Bob Carlson

Every time there’s a major scandal or financial catastrophe, the question eventually is asked, “Where was the SEC?” The answer, straight from the SEC itself, is that it is investigating and picking on the little guys. Apparently, the SEC’s focus is on presenting a lot of enforcement data to Congress after the end of the year. Its more efficient for the SEC to generate a lot of small cases and disciplinary actions rather than butt heads with the large firms. So, the big boys can get away with almost anything they want. Read about it here.

In the last year or so I’ve heard from several attorneys who represent smaller clients who tell me they’re flabbergasted, watching the S.E.C. give the Chases, Goldmans, and Citigroups free ride after free ride while their pockmarked little clients at fledgling public companies get served the whole regulatory meal for minor disclosure violations – even cases that simply involve bad paperwork, where money isn’t even stolen. If you’re a little tech startup and there’s a $100,000 problem in your books, you can expect the full Princess Bride torture machine treatment, with multiple agents assigned to your case, serious criminal penalties, asset seizures, etc.

Investors were lulled into a complacent state by the effects of the massive monetary injection by global central banks in late 2011. The new money turned around major global economies and boosted asset prices, especially equities and real estate. But that’s the past. The monetary expansion programs are winding down, and the global economy is showing negative effects. It appears to me that there isn’t any country where the economy is self-sustaining right now without a large amount of stimulus. Consider these points:

* Europe continues to deteriorate at a rapid rate. After four years of crisis, things are worse than they were at the start. The debt to GDP ratio of the troubled countries continues to rise. The countries are paying more to service their debts because interest rates are rising. At the same time, revenues are declining because of poor economies and capital flight. Banks in the core countries that lent all the money in the first place aren’t lending now, because they need to shore up their balance sheets.

* India and China are having problems. These are the two leading emerging economies and a major factor in the emerging economic boom of the last few years. India’s problems seem rather serious, though they haven’t been widely reported. Its currency is in trouble; the stock market is down; and the economy just recorded its lowest growth rate in nine years. See here for details.

* The U.S. economy and stock market had been doing well, causing some to argue it now was delinked from the global economy. I don’t see that. The latest data for the U.S. largely were below expectations. Growth in the U.S. clearly is slowing toward zero and perhaps below. See here for some details.

* U.S. stocks are about to turn in their worst month since Sept. 2011, which was pretty bad. The news is so bad that even gold, the usual crisis hedge, is having problems, turning in its worst month in 13 years.

A number of investors and businesses are counting on the central banks to come to the rescue again with another round of monetary stimulus. But you don’t know when that might come, and how bad things will become before they act. Also, there’s no guarantee that the stimulus will be as effective as in the last few years. I recommend you take less risk in both your portfolio and your business than you would in normal times. Stay balanced and diversified. There’s a probability of 25% or more that policymakers in Europe will continue to make mistakes and allow the situation to spin out of control as it did after the Lehman Brothers bankruptcy.

Most people don’t know much about Medicare, even current beneficiaries. People planning for retirement don’t know much either, as surveys consistently show. As this article says, they’re clueless. A few points it makes are that we aren’t paying into a trust fund that funds our benefits during retirement. In fact, most of the benefits paid by Medicare come from current federal tax collections. Premiums pay about 12% of the costs each year. The small and shrinking trust fund covers about 39% of the costs.

The situation will become worse, because the working age population is shrinking while the number of beneficiaries is increasing. It’s an unsustainable program, but no one is willing to do anything about it. The Affordable Health Care Act of 2010 makes things worse by taking some money from Medicare and shifting it to other parts of the government health benefit structure. When the older part of the population is increasing and the younger part is decreasing, a program that transfers wealth from the younger to the older won’t last indefinitely.

The net present value of the transfer — the amount that would have to be set aside today to fund Medicare’s future intergenerational promises — has grown to at least $25 trillion, as calculated by the Government Accountability Office. This number is buried in footnotes of the annual Treasury-OMB report and is so large (almost twice the $14 trillion value of all public U.S. companies) that it defies comprehension. It’s not surprising that Americans can’t relate the alarming cost of this transfer to their own lives.

But recent work by the Urban Institute calculates the amount of the transfer to an average retiree. An American man retiring in 2011 could expect to receive Medicare benefits worth $170,000 (in 2011 dollars). If he had worked from age 22 at the average U.S. wage each year, he would have paid Medicare taxes (plus interest) worth $60,000 (also in 2011 dollars). So the average male worker retiring in 2011 will receive benefits worth almost three times what he paid in. And the transfer to that retiree will be $110,000 from younger Americans, perhaps including his grandchildren.

