Financial Review

Lie or Be Lehman

Sinclair Noe — May 27, 2015

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

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DOW + 121 = 18,162
SPX + 19 = 2123
NAS + 73 = 5106
10 YR YLD – .01 = 2.13%
OIL – .38 = 57.65
GOLD + .20 = 1189.00
SILV – .07 = 16.75

Yesterday the Dow posted a triple digit loss, today a triple digit gain; not enough to cover yesterday’s losses. The Nasdaq was higher on strength in semiconductor stocks; the Nasdaq posted a new record high close, taking out the high from April 24. The dollar was slightly stronger, oil was down again.

Severe storms and devastating floods over the weekend in Texas and Oklahoma have killed at least 19 people. Another 14 people are missing in Texas, including eight members of two families whose vacation home was swept away. The flooding has also resulted in complications for business travelers. About 11 inches of rain fell in Houston on Monday while parts of Austin have been hit by as much as 7 inches. Helicopter crews in both cities rescued people who had been stranded in cars and on top of buildings. The National Weather Service issued a new flash flood warning today.

The IRS says tax return information for about 100,000 U.S. taxpayers was illegally accessed by cyber criminals over the past four months. The stolen information included tax returns and other tax information on file with the IRS. The IRS said the thieves accessed a system called “Get Transcript.” In order to access the information, the thieves cleared a security screen that required knowledge about the taxpayer, including Social Security number, date of birth, tax filing status and street address. The IRS is notifying those affected. The IRS said the breach does not involve its main computer system that handles tax filing submission, and that system remains secure…, for now.

A red card for FIFA, the Federacion Internationale de Football Association, plus 14 arrests for illegal activities that make the governing body for soccer look more like a mafia crime family. The Department of Justice indictment names 14 people on charges including racketeering, wire fraud and money laundering conspiracy. In addition to senior soccer officials, the indictment also named sports-marketing executives from the United States and South America who are accused of paying more than $150 million in bribes and kickbacks in exchange for media deals associated with major soccer tournaments. Law enforcement officials say their investigation has just begun and there will be more action taken to clean up the sport.

As leaders of FIFA gathered in Zurich for their annual meeting, more than a dozen plainclothes Swiss law enforcement officials arrived unannounced at the Baur au Lac hotel, an elegant five-star property with views of the Alps and Lake Zurich. They went to the front desk to get room numbers and then proceeded upstairs. The concierge called the guest and informed them they should open their hotel door rather than having police break it down.

Swiss police arrested seven FIFA officials who are now awaiting extradition to the United States. Swiss prosecutors said they had opened their own criminal proceedings against unidentified people on suspicion of mismanagement and money laundering related to the awarding of rights to host the 2018 World Cup in Russia and the 2022 World Cup in Qatar. The president of FIFA, Sepp Blatter, was not arrested but he might be questioned in coming weeks.

Meanwhile, the US Department of Justice alleges a “24-year scheme” for FIFA officials “to enrich themselves through the corruption of international soccer.” Why is the US leading this investigation? Well, it involves some US sports marketing people and apparently many of the bribes were paid in US dollars and funneled through US banks. Beyond that, we just really don’t like soccer.

G-7 finance ministers and central bankers are meeting in Dresden, Germany. The host country set the agenda and it did not include discussion of Greece. They might not stick to plans. US Treasury Secretary Jack Lew spoke with Greek Prime Minister Alexis Tsipras today for the second time in less than a week and told a London audience that “everyone has to double down” on reaching an accord. While the G-7 doesn’t have a mandate to decide how to deal with Greece, it brings together officials from the Eurozone’s three biggest economies, as well as the European Central Bank, The International Monetary Fund, and the European Union – the institutions backing the $262 billion aid package that expires next week.  The Greeks are reportedly drafting an accord.  Maybe they could borrow some money from FIFA.

Richmond Fed boss Jeffrey Lacker says policymakers must ensure that financial industry creditors do not expect government bailouts and must be willing to let firms fail in order to restore market discipline. Lacker also continued his assault on Dodd-Frank’s Title II and repeated his call to repeal the Fed’s emergency lending authority, arguing that less regulation, not more, is needed to make the system safer. British monarchy may appear to be nothing more than a vestigial ceremonial version of leadership, yet in that role, Queen Elizabeth delivered a speech today to mark the State Opening of Parliament and she promised an in-or-out popular vote on membership in the European Union. That has been a matter of debate and now the path towards a vote looks potentially shorter than anticipated, with some now talking of a referendum in 2016 rather than 2017.

