A Year of Divergence

Mohamed A. El-Erian

DEC 8, 2014

Arrows road directions

LAGUNA BEACH – In the coming year, “divergence” will be a major global economic theme, applying to economic trends, policies, and performance. As the year progresses, these divergences will become increasingly difficult to reconcile, leaving policymakers with a choice: overcome the obstacles that have so far impeded effective action, or risk allowing their economies to be destabilized.
The multi-speed global economy will be dominated by four groups of countries. The first, led by the United States, will experience continued improvement in economic performance. Their labor markets will become stronger, with job creation accompanied by wage recovery. The benefits of economic growth will be less unequally distributed than in the past few years, though they will still accrue disproportionately to those who are already better off.
The second group, led by China, will stabilize at lower growth rates than recent historical averages, while continuing to mature structurally. They will gradually reorient their growth models to make them more sustainable – an effort that occasional bouts of global financial-market instability will shake, but not derail. And they will work to deepen their internal markets, improve regulatory frameworks, empower the private sector, and expand the scope of market-based economic management.
The third group, led by Europe, will struggle, as continued economic stagnation fuels social and political disenchantment in some countries and complicates regional policy decisions. Anemic growth, deflationary forces, and pockets of excessive indebtedness will hamper investment, tilting the balance of risk to the downside. In the most challenged economies, unemployment, particularly among young people, will remain alarmingly high and persistent.
The final group comprises the “wild card” countries, whose size and connectivity have important systemic implications. The most notable example is Russia. Faced with a deepening economic recession, a collapsing currency, capital flight, and shortages caused by contracting imports, President Vladimir Putin will need to decide whether to change his approach to Ukraine, re-engage with the West to allow for the lifting of sanctions, and build a more sustainable, diversified economy.
The alternative would be to attempt to divert popular discontent at home by expanding Russia’s intervention in Ukraine. This approach would most likely result in a new round of sanctions and counter-sanctions, tipping Russia into an even deeper recession – and perhaps even triggering political instability or more foreign-policy risk-taking – while exacerbating Europe’s economic malaise.
Brazil is the other notable wild card. President Dilma Rousseff, chastened by her near loss in the recent presidential election, has signaled a willingness to improve macroeconomic management, including by resisting a relapse into statism, the potential benefits of which now pale in comparison to its collateral damage and unintended consequences. If she delivers, Brazil would join Mexico in anchoring a more stable Latin America in 2015, helping the region to overcome the disruptive effects of a Venezuelan economy roiled by lower oil prices.
This multi-speed economic performance will contribute to multi-track central banking, as pressure for divergent monetary policies intensifies, particularly in the systemically important advanced economies. The US Federal Reserve, having already stopped its large-scale purchases of long-term assets, is likely to begin hiking interest rates in the third quarter of 2015. By contrast, the European Central Bank will pursue its own version of quantitative easing, introducing in the first quarter of the year a set of new measures to expand its balance sheet.

The Bank of Japan will maintain its pedal-to-the-metal approach to monetary stimulus.
Of course, there is no theoretical limit on divergence. The problem is that exchange-rate shifts now represent the only mechanism for reconciliation, and the divide between certain market valuations and their fundamentals has become so large that prices are vulnerable to bouts of volatility.
For the US, the combination of a stronger economy and less accommodative monetary policy will put additional upward pressure on the dollar’s exchange rate – which has already appreciated significantly – against both the euro and the yen. With few other countries willing to allow their currencies to strengthen, the dollar’s tendency toward appreciation will remain strong and broad-based, potentially triggering domestic political opposition.
Moreover, as it becomes increasingly difficult for currency markets to perform the role of orderly reconcilers, friction may arise among countries. This could disturb the unusual calm that lately has been comforting equity markets.
Fortunately, there are ways to ensure that 2015’s divergences do not lead to economic and financial disruptions. Indeed, most governments – particularly in Europe, Japan, and the US – have the tools they need to defuse the rising tensions and, in the process, unleash their economies’ productive potential.
Avoiding the disruptive potential of divergence is not a question of policy design; there is already broad, albeit not universal, agreement among economists about the measures that are needed at the national, regional, and global levels. Rather, it a question of implementation – and getting that right requires significant and sustained political will.
The pressure on policymakers to address the risks of divergence will increase next year. The consequences of inaction will extend well beyond 2015.

Read more at http://www.project-syndicate.org/commentary/economic-monetary-policy-divergence-2015-by-mohamed-a--el-erian-2014-12#BGUReFq8Z6weR4cJ.99

Dollar surge endangers global debt edifice, warns BIS

Bank for International Settlements concerned about underlying health of world economy as dollar loans to emerging markets increase rapidly

By Ambrose Evans-Pritchard

1:16PM GMT 07 Dec 2014

Dollar surge endangers global debt edifice warns BIS

BIS warned that dollar loans to Chinese banks and companies are rising at annual rate of 47pc and now stand at $1.1 trillion Photo: Oliver Yao / Alamy
Off-shore lending in US dollars has soared to $9 trillion and poses a growing risk to both emerging markets and the world's financial stability, the Bank for International Settlements has warned.

The Swiss-based global watchdog said dollar loans to Chinese banks and companies are rising at annual rate of 47pc. They have jumped to $1.1 trillion from almost nothing five years ago.

Cross-border dollar credit has ballooned to $456bn in Brazil, and $381bn in Mexico. External debt has reached $715bn in Russia, mostly in dollars.
A chunk of China's borrowing is disguised as intra-firm financing. This replicates practices by German industrial companies in the 1920s, which hid their real level of exposure as the 1929 debt trauma was building up. "To the extent that these flows are driven by financial operations rather than real activities, they could give rise to financial stability concerns," said the BIS in its quarterly report.

