Thursday, April 30, 2009


CNBC nitwits are talking about DOW 10K today.


Credit Spreads - Time To Fade This Market

As I walk in this morning, I notice that SP E-Mini Futures are up 17 points, implying a 2% plus advance this morning. This is on the backs of European markets trying to get back into the black after a horrid start to 2009. This is after yesterdays non event Fed Meeting, and Obama's speech last night. There really was nothing special other then the usual quite brilliant and eloquent tone in our Presidents voice. Even though I have been harsh on Obama's tactics in handle the banking fiasco, I still think he will eventually do the inevitable but politically painful receiverships of at least 3 major banks.

As I have stated in the past, watching the credit markets and most importantly credit spreads in general is usually the best way to find a trend. I understand that these markets including the CDS Market have inherent drawbacks, like transparency and regulation, but the liquidity in these markets and the size of trades being executed dwarf whats going on in Equity Land. Also of importance, the credit markets act less on emotion and are more forward thinking then equities. Equities tend to be more reactionary.

From reading and observing during periods of insanity, I have come to an interesting observation on the credit to equity duality, which has helped me put the recent market rally in more of a educated and cohesive perspective.

The recent rally in the S&P 500 may appear to be topping out as it looks overdone (The market generally moves 6-9 months ahead of an assumed pick up in the economy) from a fundamental and technical viewpoint. But from a credit and options market perspective, looking back a few months, it was way overdue.

Why You May Ask? Was there a silver bullet? Yes and No.

From looking at various credit/options indicator indices and ratios, I was able to surmise after great anxiety the following.


When I say SPX or the "Market"- I mean S&P 500
When I say Credit Markets - I am speaking of the SPX 5 year CDS Spread.
When I say Options Markets - I am speaking of Equity Implied Volatility.

Options/Credit Markets showed increased anxiety levels despite the fact that the SPX was moving sideways for the better part of 2007. I understand that the SPX hit new highs on 3 occasions in 2007, but credit markets were steadily getting more nervous even after the market hit new highs in mid October 2007. Credit Spreads widened vastly towards the end of 2007. Beginning in 2008, as we all know, the global markets started a drastic down turn, which also precipitated more extreme widening in Credit Spreads, even after the Fed lowered rates in late January 2008 to alleviate strains in the credit system. Even as the market regained some footing over the next few month, credit spreads continued to widen and finally exploded to the upside after the Bear Stearn's fiasco. Again the markets recovered some 15% after Bear was sold to JP Morgan, but what we saw was more severe deterioration in the credit markets as the CDS Market started to peculate. What we saw over the summer and into the fall after Labor Day were the double edged sword of spiraling credit spreads and an expansion of Option Prices to extremely dangerous levels. After Labor Day 2008, the dye was cast for much lower equity prices across the globe. So the assumption to be made was to watch what happens to credit spreads and options volatility in regards to equity prices. Many many equity investors were totally caught off guard, that is why Options Volatility gauged by the CBOE VIX nearly quadrupled, as it seemed the entire planet was going to cash at the same time. During this entire global de-leveraging, we saw serious degradation in CDS Credit Spreads and Options Implied Volatility. So what was happening was that equity markets were finally catching up and listening to the credit markets.

Towards the end of 2008 and into March 2009, credit & options markets eased, while equity sold off more sharply, and made fresh new lows. On March 9Th, the SPX closed 10% below its November 20Th lows, but equity options volatility had relaxed some 25%, and more importantly Credit CDS Spreads were relatively flat with November levels.


Flat credit spreads and lower equity options prices are evidence of reduced hedging demand in both markets, signaling increased comfort with current levels. In hindsight, this was a clear and extreme divergence and an opportunity to become more constructive on equities in the very short short-term.

As I have written in earlier posts, I believed that the Nasdaq would rally huge once the market stopped going down, I will take credit for that one, as the COMP is up roughly 10% this year, as the SPX is still down. But I will have to take a Mia Culpa on the banks, I didn't foresee the huge run up in the financials, that is my bad (Even though I still they are basically insolvent).

What I am seeing today:

As the equity markets “caught up” to credit & options markets, risk in those markets did not continue to ease as meaningfully. No longer supported by credit and options market easing, the equity market seems set up to stall as fundamentals and financials sector stresses take center stage once again. In stark contrast, as the markets have exploded to the upside, bond/credit spreads remained wide, even wider than CDS would indicate, and longer-dated volatility, while down somewhat, continued to price in Depression Era levels of volatility. The VIX, which is the 30 day volatility gauge has screamed back down to levels we saw in August 2008. The equity markets have caught up with Credit and Option markets, and recently have surpassed them. For example The Financials (PHLX BANKING) as a group have outperformed the SPX by a factor of 3x, yet CDS Spreads have improved only so slightly. When looking at Options Implied Volatility, we have started to see investors pricing in more risk going forward.

Net...Net...The financials as a group were extremely heavily shorted and oversold, and a serious snap back rally ensued, but they are seriously overvalued with respect to their CDS moves. As the past two month's non stop rally has been predicated upon the Financials upside, the next leg down will also be driven by that sector, as equity metrics catch up with credit and options implied risk.

The banks have rallied in the face of investors concerns over their balance sheet risk, The SP Financials have rallied 3x the broader market, while the Financials 5 year CDS spreads have continued to widen way above October levels.

YTD, Financials CDS spreads have actually widened 42% and options implied volatility is up 4%, as the market has rallied. The elevated risk priced into credit and options markets may foreshadow some major weakness in the financials, which will hit the broader markets in general. The credit market has become increasingly nervous about the potential for losses at BOFA, C, WFC, and JP, even after these banks have taken TARP money. Most of the people on the credit side of the market I think are becoming less favorable with regards to the government and their actions.

Its not surprising to see the markets rally even today, they are moving in the face of all this data that is so negative with regards to the banks and general economy. But what I am seeing is a major dislocation of credit fundamentals to equity fundamentals. At some point, the credit fundamentals will catch up stocks. Until then, maybe today, tomorrow, next week, the technicals are in charge, but beware.

Wednesday, April 29, 2009

Halcyon Days

We have seen over the last few weeks stronger earnings from the financials. On the surface it looks like the banks are finally turning the corner. But in reality, the opposite is happening. The bank earnings like I have written about in the past were all accounting driven, not operationally driven. The Treasury along with the Fed have been on a major liquidity hunt the last 6 months or so. These two government parties just completed one of the biggest purchase programs on the secondary MBS market. They basically bought toxic mortgage paper that nobody wanted or even priced, and payed top dollar to the banks, using Tax Payer money to do it. The banks thus booked fake profits on these securities and then marked up all of the rest of the toxic crap on their books. Problem is, absence of another $500 Billion Government spending spree, where is the real market for these MBS? That is the problem. When the banks report 2ND results in July, are they still going to have overvalued and miss priced securities on their books? The banks have re priced all of their MBS positions to such a level that one would think that no such global crisis ever existed.

Why in the world does the Treasury, Federal Reserve, and the Obama Administration continually put a band aid on a situation that requires a drastic surgical procedure?
Why are they still allowing the banks to hold all of the cards? Why isn't the same surgical efficiency that was shown to GM and Chrysler not being inflicted on the Banks?

We all know that the recent stealth gains in the financials have most if not all analysts quite overly optimistic that these bank CEO's can actually run a business, but what is lost on me is the cheerleading from the best analysts that are covering the financials. We are right back to the halcyon days of the Tech Bubble.

Of the many difficult issues that have risen from this crisis, its easy to see how it corrupts even the most well intentioned parties. I would expect this type of behavior from Wall Street and Tim Geithner, but I expected better from Barack Obama.

At the end of the day, The Stress Tests were just window dressing. An exercise to let the masses know that government is doing something, not just wasting their money. So after the results came in, we found out that the entire exercise was much larger then even the Madoff Ponzy Scheme. We have found out even before the stress tests that Mark To Market accounting was the central theme to what ailed the banks. All that needed to be done was to allow the banks to put any phony price that they wanted to and let the government use tax payer money to buy them at those absurd high prices. The entire idea of TARP, TALF, and TAF that Paulson originally thought of is in actuality the biggest PONZY SCHEME of all time eclipsing Bernie Madoff by Trillions!