Fed Chair Janet Yellen plans to skip the annual gathering of economists and policy makers in Jackson Hole this year, marking the second time in three years the Fed’s top official won’t be traveling to Wyoming. Yellen’s predecessor, Ben Bernanke, skipped the 2013 gathering. The topic of this year’s conference is inflation dynamics and monetary policy.

Former Federal Reserve Chairman Ben Bernanke said he does not see signs of extreme movements in the US real estate and financial markets. Bernanke also said that if the Fed lifts interest rates, it would be good news because it means the U.S. economy is strong enough.

Royal Bank of Scotland, Britain’s largest taxpayer-owned lender, could pay as much as $4.5 billion to resolve claims of misconduct in its handling of US mortgage securities. The legal action relates to $32 billion in residential mortgage-backed securities sold to Fannie and Freddie from 2005 to 2007.

Back in 2005 Deutsche Bank was selling derivatives that were supposed to be a form of insurance against a huge financial disaster. And after they had sold billions of dollars of these derivatives, they started writing guarantees to the pool, or conduit, that was writing the guarantees. Deutsche was getting its derivative based version of insurance from Deutsche Bank’s own money; essentially selling derivatives on the derivatives it was selling to itself; while taking a commission off the top, of course. And by the way, these derivatives were super-senior, so they were highly rated – that’s an important point. When things went bad in 2008, they charged more for the derivative form of insurance because it was highly rated, but they also still treated it as if it was very highly rated, even though the world of finance was melting down. Deutsche figured that there was not a reliable method to measure the risk in light of the market conditions, and so they just figured there was zero risk.

Ultimately, the realities of 2008 showed that risk was quite a bit higher than zero. The SEC thought the whole thing was a bit fishy, but Deutsche maintained that it did not suffer any losses. Which was true because the insurance/derivatives never paid off. And the reason it never paid off was because it was highly leveraged, and it might have destroyed the bank, and they were clever enough to write into the derivative contract that they might not pay if they didn’t want to, so they did not pay. And in Deutsche’s twisted logic that meant the derivatives were very high quality; so good that they sold them to clients and even bought some themselves and then held it on their books as high credit quality capital.

In 2010, three whistle blowers stepped up to say that Deutsche had mismarked billions in exposures in 2008 and 2009 to make it look healthier than it really was. And this is important because banks are required to keep a certain amount of very safe capital available in the event of a problem; this is called tier one capital; and if a bank does not have enough tier one capital on hand, then they are basically considered insolvent. For example, in 2008, Lehman Brothers did not have enough tier one capital and they collapsed. As it turns out, Deutsche Bank did not have enough tier one capital on its books in 2008, but they did have highly leveraged derivatives, which were kind of, sort of like insurance created out of thin air, and backed by other derivatives, which were backed by their own capital, which was protected by nothing more than imagination and bogus credit ratings.

If Lehman Brothers had been smart enough to create derivatives out of thin air and call them insurance, they might never have collapsed. And If Deutsche Bank had not lied about the credit quality of their derivatives, they could have ended up like Lehman. But that didn’t happen, because Deutsche Bank lied. Yesterday, the Securities and Exchange Commission said that Deutsche Bank made material misstatements about a giant derivatives portfolio, inflating its value at the height of the financial crisis; and the bank failed to account for a “material risk for potential losses estimated to be in the billions of dollars”. The bank agreed to pay a $55 million penalty, without admitting or denying wrongdoing. Nobody goes to jail. The bank is not sanctioned. Deutsche said it had cooperated with regulators throughout the investigation and said the settlement “will have no impact on previous financial reports.” Hey it was a long time ago, in the ancient past. And the moral of this story is that when a bank gets in trouble, they should lie or be Lehman.

