Morning in Arizona

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Rainbows over Canyonlands - Dave Stoker

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Thursday, August 10, 2017

10 Years On

Financial Review

10 Years On

DOW – 36 = 22,048
SPX – 0.90 = 2474
NAS – 18 = 6352
RUT – 13 = 1396
10 Y – .04 = 22.4%
OIL + .52 = 49.69
GOLD + 16.20 = 1277.90

“Fire and fury, and, frankly, power the likes of which this world has never seen,” is not a phrase that resonates well on Wall Street. Following Trump’s remarks, North Korea said it was “carefully examining” plans for a missile attack on the US Pacific territory of Guam, which is home to a large US military base. U.S. Defense Secretary Jim Mattis told Pyongyang it should stop any actions that would lead to the “end of its regime and the destruction of its people.”

Investors scurried to safe haven assets today. At this point, the threats are just rhetoric, so there was no freak out. Global markets switched to risk-off mode, with gold, bonds and the yen all rising but world financial markets don’t seem to be worried about war breaking out on the Korean Peninsula any time soon.

Historically, financial markets haven’t exhibited any extraordinary volatility in response to provocations from North Korea. North Korea says crazy stuff and the country has a very long history of not delivering on its threats.

South Korea’s Kospi index fell 1.1% and its won currency fell 0.9% against the dollar. The South Korean stock market has year-to-date roughly tripled the performance of the US market, and is up more than 30% and that outperformance comes despite the geopolitical risks posed by North Korea.

Actual war or military action would be cause for alarm but right now, thankfully, it is just saber rattling. Secretary of State Tillerson says that “Americans should sleep well at night.” (At least until 3am, when the next Tweet drops.) We’ll see what tomorrow brings.

A handful of defense contractors trended higher with the saber-rattling. Shares of Raytheon, L3 Technologies, Lockheed Martin, Northrop Grumman, and General Dynamics, all rose more than 1%.

Retailer Office Depot plummeted nearly 26% after it posted a quarterly profit that missed expectations.

The FBI searched a home belonging to Paul Manafort, President Donald Trump’s former campaign chairman, as part of the federal probe into Russian meddling in the 2016 election. The raid took place at Manafort’s residence in Alexandria, Virginia, on July 26, according to a person familiar with the details of the search.

Investigators collected some material during the search that they then took with them. FBI agents are working with a team of prosecutors led by special counsel Robert Mueller. The Trump campaign last week turned over about 20,000 pages of documents to the Senate Judiciary Committee, which is conducting its own Russia probe. Manafort provided about 400 pages on Aug. 2, including his foreign-advocacy filing.

Productivity grew more than expected in the second quarter as hours worked rose at their fastest pace in 1-1/2 years, leading to a modest increase in labor costs. The trend in productivity, however, remains weak, suggesting robust economic growth will be hard to achieve.

The Labor Department said nonfarm productivity, which measures hourly output per worker, rose at a 0.9 percent annualized rate in the April-June period. First-quarter productivity was revised to show it edging up at a 0.1 percent pace instead of being unchanged as previously reported.

With productivity rising, unit labor costs, the price of labor per single unit of output, increased at only a 0.6 percent pace in the second quarter after jumping at a 5.4 percent rate in the January-March period.

Productivity increased at an average annual rate of 1.2 percent from 2007 to 2016, below its long-term rate of 2.1 percent from 1947 to 2016, indicating the economy’s potential growth rate has declined.

To get back to 3 percent real GDP growth with the demographics the US is facing, productivity growth will have to exceed its long-run average growth rate of 2.1 percent – don’t hold your breath.

U.S. credit card processing company Vantiv secured a deal to buy British-based rival Worldpay for $10.4 billion. Although Vantiv’s deal was first announced on July 5, it has taken several weeks to conclude, with the deadline for a formal offer extended twice.

Goldman Sachs is acknowledging that it’s getting harder for institutional investors to ignore the Bitcoin market, which has ballooned to about $120 billion. The debate has shifted from its legitimacy to how fast new entrants are raising funds.

Do a lot of investors use digital currencies like bitcoin? Are those digital currencies a big part of a lot of investors’ portfolios? Are those digital currencies a threat to financial institutions in any way, or a potential ally?

