Archive for May 13th, 2010
Posted by Karl Denninger
To follow up and expand upon my other writings regarding the ECB/Euro bailout package of last weekend, I want to focus on why I believe the markets responded to the north as strongly as they did – and why believing in this may be dangerous to your portfolio.
Markets try to suss out the impact of events based on history. The more recent the history the more impact that event has in the collective consciousness. This is true in all human endeavors where psychology is a factor, and the equity markets are the epitome of human psychology interacting with money.
About 18 months ago the United States Congress passed TARP, and The Fed opened unprecedented policy actions (many of which I have argued were illegal, and still do.) But the markets, at least initially, did not respond. Indeed, it was not until about six months later, when FASB changed mark-to-market accounting rules and thus allowed financial institutions to lie about balance sheet values in the United States, that the “recovery” of the markets really took hold.
The pundits, however, all point to “easy money” and “monetization” (whether true or not) as the reason for the market turn. I disagree, and point to the fact that both consumer and business credit have not turned around. We can therefore disregard that claim as mathematically deficient (incidentally it was correct in 2003, as the numbers show.) It didn’t work this time because the market is (still) debt-saturated, which is why we entered the recession and housing crash in the first place.
I have spent many hundreds of hours studying the credit crunch and the alleged “recovery” therefrom thus far, which has led me to my primary thesis for the stock market rally and alleged “stabilization” in the US Economy. The truth is found right here in my favorite (of late) chart:
That is, we didn’t “recover” in the stock market because of a “bottoming” in the economy nor, in the main, because of ZIRP. We can exclude the zero-rate policy as a recovery catalyst as it didn’t work in Japan, which tried the same thing and got two decades of deflation and a stock market stuck at 2/3rds off all-time highs in response.
So what “moved the needle”, at least temporarily?
- Blowing budget deficits wide. Japan had them before, thus their budgetary profile just continued to deteriorate – they lacked the ability to make meaningful additions to that program and move the needle. We could, we did, and it mattered – for now.
- FASB changes. They were a game-changer in the short term, but are ruinously bad in the intermediate and longer term. The game has been and continues to be to allow banks to claim valuations that don’t exist in the hope that (1) they can “earn” enough to close the gap or (2) asset values will recover. The latter is an idiotic premise as the values were never real in the first place and the former won’t work because instead of rebuilding cash reserves with these “earnings” the banks have instead bonused out all the money! But in the short term it all looks good, and most of these stocks have doubled – or more.
That’s where your rally came from and it’s also where your positive GDP prints have come from in the US. My belief that the government couldn’t get away with (1) for more than 12 months or so, by the way, is why my original belief that this move upward wouldn’t have the power or duration it has proved incorrect. Sadly, it also means that when the pump wears off the collapse will be significantly worse than if they had left it alone – they’ve blown the money but the debt is still there.
By the way, for those who argue differently – show me the math. Specifically, show me how blowing a budget deficit from 3.5% of GDP to 11% of GDP does anything other than what’s happened, and how allowing firms like Wells Fargo to maintain $1.7 trillion off balance sheet without a market price for those “assets” fails to cause people to “believe” that the firm is solid and stable, and thus be willing to buy their stock (along with the rest of the financial sector.) I’ll take that analysis on the latter point in the form of actual valuations of those assets against the market and compare the divergence against these firm’s Tier 1 Common Equity (and I’ll wager all will print a number in parenthesis if you do that.)
Now let’s analyze against the European/ECB announcement.
First, the ECB announcement is the exact opposite of point #1 above. That is, the announcement contains formal claims of austerity for governments, which means reducing the debt-issuance spike to GDP. Whether through tax increases, spending cuts or both, the impact will be the same, and it will be materially negative on a macro economic level. There is no possible way to avoid this if the actual austerity measures are taken, and yet the “bailouts” are conditioned on them so it is reasonable to assume that either (1) they won’t be taken and the bailouts won’t happen or (2) they will be taken and the effects will flow from them.
Second, European banks were already lying about asset valuations. That is, there’s no “goose” that can come from that here in this case, as Euroland banks were never honest about their leverage or asset valuation levels to the degree that US banks used to be. Thus, there’s nothing to “rig the market with” there, as the impact of that rigging has already been had years ago.
The FX markets have already figured this out and reacted accordingly; indeed, the Euro traders figured it out in less than 12 hours. But the bond and equity markets haven’t – yet.
Putting off the collapse of a sovereign bond market by buying their bonds when you are sterilizing the buying doesn’t work for long. The credit markets will call that bluff sooner rather than later, and when they do spreads will start to force open again.
