Sunday, July 29, 2012

Can "Super Mario" Draghi and Friends Save the World?

After declining performance by global markets early in the week, on Thursday, European Central Bank Chief Mario Draghi said “the ECB is ready to do whatever it takes to preserve the euro. . . . Believe me, it will be enough” and markets swiftly reversed the downward trend.  On Friday, German Chancellor Angela Merkel and French President Francois Hollande said they are ready to “do everything to protect” the Euro.  Additionally, the U.S. Commerce Department reported that second quarter GDP grew at a weak, but expected, rate of 1.5%.


With most economic data and commentary from business leaders pointing toward a global economic slowdown, any action to reverse the trend is welcome news.  However, prior comments from Eurozone leaders have led to mixed results.  The strong positive market moves last week suggest that expectations are high for how Eurozone leaders will proceed.  Hopefully, their actions will support their words and meet expectations.  Anything less will be unfortunate.

Sunday, July 22, 2012

Flaws, Frauds and the $300 Trillion LIBOR Crisis

As the probe expand globally, after senior executives at Barclays Bank resign and the firm pays multi-million dollar settlement fees for LIBOR manipulation, consider the following commentaries: The Economist – it is “the rotten heart of finance”, Barney Frank – “this is fundamental dishonesty” and “this notion of self-regulation is a mistake”,   Eliot Spitzer  - “this is about as big as it gets in the financial world and goes to the heart of every piece of debt that’s issued to consumers”,  MIT finance professor Andrew Lo - "this dwarfs by orders of magnitude any financial scams in the history of markets",  Elizabeth Warren - "the Libor fraud exposes rot at the core of the financial system", the U.S. Treasury’s Office of Financial Research - “this type of manipulation -- poses significant risks to market integrity and investor trust, and will require continuing regulatory focus”,  Federal Reserve Chairman Ben Bernanke - “the Libor system is structurally flawed,” and “it is a major problem for our financial system and for the confidence in the financial system, and we need to address it.”

A brief primer on LIBOR (London Interbank Offered Rate)
  • LIBOR is an index used to set pricing of between $300 and $500 trillion worth of mortgages, student loans, commercial loans and derivative contracts
  • small changes in the index can impact financial markets and borrowers -  a 0.01% change can have a $30 to $50 billion impact,
  • over 75% of U.S .commercial and mortgage loan valuations are dependent on the index,
  • the rate is not set by market demand, but an “honor system” by bankers and traders at 16  major financial firms – many of the usual suspects,
  • manipulating LIBOR can  help traders make more money and improve their firm’s  financial appearance and
  • emails by bankers and traders related to potential LIBOR rigging are emerging such as  “Dude. I owe you big time! Come over one day after work and I’m opening a bottle of Bollinger”.

While the scale of the LIBOR manipulation problem is amazing (the abuses extent back to at least 2007), the discovery of continuing problems in the global financial system and complacency and lack of oversight by regulators and policy makers is no longer shocking.   Perhaps a factor contributing to the long recovery process from a major financial crisis is that it takes time to remove a generation of “bad actors” from the stage.    

Sunday, July 15, 2012

The Moment of Truth and the Fiscal Cliff

On Friday, an op-ed by Honeywell Corp. CEO David Cote in the Financial Times mentioned, “As we approach the end of the year, we get closer to the edge of the “fiscal cliff”. If there is no political deal, the US will face a triple witching hour of automatically triggered spending cuts, the expiry of tax cuts, and a failure to raise the debt ceiling. We all saw what happened during the last debt ceiling ‘discussion’. It wouldn’t be a surprise to see the same dysfunctional process or another agreement to ‘kick the can down the road’, as they say in Washington.”  

Additionally, as focus increases on the Simpson-Bowles report (officially titled the “Report of the National Commission on Fiscal Responsibility and Reform: The Moment of Truth”), CNBC provided a joint interview with Warren Buffett, Alan Simpson and Erskine Bowles last week which included:  Buffet - “Congress has not done its job”, Bowles - “the problem's real, the solutions are all painful. And there's no easy way out” and “I think if I had to tell you the probability, I’d say the chances are we are going over the fiscal cliff” and Simpson - “politically nothing will be done between now and November 6th. it’s just posturing and guys get up and say we can get this terrible thing resolved without touching precious Medicare, precious Medicaid, precious Social Security and precious Defense.”

