4/19/12…a not so brief history of risk and the Volcker Rule

Bloomberg Quote of the Day: “Fiction reveals truths that reality obscures.”- Jessamyn West


Bloomberg Top Stories:

*Bank of America’s Profit Tops Analyst’s Estimates as Trading Results Rebound – for now!

*Morgan Stanley Beats Estimates as Fixe-Income Sales Top Major U.S. Banks – but stocks?

*Soaring Spanish Bad Loans Cast Doubt on Public Cost of Propping Up Banks! Do tell!

*European Stocks Drop as BOE Inflation Forecast Sinks Gilts, Bolsters Pound

*Spanish Banks Gorging on Sovereign Bonds Shifts Risk to European Taxpayers – atta boy!

*Posen Ends Push for Bank of England Stimulus on Inflation Concern – nobody knows!

*Fannie Mae Proposal Is Said to Include U.S. Safety Net for Home Mortgages – oh buy!

*Bank Credit Worst to Companies Since Peak of Global Crisis – oh yeah, their lending, right!

*Citigroup to Fix Pandit’s Pay After Shareholder Rejection – finally listening to owners!

*Halliburton Earnings Rise as Higher Oil Prices Drive U.S. Drilling Demand


What a whipsaw! Just when you thought it was safe…and TB played the fool, It was another down session. BUT Dow still is holidng13k…but will it by Friday’s close? Support lies above and below the psychological 13k: 12998, the 50 day m/a and 13033, the 40 day, so the magic number could still be fleeting. Big Caution Flags!”  One day after all 30 Dow stocks were up, led by IBM with 36 index points and 7 others gaining at least 10 points, ¾ of them were down led by TA DAH! IBM with -55 points for a net MINUS 19 points! JNJ, JPM, ITNC, and TRV all lost more than 4 points! Volume was stable for a SIXTH straight day at an unremarkable 3.44B shares on NYSE listed stocks (compare to 4.66B on last Tuesday’s downdraft). Also, NYSE stocks executed on the Big Board rose but barely above Tuesday’s lowest level since March 12th, 710M shares, to 724M – after the surge to 972M on a week ago Tuesday’s selloff,  250M below the falling 12 month average (970M)! 8 of the last 9 sessions have been less than 800M shares! Since 2/29 there have now been just THREE ‘average’ days, including 3/16’s high for 2012, and the average has fallen to 805M shares. Since 11/1 there have been just eight 1B share days…only three in 2012! Since 2/6 there have been FIVE sessions less than 700M shares. 104 of the last 114 sessions have been less than the 12 month average! Advance/Declines were negative: -2.1x vs +3.4x vs +1.3x vs +-3.3x vs 4.6x on NYSE and -2.3x vs +3.2x vs +1.1x vs -3.5x vs +2.1x on Nasdaq. Breadth was similar: -2.4x vs +7.3x! vs +1.2x vs -6.4x! vs  +9.5x!!! on NYSE and -2.3x vs +5x! vs -1.4x vs -6.4x vs +4.5x vs  +4.3x on Nasdaq. New 52 week highs plunged again to 114 vs 180 (high was 420 on 3/26), while new lows doubled to 107 vs 53! Ratio is 1:1 again vs  +3.5x vs 1:1 vs  -2.9x vs +3x vs 1:1 vs -3x!!! vs -2x. The S&P VIX barely moved, probably due to tomorrow’s options expiry to 18.64 up just .18.


Here are the results of the last five sessions: Dow -06% vs +1.5% vs +0.6% vs -1.1% vs +1.4%; Transports -0.1% vs +1.4% vs +0.9% vs -1% vs +2.2%; Dow Utilities -0.2% vs +0.6% vs +0.6% vs -0.3% vs +0.5%; S&P 500 -0.4% vs +1.6% vs -0.1% vs -1.3% vs +1.4% vs +0.7%; Nasdaq Composite -0.3% +1.8% vs -0.8% vs -1.5% vs +1.3%; Nasdaq 100 -0.3% vs +2% vs -1.1% vs -1.5% vs +1.2%; Russell 2000 -0.9%! vs +1.6% vs +0.2% vs -1.5% vs +1.5%; NYSE Financials -0.8%! vs +1.6% vs +0.6% vs +1.9% vs +1.6% vs -2.2%!!. NYSE Financial Leaders: BAC FLAT vs +1.5% vs +1.3% vs -5.3%!!! vs +3.4% vs +3.8% vs -4.4%!!! vs -3.3%!!, Citi FLAT vs +3.2% vs +1.8% vs -3.5% and since peaking at $38.40 on 3/19, it is now off 8.3%!!! When is the last time you saw even one of the stocks, let alone BOTH, unchantged??? This is totally insane!!!


