Archive - Jan 2011

Social Security is unraveling, and aligning its outlays to its income requires a new understanding of tough truths. There is no mystery why the system's revenues are collapsing: 9 million jobs have vanished, and millions more have slipped from full-time to part-time or temporary. The Social Security payroll tax (including the Medicare sliver) is 15.3% of payroll. So as total payroll plummets, so does Social Security's revenue. Meanwhile, an aging populace is flooding into the system at an unprecedented rate. As noted yesterday, millions of financially crimped Boomers are applying for Social Security benefits the moment they qualify at 62 years of age rather than wait another 5 years for their full benefits. Many can't afford the luxury of waiting 5 years, while others anticipate the system's insolvency and are prudently extracting something before it runs aground.

Read this, take a deep breath, read it again....then feel free to start ranting...

Ok this is it. Someone (preferably of the less than multi-millionaire Wall Street marionette variety) in Congress has to look into the blatant bond churn-cum-flip (that was happening behind the scenes a few months ago and is now so blatantly in your face it is a slap to all US taxpayers) which has the Fed paying Primary Dealers billions in commissions for a trade that has absolutely no value added. And while we have been complaining about this for months, today just takes the cake. Below we present the entire list of permitted issues to be monetized by Frosty-Sack. Note that there were 29 CUSIP eligible for buybacks. What happened - the Primary Dealers flipped virtually the entire operation in the form of the just auctioned off 3 Year PQ7! This is half the entire Primary Dealer allocation in the bond auction that was completed on January 11 (whose technical original issue date was yesterday). One more 3 Year POMO, the next of which is on January 31, in which PDs flip a like amount, and the Fed will have monetized the entire auction, but in the process having paid at least a few hundred million of taxpayer capital to the PDs for absolutely no value added! This is a daylight robbery and has to stop.

In silver, the contango was hit hard about 3 AM this morning with 2 year futures coming in as much as 15 cents relative to spot. The Z11/Z12 futures spread settled 21.40 yesterday and the market today is 13/15. The H/Z futures spread settled 19.2 The market today is 9/11. What could cause this? Factually speaking, 2 reasons cause contango to collapse. The first is interest rates and interest rates would have to decrease a large amount for this type of move in the spreads. The second is delivery concerns. When a producer, bullion dealer, or speculator is short the front month, come expiration, it has a a choice: make delivery or don’t make delivery.

When we first presented the TVIX, or the double levered short-term VIX ETF, as well a few more insane ETFs just created by Standard & Poor's Financial Services LLC (yes, S&P) less than two shorts months ago, we summarized this development as follows: "Ever feel like this market just does not provide enough unique and suicidal ways for you to lose your hard stolen money within nanoseconds of trade execution? Never fear - here comes the TVIX, a levered third derivative bet on volatility: simply said, the TVIX will be the world's first double leveraged VIX ETF... Why not just call these what they are: a novel way (brought to you via the synthetic CDO legacy product known as ETFs) to lose money with a 99.999% guarantee. As always, we wonder why anyone would trade this product, when, with much better odds, one would at least get comped in Vegas..." Well, we were right. The chart below shows what happens when one believes there is any vol, let alone double leveraged volatility left in a centrally planned, perpetually melting up stock market. The TVIX has plunged from $110 to just over $42... in a little over a month.

Today's flash crash du jour comes to you courtesy of Magnum Hunter Corporation (MHR), which in the span of a few tick lost half its $500 million market cap. Unlike most other such HFT triggered events, there was actionable news, after the company announced it would acquire NuLoch Resources, yet still the fact that a selling algo can take out virtually the entire orderbook half way down to zero would once be considered at least modestly surprising. Not so much anymore.

We often disparage the Wall Street Journal for being too spineless to tell it like it is when reporting on the state of the economy, but with last Friday’s lead story, New Hit to Strapped States, they pulled no punches. You can almost pick a paragraph at random and get a sense of how serious the cities’ credit problems are. This paragraph, for instance “Municipalities borrowed $122 billion of variable rate demand debt in 2008, roughly twice the amount of these types of loans borrowed the year before…” How did they get in so deep?

Up until recently, the banks have been enjoying a free ride at the savers expense. The yield curve is at its steepest slope since 1977. The spread between the US 2 year and 30 year is 400 bps while the 2-10 spread is 275 bps. The plan was for that big fat spread to add up to big fat bank revenues (witness Citigroup 4Q net interest revenue of over $12 billion). But just like most bank robberies, the plan usually goes wrong and the robbers are caught by the cops. This time the cops are the bond market. Prices on treasuries dropped 13% in the 4Q of 2010. This has wrecked havoc on the banks free money plan and we are now seeing this in the investment portfolio losses of the banks (witness State Street earnings report this morning where their revenue dropped 12% due to “investment portfolio repositioning”).

