April 24, 2014

Groupthink Or Black Swan Rising? Not A Single 'Economist' Expects An Economic Downturn

A 100% Consensus


This doesn't happen very often.  Marketwatch reports that Jim Bianco points out in a recent market comment that the 67 economists taking part in a regular Bloomberg survey have a unanimous forecast regarding treasury bond yields: they will be higher 6 months from now. This is a truly striking result, and given the well-known propensity of mainstream economists to guess wrong (their forecasts largely consist of extrapolating the most recent short term trend), it may provide us with a few insights.

In fact, considering that there have been only a handful of instances since 2009 when a majority of the economists surveyed predicted a decline in yields, we can already state that their forecasts regarding treasuries are quite often (though obviously not always) wide of the mark. In fact, so far this year they are already wrong again – and so are fund managers, as they hold their lowest exposure to treasuries in seven years.

This is not the only thing there is complete unanimity about. Not a single economist taking part in a separate survey believes an economic downturn is possible.
“Economists are unwavering in their assessment of where yields are headed in the next half year.

Jim Bianco, of Bianco Research, points out in a market comment Tuesday that a survey of 67 economists this month shows every single one of them expects the 10-year Treasury yield to rise in the next six months.

The survey, which is done each month by Bloomberg, has been notably bearish for some time now, with nearly everyone expecting rising rates. In March, 97% expected rising rates. In February, 95% expected yields to climb. And in January, 97% held that expectation. Since the beginning of 2009, there have only been a handful of instances where less than 50% expected rates to rise.

Still, the fact that every single survey participant is bearish is striking. The last time the survey had that result was in May 2012, when benchmark yields were well below 2%.

“Literally there is maybe one economist in the United States straddling the bullish/bearish divide on interest rates. The rest are bearish,” Bianco writes.

He adds that a J.P. Morgan client survey shows that the percentage of money manager respondents who said they are underweight Treasurys is the second highest in seven years.

This is all the more surprising when we consider that investors went into 2014 thinking yields would rise significantly. Instead, the benchmark yield is lower than when the year started, as the market waded throw subpar economic data, geopolitical tensions, and uncertainty over the Federal Reserve. The 10-year note last traded at a yield of 2.72% on Tuesday, down from just over 3% on Dec. 31.

Then again, a separate poll of economists recently showed that exactly zero expect the economy to contract.

But when the entire market thinks one thing is about to happen, the opposite outcome is often in store, notes James Camp, managing director of fixed income at Eagle Asset Management. So don’t count out that result with Treasurys, he advises.

“It’s the most hated asset class,” says Camp, but Treasurys are some of the best performers year-to-date.”
(emphasis added)

Color us unsurprised regarding the fact that the 'most hated asset class' has turned out to be one of the better performing so far this year. Gold is probably hated even more, and for similar reasons. Everybody expects the weakest recovery of the entire post WW2 era to reach 'escape velocity' (whatever that is supposed to mean), even after adding almost $8 trillion to the federal debt and some $4.8 trillion to the broad true money supply since the 2008 crisis have led to such a dismal outcome (of course as card-carrying Austrians we believe this development is precisely what should have been expected). 

Likely Outcomes


While treasury bond yields have only moved down a little so far this year, one must keep in mind that they are at a historically very low level to begin with. At a yield of roughly 4%, a 50 basis points move represents 12.5% of the entire distance to zero. However, we also know that a lot more downside is possible. Yields have already been quite a bit lower on a number of occasions.

There can be little doubt that if the consensus of economists turns out to be wrong again, it will likely be wrong on both t-bond yields and the economy. As an aside, it is noteworthy that long term yields have weakened considerably even while five year yields have remained roughly unchanged and yields on the short end of the curve have actually risen slightly since the beginning of the year.

We interpret this as the market judging the Fed to be adopting a tighter monetary policy, and expecting weaker aggregate economic activity to ultimately result from this new stance. Clearly, the 'tapering' of 'QE' does represent a tightening of policy, no matter what Fed members are saying about it. It means the pace of money supply inflation is being slowed down.

Note that something similar happened in the run-up to the 2008 crisis, only in this instance the yield curve actually inverted prior to the economic downturn. One should not expect a complete yield curve inversion to warn in a timely fashion of a recession when the central bank is hell-bent on keeping its policy rate at or near zero. We know this from 'ZIRP' experiments that have been undertaken in other countries, such as e.g. Japan.

If the economy doesn't do what seemingly everybody expects it to do in the famed 'second half' (practically the entire sell-side shares the consensus of the economists surveyed by Bloomberg), then treasuries and gold should be expected to rise, while equities could end up getting hit quite badly.


30 year t-bond yield: declining since the beginning of the year – click to enlarge.

It is clear that one of the reasons why economists expect no contraction in the economy is that 'traditional' recession indicators still appear largely benign, if somewhat weaker than previously. We prefer to keep an eye on things most people don't watch, such as the ratio of capital to consumer goods production, which shows how factors of production are pulled toward the higher stages of the capital structure when monetary pumping is underway. This ratio tends to peak and reverse close to recessions. Its recent trend isn't entirely conclusive yet as it has begun to move sideways, but it clearly seems to be issuing a 'heads up' type warning signal.

Capital vs. consumer goods production – it tends to peak close to the beginning of recession periods, and declines while recessions are underway, as the production structure is temporarily shortened again – click to enlarge.

Note also that the transition from expansion to contraction is usually quite swift, and never widely expected.

Conclusion:

This is an astonishing degree of consensus thinking, but it perfectly mirrors the complacency we see in stock market sentiment and positioning data. The probability that such a unanimous view will turn out to be correct is traditionally extremely low. The economy is likely resting on a much weaker foundation than is generally believed. This is not least the result of massive monetary pumping and deficit spending, both of which tend to severely weaken the economy on a structural level, even though they can create a temporary illusion of 'growth'.

April 23, 2014

The Middle Class In Canada Is Now Doing Better Than The Middle Class In America

For most of Canada's existence, it has been regarded as the weak neighbor to the north by most Americans.  Well, that has changed dramatically over the past decade or so.  Back in the year 2000, middle class Canadians were earning much less than middle class Americans, but since then there has been a dramatic shift.  At this point, middle class Canadians are actually earning more than middle class Americans are.  The Canadian economy has been booming thanks to a rapidly growing oil industry, and meanwhile the U.S. middle class has been steadily shrinking.  If current trends continue, a whole bunch of other countries are going to start passing us too.  The era of the "great U.S. middle class" is rapidly coming to a bitter end.