The shadow banking system was a major impetus behind the blow off phase of the late economic boom and investment bull market. In 2008 this informal market of asset-backed securities has been dormant. The Fed has been the major purchaser of debt and provider of credit to the economy. A major reason I’ve been cautious on the economy and markets the last few years is that there’s been little sign of a healthy private credit market, and the demise of the shadow banking sector is a key there.

Here’s an update on the shadow banking market from FTAlphaville. The article admits that it’s not easy to measure and chart this market, but that by its measures the market remains at about half its 2008 level.

Back on tax filing day, I pointed out that many of us have to pay twice to file our taxes because of the power of lobbyists for technology copies. They’ve prevented the IRS from creating its own online filing system. Instead, you have to pay a software company for its tax filing software. Then, you have to pay again to electronically file the return. In addition, the IRS has to pay to create a cumbersome system that imperfectly gathers information from the electronic filing into its database. There are other problems I mention.

Here’s another problem from the current system. It turns out that it’s really easy for crooks to circumvent IRS systems to file tax returns claiming false refunds and having the refunds deposited in their bank accounts. This article explains the fraud and some simple steps that would let the IRS stop most of it. The fraud also could be stopped if the IRS had its own online filing system and could use that to determine if a Social Security number is legitimate, if the number’s been used on another return, and if the bank account receiving the electronic deposit has been used for other returns. But the lobbyists stop the progress and cost all of us more money.

News media often have stories about pro athletes who made a lot of money but became bankrupt. Here’s a piece with a more positive take. It interviewed a collection of retired pro athletes who did smart things with their money and are having successful retirements. The article isn’t just for athletes and prospective athletes. You can use the lessons these pros offer to improve your retirement planning or pass on to your children and grandchildren. They might be more impressed with the lessons from an athlete than from you or me.

Kris Draper, formerly with the NHL, is very savings conscious, telling me,  “After taxes, I always tried to save at least 50% of my game checks;” adding that he recently spoke with his advisor and structured his allocation toward 40% stocks, 35% bonds and fixed income, and 25% cash.  When I asked him about the heavy cash position, he said, “I want to be protected from the market’s volatility and not lose a bunch of money.” That on-guard philosophy matches his hockey playing style, as evidenced by being awarded the Frank J. Selke Trophy recognizing the NHL’s most defensive-minded forward.

Retired football pro Desmond Howard is also in the moderates’ camp but followed a different savings formula.  “I was advised to save my signing bonus for a rainy day,” he said, “and to live on the money I was generating off the field through trading cards deals and other endorsements.”  “Many players live beyond their means,” he carefully suggested.  “It’s not that they are overspending but they’re acting like the money they are making now is going to be there forever.”

Details continue to come out about how JPMorgan Chase lost $2 billion or $3 billion or more in a trade that supposedly was simply to hedge against other risks of the bank. The New York Times has a detailed piece about how the hedge funds spotted an opportunity and seized it. The article focuses on Boaz Weinstein, well known in hedge fund circles but hardly anywhere else, though it says Weinstein wouldn’t be interviewed for the article. The article is entertaining and also presents a theory about why traders at JPMorgan Chase ignored the effects their trades were having on the markets and how that would attract aggressive hedge fund investors.While the hedge funds made a lot of money, for a while they were losing big bucks while JPMorgan continued to control the market.

But the London Whale was so big that, for months, the hedge funds betting against him simply got steamrolled. One of Mr. Weinstein’s funds at Saba was down 20 percent heading into May.

Then the tables began to turn, as news reports about Mr. Iksil, fed by the hedge funds, began to surface on both sides of the Atlantic. Suddenly, everyone was checking out the obscure index that Mr. Weinstein and others had seized upon.

By May, when fears over Europe’s debt crisis again came to the fore, the trade reversed. The London Whale was losing. And Mr. Weinstein began to make back all of his losses — and then some — in a matter of weeks.

Europe’s financial distress is dominating the financial headlines and the direction of the markets. While the U.S. enjoyed a three-day holiday weekend, things were deteriorating in Europe, especially in Spain. The crisis that was supposed to be contained to Greece and its unique problems now is spreading to larger countries. You need look no further than Forbes.com today to see a collection of headlines describing what’s happening in Europe.

