Dodd – Frank vs. the Financial Industry

The capitalist version of the Golden Rule goes something like this, “He who has the gold, makes the rules.” This is exactly what we are seeing with the implementation of the Dodd – Frank Act. The financial institutions have the resources to stall, drag, markup, and negotiate on every one of the 243 rules, 67 studies and 22 periodic reports the Act contains. The most recent markup session was a classic example of, “The Golden Rule” at work. The House Agricultural Committee’s recent markup session included bills to gut the most important parts of the Dodd – Frank Act. The committee invited 5 individuals to discuss these matters, four from the financial industry and one person from the private sector, Wallace Turbeville of the Americans for Financial Reform.

The timing of this session was critical as it came right on the heels of the London Whale testimony before the Senate Permanent Subcommittee on Investigations. The London whale was the JP Morgan trader who accumulated an outsize losing position, at one point reaching a negative value of more than $150 billion dollars before finally paring the reported loss to just over $6 billion. The crucial point here is that JP Morgan lied about the debt from beginning to end and was able to transfer funds internationally among its branches to hide the loss. One of Dodd – Franks’ most important pieces is, “extraterritoriality.”

Extraterritoriality is what is supposed to protect the American financial system from a meltdown somewhere else on the globe. This act would ensure that American firms who hold risk outside of the U.S. must still use our reporting standards. This is the loophole JP Morgan used to hide the losses of the London Whale for so long. This piece of legislation also increases transparency by creating a public swaps global clearinghouse so that the vast majority of these can be readily monitored. This is a good thing. However, this would hurt the financial industry’s profits through more reporting man-hours as well as additional execution, clearing and margin requirements.

The next major challenge with the implementation of the Dodd Frank Act is the, “Bank Derivatives Subsidiaries.” This is intended to eliminate, “too big to fail.” The financial industry is having a hard time coming to grips with the notion that it may have to separate its trading and banking operations. Dodd-Frank got this right. Investment firms should be investment firms and banks should be banks. It’s one thing for a bank to loan out excess deposits. It’s quite a different matter when the bank is using your excess deposits to trade European debt markets, crude oil or any other trade the bank would like to initiate with your funds. Just a few years post crisis and the banks already want us to allow access to taxpayer funds to cover their losses. Trading becomes a pretty easy game when the taxpayer money is there to cover the losers.

These are the two primary points of contention with several others falling under the umbrella of the previous two paragraphs like, “Business Risk Mitigation and Price Stabilization Act.” This is a margin act. When a product is hedged, there is still risk for the financial institution. Therefore, the Dodd-Frank stipulation that the financial entity engaged in the hedge transaction should keep sufficient margin on hand to cover market movement. This splits the previous points if the trading entities are spun off from the banking sector as well as creating a trading entity that can be monitored while assuring client funds in the banking side of the business remain safe.

The era of, “too big to fail” must come to an end. Individuals who put their money in banks deserve to know that it’s safe. There was a time when customers worried that their money may be stolen by crooks robbing the bank. I doubt anyone ever thought of the crooks in the bank stealing their money. The financial industry must undergo a paradigm shift in this respect and realize that they cannot be all things to all people and therefore must choose between investment banking and customer banking. Dodd-Frank implementation is a daunting task. Current estimates are that somewhere between one quarter and one half of it has been put into place. If the finance industry has its way, that’s as far as it will go and the people with the gold will have arranged the rules to suit themselves once more.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Cyprus Citizens vs. Russian Oligarchs

Cyprus has found its way into the epicenter of the European debt crisis by forcing their government to publicly choose whether they’re on the side of their citizens or whether they’ll side with billions of Rubles. It’s been several months since we’ve discussed the European debt crisis, which has now been brought to the fore by tiny little Cyprus. This little island in the Mediterranean is home to about 1.2 million people and sits on about 3,500 square miles. This makes its population smaller than Dallas and San Diego and slightly larger than San Jose or, Jacksonville while physically it fits between Rhode Island and Delaware.

Cyprus joined the European Union in 2004 amidst reports that Cyprus is primarily a money laundering country used mostly by Russians. Der Spiegel, a German newspaper, published a lengthy article in January based on an investigation by Germany’s Federal Intelligence Service regarding the degree of money laundering in Cyprus. The report found that more than $26 billion of the $80 billion that flowed out of Russia in 2011 ended up in Cypriot banks. The $26 billion that found its way into Cyprus is greater than their entire annual GDP.

