2008 March « Traderbill's Financial Markets Weblog

Archive for March, 2008

3/31/08…the ides of April

March 31, 2008 at 5:53 am · Filed under economy, financial, markets

Bloomberg Quote of the day: Eternity’s a terrible thought. I mean, where’s it all going to stop.?” – Tom Stoppard – Czech playright (Rosencrantz and Guilderstein are Dead)

…last week, TB warned about the lack of liquidity created by the ‘failed auctions’ in the auction rate securities market which had been used for 24 years as a cashbox quite efficiently. These 7, 28, 35 day investments were puttable and thru 2007 less than 50 failed and were eventually paid off in one form or another. This was due to some having hard puts to banks (VRDO’s), and all having insurance on the principal and interest from the now troubled, monoline insurers. To recap, there were only two times a year that they were illiquid: yearend and April 15…plus the occasional quarterend for a broker, but that was only if you wanted to sell the notes between auctions, not to put them. That this could happen is as unthinkable as going to the bank to make a cash withdrawal and being refused. Plus there was the incentive of earning 0.25% in perpetuity for conducting and servicing the auctions…why kill the goose that laid the golden egg? Thank you banks, mortgage companies, investment banks, rating agencies, insurers, and hedge funds for allowing 6% of mortgage loans to nearly destroy a global financial system…and they still could. Special thanks to the Federal Reserve, SEC, and Congress (they should almost have a special, special thanks for repealing Glass-Steagall in 1999 thus allowing Sandy Weil, who Treasury Secretary Robert Rubin went to work for and was shocked…shocked…that these kinds of investments (sic) were being made.

Remember that in addition to the calendar dates (March 31 which hopefully doesn’t create a bad April Fool’s joke) that could cause volatility, we have a slew of economic data this week starting with Chicago Purchasing Managers today and culminating Friday with the payrolls report for March which could be very ugly (see overnight section below for specifics).

Today’s Topics:

1. Sir Alan of Greenspan

2. Deleveraging

3. Commodities

4. Hedge funds and the Bear – a critique

4. The TB Stock Index – the only one you need

1. Greenspan. Since Alan the Great began his crusade to create the greatest economy in the history of the world, he has overseen a stock market crash (1987), an Asia/Russia crisis, the collapse of LTCM and other hedge funds, a stock market bubble that burst, a housing market that burst, and now a commodities market on the verge of imploding.

He gets points for properly handling the ‘87 crash, correctly identifying the stock market bubble yet not only ignoring it once he made a public statement but aiding and abetting it by making even speculative stocks marginable. He gets no points for the housing bubble and in fact gigged for ignoring the advice of other governors and economists, most notably Fed Governor Edward Gramlich, who the Federal Reserve Buildng in D.C. should be renamed after!

Not only did Greenspan fail to act in his belief that they weren’t equipped to do so, on his watch, bank examiners were told not to look at non-bank mortgage activities, when these very non-bank subs were some of the largest originators of subprime mortgages. Wells Fargo was by far the largest. He even went so far as to advise homebuyers to take advantage of variable rate loans (this from a man who put his entire investment portfolio in treasury bills when he took office to avoid a conflict of interest). He is now out stumping for his book, acting as advisor to Deutsche Bank and its sister PIMCO. As noted Friday, his book is being vastly outsold by Nicholas Taleb’s, The Black Swan, which is not only more informative but a more interesting read. Recently, we learned that The Master received his PhD in Economics from NYU without completing his dissertation, only an assemblage from some of his old papers. This came after he was Chairman of the Council of Economic Adivsors to Ford, during a period of inflation when he failed in his purpose. He was an unlikely candidate for Fed Chairman.

TB knows some of you hold him in esteem, and his prior background aside, so did TB, but he is a major cause of the mess we are in and the problems Ben Bernanke is trying to cure…he is doing his best. It is unlikely history will treat Sir Alan kindly…along with the current Administration. What can be said of him is the he governed almost by fiat, whereas the professorial Bernanke tries (tried?) to govern by consensus.

2. Deleveraging. TB cannot stress enough that we are in the biggest deleveraging in the history of the world…thus it qualifies as the greatest financial crisis of all time. TB said a week ago that leverage drives market psychology and a reader corrected him that psychology drives leveraging. No matter as once the reaction starts it feeds upon itself, whether it be in housing, stocks, bonds, or now the most violent and unpredictable sector: commodities (broadly including futures and options).

We have seen massive leverage of unprecedented proportions. Not only hedge funds but investment banks, and the largest banks through their non-bank subsidiaries…in fact it has been worse in Europe where it is averaging more than 40 to one…a far cry from the 5% minimum capital requirements. But is worse as they are holding derivatives in the trillions. Already the Fed has committed half of its assets with little impact and half of the banking systems assets are also at risk. For the record most hedge funds are not highly leveraged, in fact most are less than 5 times, but we saw a fixed income fund (Blue River) that was levered in muni’s while short US treasury’s with $1.8B in capital funding $15 billion in muni’s which TB can tell you, in size are not liquid…in fact to move them on Feb. 28-29 not only caused the long muni market to back up but extracted further concessions of 30-50 basis points, while the other side of the “hedge,” long treasury’s rallied by more than 3 points.

As we delever it is in a choppy manner and can be watched by following the Yen, as low interest loans taken out there are repatriated to be paid, even as their interest rates are rising. The deleveraging was mainly in stocks, although there is a forced deleveraging…or more accurately an inability to expand leverage in private equity thus killing deals in progress even as banks are balking at their commitments, no longer for credit reasons, but just because they don’t want to do an unfavorable deal…and they are being sued. 2008 will be the year of the lawyer…corporate, trial, plaintiff’s and finally criminal…all will benefit.

There is little doubt that the rally in the first part of 2007 was due to expanding leverage. That allowed us to value companies like Amazon, Apple, Google, and Research in Motion at astronomical levels. Where companies like Mastercard (MA) , effectively a low fee, high transaction, broker to trade at nearly 40 times earnings, and big brother Visa (V) that did well on the IPO but has gone sideways since.

3. Commodities. The leverage has migrated to the commodities market, one with a market cap less than some of the larger stocks on the NYSE. We have seen a huge runup in energy, precious metals, and even grains thanks to our flawed energy policy (sic), that converts corn to energy consuming ethanol thus driving up other grains…in two days last week Wheat was +11%, only to decline 5% the next. In fact, the only commodities not joining in are livestock…and that will come as the cattle mature and come to market, a lot longer cycle than chicken.

It is this speculation in commodities which Barron’s finally conceded by making it their cover story this week (one issue after asking if the bottom is in for commercial banks!), that is driving the food and energy components higher and higher and insidiously narrowing margins for intermediate producers and retailers, while making economists like Brian Wesbury worry that the Fed is ignoring inflation, and thus telling them that not only should they not be easing, but tightening! Thankfully, neither he or Kudlow are candidates for Fed Chairman. But now we are seeing a ‘peaking’ (at least short term in energy and precious metals prices), and some feel Gold could fall back to $900 or even $800 an ounce, and Crude to $85-90 before resuming their up trend. This at a time when investors who did not even know what a commodity was a year ago are flocking to commodities funds and newly designed ETF’s (find a need, fill a need). Undoubtedly, the people who lost money in stocks…twice, and then housing…will get the education of a lifetime in commodities…as they will with ultra-short stock funds…they are the followers, the sheep if you will…or is it pigs that get slaughtered?

4. Bear/Hedge funds. The SEC is investigating unusual trading patterns in Bear Stearns stock on Thursday and Friday before the Fed stepped in. A lot has been said about the moral hazard created by the Fed by bailing out a medium sized broker. Read the Barron’s interview with Blackrock (not Black Stone), CEO Lawrence Fink. Fink said, in an interview last week, the SEC should investigate hedge fund trading in the stock and also says it is absurd that everyone else but hedge funds should be regulated. TB made the same observation thinking that is was interesting that at the same time, several

large funds canceled their prime broker agreements, huge shorting was occurring…aided and abetted by the SEC eliminating the uptick rule…which TB’s hedge fund friends have argued is a good thing…for them! Hedge funds make money in two ways: insider information (at least information that others might not know) and leverage…that is how they get those great returns although many are not looking so great now after that 2% fee…or 3% with a fund of funds. The four funds are: Harbinger, Greenlight, Tremblant and Paulson & Co. If it is traced that they talked…conspired?…it is indeed scary that a major financial company could be brought to its knees on rumor and innuendo…by the insiders themselves (they had information that no one else had access to and in fact may have promulgated that information to the media and other hedge funds. This is the dirty little secret of hedge funds…again, not all, but some. Harbinger, by the way, is an activist hedge funds that invests in companies that it deems undervalued and pressures management in an attempt to drive the stock price higher…at times at the disadvantage of long term investors.

4. The TB Stock Index. Why bother to follow all those stocks and indices when you can follow less than 20 stocks and see what is driving the market? We all know of four…the legendary four horsemen mentioned above, while others are XOM, AXP, C, IBM, BA, AA, QCOM, and BTI (British Tobacco, and IMO (Imperial Oil), a Canadian oil sands company that today had restrictions imposed by the Canadian government on water usage due to failure to observe environmental rules. That these two stocks can be not only the only movers every single day on the AMEX Composite, a 700 plus stock index is preposterous! Watch today to see what IMO does and how it impacts the AMEX…TB will!

That this few stocks can drive markets and in size trading make speculators very profitable trades each and every day attests to the lack of liquidity and breadth in the markets today…and should make the bulls rethink their stance. Schwab’s Liz Ann Sonders on CNBC today made her usual always bullish comments…a bit deeper recession than in 2001 but lasting the same amount of time…huh? She has a tremendous advantage in her looks as being ask to appear on shows…her performance over time has been less so. She was also a favorite of Lou Rukyser which is how TB began following her in case you think the above comments were sexist…she only happened to be the commentator du jour.

Have a great day and don’t feel you have to rush in to buy anything! This is going to take a long time to play out and in the meantime cash (true cash), is, and will be king…it is better to earn 2% than lose 10%, or more…perhaps a lot more! One other thing, this does not mean sell everything but rather to take the time to review your portfolio for stocks you would feel better not owning.

A good day to all,

Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are.merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Hope you find it useful.
Copyright TBD Capital LLC March 31, 2008

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3/28/08…solvency

March 28, 2008 at 5:35 am · Filed under economy, financial, markets

Solvency: The ability of a corporation to meet its long-term fixed expenses and to accomplish long-term expansion and growth.

…TB has referred to the current situation alternatively as a liquidity crisis and a credit crisis. In the past week or so he has seen this described as a solvency crisis. For the Administration it has become a credibility crisis. Today we will examine the layers and how we got to where we are today.

Topics:

1. Gimme Credit

2. Monotonous monolines and auction rate securities – not monotonous

3. I am solvent…my company is solvent…I just don’t have any money

4. Something truly scary

1. Credit. For 25 years we have been told that we, as individuals are creditworthy. Some of us were and some weren’t but being a democracy we blurred the difference. Let’s go back another decade and notice how we saw the gasoline credit card morph into the general credit card which could be readily used for most transactions…except food which was a no-no because as Mork of Mork & Mindy fame would say, ”it’s too hard to repossess.” Home buying was not easy: 10% down was the minimum and the banks wanted 20% down for the best rates and they also wanted to see the source of the downpayment…did mom and dad give it to you gratuitously or was it a loan? Auto loans expanded and GM and Ford credit became huge in the traditional realm of banks.

