GAAP

Moments ago, Bank of America and MBIA both formally announced the earlier leaked settlement that sees the bank pay the monoline a long-overdue $1.6 billion in cash plus the issuance of MBIA warrants to buy 9.94 million shares, or 4.9%, of MBI stock at an exercise prices of $9.59/share, which may be exercised at any time prior to May 2018. It is perhaps worth point out that the settlement took place with nearly half of the second quarter already in the books. In addition, BAC will also provide a $500MM credit facility to MBIA. End result: a $1.6 billion pretax charge for Bank of America. And yet, none of this settlement will impact any Bank of America Q2 numbers. Why? The press release explains.

Some have attributed the resurrection of the financial markets (or more appropriately the banks) from the March 2009 lows to the IASB/FASB changes to factual to fantasy accounting. The Telegraph reports today that from PIRC's and the Bank of England's Financial Policy Committee that while banker bonuses continue to rise (for now), 'hidden' losses among UK banks could total GBP60 Billion (USD 90 Billion). HSBC topped the list with GBP10.4 Billion in bad debts that have yet to be written off and while the 'accounting' bodies are suggesting they will address criticism of this farce, as one analyst notes, they "can still make unprofitable lending appear profitable." Regulators expect to hear plans from lenders on how they intend to fill these holes before the end of the month to coincide either with the FPC’s meeting on March 19 or a statement scheduled for March 27. While outright recaps are unlikely, banks are expected to restructure and set out plans to raise their capital levels over the next couple of years. More fantasy...

As the investing world celebrates the all time nominal high of an archaically-weighted index of an ever-changing basket of stocks, there is another - this time unprintable asset - that appears in all-time high demand - firearms. Smith & Wesson just released earnings not only with record high revenues but increasing their outlook dramatically for fiscal year 2013. The surge in 'background checks' and sales since the election (and furthermore since the Tragedy in Newtown) continues (+29% YoY) and as SHWC notes "The tragedy in Newtown has understandably inspired an important national discussion about how to cope with violence in our communities - we possess a broad range of products and a highly flexible manufacturing operation. Taken together, these allow us to be highly responsive should the market and/or legislative developments drive a change in sales mix."

The 2011 changes by the FDIC to the safe harbor for "true sales" may have been the end of "Too Big To Fail."

One of the recurring memes of the now nearly 4 years old "bull market" (assuming the recession ended in June 2009 as the NBER has opined), is that corporate profits are soaring, and that despite recent weakness in Q4 earnings (profiled most recently here), have now surpassed 2007 highs on an "actual" basis. For purely optical, sell-side research purposes that is fine: after all one has to sell the myth that the US private sector has never been healthier which is why it has to immediately respond to demands that it not only repatriate the $1+ trillion in cash held overseas, but to hand it over to shareholders post-haste (see recent "sideshow" between David Einhorn and Apple). However, a problem emerges when trying to back this number into the inverse: or how much money the US government is receiving as a result of taxes levied on these supposedly record profits. The problem is that while back in the summer 2007, or when the last secular peak in corporate profitability hit, corporate taxes peaked at well over $30 billion per month based, the most recent such number shows corporate taxes barely scraping $20 billion per month!

One of the first axioms of analysis is: "Garbage In, Garbage Out"! If your data is flawed, everything you do with it and the decisions stemming from it are flawed and dangerous to your financial health. Experienced analysts will often be found relentlessly checking, rechecking and validating their inputs and assumptions. If only our economists and the sell side analyst community were this diligent. But then it isn't their money. Only a year-end bonus for the 'extras' in their life is at risk. If economic practitioners were held to higher standards of accountability, they simply wouldn't accept the raft of fundamental data points that are the pillars of most economic assessment. Markets have become so dysfunctional with so much cheap money chasing so few real opportunities, that collateral values within the rehypothecation process are now in jeopardy and exposed to collateral contagion. The question is - what would things look like if the Fed wasn't engaged in Monetary Malpractice?

The fact that this report exists, confirms to me that some Fed members are increasingly uncomfortable with those risks.