To find out, Fidelity Labs — the R&D arm of Boston-based Fidelity Investments — is starting a test to let its customers see their digital currency holdings on, like any other security in their portfolio’s summary view. Fidelity is partnering with Coinbase, a digital wallet and asset-exchange platform.

Customers can give Coinbase permission to share data about their holdings in Coinbase wallet accounts with Fidelity. Customers can then view their bitcoin, Ethereum and Litecoin balances like any other information in their Fidelity accounts. Bitcoin is a digital currency. It operates through its own blockchain, the shared, tamper-resistant record-keeping technology that can also be used to verify other transactions.

Fidelity has a stake in the emerging technology. The organization has venture investments in organizations performing blockchain research, including TradeBlock and Axoni. And while the blockchain technology behind bitcoin might have value, the actual bitcoins have no inherent value, just what the market is willing to pay. What could go wrong?

Today marks the 10-year anniversary of the financial crisis. On Aug. 9, 2007, BNP Paribas froze three of its investment funds—barring investors from withdrawing billions of euros—because of a lack of liquidity in the US markets. At that time, the French bank was the third-largest in the world by assets. BNP had invested in mortgage backed securities and 10 years ago today, they could not figure out valuations, and when that happens it means the investments are worthless.

For a bank that size to admit that it simply had no idea what some of its US property assets were worth rattled the markets. Many now consider this the unofficial start of the global financial crisis, which led to millions of job losses and trillions of dollars spent to bail out banks around the world.

At the time, banks really didn’t know what was hitting them. There were earlier warning signs. In June of 2007 Bear Stearns, a venerable Wall Street bank, had to stop customers withdrawing money from two of its investment funds.

The funds had specialized in the financial products that had been created on the back of those sub-prime mortgages. These products were, in theory, designed to spread risk; individual loans were packaged up into new types of securities called collateralized debt obligations, or CDOs.

These packages contained a mix of loans; the plan was that because it was highly unlikely that all the loans would fail, they were safer. But Wall Street built a financial pyramid on top of them, creating new derivative trades that piled risk and leverage on top of the basic lending.

When a few of the loans started to go wrong, the panic spread. Bear Stearns found, suddenly, that it could not find a buyer for any of its investment funds; at that moment, they were worthless. The crisis peaked with the demise of Lehman Brothers, another Wall Street bank that, like Bear Stearns, had piled aggressively into various derivatives that bet on other derivatives, with no inherent value.

Credit became unavailable throughout the economy. A full-blown systemic banking crisis was at hand, the root of which was a lack of trust. Banks would not lend to each other. Knowing all too well the dodgy assets on their own books, they feared they would not be repaid. Countrywide Financial and numerous other lenders could no longer obtain financing starting in 2007. Housing values came racing down, and stock prices followed their precipitous descent.

One of the most remarkable commentaries—in retrospect—about the burgeoning crisis came from Bear Stearns chief economist David Malpass, writing for the Wall Street Journal  on Aug. 7, 2007, days before the BNP fund freeze. “Don’t Panic About the Credit Market,” read the op-ed’s headline.

Malpass wrote: “Housing and debt markets are not that big a part of the U.S. economy, or of job creation. It’s more likely the economy is sturdy and will grow solidly in coming months, and perhaps years.”

Last week, Malpass was confirmed by the US senate to serve as Undersecretary for International Affairs at the Treasury Department.

10 years ago, the four biggest banks in the world were Royal Bank of Scotland, Deutsche Bank, BNP and UBS. Today, the 4 biggest banks in the world are all in China. The Royal Bank of Scotland and Deutsche Bank, the first- and second-ranked global banks (by assets) at the end of 2007, are still paying the price for their involvement in the selling of dodgy US mortgages and many other misdeeds.

RBS, which was bailed out by the UK government and is still majority owned by British taxpayers, expects to make it a full 10 years before it returns to making annual profits. It is now the 24th largest bank in the world. Meanwhile, Deutsche Bank’s share price has fallen by 80% over the past decade.

The US government pumped money into its banking system to recapitalize shaky lenders during the depths of the crisis, and strict new regulations to make the system safer were introduced faster than in Europe. If US banks were “too big to fail” back then, they are even more so now.

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