"More than a quantum of fragility underlies the current elevated mood in financial markets," it warned. Officials are disturbed by the "risk-on, risk-off, flip-flopping" by investors. Some of the violent moves lately go beyond stress seen in earlier crises, a sign that markets may be dangerously stretched and that many fund managers do not really believe their own Goldilocks narrative.
"Mid-October’s extreme intraday price movements underscore how sensitive markets have become to even small surprises. On 15 October, the yield on 10-year US Treasury bonds fell almost 37 basis points, more than the drop on 15 September 2008 when Lehman Brothers filed for bankruptcy."

"These fluctuations were large relative to actual economic and policy surprises, as the only notable negative piece of news that day was the release of somewhat weaker than expected retail sales data for the US one hour before the event," it said.
The BIS said 55pc of collateralised debt obligations (CDOs) now being issued are based on leveraged loans, an "unprecedented level". This raises eyebrows because CDOs were pivotal in the 2008 crash. 
"Activity in the leveraged loan markets even surpassed the levels recorded before the crisis: average quarterly announcements during the year to end-September 2014 were $250bn," it said.
BIS officials are worried that tightening by the US Federal Reserve will transmit a credit shock through East Asia and the emerging world, both by raising the cost of borrowing and by pushing up the dollar.
"The appreciation of the dollar against the backdrop of divergent monetary policies may, if persistent, have a profound impact on the global economy. A continued depreciation of the domestic currency against the dollar could reduce the creditworthiness of many firms, potentially inducing a tightening of financial conditions," it said.
The dollar index (DXY) has surged 12pc since late June to 89.36, smashing through its 30-year downtrend line. The currency has risen 55pc against the Russian rouble and 18pc against Brazil's real over the same period.
Hyun Song Shin, the BIS's head of research, said the world's central banks still hold over 60pc of their reserves in dollars. This ratio has changed remarkably little in forty years, but the overall level has soared -- from $1 trillion to $12 trillion just since 2000.

Cross-border lending in dollars has tripled to $9 trillion in a decade. Some $7 trillion of this is entirely outside the American regulatory sphere. "Neither a borrower nor a lender is a US resident. The role that the US dollar plays in debt contracts is very important. It is a global currency, and no other currency has this role," he said.
The implication is that there is no lender-of-last resort standing behind trillions of off-shore dollar bank transactions. This increases the risks of a chain-reaction if it ever goes wrong.

China's central bank has ample dollar reserves to bail out its companies - should it wish to do so - but the jury is out on Brazil, Russia, and other countries.
This flaw in the global system may be tested as the Fed prepares to raise interest rates for the first time in seven years. The US economy is growing at a blistering pace of 3.9pc. Non-farm payrolls surged by 321,000 in November and wage growth is at last picking up.
Two years ago the Fed expected unemployment to be 7.4pc at this stage. In fact it is 5.8pc. The Fed's new “optimal control” model suggest that raise rates may rise sooner and faster than markets expect. This has the makings of a global shock.
The great unknown is whether the current cycle of Fed tightening will lead to the same sort of stress seen in the Latin American debt crisis in the early 1980s or the East Asia/Russia crisis in the late 1990s. This time governments have far less dollar debt, but corporate dollar debt has replaced it, with mounting excesses in the non-bank bond markets. Emerging market bond issuance in dollars has jumped by $550bn since 2009. "This trend could have important financial stability implications," it said.
BIS officials are concerned that the risks may be just as great in this episode, though the weak links may not be where we think they are. Just as generals fight the last war, regulators have be fretting chiefly about bank leverage since the Lehman crisis.
Yet the new threat may lie in non-leveraged investments by asset managers and pension funds funnelling vast sums of excess capital around the world, especially into emerging markets. Many of these are so-called "macro-tourists" chasing yield, in some cases with little grasp of global geopolitics.
Studies suggest that they have a low tolerance for losses. They engage in clustering and crowd behaviours, and are apt to pull-out en masse, risking a bad feedback-loop. This could prove to be today's systemic danger. "If we rely too much on the familiar mechanisms, we may be missing the new vulnerabilities building up," said Mr Shin in a speech to the Brookings Institution last week.

The BIS has particular authority since its job is to track global lending. It was the only major body to warn of serious trouble before the Great Recession - and did so clearly, without the usual ifs and buts.

It now warns that the world is in many ways even more stretched today than it was in 2008, since emerging markets have been drawn into the global debt morass as well, and some have hit the limits of easy catch-up growth.
Debt levels in rich countries have jumped by 30 percentage points since the Lehman crisis to 275pc of GDP, and by the same amount to 175pc in emerging markets. The world has exhausted almost all of its buffer

A passage to India — Putin goes to New Delhi

Nick Butler

Dec 07 10:19

Russia’s President Vladimir Putin heads to New Delhi next weekend and will sign a deal with India on energy supply, marking the latest step in a remarkable set of developments that will reshape the international energy business and particularly the natural gas market for years to come.

The deal between India and Russia will centre on the long-term supply of gas and oil. The deal is likely to account for a substantial proportion of India’s growing needs well into the 2020s. This will follow the deal signed in May and another signed last month which will give China more than 30bn cubic metres of gas annually from east Siberia, once the necessary infrastructure is in place. The first Chinese deal was said to be worth $400bn; the second slightly less. The agreement with India also follows last week’s announcement that Russia is considering abandoning the South Stream project to supply gas through a pipeline running through southern Europe in favour of creating a new gas trading hub in Turkey.

The South Stream story may be a political manoeuvre, intended to separate the countries in southeast Europe — such as Hungary and Bulgaria — which hoped to benefit from South Stream from the rest of the EU when it comes to considering whether to maintain or extend sanctions against Russia to punish its behaviour in Ukraine. In a union of 28, every member country has a veto and the insecure coalition over Ukraine looks very shaky. In the gas market, however, the focus will be on the deal with Turkey and the creation of a new hub through which a strong flow of Russian supplies could swamp the Mediterranean market.