Creditworthiness became a moving target along the lines of “we finance what we sell.” This was largely a function of the rising inflation in the 70’s and 80’s brought on by Johnson’s ‘guns and butter’ approach to the Viet Nam war which produced huge deficits. Buy it now because it will cost more tomorrow made sense in those days but that produced a lack of discipline so that after Paul Volcker killed inflation in a painful experiment we continued to buy now…not because it was cheaper, we wanted it now. Like anything it is the desire to own something that produces satisfaction when you acquire it and that quickly fades as we look at the next new thing that we ‘gotta have,’ even though we really don’t. Does anyone else remember the US chastising the Japanese for not consuming enough…as if they needed two TV’s in an 800 square foot home…after all, we did! Imagine what would have happened had they followed our government’s advice…they would be worse off and probably where we are approaching today.

We have foregone savings (after all we had it in stocks…oops, they crashed but we still had our homes and they didn’t…till now), and ridiculed people who keep money in savings accounts. Banks were morphed into financial supermarkets with the 1999 repeal of Glass-Steagall, and with that there credit standards declined more…and they already had in the 1980’s rush for credit card accounts. Thanks to a 1978 Supreme Court ruling that national banks could charge any interest rate, all state laws went off the books or were revised up to insane levels that were more like loansharking…but at least they didn’t break your kneecaps. In fact, you could file bankruptcy and pick up a credit card application on a table at the rear of the courtroom…true story! People had 5, 10, TB even saw a guy on People’s Court who had 50.

Homes became ATM’s and thus even more attractive as the values started rising…move in and six months later take a vacation and buy that BMW you always wanted…that too with no money down, better yet lease it. But now that the cycle has turned people are finding the ATM closed, the money spent and unavailable, locked in the lease, having their mortgage reset, and not able to get new credit let alone another car lease.

TB predicted when GM and Ford were doing all those 5 year 0% leases mainly on big SUV’s that there would be problems and as gas prices rose the value of those they plummeted in value…these were the first upside down loans where you had to pay up to get out of it. Want to take over someone else’s lease? They are all over the lot now but of course you will be on the hook if they don’t pay up, unless they can qualify and if they can why do they want to take over yours?

TB can still hear Larry Kudlow and Brian Wesbury chortling about how stupid and blown out of proportion the subprime mess was…and both are clinging on in the belief that the economy is coming back despite all evidence to the contrary. Either a total lack of understanding of the derivatives market or just ‘dissing’ it

Now we see that subprime delinquencies have extended to Alt-A mortgages that are variable and now to prime (imagine the guy who bought a tract home in Vallejo and put down 10-20% while everyone else went subprime…he has now lost all his equity and then some and still can’t sell if he has to)…yet we are continually told that people who have owned their homes for five or six years are OK, they may be but most likely aren’t if they availed themselves of extracting their home ‘equity.’ Some of this was frivolous (vacations, cars), and some was to improve their homes, normally a good investment, and some were required due to a lack of pay increases or one person losing a job, or for medical expenses. So we have no idea how the person who has owned a home for six years is really doing…none…and we can’t judge by their lifestyle, the car they drive or how they spend their leisure time…it is all a blur.

We are now seeing the crisis extend to home equity and former Fed governor Lawrence Lindsay who wrote a book on the crisis said this morning on CNBC that auto loans are next…add to that credit cards. TB was discussing this the other day…what choice does the holder of the second have…other than to pick up the first mortgage…and that would prove futile. Already we are seeing people make their car payment (you need transportation) and credit cards (you need gas and to eat), and forego their mortgage payment as it takes about 15 months to get you out of the house and if for some reason you are doing better and make it up, all will be forgiven…probably without penalty…but don’t bet on that.

2. Monolines. After the subprime losses came to light…and by the way they will not peak until about midyear but you won’t know about it with the banks because they will report as they become delinquent so it will be the second quarter of next year at least before we know the extent of the damage to them, whereas we probably no the damage to brokers now just not how they will dig their way out. Had monoline insurers done what they do best (and the rating agencies done their jobs), insure states and municipalities who didn’t need it in the first place…and as a side effect destroyed the incentive to analyze credits by the buyers of these securities…rather than branch out into insuring credit derivatives that reached massive proportions we would not be at this juncture. Without the insurance, the auction rate securities market is a shambles because the brokers who act as issuing agents have their capital so impaired that they cannot do what they have done consistently since 1984…support their own auctions by buying back any excess paper…this is the unthinkable (over that 23 year period there were less than 50 ‘failed’ auctions. Now, we are routinely seeing more than 500 in a single day). since he has been buying ARS, around 1990, by carefully choosing the securities he bought, he only had one ‘failed auction’ and that worked out with a month or so. Currently he has had four different issues called and redeemed by issuing bonds and will undoubtedly see more called as he does not buy or hold any of the exotic varieties. Also, his have had reset rates from as low as 4% tax free to as high as 12% (Dallas Fort Worth Airport to avoid a cap of 7.25% just issued bonds yielding over 6%), but sadly some issues have yielded less than 2% due to formulas and some do to caps during a computation period are at ZERO with no ability to get out of the securities…TB was shocked to learn this.

There are only two times a year (normally) where liquidity is an issue for ARS: yearend, and April 15th. At yearend the rates rose modestly as they always do but in January they didn’t come back down. Suddenly, there was no out from the auctions except by luck. Fortunately, on the good issues, people are getting wise to the situation and some buyers are coming in and thus providing some measure of liquidity, yet, yesterday, TB attempted to put back 300M of an issue and only got rid of 25M despite being a buyer of $100M on the other side so that should give you some idea of the ratio of buyers versus sellers.

After NY State started going after the monolines it appeared a solution would be in place within weeks or a month or so…perhaps due to the Spitzer scandal you don’t hear a peep anymore…in something that has reached crisis proportions. TB had to sell some bonds yesterday to raise cash for an account. He had issues with guarantees by AGS, MBIA and AMBAC. Before putting them out for bid he discussed with a salesman who listed priorities as shown above so he didn’t sell any of the AMBAC. These were not crap, but good solid stand alone credits. He got terrific bids on both securities but one broker would not bid the AGS even though it is the strongest of the insurers…in other words they will only bid the insurers they know completely. Again, this is unheard of.

TB also heard from an investor in a pool of asset backed securities…collateralized loans which TB has said were trading cheaper than junk bonds of the underlying issuer. When he saw the collateral he was shocked by the ratings and also that issues maturing within a month were marked at less than 90% of their face value. This, folks, is a credit crisis…and if nobody wants this paper which is most likely money good, how is a company supposed to finance its operations? How is an investor to get the money necessary to continue to finance his investments?

3. Solvency. As the above statement suggests, credit (caused by a failure of the monoline insurers), has created a liquidity crisis, which has in turn created a solvency crisis. Perfectly good companies do not have access to the capital markets (CIT can no longer issue asset backed commercial paper and had to resort to its bank lines…for how long before they must restructure their debt?). Investors are more willing to buy less senior junk bonds than collateralized loans of the same company. At the least this raises their borrowing costs and at worst can render them insolvent. So far we have addressed only large public companies, but what about smaller ones…and small banks who are being squeezed as rates are cut but they must maintain deposit rates to hold on to customers even as the big commercials bid up for those deposits. Small businesses rely on credit card financing not bank lines…and their credit is being cut. TB told of a small private bank that had its corporate credit card limits cut by AmEx to $5,000…in total. How can a business operate on this…and there was no reason for the cut. John Mauldin wrote recently of when he was a young man and had a small but profitable business that was growing and financed by a bank. Suddenly, and without reason the called his loan. He didn’t have the money to pay it back but could…they went so far as to call his mother demanding payment or they would take him to court. When he heard this he shut down the business in order to repay the loan…is this what we are coming to? Have an unused home equity line…read your contract…they can reduce it at will if your credit or the value of your home declines…so don’t count on that as a backstop. You have just seen what is happening from top to bottom and it brings everyone’s solvency into question…there are no guarantees of liquidity…hence Treasury bills at 1%.

4. Scary. This was not meant to be entertaining and might be frightening but was prompted by the different conversations yesterday with experienced investment professionals with three separate areas of expertise that TB has known and respected for more than ten years and the fact that all were concerned, to put it mildly, about the current situation. Never in his 38 years experience has TB ever seen this level of concern and each of the conversations resolved around corporate credit that has been eroded due to the insurance crisis impacting the liquidity and borrowing ability.

TB has continually said that you cannot solve a problem until you identify it. TB has identified it, the government knows the problem (yet Economic Advisor to the President Ed Lazear continued to say this morning that they see just a slowdown with the consumer bringing us out of it in the second half of this year!), and only Ben Bernanke, who does understand it, is doing anything about it. Thankfully, he, not good times Alan, is the Fed Chairman, but what a mess he inherited. The answers are not and will not be simple but they must be found before our standard of living erodes further.

TB remains bearish on stocks…and watch out for the ides of April as the tax date approaches and people who had short term investments to pay their taxes are forced to sell stocks…the only ’liquid’ assets available to them. Why do people persist in saying the bottom is in?…it isn’t.

TB apologizes for the length and tone of today’s commentary, but someone has to say it unless we want to see the situation deteriorate further with global impact.Hope you do have a relaxing weekend because with quarterend next week could be stressful.

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3/27/08…kaching!

March 27, 2008 at 5:38 am · Filed under economy, financial, markets ·Tagged Bethany McClean, Bloomberg News, Caroline Baum, Citigroup, CNBC. Dennis Neal, ETF's, Forbes, Fortune, Graef Crystal, Jonathan Weil, Mark Gilbert, Meridith Whitney, Merrill Lynch, Oppenheimer, Raymond Dirks, UBS

Bloomberg Quote of the Day: “Ability will never catch up with the demand for it.” – Malcolm Forbes. That is Sr., not Jr., aka “Steve”. Wall Street is living proof of this. TB.

…that is the sound of the cash register as the bottom fisher’s throw money at this market. Someone is making money and it appears to be a few wise hedge funds. On a historical basis the gains are not at all impressive but they are positive. Note TB said “a few,” not many, not most. TB has an inkling that one of these may be James Simon’s Renaissance Funds which are scientifically modeled and boast of not having a single Wall Streeter on board. Run by all academics, more accurately, using models created by academics, and run by computers, these algorithmic models, trade without emotion. That their flagship Renaissance Technologies Fund ($27B), and the smaller Medallion Fund ($45B) have been two of the top performing funds since inception in 1982 and 1989 respectively, attests not only to their modeling ability but their reaction to changing market conditions and cloning by others. Time will tell if it is still working. Simon’s noted last year that had they not updated their models they would have had about 20% worse performance and they were in the soup last August but pulled back out of it. That is what discipline and a lack of emotion can do…if you have the right model.

Today’s Topics:

1. Bloomberg Top 10 – market mover?

2. Analysts and other forms of sin

3. ETF’s and the ’Uptick Rule’

1. The Top Ten. One of the first thing Bloomberg users tend to do it hit ‘TOP,’ the top ten financial news stories on BB, top 5 Worldwide stories, and a couple of opinion stories. TB had noted that the overnight Globex market tends to react to these and a friend, who has been looking, hoping, and praying for a bottom here, mentioned this to TB yesterday. Certainly, breaking stories while the US markets are open move the markets (economics of late is an exception as it is generally ignored of late), but these set the tone in Globex futures for the market opening…sometimes it sticks, sometimes it doesn’t.

Today may be a test of that as banks, insurers and mining companies traded up in Europe overnight on higher earnings and higher forecasts. But are the European financials indicative or predictive of what is happening to US companies? For one thing, they don’t have a weak dollar hindering foreign investing and that alone could cause US money to migrate to foreign stocks…note that Sterling is almost $2.02 overnight and the Euro is above $1.58 while the Yen is safely ensconced below (above) 100 with their fiscal yearend approaching Monday. No, TB feels that our problems are different due to the composition of our banking system, one that is built on ‘retail’ deposits with the smaller banks who are caught in a squeeze as the Fed cuts rates yet if they cut their CD rates commensurately they will lose money to capital needy big banks and other alternatives.

