THE BIG FIX
WASHINGTON (Reuters) - Treasury Secretary Henry Paulson said on Monday a sweeping revamp of the U.S. financial regulatory landscape was not intended as a response to current market turmoil and should not be implemented until the difficulties are resolved.
Monday, March 31, 2008
THE BIG FIX
Sunday, March 30, 2008
- Interest rates too low in 2003-2004
- Higher supply of dollars and higher imports
- Dollar continues depreciating
- Fed raises interest rates
- Real estate market tops in mid 2005
- Domestic credit crisis in real estate financing starting in August of 2007
- Dollar continues to fall
- Fed cannot extinguish excess dollars (it would make the crisis worse) and cannot expand dollars (to offset deflation) as it may severely impact the market for U.S. treasuries ... so it essentially freezes the monetary base and "follows the market down" (we're here now)
- Lower interest rates and rising prices spur inflationists to declare victory (perhaps they are right, but isn't it premature?)
- Deflationary effects begin to overcome the initial inflationary effects perhaps late in 2008 or in 2009, although oil and other goods remain buoyant (supply / demand).
- 1 trillion in losses and 2-3 trillion in credit disappears, the net effect being several hundred billion subtracted out of GDP (about 2%-4% lost). The knock-on effects are larger than any correction since the great depression. Interest rates remain stubbornly high as risk aversion continues. Supply/Demand issues dominate in mortgage banking with "too many banks" being propped up for fear of a cascade of losses (like Countrywide).
- The near future coincides with extremes in Euro valuation against the dollar ... which will likely reverse, until both currencies see themselves in trouble against the Yuan.
- The Euro is given second thought as China will roughly equal U.S. GDP in 2011 (or near there) and their growth prospects, with some corrections, looks huge with the size of their population and available capital outbuild. Per capita GDP won't hit the U.S. level until an estimated 2040. Imagine the size...
Let me give you three numbers that will put this economic asteroid into perspective: $200 billion, $14.1 trillion, and $53 trillion.
$200 billion is the approximate total amount of write-downs announced so far as a result of the current credit crisis.
$14.1 trillion is the size of the entire U.S. economy
And $53 trillion is (drum roll please) the approximate size of this country's bill for the Social Security and Medicare promises we've made.
- NYT: March 31: Treasury's Blueprint for regulatory reform: Consolidate a large number of regulators into roughly three big new agencies: 1) Prudential Financial Regulator for deposit institutions; 2) merge the Commodity Futures Trading Commission with the S.E.C. for investor protection across all markets and instruments; 3) create a national regulator for insurance companies.
- NYT: Paulson: expand Fed's troubleshooter role and authority to intervene when system stability is threatened wrt banks, broker dealers, hedge funds, private equtiy. However: no calls for tighter regulation.
- March 26: Secretary Paulson wrt primary dealer discount window: Tight regulation/supervision for broker dealers necessary as long as they have access to discount window. However, this is a temporary emergency feature, not permanent.
- Frank: Single regulator/greater power to Fed good idea. Regulators should re-examine capital reserves, risk-management practices and consumer protection without regard to whether companies were commercial banks, investment banks or nonbank mortgage lenders.
- Wolf: Remember Friday March 14 2008: it was the day the dream of global free- market capitalism died.Implication: there will have to be far greater regulation of complex financial institutions.
- Both President Bush and Mr. Paulson remain philosophically opposed to restrictions and requirements that might hamper economic activity--> major overhaul unlikely this year.
- Bernanke: 3 principal public policy objectives: financial stability, investor protection, and market integrity. Challenges: Complexity, illiquidity, leverage
--> central banks and other regulators should resist the temptation to devise ad hoc rules for each new type of financial instrument or institution. Rather develop common, principles-based policy responses that can be applied consistently across the financial sector to meet clearly defined objectives.
- Roubini: It would be a most dangerous step to expand the lender of last resort support of the central bank to most non-bank financial institutions beyond the few systemically important ones, even to all securities firms: risks of additional fiscal bailout costs of insolvent securities firms would be serious.
- Economist: Deposit-taking banks should keep their government guarantee, whereas banks that want to live like hedge funds should learn to die like them too.
- Krugman, Lex: Banking crisis of the 1930s showed that unregulated, unsupervised financial markets can all too easily suffer catastrophic failure--> reintroduce variant of Glass-Steagal separating banking and securities business and was repealed in 1999.
- SIPC: customers of a failed brokerage firm receive all non-negotiable securities - such as stocks or bonds -- that are already registered in their names. At the same time, funds from the SIPC reserve are available to satisfy the remaining claims of each customer up to a maximum of $500,000. This figure includes a maximum of $100,000 on claims for cash.
http://www.msnbc.msn.com/id/23853415 Most sweeping changes since the great depression: msnbc
Ed Yardeni at Yardeni Research said Fed chairman Ben Bernanke "made monetary history" by opening the discount window and "crossed even further over to the dark side of financial socialism" by allowing the firms to pledge illiquid mortgage debt as collateral.
"Comrade Ben is determined that there will be no financial meltdown and no depression while he is in command," Yardeni said. "Given the initial positive reaction in stock prices last week, I suppose this means that on Wall Street, we are all financial socialists now."
Todd Harrison, a former Wall Street trader who writes a blog on the website Minyanville, argues that the Fed is placing its balance sheet at risk by assuming troubled mortgage debt.
"If the economy continues to deteriorate, the Federal Reserve would effectively and eventually become insolvent. It won't go bankrupt -- it will simply print more currency and further dilute the value of the dollar."
But Harrison said the problems would fix themselves if authorities allowed the free market to work.
"Our current conundrum can be traced back to the implosion of the tech bubble," he said. "If we were allowed to take our medicine rather than being injected with artificial drugs, we would already be on the road to recovery."
http://www.banknet360.com/blogs/Item.do?pkId=348&serviceId=2 Roland Arnall, an architect of modern subprime mortgage finance, died yesterday, He was 68. He was a secretive person, reportedly amassing a fortune of $1.5 billion. He was a survivor of the Holocaust, and was a founder of the Simon Weisenthal Center in Los Angeles, which tracked down and brought to justice Nazis worldwide.
