Leftovers -- Radio Show 5/22/2010

Bank analyst, Meredith Whitney, said investors should avoid bank stocks at all costs.  In the second half of 2010, she expects job losses and a housing double dip.  The drop in reported credit card delinquencies was actually the result of new credit card rules which took effect earlier this year.  She thinks the financial reform bill will "be very bad" for banks".

When it comes to credit cards, the banks are gaming the payments, because, under the new laws which were designed to appear to protect consumers from self-serving billing practices, only the amount of the payment in excess of the minimum must be applied to higher rate balances.  The minimum payment is applied by the banks to lower interest rate balances first.

Elizabeth Warren continues to argue that the loopholes in financial reform which allow the big interstate banks to escape tougher state laws and rules on banks and credit unions create unfair competition, a destruction of a level playing field, and subjects consumers to higher interest rates if not usury.  Senator Whitehouse's amendment would close these loopholes and make big banks subject to stronger state laws if they want to do business in those states.

Another financial reform amendment by Senator Durbin would require credit card companies to cease charging transaction fees if the business also accepts debit cards.  This will help businesses, but it is expected the credit card companies will pass the lost transaction fees in higher card fees to credit card holders.

April CPI went down one-tenth just as it went up one-tenth in March for an annual inflation rate of 2.2%.  Core inflation was unchanged at .9%.  Using the 1980's calculation for inflation, inflation would be approximately 9.5-9.6%.  Using the 1990's calculation for inflation, inflation would be approximately 5.5%.

In the April meeting minutes of the Federal Open Market Committee meeting of the Federal Reserve, it was observed that business conditions are improving but most anticipated the pick up in output would be slower relative to past recoveries.  It is unlikely that consumer spending will be driving economic recovery and the savings rate has dropped.  The housing market appeared to have stalled.  Commercial real estate activity continued to to fall on deteriorating fundamentals.  Small businesses continue to have continuing difficulty in obtaining bank loans.  Small and regional banks are vulnerable to commercial real estate loans.  If European countries expand fiscal consolidation (cut deficits), the result would likely be slower growth in in Europe and a weaker global economy.  As I have noted on several occasions, and as one participant in the FOMC commented, core inflation appears to have been held down in recent quarters by unusually slow increases in the price index for shelter (its composition was changed)  and the recent behavior of core inflation might be a misleading indicator of the underlying inflation trend.  While inflation remains low to flat, expectations of inflation are increasing among market participants.  Again Mr. Hoenig was the sole dissenting vote on "exceptionally low levels of the federal funds rate  for an extended period", because he fears it will lead to a build up of future financial imbalances increasing the risks of longer run macroeconomic and financial stability and limit the FOMC's flexibility in when and how it begins to raise rates.

David Beckworth has concluded that a current high unemployment is not cyclical but structural, which means there are thousands of jobs which are permanently gone and will never be refilled.  In my opinion, this also means those unemployed over 55 years old will particularly have a hard time find comparable work or comparable pay to their former jobs.

The SEC suspects ETFs fueled the May 6th drop.  ETFs accounted for 70% of the securities that fell 60% or more from their price at 2:40 P.M.  Bond ETFs did not see sharp drops.  Many of the trades involved stub quotes or place holders (one cent) as the result of computer programs.

John Hussman in his weekly commentary is concerned that the ECB's pledge to buy sovereign bonds from European banks will place weak assets on their balance sheet just as the Fed did with toxic mortgage backed assets.  I personally do not think they are comparable assets.  Hussman sees monetary policy as being only as good as fiscal policy.  Unfortunately, the eurozone has removed monetary policy from its member nations control and the Stability and Growth Pact has significantly crippled member nations' fiscal policy applications consistent with internal economic needs.  Hussman is also ignoring the current account imbalances within the eurozone.  He believes that without a central taxing authority, the eurozone lacks the ability to control deficits.  Consequently, he thinks Greece will have to restructure debt, but he is ignoring that the IMF/EU bailout forbids restructuring.  He actually thinks Greece and other countries will pull out of the euro, but he is not acknowledging that that would require withdrawal from the European Union in totality, which is very unlikely and difficult to happen.  He sees tepid wage growth for the next several years and inflation not being a factor until the last half of this decade.

Congress will be considering a mish-mash conglomerative bill which includes several diverse issues: a 30 day extension of jobless benefits, retroactive reinstatement of expired tax cuts, summer jobs, police and teacher jobs, and increased taxes on investment fund managers from 15% capital gains to 35% as well as other oil barrel tax, a three year delay in Medicare payment cuts to doctors, etc.  These bills are designed to have a little something for each party and often end up either mired in controversy.or whisked by the wind.

Hundreds of cases have been referred to the Justice Department over several years involving bid rigging of municipal bond sales by financial advisors and traders, including banks.  This also involved the sell of interest rate swaps to local governments that backfired.  The process was pervasive and may have involved many, if not most, of the largest banks.

Pinalto, Cleveland Fed President, sees a gradual recovery and low inflation.  She sees high unemployment and overwhelming cautiousness by consumers and businesses as a major impediment ("headwind") to recovery.  Kohn, Fed vice-chairman, sees keeping future price expectations intact as vital with interest rates are very low.  Unanchored expectation would be risky and far too costly.  He addressed the uncertainty of determining proper price stability, asset bubbles, asset purchases and sells, and balancing financial stability.  Dudley, New York Fed President, said the recovery will not be robust, household deleveraging started last year, and the transitory inventory boost to GDP is over.  Tarullo, Fed Board Governor, in Congressional testimony said the European credit crisis could spill over and cause U.S. bank losses on credit exposures.

The passage of the Senate financial reform bill has a variety of winners and losers, but it is going to Conference Committee with the vastly different House version and in conference committee anything can happen and a bill could emerge which is vastly different from the two which went into Conference Committee.  You can expect many amendments which were not debated publicly and the bank and financial services lobbyists will have their knives out and counter attacks washing across the Conference Committee like the waves of the ocean.

Economic information we did not get to on the show:

The IMF said the European Union fiscal tightening will slow recovery.

The new UK government will cut $8.75 billion in spending.

Japanese core machinery orders were up 5.4% in March.

EU plans hedge fund crack down with rules to control pay and borrowing as well as force disclosure of investing information.  Some think this will discriminate against U.S. hedge funds and other none EU funds.

Germany unilaterally and without consultation with other EU countries banned short selling of equities and sovereign debt swaps.  It had negative effect on the markets, but it is essentially meaningless without action by other countries as the trades will just be executed in other foreign markets.

Eurozone CPI was up .5% in April on rising energy prices.  CPI was up 1.5% vs year ago.

UK CPI was up 3.7% April vs year ago with higher food and tobacco/alcohol taxes.

Chinese CPI is expected by the government to rise 3% vs year ago in May and June.

Dubai World reached a tentative agreement with creditors to restructure $28.5 billion in liabilities.

Japan's economy grew 4.5% (expected 5.4%).

Spain's lar4gest union may call for a general strike.

Greek demonstrations were mild after last week's violence,


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