Wednesday, August 06, 2014 - Where Water Flows

Financial Review with Sinclair Noe

DOW + 13 = 16,443
SPX +.03 = 1920
NAS + 2 = 4355
10 YR YLD - .01 = 2.47%
OIL - .54 = 96.84
GOLD + 17.30 = 1306.30
SILV + .27 = 20.11

Let’s start with the economic news of the day:

The Commerce Department says the trade gap for June shrank 7% to $41.5 billion, the lowest reading since January. That was smaller than the roughly $44.8 billion shortfall the government had assumed in its first snapshot of second-quarter gross domestic product published last week; so that would indicate the 2Q GDP number could be revised higher by 0.3%.

Exports edged up 0.1% to a record high of $195.9 billion in June, supported by a surge in automobiles, parts and engines, which rose to an all-time high. Consumer goods exports also hit a record high. There was also a jump in crude oil exports. Imports fell 1.2% in June, the largest drop in a year; petroleum imports declined to $27.4 billion, the lowest level since November 2010, from $28.3 billion in May.

Elsewhere, the Gaza-Israel ceasefire is holding for a second day. The Iraqi government carried out an airstrike on ISIS, killing 60 in the city of Mosul. Russia is massing troops near the Ukrainian border. Renewed fighting in eastern Ukraine has forced the suspension of a search for the remains of the victims of crashed flight MH17. Russian President Putin has banned agricultural imports from countries imposing sanctions on Russia. So, it might be difficult to buy California avocados in Moscow, although the Kremlin hasn’t yet created a list of food and ag products that will be banned.

Of course it might be difficult to buy California avocados anywhere, unless California gets some rain. The entire state is experiencing drought, and 82% of California is in “extreme” drought; of that, 58% of the state is in an “exceptional drought”, the driest conditions possible, an increase of more than 20% in a single week. Record-low rainfall has sent rivers, lakes and water reservoirs to their lowest levels in decades; threatening the water supply of many cities. The unusually dry conditions have increased the risk of wildfires, which have already ravaged parts of the state; most recently an area near Yosemite National Park.

The long-term drought cutting off California's water supply continues to parch the state, and even NASA can see it now. With the entire state now in severe drought, NASA's Aqua satellite took a picture of California to compare the terrain with a similar image taken from 2011. California is turning brown and parched. In 119 years of record keeping, 2013 was the driest calendar year for California, and it’s even worse this year. Even with a possible El Niño lurking in the tropical Pacific, there is no quick fix to this drought. It will take years of above-average rainfall to recover.

In the major cities like Los Angeles, residents are getting mixed messages: don’t water your lawns or hose off the sidewalk or you could face a fine of $500; at the same time they could be fined if they don’t keep their lawns and neighborhoods looking nice. That has spawned a new side business for landscapers: lawn painting. Prices vary but typically range from 25 cents to 35 cents per square foot of grass. On average, a 500-square-foot lawn is likely to cost $175 for a fresh coat of green paint. The dye is marketed as safe and nontoxic.

The drought’s biggest victim could be California’s Central Valley, the source of fully half the nation’s fruits and vegetables, where panicked farmers are taking extraordinary steps to survive a drought that could drive them out of business. Some farmers are drilling water wells thousands of feet, others are paying more than $2,500 for an acre foot of water; that’s at least 6 times the price of what water was going for last year. Desperate farmers have scrambled to save valuable citrus orchards; others have already lost the battle and been forced to bulldoze dead trees. It’s estimated that 10% of California’s farmland went unplanted this season. And the environmental damage might not be repaired in our lifetimes.

A recent University of California, Davis, study found the state’s agriculture industry stands to lose at least $1.5 billion this year alone due to the drought; losses that threaten to devastate a region where virtually everything is tied to farming. Already, small towns where the population is made up primarily of farm laborers, are warning unemployment rates could hit 50% in coming months because there will be no crops to harvest. That’s terrible news for an area already stricken by some of the highest poverty rates in the nation and where many cities still haven’t fully recovered from the Great Recession. And that’s just the start of a vicious cycle. No crops means people can’t work. Prices for produce go up, and people can’t afford to eat.