Here are today’s key top 10’s”

1. ConAgra agrees to sell commodity trading unit to Ospraie for $2.1B…interesting…why do this?

2. Fed may emerge from crisis, Bear rescue with more influence at SEC expense – this is what TB has been saying where a politically governed SEC (3 GOP, 2 Dems plus one vacancy, GOP Chmn), has failed its responsibilities…naked shorts, uptick rule, etc. IMHO.

3. US economy probably neared recession if fourth quarter as housing sank….probably neared???

4. Oppenheimer’s Whitney says Merrill Lynch, UBS to post losses this quarter (see #2 below)

5. Grassley says he’ll probe whether Paulson pressed Fed on Bear Stearns rule…HE’s a Republican!

6. King ‘behind the curve’ on interest rates, former policy maker Julius says. BOE needs 1/2 point cut.

7. Taleb outsells Greenspan as Black Swan gives worst turbulence…this book is the bible for what we are experiencing here…the outcome that is so off the charts it is ignored…as should be Greenspan.

2. Analysts. There are two guys on CNBC who grate with TB and make him want to destroy his monitor (aside from the already disclosed Barteromo, Kudlow, Cramer and consultant Wesbury); Forbes writer Dennis Neal and the baldheaded guy that screams and overpowers everyone else on the panel as if he knows everything…a jerk as far as TB is concerned.

In the top 10 category above, Oppenheimer analyst Meridith Whitney has been hot! She predicted that Citi would be forced to cut the dividend and has been hounding financial stocks incessantly…and more importantly she has been right, so when she warns on Merrill and UBS today, TB heeds them. Most street analysts are worthless as TB sees it and have not even asked the question that if we are at a bottom for financials (or the broad market for that matter), where the replacement revenues will come from since the most profitable sectors, all related to housing and mortgages, are history. Whitney hasn’t even finished filtering through the flotsam and jetsam let alone need to worry about revenues. Markets do not go sideways…at least not for long especially when you have volatility which Bernanke and others thought was behind us has once again reared its ugly head (bad for long term investors but potentially good…or bad…for traders). So Dennis Neal, who it appears has never put a dollar of his own money at risk, says she lacks credibility because unlike reporters she doesn’t have confirmation from within the companies…hello Dennis you twit…reporters don’t forecast they report on past events…that is your problem and while you always are bull you speak more negatively than TB. Also, Neal has been trying to call a bottom in financials for the past month…unsuccessfully need TB add? Would a reporter have found the problems in Equity Funding? Wall Street firms that went to them and were assured that analyst Ray Dirks from a boutique firm (as is Oppenheimer) was wrong. There are exceptions in investigative reporting but they did not rely on the company for confirmation. Notably the Wall Street Journal reporters (despite contrary opinions by the editorial staff) on Mike Milken which eventually sunk Drexel Burnham, and Fortune reporter Bethany McLean who blew up Enron management’s claims. But Dennis Neal clearly is not in this camp. He also likened Whitney today to Morgan Stanley’s Stephen Roach “who has been wrong on markets for the last 5 to 10 years.” That, Dennis, is not possible as he had to be right part of that time given the cycle we have been in over that timeframe…for the record Roach is bearish and warns the we need to look to Japan for what can happen and especially to their demographics for what is to come if we don’t react properly to this crisis. We need more Roach’s, Whitney’s and McClean’s…not Dennis Neal’s. TB also lauds the Bloomberg staff for independent thinking including Graef Crystal, Caroline Baum, Jonathan Weil, and TB’s Brit friend Mark Gilbert. It doesn’t matter if one is right or wrong…what matters is if they think and they make you think!

3. ETF’s. Yesterday, TB omitted the segment on ETF’s and the uptick rule, but corrected it on the blog. ETF’s should be, for reason TB has mentioned in the past and contrary to opinions expressed on CNBC, that they are a derivative of sorts, in that they replicate an index they do not mimic it. Therefore, there is no predictable correlation to a change in the price of an ETF and the underlying securities in the index, except over time. Tracking error is provided by the sponsors so you know if they are doing what they say they do. Furthermore, buying or selling large blocks of ETF’s is done in a third market sense directly with the traders who will cross them without it appearing on screens. This is important and occurs with large blocks of stock also as it filters what could have a significant effect on the market yet might be for reasons unrelated to stocks. Compare to the municipal market which used to operate in a veil of secrecy but trades are now required to be reported within minutes and as we saw on February 29 when muni’s tanked and the long bond rallied by more than 3 points, transparency is not always a good thing…in the short run. TB wants to reiterate some key points you need to know on ETF’s if you are going to use them as part of your portfolio strategy:

1. Fees. They should be low and most are less than 25 basis points…compare to funds that can run 1% or more. Also note that you are only paying 1/365 of the fee per day so you are only paying for the time period you hold them unlike funds which are taken out monthly or quarterly.

2. Tax Efficiency. By ‘harvesting’ losses they for the most part (iShares has reported no gains or losses on over 250 funds since inception), you avoid the problems with mutual funds…the worst being getting a capital gain when the value of your fund is plunging.

3. Transparency. Most post their positions weekly or more frequently…iShares updates daily! This is important because before you invest you need to know what is in the portfolio, especially if you invest in several ETF’s or mutual funds that hold the same security…Citigroup (C) immediately comes to mind.

4. Correlation to your other investments, including other ETF’s. Some ETF’s will accordingly increase your exposure to stocks you already hold and defeat your objective. This is particularly true of HOLDERS which are investment trusts with the percentages balanced at inception but then become overweighted with the winners and underweight losers if you buy later…some of these may have percentages as high as 20-25% in a single stock.

These are not all of the considerations but hopefully they are the most important ones. ETF’s are a great way for an investor, especially top down (economic fundamentals vs. bottom up, company fundamentals), investors who don’t have time to try to pick the right stock in a sector. It is far easier to get the sector right than the right stock…especially in these trying times. Jim Cramer argues they provide mediocre performance which in some cases is true…certainly not energy these day…but they also dampen some of the volatility and also provide diversification for investors in corporate and municipal bonds while reducing fees and providing instant liquidity.

Don’t take any wooden nickels!

All the best,

Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and do not necessarily reflect the views of anyone other than himself. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are.merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Hope you find it useful.
Copyright TBD Capital LLC March 27, 2008

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3/26/08…vindication

March 26, 2008 at 5:56 am · Filed under economy, financial, markets ·Tagged Bloomberg, Citigroup, CNBC, ETF's, General Electric, Merrill Lynch, SEC, subrpime mortgages, T2 Partners LLC, uptick rule

Faux headline of the day: Citi cuts Countrywide and Thornburg to JUNK; Countrywide and Thornburg cut Citi to AVOID. Explained in #3 below

Today’s Topics:

1. Redemption and CNBC rant

2. Leverage moves markets

3. The ‘rating’ game

4. The ‘Uptick Rule’ explained and why ETF’s are different from stocks

1…golfer’s know what a ‘provisional’ is: when you hit your tee shot and have no idea where it went so you take another in case you can’t find the first ball, thus saving time (unlike a Mulligan where the second drive replaces the first). So guess you could call TB’s commentary yesterday a provisional. TB wonders whether Tiger Woods has ever taken a provisional. A few times TB has referred to a former colleague who also managed bonds in a firm several years ago. Whenever TB was nervous about the market he would walk over to him and ask if he too was concerned. If he was, then TB was, but usually he would say, “it feels bad…but I haven’t got that gut-wrenching feeling in my stomach yet that tells me I blew it.” Monday set the tone for one of those days and by the morn the feeling was haunting TB. Had he stayed the course too long? Was he in fact a perma-bear? So, he jotted down the reasons he would be bullish or bearish and they all came up on the bearish side…except for the strong rally on Monday that seemed to defy gravity. So by writing it down, he purged his soul and hopefully provided some solace to his readers who also might be thinking it was time to buy.

As critical as TB is of the talking heads on CNBC, they are just doing a job…one that someone at GE feels is important…but is of little use to most investors other than for a few key interviews and breaking news. Constantly they trot out money managers and economists billed as experts showing you what to do to make money in the turbulence…to what avail? They are talking from position. Do you honestly think they are going to say something other than talk from position? Do they have a death wish to be fired or sued by their clients? No, misery loves company…so tune it out! This, by the way, is only true of the US version of CNBC…listen to Europe or Asia and you see professionalism…no hype or hyperbola. No out of breath commentator or Maria B. with her windblown hair trying to tell you how it is, just good professional reporting as you get on Bloomberg. How they can claim they are the best source of financial news is beyond comprehension…and how CEO’s can lend their imprimatur to the madness can be nothing less than egobuilding…after all they had them on, didn’t they?

2. There are two reasons TB does not believe the bottom is in yet and at the risk of being repetitive, here they are and they are related. First, this is a credit crisis and as Wes Edens, CEO of Fortress Group (FIG) says, “one of the great de-leveraging events of our lifetime.” Think about that statement made yesterday in an article in DowJones Marketwatch. This from a hedge fund manager…TB has said it but what does he know about hedge funds? His hedge fund friends sometimes tell him little or nothing. To be sure, all hedge funds are not alike…they, like other investors have different objectives, risk tolerances (why not just call some of them gambling funds or speculation funds?), and most importantly different degrees of leverage. Leverage is what makes the world go round…not investor psychology as you have been told. How else to explain the contempt for bad economic data of late as the market rallied off the lows? Often that leverage is in conflict and you get the volatility that has once again reared its ugly head leading to the February 2007 selloff which has not since returned to the placid levels of the past few years. But volatility is really nothing more than noise…like a good soccer (football to our Brit friends) game where the action shifts from one end of the field to the other but in the end it is the scoring that matters.

The problem is that people are infected with greed…particularly those in the financial services industry and that, believe it or not is a good thing…so long as someone is looking over their shoulder to protect us, and them, from extinction. Unfortunately, the regulators at all levels have failed miserably in their responsibilities. No need to go further as you know who and what failed, it has been chronicled here enough times.

Imagine a closed society, a deserted island if you will with 100 people who can only barter for everything. It is cumbersome and inefficient. Try dragging a bale of hay over to get a loaf of bread and a gallon of milk some time. But on this island stands a huge rock, imagine one of the Easter Island monoliths set on a prominent point above the sea. Some ‘capitalist’ calls the people together and proposes dividing the rock into 1000 pieces and giving 10 to each person. Soon equivalent values are established and trade begins. That is all well and good but there can be no growth because there are no new products and no additional ‘currency.’ So one guy with few needs tells his friend one day that he will lend him two POR’s (pieces of the rock), if he will give him 3 POR’s back at a later date. Now we have a banker…of sorts. But soon others ask him to do the same with their excess POR’s, business picks up but isn’t exactly booming.

One day there is a huge earthquake and the rock tumbles to the sea. All trade ceases except by barter, perhaps people are burning their POR’s. One particularly beautiful day a boy is exploring and goes up on the hill and looks down to the sea…there clearly is ’the rock.’ He runs to tell the others who race out there. Once again trade resumes and everyone lived happily everafter. They were not capitalists.

The basis of this story is not original but comes from a book TB read many moons ago in a Money and Banking course. TB always loved it and wishes he could find the reference…if you know it, tell him. The point however is how shallow confidence can be. In the early days of the United States when the states each issued currency, it was usually worthless outside the state and frequently within. We endured several banking crises, the last being the Panic of 1907 and that led to the creation of the Federal Reserve. As we know even that failed us for the most part in the Great Depression and runs on banks were frequent. People want to see their money, hold it, then so long as everyone gets it back they are again willing to deposit it again (isn’t this similar to a stock market selloff?). But the problem is leverage. It is impossible for a bank to immediately pay back even 10% of their customers. Leverage must be measured and bankers prudent…or had to be until 1999 with the repeal of Glass-Steagall…a major mistake that will be undoubtedly reborn next year. Banks are different from non-banks! We know this!

