Archive - Apr 2011

One of the most flagrant forms of abuse of US accounting rules was the implementation of FAS 157 and 115 discussed over two years ago by Zero Hedge here. The rules, which were implemented in advance of the end of Mark To Market back in 2009 to prevent fair value from creeping into bank asset valuations, segregated bank assets into three categories: trading, available-for-sale and held-to-maturity (also known as banking). The chief distinction was that while "trading" assets could be, well, traded, on an ad hoc basis, they would also need to be marked-to-market, and as a result suffer valuation shortfalls which would possibly lead to bank undercapitalization when markets swooned. The held-to-maturity assets, on the other hand, were encased in a shell of impenetrable valuation, traditionally held on the bank books at par, as the assumption is that all would be money good at maturity. The one caveat is that banks could not trade out of these assets without a solid reason to justify shifting underlying assets from one class to another. Not surprisingly, in the volatile days of 2009 and 2010, most banks moved their asset holdings to the banking category leaving trading books empty. And while the FASB recently pushed to reinforce mark to market, that failed. Yet what seems to be happening is that banks are now voluntarily going back to Mark-to-Market in order to take advantage of what even they are obviously perceiving as ludicrous valuations for toxic assets. As the FT reports, Citi shifted  $12.7 billion in bad assets from its banking book to its trading book, supposedly so it can be shielded from onerous Basel III capitalization requirements (minimum 7% equity buffer on banking book assets), but really so it can take advantage of an environment in which bidders for Maiden Lane II assets (primarily AIG itself indirectly through banks) are scrambling to bid on last pockets of remaining yield. What this means is that pretty soon all bank assets will be moved back to Mark To Market, leading in much more incremental volatility as these will be reflexive of market momentum and vol. But that is at least a few weeks away. And by then it will be some other CFO's problem.

"Our liquidity position is stronger than ever..."--Dick Fuld

The flashing fuchsia elephant at the core of our economic, and thus budget problems – remains the response to the financial homicide imparted by the big-banks and abetted by the Federal Reserve and the Treasury Department. There was a choice to be made in Washington in the fall of 2008 - smack Wall Street into place, do a good-ole free-market – you fail if you deserve to fail, we’ll protect consumer assets and that’s it maneuver - and deal with possibly intense, but definable fall-out for a short period. Or - lavish bailout upon guarantee upon subsidy upon asset purchase upon the lowest rates in our nation’s history on Wall Street, and wring the very possibility of a recovery out of the general economy from the get-go. Of course, the brilliant minds of our exceedingly-privileged, out-of-touch, economic leadership decided on the former, and are acting their asses off to pretend that that decision, in itself, wasn’t the cause of the economic problems that followed, from Main Street anemia, to commodity inflation to international disdain and a weak currency that has no right to even have the purchasing capacity it still does. And, yet Tim Geithner had the audacity of job-security to take his debt ceiling ‘plea’, on the Sunday Morning talk show circuit – really, we will be in crisis and other countries will think poorly of our ability to pay our debts if we don’t raise the ceiling and increase our debt. In truth, it is Tim Geithner’s ego on the line, while his boss, through staggering absence of mention, is fine with assuaging it. Federal Reserve Chairman, Ben Bernanke remained silent about the topic, not least because between the Fed and the Treasury department, more debt has been racked up and issued in the past two years than ever before. Of course, the debt cap will get raised, just as it got raised under Treasury Secretaries Paul O’Neil, John Snow and Hank Paulson.

Only a very few names managed gains in both equity and credit today (an interesting bunch - MAR, TOL, HOT, DHI, PEP, and SVU) as homebuilders were interestingly near the tope on the list of better performers in credit (which we suspect was related to the underperformance of the CMBX and ABX tranche markets as well as the higher beta exposure in some of the credit indices). Every sector was in agreement between credit and equity with a deteriorating move today as we note financials, leisure, and media were the worst beta-adjusted in credit relative to stocks on the day. Capital Goods, Utilities, and Consumer Noncyclicals performed the relative worst in stocks versus credit. The up-in-quality theme in credit is increasingly leaking into vol as we saw much less impact higher in vols in better-rated credits than in lower-rated credits. This was also the picture in credit though we did see the very highest rated names underperforming (financials?). This picture was somewhat different in equity-land where BB-rated and below names saw their stocks drop far less than A- rated and above names - once again we think this is to do with both financials dominating performance as well as the typical ratings/momentum correlation unwind.

Importantly, this inflationary episode, which threatens to last as long as the U.S. does not raise nominal interest rates above present rates of inflation (or, more to the point, real rates above the growth rate of the economy), has serious recessionary consequences, especially when wage and salary costs lag prices. In other words, what is being touted as a constructive element, the fact that labour costs are not showing signs of inflation, is reason to believe that the economy will soon be hit by another wave of retrenchments, as consumers are hit by shrinking real paycheques. Recessionary pressures in the U.S., adumbrated by downward revisions to second-quarter GDP forecasts in recent weeks, are being reinforced by economic weakness in the U.K., which is already undergoing a more severe bout of inflation, and the Eurozone (with the exception of Germany), which is in the grips of extremely high unemployment and negative growth per capita and stifled by excessive debt, rising taxes, and, believe it or not, low money supply growth. Consider, too, that most of the emerging markets are engaged in belated and not always conventional forms of monetary tightening in a desperate but ultimately futile hope of reducing inflationary pressures without disrupting real economic growth, and the resulting mix, you might guess, can only spell global economic trouble.