European equities weaker, Asia mixed:  FTSE -0.4% vs -0.4% vs +0.8% vs +0.3% vs -0.4%; CAC40 -0.7% vs -1.6% vs +1.4% vs +0.6% vs -1.1%; DAX -0.1% vs -0.9% vs +1.2% vs +0.3% vs -0.9%; Nikkei -0.8% vs +2.1%! vs -0.1% vs -1.7%! vs +1.2%!; Hang Seng +1% vs +1.1% vs -0.2% vs -0.4% vs +1.8%!!; Korean KOSPI -0.2% vs +1% vs -0.4% vs -0.8% vs +1.2%; Indian Sensex  +0.6% vs +0.2% vs +1.2% vs+0.3% vs -1.4% vs +0.8%. U.S. stocks opening weaker – Dow below 13k and supports!: DOW -59; SPX -5.80; NDQ -5. Bonds continuing to rally…hmmm TIPS starting to lag!?! 10’s still thru 2% but 30’s still well above 3%.10 yr 1.95% +1/4, RECORD low 9/23 of 1.6855%; 30 yr 3.10% +1/2; Long TIP 0.72% -1/16. It was 0.57% at high. The 5 yr TIP yields MINUS 1.28%; 10 yr -.30%. Bills 0.04% 1 month; 0.07%; 3 months; 0.12% 6 mos.. Reverse Repo 0.17% vs 0.23%! 3 mo. Libor 0.47%, and 0.73%; steady. New section on euro sovereign 10 years, for reference Germany 1.69% -3 bp’s (benchmark for the matrix); Italy 5.56% +11; Spain 5.85% +9; Greece 20.52% +11; Portugal 11.65% -21; Ireland 6.55% -12.

Gold closed below $1700 for a 26th straight session, -$12, making the hit $153 since 2/28, closing $1639.60 -$11.50. 2/28’s $1792.70 intraday high was not seen since 11/16! It has been above $1600 since Jan. 31, which remains below major support!!! The record high is $1923.70, a buying climax on 9/6. Res is $1685, the 40 day and $1695, the 50 day, then $1698, the 200 day. It is now $1647.60 +$8.00. Crude took a dive, closing at $102.67 -$1.53. Tuesday’s low of $100.68 was worst since 2/15/12! It remains below the range of $105-110 which held from to 3/28!!! RES still at the 50 day (104.59), the 40 day (105.48), and major support at $95.93, the 200 day, all still rising. Little changed o/n, now $102.20 -.47. $101.08, the April 4 low is still minor support – Last 4/10’s low $100.68!!! – lowest since 2/15/12!.


One day after a major breakout on the Dow…taking out the 40 and 50 day m/a’s in a single session while going thru 13k like buttah, it reversed putting 13k and the 40/50 day’s at risk…both taken out briefly this morning an now just 13006 -27! Look at IBM the chief factor in Wednesday rally (+36 index points) then down 55 yesterday for a NET LOSS of 19 points??? Worse yet it gapped DOWN on the open so far that it would have still been a gap from Tuesdays’ strong close! That is a whipsaw of epic proportions!

As for the NDQ 100 2/3 were down led by INTC/MSFT -2.5 and APPL -1. Thank you flash traders and the SEC for its complacency in converting a market to a casino.


TB still recommends either staying sidelined but and recommending raising those trailing stops when possible. Two whipsaws in a row prove you are gambling not investing here!


. . .   – – –  . . .  (SOS)   . . .   – – –  . . .  (SOS)   . . .   – – –  . . .  (SOS)   . . .   – – –  . . .  (SOS)


(This is way too long but only way to explain it)


…there is much discussion, pro and con, about the Volcker Rule which would prohibit banks from proprietary trading. An Op-Ed in the WSJ triggered a response from a former banker and friend who TB respects. We exchanged views and here are TB’s opinions, built around the points and criticisms he offered; TB accepts full responsibility for them:


TB learned when he was in banking, that banking laws were of the bankers, by the bankers, and for the bankers. This applies to small banks who got unit banking laws passed to keep the big banks out particularly in the Midwestern states. TB learned this first hand when he was with Western Bancorp (which morphed to First Interstate).


But what about BofA, you might ask? A.P. Giannini alienated some people when he branched into insurance as well as banking. Thus he had to spin off both Transamerica and First America which became Western Ban, and held on to BofA. Other bank holding companies were raising the ire of small bankers, so the Douglas Amendment was added to Glass-Steagall which grandfathered in existing multi-state bank holding companies, but banning new ones or buying up other banks.


