October 22, 2008
Duncan sends along this link to 'Lehman default swaps still pending, DTCC says', on MarketWatch.Com. I quote it below.
The Orange Section added to the discussion of CDS with these words.
Credit Default Swaps 101
A credit default swap (CDS) is a contractual agreement between two parties involving default risk and the risk premium on an underlying security. One side agrees to pay the other a predetermined amount in the event of a default. (or other credit event, such as ratings downgrade) The other side pays an income stream based on a predetermined rate calculated on the notional.
A simple example: You own 100 Best Buy Bonds or 100,000 Par. You are worried about the bonds defaulting so you enter into a Credit Default Swap with Merrill Lynch. They pay you $100,000 in the event of a default by Best Buy on your bonds. You pay them 5% per year on the 100,000 or $5000 per year. If no default happens Merrill pays you nothing. You always pay the 5% Premium.
I chose 5% arbitrarily. However, typically the premium on a swap is based on coupon of the bond and the risk premium. This is typically calculated based off of Treasuries. Say the appropriate Treasury security is paying 4%. Our Best Buy bonds from above are paying 9%. 4% of the 9% is considered the Risk Free rate of interest. The remaining 5% is the risk premium.
Some have said that you can enter into CDS with no holding of the underlying asset. This is quite true. However consider this as part of a strategy: If I sell you protection and you pay me the risk premium my risk is identical to that of the holder of the bond. The CDS creates what is essentially a synthetic long position. I am paid a premium above and beyond the risk free rate of interest and I assume all credit risk. The only difference is I have not deployed $X do buy the bonds. This relationship could be the foundation for a very interesting investment strategy involving leverage.
In terms of the market crisis we are in, Credit Default swaps were written on MTG Backed Securities (MBS) as part of securitization structures in order to guarantee debt so the rating on the MBS would be higher. (and this more marketable to investors.) The Credit Default Swap was (is) a tool. From my initial example above, do you blame the Carpenter or the Circular Saw?
Lets talk about that $50+ Trillion dollar number that the everyone has been tossing around to create fear. It is true, there is over $50 trillion dollars of Credit Derivative Notional Value. But what does this number really mean? It means that the total notional value of Credit Derivatives is huge. How did that happen? Well lets consider the following scenario: The Bender and I enter into a CDS where I sell him protection on $1,000,000. I then decided that this risk is too much, so I call up Mr. Jones and get him to sell me protection on the same $1,000,000. Mr. Jones then decides that he doesn't like the risk either so he calls up Mr. Smith and buys some protection from him. 3 Swaps all on the same underlying. In terms of notional value, we have over $3,000,000 dollars. However, our net balance outstanding is still just $1,000,000. This is how that $50 Trillion amount came to be. The number that really matters is the net balance of credit derivatives. As of May 2007 this amount was ~$500 billion."
There used to be a character in the Popeye cartoons named 'Wimpy'. He always used to say: 'I would gladly pay you Tuesday for a hamburger today.'
Red and White D pointed out this morning at coffee that we seem to have been living in a 'Wimpy' universe lately.
October 21, 2008
Duncan sent along this link to 'The Financial Crisis Blame Game', by Ben Steverman and David Bogoslaw on Yahoo Finance. I quote it below.
...Securitization, and the new investment products it could spawn, seemed to be the answer for a Wall Street seeking a bigger payoff."
Duncan then commented:
Red and White D has been making the same point, that you need not have had any interest at all in the original transaction in order to buy this 'insurance'. He sent along this link to 'Why I'm Still Buying', by Ben Stein on Yahoo.Com. I quote it below.
...I might well be too alarmist here, but I think the only rational possibility is for the federal government or the New York State government (because most of the CDS were entered into in New York) to simply annul the credit default swaps as void as being against public policy. After all, there was no insurable interest in most cases, which tends to void insurance contracts, which is what a CDS is."
Red and White D then added his own comments.
Only those purchasers with legitimate 'insurable insterest' in the underlying debt would able to make a claim. If I understand this correctly, this would eliminate most of the tens of trillions of dollars of loss which the banks and insurance companies underwrote (actually bet is a better word) and remove much of the red ink from their balance sheets.
This is the right thing to do from a public policy point of view which means of course it will never happen."
Vegas sent along these words.
October 20, 2008
Reactions to yesterday's comments:
Rich Kolon reacted with this.
