Traderbill's Financial Markets Weblog

…that is the way TB feels today. Yesterday’s selloff was blamed on S&P placing GE on creditwatch for a possible downgrade…from AAA…you would have thought it was to junk status as the debt already trades like single A…the markets NOT the rating agencies determine trading quality…no reasonable investor trusts the ratings anymore…not when all the agencies were stupid enough to rate subprime loan pools AAA or greater than the sum of the parts (this was accomplished by not even considering that home prices could fall!), only the municipal bond insurers were stupid enough…and it cost them…they who had a license to steal as municipal defaults are (were) practically non-existent!

GE was the catalyst but no more responsible than the assassination of the Archduke Ferdinand caused World War I or attacking Pearl Harbor caused World War II. With GE specifically, it opened $17.60, up17 cents from Wednesday’s close…after a quick drop below $17, it then traded down to $16.45 in a slow steady manner then dropped on the S&P news to the $15.77 low afterwards before recovering slightly to $15.96 on the close. Note that the 40 day moving average is $17.40, so it was merely flirting above that as all the indices have been doing for two weeks now! So let’s put blame where blame is due! (in the spirit of full disclosure, TB had only a couple of hours earlier told a client to wait to sell his G.E. stock as it was already down on the day and should have hovered around the 40 day moving average…and had bought some GE bonds for two other clients just minutes before the announcement came…but they were already trading like single ‘A’s.)

The S&P 500 stayed above Wednesday’s close most of the morning but was never up more than six points. Two hours before the S&P 500 it began to decline sharply and was down more than 10 points when the announcement came. It then dropped to -27 before closing -19. TB believes today’s options expiration was much more significant than GE. But it didn’t help to have one of the few remaining AAA companies in danger of losing it. Madoff has compounded the problem due to just how many options his firm might have held. TB is concerned though that both the VIX (S&P 500) and VXN (NDQ 100) options indices have been plunging…in fact they have each dropped about 5% per day the last two sessions…how can that mesh with a 2.5% decline in the Dow Yesterday?

First, the dropped thru the 40 day early in the week, then three more straight days of decline has brought them about 2/3 of the way to the 200 day moving average which is still historically elevated but well below those record setting levels. The strange thing is that you would have expected them to rise sharply on the GE story…this indicates it is expiration related…it is inconceivable to TB that volatility (risk) should have declined!

A top story overnight is that S&P did in fact lower the ratings on Goldman Sachs to A from AA-, Citibank to A+ from AA (this raises questions as Citi is less viable than GS!), HSBC was placed on credit watch but rating maintained at AA-. Here are the others: Wells Fargo from AAA to AA+; BofA, Barclays, JPMorgan, to AA- from AA; Credit Suisse, Deutsche, Royal Bank of Scotland and UBS to A+ from AA-. After the rate cuts almost all are still on watchlist for possible further downgrades. Meanwhile, GE was only placed on creditwatch…so the worst that could happen is a AA, right?

These downgrades support the analysis by ING strategist Padhraic Garvey, who believes Libor may suffer a ‘re-explosion’ by June. With 1 month Libor, which is over yearend, at just 0.48% this seems logical…risk is factored out of the equation while banks (and their customers) don’t trust each other. Our assessment of the value of risk is insane by any standards…if you were concerned about a company failing would you rather lend to them for three months or three years? As Mike Milken would say, if you are going to take risk take it where it produces income…income that can be reinvested and thus compounded at the least mitigating any future loss…in one month or three even if they offer you 10% it is a pittance and won’t do a thing against the loss. One scary thing is that TB has noted several waves of GIC’s (Guaranteed Insurance Contracts) hitting the market and they are being offered at 10%!…mostly due in September! Perception is that GIC’s are sacrosanct which they are not. They are issued by insurance companies and collateralized with the insurers asset…mostly commercial real estate loans. If you watched 60 Minutes Sunday you know that there was a segment on the credit crisis and credit cards and commercial real estate were seen as the next problem areas.

This myth of safety has been perpetuated by Congress…yep, once again bought and paid for. An insurer is only allowed to issue GIC’s to 20% of capital and during the Milken era when companies were being gobbled up by raiders who fleeced the overfunded pensions (you haven’t heard that term in years), and then defeased them. This is where your loyal public servants come into play. A pension fund can only be defeased with…GIC’s! Not corporate bonds, or stocks OR U.S. treasury obligations…can you believe that? During the eighties Wall Street (specifically Salomon) petitioned them to allow defeasance with treasuries. No dice! Had to be GIC’s. So what happened? Good old Freddie Carr’s Executive Life in ‘conjunction’ with Mike Milken bought loads of JUNK BONDS. Then put them up as collateral to the GIC’s…wait, it gets better. Some of that collateral was the new bonds of the companies whose pension funds were being systematically raided. Two examples of how these funds were demolished were Kaiser Industries and Pacific Lumber. So due to the efforts of insurance company lobbyists, thousands of employees pensions were wiped out…fortunately, Carr suffered as California’s first Insurance Commissioner John Garimendi seized control, but the damage was already done. Can you imagine anybody refusing to allow U.S. treasury obligations to be eligible to defease a pension fund? TB means then, not now! Sure…if you tell them not to and pay them for it!

By the way, at the peak, due to heavy demand and the 20% of capital cap on them, GIC yields were right on top of U.S. treasuries! Imagine the stupidity of that!

Mary Shapiro appears to be a good choice for SEC Chairman bring with her SEC trial experience as well as Chairman of the CFTC. Her first comment puzzled me when she praised the work of her predecessor who is so busy blaming the investigators. True, they deserve blame but he reprimanded his investigators before the media for engaging in witch hunts…he can’t have it both ways. She would be smart to disassociate herself from Chairman Cox. By the way pointing the finger at investigators is the only active thing he has done in months…perhaps we should feel lucky since what he did do before that exacerbated our problems. Anyway, let’s hope she does the job we expect!

There is a huge debate over the reported $50 billion of losses at Madoff. Some say it is overstated and more likely only about $1 billion. No, the difference is in how much Bernie took out of it…likely the smaller number or less…but we will have to wait and see…the rest went to expired options and margin calls. However, this morning stories indicate investors had about $36 billion with him…of course that doesn’t count the funds that were withdrawn and now will be claimed by other investors. Now get this: the options strategy Madoff claimed he used to create 17 straight years of profits would have required at least 10 times the contracts that trade on U.S. exchanges, according to a Bloomberg article this morning! So where did the money go? Who knows and may never fully know.

This brings us to another point: why on earth is Madoff out on bail? He claims he didn’t have the $10 million for the bail and was able to put up four homes for collateral…in this market? Besides he is a flight risk and more importantly to TB a suicide risk. On that basis alone he should have been held and on a 24 hour suicide watch, right? Because if he is dead, it will take that much longer to learn what was done. By the way, after sentencing (assuming conviction), he should be placed in the general population, not some Club Fed. What he did was despicable and only adds to the ‘perfect storm’ we are experiencing.