With the repeal in 1999 of Glass-Steagal, WBC, First Bank System, Norwest, and a few others no longer had a lock on that business. Then with mergers they became part of U.S. Bank, Wells Fargo, etc. At the same time, Hugh McColl of Nation’s Bank was buying up everything


(Note: the author, Peter Wallison, is a senior fellow with the American Enterprise Institute and thus not unbiased. TB’s comes from his own experience and what we just witnessed in the financial meltdown. That is not to say TB is right, but at least he doesn’t have an axe. What disturbed TB was he offered no alternatives, simply that the rule was wrong. Does he seriously believe that no regulation is required?)


If we go back to pre-Glass-Steagall, we get the reason that trading was restricted to government securities and municipal bonds (the reason for that is for the banks own portfolios and to provide bonds for their customers, recall at the time changes in yield would not produce dramatic price changes like today…we have seen 2% changes in the long bond in one session, something that used to take perhaps six months). When the crash came banks went under, just as we experienced in 2008. Thus the banning of speculative trading and for that reason FNB Boston, for example became a bank and First Boston Corp. There was no connection, not even under holding companies allowed. This worked fine and probably still would today if hadn’t been for bankers wanting to make more money. So with the abolishment, banks were allowed to do so under the holding company umbrella, but the two functions were separate.


This too worked fine until the advent of derivatives. First came mortgage-backed securities thanks to Salomon’s Lou Ranieri who understood the value of diversification (until recently when the bank he owned imploded due to a concentration in Florida and California mortgages…how could someone as knowledgeable as him make that mistake? I asked this of Michael Lewis who lit up when I mentioned it because nobody else had. He said he had contacted Ranieri but his wife had recently passed away and he wasn’t in a mood to talk…hopefully he will at some point as it defies explanation). Thus we hade Fannie Mae and Freddie Mac originations…still no problem.


Then, as mentioned yesterday they dove into derivatives (prior to briefly being involved in financial futures which again were just U.S. government securities), and dramatically increased the leverage. This was further compounded by the fact that effectively the Fed no longer holds bank reserves…thus they, not the banks as originally intended did the bailing out.


But the worst was yet to come. William Donaldson, former head of an investment firm, was head of the SEC and he planned to do ‘routine audits’ of the Big Five, so at least they had some supervision. Unfortunately, his term was up and Chris Cox, former GOP representative from Orange County, was his successor. Cox knew nothing about securities of if he did, hid it successfully. Under his control, not one audit was done of the Big Five…zip. Regulation and enforcement were lax and good investigators left in disgust.


Where is Cox today?  A partner in the M&A and securities division of Boston-based international law firm of Bingham McCutchen LLP. He is also a principal in Bingham Consulting Group, the firm’s affiliated consulting business, along with former California governor Pete Wilson and former New Hampshire governor Steve Merrill, who is its president partner in a law firm which seems to be a retirement home for former politicians.
While, banks were now required to carry on trading and securities speculation in separately capitalized companies, they were under the same holding company umbrella and that would have been fine except they ballooned the balance sheets and it was the holding companies, not even just the bank as Reagan had done, that received bailout funds. Worse, Goldman Sachs, and Morgan Stanley were made banks, which even Lloyd Blankfein declared would ‘never accept deposits.’ So was Merrill Lynch until being bought out by BofA in another questionable move.


So despite the fact that only deposits were insured (raised to $250,000 to prevent a run on the banks), we, the people, accepted liability for even their speculative investments.


The issue is the lack of regulation and laws that allow for the failure of a bank and its effective and efficient liquidation. This issue has always existed whether the bank was failing because of bad credit decisions (commercial real estate, foreign governments) or bad asset/liability mixes (BofA). Trading and speculative trading has become the whipping boy for this problem. It is a result of the problem not the cause of the problem.


Derivatives, with a profit motive changed the entire matrix. Due to the real estate boom and

We were told that the government could not take over a bank but that is not true. Let them take over the bank and challenge the companies to take them to court! They could sue, but to what avail? Nothing from nothing equals nothing except receipts for lawyers fees. TB believes Volcker would have attempted it and simply said, sue me!


One of the more egregious acts was to try to ‘give’ ailing Wachovia to Citi on the false premise that two bad banks would make a stronger bigger bank. Thankfully, Wells Fargo interceded and not only widened their diversification (that word again), but Wells’ strength.


Leverage was obscene in an industry with a low profit margin (1% – $1 per $100 of assets used to be the standard for a bank…yesterday TB showed that return: USB $1.46; WFC $1.17; JPM $0.84;  – when TB was in banking they were always the most profitable bank in both dollars and per employee; C $0.56; BofA $0)…losses of just 5% would be enough to make even JPMorgan insolvent (over 20 times leverage at the peak)! Also note that the prices of bank stocks peaked in 2007 – about a year before the collapse. Something should have been apparent…even to Greenspan who never saw a bubble he didn’t like.


