Thursday, April 30, 2009

Bond Vigilantes to Fed: F*ck You

The Fed has been embarking on their quest to drive down interest rates by buying longer-term dated Treasuries, Agency debt, and MBS. Originally, the initial announcement at the very beginning of December (shown in the first circle) managed to drive prices up on the 10 year (which is the most often used proxy for mortgage rates since it best approximates the average mortgage life), and inversely, yields down.

However, soon after yields began rising again, presumably because lip service only moves markets for so long. When tangible plans were announced in mid-March (shown in the second circle) that the Fed was going to imminently begin to purchase the debt, this also triggered a massive price spike - and yield drop.

Yield found technical support at its lower bound of the Moving Average Envelope, and surprisingly has been trending higher ever since.

And then, they actually began buying.

And yields rose.

In fact, yield now stands at a level higher than when the Fed plans were initially announced last December. It has now broken through both a long-standing resistance level and its 200 day moving average (EMA). This could be quite bullish and yields may first target the upper bound of the envelope at around 3.4-3.5%. Overbought conditions may have to be worked off as the Relative Strength Index is approaching 70.

So far the Fed has purchased around $75 billion of Treasuries out of a total $300 billion planned for. So, it is true that the efforts are early. Additionally, as far as I can tell from the NY Fed Open Market Operations activity, only a few billion dollars of the 10 year have been purchased. In a market as massive as Treasuries, that is miniscule.


That explanation seems to be one of the biggest problems: Fed intentions amount to trying to boil the is seemingly too large.

Rather, what seems to be happening is that foreign investors are becoming ever more wary of seeing the US government attempt to monetize debt and flood the market with new Treasury issues to finance their budget.

There is a fear in the market that the Fed is going to crowd out private capital (i.e., foreign investors). When China takes its ball and goes home, look out below.

Wednesday, April 29, 2009

Is China the Next Great Bubble?

Much like here in the US, the China story is one where people evaluate data points in a vacuum and conclude that recovery is on its way.

For instance, the Shanghai Composite bottoming and rising nearly 30% is a positive sign in isolation. However, months ago Michael Pettis had identified that the growth in lending that the market rose on the back of was actually heavily attributable to sham transactions to appease Chinese government directives. Further, evidence coming out of China was demonstrating that 1/3 of the lending that did take place was not done so for productive investment purposes, or even consumption. Rather, it went into the stock markets, which indicates a complete unsustainability (um, since debt has to be paid back and not always at the best or most liquid of times).

In my post PIMPCO Strikes Again, I disputed the recovery case in China because sustainable signs are non-existent.

Vitaliy N. Katsenelson, CFA, Director of Research at Investment Management Associates in Denver, Colo presents an excellent case of support in "The Next Great Bubble?" I have excerpted portions, but the entire post is definitely worth a read.

...I get the distinct feeling that investors’ prayers are now being answered: There’s a new bubble now - or an old one is being re-inflated, depending on your perspective even as I type this. I’d like to call it the Troubled China Revival Program (TCRP).

Why start reserving bubble-naming rights? Well, I recently received an email from a friend that had the following subject line: “China … Record Loan Addition, RecordMoney Supply, Record Auto Sales, Record Imports of Copper, Iron Ore, andCoal, Strong Property Sales.”

I checked every figure (the hyperlinks above are mine), and every single one checked out. I couldn’t quite believe what I was reading. I had thought China was in a spiraling-down recession. But even the decline inelectricity consumption — a true gauge of economic growth — decelerated from 3.7% in January and February to a mere 0.7% in March. (Take a look at the FXI for more.)

So is China really the first nation to rebound? Is this the first sign of a rebounding global economy?

I’m sorry to say that the answer to both questions is no...

...Though China can’t control consumer spending, the consumer is a comparatively small part of its economy: Currency control diminishes the consumer’s buying power. All of this makes TARP 1 and 2 look like child’s play. If China wants to stimulate the economy, it does so - and fast.That’s why we’re seeing such robust economic numbers...

...It’s literally forcing banks to lend - which will create a huge pile of horrible loans on top of the ones they’ve originated over the last decade (though of course we can’t see them). Don’t confuse fast growth with sustainable growth. As I’ve discussed in the past, China is suffering from Late Stage Growth Obesity. A not-inconsequential part of the tremendous growth it’s seen over the last 10 years came from lending to the US. Additionally, the quality of late-period growth was, in all likelihood, very poor,and the country now suffers from real overcapacity...

...Now China needs to stimulate its economy. It’s facing a very delicate situation indeed - which is a nice way of saying that China’s screwed. China needs the money internally to finance its continued growth. However, if it were to sell dollar-denominated treasuries, several bad things would happen...

...This is why China is desperately trying to figure out how to withdraw its funds from the US dollar without driving the dollar down. Good luck with that...

Tuesday, April 28, 2009

More Than One Type of Car Crash

This will be a short and sweet post. I'm listening to an Ernst & Young presentation on supply chain risks right now and something has struck me as odd (to hear out loud).

The common public face is that auto sales should stabilize and rise sometime in the very near future, which is something I have taken issue with. There is an auto industry executive on this panel that just asserted that they believe that the worst is yet to come. In fact, the phrase "few years" was used to describe when a bottoming may occur. I find this view far more credible based on the lack of recovery engine.

I think it is reasonable to think that this could act as a proxy for the greater economy in general, particularly because auto industry sales levels have suffered far more severely than other sectors, and they may act as a leading indicator.

Dow Theory: "The Primary Trend is Down"

Richard Russell is a legend in the markets. When he talks people tend to listen and with good reason. His current views as expressed in "Let the Bear Market do its Work":

“People in this country don’t realize how bad things can be,” said Richard Russell on Saturday night.

“I lived through the Great Depression. I remember people standing in bread lines. It was hard to get a job, any job, back then. But now, you see the restaurants are still full. People are still spending money. They may be worried and they may be beginning to save, but there’s no sense of urgency. And there’s a rally on Wall Street. You know, every bear market produces a rally. You can expect the market to retrace its steps by one- to two-thirds.

“And every bear market has a surprise. I think the surprise is that this is going to be a lot worse than people expect.”

Richard Russell is 84. He’s been writing his investment newsletter, Dow Theory Letters, for 50 years. This weekend a group of his admirers, including your editor, came together to say thanks.

There are a lot of people with opinions on the economy and the stock market. You can hardly turn on your computer without getting dozens of them. But there are not many opinions with the depth of experience and knowledge behind them as those of Richard Russell. He’s been studying “the language of the markets” for more than half a century. Though no one ever fully masters the language of the market, Richard can at least carry on a conversation with it.

The primary trend is down,” says he. In the end, he continues, no matter what Obama and Bernanke do, the primary trend will have its way. The bear market will continue until it “has fully expressed itself.”

Friday, April 24, 2009

Stress Test aka Simon Says

Well, details are now out about the summary conclusion of the health of US banks (Surprise! It's good) and the methodology used for the evaluation (Surprise! It's bad).

And thanks to this information, any remaining doubts I had about whether or not we are becoming a Banana Republic are now scarce.

