Financial Review

Inmates Run the Asylum

Financial Review by Sinclair Noe

DOW + 20 = 18,272
SPX + 1 = 2122
NAS – 2 = 5048
10 YR YLD – .10 = 2.14%
OIL – .01 = 59.87
 

The S&P 500 index hit a record high close for the second day in a row. The S&P added 0.3 percent this week for its first back-to-back weekly gain in more than a month. The Nasdaq posted a small gain for the week.  The Dow Jones Industrial Average gained about 0.4 percent for the week. The Dow is close to another record. The old record is 18,288 from March 2.

 

So, to see if this little rally has legs, we can look at the Dow Jones Transportation Index, because according to Dow Theory, if the industrials are performing, they have to ship their products to market, so the Dow Transports should confirm any move by the Industrials. We are not getting confirmation. Transports topped out in November, and then there were 4 failed attempts to break through the high of 9310. And since March, the Transports have been consolidating lower. Now this doesn’t mean that the Industrials can’t hit a new record on Monday; after all the index is within spitting distance of the old record; but if the rally has legs, we would need to see Transports exhibit some signs of life. When we see a divergence, the we can expect the transports to drag down the broader market.

 

Industrial production fell a seasonally adjusted 0.3% in April.  Excluding autos, manufacturing was down 0.1%. As expected, mining and utilities output declined last month; that category includes oil exploration – which was down 14.5%. Capacity utilization dipped to 78.2% from 78.6% in March, indicating little cost pressure on goods prices. Meanwhile, the University of Michigan Consumer Sentiment Index fell to a preliminary May reading of 88.6, a seven-month low, compared with a final April level of 95.9.

 

A new study of labor market data by the Kansas City Fed concludes that since 2009, job growth has been strong for middle-skill and high-skill workers, but has remained weak for low-skill jobs. Middle-skill jobs rebounded in the first two years of the recovery and high-skilled jobs started to return in 2012. Growth in the upper two sectors has improved in each of the past three years. Low-skill jobs remain the one segment of the labor market that has yet to return to prerecession growth levels.

 

Note, the study talks about skill jobs, not about wages, although it may rightly be assumed that a highly skilled adjunct professor would make more than burger flipper – that is not always the case. Last week’s jobs report showed average hourly wages increased by only 0.1% in April and 2.2% for the past twelve months, which really means wages were flat after factoring inflation, and even in a recovering job market. What we have seen is wages fall in a recession, but remain flat in an economic recovery. Because wages remain sluggish, monetary policy doves are urging the Fed to hold off on raising rates. Yellen acknowledged that wages are not where they should be at her Congressional testimony last month.

 

So, where is the slack in the labor market? Much of it comes from workers who lost jobs in the downturn, and just left the labor pool; many of those workers were discouraged at prospects, and many others took a somewhat forced version of retirement. It is estimated that somewhere between 6 million to 17 million workers are under-employed, while another 6 or 7 million left the labor pool and are no longer counted. And don’t forget that new workers are added to the labor pool at the rate of about 80,000 per month. All those students in their graduation caps and gowns will be looking for jobs next week. So, there is plenty of slack (without even touching on globalization), and that is all reflected in wages.

 

The median weekly real income of men (including both wage and salary workers) working full time is an amazing $80 per week less today than it was 36 years ago in 1979, when converting to current dollars. That adds up to some $4,000 per year. And the median household income is down $5,000 per year over the past 15 years. And this is happening even as the jobs that are available demand a higher and higher skill set.

 

Dealmaking in the U.S. in 2015 has climbed 48 percent year-on-year to $565 billion, the highest level since 2007, following a string of multi-billion dollar acquisitions this week, including: Danaher acquiring Pall for $13.8 billion, Williams Companies acquiring Williams Partners for $13.8 billion, and Verizon acquiring AOL in a $4.4 billion deal. JPMorgan tops the list of U.S. M&A advisers with $153 billion from 52 deal. The New York Times is reporting that Visa, the credit card company is said to be in talks to buy its former subsidiary, Visa Europe, for as much as $20 billion. And the Wall Street Journal is reporting. Shutterfly, which is in a proxy fight with Marathon Partners Equity Management, said it would continue to consider “strategic transactions that provide compelling value”

 

 

Next week, four banks are expected to plead guilty to criminal antitrust charges in relation to manipulating the foreign exchange, or Forex, markets. The four banks are Barclays, JPMorgan Chase, Citigroup, and Royal Bank of Scotland. UBS will escape a guilty plea to fraud and antitrust charges related to foreign-currency rigging.