Much of the coverage of the Chinese deal has focused on the low price being paid. The Turkish deal is also reported to offer the Turks a material, long-term discount. I have no doubt that any deal with India will also be completed at an attractively low Price.

But this focus on price misses the point. Mr Putin, who has a better understanding of the global energy market than any western leader, is focused on market share rather than price. In three moves he has established Russian dominance in some of the key global markets for the medium to long-term. The relatively low prices (and in the case of India, no doubt also some attractive defence supply deals) establish a sense of mutual advantage. In what has become a buyers’ market, Mr Putin has played a weak hand very well. (The weak hand, of course, is the fact that Russia’s economy continues to rely on oil and gas for employment, revenue and export trade.)

By settling for discounted prices to secure market share Mr Putin is paying a price. There will be a sharp squeeze on costs and margins and one would not want to be a private shareholder in Gazprom. But Mr Putin and Gazprom are not alone in paying the only people who will pay a price for what is happening. If anything the impact on the rest of the global gas market will be even greater.

All the deals being done by Mr Putin represent state-to-state deals. Others will have to follow this trend, if they can, or risk being left behind holding large-scale high-cost gas in an open — and rapidly shrinking — market. This is very bad news for the owners of the many prospective liquefied natural gas projects — from Australia and Brazil to Cyprus, Mozambique and Tanzania — which have yet to come to market. Some suppliers, including Qatar and one day Iraq and Iran, should be capable of responding by keeping prices down thanks to low unit costs. Some can create their own version of state-to-state deals with India and China, but they will have to hurry.

Does all this mean that Mr Putin has given up on the European market? Not quite. The deals with China, Turkey and prospectively India are for the medium and long-term. They bring no immediate revenue. Gazprom’s gas sales to Europe, which were worth more than $60bn last year, may be declining and will continue to do so for the time being. Europe needs the gas and Russia needs the money. Europe’s attempts to diversify its supplies and strengthen its infrastructure links to reduce dependence are sound on paper but nothing is happening. The European Commission produces regular reports listing infrastructure projects which would help enhance resilience and energy security but very few are actually being built. Jean-Claude Juncker, the commission president, has proposed a €300bn fund part of which is intended to support such projects but the fund turns out to be little more than one layer of debt built on another as Wolfgang Münchau laid out in a clinical analysis in the Financial Times last week.

So Russia continues to supply to Europe, including Ukraine, particularly now that the EU has so helpfully agreed to pay Kiev’s bills. But Europe is not the future. Gas demand in the main markets such as Germany is falling. The transition to low-carbon energy supplies continues, regardless of the cost. If you want to sell gas, the future lies in Asia.

Mr Putin’s approach is clear and strategic — a cool and unsentimental response to a changing world. It is only a pity that western leaders and the international energy companies lack any such clarity and remain stuck in the past.

Op-Ed Columnist

Recovery at Last?

Paul Krugman

DEC. 7, 2014

Last week we got an actually good employment report — arguably the first truly good report in a long time. The U.S. economy added well over 300,000 jobs; wages, which have been stagnant for far too long, picked up a bit. Other indicators, like the rate at which workers are quitting (a sign that they expect to find new jobs), continue to improve. We’re still nowhere near full employment, but getting there no longer seems like an impossible dream.
And there are some important lessons from this belated good news. It doesn’t vindicate policies that permitted seven years and counting of depressed incomes and employment. But it does put the lie to some of the nonsense you hear about why the economy has lagged.
Let’s talk first about reasons not to celebrate. 

Things are finally looking better for American workers, but this improvement comes after years of suffering, with long-term unemployment in particular lingering at levels not seen since the 1930s. Millions of families lost their homes, their savings, or both. Many young Americans graduated into a labor market that didn’t want their skills, and will never get back onto the career tracks they should have had.
And the long slump hasn’t just scarred families; it has done immense damage to our long-run prospects. Estimates of the economy’s potential — the amount it can produce if and when it finally reaches full employment — have been steadily marked down in recent years, and many researchers now believe that the slump itself damaged future potential.

So it has been a terrible seven years, and even a string of good job reports won’t undo the damage. Why was it so bad?
You often hear claims, sometimes from pundits who should know better, that nobody predicted a sluggish recovery, and that this proves that mainstream macroeconomics is all wrong. The truth is that many economists, myself included, predicted a slow recovery from the very beginning. Why?

The answer, in brief, is that there are recessions and then there are recessions. Some recessions are deliberately engineered to cool off an overheated, inflating economy. For example, the Fed caused the 1981-82 recession with tight-money policies that temporarily sent interest rates to almost 20 percent. And ending that recession was easy: Once the Fed decided that we had suffered enough, it relented, interest rates tumbled, and it was morning in America.
But “postmodern” recessions, like the downturns of 2001 and 2007-9, reflect bursting bubbles rather than tight money, and they’re hard to end; even if the Fed cuts interest rates all the way to zero, it may find itself pushing on a string, unable to have much of a positive effect. As a result, you don’t expect to see V-shaped recoveries like 1982-84 — and sure enough, we didn’t.
This doesn’t mean that we were fated to experience a seven-year slump. We could have had a much faster recovery if the U.S. government had ramped up public investment and put more money in the hands of families likely to spend it. But the Obama stimulus was much too small and short-lived — as many of us warned, in advance, it would be — and since 2010 what we have actually seen, thanks to scorched-earth Republican opposition on all fronts, are unprecedented cutbacks in government spending, especially investment, and in government employment.
O.K., at this point I’m sure many readers are thinking that they’ve been hearing a very different story about what went wrong — the conservative story that attributes the sluggish recovery to the terrible, horrible, no-good attitude of the Obama administration. The president, we’re told, scared businesspeople by talking about “fat cats” on Wall Street and generally looking at them funny. Also, Obamacare has killed jobs, right?
Which is where the new job numbers come in. At this point we have enough data points to compare the job recovery under President Obama with the job recovery under former President George W. Bush, who also presided over a postmodern recession but certainly never insulted fat cats. And by any measure you might choose — but especially if you compare rates of job creation in the private sector — the Obama recovery has been stronger and faster. Oh, and its pace has picked up over the past year, as health reform has gone fully into effect.
Just to be clear, I’m not calling the Obama-era economy a success story. We needed faster job growth this time around than under Mr. Bush, because the recession was deeper, and unemployment stayed far too high for far too long. But we can now say with confidence that the recovery’s weakness had nothing to do with Mr. Obama’s (falsely) alleged anti-business slant.