I want to highlight a few key passages from the CNBC breaking story "Most Banks Have Enough Capital After Stress Tests: US":

The US government, releasing details of how it conducted "stress tests" on the nation's 19 largest financial institutions, said “most banks currently have capital levels well in excess of the amounts needed to be well capitalized."

The report said the tests are a “forward-looking exercise designed to estimate losses, revenues and reserve needs” under two different macroeconomic scenarios, including an adverse one.

According to the report, the "banks were asked to project their credit losses and revenues for two years." The process "involves the projection of losses on loans, assets held in investment potfolios and trading-related exposures, as well as the firm's capacity to absorb losses in order to determine a sufficient capital level to support lending."

Let me address these excerpts one by one:

First, in regards to these banks having more than enough capital, I'll simply say stay tuned. If this is the case, not one more dime of taxpayer money should be allocated to bailouts in kind, loans, or any other forms of guarantees against losses.

Of course, this will not be the case, and if I was stupid enough to be a shareholder in any of these banks right now for anything other than a quick trade, I'd have my attorney on speed dial with my finger hawking over the button.

And the simple reason is this: there is not remotely close to enough capital in the banks based on the deterioration of the economy and their assets as they are correlated. And one of 2 things (or both) is going to happen: Outright nationalization whereby common stock is zeroed out, and/or further issuance of common stock or conversion into it, thereby massively diluting shareholders.

Second, the scenarios are essentially a joke. Nouriel Roubini has already noted that many of the scenario conditions / metrics have already been superceded by the actual conditions / metrics that we have deteriorated so quickly to.

Third - and this is my favorite - was the statement I highlighted above, "banks were asked to project their credit losses and revenues for two years."

Wait, maybe I should re-read that again just to be sure that it wasn't a joke. Hmm, no subsequent punchline.

Uh oh.

Let me put this in very simple perspective. The Treasury was conducting a test. This test was to assess the potential that an financial organization had for future success or failure. MUCH LIKE THE WAY ANY SCHOOL TEST ASSESSES THE SAME FOR A STUDENT.

Were you ever given a test where the administrator asked you to tell them what you think the answer should be? And then it was? This is not a test. This is a game.

And that is what we have become. A land of fiction and fantasy, where the potential for any company is limited only to their imagination (and self-interest, of course).

New Commercial: Change of Auto Strategy

It was bound to happen sooner or later at the rate that things are going....

Thanks Corey.

Thursday, April 23, 2009

Oh Yeah, Wells Fargo Seems Legit. Part II

In my post Oh Yeah, Wells Fargo Seems Legit I went oh-so-far out on a limb to suggest that Wells' earnings were a sham accomplished through accounting tricks - specifically under-reserving for bad assets which are known to be underperforming.

Oh, guess what?

Wells Fargo's Papier-Mâché Earnings Report

This just in from Dave the Bond Trader.

We would not have minded this bit of accounting chicanery so much, if Wells had not accompanied their earnings with so much "master of the universe" bravado and bluster about their superior banking management.

But we suppose when you are down on your chips and running a bluff, you have to give out the right sort of attitude and moral high ground to make it work, to hide the fact that you are just crooking the books like everyone else.

That smoke you feel being blown up your backside is nothing more than legalized accounting fraud being presented to the world in the form of Wells Fargo's 1st Qtr 2009 earnings release. As suspected, the infamous "record profits" preannounced 2 weeks ago by Wells Fargo are nothing more than a result of our Wall Street-financed Government, including our President, forcing the FASB to change the way big banks account for toxic assets. As per WFC's earnings release today:

"The net unrealized loss on securities available for sale declined to $4.7 billion at March 31, 2009, from $9.9 billion at December 31, 2008. Approximately $850 million of the improvement was due to declining interest rates and narrower credit spreads. The remainder was due to the early adoption of FAS FSP 157-4, which clarified the use of trading prices in determining fair value for distressed securities in illiquid markets, thus moderating the need to use excessively distressed prices in valuing these securities in illiquid markets as we had done in prior periods"

Essentially, what WFC did was post $5.2 billion mark to fantasy gains, which were then added into its revenues, by reversing out previous charges expensed against their securities and loans held for sale. Without this gain, Wells Fargo loses a couple billion.

In looking at WFC's balance sheet, I see that their "securities held for sale" miraculously jumped to 27% of their net loans vs. being only 21% of loans at the end 2008. This is obviously WFC taking full advantage of the new mark to fantasy accounting standard and piling as much toxic waste into this category and marking the price levels up substantially. Be really interesting to see what kind of worthless crap was conveniently moved into this category.

I can't say this following sentence loudly enough: If you jump into the markets (or stay in) with manipulated earnings like this as your catalyst for believing that stabilization is imminent, beware.

Wednesday, April 22, 2009

Good Ole Days

Ah, this seems familiar. The sweet siren call of the last hour of trading (in this case last 30 minutes) that tempts the bravest and most determined of start dumping shares vigilantly.

This may be a good indication of how the next few weeks will likely play out, depending on volume. I was within a few points of my recent 7750 support call when the market bounced. I don't believe that holds again this time around.

Daily Show on Bank Profits

This fits perfectly with the theme from yesterday's post Are We Descending Into a Banana Republic?

The Daily Show With Jon StewartM - Th 11p / 10c
Daily Show
Full Episodes
Economic CrisisPolitical Humor

Tuesday, April 21, 2009

Are We Descending Into a Banana Republic?

In the upcoming May issue of The Atlantic, Simon Johnson addresses some unpleasant similarities between unstable emerging economies he dealt with while at the IMF and the current state of the US.

The Quiet Coup

Some key excerpts:
"...Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks. Emerging-market governments and their private-sector allies commonly form a tight-knit—and, most of the time, genteel—oligarchy, running the country rather like a profit-seeking company in which they are the controlling shareholders. When a country like Indonesia or South Korea or Russia grows, so do the ambitions of its captains of industry. As masters of their mini-universe, these people make some investments that clearly benefit the broader economy, but they also start making bigger and riskier bets. They reckon—correctly, in most cases—that their political connections will allow them to push onto the government any substantial problems that arise..."

"...The downward spiral that follows is remarkably steep. Enormous companies teeter on the brink of default, and the local banks that have lent to them collapse. Yesterday’s “public-private partnerships” are relabeled “crony capitalism.” With credit unavailable, economic paralysis ensues, and conditions just get worse and worse. The government is forced to draw down its foreign-currency reserves to pay for imports, service debt, and cover private losses. But these reserves will eventually run out. If the country cannot right itself before that happens, it will default on its sovereign debt and become an economic pariah. The government, in its race to stop the bleeding, will typically need to wipe out some of the national champions—now hemorrhaging cash—and usually restructure a banking system that’s gone badly out of balance. It will, in other words, need to squeeze at least some of its oligarchs..."
And the best for last under the section heading "Becoming a Banana Republic":
"...In its depth and suddenness, the U.S. economic and financial crisis is shockingly reminiscent of moments we have recently seen in emerging markets (and only in emerging markets): South Korea (1997), Malaysia (1998), Russia and Argentina (time and again). In each of those cases, global investors, afraid that the country or its financial sector wouldn’t be able to pay off mountainous debt, suddenly stopped lending. And in each case, that fear became self-fulfilling, as banks that couldn’t roll over their debt did, in fact, become unable to pay. This is precisely what drove Lehman Brothers into bankruptcy on September 15, causing all sources of funding to the U.S. financial sector to dry up overnight. Just as in emerging-market crises, the weakness in the banking system has quickly rippled out into the rest of the economy, causing a severe economic contraction and hardship for millions of people..."

