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.
A very interesting week with some notable divergences among capital structures and asset classes. Most notable is the widespread underperformance of FINLs, IG corporates, Sovereigns, and TSYs as HY and equities continue to charge higher. Steepening in corporate curves coincided with flattening in TSYs which suggests deep-down some risk-aversion as credit duration is reduced and extended in govvies but HY saw flattening (duration extension) at the short-end which may explain where that risk went.
The Republican escalation into the SEC's Goldman investigation is hitting new highs: late today, Darrell Issa sent a letter (see below) to the SEC Inspector General, David Kotz, demanding an investigation into the timing of the Goldman lawsuit. "The circumstances of the filing and subsequent events fueled suspicion that the Commission, or one or more of its officials or employees, may have engaged in unauthorized disclosure or discussion of Commission proceedings in order to affect the debate over financial regulatory legislation currently pending before the United States Senate." He concludes" Disclosure rules and procedures at the SEC are importnat to efforts to prevent insider trading and any violation would be deeply troubling." An interesting tidbit from the letter: "the online publication by the New York Times of an article describing the Goldman suit prior to the release of the Commission's official announcement is evidence that news of the suit leaked form the Commission via unofficial channels." The last thing the porn lovers at the SEC need is for the IG to find both Mary Schapiro, and the President of the United States, guilty of lying on air seeing how they both denied Issa's allegation. In retrospect, that finding by Kotz alone would be worth the price of admission that Goldman is perfectly innocent of disclosure fraud (we'll leave that one to the jury, what Goldman is much more guilty of is being a market monopolist and there is little disputing that particular fact, which is why we believe Kaufman's noble campaign to cap bank size is very much doomed).
Many is the time I would review a write-up of a new deal and scribble in the margins, "Get to the bleeping point!'' Unless you can articulate, up front, exactly what assets we would be lending against, and what circumstances would cause us to lose money (i.e. a quick-and-dirty breakeven analysis), you don't really know what you're talking about. And if you don't have a good grasp of that issue, everything else you have to say is superfluous, a waste of time. This lack of common sense is pervasive, extending far beyond the financial services industry. (When, over the last seven years, have you ever heard a journalist ask, "How many troops do we have to replace those currently deployed in Iraq?") In certain markets, most notably, CDOs, this lack of common sense was institutionalized. It's evident in the deal book for Abacus 2007 AC-1, at the center of the S.E.C.'s case against Goldman. What risks are investors assuming? The presentation doesn't say. There's a reference portfolio of 90 subprime mortgage bonds, on pages 55 and 56, which ostensibly would be insured via credit default swaps for the benefit of Goldman. But, as the small print says, "Goldman Sachs neither represents nor provides any assurances that the actual Reference Portfolio on the Closing Date or any future date will have the same characteristics as represented above." According to my bias, everything else in the 66-page presentation is superfluous. And the real reference portfolio for Abacus 2001 AC-1 remains, to my knowledge at this point in time, hidden from public view.
It is a well observed fact that every time a country builds the tallest buildings in the world, or decides to venture into similar kinds of excess, it usually is a good sign of the end of a speculative era and is a good market top indicator. Similarly, we clearly had a run up in Chinese equities ahead of the Olympics last year as the country was building infrastructure to host the worl, and a whole lot more. Well, now get ready for the world cup effect. With 0.7% of the world population and 17% of the HIV epidemic, the country has a lot of problems and once the momentum post world cup abates we think the economy could tank pretty seriously. - Nic Lenoir
Carry Trade Fully Armed And Primed: JPY Shorts Near Recent Record Highs, As EUR, GBP And CHF All Remain At Net Short SpecSubmitted by Tyler Durden on 04/23/2010 - 18:10
The latest COT report by the CFTC is out: no surprises - the JPY shorts came in at near record levels after four weeks of increasing net spec short exposure. If you need to know what the funding mechanism has been for everyone who does not have access to the Fed's discount window to buy stocks at negative carry, here you go. Everyone and their grandmother is now shorting yen and using the proceeds to buy, buy, buy all risky assets. And not just yen: all the major currency pairs had net a spec short balance the week ended April 20: EUR non-commercial shorts jumped by 15,960 to -71,424, also close to record levels, while the GBP and CHF were also being shorted as the stock buying rampage was in full nitrous mode. From a massive dollar carry trade late last year, we have no moved to an even massiver non-dollar carry trade as every non-developing central bank is rushing to keep ZIRP in perpetuity.
