Wednesday, May 16, 2012

Wednesday, May 16, 2012 – An All Out Jog to the Finish – by Sinclair Noe

DOW – 33= 12,598
SPX – 5 = 1324
NAS – 19 = 2874
10 YR YLD -.01 = 1.76%
OIL – 1.16 = 92.82
GOLD – 4.00 = 1541.30
SILV -.45 = 27.37
PLAT + 3.00 = 1439.00

A Judge has been appointed to lead Greece until the next round of elections in June; leading Greece is a misnomer. The judge will be the caretaker prime minister, replacing another caretaker prime minister. Yesterday, we told you about the run on the banks. On Monday, Greeks pulled out about $900 million dollars, Euros actually. Makes sense. If you think your country will exit or be kicked out of the Euro-union, and be forced back to the drachma at about half the value, you might want to grab some Euros and hold on. Having the actually paper money in your hands prevents the banks from cutting the value in half; banks will do that sort of thing. Right now, it's not really a bank run, more of a jog. Paul Krugman explained why it is a problem:
Where are the euros coming from? Basically, banks are borrowing them from the Greek central bank, which in turn must borrow them from the European Central Bank. The question then becomes how far the ECB is willing to go here; is it willing, in effect, to lend enough money to buy up the entire balance sheet of the Greek banking sector, given the likelihood that this sector will be left insolvent by Greek default? Yet if the ECB says no more, Greek banks stop operating — and it’s hard to see how they can be restored to operation except by ditching the euro and using something else.

And if that happens, surely depositors in other European countries will start their own bank jogs.”

Where are the Euros coming from? Well, they're not. Today, the European Central Bank stopped funding operations for some Greek banks. Is this how it ends? With a bank jog?

What happens if Greece tells the Euro-union to go to hell? What happens if the Greeks do a full-fledged “shove this” default on all their outstanding debt? Well, someone did a study and they conclude that it would cost France around 66-billion-euro, and it would cost Germany about 90-billion-euro. The looses for French banks would run about 20-billion-euro, and the losses for German banks would be around 4.5-billion-euro. That's just from the default; it doesn't include the fallout. The real danger is contagion to Portugal, Ireland, Spain, Italy, Belgium, France, and the deadly linkages between 15-trillion-euro in public and private debt in these countries and the 27-trillion-euro European banking network.

Has the economy slowed enough to cause the Fed to dish out free money? Most of the reports indicate the economy is shuffling along. The stock market is stumbling. Is that enough to motivate the Fed? The Fed's program to "extend the average maturity of its holdings of securities" (aka Operation Twist) is scheduled to end in June. The FOMC meets in June. Today, the Fed released the minutes of the April meeting and we learn that “several members indicated that additional monetary policy accommodation could be necessary if the economic recovery lost momentum or the downside risks to the forecast became great enough.”

What exactly would be considered momentum lost or a greater downside risk? Two quick thoughts: first, the whole mess in Europe deteriorates; second, Washington screws up. Yesterday, House Speaker John Boehner promised to oppose any increase in the debt ceiling unless there are big spending cuts. It's deja vu all over again. You remember, last year we had the same problem, resulting in the loss of the United States' Triple-A credit rating. Remember, when they appointed the bi-partisan Super Committee? And remember how the Super Committee failed miserably at everything except collecting campaign bribes? And remember how the Super Committee was designed to trigger automatic and simultaneous tax increases at the end of the year? Mutually assured destruction for both political parties and for the economy. And it turned out the politicians on the Super Committee cared more about their campaign donors and their political parties than they cared about the well being of their country. Tax increase and spending cuts could vaporize about $500 billion dollars next year and trillions over the next decade, and result in another credit downgrade. Yea, that might be considered “momentum lost”.

For now, Bernanke is saying it is up to fiscal policymakers to save the economy, but if he's expecting Congress to do anything, he has clearly lost his sanity. The Fed will have an accommodative easing policy, which may or may not be called QE3, and they might wait past the June FOMC meeting if they feel the need to keep their powder dry, but make no mistake – the Fed will have an accommodative monetary policy. Of course, the Fed has tried an accommodative monetary policy two times before and the results were pathetic; well, it was pathetic for the economy but it was pretty sweet for the banksters. Of course, if the Fed decides to do nothing, no Quantitative Easing Part 3, then the money that's been coming out of the stock market will turn into a torrent. Has the economy slowed enough to cause the Fed to dish out free money? Wrong question.

With all the malfeasance associated with JPMorgan this week, this next story hasn't received the attention it deserves. Once again, MattTaibbi has dished some great dirt on Goldman Sachs. There has been an ongoing legal battle between Goldman Sachs, Bank of America/Merrill Lynch and Last week, the banks filed some paperwork with the courts and they filed an unredacted version, and they inadvertently entered into public record a laundry list of misdeeds.

Specifically, the documents relate to short selling, which is a legal practice, except the way Goldman Sachs did it. Normally, short selling involves borrowing shares from a brokerage account. For example, if I think stock xyz is heading lower, I instruct my broker to borrow shares from your broker. Your broker takes the shares out of your account and gives them to me. I sell the shares, for example 1 million shares for $1 million, or a dollar per share. The price drops, and in a little time, I go out into the market and buy 1 million shares for 50 cents each, and I return those million shares to your broker and your broker puts a million shares into your account. You get nothing. Your broker collects a fee. I pocket $500k. All legal.

Although sometimes, it isn't easy to find 1 million shares to lend to someone. When that happens, I have to pay your broker a premium to borrow the million shares. These hard-to-borrow stocks, stocks that cost money to borrow, are called negative rebate stocks. In some cases, these negative rebate stocks cost so much just to borrow that it doesn't make sense to do the trade. Goldman Sachs figured out a way around that problem. Even if they couldn't find another broker willing to lend shares, they did the trade anyway. Why bother paying the high cost of borrowing “negative rebate” stocks? Instead, Goldman Sachs just sold stock they didn't possess. If you don’t have to actually locate and borrow stock before you short it, you’re creating an artificial supply of stock shares. At one point, 107% of all Overstock shares available for trade were short – a physical impossibility.

Here's what it means – Goldman and Merrill made it cheaper and easier to bet down the value of the stock by adding fake supply, in turn making it easier to make money by destroying value. This is what the banks like Goldman Sachs and Merrill Lynch do when they turn the stock market into a casino – they destroy real, job-creating growth.

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