Ratings Agencies

The SEC’s crackdown on the State of New Jersey this week for misrepresenting the condition of its pension funds has cities and states scrambling to make sure their pension disclosures are in order. Is this the tip of the iceberg?

The American public thinks they are rugged individualists, who come
to conclusions based upon sound reason and a rational thought process.
The truth is that the vast majority of Americans act like a herd of
cattle or a horde of lemmings. Throughout history there have been many
instances of mass delusion. They include the South Sea Company bubble,
Mississippi Company bubble, Dutch Tulip bubble, and Salem witch trials.
It appears that mass delusion has replaced baseball as the
national past-time in America. In the space of the last 15 years the
American public have fallen for the three whopper delusions:

1. Buy stocks for the long run
2. Homes are always a great investment
3. Globalization will benefit all Americans

A New Normal world is likely to
be one with frequent flips between “risk on” and “risk off” days. With
so much profit and loss riding on tail events and so little profit and
loss tied to the cluster of outcomes near ex ante means,
repositioning will likely be more frequent. This is because many
investors lack conviction in their understanding of the true
distribution, so that each passing day provides an opportunity to learn
or unlearn how likely the relevant tail events are. Positioning
for mean reversion will be a less compelling investment theme in a world
where realized returns cluster nearer the tails and away from the
mean. James Carville said twenty years ago that he
wanted to be reincarnated as the bond market because the vigilantes had
so much clout over policymakers. But in the New Normal world, he might
wish to be reincarnated as the Asian equity markets because they are
where traders in Europe and the U.S. look to see if it is a “risk on” or
“risk off” day. With so much money chasing fewer assets with known
return distributions, and with reliable investment rules of thumb
scarce, frequent flips between “risk on” and “risk off” days will likely
be a continuing symptom of the Knightian uncertainty that still, to
some extent, hangs over global financial markets.

- Richard Clarida, Pimco

As if to confirm the recent slams from Dagong, the largest Chinese credit rating agency, WSJ reported today that the U.S.-based big three credit firms have made an urgent new request of their clients: Do not use our names on bond issues.

The recently passed Donk (Dodd-Frank) Finreg abomination, which nobody has yet read is finally starting to disclose some of the interesting side effects of its harried passage. Such as that the rating agencies may have suddenly become extinct. As the WSJ's Anusha Shrivastava discloses: "The nation's three dominant credit-ratings providers have made an urgent new request of their clients: Please don't use our credit ratings." The Moodies of the world suddenly have good reason to not want their name appearing next to those three A letters (at least in Goldman CDO and bankrupt sovereign cases) out there: "The new law will make ratings firms liable for the quality of their
ratings decisions, effective immediately." In other words, "advice by the services will be considered "expert" if used in formal documents filed with the Securities and Exchange Commission. That definition would make them legally liable for their work, meaning that it will be easier to sue an firm if a bond doesn't perform up to the stated rating." And since ratings are officially a part of a vast majority of Reg-S filed documentation, the response by issuers has been a complete standstill in new issuance, especially asset-backed underwriting and non-144A high yield issues, as the raters evaluate how to proceed. Alas, as there is no easy fix, underwriters' counsel and issuers will promptly uncover new loopholes and ways  to issue bonds without the rating agencies' participation. Did Moody's and S&P just become extinct?

For the first two quarters of this year, we’ve been pounding the
pavement on the risks inherent throughout Europe. The 50+ article (and
counting) series known as the Pan-European Sovereign Debt Crisis is
rife with opinion, analysis, commentary (albeit rather smart ass
commentary), and data that is hard to come across from objective
sources.