Welcome To The Banana Republic: GM In Hot Water With FTC Over Misleading "Repaid Bailout" Ad When All Just TARP ShuffleSubmitted by Tyler Durden on 04/23/2010 - 16:34
We are too busy maxing out our credit cards buying AAPL shares after hours into the parabolic blow out (using Sigma X of course, how else could we subpenny front run our own orders?), stacks of Kindles, 7th vacation homes with negative equity, and LBOing zero EBITDA companies to comment on this, suffice to say that if you ever needed confirmation that America is a banana republic in which fraud, corruption and lies are now the norm, here you go: Government Motors is now blatantly lying to its existing and future buyers, and everyone in the administration is complicit.
It’s spring, and this spring a young man’s fancy lightly turns to thoughts of speculation. The Fed’s promises look good and, as long as you’re not a small business, you can borrow to invest or speculate at no cost. The market has had a near record rally, sprinting far past our estimated fair value of 875 for the S&P 500. Bernanke is, in fact, begging us to speculate, and is being mean only to conservative investors like pensioners who cannot make a penny on their cash. Collectively, we forego hundreds of billions of potential interest, but at least we can feel noble because we are helping to restore the financial health of the banks and bankers, who under these conditions could not fail to make a fortune even if brain dead. We are also lucky to have a tiny fraction of our foregone interest returned by the banks as loan repayments with “profit.” Some profit! Oh, for the good old days when we could just settle for a normal market-clearing rate of interest. But that, I suppose, would be wicked capitalism, and we had better get used to bank- and speculator-benefiting socialism. - Jeremy Grantham, GMO
Larry Summers, whose days in the Obama administration are thankfully numbered, presents the most incoherent rambling defense of our monopoly banking system, yet to appear in the public domain. When asked if US mega banks should be broken up, reports the HuffPo, "Summers said no. He added that it's not significant. But that's not the important issue," Summers said during the interview, adding to his answer as to why the U.S. shouldn't break up megabanks. "[Observers] believe that it would actually make us less stable, because the individual banks would be less diversified and, therefore, at greater risk of failing, because they would haven't profits in one area to turn to when a different area got in trouble. And most observers believe that dealing with the simultaneous failure of many -- many small institutions would actually generate more need for bailouts and reliance on taxpayers than the current economic environment." We dare you to reread the above from Larry the Hutt and not have your frontal lobe disintegrate into antimatter. Sure, 4 out of 5 Goldman CDO traders totally agree that Goldman's monopoly in the capital markets is terrific, and, in fact, if someone could "organize" a liquidity event at RBC, Barclays, UBS and CS, they would really apprciate it, doubly so if, like JPM, they could then acquire the firms for a dollar over their Fed guaranteed debt. As for everybody else, well, if you have any doubt that Larry Summers is having his future personal assistant organizing his corner office at 200 West, he hope this should resolve it.
