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Friday, April 11, 2014

Friday, April 11, 2014 - Corrupt or Incompetent, Take Your Pick

Financial Review with Sinclair Noe

DOW – 143 = 16,026
SPX – 17 = 1815
NAS – 54 = 3999
10 YR YLD - .01 = 2.62%
OIL - .07 = 103.33
GOLD + .30 = 1319.40
SILV - .07 = 20.06

The S&P 500 closed at its lowest level in two months. The gauge slipped 2.7% this week, the biggest loss since 2012. The Dow Industrial are down 2.4% for the week. The Nasdaq Composite Index dropped 1.3% today, capping its biggest two-day retreat since 2011; and down 3.1% for the week; closing at its lowest level in 4 months. The major US indices are all back in the red year to date. Biotechs fell for the 7th week in a row; the worst run since 1998; and now down 21% from recent highs. About 7.4 billion shares changed hands on US exchanges, 5.8% higher than the three-month average.

We are entering a period that has historically been very poor for stocks. The idea is called “Sell in May” or the worst six months. According to the Ned Davis (NDR) database, had you invested $10,000 in the S&P 500 every May 1st starting in 1950 and sold October 31 of the same year, your initial position would only be worth $10,026. Put another way, by investing only from May through October, a $10,000 stake invested in 1950 would have only made $26.

The Labor Department reports the producer price index, gained 0.5% for March. Excluding the volatile categories of food and energy, core PPI prices rose 0.6% after falling 0.2% in February. The University of Michigan/ Thomson Reuters consumer sentiment rose to a preliminary April reading of 82.6, the highest reading since July, from a final March level of 80.

You’ve probably heard about the Heartbleed bug.  Heartbleed is a flaw in OpenSSL, a piece of code intended to create a secure connection between a server and Web browser; for example, between an online shop and customer. The bug allows an attacker to make the server surrender bits of information out of its memory that should not be accessible. What's more, the exploit leaves no trace. The fear is that the bug may expose credit card numbers, passwords, and more.

By some estimates the Heartbleed bug puts two-thirds of all websites at risk. Millions of smartphones and tablets running Google’s Android operating system have the Heartbleed bug. The government has issued a warning to businesses and banks to be on alert for hackers possibly stealing data.

The Federal Financial Institutions Examination Council, made up of representatives from the Federal Reserve Board of Governors, the Consumer Financial Protection Bureau and other regulators, said: “The vulnerability could allow an attacker to potentially access a server’s private cryptographic keys compromising the security of the server and its users. Attackers could potentially impersonate bank services or users, steal login credentials, access sensitive e-mail, or gain access to internal networks.”

And there’s not a lot you, as a consumer, can do until the websites fix the problem on their end. It may take some time. The Heartbleed bug has been found in the hardware connecting homes and businesses to the Internet. Cisco Systems and Juniper Networks said some of their networking products are susceptible to the encryption bug. Security experts say it might help to change passwords on sites you visit, but fixing the network equipment and software means the companies will rely on customers applying patches as they become available. Cisco said it would tell customers when software patches for its affected products are available.
Now for the scary part.

Bloomberg News reports the National Security Agency has known about the Heartbleed bug for 2 years, and rather than report it, or take steps to close it down, the NSA instead regularly used the encryption flaw to gather intelligence. Putting the Heartbleed bug in its arsenal, the NSA was able to obtain passwords and other basic data that are the building blocks of sophisticated hacking operations. The agency found the Heartbleed glitch shortly after its introduction, according to one of the people familiar with the matter, and it became a basic part of the agency’s toolkit for stealing account passwords and other common tasks.

The revelations have created a clearer picture of the two roles, sometimes contradictory, played by the US’s largest spy agency. The NSA protects the computers of the government and critical industry from cyberattacks, while gathering troves of intelligence attacking the computers of others, including terrorist organizations, nuclear smugglers and other governments.

Questions remain about whether anyone other than the US government might have exploited the flaw before the public disclosure. Sophisticated intelligence agencies in other countries are one possibility. If criminals found the flaw before a fix was published this week, they could have scooped up millions of passwords for online bank accounts, e-commerce sites, and e-mail accounts across the world.