But by launching his campaign with outrageous demagoguery, Pres. Barack Obama “made it clear” he will avoid fundamentals. He counts on emotional appeals to self interest – private and corporate welfare recipients, elderly who make old age a profession out of human tragedy, all interests vying for favor at the public trough.

Never have so many, said so much, that's so wrong. It seems like a combination of deficits and rating agency action have sparked a myriad of comments, many of which are just plain wrong....First, on the deficit. NEITHER party is reducing the existing cumulative deficit nor amount of debt outstanding. They are NOT creating surpluses anytime in the next few years (decades)! They are cutting the projected deficit...Secondly, after getting wrong what the deficit reduction really is, they get wrong the likelihood. Talks about 2030 being balanced. Excuse me???? In November the talking heads thought we might see tax cuts expire. They didn't see new spending. In December, we got both! Why do we assume things will be better 15 years from now when we can't predict a few months out very well? Probably, the obvious reason. IBGYBG. I'll Be Gone, You'll Be Gone. Stocks have rallied from 900's to 1,300 as the smart money bet on unwavering and unlimited government support. Tepper was spot on. He called it for what is was. Now, smart money may be realizing that game is over... The pundits can continue to be wrong about their budget commentary, can scream til they are blue in the face that the rating agencies don't get it, but we have moved one more step towards that slippery slope where government support for stock prices is getting more difficult to implement.

Just like the Fed and banks ...

TXN which is merely the latest company to post weaker than expected earnings in a quarter which so far has been a major disappointment across the board, also has the dubious distinction of being the first company to blame its outlook cut on Japan:

Outlook

For the second quarter of 2011, TI expects: 

• Revenue:  $3.41 – 3.69 billion
• Earnings per share:  $0.52 – 0.60

This estimate includes a negative impact of about 5 cents for costs resulting from the earthquake and its aftermath in Japan. 

As the street was expecting $0.63 this is not good, but the market will promptly forgive this weakness now that every company will start using the Japanese wildcard.

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 18/04/11

Things like this don't all happen at once, today just happens to be a day that the S&P happens to mention that we are standing dangerously close to the ledge. Brazil was much smaller than Greece when they defaulted in 1983 and they took the US economy down with them...

A quick look at today's just released total debt to the penny from the Treasury may crimp the artificial smile of even such die hard administration sycophants as Moodys. Why: because the total debt, as we predicted when we observed last week's 30 Year auction, is now at $14,305,336,580,992.11. This is a problem because as anyone who rails against the broken US fiscal apparatus should be able to tell you, the debt ceiling is $14.294 trillion. In other words we have now officially breached the debt ceiling by $11 billion. So why has the US not filed a notice of default yet? Because the actual debt that matters for legal purposes is the debt "subject to the limit", which is $52 billion less than the total debt primarily due to $10 billion held at the Federal Financing Bank, and $41 billion in unamortized discount: a number which fluctuates in time depending on how much over or under par bonds are issued, but which ultimately will be zero at maturity of all debt (haha). In other words, as of today, the US Treasury has dry powder for just another $41 billion in issuance, or just over your average 5 Year auction. This can be seen best on the following chart from the Treasury where the total debt line has just passed the limit.

So it starts. Where will it end?

Two interesting charts indicate that following the earlier S&P announcement, which for the first time saw a risk aversion reaction that resulted in a selloff in equities and bonds, the 10 Year is surprisingly rich to the ES. In fact, a quick look at the chart below shows that while most asset pair (FX, Crude, ES) continue to correlate tightly following the downgrade, the 10 Year point is a major outlier. What is even more curious is that while the 10 Year may be outlying notably, the actual curve itself, as depicted by the 2s10s30s continues to correlate perfectly with ES despite some earlier choppiness. For those so inclined, an appropriate convergence trade would be a 2s10s30s neutral: essentially locking out for parallel curve shifts to moves in the ES, while trading the 10 Year spot for a compression trade with the ES, but keeping the wings of the butterfly constant as both the ES and the 10 Year is bought. This trade makes even more sense if the Fed proceeds with one of its late MOVE dumps, whereby it sells vol via off-balance sheet SPVs.

Earlier during the S&P conference call, one of the participants asked the brilliantly simple question: with the Fed monetizing debt, why should the US even bother to collect taxes? When one steps back from the apparent insanity of this rhetorical question, it does present a very good though experiment: after all what better way to stimulate the consumer part of the economy than to let 'taxpayers' no longer be that, and retain 100% of their cash. In the meantime, since nothing impacts bond yields, the statists will say, the Fed can continue to monetize debt indefinitely: after all we have a printing press and a reserve currency (an argument so asinine even the S&P laughed at it), until we get to a point where consumers have no choice but to lever up in the face of rampant inflation. And don't forget - the Fed can print an infinite amount of Treasury puts to where it alone pins yields to desired levels. While we hope to see much more discussion over this very simplistic yet so crucial question in the future, for all those (and at about 53%, it's not that many) in the US population who pay income and other taxes, courtesy of the White House, here is a schedule that shows where tax dollars are being spent. And don't forget: the Fed continues to match roughly one dollar for every dollar reimbursed back to the IRS.