Financial Review

10 Years On

Sinclair Noe — August 9, 2017

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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 Fidelity.com, 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.

Financial Review

Wisdom of Solomon

Sinclair Noe — June 15, 2015

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DOW – 107 = 17,791
SPX – 9 = 2084
NAS – 21 = 5029
10 YR YLD – .03 = 2.36%
OIL – .44 = 59.52
GOLD + 4.90 = 1187.20
SILV + .12 = 16.17

Debt discussions between Greece and its European creditors collapsed last night; talks broke down after just 45 minutes. It is believed that Greece has until the eurogroup meeting on Thursday to agree on a deal or the risk of default grows enormously. It takes time for any deal to pass through parliaments and therefore any deal beyond 18 June meeting may delay payments being made to Greece to beyond the end of the month.

The other key event this week is the Fed FOMC meeting and while few people now anticipate a rate hike at Wednesday’s meeting, there could be hints that it will come in September which could spark further volatility in the markets. Despite a slow start to the year, the data is improving and we’re now seeing rising wages and spending which is necessary if inflation is going to reach the Fed’s target within the forecasting period. This month’s decision will also be accompanied by a press conference with Chair Janet Yellen; if nothing else, that means Yellen has a good opportunity to float some trial balloons.

The reality is that growth has been tepid despite unprecedented monetary easing and years of Zero Interest Rate Policy. There has been progress in the labor market; the economy adds jobs but wage growth has been stagnant and the labor participation rate has been near historic lows. There are certainly reasons for the Fed to remain cautious but there are also many policymakers desperate to raise rates because they are afraid of another financial bubble; and bubbles always pop eventually, and they want to make sure they can respond; which is difficult with rates near zero.

So far this year, bonds, commodities, and emerging markets have seen increasing volatility even as the major US stock indices have been trading in a very tight range. Something has to give; money either positions for further gains in US stocks or money moves out of stocks, either to the sidelines or to some other areas of the market. We should get some further ideas on where the money is going following the Fed’s meeting on Wednesday.

Industrial output sank 0.2% in May. Compared to 12 months ago, industrial production was up 1.4%, compared to 4.8% growth as recently as November. Since November it has been all downhill. The six-month drop in output, adjusted for inflation, puts the sector in a technical recession.

Saudi Arabia’s $560 billion stock market opened to foreigners today, giving international investors direct access to the Middle East’s largest economy for the first time. Some restrictions on trading will still apply: Foreign investors must have a minimum of $5 billion in assets under management, at least five years of trading experience, and will only be able to own 49% of a single stock.

Remember the Umbrella Revolution? Hong Kong is gearing up for a vote this week on a contentious electoral reform package backed by Beijing, with a weekend poll showing public support has shifted against the proposal. Police are not taking any chances this time around, setting up patrols and barriers, following the sometimes violent clashes during demonstrations last year against the package. More than 100,000 people took to the streets during the height of the protests, bringing key areas of the city to a standstill and taking a heavy toll on GDP.

Stocks with primary listings in China are now valued at just over $10 trillion, an increase of $6.7 trillion in the past 12 months. Many consider the heavy expansion as worrisome. No other stock market has grown as much in dollar terms over a 12-month period; valuations are now their greatest in five years and margin debt has climbed to record highs, all while the economy is mired in its weakest expansion since 1990. Putting it into perspective: The size of Japan’s stock market is $5 trillion. The U.S. market is valued at almost $25 trillion.

Homebuilders are feeling more confident about their sales prospects than they have since last fall, while their outlook for sales over the next six months is at the highest level in 10 years. The National Association of Home Builders/Wells Fargo builder sentiment index climbed to 59 this month, up five points from 54 in May.

California-based homebuilders Standard Pacific and Ryland Group have announced plans to merge, creating the fourth-largest U.S. home builder with a market cap of $5.2 billion. Upon closing of the deal, Standard Pacific stockholders will own about 59% of the combined company.