In recent years, I have been up to Canada frequently, and I am always amazed at how much nicer things are up there.  The stores and streets are cleaner, the people are more polite and it seems like almost everyone that wants to work has a job.

But despite knowing all this, I was still surprised when the New York Times reported this week that middle class incomes in Canada have now surpassed middle class incomes in the United States...
After-tax middle-class incomes in Canada — substantially behind in 2000 — now appear to be higher than in the United States. The poor in much of Europe earn more than poor Americans.
And things are particularly dire for those in the U.S. on the low end of the scale...
The struggles of the poor in the United States are even starker than those of the middle class. A family at the 20th percentile of the income distribution in this country makes significantly less money than a similar family in Canada, Sweden, Norway, Finland or the Netherlands. Thirty-five years ago, the reverse was true.
Even while our politicians and the media continue to proclaim that everything is "just fine", the U.S. middle class continues to slide toward oblivion.

The biggest reason for this is the lack of middle class jobs.  Millions of good jobs have been shipped overseas, and millions of other good jobs have been replaced by technology.

The value of our labor is declining with each passing day, and this has forced millions upon millions of very qualified Americans to take whatever they can get.  As NBC News recently noted, this is a big reason why the temp industry has been booming...
For Americans who can't find jobs, the booming demand for temp workers has been a path out of unemployment, but now many fear it's a dead-end route. 
With full-time work hard to find, these workers have built temping into a de facto career, minus vacation, sick days or insurance. The assignments might be temporary — a few months here, a year there — but labor economists warn that companies' growing hunger for a workforce they can switch on and off could do permanent damage to these workers' career trajectories and retirement plans. 
"It seems to be the new norm in the working world," said Kelly Sibla, 54. The computer systems engineer has been looking for a full-time job for four years now, but the Amherst, Ohio, resident said she has to take whatever she can find.
It has been estimated that one out of every ten jobs is now filled by a temp agency.  I have worked for temp agencies myself in the past.  Big companies like the idea of having "disposable workers", and this is a trend that is likely to only grow in the years ahead.

But temp jobs and part-time jobs don't pay as well as normal jobs.  And those kinds of jobs generally cannot support middle class families.

At this point, nine out of the top ten occupations in the United States pay an average wage of less than $35,000 a year.

That is absolutely stunning.

These days most families are barely scraping by, and they don't have much extra money to go shopping with.

This is a big reason for the "retail apocalypse" that we are now witnessing.  This week we learned that retail stores in the United States are closing at the fastest pace that we have seen since the collapse of Lehman Brothers.  But you won't hear much about that on the mainstream news.

You can find lots of "space available" signs and empty buildings in formerly middle class neighborhoods all over the country.  For example, one of my readers recently shot the following YouTube video in Scottsdale, Arizona.  As you can see, empty commercial buildings are all over the place...

As the middle class shrinks, more families are being forced to take in family members that can't find decent work.  I have written previously about the huge rise in the number of young adults that are moving back in with their parents.  But this is not just happening to young people.  As the Los Angeles Times recently detailed, the number of Americans 50 and older that are moving in with their parents has absolutely soared in recent years...
For seven years through 2012, the number of Californians aged 50 to 64 who live in their parents' homes swelled 67.6% to about 194,000, according to the UCLA Center for Health Policy Research and the Insight Center for Community Economic Development. 
The jump is almost exclusively the result of financial hardship caused by the recession rather than for other reasons, such as the need to care for aging parents, said Steven P. Wallace, a UCLA professor of public health who crunched the data. 
"The numbers are pretty amazing," Wallace said. "It's an age group that you normally think of as pretty financially stable. They're mid-career. They may be thinking ahead toward retirement. They've got a nest egg going. And then all of a sudden you see this huge push back into their parents' homes."
The U.S. economy is slowly but steadily falling apart, and more people fall out of the middle class every single day.

A recent Gallup survey found that 14 percent of all Americans would experience "significant financial hardship" within one week of a job loss.

An additional 29 percent of all Americans would experience "significant financial hardship" within one month of a job loss.

That means that 43 percent of the entire country is living right on the edge.

It is no wonder why only about 30 percent of all Americans believe that we are moving in the right direction as a nation.

Most people know deep down that something is seriously wrong.  But most people can't explain exactly what that is or how to fix it.

Meanwhile, the politicians and the media keep telling us that if we just keep doing the same old things that everything will work out okay somehow.  The blind are leading the blind, and we are rapidly marching toward disaster.

April 22, 2014

Reuters Analysis: Printing Money Is More Important Than Ever for Yellen

Yellen shows her hand ... Yellen said this week that she is more worried that a shock to the economy might lead to deflation — a debilitating spiral downward in prices and demand — than rampant inflation. Those who cling to old certainties about the economic notions that dominated policy between the 1980s and late 2008 find themselves today tilting at windmills such as the likelihood of a return to high inflation. – Reuters 

Dominant Social Theme: Just print, baby. 

Free-Market Analysis: This Reuters editorial presents the reality of Yellen's upcoming Fed regime. Peter Schiff and others – including The Daily Bell – were correct. 

There is not going to be any radical tightening at the Fed. 

Supposedly, Yellen was going to cease quantitative easing. But QE is simply a strategy and whether or not it continues does not necessarily have an effect on the larger money-printing environment. 

This article tells us what is probably the truth about the Fed regime: People misinterpreted Yellen's initial remarks on the subject. Just because she is departing from Ben Bernanke's goal-based employment doesn't mean Yellen is departing from the idea of printing currency to create jobs. 

 The idea of keeping interest rates artificially low while finding ways to inject increased currency into the economy is a purely Keynesian approach to prosperity. 

When recessions are shallow, additional amounts of currency in large doses can have an economic influence. But today's Great Recession is fairly impervious to this sort of stimulation. 

That doesn't mean Yellen is stopping, however. The entire central banking paradigm is built around injecting funds into the economy. 

It's a very simple procedure, but the mainstream media makes it sound complex. 