It is quite obvious to me that the banks cure for inadequate capital was not more capital, but an accounting magic trick. First, mark up the securities, if that doesn't work, convert all preferred stock to common stock, automatically increasing financial ratios. All this is in the most basic form is Financial Engineering or Financial Alchemy.

Thus the Stress Test was a waste of time and inadequate to even identify the underlying issue.

Most US Financials have a solvency issue like I have been saying for months. What they need is exponentially more dilutive capital. This is the only way for the banks and the broader economy to right itself. What the government and regulators are offering them is more accounting shenanigans, the same shenanigans that got the banks and the planet in this horrible mess to begin with.

This just gets back to my original message of bank nationalization and or receivership was and is the only correct ethical moral solution to this issue. Instead of cleaning the system up, we get more of the nonsense that got us in this quandary.

The whole entire system has been corrupted to the core for decades, please include the government, as they are no longer considered honest and straight forward with respect to how they have gone about handling this crisis.

Tuesday, April 28, 2009

Lower Prices are Inevitable.

"Recovering Economy".."Healthy Financials".."Government Stimulus".."Housing Stabilization"

..These are the words currently being used by everyone in the main stream media.

"Unavoidable".."Inevitable".."Greatly Underestimated Risk".."Overly Optimistic Assumptions"...'Next Down Cycle Of Credit Destruction".

..These are words to describe what I see happening over the coming months.

I just don't see the logic in thinking and assuming that after $20 Trillion in Global Wealth that has been lost, that suddenly after just 10 months worth of pain - we are back to business as usual. It cant be all that easy? Can it?

We are now past the 100 day mark of Obama's Presidency, and all I have been hearing is what a great job he has been doing. The media's love affair with Barack Obama (I Voted For Him BTW), is truly mind boggling. Sure, he has been efficient, thoughtful, and is a brilliant thinker, but lets get real, $3 Trillion in stimulus has not nearly stabilized the banking system, and the economy is not showing any signs of getting out of its funk. We have millions in job losses, housing prices are set to hit another round of declines after the banks begin to foreclose once again, credit is still deteriorating, and the banks are still insolvent, regardless of what the Stress Tests say. Any talk to the contrary is pure fiction and not based with respect to reality.

The S&P 500 is up over 30% since the March lows, but down 46% from its highs. This market has been dominated by the short/sell side community for the last 16 months or so. They forced the market down to levels not seen in decades, then had to cover their shorts in the recent rally. There has been not a single statistic that leads me to believe that Institutions, Pension Funds, and large investors are back in this market. Just look at the recent cash and money market levels, which have barely moved.

The recent gains in this market is based off of the faulty and erroneous earnings results stemming from the one time accounting gains that the banks were able to use to inflate profits. There are no more rabbits for Wells Fargo, BOFA, and JP to pull from their hats. We will see serious credit quality issues in the coming months.

All is not that bad....

What is nice to see is that the NASDAQ (As Previously Predicted) has shown some serious leadership as earnings reports from the likes of Intel, Apple, Amazon, and RIM have that index vastly out performing the broader markets. This will continue as investors focus on healthy balance sheets and predictable, stable, and real earnings from tech land. It also helps that technology companies like IBM are actually buying back shares in this market.

Thursday, April 23, 2009

Not Enough Risk At The Moose?

Morgan Stanley like I predicted posted a much worse loss then expected. The primary reason, like I predicted were bigger losses /writedowns in their Commercial Real Estate portfolio. Not to say I got this one right, you would have to be living in a cave the last 6-9 months not to realize that the Moose was treading badly in CRE. Well, let me take that back, many Wall Street analysts had them making money on lower loss assumptions in Real Estate. Don't know what Real Estate market they were analyzing, certainly not the one on this planet.

But what is somewhat troubling is the Moose's aversion to risk, from reading the earnings report, they really pulled back on many risk trading strategies, which severely hurt them this past quarter. Goldman, JP, BOFA (Ex-Merrill), even the morons at Citigroup had stellar trading results this past 3 months. The Jan-Feb-March period was shangra-la for fixed income, equities, and commodities prop trading, but Morgan Stanley couldn't participate as they sat out on the good times. What does this say about the state of affairs at the Moose? Were they the only ones to realize whats actually happening? Were they the only ones to cut down on risk? Moose's leverage ratio is down to 11-1 from 13-1 at the end of 2008. Goldman on the other hand is back up to 20-1 leverage. The drop in leverage is ultimately good for Morgan Stanley and the broader markets, but leverage ratios in general have started to rise once again, meaning risk appetites are again increasing. This is a development that must be monitored.

This is not surprising, as the financials are borrowing at zero interest rate levels and lending/investing much higher, as well as the nearly hundreds in billions they have raised via the governments TLGP program at low rates which they are using not to lend but to finance their trading positions.


Is Morgan Stanley's lack of risk taking something that should be monitored? Is there something that the company is not telling the public about their debt exposure? Risk taking is as natural to the Moose, then say sex is to rabbits. If the Moose is not going to take risks, why should investors afford them a higher P/E Multiple relative to Goldman? Goldman currently trades at 12x 2009 earnings, while Morgan trades at 15X. The trade that investors are putting in is to go long GS and short MS, to take advantage of this PE abnormality. I personally think both companies should trade at around 7-8x 2009 earnings, until the broader credit markets/economies improve.

I can understand CEO John Mack is trying to remake the company into a more diversified company, the type that doesn't take such large risks that resulted in huge losses in 2007-2008, but the unexpected losses they had this quarter is a direct result of this type of strategy. Does this mean that Morgan wont have much bigger losses the rest of the year when markets eventually turn over and go back down? Are they already taking into account the next down leg of the credit cycle? Morgan's defensive strategy still could prove to be the right move if markets remain shaky. I commend the Moose (backhandedly) for taking such a stance, it actually looks like they learned something in this entire credit fiasco. I applaud the decrease in leverage to 11-1, when the markets do correct again severely, maybe the Moose will only take $5 Billion instead of the $10 Billion they took the last time when the markets "froze up".

Too many people have become too positive on the financials. The market has rallied nearly 30% on a roughly 70% move in the PHLX Banking Index. This market needs the financials to rally, and rally further, but these stocks are trading on air, and are running out of gas. The reasons I am still very negative on them are as follows:

-Buying the banks is like buying the economy. Its a leveraged bet on things getting better from here on out. I just don't see it as the market is running ahead of a general economic upswing. The markets have all of the face cards here.

-Does the general public have any clue how the banks are structured? The public still doesn't understand what the banks own on their books as well as off their books. The transparency is way to murky.

-Stress tests are out tomorrow, most believe that the regional banks like Suntrust, Regions, Zions, Fifth Third, and others need much more capital.

-The earnings have generally sucked, as I have written, the earnings are all accounting driven.

-The amount of wealth destroyed does not equal the amount that has been put back into the system, meaning the system needs an additional $5 Trillion of stimulus at this rate.

-More and more regulation of the financial system is on the way, the banks have been raping customers for years, now Congress is on the war path with credit card reforms.

-Banks are in no position to pay back TARP, no matter what they say.

-Retail Mortgage exposure is the tip of the iceberg, they figured out a way to sidestep CDS, and CDO RMBS exposure, but what about CMBS? HELOC? Auto Loans? Credit Cards?

-The market is too obsessed with the financials, these banks have become the high flying Tech/Internet stocks of the late 90's. Those stocks cratered and never came back, but the markets did. Why?...because the market moved on to other sectors.

-The government has not properly punished the banks for their absurd and ridiculous behavior, sure they are not the only ones to blame for the current crisis, but they are the only ones who to get bail outs... have they not?

-The underlying problems of the financial system have yet to be even investigated. The system is corrupt and rotten, letting the banks earn there way out with tax payer money sets a dangerous precedent for the future.