"...But there’s a deeper and more disturbing similarity: elite business interests—financiers, in the case of the U.S.—played a central role in creating the crisis, making ever-larger gambles, with the implicit backing of the government, until the inevitable collapse. More alarming, they are now using their influence to prevent precisely the sorts of reforms that are needed, and fast, to pull the economy out of its nosedive. The government seems helpless, or unwilling, to act against them..."

Monday, April 20, 2009

Future Tax Liabilities

I find the current stance of the President and his Administration very disingenuous surrounding tax implications.

First, a few key excerpts from the article Obama aide takes dim view of anti-tax tea parties:

A top adviser to President Barack Obama takes a dim view of last week's anti-tax "tea parties," promoted by organizers in the spirit of the Boston Tea Party.

"The thing that bewilders me is this president just cut taxes for 95 percent of the American people. So I think the tea bags should be directed elsewhere because he certainly understands the burden that people face," David Axelrod said Sunday.

Axelrod was asked on CBS' "Face the Nation" for his opinion on what the show's host described as "this spreading and very public disaffection with not only the government, but especially the Obama administration."
Here's the obvious problem with the Presidential sleight of hand: It is a myopic, here-and-now examination of tax burdens and does not evaluate out into the future the detrimental impact of current actions.

Our government is essentially calling the American taxpayer stupid, saying, "Here's an extra banana Monkey," and assuming that our intellect is limited to gleefully understanding only the banana in hand.

That's the dissent. We will pay dearly down the road for the seeds of destruction sown today. Whether or not we pay for it today.

Let's do some quick math to make this fun.

An estimated 130 million Americans file a tax return each year. The CBO projects that the current Federal budget proposals will ADD $9.3 trillion to the national debt in the next 10 years.

What happens?

Every American that files a tax return will owe an additional $71,500. And that's not even factoring in the exponential impact that compounding interest on that debt has on the total to actually be paid back through taxes.

Oh yeah, I don't see what the big fuss is about.

Stress Test Results

Rumor? I won't pretend that I can confirm as to whether these are the actual results, but I do know that (most?) tests seem to be over and the Treasury Department is blatantly lying now.

This speaks for itself.

Treasury: Caught Lying Again

"Last night Hal Turner (who has a reputation that is best described as heavily-adorned with Reynolds Wrap) published this:

The Turner Radio Network has obtained "stress test" results for the top 19 Banks in the USA.

1) Of the top nineteen (19) banks in the nation, sixteen (16) are already technically insolvent.

2) Of the 16 banks that are already technically insolvent, not even one can withstand any disruption of cash flow at all or any further deterioration in non-paying loans.

3) If any two of the 16 insolvent banks go under, they will totally wipe out all remaining FDIC insurance funding.

4) Of the top 19 banks in the nation, the top five (5) largest banks are under capitalized so dangerously, there is serious doubt about their ability to continue as ongoing businesses.

He then goes on to list things that we know to be factual, including derivatives exposure (mostly in interest-rate swaps and similar.)

This appears to have led to Treasury issuing the following statement this morning:

The U.S. Treasury Department has not yet received the results of "stress tests'' on the health of the nation's 19 top banks, spokesman Andrew Williams said Monday, after a blog said it had obtained the test results and some U.S. bank shares moved lower.

That's a lie.

How do we know its a lie?

Because of this from April 10th:

April 10 (Bloomberg) -- The U.S. Federal Reserve has told Goldman Sachs Group Inc., Citigroup Inc. and other banks to keep mum on the results of “stress tests” that will gauge their ability to weather the recession, people familiar with the matter said.

The Fed wants to ensure that the report cards don’t leak during earnings conference calls scheduled for this month. Such a scenario might push stock prices lower for banks perceived as weak and interfere with the government’s plan to release the results in an orderly fashion later this month.

How can you be ordered not to release something you don't have?

Since that was published on the 10th of April, we therefore know that the results exist and Treasury, the banks involved and The Fed have them, as The Fed was concerned that some banks might try to use them (perhaps in a misleading fashion) during their first quarter conference calls and earnings releases...."

Get Short(y)?

As I wrote in my post It's Go Time, the Dow finally broke out of its ascending triangle very calmly to the downside (in more of a consolidation than a break). It rode the lower ascending trendline up as resistance, and once it reached the 8100 level of resistance that it has done battle with so many times recently, it broke through just enough to again test the ascending trendline on Friday unsuccessfully. On massive volume.

And now, it has broken a trendline on the RSI that has held for over a month. That should be good for a few shorting opportunities in the near-term.

Friday, April 17, 2009

Carving Another 2/3 Off the Stock Market

In my post How Low Can You Go?, I presented the equivalent of Exhibits A and B in the case of a market plunge far deeper that what has been experienced so far.

I guess this would be Exhibit C then:

Federated’s Tice Says S&P 500 Is Poised to Plunge 62%

The Standard & Poor’s 500 Index’s 28 percent rise since March 9 is a “sucker’s rally,” and the overvalued measure may plunge 62 percent as earnings continue to shrink, according to David Tice of Federated Investors Inc.

Stocks are overpriced relative to earnings, which won’t rebound soon after posting the longest quarterly slump since the Great Depression, said Tice, the chief portfolio strategist for bear markets at Federated. Analysts estimate that the S&P 500 earnings decline, which has lasted for six quarters, will continue for three more quarters before profits improve, according to data compiled by Bloomberg.

The S&P 500’s five-week advance, the steepest since the 1930s, according to S&P analyst Howard Silverblatt, may carry the index 16 percent higher to 1,000 points before faltering, Tice said.

“Stocks are overpriced in terms of earnings,” he said in a Bloomberg Television interview. “We are closing down factories and retailers and businesses all over the place. How in the world are earnings going to stabilize? We just don’t see it.”

The Federated Prudent Bear Fund that Tice founded returned 27 percent last year as the S&P 500 plunged 38 percent, the most since 1937.

Tice said the benchmark index for U.S. stocks may end the year at 500, representing a 42 percent slide from today’s close of 865.30. It may eventually fall to 325, he said.

Companies in the S&P 500 trade at 1.9 times their liquidation value, according to data compiled by Bloomberg. Tice said that ratio may fall to between 1 and 0.5.

“I’ve never been more confident that this market will fall back to at least book value,” Tice said.

Now back to commentary. And this is why the rebound story is a farce. I have yet to hear from one bull as to exactly how this stabilization and recovery will be orchestrated. For fun, try it. I have, and every time I ask, I get some touchy, feely response about stimulus and the fact that America is the greatest, most innovative country on Earth, so it's inevitable.