What it reflected, instead, was the damage done by government paralysis — paralysis that has, alas, richly rewarded the very politicians who caused it.

12/08/2014 01:57 AM ET

Banks Urge Clients to Take Cash Elsewhere

By Kirsten Grind, James Sterngold and Juliet Chung 

Citigroup and other banks have told big institutional clients that new regulations are making some deposits less profitable. Photo: Reuters          

 Banks are urging some of their largest customers in the U.S. to take their cash elsewhere or be slapped with fees, citing new regulations that make it onerous for them to hold certain deposits.

The banks, including J.P. Morgan Chase & Co., Citigroup Inc., HSBC Holdings PLC, Deutsche Bank AG and Bank of America Corp., have spoken privately with clients in recent months to tell them that the new regulations are making some deposits less profitable, according to people familiar with the conversations.

In some cases, the banks have told clients, which range from large companies to hedge funds, insurers and smaller banks, that they will begin charging fees on accounts that have been free for big customers, the people said. Bank officials are also working with these firms to find alternatives for some of their deposits, they said.

The change upends one of the cornerstones of banking, in which deposits have been seen as one of the industry’s most attractive forms of funding, said more than a dozen corporate officials, consultants and bank executives interviewed by The Wall Street Journal.

Deposits have traditionally been a crucial growth engine for banks. Banks generally pay depositors one interest rate and then make loans with higher rates, often collecting fees in the process. But deposits also can be withdrawn at any time, potentially leaving a bank short of cash if too much money is removed at once.

The new rule driving the action is part of a broader effort by U.S. regulators and policy makers to make the financial system safer. But the move may inconvenience corporations that now have to pay new fees or look for alternatives to their bank.

Sal Sammartino, vice president of banking at Stewart Title, a unit of Stewart Information Services Corp., a global title insurance company based in Houston, said he has had sleepless nights in recent weeks as he has negotiated with large banks to try to keep the firm’s deposits there. He declined to name the banks.

“Ultimately my balances aren’t as profitable for the banks, and that’s going to impact my business,” he said.

In an environment of slow economic growth with fewer opportunities to make loans and ultralow interest rates, some banks feel they have too much money on deposit.

Some banks, including J.P. Morgan and Bank of New York Mellon Corp., have also started charging institutional clients fees to hold euro deposits, mainly driven by the European Central Bank’s move to make firms pay to park their cash with the ECB. BNY Mellon recently started charging 0.2% on euro deposits. State Street Corp. said in its third-quarter earnings call in October that it planned to begin charging fees later this year on euro deposits.

U.S. banking rules set to go into effect Jan. 1 compound the issue, especially for deposits that are viewed as less likely to stay at the bank through difficult times.

The new U.S. rules, designed to make bank balance sheets more resistant to the types of shocks that contributed to the 2008 financial crisis, will likely have little effect on retail deposits, insured up to $250,000 by federal deposit insurance. But the rules do affect larger deposits that often come from big corporations, smaller banks and big financial firms such as hedge funds.

Hundreds of companies and other bank customers with deposits that exceed the insurance limits could be affected by the banks’ actions.

Overall, about $4 trillion in deposits at banks in the U.S. were uninsured, covering more than 3.5 million accounts, according to Federal Deposit Insurance Corp. data.

The rule primarily responsible involves the liquidity coverage ratio, overseen by the Federal Reserve and other banking regulators. The new measure, finalized in September, as well as some other recent global regulations, are designed to make banks safer by helping them manage sudden outflows of deposits in a crisis.

The banks are required to maintain enough high-quality assets that could be converted into cash during a crisis to cover a projected flight of deposits over 30 days.

Because large, uninsured deposits would be expected to leave most quickly, the rule will now require that banks maintain reserves that they cannot use for profitable activities like making loans. That makes it much less efficient or profitable for banks to hold these deposits.

The new rules treat various types of deposits differently, based on how fast they are likely to be withdrawn. Insured deposits from retail customers are regarded as more safe and require that banks hold reserves equal to as little as 3% of the sums.

But the banks must hold reserves of as much as 40% against certain corporate deposits and as much as 100% of some big deposits from financial institutions such as hedge funds.

Some corporate officials said the new rules could make it more expensive for them to keep money in the bank or push them into riskier savings instruments such as short-term bond funds or uninsured money-market funds.

“You’re going to see a lot of corporations that have had much simpler portfolios that are going to move toward more sophisticated portfolios,” said Tory Hazard, president and chief operating officer of Institutional Cash Distributors, a broker to large clients looking for places to hold their cash.

Some bankers said they are advising corporate clients to break up large deposits across several banks, including smaller ones not affected by all of the new rules. Others might be attracted to other products offered by banks or products being created by asset managers.

Some customers are negotiating for a reduction in the fees, said people familiar with the discussions.