The focus areas of Simpson-Bowles are:
  • Enact tough discretionary spending cuts to force budget discipline in Congress,
  • Simplify the tax code,
  • Pursue “common-sense” health care reforms to physician payments, cost sharing, malpractice law, prescription drug costs, government-subsidized medical  education, and other sources,
  • Cut agriculture subsidies, modernize military and civil service retirement systems, reforms student loan programs and put the Pension Benefit Guarantee Corporation on a sustainable path;
  • Reform Social Security for its own sake, and not for deficit reduction; and
  • Reform the budget process to ensure that spending stays under control, inflation is measured accurately, and taxpayer dollars go where they belong.

As global market “mood swings” continue, it is important not to lose sight that significant work remains to be done to repair the global economy.  With the U.S. political season in full swing (accompanied by aggressive fundraising and campaign spending), increased political accountability is needed on the campaign trail.  David Cote suggests focusing on the “Campaign to Fix the Debt”, which launches on July 17  NOTE TO WASHINGTON BELTWAY PLAYERS: we do not want another recession – get with the program or get out of town!

Sunday, July 8, 2012

As the Global Economy says "Slow Down", California says "Speed Up"

Last week, a measure of U.S. manufacturing activity from the Institute for Supply Management (ISM) declined to 49.7 in June, from 53.5 in May – the surprising drop below 50 suggests contraction.  Also, the U.S. Department of Labor reported that for June: 1) payrolls growth was lower than expected at 80,000, 2) unemployment remained at 8.2% and 3) the labor force participation rate (people either working or looking for work - 16 years and older) remains near a multi-decade low at 63.8% (see chart 2 of PDF).  Additionally, International Monetary Fund (IMF) Managing Director Christine Lagarde said, "in the last few months, the global outlook has been more worrying for Europe, the United States and large emerging markets," and its growth forecasts are likely to be lowered.  Against this backdrop, California legislators approved financing for an initial segment of a dedicated high-speed rail line connecting Los Angeles and San Francisco (the project will improve some existing rail lines, cost about $68 billion and support 220 mile-per-hour trains).

With significant economic commentary focusing on “bumping along the bottom” and potential “free-fall” deceleration, moving out of this cycle requires many things including job creation and a vision the future. Debates about the effectiveness of government in stimulating growth and the value of large-scale public works efforts will continue – but the high-speed rail project should: 1) create jobs, 2) provide some of the “vision thing” and 3) potentially have a positive environmental impact. Economic successes and failures will continue as we move beyond the financial crisis.  Let’s move beyond some of the debates and create some jobs!

Sunday, July 1, 2012

For the Eurozone and the Global Economy - is 19 the Lucky Number?

Last week, Eurozone leaders held their 19th summit in Brussels to work on the region’s numerous financial problems. Given that prior meetings ended with disappointing results, global investors were positively surprised that any progress was made at last week’s gathering.  The meeting resulted in announcements that:
  • rescue funding would be made available  to help Spain’s fragile banking system and to buy Italian sovereign bonds,
  • the European Central Bank would move forward with a plan to oversee Eurozone banks and
  • €120bn of funding will be made available to stimulate economic growth within the region.  
On Friday, global market responded positively.  The Euro rose 1.8 %, Spanish 10-year bonds dropped to 6.32%, Italian bonds dropped to 5.81%, the S&P 500 increased 2.5%, the European FTSE 100 increased 1.4%, the Italian stock market increased 6.5% and Spain’s stock market was up 5.6%.  Among commodities, gold increased 2.8%, copper increased 4.9% and oil was up 7.0% for Brent and 9.3% for WTI.

  • Expectations were very low for the summit, and Friday’s news does represent progress in a very protracted process - it has taken over 3 years and 19 summits for the Eurozone leaders to get to this point.  
  • Skepticism remains high about the ability for diverse Eurozone interest groups to deliver on Friday’s plans.  Given the almost glacial pace of progress, investors should recalibrate expectations for a quick fix, as there are many details to work out.  Government deficits remain high and debates continue on austerity driven budget cuts and growth driven spending programs.  The a significant challenge in resolving the Eurozone’s problems is that they are financial, political and cultural – how much control will Eurozone member countries hand over to a central authority such as the European Central Bank?  
  • For now, global investors can seek comfort that the Euro currency will not imminently collapse, but they are left wondering if the actions from summit number 19 are simply the result of a “shotgun wedding”.  
  • Note: Among the euphoria of Friday’s market moves, Nike Inc. was down 9.4% based on disappointing earnings driven partially by weakness in Europe and China, and Ford Motor Company was down 5% after announcing that “our operations outside of North America are under increasing pressure."  There may be light, but there are still clouds.