Politically Dysfunctional Insanity
by Sinclair Noe
DOW – 128 = 15,129
SPX – 10 = 1681
NAS – 10 = 3771
10 YR YLD – .04 = 2.61%
OIL – .56 = 102.31
GOLD – 8.30 = 1328.90
SILV – .07 = 21.81
We’ll get to the shutdown and all that fun politically dysfunctional insanity in just a moment, but first we need to wrap up the third quarter. The Dow Industrials are up about 260 points for the third quarter, and the S&P500 is up 80 points. Year to date the Dow has gained about 2000 points and the S&P has gained about 260. Since the start of the year, the yield on the 10 year Treasury note has climbed from around 1.75% to 2.51% at the end of the second quarter (briefly touching 3%). Oil prices dropped from around $110 in just about a week’s worth of trading, but prices are up about $10 dollars since the start of the year, and down about $1 for 3Q.
If you’re wondering how the Sell in May idea has worked out, well the Dow is down about 130 points from the May sell signal and the S&P is down 35 points. So, Sell in May is looking good and could look a whole lot better if the government shuts down in a little less than 5 hours. Tomorrow, the fourth quarter begins. A potential federal government shutdown looms at midnight.So, the question is whether underperforming Wall Street traders will push prices higher in the face of government stupidity; and the answer is probably not.
Of course Congress could finally realize how stupid they are and they could come to some sort of resolution to keep the government open. An eleventh-hour deal looks unlikely at this point. But if you recall, the fiscal cliff bargain that started 2013 actually came in after the mandated deadline. It wouldn’t surprise me to see these clowns come in with a late save again.
The similarities between the fiscal cliff market reaction and the current shutdown threat are striking. The broad market fell 6 out of 7 days immediately leading up to the fiscal cliff scare. This time around, the market is down 7 out of 8 sessions heading into the shutdown.
On March 6, 2009 the market officially hit bottom with the S&P at 666 (yes, that is an ominous place to start something good). From there we have enjoyed a healthy and lengthy bull market; you can argue it is a cyclical bull, but it has been a pretty neat rally.
Unfortunately all good things must come to an end. So lets consider what will bring about the end to this bull rally. Traditionally, there are the 2 main reasons that end a bull market and bring about the next bear: a recession is on the way, or because stocks very overvalued. Typically, bulls die because of a looming recession. However, you may remember 2000, where valuation became extreme and the exuberance was eventually deflated with the popping of the tech bubble.
So, here we are, stocks down 7 out of the past 8 sessions. The media is riveted with the crisis; the shutdown clocks are ticking; traders are nervous about the shutdown because it can do some very real damage to the economy; make no mistake and do not underestimate the potential harm and the possibility that Congress could push the economy into recession. Or the politicians could come up with a Hail Mary.
Beyond the immediate, there are underlying problems. Remember the Fed’s recent non-taper, alongside lowered growth forecasts for 2014 would actually suggest things are not as rosy as Wall Street would have you believe. Yields continued to fall, for the basic reason that you can not normalize yields unless you also normalize growth and inflation. The forgotten idea is that QE3 has not resulted in an increase in inflation expectations. Stocks fell when taper talk took hold from mid-May to June, and are now dropping after the Fed said no taper at all. The economic data simply does not support an easing of stimulus. The third round of QE has lost its reflationary punch, and if $85 billion a month is not enough to kick-start growth, then maybe we should reconsider valuations. Now toss in a government shutdown and it’s like tossing a match on gasoline.
The US will be downgraded to “selective default” (SD) if the debt ceiling isn’t raised by mid-October and the government fails to service a debt, says S&P, the ratings agency, but there will be no change to the AA+ credit rating as long as the impasse is short-lived. “This sort of political brinkmanship is the dominant reason the rating is no longer AAA.”
If this all sounds familiar, it is.
Come mid-October, the United States will have only $30 billion of cash on hand. On any given day, its net payments can reach as high as $60 billion. That means that unless Congress raises the debt ceiling, allowing the Treasury to issue new debt, the United States may find itself unable to make all of its payments — stiffing government contractors, or state and local governments, or even its bondholders.
Economists widely agree that such an unprecedented event would have profound effects for the markets, likely precipitating a stock-market sell-off and setting off a round of global financial turbulence. But it has always been a little unclear just how it may play out. The Treasury might announce it would be forced to delay some payments, promising to do what it could to make sure bondholders were made whole. But then what?
Let us be perfectly clear: crossing the debt ceiling would be catastrophic. The Treasury’s systems do not clearly mark what scheduled payments are for what reasons, so it is impractical to try to prioritize payments. And clearing systems like Fedwire do not allow defaulted securities to flow, so the system would seize. In order for the clearing systems to work, the Treasury would need to notify the market of a default almost a day before the default happened (to give everyone time to modify payments), and that is not going to happen because the Treasury will not want to declare default while Congress still has time to pass a bill. Also the Fed does not take defaulted securities as collateral at the discount window, even if those securities are still trading at par.
While we think the probability of the debt ceiling causing a technical default in the Treasury market is near zero, nonetheless, there are likely to be market disruptions. The main issue is that the markets are not set up to trade or finance defaulted Treasuries. While many RP documents say that defaulted securities cannot be delivered as collateral, delivery systems are not set up to easily sort out which Treasuries have defaulted and which have not (there are no cross-defaults on Treasuries), so the RP markets can seize up as the debt ceiling drop-dead date approaches.