Wednesday, April 22, 2009

CRE - Get Ready For The Next Down Leg

CRE - Commercial Real Estate is the most dangerous financial entity that will spark the next severe downdraft in the global markets.

From reading various earnings reports from JP, BOFA, C, and others, the alarm bells have already started, but the equity markets with Tim Geithner leading the cheers keep on hitting the snooze bottom. Give the banks some credit, they are very worried about severe blow back from commercial real estate, and have made it clear to investors that is the next major reason for concern. The partial reason for some gains recently is that the government is working on integrating CRE losses within TARP/TALF.

With General Growth Properties, the nations 2ND largest mall operator filling for bankruptcy protection last week, this is just a small portent of whats coming up for debt holders. Although GGP is still cash flow/EPS positive, it succumbed to the mounting debt that it could not refinance in 2009. All around the country default rates for small and medium sized businesses are under severe pressure.

The Federal Reserves most recent "beige book" survey of regional economic conditions, released last week, found that commercial real-estate conditions "continued to deteriorate over the past six weeks." Demand for space fell, the supply of sublease space rose and property values moved lower as reality "set in," the survey found. The slump in the commercial real-estate sector could be a drag on the economic recovery as well as recent market gains.

About $248 billion in commercial real-estate debt comes due this year, In 2010 and 2011, a total of $566 billion matures. Most cities have seen speculative office development, many are suffering from an oversupply of new condos and retail space. Other places are hurting as surplus office space is dumped by companies and from declining values of properties purchased when times were good. The current economic climate is bad, but the damage in commercial real estate has not completely been focused on, and who do you think is standing there holding the bag?

The delinquency rate on about $700 billion in securitized loans backed by office buildings, hotels, stores and other investment property has more than doubled since September to 1.8% this month, while that's low compared with the home mortgage delinquency rate, it's just short of the highest rate during the last downturn early this decade. My friend who is a real estate lawyer says... "it now looks as if the current commercial real-estate slump will rival or even exceed the one in the early 1990s, when bad commercial-property debt played a big role in dragging the economy into a recession. Then, close to 1,000 U.S. banks and savings institutions failed. Lenders took about $48.5 billion in charges on commercial real-estate debt between 1990 and 1995, representing 7.9% of such debt outstanding. Since late 2007, a total of 47 banks and savings institutions have failed, of which a dozen or so had unusually high commercial-mortgage exposure. The U.S. banking sector could suffer as much as $250 billion in commercial real-estate losses in this current downturn, as well as an additional 700-1000 banks could fail as a direct result of their exposure to CRE.

Commercial real estate debt is potentially more dangerous to the financial system than debt classes such as credit cards and student loans because of its size. Some estimate that commercial real estate in the U.S. is worth $6.5 trillion and financed by about $3.1 trillion in debt. Also, the commercial real-estate debt market is nearly three times as big now as in the early 1990s, potential losses in dollar terms loom larger.

Moody's and Fitch have already started to downgrade many CMBS backed securities underscoring the need for banks to start thinking about Real Estate Reserve exposure. The banks today are more leveraged to CRE then ever before via CMBS. The big danger is a repeat of what happened on the residential side, a complete choking up, foreclosure disasters and increased stress on the banking system.

Coming back to General Growth Properties, bankruptcy was the only avenue because the company just couldn't come to terms with restructuring or modifying their debt. Of $154.5 billion of securitized commercial mortgages coming due between now and 2012, about two-thirds likely won't qualify for refinancing. Most analysts estimates assumes declines in commercial-property values of 35% to 45% from the peak in 2007. That would exceed the price drops in the downturn of the early 1990s. The default rates on the $700 billion of commercial-mortgage-backed securities could hit at least 30%, and loss rates, which figure in the amounts recovered by lenders, could reach more than 10%, the peak seen in the early 1990s. Besides securities backed by commercial real-estate loans, about $524 billion of whole commercial mortgages held by U.S. banks and thrifts are expected to come due between this year and 2012. Nearly 50% of that wouldn't qualify for refinancing in a today's tight credit environment, as they exceed 90% of the property's value.

So what does this mean to the majority of the banks?

In contrast to home mortgages, the majority of which were made by only 10 or so giant institutions, hundreds of small and regional banks loaded up on commercial real estate. As of last year, more than 2,900 banks and savings institutions had more than 300% of their risk-based capital in commercial real-estate loans, including both commercial mortgages and construction loans.

All of this, plus a massive 30% move off of the lows tells me that the recent rally phase is over. The market when it was trading at 6500, was fore shadowing and pricing in a depression, currently the markets around the 8000 level is telling us that we are in a bad recession. But if CRE comes undone, we are headed towards the lows.

For years the entire market was obsessed with Alpha Risk (Performance), so they leveraged up the Beta (Risk). That entire trade had to be unwound and we are still in the 4Th or 5Th inning of that great unwinding. Perception always trumps reality, and the perception at the moment is that we are out of the woods. The current run up has exceeded the typical bear market rally of about 20%, but definite disappointment awaits. This is not the real thing, when $15 Trillion in global wealth has been destroyed, it takes more then 10 months to get back in gear.

The key reasons I feel this way is real simple:

-Recessions such as the current one we are experiencing, which was brought upon us by the financials typically take longer to resolve. The massive deleveraging of the 30 year credit cycle is not finished, and is about to get another round of losses.

-Government debt levels are huge, and will get exponentially bigger as the crisis heads on. Is this type of fiscal/monetary stimulus sustainable? What is the by product of such stimulus? Hyper INFLATION?

-After CRE losses, we got HELOC, auto, and credit card losses to suffer through.

-Corporate profits could fall by some 40% this year.

Bottom line, when you have a banking crisis combined with a cyclical downturn, you cant believe you can come out of it this quickly, no matter how much the government does.

Benedict Geithner Speaks.

The entire financial/market rally yesterday was on the backs of Tim Geithners speech to Congress about the state of the economy/banks. The PHLX Banking Index went from being down 5% to up over 7% by the end of the day. Geithner basically reiterated what I said he would last week with regards to Stress Test Results, that everything is all good, and that the banks don't need any additional capital. Theoretically the banks don't need any money, because collectively they all think a turn in the economy is imminent and that employers cant wait to start adding jobs by the busloads as soon as the dust settles. This is why banks like Wells Fargo don't want to take on additional reserves for future credit losses, why take reserves when we know the economy is going to get better?

Geithner is hinting that most banks will pass stress tests because their capital ratios have been getting better since the treasury pumped in only $3 Trillion. Lets back track here for a moment, even after the treasury loaded the system with stimulus, the banks were still crap, it was only after they started to cut dividends as well as mark up bad positions on their balance sheets did the ratios start to get better. Remember, the entire fiasco could have been prevented if the banks were just allowed to participate in accounting fraud via mark to market pricing. Also, the banks are going to have to reinstate dividends some time in the future. This is all taking into account if the losses just magically stop here today. What we have heard from JP Morgan and Bank Of America about deteriorating credit fundamentals cant be pushed aside, has the Treasury Sec even read the earnings reports so far from Citigroup, BOFA, Zions, JP, MS, State Street, and BONY? Or is he just reading the state of affairs by looking at Goldman's and Wells Fargo's earnings shenanigans? I am thinking the latter of course. No well read or self suspecting rational person who was listening to Zion's, BOFA, JP, BONY, C, or even Moose's Earnings call this morning can come away with stating that "everything is all good". The entire Obama Administration is in total damage control containment mode. Minimize the bad news while talking up anything that is positive. Again, I see no change from the Bush Days, actually its worse.

From reading the WSJ as well as a few Dow Jones stories, I get the idea that somehow Geithner has taken a "tough" stance with the banks. Don't believe it for a second, Geithner doesn't work for the taxpayer or even Obama, he works for the likes of Blankfein, Dimon, and Ken Lewis. His basic obligation should be towards public service, but its total submission to the banks is what his true obligations are. The banks have been on a "Jihad" ever since Obama got elected. No ax to grind, look at the facts. They wasted every ones time with these ridiculous Stress Tests, that were never going to be properly audited anyway. The banks knew the primary problem they had was the pricing of toxic securities on their balance sheets and that relaxation (fraud) of mark to market was the way out of it, but if the government is going to hand out trillions anyway, why not take it to finance their trading positions and mortgage origination's?

