention in Syria, it will make the job of Congressional support more difficult. Various handicappers believe the resolution would go down to defeat if the vote were held today. So far, the Administration has been unable to make much of a case, beyond moral outrage. In a post Iraq world, people are actually asking pertinent questions like: how long will it last? What is the objective? How much will it cost? So far these are unanswered or inadequately answered questions. It's interesting that they can always find money for military action isn't it?

It is entirely possible that we could soon witness the amazing spectacle of Congress defeating a war resolution backed by the president and every top elected leader.

Of course, a resolution can be defeated and not killed outright. Remember TARP? The first vote for TARP was defeated and it took a market swan dive, a second TARP vote, and the addition of lots of pork to reverse the initial vote. But also bear in mind that the reason TARP was initially voted down was the barrage of voter phone calls and e-mails against it, reportedly 99% opposed until financial services firms started getting employees to call in favor of the bill, which shifted the tally to a mere 80% or so of callers opposed.

Even if the President musters enough votes to strike Syria, at what political cost? Any president has a limited amount of political capital to mobilize support for his agenda, in Congress and, more fundamentally, with the American people. Time and again we have seen domestic agendas succumb to military adventures abroad — both because the military-industrial-congressional complex drains money that might otherwise be used for domestic goals, and because the public’s attention is diverted from urgent problems at home to exigencies elsewhere around the globe.

We've mentioned before that Syria is a minor player in the oil markets, but geographically any action there would have an affect on oil prices. The rarely noticed reason is that Syria is closely allied with Iran, and indeed this whole Syria thing may have more to do with Iran than Syria. Anyway, if something happens, we'll likely see a spike in oil prices. We've been seeing oil over $100 a barrel and gasoline above $3.40 a gallon for much of the last 3 years. Those prices would have shocked many Americans a few years ago, but have now become the new normal.

What changed? Well, Americans are breaking their addiction to driving, at least a little. We own fewer cars per household than just a few years ago. Unfortunately, some of the reduction in motor gasoline consumption directly relates to massive under-employment, especially among those under 25, as well as lower wages among the employed. And the cars we own are more fuel efficient. The average fuel efficiency for new cars sold in the US just six years ago was only 20.8 miles per gallon; today it's 24.8 MPG. That may not sound like much, but it's about a 20% improvement.

Higher domestic production and lower American consumption have meant declining imports of crude oil and petroleum products-- a reversal of another once seemingly inexorable trend. The economic burden of imported oil is represented not by the number of barrels, but instead by the real value of the resources we must surrender in order to obtain the oil. The dollar value of petroleum imports as a share of GDP has come down a little as a result of recent gains in production and conservation, but still remains significantly elevated relative to the levels of a decade ago.

Let's get back to economic news.

Tomorrow we'll see the monthly jobs report for August. We got some clues today. Jobless claims declined by 9,000 to 323,000 in the week ended Aug. 3. Employers seem to be holding the line on dismissals. Meanwhile, ADP, the private payroll processing firm issued their monthly report which showed companies increasing employment by 176,000 workers in August. The ADP report does not always match with the government report, but folks like to use it for guesstimates anyway. It's widely expected the economy added 175,000 to 180,000 jobs last month, up from July's gain of just 162,000. Anything over 200,000 would tilt the odds heavily in favor of the Fed beginning to taper QE security purchases at the FOMC meeting in two weeks.

 

Bill Gross, the head of PIMCO, in his September letter to investors says that central banks' easy money policies have become less effective in generating economic stability, and that zero-bound interest rates have threatened finance and investment in the "real economy."

Gross writes: "Why invest in financial or real assets if bond prices could only go down, and/or stock prices could no longer be pumped up via the artificial steroids of QE?"

Gross added that liquidity will be "challenged" when policymakers start to tighten easy money policies and stocks may also be "at risk" when the Fed ends its bond-buying program. In other words, the Fed's exit from QE might not be baked into the cake just yet.

If you've been listening to the Financial Review for more than a day or two, you know that I think the banking system poses a systemic threat to the economy. A few years ago I wrote a book called “Eat theBankers”, and you can follow these daily broadcasts at the website EattheBankers.com. So, it is reassuring for me when I hear others jumping on the bandwagon. I'm not going to go into detail, but Simon Johnson, the former chief economist for the International Monetary Fund, recently wrote an article for Bloomberg, and I'm posting the link: The title is: Bank Leverage is the DefiningDebate of Our Time.

The basic idea of the article is that excessive leverage could bring down the world economy again. And the next financial collapse could be even worse than what we experienced in the fall of 2008. The debate is between the Too Big to Fail Banks that want to take more risks precisely because they can draw on implicit or explicit government guarantees, and on the other side are sane people who realize that the banks could destroy the economy.

