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Archive for September, 2008

Black Monday…

Ironic, isn’t it? Credit markets are frozen (LIBOR is marked at 5.22%, as credit spreads widen even further). I posed a question in an earlier post trying to figure out where the rest of the world stands, and why they haven’t come to our aid…this should help explain:

The U.K. Treasury seized Bradford & Bingley Plc, Britain’s biggest lender to landlords, while governments in Belgium, the Netherlands and Luxembourg extended an 11.2 billion-euro ($16.2 billion) lifeline to Fortis, Belgium’s largest financial- services firm. Hypo Real Estate Holding AG, Germany’s second- biggest commercial-property lender, received a 35 billion-euro loan guarantee from the state, and Iceland agreed to buy 75 percent of Glitnir Bank hf, the nation’s third-largest lender.

Europe clearly has problems of their own, and won’t be able to come in like a “JP Morgan of the public sector” and save us all.

Meanwhile, the ban of short selling has A) done nothing to slow down the precipitous selling and B) perhaps exacerbated our down swing, because there are no outstanding shorts in financials to be covered.

Dow components on the banned short-sale list

GM     -11.89%

JPM    -8.93%

C       -6.40%

BAC   -12.72%

Maybe the SEC singled out the wrong guys; we haven’t heard much about CDS regulation latley, but various ETF’s which use Credit-Default Swaps to short financials (SKF, SEF) were both fully effective in delivering results today.

There was good news today for people who keep their money at Citi, though; they no longer have to pay $3.00 fees at Wachovia ATM’s!

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Nouriel Roubini is an NYU economics professor who has nailed every last detail of our financial crisis to date.

He recently had a conference call with his “RGE Economonitor” subscribers to review the problems at hand, and to discuss where he thinks we go from here. Unfortunately, access to his service is very expensive, but is probably worth while if you are a hedge fund manager (that will become more clear if you read the transcript of his call). If that is too time consuming, CNN money has provided us with a short summary…here are some key points:

  • Reduce mortgage balances to market prices and refinance them to lower mortgage payments.
  • Home prices will probably fall another 15%, putting 40% of mortgage owners under water, making the mortgage payments worth more than the house.
  • Consumer spending (or 70% of our economy) has fallen for 3 straight months after the temporary relief of the stimulus checks.
  • Roubini predicts that unemployment rate will top out over 8%

Interestingly, Roubini does not think that all of the skeletons are out of the closet, yet.

The next shoe to drop will be the insolvency of thousands of highly leveraged hedge funds.

As nervous investors cash in, the funds will be forced to liquidate highly leveraged assets at a deep discount, causing the collapse of hundreds of smaller funds that have taken on excessive risk.

As I said before, if you are a hedge fund manager, it might be worth while to listen to this guy.

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I have to first congratulate my old economics professor for nailing the root of the dollar’s weakness in a prior post:

The US economy, rightly, faltered first – With no fiscal policy upon which to draw, Bernanke got it all with not even a blindfold to keep him company. Rates were slashed, time and again. Meanwhile, the UK, Europe and any number of other economies were (i) not faltering, yet, but as importantly (ii) more concerned with inflation which, while still measured dodgily and with political expedience in mind, is nevertheless still measured more accurately, and taken more seriously, everywhere better than in or by the US…Thus my argument. The US dollar is not appreciating in value because it is normalising upward: it is appreciating because the rest of us are normalising downwards.

That was written before the Fannie & Freddie bailout (he doesn’t live in the US, which is why he speaks from a European perspective). If he had an adjusting entry, it may have added an analysis not unlike mine:

1) Suddenly, the prospects of serious inflation are back; this time, not driven by expensive commodities, but by high rates of growth in the money supply…Think of the market for the dollar like a stock: the value of the dollar is driven by factors of supply and demand. However, what happens when a company holds another stock offering…Using Merrill Lynch as an example, they dilute their shares and make each share in the company worth less than before. Adding more dollars into the economy would effectively be the same as a company diluting their share base. When there is more of something, it does not have the same purchasing power/value as before.

The unprecedented $25 rise in oil today is pegged directly to the weakness of the dollar…hmm.

Doesn’t this seem a little strange? Today officially marks the first week of the SEC’s action to ban the short selling of virtually every financial institution, and we see a flood of money going back into the commodity realm. One explanation is the most sensible investment was eliminated (shorting financials), so the market was left to find somewhere else to invest.

  • Retail has already had a run out of its element as a play against falling oil, so that’s out.
  • Technology is the first expense businesses will cut in bad times, so that doesn’t work either.
  • Autos and Airlines? Ha
  • Financials? Well they just rallied 20% in two days, and now they’re selling off.
  • Commodities? Of course. Oil has fallen 35%, and the dollar will be weaker than we thought, in a United States with a $1.1 trillion budget deficit.

This is when the “Free market” guys look really smart; the government came in, made an enormous intervention, enforced new regulations which limit our flexibility, and ultimately caused more problems (at least for now).

I think the only good way to look at the ban, is it provided Morgan Stanley and Goldman Sachs time to become holding banks. Now that they have a deposit base (the FED, and any commercial bank they choose to acquire), their business structure is no longer flawed, and bearish investors will have a much harder time justifying shorting these guys to oblivion.

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No, not from the US government. That title would be ridiculous…I meant more along the lines of a global effort to prop up our financial system.

