Archive - May 2010

What was David Stevens thinking of? Possibly the truth.

Game theory causal relations are now superseding simple myopic "in-a-vacuum" economic variables. Are you prepared for the paradigm shift? David Einhorn is (and so are we).

Remember the Bushism, "fool me once, shame on -- shame on you. Fool me -- you can't get fooled again." The National Association For Business Economics just came out with their latest forecasts for the economy. That's what brought up the old saying, "Fool me once, shame on you; fool me twice, shame on me" that George W. so magnificently bumbled.

A must watch two part interview of Eric Sprott by BNN, in which the Canadian asset manager shares his views on the economy, financial markets, sovereign overleverage, industrial commodities, and, of course, gold. The man who created the PHYS index to invest in physical gold, is, not surprisingly, not too excited about perspectives for stocks, and markets in general, which he qualifies as a "financial farce." Sprott is, and has been for a while, confident we will retest the March 2009 666 lows in the S&P. Slowly, more and more "experts" are moving to his camp. He also gives an advance glimpse of the topic of his upcoming May missive for all you Sprott groupies.

A week ago the FRBNY's Task Force On Tri-Party Infrastructure came out with an exhaustive must read report discussing its concerns about the massive $1.7 trillion US tri-party repo market, and specifically proposing several ideas that could prevent a bank run on a shadow market that is second in size only to the money-market $2+ trillion US money market. Incidentally, both markets were on the verge in the days after Lehman. Their day of reckoning may be coming again soon, and with the FRBNY task force's explicit attention on Tri-Party repos, all is probably not well. In fact even Moody's today agreed that until the proposed fixes are implemented (likely many months, if not years away), the tri-party repo "market will remain a major source of systemic risk, especially given the current market volatility and the fact that the Federal Reserve’s primary dealer emergency lending facilities are no longer in place." This should be another bright red flashing warning to those who still have to realize that the liquidity situation from a month ago and now are diametrically opposite.

Despite a better Friday, European sovereign risk and US financial reform continue to weigh on markets, causing some to connect the dots from these sorts of concerns to broader questions about the health and sustainability of the global cycle. Our baseline view remains that these fears are overdone. Indeed, in Wednesday’s Global Economics Weekly, Jim O’Neill argued that the world remains “Better than you think” with the needed austerity in peripheral Europe posing only minimal challenges to our above consensus global real GDP growth view. Importantly, conclusive economic evidence of a shift in the business cycle has yet to materialize. However, there are some faint signs of fraying around the edges of the evolving macro data set, and, especially in the US, we continue to expect a second half slowdown. US retail spending continued to grow in April, but the acceleration in spending has paused. Weekly UI claims have stalled, and shown no improvement for several months. The Philly Fed survey inched up by a tenth of a point in May, but key leading subcomponents (New Orders less Inventories in particular) failed to make headway, as has been the case for several months. Euroland PMI fell in May, though it remains solidly in expansionary territory, indicating a slowdown in the rate of growth but not a shift in direction, as did German PMI after a blowout reading in April. - Goldman's Noah "Top Trades For 2010" Weisberger

Following an ongoing outcry over opacity in the dark pool markets, a topic discussed to death on Zero Hedge, six investment banks have finally started providing some modicum of transparency into how much trading actually occurs in their dark pool venues. Today, MarkIt will start disclosing European trades matched in the internal crossing engines of Citigroup, Morgan Stanley, Credit Suisse, JPMorgan, UBS and Deutsche Bank. The first ever report of this kind can be read on the following MarkIt site. The data will be published on a T+1 basis. As MarkIt notes, "The aim of the Markit BCS (Broker Crossing System) product is to provide the market with greater visibility of the total volume crossed within their systems by the reporting brokers." Europe is a good place to start with such disclosure, as estimates on European dark pool trading are extremely wide: as Bloomberg notes, "The U.K.’s Financial Services Authority says the pools account for 1.25 percent of trades, whereas the Federation of European Securities Exchanges, which represents exchanges, estimates the figure is closer to 40 percent. The lack of reliable information on volumes and pricing of securities in dark pools has posed a problem for regulators trying to keep pace with market innovation." Curiously, this major development in dark pool opacity comes on the heels of the announcement that non-investment bank dark pools, those of Chi-X and BATS, will curb market data disclosure. Again Bloomberg: "Chi-X Europe Ltd., the region’s biggest alternative stock-trading system, began suppressing some market data from its dark pool after customer concern about information leaks led to a decline in business. Starting today, London-based Chi-X Europe will no longer disclose customer identification or order numbers in Chi-Delta, its dark pool. Bats Europe, the second-largest multilateral trading facility, will impose similar controls on May 24." We believe this is a byproduct of accelerating cannibalization between investment bank and 3rd party ATS venues (not to mention dinosaurs such as NYSE-ARCA), as margins continue to dwindle in the rapid evolution to a zero margin trading business, be it exchange or dark pool based. In their pursuit of the fastest, biggest, newest, market participants are destroying each other in the process, and further destabilizing market structure in the process.