J.P. Morgan told some clients of its commercial bank recently that it would begin charging monthly fees on deposit accounts from which clients can withdraw money at any time. The new charges will start Jan. 1 for U.S. accounts, according to an Oct. 21 memo reviewed by the Journal, and later for international accounts.

“New liquidity and capital requirements have changed the operating environment and increased the cost of doing business with financial institutions,” the memo read.

The change affects some hedge-fund customers, rather than corporate accounts. The charges include items such as a $500 monthly account maintenance fee for demand deposits and a $25 charge per paper statement.

Larger clients with broad, long-term relationships with their banks may get a break on the new fees, according to people familiar with the situation. Banks also are likely to differentiate between clients’ operational deposits, used for things like payroll, and excess cash that can be pulled more easily, the people said.

At a National Association of Corporate Treasurers conference in October, consultant Treasury Strategies noted that the new rules “will redefine the economics and dynamics of corporate banking relationships.”

Some argue that while it is a good policy on its face, the rule potentially magnifies problems in a recession by encouraging banks to hoard high-quality assets, potentially paralyzing markets for these assets such as Treasury securities and some corporate bonds.

“This proposal, which is supposed to promote financial stability, actually does the opposite,” said Thomas Quaadman, a vice president at the U.S. Chamber of Commerce.

Thomas Deas, treasurer at chemicals company FMC Corp. said dialogue is increasing between banks and corporate clients as company executives get their arms around the potential new fees.

Robert Marley, assistant treasurer at EnerSys Inc., a maker of industrial batteries in Reading, Pa., said he was recently told by banks that his company would need to move cash that had been sitting in short-term deposit accounts in Europe or face new fees. “I’m not happy about it,” he said.

jueves, diciembre 11, 2014



The VIX Is Going Crazy


Stocks are tumbling and oil is getting crushed on Wednesday. 

So you know what that means: the VIX is soaring!

The VIX, or volatility index, is up almost 50% since last Friday, rising from around 11 to almost 19 in less than four trading days. 

Headlines crossing Reuters on Wednesday said the VIX, which is up more than 21% just today, is on track for its biggest percentage gain since October 9.

The VIX measures expected volatility in upcoming trading sessions.

Back in the summer, a big story was how low the VIX was and how volatility had completely disappeared. And while markets were shook up in the fall, the VIX has still remained historically low.

But in the last few days, the VIX has come alive. 

In a big way.

With Bank of America Order, S.E.C. Breaks the Mold

By Peter J. Henning

December 8, 2014 12:47 pm

A Bank of America settlement was held up because the S.E.C.’s commissioners could not agree on granting the bank a waiver from rules that could prevent it from selling certain investments.Credit Spencer Platt/Getty Images

The recidivism rate among companies caught violating securities laws can be a bit disheartening. Despite settlements that include corporate proclamations of a commitment to compliance, the same names seem to appear again and again in settlements for new violations. 

The Securities and Exchange Commission has recently taken a small step toward making the cost of a violation a bit steeper by refusing to give companies a free pass.
In August, Bank of America reached a $16.65 billion settlement with the Justice Department over accusations that it duped investors into buying troubled residential mortgage-backed securities. As part of that settlement, the S.E.C. filed charges of securities fraud. That case was fairly small, requiring the bank to admit it engaged in fraudulent conduct and pay about $225 million for selling a security that resulted in heavy losses to investors.
But getting the settlement approved was held up until late last month because the S.E.C.’s commissioners could not agree on granting the bank a waiver from rules that could prevent it from selling certain investments. That would have had a significant effect on its Merrill Lynch subsidiary by cutting off access to certain types of hedge fund investments, a lucrative segment of the market that would probably cost it clients.
S.E.C. Rule 506 permits sales of an unlimited amount of securities to “accredited investors,” generally defined as those with the financial wherewithal to fend for themselves that do not need the protections provided by the disclosure requirements in the law. This avenue is used annually to sell hundreds of billions of dollars in investments to large investors, like hedge funds and pension plans, and is a significant avenue for raising capital.
In the Dodd-Frank Act, Congress directed the S.E.C. to write a “bad actor” rule. That rule doesn’t allow the exemption if the issuer of the securities or its underwriters was subject to a judicial or administrative order for engaging in fraud or similar types of violations, like failing to maintain adequate books and records. Adopted in 2013 as an amendment to Rule 506, it imposes a five-year ban on participating in securities offerings unless the firm can convince the S.E.C. that there is good cause “that it is not necessary under the circumstances.”
There is another “bad actor” rule important to large companies like Bank of America that routinely access the securities markets to raise capital. Under Rule 405, a “well-known seasoned issuer” does not have to submit its offering documents in advance for review by the S.E.C. before selling securities, allowing it to act quickly when market conditions are favorable. Like Rule 506, this provision cannot be used by a company subject to an order prohibiting violations of the anti-fraud provisions of the securities laws as part of a settlement. But it can be waived for “good cause.”
Those waivers had become routine after a settlement with the S.E.C. Some companies, in fact, received multiple waivers. But last April, Kara M. Stein, one of the five commissioners, dissented from the order granting a waiver to the Royal Bank of Scotland after one of its subsidiaries pleaded guilty to manipulating the London interbank offered rate, or Libor. In a statement, Ms. Stein warned that by routinely granting such waivers, the S.E.C. “may have enshrined a new policy — that some firms are just too big to bar.”
That warning came to haunt Bank of America when it sought a waiver from the bad actor exclusion under Rule 506 after its mortgage-backed security settlement. The bank was a victim of circumstances because Mary Jo White, the chairwoman of the S.E.C., had to recuse herself from the case because of her prior representation of Kenneth D. Lewis, the bank’s former chief executive.
Bloomberg reported that the four remaining commissioners were split 2 to 2 on whether to grant a waiver, with Ms. Stein’s fellow Democratic commissioner, Luis A. Aguilar, joining her in holding up approval of the settlement until the waiver issue could be resolved.
The settlement was finally approved right before Thanksgiving when Bank of America agreed to appoint an outside monitor “not unacceptable” to the S.E.C. to conduct a comprehensive review of its compliance with Rule 506 in exchange for a waiver of the bad actor ban. Importantly, the waiver is only good for 30 months, so Bank of America will have to come back to the S.E.C. to show there is good cause for a waiver of the rest of the five-year prohibition.
The order also does not grant a waiver from the ban in Rule 405 on bad actors using the well-known seasoned issuer exemption. Although it is likely that Bank of America will seek such a waiver in the future, for the moment, it will be a bit more difficult for the bank to quickly access the securities markets.
With settlements looming for big banks over their role in manipulation of foreign exchange rates, the question is whether the treatment of Bank of America will become the norm for obtaining waivers from the bad actor rules or whether the S.E.C. will revert to its earlier pattern of routinely granting those requests. The circumstances requiring Bank of America to work hard for a waiver were unusual because Ms. White’s withdrawal from the case led to the even split between the remaining commissioners. So it could be a one-time situation.
One issue that has divided the commission is whether to view the bad actor rules as another form of punishment for a violation, or as a remedy limited to violations that directly involve a company’s financial reporting. A Republican commissioner, Daniel M. Gallagher, issued a statement in April arguing that “the punishment-focused view” of waivers of the well-known seasoned issuer rule “is even more troubling” because the harm is inflicted on shareholders from the increased costs of issuing securities. “We must have a robust waiver program to appropriately distinguish between cases when disqualification is and is not justified,” he said.
In a speech on Dec. 4, Ms. Stein celebrated the aggressive approach taken with Bank of America, stating that “we should be flexible and nuanced in our approach to these waivers, so that we make the most of this powerful tool.” She described the Bank of America order as “a breakthrough in the commission’s method of handling waivers, and I hope to see more of this and other thoughtful approaches in the future.”
The terms of Bank of America’s waiver that require appointment of a monitor are not particularly onerous. But they are a change from the days when granting such requests was almost a matter of routine. No agency wants to be known as going soft on the companies it regulates, and the bad actor rules had become like sending a child to the time-out chair at home — a mild threat that was easily discarded once the appropriate apology was made.
The S.E.C. is likely to take a tougher stance in agreeing to waivers of the bad actor prohibition, which means defense lawyers will have to consider the waiver issue right from the start rather than assuming the agency will rubber-stamp requests.

