Monday, October 31, 2011

October, Monday 31, 2011

DOW – 276 = 11955
SPX – 31 = 1253
NAS – 52 = 2684
10 YR YLD –0.13 bp = 2.17%
OIL - .46 = 92.73
GOLD – 28.30 = 1716.10
SILV – 1.05 = 34.34
PLAT – 52.00 = 1601.00

For the month, the Dow rose more than 1,000 points. It gained 9.5 percent, its best showing since October 2002. The Standard & Poor's 500 index, the broadest major market average, rose 10.8 percent for the month, the best since December 1991.
On Oct. 3, both the Dow and the S&P closed at their lows of the year. The market had been through a brutal summer and was one bad day away from falling into bear market territory, down 20 percent from its most recent peak.
So, did October “Turn the Bear Market”? We won’t know till after the fact, but there are several factors that gave us the rally. Seasonality – we moved into the best six months of the year, we’re headed for the holiday season, the presidential election cycle. Also, oil prices going inot October – oil prices were down

Oil soared 17.7 percent in October. West Texas Intermediate, the benchmark oil in the U.S., jumped from about $79 to $93 per barrel during the month. Recession? Oil market says different. Emerging market demand - 7 billion people.
Can we continue a rally with oil prices moving higher?
And then there is the concern that the European situation could crumble, and the debt problems in the US – we postponed those until November, and we left them in the hands of a super committee, which might not be so super.

And then we got a big casualty today.

MF Global Holdings has filed for bankruptcy protection after a tentative deal with a buyer fell apart. MF Global – turns out they named that right - The 200 year old futures firm becomes the seventh-largest, bankruptcy as measured by assets in U.S. history.
The New York Federal Reserve suspended MF Global from conducting new business with the central bank. CME Group, IntercontinentalExchange  and Singapore Exchange and Singapore's central bank all halted the broker's operations in some form except for liquidations.

CNBC last week talking about the collapse of MF Global. To their credit, most of the analysts were saying MF Global was incredibly risky and generally the opinion was that it was headed for bankruptcy. Then they bring in the big gun, bank analyst Dick Bove, you may remember he was the guy that, 3 ½ years ago upgraded Lehman Brothers. Bove has been ripped for the idea that he is recommending buying MF Global assets at the very moment they are going down the drain. But Dick Bove is not an idiot with bad timing – he actually said something very clever, but of course the CNBC analysts didn’t catch it. I didn’t catch it the first time I listened to it. Bove is basically saying MF global will find a buyer, but listen closely to what he says about Italian bonds.


Bove is saying Italian bonds are going to be revalued – perhaps a “voluntary haircut” like we saw last week on Greek bonds. First, for that to happen, Italy would be insolvent; we would be looking at a Euro-crisis on an even bigger scale than the Greek Debt crisis. Italy is a much bigger danger to Europe and the World.

So how can Bove make a quick buck on the collapse of Italy? I think I’m following Bove’s twisted logic – he was thinking someone could step in and buy MF Global’s bonds for 10 or 20 cents on the dollar, then turn around an demand 50 cents on the dollar from the Italian government. It really is a clever little arbitrage deal. It is also incredibly nasty and evil.

This raises the same question as last week, regarding when is a default a default. What would trigger a default of Italian bonds? When the Italian government works a deal to pay only 50% of the value of the bonds? When some vulture picks up Italian bonds from the MF portfolio for just 10 cents on the dollar? Or have we gotten to the point where

Let’s be clear what is going on here. MF Global has a fire sale of Italian bonds for 10 cents on the dollar. The vulture buys the bonds and demands 50 cents on the dollar. Who pays the difference? The Italians, the Europeans, and eventually the US Federal Reserve will put the US taxpayer on the line. Quick little profit for the vulture investor or for Bove? Probably, but it raises the question? What did they do to earn that profit? Did they build a house, did they bake a loaf of bread? Did they reduce risk? No, I think you could say they increased risk. Did they do anything productive?