Another DowJones Marketwatch article from March 19 (referenced in the above article), was on leverage or more specifically ‘deleveraging.’ According to analysts at Citi European Bank Research, in the last banking crisis (1998 LTCM), European banks were levered 26:1, after the millennium that rose to 32:1 and reached 40:1 on average last year…if that was average what was the high end? Banks used to use a 5% capital guideline but at 40:1 that is just 2.5% capital to assets and when even 10% of those assets go bad you have a major headache. That is why subprime loans which were just 6% of total loans were such a big problem…and worse thru securitization these banks were using SIV’s to fund them!

“Steady growth, low inflation and rock-bottom interest rates encouraged economic and financial participants across the world economy to gear up over the past few years,” Robert Buckland and his colleagues on Citi’s global strategy team wrote in a note to clients. “Easy money encouraged many to buy a bigger house, a bigger car or a bigger speculative position.”

“But now, any behavior that relied upon continued access to easy money is being dramatically reassessed,” they added. “Leveraged banks must lend less, leveraged consumers must consume less, leveraged companies must acquire or invest less, and leveraged speculators must speculate less.”

Citi goes on to say that investors should avoid hedge funds and private equity due to the deleverging. They also add that banks have not been as successful at gathering assets lately due to concerns on the amount of losses that will eventually be sustained. Despite all the efforts of Congress, Treasury, the Fed, this crisis is global and thus nowhere near over…there is more to come before it gets better.

T2 Partners LLC (a hedge fund by the way) authored a 56 page report with great data and incredible charts. It shows that the fourth quarter of 2007 was a peak in adjustable mortgage resets, but Q1 2008 is only slightly lower and the second and third quarters are almost as large. There is an average lag of 15 months from reset to foreclosure on loans that go bad. This means that banks will be continuing to write down assets until well into 2009 not the last half of this year as you have heard. That is why TB said yesterday the worst is behind us for brokers, but other non-bank financials (even sound ones) will have difficulty funding their operations until the banks can rebuild their capital base. That can only occur by taking the writedowns, rebuilding the loan loss reserve as mandated, and getting capital infusions from sovereign wealth funds and others. It is a slow process.

Keep in mind that while just 6% of mortgages may be subprime in 1994 just 0.9% of all mortgages originated in that category and in 2006 13.6% were subprime. Much is made of the low foreclosure rate as a percent of total morgtages, yet they rose 57% and repossessions rose 90% in January year over year. 30% of subprime loans written in 2005 and 2006 are already underwater and most of the foreclosures are due to credit…i.e. loans that never should have been made in the first place…not the resets (bankers please keep this in mind as you blame the borrowers as Wells’ Chairman did, whose company owned the largest originator of subprime loans…keep in mind that many subprime borrowers had a reversal of fortune that stopped them from refinancing…TB knows of some of these).

Here are some more points from the T2 study:

1. 8.8M homeowners will have mortgage balances greater than their home value by the end of March according to Moody’sEconomy.com.

2. Nearly 3M homeowners were behind on their mortgages at the end of 2007 with an additional 1M at risk of imminent foreclosure. In Q4 2007, 5.82% of mortgages were delinquent, highest in 23 years, and 0.83% were in foreclosure an all-time high.

3. In subprime, 20.02% were delinquent and 5.82% were in foreclosure.

4. Homeowners equity is below 50% for the first time since 1945 (zero down, FHA/VA loans but prices were rising then and debt levels were low).

5. For the first time ever, government guaranteed mortgages are also suffering despite the lack of risk (not just FNMA and FHLMC but GinnieMae spreads too).

You can believe we are closer to the bottom than the beginning if you want but you better have a backup plan as that does not appear to be the case, and if so the stock market will pay dearly.

3. Ratings. There was a time when brokers did not rate one anothers paper…call it professional courtesy or what you will but it is the same reason that cops don’t get tickets. You do not want reprisals. That thinking is out the window now however as analysts bash one another’s stock and the brokers with the worst performance lately are slamming other companies with downgrades. TB expects this to continue and increase as earnings slow and those extrapolated earnings forecasts which allowed the higher p/e ratios to stay well into double digits can be expected to decline. That should occur even as earnings once again begin to turn up…again extrapolation or uncertainty about the future as well they should. But why should you believe in the ratings of a Citi, Merrill, or even a Goldman analyst these days. If subprime borrowers are responsible for their problems, you as an investor must assume responsibility for your well-being and not believe what you hear or read…even from TB. Got it? We need more educated investors…not more sheep. Also, do not chase performance! Past performance is no guarantee of future performance and if your manager performed well: ask how they did it? Fair?

4. Uptick Rule. A reader wrote that he didn’t understand it. The rule means that you can put in an order to short sell a stock but it cannot be executed until there is an ‘uptick’ in the stock. The reason for this is simple: without it a stock can be shorted until the buyers are exhausted and then when it all stops the shortsellers start buying and even going long. The advocates of abolishment are traders and hedge funds who feel if a stock is in trouble that is management’s problem but that is an oversimplification as a mere rumor (witness Bear and Lehman recently…they should not be in the same sentence, however). The Uptick Rule was eliminated by the Cox (GOP) SEC on July 3, 2007 leading to a second leg of increased volatility and notice how close that was to the market peak! Sometimes we must be protected from ourselves. This is especially true when highly leveraged funds can short without any controls and still have 45 days to go ‘naked’ on those shorts. Another rule that should be changed…if they want to spec use the options market! Isn’t maintaining orderly markets a responsibility of the NY Fed…and the SEC? This should not apply to ETF’s which are indexes and thus a form of derivative and do not impact individual stocks. There can be large moves in and ETF without impacting the underlying securities.

These continue to be trying times…with no end in sight. We are in a one hundred year event that has been exacerbated by excessive leverage and those excesses must be worked off before we continue.

All the best,TB

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3/25/08…is this for real?

March 25, 2008 at 4:53 am · Filed under economy, financial, markets ·Tagged CIT, Goldman Sachs, JPMorgan Chase, Merrill Lynch

…since the October 11 highs on the Dow this is the fourth major attempt to rally and each has produced a lower high, and only the last subsequent selloff failed to produce a lower low…on the Dow. The fourth attempt made two thrust the second high inches below the prior one and so that level, which we are rapidly approaching with no visible resistance (12756 on 2/27 and 12767 on 2/1), should be easily attained as there is no other resistance until then…and since those targets are just 200 points higher TB is content to wait before plunging in. Even then this could still be just a bear market rally, which TB fully believes it is but based on the irrational (to TB’s way of thinking) comments on how a bailout can solve the massive global financial crisis we face, TB will wade in slowly…once those targets are reached. So today let’s examine some of the reasons for doubt:

1. the continued weakness in the economy with an employment situation that is much worse than it appears, especially in financial services and construction (manufacturing however may get a boost as foreign companies are now finding it cheaper to produce here than in Europe…aside from states like Michigan, California, New York etc that are unfavorable to business). The housing market which had a boost in existing home sales, this will be a tough year for seasonals however since we had a mild winter in most places and an early Easter.

2. The steepness of the yield curve which has been exacerbated by the flight to quality and problems with monoline insurers thus destroying the auction rate securities market and driving short term rates well below the Fed Funds rate…the 5 yr note yields just 37 basis points over Fed Funds! This should attract money to the longer maturities pulling those rates down and perhaps leading to lower mortgage rates.

3. The financial crisis, as discussed yesterday is not by any means over…some say that the collapse of the Bear was the low point…and it might well be for brokers, but if so, why did Goldie rally yesterday only to end the day to the downside, while troubled Lehman plunged further…the sole benefactor was Merrill…and that will be short-lived as JPM just lowered their earnings forecast (-1-2% overnight)! TB cannot say too often: where will the replacement revenues come from? The situation is worse on the banking side as delinquencies and foreclosures continue to rise and due to bank accounting rules they cannot write down in anticipation as the brokers do, until the event occurs, which also triggers increases in loan loss reserves. With the peak in subprime resets not until early in the 3rd quarter, it will be a tough year for the banks. Worse yet are the non-bank financials, witness CIT which, as the banking problems continue will find it harder to fund loans…witness CIT, and the smaller, not necessarily weaker, lenders. Bush has repeatedly said small business is the backbone of the economy, and that is correct, but with their credit lines being reduced and any number of other problems they cannot be expected to carry the burden. Now perhaps the GOP can see how they have suffered at the expense of big business and tax cuts for the wealthiest Americans. This will be a huge drag on growth.

4. The twin deficits which are finding it hard to improve while funding a war in Iraq and Afghanistan, and fiscal stimulus that is assured to fail as it will be used for the most part for living expenses or to pay down debt…yet it is a necessity…something has to be done. The weak dollar is also hurting the trade balance.

5. Election year. If the best combination historically for the stock market has been a Democratic President and a GOP Congress, the worst is that both be Democrat. This is based on history not ideology, but look what happened under a GOP President with a GOP President…and how little better has happened with the shift of power in Congress to the Dems? With lobbyists in control it will be difficult to change much of anything…a sad story. Also, the first year of a new President is not the best for the stock market or economy.

TB is sure he has left out many other factors but let’s return to the stock market for technical clues.

1. S&P 500: This index did put in a new low but there was no capitulation trade like we had in January. There was a delayed reaction of a day but this may have been due to the Bear Stearns solution not being clear at the time. This is the key to TB has it has had a much more even pattern of lower highs and lower lows than the Dow. The S&P 500 closed at 1350 yesterday with a 20 point gain…so TB has the patience to wait a pit longer for two key double tops above: the first, 1388 was created on 2/26-27 and taking it out would break the series of lower highs but why not wait for just 8 more points to the 2/1-2/4 396 tops? IF that is taken out the rally has legs, and TB doesn’t believe it does. There are two many things that could kill it in the interim.

2. Dow Transports: Yesterday on a massive spike, the index took out a series of tops at 4826-28 and closed at 4861. Given the high energy costs this is impressive. Also only one index member LUV which has had big fines due to faulty aircraft, was down and that only slightly…the rest were up big! Watch it!

3. Nasdaq and Russell 2000. These were among the best gainers yesterday and have also been beaten up the most. Yet they have to go significantly higher just to get to any meaningful resistance, so they could be the canary in the coal mine.

4. Bonds. We need to see further weakness in the front end of the curve and continued strength in the long end after yesterday’s big selloff to help the financial problems we face. Of course, if the dollar continues to decline it will make it that much more difficult to attract foreign investors.

These are just a few things that could make or break this ‘rally’ and determine whether it is real or Memorex. Had we taken that one last big hit and then had a capitulation trade TB would be on board, but as things stand he is content to stay sidelined. There is one exception: as TB has reported lately, it is the same stocks that are the big movers every day (XOM, AAPL, RIMM, GOOG, and BTI and IMO on the AMEX). But yesterday it was broader with some of the strugglers doing better like CAT, AXP, BA and other defense stocks. Meanwhile some of the stocks he has been following that have not gone down too badly but boast nice dividends with double digit growth rates, reasonable p/e’s and solid earnings growth have not yet participated in the rally…some of those could be bought here. TB leaves it to you to decide which ones they are. Remember TB knows no more than anyone else, he just offers these thoughts to aid your decision making. That, to TB is more valuable than any guru. Good luck!

We live in trying times…invest accordingly.