Cox Automotive announced it would buy Dealertrack Technologies for $4 billion in cash. Dealertrack provides web-based software and services to the automotive industry, including dealers, lenders and vehicle manufacturers. Its products include the industry’s largest online credit application network. Cox Automotive provides digital marketing and software for consumers, auto dealers and manufacturers. Its properties include Autotrader.com and Kelley Blue Book.

The Hudson’s Bay Company, the Canadian owner of Saks Fifth Avenue and Lord & Taylor, has agreed to acquire the Galeria Kaufhof department store chain in Germany and its Belgian subsidiary from the Metro Group for $3.2 billion, including debt.

CVS Health will pay $1.9 billion to buy Target’s pharmacies and clinics, expanding its reach by adding stores bearing its name inside the Target stores. CVS, which already has 7,800 drugstores, will acquire Target’s more than 1,660 pharmacies across 47 states, renaming them as CVS/pharmacy.

Putting a timeline on its helicopter exit, United Technologies has announced it will decide on spinning off or selling its Sikorsky Aircraft business by the end of the third quarter.

The Paris Air Show is underway. Boeing and Airbus are poised to win at least 220 orders, with a value of $23 billion, for competing narrow-body jets. Last week, Boeing raised its 20-year outlook by about 1,000 jet deliveries to 38,000 planes valued at $5.6 trillion.

North America’s largest video game trade show, the Electronic Entertainment Expo, opens a three-day run at the Los Angeles Convention Center on Tuesday, and you can go. E3, as it’s known, typically attracts more than 40,000 industry-only attendees. For the first time, the event is opening the show to 5,000 members of the public. The gaming industry pulled down about $11 billion in 2011; this year it will be closer to about $120 billion; which means that video games are bigger than Hollywood and the music industry. And gaming is about to get much bigger with 3-D virtual reality headsets making a big buzz this year.

The record $9 billion fine levied against BNP Paribas is presenting US authorities with novel legal questions, after morphing into a fight over whether terrorism victims should get any of the money. BNP pleaded guilty to violating sanctions in June 2014 by funneling billions of dollars through the US financial system for clients in Sudan, Iran and Cuba. Now, a group of terrorism victims is asking the DOJ to compensate them with funds from the BNP settlement, attempting to draw a connection between the French bank’s misconduct and terrorist acts overseas.

Back in 2008 the government provided bailout money to several faltering financial institutions, including the trading unit of AIG. The government demanded a 79.9% equity stake in the financial-services conglomerate in exchange for providing an $85 billion loan at an initial 14.5% interest rate. At the time, U.S. officials said the government acted because AIG was so entangled with other firms around the world that they feared its collapse would be catastrophic to the global financial system. Hank Greenberg, the former AIG chief felt the terms of the bailout were unfair and a bit harsh. He sued. At the center of the case is a dispute about the breadth of the Federal Reserve’s powers, and the limits on its discretion. Today a federal judge issued a ruling saying that AIG was treated unfairly and the government exceeded its authority. And then, with the Wisdom of Solomon, the judge decided that Greenberg would not get any money, because he is just such an ungrateful cuss.

U.S. authorities are also examining payments made by Nike under a 1996 soccer sponsorship with Brazil for possible evidence of wrongdoing by the company or others. Nike has not yet been formally named or charged with any wrongdoing, but allegations of corruption around its $160 million deal are discussed in the Justice Department’s 161-page indictment of FIFA officials.

At some time or another, you’ve probably been to a drive-in teller at the bank and used one of those cylindrical canisters to make a transaction; you put your things in the canister, put the canister in a tube, and it is whisked away with air pressure to the teller. Yea, you don’t see those much anymore, probably because the canisters could become jammed, especially if someone put a bunch of coins in it, which would weigh it down. Anyway, Elon Musk thinks those things are way cool. Elon Musk is the guy behind Tesla electric cars and Space X, the private rocket company. He’s proposing building a big version, he calls it a Hyperloop, and he thinks this might be a way to transport people from city to city.