But it was his role in subprime mortgage finance that will be his legacy. In 2006, Ameriquest/Argent paid $325 million as part of a predatory-lending settlement with 49 states and the District of Columbia. Ameriquest/Argent was a vapid, aggressive lender, pricing loans to amass tremendous volumes, at one point reaching around $10 billion of loan originations per month.
The credit crunch is exposing the masters of the universe as mere mortals after all, reports Louise Armitstead With their dominance came increasingly displays of hubris and extravagance. Two years ago Albourne Partners, a hedge fund adviser, hired Knebworth and staged Hedgestock - the "alternative conference for the alternative investment industry" - one of the most extravagant and bizarre business meetings ever organised.
There were talks and meetings like any normal business conference, except the grounds were decked out as if it were a 1960s music festival, with the additions of a polo field, laser clay pigeon shooting range, hot-air balloon station and remote-controlled duck racing, while 4,000 delegates were dressed as hippies and danced to a live performance by rock giants The Who.
Meanwhile, London's annual Ark dinner, the industry charity night, became the biggest fund-raising night in the world. Organised by Arpad "Arki" Busson, the multi-millionaire French financier and former boyfriend of supermodel Elle Macpherson, more than 1,000 hedge fund managers and celebrities, including Jemima Khan, Bob Geldof and Liz Hurley, paid up to £50,000 for a table. Last year, a speech by Bill Clinton, a private concert by Prince and an appeal from Madonna helped raise a record of £28m.
Even when the markets turned last year, the hedge funds' high jinks continued. Stephen Partridge-Hicks, the former Citibank debt guru and head of Gordian Knot, one of the big credit hedge funds and so hit first, tackled the crisis by splurging thousands of pounds on a show-stopping party. In October, as his fund tanked, he chartered a plane to fly 150 mates to Morocco where he had hired Marrakech's upmarket Amanjena hotel for a James Bond-themed party. On top of the usual champagne and haute cuisine, Patridge-Hicks staged a James Bond scene - complete with actors, stunts, a real submarine and a fly-by from two Mig jets - starring himself as 007.
At the start of this year, hedge funds had been protected from the full impact of the credit crunch. While private equity houses experienced a sudden severance from lending, investment banks largely kept open for the hedge funds....In recent weeks, this has changed....bank bosses ordered their prime brokerage and repo departments to comb through their books again and slash risk exposure.
Lending lines have been cut, just as the funds needed them most to cope with the volatility....
A new view of hedge funds has been revealed, particularly with regards to borrowing levels. In recent years, leverage in the funds has spiralled. While hedge funds have traditionally used two or three times leverage in their funds, this figure has been multiplied to eight or nine times in many cases - and even more in some.
One prime broker said: "Hedge funds have had it easy. Every man in a pink Cadilac has been able to raise money, start a fund and do really well. Frankly, those who have taken the biggest risks have come off best because markets have been so extraordinarily kind."
The leverage that magnified gains in the rising markets has had the same impact on the way down. Weaker funds were the first victims. But now the squeezing by the lenders has meant that a far bigger number have had no cushion or protection against short-term swings.
[Ron] Beller [of failed hedge fund manager Peloton] wrote to his investors: "Because of their own well-publicised issues, credit providers have been severely tightening terms without regard to the creditworthiness or track record of individual firms, which has . . . made it impossible to meet margin calls."
In the aftermath, others have a different view. One observer says: "The only way to generate 90 per cent returns off AAA-rated bonds is if you are taking too much risk. Simple as that."
Another friend says that he often boasted that Peloton was sailing close to the wind. "I once asked Beller how he would cope if the market suddenly turned and he was forced to mark to market. He said he'd be in trouble but that would never happen."
Focus Capital, the fund that liquidated two weeks ago, was managed by Tim O'Brien and Philippe Bubb, who formerly worked at Pictet & Cie in Geneva. Focus won a EuroHedge industry award after returning more than 100 per cent in 2006. O'Brien and Bubb told investors that they had been the victims of the credit crunch and short selling. But observers disagree: "Focus took large stakes in very small, illiquid companies. In these markets that's a dangerous position to be in."....
Meanwhile, Platinum Grove, the $5.5bn New York-based hedge fund set up by former Long Term Capital Management co-founder Myron Scholes, fell 7 per cent when Japanese prices moved suddenly....
Prime brokers say that the survivors are big funds with diversified portfolios and are not overleveraged. One said: "Over the next few months, there will be a shake-up of hedge funds and the ones that survive will be stronger and more robust - essentially, the new breed of hedge funds that take the sector to the next stage of development."....
One said: "Hedge funds got carried away. Benevolent markets meant that anyone could be a superstar which couldn't be true. The current crisis will quickly show the pretenders and leave behind those that are genuine hedge funds - that can make money whatever the weather."
http://www.nytimes.com/2008/03/29/business/worldbusiness/29swiss.html?ei=5065&en=be96c778a5f8828a&ex=1207368000&partner=MYWAY&pagewanted=print GENEVA — Like Paul Revere, Konrad Hummler sounded the alarm last week as he made his way by train and by plane to his bank's branches across Switzerland. This country's storied role as secret banker to the world's wealthy is under threat like never before, Mr. Hummler warned.
http://www.ft.com/cms/s/0/4b243902-fd06-11dc-961e-000077b07658.html California Gold Rush
Friday, March 28, 2008
http://www.washingtonpost.com/wp-dyn/content/article/2008/03/27/AR2008032703662_pf.html Leaders of the central bank had no master plan when they took those actions, no long-term strategy for taking on a more assertive role regulating Wall Street. They were focused on the immediate crisis in world financial markets. But they now recognize that a broader role may be the result of the unprecedented intervention and are being forced to consider whether it makes sense to expand the scope of their formal powers over the investment industry.
http://money.cnn.com/2008/03/28/markets/thebuzz/index.htm?postversion=2008032812 NEW YORK (CNNMoney.com) -- Where are investors putting their money in these uncertain times? Apparently, more and more are seeking safer havens in Europe, India, China and Latin America.