Just headlines for now, citing a Handelsblatt article. Per Feld's recommendation, Germany would need to set aside funds for the inevitable Greek default. This dovetails nicely on the German forecast that the EFSF will have no choice but to buy sovereign debt in the secondary market, in essence removing sovereign debt purchases from the SMP program, and through a CDO conduit. This will not end in tears.

Pssst.... Hey, did you see those latest numbers out of Goldman yet?

Tom DeMark, whose Sequential and Combo indicators are among the most used indicators by professional technicians and chartists on Wall Street, is out with some chilling words overnight. The Market Studies LLC president told Bloomberg that U.S. stocks are within a week of “a
significant market top” that is likely to precede a drop of at
least 11 percent in the Standard & Poor’s 500 Index. “I’m pretty confident that in one to two weeks, the market
will be in a descent,” said DeMark, founder and chief executive
officer of Market Studies LLC. “It could be pretty sharp.” And since the Hindenburg Omen in mid-August was prevented from taking its share of scalps only by dint of the Chairman's Woods Hole speech a week later which set off the market on the biggest melt up since... well August of 2009, we wonder if the Fed's Open Market Operations desk will take this warning as a leading indicator to start spreading rumors of another QE expansion. Keep a close eye on those Jon Hilsenrath "leaks."

More weak economic data today, as Housing starts were reported at 529K on expectations of 550K, another sequential decline from the prior revised 553K. The silver lining was in the housing permit number which was 635K on expectations of 554K (compared to a prior revised 544K). Yet as the note from GS below explains the only reason for the surge in permits is due to a jump in applications ahead of the implementation of new building codes in 2011. As Hatzius notes: "If building code changes are the main explanation for the rise in permits, we should see a substantial drop back in multifamily permits next month."

Goldman reported Q4 numbers today and they were ugly. While earnings were in line with expectations (bank EPS has become completely irrelevant as the FASB now affords banks with a practically infinite array of options to game the bottom line), the revenues were more difficult to fudge. And now that the firm finally spreads its revenues in the new method which breaks out Prop (and FICC from Equities as part of client flow), we can see just why prop trading is so critical to the firm. The traditional golden goose for the firm: Fixed Income, Currency and Commodities trading on a flow basis was abysmal, plunging from $2,687 million to $1,636 million sequentially, and from $3,129 million in Q4 2009. As the chart below shows, this number peaked at $6,017 million in Q1 2010. Combined, total revenues by all segments came at a five quarter low with FICC posting the lowest contribution since 2009. Yet the one segment which did post an increase was Prop Trading, also known as Investing and Lending, which increased from $1,797 million to $1,988 million. And as we noted previously, the margins in this group are by far the highest, averaging just under 50%, confirming why as Bloomberg noted earlier, attempts to reintegrate prop into Wall Street trading are ramping up big now that Volcker is gone. But the number everyone is waiting for is comp, which was $2,253 million in Q4 (unlike the negative number posted in Q4 2009 when the outcry against banker bonuses was apparently louder). This was a 26.1% comp margin, and brought the year total to $15,376 or a 39.3% margin on total revenues of $39,161. Based on "total staff at period end" of 35,700 this comes to precisely $430,700 per employee. Surely this is admirable compensation for a Fed-backstopped hedge fund job well done.

• Define irony: Goldman among four underwriters picked to manage AIG share sale (Reuters)
• Prop trading is baaaack: Volcker Rule Should Require Sign-Off by Bank CEOs, Panel Says (Bloomberg)
• Wells Fargo Misses Profit Estimates as Mortgage Banking Weakens (Bloomberg)
• Asia to See Soaring Prices in 2011 (Reuters)
• Chinese Premier stresses stabilizing food prices, housing market in 1st quarter (Xinhua)
• China and U.S. Set to Square Off (WSJ)
• China Needs Urgent Guidance on Euro Debt Risk, Yu Yongding Says (Bloomberg)
• Gerova Hires Investigator in Bid to Refute Critical Report (NYT)... stock plunges again (report posted here first)
• José Sócrates reportedly begged for help last week as Portugal became the latest eurozone country tipped for a bailout (Guardian)
• European banks face tougher stress tests (Irish Times)

For those who were wondering why deposed Tunisian president Ben Ali recently pulled a ton (literally) of gold from the country's central bank, here is your answer: Reuters reports that Switzerland has just frozen all of his (paper) assets. Unfortunately, they have little access to his holdings of actual physical assets, such as the case may be, gold. And as we speculated when we discussed the curious case of deposed Ivory Coast's president Laurent Gbagbo (who in a clever scheme is using bondholders as leverage to legitimize his regime), that the world's largest cocoa exporter would be next to part with a substantial portion of its gold (which it does not technically have), this appears to be shaping up to be the case: Switzerland has also frozen assets of Ivory Coast president Laurent Gbagbo. Which also means that all those bondhodlers which were used as leverage by Gbagbo to legitimize his regime may be now irrelevant. Look for some interesting action in Cote D'Ivoire bond prices as a result of this development, demonstrating the curiously interconnected nature of globalized markets .