In a nutshell, Hyperloop involves blasting pods down pressurized tubes at extremely high speeds. In the most popular example given, the transportation would get you from San Francisco to Los Angeles in 30 minutes. Musk has said that he’s not going to build the Hyperloop himself, but has expressed interest in helping the technology along. Most recently he said that he would fund the construction of a test track to illustrate the technology. And today, Musk announced Space X will build a test track near Hawthorne California and he also announced a competition for someone to design a Hyperloop pod. We don’t know what you win, but good luck.

Monday, May 19, 2014 - Still Too Big to Jail

Financial Review with Sinclair Noe

DOW + 20 = 16511
SPX + 7 = 1885
NAS + 35 = 4125
10 YR YLD + .02 = 2.54%
OIL + .58 = 102.16
GOLD - .10 = 1293.60
SILV - .01 = 19.44

Merger Mania Monday. Late yesterday, AT&T announced an offer to buy DirecTV for $48 billion, or $95 per share. The combined AT&T-DirecTV would serve 26 million customers; that would make it the second-largest pay TV operator behind a combined Comcast-Time Warner Cable, which would serve 30 million under a $45 billion merger proposed in February. The Comcast deal still faces regulatory hurdles.

AT&T and DirecTV promised consumer benefits like more economical bundles that tie mobile phone, pay TV and Internet service together on a single bill. The deal could face regulatory scrutiny from the Federal Communications Commission and Department of Justice. Unlike the cable company tie-up, the AT&T-DirecTV merger would effectively cut the number of video providers from four to three for about 25% of US households. That's a situation that could result in higher prices for consumers and usually gives regulators cause for concern.

The value that DirecTV offers that no other national TV provider offers is a special deal for football fans; for $240 to $330 you can buy a special package that gets you all the NFL football games, including your hometown favorite no matter where you live. That’s why DirecTV paid an estimated $4 billion to the NFL for the latest Sunday Ticket contract; that deal expires at the end of the upcoming NFL season. If the Sunday Ticket arrangement were not to be extended, AT&T would reportedly have a legal out, according to terms of the takeover.

Part of the value of DirecTV is what it isn’t. DirecTV does not offer fixed-line or mobile Internet service, and its rights to airwave frequencies for satellite TV are not the kind that AT&T can use to improve its mobile phone network. If AT&T can convert DirecTV’s customers into high-speed Internet subscribers, they could have 25% of all pay TV subscribers and then two companies would control 55% to 60% of all Internet subscriptions in the US.

The board of AstraZeneca has rejected the improved, and apparently final $119 billion takeover offer from US drugmaker Pfizer. Pfizer, which is the world's second-biggest drugmaker by revenue, has been courting No. 8 AstraZeneca since January. Yesterday, Pfizer raised the offer 15% to $119 billion; that would be the richest acquisition ever among drugmakers and the third-biggest in any industry. AstraZeneca didn't take long to reject the new offer, its board arguing Pfizer is making "an opportunistic attempt to acquire a transformed AstraZeneca, without reflecting the value of its exciting pipeline" of experimental drugs.

Pfizer's offer comes amid a surge of other deals among drugmakers. Those deals include Switzerland's Novartis agreeing to buy GlaxoSmithKline's cancer-drug business for up to $16 billion, to sell most of its vaccines business to GSK for $7.1 billion, plus royalties, and to sell its animal health division to Eli Lilly for about $5.4 billion. Canada's Valeant Pharmaceuticals has also made an unsolicited offer of nearly $46 billion for Botox maker Allergan, which has turned it down, so far.