How High Can the Mighty Greenback Go?

For a few weeks now, we’ve been writing about how long positions on the dollar have broken fresh records each week, as investors continued to ditch the yen, the euro, and commodity currencies for the mighty greenback.
On Monday the greenback surged to a seven-and-a-half-year high against the yen and a two-year high against the euro having received a fresh boost from healthy U.S. jobs figures.
Total long positions held in the dollar remained at a record $49 billion in the week up to Dec. 2, with the dollar held long against every other currency, according to Commodity Futures Trading Commission. The report represents a tiny slice of the overall market, but still a reasonable proxy for the whole.
How many euros $1 buys
How many yen $1 buys
So how high can the dollar really go?
Strategists at the largest three banks for forex trading, expect the greenback to extend its rally towards and beyond parity with the euro, which buys about 1.227 dollars today.
Citigroup, the biggest of the big foreign exchange trading banks, is advising clients to position now for another round of dollar strength, proposing going long the dollar via options.
“Euro and yen negatives are well known, dollar positives less so. Fed normalization will be the main dollar driver in 2015,” says Steven Englander, head of G-10 strategy at the bank. Citi thinks the euro will weaken to 1.15 “or a bit lower” against the dollar by the end of 2015, adding — crucially — that it could fall further and faster if the ECB embarks on quantitative easing or if expectations of a rate hike in the U.S. become firmer.
Deutsche Bank, the second largest forex-trading bank, is far more bearish on the euro’s prospects against the surging dollar. It’s going one better than parity, expecing the euro to hit 0.95 to the dollar in 2017, before recovering to 1.15 in 2019.  Strategist Alan Ruskin thinks the euro will be trading around 1.15 in a year from now.
“This year the dollar has proved it can still rally when U.S. risk appetite and stocks improve and U.S. yields move lower, not traditionally a dollar positive environment,” Mr. Ruskin said. How far the dollar has come in breaking old correlations, he added, “is one indication of how far it can go when the higher rates story finally kicks into gear.”
Barclays, number three in the market, forecasts the euro to trade 1.07 against the dollar by the end of 2015.
It’s a bull run with deep consequences, as these thoughts by the Bank for International Settlements attest, and emerging markets are already feeling the fallout.

7 Questions Gold Bears Must Answer

Jeff Clark, Senior Precious Metals Analyst

December 8, 2014

A glance at any gold price chart reveals the severity of the bear mauling it has endured over the last three years.

More alarming, even for die-hard gold investors, is that some of the fundamental drivers that would normally push gold higher, like a weak US dollar, have reversed.

Throw in a correction-defying Wall Street stock market, and the never-ending rain of disdain for gold from the mainstream, and it may seem that there’s no reason to buy gold; the bear is here to stay.

If so, then I have a question. Actually, a whole bunch of questions.

If we’re in a bear market, then…

Why Is China Accumulating Record Amounts of Gold?

Mainstream reports will tell you Chinese imports through Hong Kong are down. They are.

But total gold imports are up. Most journalists continue to overlook the fact that China imports gold directly into Beijing and Shanghai now. There are at least 12 importing banks—that we know of.

Counting these “unreported” sources, imports have risen sharply. How do we know? From other countries’ export data. Take Switzerland, for example:

So far in 2014, Switzerland has shipped 153 tonnes (4.9 million ounces) to China directly. This represents over 50% of what they sent through Hong Kong (299 tonnes).