James Cramer pointed out Paulson's former connection to Goldman Sachs on several occasions. So you are not alone in seeing the possibility of "favoratism". But who has the money to make that a legal issue against a government that is literally printing a trillion more up?
The Press? Hey they are stuck in the mind of supporting Democrats and Republicans to the exclusion of many others, except as sound bytes."
The Orange Section reacted this way.
We live in the provinces. We are plebs to the New York City Financial Nobility. Who are we with our State College educations to question the intellect and motivations of the exalted membership of New York City Finance? We did not attend Harvard or Wharton, we are probably too stupid to understand the logic and reason behind their decision making.
Of course, this is just another manifestation of the Buttonwood agreement. It was a club then, it is still a club today. The rules and borders may have changed with the time, but there is still a club and we are not in it."
And Vegas sent this link.
''We're All Hosed': A Wall Street Insider on the Economic Crisis'
October 19, 2008
Conflicts of Interest.
Am I the only one thinking about this issue? I am reading nothing about it yet online. But the massive bailout of financials going on right now also sets up a potential problem. It's like a green giant just set a giant paper bag on Uncle Sam's porch full of tons of doo doo, lit the bag on fire, and is about to ring the doorbell.
For example: Let's say that Treasury Secretary Paulson goes back to work for his old firm. Is that a problem? Well, as the head of Goldman he lobbied Congress to allow firms like his to use more leverage, a lot more, than they had been using. They got what they wished for, the rule got 'relaxed', and the debacle we are seeing is, in part, a result of that. But the current bailout adds a new wrinkle to the Conflict issue. He, and the President, and Bernanke lead the charge for the bailout. Now his old firm gets Billions from the bailout program, a program run by his very own Treasury Department. Sweet huh?
Paulson is certainly not the lone ranger. U.S. Senator Chris Dodd (D-Conn) got big piles of money for his reelection from Fannie and Freddie. Is it a problem for him to vote money to bail out those firms and collect contributions from them in the future? Is it a conflict for him to get any contributions from any firm that got, or is about to get bailout money? It is by my way of thinking.
Let's see, there are hundreds of Congressmen and Congresswomen, a hundred U.S. Senators, and potentially thousands of banks that could get bailout money. Is there a potential problem here? Methinks there is.
The bag is already on the porch. Recipiants of the bailout have already made, and are in the process of making, contributions to campaigns. The giant has to be 'green' because that's the color of money. And I'm telling you, dear readers, the stuff in the bag smells really really bad.
October 14, 2008
We have to quit thinking in the old ruts that are so well worn and familiar. These are unique times. I have to keep reminding myself of that every day, because every day I find my thoughts creeping back to the old ruts, the old ways of doing things.
We are in a recession. My instinct is to position myself to buy a bottom, so as to go long. Wrong! I needed to position myself at the top of the rebound. In a declining market that is not easy to spot, particularly since the last rebound lasted less than a day and a half. I missed the last top, my bad. I should have gone massively short and did not. I will tomorrow.
This is a deep recession we are sliding into and some ideas that used to work fine are simply dangerous if applied to these conditions. Here is one: the 52-week-low. It is absolutely meaningless. I found myself looking at a potential long today in a stock that is way oversold. What just about got me to pull the trigger was the fact that it is at a 52-week-low. So what? Is that a guarantee that it can not go 50 percent lower from here? It certainly is not!
It is time to reexamine everything that we do as traders and investors. These are new times that require new thinking.
Here are some somber thoughts:
Most hedge funds are down 25 percent on the year right now. When pressed, like they were this afternoon, they will sell like crazy no matter how crazy prices get.
Markets are down 25 percent from the Lehman Brothers debacle. They might 'stabilize here', but I would not call 8,000 on the DJIA "the bottom". "The bottom" will come much later and will be lower by a thousand or two points.
So adjust your thinking. You really should be more short than long in these times.
October 13, 2008
This is the latest word from Jay
Steele.
Red and White D sends this link to 'How to capitalise the banks and save finance', by George Soros.
He also sends this link to 'Swept Up by Insanity of Markets' , by Joe Nocera.
Ben Smith sends this link to 'Gold: The Last Carry Trade' .
I found this link to 'Monday Morning Quarterback: Salvation Lies Within', by Todd Harrison on Minyanville.Com.
I read Jay Steele's words this morning and realized I just had to violate part of my own trading plan. I had to get more money into the market in a long postion. So I threw some money into UYG. I have started waiting for SKF to fall down to where I could buy it again. UYG is the exact opposite trade. It stands to reason that for SKF to fall...UYG must rise.