Law enforcement agents have arrested more than 90 hackers accused of infecting more than half-a-million computers worldwide with malicious snooping software. The suspects were charged with developing, selling and marketing a remote access tool, or “RAT,” that allowed users to infiltrate computers, view files and steal personal data from unwitting victims. Talk about creepy; the malware could even take over your webcam and take pictures and videos of you. The original creator of the software, who founded an organization called “Blackshades,” was arrested in June 2012, but investigators said an international ring of hackers continued to sell and disseminate the software after his arrest, reaching thousands of people in more than 100 countries; 19 countries participated in the arrests, and more than 300 searches had been conducted in what law enforcers described as one of the largest cybersecurity operations in history.

The United States charged five Chinese government officials with allegedly orchestrating cyber-attacks against six major American companies. It marks the first time the US has formally charged foreign government officials for explicitly acting at the behest of a foreign government in cyber-crimes. The companies targeted by hackers were Alcoa, Westinghouse, Allegheny Technologies, US Steel, United Steelworkers Union, and Solar World.

Attorney General Eric Holder said: “In some cases, they stole trade secrets that would have been particularly beneficial to Chinese companies at the time they were stolen. In others, they stole sensitive, internal communications that would provide a competitor, or adversary in litigation, with insight into the strategy and vulnerabilities of the American entity. In sum, the alleged hacking appears to have been conducted for no reason other than to advantage state-owned companies and other interests in China, at the expense of businesses here in the United States.”

The Justice Department has criminally charged Credit Suisse AG and two of its units with conspiring to willfully help Americans evade taxes. A Virginia federal court filing accuses Credit Suisse of conspiring to in part "advise the preparation and presentation of false income tax returns and other documents to the Internal Revenue Service.'' The four-page criminal information charges the bank with "assisting clients in using sham entities'' as the purported owners of secret offshore accounts and "soliciting IRS forms that falsely stated under penalties of perjury that the sham entities … owned the assets in the accounts.''

The criminal case follows a Senate subcommittee investigation that found the bank provided accounts in Switzerland for more than 22,000 US clients totaling $10 billion to $12 billion. The report said Credit Suisse sent Swiss bankers to recruit American clients at golf tournaments and other events, encouraged US customers to travel to Switzerland and actively helped them hide their assets.

Credit Suisse has apparently agreed as part of a settlement to plead to one count of conspiring to aid tax evasion. It would mark the first time in more than 20 years that a major bank has plead guilty to criminal wrongdoing. But make no mistake, this was a negotiated guilty plea that does not bear the consequences of criminal guilt. Credit Suisse will pay about $2.6 billion in penalties and hire an independent monitor for up to two years, which sounds exactly like a civil penalty. Recognizing that criminal charges could prompt regulators to revoke a bank’s license to operate, the corporate equivalent of the death penalty, prosecutors met with regulators to discuss punishing Credit Suisse without putting it out of business and imperiling the economy. The biggest challenge facing Credit Suisse could be that some of its own clients, such as pension funds, have internal requirements that prohibit them from doing business with an entity that has pleaded guilty to a crime.

Otherwise, this amounts to another slap on the wrist. The CEO and Chairman keep their positions. Credit Suisse will admit to a statement of facts that shows the U.S. tax evasion was widely fostered by the bank, the people said. The firm won’t have to disclose the names of US account holders under terms of the agreement.

The Credit Suisse plea won’t be the last. BNP Paribas is expected to plead guilty in coming weeks to doing business with countries like Sudan and Iran that the United States has blacklisted; BNP is also expected to pay more than $5 billion in fines. And eventually, we could see criminal charges brought against American banks such as JPMorgan and Citigroup, which are the subjects of criminal investigations, but those inquiries are at an earlier stage and it is unclear whether they would result in criminal charges. The Justice Department's highest-profile settlement over sales of risky mortgage securities in the run-up to the financial crisis — the $13 billion deal among the department, state regulators and JPMorgan Chase — was a civil case, and no bank executives were charged. Federal prosecutors in California have been conducting a related criminal investigation.