The UK has also exported £15 billion in gold so far in 2014, according to customs data. In fact, London has shipped so much gold to China (and other parts of Asia) that their domestic market has “tightened significantly” according to bullion analysts there.

Why Is China Working to Accelerate Its Accumulation?

This is a growing trend. The People’s Bank of China released a plan just last Wednesday to open up gold imports to qualified miners, as well as all banks that are members of the Shanghai Gold Exchange. Even commemorative gold maker China Gold Coin could qualify to import bullion. Not only will this further increase imports, but it will serve to lower premiums for Chinese buyers, making purchases more affordable.

As evidence of burgeoning demand, gold trading on China’s largest physical exchange has already exceeded last year’s record volume. YTD volume on the Shanghai Gold Exchange, including the city’s free-trade zone, was 12,077 tonnes through October vs. 11,614 tonnes in all of 2013.

The Chinese wave has reached tidal proportions—and it’s still growing.

Why Are Other Countries Hoarding Gold?

The World Gold Council (WGC) reports that for the 12 months ending September 2014, gold demand outside of China and India was 1,566 tonnes (50.3 million ounces). The problem is that demand from China and India already equals global production!

India and China currently account for approximately 3,100 tonnes of gold demand, and the WGC says new mine production was 3,115 tonnes during the same period.

And in spite of all the government attempts to limit gold imports, India just recorded the highest level of imports in 41 months; the country imported over 39 tonnes in November alone, the most since May 2011.

Let’s not forget Russia. Not only does the Russian central bank continue to buy aggressively on the international market, Moscow now buys directly from Russian miners. This is largely because banks and brokers are blocked from using international markets by US sanctions.

Despite this, and the fact that Russia doesn’t have to buy gold but keeps doing so anyway.

Global gold demand now eats up more than miners around the world can produce. Do all these countries see something we don’t?

Why Are Retail Investors NOT Selling SLV?

SPDR gold ETF (GLD) holdings continue to largely track the price of gold—but not the iShares silver ETF (SLV). The latter has more retail investors than GLD, and they’re not selling. In fact, while GLD holdings continue to decline, SLV holdings have shot higher.

While the silver price has fallen 16.5% so far this year, SLV holdings have risen 9.5%.

Why are so many silver investors not only holding on to their ETF shares but buying more?

Why Are Bullion Sales Setting New Records?

2013 was a record-setting year for gold and silver purchases from the US Mint. Pretty bullish when you consider the price crashed and headlines were universally negative.

And yet 2014 is on track to exceed last year’s record-setting pace, particularly with silver…
  • November silver Eagle sales from the US Mint totaled 3,426,000 ounces, 49% more than the previous year. If December sales surpass 1.1 million coins—a near certainty at this point—2014 will be another record-breaking year.
  • Silver sales at the Perth Mint last month also hit their highest level since January. Silver coin sales jumped to 851,836 ounces in November. That was also substantially higher than the 655,881 ounces in October.
  • And India’s silver imports rose 14% for the first 10 months of the year and set a record for that period. Silver imports totaled a massive 169 million ounces, draining many vaults in the UK, similar to the drain for gold I mentioned above.
To be fair, the Royal Canadian Mint reported lower gold and silver bullion sales for Q3. But volumes are still historically high.

Why Are Some Mainstream Investors Buying Gold?

The negative headlines we all see about gold come from the mainstream. Yet, some in that group are buyers…

Ray Dalio runs the world’s largest hedge fund, with approximately $150 billion in assets under management. As my colleague Marin Katusa puts it, “When Ray talks, you listen.”

And Ray currently allocates 7.5% of his portfolio to gold.

He’s not alone. Joe Wickwire, portfolio manager of Fidelity Investments, said last week, “I believe now is a good time to take advantage of negative short-term trading sentiment in gold.”

Then there are Japanese pension funds, which as recently as 2011 did not invest in gold at all.

Today, several hundred Japanese pension funds actively invest in the metal. Consider that Japan is the second-largest pension market in the world. Demand is also reportedly growing from defined benefit and defined contribution plans.

And just last Friday, Credit Suisse sold $24 million of US notes tied to an index of gold stocks, the largest offering in 14 months. That’s a bet that producers will rebound from near six-year lows.

These (and other) mainstream investors are clearly not expecting gold and gold stocks to keep declining.

Why Are Countries Repatriating Gold?

I mean, it’s not as if the New York depository is unsafe. It and Ft. Knox rank as among the most secure storage facilities in the world. That makes the following developments very curious:
  • Netherlands repatriated 122 tonnes (3.9 million ounces) last month.
  • France’s National Front leader urged the Bank of France last month to repatriate all its gold from overseas vaults, and to increase its bullion assets by 20%.
  • The Swiss Gold Initiative, which did not pass a popular vote, would’ve required all overseas gold be repatriated, as well as gold to comprise 20% of Swiss assets.
  • Germany announced a repatriation program last year, though the plan has since fizzled.
  • And this just in: there are reports that the Belgian central bank is investigating repatriation of its gold reserves.
What’s so important about gold right now that’s spurned a new trend to store it closer to home and increase reserves?

 These strong signs of demand don’t normally correlate with an asset in a bear market. Do you know of any bear market, in any asset, that’s seen this kind of demand?

Neither do I.

My friends, there’s only one explanation: all these parties see the bear soon yielding to the bull. You and I aren’t the only ones that see it on the horizon.

Christmas Wishes Come True…

One more thing: our founder and chairman, Doug Casey himself, is now willing to go on the record saying that he thinks the bottom is in for gold.

I say we back up the truck for the bargain of the century. Just like all the others above are doing.