Thursday, March 27, 2008
http://www.informationarbitrage.com/2008/03/discontinuous-t.html I grew up in a time when markets were considered to be "continuous." Portfolio insurance. Robert Merton's 1987 treatise Continuous-Time Finance. Liquidity was presumed to be available. And while markets could and did gap due to an event, new information, etc., it could and would clear with transactions taking place at the new level. The financial markets, through price discovery in the presence of liquidity, conveyed valuable information that could be used for both security selection and asset allocation. The field of financial economics, as such, was predicated upon the existence of bids and offers and, therefore, liquidity. And this phenomenon was assumed to persist across time.
But this is not the world I observe today; quite the contrary. Price movements are not only discontinuous, but the notion of liquidity across time as traditionally assumed simply does not exist. Something has happened to rock the prevailing academic paradigm. Have the experiences of the past six months essentially blown a hole through the heart of modern financial theory?
Today we live in a world fraught with risks that we barely understand, risks that modern financial theory doesn't have great answers for. A new model is needed that incorporates the effects of discontinuity as an outgrowth of, among other things:
- Complexity - structured securities, derivative instruments;
- Interdependency - widely disseminated holdings that can pollute portfolios globally, hundreds of trillions in counterparty exposures;
- Intermediary errors - ratings that don't reflect the risks, financial institutions with weak control environments and poor risk management practices; and
- Bad actors - originators, underwriters, traders and managers with mis-aligned motives.
According to LEAP/E2020, by the end of 2008, a formidable debacle will affect pension funds all over the world, endangering the entire system of capital-based pensions. This financial calamity will bear a particularly dramatic human dimension because it will come at the precise moment when the first wave of baby-boomers phase out of the labour force in the US, EU and Japan: pension fund revenues are collapsing at the very moment when they should be making their first large series of payments to pensioners. In this 23rd edition of the GEAB, our team anticipates the evolution of the upcoming pension fund crisis, details which countries are the most exposed (in particular in Europe) and provides a number of operational and strategic recommendations to face the situation.
Realtors eager to show off rash of properties meet with buyers in bulk
"... plus you get a cool set of really cheap luggage all the way from China just for listening to our sales presentation." - M. R.
Paul Solman uses a domino metaphor, taking the viewer step by step through how problems in the housing market spread into the wider economy.
South Korea's pension fund will no longer buy low-yield US Treasuries because it wants to diversity its portfolio and boost returns, an official said Thursday.
"Patriotism is the last refuge of a scoundrel," said author Samuel Johnson. Bush's deceit leading to the invasion of Iraq perverted the meaning of patriotism by enabling our corrupt military-industrial complex to make outrageous profits for multinational corporations. Corporate greed and war profiteering have made endless war a corporate imperative.
New government research has found "large and growing" disparities in life expectancy for richer and poorer Americans, paralleling the growth of income inequality in the last two decades.
Tuesday, March 25, 2008
Has Wall Street lost their edge?
Last week, traders were gloating over JPM's coup over Bear Stearns, without taking any consideration for the fallout. If someone offered you $100 for your home, although there was toxic waste in the backyard, would you accept? Of course not – you wouldn't sell for pennies on the dollar no matter how bad your property looked.
Offering $2 a share for previously one of Wall Street's most prestigious investment banks, was not only an insult to Bear Shareholders, but a revealing insight into the valuation process – if Bear is worth only $2 – how bad is the toxic debt they are holding? While everyone was applauding JPM's coup, only 1 voice was heard saying "how bad is the problem at Bear if it's worth only $2 a share?"
The message Wall St. is sending to the world's financial markets are that they have lost their edge, they do not know what they are doing – they are not professionals. Thinking they 'stole' Bear Stearns, in the final analysis they created more than the money they 'saved' in lawsuits, and loss of credibility. It doesn't take an MBA at Wharton to come to these conclusions – common sense will tell you if you purchase something for $2 it is worth $2, or as the expression goes 'you get what you pay for'.
Maybe you have known someone in your life who is the type of person that will drive 10 miles to save $.20 on a gallon of milk, spending $.30 in gas for the savings. It is common in old ladies, but not expected from the world's leading investment banks such as JPM, the firm who saved Wall St. from bankruptcy during the panic of 1909.
The mixed implications of the $2 offer were: Bear is junk, JPM is cheap, JPM is not serious. Of course, we are not privy to 100% of the information of the deal, nor were we there over the weekend as the deal transpired. However, we can make a strong analysis based on the results, and based on the information we do have.
What we know is that at a recent auction of government debt, foreign purchases declined by over 400%. Since the FED has intervened to save Wall Street, the US Dollar has declined by more than 10%, a clear indication that foreign investors are not confident in the US backed Wall Street bailout.
M&A has been a significant trend on Wall Street, the theme being the consolidation of many firms into several – the merging of Main Street and Wall Street. Instead of small town banks owned and operated by the same guy who is the Mayor and the streets are named after, we are consolidating them into large national corporations, instead of 5,000 individual companies we are centralizing them into 1 company with 5,000 branch offices. But still, you don't want your local branch office to sue you or worse.. If JPM is acquiring a firm of quality, why fire any Bear employees? Why sell any Bear assets, if they are so valuable? In any case, why create a situation, where you will have lawsuits from multiple parties, lasting for over 5 years, with no winners? From any perspective, it doesn't appear to be a good deal. Yet, it is the driving force behind a stock market rally.
What is safe?
Swiss government bonds, farms, hard commodities, metals, or anything that has intrinsic value such as tools. A business should invest in what it does best, a professional should invest in professional development. Energy (electricity not oil), food production, and water should not be forgotten; the basic building blocks of any civilization. People can live without oil if need be – you can decide not to drive to work you can take a bus or ride a bike, but you cannot decide not to eat. In a volatile climate change, combined with rising fuel prices and corn being used for ethanol production, food will be in short supply and high demand.
The average investor does not have a magic bullet solution. Every portfolio should be designed based on specific requirements and circumstances. Saving for a retirement, and running a business, are on 2 opposite sides of the spectrum. If the world falls on hard times, service industries and luxury consumption may suffer. When spending is limited, and consumers need to choose between basic food groups or Gucci handbags, what do you think they will choose?
The rich cannot drive the economy – Bill Gates can only buy so many pair of shoes. What drives the world are the people, the consumer.