So for now we have a new strategy for controlling the illegality of the big banks: charge them with criminal activity and punish them with civil penalties. So what we have, in the end, seems to be a version of the anemic civil settlements and deferred-prosecution agreements that banks always get when they commit crimes. As usual, it is little more than the cost of doing business. Eric Holder can say that no bank is too big to jail, but then he folds like a tortilla when it comes to pursuing criminal charges that actually carry criminal penalties. For now, the government's message to banks remains the same: Go ahead and break the law. If worse comes to worst, your low-level bankers will take the fall, and your shareholders will pick up the tab.

Monday, May 12, 2014 - More Milk and Cookies

Financial Review with Sinclair Noe

DOW + 112 = 16,695
SPX + 18 = 1896
NAS + 71 = 4143
10 YR YLD + .03 = 2.65%
OIL + .63 – 100.62
GOLD + 5.60 = 1296.70
SILV + .35 = 19.60

Record highs for both the Dow and the S&P 500. We celebrate when the Dow hits a record high; there is no specific celebration for the S&P, which doesn’t really make sense. We have a party with milk and cookies. Today we have some lemon zest cookies and I think they have poppy seed sprinkles, which means we would all fail a drug test for the next few days.

The latest thing to worry about is the market divergence. The Dow hit record highs but the Russell 2000 index of small and midcap stocks closed below its 200 day moving average last week. The idea is that small caps will drag down the blue chips, or maybe the blue chips will lift up the small caps, but one way or another, something has got to give. Another consideration is the number of NYSE stocks making new highs minus the number of NYSE stocks making new lows continues to look mediocre at best even as the Dow and S&P make all-time highs. You don't typically want to see large caps struggling at recent highs with less underlying participation by individual stocks because narrowing of participation at highs is how tops are formed. You also don't typically want to see new all-time highs for the S&P while the more economically sensitive small caps are in a correction. These things can resolve in either direction, but the historical bias is toward a resolution to the downside.

The basic truth is that not all stocks are hitting record highs. That’s not how it works; there are winners and losers, even in a bull market, even in a bear market. The other reality is that we don’t make record highs forever, 2013 being the exception to the rule. At some point this market will roll-over, we don’t know exactly when, but rather than sticking our head in the sand, we remain vigilant.

Yesterday was Election Day in Ukraine. A preliminary count from eastern Ukraine showed 89% of voters in the Donetsk region and 97% in neighboring Luhansk voted for greater autonomy; which is to say they are voting to split from Ukraine and be more closely associated with Russia. The Russian government did not even say that it recognized the results of the voting, which the authorities in Kiev and their Western supporters all declared illegal from the start. The Kremlin issued a statement saying only that it “respects the will of the population of the Donetsk and Luhansk regions,” and that the crisis should be resolved through dialogue.

As part of that dialogue, Gazprom, the gas company controlled by the Russian government, announced it would send Ukraine an advance bill for natural gas deliveries in June. So the dialogue is “pay up or no gas.” The Euro Union is slowly tightening economic sanctions on Russia, but slowly, hoping they don’t have to face Gazprom turning off the spigot on supplies to the continent. This entire conflict could turn ugly fast, but each day that goes on without a meltdown is a good day for the markets.

Meanwhile, the Department of Justice is reportedly getting closer to actually enforcing the law, at least with respect towards a big bank. There are signs and last minute meetings that point toward possible criminal charges against two large European banks. No giant bank has been found guilty of criminal charges in the US for at least 20 years. Lawyers for BNP Paribas and Credit Suisse have been meeting with prosecutors to try and wrangle a deal for leniency. BNP is suspected of doing business with countries like Sudan and Iran that were on a US sanctions blacklist; Credit Suisse is suspected of offering tax shelters to wealthy Americans.

There have been criminal charges against subsidiaries of big banks, but the parent companies have been spared. Credit Suisse recently set up a subsidiary to house their US offshore business; the idea being that they could create a subsidiary to serve as a sacrificial lamb. Word is that US prosecutors are unwilling to criminally charge the newly formed unit.