When the economy is doing badly, money printing is on the agenda. When the economy is doing well, the wise men are apt to recommend additional money printing anyway, just to be safe. 

Central banks are therefore always printing currency in excess of what the economy needs. And really it cannot be any other way. The modern debt-based system runs on adding significant amounts of paper into circulation. 

Yellen was never going to do anything differently. Here's more from the Reuters article: 

The difference between the Federal Reserve Board of Chairwoman Janet Yellen and that of her immediate predecessor Ben Bernanke is becoming clear. No more so than in their approach to the problem of joblessness. Bernanke made clear that in the post-2008 economy, his principal goal was the creation of jobs, not curbing inflation. He settled on a figure, 6.5 percent unemployment, as the threshold that would guide his actions. ... 

Before scampering off to sell their stocks, the traders would have done well to wait to read the full Fed statement that revealed there had been a secret session of the Fed board on March 4, a week before the full session. 

The minutes of that meeting reveal the board's interest in "qualitative language" about jobs that focus "on a broader set of economic indicators" — that is, seeing the true unemployment picture beyond the bald percentages. As the minutes show, the board was concerned to avoid "uncertainty associated with defining and measuring the unemployment rate and the level of employment that would be most consistent with the Committee's maximum employment objective." 

Reiterating that policy in a speech Wednesday, Yellen declared, "there is little question that the economy has remained far from maximum employment." ... 

The ... recovery has been long, slow and sluggish. It was perhaps no more dilatory than the snails'-pace recovery of the 1930s, the last time the world economy careered off a cliff. ... 

By far the most effective way of stimulating the economy and creating new jobs, as former Treasury Secretary Lawrence Summers told new graduates at Smith College recently, is for the federal and state governments to spend freely on infrastructure. 

Money has never been cheaper; labor has never been cheaper; there is no risk of inflation; the new facilities, whether roads, schools, colleges, railways, power stations, airports or whatever, would help supply the economy with a well-trained workforce and a set of commonly used amenities that private enterprise desperately needs to spur growth. 

Article after article in the mainstream press confirms the relative simplicity of central banking. It doesn't work, but more of the same may somehow provide a cure, nonetheless. 

How can it work, in fact? When you print money, you distort economic growth. So this longish Reuters article/editorial ends up leaving us with what we already knew a while ago. 

The result will inevitably be booms in various asset classes, especially the stock market and then high-end real estate. Finally, multinational progress. 

All of the above is accomplished by force-feeding commercial banks. It is the top-end clients and corporations that benefit from this sort of exercise because there is no DEMAND for money from the general public. 

Even five years later, there is no surety over what companies are solvent and what companies – and entrepreneurs – are bankrupt. The "recovery" within this context is surely a phony one. 

But we can see from the Reuters article that nothing has changed. It's not complicated. Yellen will print more and supposedly – though this won't actually happen – government will "prime the pump." 

What is interesting is that this article we are commenting on today and yesterday's lead article on central banks needing to "partner" with government and business is obviously setting the stage for some sort of effort based on more aggressive FDR-style stimulation. 

It didn't work then and it won't work now. The globalists pushing these strategies along simply need a narrative of sufficient complexity. Central banking corrupts and hollows out economies. The power elite seeks as much centralization as possible. 

If Yellen ceased to print currency, then those behind her would find someone else. The strategy is necessary to achieve further centralization of money and power. In the meantime, we will have to read articles and listen to analyses explaining what is inexplicable. 

It is inexplicable because it doesn't work. It doesn't work because it is not supposed to work. It is truly a devious system. It will no doubt result in a further boom – a continued Wall Street Party, at least for a while. But not forever. 

Conclusion In the meantime, Yellen will keep dancing. And we are not surprised. 

Source

April 21, 2014

The Dow Jones Index is the Greatest of All Ponzi Schemes

The Dow Jones Industrial Average (DJIA) Index – the oldest stock exchange in the U.S. and most influential in the world – consists of 30 companies and has an extremely interesting and distressing history regarding its beginnings, transformation and structural development which has all the trappings of what is commonly referred to as pyramid or Ponzi scheme.

The Dow Index was first published in 1896 when it consisted of just 12 constituents and was a simple price average index in which the sum total value of the shares of the 12 constituents were simply divided by 12. As such those shares with the highest prices had the greatest influence on the movements of the index as a whole. In 1916 the Dow 12 became the Dow 20 with four companies being removed from the original twelve and twelve new companies being added. In October, 1928 the Dow 20 became the Dow 30 but the calculation of the index was changed to be the sum of the value of the shares of the 30 constituents divided by what is known as the Dow Divisor.

While the inclusion of the Dow Divisor may have seemed totally straightforward it was – and still is – anything but! Why so? Because every time the number of, or specific constituent, companies change in the index any comparison of the new index value with the old index value is impossible to make with any validity whatsoever. It is like comparing the taste of a cocktail of fruits when the number of different fruits and their distinctive flavours – keep changing. Let me explain the aforementioned as it relates to the Dow.

Companies Go Through 5 Transition Phases

On one hand, generally speaking, the companies that are removed from the index are in either the stabilization or degeneration transition phases of which there are five, namely:

1. the pre-development phase in which the present status does not visibly change.

2. the takeThe Dow Jones Industrial Average (DJIA) Index – the oldest stock exchange in the U.S. and most influential in the world – consists of 30 companies and has an extremely interesting and distressing history regarding its beginnings, transformation and structural development which has all the trappings of what is commonly referred to as pyramid or Ponzi scheme.-off phase in which the process of change starts because of changes to the system.

3. the acceleration phase in which visible structural changes – social, cultural, economical, ecological, institutional – influence each other.

4. the stabilization phase in which the speed of sociological change slows down and a new dynamic is achieved through learning.

5. the degeneration phase in which costs rise because of over-capacity leading to the producing company finally withdrawing from the market.

The Dow Index is a Pyramid Scheme

On the other hand, companies in the take-off or acceleration phase are added to the index. This greatly increases the chances that the index will always continue to advance rather than decline. In fact, the manner in which the Dow index is maintained actually creates a kind of pyramid scheme! All goes well as long as companies are added that are in their take-off or acceleration phase in place of companies in their stabilization or degeneration phase.