Um, no. It's not.

Our productive capacity, organized labor system, and economy in general is structurally damaged in a profound way. Not the least of which is the leverage embedded (I'll likely be touching on that in more detail this weekend).

The past few days I have been in countless meetings with a leading edge global manufacturing client, and heard firsthand that bookings - and their bookings typically cover a WIP time of 12-18 months, so this is a serious leading indicator - are almost nonexistant. I was made aware of other grim details that I won't discuss, but none of it paints a picture where the bleeding stops in a sustainable way.

While historically the stock market does bottom between 6-9 months prior to the economy, there is no legitimate reason to believe that economic recovery is anywhere in sight.

Wednesday, April 15, 2009

How Low Can You Go? Elliott Wave and Q Ratio Style.

Within technical analysis, Elliott Wave theory is one of the most useful indicators to try to forecast major market trends. While very controversial - as no indicator is always right and conclusions among analysts can vary - it draws legitimacy from the fact that human nature, specifically oscillations between greed and fear, is repetitive. And as such, it is predictive.

As Elliott Wave International explains, "It reveals that mass psychology swings from pessimism to optimism and back in a natural sequence, creating specific and measurable patterns. One of the easiest places to see this phenomenon at work is in the financial markets, where changing investor psychology is recorded in the form of price movements. If you can identify repeating patterns in prices, and figure out where in those repeating patterns we are today, then you can predict where we are going in the future."

The Elliott Wave experts currently believe that we are in a primary up wave (i.e., countertrend rally / retracement wave) within the context of a secular bear market. While there may be a very near-term pullback, the expectation is for prices to retrace a previous wave pattern to around 10,000 on the Dow. Near this level also represents a valid Fibonacci retracement level, which could add credibility to it as a final target.

But make no mistake, this bullish frenzy will end.

While this bear market could be halfway done in terms of time, it is likely less than halfway over in terms of price decline. And it is extremely naive to assume that prices will quickly rally off of the ultimate lows when they are formed. Neither the technical, nor fundamental picture makes this probable. Anything is possible. But probable? No.

A supercycle (think Kondratieff) ascending price channel on the Dow that has held up for 80 years has now been broken. It appears that the lower channel support sits between 3800 - 4000 on the Dow. This would be bad enough if prices were expected to halt their decline at this level.

That is not the case.

Based on the historical breach of the Wave 5 channel line in the Great Depression - Elliott Waves move in 5 wave patterns and the Dow just completed its 5th wave prior to the current decline - that support may hold as well as a swimming pool surface can hold off a diver. While prices may retest those levels as new resistance, they are not expected to be successful.

There are renown analysts that are forecasting bottoms in the 1000s, 2000s, and 3000s. Tobin's Q Ratio is one of those tools that makes this case.


A global stock slump may have further to go, according to Tobin’s Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said.

The ratio, developed in 1969 by Nobel Prize-winning economist James Tobin, shows the Standard & Poor’s 500 Index is still too expensive relative to the cost of replacing assets, said Napier. While the 39 percent drop in the index this year pushed equity prices below replacement cost, history suggests the ratio must sink further as deflation sets in, he said. The S&P may plunge another 55 percent to 400 by 2014, Napier said.

“The Q has come down to its average, however it’s not always stopped at the average,” said Napier, Institutional Investor’s top-ranked Asia strategist from 1997-1999. “It has tended to go significantly below that in long bear markets.”

Napier, who teaches at Edinburgh Business School and advised clients to buy oil in 2002 before it tripled, based his S&P 500 forecast on the Q ratio for U.S. equities as well as the 10-year cyclically adjusted price-to-earnings ratio, another measure of long-term value.

Before the trough in 2014, investors are likely to see a so-called bear market rally for the next two years as central bank actions delay the onset of deflation, Napier said.

In the long run, stocks will become even cheaper,” said Brian Shepardson, who helps manage $1.9 billion at Xenia, Ohio- based James Investment Research. The firm’s James Balanced Golden Rainbow Fund beat 98 percent of similar funds this year. “There’s a likelihood of some type of rally and further pullback surpassing the lows we’ve already set.”

The Q ratio on U.S. equities has dropped to 0.7 from a peak of 2.9 in 1999, and reaching 0.3 has always signaled the end of a bear market, said Napier, 44, the author of “Anatomy of the Bear,” a study of how business cycles change course. The Q ratio for U.S. equities has fluctuated between 0.3 and 3 in the past 130 years.

"At the end of the four largest U.S. bear markets in 1921, 1932, 1949 and 1982, the Q ratio fell to 0.3 or lower, and history is likely to repeat", said Napier.

“Bear markets always end for exactly the same reason, and that is the market begins to price in deflation,” he said. “The results are always horrific.”

As a final word on the article above, the opponents of the Q ratio argue that for it to be relevant now we would have to experience widespread deflation.

Well, as I have argued for 2 years, that day is now here.

Why Socialism Doesn't Work. "Are You Smarter than a Fifth Grader" Style.

Been in NY on business most of the week with little time to post, but had to put this up. A little story (think of it like Aesop's Fables...there is a moral to this story):

"An economics professor said he had never failed a single student before but had, once, failed an entire class. That class had insisted that socialism worked and that no one would be poor and no one would be rich, a great equalizer. The professor offered an experiment to test their theory.

All grades would be averaged and everyone would receive the same grade so no one would fail and no one would receive an A. After the 1st test, the grades were averaged and everyone got a B. The students who studied hard were upset and the students who studied little were happy. But, as the 2nd test rolled around, the students who studied little had studied even less and the ones who studied hard decided they wanted a free ride too; so they studied little. The second test average was a D! No one was happy. When the 3rd test rolled around the average was an F.

The scores never increased as bickering, blame, name calling all resulted in hard feelings and no one would study for the benefit of anyone else. All failed, to their great surprise, and the professor told them that socialism would also ultimately fail.

When the reward is great, the effort to succeed is great; but when government takes all the reward away, no one will try or want to succeed."

These are the basic tenets of the way that human nature has always responded to economic incentivization - or lack thereof - that seem to escape our government.

Monday, April 13, 2009

It's Go Time.

This is not a Dow chart that inspires confidence. I'm long overdue on posting what Elliott Wave analysis is forecasting (near-term bullishness), but simple charts are hard to argue with. Typically, an ascending triangle pattern such as this - note the straight line across the top near the 8100 mark and the rising trendline of support - tips a bullish signal. However, the divergences (noted with my white markings) between new short-term trend price highs and 1) lower momentum, 2) lower volume, and 3) Relative Strength that can't break its resistance with these highs are not feel-good signs. Additionally, these are atypical of reversal patterns, so it further clouds the signal.

Since price has reached the apex of this trading range, it looks like a breakout is near. Should price break to the downside, legitimate support seems to be forming around 7750 where the 20 day and 50 day moving averages are converging (and rising).

More Housing Pain

This is one of the few guys CNBC has had on that gets it.

2 key issues he discusses that I am in complete agreement with:

1) The fact that banks are trying to unload ALL assets is an indication that, other than for superficial purposes, there is no way that they intend on ramping up lending in a period of dramatic economic decline. The TARP was never going to accomplish this, and was doomed from the start.

