Archive - Sep 2011

Yesterday Fed Chairman Ben Bernanke pulled out the last bullet in his arsenal reaching back almost 50 years in a hope that just maybe this "silver bullet" will kill the vampiric drain of excess debt on the economy.   Unfortunately, silver bullets don't kill vampires.  There is more to this analogy than just the approaching Halloween season.   Our problem isn't low interest rates - it is excess debt which literally drains the demand for more credit.  The recent release of the NFIB Small Business Survey showed this as businesses stated that acces to credit is not an issue.   "Poor sales" are their number one concern and the lack of demand on their businesses do not warrant adding on more leverage.  The number of businesses currently thinking this is a "good time to expand" is at some of the lowest levels on record.  Likewise, consumers, are trying to pay down debt as worries about job security, rising food and energy costs and stagnant wages reduce their desire to consume and make debt reduction a priority.  The excess debt that has been accumulated over the last 30 years as interest rates were in a steady decline, lending standards were reduced and massive pools of available credit were supplied has now begun the inevitable unwinding process.  

Today at some point, the House votes (again) on a continuing resolution to fund government past Sept. 30. Will it fail to reach an agreement as it did yesterday, with just a day before yet another break which will likely mean no more votes until the actual shutdown? Goldman explains what to expect from the events this afternoon/evening.

"We look at conservatively estimated earnings yields and compute an equity risk premium of 600 to 700 basis points.  That is an extraordinarily high reward for anyone willing to invest in stocks.  History shows it is a bargain.  We will seize it.  Our longer-term target for the S&P is above 2000 by the end of this decade, if not before." -- David Kotok

While bank CEOs across Europe (and the US) continue to deny-deny-deny that they have any liquidity issues, the markets seem to be calling their bluff (once bitten twice shy?). EURIBOR-OIS has just reached back to March 2009 levels, 3 month EUR-USD basis swap is almost back to late 2008 lows at -106bps, and while for once the ECB's liquidity facility was not taken advantage of in size (only EUR179mm), counterparty risk is clearly on the mind of traders as CDS curves invert and Senior Financials jump 15bps to 304bps (and Subordinated +36 to 538bps!).

With French banks now a daily highlight in the market's search for the next source of contagion, and big, multi-syllable words such as conservatorship and nationalization being thrown about with increasingly reckless abandon, perhaps it is time to consider the downstream effects of a French bank blow up. And we are not talking French sovereign troubles, which are about to get far worse with the country's CDS once again at record highs means the country's AAA rating is as good as gone. No: banks, as in those entities that are completely locked out from the dollar funding market, and which will be toppled following a few major redemption requests in native USD currency. Which in turn brings us to...Morgan Stanley, the little bank that everyone continues to ignore for assumptions of a pristine balance sheet and no mortgage exposure. Well, hopefully we can debunk one of these assumptions by presenting the bank's Cross-Border Outstandings, which "include cash, receivables, securities purchased under agreements to resell, securities borrowed and cash trading instruments but exclude derivative instruments and commitments. Securities purchased under agreements to resell and Securities borrowed are presented based on the domicile of the counterparty, without reduction for related securities collateral held." We'll leave it up to readers to find the relevant number.

Following yesterday's 1-2 BAC/WFC downgrade double penetration (which the market will very soon realize has substantial impacts on money market and other prime money access) performed on ye olde' Octogenrian of Omaha by Moody's (in which, adding insult to injury, Buffett is an investor as well) the market has had a violent reminder that Berkshire is nothing but a procyclial and levered derivative of downside market risk courtesy of the "insurance" company's massive bet that the market will only go up, yes we are talking about all those sold index puts. As a result, for the first time in 20 months, anyone owning a share of BRK/A can no longer say they have over $100,000 with the stock dropping to 99,275. And if, as the market indicates, Buffett's buddies at the global central planning committee no longer have control of the markets, pretty soon the thousands separator comma will be converted into a decimal point.

Special Note: In this latest Alt-Market piece we try something a little different; short fiction based on fact. Make no mistake; while the characters and events in this story are products of imagination, the issues presented and their probable consequences are anything but fantasy. The message? What will you choose to be in the face of hardship and crisis; a mountain? An impassable obstacle to tyranny? Or, a silent and beaten passenger of the Redline?

