Cyberthief Malware Targets Banking Credentials on Smartphones

Cyberthief Malware Targets Banking Credentials on Smartphones

It used to be you were concerned with losing your check-book, then it was either losing your credit card or having someone lift the account number, expiration date and 3-digit code. Through the wonders of technology and the adoption of Cashless Consumption,  thieves are now targeting smartphones. This dark side of our Cashless Consumption investing theme is a tailwind for Safety & Security applications be they for locking down a smartphone or proactively alerting you when the offender uses your banking credentials.

Cyberthieves have a new way to hack into consumer bank accounts: mobile phones.

Malicious software programs with names like Acecard and GM Bot are gaining popularity around the world as criminals look for new and lucrative ways to attack the financial-services industry. Cyberthieves are using such so-called malware to steal banking credentials from unsuspecting consumers when they log on to their bank accounts via their mobile phones, according to law-enforcement officials and cybersecurity specialists.

The malware typically gets onto a phone when a user clicks on a text message from an unknown source or taps an advertisement on a website. Once installed, it often lies dormant until the user opens a banking app.

The malware then creates a customized overlay on the authentic banking app. This allows criminals to follow a user’s movements on the phone and eventually grab credentials to the account.

Source: Mobile Bank Heist: Hackers Target Your Phone – WSJ

Italian Bank Stress Test Results

On July 29th I spoke with David Asman on Fox Business concerning the results of the Italian Bank stress tests along with Adam Shapiro, Charles Payne and Steve Forbes. The recent vote in the UK to leave the European Union put a good deal of pressure on the banks in the remaining European Union, with the banks in Italy struggling the most.  Like any good Italian drama, this is likely to be a tight ride until the very end… at which point tutti bene, at least for the next few months!

The Connected Society and growing Cashless Consumption comfort are enabling BofA to cut jobs

The Connected Society and growing Cashless Consumption comfort are enabling BofA to cut jobs

Banks are increasingly adapting their business to the growing Connected Society. As comfort levels among consumers rise with Cashless Consumption, banks are able drive productivity higher and costs lower. Fewer people mean fewer salaries and lower benefit costs at a time when healthcare costs continue to climb no thanks to the Affordable Care Act. Without question one downside to this  is jobs and eventually entire branches offices, which translates into a continuation of our Cash-strapped Consumer investing theme. While we note BofA is doing this to drive returns and profits, we can probably take it to the bank that it is not the only financial company doing this or at least planning to do so. 

Bank of America had 4,689 branches as of the end of the first quarter, down from an average of 6,100 in 2009.

Bank of America’s shrinking headcount and branch footprint is a reflection of the powerful shift in habits by users. Instead of walking into traditional bank branches, Americans are growing increasing comfortable with banking on PCs and using their smartphones for everything from money transfers to depositing checks.

Digital transactions are way less expensive and keep customers happy. In fact, BofA said it costs less than a tenth of the expenses of traditional banks.

“Our strategy is putting everything on the mobile phone. If you have a thumb, you can bank,” Thong Nguyen, Bank of America’s co-head of consumer banking, said at an industry conference on Tuesday. “That’s where a lot of our strategy is going to move going forward.”

Source: Bank of America cuts more jobs in Charlotte, elsewhere | The Charlotte Observer

Banks & the Fed – Bail 'em Out then Beat 'em Up

While shoppers were watching their pennies this holiday season, I was grinching over the relationship between the Fed and the big banks as reminiscent of the abusive relationship between Ike and Tina Turner – bail them out then beat them up with an onslaught of massive fines.  According to a global banking study by the Boston Consulting Group, legal claims against the world’s leading banks have reached $178 billion since the financial crisis, with heavy fines now seen as a cost of doing business, a cost ultimately born by shareholders with no banking employees or executives facing charges for wrong-doing.

All these fines do little to deter wrong-doing in the future while taking money out of the hands of those saving for retirement and give it to the government to spend with zero accountability.


 

How and Why of Greek Debt

How and Why of Greek Debt

When a nation has more debt than it can manage, it has two options (1) inflate its way out by printing more money or (2) restructure the debt.

Typically the most politically feasible solution is to inflate.  Generally wages tend to keep up to some degree with inflation, so the employed feel as if they are getting a raise and don’t gripe too much.  Those in the population who have debts prefer inflation as the relative “cost” of their debt decreases over time, e.g. with 5% inflation, debt declines in real terms by 5% every year.  It is the savers who suffer most as they watch inflation eating away at what they’ve built – in a converse to inflation reducing debt, savings declines in value by 5% every year.  This is why inflation is often referred to as a hidden tax.

