Archive - Apr 2010 - Story

RANsquawk European Morning Briefing - Stocks, Bonds, FX etc. – 26/04/10

Every now and then, congressmen (and their staffers) have a knack of taking a terrific opportunity to investigate the alleged criminality at the apex of Wall Street (such as Tuesday's hearing with Darth Blankfein), and blow it by 1) pursuing personal agendas that have nothing to do with the matter at hand and 2) having no understanding of the matter at hand. And when the matter at hand is something as complex as CDOs (just ask Lloyd or Ben Bernanke - both will tell you that only Goldman understood these products well enough to trade them, and that only the Fed is smart enough to regulate them),televised embarrassment is sure to follow. Which is why we have prepared some bedside reading for all those who intend on grilling Lloyd on Tuesday.

Goldman has been on a roll this week. After losing all credibility (or whatever they had) with the markets, the objective media and Main Street, but not their clients, who were the ones losing the most for interacting with the squid, yet refuse to take their business elsewhere for fear of being locked out from the market monopolist with the greatest amount of inventory (yes, economies of scale when compounded with not so subtle forced liquidations of key competitors end up in monopolistic outcomes), now their economic team is taking a gamble with its own reputation (this is the team that won the best big bank economic team aware for 2009). In a note distributed to clients, entitled "What's the Right Measure of US Government Debt?" Andrew Tilton and Alec Phillips try to present the case that contrary to what you may have heard, the $12.8 trillion of US debt is not really worth losing sleep over. In fact the next time Goldman needs a bailout and the resultant $2-20 trillion of new debt are added to the make the 2s30s at about 100%, that should not be a source of concern either.

One of the key topics over the next week will be just what was Goldman's exposure to the mortgage industry in 2006 and 2007, and was the firm actively short mortgage exposure or was it merely, as it claims, just a market maker without any active positions on its prop desk. Courtesy of Carl Levin's recently declassified Goldman emails and presentations we get an extensive glimpse into Goldman's net exposure, its DV01, its counterparties, as well as how the firm was planning on interfering with the market when it needed liquidity to offload legacy positions. We also get a rare glimpse into the contributions from Tourre's mentor, Jonathan Egol. Let's dig in.

As Zero Hedge first reported, rumors within the South Korean community that North Korea would receive the full blame for the tragic sinking of the South Korean ship Cheonan have turned out to be true. Today, the WSJ confirms: "South Korea's top military official said Sunday that a torpedo likely
exploded under the Cheonan, the South Korean patrol boat that sank a
month ago near the maritime border with North Korea, edging Seoul even
closer to declaring it was attacked by forces from the North." So with the obvious finally confirmed by everyone, the only question now is "what's next?" According to the WSJ, "South
Korea faces several constraints in penalizing Pyongyang, starting with
the prospect that a military response could escalate into a war that no
one here wants. And the timing of a response may be shaped by an
approaching election and the amount of time and effort it takes to
rally international support for economic penalties." Alas, the animosity between the two countries runs so deep that mitigating the populist response may just be a task a tad too impossible for either administration to accomplish.

Let me start off by saying the market should be correcting. Sentiment has reached ridiculous bullish extremes, the kind of extremes that led to the January /February correction. That correction separated the second leg of the bull from the third. But let’s face it, sentiment has been in this condition for several weeks now and the best we could muster was a minor correction of 30 points on the news the SEC was filing charges against Goldman Sachs for fraud.
We’ve had three opportunities to “sell the news” with the April jobs report and recently with INTC and AAPL earnings. None of them have panned out. The market could use the Greek excuse as a downside catalyst, the same as it did in January. And now Greek short term bonds are tanking as the EU waffles about writing that check in front of the German elections in May. All in all it boils down to the market has had every chance to correct and it has failed to do so. Last month I speculated that we were On the Brink of an Asset Explosion. Well, we may not be on the brink anymore. We may very well be moving into the heart of the explosion right now.

