Fed's Letter to Deutsche Bank

"In reviewing your earnings per annum,
We're less than impressed, and we pan 'em.
The bank may have gains,
But this letter pertains
To the haphazard way that you ran 'em."

The Wall Street Journal reports that the Federal Reserve Bank of New York has vented its frustration with the sloppy reporting of Deutsche Bank's US branches and subsidiaries.  In a December 2013 letter to the bank, senior Fed supervisor Daniel Muccia complained  that the bank's reports "are of low quality, inaccurate and unreliable. The size and breadth of errors strongly suggest that the firm's entire U.S. regulatory reporting structure requires wide-ranging remedial action."  It's a problem long in the making, wrote Mr. Muccia: "Since 2002, the FRBNY has highlighted significant weaknesses in the firm's regulatory reporting framework that have remained outstanding for a decade."

Of course, it's not only the Fed that should be concerned.  Investors too rely on firms' financial reports to value their securities and decide when to buy, sell or hold.  Lest we forget, the feeling that "you can't trust the numbers" was a factor in the global financial meltdown of not so long ago.

Recovery?

Fed Chairmen (paternal or motherly)
Have made a depressing discovery:
If demand isn't great,
You can lower the rate
But you can't cut your way to recovery.

WSJ: No Security in Book Value

Here is my latest post for the Journal's Total Return blog, on the fight over banks' having to mark to market their securities held for sale. Please enjoy, and leave a comment!

WSJ: Sandy Saga

In today's Wall Street Journal Total Return blog, Dr. Goose has contributed a lyrical ode to Hurricane Sandy, running wild in Wall Street's canyon of high finance. Please visit me at the Journal, and be sure to leave a greeting.

A Chicken & Egg Problem

For GDP growth to look handsome,
Manufacturing's got to expand some,
But someone must buy
That expanded supply,
So we've got to expand our demand some.

"Without Demand, Manufacturing Can’t Pump Up Output or Jobs," says The Wall Street Journal's Real Time Economics blog. As much as many, including the White House, have pinned their expansionary hopes on a US manufacturing renaissance, this only works if foreign and domestic demand keeps those factories busy. Right now, both appear to be softening.

Recent factory surveys from the Federal Reserve Banks of New York, Philadelphia, Richmond and Kansas City show more respondents reporting falling orders than expanding. Moreover, "a third-quarter survey done by professional services firm PwC found 67% of major U.S. industrial multinationals said 'lack of demand' was an expected barrier to their company’s growth over the next year. That was the No. 1 choice among a list of obstacles that included energy prices, regulatory pressures and taxes, and was a jump from 48% pointing to a lack of demand in the second quarter."

Third quarter US GDP is set to be announced this morning at 8:30, with the consensus forecast of an expansion at a tepid 1.7% annualized rate. At the moment, the prospect of manufacturing our way to faster growth looks dim.

WSJ: No Debt Limit

Here is the 2nd of Dr. Goose's now regular contributions to the WSJ Total Return blog, regarding Joe Stiglitz' thoughts on the US debt/GDP ratio. I am thrilled to become a regular contributor to the Wall Street Journal's website, and hope that readers of this space will visit me there as well.

Repent, O Ye Bankers

Said the Bishop, in humbling homily:
"You bankers are quite the anomaly.
I'd like to convert you
To living in virtue,
Instead of behaving abom'nably."

The Wall Street Journal's Jason Zweig writes that the Church of England has called for "the financial industry [to] look within and search its soul." This call to soul-searching followed an invitation from the British parliamentary commission on the LIBOR-fixing scandal for public comment on how to reform finance. "The church calls for two striking steps," writes Zweig.

First, bankers should seek to build “a culture of the virtues” that would enable anyone working in finance to answer the question, “What would it mean to be a good banker?”... Second, the financial industry needs to apologize and repent.