The Europeans cannot inflate their way out of too much debt for the PIIGS as the U.S. is way ahead of them in the race to the bottom and they have conflicting needs across countries.  A monetary union without a political, fiscal and cultural union is complicated at best.  So why the continued kick the can?  The largest banks (German Deutsche Bank, the French BNP Paribas, Société Générale and Crédit Agricole SA among many others) have not increased their reserve capital, which would dilute shareholders, and do not want to take losses on their significant holdings of PIIGS bonds.  The euphemistic “restructuring” of these bonds would by definition require some sort of write down in value for the banks.http://www.insidermonkey.com/blog/wp-content/uploads/2011/06/Who-holds-Greek-debt.jpg

Bank’s hold these bonds as assets on their balance sheets.  They are required to maintain a certain level of assets relative to the amount of loans they give.  If the value of their assets were to suddenly drop, they could find themselves in violation of the regulations concerning this ratio.  As you can imagine – that is not good for the banking sector and lending!  We saw the last time this occurred the credit markets effectively shut down, any type of borrowing was nearly impossible, and the engine of the global economy geared way down.

So how did the U.S. get out of the bog in which the Eurozone is currently mired?  In the Spring of 2009, the U.S. banks were eventually forced to raise hard common equity that was then used to absorb losses on loans.  The fixed income market did bottom out in the Fall of 2008, but when banks sought this equity, their stocks did not wither on the vine, albeit life wasn’t exactly rosy.  Rather than taking this approach, the International Monetary Fund (IMF), the European Central Bank (ECB) and the German and French banks are giving Greece just enough liquidity to roll their debt, not the permanent equity investments that were made here in the U.S.  The Euro approach is just a temporary patch on a cracking dam.  Only when the European banks raise equity, as we did here, and the PIIGS debt is restructured will there be a true resolution.

We Aren't Out of the Woods Yet

We Aren't Out of the Woods Yet

The growth of an economy is dependent primarily on just two factors, (1) the quantity and quality of the labor pool and (2) the amount of available investment capital. With the current unemployment rate, clearly the quantity of the labor pool is not a problem. The quality of that pool is a discussion for another time. So what about the amount of available investment capital? The talk in the investment world is about QE2, and unfortunately they aren’t referring to the Cunard ocean liner. QE2 refers to the second round of “Quantitative Easing” by the Federal Reserve, which is a politically savvy way of describing the Fed printing money. (Please see “U.S. Banking System” on this blog for more details.) At its November 3rd meeting, the Fed is expected to announce the launch of QE2. Expectations are for an initial level of $500 billion, with room for upward revisions. Last week Goldman Sachs opined that $4 trillion is quite possible, according to their analysis using the Taylor Rule, which is a measure of inflation, GDP and the impact of Fed rate cuts. This rule has been fairly spot on so far in tracking the Fed’s rate decisions so their analysis warrants attention.
When credit contracts, the economy is contracting, when credit expands, the economy is expanding. The Fed is hoping that by increasing banks’ ability to lend, it can jump start the economy. Mr. Bernanke is a bit like 49er and Charger fans in the 4th quarter. This time it will be different! Anyone who saw the 49er and Charger games on October 24th understands our pain. For credit to expand, borrowers need to want to borrow, and banks need to want to lend. According to an August 23, 2010 article in the Wall Street Journal, non-financial companies in the S&P 500 are sitting on a record $2 trillion in cash.  Doesn’t sound like the problem is that businesses are lacking the funds necessary to expand, now does it? So what about existing bank reserves? This chart, using data from the Federal Reserve, shows that bank reserves are at record highs, so that seems unlikely as well.

Both corporate and household lending rates are at historical lows. So the lack of borrowing can’t be because the interest rates are too high, yet the Fed is intent on lowering these already historically low rates. Be wary as history shows that excessively low interest rates inevitably lead to asset bubbles as those who have cash desperately seek some place to generate returns.