What drives the world economy is the middle class. Throughout the industrial age, the middle class has served as a financier and consumer of elite products promulgated by Wall Street. The middle class is all but gone – leaving no one to subsidize the upper class. The fact is, the elite thrive on the middle class, and they are the cornerstone of modern society. Without a doubt, the rich have become superrich, but that is not a solid reason in the case for a good economy. A new yacht design includes a garden onboard, for those who want to have their cake and eat it too. This type of hyper-consumerism is not a driving force of the economy, because this yacht has no utility in itself. A yacht does not have the same use-value as a factory, or a commercial building, or many other alternatives. We are building jet airplanes with fireplaces, catering to a growing class of eccentric elites, while manufacturing declines.
In the meantime, the world waits for a US election, to reign in even worse policies than the bush administration. Politics is connected to the markets because the US government is financing their debt with the US Treasury, and the Fed, through the US Dollar and the sale of T-Bills. In the bond world, Treasuries have the highest credit rating because no one can imagine the Fed defaulting – but it can happen. In fact, the Fed has a set of protocols in place in the event of a default. It is not important to calculate the likelihood of a default, but one should understand that when foreign capital does not flow into the US, it is because they do not feel the US is a safe environment to invest in. Capital flows into the US are not only supporting US Government debt, it is supporting the DOW, and the real-estate market.
"If you don't feel safe in the currency how can you feel safe in the financial system. If you don't have a banking system, you don't have a capitalistic system." – Saxo Bank CIO
Senator Frank is calling for a single, US regulator. Fast trains, legalized marijuana (another proposal by Senator Frank), and legalized gambling are all great ideas, but how practical are they? Imagine a government with 100 agencies, 100 agendas, combining into one. To make matters worse, the architects of this regulator are the same professionals who created the problem which regulator will supposedly solve. This is a logical paradox; however it is the reality that needs to be dealt with. It is always dangerous to regulate something that is not fully understood, the result could be more disastrous than the problem that originally needed fixing.
Not the end of the world
There are opportunities abound – no one who understands the markets and sees a commodity boom thinks it's the end of the world, far from it. However, if you are an employee of Bear Stearns, it is the end of the world. Things will change, however if you have been trained to run a race for 30 years and now you need to paddle a canoe, it may not be an easy adjustment, some may completely give up and not even try to adjust. The majority of the economy is comprised of superfluous 'industries' that shouldn't even exist in the first place. For example, you do not really need a broker to buy your stocks for you – it is possible to trade yourself. Yes, a broker may give you tips, and there is a value in having a good broker, but it is not a necessity. Neither is travelling, even for business, when you can have online meetings. It's not necessary to go out to eat at restaurants or bars, go to the barber, hire lawn care companies, or to live in a McMansion. It is not necessary to drive the latest car fresh off the dealers floor, when you can buy an old one for 20% of the price which works mechanically just as well, and insurance will even be less. This is not a philosophical observation, consumers will be forced to cut luxury consumption or cease to exist, because the financing has been extended well beyond it's payment period, the bill is past overdue and there is only $1 to pay more than $50 in debt.
Markets will become more volatile. Opportunities will emerge daily, but it will be necessary to capitalize on them almost immediately. Investing locally in anything with value or that has utility is the best bet for long term stability.
Last year, Elite E Services fund FXV1 returned over 65% on the year, and it was not the best rated CTA program in many tracking services – there are funds that did even better! Some FX traders have been making over 40% a year, consistently, for over 5 years! Sure there are many failed traders who have not had such success, but you don't have to invest with them! Invest with the winners with proven results, experience, and reputations.
Contact Elite E Services for more information about FX, Commodities, and Global Market Intelligence. www.eliteeservices.net 646-837-0059
Monday, March 24, 2008
News from Bloomberg:
Recession is a given. Can we avoid depression
When economist Robert Parks predicted early last week that there was more than a 60 percent probability the current financial meltdown in the United States would lead to the "Bush depression," his phone began ringing like crazy with calls from the media."
With banks collapsing, the dollar reeling, the Federal Reserve making up new rules as it goes and observers discussing a new Great Depression, the presidential candidates are still on scripts they wrote a year ago.
In this pdf file, Table 1 is as follows:
As the article states:
The undeniable truth: In the grand casino of derivatives trading, JPMorgan Chase is overwhelmingly and unabashedly the biggest player of them all. As you can plainly see in the table above, it controls ...
$91.7 trillion in derivatives, or over 53% of all derivatives held by U.S. commercial banks, among which are ...
Nearly $7.8 trillion in the oft-inflammable credit derivatives, or 55.6% of the total.
And all with little more than $1.2 trillion in assets!
http://home.peoplepc.com/psp/newsstory.asp?cat=business&id=20080323/47e5e3d0_3421_1334520080323-1979878187 High Gas Prices Aid Prop-Plane Comeback
Sunday, March 23, 2008
The U.S. stock market is the most volatile in 70 years, according to a Standard & Poor's study of daily price swings in the S&P 500.... http://www.bloomberg.com/apps/news?pid=20601213&sid=av840GLwE4UA&refer=home
They are borrowing from the Fed at a low interest rate, and buying foreign euro-denominated bonds yielding a higher interest rate--and in the process, making a currency gain as the euro rises against dollar-denominated assets. The Fed thus is subsidizing capital flight, exacerbating inflation by making the price of imports (headed by oil and other raw materials) more expensive. These commodities are not more expensive to European buyers, but only to buyers paying in depreciated dollars."
The Plunge Protection Team is a panel that includes Fed Chairman Ben Bernanke, Treasury Secretary Henry Paulson, Securities and Exchange Commission Chairman Christopher Cox, and acting Commodity Futures Trading Commission head Walter Lukken. According to John Crudele of the New York Post , the Plunge Protection Team's (PPT) objective is to redirect the stock market by "buying market averages in the futures market, thus stabilizing the market as a whole."... http://www.marketoracle.co.uk/Article4074.html
In Congress, Democrats are drafting bills that would create a powerful new regulator — or simply confer new powers on the Federal Reserve — to oversee practices across the entire array of commercial banks, Wall Street firms, hedge funds and nonbank financial companies. http://www.nytimes.com/2008/03/23/business/23regulate.html?ei=5065&en=71e656b05114c042&ex=1206849600&partner=MYWAY&pagewanted=print
Friday, March 21, 2008
J.P. Morgan Adds to Derivatives Muscle
Bear's Collapse Risked
Weakening Big Market
For Spreading Out Risk
By SERENA NG and DAVID REILLY
March 19, 2008; Page C2
J.P. Morgan has a derivatives portfolio that is the largest by far among U.S. commercial banks. At the end of last year, its portfolio hit $77 trillion in "notional value," which is the value of the assets underlying these contracts, according to its regulatory filings.