All the best,TB

Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and in no way reflect the views of anyone other than himself. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. No fee…nothing to sell…merely observations of events in the marketplace offering a non-mainstream viewpoint…sometimes…usually? Hope you find it useful.
Copyright TBD Capital LLC March 25, 2008

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3/24/08…believe it…or not!

March 24, 2008 at 5:50 am · Filed under economy, financial, markets

Today’s Topics:

1. Thursday’s markets – a witches brew

2. Financial Sector…when is a bank not a bank?

3. More Financial Sector problems…is the Fed out of the loop?

4. TB’s Outlook for Financial stocks

1. Thursday’s rally. …in other words as the bordello madam titled her book: A House is not a Home. TB had to go out of the office Thursday morning and it is interesting how disoriented one can become without the usual reference points. He kept hearing on the radio how the Dow was up 200 or so points. Then he stopped at Charles Schwab where a screen was showing CNBC where everyone was talking about the monster rally. TB felt he might have erred, but when he returned to his office he saw that in spite of climbing higher all day, the rally fell short of offsetting Wednesday’s declines, not only on the Dow but other major indices as well. Of course, they could at least crow that it was a plus week but those of you who took the time to read the summaries know that was nothing to write home about. The other point is we had not only a quadruple witching (options expiry) but index rebalancing and that allows specs to run the market ahead of the funds who come in close to the close…keep that in mind.

As you know, the selloff began on TB’s birthday (12/26), which in itself is unusual given the yearend ennui that we usually have and continued to fall thru Jan 22 when we got a capitulation trade which almost failed the following day but which produce a real monster rally…but since then we have probed the bottom twice…on 3/10 establishing a new low close and another probe down on March 17. But if you take the time to examine stocks during the period from 1/23 you will see a lot of volatility but basically trading sideways in a broad band. Technically the only two factors to come into play have been the sharply declining 40 day moving averages which have for the most part provided resistance and any time one bought above them they have been clocked. Furthermore, the rallies were on news of new attempts at stability which didn’t incite buying per se but shortcovering…and can you blame them? Each time as soon as the shorts had covered…TB would say voluntarily as they were able to lock in profits and reload…the rally fizzled. We are now in the third such attempt and TB feels it too will fail. Consider Friday’s Dow close at 12361…the 40 day is 12313 but the 200 day is way up at 13188…and that is a long ways away. The broader S&P 500 has fared even worse

2. Financial Sector. A bank is not always a bank. The financial sector is made up of banks and non-banks. The ‘banks’ are commercial banks while the non-banks are investment banks and other financial services companies. TB had his entire column mapped out until he got to his computer this morning and found the following piece which links them all wonderful. Since 1999, the distinction has become blurred and as a result of our myopia we have gotten to the point where we now stand…like one of those Acapulco cliff divers, poised on the brink and ready to plunge…only difference is we don’t decide when to push off.

The following popped up this morning on TB’s google search for mortgages. It comes from a weblog: Wild Eggs (quite appropriate for Easter and is on something this writer has been trying to get across to you over the past month or so. Banks are banks…investment banks are not banks and that is crucial to your understanding of today’s problem and how we were brought to the brink.

“Ralph Brauer at Progressive Historians reports about Bill Clinton’s role in the mortgage crisis and the demise of the Glass-Steagall Act:

In his economic history of the Great Depression, John Kenneth Galbraith pointed out one of the causes was:

“The large-scale corporate thimblerigging that was going on. This took a variety of forms, of which by far the most common was the organization of corporations to hold stock in yet other corporations, which in turn held stock in yet other corporations.”

During 1929 one investment house, Goldman, Sachs & Company, organized and sold nearly a billion dollars’ worth of securities in three interconnected investment trusts—Goldman Sachs Trading Corporation; Shenandoah Corporation; and Blue Ridge Corporation. All eventually depreciated virtually to nothing.

It is hard to imagine today what it felt like to walk through the door of a bank in those days and learn that the dollars you had earned had vanished. Every day spent working and saving had been for nothing. A great many farmers, brick layers, carpenters, factory workers believed the bankers had stolen their lives.

When Franklin Roosevelt took office, both the President and Congress knew the banking crisis demanded immediate action.

The result was one of the crown jewels of the New Deal: the Glass-Steagall Act, officially known as the Banking Act of 1933. Glass made sure the bill forbid banks from getting into the investment business. In addition, the bill established the Federal Deposit Insurance Company, which protects our bank deposits.

In 1971, in Investment Company Institute v. Camp, no less than the United States Supreme Court would write what stands as the most cogent summary of the reasons for Glass-Steagall:

Congress was concerned that commercial banks in general and member banks of the Federal Reserve System in particular had both aggravated and been damaged by stock market decline partly because of their direct and indirect involvement in the trading and ownership of speculative securities.

The legislative history of the Glass-Steagall Act shows that Congress also had in mind and repeatedly focused on the more subtle hazards that arise when a commercial bank goes beyond the business of acting as fiduciary or managing agent and enters the investment banking business either directly or by establishing an affiliate to hold and sell particular investments.

Put under intense pressure from Sanford Weil and Citigroup, Bill Clinton repealed the Glass-Steagal act in 1999, allowing commercial and investment banks to consolidate … guaranteeing a return to the great crash of 1929.

Since repeal of Glass Steagall in 1999, after more than a decade of de facto inroads, super-banks have been able to re-enact the same kinds of structural conflicts of interest that were endemic in the 1920s – lending to speculators, packaging and securitizing credits and then selling them off, wholesale or retail, and extracting fees at every step along the way.”

There you have it. Goldman Sachs, Citigroup and Sandy Weill all in the same context. You can be the next Congress will resurrect Glass-Steagall…now that has cost us hundreds of billions and eventually trillions and much of that burden will fall smack on the shoulders of the US taxpayer. As for Bill Clinton, who would have encouraged him to do this? None other than Treasury Secretary Robert Rubin…the man who knew not enough and remember he came from Goldman (“where I made $100 million from trading…”), and where did he end up…as a Vice Chairman of Citi…interesting word: vice. Also of interest to TB was that the Supreme Court decision came less than one year before TB began his journey into the investment business and with a multi-state bank holding company that was created by A.P. Giannini (along with insurance, Transamerica). Not only did the courts hold that Bank of America not engage in banking and insurance, but it made them spinoff First America which became Western Bancorporation morphing into Western Bancorporation and finally First Interstate before being absorbed into Well Fargo. Yet, in an odd twist of fate, A.P. Giannini’s dream for the old Bank of Italy becoming the Bank of America from coast to coast finally came to fruition when it was bought by Nations Bank who wisely kept the BofA name. One other side effect of all this was Congress’ enactment of the Douglas Amendment to the Bank Holding Company Act of 1956, which grandfathered in Western Bancorporation, First Bank System, Northwest Bancorporation and a few others into interstate banking and leaving WBC with an exclusive franchise in the eleven western states.

Fannie and Freddie now are being handed the baton and told to make loans…this runs against the prior advice of both Greenspan and Bernanke and will undoubtedly end badly with the taxpayers picking up the tab…and as for the shareholders there have already been suggestions that they must cut the dividend…something not reflected in the share price run up of either.

3. More Financial problems. Two major events have come up since the last column. First, on Thursday, CIT Financial (CIT), due to downgrades of its bond and short-term debt ratings at Moody’s, S&P, and finally Fitch, lost access to the commercial paper market and was forced to draw down all of its lines of credit. The stock fell as much as 42% intraday while its 3 year notes plunged from a dollar price of 93 to 68! Admittedly, they have problems with their loan portfolio as most others do but they are very good at what they do. This is a sign of the times. Even good companies can have problems that would otherwise not be critical but now any association with problems is a pox and one that will not go away quickly. Second, over the weekend, JPMorgan Chase, acting without the Fed sweetened the offer for Bear fivefold to $10 a share…remember this is an all stock deal. To TB this is troubling because no longer are companies willing to, as they did in the Panic of 1907 willing to knuckle under to the Fed. Too many have too much to lose and so what the Fed says…even as late as 1998 with LTCM, is no longer gospel. We are the penultimate legitimus society.

This is a major black mark and yet another failure of Treasury Secretary Paulson, since he lent his imprimatur to the deal as did the NY Fed that engineered it. To TB this brings us even closer to the brink as confidence that what the regulators says goes…well, went…right out the window! Worse, any challenge to the Fed, rightly or wrongly, is a blow against its power to control a crisis. Bear Stearns, if it is successful in getting the higher price will have struck a blow that has huge unforeseen consequences. Already, this has been viewed by those not on the street as a) unnecessary…let them fail, and b) a bailout. TB cannot fathom what would have happened a week ago today if the Fed had not intervened with an emergency meeting and announced the deal. Bear was a firm that would never have been able to touch its capital and its book value per share would have been fleeting at best. But the global ramifications would have been of epic proportions due to the leverage and the fact that while Bear is the fifth largest broker it is much bigger than that in derivative exposure as counterparty on thousands of swaps, a failure on anyone could have forced margin calls on hedge funds etc…and we know how the ranks of the derivative funds have been decimated of late. But if the improved price goes through it will set a precedent for every action going forward and when you have firms of this size and people involved in them with powerful friends it sets the stage for chaos. This is the equivalent of Carl Icahn as he forces companies to do his bidding, only on a grander scale.

Who is the most powerful analyst on the street these days? Oppenheimer’s Meridith Whitney who first predicted Citi would cut their dividend. Now she has cut beleaguered Lehman from outperform to “in-line” with its peers. This is tough for Lehman after having posted better earnings after the stock plummeted 20% on March 17 then surged 46% on the positive earnings surprise…this is not just a question of share price but in this market can affect the viability of the firm as financial firms revolve around investor and client confidence as we saw with the Bear. Hopefully this action will not put Lehman under the lights again.

TB predicts two things: first, that the worst is over for the non-bank financials, but only due to a bid reemerging for subprime debt allowing them to mark to market in a positive measure but this does nothing more than erase some of the earlier losses. We saw this with Morgan Stanley last week and will likely see more. Still, imagine if these firms actually tried to sell more than a few million of these assets (sic)? But the question TB has posed remains: where will the replacement revenues come from?

The second is that the banks will report poorly…who knows how much worse in relation to street estimates and who cares? Whereas, brokers had to mark to market, most bank assets are of the illiquid variety (especially now), and these will have to continue to be written down as delinquencies (which have now spread to the credit card and auto sector as well as Alt A and prime mortgages) continue to rise and foreclosures continue to rise exponentially.

Retiring Wells Chairman Dennis Kovacevich was interviewed Friday on Bloomberg TV. He talked positively and when questioned about who was responsible for the subprime crisis put it on the shoulders of borrowers who knew they wouldn’t be able to make the payments…with prodding he then also accused the non-bank financials of lowering credit standards…omitting the fact the WFC was the largest subprime lender and sold off all of their subprime loans to the suckers…although they did err in holding on to the subprime home equity portion frankly due to the fact that wasn’t salable…as TB sees it…and that is similar to Merrill holding on to the Aaa tranches of the mortgage pools since the spreads were too narrow. Kovacevich early has stated that they held them because they felt they were more secure…a statement that defies logic since when is a junior lien ever worth more than a senior lien fundamentally? TB has to add fundamentally since senior collateralized loans now trade cheaper than like junk bonds due to the volume of them that is being put out for bid…and the buyer sees problems with anything anyone wants to sell!