The purpose of asset purchases by the Fed might no longer be improvements in the real economy, but rather a more subtle financing of U.S. government deficits. However, in the long run, expanding the money supply inevitably leads to inflationary pressures. Luckily for the Fed and the U.S. government, there is so much slack in the labour market that inflation might be years away. And, if we are right about the long run unemployment rate being structurally higher, then the Fed has all the room it needs to continue Quantitative Easing (QE) to infinity. This might allow them to continue to hide the true financial position of the government for many years to come. Nonetheless, the rising GAAP deficit and the sheer size of the U.S. Federal Government’s liabilities to its citizens makes it clear that one day or another, services (health care, social security) will have to be cut. Financial alchemy can hide reality, but it does not provide any tangible services. Europe’s (unresolved) experience with its debt crisis provides an insightful window into the future. Austerity measures in Ireland, Portugal, Spain and Greece have caused tremendous pain to their citizens (25% unemployment rates) and wreaked havoc in their economies (double digit retail sales declines). Are we going to ignore the obvious?

There has been an burst of exuberance as of late as the market, after four arduous years, got back to its pre-crisis levels.  Much has been attributed to the recent burst of optimism in the financial markets from: better than expected earnings, stronger economic growth ahead, the end of the bond bubble is near, the long term outlook is getting better, valuations are cheap, and the great rotation is here - all of which have egregious holes. However, with the markets fully inflated, we have reached the point that where even a small exogenous shock will likely have an exaggerated effect on the markets.  There are times that investors can safely "buy and hold" investments - this likely isn't one of them.

With minutes to go, this is what the world (according to the Google machine) is thinking ahead of Apple's earnings... and what the market expects...

As the video denotes below, here we have big brother traded on an exchange

The algos have gone nuts after hours, but here are the numbers:

• GOOGLE 4Q REV. EX TAC $11.34B, Exp. $12.36
• GOOGLE 4Q AVERAGE COST-PER-CLICK FELL 6% VS YEAR AGO
• GOOGLE 4Q EPS EX ITEMS $10.65, EST. $10.50

Fraudulent Chinese corporations are nothing new - we have been warning about them since late 2010, spurring the creation of a cottage industry focused exclusively on unmasking such public reverse merger companies (and generating trading profits along the way). One company, however, which apparently was completely unaware of the now pervasive and proven for the past two years Chinese corporate fraud, is US industrial titan Caterpillar. This was made clear when, after hours on Friday night naturally, the company revealed that it had been misled by "deliberate, multi-year, coordinated accounting misconduct" at a subsidiary of a Chinese company it acquired last summer, leading it to write off most of the value of the deal. In the process it would also take a $580 million, or $0.87 cent charge to earnings, which would wipe out more than half its expected earnings of $1.70 for the fourth quarter of 2012. One wonders, however, is there more to this story than just a case of a gentle, naive board duped by fraudulent, evil, cunning "Chinamen" which may have watched one too many episodes of Autonomy does Hewlett Packard?

Over a year ago we noted that when it comes to Bank of America "earnings", items which traditionally are classified as non-recurring, one-time: primarily litigation and mortgage related charges, have now become recurring, and all the time, courtesy of the worst M&A transaction of all time - the purchase of Countrywide and its horrifying mortgage book. Today, this is finally being appreciated by the market where even the pompom carriers have said that it is time to start ignoring the endless addbacks and focus on actual earnings. The same cheerleaders have also, finally, understood that the primary source of "profitability" at this lawsuit magnet of a company, is nothing other than the accounting trick known as loan loss reserve releases - not actual profits but merely bottom line adjustments whose purpose is to mitigate the impact of quarterly charge offs on loans gone horrible bad. Remember that Bank of America has some $908 billion in total consumer loans and leases, and every day hundreds of millions of these go 'bad' and ultimately have to be discharged, offset by "hopes" that the future will improve. This hits both the balance sheet and the P&L. So, if one steps back and ignores the non-recurring, one-time noise, what emerges? A truly frightening picture.