• The Issue: J.P. Morgan, already one of the biggest players in derivatives, is even bigger after taking on Bear Stearns's trading obligations.
• Background: In rescuing Bear, J.P. Morgan had an interest in helping to prevent a broader market meltdown that could have hurt other firms it trades derivatives with.
• What It Means: As financial institutions merge, the risks that derivatives are meant to disperse could become more concentrated among fewer players.
The company's positions were more than twice as large as those of Citigroup Inc. and Bank of America Corp., according to data from the Office of the Comptroller of the Currency. They run the range from straightforward stock futures contracts to interest-rate swaps and more complex agreements with individual trading partners.
Analysts say J.P. Morgan's large position in the derivatives markets meant it had an interest in seeing Bear Stearns's problems sorted in an orderly way, because Bear is another big derivatives player. Bear's failure might have weakened the entire market.
Now, the planned acquisition of Bear means the risks that derivatives are meant to disperse may be getting more concentrated among fewer players. J.P. Morgan's influence in the market has risen because it is now standing behind Bear's derivatives book.
"'Many pathways through this maze of derivatives lead back to J.P. Morgan," said Martin Weiss, president of Weiss Research, an investment-research firm in Jupiter, Fla. "The domino effect of a major firm like Bear defaulting on its derivative transactions may have hurt other counterparties in the marketplace, many of which trade with J.P. Morgan."
According to its regulatory filings, Bear had derivatives covering notional amounts of $13.4 trillion at the end of November. Around $1.85 trillion of these were in futures and options contracts that trade on exchanges. Nearly $11 trillion were more complex agreements with individual parties.
In the fast-growing credit derivatives market, the 10 biggest players were parties to nearly 90% of the volume of contracts traded in 2006, according to a survey last year by Fitch Ratings. J.P. Morgan was ranked third. Bear was ranked No. 9.
While most investors are more familiar with stock and bond markets, the world of derivatives linked to debt, interest rates and currencies is far larger and more opaque.
Some derivatives, such as popular futures and options contracts, trade on organized markets such as the Chicago Mercantile Exchange. The vast majority trade directly between big banks and financial institutions in the over-the-counter market.
Customers in that market, which can range from companies looking to protect against swings in currencies to banks betting on the direction of interest rates, deal either directly with each other, or through intermediaries called interdealer brokers.
The market is vital to the functioning of companies and the financial system. The total amount of interest-rate, currency and credit derivatives outstanding at the end of 2007 was about a notional $400 trillion, the International Swaps and Derivatives Association says.
Eye-popping notional amounts can be somewhat deceptive. They represent the total value of the underlying securities affected by a contract, although actual contract values could be a fraction of that. J.P. Morgan, for example, said in its regulatory filings that while its total derivative notional amounts were $77 trillion, what it is owed on these contracts is 0.1% of that, or $77 billion.
Kristin Lemkau, a J.P. Morgan spokeswoman, said the bank didn't feel overly exposed to Bear before the deal. "We are comfortable with the risks we are taking in acquiring Bear at the price we paid," she said.
Policy makers are deeply worried about the threat of a big player in these markets failing, which could cause problems for many of its trading partners.
Sunday night, in unveiling its acquisition of Bear, J.P. Morgan said it would immediately guarantee the Wall Street firm's trading obligations and its counterparty risk. "J.P Morgan Chase stands behind Bear Stearns," the bank's chief executive, James Dimon, said in a statement.
J.P. Morgan's guarantees effectively provided a backstop for Bear, whose credit ratings were cut Friday by the major rating services to the low-investment-grade rung of triple-B from single-A because of the firm's funding problems.
Those downgrades could have forced Bear to fork over significant amounts of cash or collateral to some of its swap counterparties, demands that could have bankrupted the firm. The backing of J.P. Morgan, with its stronger credit rating, prevented that from happening.
"The immediate counterparty problem we tried to avert is tabled for now," said Carlos Mendez, a senior managing director at Institutional Credit Partners, a boutique investment firm in New York. "However, widespread credit problems persist, and no solutions are on the table."
--Tom McGinty contributed to this article
In other news…
Wednesday, March 19, 2008
Wed Mar 19 14:02:00 2008(EST)
* 19 Mar 08: 19:01(LDN) - FX NOW! EUR/USD, USD/JPY Flows - Profit taking?; hopefully, but position squaring for sure
It appears that dealers are starting their pre-Easter house cleaning early. EUR/USD sellers are said to be dealers clearing out long positions in advance of Thur's abbreviated trading session that leads into the four day holiday for Easter. USD/JPY has blipped up and the same rationale is being used to justify the move. M.B.
* 19 Mar 08: 18:52(NYC) - FX NOW! USD/CAD, NYMEX crude oil flows - oil unwinding hurts CAD
Someone just dropped the phrase "commodity bubble bursting" - seems a little premature even if gold, oil and the rest of the commodities are making a hefty move lower today. Oil is down $6 despite weak EIA inventory data with not much of a background story apart from suggestions that a weaker US economy will weigh on demand... which planet did they just come from? We mentioned earlier that oil is a more likely candidate for sending USD/CAD through parity than data, which has printed another string of strong numbers this week. CAD's move lower is likely exaggerated by early position squaring ahead of the long Easter weekend but USD/CAD should find some offers in the 1.01-1.0120 area. VSNYMEX Crude OilUSD/CAD
Monday, March 17, 2008
GREENSPAN: FINANCIAL MESS WORST SINCE WWII...
Wall Street waits for next domino to fall...
FED GIVES ANOTHER QUARTER...
PAPER: Foreign investors veto Fed rescue...
The Dollar Doomsayers...
Euro, Gold Hit New Records...
Bush: 'We're in Challenging Times'...
3-month bill yield seen lowest in 50 years...
