At Least It's Not Any Worse!

Capital Markets Update

By Louis S. Barnes **************Friday February 22nd, 2013**************** Interest rates, stocks, and hopes for the economy all crested in the last week; not rolled over, just flattened, without acceleration. Applications for purchase mortgages fell, starts of new homes crept up 0.8% from December, and sales of existing homes rose 9.1% from the year-ago, dead-low base. Europe is still rolling downhill, all of the weak economies (including France) falling out from under fiscal-austerity promises. Leadership throughout the zone sounds like a convention of Baghdad Bobs competing for phony optimism. (If you missed it, Muhammad al-Sahhaf became famous for his daily “There are no Americans within 100 miles of Baghdad!” while on split-screen M-1As clanked by, two blocks away). The Fed released minutes of its January meeting, which in the name of openness and clarity confused everyone. Perfesser Bernanke unlike his predecessors runs the place like the Princeton Faculty Club, letting everyone have a public say. The minutes are anonymous, describing “several” with one view, “many” with another, and “a few” over there. Each meeting includes the Chairman, six Presidentially appointed and Congressionally confirmed governors, and 12 presidents of regional Feds (five of whom rotate as voting members, but all yap). These minutes revealed a long, aimless discussion of when and at what slope the Fed will conclude QE purchases of Treasurys and MBS. Several regional presidents reflect provincial boards filled with hard-money bankers and local made-theirs. Disregard any news story containing these names, lowest regard first: Ms. George, Messrs Fisher, Bullard, Plosser, Kocherlakota, and Lacker. For now Perfesser Bernanke, the appointed governors, and the brightest of the regionals are firmly in control and of one mind: this economy is not ready to leave ICU. Instead of Fed-worry, consider a puzzle (data thanks to John Mauldin and Ankur Shah). Beginning in the late 1990s, corporate profits leaped from a 50-year normal 5%-6% of GDP to a record over 10%. From WW II through 1970s, US wages were equal to about 50% of GDP, then in the 1980s slipped to 47%, and since the late 1990s to about 44%. In that same span, union membership has collapsed from nearly 40% to about 11%, and more than half of the remainder are unionized government employees, the most secure jobs with the best benefits. I can hear my friends on the Left sputtering at predation by the 1%. Instead, glance outside that box. At least 60% of S&P500 profits are earned overseas, thus largely irrelevant to domestic wages. US labor law is as friendly to unionization as ever; if corporate oppression were the case, we would be organizing in record numbers. One hundred years ago, the 1% were predators, Rockefeller, Carnegie, Gould and all, and the US Army visited town to break strikes. From 1990 to 2008, world trade excluding energy, just merchandise and services, exploded from $4 trillion to $19 trillion. Something more than one billion Asians entered the global workforce, willing to work for a small percent of any Western worker’s pay. Modern US corporations, light on their feet, flat organization charts, co-opting unions by treating labor as valued capital, have been making a fortune via turnstiles set up in the flow of trade, especially in the emerging world. Here in the US, a Darwinian experience. If you’re tech-savvy, plugged into the world economy, competent and motivated no matter how well-educated; or on the health-care gravy train (the only sector of the US economy to add jobs every month of the Great Recession), or in higher-ed… most have not known anything has gone wrong. Not predators, just successful, which I hope still is not a dirty word. If however you faced direct competition with the global labor pool, products and services delivered, measured in, or made of electrons, you’ve been in a lot of trouble. The national what-to-do debate should focus on how to open the path to success for this half or more of our people. Clawing at the successful won’t do it. Compassion and fairness aside, we need the tax base.