And as the state dries up, we are seeing the commoditization of water. Actually, that’s nothing new. For at least the last 10 years, the big banks and wealthy investors have been buying up water, or water rights. In 2008, during its annual “Top Five Risks” conference, Goldman Sachs called water “the petroleum for the next century” and those investors who know how to play the infrastructure boom will reap huge rewards. A 2008 New York Times article mentioned Goldman Sachs, Morgan Stanley, Credit Suisse, Kohlberg Kravis Roberts, and the Carlyle Group, had “amassed an estimated an estimated $250 billion war chest to finance a tidal wave of infrastructure projects in the United States and overseas.” In a 2012 JP Morgan equity research document, it states clearly that “Wall Street appears well aware of the investment opportunities in water supply infrastructure, wastewater treatment, and demand management technologies.” Billionaire T. Boone Pickens owned more water rights than any other individuals in America, with rights over enough of the Ogallala Aquifer to drain approximately 200,000 acre-feet (or 65 billion gallons of water) a year.

This summer, various business forces are combining to remind us that fresh water isn’t necessarily or automatically a free resource. It could all too easily end up becoming just another economic commodity. At the forefront of this debate is Peter Brabeck, chairman and former CEO of Nestle. In his view, citizens don’t have an automatic right to more than the water they require for mere “survival”, unless they can afford to pay for it. For context, the World Health Organization sets such “survival” consumption levels at a minimum of 20 liters a day for basic hygiene and food hygiene – higher, if you add laundry and bathing. In the United States, the odds are that flushing your toilet consumes 50 liters of water a day, and your average daily consumption of water probably tops 125 gallons.

If you’re curious to know what a society existing on “survival” water supplies might look like, just take a glance at Detroit. When the city became the largest US municipality ever to file for bankruptcy protection, they began to look at the payments residents owed to city hall, including delinquent water bills. Instead of letting it slide, the city cut off water; leaving more than 100,000 of the city’s 700,000 citizens without running water in their homes.

Just this past week, we saw the city of Toledo, Ohio tell a half million residents the water wasn’t safe to drink. Flooded by tides of phosphorus washed from fertilized farms, cattle feedlots and leaky septic systems, the most intensely developed of the Great Lakes is increasingly being choked each summer by thick mats of algae, much of it poisonous. Toledo was unlucky: A small bloom of toxic algae happened to form directly over the city’s water-intake pipe in Lake Erie, miles offshore. Beyond the dangers to people and animals, the algae wreaks tens of billions of dollars of damage on commercial fishing and on the recreational and vacation trades. Ohio has stopped well short of actually ordering the sources of phosphorus runoff to cap their production.

Nestle Waters North America division is the largest bottled water company in the country; they have to pay for water, at least some of it. Nestle pumps some of its bottled water from an aquifer near Palm Springs, thanks to a partnership with the Morongo Indian nation. Their joint venture, bottling water from a spring on land owned by the Morongo in Millard Canyon, has another advantage: since the Morongo are considered a sovereign nation, no one needs to report exactly how much water is being drawn from the aquifer.

And there is some validity to the argument that we risk depleting the supply of fresh water through careless and irresponsible consumption of what many think of as a free or nearly free resource. But what, exactly is that role? Is it to allow large corporations to buy up water rights, and possible corner the market for water? One role for the markets might well be in developing water related technologies to treat waste water or desalinate water, or even to extract water from the air; or to develop ways to use less water than we use now to grow crops and make products such as paper, or electronics, or the billions of gallons used to dye clothes.

So far, private equity hasn’t been able to figure out the technology or the potential for startups in this relatively nascent field. There is hard science, and a fair amount of infrastructure investment required. Venture capital favors the get rich quick schemes, even if the latest phone app might fade in 18 months, they can make a quick strike. Venture capital tends to gravitate to areas it knows, and areas it knows will not require heavy upfront costs, even if it could provide a steady flow of income and water for decades to come.