Criminal charges could prompt regulators to revoke a bank’s license to operate, the corporate equivalent of the death penalty. When HSBC faced criminal charges a couple of years ago, the bank set up a subsidiary in Asia to take the fall. That deal was apparently accepted because the Justice Department is afraid of a criminal charge of the parent company could wreak havoc on the broader economy, far beyond the boundaries of France or Switzerland. The BNP and Credit Suisse investigations could lay the groundwork for actions against American banks as well. We may see how this strategy develops within the week.

There were no significant economic reports today, there was a fairly important weather report from NASA and some scientists at the University of California – Irvine. They say that glaciers and ices shelves along the western part of Antarctica are melting, and as they melt they’re releasing roughly the equivalent of the entire Greenland ice sheet into the ocean every year; enough ice to raise the world’s sea level by about 4 feet, which means my dream of owning oceanfront property in Arizona is alive and well. Eventually, they say the oceans will rise by about 14 feet, but that’s a long way down the road. The scientists say the melting process has passed the point of no return.

Now, why do we talk about it here on the Financial Review? Because it is changing the financial landscape. John Nelson, the chairman of Lloyd’s of London has posted an article in the Guardian explaining how climate change is changing the insurance industry’s catastrophe modeling. “According to the World Bank, weather-related losses and damage have risen from an annual average of about $50bn in the 1980s to close to $200bn. Lloyd's knows this all too well, the damage wrought on the US by the hurricanes Katrina, Rita and Wilma in 2005 and Superstorm Sandy in 2012 to name but a few all brought significant claims to the insurance market.”

And so, Lloyd’s is changing models to account for climate change, by building in forward projections, not just historical data. This will likely lead to changes in insurance pricing, and in this way, we will all be affected, but it doesn’t stop there. This means changes in environmental policy of course, and also housing and land use policy. And this is not just about insurance companies trying to jack your rates. “Ultimately, insurance exists to pick up the pieces and pay the claims” when extreme weather hits, but there may also come a time when insurance companies stop paying claims, and deem certain areas uninsurable, which is the equivalent of a financial death sentence. And that’s just the start; wait until the Environmental Protection Agency announces rules intended to slow the pace of climate change.

And what happens when the EPA moves on to regulation of greenhouse gas emissions? And it won’t be long before you start hearing more about cap and trade; and I predict that in the not so distant future we’ll all be familiar with the R.E.C. market, which is almost non-existent today. You don’t know about REC now, but you will.

Flood insurance will disappear for some areas, drought and crop insurance will vanish in other areas. And even if you live on a hill, it doesn’t mean you escape consequences, because this will also require massive investment in infrastructure; above and beyond updating outdated bridges. And this will eventually result in a complete revamp of our power structure. The days of coal fired power plants and flaring off natural gas in the oil fields are coming to an end just as surely as the days of whale oil lanterns passed into the darkness of history. And because necessity is the mother of invention, these are when we need, and I believe we will find imaginative and innovative solutions.

Thursday, May 01, 2014 - If the Cops Never Arrest the Killer, Nobody Really Died

Financial Review with Sinclair Noe

DOW – 21 = 16,558
SPX – 0.27 = 1883
NAS + 12 = 4127
10 YR YLD - .04 = 2.60%
OIL - .39 = 99.35
GOLD – 6.40 = 1285.90
SILV - .13 = 19.12

No record high for the Dow today. The Industrial Average was up and down, up and down throughout the day, but couldn’t hold positive territory. Today’s economic reports showed consumer spending increased, as did manufacturing activity, and unemployment claims.

Consumer spending increased 0.9 percent in March after rising by 0.5 percent in February, the largest gain in more than 4-1/2 years. The top 6 automakers backed up the spending report by reporting year over year gains in sales. The spending report supports the notion that cold weather just paused consumer activity and there is pent up demand that will lead to more economic activity in the second quarter. Income increased 0.5 percent in March, the biggest gain since last summer, but with spending outpacing income growth, the saving rate, which is the percentage of disposable income households are socking away, hit a 14-month low.