The banks want to pay back TARP, because guess what?, they never really needed it anyway! The only thing it made the banks was more diluted. The banks actually got a much sweeter deal with TLGP (Temporary Liquidity Guarantee Program) This is a FDIC program that basically guarantess any bonds/debt securities that are issued by the banks. The debt that is issued via this program is loss cost, so the banks collectively have saved $600 Million issuing via TLGP then on their own. Also TLGP has less stringent rules with regards to executive compensation. This program was originally intended to help banks re build balance sheets and facilitate lending, but currently Bank Of America and Goldman Sachs are using it to cheaply finance their trading positions. Actually Goldman does little lending, as they boasted on their conference call that they have no exposure to consumers via loans.

Goldman and BOFA want to have it both ways. They want the explicit and implicit financial benefits that come from Uncle Sam, including the widespread perception that it is "too big to fail," and it also wants to be relatively unfettered in its ability to pay people and make investments. Even after raising $5 billion of equity capital last week in a common share offering, Goldman's tangible leverage is still 20-to-1. Goldman would love to repay TARP and get back to doing business more or less as usual, paying its employees whatever it wants to pay them. Back in its record year of 2007.

Geithner has been told by the financials that they want to go back to business as usual. What else can we expect going forward?

Tuesday, April 21, 2009

Fatal Flaws and the Credit Cycle.

I find it funny and interesting that the original intent of all of the bailout money was to unlock a frozen credit system so that banks can go back to lending. But what I am increasingly finding out is if banks don't want to that necessarily a bad thing? It shouldn't be, as the economy sinks deeper into a recession, wouldn't it be beneficial for banks to become more stringent in their loan practices? Who is the government kidding? Why is the government so obsessed with increased lending activity in the banking sector? They must be aware that unemployment and falling home prices have a direct correlation with a persons ability to pay ones debts? Don't they? You would think, but then again its just one more way for the powers that be to look for answers other then the obvious to fix a corrupt system. They can not explicitly come out and say stop lending, study your loan practices, and fix your loan books, because the political, public, and economic fallout would be huge, so they make a thin mandate to the banks.

The Paulson treasury knew that the credit cycle was getting very gray in the tooth, but the mammoth trading positions that all of the financials had, needed to be financed and turned over on a daily basis and no interbank lending was taking place. Libor rates were sky rocketing and banks couldn't lend with each other to pay every day expenses. This is what eventually doomed Bear Stearns. But then again, they couldn't come out and hand over hundreds of billions of taxpayer money to make sure Lehman or Merrill can make payroll, so they invent this idea of unlocking the credit system so that everyday American Citizens can buy that big screen TV, car, and or house. Forget the fact that the consumer is already tapped out, the banks just need to lend.

So when TARP money was handed out by the government, the banks couldn't lend because... guess what...its bad business! The reason the banks are in this mess, was predatory and out of control lending with no risk assessment, so the obvious fix is to lend more? Even the banks are not that stupid. So even after $3 Trillion has been handed out, there is still not one single change in any consumer/commercial metric with regards to lending. Congress is up in arms because the banks are not lending, the banks say they are lending...Yada Yada Yada.

The banks are not lending because they cant quantify the bad loans they already have on their books, let alone any new loans they wish to make. It doesn't matter if they lend to good credit borrowers, because unemployment trends are getting worse across the board.
The banks should stop the charade and just come out and say we are not lending, because we refuse to go about business as usual.

In yesterdays BOFA earnings release, we heard the following from CEO Ken Lewis.

- "Credit is bad and we believe credit is going to get worse before it will eventually stabilize and improve."
-"Even our internal economists are a little at odds as to the timing with some seeing recovery earlier (than year-end)."
-"We believe unemployment levels won't peak until next year at somewhere in the high single-digits."

But...he goes on to add, we are still lending and doing whats needed to get the economy back to where it should be.

Something doesn't jive here. So the CEO is bearish on the economy yet bullish on loan growth? He cant be that short sighted.

No bank CEO can reconcile more lending with a deteriorating economy, especially one in which economic conditions are the worst than they've been in generations. But that's exactly the claim Ken Lewis is making.

Lewis described a deep recession that's going to be here for months. Still, BOFA touts that it's "helping" homeowners and small businesses with new loans. It claims to have added 45,000 customers and provided them credit.

The reality, however, is less impressive: BOFA loaned $183 billion during the quarter, up just 1.6% from the last quarter of 2008, when lending took a big dive industry-wide.

All of the financials are in the same like you are lending, but hoard the money. Again...I agree that banks should stop lending until unemployment and the economy some what improves, just stop the double talk.

Every bank that has taken TARP money has curtailed lending, you would have to be stupid not to.

One of the main intentions behind TARP was for it to be a stimulus program made through the banks. After plugging holes on each bank's balance sheet, the TARP cash was supposed to flow into new mortgages, auto loans, credit card lines and corporate lending. Six months later, it's fair to say TARP has helped prop up some banks, but it hasn't flowed into the consumer credit markets the way the framers intended.

Now, critics have argued that the banks should be loaning this money to help stimulate the economy. Companies need credit to expand and hire, they say, and consumers need credit to buy products and help feed the economy. In almost any other economic time, this would be true, but not in a time where an over extension of credit created the recession we are fighting.

Credit cycles by definition are periods where banks overextend credit and then pull back to correct the over extension. If the government forces banks to lend to at-risk borrowers, we're going to aggravate an already dire credit picture and require more government intervention. Again....the wrong policy message.

Forget about low income, no income, and weak credit borrowers who cant afford any loan or mortgage, how about small businesses? The so called life blood of the economy? It turns out that even small businesses are in trouble as the default rates are climbing there as well.

It doesn't matter what type of loan, lending into an economic downturn is an invitation to trouble, too bad the government doesn't think so

Monday, April 20, 2009

What Ails Obama...Ails The Economy.

People have spoken to me about my Obama piece from last week.

Let me clarify....

Every response by the Obama Administration to counter the global credit crisis to this point has only served to worsen and exacerbate the current situation and has accomplished virtually nothing in rectifying what is first wrong with the banks (INSOLVENCY), and attacking the root cause of this crisis, which is an out of control, over leveraged, and overly complicated rotten to the core financial system. Hence, it is next to impossible to solve a problem and or crisis that has been decades and generations in the making by implementing the same plan, and enabling the same ones who got us in this mess. Why is so hard for everyone to understand this simply statement?

The reasons that Obama/Geithner/Treasury/Government will all fail the country are as follows: Drum Roll please.......

1-Obama originally voted for the first TARP of $700 Billion. So he had to come up with a similar plans once he was elected President. This was the same plan that did absolutely ZERO in fixing the credit system while transferring the wealth not to the people most effected by the crisis, but to the ones that were responsible in creating it. Obama must have known this when he was voting for it, but he signed off on it anyway...Case closed!

2-Not one central bank or government has come out with an intelligent plan to fix the crisis. Its just one hand out after another here in the States, and a race to Zero Rates everywhere else in the world. No single person or entity has thought of a plan to completely overhaul the financial system. The system is again...ROTTEN to the CORE! Who are which entity has the courage to level the financial system? So far Obama has shown no such courage nor does he have the fortitude to address the root problem.

3- There is too much emphasis on the Keynesian Economic Model of spending your way out of the crisis. You just cant keep on doing the same thing...expecting different results. That my friend is the definition of Insanity. Of course, you will have varied results over time, but any fix is 100% illusory, and will only delay the real recovery while destroying more wealth via inflation.

4- Do we even need to go into Obama's Cabinet appointments? Where is the change? Where are Oprah's tears? His appointments are the opposite of what we heard from him. It was just 100% rhetoric. Vote gathering. Tim Geithner pure and simple is a traitor to every man, women and child in this country the way he has handled the crisis so far. After further inspection of Obama's economic inner circle, it looks to be a Wall Street/Investment Banking Dream Team. Paul Volcker is high on Obama's eyes, this is the same person who suspended gold convertibility in 1971, a decision that left the global economies in the position of overvalued global currencies, thus setting the stage for whats happening today.