Tuesday, July 22, 2014 - Curb Your Enthusiasm

Financial Review with Sinclair Noe

DOW + 61 = 17,113
SPX + 9 = 1983
NAS + 31 = 4456
10 YR YLD - .01 = 2.46%
OIL - .17 = 104.42
GOLD – 4.70 = 1308.50
SILV + .04 = 21.07

We start with a couple of economic reports. The National Association of Realtors reports existing home sales were up 2.6% in June to a seasonally adjusted rate of 5.04 million, compared to 4.91 million in May. Sales in June were 2.6% higher than last month, but were 2.3% below the June 2013 rate. Total inventory rose 2.2% in June to 2.3 million existing homes for sale; unsold inventory is up 6.5% from a year ago.

At June’s pace of sales, there was a 5.5-month supply of homes for sale. The Realtors’ group considers a 6-month supply to be a balanced market. Higher supplies favor buyers and lower supplies favor sellers. The Federal Housing Finance Agency says home prices in May rose 0.4% from the prior month and were 5.5% above their level of May 2013. Distressed sales accounted for just 11% of sales in June, down from 15% last year, 25% in 2012, and 30% in 2011. Fewer distressed sales probably explain why there were fewer sales than June of last year.

The Consumer Price Index, or CPI, measures inflation at the retail level; the CPI increased 0.3% in June. The core CPI looks at prices excluding food and energy, which is important for people who don’t eat food or drive cars or use electricity; core CPI was up 0.1% in June. On a year over year basis, CPI is up 2.1%, and the core CPI is up 1.9%. The big driver for the increase in June was higher prices for gasoline.

In earnings reports:

Quarterly profit at McDonald's fell more than expected. Second quarter net income fell almost 1% to $1.3 billion, or $1.40 per share. Sales at McDonald’s restaurants in the US dropped for a third straight quarter.

Coca Cola’s 2Q net income dropped to $2.6 billion from $2.68 billion a year earlier.

Verizon reported second quarter earnings nearly doubled, but it was a confusing report because Verizon paid for Vodaphone shareholders in the quarter, plus they sold some of their wireless spectrum to T-Mobile; cutting through the clutter, Verizon added 1.4 million devices; Verizon added three tablets for every new smartphone. Earnings were just a smidge above expectations.

Comcast reported net income of almost $2 billion for the second quarter, with total revenue of $16.8 billion, up 3.5% from the same period last year. The revenue increase came from high-speed internet service. Comcast lost cable video customers, as more people bypass cable and satellite subscriptions in favor of cheaper streaming alternatives.

Credit Suisse reported a second quarter loss of $779 million, the largest loss since 2008; reflecting the charge of $2.6 billion related to the settlement with US law enforcement for a guilty plea to conspiring to aid tax evasion in helping American customers hide money in Swiss accounts. On the other hand, another way to look at it, they were one criminal conviction away from a $1 billion quarterly profit. Credit Suisse also announced it would exit the commodities trading business.

Meanwhile, it looks like bond traders are exiting the bond trading business. Trading in US government bonds has dropped 25% in the past few weeks compared to the same period a year ago. Since the end of the second quarter, trading in investment grade bonds has dropped 17% and trading in junk bonds has dropped 8%.

Last week, Fed Chair Janet Yellen talked about overvaluation in the biotech and social media sectors. One of the most common measures of value is the P/E, or price to earnings ratio; there are certainly other measures of value, but PE is common. Generally, a low PE can point toward value, while a high PE might indicate overvaluation, or even an unprofitable company. Currently the S&P 500 trades at 16.1 times forward 12-month consensus earnings per share. Therefore, you might think a PE of 165 would mean a stock was extremely overvalued, ready to crash; or not. In September 2003, Apple had a PE of 165; since then it has gained about 6,000%.

After the close of trade today, Apple posted fiscal third quarter results. Revenue came in at $37.4 billion versus $38 billion expected; EPS was $1.28 versus $1.23 expected; iPhone sales were on track; iPad sales were a little weak; Mac sales were a little better than expected. Apple posted profit of $7.75 billion, up from $6.9 billion in the year-ago period. Apple announced a new iPhone 6, not yet available, but ready to swamp stores before the end of the year; it will have a bigger screen. Curb your enthusiasm.