"Greece will remain in the spotlight. Reportedly, PM Papandreou is planning to appoint a central coordinator for the government’s interactions with the IMF and the European counterparties. According to the FT, highly respected outgoing ECB vice-president Papademos has turned down the offer of the post, which – if confirmed - makes me wonder whether Papademos sees what I see, namely an overwhelming probability that we are indeed heading towards a debt restructuring, and being in the middle of this mess is just not the way he wants to end his fine career. IMF negotiations continue and will presumably pick up pace once Papaconstantinou returns to Athens, but on my schedule they really need to get done around May 6 so that disbursement can take place before May 19. In the European capitals, draft legislation for the loans is likely to be presented in several parliaments this coming week, including in Germany, but no decisions at least for another week or so. The whole thing is moving terribly close to the wire, so one must hope (and assume) that bridging arrangements are being put in place in case something slips." - Erik Nielsen, Goldman Sachs

Zero Hedge is currently going through the 100 or so pages of just released Goldman emails that disclose in excruciating detail the events from late 2006 to late 2007 occurring in Goldman's mortgage trading business. We will have a lot more to say on this tomorrow, suffice to say that we were pleasantly surprised that C-BASS, which we uncovered recently may be implicated in the Goldman SEC fraud scandal, is again involved. We also feel bad for Harvard and MS Prop, and a little better for Hayman Capital. Stay tuned. In the meantime, we will take a brief detour into the financial yellow pages, as we focus on the curious case of Fabrice Tourre, who once again plays a prominent role in today's email discovery. The first thing that caught our attention is the original "Fab Fab" email, finally reproduced in its entirety. One tangent that may be relevant to gleaning some more insight into the character of the "fabulous" 27 year-old mortgage god, is that at the time he penned his email to girlfriend (#1), then Goldman co-worker, Marine Serres, he was likely also with girlfriend (#2) Fatiha Bouktouche, a Columbia University post Doc, to whom he may have been disclosing proprietary Goldman holdings and trades. Who knows to whom, when or how Fatiha may have leaked insider trades whispered to her by Fabrice, and who knows what CDO trades Marine was pitching to the retarded (and soon to be bankrupt) European banks gobbling up everything Goldman would sell them, structured and originated by her boyfriend.

Yesterday we first posted Jeremy Grantham's latest letter which incidentally is a must read for everyone who still is stupid enough to think this market reflects anything remotely related to fundamentals, when instead all it is pricing in is the money printing Kommendant's daily predisposition to continuing his dollar decimation via ZIRP and shadow QE. Just like all those who are buying Apple at these stratospheric prices are in essence selling life insurance on Steve Jobs (sorry, someone had to say it), all those buying into the market here are betting the Fed is apolitical when it comes to monetary policy decisions: a proposition so naive and ludicrous, it is not surprising that only the momos continue to buy into the rally, which is driven purely by Primary Dealers recycling money they lend to the treasury which in turn is repoed back by the Fed, so that the banks can buy 100x P/E risky stocks with the same money used to keep the treasury curve diagonal. This is nothing but Fed-sponsored monetary pornography at its NC-17 best. Of course, those who grasp it are few and far between, while the rest of the population is ignorant in its hopes that S&P 1,500 is just over the horizon, without a resultant crash back to 0 on the other side of the bubble. So for all those who are still confused (this means you Kommendant Bernanke) here is a 6 minute clip in which Grantham tells it just the way it is: there is nothing more to this rally that free money and banks' last ditch attempt to lock in another year of record bonuses before it all goes to shit. And the implication - play with the big boys at your own peril. "Bubbles are when you should cash in your "career risk units" and do something brave to protect the investors. There is nothing more dangerous and damaging to the economy than a
great asset bubble that breaks, and this is something that the Fed
never seems to get. Under Greenspan's incredible leadership he managed to give us the
tech bubble, and by keeping interest rates at negative levels for three
years drove up the housing bubble, and finally the risk bubble. And
Bernanke has happily picked up the mantle, and seems totally
unconcerned about creating yet another bubble. He has interest rates so
low banks can't possible not make a fortune. Savers are being
penalized, anyone who wants to buy cash faces a painful experience, and
so we are all tempted into speculating, which is apparently what he
wants and we've just had one of the great speculative rallies in
history, second only to 1932-33."

Has G-Pap chosen the US and the IMF, over a no-strings attached, no austerity package, provided by Russia and China? "The person alleging this information was supposedly involved in the actual meetings in which these decisions were made. If this turns out to be true, and makes headlines, expect serious social unrest and possibly the Greek government to fall in short order."