But Kovacevich’s most amazing statement was this (paraphrased to the best of TB’s recollection): I don’t understand how people think this is the worst financial crisis…this is not like the 1980’s when you couldn’t obtain a mortgage due to high rates. That was a much worse situation than we have now. TB’s jaw was hanging that a banker could make that kind of statement…much as he was by the earlier quote on home equity loans. Has he no idea of the magnitude of the problem and the global nature of it? It is truly shocking that one of the most successful bankers in this country could make that kind of statement. A reversal of credit standards always comes at the wrong time and hits people who believe they can borrow whenever they want to. TB has heard of credit lines being pulled on small businesses…and that includes reducing their credit card limits. TB talked to the CEO of a small bank who said the limit on the their corporate credit cards (in total) had been cut to $5,000…yet his private limit was not cut, and this is a bank that is not in trouble.

Lastly, it is small banks that are feeling the pain…they must satisfy the needs of their clients and they have no backstop from the big banks. They are much more local in nature and micro-regional at best which will mean many will fail and not due to their own errors…just victims of circumstance. Some may be acquired by big banks but that will be a slow process. This too resembles what happened in the 1930’s.

TB is not trying to be gloom and doom but we have to recognize there is a problem before we can solve it. Come on Bush and Paulson…say it…the ‘R’ word! A majority of citizens, CEO’s and CFO’s know we are in recession so who are you trying to keep it from?…also, your stimulus package will fail…miserably.

It was refreshing to finally see the talk shows shift to the economy…and most importantly the markets, although Stepanopolous had Schuemer and Hagel while Tim Russert had Maria Barteromo (now billed on CNBC as the most powerful woman on Wall Street) and her colleague Erin Burnette. Their answers were very pedestrian and predictable.Who knows…a year from now the government might even start focusing on the economy?

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3/20/08…all that glitters

March 20, 2008 at 5:09 am · Filed under economy, financial, markets

TB’s Quote of the day by Dennis Gartman, proclaimed “the commodities king”, and author of The Gartman Letter on CNBC: “Worried? I sleep like a baby… I wake up every hour and cry.” With Gold and Oil in freefall…it is impacting emerging markets so more trouble ahead. TB

…is not gold…even if it is black gold. Precious metals, energy, industrials, soft commodities, grains all hammered the past three days…victims of excess speculation as investors have run from stocks and thought they were safe places to play. Commodities are never a safe place to play unless you are a ‘commercial’ and using them for hedging purposes. The only other good place to play them is as a ‘local’ in the pits…you cannot play them on a screen with a 20 minute lag! Speaking of lags, if the regulators want transparency and efficient markets why don’t they tell Dow Jones, S&P and the rest of the bunch that they cannot charge for live quotes? Call your Congressman and complain!

Speaking of complaining, a fellow writer who like TB is incensed at Sen. Chris Dodd for holding the Fed and the taxpayers hostage by holding up nominations of two prospective Fed governors. This at a time when two more have their terms expiring which would leave just 8. Five are required for a quorum so if another Bear situation emerges, which it most likely will it is possible they could not reach consensus. So he called both Sens. Boxer and Feinstein and sternly told their aides to tell Dodd to knock it off. We have had seven years of this crap from the GOP…as happened during the Clinton term…and if the Dems don’t wake up they too will be seen as obstructionist. TB urges you to call your Senators too…the situation is to dire for this nonsense. Thank you.

Today’s Topics:

1. Bearing up – beats going belly up…unless you are a shareholder

2. Veni, Vini, Visa – I came, I bought wine, I charged it!

3. The Crisis – you all know what it is but some refining.

1. Bear. There is a lot of talk about why a $2 stock should be a $5 stock but the main reason is bondholders buying up some to protect their interest as they need the Gip’em deal to go thru, and after more of the details came out it will go thru. To recap: with the blessing of the NY Fed, as they are entrusted with financial market stability, not the FOMC, JPM was to buy the Bear for $2…according to CNBC’s David Faber they were willing to pay more but the Fed said absolutely not…wanted to make a point that this is not a bailout and if you can’t keep your house in order, you sir are going to pay. Both boards unanimously agreed…including Jimmy Cayne, the Chairman and Alan Schwartz, the President. But by Monday morning they were either feeling sellers remorse or had their fingers crossed, knowing they would have been in Chapter 11 if they had not done the deal. See, those of you across the pond, in the US anybody can take anyone to court over…well…anything, and that takes time. A third possibility is that Joe Lewis the number 2 shareholder who owns almost 10% of the company…second only to a Dallas based value investment management firm who shall remain nameless out of consideration…and just might get sued too, right? Well, there are a lot of poison pills in the deal to stop them from seeking another buyer…the Fed wants this problem solved, not passed on, and so they want the deepest pockets and a firm knowledgeable on derivatives and risk to be the ultimate buyer…after all the Fed is standing behind any losses and posting bail of $30 billion to help defray costs. Here are three of the pills: JPM can hold several stockholder votes until they get their way…in other words break them down and because this could be a costly proposition deters other buyers. In addition, they can buy 20% of the stock for the stated $2 a share no matter who buys it…would you want to buy a company with a key competitor looking down your throat? Not hardly…also heard they get the headquarters building if the deal falls through. OK, enough on Bear except to say this was not a bailout and IF Bear had imploded the ramifications would have been felt around the world as there was scarcely a major play that Bear wasn’t a counterparty to: highly leveraged hands are weak hands, no matter how big they are.

Visa with a ‘V’. If you were wondering where TB came up with that obscene market cap for Visa yesterday it was due to a misread in a hurry. On Bloomberg, the details were shown including offering price ($44) and number of shares…but they also added the market cap and the way it was laid out it didn’t look like dollars…soooo TB multiplied 44 times the market cap and produced a mega cap. Very sorry but still it is the largest IPO of all time. But how did it do? Well, best for the company, since the talk was $37-42 a share and it was priced $2 above the top end (TB wonders if some of that big rally on Tuesday was due to specs taking it up to make sure it flew. Anyway it opened at 55 was at 69 in minutes then came all the way back down to $56.50. Volume was 177 million shares or 43% of the total so a lot of investors were in and out and in this market you can’t go broke taking a nice profit. Meanwhile hot competitor MA which gained $8.73 of Tuesday gave back almost $2. At 36x trailing earnings and 27x forecast it doesn’t look attractive to TB…not with a Beta of 1.07 so not a defensive stock although both are billed that way since they are paid a fee strictly per transaction. But remember credit is contracting now not expanding sot TB would trust the trailing P/E more. One more point: the trading pattern on opening day is reminiscent of Blackstone (BX), Fortress Group (FIG) and others in this market as leveraged funds try to book some easy gains…TB does not however expect V to tank like the others…but is it a buy?

3. The Crisis. We are in the worst financial crisis in terms of magnitude that the world has ever seen. Furthermore, while the Depression involved leverage and credit, the decline in credit standards and degree of leverage we have now dwarfs anything. Yet optimists expect the dawning of a new bull market to be right around the corner…in fact now! Every time they take it up…they take it right back down. Merrill’s David Rosenberg points out that this week’s FOMC meeting was the fifth straight with dissenting votes…the reason is that the faster they ease and the lower the Fed Funds target gets, the closer they are to running of ammo and at 2.25% it is worrisome…could be that was the reason for the 75BP cut so they have a quarter cushion before plunging into a ‘1′ handle. Then there is the risk of staying too low for too long.

If you think TB is over-reacting you haven’t been reading enough. According to Rosenberg, a recent Gallop poll shows 76% of the public see a recession, 59% a depression…does that mean they either lost their, job, home, or car? Thus it is not surprising the three month T-Bill is trading at a yield of 0.60%.

TB also read John Mauldin’s Outside the Box, where the normally soft-spoken Mauldin didn’t mince words and sounded like a Dutch uncle while his two contributors, Michael Lewitt of Harch Capital Partners and Bob Eisenhies of Cumberland Advisors and a former EVP at the Atlanta Fed discussed why Bear was not a bailout and what would have happened it the Fed had not acted before our markets opened on Monday. Even a majority of CFO’s and CEO’s see us in recession and not coming out of it until 2009 and they have been quite accurate in the past…notably in 2001. So who are you to believe? Them, or the talking heads on CNBC? Is it riskier to hold cash and take a chance at missing a rally or to jump in and get your clock cleaned? You decide but as stated yesterday, be sure…be very sure.

TB poses that either you believe the data or those with a vested interest in getting you to buy stocks. With a quadrulple witching today and index rebalancing it seems foolhardy to take a position today in front of a long weekend and we all know how much can change in three days…especially when other markets are open…don’t be a hero!

TB has been pretty kindly to Bush lately considering all his smirking and inane comments before the Economics Club of New York, not to mention incomplete answers to Paul Gigot’s spot on question about the pain felt by Americans not only due to housing but to food and energy prices. But Tuesday, Robert Scheer writing in the NY Times let him have it with both barrels in a piece titled Bush’s Legacy of Failure, citing his failed businesses (Texas Rangers aside and that was mere luck of timing), and asserting that he is out of touch with reality. Included was reference to a five year study that they tried to quash as “too politically sensitive.” Over the Administrations objections it was required to be posted on the web and found absolutely no link between Saddam Hussein and Al Quiada…this after studying 600,000 Iraqi documents. Yet he insists that it was the right thing to do…meanwhile Al Quiada is moving in to Afghanistan again and Pakistan. IF it was the right thing to do it was wrong to do it in such an ideological manner in what could have been a one month war, like Gulf War I, and then had we not outlawed the Baathists and made a point of differentiating Kurds, from Shia and Sunni’s it most likely would have been a success without costing, 4,000 soldiers their lives, 30,000 injuries and $2 trillion and counting…money that could have been used to solve our problems here…meanwhile the deficit continues to swell causing the dollar to sink further. Think about it, then you decide.

Hope you have a wonderful three day weekend…you earned it…TB will be back on Monday.

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3/19/08…Bear to middlin’ (corrected for ‘V’ data)

March 19, 2008 at 5:25 am · Filed under economy, financial, markets ·Tagged Bear Stearns, Ben Bernanke, JPMorgan Chase, Mastercard, Visa

Today’s topics:

1. Bear redux – Sold!…or not!

2. Visa IPO – the $44 sure thing? ‘V; for Victory?

3. Global Markets – trending lower? Asia and the ETF

1. The Bear. This is number one because of the turmoil and emergency Fed meeting Sunday that it triggered…unprecedented two days before an FOMC meeting and the only other one was a tightening on Volcker’s Saturday Night Special to curb runaway inflation. A writer TB likes and former Bear employee said from the get-go that the sale was a sham. She may be right…it was to provide comfort and who better to do it then Gip’em with $90 trillion in notional derivatives exposure while Bear has a mere $13 trillion…if you are having trouble comprehending these numbers you are not alone…consider in 1970 the US hit $1 trillion GDP for the first time ($1.038T)…TB knows this because he was taking Econ 101 at UCLA at the time and stuck with him. Last year it was $13.843T. With semi-annual compounding that is a growth rate of 7.1%…but chain weighted in 2000 dollars (they change it every year so TB can’t readily get the rate from 1970 but it is currently $11.567T), so inflation has taken its toll…but TB digresses.

The three largest shareholders of Bear are Barrow, Hanley, Mewhinney, & Lewis, a Dallas value oriented investment advisor that stands to lose over $1 billion (11.5M shares or 9.7%), Joe Lewis (11M shares or 9.4%), Morgan Stanley (6.3M or 5.4%) and Jimmy Cayne (5.8M or 4.9%). Now, those four entities plus other Bear employees have the power to blow that $2 offer to shreds and they will. Further there has already been a lawsuit filed to stop the sale. Now who is ‘gipped’? What the aforementioned writer said was that this was a way of restoring stability to the market…better yet if it gets sold at a much higher price. as Gip’em was getting it for half the value of the headquarters building alone. So in one stroke we salvage the integrity (in the nautical sense only) of the two firms and prevent a cascade of failed CDS swaps, etc. that would endanger the entire global financial system…the point is that Bear while big is not that big in terms of the entire market…and the swaps are in weak (highly leveraged hands), and stacked atop one another so that even if they appear hedged they are exposed.