The False Appreciation of the Dow Explained

On October 1st, 1928, when the Dow was enlarged to 30 constituents, the calculation formula for the index was changed to take into account the fact that the shares of companies in the Index split on occasion. It was determined that, to allow the value of the Index to remain constant, the sum total of the share values of the 30 constituent companies would be divided by 16.67 ( called the Dow Divisor) as opposed to the previous 30.

On October 1st, 1928 the sum value of the shares of the 30 constituents of the Dow 30 was $3,984 which was then divided by 16.67 rather than 30 thereby generating an index value of 239 (3984 divided by 16.67) instead of 132.8 (3984 divided by 30) representing an increase of 80% overnight!! This action had the affect of putting dramatically more importance on the absolute dollar changes of those shares with the greatest price changes. But it didn’t stop there!

On September, 1929 the Dow divisor was adjusted yet again. This time it was reduced even further down to 10.47 as a way of better accounting for the change in the deletion and addition of constituents back in October, 1928 which, in effect, increased the October 1st, 1928 index value to 380.5 from the original 132.8 for a paper increase of 186.5%!!! From September, 1929 onwards (at least for a while) this “adjustment” had the affect – and I repeat myself – of putting even that much more importance on the absolute dollar changes of those shares with the greatest changes.

How the Dow Divisor Contributed to the Crash of ‘29

From the above analyses/explanation it is evident that the dramatic “adjustments” to the Dow Divisor (coupled with the addition/deletion of constituent companies according to which transition phase they were in) were major contributors to the dramatic increase in the Dow from 1920 until October 1929 and the following dramatic decrease in the Dow 30 from then until 1932 notwithstanding the economic conditions of the time as well.

Exponential Rise in the Dow 30 is Revealed

The 1980s and ‘90s saw a continuation of the undermining of the true value of the Dow 30. Yes – you guessed correctly –further “adjustments” in the Dow Divisor kept coming and coming! As the set of constituents of the Dow changed over the years (almost all of them) and many shares were split the Dow Divisor kept changing. By 1985 it was only 1.116 and today it is only 0.132129493. Indeed, a rise of $1 in share value of the 30 constituents actually results in 8.446 more index points than in 1985 (1.116 divided by 0.132129493). Had it not been for this dramatic decrease in the Dow Divisor the Nov.3/10 Dow 30 index value of 12,215 (sum total of the current prices of the 30 constituent shares of $1481.85 divided by 0.132129493) would only be 1327.82 ($1481.85 divided by 1.116) in 1985 terms. Were we still using the original formula the Dow 30 would actually be only 49.395 ($1481.85 divided by 30)!

The crucial questions today are:

1. Is the current underlying economy strong enough to keep the Dow 30 at its present level?

2. Will the 30 constituents of the Dow remain robust or evolve into the stabilization and degeneration phases?

3. Will there be enough new companies to act as new “up-lifters” of the Dow?

4. When will the Dow Divisor change – yet again??

The Dow 30 is the Greatest of All Ponzi Schemes

I call on the financial community to take a critical look at the Dow Divisor. If it is retained societies will continue to be deceived with every new transition from one phase to another and the greatest of all Ponzi schemes will have major financial consequences for every investor.

April 18, 2014

It's Time To Ditch The Consumer Price Index (CPI)

So why does the government maintain such a transparently inaccurate and misleading metric? For three reasons.

That the official rate of inflation doesn't reflect reality is obvious to anyone paying college tuition and healthcare out of pocket. The debate over the accuracy of the official consumer price index (CPI) and personal consumption expenditures (PCE--the so-called core rate of inflation) has raged for years, with no resolution in sight.

The CPI calculates inflation based on the prices of a basket of goods and services that are adjusted by hedonics, i.e. improvements that are not reflected in the price of the goods. Housing costs are largely calculated on equivalent rent, i.e. what homeowners reckon they would pay if they were renting their house.


The CPI attempts to measure the relative weight of each component:



Many argue that these weightings skew the CPI lower, as do hedonic adjustments. The motivation for this skew is transparent: since the government increases Social Security benefits and Federal employees' pay annually to keep up with inflation (the cost of living allowance or COLA), a low rate of inflation keeps these increases modest.

Over time, an artificially low CPI/COLA lowers government expenditures (and deficits, provided tax revenues rise at rates above official inflation).

Those claiming the weighting is accurate face a blizzard of legitimate questions. For example, if healthcare is 18% of the U.S. GDP, i.e. 18 cents of every dollar goes to healthcare, then how can a mere 7% wedge of the CPI devoted to healthcare be remotely accurate?

In my analysis, the debate over inflation is intrinsically flawed. What really matters is not the overall rate of inflation, which can be endlessly debated, but the purchasing power of earned income, i.e. wages and the exposure to real-world costs.

In other words, those households with zero exposure to college tuition and the full costs of daycare, medical care and healthcare insurance may well experience low inflation, while the household paying the full costs of daycare, college tuition and healthcare insurance will experience soaring inflation.

Here's one example of how CPI fails to capture real-world inflation/loss of purchasing power. Let's say an employee works for a company or agency that pays his/her healthcare insurance. The monthly cost has risen from $1,000/month to $1,500/month. The employee's wage has remained stagnant but the total compensation costs paid by the employer have gone up by $500/month.

Now the employer shifts that $500/month to the employee as their share of the healthcare insurance cost. Since the average full-time worker earns around $40,000 a year, and pays around 18% in taxes, their take-home pay is around $33,000 annually.

The employee's co-pay of $6,000 a year ($500/month) represents 18% of their take-home wage. This is an 18% reduction in earnings, or the equivalent of 18% inflation (i.e. a reduction in purchasing power).
This shifting of the skyrocketing burden of healthcare costs acts the same as 20% inflation, yet it doesn't even register in the current CPI.

The geography of inflation doesn't register, either. Soaring rents in Brooklyn, NY and the San Francisco Bay Area have a profound effect on those exposed to these rapidly rising costs, yet these impacts are massaged to zero by national CPI calculations.

So once again we have a bifurcated society: those protected by the state from rising costs and those exposed to real-world reductions in purchasing power.Households that receive government subsidies and direct payments have little exposure to real-world healthcare costs, since they are covered by Medicaid, and modest exposure to housing if they receive Section 8 benefits (Section 8 recipients pay 30% of their income for rent, regardless of the market price of the rental). Retirees on Medicare also have limited exposure to the real-world costs of their care paid by the government.