The issue that Cyprus faces is that their role as a financial services hub has been severely hampered by the economic collapse of 2008. This has been made worse by the low tax rates and favorable corporate regulations that were used as incentives to attract capital in the first place. Therefore, Cyprus is stuck with the compounded slowdown of a declining economic base due to increased regulation along with a declining domestic tax base. The final blow to the Cypriot banking system is due to the failure of their banks’ investments in Greece.

The Cyprus government is now left with the unenviable task of finding a balance between its residents and the appeasement of its Russian investors. Current proposals suggest sharing the load between the Cypriot citizens and the Russian oligarchs. The European troika, (European Safety Mechanism, European Central Bank and the International Monetary Fund) wants Cyprus to come up with matching funds to bail them out.

The original proposal would have taxed bank accounts under $100,000 6.75% and accounts over $100,000 9.9%. The second proposal has several splits including removing the protection on deposits over $100,000 and taking the money from over funded accounts most likely held by Russian businesses. The downside, according to JP Morgan is that this would cost investors about 15% of their funds above $100,000. The third option is to split the costs of the failing banks by charging  3% on accounts less than $100,000, 10% on accounts between $100,000 – $500,000 and 15% on accounts above $500,000.

These are all logical solutions to an illogical problem that must be addressed by our societies as a whole. We’ve been discussing the flight of capital and capital will always flow towards the greatest possible potential. Cypriot corporate tax rates are half of the Russian rates and their capital gains taxes are even friendlier. The policies that have been put in place to attract capital come at the expense of those with no capital to spare. These morals are not tied to foreign capital and money laundering; they’re based on the collusion and graft of the people making the rules. Unfortunately, those of us with no voice will be expected to pay their share when things turn south.

Cyprus has seen its banks closed for days. There could be a run on the banks but I don’t think there will be. The billions of Rubles that flow through Cyprus will provide enough grease to absorb the bad debts on Grecian investments. Russia has no desire to see the back door closed. There will be a battle between transparency to the general public and the Great Oz who will do everything they can to ensure business as usual, regardless of the income source or destination of profits.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Commercial Support in the Canadian Dollar

The Commodity Futures Trading Commission releases its Commitment of Traders data weekly. This data tracks the amount of buying or selling in the commodity markets by the markets’ primary trader categories. I review this data every Sunday night when I begin compiling my trading plan for the coming week. The Canadian Dollar has hit my radar for each of the last three weeks as the commercial traders’ position has grown faster than at any time in the past and their total position has only been exceeded once in the history of the data set.

The Commitment of Traders data goes back to 1983 in the Canadian Dollar and the first meaningful blip on the radar shows up in February of 1986 when the Canadian Dollar bottomed around $.69 cents to the U.S. Dollar. Commercial traders went from neutral to net long more than 9,400 contracts, the equivalent of nearly $1 billion dollars at full contract value. The market rallied nearly 6% over the next three months. Commercial traders next set a record long position in March of 1990 at 10,270 contracts or, just over $1 billion at full contract value and the market rallied 5.5% in the next few months.

Commercial traders’ buying the futures doesn’t always lead directly to a rally. There are times when it simply slows the decline as they cover short positions, as well. There are considerable spikes in August of 1993 and January of 1995 when the Canadian Dollar had been on a steady decline since its $.90 cent peak in 1991. In fact, the commercial buying peaked at 28,000 contracts at the bottom of the market in January of 1995. In this case it’s important to remember the old rule, “Whether getting long or, covering shorts; buying is buying.” It would take another three years and the, “Asian contagion” to generate enough commercial interest to eclipse the buying peak at the 1995 trough.

The Canadian government has done an amazing job of revamping their monetary policies and budgets over the last 15 years. The primary impetus for this was the 1995 budget, which cut governmental spending across the board while allowing greater freedom to the individual provinces as to how they could spend the federal money they received. The provinces were then able to target the funds to their individual needs. Furthermore, the corporate tax and capital gains taxes were restructured to facilitate capital expenditures and new business generation. Finally, they implemented a federal General Services Tax. This is similar to the European Union VAT (Value Added Tax), which is a consumption tax that is paid proportionately by higher income people who spend more.

These changes significantly improved the Canadian economy. Their workforce has grown substantially. Unemployment has declined and jobs have been added to the economy. Welfare recipients declined along with the percentage of people below the poverty line. In fact, the number of low-income families declined by more than 30%. This was all achieved while cutting their debt to GDP ratio from 80% down to 45%. Their current debt to GDP has now reverted back around 85% due to the economic collapse. Meanwhile, our debt to GDP ratio has surpassed 100%. There is no question that our neighbors to the north are doing a far better job of maintaining their budget than we are.

