Archive - Feb 2013

Just under a year ago, when JPMorgan's London Whale trading fiasco was exposed as much more than just the proverbial "tempest in a teapot", Morgan watchers were left scratching their heads over another very curious development: the dramatic surge in the company's reported VaR, which as we showed last June nearly doubled, rising by some 93% year over year. Specifically we said that "in the 10-Q filing, the bank reported a VaR of $170 million for the three months ending March 31, 2012. This compared to a tiny $88 million for the previous year." JPM, which was desperate to cover up this modelling snafu, kept mum and shed as little light on the issue as possible. In its own words from the Q1 2012 10-Q filing: "the increase in average VaR was primarily driven by an increase in CIO VaR and a decrease in diversification benefit across the Firm." And furthermore: "CIO VaR averaged $129 million for the three months ended March 31, 2012, compared with $60 million for the comparable 2011 period. The increase in CIO average VaR was due to changes in the synthetic credit portfolio held by CIO as part of its management of structural and other risks arising from the Firm's on-going business activities." Keep the bolded sentence in mind, because as it turns out it is nothing but a euphemism for, drumroll, epic, amateur Excel error!

Selling snake oil and issuing unbacked paper currency are not so different. They're both wildly successful ploys for the guys pulling the strings. And they're both complete scams that depend solely on the confidence of a willing, ignorant public. But once the confidence begins to erode, the fraud unravels very, very quickly, and the perpetrators resort to desperate measures in order to keep the party going. In the case of fiat currency, governments in terminal decline resort to a very limited, highly predictable playbook in which they try to control... everything... imposing capital controls, exchange controls, wage controls, price controls, trade controls, border controls, and sometimes even people controls. These tactics have been used since the ancient Sumerians. This time is not different.

Concerns about the devaluations and the growing risk of a severe bout of inflation have led to calls for a return to fixed exchange rates and a gold standard. Bloomberg’s Trish Regan and Adam Johnson interviewed TCW Group’s Komal Sri-Kumar and Bank of New York Mellon's Michael Woolfolk about the risks from currency wars on Bloomberg Television's "Street Smart." Trish Regan asks whether there is a danger that “we have massive inflation worldwide for years to come?” The answer is yes and both agree that inflation is a real risk as is a loss of credibility by central banks.

Just when you thought you had heard it all - from Spanish politicians to Italian bankers - along comes the CEO of Italy's Finmeccanica. Giuseppe Orsi has been arrested for his alleged involvement in a bribery to ensure the Italian aerospace company got the order for Indian military helicopters in 2010. The $750 million deal, as reported by the WSJ, is now under investigation by the Indian defense minister but is not the first such 'bribery scandal' for Finmeccanica - whose CEO generously offered to step down if the Italian government (which owns 30.2% of the firm) asks him to. The share price plunged over 8% and was halted as analysts suggested - rather remarkably - that this might make it harder for Finmeccanica to compete for contracts in an already difficult market in which governments are cutting back on military spending. The sad truth appears to be that, whether pandemic or recently driven by a tougher economic environment, fraud runs deep - and its just a matter of time before it comes out, especially with the election so close.

Just because Europe is such a vast and open democracy, where nobody keeps secrets from anyone, it is only logical that Mario Draghi's visit to Spain, where he spoke to domestic lawmakers in the Congress, would be shrouded in secrecy so stringent and oppressive, that all forms of electronic communication were purposefully killed ahead of the speech.

While UBS' Art Cashin sees the 'uptrend' in stocks as largely in tact, though warns of the start of what appears to be a stalling formation, there is another 'bigger' potential crash on his mind. Having survived the Mayan apocalypse, and a Papal resignation, our home planet is due for a record setting space encounter on Friday (Feb. 15) of this week... which means it is now too late to even send Bruce Willis (or better yet, Bob Pisani) into space for an Armageddon sequel. We are told to keep calm and carry on - Bernanke-like "there is nothing to worry about", but no known asteroid has traveled this close to earth in recorded history. Let's hope the slide rule guys have it nailed - or the grand central planner.

The problem with “too-big-to-fail” is first and foremost the behavior of our beloved political leaders in Washington

First domestic fiscal policy, and now global monetary policy has become an utter circus:

• G7 OFFICIAL SAYS G7 STATEMENT WAS MISINTERPRETED, STATEMENT SIGNALED CONCERN ABOUT EXCESS MOVES IN JAPANESE YEN
• G-7 OFFICIAL: G-7 CONCERNED ABOUT UNILATERAL GUIDANCE ON YEN
• G7 OFFICIAL SAYS G7 IS CONCERNED ABOUT UNILATERAL GUIDANCE ON THE YEN, JAPAN WILL BE IN SPOTLIGHT AT G20 MEETING IN MOSCOW

We already mocked the G-7's original stupidity... and now they say it was not what they meant. Because what the G-7 clarification really means it that while the G-7 will supposedly "allow the market to set rates", the G-7 was not happy with how the market set rates following the G-7 statement. And... #Ref!