Household income is showing slight improvements, savings is trending up while spending is trending down. This doesn’t seem to indicate a desire by households to borrow. (The following chart is derived from Data from the U.S. Department of Commerce, Bureau of Labor Statistics)

What is QE2 likely to accomplish? The Fed will once again create money out of thin air and most likely use it to purchase Treasury bonds to send long-term interest rates even lower. If this works, bond yields should fall, the dollar will fall and stocks and commodities should rise. A good deal of this has already been “baked in” to the market, meaning since the markets are convinced Bernanke is going for round two, they’ve already adjusted as if it were a done deal. Shorting the dollar has become a favorite pastime of many market professionals, so we could even see a rally in the dollar if QE2 doesn’t come on as strong initially as some have predicted. In the short run, things could go in a variety of directions, all of which are becoming increasingly difficult to anticipate. In the long run, inflation and potentially high inflation is a real possibility with all this expansion of bank reserves. I recently attended a meeting of the Mont Pelerin Society, (an international organization composed of economists, Nobel Prize winners, philosophers, historians, and business leaders) in Sydney, Australia. A topic of discussion at this conference was the possible destructive consequence of the developed nations’ seeming race towards the bottom through currency debasement. The investing world is becoming a more challenging jungle to navigate as the actions of individuals in governments around the world have increasing impact on the global economy, rather than market fundamentals. This past weekend the finance ministers of the G20 countries met in Korea to discuss “re-balancing the world.” When 20 fallible human bureaucrats, with imperfect knowledge under great political pressure try to impact the world, it usually doesn’t turn out well. For investors a defensive position that does not rely on strong GDP growth or economic stability is in our opinion, a wise choice.

Now how about those banks that Bernanke wants to nudge along with increased reserves? This past week PIMCO, Black Rock, Freddie Mac, the New York Fed, and Neuberger Berman Europe, LTD., collectively sued Countrywide for not putting back bad mortgages to its parent, Bank of America. This is surely the first in a series of suits aimed at getting control of the mortgage-backed security portfolios. Then there is the testimony from Mr. Richard Bowen, former chief underwriter with CitiMortgage given in April to the Financial Crisis Inquiry Commission Hearing on Subprime Lending and Securitization and Government Sponsored Enterprises, (why are government activities always so wordy!?). He stated that, “In mid-2006 I discovered that over 60% of these mortgages purchased and sold were defective. Because Citi had given reps and warrants to the investors that the mortgages were not defective, the investors could force Citi to repurchase many billions of dollars of these defective assets….We continued to purchase and sell to investors even larger volumes of mortgages through 2007. And defective mortgages increased during 2007 to over 80% of production.” Does anyone really believe that Citibank was the only one up to this mischief, and we use the term mischief generously! We could see substantial level of lawsuits launched against these institutions, which would further serve to undermine an already weakened economy.

As for the banking sectors’ recent financial performance, there were mixed results with Bank of America posting a $7.3 billion loss in the third quarter and Goldman Sachs profit down 40% and Morgan Stanley’s profits fell 67%. Regional banks have shown some positive results, but smaller banks continue to close. There have been more than 300 bank failures since the recession began with 132 this year alone. There is considerable opportunity in the banking sector for mergers and acquisitions and all this tumult provides some opportunities, but again, defensive posturing is the name of the game for those investors who want to be successful in the long run.

Consumer confidence, which improved to August to 53.2, dropped to 48.5 in September. According to Lynn Franco, Directors of the Conference Board Consumer Research Center: “September’s pull-back in confidence was due to less favorable business and labor market conditions, coupled with a more pessimistic short-term outlook. Overall, consumers’ confidence in the state of the economy remains quite grim. And, with so few expecting conditions to improve in the near term, the pace of economic growth is not likely to pick up on the coming months.”

Is there any hope? I attended an investment conference in July where Niels Veldhuis of the Fraser Institute discussed the Canadian success story. Canada came through the recent financial crisis with no major bank failures, stronger GDP than the U.S. and the Canadian dollar is now selling at close to par against the USD. It has one of the lowest debt to GDP ratios among industrial nations and one of the fastest economic growth rates since adopting fiscal reforms in 1995. The Heritage Foundation/WSJ Economic Freedom Index ranks Canada No. 7, the U.S. is now at No. 11.

In 1995 Canada faced a crisis similar to the one facing the U.S. today with a downward spiraling currency, huge deficits, a tripling of the national debt since 1965, ballooning entitlements, government spending approaching 53% of GDP, and rampant inflation. The government cut spending by 10% over two years, laid off 60,000 federal workers over three years and eliminated the deficit in two years. For the next 11 years they ran a surplus, cut the national debt in half and reduced the size of government from 53% of GDP to today’s 39% all without raising taxes.

There is hope, but it will require discipline and an end to kick the can down the road solutions. We are positioning our clients to be able to take advantage of and be protected from the inevitable volatility as sovereign nations take actions that are impossible to predict in addressing their economic and financial problems. We are also cognizant of and prepared for impending inflation, that while unlikely in the short-term is highly likely in the longer-term and will be devastating for those who are not prepared.