The IMF has issued a less than stellar outlook of the US economy after consultations with US government authorities, in which it cautions that even as the outlook has generally improved, major downside risks remain: "On the downside, the backlog of foreclosures and high levels of negative equity, combined with elevated unemployment, pose risks of a double dip in housing; the continued deterioration in commercial real estate poses risks for smaller banks; and financing conditions remain tight, especially for smaller firms reliant on bank finance. Most recently, and tipping the balance of risks to the downside, sovereign strains in Europe have become an increasing concern, potentially impacting the United States through financial market and, in a tail risk scenario, trade links." Also notable is the fund's warning on the state of the US consumer and the perceived overvaluation of the dollar: "It follows, as also emphasized in last year’s Article IV, that the United States can no longer play the role of global consumer of last resort, underscoring the importance of measures to boost growth and demand in current account surplus countries. With the U.S. dollar now moderately overvalued from a medium term perspective, this will need to be accompanied by greater exchange rate flexibility/appreciation elsewhere."

Yesterday, NY's pension fund sued BP for having the temerity to see its shares drop. Today, the Democratic candidate for Texas  AG has filed a Legal Complaint and Legal Brief against Goldman Sachs et literally al for "causing financial crisis and physical harms; recession; unemployment;
home and wealth loss; forced cutbacks in a wide variety of critical
areas, including medical care, social services, and environmental
protection" and pretty much everything that is bad in the world. Tomorrow, one million Americans file a class action lawsuit against E-Trade for experiencing a downday.

Making money as the sell side turns on itself...

A quick piece on how we're selecting stocks to short for the balance of 2010, along with a live spreadsheet of over 1,400 non-financial stocks in our initial pool of candidates, including their pricing and key solvency metrics.

The bankruptcies and debt collapses are coming as a result of overcrowding in the sovereign and public debt markets. This series aims to prepare you for the coming collapse... The Doo Doo 32 revisited!

The primary indicator used by Jim Caron in his daily letter to assuage client fears about contagion, 3 month Libor, has taken a step for the worse. As Market News reports: "Dollar and euro 3-month LIBOR both rose Tuesday, with the dollar rate at its highest since July 6 last year and the euro rate at its highest since Dec 29 2009. The euro overnight LIBOR rate rose 32.13 basis points, due to the end of the European Central Bank maintenance period, while the 3-month LIBOR rate was up 0.19 points." Adding to increasing short term funding concerns was the fact that going forward the ECB will take a 5% haircut on all Greek bonds posted as collateral with the ECB. As this amount has surged recently, Greece will be now forced to post yet more bonds just to cover the spread. Luckily, Greece is allowed to post any collateral at all, as the once-prudent ECB now allows for any worthless collateral to be pledged for cash on its balance sheet. Very much like our own Fed. Lastly, yesterday's Greek downgrade by Moody's drew harsh criticism by Europe. As Reuters reports: "Moody's decision came at quite an astonishing and unfortunate moment" according to Olli Rehn, who added "the downgrade had not taken into account latest developments in Greece." On the other hand, seeing how much credibility (none) the Greek government has, after having been caught lying about its deficit for years, is this really a surprise?

The European Commission is proposing that an already-planned central European Union regulatory body — the European Security Markets Authority — should take on oversight of the existing rating agencies when it is due to begin work in January 2011. Will this be enough?

The title says it all...

Goldman's Erik Nielsen has yet to disclose if he is joining his Euro-pal Jim O'Neill in declaring all out war on the bears (for those unsure about the reference see here, and FYI Jim, the grizzlies send their love... and in keeping with the animal references, they don't really give a rats ass about the occasional dead cat bounce). What he has no problem disclosing, however, is his latest round of rose-colored ebullience, even as other, "slightly" more objective europundits see the end of the Eurozone as ever more imminent. It is stunning how cognitive dissonance can lead two people to the following diametrically opposite conclusions: Erik Nielsen: "The European recovery continues to look pretty good and solid to me" and Ambrose Evans-Pritchard: "[the Pan-European austerity package] can end only in two ways. Either Germany tolerates massive monetary reflation by the ECB or Spain will be forced out of EMU, setting off a catastrophic chain-reaction through north Europe's banking system." Of course, when one is in the business of perpetuating ponzies, while another has a page view quota, the truth likely is somewhere inbetween. Then again, "inbetween" two polar opposites is a wide range. Anyway, since we will likely see a lot more pain "on the plain" shortly, here are some soothing words for all those who are still long and strong and need goal-seeked analyses.