Daily Credit Summary: August 10 - Bad Start, Queasy Finish

Spreads closed wider today with HY underperforming IG and for the sixth day in a row, credit underperformed equity on a beta-adjusted basis. The IG and HY indices closed off their worst levels of the day (just prior to the Fed comments) but notably underperformed stocks in the subsequent rally as every correlated asset class disconnected from stocks post Fed. This was a day of three parts to a great degree: pre-market, pre-Fed, and post-Fed; with credit underperforming equities through each phase and financials weak in general - particularly the majors. IG closed at its widest level since 7/28 and HY its widest close in August. IG and HY saw their largest close-to-close widenings since 7/16 (in percentage terms) - the day of the big drop in Consumer Sentiment.

Goldman Explains Why It Is "QE2 Or Bust" For Stocks Tomorrow

Just in case you missed Goldman's economic team shift to outright bearishness, Jan Hatzius presents several key observations that other economists (particularly BofA's Bianco and Dutta) have yet to grasp. And even as Goldman openly expects a recommencement in debt monetization tomorrow to the tune of $1 trillion, Hatzius openly acknowledges that this decision could be delayed... And such a decision would be a major mistake, as it is already priced in: "Such a decision could prove to be a serious mistake, because a
significant part of the recent easing in financial conditions is
probably due to market expectations of a more expansionary monetary
Indeed, if a disappointment on Tuesday results in a significant
renewed tightening of conditions, the decision might ultimately hasten
the transition to further easing steps." In other words, it is pretty much QE or bust for stocks.

Goldman Made Between $11 And $16 Billion In 2009 Trading CDS And Other Derivatives

As part of its most recent FCIC grilling, David Viniar left the political theater a month ago with a homework assignment to disclose all of the firm's derivative profits, as well as provide granular detail on its derivative trades. Today, courtesy of a memo from Goldman intercepted by the WSJ, we now know that derivative trades accounted for between 25% and 35% of 2009 revenue. "Based on the percentages provided by Goldman, such businesses generated $11.3 billion to $15.9 billion of the company's $45.17 billion in net revenue for 2009." As a reminder, the Office of the Currency Comptroller noted (table 2) Goldman had $49 trillion in total derivatives as of Q1. However, the bulk of the profit comes from trading credit derivatives where Goldman, post the assimilation of Bear and Lehman into the collective, is now virtually an undisputed trading powerhouse, and due to the OTC nature of the product allowing firms to set bids and asks as is, as long as liquidity in cash products continues to decline, Goldman will continue to dominate not only the most profitable vertical of derivative trading, but CDS will continue to generate roughly a third of the firm's profits, for both flow and prop. Post the recent shifts in prop trading across Wall Street, it will be interesting to see what the impact on the top line will be now that allegedly CDS trading at Goldman will be exclusively on a flow basis. The irony is that the Volcker Rule seems to focus almost exclusively on equity trading, while the bulk of the firm's questionable flow-prop "Chinese wall" transgressions may occur precisely in derivative trading, and should be the one area under much more scrutiny by regulators and legislators.

To Avoid Volcker, Goldman Goes All Flow, And Why This Could Be The Beginning Of The End For Goldman's Trading "Perfection"

Yesterday Fox Biz' Charlie Gasparino had some unique perspectives into what Goldman's most recent trick to avoid the Volcker prohibition on prop trading is: "The big Wall Street firm has moved about half of its “proprietary” stock-trading operations — which had made market bets using the firm’s own capital — into its asset management division, where these traders can talk to Goldman clients and then place their market bets."It is odd for the firm to jump through such hoops when it itself said, with a very serious face, that prop trading accounts for just 10% of revenue. And there is no reason to doubt that, is there: after all, ignore the fact that as we disclosed this weekend, Goldman would actually have had a ($2.8) billion short CDS position into AIG had its CVA group not intervened and netted off the counterparty risk, thereby the prop group saving the firm once again over and above the stupidity of its flow traders, and believe the latest piece of ARS prop (not as in Auction Rate Securities and not as inproprietary ). Yet even if Goldman does follow through with this move, the logistics involved in this transition will dramatically impair the traditionally exception ROI for Goldman's prop which has generically been the firm's sophisticated version of a front running syndicate to whale flow orders as we have repeatedly claimed. Due to the collocation of prop and flow on the same trading floor, historically prop traders could "claim" they had a brilliant idea of buying X or shorting Y, just seconds after they heard flow sales guy Z shout across the floor that Fidelity was a better buyer|seller of X or Y. Now that the "prop" guys will be integrated into flow operations, the great internalities associated with collocation for big flow accounts will disappear as every trade ticket will have to provide allocation, and major trades that are prorated X to the account and Y to Goldman will draw far more attention if they continue to be 100% profitable, i.e. not trading alongside the failed trades, and only pocketing dimes on the successful trades. Bottom line,Goldman has just gone all flow, and it could well be the beginning of the end for the firm.