The Institute for Supply Management said its manufacturing index of national factory activity rose to 54.9 last month, up from 53.7 in March. A reading above 50 indicates expansion in the nation's factories. Manufacturing activity has now accelerated for 3 consecutive months and last month's gains were driven by a pickup in employment, export orders and inventories; although new orders were unchanged.

The Labor Department reports initial claims for state unemployment benefits increased 14,000 to a seasonally adjusted 344,000. Tomorrow morning we’ll get the monthly nonfarm payrolls report; look for 210,000 net new jobs in April and the unemployment rate to dip to 6.6%. That wouldn’t be enough to lift the labor market out of the doldrums but it would be another small step in the right direction.

A couple of news articles caught my attention, one from the Murdoch Street Journal and the other from the NY Times. You are forgiven if you missed them; they deal with banksters, and fraud, and regulators who look the other way, hoping for a post-government job with a golden parachute, and prosecutors without spines.

The Journal story deals with the Swiss units of Goldman Sachs and Morgan Stanley, and how they’ve agreed to hand over potentially incriminating details about how they helped Americans evade taxes; in return the banks won’t face prosecution.  Goldman's Swiss private bank had about $12 billion in assets under supervision as of the end of last year. Morgan Stanley's Swiss private bank had $50.7 billion in assets under management as of last year. The other big US banks likely did the same things, but they haven’t worked out a deal just yet.

Goldman and Morgan Stanley figured out the playbook, and it appears to go something like this: Senior officers of the banks aid and abet tax fraud by wealthy American clients, fail to make legally required criminal referrals, fail to comply with subpoenas, and then demand immunity from prosecution. Department of Justice prosecutors pee their pants and cave in to a slap on the wrist deal. No senior banker or bank was prosecuted. No banker was sued civilly by the government. No banker had to pay back his bonus that he “earned” through fraud. And the tax cheats that they aided and abetted have plenty of time to cover their tracks and might get away scot free, because the banksters aren’t required to turn over the client lists.

Then I read a New York Times story that claims federal prosecutors are getting close to criminal charges against at least a couple of major banks: Credit Suisse, for offering tax shelters to Americans, and BNP Paribas for doing business with countries like Sudan and Iran that the US has placed under sanctions. Prosecutors in New York and Washington have apparently held talks with BNP about a guilty plea from the bank’s parent company. Ben Lawsky, New York’s top regulator reportedly plans to impose steep penalties against BNP and its employees but would not revoke the bank’s license. Prosecutors have secured similar assurances from the New York Fed.

The discussions between regulators and prosecutors and lawyers was obtained under the Freedom of Information Act, and they demonstrate that defense lawyers were pushing prosecutors not to act without assurances that regulators will keep a bank in business. The question of culpability seems fairly straightforward; BNP conducted its own internal investigation that identified significant volume of transactions that could be considered impermissible under sanctions in place between 2002 and 2009, including improperly routing money through its New York branches.

There doesn’t seem to be a big concern at BNP about the possibility of criminal convictions that might result in loss of the bank’s charter, much less worry over executives facing jail time. It’s as if the criminal acts were performed by ghosts or phantasms.  BNP has set aside $1.1 billion in legal reserves; they expect a fine; it’s the cost of doing business.

Of course this is nothing new; two years ago, HSBC escaped criminal charges for violating economic sanctions and what appeared to be clear cut money laundering. JPMorgan recently paid a $2 billion dollar fine for its role in assisting Bernie Madoff’s Ponzi scheme, without having to admit guilt. Of course no one goes to jail. Almost no one. In January, Kareem Serageldin, a mid-to-upper level executive for Credit Suisse (not a CEO or CFO) was sentenced to 30 months in prison for concealing hundreds of millions in losses in the bank’s mortgage backed securities portfolio. Why this guy ended up going to prison and not somebody from Lehman, Bear Stearns, AIG, Countrywide, Bank of America, Merrill Lynch, Citigroup, HSBC – go figure; there is no rhyme or reason beyond the notion that regulators and prosecutors are simpering little cowards.