If we analyze inflation by these two metrics, we find the middle class is increasingly exposed to skyrocketing real-world prices. Pundits in the top 5% have the luxury of pontificating on the accuracy of the CPI while those protected by government subsidies and coverage have the luxury of wondering what all the fuss is about. Only those 100% exposed to the real costs experience the full fury of actual inflation.

So why does the government maintain such a transparently inaccurate and misleading metric? For three reasons: 1) it is useful propaganda; 2) it suppresses the state's cost-of-living increases and 3) it lowers the government's cost of borrowing. The benefits of reducing COLA adjustments are self-evident, as is the benefit of borrowing money at low rates of interest, but the propaganda benefits are more subtle.

The key to enabling the endless printing of money that enriches the banks and the top .1% is low inflation. Asset bubbles can be inflated, ballooning the wealth of the owners of the assets, as long as inflation is near-zero.
Indeed, the Federal Reserve claims it must print money to counter low inflation.

Meanwhile, in the real economy, those exposed to the real costs of college tuition, healthcare, childcare, etc. are seeing their purchasing power evaporate like a puddle of water in Death Valley. The Fed needs low inflation to justify its continuing enrichment of the financial elite, and the Federal government needs low inflation to keep its COLAs and borrowing costs low.

There are two ways to mask real-world reductions of purchasing power: 1) skew the CPI by distorting the component percentages, hedonics and how costs are measured, and 2) protect enough of the populace from real-world increases so they no longer care. Seniors, who famously vote in droves, have no idea what their Medicare benefits actually cost. As a result, they have no experience of healthcare inflation /reduction of purchasing power.

This works in all sorts of industries. As I have often mentioned here, the F-35 Lightning fighter aircraft costs in excess of $200 million each, roughly four times the cost of the F-18F it replaces. This extraordinary inflation is not experienced directly by the taxpayer who is paying for the boondoggle, as the Federal government borrows trillions of dollars to pay for such boondoggles, effectively passing the inflated costs on to future generations.

These costs are hidden by the low cost of borrowing trillions to pay for boondoggles. If real-world inflation is (say) 5%, then interest rates would typically adjust to a few points above that rate, to compensate capital for the erosion of purchasing power. If the Treasury had to pay 7% to borrow money, the interest cost would soon cripple Federal spending. People would be forced to focus on how all those trillions of dollars are being spent, and to whose benefit.

But with borrowing costs so low, nobody cares.

The solution? One, abolish the Fed and let the market discover interest rates, and two, abandon the simplistic notion that one number of inflation has any meaning in a complex economy with numerous subsets of exposure to market costs and the loss or gain of purchasing power.

Will we muster the will to look past failed models and metrics? Sadly, the answer is no. Why?

As I noted yesterday in What's the Difference Between Fascism, Communism and Crony-Capitalism? Nothinga system set up to enrich political and financial elites is incapable of reform. the only way the CPI will ever be replaced is when the Status Quo collapses in a heap of lies and insolvency. Until then, propaganda and gaming the system to protect vested interests will rule.

April 17, 2014

SEC is Kinda Thinking About Doing Something About High Frequency Trading

Before you get too excited about the notion that the SEC might actually be saddling up to Do Something about high frequency trading, the agency has roused itself to issue a leak….that it is pondering launching a limited trial to address all of one practice.

I’m not making this up. From the Wall Street Journal:
SEC officials, including some commissioners, are considering a trial program to curb fees and rebates they say can make trading overly complex and pose a conflict of interest for brokers handling trades on behalf of big investors such as mutual funds. 
At issue are “maker-taker” fee plans, which pay firms that “make” orders happen—often high-frequency trading firms that specialize in trading strategies designed to capture payments. The plans charge firms that “take” trades—typically big investment firms looking to buy or sell a chunk of stock or hedge funds making bets on short-term price swings. 
The trial program would eliminate maker-taker fees in a select number of stocks for a period to show how trading in those securities compares with similar stocks that keep the payment system.

Now let us consider the rather awkward position the SEC finds itself in. It sat by as the NYSE and Nasdaq allowed HFT firms to co-locate servers so as to get advantaged access to orders. The exchanges were eager to play ball because the high frequency traders paid for this privilege. And the fig leaf is that while FINRA, Wall Street’s self regulatory body, has a rule against brokers front-running their clients, the high frequency traders aren’t acting as brokers. As the New York Times noted:
There is no small paradox in the stock exchanges profiting by selling access to information that can be used for something that looks an awful lot like front-running, while Finra enforces a rule prohibiting brokers from doing the same thing.
Now unless the high frequency tradingfuror dies down quickly (which it might, scandals can sometimes have a short half life), we are likely to have Congressional hearings and the SEC will have to explain itself.

The SEC is almost certain to contend that it not only does take l’affaire high frequency trading seriously, it’s been moving with all deliberate speed. As a Bloomberg story pointed out last week:
The SEC took its first deep dive into HFT in January 2010, before many other enforcement agencies had waded into the debate. As part of a broad review of market structure, it examined how brokers route the electronic orders of speed traders and questioned whether that put other investors at a disadvantage. The report elicited more than 400 comment letters from banks, exchanges, retail brokerages, and large institutional investment firms.
Yves here. Notice how all of nothing happened? That means the SEC ran into such a thicket of competing interests that it didn’t see an easy path forward. And mind you, later that year, the flash crash took place. But the SEC has yet to implement any measures to prevent a recurrence.

Now here is the beautiful part:
The trick for regulators is finding ways to prevent abuses without blocking high-speed firms that actually benefit investors… 
The problem is that the SEC doesn’t have all the data it needs. In 2012 the agency spent $2.5 million on a surveillance system named Midas (Market Information Data Analytics System) that collects information from all 13 public exchanges in the U.S. This essentially gives the SEC the same view of the market that many speed traders have. It doesn’t, however, give it a picture of the whole market. Only about 70 percent of trades happen on public exchanges; the rest take place offline, either inside large wholesale brokerages that match buy and sell orders internally or in private trading venues called dark pools. To see that activity, the SEC needs a much more powerful system that can track the life of every stock quote, order, and trade… 
In 2010, White’s predecessor, Mary Schapiro, approved a project to build such a system to funnel terabytes of information every day into one massive feed that regulators could monitor. Called the consolidated audit trail (CAT), the system would allow the SEC to conduct detailed forensic analysis and weed out abuses. The contract for the huge project, which will cost more than $1 billion, still hasn’t been awarded. The SEC estimates that CAT won’t be finished until 2016.
One billion dollars? For a ginormous data feed to gather info on the 30% of the market the SEC does not see now? And given how most IT initiatives go, this “one data feed to rule them all” project could easily come in vastly over budget.