The Rev. Dr. Malcolm Brown, director of the Church of England’s Mission and Public Affairs Council, elaborates:

It’s like shoplifting: Even if you put what you took back onto the shelf, you still did something wrong. Just restoring the status quo ante doesn’t give people the sense that trust has been restored. You can’t just put it back on the shelf; you have to admit that the way things were done was wrong.

QE3

It's expected the FOMC
Will finally enact QE3,
Prodigiously trying
By means of bond-buying
In some way to boost GDP.

If 500 billion is loosed,
There's a zero-point-one percent boost
In the rate of employed,
Which may leave one annoyed
With the gain this investment produced.

"Economists are skeptical about the benefits of another round of bond-buying by the Federal Reserve," writes Phil Izzo in the Wall Street Journal, but nearly all of them expect it, anyway. QE3, the third round of quantitative easing, will comprise more buying of Treasury and mortgage bonds, in a further attempt to reduce long-term interest rates and boost economic activity. Within the economic community, however, expectations for QE3's effectiveness could hardly be lower. 47 forecasters surveyed by the Journal estimate on average that, for every $500 billion in bond purchases, we can expect a 0.1 percentage point drop in the unemployment rate and a 0.2 percentage point increase in GDP. At least there will be no harm done: the group expects inflation to tick up by only 0.2 percentage points.

Bernanke Trilogy

There once was a man named Bernank',
Who didn’t want markets to tank.
Whenever he'd ease,
Like a golfer who tees,
He took care not to hook or to shank.

A Princetonian prof named Bernank',
Who didn't want markets to tank,
Would provide some relief
Très quantitatif
À trois, sinon quatre ou à cinq.

A Central Bank chief named Bernank',
Who doesn't want markets to tank,
Instinctively knows
How not to expose
His political left or right flank.

Over in the august (web-)pages of the Wall Street Journal's Total Return personal finance blog, columnist Jason Zweig put out the clarion call for would-be limerickers to finish these opening two lines:

There once was a man named Bernank,
Who didn’t want markets to tank….

Sounds good, and Dr. Goose humbly offers his threefold contribution above, while hoping that some of you reading this will do the same. But what's this? Mr. Zweig proceeds to "correct" his perfectly adequate opening lines, in the mistaken belief that they do not scan well.

[T]hese lines don’t quite scan; in a conventionally formed limerick, the first two lines have nine syllables, the next two have six apiece and the closing line again has nine. Our first two lines had eight syllables apiece...So let’s try it again. We’ll start the limerick off, fixing the meter so it scans correctly, and you finish it with three new lines of your own. Between now and the Fed’s next meeting on Sept. 12-13, there’s plenty of time to come up with something fun. Here goes:

There once was a man named The Bernank,
Who didn’t want the markets to tank…

(*Sigh*)... amateurs.

As readers of this blog have no doubt grown to appreciate, what distinguishes a limerick is not the number of syllables in a line, but the anapestic (or amphibrachic) meter and rhythm. If one must count something, let it be the number of beats: three, plus one silent beat, in each of the first two lines; two beats each in the third and fourth lines, and three beats again in the fifth line. For more lessons in limerick rhythm and rhyme, I refer Mr. Zweig and all interested readers to my friend Madeleine Begun Kane's "How To Write A Limerick".

Unqualified Interest

As a primary task of the Fed, it
Should cheapen the cost of our credit,
Which would help a lot more
If the mean credit score
Would qualify many to get it.

The Wall Street Journal's Jon Hilsenrath reports that the Fed's efforts to spread the stimulant of low interest rates throughout the US economy is stymied by the many borrowers who are over-leveraged, underwater and therefore unqualified to refinance at lower rates. Moreover, the fortunate few who can refi at will tend to reinvest rather than spend the proceeds, as they were already able to buy whatever they wanted. In a response that is short on verbiage but long on sarcasm and contempt, the Zero Hedge blog suggests that our national economic model - borrowing to fund consumer-driven growth - may not be sustainable.