Not Much to Write Home About

Capital Markets Update

By Louis S. Barnes **************Friday February 15th, 2013**************** The 10-year T-note continued to creep its way upward, at 2.03% this week the highest in 10 months. Hardly a rocket-ride, but disquieting. Perhaps the US and global economies are turning the long-expected corner, but that turn is still in forecasts, not current data. The gold market suddenly believes the greatest economic danger is past, crashing thirty bucks today. Yet, the NFIB survey of small business is stumbling along in recession. Two other explanations for market movements: just another false-recovery party; and/or queasiest of all, the Fed is losing its ability to hold down long-term rates. In a week dominated by speeches, let them speak. Mr. Obama’s State of the Union, a time warp to the Great Society: “Our government shouldn’t make promises it cannot keep — but we must keep the promises we’ve already made.” In at least half of the households listening, the last dozen years have failed economic expectations, and grown-ups have un-made promises even to children. That’s what sensible people do. Marco Rubio gave the Republican reply. A nice, earnest young man, concerned “not for billionaires, but neighbors.” It was hard to concentrate on his words. His shirt collars are an inch too big… Ichabod Crane? Will his head will fall into his shirt? Cottonmouth-nervous? Wear a Camelback. Not Presidential timber. Not even a splinter. One thing in common with the President: neither has a plan for economic growth. Larry Summers does. And how! In a WaPo OpEd on Monday: focus on growth; make any deal to stretch out the sequester; immediately address corporate tax reform and repatriate the $2 trillion in cash marooned overseas; accelerate the “transformation of North American energy,” Keystone XL and all. “No American should be satisfied with the way the nation’s housing finance system is working. It is high time Fannie Mae and Freddie Mac be forced to step up.” Summers got tossed from this White House. Blocked the view of the Ego in Chief. Then on Tuesday Fed Vice Chair Janet Yellen filed her application to replace Ben Bernanke next year. An able and wise Democrat, her inspired speech and charts are worth study at www.federalreserve.gov. She began by listing three tailwinds usually propelling recoveries, this time faint or stilled. First, fiscal policy cannot act as it might because we have already borrowed and spent our safety margin. If we owed 30% of GDP instead of 80% and rising, fiscal stimulus would have us going. Second, housing is MIA. Which everyone seems to know except government-hating Republicans and the White House, an odd pair. Third, past faith that recessions are short-term, transient affairs helped them to stay short. The longer we’re mired this time, the more endlessly depressing the swamp appears. If that were not enough, Ms. Yellen then spoke to headwinds. First, credit shortage. The rest of her party marches on with Dodd-Frank pitchforks and torches, but she gets it. Over-regulation is as stupid as not enough regulation. Then a couple of magnificent pages in defense of American labor, its skills and motivation. “The increase in unemployment since the onset of the Great Recession has been largely cyclical, not structural.” Those who argue against an active Fed claim that unemployment is the result of obsolete skills and faltered get-up-and-go, and we should take our medicine: collapsed wages and 8% joblessness. Yellen killed ‘em. Last she articulated proper future Fed action. The Fed “does not expect to raise the federal funds rate as long as unemployment remains above 6.5% and [her emphasis] inflation… is projected to be less than .5% above its 2% objective. When one of these thresholds is crossed, action is possible but not assured.” Magnificent. The dim who want mechanical responses will remain… dim. We will not induce inflation beyond target (which so, so many assume and some fools want), nor will we panic at a transient up-tick. May Ms. Yellen’s example of good government at work not be lost on the others. And may those who think the economy is turning fast consider her words, too. Wall Street’s entire focus is on the S&P500 companies whose business models benefit from global turnstiles. Most small business is right here at home.

Range Bound

Capital Markets Update

By Louis S. Barnes **************Friday February 8th, 2013***************** Long-term rates slid back a bit this week, the 10-year T-note holding 2.00%, mortgages near 3.75%, higher than 2012 second-half, but nothing dramatic. It was a thin week for data, but two reports were startling. First, the US trade deficit in December arrived 20% lower than forecast because of a surge in exports of... oil. Second, consumer credit continued its rise: a $15.9 billion jump in November, and $14.6 billion in December. The usual suspects have seized on this run as a sign of normal, cyclical recovery ahead, and it is not. The only two components growing: student loans and car paper, one crushing the next generation, the other available only because it's the only consumer collateral that's easy to repossess. All other categories of consumer credit are falling, from credit cards to mortgages. The best news in a long while, maybe since the financial crisis began in 2007: The Justice Department's suit against S&P. Here we are, eight years after the subprime peak early in 2006, five years after the bankruptcy of Fannie and Freddie, and we still have no national consensus on Who Shot John. Absent that consensus, everyone from government to regulators to civilians to bankers to markets has struggled to function, swinging wildly at each other, punishing for the sake of punishing, and artfully shifting blame for political reasons, score-settling, or to take cover. The two worst actors in the last years: Big Lie people on the Right insisting that the whole credit disaster was the fault of government, especially its lending agencies; and second, the perps themselves -- who can hardly be blamed for failure to confess but have thus far escaped by obfuscation, muddying evidence. The perps were the investment bankers. Never doubt it. There were hangers-on, and the fantastic personal failure of Alan Greenspan. However, the IBs drunk on cash, each one with supreme faith that he and he alone would get out before the crash, operating entirely in private markets... ruined them. One damning datum has been in plain sight like the booze in "Untouchables:" private-label MBS were $543 billion in 2002, and $2.2 trillion four years later. Today more than half that is a dead loss. The IBs have claimed throughout, "How were we to know that housing would crash? And those awful mortgage brokers tricked us." These guys were -- and are -- the best analysts of credit in the world. That's the job. But when they went Dark Side, they needed one, small group of enablers. And they bought them. The two dominant credit-rating agencies, S&P and Moody's (the latter controlled by that nice man in Omaha) have operated in bizarre space ever since the Depression. Everyone uses their ratings, often commanded to do so by law (legal investments by broad classes of institutions and agencies), yet they cannot be held liable for mistakes, protected by free speech (!!), and they are paid by the IB-issuers who make more money the higher the rating. For Justice to prove fraud, it must show that the raters knowingly up-rated bad paper. That's a tough case. However, authorities long after the Depression used iffy lawsuits like this to bring daylight, and to see who under enough pressure might turn state's evidence. If we can at last agree on the story, the real story, then we can begin to relax this Keystone Kops episode of beating hell out of the honest because there used to be bad guys in the neighborhood. Today, if every regulator shut down, you couldn't get a subprime loan out of securitization for a generation. No buyers. We could begin to discuss banks and banking in adult fashion, acknowledging their proclivity to fail in heaps, the need for government and social backstop, and the impossibility of turning them into independent bomb-proofs, large or small. Then get around to the essential: make clear what we expect of each individual banker, and the personal consequences of failure, even by the accident-prone. There is no other way back to an adequate supply of credit, and a sound one. Maybe, just maybe, this S&P case will bring the light to begin the process.