The chart below, from the Economist, takes a look at how long it would take an individual from any given country to become a millionaire based on "how much the main breadwinner in an average household makes each year (before tax)." No major surprises here: the fastest spawning place for a budding millionaire, a term that has long ago lost its one-time cachet thanks to the world's central banks who have pumped some $14 trillion into the market, is the US, while those hoping to hit the vaunted seven figures in Bulgaria, Mexico and Romania would need to wait about 2-3 average lifetimes before they hit their monetary goal.

One of the largest potential volatility events for the equity markets this year will be the Q1 US Debtapalooza.  There are three main issues that are to be debated with a crescendo coming in late February – the Long Term Budget Deal, the 2013 Budget Deal and the Debt Limit.  There will obviously be many consequential threats and theatrics associated with these events – including potential threats for government shutdowns and debt defaults – while the very real consequences could be additional US ratings downgrades.  It is important to remember that outside of the 2008 shock, the Debt Ceiling Debate and consequent US Debt Downgrade in Summer 2011 created the biggest volatility event of the past two decades. Volatility metrics show that the market is extremely complacent heading into these events.

Manias occur for many reasons, but great manias are made possible and sustained by errant government policies that may seem to have good reasons, none of them with any long-term economic value. Housing, despite high leverage, high transaction costs, and poor liquidity, was promoted as a dream investment for everyone. Massive intervention in this market by populist government policies and agencies fostering affordability exacerbated these normal defects and disastrously distorted the market. It was a "dream," in the sense of confused, wishful thinking. But to think and act this way with many trillions of dollars, most of it borrowed, was irresponsible on an historic scale.

Confused what the earlier released statement by the G-7 means? Fear not, because here comes Goldman with a post-mortem. And just in case anyone puts too much credibility into a few sentences by the world's developed nations (whose viability depends in how quickly each can devalue relative to everyone else) in which they say nothing about what every central bank in the world is actually doing, here is a history of four years of G-7 statements full of "affirmations" and support for an open market exchange policy yet resulting in the current round of global FX war, confirming just how 'effective' the group has been.

• The Man Who Killed Osama bin Laden... Is Screwed (Esquire)
• G7 fires currency warning shot, Japan sanguine (Reuters)
• North Korea Confirms It Conducted 3rd Nuclear Test (NYT)
• Italian Police Arrest Finmeccanica CEO (WSJ)
• Legacy, political calendar frame Obama's State of the Union address (Reuters)
• China joins U.S., Japan, EU in condemning North Korea nuclear test (Reuters)
• Wall Street Fading as Emerging-Market Banks Gain Share (BBG)
• Berlin Conference 2.0: Drugmakers eye Africa's middle classes as next growth market (Reuters)
• Barclays to Cut 3,700 Jobs After Full-Year Loss (BBG)
• US Treasury comment triggers fall in yen (FT)
• ECB Ready to Offset Banks’ Accelerated LTRO Payback (BBG)
• Fed's Yellen Supports Stimulus to Spur Jobs (WSJ)
• Libor Scrutiny Turns to Middlemen (WSJ)
• Samsung Girds for Life After Apple in Disruption Devotion (BBG)

With the world so obviously gripped in currency war even the hotdog guy has moved away from saying how technically undervalued AAPL stock is to opining on who is leading the global race to debase, it was only a matter of time before the G-7 confirmed the only strategy left is FX devaluation by denying it. Sure enough, a preliminary statement from the G-7 came earlier, in which the leading "developed" nations said, well, absolutely nothing:

We, the G7 Ministers and Governors, reaffirm our longstanding commitment to market determined exchange rates and to consult closely in regard to actions in foreign exchange markets. We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates. We are agreed that excessive volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability. We will continue to consult closely on exchange markets and cooperate as appropriate.

This follows a statement by the US Treasury's Lael Branaird yesterday in which she said that she is supportive of the effort in Japan to end deflation and “reinvigorate growth”. Lastly, the SNB's Jordan also confirmed that the Swiss National Bank will continue to do everything to crush its own currency, and will the 1.20 EURCHF floor, stating that Japan is merely doing the right thing to stimulate growth (i.e., doing what "we" are doing).  In other words, let the FX wars continue and may the biggest balance sheet win, all the while everyone pretends nothing is happening.