Financial Review

Sunlight is the Best of Disinfectants

08202014

DOW + 59 = 16979
SPX + 4 = 1986
NAS – 1 = 4526
10 YR YLD + .02 = 2.42%
OIL + .63 = 93.49
GOLD – 3.80 = 1292.40
SILV + .04 = 19.55

No economic reports today, but the Federal Reserve released the minutes of the July 29-30 FOMC meeting. You will recall that the Fed left interest rates unchanged and continued the taper by reducing large scale asset purchases by $10 billion a month, with the plan to end purchases by October. The Fed had said in its policy statement following the July meeting that there was “significant” labor market slack, but the minutes showed many members of its policy-setting panel thought this characterization “might have to change before long.”

Most Fed officials wanted further evidence the labor market and the economy were showing significant improvement before changing their view on raising rates, but they said, “Labor market conditions had moved noticeably closer to those viewed as normal in the longer run,” and policymakers “generally agreed” the job market was healing faster than they had expected.

Most Fed policymakers felt any change in their view on when to start raising rates “would depend on further information on the trajectories of economic activity, the labor market and inflation.” Well, we got more data yesterday showing that inflation is not a problem yet; so that leaves economic activity and the labor market. The economic trajectory has remained sluggish since the beginning of the recovery; GDP turned negative in the first quarter of this year and then showed a very strong bounce in the second quarter. Is the second quarter bounce sustainable? It seems most Fed officials think it could be. And the Fed minutes almost seem to gloss over this long-term sluggishness, or what the Center for Economic Policy Research calls secular stagnation. What is secular stagnation?

A persistent gap between actual and potential output. Because of an imbalance between saving and investment, the nominal interest rate required to maintain full employment falls to less than zero — not just briefly, but persistently. Since the rate can’t be cut to less than zero, monetary policy (as currently conceived) can’t keep the economy running at full potential.

A slowdown in growth of potential output. This may happen because of demographic changes, or because innovation isn’t what it used to be, or for other reasons.

An irreversible drop in the level of potential output. Even if the full-employment rate of interest is still positive and the growth in potential output hasn’t slowed, the recession may have permanently cut its level — for instance, by causing workers to leave the labor force and not come back. Even if the economy now grows as fast as it did before, it’s on a lower track and won’t ever converge with the path it was on pre-crash.

This all means that the Fed’s long awaited economic liftoff might not happen, at least for another 20 years or so. But the Fed doesn’t seem to be concerned with this problem, which means that if the US economy experiences secular stagnation, the condition will be self-inflicted.

That leaves the Fed with the question of the recovery in the labor market. So, it really boils down to jobs. More jobs, and specifically, the quality of the jobs. So far, the average wage is stuck at $24.25 an hour; too many jobs are part-time or temporary. If we start to see some movement on wages, and more full-time positions, that might be a sign for rate increases. One area of remaining slack is the low participation rate, the percentage of working age population that is still in the labor pool; many people got out of the pool. Last month the economy added 209,000 net new jobs. The unemployment rate moved up to 6.2% from 6.1%. The jobless rate can rise for both good reasons (more people looking for work) and bad reasons (fewer people having a job). Even though the economy added jobs, more people joined the labor force, and that is why the unemployment rate moved higher.

There are many things that could derail the recovery in the labor market, but for now the Fed thinks things are on track, and that means a probable rate increase in the first half of 2015. Any rate increase is likely to be incremental. Right now the fed funds target rate is between zero and 0.25%. It would likely be increased by 25 basis points, with the lower range representing the rate on overnight reverse repurchase operations. In reverse repos, the Fed borrows funds overnight from banks to mop up excess cash in the financial system.

Market reaction to a slightly more hawkish Fed stance: well, the dollar index continued higher, Treasuries dropped but then settled down, precious metals were a little lower, oil was higher, stocks initially threw a little tantrum and then recovered. After all, there were no real surprises.