Ouch Continued!

Capital Markets Update

By Louis S. Barnes*****************************Friday, February 1st, 2013 The sustained rise in long-term rates in January has stabilized for the moment, and its causes are coming clear. Mortgages have risen from 3.50% or below in the prior five months to roughly 3.75%, and the almighty 10-year T-note from a centerline near1.75% to almost 2.00%. The rise has been puzzling. The Fed committed just last fall to buy $85 billion each month in MBS and long Treasurys, with the expressed purpose of holding rates down until our economy turns sharply better. Which it hasn’t. Today’s employment report had its usual ambiguities. Optimists and the White House are pleased at 157,000 new “non-farm payroll” jobs, and the Nov-Dec upward revision of another 127,000. Markets watch this number, due on the first Friday of each month, more than any other report because jobs are such a tender spot for the Fed and inflation. However, it is one of the least accurate of all data series. The rate of unemployment most civilians seem to have learned is even more unreliable, but rising to 7.9% in January certainly gives the Fed more space to buy bonds, and pushes back the yips that the Fed would tighten policy in 2013. Other than those headline items, payrolls and jobless, the employment details were dim. Year over year, wages have grown 2.1%, barely above core CPI. There is no movement in hours worked, overtime, or participation rate — nor perhaps most telling of all, in unemployment inclusive of “involuntary part-time” stuck at 14.5%. That figure supports the argument that the new jobs being created are inferior to the ones we lost. So, why the rate rise, one nearly always reflecting an improving US economy? In a precursor of our long-term future, rates have risen because forces overseas are larger relative to the US economy than at any time in more than a century. Part of the reason that long-term rates fell so low last year was fear of implosion in Europe, driving global cash to Treasurys and the dollar. The ECB last fall engaged in one of the great bluffs of all time, stopping the run on Club Med bonds by Outright Monetary Transaction — just buy the bonds with invented money. The ECB has yet to execute a single OMT purchase; they are contingent on any nation requesting help also accepting enough austerity to get German permission for the ECB to proceed. That would be suicidal austerity, but the bluff has held. In a world desperate for yield, investors have bought fat yields for exceedingly dubious credits (Spain, Italy) on the theory that the ECB will protect them. Thus cash sloshes out of Treasurys and the dollar and into the euro and silly-bonds. In charts in the on-line edition, you can clearly see the euro and 10-year note yield moving in tandem. Then turn to one of the strangest places on Earth. Japan. In deflation for 20 years, its government a turnstile spinning in and out one ineffective bunch after another, and running out of places to hide new debt annually half of government expenditure… now is trying to do the right thing. Panic. New Prime Minister Abe (also one of the old ones) has instructed the Bank of Japan to print as necessary to turn 1%-2% deflation into 2% inflation. Buy Japanese Government Bonds (JGBs) or foreign bonds, or both. The BOJ is resisting as only it can, but Abe will replace its leaders. Japan is in bluff, too, the BOJ still inactive, but the bluff has had two large effects. First on the yen, in 90 days from 78/dollar to 93 — the weakest in three years. The yen move in the last six months also coincides with higher Treasury yields. A lot of people have been mistakenly worried about inflation for, shoot, twenty years, and especially during the last four years’ QE by the Fed. However, if the Germans let the ECB buy, and the BOJ buys like crazy, inducing inflation on purpose, the world deciding that inflation is better than recession… then sell long Treasurys. That’s the fear, but I don’t think it’s the reality. Neither the Fed nor ECB will tolerate inflation, and Abe’s plan for Krugmanism at the BOJ has all the long-term benefit for Japan of Pearl Harbor. As central-bank inflation bejabbers recede, there’s a pretty good chance to see our rates come back down.