The banks don't want to set aside safe, reserves, they'd rather take that money and gamble. Letting banks calculate their own risk weights or develop their own methodologies makes no sense -- conflicts of interest predominate when you are too big to fail. But asking rating companies or government officials to come up with meaningful risk weights also is doomed to fail. They lack the information, motivation and compensation incentives to do this right.

We've had this debate before; at the beginning of the 20^th century Teddy Roosevelt brought a case against JPMorgan's Northern Securities Company as part of the anti-trust movement. The case was ultimately decided by the Supreme Court in the government's favor. Had the monopolists won, instead of enjoying a vibrant competitive economy and a century of unprecedented growth that made the U.S. the world’s greatest power, we would have likely ended up like other unfortunate countries where a few oligarchs rule to the disservice of the broader public and the greater good of the economy. 

Wednesday, September 04, 2013 - Not Yet but Closer

Not Yet but Closer
by Sinclair Noe

DOW + 96 = 14,930
SPX + 13 = 1653
NAS + 36 = 3649
10 YR YLD + .05 = 2.90%
OIL – 1.24 = 107.30
GOLD – 20.60 = 1392.60
SILV - .82 = 23.56

The Senate Foreign Relations Committee approved a resolution on authorizing limited military intervention in Syria, setting the stage for a debate in the full Senate next week on the use of force.

The committee voted 10-7 in favor of a compromise resolution that sets a 60-day limit on any engagement in Syria, with a possible 30-day extension, and bars the use of troops on the ground for combat operations. The compromise is more limited than President Barack Obama's original proposal but would meet his administration's goal of..., well, actually, I'm not sure what the goal is, except that it would be limited and narrow, and now it would be even more limited.

Yesterday we talked about some of the challenges or headwinds facing the economy and the markets. Today, the Federal Reserve released its Beige Book, and apparently things are better than they look. Conditions continued to improve over the past quarter. The central bank said growth was moving at a "modest to moderate pace" with improvements coming across all the Fed districts.

The Fed said in its Beige Book report: "Consumer spending rose in most districts, reflecting, in part, strong demand for automobiles and housing-related goods."

Increased activity also was reported in travel and tourism, nonfinancial services and manufacturing, which the central bank said had grown "modestly." For most occupations and industries, hiring held steady or increased modestly relative to the prior reporting period," the Beige Book said. "Upward price pressures remained subdued, and prices increased slightly during the reporting period. Wage pressures continued to be modest overall."

Last week, the Thomson Reuters/University of Michigan index climbed to 85.1 in this month’s report, from 84.1 in June. It is the highest level since July 2007. More Americans feel better about the economy. The survey showed they expect interest rates to rise, and that they doubt the economic improvement can keep up the pace. Fear of higher rates has caused many to buy now what they otherwise might buy later. And that would just point to continued expansion of consumer spending in the months and year ahead.

Up, up and away. What could go wrong?

First, Congress returns from recess Monday, September 9, to consider whether to put the government's operations on hold on October 1 because it no longer has an operating budget. Current Federal budgetary authority to spend, Sequester and all, expires at that time (although the Sequester plan nominally carries forward for another nine years).

Democrats want to pare down the Sequester for fiscal 2014, and make up the difference with targeted spending cuts and tax increases. Republicans want to continue the Sequester and make other cuts as well.

Second, some Republicans also want to cut all Federal funding to implement Obamacare, as a price for agreeing to any budgetary plan at all; i.e., they are willing to shut down the government on October 1 unless Obamacare is cut from any spending authority going forward. Even if Democrats and Republicans could find some “continuing resolution” compromise on the mix of spending and taxes, these Republicans would hold out for elimination of Obamacare. They realize the Senate Democrats would not initially go along but believe ultimately Obama will blink, as he did in the 2011 debt ceiling crisis, when he agreed to the doomsday Sequester device as a way to satisfy Republican calls for budget cuts equal to any increase in the ceiling.

Republican leadership certainly favors repealing Obamacare, having taken 40 fruitless votes to do so already. However, they fear the linkage of defunding it to a government shutdown. Speaker Boehner has let it be known he would like to buy time with some sort of continuing resolution to allow time to maneuver later in the fall when the debt ceiling issue is expected to come up again – maybe around Thanksgiving.

Turns out the government will run out of room to do its routine borrowing to finance its Congressionally-agreed deficit under its current budget just one month after Congress reconvenes.