There’s a piece reporting that a majority of Germans now want Greece to leave the euro. They’d rather suffer the chaos of the unwinding than spend some of their money to do some kind of a bailout. I think a Greek exit from the euro is unlikely unless the countries decide they no longer want a European monetary union. If Greece leaves, the gates open for others to leave. There’s no reason for other countries, such as Spain, to submit to austerity or take losses. They’d have an incentive to exit the euro.

Despite this, people are planning for Greece to exit the euro and for other extreme events. Britain is taking a look at its immigration policies in case the depression and continuing crisis in Greece causes a fresh exodus from that country. Insurers and other companies are looking at their businesses and preparing contingencies for either a Greece exit from the euro or a collapse of the euro.

There’s also a very interesting piece explaining why Spain’s situation is different from Greece’s. It isn’t simply that Spain is a bigger economy and more important to the European Union. The problems in Spain largely are caused by local governments being unable to pay the loans they’ve taken from banks. Catalonia, in particular, is a major cause of the need to bail out major bank Bankia last week.

There are a lot of moving parts in the European financial crisis now, and policymakers simply aren’t keep up with them or planning ahead. They continue to focus on the last problem instead of the ones coming down the road. That’s why the dollar continues to gain against most currencies. The euro, which held up well through most of the crisis, now is steadily declining. There appears to be an exodus of capital from Europe, as reported by The Financial Times. Government bonds in the U.S. and Germany are safe havens while investors are selling other assets. Economic data in the U.S. and elsewhere doesn’t really matter, because the situation in Europe threatens the global economy.

The Spanish financial sector is falling apart.  What began with a real estate bubble in the Iberian nation now threatens the integrity of the Eurozone as a whole, despite myopic markets freaking out about Greece lately, forgetting that there is more to this puzzle than the Hellenic Republic.

On Friday, failed bank Bankia’s new management huddled together to try to figure out how much money they actually need to shore up their troubled institution.  Media reports indicate that number will be between €15 and €20 billion ($19 to $25 billion), more than all the money the federal government has committed to the emergency bailout facility they called FROB.

At the same time, local finances are still deteriorating.  Now, Spain’s richest autonomous region, Catalonia, has come out publicly asking the state to honor its commitments and fork over some more cash in order to meet monthly payments.  Artur Mas, president of the region, is calling for the creation of “hispanobonds,” backed by all regions in order to meet debt and deficit payments.  Catalonia has more than €13 billion ($16.3 billion) to refinance this year, according to the FT.

The currency markets often are the first sign that a country is nearing financial distress. Currency traders tend to sell faster than other investors, including the fabled bond market vigilantes. Also, country insiders and those with wealth are quick to move their wealth out of the local currency into something more stable. A currency decline often is followed by or causes interest rate increases. For the last two years many people have been surprised that the euro’s value has held up given the financial crisis. But there still was demand for euros. The debtors needed euros to pay their debts, and asset sales converted other assets into euros to shore up banks.

But now the euros is declining, and the decline could become sharp. It started with the musings of a Greek official that Greece might consider leaving the euro. There also were statements from some German officials that they might accept higher inflation (and a lower currency) to ease the crisis. So, now investors are selling the euro and bidding up interest rates on peripheral nation debt. It’s making the dollar stronger and creating profits in treasury bonds. Latin American countries also are being affected by the global economic slow down. The trend is well worth watching. If the European leaders announce an agreement after their latest conference, check the reaction of the currency markets to gauge how good the agreement is. You can see more details here and here.

The computerized trading systems known as high-frequency trading are believed to roil the markets and are blamed by many people for the “flash crash” that occurred in May 2010. Is the solution to regulate trading frequency and speeds in some way? Or is the solution to allow shares of stock to trade in increments of less than a penny? Economists Tyler Cowen and Alex Tabarrok argue that traders compete on speed because the penny limit won’t let them compete on price. They argue that the stock exchanges and regulators should allow shares to trade for less than a penny difference.

Penny pricing (and before that 1/16th pricing) made sense when stocks were mostly traded by humans and we needed to conserve cognition but, as Stucchio points out, most trading today is done by computers and pricing in hundredths of a penny (or less) would not impose any extra effort on the computers. Pricing in 1/100ths of a penny, however, would dramatically increase price competition and reduce wasteful quality competition.