Bear Stearns

As the flow of subsidies from Washington slowly ebbs, the TBTF banks will begin to feed upon one another...

Falling interest rates are a feature of our current monetary regime, so central that any look at a graph of 10-year Treasury yields shows that it is a ratchet (and a racket, but that is a topic for another day!).  There are corrections, but over 31 years the rate of interest has been falling too steadily and for too long to be the product of random chance.  It is a salient, if not the central fact, of life in the irredeemable US dollar system. Irving Fisher, writing about falling prices (I shall address the connection between falling prices and falling interest rates in a forthcoming paper) proposed a paradox: “The more the debtors pay, the more they owe.” Debtors slowly pay down their debts and reduce the principle owed.  This would reduce the NPV of their debts in a normal environment.  But in a falling-interest-rate environment, the NPV of outstanding debt is rising due to the falling interest rate at a pace much faster than it is falling due to debtors’ payments.  The debtors are on a treadmill and they are going backwards at an accelerating rate. How apropos is Fisher’s eloquent sentence summarizing the problem!

Do the good citizens of the Wall Street establishment broadly defined understand the risks taken by the House of Morgan?

In light of the just announced huge 8-K which has JPM admitting it was mismarking hundreds of billions in CDS, in effect destroying the CDS market for everyone (as we predicted 2 months ago would happen), the firm's earnings (and CIO losses) are very much irrelevant. But here they are regardless: $5 billion in Net Income, which includes a $4.4 billion in CIO losses offset by $1.0 billion from "securities gain in CIO investment securities" i.e., asset sales; also in Q2, the firm took a $2.1 billion "benefit" from reducing loan loss reserves (the usual accounting gimmick), and $0.8 billion DVA "profit" as a result of its CDS blowing up. Finally JPM also announced $0.5 billion gain on a "Bear Stearns related first loss note." In summary, expectations were for $0.76 in EPS; reported EPS Ex-DVA were $1.09, and ex-all one time gains, $0.67. In other words, JPM's bottom line is totally meaningless, as the bulk of profits are from totally garbage and meaningless numbers. The real question is how much net income is now forever gone as a result of i) the unwind of the CIO's synthetic division, aka the most profitable group at JPM, and ii) the fact that the entire firm's CDS marks were made up and will now have to reflect reality. Now, back to the main news of the day: the fact that JPM just threw the entire CDS market under the bus, and England's Lieborgate just arrived in the US courtesy of CDS-gate.

Digging into the details of US and UK Liebor duing the crisis period is stirring both bad memories and some very clear disclocations from reality. While we noted many of these at the time, they seem even more egregious now and as Peter Tchir of TF Market Advisors notes, outliers seem to be Citi, RBS, and to a less extent UBS. Our perception was that RBS was viewed as a worse credit than Barclay’s. CDS seems to confirm that, yet they are posting LIBOR significantly tighter. UBS always seemed to have some decent government support, so while maybe a stretch that they were quoting LIBOR close to JPM and DB, it isn’t totally unreasonable. DB if anything looks conservative relative to other prices. Citi just seems ridiculous. The CDS market was trading it as the worst of the credits, yet here they are with the best LIBOR. That looks consistent throughout the entire the period. Maybe there is something we're missing and just don’t remember, but it does seem surprising that Citi thought they could fund at the same level as JPM at the time in the unsecured interbank market. At this point it is all just speculation where the information Barclay’s has provided the FSA leads, but so many people have been talking about LIBOR so long, that we would be shocked if it ends at Barclay’s and there is enough data, in our mind, to warrant some much deeper investigation.

Last Tuesday we suggested that "Now The Fed Gets Dragged Into LiEborgate" when we observed that "Barclays also cited subsequent research by the New York Federal Reserve staff members that, according to the lender, concluded that banks’ Libor quotes were systematically below their borrowing rates by 39 basis points after the Lehman bankruptcy. “Barclays own submissions for tenors of 1 month to 1 year Libor were higher than actual Barclays trades on 97% of the occasions when Barclays had actual trades during the financial crisis,” the lender said." It seems that unlike the BOE, which had no idea of any Barclays problems and was merely calling up Diamond now and then to make sure the bank's money market risk mechanisms were operational and to chit chat about the weather (as per the BOE at least), the Fed has decided to take the high road and openly admit it was well aware of Barclays' LIBOR "problems." And like that the Senatorial circus just got exciting, while that popping noise is bottles of Bollinger going off at every class action lawsuit legal firm.

Despite BoE's Tucker telling us this morning that there is no need to look at any other market but LIBOR, it appears the world has moved on from this debacle of indication of anything. As we pointed out here, the 'stability' of LIBOR given everything going on around it is incredulous (whether due to the ECB's crappy-collateral standards-based MROs or the Fed's FX swap lines - since unsecured interbank financing is now a relic of the pre-crisis 'trust' era). Furthermore, as we discussed yesterday, the machinations of the LIBOR market and calculations (which Peter Tchir delves deeply into below) suggest that this not the act of a lone assassin suggesting quite simply that complaining or suing Barclays is redundant - any Libor-related suits (from the public or the government/regulators) must sue all the submitters or it misses the critical facts of the manipulation.