A few weeks ago we indicated that the S&P Large contracts surged in the week ended March 23by the biggest amount since the March 2009 lows (which incidentally was followed up by the latest phase of the most ridiculous market melt up since 1932), observing the capitulation phase of the melt up. So it is interesting to point out that non-commercial speculative positions in the just as relevant E-Mini contracts hit the greatest short exposure since the collapse of Lehman, declining to -51,180 in the week ended April 20th. The last time we were negative by such an amount was in November 2008, when the market was plunging daily, however then the bias was positive with E-Minis surging all the way to the March inflection point at which point they collapsed once the market started its seemingly endless creep higher. Have we reached another inflection point, with the E-Mini specs, at least, betting there is a market correction upcoming?

Goldman: "We expect the S&P 500 to rise to 1300 by mid-year (+8%), before ending 2010 at 1250 (+3%)." And here is why companies will continue to "beat" better than expected stimulus and ZIRP-driven outperformance "investors should note that in most cases analysts have not incorporated the strong 1Q results into full-year 2010 EPS forecasts. A benign interpretation is that analysts want to remain conservative in their profit forecasts to allow future quarters of “beat and raise.” Alternatively, analyst reluctance to raise profit forecasts despite strong results may reflect deeper concerns about the trajectory of the current recovery. In aggregate, 1Q EPS has surprised by 8% but 2Q-4Q estimates have risen by only 1%. Only 42 stocks experienced “Beat and Raise” where post-earnings release upward EPS revisions exceeded the magnitude of the positive
EPS surprise. The companies were concentrated in Information Technology and Consumer Discretionary sectors. In contrast, many Health Care and Financials companies were among the 16 stocks that “Beat and Lowered” and negative share price performance typically followed." And it couldn't possibly be a Goldman report without the words decoupling and BRIC thrown in for very good measure: "The proverbial “de-coupling” of demand is clearly evident in the 2007-09 change in S&P 500 revenue by geography. After adjusting for constituent changes and corporate actions, total sales for US companies fell by 4% during the past two years while sales to BRICs regions – Brazil, Russia, India, and China – surged by 10%." Yet: "S&P 500 firms generated $8.4 trillion in revenues in 2009 and 70% occurred domestically. The foreign share of aggregate US corporate sales has remained relatively static over the past two years."

The incest continues: the WSJ has informed that the SEC's chief investigator, Robert Khuzami, used to be general counsel for Deutsche Bank, and presumably reviewed numerous CDO-related transaction, while on the "other side" of the wall. "As part of that job, he worked with lawyers who advised on the CDOs
issued by the German bank and how details about them should be
disclosed to investors. The group included more than 100 lawyers who
also defended the bank against lawsuits and vetted other financial
products, these people said." The good: he probably knows more about CDOs than any other person in government administration history, and thus would not have brought on the Goldman case without being aware of all the potential tripwire nuances (and yes, if the Goldman case gets to the discovery stage, which it will, it is game over for Goldman's defense strategy, which means settlement and/or much worse). The bad: who knows how many Deustche Bank CDO's of comparable or worse nature he allowed to see the light of day. The most interesting: "Because of Mr. Khuzami's old job and his financial interest in the
company, he has recused himself from any matters related to Deutsche
Bank, according to an SEC spokesman." With Greg Lippmann's (legendary head of CDO trading at the German firm whose assets are greater than all of Germany's GDP) recent sudden departure, and the SEC being prevented from bringing CDO-related charges against the bank (for the time being), is DB currently actively cleaning up its tracks? After all the firm was one of the top 3 CDO issuers in the period under consideration.

Carl Levin's Senate Permanent Subcommittee on Investigations released several internal emails that indicate that Goldman, well duh, was actively shorting the mortgage market. Um, we all already knew that. Although what is relevant is that this once again bolsters the case for the Volcker Rule - as Levin points out: “Investment banks such as Goldman Sachs were not simply market-makers, they were self-interested promoters of risky and complicated financial schemes that helped trigger the crisis.” In other words, Goldman's traditional defense that all it does is match buyers and sellers while holding some "inventory" is blown out of the window. And this will be magnified substantially during the April 27th grilling of Blankfein (and Tourre). On the other hand didn't the president himself, with great aplomb, say that the Volcker rule is coming thus causing the February correction? So whatever happened to the presidential decree being followed true? Oh yeah, it stopped at the Chris Dodd barrier of corruption which only filters through whatever his Wall Street superiors allow him to.

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.