Elsewhere, we’ve been waiting for the Department of Justice announcement on a settlement with Bank of America. Bank of America has reportedly reached a record $17 billion settlement to resolve an investigation into its role in the sale of mortgage-backed securities before the 2008 financial crisis. The official announcement will come tomorrow. The deal works out to $10 billion in cash, and $7 billion in soft dollar consumer relief – which is really a gift to the bank involving credits for various forms of consumer aid that the bank would or should be doing anyway. So, if you have a BofA mortgage and you’ve been having trouble with a loan mod or a refinance – try again. And by the way, the bank will make money on consumer aid.

The deal requires Bank of America to acknowledge making serious misrepresentations about the quality of its residential mortgage-backed securities issued by itself and by Countrywide Financial and Merrill Lynch. In exchange, BofA will probably not have to actually admit wrongdoing, and they get a free “get out of jail” card.

Usually these settlements include a statement of facts which is most notable for its absence of facts and details. That silence means the Department of Justice is essentially protecting the banks from private lawsuits by deliberately withholding evidence which could result in even further disclosure of really bad behavior and even bigger damages and other unexpected outcomes. The biggest unexpected outcome would be that the public finally says to hell with the bankster criminals and we all see through the flimsy apologists in the media and the cronies in politics.

Most people know the banksters got away with murder; and I use the word literally, not figuratively. Most people want to see bankster executives prosecuted. Most people understand that the fines in these settlements are just a slap on the wrist, cost of business paid by shareholders, and taxpayers. Yep, the fines are typically considered tax deductible.

Tomorrow, the DOJ will announce the biggest settlement ever against a bank: $17 billion. But we know, it’s really a little under $10 billion in cash, with all kinds of little gifts to the banksters to soften the blow. And we know this will do nothing to deter future wrongdoing. You can place a huge derivative bet that they’re still committing those same crimes and new ones (such as subprime auto), so the prosecution clock resets daily.

And the crazy part is that the Department of Justice and BofA think we’re all too stupid to understand the cronyism. They will portray the settlement as a get tough stance on the bankers. Hogwash, I know it, you know it.

About 100 years ago, Supreme Court Justice Louis Brandeis wrote his famous statement that “sunlight is said to be the best of disinfectants” in a 1913 Harper’s Weekly article. He went on to say that transparency is “justly commended as a remedy for social and industrial diseases.” Brandeis actually wrote privately about the idea of transparency 20 years earlier, writing, “about the wickedness of people shielding wrongdoers and passing them off (or at least allowing them to pass themselves off) as honest men.”

About 100 years ago, the country was struggling with what was known as the Money Trust, the rough equivalent of today’s systemically important financial institutions, or too big to fail banks. Brandeis asked how the great wealth of his day had been accumulated, and he concluded: “power breeds wealth as wealth breeds power. But a main cause of these large fortunes is the huge tolls taken by those who control the avenues to capital and to investors. There has been exacted as toll literally ‘all that the traffic will bear.’”

Just a reminder, some of the mortgage problems of Bank of America date back to their acquisition of Countrywide; BofA had their own illegal mortgage problems. The guy who started Countrywide and nearly ran it into the ground is Angelo Mozillo. Until now, the harshest penalty imposed on Mozilo has been a $67 million settlement with the SEC from 2010 to resolve allegations that he misled Countrywide investors. Actually, Mozilo was forced to disgorge about $45 million from the sale of stocks, some of which may have been based on insider information; and then Bank of America paid for most of the other penalties; which is to say shareholders and consumers paid for Mozilo’s penalties.

The US attorney’s office in Los Angeles is now preparing a civil lawsuit against Mozilo and as many as 10 other former Countrywide employees. Government attorneys plan to sue Mozilo, Countrywide’s former chairman and chief executive officer, and other individuals using the Financial Institutions Reform, Recovery and Enforcement Act. The law, approved by Congress in 1989 in response to savings-and-loan scandals, gives prosecutors 10 years to bring cases and has less stringent liability requirements than criminal charges.

Prosecutors dropped a criminal probe of Mozilo in early 2011. The Citizens for Responsibility and Ethics in Washington, a watchdog group, sued the Justice Department in June to try to obtain its records detailing investigations of Mozilo and Countrywide. The group faulted the government for failing to prosecute either Mozilo or the company “despite substantial evidence of wrongdoing.”

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