That is why BSC traded as high as $8.50 yesterday and closed at $5.91 and also why the entire financial sector…OK, the majors, rallied sharply but don’t expect more and remember how far off they are. Still, large sound (oxymoron?) firms could be a good buy here…especially large banks. Wells and USBancorp come to mind although WFC could have ongoing loan problems while USB is clean, so far as TB knows and that was why he bought it although he is now at a loss…and learned from it!

2. Visa (V) IPO. After months that seem like years of discussion…even longer to the banks who desperately want to get some much needed capital, it was priced last night at $44…above the range of $37-42…not bad for the biggest IPO ever! That values it at $17.86 billion…for a cash register? Most of that money will go to the member banks and then to a reserve for the AMEX lawsuit…and $220 million in underwriting fees! Can you believe that? Now THAT is inflation! This is even bigger than the AT&T Wireless IPO. It could be an interesting barometer for the market given the success of the Mastercard (MA) IPO which was much smaller (61.5M shares at $39, peaked at $227 and is now $210 and still has a P/E of 27.6), and issued in a strong market. Some call them cash registers because they are simply transaction fees…not sure but am hearing that it is a FLAT fee per transaction not the overall fee to the merchant which is on a scale. This could be a plus as more small items…if you can call groceries small items these days but credit cards are being pulled as credit deteriorates so don’t even the number of transactions have to fall? Seems so to TB.

3. Global Markets. On would think global markets would follow suit after that huge rally yesterday. Well, they started to but then dollar concerns over the worsening credit crunch took hold and what started as strong rally in Asia gave back most of the ground and Europe opened up then quickly went negative. TB checked three ETF’s he noticed rallied sharply yesterday and it appears they LED Asia: EPP – Asia ex-Japan; FXI – Mainland China; and INP – India. Here are the returns over last 12 mos., year to date, and yesterday and yesterdays change in local market in parenthesis:

EPP +3.2% (8.2% w/div); -12.9%; +3.9%! (n/a)

FXI +32% (+34%); -22%; +5% (-5% ave)

INP +35%; -33%; +3.9% (-6%)

TB has followed INP for some time and noted on big change days the local market tends to follow the ETF’s here…wag the dog. This caused the India market to gap up sharply and hit a high of 15466 shortly after from 14810, a 4.4% gain, then drop to 14930 or just 0.8% and close up just 1%! Also checked the Kospi and Shanghai for similar patterns and found them.

Former Soros fund manager Jim Rogers overnight said he sees a good year for US stocks but is short the Financial ETF, not individual stocks which he sees as too risky. It seems there are two camps on this: the first that sans financials the other sectors look attractive. A look at the sectors in the daily summary tells another story, one shared by those in the other camp: going nowhere and with a staggering number of CFO’s and CEO’s saying we are already in a recession and no relief till 2009, any rally seems way to premature…except for a countertrend rally…worse, we could be in a secular bear market. The line of thinking goes: stocks are valued on an earnings stream, that stream is inflated by successive record earnings and record stock buybacks, in a recession the ‘P’ is supposed to fall first as it did, then when stocks appear cheap, the ‘E’ begins to fall and then bottom and turn up but investors are no longer willing to pay as much for the earnings, so any rally is impeded. Choose your category but choose wisely as it could impact your wealth and retirement for years.

Gosh if one failed financial firm and a rate cut less than expected, and more importantly there were two dissenters who wanted even less of a cut, then perhaps a second failed firm and at least one homebuilder should do wonders, right? Markets are valued at the margin and that distorts reality as does mark to market on derivatives. You overshoot, but then comes the other factor: liquidity…just how many are out there with the cash to buy…even as hedge funds are being forced to delever…or worse? Your call.

One last point and it is key: stock markets on average peak six months prior to a recession (which they did this time almost exactly…except Bear which peaked 13 months ago), and rally six months after the recession starts. So if we say it was December that would mean it would be June before we should have a rally, but this is no ordinary recession…this is a credit crisis not seen since the 1930’s…so shouldn’t it take even longer…yet we tried to rally 1 month into it and again less than 3 months into it…and the Fed is running out of bullets. Last time, following y2k, the Fed Funds rate got to 1% and they became worried about deflation. That was without a housing market collapse and a huge loss of employment that the data is currently understating. The 2001 mild recession that produced those panic tax cuts which should have been rescinded as the economy came back, saw growth resume in the third quarter of 2002, yet stocks didn’t rally for another full year and declined another 20% over that period…that is why TB thinks this is merely a countertrend rally with a lot further to go…this is evidenced by a double bottom not a capitulation trade and an early options expiry tomorrow (sorry thought it would have been pushed back), then followed by a three day weekend and a lot can happen in three days. Just be careful and watch V…after all, it’s all about the ‘V’….or is it ‘O’?

Have a good day and remember nobody is a guru…nobody has the answers, we are in uncharted territory. Good luck.

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3/18/08…the difference between the market and the Bear!

March 18, 2008 at 5:17 am · Filed under economy, financial, markets

From a friend…a sign of the times:

(visualize Bear Stearns in a high tech glass enclosed case with a $2 bill on top of it…couldn’t upload, sorry as it is priceless.TB)

TB’s Quote of the week: “Now we don’t have just Fannie and Freddie,” as Alan Abelson wrote in Barron’s, “now we have Feddie!” …and the beat goes on.

…the market recovered! Arguably so did Bear because after trading as low as $2.84 yesterday it closed at $4.81 -$25.19 from Friday’s close which was -49% from Thursday’s close. Wait a minute, normally when an announcement of a buyout comes the stock trades up but to a level less than the offer price, right? Au contraire, mon amis, not when we are resorting to the buyer of last resort and do not kid yourself the Fed is the buyer of last resort, not JPMorgan Chase.

If you had asked TB what would happen to stocks yesterday after the Sunday Night Bombshell, he would have offered just two alternatives: open on a huge gap down then down and downer (i.e. a Black Monday), or down off the charts and then a sharp bounce…i.e. a capitulation trade. But, as it turned out there was a third alternative: open down slightly – 5 points, then drop 195 which is no big deal these days, right, then rally back 350 points…again not that big in this market, and closed UP 21. But therein lies the problem as only the two Nasdaq indices set new lows and they did not bounce! The Russell 2000 small cap missed a new low by just 2 points and no new low close. As for the cast of characters (stocks), they were the usual suspects plus a few more (XOM, IMO, BTI, GOOG, RIMM, get the picture?). That was NOT a bottom…and due to the lack of bounce it will be retested again. At one point yesterday the Brokers were -14% and closed down almost 10%…but JPM tacked on 34 Dow points…can you believe that…in other words without them the Dow would have been down! What is this a garden party? Wade in at your own risk…it’s deeper than you think.

Ahem, let’s see what one of Gip’em’s key employees had to say on Bloomberg a few minutes ago: “In the U.S. we can see a king of safety net,” said Mana Nakzora, chief credit analyst (and to TB he sounds like a stock analyst rather than a bond analyst and they are the only ones that count) at JPMorgan Securities Japan Co. in Tokyo…what huge tentacles they have. “We don’t need to worry about a shortage of liquidity in the financial sector and that is a good and positive message for investors.” (Emphasis supplied by TB, who finds it interesting that half way around the world from NY City, JPM can supply this news, did they hold a freaking conference call)? Has anyone stopped to think who pays for the writing of these checks? You need look no further than yourselves!

So this is what the world has come to and according to another columnist who TB regards as credible, while Bear has $13 trillion, no we do not mean billion, notional value in credit derivatives, big brother JPM has $90 trillion! Of course, Bear was a bunch of gunslingers and JPM is a bunch of bankers…oops that can’t be because the banking side cannot talk to the dealer side…wink.

How did JPM get the call by the way? Some clerk on the Fed’s desk shuffled his Rolodex (newbies that is a way old-timers had of keeping track of addresses and phone numbers), and out popped JPM?

Not hardly. Look at those numbers above and it is pretty office that is the choice as they have the biggest derivatives book…and you were so proud of them on their lack of subpriime exposure…but TB wasn’t because he had already read of their credit default swap exposure in Nouriel Roubini’s blog months ago. The point is that if Bear went down it would have triggered a domino effect as one after another counterparty met the same fate…so what would happen if JPM went down? A meltdown.

Look, we were on the brink. Here is another priceless quote: “For bondholders, you know you’re money good because you will be saved,” said Willem Sels, head of credit strategy at Dresdner Kleinwort in London. Who is this guy, Moses? BUT, he added, “From a shareholder perspective, stocks could still drop very, very low and the uncertainty in terms of valuations is huge.” Well said!

There you have it. Unlike FDR, who said “we have nothing to fear but fear itself,” Willem Sels says we have nothing to fear…unless you are a shareholder…but so what they are rallying stocks this morning, but is the best (worst) yet to come?

TB would like to oust Hank Paulson and replace him with one of those new wave televangelists…now they are effective…they can restore confidence and God knows they can bring in money. What has Paulson done? He gives interviews to the softball reporters…Stepanopolous was almost apologetic about having to ask him questions Sunday…still he stammered. Maria B. and the cast of characters at CNBC were also deferential…these are tough times, no need for tough Q and A. Last night, Secretary Hank was interviewed by Matt Lauer of all people. Lauer asked him how when so many people in this country are feeling pain, can we ‘bail out’ a big broker like Bear Stearns? Paulson said, of course we feel their pain…and it is a tragedy but think how much pain the shareholders at Bear are feeling as they aren’t getting much for this. Well, how about passing the hat, Hank? How about all those guys who made so much by creating and selling that crap to unsuspecting investors from other firms like Goldman, Merrill, and of course, Gip’em (TB cannot take credit for that name as they were called that way back in the 70’s…true)? Gip’em led by the great Jamie Dimon who seems not to know what is going on in his bank as there have been stories of selling interest rate swaps to municipalities with layers of fees on them where the bank made more than the buyer would have stood to gain and then it turned upside down and they not only paid but they lost…or Jefferson County, Alabama where city officials entered into more swaps as that would be a good way to not just hedge but make money too. Who was looking at the suitability there? Lawsuits are starting to fly as municipalities are banding together.

OK, look, there was no choice but to do a bailout…period! But there was a choice and that was to not regulate…that blame falls squarely on the shoulders of this Administration…and that was pre-Paulson. It lies with Christopher Cox and the SEC, the banking regulators, and most of all, Alan Greenspan, the guru that people listened too who has caused three bubbles: stocks, housing, credit (by failure to listen to the pleading of the late Fed Governor Ed Gramlich), and now a commodities bubble…look at the commodities summary from yesterday and look at the magnitude of the moves…13 of the 24 commodities in the GS Commodity Index declined by more than 3% while Sugar fell 10.9% and Coffee 9.9%! On both the GS and CRB there were only THREE commodities up barely over 1%. Repeat after TB: if you have to sell (read de-lever) you sell what you can sell, not what you want to sell!

TB is thoroughly disgusted and now it is Congress’ turn to enter the foray…create a bunch of laws like Sarbanes-Oxley that are poorly thought out and will still not solve the problem. After all, we are a capitalist country and where there’s a buck, there’s a way. Some will win, some will lose. Number one shareholder at Bear is Joel Lewis who must feel a bit like Joe E. Lewis (vaudeville and later TV comedian), as he owns 11.5M shares at $80 a share…now there is a redistribution of wealth. Ousted CEO Jimmy Cayne owns 6 million but get this…Morgan Stanley owns 11 million (source is Bloomberg HDS page). Can’t wait to see the Forbes richest list next year…as they say: “there’ll be some changes made.