The SEC’s annual budget is $1.3 billion. As much as HFT is an important issue, this is a grossly disproportionate expenditures. As a management consultant, I’ve regularly had to do studies in OTC markets where we had access to only a teeny slice of market data compared to what the SEC had. You don’t need perfect information to make decisions. You can get it via sampling and qualitative assessments for an itty bitty fraction of this $1 billion price tag.

So what this really says is either the SEC is unwilling to act and is playing the Penelope game*, of making action dependent on a task that will never get done, or it is genuinely unwilling to walk into a political minefield, and so will make a proposal only if it has incontrovertible data. Needless to say, I’m leaning toward the first theory.

Now that isn’t to say that the practice the SEC has roused itself to take interest in is unimportant. The Wall Street Journal notes:
Fund managers and others concerned about the negative effects of maker-taker recently held a series of private meetings with SEC Chairman Mary Jo White and other staff members to push for its elimination, according to people familiar with the meetings. Among those who met with the SEC was Jeffrey Sprecher, chief executive of IntercontinentalExchange Group Inc., which owns the New York Stock Exchange; representatives from fund manager T. Rowe Price Group Inc; and representatives from RBC Capital Markets, a unit of the Royal Bank of Canada…. 
Maker-taker has come under a harsh spotlight in recent years, with big investment firms, academics and exchange executives saying it can hurt long-term investors and skew brokerage-firm incentives. 
A primary criticism is that the fees pose a conflict for brokers, who might choose to route an investor’s order to an exchange with the goal of earning a payment, not to get the best deal for the client. 
A recent study by finance professors Robert Battalio and Shane Corwin at the University of Notre Dame and Robert Jennings at Indiana University found stockbrokers appear to routinely route client orders to markets that provide the best payments. The study found that can saddle investors with worse results than if the brokers hadn’t factored in the payments, and that such trades are “unlikely to be consistent with the broker’s responsibility to obtain best execution” for investors.
Even so, the Journal stresses that White has only indicated she is sympathetic to the calls to eliminate maker-taker, but has not made any decision. And thinking about launching a trial looks a lot like a way to slow-walk any action.

So it looks like the SEC will have its pat answers if it is put under the Congressional hot lights: it takes all the public concerns seriously, it has been soliciting input from all the concerned parties. It’s even about to launch a project!

Don’t buy it. Remember, after the 1987 crash, President Reagan authorized a study within ten days and had an analysis and recommendations, know as the Brady Commission Report, two months later. The data gathering is admittedly more difficult due to the opaque nature of some of the market, but having no point of view on high frequency trading nearly four years after the flash crash should be seen as an indictment of the SEC’s seriousness and competence.
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*Remember the wife of Odysseus held off her suitors by saying she’s marry one of them once she finished weaving a burial shroud for her father, which she unravels every night.

April 16, 2014

The global banking game is rigged and the FDIC is suing

Taxpayers are paying billions of dollars for a swindle pulled off by the world’s biggest banks, using a form of derivative called interest-rate swaps; and the Federal Deposit Insurance Corporation has now joined a chorus of litigants suing over it.

Derivatives . . . have turned into a windfall for banks and a nightmare for taxpayers. . . . While banks are still collecting fixed rates of 3 to 6 percent, they are now regularly paying public entities as little as a tenth of one percent on the outstanding bonds, with rates expected to remain low in the future. Over the life of the deals, banks are now projected to collect billions more than they pay state and local governments—an outcome which amounts to a second bailout for banks, this one paid directly out of state and local budgets.
It is not just that local governments, universities and pension funds made a bad bet on these swaps. The game itself was rigged, as explained below. The FDIC is now suing in civil court for damages and punitive damages, a lead that other injured local governments and agencies would be well-advised to follow. But they need to hurry, because time on the statute of limitations is running out.

The largest cartel in world history

On March 14, 2014, the FDIC filed suit for LIBOR-rigging against sixteen of the world’s largest banks—including the three largest US banks (JPMorgan Chase, Bank of America, and Citigroup), the three largest UK banks, the largest German bank, the largest Japanese bank, and several of the largest Swiss banks. Bill Black, professor of law and economics and a former bank fraud investigator, calls them “the largest cartel in world history, by at least three and probably four orders of magnitude.”

LIBOR (the London Interbank Offering Rate) is the benchmark rate by which banks themselves can borrow. It is a crucial rate involved in hundreds of trillions of dollars in derivative trades, and it is set by these sixteen megabanks privately and in secret.

Interest rate swaps are now a $426 trillion business. That’s trillion with a “t”—about seven times the gross domestic product of all the countries in the world combined. According to the Office of the Comptroller of the Currency, in 2012 US banks held $183.7 trillion in interest-rate contracts, with only four firms representing 93% of total derivative holdings; and three of the four were JPMorgan Chase, Citigroup, and Bank of America, the US banks being sued by the FDIC over manipulation of LIBOR.

Lawsuits over LIBOR-rigging have been in the works for years, and regulators have scored some very impressive regulatory settlements. But so far, civil actions for damages have been unproductive for the plaintiffs. The FDIC is therefore pursuing another tack.

But before getting into all that, we need to look at how interest-rate swaps work. It has been argued that the counterparties stung by these swaps got what they bargained for—a fixed interest rate. But that is not actually what they got. The game was rigged from the start.

The sting

Interest-rate swaps are sold to parties who have taken out loans at variable interest rates, as insurance against rising rates. The most common swap is one where counterparty A (a university, municipal government, etc.) pays a fixed rate to counterparty B (the bank), while receiving from B a floating rate indexed to a reference rate such as LIBOR. If interest rates go up, the municipality gets paid more on the swap contract, offsetting its rising borrowing costs. If interest rates go down, the municipality owes money to the bank on the swap, but that extra charge is offset by the falling interest rate on its variable rate loan. The result is to fix borrowing costs at the lower variable rate.