Mon Mar 17 11:17:00 2008(EST)
* 17 Mar 08: 16:16(LDN) - FX NOW! GBP/USD, GBP/JPY Flows - USD is having a bad day, but GBP is suffering even more
GBP has been one of the day's poorest performers and there is no sign things are changing. It appears that at, or around, the afternoon fixing GBP was for sale and bids are no easier to find now than they were earlier today. The odds are that it took very modest size to push GBP lower and the parallel decline in USD vs the other majors did not help. USD has come under pressure from the downward turn in equities. M.B.
* 17 Mar 08: 15:59(LDN) - FX NOW! EUR/USD, EUR/GBP Flows - USD gets momentary support from rumor re: strong USD policy
FX and general market rumour mill has calmed down significantly since the N. American market has opened for business. Price action has calmed down with the reality hitting the market that dealers are shy of taking any risk, with Tue's Fed meeting the focus and event risk liable at any second. Newswire reports, supposedly "sourced" have given USD a momentary bid with the suggestion that the ECB was going to try to apply pressure on the US to back up its "strong USD policy". The "sourced" story and the thought of the US responding to this type of pressure has proved to lack the power to turn USD's general trend for more than the time it takes to think about it seriously. M.B.
* 17 Mar 08: 14:42(NYC) - FX NOW! EUR/USD, 1m vols flows - vols squeezed higher
FX implied vols are up from what we already pointed out as 'verbal intervention' levels last week, with USD/JPY 1m vols highest since 1998 and EUR/USD 1m highest since 2001, and only a couple of vols off the last G7 intervention levels in 2000. The G7 has not exactly been successful in generating a coherent message on FX beyond saying that excessive volatility is undesirable, with the US in particular finding few reasons to get concerned with the weak dollar. This could be changing however, if the latest USD rout turns into a wider and more systematic crisis of confidence in US assets. VS
* 17 Mar 08: 13:49(LDN) - FX NOW! EUR/USD, USD/JPY Flows - USD, pre-Pres Bush rally stalls while his comments hit wire
It seems the rumor mills have stopped working overtime. The main phobias have been covered to include intervention, cutting lines, hedge fund rumors, earnings rumors and unilateral as well as coordinated rate cuts by central banks. In advance of Pres Bush's comments, USD ticked up as dealers and speculators that have been involved, chose to lock in any gains sitting on their books. Pres Bush, after his morning briefing, has supported the Fed action and claimed to have taken "strong and decisive" action. Despite the weekend events and poor earnings reports, Pres Bush says that US financial institutions are "strong". The pre-Bush USD rally has stalled while newswires release his statement. M.B.
3:35 PMMARGINS: Due to the recent turmoil in the financial markets, we has decided to increase margin requirements on CFDs of companies in the financial sector to 50%. (Primarily within diversified banks). We will commence rerating these on a rolling basis during the next 24 hours.
3:35 PMMARGINS continued: The roll out schedule for increased CFD margin on financials: 17 March-2008: European traded instruments was rolled out @ 15:30 CET/14:30 GMT, US traded instruments is being rolled out starting @ 16:30 CET/15:30 GMT, and on 18 March-2008: Asia Pacific traded instruments starting @ 03:00 CET/02:00 GMT.
3:38 PMRe Equity Trade Recommendation: We Sold DAX.I at 6255, Target 6220. Having seen support found at 6225, we choose to close this position at 6235, as support is currently being found just below that level.
3:43 PMAccording to Bloomberg, a source from the ECB tells MNI that ECB officials will express concern about the strength of the EUR (i.e. verbal intervention)...
Swiss energy giant EGL is set to sign a 25-year deal in Teheran on Monday to buy 5.5 billion cubic meters of Iranian natural gas per year, starting in 2011, for a reported €18 billion.
The contract will be the second largest European gas deal, although EGL spokesman Bogdan Preda told The Jerusalem Post, "We are not releasing the value of the deal." ... http://www.jpost.com/servlet/Satellite?cid=1205420703987&pagename=JPost/JPArticle/ShowFull
Fed Cuts Discount Rate, Lends More to Avert Meltdown (Update4) The Federal Reserve, struggling to prevent a meltdown in financial markets, cut the rate on direct loans to banks and became lender of last resort to the biggest dealers in U.S. government bonds.
JPMorgan Agrees to Buy Bear Stearns for $240 Million (Update2) JPMorgan Chase & Co. agreed to buy Bear Stearns Cos. for $240 million, about 90 percent less than its value last week, after a run on the company ended 85 years of independence for Wall Street's fifth-largest securities firm.
Bear's Schwartz Fought Failure as Cayne Played Bridge (Update1) Alan Schwartz wasn't supposed to be running Bear Stearns Cos., and now he is presiding over the 85- year-old securities firm's sale.
Lehman's Fuld Says Liquidity Concern `Off the Table' (Update2) Lehman Brothers Holdings Inc. Chief Executive Officer Richard Fuld said the Federal Reserve's move to provide funding to brokers should alleviate investor concern that Wall Street firms may face cash shortages.
IMF tells states to plan for the worst
Sunday, March 16, 2008
http://online.wsj.com/article/SB120569598608739825.html?mod=hpp_us_inside_today Meanwhile, worries are deepening that other securities firms and commercial banks might be on shaky ground. Lehman Brothers Holdings Inc. Chief Executive Richard Fuld, concerned about the markets and possible fallout from Bear Stearns's troubles, cut short a trip to India and returned home Sunday, ahead of schedule, according to people familiar with the matter. The decision came after a series of calls Saturday to both senior executives at the firm and Treasury Secretary Henry Paulson, these people say.
Bear Stearns is the big name in financial distress right now, but it could have company soon -- thanks in part to the aftershocks of its own problems.
Bear, under new owner J.P. Morgan Chase, will be under pressure to drastically shrink its balance sheet, which stood at $395 billion in November. Hasty asset sales at Bear could do further damage to prices in many different markets. There also could be knock-on effects in the already strained $50 trillion credit-default-swap market, where Bear is a big player. It could be harder than usual for firms that have engaged in trades with Bear to unwind them.