5- People are expecting to much from Obama. He cant do it all. Every time in history, we have put to much emphasis on one person to lift the masses, it has failed miserably. Maybe they were right about his experience.

6-Obama's anger over AIG bonuses are crocodile tears. He as well as Geithner knew that this type of behavior was going to happen, after all CT Democratic Senator Chris Dodd stuffed the original TARP with this amendment. You telling me, Obama was not acutely aware of these shenanigans? If Obama was truly trying to do something over these bonuses, why talk about it? just do it! The US Government clearly changed security laws when they suspended short selling (ABSURD) last year so that bank stocks can artificially rise, they could have easily hammered AIG, but they chose not to...Pure and Simple!

7- Tremendous Hypocrisy with regards to AIG bonuses and the bonuses given to former Merrill Lynch executives. Lets see...$165Million to AIG...the sky is falling! $3.6 Billion to ML, no big problem. Hey...I think both of these entities should be thrown into the wood chipper, but it is clear to me that Wall Street is favored more than AIG.

8- Remember the original bailout that was run by Paulson? It was merely 3 pages long with no supervision, the one that Obama signed? What has happened since is more of the supervision, no due diligence...and more shenanigans. This is all on Obama.

What ails Barack Obama ails the economy. There is massive paralysis with the ones that are running the country. Everyone knows what the best course of action is, but they cant seem to pull the trigger on it. But there will come a time when there is no more hope and the best course of action may not help anymore.

I have been very harsh on Obama, a man I voted for, but this is the truth as I see it. You cant make up things that are true not only on the surface, but underneath the sheets.

Back To The Dollar Menu for Citigroup.

Citigroup shares have lost some 40% since late last week, as reality has crept back into the markets. Early Friday morning, Citigroup reported first-quarter results. Citigroup shares shot up in pre-market trading and continued to rise when markets opened. The market was elated that Citigroup like Wells, JP, and Goose before them had basically fudged their earnings to show a surprising profit.

went Beatlemania, because Citigroup had been expected to report a net loss of .34 cents a share. Apparently, the reason Citigroup lost 18 cents a share even though it "made" a "profit" of $1.59 billion owed to the albatross around its neck of a 24-cent-a-share charge for revising the conversion price on its preferred stock. So there are "Real Results" and "Illusionary Results" now that banks can report? I have reported to you that Wells, JP, and even GS have fudged their earnings so far this period. Please add Citigroup, and Bank Of America to that list.

OK- Real Results are tedious stuff like money in the bank and fraudulent ATM fees, while Illusionary Results are write downs, credit loss provisions, good will impairments, and bank savior - Mark To Market? That is correct...the market before today only looked at Real Results, but Citigroup and BOFA have alerted to everyone that the banks relatively speaking are crap investments, and need massive amounts of future capital just to cover their losses.

The only reason Citigroup even rallied from a buck to over 4, was the inherent Arbitrage opportunity that existed over the preferred conversion. There was a delay in regulators approving the potential conversion, so the shorts got nervous.

But going back to Citigroup, their earnings were pretty evenly composed of "Real and Illusionary Results". The only reason the accountants are employed at Citigroup is to take Illusionary Earnings and make them Real. Who do you believe anymore? I wouldn't even put it past the government and Geithner to say the following - "All of the banks have passed the Stress Tests based on their reporting". I really wouldn't at this moment as most of America will be glued to another 14 Run Inning at New Yankee Stadium.

The pressure on these banks will not subside any time soon, and it will quickly become clear, probably during the summer, which banks will be able to earn their way out of trouble (NONE) and which ones won't (ALL OF THEM). Things are coming to a head for Citigroup and others, but is the government and the markets prepared?

BOFA And Credit Quality

Bank of America is a pure play financial institution focused on an end to end (Last Mile) financial solution to all most every person in the country. They have created a full serve/scale banking giant with their purchases of distressed assets like Merrill Lynch and Countrywide Financial. It is the one financial institution that is the most leveraged to the general state of the economy. If you are looking for a bank that will do very well in a good economy, BOFA is the one to own. Problem is, we are in a poor economy that might very well get worse before there is any turn higher. Bank of America has all most everything covered from coast to coast, but with employment trends getting weaker and the general state if the economy in doubt, BOFA's existence is at stake.

From reading the headlines about their quarterly earnings this morning, it pretty much sums up my points above. BOFA is all ready in major trouble as the economy continues to suffer, but its irresponsible for the CEO to continue to talk about everything except the massive losses that BOFA has sitting on its balance sheet. These losses can be minimized if the economy gets better, but they exponentially get worse as both credit quality and employment worsens further.

BOFA turned a profit of .44 cents per share beating estimates by a wide margin, but they had some devastating things to say about the state of their credit quality. BOFA still faces extremely difficult issues primarily from deteriorating credit quality driven by weakness in the economy and growing unemployment. Bank of America is considered particularly vulnerable to unemployment, and the condition of its mammoth portfolio of credit-card loans is a bellwether for the rest of the industry. Credit card losses soared again during the quarter. Credit loss provisions more than doubled to $13.40 billion and climbed from the prior quarter's $8.50 billion, while the net charge-off rate rose to 2.85% from 1.25% a year earlier and 2.36% in the fourth quarter. Credit card losses increased to 8.62% from 5.19% and total nonperforming assets jumped to 2.65% from 0.9% in the prior year and 1.96% in the fourth quarter. Non Performing Assets now total over $25 Billion.

Breaking down the $4.25 Billion profit figure goes like this, $2.2Billion was from mark to market financial illusion that falsely boosted profits, $765 Million came from restructuring and cost savings, so 2/3 of their profits are non operating for the quarter. Add in the credit deterioration, and you have a stock that is down 17% today.

Whats worse is their commercial loan loss trends are far worse then retail/consumer loss trends, as small business loan loss ratio was 13.5%. I have spoken about potential Commercial Real Estate losses before, this only fortifies my thesis.

Bank Of America has continually stated that they don't need to raise additional cash, this may ring true if the economy somehow turns, but that decision is not in their hands unfortunately. Its beyond belief that the CEO still talks about repaying TARP in a few months after the breath taking losses that BOFA has incurred.

Like I stated Friday, the banks or way ahead of themselves. This announcement about credit card losses really has spooked the market, as the PHLX Bank Index is getting hammered by the tune of 11% so far today. This is just the beginging of the next down leg of the credit cycle, as Bank of America is kind of a barometer for the entire banking industry. Bank of America's results show increased erosion in credit especially with regard to its commercial real estate and commercial and industrial lending. Funny thing is JP, Wells Fargo, and Citigroup stated the same thing when they announced their earnings,but the financials and the markets rallied anyway. The market is all about perception, and the perception of the credit picture is a lot more negative today.

The downward spiral in the financials today just exemplifies not only the underlying fundamentals in the banks, but the broader economy. Today there's more of a realization that the market got a little ahead of itself last week, and that the risk has not subsided. Many investors over the past few weeks had the false sense that we were going into a quarter thinking that credit conditions were bottoming out, not there by a long shot.

Friday, April 17, 2009

Why Obama's Economic Plan Will Fail.

First of all, I would like to preface these comments by stating that I voted for Barack Obama. I am rooting for him like I root for my Mets, NY Giants, And NJ Devils. I, unlike Rush Limbough is not going to cut off my nose to spite my face.

But as the months go on, even with the roughly 30% rise in the stock markets, the jury is still out on the general health of the economy. Retail Sales reports for the first 2 months of the year were positive, but the March Report was negative. So what does that say about the state of the consumer? Gas prices have eased considerably over the last 8-10 months or so, giving the consumer a "Tax Break", but how long can that last? The crude oil trade has always been about a hedge against the credit meltdown, and a bigger hedge against the falling US Dollar, as crude is denominated in $$. How long can crude stay in the 40-50's? When crude was taken down last year, when the global economy went into a tailspin, what was lost on so many was that the "Terrorism Premium" had been eliminated from the price of crude. This premium likely is headed back as tensions will ignite in Pakistan, Iran, and lets not forget we are still fighting a war in Iraq. Things have been quite, too quite on the terrorism front.