At least, that is how it’s supposed to work. The catch is that the swap is a separate financial agreement—essentially an ongoing bet on interest rates. The borrower owes both the interest on its variable rate loan and what it must pay out on this separate swap deal. And the benchmarks for the two rates don’t necessarily track each other. As explained by Stephen Gandel on CNN Money:
The rates on the debt were based on something called the Sifma municipal bond index, which is named after the industry group that maintains the index and tracks muni bonds. And that’s what municipalities should have bought swaps based on. 
Instead, Wall Street sold municipalities LIBOR swaps, which were easier to trade and [were] quickly becoming a gravy train for the banks.
Historically, Sifma and LIBOR moved together. But that was before the greatest-ever global banking cartel got into the game of manipulating LIBOR. Gandel writes:
In 2008 and 2009, LIBOR rates, in general, fell much faster than the Sifma rate. At times, the rates even went in different directions. During the height of the financial crisis, Sifma rates spiked. LIBOR rates, though, continued to drop. The result was that the cost of the swaps that municipalities had taken out jumped in price at the same time that their borrowing costs went up, which was exactly the opposite of how the swaps were supposed to work.
The two rates had decoupled, and it was chiefly due to manipulation. As noted in the SEUI report:
[T]here is . . . mounting evidence that it is no accident that these deals have gone so badly, so quickly for state and local governments. Ongoing investigations by the U.S. Department of Justice and the California, Florida, and Connecticut Attorneys General implicate nearly every major bank in a nationwide conspiracy to rig bids and drive up the fixed rates state and local governments pay on their derivative contracts.
Changing the focus to fraud

Suits to recover damages for collusion, antitrust violations and racketeering (RICO), however, have so far failed. In March 2013, SDNY Judge Naomi Reece Buchwald dismissed antitrust and RICO claims brought by investors and traders in actions consolidated in her court, on the ground that the plaintiffs lacked standing to bring the claims. She held that the rate-setting banks’ actions did not affect competition, because those banks were not in competition with one another with respect to LIBOR rate-setting; and that “the alleged collusion occurred in an arena in which defendants never did and never were intended to compete.”

Okay, the defendants weren’t competing with each other. They were colluding with each other, in order to unfairly compete with the rest of the financial world—local banks, credit unions, and the state and local governments they lured into being counterparties to their rigged swaps. The SDNY ruling is on appeal to the Second Circuit.

In the meantime, the FDIC is taking another approach. Its 24-count complaint does include antitrust claims, but the emphasis is on damages for fraud and conspiring to keep the LIBOR rate low to enrich the banks. The FDIC is not the first to bring such claims, but its massive suit adds considerable weight to the approach.

Why would keeping interest rates low enrich the rate-setting banks? Don’t they make more money if interest rates are high?

The answer is no. Unlike most banks, they make most of their money not from ordinary commercial loans but from interest rate swaps. The FDIC suit seeks to recover losses caused to 38 US banking institutions that did make their profits from ordinary business and consumer loans—banks that failed during the financial crisis and were taken over by the FDIC. They include Washington Mutual, the largest bank failure in US history. Since the FDIC had to cover the deposits of these failed banks, it clearly has standing to recover damages, and maybe punitive damages, if intentional fraud is proved.

The key role of the Federal Reserve

The rate-rigging banks have been caught red-handed, but the greater manipulation of interest rates was done by the Federal Reserve itself. The Fed aggressively drove down interest rates to save the big banks and spur economic recovery after the financial collapse. In the fall of 2008, it dropped the prime rate (the rate at which banks borrow from each other) nearly to zero.

This gross manipulation of interest rates was a giant windfall for the major derivative banks. Indeed, the Fed has been called a tool of the global banking cartel. It is composed of 12 branches, all of which are 100% owned by the private banks in their districts; and the Federal Reserve Bank of New York has always been the most important by far of these regional Fed banks. New York, of course is where Wall Street is located.

LIBOR is set in London; but as Simon Johnson observed in a New York Times article, titled The Federal Reserve and the LIBOR Scandal, the Fed has jurisdiction whenever the “safety and soundness” of the US financial system is at stake. The scandal, he writes, “involves egregious, flagrant criminal conduct, with traders caught red-handed in e-mails and on tape.” He concludes:
This could even become a “tobacco moment,” in which an industry is forced to acknowledge its practices have been harmful—and enters into a long-term agreement that changes those practices and provides continuing financial compensation.
Bill Black concurs, stating, “Our system is completely rotten. All of the largest banks are involved—eagerly engaged in this fraud for years, covering it up.” The system needs a complete overhaul.

In the meantime, if the FDIC can bring a civil action for breach of contract and fraud, so can state and local governments, universities, and pension funds. The possibilities this opens up for California (where I’m currently running for State Treasurer) are huge. Fraud is grounds for rescission (terminating the contract) without paying penalties, potentially saving taxpayers enormous sums in fees for swap deals that are crippling cities, universities and other public entities across the state. Fraud is also grounds for punitive damages, something an outraged jury might be inclined to impose. My next post will explore the possibilities for California in more detail. Stay tuned.

Source

April 15, 2014

Predictably, Central Bankers Suggest the 'S-Word' ... Securitization

Why Europe needs the City's financial weapons of mass destruction ... There is very little chance of a market-led recovery taking hold in Europe without a revival in securitised lending to give it legs. America's sub-prime lending boom led to the banking crisis, yet securitisation is poised to make a comeback ... They were the "financial weapons of mass destruction" which blew up the world economy, yet perhaps surprisingly, they are poised to make a comeback – and what's more, it is with the active encouragement of Europe's new generation of central bank governors. – UK Telegraph 

Dominant Social Theme: Wall Street does God's work after all. 

Free-Market Analysis: So Europe's central bankers have decided that the only way to revitalize the European economy – especially Southern Europe – is via securitization of assets. 

This we learn from Jeremy Warner, assistant editor of The Daily Telegraph, and author of the article excerpted above. Is it possible that Mr. Warner did not think up this thesis all by himself? 

