Archive - Aug 2011 - Story

When we last looked at the Bank of America joke of a "non-settlement" settlement for a paltry $8.5 billion when $424 billion in total misrepresented (530 in total) Countrywide mortgage trusts were at stake, we said, "we are confident that the legal process will prevail and that the presiding judge on this case, and if not him then certainly the New York District Attorney, will step up and demand a thorough reevaluation of the settlement process." We were, oddly enough, correct. According to a just released filing from the New York Attorney General Eric Schneiderman, Bank of America (and Bank of New York Mellon, one of the tri-party repo banks mind you), violated New York state law and "misled investors." In a knock out punch to Bank of America (and Brian Lin who was profiled here previously), the  bank allegedly violated the New York’s Martin Act and misled investors about its conduct tied to mortgage securitization as Bloomberg summarizes. Schneiderman said he has "potential claims" against Bank of America Corp. and its Countrywide Financial unit. As Zero Hedge alleged all along, "The proposed cash payment is far less than the massive losses investors have faced and will continue to face." What does that mean? Well, as the countersuit by the FHLB indicated (which we are certain will be the basis for the NY AG claims), the likely final settlement is probably going to be about $22 to $27.5 billion. Which also means that the bank's Tier 1  capital is about to be discounted by about 25% lower. Which, lastly, means that the stock is about to plunge due to a massive litigation reserve shortfall which will have to be plugged with, surprise, a new equity capital raise. Which brings us to our original question: got CDS (which closed around 200 bps today, roughly 25 bps wider - it is going much wider tomorrow, especially if the expected Sarkozy-Merkel-Zapatero meeting achieves absolutely nothing)? Cause this baby is going down...and it is probably about to be broken up into good BAC and bad bank, consisting almost entirely of all legacy Countrywide operations. Said otherwise, it could well be time for a CFC-BAC CDS pair trade.

Being honest, no one knows. But, using the current road map it appears we may have a little more selling before a decent move higher. Below is the updated 2007 "analog" as compared to the current market. Few interesting points. At some point this market will rally and will rally hard. Remember there are a lot of participants who view this selloff as excessive and based on fear. They view the macro data as a soft patch and see the Fed ready to launch QE3. When this market rallies they will be very loud in their "I told you calls." Many shorts with conviction after a day or two of market strength will in fact panic and begin to believe in the health of the economy contrary to what they know in their heart.  When studying the 2007-08 chart remember Bear Stearns was "bailed out" by JPM in March 2008 which caused a multi month rally that preceded the epic selloff. My personal view is we are headed for a similar epic selloff. I'm not sure when but suspect it is sooner than most think. BAC breaking down could very well be the modern day LEH failure. We are surrounded by "black swans" right now from rumors of Italian run on the banks to failed Spanish auctions and more.

The irony about the blow up over the past month in "all things Italian" is that the facts about its sovereign debt and viability profile have always been available for anyone to not only see, but make the conclusion that the situation is unsustainable. The fact that so few dared to do so only confirms that affirmative confirmation bias that dominates within 99% of the investing population. Sites such as Zero Hedge and others had been warning for over a year that the Italian "contagion" (which is a misnomer: Italy's lack of viability is perfectly-self contained: it does not need Greece or Portugal to blow up, and can do so perfectly well on its own, but the punditry certainly needs a scapegoat, in this case the incremental layering of "revelations" about how insolvent Europe is) and we have long presented primary source data confirming just how precarious the house of cards is not only in Italy but everywhere else too. Regardless, no matter how conventional wisdom got to the big picture revelation of just how ugly Italy's reality is (and don't think for a minute that Spain is any better) the truth is that the cat is not only out of the bag, but is widely rampaging through the china store (no pun intended), high on speed and methadone. So for everyone who still wishes to know why the Italian jobs is very much hopeless absent the ECB stepping in an bailout out the country, below is a succinct list of 15 bullet points courtesy of The Telegraph, which explains all there is to know about the country's current predicament. In retrospect we certainly can not blame Tremonti for wanting to get the hell out of there.

Alternative economic analysis brings with it a certain number of advantages and insights, but also many uncomfortable burdens. Honest financial research is a discipline. It requires us to not only understand the fundamentals, but to question the fundamentals. It requires us to look beyond what we would LIKE to see in the economy, and accept the reality of what is actually there. With this methodology comes the difficulty of knowing the dangers ahead while the mainstream stumbles about well behind the curve. It means constantly having to qualify one’s conclusions, no matter how factual, because the skeptics and opposition base their views on an entirely different set of rules; farcical rules that no longer (or never did) apply to the true state of our country’s fiscal health.

Less than an hour ago, Larry Kudlow tweeted the following: "Sources tell me Italy has to restructure bonds.Deposit run on Italian banks.EU will have to mount Tarp rescue.Big stress on interbank loans." Basically, this is the worst possible combination for Europe which means that another bailout is not only imminent but has to happen tomorrow. Incidentally Reuters is reporting of an emergency meeting between Sarkozy and Merkel and Zapatero on "the markets" which can only mean damage control following today's disastrous Trichet performance. Too bad the markets won't buy it any longer absent some actual actions to back up the deeds. Yet what we are more concerned about is whether or not there really is a bank run in Italy which would be the end of the euro. For that we went to the most trustworthy indicator for European "bankrunness" the EURCHF. To our surprise, the pair just plunged nearly 100 pips after hours, after dropping over 200 pips from intraday highs following yesterday's SNB intervention. Will this force the SNB to intervene again? Find out shortly. AS to what Sarkozy has up his sleeve, we will just have to wait and see when the European markets open in about 10 hours.