With gold on sale for the holidays, I arranged for premium discounts on SEVEN different bullion products in the new issue of BIG GOLD. With gold and silver prices at four-year lows and fundamental forces that will someday propel them a lot higher, we have a truly unique buying opportunity. I want to capitalize on today’s “most mispriced asset” before sentiment reverses and the next uptrend in precious metals kicks into gear.

It’s our first ever Bullion Buyers Blowout—and I hope you’ll take advantage of the can’t-beat offers.

Someday soon you will pay a lot more for your insurance. Save now with these discounts.

December 7, 2014 7:10 pm

Crumbling infrastructure is a sign of lost collective faith

The only answer is prompt and aggressive responses to failure
It will take almost half as long to fix LaGuardia's escalator as it took to build the Empire State building©Getty
It will take almost half as long to fix LaGuardia's escalator as it took to build the Empire State building
Take a walk from the US Air Shuttle in New York’s LaGuardia airport to ground transportation. For months you will have encountered a sign saying “New escalator coming in Spring 2015”. Or take the Charles River at a key point separating Boston and Cambridge which is little more than 100 yards wide. Traffic has been diverted to support the repair of a major bridge crossing the river for more than two years, and yet work is expected to continue into 2016.

The world is said to progress but things that would once have seemed easy now seem hard. The Rhine river is much wider than the Charles yet General George Patton needed just a day to build bridges that permitted squadrons of tanks to get across it. It will take almost half as long to fix the escalator in LaGuardia as it took to build the Empire State building 85 years ago.

Is it any wonder that the American people have lost faith in the future and in institutions of all kinds? If rudimentary tasks such as keeping escalators going and bridges repaired are too much to handle, it is little surprise that disillusionment and cynicism flourish.

Political debates are often framed in terms of the respective roles of the public and private sector with progressives stressing the importance of private market failure and conservatives stressing the dysfunctionality of the public sector. The sad truth is that there is merit in both arguments.

The escalator that will take five months to repair is privately owned. Although it is in an airport, failure cannot be blamed on public authorities. Necessary maintenance had been delayed for years — with the escalator in question even being stripped for spare parts to support other escalators. Now the new owner has many priorities; the replacement of the escalator system is only one.

On the other hand, repair of the bridge across the Charles River is the responsibility of local governments. A combination of budgetary short sightedness, excessively rigid labour practices, and a failure to take account of the costs of traffic delays appears to account for the project’s remarkably long gestation period.

While much of the political debate takes place on a macro level, focusing on large scale changes in spending, tax or regulatory policies, I suspect that much of what frustrates the public happens on a more micro scale.

A government that has to install safety nets under bridges to catch failing debris will not inspire when it aspires to rebuild other nations.

When big companies are cannibalising their machinery for spare parts, it is hardly surprising that they are not trusted to embark on voluntary long run programmes to control greenhouse gases, promote diversity or develop new technologies.

What is to be done? First, the focus of infrastructure discussions in both the public and the private sector needs to shift from major new projects whose initiation and completion can be the occasion for grand celebration to more prosaic issues of upkeep, maintenance, and project implementation.

For example, before anyone contemplates spiffy new high-speed railway systems, careful consideration should be given to repairing existing rail lines and stations.

Second, accountants in the public and private sector need to develop methodologies for capturing deferred maintenance and showing this in the financial accounts for what it is — borrowing from the future. What is counted counts and so if maintenance deferrals were made transparent they would become much more expensive for decision makers.

Third, the public and the media on their behalf need to be much less accepting of institutional failure. It has been said that we do not want to know all to which we can become accustomed. A vicious cycle in which governments perform poorly and so are starved of resources and so perform worse is serious threat to healthy democracy.

Something similar can happen to business. If owners distrust management they will insist on taking cash out rather than permitting its use for long term investment. The only answer is prompt and aggressive responses to failure that ensure that it is shortlived.

More important than any specific remedy, there is a reason beyond the media and the public’s own economic problems why there is so much disillusionment with so many institutions. They do not seem to perform as well as they once did. We see it every day.

Fixing escalators and building bridges may seem like small stuff at a time of economic crisis and geopolitical instability. But it is time we recognise the importance of what may seem small to what is ultimately important — the faith of citizens in their collective future.

The writer is Charles W Eliot university professor at Harvard and a former US Treasury secretary

Heard on the Street

Fickle Trading Wind Again Blows Banks’ Way

Bond Trading’s Rebound Could Help Bank Earnings

By John Carney  
Dec. 7, 2014 12:01 p.m. ET

Bond traders are (almost) back. October and November put debt markets on a path to hit the highest quarterly trading levels in more than a year.

October saw an average daily trading volume not seen since the bond-market trading slump hit in the last quarter of 2013, according to data from the Securities Industry and Financial Markets Association out late last week.

This should benefit banks with big bond-trading operations, particularly Goldman Sachs and J.P. Morgan Chase . Bank of America should see higher trading revenues as well because its fixed-income currency and commodities unit is heavily tilted toward corporate-bond trading.

Much of the heightened activity was driven by the return of volatility in October. One measure of this showed volatility in mid-October reached its highest level of the year.

Trading in corporate bonds was up nearly 15% compared with October and November of last year. Trading in mortgage-backed securities guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac was up 5.63%.

Daily volume in Treasurys came near its highest level all year in October, but declined sharply in November. Even so, average volume for those two months is about close to even with the period a year earlier.

Of course, it remains to be seen what December holds. Last year, December volumes were the worst of the year. Volatility has been steadily declining since the start of the month—an indicator that trading is sliding again.

But even if trading falls off in December, banks haven’t seen two consecutive months of elevated trading volume in more than a year. That could translate into significantly higher trading revenues when banks report fourth-quarter earnings. That would certainly make for a happier new year.