It didn’t used to be this way. After the crash of 1929, the Pecora Hearings seized upon public outrage, and the head of the New York Stock Exchange landed in prison. When FDR took office he immediately announced a banking holiday and the bankers snapped to attention. After the savings-and-loan scandals of the 1980s, 1,100 people were prosecuted, including top executives at many of the largest failed banks and S&Ls. In the late 90s and the turn of the century, when the tech bubble burst and revealed widespread corporate accounting scandals, top executives from WorldCom, Enron, Qwest and Tyco, among others, went to prison. And the accounting firm of Arthur Andersen was criminally convicted for its complicity in the fraudulent steaming scam that was Enron; Andersen went out of business in 2002; delivering pink slips to many good and decent accountants along with the pond scum. Since then prosecutors have walked lightly for fear of collateral damage.

Since then, the bankers realized they could act with impunity, and they have. There has been no crackdown following the meltdown of 2008. From 2004 to 2012, the Justice Department reached 242 deferred and nonprosecution agreements with corporations, compared with 26 in the previous 12 years. The idea behind a deferred prosecution agreement, or DPA, is that the banksters stop doing the illegal stuff and if they do any other illegal stuff, the deal is off the table, and prosecutors can come down with full weight for past and current wrongdoing. Instead, there is no follow-up. It’s like a criminal is released on parole, violates parole, violates parole again, and again, and again; and the courts turn a blind eye.

So, now, with the BNP and Credit Suisse cases, the prosecutors goal seems to be criminal prosecution without making the banks actually suffer the consequences of criminal charges. Prosecutors consider them test cases; BNP and Credit Suisse aren’t the biggest banks; prosecutors aren’t sure what would happen with criminal charges; they don’t really know what to expect if they actually get a criminal guilty plea. If they start small, it might mean the end of the BNP tennis tournament or it might mean 200-thousand pink slips for bank employees, or it might be the spark that ignites a financial panic. They overlook the slow, insidious, systemic rot of the foundations of all global financial transactions – trust. In the long run, that seems far more dangerous.

Attorney General Eric Holder has testified before the Senate “that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if we do prosecute, if we do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy.”

The bank lawyers play on this fear; they claim bank clients -- including trustees, fiduciaries and pension funds -- could be forced to cut ties with a financial institution labeled a criminal enterprise.  Counterparties also might think twice before entering into billion-dollar transactions with such firms. Damaging a bank’s business could lead to broader fallout across the financial industry, just as Lehman’s collapse in 2008 prompted investors to withdraw from other firms on concern its exit would set off a wave of losses. Even the threat of criminal action must be handled in such a way as to not spook customers.  

It seems to be a spurious argument; akin to a doctor telling you that surgery to remove a cancerous tumor is dangerous and painful, so there is nothing to do but let the cancer overwhelm the host, curl up and wait to die. And then there is the more absurd part of the defense; the idea that pension funds would be forced to cut ties with criminal banksters; as if it is perfectly fine to have pension funds and trustees doing business with bankers involved in criminal activity, just so long as there are no official criminal charges. A complete denial of wrongdoing based upon a lack of enforcement. If the cops never arrest the killer, nobody really died. Yea, that’s it, pay no attention to the bloody corpse, pay no attention to the wreckage and devastation of the global financial meltdown; whistle past the graveyard.

You know the meltdown involved criminal wrongdoing; the regulators know it; the prosecutors know it. What they don’t seem to know is the collateral damage from non-enforcement and non-prosecution. Every action has a consequence, and non-action is a form of action.