Then there are the less-direct effects. The prospect of a hanging concentrates the mind and, after Bear's near-failure, brokers and banks will be more intent on cutting borrowing levels even if they have to take losses. Despite the Federal Reserve's move to save Bear last week, the brokerage house's cash-flow crisis will intensify banks' current reluctance to lend to other financial institutions. The borrowing costs of some of Bear's rivals, as implied by CDS prices, increased sharply Friday, and some bank stocks took a hammering.
Meanwhile, Wall Street will take another $50 billion or so of write-downs in the first quarter, according to a Bear analyst. The troubled brokerage house was scheduled to kick off the Wall Street earnings season today, with others to follow this week. There could be more bad quarters to come, with U.S. house prices still falling and defaults on other types of consumer debt starting to rise.
The authorities will try to prevent a vicious cycle taking hold. On top of Fed measures to pump cash into the system, traders expect a full percentage point cut in the fed-funds overnight interest rate this week.
But low rates won't help firms on the financial brink much in the short term. The Fed's willingness to engineer the rescue of Bear makes a broader, taxpayer-funded financial bailout seem more likely. Combined with superlow rates, that perception will add to pressure on the already beleaguered dollar. Bear Stearns is the biggest financial firm to hit the wall this time around. But the biggest name in financial distress could eventually be the U.S.
Beijing Backs Away From Bear
0336 GMT [Dow Jones] JP Morgan buyout of Bear Stearns, Fed liquidity actions are "bad news for risky assets and the U.S. dollar," says Barclays Capital. "The Fed likely got its first look at Bear Stearns' balance sheet over the weekend and today's action at the discount window demonstrates their concern. The Fed's action (though) has failed to ease credit concerns...iTRAXX spreads in Japan and Australia have started to rise as the counterparty risk on banks has been increased." Also, has been substantial destruction of wealth; Bear Stearns' shares were trading at $30 on Friday and $100 in December 2007. That is all bad for USD: Financial sector problems in U.S. continue to get grow and force market to price in greater chances of Fed cuts; in meantime, is little sign from economic data in rest of world that U.S.' problems are dragging on global growth, though this should change in coming months. "We expect this week to be a tough one for the equity markets and risky assets and for the swiss franc and yen to continue to outperform amongst the G10 currencies and" AUD, NZD to underperform.(RXM)
http://www.businessspectator.com.au/bs.nsf/Article/Dogged-by-a-shadow-CT5BM?OpenDocument The key to the rescue appears to be not the $US2 a share that JP Morgan will pay for the investment bank, whose shares were trading at $US30 last week, but the willingness of the Federal Reserve Board to fund $US30 billion of Bear Stearns "less liquid" assets – inevitably its sub-prime exposures, which enabled JP Morgan to guarantee its former rival's counterparty risks.
Word began to spread among fixed-income traders nine days ago that European banks had stopped trading with Bear. Some U.S. fixed-income and stock traders began doing the same on Monday, pulling their cash from Bear for fear it could get locked up if there was a bankruptcy... http://online.wsj.com/article/SB120567392987839629.html?mod=googlenews_wsj
The developer of the Cosmopolitan Resort Casino, a $3.9 billion condo-hotel complex on the Las Vegas Strip, has been notified by its primary lender that it will begin foreclosure proceedings.
The move by Deutsche Bank AG, the lender on a $760 million senior loan, comes after the developer, Ian Bruce Eichner, wasn't able to finalize a deal for new financing amid the credit crunch. Mr. Eichner in late February cut a tentative deal with two of his other lenders, Global Hyatt Corp. and New York hedge fund Marathon Asset Management, for a possible rescue of the twin-tower project. A default ... http://online.wsj.com/article/SB120554452781938671.html?mod=googlenews_wsj
One UK economist warned that the world is now close to a 1930s-like Great Depression, while New York traders said they had never experienced such fear. The Fed's emergency funding procedure was first used in the Depression and has rarely been used since.
A Goldman Sachs trader in New York said: "Everyone is in a total state of shock, aghast at what is happening. No one wants to talk, let alone deal; we're just standing by waiting. Everyone is nervous about what is going to emerge when trading starts tomorrow."... http://www.independent.co.uk/news/business/news/wall-street-fears-for-next-great-depression-796428.html
Can there be USD Intervention?
# Bloomberg: Goldman Sachs and Morgan Stanley say coordinated action by policy makers to stem US dollar slide increasingly likely
# March 2008: Europe and Japan express concern over sliding dollar - may intervene
# CIBC: Intervention unlikely until USD/JPY moves below 100 and EUR/USD moves to $1.60
# MS: Intervention more likely if EUR/USD surpasses 1.50, USD/JPY nears 100; MoF may have conducted stealth interventions or bought EUR/USD in Q407
# SG: Official intervention in support of the dollar likely to materialize in the event of a sharp (and disorderly) move in USD or sharp and broad-based deterioration in growth outside US
# Econocator (not online): 30% chance of intervention by BoJ, RBA, RBNZ on a rapid unwind of carry trade
# Feldstein: Europe must focus on dollar peggers (asia, oil exporters) to halt EUR/USD appreciation
# Whereas Australia, New Zealand intervened to slow appreciation in 2007, subprime turmoil later had Australia intervene to slow depreciation in August
# In 2007, New Zealand switched to unhedged FX reserves to improve tool for 'moderating extremes in NZD
Saturday, March 15, 2008
Could we really run out of food?
Biofuel production, poor harvests and emerging nations' growing appetites are emptying the world's pantry, sending prices soaring. It's a good time to invest in agricultural stocks.
By Jon Markman
March 06, 2008
As if a bear market, U.S. credit crunch, energy crisis and city financing emergency were not enough for one year, experts say the world is now facing down the barrel of the worst catastrophe of all: famine.
The very idea that the modern world could run out of food seems ludicrous, but that is the flip side, or cause, of the tremendous recent increase in the cost of raw wheat, corn, rice, oats and soybeans. Food prices are not escalating because speculators have run them up for sport and profit, but because accelerating demand in developing nations, biofuel production and poor harvests in some areas have made basic foodstuffs truly scarce.
In energy circles, folks who warn about the beginning of the end of cheap fossil fuels talk about "peak oil" as a point we have dangerously and expensively crossed. Likewise, you can now add "peak wheat" to your political and investment lexicon. And it's a lot worse.