If the reports are true, they would represent a serious breach of the NSA's mission.  There’s no excuse for leaving Americans and businesses vulnerable to breaches on this scale. They should be helping to shore up vulnerabilities, not exploiting them. The NSA has issued a statement denying prior knowledge of the Heartbleed bug; which is not a reassuring denial. This is one of the biggest breaches in the history of the internet, and the NSA, which is supposed to watch this stuff, claims they know nothing. For now, the NSA is sticking to their story that they are incompetent rather than corrupt.

Earnings reporting season is gearing up, with an epic miss from the biggest US bank. JPMorgan Chase said its first-quarter earnings fell 20%, driven by a decline in investment banking and mortgage lending. The bank reported net income of $4.9 billion for the first quarter, after stripping out payments to preferred stockholders. That was down from $6.1 billion in the same period a year earlier. On a per-share basis, the earnings amounted to $1.28, missing estimates of $1.39. Revenue, after stripping out the effect of an accounting charge for credit losses, was $23.8 billion, down 8 percent from $25.8 billion a year earlier. Revenues at the bank's fixed income trading business, part of its investment banking unit, slumped 21% to $3.8 billion. Mortgage originations plunged 68% to $6.7 billion, compared with the same period last year; the bank doesn't expect the trend to change anytime soon.

Wells Fargo posted a profit of $5.9 billion, up 14% from the same period in 2013. Still, the bank’s revenue for the quarter fell to $20.6 billion from $21.3 billion in the same period a year ago.

A federal judge has approved the city of Detroit’s latest attempt to extricate itself from some long-term derivatives contracts that have been costing it tens of millions of dollars a year, holding up a settlement as an example of “the very spirit of negotiation and compromise” that he hoped other creditors would follow. Judge Steven Rhodes of United States Bankruptcy Court ruled that Detroit could proceed with a plan to pay $85 million to UBS and Bank of America to terminate the financial contracts, known as interest-rate swaps, that were used to help finance pensions.

Under the terms of the settlement, the two banks agreed to back Detroit’s overall plan of adjustment, which is critical for the city’s push to resolve its bankruptcy by early fall. Municipal bankruptcy rules say that if one class of impaired creditors votes to approve the city’s plan of debt adjustment, the judge may be able to impose the terms forcibly on everybody else. The judge’s decision gives Detroit leverage for settlements with other creditors.

Earlier this year, Judge Rhodes had rejected a previous attempt to end the swaps that called for Detroit to pay the banks $165 million. He called that proposal “just too much money” and noted that Detroit would have a reasonable chance of success if it sued the banks outright, calling the swaps invalid and refusing to make any termination payments at all. The message was to re-engage in negotiations, and apparently it worked.

Detroit’s emergency manager, Kevyn Orr, and other officials have been calling for creditors to negotiate settlements quickly out of fear that Detroit’s case will become a hopeless quagmire if creditors keep fighting the city’s proposals for resolving their debts. The state law that put Detroit under emergency management is scheduled to expire in September.

Detroit entered into the swap contracts in 2005, when it tapped the municipal bond market for $1.4 billion to put into its workers’ pension funds. Much of the deal was structured with variable-rate debt, and the swaps were intended to work as a hedge, to protect Detroit if interest rates rose. But rates fell, and under those circumstances, the terms of the swaps called for Detroit to make regular payments to UBS and Bank of America. The swaps cost Detroit about $36 million a year.

The 2005 borrowing also required an unusual structure to avoid violating the city’s legal debt limit. In 2009, the debt was downgraded to junk, putting the city out of compliance with the terms of the swaps. So Detroit restructured the swap obligations, offering the two banks the tax revenue that it received from local casinos as a backstop.

When Detroit declared bankruptcy last summer, it estimated the cost of terminating its swaps at about $345 million. Days before filing its bankruptcy petition, Detroit said Bank of America and UBS had given it a break, so that it would have to pay only about $250 million to cancel the contracts. But other creditors, facing bigger relative losses, complained that the two banks were still getting way too much. They argued, among other things, that the interest-rate swaps were invalid from the beginning because the use of casino taxes for financial hedges is not allowed under state law. So, Detroit either got off cheap at $85 billion or the banks just stole $85 billion.

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