Before you think I’m labeling dick Bove as a contrarian mastermind – he also said in the interview that he thought the European banks were well capitalized, so there is a real good chance that he’s just a moron.

And while we’re at it let’s hand out the Kool-Aid Awards to the ratings agencies:  Moody's Ba2-; S&P: BBB-; Fitch: BB+

Europe’s breathing space had a little breathing room last week, a nice little rally, but today was a reality check. Lat week, European leaders sent bank shares soaring last week after delivering more than the markets expected on their promise to provide a comprehensive programme for resolving the Greek sovereign crisis; well let’s clarify – they delivered a plan – no, they delivered the possibility of a plan – no they didn’t really deliver a plan they talked about a plan – and somehow or other – they threw it on the wall and it stuck. A 50 per cent writedown on Greek debt held by private investors, coupled with a pledge to support the short term funding market and a €106bn recapitalisation plan has boosted confidence that banks’ share prices – and after a weekend to think about the Grand Plan - it may have finally bottomed out.
In the days following the deal, Europe’s lenders have tried to assure investors that they will be able to meet regulators’ demands they hold a higher, 9 per cent threshold of highest quality capital without tapping the market or state bail-out funds. One little detail – how are the banks going to raise equity in the coming months, given their depressed share prices and uncertain investor appetite.
For very different reasons, banks in the UK and those in Greece and Portugal may have the clearest paths to meeting the tough new capital requirements outlined last .
Britain’s leading banks emerged from the latest capital review relatively unscathed and have been told they do not need to raise fresh funds to hit the new capital target.
Either they do not have large exposures to European sovereign debt or, like Royal Bank of Scotland, have already taken big hits on the value of the bonds.
At the opposite end of the scale, lenders in Greece and Portugal, two of the most troubled eurozone countries, are largely considered too feeble to raise fresh capital themselves – and face the prospect of nationalisation.
Their governments are ready to inject billions of euros from state funds into their banks.
As for other banks, we start to guess at how much Euro-exposure they really face. 

Saturday, October 29, 2011

October, Friday 28, 2011

DOW + 22 = 12231
SPX +0.5 = 1285
NAS – 1 = 2737
10 YR YLD - = 2.30
OIL - .47 = 93.49
GOLD –2.30 = 1744.40
SILV +.20 = 35.39
PLAT + 14.00 = 1651.00

It’s Friday!

Just in time; I think my brain is going soft; a spongy degenerative condition perhaps. I just can’t seem to grasp the fine points of the Grand Plan that came out of Europe yesterday. I think I get the dominant theme – the Europeans are going to hand out FREE MONEY to the banks, but I just can’t seem to comprehend the non-existent details.

What has me troubled is the notion that banks will take a 50% haircut but only on the condition that it does not trigger Credit Default Swap hedges. The plan asks Greece's private creditors to take losses of 50 per cent on the country's bond they hold. Along with new loans and other measures, that is meant to bring Greece's debt down to 120 per cent of economic output by 2020.

After the private creditors have swapped their Greek bonds for new ones with a lower value, the country's rating is likely to remain in the 'B' category, only a few notches up from its current CCC grade. Fitch rating agency says the deal would result in a temporary default.

However, the ISDA, the International Swaps and Derivatives Association, claims the default is not a default and will not trigger a payout on Credit Default Swaps because acceptance of the haircut is voluntary.

Apparently the Swaps are unregulated private contracts between private parties. In order to know whether a trigger occurred you have to read each individual contract. As a result, what the ISDA says about whether a trigger occurred as to private contracts that are out there is totally meaningless – I mean they haven’t read all those private contracts.

As to whether the 50% haircuts are voluntary, well that’s kind of like a guy holding a gun to my head and saying “your money or your life.” That’s my choice; I don’t necessarily have to give the robber my money.

Now imagine you bought something – it could be anything, a boat, a car, a widget – but let’s just call that something a “bond” – and then you went to your local insurance agent and said I want to insure this “bond” from going down in value; you pay the insurance company the agreed upon premium and they give you a contract that says if your bond goes down in value – say it drops 20% or more, your insurance policy will pay off the losses.