Financial Review

HSBC – Too Big To Jail

Sinclair Noe — February 9, 2015

 

Podcast: Play in new window | Download (Duration: 13:18 — 6.1MB)

DOW – 95 = 17,729
SPX – 8 = 2046
NAS – 18 = 4726
10 YR YLD + .02 = 1.95%
OIL + .90 = 52.59
GOLD + 5.40 = 1239.70
SILV + .28 = 17.07

Let’s start with oil; OPEC lowered its estimate for non-OPEC supply growth this year by about 400,000 barrels a day, the biggest reduction since the forecast was introduced in August. The US led with a cut of 130,000 barrels a day while estimates for Colombia, Canada and Yemen were also trimmed. The group said it may boost global demand forecasts beyond this month’s slight increase amid rising U.S. gasoline use.

OPEC’s research department said: “The main factors for the lower growth prediction in 2015 are price expectations, a declining number of active rigs in North America, a decrease in drilling permits in the US and a reduction in the 2015 spending plans of international oil companies.”

The United Steelworkers strike continues with walkouts at two of BP’s refineries over the weekend. The strike now encompasses more than 5,000 workers at 11 refineries across the country, which account for about 13% of U.S. fuel-making capacity. Facility owners also hit by the strike include Shell, Tesoro, Marathon Petroleum and LyondellBasell.

Cheap gasoline prices have increased 13 cents in the past two weeks to $2.20 a gallon, nationwide average; but not everybody is buying the idea that oil will keep going up from here. According to US Commodity Futures Trading Commission data cited on Bloomberg. After a two-week rally that pushed oil up 14%, short bets on West Texas Intermediate jumped 1.2% while net-long positions dropped for a third week.

Edward Morse, Citigroup’s global head of commodity research writes that the recent surge in oil prices is just a “head-fake,” and oil as cheap as $20 a barrel may soon be on the way. Brazil and Russia are pumping oil at record levels, and Saudi Arabia, Iraq and Iran have been fighting to maintain their market share by cutting prices to Asia. The market is oversupplied, and storage tanks are topping out. A pullback in production isn’t likely until the third quarter. Citi reduced its annual forecast for Brent crude for the second time in 2015. Prices in the $45-$55 range are unsustainable and will trigger “disinvestment from oil” and a fourth-quarter rebound to $75 a barrel. According to the report prices this year will likely average $54 a barrel.

Of course that’s just a guess. I don’t know, you don’t know, and Citigroup doesn’t know, but they print their guesses on glossy paper.

HSBC is a British multi-national bank; it used to be called the Hong Kong and Shanghai Banking Corporation; the UK and Hong Kong are considered home markets, but they also have a subsidiary in Switzerland. And it turns out, they have been misbehaving for quite some time.

At its height, HSBC’s secretive Swiss arm hid a total of $120 billion in assets. These funds were collected from wealthy clients all over the world and have already led to criminal investigations and charges against the bank in France, Belgium, the US and Argentina.

In a report released on Sunday, the International Consortium of Investigative Journalists, an organization based in Washington, along with the newspaper Le Monde in France, The Guardian in Britain, the BBC program “Panorama” and CBS News’s “60 Minutes,” said that secret documents revealed that bank employees had reassured clients that HSBC would not disclose details of their accounts to tax authorities in their home countries and discussed options to avoid paying taxes on those assets.

The documents were stolen from HSBC by a former employee in Switzerland in 2007 and were given to the French authorities, who in 2010 shared them with officials in Britain, Spain and the United States, among other nations. The leaked Swiss HSBC files implicate the bank in apparent misbehavior all over the world; some 30,000 accounts, and about 2,900 clients connected to the US, providing the IRS with a trail of evidence of potential American taxpayers who may have been hiding assets in Geneva. The US Department of Justice and IRS have been investigating HSBC’s Swiss banking operations since the documents were first handed over in 2010 but the scale of those inquiries remain unclear. Tomorrow, Maryann Hunter, who is on the board of governors of the Federal Reserve, and has some responsibility for regulation of foreign banking organizations operating in the US, will give evidence to the Senate banking committee. On Thursday, Geoffrey Graber, a deputy associate attorney general at the DoJ who oversees settlements with Wall Street banks, will appear before a House judiciary subcommittee. Both are expected to be questioned about the leak.