Note that I still have half my monies in cash right now. I still want to be in a large short position soon because we have more downslope to negotiate. But for right now, we could get a sharp rally here. I don't expect to hold UYG more than three days. I may only hold it for 24 hours.
October 12, 2008
In the interest of fairness, here are Duncan's latest comments.
(This page will not longer be available after October 31st since AOL is eliminating this feature for their subscribers.)"
October 10, 2008
|
Is there a way to play this market long?. This market has awful breadth, far more new lows than new highs. Just when you think a stock like GM or one of your favorites could not go lower it does. The whole world is jittery. American markets catch a cold and foreign markets get pneumonia. Forced sales are happening everywhere. A hedge fund is alright in its positions and would like to ride it out, but can't because everything was bought with 'leverage' (borrowed money) and now the bank is calling the money back in. So the hedgy is selling perfectly good stocks into a storm of selling. Ouch! So, is there a rational way to play these markets long? Yes, I think there is. First, raise cash, lots of it. You should have already done this. Your starting postition should be at least 90 percent cash. Second, just nibble. Don't go crazy on the volume dial. Spend small conservative amounts of money. Third, buy your favorites, the stocks you would have considered buying a month ago. Buy a company that produces stuff that will still be in demand in a slower economy; which is what we are going to have coming out of the other end of this. Fourth, position yourself to be 'the last buyer standing'. Don't just put in a low bid. Make it a 'crazy' low bid. Make it 40 percent of what you would have conservatively paid a month ago, make it below the current 52-week-low. There might occur a moment today or next week when all the other buyers have cleared out of your stock, and you are one of just a handful of buyers left. You might just get your stock at that 'crazy' price. I currently have four 'crazy' little nibbles in for UNG at 19, ARD at 19, GMXR at 18, and SLW at 4. |
October 9, 2008
|
Well, I have some egg on my face for calling for the market to rally yesterday, but not too much egg. I may be a day or two off, but soon this down thing will be over, temporarily, and stocks will rebound. Some tech stocks were rebounding today. I have my ARD and UNG bracketed. If they fall to a ridiculously lower level I will buy more. If they rally well over a one or two day period, I will sell. I will still keep a lot of my funds in cash. I do think SKF, SRS, SIJ, and DUG are very overbought. In normal markets the reaction would be bullish short term markets in those areas (financials, real estate, industrials, and oil & gas). But these are not normal times. Keep lots of cash on hand. Take up a short fund if the price gets to be right for it. Place no large serious longs until October 30 or later. |
October 8, 2008
Here are two interesting articles.
The first link was sent over by Lar. It is 'Why globalisation will yield to regional fiefdoms', by Carl Mortished of the London Times.
The second link was sent by Ben Smith. It is 'Dow and S&P 500 Capitulation Pre-Alert', by Bob Hoye of 321Gold.Com.
I think Mr. Hoye may be ahead of himself. Here is why. I have been following four short funds very closely lately: SKF, SRS, SIJ, and DUG. Not only have they been looking toppy lately. They all put revealed black hammers today in their bar graphs. Yeow, that's a down signal if there ever was one. So if short funds are headed down...and I mean starting tomorrow...the markets in general should be going up starting tomorrow. You read it here first. We are in for a short but sharp rally here.
October 7, 2008
Here is an excellent read sent by Red and White D: 'How to Ruin the U.S. Economy', by Ben Stein on Yahoo.Com.
And here is another good one: 'Debt Crisis vs. Liquidity Crisis', by Kevin Depew of Minyanville.Com.
October 5, 2008
Red and White D writes this note.
From a french/english dictionary:
tranche Noun, feminine slice of meat, cake, bread, rasher of bacon; edge of a coin, book; section, tax band, bracket, credit instalment, time slot; ~ de boeuf beefsteak; couper en ~s to slice
Seems funny to me that the wizards of wall street resorted to a foreign language to disguise and market their wares. Based on what I've read about this whole debacle the scheme ended up isolating the collateral from the ultimate lender so the lender really never knew (and probably didn't care) what he was buying. He only cared about return. He trusted the seller to worry about risk.
The whole deal was based on a trust relationship between buyer and seller. A trust that ended up being misplaced. When real estate prices started to fall and that bond of trust was broken when the poop started to fly.
It's hard to imagine how long or what it will take to re-establish that bond of trust between buyers and sellers.