Next thing you know, you’re walking down a cobblestone street in Brussels, it’s 2AM and suddenly a gang of thugs jump out behind a shadowy corner – and Angela Merkel puts a gun to your head and say give us 50% of your bond or die. You surrender 50% of the value of the bond.

But you live to call your insurance agent who says – don’t get ahead of me – your insurance agent says what any insurance agent always says when you submit a claim – he says “you’re not covered; you see the problem is you made a voluntary choice to give up 50% of the value of the bond.”

You gasp for breath, the spittle forms around the corner of your lips, you feel your left arm go numb, with your right arm you reach for the blood pressure medication and you wash it down with a big slug of tequila.

And then you nearly break your fingers dialing your lawyer.

A little time passes and the billable hours add up and lawsuits are filed. Lots and lots of lawsuits.

And then we learn what Fitch ratings means by the term “temporary default” Greece won’t actually default; the bonds won’t really be cut in half by 50% of the value. Instead, the Europeans will just extend the maturity of the bonds from 5 years to maybe 20 years, but the value remains the same. This is known as the Super Grand Argentine Debt Solution, which was so successful six years ago.

This all seems to make sense, but then I read a very cogent email from a very intelligent listener who very astutely asks: Who in their right mind would buy bonds from the EU at this point as they obviously are manipulative and the bonds are so risky?  They have destroyed their credibility and I think this worsens rates in the long and short run as they have put on more risk that cannot be hedged. 

Yes, well, this is the dilemma. After you learn that insurance companies are in the premium collection business and not the claims payment business, should you still buy insurance?

And then the next part of the equation – if you can’t insure against loss, should you really buy that car, or that boat, or that widget, or that bond?

I suppose only time will tell.

Let me clarify a point here – the Credit Default Swaps aren’t really insurance and they are not really sold by insurance companies, banks sell them; and they are sold to people who don’t have an insurable interest. Insurable interest is important because it may create a moral hazard – for example – you don’t want your pharmacist to buy a life insurance policy on you. “Oh, yes Mr. Noe, here’s your Tylenol tablets. Oh sure, Tylenol always smells like rat poison, why do you ask?”

And you may wonder -  why are banks selling an unregulated version of insurance? And the answer is they get paid for selling this stuff.

And you may ask – wouldn’t it be a big problem if there were an actual default? And the answer is maybe, maybe not. Since banks are not really insurance companies, and since Credit Default Swaps are not really insurance and because the whole market is not really regulated, the banks don’t really have any money to pay off a claim in the event of a default.

When you consider that the entire worldwide global domestic product, everything produced in the entire world every year is valued at about $60 trillion dollars – and when you consider the entire US banks derivative exposure is somewhere between $250 trillion and $600 trillion (nobody really knows).  And when you consider that the total value of notional derivatives held by Goldman Sachs is 537 times its total assets. And when you realize that the top four banks control 94% of all derivatives. And when you realize that 25 banks worldwide control all derivatives.

And when you realize the derivatives markets are just one big, incestuous pool of greed that does nothing to hedge risk – at that point you may very well ask – why do we have this stuff anyway?

And this is where my brain feels like a sponge and I have a craving for tequila shots, even though I don’t drink tequila.

Meanwhile, let’s get back to analyzing the details of the Super Grand European Debt Solution that was announced yesterday.

It appears the indebted European Nations will borrow money, or create money out of thin air to bail out other indebted nations, who will in turn ask insolvent banks to accept a 50% off deal on the bonds of the indebted nations that are borrowing money from the insolvent banks that are given loans in order to recapitalize through raising capital which they will of course accomplish by borrowing from the indebted nations they just gave the money to.

So, we’re all reminded of Occam’s Razor which says: the simplest explanation is most likely the correct one.

Problem solved. Glad I could help.

