Traderbill's Financial Markets Weblog

 

…if you have an April Fool’s joke played on you, may it be one you enjoy. Hopefully, the market won’t or that you won’t let it make a fool of you. TB has been reading some informative but scary emails from John Mauldin and TB doesn’t believe the are overstating the issues we face today. If you listened to Paulson yesterday, you should understand that by the sweeping proposals he introduced that we are in an era no one in the US has ever experienced…or at least was old enough to understand. The sheer magnitude however dwarfs any such crisis in the history of mankind…as well as the degree of leverage!

First, over the weekend, TB read Mauldin’s commentary which well described the situation, then he reread a piece by Peter Bernstein who has forgotten more about investing than most of us will ever know and at 87 is one of the wisest student of investing on the planet…TB says student because even Bernstein would never call himself an expert…let his readers make that decision. Lastly, he read yesterday’s piece by Michael Lewitt of HCM which was nothing less than taking the government and financial sector out to the woodshed for a well deserved whuppin’! It is becoming increasingly difficult to write this column, not for a lack of material but for an excess of it. What TB planned to write Monday became today’s fodder. But by last night that was tossed in the trash due to the events of yesterday and last night’s reading.

1. Paulson’s Follies. What is this now his fourth proposal? With three failures. Paulson is acting like a ‘drawer slammer,’ you know the employee who does nothing till someone walks in his office and then he begins opening and slamming drawers so it appears he is doing something. TB does not to infer he isn’t trying but his super SIV, two attempts to re-fi mortgages to forego foreclosure, have all failed to accomplish their goals. His best move to date was the joint press conference with Bernanke to show solidarity, that was uprooted during the conference when Dubya speaking from Iraq in answer to a reporter’s question said we would not have a recession…really, they cut from D.C. to Iraq while the two were speaking! TB has commented on his delivery with pauses, stammering, etc. which indicate he doesn’t have a clue how to stop this mess…can you blame him? Yesterday, with a prepared speech, he got lost twice and again stammered during the Q and A. This does not happen to CEO’s, especially one from Goldman Sachs unless…they don’t believe what they are saying…or know what they are talking about. For the life of TB, he cannot fathom why this multimillionaire took the job…with a lame duck President who had already gone thru two Treasury Secretary’s, the first was lied to on access to the President and hung out to dry, the second a mere mouthpiece who is just now beginning to speak his mind. Whenever TB hears the term ‘folly’ Minsky’s Follies come to mind, but rather than vaudeville and burlesque, the Minsky TB thinks about is Hyman, the noted economist who wrote on financial instability and describes accurately what we are facing today…and that is not sexy…or funny.

Look at the reaction to Paulson’s proposals regarding merging all financial regulators into one: securities, commodities, and insurance. It would take an ‘Act of Congress’ to do that…literally! More importantly, it will take time…and with apologies to Mick Jagger and the Stones, it is not on our side. No, it isn’t. Let’s look at some of the comments:

1. An SEC member thought it was a good thing…that since this commission with an equal number of Dems and Reps and a vacancy for a Dem, but with the tie vote cast by Chairman Cox (R), has allowed naked shorts to go uncovered for 45 days and eliminated the ‘uptick’ rule which, if they weren’t afraid of exposing their stupidity they would immediately restore (as Congress should Glass-Steagall).

2. A CFTC member was up in arms as they have done an incredible job of regulating…why blend them with the SEC? Besides if we put all of these under one roof think of the backload…already SEC enforcement cannot get to more than a fraction of the complaints and investigations that should be done. TB thinks that if this is done, the CFTC should be the model, not the SEC which is already being put to shame by the NY Fed!

3. Three state insurance commissioners were interviewed, one a woman who said the states know best. Really? We have an inefficient system with 50 different state laws that provide barriers to entry to insurers and thus cause rates to be higher…Florida and California have had a mass exodus of casualty insurers due to fires, hurricanes and earthquakes…this would allow a more competitive market. As a state registered investment advisor, TB believes insurance should be handled in a similar manner: File with the state, register nationally on line and if you need to add states you simply check a box and pay another small fee. This insures that all statements are the same and increases chances of proper enforcement (to register with the SEC you know have to have $15 million in assets under management). The second commissioner whined that he was in NC and why should they subsidize costs in NY? The interviewer answered what about them subsidizing the cost of your hurricanes? Besides rates could be set by geographical or demographical area not standardized. Lastly, and this is rich, NY State Insurance Commissioner Eric Dinallo said that they were on top of the monolines and began working with them a year ago to fix the problem. He noted that neither of the two biggest monoline insurers has failed to handle their obligations. Funny, as TB had been thinking that while this guy had been getting a lot of press it fizzled after l’affaire Spitzer, and a capital infusion to AMBAC which came with a six month stay of execution from Moody’s, S&P, and Fitch. Wonder if Mr. Dinallo owns any muni bonds and has tried to get a bid on one with AMBAC insurance lately!

Monoline insurers at least should be regulated federally and we won’t know how serious the problem is until one fails to meet its obligations which could have been as early as two weeks ago had Bear Stearns failed…the problem is credit default insurance not municipal insurance yet they have destroyed an auction rate securities market and created turmoil in the muni bond market as ARS issuers rush to put out those bonds and they are all in the long end of the market. There is some progress being made with issuers offering 4 and 7 year puts on the longer debt which reduces the expense but is still overloading the long end with supply causing the yield curve to steepen even further and the tax free yield well above long treasury yields…were it not for this supply extending as far as the eye can seen muni’s would be a steal.