As usual getting Art Cashin's pragmatic take on something as important as the Fed's decision (which at this rate will need to be revised very soon), is quite a morning coffee, or for some, "fermentation", treat.

Seat belts on. Impact is imminent.

A dramatic Hail Mary appeared in the FX markets earlier this morning following the circulation of a rumor, since attributed to Goldman sales, that the FRBNY is preparing to slash its FX swap line with the ECB rate, which would in turn make it virtually free to borrow Dollars from the Fed and make the Libor funding market completely irrelevant as the Fed would give dollars to European banks for virtually no money. Frankly, we will believe it when we see it, especially when one considers the source. Why it is none other than the firm's Dominic Wilson who reminded us today that Goldman clients should "Stay long EUR/$, opened at 1.4085 on 18 March 2011, with a target of 1.50 and a stop on a close below 1.35, now at 1.3545"... well make that 1.339 when the supposedly Goldman-initiated rumor hit and has since pushed the currency to nearly 1.35. The problem is this rumor is, without confirmation, patent bullshit, as the last thing the Fed need is for Republican to take it to task, this time completely justified, for sending dollars abroad on a cost-free basis just to bail out Europe again. We would fade this rumor all the way, especially with the EURUSD about 100 pips rich to pre-rumor fair value. Furthermore should the EURUSD close below 1.35, which it will, look for major stop loss signals to be activated which purely on technicals will send the EUR far lower.

The big news yesterday was not of the twist type, but of another dance number (or slumber) between Bernanke and Obama.

As early as July, we pointed out the increasingly likely endgame in Europe with regard to the EFSF and centralizing/concentrating credit risk. Well sure enough, sovereign risk has risen dramatically for Germany (among many others obviously) as traders realized standing on the shoulders of giants does nothing but push them further into the dirt. What is becoming more worrisome, and dramatically escalating, is the rise in sovereign CDS relative to government bond yields - or the so-called 'basis' - as it becomes ever more clear that government-bond-yield-by-mandate may not be as 'real' a measure of the risk-free rate as CDS.

Time for Rule 49?

Yesterday's downgrade of BAC was potentially problematic for credit markets.  I am less concerned about the holding company downgrade.  Downgrading the bank to A2 from Aa3 could become problematic.  That is the entity most derivative counterparties will face.  A2 is still fine, but I suspect many counterparties will be having meetings over the next few days to discuss how comfortable they are facing BAC as a derivative counterparty.  It might be wrong, and unnecessary, but it is something that will be occurring.  BAC should be doing everything in their power to address this potential risk immediately. The risk of ratings downgrades to a bank is twofold.  On a basic level, it may reduce the flows they see as counterparties prefer to trade with higher rated entities for their derivative trades.  That is manageable.  The bigger, and far more problematic issue, will be if firms cut their lines to that bank.  This would cause banks to unwind or assign existing trades, or to buy protection on the downgraded banks to "hedge their hedge".  Protection buying would drive their spread higher (if this was all exchange traded, it wouldn't be an issue).  Unwinds could force the bank to raise some cash.  Most hedge funds will have one way collateral agreements with banks, so that on any positive mark to market, they are posting collateral to the bank, which the bank can typically use "rehypothecate".  Hedge funds will unwind or assign profitable trades, which will force the bank to return collateral to the hedge fund.  It is a subtle, but painful, way for a bank to experience a run.  It happened with Bear and with Lehman. 

Another day, another chance for the BLS to fudge jobs data by revising last week's claims miss to an even worse number: sure enough last week's -428K drop was just revised to -432K. Which means that this week's consensus miss, which was at 420K, is irrelevant, with the weekly number coming at 423K because all headlines will blare than claims actually declined by 9K. The game has become so old (and we mean old: the BLS has been doing this very same fudge for 2 years in a row now) we are stunned anyone falls for it. And one thing that will also most certainly be ignored is that the 423K number is really 427K because as the BLS reported, a -3,776 drop in claims in Texas was due to "Fewer layoffs due to holiday" - well the holiday is over. Lastly, and most troubling for the economy is that another massive 103,000 people dropped off extended benefit claims in one week. Just as troubling is that 1.7 million people have dropped off the government's dole in the past year as can be seen in the chart below: these are people that haven't gotten a job, they have just stopped being counted by the govt.