HSBC global and its US bank was forced to pay a $1.9 billion fine two years ago after the DoJ uncovered evidence HSBC subsidiaries had enabled clients to breach US sanctions against Cuba, Sudan and Iran and, due to oversight failures, allowed Mexican drug cartels launder billions of dollars. At the time, the settlement allowed HSBC to escape criminal indictments and keep the banking charter which enables it to operate in the US but the bank had to submit to a 5-year plan to stamp out money-laundering and other illicit practices, and the banks’ compliance would be overseen by an independent, court-appointed monitor.

HSBC is now just over two years into its reform plan, and has been deemed to be complying with the terms of the settlement. However, there are some concerns. In November, the bank reached a settlement with the Securities and Exchange Commission in which HSBC agreed to pay $12.5 million to resolve charges that its Swiss private banking division illegally provided investment and brokerage services to US clients.

So much for the idea that the problems are in the past. The huge amount of leaked info is quite bad for HSBC; it includes stories of coaching clients how to evade taxes; stories of clients being assisted in withdrawing bricks of cash from the Swiss bank. The evidence is quite damning, and yet, still no criminal charges. The Department of Justice will soon face a moment of truth, when they will have to decide whether the phrase “too big to jail” was real or just a crock.

And of course, HSBC is not the only bank that has misbehaved. Financial Times is reporting that the US Department of Justice is investigating whether Barclays and UBS sold structured products without disclosing the profit they were making from currency trades used to generate the products’ returns; essentially skimming profits or perhaps even betting against their own clients. Five major banks, including UBS, were fined $3.4B in November to settle forex allegations, although the DOJ was not one of the agencies involved in the deal. Barclays also did not take part in the earlier settlement.

The S&P 500 rose 3 percent last week, the most in seven weeks, as oil rebounded. The Dow posted its best weekly gain in more than a year. Of the firms that have reported profit so far this season, 78 percent beat analysts’ estimates, while 56 percent topped sales projections. Coca Cola, Time Warner, and MetLife are among 66 S&P 500 companies reporting quarterly results this week.

Comcast and Time Warner Cable’s $45B merger still remains in limbo, with the DOJ and FCC scrutinizing the deal and Tom Wheeler’s new net neutrality proposal. Investors began betting against the combination late last month, with shares of Comcast and Time Warner Cable falling sharply before recovering last week. If regulators allow the deal as is, the merged company would control about 35% of the country’s broadband Internet service coverage and just under 30% of pay television subscribers.

The National Association of Insurance Commissioners, a group representing state regulators, has announced the launch of an investigation into the recent data breach at Anthem. The health insurer revealed last week that hackers had broken into its database containing the personal information of about 80 million customers and employees. Anthem said it welcomes the review and “will cooperate fully.”

If you are one of the 80 million,1 of every 4, Americans who has ever had health insurance with Anthem Blue Cross, Anthem Blue Cross and Blue Shield, Blue Cross and Blue Shield of Georgia, Empire Blue Cross and Blue Shield, Amerigroup, Caremore, Unicare, Healthlink, and DeCare; I am sorry to inform you that your privacy and personal identity has been flushed down the toilet; let the class action lawsuits begin. Not all data breaches are created equal, and the Anthem health insurance hack is about as bad as they get for consumers.

Why? This time the crooks got Social Security numbers. For identity thieves, the Social Security number is the key that unlocks the vault, and they now have millions of them, plus they stole all sorts of other info, so they don’t have to guess when it comes to matching the Social Security data to you and everything you’ve ever worked for. If you have managed to save a nest egg for retirement, you will need to defend it, forever. How could this happen? Because Anthem didn’t encrypt our data, and there is no law that says they must.

Harris Poll has released a survey of America’s most- and least-loved corporations. Wegmans, a Rochester, New York grocer, claimed first place, followed by Amazon, Samsung, Costco, and Johnson & Johnson. Halliburton, Monsanto, Dish Network, and AIG were near the bottom of the list. The most hated company: Goldman Sachs.

Samsung’s TVs are listening to your every word. The company disclosed that its smart TVs will automatically capture all nearby conversations as part of its voice recognition features, and potentially transmit sensitive data to a third-party service. George Orwell saw it coming years ago.

A South Korean vacuum robot tried to devour its owner…Firefighters were called after it consumed some of her hair and refused to let go. …Yet Japan is still launching a robot hotel. A 72-room getaway will open this summer, staffed by 10 multilingual humanoids. What could go wrong?