Loss of Face in the Options Market

An Internet social sensation
Went to market with high expectation;
Before many fortnights,
The traders had bought rights
To sell it (without obligation).

The Wall Street Journal's options reporter Kaitlyn Kiernan writes that the put-call ratio on shares of Facebook turned decidedly bearish on the first day of options trading after the company's controversial IPO. Options traders bought 20.3 millions puts (the right, but not the obligation, to sell shares at a fixed "strike" price) but only 16.2 million calls (the right, but not the obligation, to buy shares at the strike price). The preponderance of puts indicates the prevailing sentiment that the price of $FB shares will continue to fall. The stock market took note, and Facebook shares slid another 9.6% to $28.84, a 24% drop from the initial public offer price of $38.

Student Loan Blues

"Though college, I felt, was a sure thing,
As of now, unless gold I'm unearthing,
To pay off my loan,
I'll have to postpone
My homebuying, wedding and birthing."

An entire generation is blocked from building a life while in the thrall of its towering college debts, writes Sue Shellenbarger in The Wall Street Journal. Student loans, which reached $1 trillion last year according to the Consumer Financial Protection Bureau, may ofter eat up half of a young graduate's income, particularly if they have had to settle for a lower-paying job than they expected. Like the killer who won't die in a horror film, student loans can not only prevent one's qualifying for a home mortgage or car loan, but cannot be extinguished in a bankruptcy.

What can young people do to avoid such an unhappy fate? There are no panaceas, but some sensible suggestions would include:

• Approaching college with the goal of building valuable, employable skills by which to enable one to pay the loans down faster; 
• Taking price into account while shopping for schools, with a willingness to consider the lowest priced option;
• Accepting federal or state loans (preferably subsidized) before private ones.

No More Fed Action?

"The economy's growing respectably,"
Said economists surveyed collectively,
"So a Fed funds regime
At a low-rate extreme
Is an outlook we look upon skeptic'ly."

The Wall Street Journal has reported the results of its latest survey of US economists, and, while not especially pretty, they do not paint an ugly picture either. Writes the Journal's Phil Izzo, "More economists are convinced the Federal Reserve won't take further action to spur growth this year, as the economy appears to be on firmer footing." The "respectable" 2.2% first quarter growth rate is forecast to bump up to an annual 2.7% GDP increase by year end. As a result, 36 of the 51 economists surveyed expect the Fed to refrain from any additional large-scale bond-buying. Interest rates? The consensus is that they've gone about as low as they can go, and the mean forecast for the June 2014 Fed funds rate is 1%. Come to think of it, that is a rather mean forecast, but it's better than nothing.

Overheard in the Supreme Court

"I've studied Congressional acts a lot
On the government's power to tax a lot,
Which I'll argue today,
Though tomorrow I may
Invoke contradictory facts a lot."

Intense public interest in the Supreme Court hearing on the Affordable Care Act (a.k.a. Obamacare) means that even the most obscure preliminary arguments are followed with intense focus. Thus, the Wall Street Journal's article on the opening arguments was among the day's most popular, though it should normally have made one's eyes glaze over. The first day's argument turned on whether the penalty for non-compliance with mandated insurance is a tax. If so, argued Washington trial lawyer Robert Long, it is covered by the Anti-Injunction Act, which holds that taxes cannot be legally challenged until they are effective; in this case, that's not until 2014. The Obama administration, which evidently wants to get the legal challenges over with, did not agree, saying that the penalty is not a tax under the AIA. However, they intended to argue the next day that the penalty is covered by the government's constitutional power to levy taxes; certainly a nuanced position, to say the least.

Dim Sum Debt

The market for bonds in renminbi
Heretofore has been traded quite thinly,
Though it's possible, thanks
To the world's central banks,
For yuan to be all that it kin be.