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 24/05/10

Just as Friday saw a massive ramp in the last 30 minutes of trading, so Monday saw a mirror image of Friday's half an hour action, once volume picked up in ES toward the end of the day. And with that the most ridiculous statistical phenomenon in recent history, better known as the Mutual Fund Monday ramp, is now over. This is bad for algos as yet another reliable correlation ends with a bang.

As the United States edges closer to issuing a fresh round of sanctions against Iran, foreign investors so far unmoved by international pressure will end up doing business with a Revolutionary Guard that makes even local firms nervous, an analyst warns. The Islamic Revolutionary Guard Corps, known as the IRGC or Revolutionary Guard, is a military branch set up after the 1979 revolution to protect the regime and has become more ingrained in the Iranian economy particularly under President Mahmoud Ahmadinejad’s administration. In recent weeks, the Revolutionary Guard has declared that it can assume control of the energy industry if Westerners flee under the crush of coming U.S. sanctions. Over the last two-and-a-half decades, the powerful force has gradually moved into sectors like construction, energy and telecommunications, said Alex Vatanka, a scholar at the Washington-based Middle East Institute.

One of the very few "green shoots" pertaining to our extremely unstable financial system, that had been greeted by bulls far and wide was the alleged decline in loss provisions and charge-offs by banks and credit card companies in recent months. In fact, JPMorgan's rose-colored commentary on trends observed in this area during Q1 was supposed to be the catalyst to push financials to a new high during this earning season, until we uncovered that Europe is broke, and that everyone decided to sue Goldman, which had a slightly more adverse reaction on stocks. Amusingly enough, and in confirmation that no lessons have been learned, the San Fran Fed has released a mistitled paper called "Loss Provisions and Bank Charge-offs in the Financial Crisis: lesson learned" which confirms that banks are once again blindly rushing to repeat the very same mistakes that were part and parcel of the array of flawed judgments that led to the bursting of the credit bubble built on a house of cards of good intentions and optimistic projections. The paper concludes: "The recent financial crisis and recession have painfully demonstrated the vulnerabilities associated with the bank loss-provisioning process. It’s clear that provisioning should be more forward  looking. However, even a more forward-looking provisioning process would not have fully addressed bank vulnerability to the extraordinary events of the past few years. By definition, loan loss reserves are designed to absorb expected losses. Even if banks had better forecasts and more discretion in setting reserves, they would probably still be unable to adequately provision against unexpected large economic shocks. Guarding against such shocks is the role of capital. The lesson of the financial crisis is that the buffer against downside risk must come in the form of higher bank capitalization." Amusingly, just as various amendments seek to cut regulatory cap ratios, banks are once again rushing to lower their loss provisions, soundly refuting the FRBSF's thesis that the US financial system can ever learn from anything that occurred more than 24 hours prior. We are confident that as the "priced to perfection" scenario unravels, even such overly optimistic captains of industry as Jamie Dimon will once again be forced to readjust their loss provisions materially higher, leading to a new regime in financials, in a direction which however will not be to the bulls' liking.

With hundreds of amendments crammed into the Senate version of Financial Reform, the dust is only now settling on what the impact of all these will be for Wall Street firms. One of the less discussed amendments is that of Maine Senator Collins, which would result in the disqualification of Trust Preferred Securities from Tier 1 regulatory capital, and which if passed into law, will trim about $108 billion from bank holdco Tier 1 capital, an amount which is about 13% of the "Big 4" banks' total Tier 1 capital according to Moody's. The resulting need to shore up bank holdco balance sheets would be substantial and would require additional equity infusions and/or debt dispositions, as well as more FASB suspensions of various Mark-To-Market rules. Additionally, the enactment of this amendment would likely result in future downgrades of holdcos by discredited rating agencies such as Moody's.

We have long claimed that any financial reform, determined by the Senator from Countrywide and the Rep from Fannie (thank you Cliff Asness), is worthless, and any debate over it is completely useless as it will achieve absolutely nothing. Sure, it fills blog pages and editorials but at the end of the day, the only thing that can save the financial system is, paradoxically, its destruction. There are just too many vested interests in the status quo, that absent a full blown implosion and subsequent reset of the system, it is all just smoke and mirrors. Luckily D-Day is approaching. We present an opinion by Robert Reich which validates our view that FinReg, and any debate thereof, is a joke.

What happens when we look at all of the costs?

Reuters and Bloomberg report that 4 Spanish savings banks are set to merge, likely as a result of the pent up fallout from the failure of CajaSur, which as we noted earlier, was taken over by the Bank of Spain. The culprit it appears is Caja de Ahorros del Mediterraneo which is merging with 3 other banks, Caja de Ahorros de Asturias, Caja de Ahorros de Santander y Cabria and Caja MP de Extremadura, to prevent a collapse. Since Spain apparently lacks the FDIC's tender wealth redistribution hand, it is still unclear whether the transaction will obtain government funding. Just as the subprime collapse started with a few names toppling, this could easily be the start of implosion of the allegedly insolvent Spanish banking system.