There have been so many reports of a pending turn in the credit markets that I have lost count. Jobless claims figures that came out earlier this week, convinced people that the state of employment is getting better, this is after a year of severe job losses, we are saying that employment is turning after one non conclusive report? Recent earnings from Wells Fargo, JP Morgan, and Citigroup have alerted investors that the worst is behind us in the financial space, totally ignoring, the only reason the earnings have been good because the FASB has allowed the banks to mark up bad securities to what ever price, thus the banks have to take smaller writedowns and lower loss reserves to inflate their bottom line. The market is starved for positive information, it will go to no end to see higher prices, but at what costs? To many people who were completely wrong in predicting the downturn are now stating that the worst is over. Too many analysts who had the entire credit fiasco misjudged are now suddenly back on CNBC/Bloomberg/Fox saying its time to put your toe back in the water.

The doubling of the PHLX Banking Index has some how convinced the street that the banks can finally go back to doing what they do best...Rape the public with fees and sell structured derivative products that no one understands with little or no compliance and regulation. They don't understand that the BKX is still down 72% AFTER THIS RECENT RUN UP! Most financials are off some 80% off their all-time highs, while others like Bear Stearns, Wamu, And most notably Lehman are gone. You are telling me that the entire financial maelstrom only lasted less then 10 months? You are kidding me right? This is even after most people opinions that TARP, TALF, and other Government programs have failed miserably. Why in the world should we believe that the recent run up in the S&P 500, which is still down 40% from its all time high, is anything more then a severe dangerous Bear Market Rally? This market has all of the trappings of a classic Bear Trap.

When markets fall apart for systemic reasons, they do not recover in 10 months, nor do they just recover because there is sailor like spending ($3 Trillion and counting) by the government. The markets are behaving like it should at this moment, which is mass confusion. Short sellers, like they always do overreached to the downside, and they have been cleaned out in certain sectors, and buyers are still nervous about putting cash to work. So this recent rally has definitely been a short covering rally, the type of rallies you generally see in long term bear markets. I am not saying we are headed back to the lows, but this is nothing more then that.

The banks and the markets are trying to suck in the last few people on the sidelines before the death blow will be delivered.

What does this all mean to the state of the economy? Will it just delay the snap back? Will it just prolong the pain? I am not here to give an opinion, but I will say this...The economy wont turn until home foreclosures have stopped, so far the pace of foreclosures have increased this year, with no slowdown in sight. Banks like BOFA, Wells, and JP have ramped up the pace of foreclosures this year, right in the teeth of the Obama housing rescue plan. The moratorium on foreclosures have been lifted at most institutions. Thus the resulting increases in the supply of foreclosed homes could and will depress home prices across the country and put pressure on bank earnings as troubled loans are written off. All of this after most financial institutions have received government funds to try to stem home foreclosures. Home prices will continue to fall, probably anywhere from 15-20% additionally. More then 2.1 million homes will be lost this year, up from 1.6 million in 2008, this is according to Moody's. Since the Obama housing program went into effect, it has only been effective for 10% of borrowers, the rest will lose their homes. What good is it to renegotiate mortgage terms, if you don't have a job to pay for the house?

Employment is also a huge factor, with the impending bankruptcy of GM and Chrysler, this figure is still awful, and getting worse. How about we start to add jobs? This is not happening anytime soon. The last recession, it took 18 months after positive GDP revisions for employers to start hiring.

Barack Obama's presidency will likely be decided by one single issue. His ability to deal with the financial crisis and economic meltdown. I give him credit. He has tried many things, most of them have left the crisis unresolved. My view is that an unresolved crisis or even an illusionary recovery will only make the economic pain that much worse. The loss of Political Capital and Popular Support that would ensue will cripple his administration. The fiscal stimulus that will kill our finances long term will only allow us to fend off a worse case outcome.

Will the Obama Plan do the following:

1- Make the Geithner Bank Bailout Plan successful?
2- Make the economic/fiscal stimulus actually work?
3-Connect the disenfranchised of the country?
4-Enforce Obama's political will and capital?
5-Will the foreclosure plan actually halt foreclosures?

I don't think so...But I am rooting for him

Wednesday, April 15, 2009

What Needs To Happen Now.

UBS is forecasting a much deeper loss of $1.75 Billion and they are cutting almost 11% of its workforce (Probably not the ones responsible for the Billions in losses). The bank said its net loss for the first three months was caused by roughly 3.9 billion Francs in losses on illiquid securities, expenses for credit losses, and lower value of assets on the remaining positions transferred to the Swiss National Bank as part of a government shore-up.

These type of announcements are going to be the norm going forward. We will find out that so-called positive announcements from the likes of GS and WFC are in the minority.

The financials paired back some gains yesterday on the backs of the Goldman earnings announcement. So far today, they look down as well.

The market currently is made up of two various differing opinions on the state of the financials. The reason I am stressing the financials, is that this economy and stock market is going no where with out a valid plan to fix the fundamental problem that is facing the banks....Which is INSOLVENCY.

So far the only response that the Obama Administration has given is just throwing taxpayer money at the dartboard, hoping one of these trillion dollar outlays hits bulls eye. Is this any different then the Bush Administration Model of saying "If lower taxes don't fix the problem, heck...then I am out of ideas"? The Obama/Geithner stance of transferring money from tax payers to the banks has set the most ludicrous and dangerous precedent in the history of our country. There! I said it. At least Bush had a valid excuse (9/11) to go to war with the Muslim world, what will Obama's excuse be when the latest round of subsidies fail? Sorry Barack/ cant blame Bin-Laden, terrorism, and Islam this time. The terrorists didn't invent Credit Default Swaps, if they would have known, they would have, and spared all of those Innocent lives lost on that day. You only have to look at Geithner's inner circle to find who the real culprits are.

If I sound emotional and angry, guess what! I am! Its totally frustrating and makes me angry when everything that the government has done has failed, and failed miserably so far. What I have seen is total outright fraud being committed by the financials with little or no response from the government. Do we have to go into AIG paying Goldman and Society General (Foreign Entity) taxpayer money for no good reason. Wall Street was given tremendous power and influence, and they failed us miserably because at the end of the day, Wall Street and the entire financial system is rotten to the core, and government wants the rotten system to fix itself? My dad was right when he told me "The More you know...The More Angry you will get"

The Obama Administration has no clue where the financial markets are headed, they have no idea other than subsidizing losses to find a solution. If you cant find the iceberg, you cant see disaster coming. If you see the iceberg, and don't get out of the way, because you think people are conscientious, then you are truly stupid. After stupid behavior is subsidized on the backs of everyday citizens, what makes it possible for financials to continue on with the shenanigans? You cant allow the same people who steered us into the iceberg, to now call the shots on how to get more lifeboats onto the ship. The taxpayer is not here to make the investment bankers and executives more wealthy. The bank executives are clueless, and the Obama Administration is in denial over the fact that the entire financial system needs a major structural revamping. At this moment Obama has lost my vote in 2012...regardless of who runs against him.

Everything that has been done has NOT made the markets stable in any fashion. The markets may have bounced recently, but don't be fooled. The financials and broader markets are no less fragile then they were 2-3 weeks or even 6 months ago. The basic principle that is lost to the people in power is that COMPLEXITY and a hatred for RISK CONTROL are what ruined the system, not securitiuzation or leverage. Sure these things had a hand in it, but it was the overall complex nature of structured products that doomed the market. So far the Obama Administration has done nothing to curb the appetite of structured product development. They have just enabled the enablers to continue to create complex derivatives products that very few understand. The more pressing need is to get things back in equilibrium. Currently we are trying to patch together bad banks and good banks, but the whole structure and flow of credit is out of whack. Equity investments are not accommodative to debt investments. Private equity and hedge funds don't have the will to invest after the Madoff event. Nothing is lining up properly, because the basic issues are not being focused on.