Thursday, June 19, 2014 - Market Hits Record Highs and Supreme Court Hands Down More Decisions

Financial Review with Sinclair Noe

DOW + 14 = 16,921
SPX + 2 = 1959
NAS – 3 = 4359
10 YR YLD + .01 = 2.62%
OIL + .48 = 106.07
GOLD + 42.80 = 1321.30
SILV + .86 = 20.86

Taking a look at economic data, weekly claims for jobless benefits fell 6,000 to 312,000; the labor market still has plenty of slack but still shows signs of modest improvement. The Philly Fed manufacturing index was up to its highest reading since last September. And the Conference Board's index of leading economic indicators rose 0.5% to 101.7 in May.

President Obama said today that the United States would deploy up to 300 military advisers to Iraq to help its Iraqi government forces fend off Sunni militants. Obama emphasized again that he would not send combat troops to Iraq, although there seems to be a fine line between combat troops and advisers; he said the United States would help the Iraqis “take the fight” to the militants, who he said pose a threat to Iraq’s stability and to American interests, because Iraq could become a sanctuary for terrorists who could strike the United States or its allies.

Secretary of State John Kerry will go to Europe and the Middle East this weekend to build support among Iraq’s Arab neighbors for a multisectarian government in Baghdad.

Markets were in negative territory most of the day, nothing big, then we recovered near the end of the session, nothing big; the S&P 500 hit its 21^st record high close of the year. This market is just slowly scratching and clawing its way higher, and that’s a good thing. When the markets go on a sharp move higher, sometimes called a parabolic run, it usually ends with a nasty fall. For now, the markets are moving higher but staying within the channels of standard deviation.

There are plenty of geopolitical hotspots, and a boatload of economic uncertainty, but the US equity markets are as constant as you could want. The past 44 consecutive sessions of the Standard & Poor's 500 index have fluctuated upward or downward by less than 1 percent. To put that streak in context, the S&P 500 hasn't seen this little movement since 1995, when the index didn't change by a full percentage point for 95 days. All the while, stocks have been steadily ticking up. The S&P 500 is up 6% year-to-date.

There always seems to be a crisis somewhere and maybe investors and Wall Street traders are just crisis weary, even if it is a little dangerous to wait for the next hotspot to implode. Ukraine hasn’t resulted in disaster, at least not for the US. We’ve been dealing with a mess in Iraq for more than 10 years, so there’s no reason to freak out now. The full impact of recent world events is still unclear, so just keep trading. Compared with past conflicts in the Middle East, America has reduced its dependence on oil in the region and thus may not be feeling the effects of the current crisis as strongly.

The Federal Reserve’s QE policy has been a tremendous success for Wall Street, even if it hasn’t trickled down to Main Street. Impressive corporate earnings growth may be outweighing any effects that world events are having on the markets. Earnings of companies in the S&P 500 are expected to growth by a rate of 5.4% in Q2 2014, with nine of the ten sectors in the index projecting higher growth than last year.

Yesterday, Fed Chairwoman Janet Yellen dismissed inflation as nothing more than noisy. Wall Street traders loved the dismissal of rising prices as an indication that the Fed would not be swayed from their ongoing accommodative policy. Still, you have to wonder where the Fed is going as they try to oversee an uneven recovery and a benign exit from QE.

Like the Fed, the Bank of England has kept interest rates in the near zero range for the past 5 years. Last week, BOE Governor Mark Carney indicated that economic liftoff might come sooner than the markets think. Unemployment in Britain has been falling faster than expected, even though there is still considerable slack in the labor market. British GDP has steadily risen over the past year and is now just 0.6% below its pre-crisis peak. The improving picture could nudge the BOE toward a rate increase sooner rather than later. And so the BOE has its own form of forward guidance, stressing that the timing of the first rate increase is less important than the idea that once rates increase, the degree and pace of increases will be gradual and limited; in other words, a soft and gentle slope.

The Supreme Court is handing down decisions this week. Today they issued a unanimous ruling on Alice Corp v. CLS Bank International, a case that deals with patents. Alice Corporation, an Australian company developed a method for mitigating settlement risks among multiple parties. In its Supreme Court brief, the company said the method was eligible to be patented largely because it involved shadow records updated in real time that “require a substantial and meaningful role for the computer.”