Greeks Call For Referendum On IMF Bailout, Call Austerity "Barbaric Attack" And "Premeditated Crime Against Greek Society"Submitted by Tyler Durden on 04/23/2010 - 14:08
Looks like the downloads of "Austerity for Bankrupt Dummies" on all those paradropped Kindles, which Amazon was forced to do after the market did not share its outlook enthusiasm, has had the desired effect: suddenly with everyone understanding what is required, the threats of an revolution (both literal and metaphoric) are hitting a crescendo. As Bloomberg reports: "ADEDY, the Athens-based federation representing the more than 500,000 Greek civil servants who have seen wages cut this year, said the move signaled a new and “barbaric attack,” and called a protest rally for April 27 [yep, another day of strikes and rioting]. Another demonstration has been set by the opposition Syriza party for today in Athens. "This is a premeditated crime against Greek society,” Alexis Tsipras, the head of Syriza said in an e-mailed statement. “The majority of the Greek people are being tossed helplessly in the tempest of insecurity, unemployment and poverty.” He called for a referendum on the decision to seek IMF support." So here we are, and neither Germany nor Greece really wants the bailout So who the hell is benefiting from all this theater? Why, the major banks, of course, and a few politicians who are, and tried and true Chris Dodd fashion, are merely their lackeys for life. We are now convinced that there will be a government overhaul, hopefully peaceful, but most likely violent, in Greece in the next 3 months if the IMF bailout in fact occurs. We wish we could say the same thing about the United States.
"Who is this market participant stepping in front of my displayed offer? Who is this market participant intercepting the buy orders that are trying to take my displayed offer? Who is this market participant forcing me to pay the spread and hit the bid below? According to the implied exemption given under SEC rule 612, the only market participants capable of trading in sub-pennies are broker-dealers, to offer price improvement. Is this $0.0001 price improvement justification for compromising the displayed quote? This isn’t an isolated event, these events happen continuously every day in this two-tiered market structure. This is a crime of epic proportions, and our regulators need to deal with this immediately." Dennis Dick, Bright Trading
All you need to know about why the Greek bailout decision changes literally every 15 minutes.
"In the depths of the 2008 crisis it was the governments that stepped in to provide a guarantee on financial assets. It was the governments that backed our savings accounts, money market funds, day-to-day business banking accounts, as well as debt issued by US banks. But what happens when confidence in the government guarantee begins to erode? We’ve seen what happened to Greece. Leverage inherent in the banking system elevated a bank run, equivalent to a mere 3.6 percent of deposits, into another full blown banking crisis. In our view it’s time for investors to acknowledge sovereign risk. The ratings agencies can opine all they want, but it seems clear to us that the only true AAA asset to protect your wealth is gold. " Eric Sprott
Playing The Contagion II: Goldman Recommends Betting On Contagion Risk In Portuguese, Spanish And Italian BanksSubmitted by Tyler Durden on 04/23/2010 - 12:43
Earlier we pointed out the surge in CDS on a variety of PIIGS banks, mostly in Portugal and Spain. Now we know why: Goldman's Charles Himmelberg has just reiterrated his call for Long CDS on local banks in Portugal, Spain and Italy, hedged by selling Main (iTraxx) protection. It is our view that as accounts plough into this trade and as bank spreads blow out, it will only accelerate the funding complexities, the bank runs and the inevitable collapse of the financial systems in all of the other imparied peripheral countries, ultimately leading to the collapse of the EMU. Will Goldman be accused next of destroying Europe? Stay tuned.
We see considerable scope for other, fiscally weak EMU markets to underperform in the current environment. Portugal, another dual deficit economy, has underperformed sharply over the past week, with 10yr spreads to Germany reaching new wides and PGBs now trading around 20bp wider in ASW terms than Irish gilts in the 10yr sector. Spain continues to defy its relative fundamental weakness and remains particularly rich in the EMU space, as shown by our rankings. However, we sense that SPGBs are starting to lose favour and increasingly Spain should be exposed to tighter liquidity conditions as the ECB withdraws its special OMOs. The collapse of the Belgian government has finally been the catalyst for a repricing of OLOs, which in our view have already out-punched their weight relative to core EMU markets, notably Germany. We would also consider shorting OLOs versus the smaller core markets of the Netherlands, Finland and Austria or, indeed BTPs. - Citigroup