KEY ECONOMIC METRICS

Gross Domestic Product (GDP): GDP dropped to 1.7% annualized rate in Q2 from 3.7% in Q1 and 5.0% in Q4 of 2009. GDP is expected to remain at 1.5% in Q3 and drop to 1.2% in Q4. Traditional buy-and-hold strategies struggle with such dismal growth prospects.

Unemployment continues to be the biggest economic concern and appears to be stagnating. The Bureau of Labor Statistics reported a rate of 9.6% in September with the number of unemployed persons at 14.8 million, essentially unchanged from August. There are currently 1.2 million discouraged workers, defined as persons not currently looking for work because they believe no jobs are available for them, which has increased by a staggering 503,000 over the past year.

Housing: Mortgage rates have dropped nearly 1% in the past year to a historic low of 4.42% for the 30-year, yet existing home sales dropped a record 27% (measured month-over-month) to an all time low, since data tracking began in 1999, of 3.83 million units at an annual rate. If record low rates cannot stimulating housing, pay attention!

Market Volume: CNBC recently reported that currently 90% of all trading volume in the markets is in 5% of the stocks. This means that a very small number of stocks are moving to manipulate the indices, which calls in question the meaning of the trends. In addition, the majority of the trading that is taking place is now generated by high-frequency computers and these programs can enter more orders in one second than a whole trading room of traders can enter in a month. Just one more reason to maintain a defensive portfolio.

Inflation vs. Deleveraging

Inflation vs. Deleveraging

The majority of the developed world is currently dealing with one whopper of a liquidity hangover.  Across the world households, businesses, and government got themselves hooked on the drug of cheap and easy debt.  When the markets inevitably cut the supply the liquidity drug, the Fed quickly stepped in to keep at least the U.S. junkie functioning with a rapid rise in banking reserves through the “toxic asset” bailout.  This bailout created an environment ripe for rampant inflation.  From August of 2008 to January of 2010, big-bank cash balances at the Federal Reserve increased at an unprecedented scale from $10 billion to $994 billion.  Using the historical money supply multiplier, this could result in an increase in the money supply that is 9-10x the increase in reserves, meaning an increase of almost $10 trillion dollars in the money supply.  To put that into perspective, the current supply of U.S. dollars in circulation is estimated to be a bit over $14 trillion.  Clearly an additional $10 trillion entering the economy would cause massive inflation… so why aren’t we seeing any indication of that yet?

For the additional bank reserves to make their way into the economy two things need to happen:  (1) banks need to want to lend and (2) households and businesses need to want to borrow.   The chart below shows an astounding increase in debt as a percentage of GDP from 2000 to 2007.  For the United States, the majority of that increase was in the form of residential mortgages.

If we look at the composition of debt, only the UK and Switzerland have higher household debt as a percentage of GDP.  While I love to gripe about our out-of-control national debt, household debt is currently an significant problem as well..  The BRIC nations have comparatively insignificant levels of household debt, which gave them a lot more wiggle room during the global meltdown.

Household debt in the United States is exceptionally high and unemployment continues to plague the economy.  We’ve got ourselves into quite a pickle.  Businesses are hesitant to expand with consumers unlikely to increase purchasing significantly due to their debt load and the unemployment rate.  With production well below capacity, the need for businesses to borrow when they do begin to expand is minimal.  The unemployment rate obviously impacts households’ ability to pay down their debt is unlikely to improve much as long as businesses hold back on expansion.  Add to this that we have yet to see the true impact of the real estate debacle in the commercial sector AND we still have a good ways to go on in the residential foreclosures.  All this creates a wet blanket on the potential inflation fire and creates an environment in which banks are unlikely to dip much into their pool of reserves.  That being said, I would be very surprised if we don’t experience some type of challenging inflation, but exactly when that occurs is a more difficult question to answer.  The global economy is an extremely complex system with nearly infinite variables whose level of impact is endlessly changing.  We approach this market with humility and caution, knowing that what is unknown vastly outweigh what is known.

So what are we doing about it?  Either way, we expect that with all the debt out there, interest rates will rise so we have significantly shortened the duration of our bond holdings and are underweight in domestic equities.  As I mentioned in an earlier post,  domestic equities are also currently over-valued.  This is an environment in which a good defense is the best offense as we wait for the inevitable opportunities to emerge, holding firm to our principles of valuation and tactical allocation.