Get this: two hedge funds have just purchased seats on the NYSE! Do you recall that Bear had two of it’s hedge funds fail and Goldman one? Hold that thought.

Important point on auction rate securities: TB saw this on Thursday and has been meaning to tell you: the SEC has issued a no action letter to any issuer of auction rate securities who bids for their own paper…a bit late but that should supply some liquidity to the auction rate market, other than the municipal issuers who have gone the route of reissuing the underlying bonds which is a slow process and creates huge supply in the marketplace.

Boy can these candidates do a smooth two-step…let’s not talk about anything unpleasant…unless in passing…we want you to like us…vote for us…even though we haven’t a clue what to do! John McCain and Hillary…what good is your experience here? Obama…what’ the Rev say? Sorry, that was a cheap shot but TB is rethinking his support of this guy even though he represents the only chance of change. How can he attend church for 20 years with that flamer and not have heard one of those rants? Add to this his wife saying that now that her hubby is running for President it is the first time in her life she has been proud of America. You can bet those two issues will come back to haunt him in the general election and he had better have some solid answers.

God bless America…and the Fed,

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3/17/08…grim and Bear it!

March 17, 2008 at 4:12 am · Filed under economy, financial, markets

TB’s Epitaph of the Day TB: ”Glass-Steagall Act 1933-99…RIP”… and now we are paying for it.

Most of today’s commentary was written on Saturday, On Sunday, it was announced that JPMorgan Chase (JPM) was buying Bear Stearns (BSC), for $2.00 a share which is amazing as Friday’s close at $30 was a 49% decline from the prior day and on Jan. 18, 2007, it hit a record high of $172.61 a share. According to Barron’s the theoretical book value was $84 billion a share in November although they had $28 billion in Level Three ‘mark to market assets’, so that is a very questionable assumption. On Friday, the options price valued the shares at zero but that is theoretical pricing, this is real. While JPMorgan Chase is much bigger in credit derivatives, as a bank they have a better handle of the credit conditions…or do they since there has to be a ‘Chinese wall’ between the bank and the brokerage. Certainly they are better capitalized and much better positioned to weather the storm but it was clearly in their interest to be the one pursuing acquiring the Bear.

A friend called TB yesterday evening saying he heard the Fed had cut the discount rated which seemed preposterous given that the FOMC meeting is just Tuesday. In fact, on Sunday at an emergency meeting, they did cut it in an unprecedented move that does more to worry TB than to console him, and also unprecedented, opened the discount window to non-banks Primary Government Dealers (had they done this three days earlier Bear Stearns might still exist. This is Volcker’s Saturday night special in reverse with equal and opposite reactions. The Fed is also providing $30 billion to JPM to finance the purchase. According to Vince Reinhart, former director of Monetary Affairs at the Fed as reported on Bloomberg “It is a serous extension of putting the Federal Reserve’s balance sheet in harm’s way. That’s got to tell you the economy in a pretty precarious state.” Lender of last resort makes a last resort move?

Meanwhile the currency markets were tanking the dollar…the Index fell to a a record low of 70.698 and has only regained about half the loss, yen hit a 15 year high of 95.78, and Sterling to a record high of $1.5904. Globex futures on DOW, SPX, NDQ were all down 2.5% and Gold soared to $1,033.90 a $33.40 gain and $24.90 above Friday’s record high! Crude bested the Thursday’s high by a more muted 80 cents. Can we not expect commodities prices to continue to rise when the dollar is in freefall?

Keep all of the above in mind and then remember that we repealed Glass-Steagall putting our banks at the same level as risk as broker-dealers. Also, TB was as he always is with the European and Asian coverage of the crisis on CNBC…then this morning he had to wake up to their US counterparts…ugh!

…if that seems a bit “stearn”, then read the report that Paulson referred to in his press conference on Thursday that shook the markets…until S&P tried to tell us there was light at the end of the tunnel, stopping short of telling us that it was an oncoming train. Here is the link:

http://www.treasury.gov/press/releases/reports/pwgpolicystatemktturmoil_03122008.pdf

Meanwhile a rumor circulated late Friday that Bear Stearns employees were buying ‘put’ options in their own stock….or could it have been several hedge funds, canceling their ‘prime broker’ agreements with Bear and simultaneously buying puts as well as selling or shorting the stock? Time will tell but options volatility in BSC early Friday was valuing the stock at ZERO! Later in the day it settled down but remained very high. IF said employees were doing this they may not have seen it as manipulating the stock price which fell by 47% on Friday, but merely diversifying their investments! Perhaps they had watched Angelo Mozillo’s testimony before Congress a week ago when he said he merely stepped up the selling program for his holdings to diversify his investments for his retirement…also interesting since he had just signed a contract giving the founder of the company 40 years ago a signing bonus or more accurately a retention bonus to ‘incent’ him into staying. At the same time CFC was implementing a stock buyback program as that was the best use of the shareholders hard earned money (never give it back to them in the form of dividends as they might squander it on frivolous things like management and the board of directors buy…you know “Giffen goods” where the higher the price goes the more the demand for it increases), besides that is the safest way to get a healthy bonus due to those share price incentives in their contracts…or at least Angelo’s and after all: isn’t it all about Angelo?

Time was, when spreading rumors about the demise of a financial company was a crime and one that was dealt with severely since it could cause a run on the institution. Not so these days when we have a ‘restriction lite’ SEC and Justice Department…even the Great State of New York isn’t much of a factor what with their ‘Starr’ prosecutor now in the hot seat and having proved he is a lousy shopper of pleasure, and at the same time creating a topic of discussion for couples who may not have even spoken to one another for years…and hubby better provide the right answers to wifey’s questions or there will be hell to pay. Memo to husbands: do not, as CNBC’s Charlie Gasparino did, refer to prostitution as a victimless crime. No sir!

There were two bright spots last week: the first being l’affaire d’Spitzer (which hardly qualifies as an affair since it could only have been in his fantasies…play for pay is not an affair…OK, at least not when there is an exchange of money rather than expensive gifts), as it took attention away from the presidential campaign…wonder which will win on the Sunday funnies…er, talk shows; the second was that Bear Stearns saved two purposes by taking attention from the Spitzer story, and away from Paulson’s one hour press conference which was based on op cit above. Please get the spelling of Spitzer’s first name correctly, you wouldn’t spell idiot, idiiott would you? More importantly, the embarrassing speech by Dubya at the Economics Club of New York (“there have been several crises in my Administration and somehow the American people have always comes thru,” the assumption being that you can come to the trough an infinite number of times and we will do what Americans do best…shop until we drop…dead, this time). Can you blame him as even some well-known economists have said “for 25 years every time there is a crisis we think consumption will slow but it doesn’t.” You can see the logic: as Frank Zappa and the Mothers of Invention said in one of their songs “it can’t happen here.” But it can and only hasn’t due to the flawed logic of trickle down theory, better known as supply side economics or Reaganomics, which worked so long as we kept borrowing and spending more. That, along with the help of the Great Facilitator, Sir Alan Greenspan, it worked, never mind that over the last ten years we have had an Asia/Russia crisis cause by the moral hazard (not to be confused with the moral turpitude conducted by Governor Eliot), created by the Fed Chairman and Treasury Secretary Rubin, then the collapse of LTCM, followed and caused by the former along with 10+ times leverage, the stock market implosion after he poured gasoline on the fire by making all NASDAQ listed stocks marginable the day after issuance which caused a record increase in margin borrowing even though only the electronic trading firms that catered to day traders did so…and to the most credit unworthy people. Then to his credit he did get us through y2k and 9/11…with the help of the Spitzer defrocked, Dick Grasso. That was followed by telling homebuyers to use adjustable rate mortgages which he later modified…much later, and then went on to ignore the stern warnings of Fed Governor Ed Gramlich who then spent the last six months of his life while dying of cancer, writing a book on the dangers since Alan wouldn’t listen and would only say: we have no expertise in controlling credit…wait, Alan? YOU are the head banker!

Then, like a runner in a two man relay he handed off the baton to Ben Bernanke, a scholarly type, who seemed the proper choice as he had extensively studied the errors of the Fed in the 1930’s which managed to turn a major recession of global proportions (it didn’t start here, only the 1929 stock market crash…it began in Austria with the collapse of the largest bank in the world, Credit-Anstalt in 1931 which caused losses in banks around the word), and then raised reserve requirements three times causing more loans to be called each time and that folks (if Dubya can say it, so can TB), was the beginnings of The Great Depression! It is depressing to even think of it. But the problem today is we are a generation not of haves and havenots, or haves and have mores that are Dubya’s supporters, but a nation of gotta haves! It began in the ’70’s with inflation rising due to the costs of the Viet Nam war and Johnson’s guns and butter approach and as prices rise we saw credit cards come into vogue…the first was actually Diner’s, then American Express morphed from travelers checques to plastic, then the banks not to be outdone created MasterCard and later Visa, which only became widely accepted in Europe after the French bank Societe Generale (you surely have heard of them?), endorsed them. Then, as France went so did all of Europe and the globe. Now you could finally finance your trip to Europe as well as your car, your home…eventually even groceries…with plastic. Then came tapping home equity for all of the above and to pay off those costly credit cards. In turn, the credit card companies resorted to teaser rates…sometimes even zero interest for a year…but be sure to read the fine print.

So now, 10 years later we have Team Bernanke/Paulson replacing Team Greenspan/Rubin but there are no easy solutions. The standard of living in the US is rapidly eroding, financial markets and institutiones are near ruin, deficits and inflation are rising, unemployment and consumption are slowing, and the dollar index is at a record low just as margin requirements for hedge funds are being increased even as asset price declines are causing more margin calls (if this sounds familiar refer to the paragraph above and you will see exactly why Bernanke, despite his calm exterior, is clearly concerned… a helicopter is not big enough to hold enough dollars to drop meaningfully. The only solution, and it is a painful one is to start living within our means but it we do that we will most likely have a global depression which would be a failure of the noble experiment. Whereas, Credit-Anstalt (now Creditantalt) was the catalyst the first time, lax regulation is the culprit this go around…and now we have the government issuing regulations for stricter credit…it is impossible to comprehend. But, we are Americans and some way we will rise to the occasion…as will our financial institutions so long as there is a buck in it…it’s the American way.

Now we don’t have just Fannie and Freddie, as Alan Abelson wrote in Barron’s, now we have Feddie!

Yesterday, Treasury Secretary Hank Paulson was on This Week and started out very calm and collected. Then as George Stepanopolous began to ask questions he began to stammer again…the same way he does at press conferences suggesting he is out of his element in this crisis…hopefully he is not.Obama is now in the hot seat and TB. who likes him. wants to know how he could have spent 20 years attending a church with a pastor that is a racist and America hater…what could he have possibly seen in this man? Also, he says he never heard the man talk this way…very doubtful and you can bet the Clinton camp is researching his days of attendance and what was said. More importantly, it calls into question the type of appointments he might make…we need change but that kind of change? Not for TB.

This will be a very trying today so never a buyer or a seller be if your stock is in freefall…too late for that. At dinner Saturday night with friends the subject of taxation came up and TB has done a reversal on increasing the taxes to the wealthy having been watching this situation closely. They should have been raised long ago when the economy rebounded…not raised but merely had the cuts restored. It was amazing how upset they became at the suggestion…it really is later than we think.

Erin go braugh…and TB wishes he were in Carrickfergus!

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Archive for March, 2008

3/31/08…the ides of April

3/28/08…solvency

3/27/08…kaching!

3/26/08…vindication

3/25/08…is this for real?

3/24/08…believe it…or not!

3/20/08…all that glitters

3/19/08…Bear to middlin’ (corrected for ‘V’ data)

3/18/08…the difference between the market and the Bear!

3/17/08…grim and Bear it!

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