Bloomberg Quote of the Day: “Laws are like sausages. It’s better not to see them being made.” – Otto von Bismarck. Ja wohl!
…it was a good month for stocks…of course the second to the last week was a disaster and while the last week was better we were still net down for the two weeks. TB’s guess…and this is just a guess is that June will start with a dive down…a recovery and then a selloff into monthend…why not? we did that in December and in March…is this the revenge of the hedge funds? Trying to make their own shabby performance of late look better by making conventional money managers look worse? Think about it!
Today’s Topics:
1. Auction rate securities…the gift that keeps on giving
2. China and Asia…trouble in paradise?
3. Other top stories: UK housing, Oil, and Cerberus/Chrysler
1. ARS. What a pleasant surprise from the rating agencies for the monoline insurers as Moody’s new, improved ‘ratings lab’ has cut AMBAC, MBIA and others to ‘CAA’, which in case you don’t know it means junk, not high yield, but JUNK! Meanwhile they are holding their ratings at Aaa…isn’t that great? Why? Because if they cut the rating…even to Aa that would render their municipal bond insurance worthless. How could the monoline insurers get themselves into this mess? Simple, by selling credit default swaps! In other words, saying that they know more about credit than the swaps traders…and they are being proved wrong…the insurers not the swap traders. What does the Moody’s ratings lab do? It judges the companies on the basis of how their own credit default swaps. Now think this through: a ratings agency assigns a rating to a monoline insurer of Aaa or AAA; traders think that the risks of default are ring so they buy credit default insurance on the insurers…in effect saying that the rating agencies don’t have a clue (a case TB would be hard pressed to argue). So they have two businesses…one is plain vanilla insuring municipalities with little chance of defaut (or they have been for the three decades or so they have been doing this but with the economy on the skids even that might not be such a safe bet); the other business is writing credit default swaps a la Bear Stearns and JPMorgan, which are theoretically hedged in most cases by offsetting buys and sells…theoretically…so long as some of the counterparties don’t fail starting a huge domino effect. So add to the list of financial companies we don’t trust…and who don’t trust one another, rating agencies and monoline insurers…we already had some of the biggest and best (?) banks, insurance companies, and brokers in the country…and the world. This is a crisis of trust!
For a financial institution, it is all about trust, but be they your friendly banker, mortgage company, broker, you name it, they have systematically changed the rules. How many of you have had terms of credit cards or other loans altered…be it by cutting the days between billing date and payment to service charges. Even the respected LIBOR which replaced Prime and Fed Funds floaters with an index of 8 major global banks, throwing out the highest and the lowest…what could be simpler? The problem is that we are in a world of unthinkables: it is unthinkable that a bank would understate LIBOR…why reduce the income to yourself?…because they don’t want others to know they are paying a penalty rate above LIBOR to borrow themselves! We already saw it in auction rate securities where the issuing agent just let the auctions fail, thereby killing the goose that laid the golden egg. Would brokers cheat clients by creating obtuse financial derivatives then watching idly as they melt down? TB could go on and on.
Bloomberg news reports this morning that Brazo’s Group…you are forgiven if you have never heard of them, but at $7 billion of auction rate securities backed by student loans are the biggest issuer in the $330 billion ARS market. They chose to use ARS rather than fixed rated financing and to not pay for a line of credit to a bank to buy any or all of the notes that were put back to them because both were cheaper. Now they are paying an average of 5% up from 2% while the student loans only return 4% to them and the government has cut way back on the subsidies…they can’t afford to keep paying this, can’t afford to restructure and don’t have the money to redeem the notes.
TB was cleaning out some files and ran across an analysis of Auction Rate Securities from Wachovia dated October 31, 2004 (see more on Wachovia below). TB reread it and while it told of the risks (at the very end) while giving many of the acronyms (AMPS, ARPS, VRP, MMP, MARS, PARS…should have had one for WARS – Wachovia Auction Rate Securities…how did they miss that?…the same way they missed everything else).
The three page memorandum, accurately described how an auction works, lists the benefits of ARS, in italics told you to read the prospectus before investing in a money market fund? Wait…we are buying auction rate securities NOT investing in a money market fund? It goes on to extol the virtues and says they may “enhance investment period flexibility,” that insurance pertains to timely payment of principle and interest and not to the market value of the securities as payments are subject to the claims-paying ability of the insurer (i.e., Brazos and many hospital issuers). Then under Risks they explain failed auctions and how the rate in that instance is determined in accordance with the prospectus…as an institutional investor, TB has never received a prospectus on a single issue…and in the event of a failed auction, shareholders may not be able to sell some or all of their shares until the next ”successful” auction…which TB has found to usually be the next auction date so long as the underlying credit was ‘A’ or better…lastly, it states that the SEC is currently investigating bid rigging and closes with “if the SEC were to rule that broker-dealers were prohibited from bidding at auctions, liquidity in the auction-rate securities could decline. This might also cause the number of auction failures, which have been extremely rare, to increase.” Hmmm…that was written more than three years before a problem developed…in a security that worked properly for well over two decades. Today, months after the problem developed, data from Lehman and Bloomberg suggests that between 2/3 and 3/4 of all auctions are still failing, although a huge dent has been made in the amount outstanding…perhaps by as much as 40%.
