What a crazy week?

What a crazy week?
David R. Kotok
July 7, 2012




Markets reacted to this crazy week of discredited, ADP-based employment forecasts, LIBOR revelations and central bank fizzle. The result is plain ugly.

In Europe, post-ECB, credit spreads widened. Good-guy yields declined; bad-guy yields rose. See our updated EU contagion series at www.cumber.com. Note how Swiss yields are negative until the 5-year maturity (which is a whopping 7 basis points). For new readers, see our archives on why the Swiss 10-year government bond is now the de facto benchmark for the eurozone. The European Central Bank demonstrated too little, too late. This week’s Draghi Q&A did not help matters. We continue to underweight Europe. It is still too soon to bottom fish.

In the US, the employment statistics release shows an ongoing but weakening, very slow recovery. A plus 80 thousand nonfarm jobs is better than minus 80 thousand. We see nothing to alter this slow but marginally positive growth outlook. The Fed’s additional “Twist” is a whimper, not a shout. In fact, that is probably a good thing, since monetary policy has its limits, and we are near them. We expect no more from the Fed for the rest of this year unless there is a seriously negative event. In our US ETF accounts we are still holding a cash reserve. In managed taxable and tax-free bond accounts we are slowly bringing in duration and using tactical hedging where appropriate. Our newly launched US high-yield debt strategy is developing well.

LIBOR-gate, as Michael Lewitt titled it, is a mess. It is potentially huge. We expect more ugly revelations. Other institutions may be implicated. Critics of emerging-market governance standards need to look in the mirror. The so-called developed markets now exude a rising stench.

We will end this weekend missive with an email exchange.

Steve wrote, “David, Do you have any insight into this article? To what degree is it true / false?” He furnished this link to a Business Insider piece that discusses corruption in China.

My answer follows.

Steve, we have continuing questions about reporting from China. It takes on-site anecdotes to gain a picture that reveals trends. We do that by obtaining data from sources we know and trust. For example, one can count containers on ships or coal inventories or financial holdings at public institutions.

But why is the writer looking at China?

Business Insider penned this opening: “[Other articles have described the] widespread fraud that has become apparent, both in mainland and US listed Chinese companies…..an extraordinary number of the Communist Party and the military cadre had massive unexplained wealth …”

Let’s take a different approach. I have rewritten his sentence into a different context. Suppose you, Steve, were an honest Chinese observer, reading the following sentences about the United States.

“Widespread fraud has become apparent in the Mainland US and among US-listed financial firms. Extraordinary numbers of political figures and public appointees have massive wealth. Examples include (1) Dick Fuld, who was a director of the Federal Reserve Bank of NY until his firm, Lehman Brothers, went into bankruptcy. He has not been charged with any crime. He denied knowledge of any accounting irregularities. (2) Former US Senator Jon Corzine’s firm was a Federal Reserve primary dealer before it failed. Huge balances of client funds are unaccounted for at MF Global. Corzine says he does not know what happened. (3) No one knows the counterparties of the transactions that cost JPM billions. (4) Members of Congress and their staffs trade on insider information and are not violating US law because of the congressional exemption that Congress legislated for itself.”

Steve, I could lengthen this but you get my point.

I will stop with my own personal observation about the LIBOR scandal. My colleagues Michael Lewitt, Bob Eisenbeis, and Bill Witherell have written about it this week. (www.cumber.com)

The LIBOR rigging is systemic. For evidence see a Bloomberg report from May 29, 2008, under the headline, “Libor Banks Misstated Rates, Bond at Barclays Says.” (Yes, the article ran more than four years before Barclays’s $453 million settlement last month with U.S. and U.K. authorities for manipulating Libor.)

Steve, this scandal is going to take down many more than just Barclay’s leaders. The claims are likely to be in the trillions.

Imagine the board meeting at Barclays. The general counsel says, “I have a settlement proposal. We can pay 1/2 billion in fines to the US and UK authorities now; and you, Mr. Chairman, and you, Mr. CEO, and you, Mr. COO, will resign at once. Others will also resign or be dismissed. Gentlemen, I can make this deal right now and settle it or we can have a prolonged investigation. In my opinion, paying the half billion now and taking the resignations early is the cheapest way out of this mess.” The board votes yes.

Steve, the insiders on that board know the facts. Watch out for what is coming. It may dwarf allegations about Chinese corruption.

The US and UK systems were once the models for the world. They are now sick and corrupt. We are five years into a financial crisis and nothing has changed. Who are we to throw stones at others?


David R. Kotok, Chairman and Chief Investment Officer

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