Hello Doctor Sinclair Noe:

I appreciate the opportunity you provide for email questions.  I am unable to listen or call into your show live but I religiously listen to your show later after work thanks to the Money Radio 1510 archives.

My question relates to the derivatives at Bank of America where the derivatives were moved from the investment banking side to the FDIC deposit insured side.  I have personal and business accounts with Bank of America.  Of course, I am upset with this change not only as a user of Bank of America but also as a taxpayer that may be called on to bail out the FDIC should the derivatives "blow up".

My specific question relates to the overall exposure the derivatives place on the FDIC.  I believe the Bank of America derivatives exposure is approximately 57 trillion.  However, FDIC insurance is capped at 250,000 per account.  Does this imply that only a small portion of the 57 trillion or so in derivatives would be covered by the FDIC insurance making the risk to the taxpayers less than it may appear on the surface?

Thank you for any insights you may have,

loyal listener from Mesa, AZ.

Don’t thank me yet.

Here’s the deal. Bank of America might have $57 trillion in derivatives in the retail bank, backed up, in part by $1 trillion in deposits held by widows, orphans, Mom and Pop retail investors in checking and savings accounts with FDIC insurance up to $250,000 per account.

And you’re thinking that if just 2% of that $57 trillion goes bust, it’s the end of the world – But don’t worry – I mean, what could go wrong?

Actually, that $57 trillion dollar figure is misleading – that is a notional figure. In other words, they have taken bets on both sides at the same time. For example – let’s say BofA is betting on whether an apple will turn rotten. They write a derivative for one million dollars that says the apple will rot. They write another derivative for one million dollars that says the apple will not rot. They now have $2 million dollars in notional value. BofA pockets the commissions for writing the derivatives.

The apple rots.

The two derivatives contracts cancel each other out. Net loss is about 50 cents for the rotten apple. BofA keeps the commissions.

Now, let’s look at the quality of the underlying apple. The best estimates I have seen show that out of the total notional value of credit derivatives held by bank of America, approximately 37% are non-investment grade credit derivatives – just over one-third are bad apples. While that may sound incredibly reckless and dangerous, it is actually in line with industry standards. Citi holds about 55% in non-investment grade, Goldman Sachs around 52%, and JPMorgan about 35%.

Let’s put this in perspective; back in February 2008, Bear Stearns had total net derivative exposure rated BBB or below stood at about 17%. In May 2008 Lehman Brothers non-investment grade derivatives exposure was at 9.2%

But again – not to worry – even though there is a whole bunch of junk – it all cancels out – almost.

I’ve seen estimates that Bank of America has about $32 billion in un-hedged or naked swaps – which sounds like a lot considering the entire market capitalization of BofA is about $74 billion. But again, not to worry – it is highly unlikely that the entire $32 billion in naked swaps would all go bad at one time – that would have to be like some sort of contagion from Europe or a credit freeze like Lehman, and you really shouldn’t worry about such things.

Especially when you consider that those naked swaps would be covered, because under the 2005 bankruptcy act, derivatives counterparties are first in line and they get to grab assets first and leave everyone else to scramble for the crumbs. So the naked swaps get paid first, and if that means dipping into the retail checking and savings accounts – well there’s about $1 trillion just sitting there and it’s protected by the FDIC, which is guaranteed by the full faith and credit of the United States Government – you know – we the people.

Friday, October 28, 2011

October, Thursday 27, 2011

DOW + 339 = 12208
SPX + 42 = 1284
NAS + 87 = 2738
10 Yr. YLD +0.19 = 2.39%
OIL - .21 = 93.75
GOLD + 20.20 = 1746.70
SILV + 1.72 = 35.19
PLAT + 40.00 = 1643.00

Over the past few weeks I’ve been reading newsletters and blogs that seemed to have a recurring theme and similar screaming headlines: Euro collapse, Euro Crisis, Euro Armageddon, Global Meltdown.
I didn’t read much saying the Euro leaders would play a game of extend and pretend and we’ll probably see an imperfect deal and there will probably be a rally on Wall Street, but that was my conclusion – that’s what I’ve been telling you – You’re welcome.