2. China. Wow! Top stories today on Bloomberg are chock full of China news. TB warned last week on stock market performance problems in China and India. Whereas the Asia crisis of 1998 (Asian Contagion) was due to a currency collapse, inflation is now the problem. That is largely due to the hard or soft pegs to the dollar and how nobody wanted to revalue and lose exports to the US. This is causing inflation to surge and it is India that felt it first but it is spreading to China where growth is starting to fall. Another article was on how China’s Zhou is losing ground against inflation and the earthquake there is not helping matters. Then China Telecom, a landline provider is buying the mobile phone assets of China for $15.9 billion!…is the equivalent of TimeWarner buying AOL at the top of the market? Chalcoa, or the Chinese version of Alcoa is selling 23% below US shares of Alcoa despite higher revenues…is there a message here? Is Chinese investment in the US similar to what Japan was doing in the ’80’s?…you know buying NY office buildings at ridiculous prices…which turned out to be bargains…definitely when you factor in the decline of the Yen! Problem is that China is supposed to be revaluing not devaluing…and make no mistake about it: China needs to sell to the US!
Miscellany. Following the China thread, UK factory growth unexpectedly slowed while UK mortgage approvals slumped to the lowest level since 1999 when they began keeping records…add the UK to Germany and you have the makings of a global slowdown…recession…or worse. UK stocks tanked this morning led by Bradford & Bingley, the UK’s largest lender to landlords, which had an IPO in 2000 plans to sell shares at a 33% discount to market price and saying the housing market is deteriorating. Unlike the US where Merrill, Citi and others sold shares at a concession, the Brits are smart enough to react properly…they took B&B down 33% overnight!
While we are on the topic of stupid US investors get this: Cerberus announced it has sold more than 1/2 the shares of Chrysler to investors…now think about this…another Bloomberg article today talks about how the ISM Manufacturing Survey to be released this morning will be weak, led by autos. TB felt from the get go this was just another private equity bait and switch…who wants Chrysler anyway?
Another article on how ‘write-ups’ are inflating the earnings of US financials is a rehash but bears repeating: as part of mark to market accounting, if the value of a companies debt declines the difference is ‘earnings’ as it would be cheaper to buy back the debt. Merrill increased earnings by $4 BILLION due to this lunacy…this from a company that bought their own worthless derivatives and didn’t hedge them, continued to pay the dividend even though it had to raise huge amounts of capital (at a deep discount to the market value…and as stated above rallied on the news). Now TB asks you: could or even if they could, would they buy back their own bonds? Have we taken total leave of our senses?
The LIBOR story is back again and how it is creating uncertainties in the lending market…something we definitely don’t need more of now. Along with this is a restructuring at Wachovia including the forced resignation of CEO Ken Thompson who succeeded in buying Golden West Financial at the peak and now is suffering from the option arm loans. Some see the stock rallying…and why not?…after all, it had a new low close on Friday and a new low on Wednesday…so at the very least expect shortcovering!
The last article is on the CFTC investigation into hedge fund trading in oil. Since rumblings of investigation began in July 2007, hedge funds have decreased their activity which is easily measured as they are a speculator and as such have to report. But they have been replaced by Index Funds and ETF’s who unlike commercials and speculators do not have to report their activities…makes it all the more important that Crude supports at the long term trend line of $111 a barrel.
Scott McClellan is a weasel…Tim Russert virtually tore him apart on Meet the Press…with his own words. This is so typical of this Administration who has had Karl Rove and others say “this is not the Scott we knew,”…the implication being that demons have invaded him. This is so typical of everyone from Paul O’Neill to Richard Armitage and others…make them look crazy but kill them with kindness. But as for McClellan, a man who berated another turncoat…and now says he apologized to him just last week…uh huh…and wrote a book proposal that was the exact opposite of what he penned…some say that it was because when he sat down to write positively he just couldn’t do it…was it that or fear that someone would find out what he was really going to write about? No matter, he knew the Administration was all about lies for at least 10 months before he left…that is no hero in TB’s book…it’s a weasel!
Equal time…the Dems are a sorry lot…trying to get Hillary to cave in while Obama loses another election to her…a compromise on Michigan and Florida that only the US Supreme Court could appreciate…and of course the superdelegates…who’s ego’s surpass their stature! Why do you need superdelegates when the people have spoken? Something is amiss in the Democratic party as well as the GOP…and that means something is amiss in America: such as a government of the people, by the people, and for the people. Didn’t anybody ever read the Constitution???
Hope you have a successful week!
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 June 2, 2008
