March, Monday 19, 2012

DOW + 6 = 13,239
SPX + 5 = 1409
NAS + 23 = 3078
10 YR YLD +.08  = 2.38%

OIL  - .31 = 107.78
GOLD + 3.40 = 1664.50
SILV + .36 = 33.02
PLAT + 10.00 = 1685.00

The S&P 500 Index is now at its highest level since May 2008 and 10 percent below the record close of 1,565.15 set in October 2007.

Apple rose 15.53 to $601.10 per share, pushing the market cap to $560 billion. It is the first time Apple has closed above $600. The market capitalization makes Apple the most valuable publicly traded company in the world. This is a parabolic rise; Apple is up almost 50% for the quarter. Today's move followed an announcement they would pay a dividend of $2.65 per quarter starting in July, and also a $10 billion stock buyback program, and also that sales of the iPad 3 topped 3 million over the weekend.  It all sounds a little frothy. I mean, what are they going to do next Monday?

Treasuries continued to drop. Thirty-year-bond yield added 7 basis points to 3.48%, a level it hasn’t close above since September. Yields on 10-year notes rose for a fifth day, by 8 basis points to 2.38%, from as low as 2.26% touched during European trading hours. Yields haven’t closed above that level since Oct. 27. Yield moves inversely to prices. In a speech, William Dudley, president of the New York Federal Reserve Bank said “the economy still faces significant headwinds” and inflation is expected to moderate. Separately, Dallas Fed president Richard Fisher said there is no need for another round of bond purchases. Fisher was referring to another round of Quantitative Easing because the reality is that the Fed is scheduled to buy Treasury debt every day this week. The purchases are part of the central bank’s program known as Operation Twist, in which it buys long-term debt and sells shorter-dated holdings. The idea is to hold down interest rates without the central bank further expanding its balance sheet.

Last Friday we had a couple of very good phone calls about the direction of interest rates, and I think the Fed will step in with more purchases if rates move much higher. The Fed still guides policy rates near zero out to 2014, so they don’t appear overly swayed by the recent positive economic data. For now, it would be hard to see treasuries trading outside of a range.

There was a great deal of publicity last week to the resignation letter of a guy named Greg Smith as he quit  his job at Goldman Sachs. He basically claimed Goldman screwed its own customers and called them silly names behind their backs. I was shocked, absolutely shocked to realize that anyone would consider this information about Goldman Sachs to be shocking. Meanwhile, there was another letter, purportedly written by an employee of JPMorgan, and unlike Greg Smith at Goldman, this guy remained anonymous and he hasn't quit his job. So, there is no confirmation on this story. The whistle-blower accuses JPMorgan of manipulating the gold and silver markets and warns a "cascading credit event being triggered" by derivatives related to Greek government debt. Maybe. We don't know if this letter is real or a figment of some blogger's imagination but it brings up some interesting points

Last week, Greece officially defaulted on its debt. Of course, we've all known that Greece was defaulting for a long time. This formal default on about $100 billion triggered payment of $3 billion in credit-default swaps. These are the non-insurance insurance products that pay off in the event of a default; at least in theory. So far, there has been no cascading credit event; there has been no payment of claims.

CDS obtained their favored status as unregulated insurance policies courtesy of the Commodity Futures Modernization Act of 2000. It was sponsored by then-Sen. Phil Gramm (R-Tex.) — and benefited Enron, where his wife, Wendy, was a director on the board. The act was a radical deregulation of derivatives. It was an example of the now widely discredited belief that banks and markets could self-regulate without problems. Management would never do anything that put the company at risk, and if it did, it would be suitably punished by the shareholders.

In reality, the banks did not self-regulate; they put the franchise at risk, they were not punished by shareholders or anybody, they were bailed out by taxpayers. The Act effectively ended regulation on CDS by exempting derivative transactions from all regulations as either “futures”  or “securities”. The Act specifically exempted credit-defaults swaps and other derivatives from regulation by any state insurance board or regulator. So, CDS wasn't futures, nor securities, nor insurance. Companies that wrote insurance typically set aside reserves for expected risk of loss and payout. When it came to swaps, the companies that underwrote them had no such obligation. No reserves were required.

CDS was considered a nearly risk free trade, because they didn't have to set aside reserves. What could go wrong?

Two weeks ago, the International Swaps and Derivatives Association said that “based on current evidence the Greek bailout would not prompt payments on the credit default swaps.”

Typically, an option or futures contract expires, and it either is in or out of the money. Any tradable asset — stocks, bonds, futures, options, funds, etc. — settles on its own. There is a market price the asset closes at, a total volume of sales, and a final print for the day, month, quarter and year. No interpretation of evidence is required; the price is the evidence. On Friday, the ISDA committee ruled that Greece formally defaulted.Had they failed to do so, it would have fatally damaged the swaps market and made sovereign debt financing much more expensive. No sort of group declaration is required when a futures contract or an option must settle. No committee decision is required. Which (again) is why credit-default swaps look, sound and act a lot more like insurance than they do other tradable assets.

Why does it matter if swaps are not insurance? Reserves. That is the key difference between insurance and swaps. State insurance regulators actually require reserves from insurers, to ensure payments can be made in the event any payable event occurs. The swaps industry does not require reserves. Not even one penny against billions in potential losses. The CDS industry is in the premium collection business, not the claims payment business, and that is why it really should be considered insurance and it really should be regulated. Because the simple truth is that in its current, unregulated state, it does nothing to manage risk, it only leaves a false impression of managing risk. In fact, because multiple people can buy multiple policies on any event, there are multiple reasons why buyers of CDS would like to see a credit event trigger multiple payouts. There is no insurable interest requirement for CDS. If ever there was a reason to support failure, it would be CDS. There is no good reason for CDS, but there are many bad reasons. The simple truth is we shouldn't regulate CDS, we should end it completely.

A federal court in Brazil has issued an order barring 17 executives from U.S. oil giant Chevron and Transocean Ltd. from leaving the country while it mulls criminal charges against them for an oil spill last year.

The oil spill occurred in deep water off the coast of Rio de Janeiro in November. The next month, Brazilian federal prosecutors filed a suit against Chevron and oil rig operator Transocean for 20 billion reais, about $11 billion. The Brazilian prosecutors office issued a statement that said: "Chevron and Transocean were not able to control the damages caused by the spilling of almost 3,000 barrels of oil, which shows a lack of environmental planning and management by the companies.”

The Brazilians actually care more about their beaches than we do.