Also after the close, Microsoft posted profit of $4.6 billion, or 55 cents a share, on revenue of $23.4 billion. During the year-ago period, the world's largest software company earned $4.97 billion, or 59 cents a share, on $19.9 billion in sales. So, sales were up, profit was a slight miss, due to the Nokia acquisition. Bing search ad revenue is up 40%, and Bing now has about 20% of the market share for search engines. Microsoft is big in the cloud, where revenue is up almost 150%, topping 4 billion.

Hedge fund manager Bill Ackman went on CNBC yesterday and promised he would deliver the deathblow against Herbalife. Ackman has been shorting the stock for about a year; a $1 billion bet the company would crash. Then he delivered a 3-hour diatribe with 250 slides in his PowerPoint presentation, alleging that Herbalife is not just a multi-level marketing nutritional club, it is a pyramid scheme preying on minorities, and the biggest fraud since Enron. Ackman did not present a great deal of evidence. Today the stock was up 15%, for no apparent reason, other than surviving an Ackman deathblow.

There were two rulings from two federal appeals court panels on Obamacare today. The question was whether the government could subsidize health insurance premiums for people in states that use the federal insurance exchange; 36 states use the federal exchange, while the other states set up their own state exchanges. This goes back to wording in the original law that says subsidies can be applied to state exchanges.

 The United States Court of Appeals for the District of Columbia Circuit said that the government could not subsidize insurance for people in states that use the federal exchange. That decision could potentially cut off financial assistance for more than 4.5 million people who were found eligible for subsidized insurance in the federal exchange, or marketplace.

A couple of hours later, the United States Court of Appeals for the Fourth Circuit, in Richmond, upheld the subsidies, saying that a rule issued by the Internal Revenue Service was “a permissible exercise of the agency’s discretion.”

For now, nothing changes, with the exception that there will be many more billable hours for the attorneys.

Bloomberg reports that regulators are ready to label MetLife a potential threat to the financial system, subjecting the insurer to oversight by the Federal Reserve. MetLife, the biggest US life insurer, could be subjected to stricter capital, leverage and liquidity requirements as a result of Fed supervision. A decision by the Financial Stability Oversight Council may come as early as July 31, and MetLife would have 30 days to request a hearing before the FSOC to contest the decision.

The Dodd-Frank Wall Street Reform and Consumer Protection Act is now 4 years old, even though it isn’t really in effect; just 52% of the rules mandated under Dodd-Frank have been finalized by regulators; Another 23% have been proposed but they’re still working out details, and regulators haven’t even gotten around to 24% of the rules. A recent report by consumer watchdog Public Citizen called out the Securities and Exchange Commission as a particularly egregious delayer, noting that it had pushed back the deadlines for 13 of the 23 rules it was supposed to finalize this year.

City workers and retired city workers in Detroit have agreed to pension cuts to help bailout the city from bankruptcy. General retirees would get a 4.5% pension cut and lose annual inflation adjustments. They accepted the changes with 73% of ballots in favor. Support for the pension changes triggers an extraordinary $816 million bailout from the state of Michigan, foundations and the Detroit Institute of Arts. The money would prevent the sale of city-owned art and avoid deeper pension cuts.

Most people travel to or from Israel by air, and the major airport, really the only airport is Ben Gurion in Tel Aviv; last year, 14 million people went through Ben Gurion Airport, in a country with a population of 8 million.  Yesterday a rocket from Gaza landed about one mile from the airport; we don’t have further details on that rocket; it did not hit the airport; it was a mile away. When news spread, Delta diverted a flight to Paris. United airlines cancelled flights. The Federal Aviation Administration banned all US passenger and cargo flights to and from Tel Aviv for at least the next 24 hours. European airlines cancelled flight to Israel. The possibility of a passenger jet being shot down over a war zone is a very realistic and fresh memory.