It would be a misleading oversimplification to say that our national credit limit kicks in October 15. But because our national revenues from budgeted taxes and fees come in “lumpy” over the course of a fiscal year, we need to borrow operating funds to cover our not-so-lumpy bills as they come due.

Congress has already agreed that we must pay each of those bills, including Social Security, military pensions, Medicare, and principle and interest of U.S. Treasury securities, but has added a spurious debt ceiling law that purports to deny the government access to credit markets beyond a fixed amount that has no actual relationship to the debts we have incurred. Any corporate board of directors that imposed such a restraint on its executive officers would be successfully sued for malfeasance. But we’re stuck with this preposterous financial lunacy as a nation because it’s the law.

There is little the executive can do if the debt ceiling is reached other than what you or I would in our own financial dealings: prioritize our creditors and use whatever current revenues we have. Some in the House want to legislate that prioritization in advance, but that would be trying to make sense of insanity.

So Republican leadership plans to duck a government shutdown but kick the Obamacare issue over to late-year “leverage” on the debt ceiling issue. They’ll do this on the same theory that Obama will surely cave again as he did in the 2011 fiasco so as not to be the president who presides over the first U.S. default on its “full faith and credit.” But the president has drawn a red line against negotiating again on the debt ceiling extension.

So the financial markets could face both a government shutdown and a debt ceiling expiration just two weeks apart. And the Fed also has its own moment of truth the week of September 15 as well, as it decides whether to begin dialing back its purchases of mortgage-backed securities and Treasury bonds because the economy has been growing enough of late to survive a gradual, tapered withdrawal of such unconventional stimulus. Putting aside recent mixed-to-poor economic data, especially on the pace of housing recovery, can the Fed risk starting to taper in the face of a fiscal collapse like a shutdown and default at the same time, weeks before its next meeting?

While the events relating to Syria have spurred a modest flight to safety in US government debt, those trading waters are bound to be roiled in the coming weeks by the gathering clouds of shutdown and default. The Fed has the first chance to help avoid a market meltdown by postponing its tapering decision until the fiscal “hurricane watch” is lifted. Congress and the President have a chance to make the storm blow over by negotiating a budget deal (which would be consistent with Obama’s red line on direct debt ceiling negotiations) that satisfies enough Republicans to lift the debt ceiling separately.

Past experience with the TARP legislation and the “fiscal cliff” resolution just months ago shows that Congress doesn’t act these days until it feels the harshest winds – in this case, a stock market meltdown out of frustration with the lawmakers’ willingness to tempt fate by seeing what a few days of shutdown and default actually are like.

So, what could go wrong?

Squirrels.

Maybe not squirrels, we don't really know, but we do know the Nasdaq Stock Market had a brief outage, but the problem was resolved and trading was not affected. Nasdaq OMX, the parent company of the Nasdaq Stock Market, said the outage lasted six minutes – from 11:35 a.m. Eastern Daylight Time to 11:41 a.m. The outage is the latest technical difficulty to hit the exchange, which endured a three-hour trading outage on August 22. That outage was also blamed on the exchange's price quote disseminating system. Back in the late 90s the Nasdaq had a few power outages, blamed on squirrels chewing through cables. We don't have those problems anymore. Thanks to advances in technology we have new problems.

So, what could go wrong?

Well, we can't forget the banksters. The Federal Bureau of Investigation and prosecutors in Manhattan U.S. Attorney's office are conducting a criminal investigation into whether several employees of JPMorgan Chase tried to impede a regulatory investigation into alleged manipulation of power markets. It comes after a JPMorgan subsidiary agreed on July 30 to pay a $410 million penalty to settle a manipulation case brought by the Federal Energy Regulatory Commission.  investigators aim to determine whether individuals at JPMorgan - including three Houston-based employees - gave regulators all the information they needed to investigate JPMorgan's power market deals in California and the Midwest. Deliberately withholding information from investigators or lying during interviews conducted as part of an investigation is considered obstruction of justice, a criminal offense.

Will an attack on Syria make anything better? The case has not been made, not yet anyway. Appearing before a Senate panel yesterday and a House panel today, Secretary of State John Kerry and Defense Secretary Chuck Hagel struggled at times to frame a proposed military strike on Syria as tough enough to be worthwhile but limited enough to guarantee that the United States would not get dragged into another open-ended military commitment in the Middle East. Nonetheless, they assured lawmakers that the administration was not asking for congressional backing to “go to war,” as Kerry put it. I almost expected John Kerry from 1971 to walk into the hearing room and throw his medals at himself.