So how do we try and fix the system without wasting anymore money? Don't laugh...I am deadly serious. Here we go:

1- Eliminate margin trading except for primary dealers/market makers. Individual investors only get into trouble when they trade on margin. Most people have no clue about margin. The way I look at it is this way. If the experts failed so badly with margin/leverage...what do you think happened to the guy trading in his shorts in his garage?

2-Reduce or outright eliminate the dependence of "Complex Derivatives/Structured Products". Few people understand them, as they are too complex and far too volatile to price/trade. Why do we need 2x/3x Short ETF's? Why the need for CDS? The only reason these products are around is to make investment bankers rich.

3- Don't eliminate leverage and or securitiuzation, but make the assets within them more difficult to package, only the highest rated debt can be eligible to package.

4- Throw VAR (Value At Risk) Model out the window. We all know it doesn't work, if it did, we would not be in this mess. Its incredible that everyone still uses this crap model. After all of the de leveraging that has happened, all of the risk that has curbed, these models still don't seem to get it right. They failed with regards to LTCM in 1998...why would they not fail 10 years later.

5-Totally revamp and marginalize MBA Programs. They suck!

6-Eliminate the Nobel Prize for Economics. This is a total joke. Wall Street got off on these guys, entrusting them with trillions based on their flawed models. Merton Miller, Fisher Black, Markovitz, and Sharpe all should hang themselves, if they are all ready not dead.

7- Minimize the importance and scope of regulators. heard me. That is correct. Most regulators and compliance personal are fundamentally morons and idiots. They are easily convinced, and traders will always find a way to side step them at any given time. The regulators actually encourage people to take on more risk, over there lack of intelligence. Look at this way, the bond ratings agencies were able to rate everything AAA, because they took their Que from the regulators who told them their analysis was correct. VAR Models have been widely followed and implemented because the regulators tested them in normal times, and they worked, look what happened to the bond insures and the people who followed VAR since.

All of the above ideas stated above just simplifies the system. The system is too complex.
Leverage is only good and useful in a non-complex financial system. Leverage has become a bad word in many circles, but the complexity of financial instruments, and the lack of knowledge by the people who created them from flawed models is the real culprit.

Simplicity is the only way to get things back in equilibrium.

Tuesday, April 14, 2009

Monoline Hedging - Disaster Du Jour

Please alert me when you think I am piling on.

With the government basically throwing $3 Trillion at the system in an attempt to try and fix just the mortgage mess, are we now moving unto the next serious down leg of the credit cycle?

Whats next? Commercial Real Estate? Credit Card Losses? HELOC?

As if there was nothing else to talk about.

Another potential disaster that most analysts/investors have not spoken about is the exposure that most Investment Banks have to Monoline Insurance. These type of contracts are called Monoline Hedges, and they have yet to be properly accounted for.

We all know what Credit Default Swaps are(If you don't, please move back to the tarpits). Companies like AIG, Ambac, MBIA, and MGIC that sold insurance on toxic mortgages and complex credit derivatives subsequently blew up, but what about the companies that actually bought the insurance from them? How do you account for that? You buy insurance on bonds that you think are risky, yet the company you buy it from is insolvent?
The banks that bought this type of protection could see the value of their assets in the first half fall by tens of billions of dollars. More Write downs are coming.

Before the current credit crisis hit us full force in the grill, before rising delinquencies, falling home prices, and before the words 'Toxic' and "CDS" actually existed, there was a wonderful business called Bond Insurance that existed. The bond insurance companies sold insurance protecting holders against default. This business was a cash machine, as most of the business was centered around Muni Bond Insurance, but of course, risk management went out the window, when these outfits started to insure more complex derivative instruments like CDS, CDO, CLO, and Subprime Tranches.

But the out right defaults of many tranches of mortgages/derivatives, has prompted fears that the monlines wont be able to pay out on these defaults, basically the premiums that the banks paid for are worthless. As a result, more and more banks will have to writedown the value of their insurance contracts that they have via the Monoline Insurers.

This has the potential to be a bigger problem, as the value of these hedges have considerably dropped while the general CDS Curves have widened, portending more pain ahead.

UBS, Deutsche Bank, Credit Suisse, and Morgan Stanley are the ones with the most exposure here. I would be short the Moose ahead of its earnings report.

Market Thought-

We are going lower.

Earnings tonight from Intel will set the stage for Tech. The Nasdaq which has rallied this year, needs a strong number from INTC. The stock has rallied some 32% off its February lows. This number and their forward guidance needs to be strong to support higher prices. The stock actually looks great technically, so any good news can have this stock climb above resistance, but if they have anything bad to say about PC end user demand, we have problems in tech land.

Thursday looks to be the big day as JP Morgan and Google report their numbers.

Goldman Sachs down a nice 10% today....This stock will go to Par (100) at the minimum.

Morgan Stanley also down 11%, I have stated before that the Moose is in trouble.

I see the financials are down 6% across the board, I see a vicious sell off if JP Morgan doesn't surprise the street with great earnings.

Ben Bernanke on the tape stating that he likes the recent change in Mark to Market regulations....enough said!

The Great Financial Illusion.

Goldman Sachs reports a blow out quarter, but cuts there dividend, and just like I stated in yesterdays post, they filed for a $5 Billion secondary offering. So the mainstream clueless press/media (CNBC/WSJ) reports that Goldman cant do no wrong, great quarter, premier institution. Correct?

Absolutely Wrong!

Lets take a closer look into the Goldman Quarter. Hold on...I have to get my glasses.

Goldman Sachs reported 3 month (JAN-FEB-MARCH) earnings of $3.39, which handily beat consensus of $1.60. The headline number made the stock jump about 4 bucks and the futures the same amount when it was announced after the close.

Something immediately smelled fishy to me? How can Goldman pull off a quarter like this? How can they be on the right side of every trade this quarter? How come they go to making all of this money, after the disastrous quarter they had last time? How are they doing it? Do they have some sort of crystal ball that portents market behavior?

All I had to do was listen to the muttenheads on CNBC wax poetic about the Goose, to realize that something was missing. This is what I found out - They took a page right out of Wells Fargo's Playbook...good old fashion Smoke, Mirrors, and Illusions were on tap last night. Was David Copperfield part of the TARP package they received? Did Houdini finally get loose from that chest, and suddenly appear at Goldman headquarters?

Not quite.... Goldman Sachs as you all remember converted to a bank holding company late last year, as per that conversion, they are required to report earnings on a calender year basis going forward. So...they legally were only required to report JAN-FEB-MARCH period results to the street. There former fiscal year quarter would have included the month of December, was omitted from the results. The December month was a total disaster for everyone involved including Goose, as they posted a consolidated loss of close to a $1 Billion or $2.15 per share for that month alone, which was much worse then anyone predicted. They took writedowns, but took them in the December quarter instead, so that they would not have to include them in the consolidated results. The writedowns totalled $1.6 Billion of Fixed Income and $800 Billion in Principle Investments. The trading environment was more friendly in Feb and March, thus the earnings results were better. I am wondering, when Goldman and Morgan converted to bank holding status, they must have been aware that December would be horrible? But they can absolve themselves accounting wise, by converting to calendar year reporting period. Genius Move. Ahhh...also being able to borrow money from the Treasury, and strong-arming AIG into handing over Tax Payer bailout money to offset collateral payments in their CDS portfolio, also was a shrewd move. How can we forget that?

But why did they not include December figures?

They didn't include that figure, because they didn't have to, padding the last 3 months. If we take into account the loss from December, the earnings still look good, not great there ROE would really be around 4% instead of the 15% reported. The stock like I said it would is down 6% currently at $122. GS like all Financials in general are too hot and have run up too fast, and a normal pullback is expected, a larger pullback will happen, if investors don't warm up to quarterly numbers from JP, C, MS, and BAC. But the trend has been set...Phony Illusionary Profit Reports from all of the banks are on tap, when will investors wake up to this scam? Have they not learned anything from Bernie Madoff? Enron? Global Crossing? Adelphia? You see when stocks/markets go up, no one cares or asks questions, they just enjoy the ride, only when people get hurt, is there talk of regulation, rules, and Congressional Oversight. This time will be no different. The Stock Market Investor deserves everything they are hit with over the next few years as we sink deeper into this recession coupled with inflationary pressures.