US and United Nations diplomats are in Israel, trying to broker a ceasefire of some sort. Israel continues to pound targets across the Gaza Strip. It does not appear a ceasefire is near. If there is any light at the end of the tunnel, the tunnel will be destroyed.

The European Union today threatened Russia with harsher sanctions if Russia does not cooperate in the investigation of the downing of the Malaysian flight 17 and if Russia does not stop sending weapons to Russian backed separatists in Ukraine. However, it was just a threat, and they will get together later in the week to draft proposals for sanctions.

Wednesday, May 28, 2014 - Reflecting the Economy

Financial Review with Sinclair Noe

DOW – 42 = 16,633
SPX – 2 = 1909
NAS – 11 = 4225
10 YR YLD - .08 = 2.43%
OIL – 1.03 = 103.08
GOLD = 4.70 = 1259.60
SILV - .01 = 19.13

The major stock market indices were lower, but it wasn’t a big move, and we’ve been 4 up days, so today’s pullback was nothing but a pause. What was interesting today was the move in the bond market. The yield on the 10 year treasury dropped all the way to 2.43%; that’s the lowest rate in almost a year. The 10 year treasury has dropped 22 basis points this month, meaning treasuries are on track for the best month since January. Now, remember that the Federal Reserve is supposed to be tapering, cutting back on large scale purchases of treasury bonds.  

What’s fueling the move? It’s hard to pinpoint one thing. Europe is facing some sort of monetary stimulus package from the ECB next week; meanwhile, a report showed German unemployment rose and that pushed yields on the 10 year bund to 1.28%; that trade then spilled over to the US markets, toss in end of month window dressing and there was likely a short squeeze. There are some big short positions on treasuries right now; more shorts than longs.

At the end of the day, the bond market is supposed to reflect the economy; not an exact image but rather a mirror image. And the US economy is probably not as strong as expected. Tomorrow, we’ll get a revised look at first quarter GDP. The initial estimate on GDP showed just 0.1% growth; a pathetic rate blamed on bad weather; the revision is expected to show the economy contracted by 0.6%, maybe worse. Since the recession ended in June 2009, US GDP growth has dipped into the red only once: the first quarter of 2011, when economic output contracted at a 1.3% rate. It appears likely to happen again. The economy was repeatedly disrupted by cold and snowy weather in the first quarter and much of the activity that did not take place then is occurring now during the warmer spring months. Wall Street expects second-quarter growth to snap back with a 3.8% gain.

But where will the springtime burst of growth come from? Exports? Not to Europe and not to emerging markets. The initial GDP report said net exports subtracted 0.83 percentage point from the GDP growth rate in the first quarter. It may be a bigger drag on growth in Thursday’s update. Construction? A bit, yes, but we continue to see the housing market looking soft. Construction lending is seeing a slow, steady recovery, but it remains 66% below its boom-era peak of $631 billion in outstanding loans in early 2008. Companies restocking their shelves? Not likely. Inventories subtracted 0.57 percentage point from GDP growth, according to the first estimate, and that could grow with this week’s revision; inventories remain high and consumer spending sluggish. Corporate profits? Yes sir that is an area of strength but it’s also a two-edged sword.

The Commerce Department is starting to release a new report on corporate profits. Pretax profits adjusted for depreciation and the value of inventories climbed 1.9% in the fourth quarter to a record $2.13 trillion on a annualized basis. Corporate profits as a percentage of GDP stood at 10.2% in the fourth quarter, just a touch below a record high. Corporate profits are now higher than they’ve ever been before.

Here’s the problem; whenever profit margins reach a high, they tend to peak and then rollover, with the stock market and the economy dragging behind in like manner. It’s tough to keep pumping out record profits, in part because profit margins often depend on cost cutting, not just revenue; there are limits to how much fat a company can trim and there are limits to how much a company can increase sales while simultaneously cutting back on R&D and capital expenditures. Right now, stocks are priced to reflect very high corporate profits. Any disappointment would shake that pricing structure and translate into big stock market losses.

