Archive - Apr 23, 2010

Guest Post: For Those About To Swap (We Salute You)

1) Perverse monetary policies including ZIRP resulted in a radically steep yield curve; 2) When policy normalizes and the yield curve flattens, it will lead to significant market dislocations; 3) One dislocation will be in the interest rate swap market. Losses could lead to massive swap unwinds; 4) If losses related to unwinds are concentrated in primary dealer positions, this will carry illiquidity to other asset markets; 5)Using the price of money as a control device destroys the information content of prices. Even marginal introduction of market forces into price formation can lead to crashes; 6) When government administered backstops end or fail risk reasserts itself. The most primordial risk is counterparty risk; 7) There is a hedge, and a hedge in enough size becomes a trade.

Daily Credit Summary: April 23 - A Weak Week?

A very interesting week with some notable divergences among capital structures and asset classes. Most notable is the widespread underperformance of FINLs, IG corporates, Sovereigns, and TSYs as HY and equities continue to charge higher. Steepening in corporate curves coincided with flattening in TSYs which suggests deep-down some risk-aversion as credit duration is reduced and extended in govvies but HY saw flattening (duration extension) at the short-end which may explain where that risk went.

Darrell Issa Demands SEC Inspector General Kotz Investigate Timing Of Goldman Suit

The Republican escalation into the SEC's Goldman investigation is hitting new highs: late today, Darrell Issa sent a letter (see below) to the SEC Inspector General, David Kotz, demanding an investigation into the timing of the Goldman lawsuit. "The circumstances of the filing and subsequent events fueled suspicion that the Commission, or one or more of its officials or employees, may have engaged in unauthorized disclosure or discussion of Commission proceedings in order to affect the debate over financial regulatory legislation currently pending before the United States Senate." He concludes" Disclosure rules and procedures at the SEC are importnat to efforts to prevent insider trading and any violation would be deeply troubling." An interesting tidbit from the letter: "the online publication by the New York Times of an article describing the Goldman suit prior to the release of the Commission's official announcement is evidence that news of the suit leaked form the Commission via unofficial channels." The last thing the porn lovers at the SEC need is for the IG to find both Mary Schapiro, and the President of the United States, guilty of lying on air seeing how they both denied Issa's allegation. In retrospect, that finding by Kotz alone would be worth the price of admission that Goldman is perfectly innocent of disclosure fraud (we'll leave that one to the jury, what Goldman is much more guilty of is being a market monopolist and there is little disputing that particular fact, which is why we believe Kaufman's noble campaign to cap bank size is very much doomed).

Guest Post: Hard Evidence Of Goldman's Corrupt Intent And The Myth Of The Sophisticated Investor

Many is the time I would review a write-up of a new deal and scribble in the margins, "Get to the bleeping point!'' Unless you can articulate, up front, exactly what assets we would be lending against, and what circumstances would cause us to lose money (i.e. a quick-and-dirty breakeven analysis), you don't really know what you're talking about. And if you don't have a good grasp of that issue, everything else you have to say is superfluous, a waste of time. This lack of common sense is pervasive, extending far beyond the financial services industry. (When, over the last seven years, have you ever heard a journalist ask, "How many troops do we have to replace those currently deployed in Iraq?") In certain markets, most notably, CDOs, this lack of common sense was institutionalized. It's evident in the deal book for Abacus 2007 AC-1, at the center of the S.E.C.'s case against Goldman. What risks are investors assuming? The presentation doesn't say. There's a reference portfolio of 90 subprime mortgage bonds, on pages 55 and 56, which ostensibly would be insured via credit default swaps for the benefit of Goldman. But, as the small print says, "Goldman Sachs neither represents nor provides any assurances that the actual Reference Portfolio on the Closing Date or any future date will have the same characteristics as represented above." According to my bias, everything else in the 66-page presentation is superfluous. And the real reference portfolio for Abacus 2001 AC-1 remains, to my knowledge at this point in time, hidden from public view.

World Cup Effect

It is a well observed fact that every time a country builds the tallest buildings in the world, or decides to venture into similar kinds of excess, it usually is a good sign of the end of a speculative era and is a good market top indicator. Similarly, we clearly had a run up in Chinese equities ahead of the Olympics last year as the country was building infrastructure to host the worl, and a whole lot more. Well, now get ready for the world cup effect. With 0.7% of the world population and 17% of the HIV epidemic, the country has a lot of problems and once the momentum post world cup abates we think the economy could tank pretty seriously. - Nic Lenoir

Carry Trade Fully Armed And Primed: JPY Shorts Near Recent Record Highs, As EUR, GBP And CHF All Remain At Net Short Spec


The latest COT report by the CFTC is out: no surprises - the JPY shorts came in at near record levels after four weeks of increasing net spec short exposure. If you need to know what the funding mechanism has been for everyone who does not have access to the Fed's discount window to buy stocks at negative carry, here you go. Everyone and their grandmother is now shorting yen and using the proceeds to buy, buy, buy all risky assets. And not just yen: all the major currency pairs had net a spec short balance the week ended April 20: EUR non-commercial shorts jumped by 15,960 to -71,424, also close to record levels, while the GBP and CHF were also being shorted as the stock buying rampage was in full nitrous mode. From a massive dollar carry trade late last year, we have no moved to an even massiver non-dollar carry trade as every non-developing central bank is rushing to keep ZIRP in perpetuity.

Welcome To The Banana Republic: GM In Hot Water With FTC Over Misleading "Repaid Bailout" Ad When All Just TARP Shuffle

We are too busy maxing out our credit cards buying AAPL shares after hours into the parabolic blow out (using Sigma X of course, how else could we subpenny front run our own orders?), stacks of Kindles, 7th vacation homes with negative equity, and LBOing zero EBITDA companies to comment on this, suffice to say that if you ever needed confirmation that America is a banana republic in which fraud, corruption and lies are now the norm, here you go: Government Motors is now blatantly lying to its existing and future buyers, and everyone in the administration is complicit.

Jeremy Grantham: Playing with Fire (A Possible Race to the Old Highs)

It’s spring, and this spring a young man’s fancy lightly turns to thoughts of speculation. The Fed’s promises look good and, as long as you’re not a small business, you can borrow to invest or speculate at no cost. The market has had a near record rally, sprinting far past our estimated fair value of 875 for the S&P 500. Bernanke is, in fact, begging us to speculate, and is being mean only to conservative investors like pensioners who cannot make a penny on their cash. Collectively, we forego hundreds of billions of potential interest, but at least we can feel noble because we are helping to restore the financial health of the banks and bankers, who under these conditions could not fail to make a fortune even if brain dead. We are also lucky to have a tiny fraction of our foregone interest returned by the banks as loan repayments with “profit.” Some profit! Oh, for the good old days when we could just settle for a normal market-clearing rate of interest. But that, I suppose, would be wicked capitalism, and we had better get used to bank- and speculator-benefiting socialism. - Jeremy Grantham, GMO

Econophile's picture

When I make a mistake I will admit it.

In my analysis of consumer spending I asserted that the sources of increases in spending were (1) a draw-down of savings and (2) the redirection of defaulted mortgage payments to spending. I was half-right which another way of saying I was half-wrong.

I missed one the basic laws of economics, Bastiat's "Broken Window Fallacy." Ouch!