The human rights atrocities in Syria are real, and should be offensive and horrifying to anyone with a pulse. So the "do something, anything!" impulse isn't "liberal" or "conservative." And it isn't silly, stupid or war-mongering. It is simply a sign that you are human. What can be silly, stupid and war-mongering is to assume that the "do something, anything!" impulse is proof that one course of action - a military attack - is the only proper or humane thing to do.

The real question should be when it comes to military action, especially the kind publicly predicated on humanitarian concerns. The question is not whether you love or hate a particular dictator, because if that was the question, then the U.S. government has a lot to answer for in its alliances with many dictators. No, the question when it comes to wars of choice ostensibly waged in defense of human rights should be far more straightforward: namely, will military action result in a net increase or decrease in human suffering?

The question of U.S. military action against Syria becomes far more thorny because it is not at all clear that military action will make anything better - and that's putting it mildly. As McClatchy notes, military and geopolitical experts are telling us that the kind of military response being discussed by the Obama administration would be "symbolic and fall far short of eliminating Syria's chemical capabilities." Likewise, the Guardian's headline says it all: "Obama strike would not weaken Assad's military strength, experts warn." And Foreign Policy reports that one of the U.S. military planners who designed Syria strike blueprints "has serious misgivings" about the idea that bombing will improve anything. Even the president himself admits that "we cannot resolve the underlying conflict in Syria with our military."

Again, what is the goal? What is the objective.

Predicating military action exclusively on a chemical weapons "red line" doesn't only say to the world what the Obama administration suggests it does; more specifically, it doesn't just say that the use of such unconventional weapons is unacceptable. It also rather explicitly suggests that in the U.S. government's eyes, atrocities committed with regular old conventional weapons are fine, or at least not atrocious enough to warrant a military response. In other words, it seems to tell other dictators that as long as they kill and maim their own people with conventional armaments, they will remain on the acceptable side of the "red line" and therefore they don't risk a U.S. response.

Tuesday, September 03, 2013 - Welcome to September

Welcome to September

by Sinclair Noe

DOW + 23 = 14,833
SPX + 6 = 1639
NAS + 22 = 3612
10 YR YLD + .10 = 2.85%
OIL + .89 = 108.54
GOLD + 15.70 = 1413.20
SILV + .75 = 24.38

Well, we still haven't started the war, yet. Congressional leaders from both sides of the aisle lined up in support of military intervention. The Senate Foreign Relations Committee opened a hearing and grilled Secretaries Kerry and Hagel. Tomorrow, Kerry and Hagel are scheduled to appear before the House Foreign Affairs Committee. The debate is shifting away from “Did Assad use chemical weapons?” to “What should be done about it?”

Clarity of objectives seems to be a work in progress. Maybe all the talk will eventually consider the possible consequences of a military attack on Syria. Is it really possible to bomb a country and avoid deeper involvement? So far, the politicians are trying to work it out in a logical progression; if A, then B. That's not always how it happens in war. Logic gets thrown out the window.

At this time of crisis, it is worth remembering another time, 30 years ago in October, 1983 when US warships bombarded Lebanon, the country located next to Syria. Within weeks, the US Marine barracks in Beirut was blown up by a massive truck bomb that killed 241 American servicemen: 220 Marines, 18 sailors and three soldiers. The truck driver/suicide bomber was an Iranian national whose truck contained explosives that were the equivalent of 21,000 pounds of TNT. Two minutes later a second suicide bomber drove a truck filled with explosives into the French military compound in Beirut killing 58 French paratroopers. France is the only country standing with the Obama administration on a military strike on Syria, and they might put that support to a vote of parliament.

Mr. Obama has invited the Republican and Democratic leaders of the House and Senate defense, foreign affairs and intelligence committees to the White House this afternoon. Later, he'll fly to Russia for the previously scheduled G-20 economic summit, a forum that will put him across the table from Vladimir Putin of Russia.

August is finally behind us. No more excuses for the market. No more low-volume rallies and corrections. The Dow was red-hot at the beginning of the year. Its components were easily besting the broad market, delivering gains usually reserved for popular growth stocks. However, the summer was far from kind to the Dow. It began to slip in early July relative to the S&P 500. As of right now, the Dow has yet to find its footing. Even today's modest gains were well off session highs.

So, we head into September to the rhythm of the war drums. It promises to be an interesting month. If the major market indices can't catch a meaningful rally now, it is hard to imagine how the indices could sustain a meaningful rally later in the month. September has earned its reputation as the worst month of the year for the broader market, with the S&P down an average of 0.5% over the past 70 years. Not every year is negative; seven of the past ten years have seen positive September returns.