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 04/08/11

For all those wondering if Bernanke has given himself the permission to go ahead with QE3 (which is the only permission that matters, coming courtesy of his bosses at Goldman of course), here is the chart that confirms it. Priced in the anihilated "value" of dollar, the S&P is now almost back to Jackson Hole levels. It is also down 8.6% for the year. As for that far more prosaic chart of the market priced in gold, we won't even go there: basically the entire rally since the March 2009 low has now been wiped out.

The Dow is down more than 500. The S&P is down 60. The VIX surges 35% to 32 the highest since June 2010. Implied correlation surges to the highest since last summer. ES volume surges to the highest since the flash crash. Europe is opening in 12 hours. Margin debt is near record high levels, and mutual funds have record low cash. Liquidations galore. Did we miss anything?

For the sake of John Paulson, we sure hope he sold his BAC holdings which are now well below his cost basis. For the sake of everyone else, we also hope they sold their BAC stakes, if any. That said, we can't wait for the Fairholme Capital's conference call with Bank of America's Brian Moynihan on August 10 from 1 to 2:30 pm in which they explain to the market why it is oh so wrong on the most insolvent bank in America.

Here is a chart of what could well be the biggest concern for the market, and one we have been highlights for a long time: mutual fund cash levels, which as ICI indicates were 3.4% in June, is the lowest ever. A 4% drop in the absolute value of mutual fund investments, effectively wipes out the capital buffer of most. Enter liquidations.

Sometimes it is worth reminding our vacuum tube-based readers that after 2pm only a 3,600 point in the DJIA will force a market close for the day, unlike the FTSE MIB and the Liffe where a 4% drop is sufficient.

When looking for super bullish expectations on the economy, everyone knows where to turn to: Deutsche Bank's Joe LaVorgna of course. However, many readers probably did not know that when looking for worse than consensus expectations about the future, including those cautioning about heightened recession worries, one should turn to... Joe LaVorgna?! That's right, in a just released note to clients, the CNBC staple "pundit" has just said that tomorrow's NFP may not only be 9.2% but may in fact exceed it. He also adds that "Weak income growth, falling stocks will have "damaging effect on business confidence" and make "managers even more hesitant to spend on either labor or capital" His conclusion: "‘If the unemployment rate were to spike, investors would become even more worried about a recession, because unemployment tends to go up sharply just ahead of the onset of recession." Judging by Joey L's predictive track record it may really be time to mortgage that first born and buy everything that is not nailed down.

For those who didn't get their share of laughs listening to Barton Biggs yesterday on CNBC, and his prediction of a 7-9% rally in three weeks (make that 9-11% as of today), here is your repeat chance to do just that as he has a 3:00 pm appearance on Bloomberg TV today. Incidentally, Barton will be absolutely correct if next Tuesday the Fed announces that QE3 is starting. Of course gold will be at $2000 to celebrate the Fed pushing its balance sheet over $4 trillion. Otherwise, the outlook is not so rosy...

QE2 is dead. Long live QE3! Markets rebounded yesterday when Ben Bernanke’s BFF at the WSJ Jon Hilsenrath published an article that quoted senior officials at the Fed as saying that they would give “very serious consideration” to a new round of bond purchases, aka QE3. Not to toot my own horn or anything, but I published a note back on February 2nd called Go All In On Bernanke’s Weak QE3 Hand where I said, “The problem the Fed and Chairman Bernanke now face is that the so-called wealth effect of the rising stock market has been dependent on the existence of QE2 and removing that punch bowl could cause the party to end and reverse the gains, both economic and market, that we have seen in the last 5 months.” At the time, you’ll recall, the market was solidly convinced that QE2 would be the last and final round of QE from the Fed. I disagreed. Unfortunately, it’s starting to look like I was right. However, as a long-time buyer of gold and silver, I have to admit that these never ending rounds QE are a gift from the (finance) Gods. But why should the market get excited about a policy that’s essentially failed, twice, to do anything except temporarily juice stocks higher? I think it’s very simple, the Fed cannot afford to be seen as helpless, they must do something, anything. Otherwise, why have them as Ron Paul might ask? And besides, at this point in the game, what else can they do? Lower rates? Nope, zero-bound already. Lower reserve requirements? Not likely, our TBTF banks are already scraping by with mark-to-model accounting on real estate assets that are currently worth less than they were in 2008 yet still somehow are marked at or close to par. Lowering reserve requirements would likely cause the banking panic currently growing in Europe to quickly jump the pond and land on our shores. Which leaves us with QE3/asset purchases.

The epic blow out accelerates with the widely followed (by the administration) DJIA dropping by over 400 points at last check. And as we warned earlier, the liquidation sell offs in PM, to no small part driven by rumors of yet another CME margin hike, are picking up pace, with silver tumbling from over $42 to just $38.50. We are very concerned we may see another Flash Crash, or Crash Crash as it would be better known assuming there is no imminent bounce back. As such we urge readers to immediately put limit buy prices across the entire S&P that are 19.99% down, as down 20% is the magical border below which the exchanges cancel all trades. Just in case, with circuit breakers at 10% for the top 1000 stocks, a 9.99% limit buy may be a better deal.