That’s pretty technical, but it boils down to this: A debt-ceiling crisis could throw sand — a whole lot of sand — into the gears of the financial system, making it impossible for market participants to tell “good” collateral from “bad” collateral. As my colleague Binyamin Appelbaum points out, that’s essentially the definition of a modern financial crisis.
What’s interesting — and disconcerting — to think about is how all the new tools the Treasury and Fed developed during and after the 2008 financial crisis will work in the event of a new crisis. The Treasury would be the source of the turbulence it would desperately be trying to stop, after all.
So, here’s where we stand at last look, (you just need to use your imagination to see the Countdown clock ticking away in the lower left hand corner). House Republican leaders pushed forward a new plan to tie further government spending to a one-year delay in a requirement that individuals buy health insurance, after the Senate took less than 25 minutes to convene and dispose of a weekend budget proposal by the House Republicans.
The Republicans were planning a vote later Monday on the new plan, which also includes a denial of government subsidies to lawmakers and their staff members buying health insurance.
President Obama spoke in the White House briefing room on Monday evening, and castigated House Republicans for failing to perform one of the most basic functions by not providing money for the government. He said a shutdown would harm the economic recovery.
In their latest move, House Republicans attached language to a government funding bill that would delay the mandate that individuals obtain health insurance and would force members of Congress, their staffs and White House staff members to buy their health insurance on the new exchanges without any government subsidies.
That proposal makes it more likely that a partial shutdown of the government will begin just after midnight, barring a last-minute retreat by the House.
I wanted to take a few moments to go back over a story from last week. You may recall that last week, Jamie Dimon met with Attorney General Eric Holder to discuss a possible $11 billion dollar fine against JPMorgan for mortgage backed securities violations. We know that Dimon was looking for a smaller dollar figure and comprehensive liability coverage, but beyond that we don’t know much about their conversation. The bigger question is why there was a conversation at all. Why did Eric Holder personally meet with Jamie Dimon. Do you think any AG would have met with Michael Milken when he was being investigated? Why did Holder meet with Dimon but not with Bernie Madoff?
What we have seen is how regulators and law enforcement bow down to their masters at the banks. You’ll witness the occasional stern word in public from the Administration or the regulatory minions to maintain the appearance that they operate independently of their financial lords and masters. But Holder has been so absent from any meaningful action that it’s surprising to see him pretend to play a hands-on role. His main job seemed to be acting as propagandist for enforcement theater.
Here’s a recap from the Washington Post:
“The sage of Wall Street journeyed to Washington.., but Jamie Dimon’s visit was unlike any the JPMorgan Chase chief has made before.
“Dimon sought a meeting with Attorney General Eric H. Holder Jr. in an urgent bid to dispose of multiple government investigations into the bank’s conduct leading up to the financial crisis — and avoid criminal charges. The deal that Dimon discussed with Holder would involve paying the government at least $11 billion, the biggest settlement a single company has ever undertaken, according to several people familiar with the negotiations…
“For Holder, meanwhile, a landmark settlement with JPMorgan could help quiet criticism that the Justice Department has failed to hold Wall Street accountable for sparking the housing market’s crash and the ensuing recession. Holder was criticized by lawmakers and consumer advocates this year for saying that some banks had become too big to prosecute.”
So, WaPo considers Dimon a “Sage of Wall Street”? The financial media has been falling over themselves to kiss Dimon’s ring, perhaps forgetting that the results Dimon delivered are now being diminished by close to $18 billion in legal fees, plus maybe $11 billion in new fines. “Sage” connotes wisdom above all, and Dimon’s conduct during and after the Whale affair was anything but. Still, on CNBC, the conclusion was that Jamie Dimon was secure in his job because “the stock’s touching a ten-year high. It’s a cash-generating machine.”. Or as Maria Bartiromo asked: “How could you criticize that?” Which is kind of like saying a restaurant poisoned their diners, but the veal parmigiana was delicious.
Remember, the CFTC has not settled its Whale charges, and it might unearth some further violations or facts that make JP Morgan top brass look even worse. The DoJ (through its Southern District of New York office) has charged two JP Morgan traders. It isn’t clear whether it will succeed in getting either one extradited, but if it did, you can be sure prosecutors would be seeing if they could get them to cop a plea bargain to implicate more senior management. And at some point, some regulator might actually wake up, smell the coffee and see the clear and obvious violation of Sarbanes Oxley. That would be a slam dunk prosecution unless Jamie can prove he was out of town when the London Whale imploded, the telegraph lines were down, a blizzard made communication impossible and frozen bison blocked the railroad tracks; unless Jamie can prove that, there is no way he could Not have known what was happpening. (Sarbanes Oxley explicitly waives liability under those blizzard conditions.)
JPM’s rap sheet is so long and dirty that the gall of such in-your-face cronyism is simply breathtaking. Or maybe AG Holder is establishing new policy. Americans pride ourselves in insuring that everyone no matter their place in this society can and should expect equal justice. After all the Supreme Court building is emblazoned with “Equal Justice for All”. So Eric will you and your department, in the pursuit of equal justice, now offer all defendants the opportunity to visit your offices and discuss their case directly with you ?
Last week, for the first time since the financial crisis, the government faced off in court against a major bank over lending practices during the mortgage mania. Lawyers for the Justice Department contend that Countrywide Financial, a unit of Bank of America, misrepresented the quality of mortgages it sold to Fannie Mae and Freddie Mac, the taxpayer-owned mortgage finance giants, starting in 2007. And this may not be the only case to go to trial, there are a few others in the wings where the judge got tired of the super-lenient, no admission of wrongdoing deals being offered to the banksters.