Like any individual indicator, this is not an absolute. Corporate profit margins can remain at elevated levels anywhere from a single quarter to multiple years and don’t typically present an imminent warning threat to the stock market or economy until forming a major peak and sudden decline. Profit margins peak on average before the stock market by more than a year and before recessions by more than two years. It doesn’t work out this way all the time; in the early 70’s profits peaked with the market, and in the early 80’s profits peaked after the stock market, and it is possible that the lag time stretches out so far as to make the indicator more or less worthless.

The point is that there are other factors that must be considered. Think of profits as one measurement of the business cycle. So, despite the Fed taper, there is increasing likelihood that interest rates will remain low and possibly decline a bit; if rates decline, stocks are likely to move up with bonds, as we’ve seen can happen; and if falling long-term yields flatten the yield curve, that would increase the risk of a market crash. In a low-yield, low inflation environment, there is a good opportunity to grow profits and so those crashes tend to be preceded by periods of very strong returns. So the current bull market is likely to remain in place until inflation picks up or low-flation/deflation drags down profits.

Falling yields tend to be somewhat more bullish than bearish, but it’s a poor indicator for how the stock market will react. Falling yields are good especially when we are in a bull market, but they can be dangerous if they should drive down the yield curve spread to an unusually low level and then there is the lag effect I mentioned earlier. When the long end of the yield curve comes down that is good for stocks for a while; it can even result in parabolic increases in the short term, but it also indicates bad news for the broader economy, and eventually the bill comes due.

Yesterday we talked about the proposed new EPA regulations on coal fired power plants. Today we’ll talk about the backlash to those proposals; which, by the way, have not been officially proposed yet. It’s anticipated that the new EPA guidelines will try to reduce the percentage of US electricity generated by coal to 14% by 2030 from about 37% right now. Coal is the single biggest source of electricity generation in the US and has been for more than 60 years. The amount of electricity generated by natural gas would rise to 46% by 2030 from about 30% now under the EPA plan. That would make it the biggest generator of the nation’s electricity.

Meanwhile, opponents of the plan say it will increase the cost of electricity and cost jobs. The US Chamber of Commerce released a study showing it would cost the economy $50 billion a year and destroy a quarter million jobs. Sometimes they just pull numbers out of the air; these reports tend to overlook the externalities associated with a dirty fuel like coal, and also overlook the positive impact of cleaner fuels. Anyway, the mudslinging has started.

And a follow-up on the Detroit bankruptcy story. A task force has issued the most detailed study yet of blight in Detroit and recommended that the city spend at least $850 million to quickly tear down about 40,000 dilapidated buildings, demolish or restore tens of thousands more, and clear thousands of trash-packed lots. It also said that the hulking remains of factories that dot Detroit, crumbling reminders of the city’s manufacturing prowess, must be salvaged or demolished, which could cost as much as $1 billion more.

If carried out, the recommendations by the Detroit Blight Removal Task Force would drastically alter the face of the nation’s largest bankrupt city. They would also cost significantly more than the approximately $450 million that the city already plans to spend on blight, raising questions about the feasibility of the vast cleanup effort, which is part of its larger campaign to emerge from bankruptcy by fall and begin remaking itself.

The blight study, which is perhaps the most elaborate survey of decay conducted in any large America city, found that 30% of buildings, or 78,506 of them, scattered across the city’s 139 square miles, are dilapidated or heading that way. It found that 114,000 parcels — about 30% of the city’s total — are vacant. And it found that more than 90% of publicly held parcels are blighted. The report also made several recommendations for preventing blight in the future, including changes to property tax and foreclosure laws, and heavy fines for scrap metal theft.

The basic plan is to clean up the city, but nobody really knows how to go about the task. Do you clean up by tearing down or do you clean up by building or rebuilding? For years, some have contemplated consolidating some of the city’s neighborhoods to allow the city to provide services to a smaller area, more suited to its shrunken population; Detroit has gone from 1.8 million to about 800,000. And if they don’t get this right this time, it will likely revert to farmland.

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.