The S&P 500 was up 3.4% sending its October gain to 14 percent, the biggest monthly gain since 1974, and erasing its 2011 loss. The 20 percent monthly advance for the Dow Jones Transportation Average, a proxy for the economy, is the biggest since 1939. Benchmark gauges in France, Italy and Germany rose more than 5 percent as German and emerging-market stocks extended gains from this year’s lows to more than 20 percent. The euro surged the most in more than a year and 10-year Treasury note yields rose 17 basis points to 2.38 percent.

Maybe I’ve been too kind in calling it an imperfect deal; it is a lousy deal; it will result in more problems down the road.

So the Euro leaders worked until the wee small hours of the night to hammer out a Grand Plan; shortly after midnight they called in the bankers and laid down the law. I can’t wait to watch the mini-series.

Here are the basics: bondholders will be forced into accepting 50% writedowns on Greek debt, the EFSF rescue fund will be pumped up to $1.4 trillion dollars (Sarkozy made a point of expressing the amount in dollars, just to be sure we know it is still safe to spend dollars in Europe), European banks will be recapitalized, The International Monetary Fund will take a bigger role, Italy will commit to reduce its debt, the European Central bank will make bond purchases in the secondary markets.

Let me simplify: banks must show losses but then the ECB will pass out free money created out of thin air, the IMF will try to privatize big chunks of the economy, and the peons and serfs in euro land will have to tighten their belts.

OK, that’s not exactly the language they used but let me break down some of the key points from last night’s statement:
The statement said: “All member States of the euro area are fully determined to continue their policy of fiscal consolidation and structural reforms.”
Translation: More austerity measures; more belt tightening.

The statement also said: “ “We commend Italy’s commitment to achieve a balanced budget by 2012 and a structural surplus by 2014, bring about a reduction in gross government debt to 113% of GDP in 2014, as well as the foreseen introduction of a balanced budget rule in the constitution by mid 2012.”
Translation: We tried austerity on Greece. It didn’t work. Now we’re going to do the same thing to Italy. It won’t work but we won’t have to deal with it for at least 9 months.

The statement said: “We invite Greece, private investors and all parties concerned to develop a voluntary bond exchange with a nominal discount on notional Greek debt held by private investors.”
Translation: Greece is in default. Busted. Broke. Toast. It’ll cost 50% - and if you don’t take it, if you trigger the Credit Default Swaps -  it’ll cost you 100%.

Statement says: “If necessary, national governments should provide support, and if this support is not available, recapitalization should be funded via a loan form the EFSF in the case of Eurozone countries.”
Translation: FREE MONEY for banks. Too Big to Fail lives on in Europe.

Statement says: “We will make further progress in integrating economic and fiscal policies by reinforcing coordination, surveillance and discipline.”
Translation: You are all very, very naughty and we will punish you. We will not allow you out of the European Union. This is verboten.

After the announcement that a Grand Plan had been reached, ECB president Jean Claude Trichet said the measures agreed “have to be fully implemented, as rapidly and effectively as possible.”
Translation: We bought some time. The whole thing could fall apart if anybody sneezes.

Don’t sneeze.

Actually, this whole crisis will now be much bigger and if it fails or when it fails, it will be a bigger catastrophe. This does not solve the fundamental problem of a 30% gap in the competitiveness between North and South; it does not address the intra –monetary union German trade surplus with the deficits of the Mediterranean states. It talks about austerity but does not realistically address the inevitable defaults of Italy, Spain, and Portugal. It does not address the whole deflationary downward spiral or the recessionary impact of all these cuts, but hey – it’s a Grand plan, you know – except for the details.

And so my advice to you is: be very cautious with this rally. This is not the rally where you bet the farm.