2) The pace of decline is about to pick up velocity further up the housing price range. This should have ever more dramatic effects on the mortgage securities market.

Thursday, April 9, 2009

PPIP. Enron Will Be a Fond Memory.

I have been meaning to write about the PPIP and my foregone conclusion that it will be gamed by participants at taxpayers expense, ever since watching this video from Khanacademy.

Life, much like economics, revolves around incentives. When you set up a program like this, the incentivization for robbing taxpayers blind is about the same as drugs for an addict.

Rather than get into the details myself, Rortybomb has done the heavy lifting. And then some.

So according to the FT, it appears that the banks selling assets will also be able to bid on each other’s assets.

US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury’s $1,000bn (£680bn) plan to revive the financial system.

The plans proved controversial, with critics charging that the government’s public-private partnership - which provide generous loans to investors - are intended to help banks sell, rather than acquire, troubled securities and loans.

I brought this up when the plan was first released, via a marginalrevolutions’ post in that link, but the idea seemed so absurd that I didn’t mention it in any subsequent posts. It is apparently staying, and we need to consider what this will do to the process.

I was out at “Debaser Night”, a 90s-music dance party in San Francisco, with some friends. A riot grrl rock cover band opened, followed by lots of great singles. I was getting a bit nostalgic. A friend of mine, who used to be on an energy trading desk back in the early 2000s, was listening to me talk about the government plan. He couldn’t believe what I was telling him about letting the banks that are selling auctions also bid on them. In the middle of my explanation, he had his own wave of nostalgia: “Man does that bring back memories….”

Before we go there, what will happen with these banks when they can bid on each other’s assets? Let’s do a thought exercise. Let’s say you are a bidder for Bank A. You know your banking asset is worth $50, and you also know the asset Bank B has is worth $50. You call your buddy up, the trader at B, and make a deal. Happens all the time. You go to bid, and you bid $80 for B’s asset. Then you wait. If B doesn’t come through, you are screwed out a lot of money. And hey, isn’t this wrong? Well, you are pretty sure one of those Rubin-protégé government whiz-kids has given someone who knows someone you know a wink-wink about this. You take a drink, steady the nerves. Then, the bid comes back for your asset - $80 from B. You have each bid up each others assets and traded them. And now the government is screwed. Let’s chart out that payment:

Yup. Bad news. Bank A pays $6.50 for its new asset because of the leverage , and it loses all of that. It also loses the $50 from not having the asset anymore. However it gains $80, net profit - same as Bank B. The government has paid $73.50 for a $50 asset, twice. (See previous for how the levered non-recourse loan turns into a put option.) We tend to call this collusion if you and I did it.
So why did my energy trading friend get all nostalgic? “Because what you are telling me brings back some great memories from what Enron was up to back in the day. All of us energy traders back then watched with our jaws on the floor. 2000 was a hell of a year.”

It is August, 2000. Let’s say you are a trader for Enron. You know your energy in California is worth $50, and you also know the energy that Reliant Energy has is worth $50. You call your buddy up, the trader at Reliant, and make a deal. Happens all the time - you even have a nickname for it, The Daisy Chain Swap. You go to bid, and you bid $80 for Reliant’s energy. Then you wait. If Reliant doesn’t come through, you are screwed out a lot of money. And hey, isn’t this wrong? Well, you are pretty sure one of those Rubin-protégé government whiz-kids has given someone who knows someone you know a wink-wink about this. You take a drink, steady the nerves. Then, the bid comes back for your energy - $80 from Reliant. You have each bid up each others assets and traded them. And now the government is screwed, because it has to pay you $80. Let’s chart out that payment:
You can go ahead and replace an Enron subsidiary for Reliant in that example, as I did in the chart. Enron did, and the banks are probably going to now. My friend was very excited telling me all the strategies Enron deployed - “Forney Perpetual Loop”, “Ricochet”, “Ping Pong”, “Black Widow”, “Red Congo”, “Get Shorty”, the whole works - and how all of them will be reliable guides for gaming the legacy asset market here. Buy assets high, write them down, then pay back with “fees.” Got it. Create SIV to bid up the profits. Brilliant.

What is really exciting, from the evil point of view, is the idea that we are going to get to see one giant, massive, Enron Death Star put into play:

The Death Star strategy (yes, they called it that) was where Enron would take a fee for relieving a congested market of its excess supply by moving it elsewhere. Just like our legacy assets! There are too many of them, it is clogging up trade, let’s get them to someone else who wants them. However Enron would just move the energy in a circle, collecting a fee for not doing what it was supposed to. As their memo famously said, they are paid “for moving energy to relieve congestion, without actually moving any energy or relieving any congestion.” And, it appears, that the large banks are gearing up to do just that; with the Geitner Death Star that they’ll just be collecting a large fee to run them in a circle, without actually moving any of them off their collective books. For old time’s sake, I hope they route their loan bids through Oregon and then Utah before putting them back right where they started.

Mind you that was the electrical grid of California - this appears to be at the scale of the entire financial market. In case you are wondering, traders out there are licking their lips to try and find ways to game this even better than Enron. It appears the public will get to invest in these vehicles too. Direct Democracy in the 21st century means that all of us get to take part in collusion and ripping off taxpayers - we are the ones we’ve been waiting for!

I’m not the biggest Enron junkie - else I would have seen this connection sooner. If any people who know their playbook of strategies want to leave a comment with a move that could be made by the PPIP bidders, I’d be much obliged. And please, tell your representatives to keep the selling banks and their subsidiaries from bidding. I’m still hoping this part is a bad dream…

Oh Yeah, Wells Fargo Seems Legit.

Hmmm. So, WFC is posting a Q1 profit closely aligned with their profit this time last year. In a Depression (and yes, based on the real U-6 figures of unemployment, that's where we are). Where fewer creditworthy borrowers exist. Where demand/availability for credit cards and mortgage loans has fallen off a cliff nationally. Where defaults are spiking on debt assets across the board.

Yeah, seems like there's very little to differentiate the economic activity from Q1 2008 to Q1 2009. I'm sure these earnings are A) Legit, and B) Bound to hold up. Oh, but wait, I think we all forgot something.

Wells Fargo had $151 billion of securities available for sale, and $865 billion of loans on their books, at year-end. Over a trillion dollars in total. With a very quick back-of-the-envelope calc (not delving into the unique stratifications of loan types, ratings, etc.), we see that with their current reserves, they have now built them to a very robust 2% of total.

That's right folks, 2%. For credit card receivables, automobile loans, mortgages, unsecured debt, etc. Only 2% of those are going to go bad, or asset prices devalue by that much. The banks have been right about everything so far, so I'm sure this is legit too.


"Wells Fargo shares jumped more than 24% after the bank said that it expects to report record net income of approximately $3 billion, or 55 cents a share, for the first quarter. The company said that it is seeing strong operating results from its acquisition of Wachovia and that lending activity has been brisk. Wells said it expects consolidated net interest margin of approximately 4.1%."