The Wall Street Journal reports that bankers pushing for the development of the offshore market for yuan-denominated bonds - so-called "dim sum" bonds - have homed in on a new target group: central banks and sovereign wealth funds. The appeal to many such institutions may be the diversification of their foreign reserves away from US dollars. Though the current outstanding dim sum debt is a paltry CN¥198 billion ($31 billion), larger issues such as this past August's CN¥15 billion ($2.3 billion) notes of the Chinese Finance Ministry have begun to expand the market beyond small investors.

The Ideal Rate

"The taxation of capital gains,"
Said a student of John Maynard Keynes,
"Would ideally fall
Between 'nothing at all'
And the rate at which Buffett complains."

Writing in the Wall Street Journal on the "Three Policies That Gave Us the [Steve] Jobs Economy," Amity Shlaes cites the slashing of the capital gains rate from a confiscatory 49% to 25% in 1978. Building on this evidence, she reaches the silly conclusion that "taxes on capital should always be lowered, and dramatically." One might just as easily conclude that, because a diet improved one's physique, that mealtime portions should always be dramatically lowered, too. But what is the correct capital gains rate? Undoubtedly, it lies between encouragement of wild speculation and discouragement of capital formation.

Always Low Prices?

Said an analyst: "Time for rethinking
Whether Wal-Mart is rising or sinking;
Though still they do well,
Their core clientele
Find their incomes and credit lines shrinking."

Kelly Evans, the Wall Street Journal's Ahead of the Tape scribe, writes that Wal-Mart is at a crossroads: though retail analysts see the company's earnings growing at 10% a year, surveys indicate that 60% of Wal-Mart's customers no longer believe it has the lowest prices. This leaves Bentonville, Arkansas' big-box powerhouse in the awkward position of moving up from its financially troubled core demographic to compete more directly with the likes of Costqueau and Targét. Wal-Martre, anyone?

The Too-Quiet Markets

The US is counting the days away
From default, which we surely hope stays away,
But the markets' reaction
Shows great satisfaction
Catastrophe's still quite a ways away.

Confounding the expectations of financial journalists, the international financial markets remained calm with less than a week to go before August 2, understood by all as the date on which the US Treasury could no longer pay its bills without an increase in the federal debt ceiling. Like Sherlock Holmes investigating the case of the dog that didn't bark, the Wall Street Journal contacted fixed income portfolio managers to explain this odd silence. The general answer seems to be an expectation that the immediate problem of the debt ceiling can and will be solved quickly, even if the larger problem of deficits may be thornier.

* * *

Is there a limerick writer in you waiting to get out? Dr. Goose will appear on Marketplace Money with Tess Vigeland this weekend, and they would like your debt ceiling limericks to add to the fun! You can post them on the Marketplace Money Facebook page, or tweet them to @radiotess.

More Dollars to Gold(en Arches)

Said McDonald's competitors recently:
"While the rest of us lag, they do decently;
We must capture, like they,
An original way
Of promoting the spread of obesity."

In times of dollar distress, investors take to gold. The same holds true for the golden arches of McDonald's (NYSE: MCD) which, practically alone in the fast food industry, continues to grow same-store sales at a healthy (if that's the word for it) pace. Perhaps, as Kelly Evans writes in the Wall Street Journal's Ahead of the Tape column, it's due to the traffic drawn to those fruity smoothies and sweet iced coffee drinks. Or maybe those golden fries really are a store of (caloric) value.

Ill-Defined Contribution Plan

For things that aren't broke to be mended
May bring consequence oft unintended,
As the craftiest plan
Of mouse and of man,
Economic'ly, time and again did.

Tess Vigeland of public radio's Marketplace Money recently highlighted the surprising finding of a study first published in The Wall Street Journal: Given a default option of saving a minimal amount in their 401k plans, many employees will take it, rather than setting aside the greater portion of earnings they would have saved on their own initiative. This is too bad, because automatic enrollment at 3% of salary has been widely introduced by defined contribution plan sponsors since being mandated in a 2006 federal law. Statistical modeling has shown that many participants opt for the default, 3% withholding rate when, left to their own devices, they might have "maxed out" their retirement savings.