This Friday we get the monthly jobs report. Expectations are for a slight uptick from July's 162,000 headline result with no change to the unemployment rate from the prior reading of 7.4%. Remember good news is bad news for the markets, fearful of losing their spot at the trough of the Fed's easy money. This morning, the ISM report popped up to 55.7 as the manufacturing sector continued to expand for a third straight month; and the yield on the 10-year Treasuries popped to 2.88% In two weeks, the Fed FOMC will meet and consider slowing the flow of easy money, a cutback or taper of QE3. Toss in ongoing speculation about a replacement for Bernanke, and let the fireworks begin.

Congress will officially reconvene next Monday and they will be focused on the Syrian war, but don't forget the battles over taxes and spending, regulations and safety nets, and how to get the economy out of first gear. Which means more gridlock and continual showdowns over budget resolutions and the debt ceiling. They still haven't figured out exactly what is being cut as part of the sequester. Earlier this year, the House and the Senate passed spending bills for the 2014 fiscal year, which begins on Oct. 1, that were about $90 billion apart, but never settled on a final figure. Congress is expected to pass another stopgap bill, known as a continuing resolution, financing the government for a few more months, but it is unclear whether such funding will stay at current levels or shrink. This is actually important because if they fail to come to a deal before October, many parts of the federal government could shut down. Not a complete government shutdown, but death by a thousand cuts.

We're emerging from the depths of the worst downturn since the Great Depression but nothing fundamentally has changed. Corporate profits are up largely because payrolls are down. Cost cutting has limits, and we've started to see those limits in the revenue numbers from second quarter earnings reports. Businesses need customers, and the customers are holding tight to the purse.

While the debate rages over Syria, American workers have been taking to the streets to demand a bit more pay. So as Congress reconvenes and the battles resume, be clear about what's at stake. The only way back to a buoyant economy is through a productive system whose gains are more widely shared. One of the totally unanswered questions about Syrian military intervention is how we're going to pay for it. It's not cheap to park five destroyers in the Mediterranean; it's not cheap to lob a few hundred cruise missiles over the waves; it gets real expensive, real fast if anything goes slightly askew.

Where does the money come from? It won't be coming Detroit or San Bernardino. In July, Detroit filed for bankruptcy. Last week, San Bernardino filed for BK. Two of the biggest municipal bankruptcies in US history.

After kicking the can down the road, with increasing desperation, for many years, the end of the line has been reached. The city is finally admitting that far too many financial promises have been made, and that the majority of these simply cannot be kept. It does not matter whether the promise-holders have a good case for receiving services or needing payments, or even if they have legal protections. If the promises can be broken, they will.

Strange as it may seem, the bankruptcy filings don’t appear to have unnerved the $3.7 trillion municipal bond market. The momentum defies predictions that the muni market would go into a deep freeze following the Motor City’s financial collapse and Detroit Emergency Manager Kevyn Orr’s plan to impose losses on some bondholders. There’s not a lot of evidence to show this has been the death knell for GO [general obligation] bonds.

Everyone thinks it’s just Detroit, but Detroit is not unique. It’s the same in Chicago and New York and San Diego, San Jose, Stockton, and San Bernardino. It’s a lot of major cities in this country. They may not be as extreme as Detroit, but a lot of them face the same problems. Detroit is merely the first of many municipalities to hit the wall, where the realization dawns that far too many promises have been made, and nowhere near all of them can be kept. Different classes of stakeholders are still assuming that their claims will somehow be protected. They are typically thinking of those claims in isolation, without considering the implications for other groups whose rival claims would have to be subordinated. It has been clear for a long time that we would reach this crunch point

Investors in municipal bonds are typically looking for a dependable income, stable bond prices and shelter from taxes. They have generally come to regard these investments as risk-free, even as the obvious problems faced by municipalities have been mounting. The bankruptcy of three cities in California last year seems not to have been interpreted as the warning signs that they were, and so far, relatively speaking, neither does the bankruptcy of Detroit. This complacency is highly unlikely to last, however, as the extent of the inevitable losses in Detroit becomes clear. The clear risk is that bond prices will crash on spiking yield, and that this will precipitate a rush for the exits. A move in this direction has begun, and concern is rising, but as yet it remains a muted response.

Public pensions are also a major stumbling block; supposedly protected by Michigan state law; the law might not protect retirees. What and who will be protected by the law? Under both the Dodd-Frank Act and the 2005 Bankruptcy Act, derivative claims have super-priority over all other claims, secured and unsecured, insured and uninsured. In a major derivatives fiasco, derivative claimants could well grab all the collateral, leaving other claimants, public and private, holding the bag.

Welcome to September.