The thesis on the financials have not changed. The only thing that has changed is the FASB ruling on Mark to Market accounting which the banks are using to overvalue the toxic securities on their balance sheets, which in turn they are using to take less reserves for future potential losses. Its all smoke and mirrors to put out an illusionary recovery to the investment public.

Remember Wachovia more then doubled from its lows to the low 20's when things seemed to get better, before it was ultimately auctioned off to Wells Fargo. Indy Mac's stock price also doubled, before its was taken down by the FDIC. Washington Mutual also rallied feverishly before it was seized by the government and deposits sold to JP Morgan. We have seen this type of action before, when there is a sliver of hope out there, these stocks have surged only to make new lows as more and more people figure out its just one big scam perpetuated by bank executives.

The people running the banks know very well that the FASB ruling doesn't change fundamentally what is wrong with bank balance sheets, that its all an accounting trick. They can price the securities to what ever price they want, it wont sell at that price in the marketplace, but what they do know is that the market is short term minded, if they can finagle the quarterly results here and there, they can hope to survive for another 3 months, until the next Geithner Plan is developed. They have this strange idea that they can earn their way out of this mess? How can they? Can the banks collectively earn $8 Trillion after tax over the next few years? That is the total loss figure if you take into account the following losses:

1-Commercial Real Estate
2 Home Equity Line OF Credit
3-Auto Loans
4- Credit Cards
5-Hybrid Securities
6-Monoline CDS Insurance

The financials are in a catch 22 situation. The FASB ruling allowed them to mark up securities, take less reserves, thus padding short term earnings, but what does this mean when they actually go out and try to sell these same securities at the prices they have internally set? Its not going to happen. They are just delaying the inevitable. No hedge fund, or bond fund is going to purchase these toxic junk at the prices the banks have them marked to. Its a joke...pure and simple. This just bides them time.

This begs the question? Why in the world does the Treasury still backstop all of these losses? Why subsidize declines in bank mortgage books? Why the need for TARP? TALF? Public/Private Partnership? If the general investment public only cares about the illusionary quarterly earnings reports from these financials, why not just totally get rid of mark to market? Have the FASB just come out and give the banks free reign over all accounting matters, because at the end of the day, that is all that people care about anyway. Investors want to be told that earnings beat expectations...That's it! Don't care how we got there...who cares as long as the stocks go up. Business as usual. Until the next batch of earnings reports come out.

All of this could have been avoided if FASB just came out in October. It would have saved the Taxpayer Trillions!

When thinks go south, people scream bloody murder! We need more oversight! More regulation, but that is simply absurd. If the SEC, Congress, NASD, and other regulators just did their jobs, we would not be in this mess. Pure and Simple.

Monday, April 13, 2009

Recovery..Bounce..Bear Mkt Rally.

After Fridays surprise increased profit announcement from Wells Fargo that catapulted the market through 850 on the SPX, which was technically a break out, I had many people call me over the weekend stating that "its time to get back into the market". WRONG.

Don't get me wrong...Fridays action was very positive, but the gains were made on declining share volume. Also, although the Wells Fargo news shocked the market to the upside, most of the upside to earnings came from a lower loan loss reserve number and some adjustments to FASB accounting of securities on their books. But in the final analysis, this was good news, and the shorts had to cover their bets. Even after the run up Friday, the Dow and the SPX are down, while the NASDAQ is actually showing gains for the year. I had previously stated that once the market regains some footing , the NASDAQ is the place to be. The earnings power for technology is much better at this moment then in other sectors like Energy and Financial.


Major Market Indices

S&P 500 DOWN 5.17%


PHLX Sox-Semi UP 19.91%
AMEX Network UP 7.31%
AMEX Comp Tech
UP 12.46%
Amex Internet
UP 24.78%
MSCO High Tech UP 17.72%
Amex Broker UP 11.23%
PHLX Oil Services UP 14.91%

PHLX Banking Down 23.71%
Amex Oil & Gas Down 8.91%

MSCO Cyclicals Down 5.11%

As you can see technology has far outperformed financials and Energy in general.

Stocks just had there best five week run since 1938, so a recovery is happening, but is this just a bounce in a bear market rally? I believe so, because what we saw happen in late 2007 and early 2008 was a huge seismic event that hammered the markets, I just cant believe that the worst is over yet. Will we see the lows? Perhaps, but unlikely. Will we see incremental highs from here? I don't envision it.

The recent mark up of equities had more to do with short sellers getting a little to cute with their exposure, not institutions allocating their cash. The biggest markups happened in sectors (Financials/Energy) that were heavily shorted, as well as rotation into Technology, as the earnings estimates/revisions have bottomed there.

I still like Tech to outperform the SPX moving forward. But the financials are clearly ahead of themselves after the Wells Fargo announcement which entirely is accounting driven. The hope for the financials is that earnings from Goldman (4/14), JP (4/16), and Citi (4/17), will mirror Wells. Guess what? They most probably will, and I do see some upside to stock prices in the very short term, although I would sell Goldman Sachs right here...right now, and go short Morgan Stanley in the process...More on this in a moment.

The financials are borrowing money at near zero and lending at much higher rates, so they will be profitable, and taking into account they will have lower write downs (FASB M2M) going forward has gotten some investors convinced that the worst is over. Heck...I would love to trade this yield curve currently. But what is worrisome is credit quality in their loan books. Most of the banks are still forecasting loan losses and taking provisions for these losses which take into account a better employment picture/economy moving forward. The banks are simply too optimistic with their loss reserve assumptions. Credit Card/HELOC loss trends are getting worse and will get worse before any turn around. We have not even tackled other structured product losses like Commercial Real Estate and Hybrid Securities.

Listen...The U.S. Treasury has already pumped almost $3 Trillion into the financial system, as well as backstopped 93% of all current bank balance sheet losses. Why would the banks not rally so viciously? The Geithner/Paulson scam will eclipse the Bernie Madoff scheme 10 fold before its all said and done. This is truly the greatest transfer of wealth from private taxpayers to the public sector ever in the history of our country. The bank executives will be more wealthy then ever after this is completed.

But what I am seeing is a serious divergence between financial stock price performance and actual credit trends. Credit trends have gotten worse while the PHLX Banking Index has risen almost 60%. This cant be ignored.

At the moment, market momentum and still fearful investors who have cash on the sidelines will prolong the rallies longevity, but there are clear signs that stocks are due for a pause. Take into account that 80% of stocks are trading above its 50 day moving average, and that the banks are trading 25% above its 50 day trend, this has not happened in 20 years, buying the market here thinking the worst is over just doesn't jive with the evidence presented.

I don't have to go into housing, homeowners are still feeling the pain of losing roughly 30% of the value of their homes. Even with mortgage rates very low, REFI activity strong, the housing picture is very slow moving, coupled with banks that are still not lending as they should. Home prices will correct another 15-20% before its over. Its simple supply and demand economics, no matter what the treasury is doing in the secondary mortgage market.

Not so Random Thoughts-

Goldman Sachs is reporting earnings tomorrow before the open. Look for a decent number but beware that the stock has doubled since its February low. This stock is screaming "sell me" ahead of its earnings. There are rumors that they will announce a huge secondary stock offering so they can pay back TARP.

Morgan Stanley has risen nicely as well this year, but most investors are predicting heavy losses to the tune of $1.6 Billion in their commercial real estate portfolio. This will contribute to a loss for the quarter, where analysts are predicting profits. Morgan Stanley made huge bets in commercial real estate when times are good, its going to difficult for the Moose to escape serious damage. The reason Goldman is posting gains is because their trading book is concentrated in equities, while Moose is concentrated in real estate.

JP Morgan and Citigroup are also posting earnings later this week. I say sell them when you can, not when you have to.