 

As required by the terms of a 2012 settlement, UBS self-reported the currency rigging and provided early cooperation which helped prosecutors in their investigation, so they felt they should have immunity for the fraud and anti-trust charges. But UBS is not off the hook; they will likely skate on anti-trust but still face fraud charges; and the reason is simple – they are a repeat offender. In 2012, UBS was under investigation for rigging the Libor, interest rates; the bank reached a settlement with prosecutors in which they agreed to “commit no United States crimes whatsoever” for the two-year term of the agreement. The 2012 settlement on rigging Libor followed on the heels of a 2011 settlement related to antitrust violations in the municipal-bond market. And that followed on the heels of a deferred-prosecution agreement in 2009 to resolve charges it helped American taxpayers hide money overseas.

 

So, now UBS is whining about not getting total immunity; apparently unable to distinguish between leniency and absolution. As a result, the bank is scrambling to continue to hold its charter in the US by obtaining waivers from regulators to allow it to continue operating certain businesses and access some benefits. UBS lawyers have been in marathon talks this week with prosecutors hammering out what court-filed documents will say about the bank’s alleged violations.

 

So, it sounds like the Justice Department is finally getting tough. According to the Murdoch Street Journal, the prosecutors were blowing up the 2012 deal. It sounds tough, right? Not so much. It is very likely that UBS will be allowed to continue doing business in the US, after they pay a multi-million dollar, slap on the wrist, fine. But what about the other banks that are expected to plead guilty to criminal anti-trust charges? Well, again, it’s a slap on the wrist fine and they will be able to continue doing business despite criminal charges.

 

But wait, there’s more. For example, what will happen to the foreign exchange market? Don’t worry, it’s in good hands. The New York Federal Reserve Bank is responsible for something called the Foreign Exchange Committee meets six to eight times per year and is responsible for establishing best practices in the Forex market. The committee members are commercial banks and investment banks. The Chair of the committee is a man named Troy Rohrbaugh, who is also the head of Foreign Exchange Trading at JPMorgan Chase, now and when the criminal activity was alleged. Before him, the chair was a man named Jeff Feig, who was from Citigroup. So, at the NY Fed, the committee charged with cleaning up the Forex market was chaired by a couple of guys from a couple of banks that are about to plead guilty to criminal charges in the Forex markets. And with guilty pleas expected next week, what has the NY Fed done about this arrangement? Nothing. Because the NY Fed is a captured regulator. Truly a case of the inmates running the asylum.

 

And that brings us to former Federal Reserve Chairman Ben Bernanke’s latest blog. The Bailout Prevention Act-a bipartisan bill introduced Wednesday-would seek to curb risk-taking from large banks by removing some of the Fed’s ability to bail them out. Bernanke thinks limiting bailouts is a bad idea. Bernanke says that in the 2008 crisis, the Fed served as a lender of last resort and he takes his bows for saving the global financial system from meltdown. And there is some truth to that. Then he says the Fed should still be able to bailout the banks if another problem crops up. And there he is wrong.

 

Bernanke says limiting the Fed’s ability to protect the economy in a financial panic would be a mistake. But we know the Fed has many other tools beside bailouts. What the Fed should do is fulfill its duty as a regulator. The Fed should set strong standards for banking activity; they should work with prosecutors to enforce the rules; if the laws are broken, the offending banks should have their charters revoked and the bank officers jailed. And if that happened, I suspect the banks would become the very picture of financial probity and we would never have to worry about a bailout ever again. And if they did slip up and try to destroy the financial system, we could chop them into small digestible pieces that could no longer pose a threat.

 

 

 

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