Basel III Gutted, Delayed As Even Existing Regulatory Regime Too Burdensome For An Insolvent Banking Industry

In light of recent bombastic statements by priests of Keynesian fundamentalism that European banking is one big, non-dysfunctional, even healthy family, it would have been the logical thing that the Basel Committee on Banking Supervision would if not tighten terms on proposed Basel III implementation, then at least keep them as is. Why is why news that the recently proposed adjustments to Basel III which not only delayed implementation of the "regulatory" framework by many years, allowing banks sufficient time to blow themselves up under thecurrent regime, but also to soften liquidity requirements of all global banks, is merely an indication that global regulators realize that the last free for all, in which every bank is allowed to steal as much as it possibly can before all hell breaks loose, in many times with as little as a penny in the mythical risk reserve concept known as Tier 1 Capital, levered a few hundred billion times, is finally here. And yes, aside from the fact that even the existing massively lax regulatory rules of Basel II need to be toned down is irrelevant: all European banks are healthydammit, and just like in the US, bank failures will continue until credibility returns.

How Goldman's Counterparty Valuation Adjustment (CVA) Desk Saved The Firm From An AIG Blow Up (And Opens Up A Whole New Can Of Wormy Questions)

In today's NYT, Gretchen Morgenson does a good summary of how Goldman was demonstratively net short net short AIG (or net long its CDS, depending how one looks at it) via nearly 100 counterparties to the tune of just over $1.7 billion in net notional, after Chuck Grassley released several previously classified documents disclosing Goldman's CDS position as of September 15, 2008, the day of Lehman's bankruptcy. As Gretchen summarizes: "According to the document, Goldman held a total of $1.7 billion in insurance on A.I.G. from almost 90 institutions. Its exposure to A.I.G. at that time was $2.6 billion. Goldman bought most of the insurance from large foreign and domestic banks, including Credit Suisse ($310 million), Morgan Stanley ($243 million) and JPMorgan Chase ($216 million). Goldman also bought $223 million in insurance on A.I.G. from a variety of funds overseen by Pimco, the money management firm." While the topic of how the world's biggest asset management firm in the face of Pimco (and specifically its massive Total Return Fund) could have a net short CDS position (i.e., unlimited downside exposure), and how this is supposed to demonstrate prudent capital management, is ripe for evisceration, we will leave it for another day, as there is something more notable in the Grassley disclosure that has to be discussed. While Gretchen is correct that the external position of Goldman's exposure vis-a-vis AIG is indeed a total of $1.7 billion in long CDS, if one were to actually present the gross number, the truth would be starker: as the Grassley document reveals, the firm's gross exposure for its IG flow and structured finance desks goes from a positive $1.7 billion net exposure, to a ($2.9) billion net exposure, a massive $4.8 billion swing! What is it that in one fell swoop moved the firm from having a huge long bet on AIG, to a major short CDS position, one that nearly entirely covered the firm's $2.6 billion in legacy risk exposure? Enter Goldman's Counterparty Valuation Adjustment desk.