"Our business momentum is strong, and we expect our operating margins to remain at the top of our peer group," said Chief Executive John Stumpf in a news release. Wells Fargo's comments came amid a report in The New York Times that the 19 banks undergoing government stress tests will pass them and added steam to a morning rally in bank stocks. Citigroup shares rose more than 9%, J.P. Morgan Chase jumped about 13% and Bank of America gained 20%."

Wednesday, April 8, 2009

PIMPCO Strikes Again

There wouldn't be any chance that PIMCO went "all in" with their investments in China and now have to talk their book, would there?

Not like we've seen that on a regular basis with them. I remember an analyst report from a PIMPCO VP in Asia asserting that they were believers in the 'decoupling' story and felt that China would see relatively minimal impacts.

Um, does it qualify as de-coupling when your economy and productive capacity is primarily constructed for exporting and not domestic consumption....and then exports fall 20-26% YOY in each of the last two consecutive months?

Think they may be looking into the abyss and trying to find the 'greater fool'?

Pimco’s El-Erian Says Emerging Markets Most Capable of Recovery

April 8 (Bloomberg) -- Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., said emerging market nations that are running surpluses and willing to introduce “massive” fiscal stimulus plans have the greatest ability to recover from the global recession.

“China and Brazil are two that are leading the process,” El-Erian said from Pimco’s headquarters in Newport Beach, California, in an April 2 interview on Bloomberg Radio. “The key thing if you’re an emerging market investor is differentiation. This is not a time to treat the asset class as homogeneous.”

Pimco, the world’s biggest bond fund manager with about $747 billion in assets, expects global growth rates to slow from historical levels as household and business balance sheets shrink and place a smaller emphasis on borrowing to boost returns. Western economies such as the U.S. are going to recover more slowly because of the costs involved in reviving growth and reregulating the financial system, El-Erian said.

“You want to be investing in countries that have a creditor situation, that are running surpluses and have massive room for fiscal stimulus,” said El-Erian, who also serves as co-chief investment officer with Pimco founder William Gross. “Those are the countries that will get up quicker, and those are the countries where asset prices will outperform.”

Jim Cramer is a Buffoon

I seem to recall that someone compared the results of a monkey randomly picking stocks to those of Jim Cramer's calls a couple of years ago. I hate to give away the surprise ending, but let's just say that maybe the monkey deserves his own show instead. If you rely on Cramer, do so at your own peril.

Some excerpts:

Just weeks after "The Daily Show" host Jon Stewart took Cramer to task for trying to turn finance reporting into a "game," famous bear economist Nouriel Roubini criticized Cramer on Tuesday for predicting bull markets.

"Cramer is a buffoon," said Roubini, a New York University economics professor often called Dr. Doom. "He was one of those who called six times in a row for this bear market rally to be a bull market rally and he got it wrong. And after all this mess and Jon Stewart he should just shut up because he has no shame.

Roubini said in 2006 that the worst recession in four decades was on its way. He has attracted attention for his gloomy - and accurate - predictions of the U.S. financial market meltdown.

Roubini said the latest surge is just another bear market rally following the pattern of other rallies after the government intervened. He expects the market will test the previous low because of worse than expected macroeconomic news, disappointing earnings and because banks will fail after the stress tests come out.

"Once people get the reality check than it's going to get ugly again," Roubini said.

"He's [Cramer] not a credible analyst. Every time it was a bear market rally he said it was the beginning of a bull and he got it wrong," Roubini said in an interview with The Associated Press.

Roubini made the comments before appearing with bank analyst Meredith Whitney and Canadian bears Ian Gordon and Eric Sprott at a Toronto event titled "A Night with the Bears." They all correctly predicted the current financial meltdown.

Gordon, author of The Long Wave Analyst newsletters, told the event's audience of 1,500 that he expects the Dow Jones industrial average to plummet to 1,000 based on the idea that economic events repeat themselves in regular sequence every 60 years or so.


I'll start by saying anything is possible. I'll then continue by saying that we are in the midst of a secular bear market, and in my opinion, the chances of a bottom having been put in are near zero. The fundamentals aren't hard to identify: global exports collapsing, consumer demand shrinking, balance sheets merely beginning their necessary contraction, crippling government spending, etc.

There are many technical tools that add credence, including Elliott Wave analysis, that I will touch on at a later point when time is available, but as they say a picture is worth a thousand words. Below is the 15 year monthly chart for the Dow. Note that the resistance area from early to mid-1997 became the support level as the rally ensued over the next 10 years.

The weight of the evidence would suggest that you don't breach a long-lasting support level by 10% and then find a sustainable bottom in the midst of nothing but ozone. The market was oversold and due its countertrend rally.

The scary part is looking at this monthly chart and trying to identify a legitimate bottom. HINT: Without looking at Fibonacci retracements, it's way down there.

T-A-L-F = B-A-L-K?

At first glance, it could be presumed that government efforts were creating competing objectives and crowding out capital from some of their programs into others. I could see this being the case with the PPIP, except that the interest in PPIP seems dangerously low (dangerous for the government's politics, good for the taxpayer) as evidenced by the extended application deadline stemming from few requests.

Maybe we are entering uncharted territory. A wonderful new place where investors stop doing business with the government and intend to leave the free market to its own devices.


UPDATE: Accrued Interest raises some good points in TALF: Anoat system?

Fed Requests for TALF Loans Drop 64% to $1.7 Billion (Update2)

"April 7 (Bloomberg) -- The Federal Reserve’s requests from borrowers for loans to buy asset-backed securities fell 64 percent from last month as investors balked at visa limits and possible political efforts to tax earnings.

Investors sought $1.71 billion from the Term Asset-Backed Securities Loan Facility to purchase securities backed by auto and credit-card loans, the New York Fed bank said today on its Web site. The Fed provided $4.7 billion in loans last month to purchase securities in the TALF’s first monthly round.

The decline hinders Fed Chairman Ben S. Bernanke’s efforts to lower borrowing costs and extends a slow start for a program that the Obama administration is using as a cornerstone of plans to revive credit and end the recession. The Fed is struggling to lure investors, such as hedge funds, that are wary of government restrictions or the risk of future intervention.

“It is a big disappointment,” said Stephen Stanley, chief economist at RBS Securities Inc. in Greenwich, Connecticut. “There are some folks who have decided they just don’t want to play in any government programs.”

The total amount of securities eligible for TALF loans in April plunged to about $2.6 billion from $8.3 billion in March. The number of securities deals was unchanged at four."

Tuesday, April 7, 2009

Lock of the Century

I don't gamble very often, but there is no possible chance that the FDIC takes "no losses," and if there was a security long their position, I'd short it.
Sheila Bair does have quite the credibility though. She was the one that blamed bloggers for the severity of the economic crisis. Yeah, that must have been it.

"The Federal Deposit Insurance Corporation was set up 76 years ago with the important but simple job of insuring bank deposits.

Now, because of what could politely be called mission creep, it’s elbowing its way into the middle of the financial mess as an enabler of enormous leverage.