Worse, mortgage companies were dogged to produce more loans for product while trying to get higher rates. This was accomplished by lowering credit quality (and sometimes altering financials to raise the credit score, or steering minorities who qualified for prime to be offered only sub-prime with explosive reset triggers…or like Golden West – which was bought by Wachovia at a ridiculous price, thus increasing the likelihood of default), and increased reliance on Alt A or liar loans which were grossly overstated by the applicants on their own.


None of this would have been a problem if the law had not been changed allowing banks to make loans of more than 80% of the value. TB recalls an ad stating ‘we want you to own a home so we will give you 105% of the purchase price.’ Who said that? Ameriquest? No, Wells Fargo Mortgage! TB asked a banker friend how this could be? The answer: 80% first, 20% second, 5% unsecured! Talk about no skin in the game! But Wells was smart. They sold the loans immediately…but also dumb because they still held the home equity portion (thinking it would be refied taking it off their books while the earned the higher rates), and the unsecured portion. Thus when it blew up they suffered some big, but not fatal losses. Wells also acted as a conduit for other mortgage companies (no longer) and were the largest mortgage lender!). Note that these mortgages had only 1-3 months recourse!


Even then, this wouldn’t have caused the crisis IF the rating agencies did their job. Instead the evaluated sub-prime based on 5% historical default rates that went back to 1950…but subprime was only about 5% of the total market then. Also, brokers submitted the mortgages to be included in pools and rating agencies threw out the bad ones. Ok, BUT they could be resubmitted up to THREE times and since the pools were examined randomly, the chances of finding the bad ones was even further diminished. Unbelievable!


Let’s not let the federal government, especially Congress (and that means BOTH parties as while the Dems openly favored FNMA/FHLMC, the GOP accepted their contributions and voted for them while openly opposing them…sticks and stones!). Because they pushed the Community Reinvestment Act which was originally designed to eliminate ‘red-lining’ of minority housing areas, but both parties saw how increased home ownership helped the economy, and pandered to it.


As a former acolyte explained it: if the banks want to do a merger, add branches, etc. they had to submit their CRA numbers and if they had not done enough it would be vetoed.


Or Wall Street: in Inside Job, a former Goldman manager, said that some of the mortgages had already missed the first payment when the pools were sold to unsuspecting investors.


This brings us to the final point and conclusion where TB’ friend and he are in total agreement: once a broker went from a partnership went from partnership status to public company, the principals (now officers) had no skin in the game. The partners got their money out, no longer had just paper wealth but real money, and management was incented to take as much risk as possible for greater rewards…all with other people’s money (OPM).


It is worse with banks because they always operated with OPM, but prior to the 1990’s their wasn’t enough incentive to take excessive risk – not when the CEO made just 10x that of the average employee. But then compensation exploded and greed took over. Worse, it was blind greed because everyone was doing it so it must be OK. As Citi’s CEO, Chuck Prince said, ”when the music is playing you have to get up and dance.”  That should be engraved on his tombstone! (Some Citi execs placed the blame squarely on Robert Rubin’s shoulders as he told them they didn’t take enough risk and should be more like Goldman! He then had the audacity to say he didn’t know they were in such risky investments).


So there you have it: if managers took more risk (even commissions were paid, especially at AIG, for current sales, risk remained on the books for years…so who cares? Take the money and run!), and management didn’t care, and the regulators turned their heads, it all worked well for the individuals, the companies (not necessarily the shareholders), and the economy (read elected officials).


So while the Volcker Rule is flawed, the banks will not allow any significant reform. It is the best we will get…IF we get it! Let the banks do proprietary trading but in ‘limited risk’ investments like government and municipal securities.


As anyone who has worked on Wall Street will tell you: proprietary trading can generate years of revenue, but one bad year can wipe it all out. Put another way, as someone remarked, if you totaled up all the earnings in the history of banking it would break even.

Is that what you want to invest in? Is that what the taxpayers want to protect?


No wonder bank debt is selling at such high spreads (cheaper) to corporate bonds.


Dick Clark died yesterday at the age of 82. TB met him and his wife Kari at the Beverly Hills Hotel at a Christmas Party for L.F. Rothschild where TB was an institutional bond salesman. The reason he was there was that we had just done an IPO for  Dick Clark Productions. The IPO raised about $8 million, about $8 a share TB thinks. He was fun and charming. The bad news was that the company was a production company for him but the royalties from much of it went directly to ole Dick.


The stock did nothing but enrich Dick. How did it perform? It was taken private in 2002 for $140 million or $14.50 a share…Clark however accepted $12.50 a share for his 70% ownership in the company, most of which he sold to the buyer Mosaic Media Group but still receiving his royalties. Add him to the list of smart TV/Movie personalities who made themselves very wealthy: Bob Hope, Lawrence Welk, Tom Jones (who at one time was the wealthiest man in England). Brains are sexy, don’t you think?


Have a great day! More on political and corporate corruption tomorrow.




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