Is it possible that it was, ahem ... suggested to him? 

As we have reported regularly, those charged with maintaining economic order are bound and determined to continue to support – and expand – the current stock market boom. 

And so ... enter securitization. Of course, this financial strategy is widely held to have aggravated the 2008 financial crisis. But no matter. Five years is long enough. There is a market to stimulate and securitization provides the wherewithal. 

Perhaps this is the reason we are now treated to a securitization "white paper" by Europe's central banking crowd. (See below.) And an article, as well. 

Perhaps the groundwork is being laid. Directed history is about to welcome asset securitization back into the fold of reputable financial strategies. 

You see, the problem is (according to the bankers) that credit from banks is not being extended. To some degree, reportedly, perpetually dampened interest rates are crowding out securitization. 

This issue of low rates is obviously a big deal to central bankers. We wrote about it recently here: 

IMF Misleads on Interest Rates

The idea would be that securitization can take the place of low interest rates. The ECB wants banks to increase lending while reducing leverage. If banks can bundle their loans via securitization, they can move those loans off the books. 

Once the loans are off the books, the bank will have additional capital available for lending. Or so the thinking goes. 

Here's more: 

Could we so soon have forgotten the damage that these fiendishly complex instruments inflicted on the world? How could we be even thinking about inviting them back into the fold? 

Well we are, and the reasons for it are sounder than you might think. Indeed, I would go further, and say that there is in fact very little chance of a broadly based, market-led recovery taking hold in Europe without a revival in securitised lending to give it legs. ... 

In the run-up to the crisis [of 2008], securitisation was one of the main mechanisms by which banks expanded their balance sheets and facilitated abundant credit. New lending, whether for mortgages, credit cards, car loans, commercial property or even straight SME finance, would be routinely packaged up and sold off to investors, thereby freeing up capital for yet more lending. ... 

The reality was that the risks were becoming progressively concentrated, through securities trading operations, on bank balance sheets, or in vehicles connected to banks, so that when the sub-prime crisis hit, and many "asset-backed securities" were found to be worthless, they undermined confidence in the entire banking system. 

Why on earth would you want to bring back such collective madness? Some of the answers to this question are provided in a newly published joint paper by the Bank of England and the European Central Bank, a front runner to a more detailed consultation due to be issued next month on how to remove some of the blockages to a resurgent securitisation market. 

Amusingly, the paper regurgitates many of the arguments in favour of securitisation that ahead of the crisis had lulled banking regulators into thinking it not just safe but, positively beneficial. The following sentence could have come straight from the mouth of Alan Greenspan circa 2006; a revival in asset-backed securities (ABS) issuance "could translate into a diversified funding source for banks and potentially transfer credit risk to non-bank financial institutions, thereby providing capital relief that could be used to generate new lending to the real economy". 

But my intention is not to mock; rather, it is to praise. There is nothing wrong with securitisation per se, provided it is kept simple and transparent, and the wretched credit rating agencies are kept well away from the game, so that investors themselves can make up their minds about the risk, rather than abdicating responsibility to corrupted outside analysts. 

The article concludes by pointing out that Europe "desperately needs new sources of market-based finance" and must re-adopt the securitization schemes of the City's "Anglo-Saxon alchemists." 

The article even presents securitization as a political football. Central bankers "get it" while Brussels does not. In other words, Brussels is inclined toward strict regulation of securitized products while the banking community understands that the free market of financial instruments – maligned as they are – has a place as well. 

Should we be worried about increased securitization? Not according to the article: "Properly contained, these 'financial weapons of mass destruction' are key to unlocking renewed growth and a well functioning economy." 

This is where we depart from the article's analysis. The problem of modern Western economies is that they are central bank driven. Any single financial strategy is bound to blow up sooner or later because central-bank money printing inevitably creates great booms and busts. 

During the "boom" period, economies expand dramatically and it seems that currency available to entrepreneurs and even average workers is inexhaustible. 

During the "bust" period the reverse is true. Suddenly, companies are going bankrupt, employment is diminishing, stock markets are swooning and bankers are discovering that their balance sheets are hollowed out. 

Depending on the size of the market distortion, the gradual realignment of the economy can take months or years.

The current economic crisis has been going on for at least a half-decade or more because there is a consensus among bankers and politicians that those firms – financial and industrial – that need to go bust ... won't.

The "crony capitalism" that has led to this state of affairs is responsible for the endless Great Recession as well. Money circulates only reluctantly because people don't know where to invest. Large companies and banks may yet be secretly bankrupt. No one knows.

The modern central-bank run business cycle also makes regulation irrelevant because whatever regulations are passed during a bust – not that they would be effective anyway in the long term – are unwound toward the top of the boom.

There are arguments by the "national socialist" wing of the alternative media claiming that central banks are not responsible for money creation and that it is the "private sector" via commercial banking that creates most money via lending.

But this is fairly nonsensical. There were around five central banks at the end of the 19th century and today, some 100 years later, there are about 150, including 70 or so that are under the direction of the BIS. It is central banks that provide the command-and-control mechanism for monetary creation. Central banks these days set the parameters for commercial bank loans. Not enough "capital" (central bank electronic digits) and no loans can occur.

It is central banks that set the pace when it comes to money creation via absurdly low interest rates that are maintained in order to stimulate another bubble. And we can gauge the desperation of the central banking crowd by their determination to bring back "private market" securitization.

The "free-market" that such securitization is supposed to stimulate remains both moribund and farcical. And if it were somehow stimulated by securitization the result would inevitably be the same boom-and-bust that occurred throughout the latter half of the 20th century.

Nonetheless, we anticipate these sorts of strategies will be tried. The globalist crowd is determined to further inflate equity markets for a variety of reasons, as we have long pointed out. The Wall Street Party that we have exhaustively analyzed is not a marketplace evolution but a massive manipulation that includes fiscal, monetary and regulatory elements.

In pursuit of this "party" internationalist bankers are now, once again, floating securitization as methodology of credit expansion.

They are wedded to an excessively expansionist stock market for a variety of reasons – as we have previously reported. These sorts of proposals are not random suggestions. If the globalists have anything to do with it, markets will continue to be pumped incessantly.

Conclusion

A bigger debacle ultimately awaits. But not yet. Not for a while …