At that point the ECB has a problem: If they try to increase the size of the package they will have to deal with those who claim there’s a credibility problem in that they haven’t yet funded the original program (and might not be able to!); if they instead turn to raw monetization of debt the entire underpinning of the Euro and ECB goes down the drain and the risk of defections grow substantially. Indeed, there may already be some hints of that with Germany – if the German people haven’t figured out that this program, led to its conclusion, inexorably requires them to transfer their wealth to the PIIGS simply to keep the Ponziconomy in Europe going, they soon will.
In short this doesn’t look like a stability measure to me, it looks like an instability measure. There’s nothing worse than “reassuring” the market with something that turns out to be BS, as we saw back in 2008 with Fannie, Freddie, and Bear.
I think we’re due for another example, and would be protecting all long-side positions accordingly.
Thursday last may have been nothing more than the Fat Lady clearing her pipes.
Posted by Karl Denninger
CNBS asks this today on-air.
I’ll give you my answer – do all of the following:
No more “line-jumping” games. If I place an order my order goes to the end of the line at a given price. For instance, if I want to buy 100 shares of IBM @ 132.50 LIMIT and there are 10,000 shares at that price already on the book, my order goes behind the other 10,000. That’s fair. But what the high-frequency trader guys will do is “load the stack” with orders they never intend to execute. I see this daily in the Globex (futures markets) with bids and offers that “magically disappear” as the price approaches the number. This is done because you can cancel an order instantly, but you must go to the back of the line when you enter one. You can never do this as a person as you’re not fast enough – but the computers are, and they do. The result is that you the investor get screwed as the computers are basically always in front of you. The fix for this technologically in the current market is simple: All orders must remain valid for some reasonable period of time – say, 30 seconds, and cannot be canceled before that time expires. This makes such a strategy instantly unprofitable and stops the “line jumping” games. To prevent future “innovations” from figuring out how to get around this (again) the law must be changed to make intentionally issuing orders not intended to execute (that is, for the purpose of misleading the market, of probing liquidity or any purpose other than to actually buy or sell) a criminal (not civil) offense carrying felony penalties.
Bar trading with government-backstopped money. This means reinstating Glass-Steagall, in short. Gamble with your own money, not the government’s and not the people’s. Period.
The primary market controls. The “flash crash” occurred in no small part because when the NYSE went into “slow mode” other venues did not have to follow and in fact brokers were allowed to “route around” a working but intentionally slowed primary venue! That’s BS and makes a mockery of NBBO, or National Best Bid and Offer – a key protection that investors have every right to rely on as it is published SEC policy and rule. Companies select the primary venue for their shares to trade and spend a lot of money to be listed there. They should set the rules, not Wall Street. If a company goes to NYSE for that listing in no small part for the specialist system, it should be honored everywhere – period – with violations not resulting in broken trades but rather the brokers required to make every investor harmed by same whole.
All instruments that are underwater must be backed with cash collateral at the end of every day, no exceptions, marked to market nightly. I don’t care if you want to claim it’s a “custom agreement” or whatever – I have to post margin every night against underwater positions and so does every other individual and small investor. To let Berkshire, Goldman, Bank of America or others “off the hook” because of “perceived” balance sheet strength is hogwash. I’ve had $100k of underwater positions but have many multiples of that in liquid net worth, yet I still have to post cash. Everyone should be equal in the market in regard to backing their bets. A big part of the “advantage” these big boys have is the ability to write essentially unlimited-size bets without recognizing the impairment in cash during any time they go underwater. That’s the check and balance on excessive position size that every individual is required to observe, and it must be so for the large corporation as well.
All markets must be exposed if the securities are either issued by a public entity or are publicly traded – no exceptions. This means exchange traded, basically, with a central counterparty, so everyone can see bid, offer, size, open interest (in the case of derivatives) and last trade in real time. Everyone must have equal access to that data stream as well. “Dark Pools” and similar games must be barred.
Prosecute wrong-doers. There have been many. Blatant and obvious insider trading on various news events, unlawful front-running, allegations of firms selling securities to customers as “good investments” while in emails claiming they’re “crap”, “trash”, “turds” and similar and more. All of these are frauds of various sorts. If I bilk the little old lady next door out of $2,000 I am prosecuted and might go to prison. These firms bilked investors out of trillions over the last 20 years and few if any of them have faced any sort of criminal or civil sanction. The public cannot trust Wall Street until the cops show up.
You want ordinary investors back in the market? Do the above.
Until that all happens Americans will (correctly) conclude that it is indeed a rigged game run by the big banks for the purpose of robbing them blind – and they’re right.
by Peter Gorenstein
Even a cynic can find Washington’s hypocrisy shocking at times. The Wall Street Journal reports today a House bill that would force lawmakers to make greater disclosures on financial transactions and disallow them from trading on nonpublic information is going nowhere fast.
That’s right. Members of Congress are currently allowed to profit on insider trading!
The bill, which has been languishing in the House for four years, would require elected officials “to make their financial transactions public within 90 days of a purchase or sale” and “prohibit lawmakers from trading in financial markets based on nonpublic information they learn on the job,” the WSJ reports.