One can always move closer to work to cut down on gasoline. But be forced to eat less toast, beer and steak? Them's fightin' words.
Wheat futures prices have tripled since 2004, corn prices have almost tripled since 2005, and soybeans have tripled since 2006. Meanwhile, crude oil is up merely 60% in the past three years, which makes it seem very bearable in comparison. U.S. stock prices have barely eked out a 10% advance since 2005, underscoring the diminishment of our buying power. A large pepperoni pizza these days costs about as much as a share of Citigroup (C.N). Citigroup finished Wednesday at $22.15.
This is no joke, already, in Asia. Rice prices surged to a 20-year high this week -- more than $18 per hundred pounds -- as countries that have the most are hoarding it for their own people. Vietnam, India and Egypt have restricted exports to keep local markets stocked. Thai, Philippine and Indonesian officials are warning of civil unrest if the flow of rice does not increase.
Russia, Ukraine and Kazakhstan in recent weeks have restricted wheat exports as well, slapping on big tariffs to make sure shelves are stocked in their homelands amid soaring prices. A major Russian grains-company chief told Reuters that his country "is in a condition that has never happened before." Higher prices are not meeting any resistance from desperate buyers.
Most unusual about this phenomenon, according to BMO Financial Group strategist Don Coxe, is that until now, food crises in world history were regional concerns that arose from crop failures, war or pests. Once global trade of grains got going in the 19th century in a major way, food shortages in one country were ameliorated by imports, he said. What's happening now is a lack of supply everywhere at once.
How are you keeping your grocery bills down?
Culprits abound, but chief among them is urbanization, which has cut the amount of acreage devoted to farming. The United Nations reports that the total area devoted to crops worldwide had risen by 0.3% annually since 1961, to 3.8 billion acres through the latest survey. But the growth has stalled to 0.1% annually in the past decade. Unlike energy, you can't drill deeper in the ocean or under Arctic tundra for more food.
Also, surging income growth among emerging middle classes in China, India, Southeast Asia and South America has boosted demand for meat protein, and feed for new Asian cattle ranches and pig farms is putting intense pressure on the world's corn supply. Of course, the weather plays a role, too. A terrible drought in the breadbasket of Australia over the past two years has combined with bad harvests in Argentina and Brazil to create some of today's shortfall.
Empty global cupboards
Shortages are real. The Financial Times reports that rice stocks have fallen this year to about 70 million tons, the lowest level in 25 years and less than half the total held in global inventories in 2000. Wheat inventories, called "carry-overs" in the trade, are at 30-year lows even though world wheat production was actually up 1% last year. In the past year, reports show, wheat inventories in the European Union have plunged to 1 million tons from 14 million tons.
A leading Canadian fertilizer executive told analysts recently that according to his company's calculations, global grain reserves are "precarious," at just 1.7 months of consumption, down from 3.5 months of reserves as recently as 2000.
Now the really bad news is that we might actually have been lucky in the past few years, as global warming has lengthened growing seasons in the American Plains, sometimes called the Saudi Arabia of corn. BMO's Coxe notes that the U.S. Midwest has enjoyed 17 straight years without significant crop failure, the longest winning streak on record. If this fortunate run ends soon, we'll likely face a worldwide crisis.
Some researchers, including climatologist Elwyn Taylor of Iowa State University, believe it could happen this year, as La Niña conditions are emerging at a time when the Midwest has become vulnerable due to a drought creeping up from the South.
Food prices are already way up in North America but not as much as feed prices because manufacturers, processors and retailers such as Wal-Mart Stores (WMT.N) have found ways to hold the line by cutting expenses. But they can dam up the flood of food inflation for only so long. Just this week, Procter & Gamble (PG.N) announced it was raising prices on many of its foods products, including Folgers coffee. J&J Snack Foods said it would lift prices by as much as 12% in April to offset costs, and local newspapers have been rife with stories about pizzerias both raising prices and cutting back on crust thickness and cheese quantities.
Joseph R. Dancy, who teaches law at Southern Methodist University and runs a small hedge fund, lays the immediacy of the crisis directly on ethanol-production mandates in an energy bill recently passed in the U.S. The bill, intended to boost America's energy independence, is expected to push as much as 31% of the U.S. corn crop into biofuels production, up from 24% last year. In other words, at the exact moment we most need corn on our plates, it is being funnelled into cars. A full tank of gas requires the equivalent of a quarter of a ton of raw foodstuffs, enough to feed one person bread for a year.
Coxe's solution: As a first step, shut down all ethanol plants immediately. "It's criminal to burn corn for fuel when we are out of food," he said. In a particularly pernicious development, he noted that a big boost in demand for soybeans for use as biodiesel in Europe has driven up the price of palm oil in Southeast Asia, where it is the main source of protein for the poor.
If global famine is one bad crop away, then surely there is an investment angle. On dips, the companies to focus on are mostly the same as I described in my year-opening column, "10 market predictions for a glum '08:" Seed innovators Monsanto (MON.N) and Syngenta (SYT.N); fertilizer makers Potash of Saskatchewan (POT.N), Mosaic (MOS.N), CF Industries (CF.N) and Agrium (AGU.N); tractor maker Deere (DE.N); and, for exposure to the food futures themselves, the exchange-traded funds PowerShares DB Agriculture (DBA.N), iPath AIG Agriculture (JJA.N) and iPath AIG Grains (JJG.N).
I guess this gives a new meaning to the term "seed capital."
Coxe has published a book summarizing his view of investment bubbles and declines called "The New Reality of Wall Street." . . . To learn more about law professor Dancy, visit his Web site. . . . To keep an eye on commodity futures prices, visit here or here. The Chicago Board of Trade has a great page summarizing the action. The U.S. Department of Agriculture Web site has pages and pages of material to help you get up to speed...
I previously wrote about ethanol as bad public policy on Feb. 10 in a blog item and on Oct. 11, 2007, in a column, "Shuck the ethanol and let solar shine."
At the time of publication, Jon Markman owned shares of Monsanto, Potash of Saskatchewan, Mosaic, CF Industries, Agrium, Lindsay, Powershares DB Agriculture, iPath AIG Agriculture and iPath AIG Grains.