The patents were challenged by CLS Bank International, which says it clears $5 trillion in foreign exchange transactions a day using methods to ensure that both sides performed. The bank said that Alice Corporation’s patents merely recited “the fundamental economic concept of intermediated settlement of escrow.”

A trial court invalidated Alice’s patents and then a court of Appeals affirmed the lower court ruling. Writing for the Supremes, Justice Clarence Thomas said that was “a patent-ineligible abstract idea,” and “Merely requiring generic computer implementation fails to transform that abstract idea into a patent-eligible invention.”

The case had been closely watched by the software industry. Patent claims over the way ideas are incorporated into computers, cellphones and other devices have become a challenge for many high-tech companies. Justice Thomas indicated that the decision posed no threat to the concept of software patents, writing: “There is no dispute that many computer-implemented claims are formally addressed to patent-eligible subject matter.”

The Supremes were also unanimous in ruling on United States v. Clarke; in this case the Court held that a taxpayer may conduct an examination of IRS officials in response to a summons for information and records if the taxpayer can point to facts or circumstances that could raise an inference of bad faith on the part of the IRS.

Another unanimous ruling says the First Amendment protected an Alabama whistleblower. In Lane v. Franks, the high court ruled that Edward Lane's First Amendment rights protected him from job retaliation when he testified in the public corruption trial of then state Rep. Sue Schmitz in 2010, who was accused of being on the payroll at the college but failed to actually show up for work. Schmitz’ bogus job was uncovered and detailed, along with many other cases of corruption in the state's two-year college system as part of a two-year investigation of the system by The Birmingham News in 2006-07.

 Lane was fired by the two-year college he worked after his testimony. Lower courts had ruled against Lane, finding that he was testifying as a college employee, not as a citizen. Writing for the court, Justice Sonia Sotomayor said Lane's testimony was constitutionally protected because he was speaking as a citizen on a matter of public concern, even if it covered facts he learned at work. The decision is a win for whistleblower advocates, who said it could encourage more government workers to cooperate with prosecutors in public fraud cases without fear of losing their livelihoods.

Meanwhile, there is still some fallout, and uncertainty surrounding a Supreme Court decision earlier this week involving sovereign debt of Argentina. Argentina defaulted on nearly $100 billion of debt in 2002. Because some of the debt was sold under New York law, it faced a court challenge after it settled with only some creditors in 2005 and 2010. A few “hold out” creditors sought better repayment terms, specifically, some hedge funds bought the debt after the 2002 default for pennies on the dollar and then demanded full payment. The president of Argentina has called the hedge funds, “vultures” The Supreme Court has given the vultures a victory.

In the next 10 days, we’ll see if Argentina will succeed in defying the United States courts. On June 30, there is a scheduled interest payment on a set of Argentine bonds that its government wants to pay. But the courts say that interest may not be paid unless the country pays all it owes on bonds it defaulted on years ago, something Argentina says it cannot and will not do.

Argentina’s plan is to convert the bonds on which it wants to make payment into new bonds that would not be subject to New York law. Several banks and other financial institutions were willing to accept a partial payment but now that might risk the ire of American courts.

There is no equivalent to bankruptcy law for sovereign debtors. There is no legal procedure to resolve debts of destitute countries. There is no court to approve a restructuring plan that will wipe out some debts and convert others to equity, as there is for companies. Instead, troubled countries negotiate with lenders to restructure the debts. That restructuring could involve reducing the amount owed, lowering the interest rate, extending the maturity of the debt or some combination of the three.

The IMF would typically work with poor countries by offering emergency money contingent on financial reforms for the country; the IMF money was understood to rank above the old debts. Bondholders could, and did, hold out for full payment, but they faced the risk that the restructuring would go through and those who agreed would get partial payouts, while the holdouts got none. Now it has changed, at least for countries that issue bonds under New York law. The hand of holdouts has been strengthened immensely. Financial market service providers are now sovereign debt enforcement agents.

What would happen then? In a brief submitted to the Supreme Court, Joseph Stiglitz, the Columbia University professor who was formerly chief economist of the World Bank, offered a warning: “Unable to restructure, governments that default would be permanently shut out from the debt market, with consequential adverse effects on development and economic growth prospects.” In other words, a modern day debtors’ prison for countries with oppressive debt.

We’ll see how this one unfolds.