Fed Chairman Bernanke should be impeached if he does not restore Fed surveillance over primary dealers immediately.

It should come as no surprise to anyone that major commercial banks manipulate Libor submissions for their own benefit. As Jefferies David Zervos writes this weekend, money-center commercial banks did not want the “truth” of market prices to determine their loan rates. Rather, they wanted an oligopolistically controlled subjective survey rate to be the basis for their lending businesses. When there are only 16 players – a “gentlemen’s agreement” is relatively easy to formulate. That is the way business has been transacted in the broader OTC lending markets for nearly 30 years. The most bizarre thing to come out of the Barclays scandal, Zervos goes on to say, is the attack on the Bank of England and Paul Tucker. Is it really a scandal that central bank officials tried to affect interest rates? Absolutely NOT! That’s what they do for a living. Central bankers try to influence rates directly and indirectly EVERY day. That is their job. Congresses and Parliaments have given central banks monopoly power in the printing of money and the management of interest rate policy. These same law makers did not endow 16 commercial banks with oligopoly power to collude on the rate setting process in their privately created, over the counter, publicly backstopped marketplaces.

Seven out of the seventeen economies that belong to the European Union that need to be bailed out. This is 41% of the Euro-17 that is in trouble. The second indication of decline is the recessions in Europe. In fact virtually all of Europe is in a recession and while Germany has held its head above the water I think by the third or fourth quarter that she is also mired in an economic decline. Europe is 25% of the global economy and this is beginning to affect the United States as exemplified by the declining revenues and profits of many American corporations that have so far reported out this quarter. The axes of the financial markets are America, Europe and China and with Europe in serious decline and China also contracting the strings are vibrating so that all of the markets are likely to go down. Even without some cataclysmic shock, realization is coming. The debts of Europe are being paid off with ever more debt and the can kicking will find its walls and as the European recession deepens it will be felt in America and then adjustments will have to be made - as fact overbears fantasy.

The Fed does everything it can to keep LIBOR low. The Fed cannot affect LIBOR directly, but in general LIBOR trades in line with Fed Funds.  You can see that historically as Fed Funds was changed, LIBOR responded appropriately. That all started to break down in 2007 and re-ignited in the late summer of 2008 and peaked after Lehman and AIG. The Fed was blatantly clear that it wanted borrowing costs to go down.  They had the obvious tool of reducing Fed Funds to virtually zero, but when LIBOR didn't follow, the Fed took further action. The Fed has done a lot and trying to control LIBOR as a key borrowing rate is one of the things they have worked on, both directly and indirectly.

Now that all know bank collapse is guaranteed, what assinine steps will be taken next?

Someday, it will go down in history as the first trial of the modern American mafia. Of course, you won't hear the recent financial corruption case, United States of America v. Carollo, Goldberg and Grimm, called anything like that. If you heard about it at all, you're probably either in the municipal bond business or married to an antitrust lawyer. Even then, all you probably heard was that a threesome of bit players on Wall Street got convicted of obscure antitrust violations in one of the most inscrutable, jargon-packed legal snoozefests since the government's massive case against Microsoft in the Nineties – not exactly the thrilling courtroom drama offered by the famed trials of old-school mobsters like Al Capone or Anthony "Tony Ducks" Corallo. But this just-completed trial in downtown New York against three faceless financial executives really was historic. Over 10 years in the making, the case allowed federal prosecutors to make public for the first time the astonishing inner workings of the reigning American crime syndicate, which now operates not out of Little Italy and Las Vegas, but out of Wall Street.

Why hasn't anyone realized that JPM actually had negative revenue growth despite muppet maven analyst proclamations of the contrary?

The middle class has a gut feeling they are being screwed by somebody, they just can’t figure out who to blame. The ultra-wealthy elite keep up an endless cacophony of propaganda and misinformation designed to confuse an increasingly uneducated and willfully ignorant public while blurring the facts for those educated few capable of understanding the truth. They have been able to keep the masses dumbed down through government run education; distracted by sports, reality TV, Facebook, internet porn, and igadgets; lured by mass media messages of materialism; and shackled with the chains of debt used to acquire the goods sold by mega-corporations. We’ve become a society oppressed by a small faction of ultra-wealthy masters served by millions of impoverished, uneducated, sedated slaves. But the slaves are getting restless and angry. The illegally generated wealth disparity chasm is growing so large that even the ideologue talking head representatives of the elite are having difficulty spinning it. Even uneducated rubes understand when they are getting pissed on.