Goldman, Blackrock In Cross Hairs Again As Senator Grassley Digs Up Old Corpses

Just as Goldman's hope that the BP gusher's taking front page priority, especially in the aftermath of the rather amusing settlement between the firm and the SEC, was finally appearing to bear fruit as for the first time in over a year there was nothing relevant on the news front regarding the 200 West company, here comes Senator Chuck Grassley lobbing a grenade full of provocative and very much unanswered questions directed at the GAO, at Elizabeth Warren, and at Neil Barofsky that demand clear and prompt answers. We are also quite content that Blackrock and AIG once again manage to get themselves dirty.

Guest Post: The Strategic Ramifications Of A US-Led Withdrawal from Afghanistan

The United States and the NATO allies are preparing to disengage and soon withdraw from Afghanistan and even the most vocal advocates of the "long-term commitment" do not anticipate more than five years of active US and NATO involvement. All the local key players — in Kabul, Islamabad, and countless tribal and localized foci of power — are cognizant and are already maneuvering and posturing to deal with the new reality. Irrespective of the political solution and/or compromise which will emerge in Kabul, the US is leaving behind a huge powder keg of global and regional significance with a short fuse burning profusely: namely, the impact of Afghanistan’s growing, expanding and thriving heroin economy. The issue at hand is not just the significant impact which the easily available and relatively cheap heroin has on the addiction rates in Russia, Europe, Central Asia, Iran, Pakistan, and Afghanistan, and the consequent public health, social stability and mortality-rate issues. In global terms, the key threat is the impact that the vast sums of drug money has on the long-term regional stability of vast tracks of Eurasia: namely, the funding of a myriad of “causes” ranging from jihadist terrorism and subversion to violent and destabilizing secessionism and separatism.

Here Comes The Real Stress: Only 27% Of China Project Loans To Be Repaid In Full

And now, for today's real news: "Chinese banks may struggle to recoup about 23 percent of the 7.7 trillion yuan ($1.1 trillion) they’ve lent to finance local government infrastructure projects, according to a person with knowledge of data collected by the nation’s regulator. Only 27 percent of the loans to the financing vehicles can be repaid in full by cash generated by the projects they funded, the person said. The China Banking Regulatory Commission has told banks to write off non-performing project loans by the end of this year." Got China CDS? Because this is the point where one follows Hugh Hendry's advice about that whole panic thing.

Game Over, Radioshack LBO Rumors, Game Over

The day every sane investor has been waiting for is here - today marks the end of the Radioschack LBO rumors. After 3 years, 4 months, 50 days. 8 hours and 44 seconds (give or take) of hourly rumormongering that the increasingly irrelevant electronics retailer was supposed to be bought "any given day now" at a 10x+ EBITDA multiple by each and every PE firm in the universe, and with allegedly intelligent investors falling for it each and every time, it appears the end is here. Incidentally, according to preliminary calculations, a dedicated investor that would have done nothing but short RSH on every rumor spike would have returned about an 80% CAGR over the past 3 years. Couple this with selling RSH CDS and the ROI would have been the highest recorded in human history. From Reuters: "Blackstone Group and TPG Capital are unlikely to continue to pursue a possible bid for RadioShack Corp (RSH.N), two sources familiar with the situation said on Monday. Bain Capital had been interested earlier but is no longer in the auction, sources previously told Reuters." And with this, an entire section of rumor disseminators at the NY Post will suddenly find themselves praying Congress passes the unemployment extension bill later today.

Morning Gold Fix: July 19, 2010

The first Gold backed Currency was announced last week. This is the road to ruin for the Dollar as global reserve currency: Slow incremental acceptance of alternatives form seemingly meaningless areas of the world. Ranks break first where there is little to lose by change. Last in places that cannot afford it.

European Weekly Outlook

From Goldman's Ben Broadbent. Apparently the weather in Chiswick was not sufficiently balmy for your regularly scheduled update.

Potential Second Spill Found Near BP Blown Out Oil Well, As BP Evaluates Potential Break Up Opportunities

In case you missed George Wahsington's update, here it is straight from the AP horse's mouth. And, if this story is true, we can only hope one is not long BP stock or short the CDS. Logically, all this occurs as the Sunday Times reports that BP has "started canvassing shareholders about a restructuring in the wake of its Gulf of Mexico oil spill which could include a break up of the business."