It seems they’re above the transparency they’ve been calling for on Wall Street.
This comes a day after the same newspaper reported several lawmakers profited by betting against the housing and stock market in 2008. And some did it using derivatives they’ve recently been railing against.
As our colleague Henry Blodget wrote Tuesday, “If you’re going to complain about how awful short-selling is and how evil and venal people are for doing it, you should probably abstain from the practice yourself.”
The latest quarterly reports from the big Wall Street banks revealed a startling fact: None of the big four banks had a single day in the quarter in which they lost money trading.
For the 63 straight trading days in Q1, in other words, Goldman Sachs, JP Morgan, Bank of America, and Citigroup made money trading for their own accounts.
Trading, of course, is supposed to be a risky business: You win some, you lose some. That’s how traders justify their gargantuan bonuses–their jobs are so risky that they deserve to be paid millions for protecting their firms’ precious capital. (Of course, the only thing that happens if traders fail to protect capital is that taxpayers bail out the bank and the traders are paid huge “retention” bonuses to prevent them from leaving to trade somewhere else, but that’s a different story).
But these days, trading isn’t risky at all. In fact, it’s safer than walking down the street.
Because the US government is lending money to the big banks at near-zero interest rates. And the banks are then turning around and lending that money back to the US government at 3%-4% interest rates, making 3%+ on the spread. What’s more, the banks are leveraging this trade, borrowing at least $10 for every $1 of equity capital they have, to increase the size of their bets. Which means the banks can turn relatively small amounts of equity into huge profits–by borrowing from the taxpayer and then lending back to the taxpayer.
Why is the US government still lending banks money at near-zero interest rates? Ostensibly, for the same reason that the government bailed out the banks in the first place: So the banks will lend money to small businesses, big businesses, and other participants in the “real economy.”
But the banks aren’t lending money to the real economy: Private sector lending has fallen off a cliff.
And one reason private sector lending has fallen off a cliff is that lending money to the private sector is risky. Lending money to the government, meanwhile, is nearly risk-free. So the banks are just lending money back to the government (by scarfing up US Treasuries), collecting a nearly risk-free 3% spread, and then leveraging up this bet 10-15 times.
THAT’s how the big banks made money 63 days in a row. Importantly, doing this required no special genius: If you had the good fortune of working at a big bank, you would be making money every day, too. And then you’d get to take half of that money home as a bonus!
No wonder everyone wants to work on Wall Street.
The government’s zero-interest-rate policy, in other words, is the biggest Wall Street subsidy yet. So far, it has done little to increase the supply of credit in the real economy. But it has hosed responsible people who lived within their means and are now earning next-to-nothing on their savings. It has also allowed the big Wall Street banks to print money to offset all the dumb bets that brought the financial system to the brink of collapse two years ago. And it has fattened Wall Street bonus pools to record levels again.
Health Care: The Democrats’ reform is barely out of the gate and the Congressional Budget Office already says its previous cost estimate was too low. Either the bill’s supporters lied or they’re profoundly ignorant.
Either way, they are not fit to serve the country, much less rule it, which many of them seem to believe is their divine right.
As noted on these pages and elsewhere, government programs always cost far more than their original projections. Medicare has cost more than 10 times as much as initially estimated. It took Medicaid, the government’s other mammoth health care program, a mere five years to spend twice as much as early estimates said it would.
At the state level, the story remains the same. Maine’s 2003 program to cover the uninsured has already cost taxpayers there $150 million, but it was sold as a plan that would save them money. Tennessee’s arrangement became such a parasite — eating up 40% of the state’s budget by 2008 — that it had to be shut down. Massachusetts’ program overran cost projections so sharply it had to throw 30,000 beneficiaries off the rolls last year.
Despite this clear history, lawmakers always promise the next program won’t cost taxpayers — or that it’ll save them money.
They get support from the media that are rarely interested in what nanny-state programs cost, voters who simply are unaware of the past and too busy with their lives to think about today, and a large segment of the public that doesn’t care what the costs are because it craves yet another government entitlement.
As we recall, President Obama said his party’s health care overhaul wouldn’t increase the deficit by a single dime and would actually “bend the cost curve downward.” Supporters in and out of Congress went along with the charade.
At some point, Americans will have to deal with reality, such as the CBO’s latest analysis. Director Douglas Elmendorf now says the program will probably cost at least $115 billion more from 2010 to 2019 than had been originally thought. So it is now officially a trillion-dollar program — though unofficially, meaning realistic estimates made outside the federal government, it could cost as much as $3.5 trillion over its first 10 years.
The new estimate, released Tuesday, includes “administrative expenses for the Department of Health and Human Services and the Internal Revenue Service for carrying out key requirements of the legislation” as well as “explicit authorizations for future appropriations for a variety of grant and other program spending.”