In the fine print of Treasury Secretary Timothy F. Geithner’s plan to lend as much as $1 trillion to private investors to help them buy toxic assets from our nation’s banks, you’ll find some details of how the F.D.I.C is trying to stabilize the system by adding more risk, not less, to the system.

It’s going to be insuring 85 percent of the debt, provided by the Treasury, that private investors will use to subsidize their acquisitions of toxic assets. The program, extraordinary in its size and scope, is the equivalent of TARP 2.0. Only this time, Congress didn’t get a chance to vote.

These loans, while controversial, were given a warm welcome by the market when they were first announced. And why not? The terms are hard to beat. They are, for example, “nonrecourse,” which means that if an investor loses money, he owes taxpayers nothing. It’s the closest thing to risk-free investing — with leverage! — around.

But, as we’ve learned the hard way these last couple of years, risk-free investing is an oxymoron.

So where did the risk go this time?

To the F.D.I.C., and ultimately, to us taxpayers. A close reading of the F.D.I.C.’s statute suggests the agency is using a unique — some might call it plain wrong — reading of its own rule book to accomplish this high-wire act.
Somehow, in the name of solving the financial crisis, the F.D.I.C. has seemingly been given a blank check, with virtually no oversight by Congress.

“Nobody is paying any attention to how they’re pulling this off,” said a prominent securities lawyer who has done work for the government. Not surprisingly, he, along with others I asked to review the program, declined to be quoted by name. “They may not be breaking the letter of the law, but they’re sure disregarding its spirit.”

The F.D.I.C. is insuring the program, called the Public-Private Investment Program, by using a special provision in its charter that allows it to take extraordinary steps when an “emergency determination by secretary of the Treasury” is made to mitigate “systemic risk.”

Simple enough, but that language seems to bump up against another, perhaps more important provision. That provision clearly limits its ability to borrow, guarantee or take on obligations of more than $30 billion.

The exact legalistic language says that it “may not issue or incur any obligation” over that limit. (You can read a highlighted version of the F.D.I.C.’s charter at

So how is the F.D.I.C. planning to insure more than $1 trillion in new obligations? This is where things get complicated and questions are being raised.

The plan hinges on the unique, and somewhat perverse, way the F.D.I.C. values the loans. It considers their value not as the total obligation, but as “contingent liabilities” — meaning what it expects it could possibly lose. As the F.D.I.C’s charter dictates: “The corporation shall value any contingent liability at its expected cost to the corporation.”

So how much does the F.D.I.C. think it might lose?

We project no losses,” Sheila Bair, the chairwoman, told me in an interview. Zero? Really? “Our accountants have signed off on no net losses,” she said. (Well, that’s one way to stay under the borrowing cap.)

By this logic, though, the F.D.I.C. appears to have determined it can lend an unlimited amount of money to anyone so long as it believes, at least at the moment, that it won’t lose any money.
Here’s the F.D.I.C.’s explanation: It says it plans to carefully vet every loan that gets made and it will receive fees and collateral in exchange. And then there’s the safety net: If it loses money from insuring those investments, it will assess the financial industry a fee to pay the agency back.

But think about this for a moment: if the program doesn’t work — and let’s hope it succeeds — the F.D.I.C. would be forced to “assess” banks it is hoping to save, possibly bankrupting them in the process. After all, if the F.D.I.C. starts losing money, it will probably be because the broader economic environment is deteriorating further. So those fees will a new burden at a time when key financial players can least afford them.

Ms. Bair said that she can not imagine the F.D.I.C. losing money on the scale I suggested in my doomsday scenario. She said that before announcing the program, the F.D.I.C.’s lawyers determined that the statute allowed it to guarantee loans by valuing them as contigent liabilities.
“That’s how we’ve interpreted it,” she said, adding that the determination was made back in October when the F.D.I.C. first introduced the Temporary Liquidity Guarantee Program, which is also backed by the F.D.I.C.

She also defended her agency saying that the F.D.I.C. has not experienced mission creep: the various programs that it is participating in are meant to insure the stability of the financial system, which she says was always the goal of the agency. She also pointed out that under the Temporary Liquidity Guarantee Program, so far, the agency hasn’t lost a dollar — and more important, she said, the program has worked to stabilize the banking system.

All true, but that has come as the burden on the F.D.I.C. has increased as it pays out more to cover losses of failed banks.

In a letter to the financial industry last month seeking an assessment that could be as much as $27 billion, Ms. Bair wrote, “Without these assessments, the deposit insurance fund could become insolvent this year.” Ms. Bair seems to recognize that the borrowing limit of $30 billion makes her job difficult. And two officials with a lot of sway in this area have sought to raise the F.D.I.C.’s borrowing limit (by $100 billion, according to a bill introduced by Representative Barney Frank, and by $500 billion, in a bill introduced by Senator Christopher Dodd).

But then again, who needs a borrowing limit when the potential liabilities from the new program seem to be zero?

If the P.P.I.P. program works — and again, it’s in everybody’s interest to cheer it on — it will be a boon for the economy and participating investors, who will likely make off like bandits.
If the program fails, however, there will be heavy losses on us. In other words, taxpayers could be the ones stuck with billions of dollars in “contingent liabilities.”

And these days, whenever anybody talks about risk-free investing, it’s not hard to hear the famous line uttered by Joseph J. Cassano of A.I.G. in 2007: “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.”

Monday, April 6, 2009

Survival of the Fittest: 2009 Edition

The government won't let companies fail now. So, what could possibly go wrong with this strategy?

The New Growth Industry

To help get the US economy back on track, I have an idea for something that can sell nowadays. Enter, bailout clothing. Worn with pride on St. Patrick's Day.

It would be funny if it wasn't so pathetic.

Bill Moyers Interviews Bill Black

Click on the picture to bring up the video. This is about as blunt as you can be, and it's about time we had more honest discourse about this. Cover-up at the highest levels of government and economic policymakers is running rampant. You don't find solid foundations for growth in climates of distrust and zero accountability like this.

Saturday, April 4, 2009

Eating Crow. Or More Appropriately, Sushi.

I had an interesting conversation Friday night over drinks with the individual that runs my company’s investments. The path led unavoidably to the mark-to-market pseudo-suspension with the very new relaxed nature of the rules. His perception was one that I believe many others have.

And that is, that the market has failed in its duty to correctly price the applicable assets because of fear that overwhelms natural greed.

I couldn’t disagree more. And recent history proves it.

Make no mistake, we may very likely soon be living the Japanese experience. One of lost decades in markets. One of economic stagnation despite a robust export base. This is what happens when you try to game markets by removing the little faith that remained. As much as apologists for this current course of destruction like to disassociate our circumstances with the Japanese, there are crucial commonalities that are most prescient. Among those was the allowance of banks to hide their losses through arbitrary and inflated valuations. And our policymakers lambasted the Japanese for taking the same counterproductive measures that we are now.

One of the best lessons I ever received in my youth was during the process of selling the first car that I owned. It had been listed for what I naively considered a fair price, based on the original purchase cost, the outstanding loan balance, and a general feel for sales ranges. After months of futility, I lamented the fact that I couldn’t get what I felt was fair market from a buyer. The answer my father gave me was an obvious one that seems to escape our leaders and talking heads: I wasn't selling at market value - it was only worth what someone would pay. Someone should re-visit these basic (read: simple enough for a teenager to understand) lessons of economic value with FASB, our politicians, and bankers. Assets are worth what buyers will enter the market for. Nothing more.