Lastly, why should we trust the regulators…or Congress? Due to problems with FNMA and FHLMC, Congress created OFHEO to supervise them. OFHEO stepped up supervision, clamped down on their liabilities, and subjected them to audits on their accounting practices. Now, due to the crisis, they called OFHEO off, loosened capital requirements and these GSA’s are now seeking $15-20B in additional capital…read tapping the bond market! This, rather than solve the housing mess, will merely postpone the inevitable: a government, again read taxpayer, bailout. Meanwhile the Home Loan Bank is extended to Washington Mutual and other lenders.

TB has been writing about government’s obedience to lobbyists…especially Wall Street. Hearings have been held…private equity managers whine that if they lose a 15% tax on their income, which is not risk capital! no one will do it…this is the most Kudlowesque argument of all time. People making billions say that if they had to pay 30% or even 40% instead of 15% they would not be incented to do their jobs?

The system is broke! Congress has been corrupted by lobbyists and money from Wall Street and other big businesses, including the financial institutions that we are now being asked to bail out, without making the executives…and loan creators who received huge commissions on now failed mortgages…return some of that money. Some incentive to be honest…or prudent. John McCain sees no reason to help anyone…a la Herbert Hoover so TB can no longer vote for him. Hillary Clinton has probably the best economic proposals (but her campaign manager, woman, headed up a mortgage company that went bust earlier), and TB feels we have had enough, of the Bush’s and the Clintons. That leaves Obama who talks as a populist, hopefully only to get elected, but the change he offers is only hope…perhaps the only hope but it is an unknown quantity. What we need now is leadership…where are the leaders? 

The Dollar. The weak dollar, despite a ’strong’ dollar policy, is hurting us by driving up energy and food prices (along with our flawed energy policy and ethanol subsidies). While the dollar is trying to find a bottom, it is doubtful it will succeed. As speculators unwind commodities contracts as part of the great unleveraging of America, we are seeing the dollar improve slightly…from the lows, The Yen is back to 100 again but as those leveraged loans are unwound and repaid the Yen cannot fall much further. Also, the Euro/Yen and Sterling/Yen are in a similar situation and so the picture is muddied and to make matters more confusing yesterday was the end of the Japanese fiscal year, so stay tuned.

We have also had a huge entry into the commodities markets by hedge funds and individuals who may have textbook experience or not, but in a market that despite its relatively small size is extremely active and volatile. 5% moves are not unusual and sometimes for more than one day in the same commodity, witness Wheat which rose 11% in two days and since has seen 4-5% declines per day. Thus the commodities markets are in weak hands and we only have to look back to the early 1980’s too see how rapidly Gold and Crude unwound. TB repeats: this is not a market for amateurs or those with weak stomachs…yet it all the rage. Follow the herd and you will step in a lot of …

3. Bonds. TB repeatedly hears on CNBC that bonds are too rich…that the risk premium makes stocks attractive. This is representative of our desire to make bad things go away quickly, thus the flight to quality continues, despite heroic moves by the Fed, that have merely reduced its ability to respond to further crises, and throw more good money after bad. 300 basis points in rate cuts have barely moved the 30 year mortgage rate and even that has been offset by tighter credit standards. This should not be construed as criticism of the Bear Stearns bailout which would have caused a cascading of defaults since credit default swaps of which the Bear had $17 trillion notional (JPM has $90 trillion of derivative exposure), were to every major hedge fund and institution in the world that enters into these agreements. If a counterparty falls below investment grade the contracts are immediately canceled so think what the repercussions would have been. If subprime was destabilizing this would have trumped it.

TB believes the risk premium for stocks is as useless and antiquated as ”over any twenty year period you won’t lose money in stocks.” True over most time periods this is true but in a financial crisis comparing the inverse of the p/e on stocks to the yield on treasury’s is a waste of time…otherwise we would be in the biggest rally of all time right now…and those 20 year returns are not adjusted for inflation, taxes, or changes in composition of the S&P 500. So get a life, equity geeks! While bond yields will not decline to the extent of another 125 basis points in Fed easing it is unlikely they will rise. Meanwhile the stock market will have faux rallies (countertrend bear market rallies), each time the Fed cuts ignoring that the reason is still primarily stability of the financial markets and just beginning to be related to the recession…yes! we are in a recession…who cares what the experts say, it’s undeniable, and hopefully it isn’t worse than that. Yet, TB heard Schwab’s Liz Ann Sonders say on CNBC that she thinks the end is near due to the recession probably starting in January (TB thinks December as does Merrill’s David Rosenberg), but recoveries, even without a credit crisis do not start for at least six months, and the stock market even in the mild 2001 recession didn’t bottom for another two years…it could be worse this time due to a long string of record earnings enhanced by stock buybacks. Therefore, don’t sell bonds short just yet…except perhaps as a trading play…it ain’t over yet. 

Have a great day and don’t be an April fool! TB is mad as hell and he isn’t going to take it anymore.

TB

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 April 1, 2008