Back in the USSA, economic growth picked up in the third quarter. Total output, or GDP, grew at an estimated annual rate of 2.5 percent from July to September, still modest but almost double the 1.3 percent rate in the second quarter. The American economy has finally reached the size it was before the depression began four years ago. It has taken 15 quarters for the economy to merely recover the ground lost to the depression. That is significantly longer than in every other downturn/recovery period since World War II. In the previous 10 recessions, the average number of quarters it took to return to the pre-depression peak was 5.2, with a high of 8 quarters after the recession in the 1970s.

It’s not enough to lower unemployment; there are still plenty of problems.  What we’ve really lost here is the trillions in output between potential GDP (how the economy would have done absent the recession) and actual GDP. That’s the actual cost of the downturn—the output, jobs, incomes, opportunities, even careers, that were lost – but the GDP was up 2.5% in the third quarter and that beats a poke in the eye with a sharp stick.

More than half of the companies in the S&P 500 have released quarterly results since Oct. 11, and about three- quarters have beaten the average analyst estimate. Net income has grown 16 percent for the group on an 11 percent increase in sales.

Yesterday, I talked about the Catholic Church coming out in support of the Occupy Wall Street ideas. I said, that issues of economic justice should be much more common in more churches around the country. One of you guys sent me an email saying that in your church, the preacher had indeed done a sermon on this issue. Sent me a copy of the sermon. It’s a good sermon. But that was all you guys sent me – one sermon.
My email address is

I’ve had a lively little email debate going with one of our listeners. I wrote that we’ve seen no prosecution of the bankers. I wrote: Still, no prosecutions (except for the insider trading and such) compared to about 1,000 prosecutions from the S&L crisis. Injustice serves as salt on the wound of inequity.

Then I ran across this news item – so I have to make a correction. We have a prosecution.
A few years back, Wall Street bankers turned C.D.O.’s into vehicles for their own personal enrichment, at the expense of their customers. C.D.O.’s are Collateralized Debt obligations. They take a whole bunch of debt, credit card debt, car loans, student loans, whatever, and toss them into a big pool or fund, and then they trade that big pool of debt.
These bankers brought in sophisticated investors to buy pieces of the deals that they could not sell. These investors bet against the deals. Worse, they skewed the deals by exercising influence over what securities went into the C.D.O.’s, and they pushed for the worst possible stuff to be included.
The investment banks did not disclose any of this to the investors on the other side of the deals, or if they did, they slipped a vague, legalistic disclosure sentence into the middle of hundreds of pages of dense documentation.
In a case brought last week, Citigroup was selling the deal, called Class V Funding III, while its own traders were filling it up with garbage and betting against it. So last week, the Securities and Exchange Commission announced it had agreed to a measly $285 million dollar settlement with Citigroup over the bank having misled its own customers in selling an investment created out of bad debt that was intended to fail.
In addition, the S.E.C. accused one person — a low-level banker. The SEC complaint makes clear that the low-level Citigroup banker that it sued, a Mr. Stoker, had multiple conversations with his superiors about the details of Class V. At one point, the guy’s boss pressed him to make sure that their group got “credit” for the profits on the short that was made by another group at the bank.
Pause, and think about that. The boss was looking for credit, but as far as the S.E.C. was concerned, he got no blame. Based on the major cases the S.E.C. has brought, a pattern has emerged. It is making one settlement per firm and concentrating on only the safest, most airtight cases. The agency’s yardstick seems to be, who wrote the stupidest e-mail? Mr. Stoker of Citigroup wrote an incriminating e-mail that recommended keeping one crucial participant in the dark. Goldman’s Fabrice Tourre, the other functionary the agency has sued, wrote dumb things to his girlfriend.
Several of the big banks did this kind of sleazy deal, including Goldman Sachs, JPMorgan chase, and Citigroup. John Paulson, the hedge fund guru made a fortune at this scheme. These weren’t isolated cases. This was a business model. Goldman, JPMorgan and Citigroup were all able to settle without admitting or denying anything, which, of course, is part of the problem.
So, now the SEC has prosecuted this Fabricio guy, and they’re going after this guy Stoker at Citi. I think we can all breathe a huge sigh of relief. We finally caught the guy that caused the financial crisis.