So, where would fair market value derive from for these assets on bank books?

Only from the expected value of future income streams (interest) and future repayment of principal, based on the likelihood of each. That's why another argument that I've heard - that if these were classified as "Held to Maturity," then the banks could avoid unfair valuations in the present and realize much higher values in the future as the loans came to term - is patently untrue. The cash flows do not lie.

If you think for a second that funds, other banks, and countless private investors haven’t run extensive modeling to arrive at this value, you’re delusional. One of the most powerful forces in markets is the ability for market participants to effectively identify market anomalies (i.e., mispricing) and arbitrage it away back to an efficient state.

If just one party had felt that the likelihood of future cash flows made these assets a solid investment, they would have entered the market and paid the higher bank valuations long ago. That was the shortcoming in my colleague’s argument. Fear is easily abated when A) It’s not your money, B) There is a strong case for profit potential, or C) Both.

And yet they haven’t. And we have heard it’s because of a lack of liquidity. And yet it’s not as John Paulson has noted.

So what has happened is identical to Japan in that we allow our financial institutions to game their balance sheet to appear solvent. But it didn’t work in Japan. And it won’t work here.

And the simple reason is because all that has been done is changing the timeframe of coincidence between ‘realized’ and ‘recognized’ losses. Not the losses.

The grim economic situation of out-of-work Americans that can’t pay their mortgage is the same. The further price declines that will make it more economically prudent to walk away from houses will be the same. The adjustments in NegativeAm and OptionARM mortgages, where regardless of interest rates, payments balloon because principal is now included remain the same. In other words, the future defaults precluding cash flows that the banks can now pretend they will receive will stay the same.

What it will accomplish is playing dress-up with bank stocks. Temporarily. If you choose to ride the rally that I do expect, make sure it’s a short-term trade with a clear and legitimate price target and/or tight stop. A buy-and-hold investor should tread very lightly. When the ride is done, strong hands will sell into weak before the wave crashes down, and that may be you.

We are Japan. So we might as well grab some sake and try to enjoy it.

FASB relaxes accounting rules for banks on assets
"WASHINGTON (AP) — The board that sets U.S. accounting standards on Thursday gave companies more leeway in valuing assets and reporting losses. The changes should help boost battered banks' balance sheets and financial stocks rallied on Wall Street, but the rules may undercut a new financial rescue program.

...But others said the changes by the Financial Accounting Standards Board could undermine a crucial new rescue program mounted by the Obama administration, in which the government is joining with private investors to buy from banks hundreds of billions of dollars in toxic assets — especially the securities tied to high-risk subprime mortgages at the heart of the financial crisis.

In the short run, banks would benefit by raising the value of the assets. But higher values could drive away prospective private investors — who don't like to overpay, even though the government will absorb most of the risk.

"I do think the timing is terrible," said Sue Allon, the CEO of Allonhill in Denver, who works with hedge funds and investment banks to price assets.

...Joshua Shapiro, chief U.S. economist at MFR Inc., was more blunt, saying the FASB decision "allows financial institutions to use fictional valuations on many of their toxic assets" and further obscures their "true position."

...The FASB issued new guidelines under the so-called mark-to-market accounting rules, which require companies to value assets at prices reflecting current market conditions. The changes, which apply to the second quarter that began this month, will allow the assets to be valued at what the banks project they might sell for in the future, rather than in the current, distressed environment.

Still, investor advocates and other critics assailed the FASB, which took the action — with some dissension — at a public meeting of its five-member board at its headquarters in Norwalk, Conn. The critics said the board had sacrificed its independence and buckled to pressure from lawmakers carrying water for banking industry interests.

The FASB received hundreds of comment letters opposing the moves in the two weeks since it proposed them from mutual funds, accounting firms and others contending they would damage honest financial reckoning by masking the deficiencies and risks lurking within the system.

A House panel last month wrung a pledge from FASB Chairman Robert Herz to try to issue guidelines in three weeks that would relax the mark-to-market rules to bring relief to the nation's banks in the financial emergency. The head of the House Financial Services subcommittee, Rep. Paul Kanjorski, D-Pa., had held out the threat of legislation to pressure the standard-setting board to take the steps.

...The new guidelines remove the presumption that if there isn't a current active market for assets, they must automatically be considered distressed. They also will allow banks to avoid reporting some losses on securities by splitting them among factors like anemic markets or fluctuating interest rates that won't have to be counted toward net income or loss.

Two of the five FASB board members, Thomas Linsmeier and Marc Siegel, voted against the change in reporting of such impaired assets. Siegel said "the pressure keeps on coming back to us." They argued it was the sort of decision federal bank regulators should make, because it could affect how much capital banks would need to hold, and that the FASB had been pressured by Congress to take it.

"This is a huge mulligan for banks with junky securities," said Jack Ciesielski, an accounting expert who writes the financial newsletter The Analyst's Accounting Observer.

A key concern is the impact of the changes on the government's new program in which it is joining with private investors to buy up about $500 billion in toxic assets from banks.

With the banks now able to keep assets impaired by market factors from affecting their bottom line, they'll be more likely to hold onto them. "Buyers will be willing to buy them," possibly at less than 30 or 40 cents on the dollar, Allon said. Some investors prefer a mix of higher- and lower-quality assets, she noted.

If the assets remain on banks' books, they may continue to be reluctant to lend as they fret over the assets' future performance. That could work against the purpose of the government's program: to break the logjam in lending and get the economy pumping again, which would hurt consumers and small businesses caught in the credit squeeze."

Wednesday, April 1, 2009

Tomorrow's Market Mover

GM may have narrowly averted bankruptcy and found a company willing to acquire them. I'm not sure how they plan to achieve synergies through integration of the disparate business models. But based on the spy photo, we think we know who this potential suitor could be.....

The new IKEA/GM:

Hahaha, thanks Brad.

Uh Oh, Someone's Waking Up

A friend passed along this photo taken from the protests in London today during the G-20 Summit. While I'll concede that there are some loose cannons in the crowd, the overarching message is a legitimate one that will only get louder and more violent as time passes.

The subtle rape and pillaging of the global citizenry by inept central bankers, politicians, and countless other special interests that have tainted our markets is going to require heads to roll. Unfortunately, globally the West is becoming the preferred scapegoat. This is not going to end well.


The futures are soft again this morning, down over 100 on the Dow. It will be spun as unexpectedly weak job numbers, but at this point, if you're a trader surprised by weak employment data, you deserve to have your a** handed to you.

The market rolled over yesterday into close, which was something I was watching closely, since quarter-end fund re-balancing was at its end. I think that was the tell-tale sign even before the ADP news out this morning. Many traders expect a sideways consolidation for some time, which is very possible. However, there are some suspect major components in the indexes that could cause a larger breakdown. More on that when time is available. I'm off to Miami on business for the remainder of the week, so posting will be sporadic.