With Paulson’s $700 billion plan, our public debt has increased by 175% (from 400 billion to 1.1 trillion). Since America is the center-piece to the global economy (I shouldn’t even have to say that, but some people still think its China), the treasury’s action is saving billions in global capital, thousands of jobs, and years of preserved GDP growth. Given all of this information, we should be getting, minimum, tens of billions of dollars in aid and free loans from the entire OECD, because we’re bailing everyone out – not just the US.

Here’s some food for thought:

Bank_deriv_exposure

This was originally from thebigpicture, but I recently found a more recent rendition on Seekingalpha to affirm its validity. The first thing that is very striking, is the blunt nature of leverage; JP Morgan is representing $90 trillion in derivative exposure, by themselves. That amount dwarfs the treasury’s $700 billion infusion, and bears negative implications given the counterparty risk linked to the underlying exposures; could JP Morgan really have conducted business without dealing with Bear Stearns, AIG, or Lehman Brothers?

The treasury’s action over the past three weekends alone is a dead giveaway that we have never encountered a problem of this magnitude. Tonight, we saw the last two independent investment banks become “real” banks, or holding companies. This move provides more liquidity to the system, because they now have the luxury of accessing the FED’s discount window. The down side is that they will lose the ability to heavily leverage their investments going forward.

Check out nakedcapitalism for the preliminary explanation of the deal. More details will come out by Monday morning.

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By now we’ve heard the concession: “How can people complain about market manipulation, when our government engages in manipulation themselves?”

There has been an angry outcry about the temporary ban on short selling of 799 financial institutions because of the potential implications:

  • Besides the obvious parallels between socialism and a nationalized financial system, our markets are now artificially inflated (the gains we are witnessing would not be this dramatic if there were short selling). Unfortunately, we will be subject to more volatility once the ban expires on October 3rd. Gages such as the “VIX”, or volatility index, which traders often use to judge whether a market is overbought/oversold, will be obsolete for an indefinite time frame.
  • The thing which I am most worried about, is that since the SEC has disclosed the exact date in which short selling will be reinstated, There could a widespread collusion opportunity amongst bearish Hedge funds (That day is definitely marked down on their calendar). The SEC has effectively advertised the very time we will not be watching the gate, and potentially created a platform for more severe market manipulation. There will be a gigantic buildup of vultures waiting to make their move…a flood of shorts could overwhelm the market due to this ban.

Once the short squeeze is over, there will be no more shorts to squeeze, and the market may realize that the “legs” of this rally were unfounded.

Finally, short sellers were not the root of destroying the financials; If there had been a glimmer of transparancy, Wall Street would not be in running for its life. One thing is for sure; this bailout will force a realization of the severity of our problems, and we will find out if the market has yet priced in the truth.

Here’s a link to two of Doug Kass’s articles…he is the ultimate short seller:

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Don’t think so? Well, traders do:

The cost of protecting the debt of Morgan Stanley and Goldman Sachs with credit default swaps rose on Wednesday as shares of the two investment banks fell.

Five-year credit default swaps on Morgan Stanley rose by 40 basis points to 796 basis points, or $796,000 a year to protect $10 million of debt, while Goldman’s swaps rose by 16 basis points to 462 basis points, according to data from CMA DataVision.

As of late Tuesday, Morgan Stanley’s credit default swaps were trading as though it were rated deep into junk territory at “B2,” according to data from Moody’s Investors Service’s credit strategy group. That is 10 steps below its actual rating of “A1.

Goldman’s swaps were rating as though it were rated “Ba3,” a junk level that is nine steps below its actual rating of “Aa3,” Moody’s added.”

If you’re curious as to what a “Credit Default Swap” is, I previously wrote a post on financial instruments which provides the very basics.

Personally, I’m pretty concerned that an entire segment of our financial system has virtually vanished in less than a week.

Nouriel Roubini explains why he’s not surprised on Charlie Rose’s show. Fast forward to about the 20 minute mark, it’s informative.

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The Financial Times has an article today which shows how some banks are dealing with the Lehman Brothers bankruptcy:

“Barclays is likely to be interested in the broker dealer activities, including the equity, M&A and debt activities. It would not wish to take on any of Lehman’s troubled assets or to expose itself to any unknown pricing or capital risks.”

Ah, shrewd business. Barclays walked away from the deal over the weekend because they knew they could get any of Lehman’s good businesses for fire-sale prices, without taking any bad ones!

That’s not all. Businessweek had an article about the future of preferred shares:

“Until now, preferred stock has been a prime tool for daring investors to inject new capital into a company needing rehabilitation. The Fannie and Freddie deals indicated that preferred investors could lose big, along with common stock investors, in distressed takeovers. Both Merrill and AIG raised new capital early this year by issuing securities similar to preferred. Lehman also raised money from preferred investors, who are now likely to be wiped out in a bankruptcy. So now big issues of preferred securities may not be available to fill holes in balance sheets from new losses.”

So in addition to troubled banks not being able to find money to borrow from the more stable guys (See AIG’s $75 billion dollar bridge loan), they can’t issue common stock because it’s already trading too low, and now they may have problems issuing preferred shares since investors have been burned twice in 2 weeks…

The title is deceiving. the only winners from this crisis will be:

  1. The shorts
  2. the banks who emerge from the rubble and discover that they will run a monopoly.

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