The total net long record for commercial traders in the Canadian Dollar is 105,543 contracts. Commercial traders accumulated a net position of $10.5 billion dollars worth of Canadian Dollars in January of 2007 when the market was trading at $.85 cents to the U.S. Dollar. The Canadian Dollar then reached a record high of $1.10 by early November that same year. Equally important, these same commercial traders had pared this position down by more than 90% at the high water mark. That, my friends, is pretty darn good trading.

Currently, we have seen commercial traders’ positions increase from 4,431 contracts in mid January to more than 86,000 contracts, currently. The Canadian Dollar is currently trading around $.97 to the U.S. Dollar. This market has held above $.95 for the better part of the last three years. We view the strong commercial purchases as a sign of supporting the market at these levels. Commercial traders have demonstrated their forecasting ability admirably in the past and we will lean on them for support as we buy into this market. However, managing risk is always our number one concern. Therefore, we will place our protective stop under the current swing low of $.9650 in the June Canadian Dollar futures as we anticipate a move back to parity with our U.S. Dollar.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Bad Year to be Responsibly Average

The Dow Jones has recovered all of its losses since the financial crisis and made a new all time high this week. Unfortunately, most of you reading this will have benefitted very little from its dramatic comeback. However, there are a very few who have benefitted greatly. Professor G. William Domhoff of the University of California demonstrated that the richest 10% own 98.5% of all financial securities. Furthermore the wealth gap between the top 20% and the rest of the population has never been larger. Finally, the growth in income disparity has accelerated under President Obama.

Matt Stoller, of the Roosevelt Institute analyzed IRS data to determine who captured the lion’s share of real average income growth between 1993 and 2010 and found that under President Bush, the top one percent captured 65% of the real average income growth while under President Obama, the top 1% has captured 93% of the real average income growth. The point here is not to choose political sides; after all, income was most evenly distributed under President Clinton. The point is that regardless of what side the politicians are on or whom they pretend to be looking out for, their number one concern is lining the pockets of those that paid for their election. Left or right is irrelevant.

The political system repays two types of voters. It enacts legislation at the highest levels to foster growth in the pharmaceutical, military, raw material and financial industries, thus repaying their campaign contributors. Secondly, the popular vote is increasingly purchased through extended government subsidies on everything from an extension of unemployment benefits and disability claims to housing subsidies and mortgage forgiveness. Every additional dollar doled out through legislation or direct voucher subsidy is a dollar paid to ensure the perpetuation of a system that is withdrawing cash from the middle of our economy and redistributing it between the massive and growing welfare class and the elitist top 10%.

This not intended to slam the unemployed. Frankly, the numbers reported for unemployment like the current measure of 7.9% is woefully under reported when compared to what real unemployment feels like. The Bureau of Labor Statistics reports that there are 8 million people who are unsatisfied workers. These are people who can’t find enough work. They also report that there are another 10 million workers who have given up looking for work. When these 18 million dissatisfied and exasperated workers are added back into the working population a truer picture of unemployment approaches 14.5%. Finally, these numbers don’t reflect another 5 million people who gave up looking for work and are now drawing social security disability.

While many of us haven’t participated in the stock market rally I think one place we’ve shared the climb is at the gas pump. The price of gas has risen steadily over the last month and the Energy Information Administration says that 2012 was nearly the most expensive year on record for American drivers, second only to 2008. They said gas prices accounted for 5.8% of a $50,000 median income. This year’s price increases could push this to nearly 18% of median income and drag another $400 out of the middle’s pockets.

High gas prices stink but at least they’re not the triple economic threat of the Affordable Health Care Act, which will reduce total hiring and hours worked as employers attempt to remain below the hourly and total employment thresholds. The Affordable Health Care Act will also shift more of the deductible payment to the worker as employers seek higher deductible plans to manage the expense of administrating the plan. The Kaiser Family Foundation says this will cost employees about $3,000 in 2013 in added premiums and higher deductibles.

Gas, groceries and health care are issues we all face but the percentage of our budget we use to pay these declines as income grows. A family of four that spends $800 per month on groceries with a $50,000 annual income isn’t going to spend $8,000 a month on groceries if they make $500,000 per year. Therefore the top earners are affected very little by the rising costs of living. Meanwhile, the social safety net continues to pick up a larger portion of the population as job growth and income stagnates at the bottom threshold.

This is the pattern that we face as a country. Bureaucrats acting in their own self-interest with horizons just past the next election are too short sighted to enact long-term legislation. This is how sequestration came into being, as leverage to force Congress into action yet, in spite of their OWN poison pill, the deficit continues to grow unchecked, the voters continue to cast their ballots and the top 10% continue to cover each others’ backs.