All business relationships ultimately depend on trust. We don't need 730 billion dollars to restore our econonmy. We need trustworthy people."
I found this article to be very timely: 'Snowball From Hell', by Jeffrey Cooper on the Minyanville.Com site. I quote it below.
I have sworn off any more long positions until the last week of October. By then it MIGHT be safe to to long again.
October 3, 2008
|
REACTIONS TO YESTERDAY'S COMMENTS
Duncan rightly took me to task for implying that it was the Republicans who were mostly to blame for the mess we are in. Here is a link he sent me to: 'How the Democrats Created the Financial Crisis', by Kevin Hassett of Bloomberg.Com. I quote it below.
But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.
That such a reckless political stand could have been taken by the Democrats was obscene even then. Wallison wrote at the time: 'It is a classic case of socializing the risk while privatizing the profit. The Democrats and the few Republicans who oppose portfolio limitations could not possibly do so if their constituents understood what they were doing.'"
I would note that the above article refers to a bill in the U.S. Senate in the year 2005. I do not recall the particulars surrounding this bill. If, as the article claims, the Democrats in Congress killed the bill (and that may have been the way it happened), the Dems must have had some Republican help. The Democrats did not take over Congress until January 2007.
Here are other good links also sent by Duncan:
'The Rise and Collapse of Wall Street's House of Debt'
'15 Things You Need to Know About the Panic of 2008'
'YouTube - Shocking Video Unearthed Democrats in their own words Covering up the Mortgage problem'
Another reader wrote:
I generally enjoy this site, but I have seen this (terrible) mistake over and over. It is well known by free-market, conservative economics 'fans' that anarchy is not what is meant by a free market."
The Orange Section wrote:
In terms of the credit crisis, I think it is very easy right now for us to over shoot the regulation. Structured finance and securitization are good things for the market. They were tools of the lenders who were issuing loans under poor credit management practices. The credit analysis and due diligence is what was lacking and lead to the crisis. Derivatives get a bad name in times like this and I think people should recognize that Derivatives are just tools, it is the person using the tools that was at fault in this mess."
Ben Smith sends along this Jim Cramer Link. I quote it below.
Wow! Well, I should have picked on all the deregulators, not just those in my own party. But if this event were WWII, then deregulation of the Savings and Loans was WWI. The first event should have taught us a lesson, and did not. It illuminated a mindset toward regulation that was destructive and irrational. It was a fine example of the Average American getting walloped by the back of Adam Smith's 'invisible hand' of the market. It was the disruption and severe weakening of the Savings and Loans through deregulation that brought Fannie and Freddie to carry a much heavier burden in the mortgage world, which led in turn to this current debacle.
I, for one, am pretty disgusted with Congress in general. Its approval rating is now deservedly in the single digits. Members of both parties have labored mightily to achieve this. I wouldn't mind if the voters threw all the rascals out and we started all over again. I think an equal number of fifth graders could do a better job.
I am assuming that Cramer (see above) is right about the BRIC countries, and commodity prices are falling off the shelf, and have a long way to fall. This is very disturbing when one considers what has been happening to the Dollar. Ben Smith sends these links to 'Dollar's Recent Strength has Little to Do With U.S. Economy' and to 'The Source of the Dollar's Recent Strength'.
Over a year ago leadership in the U.S. Economy passed from the Consumer to Exporters. U.S. exports began to pick up when the Dollar began to fall. Our exports have been holding everything together. Now the customers, the BRIC countries, are dropping faster than we are. That spells doom for exports and insures that the Recession we are already in will grow deeper yet.
Starting in August I took on a new trading stategy. It was an unfortunate choice. I chose to take a longer term approach to the market with an eye on longer term gains by the stocks in the top ten in my system. Now I am swinging the other way. I want to be mostly on the short side of things. That's the way I will play it from now on.
October 2, 2008
I have not heard from Duncan lately. Today, he sent in this link to: 'What happened after yesterday's [Tuesday's] close?' a blog on the MotleyFool.Com site. I quote it below.
Yes Duncan, it seems the Specialist System is still alive an well. Those boys seem to select their targets carefully. Tuesday was not only the end of the month, but the end of the trading quarter for a lot of hedge funds. It seems the Specialists got into some of the Hedgy's back pockets.
The Orange Section sends along these comments.
I look at the bail-out as moral question of capitalism. Congress isn't just bailing out Wall Street. They are covering their own mistakes. That is the real tragedy in all of this. What will happen to the do nothing politicians that let this fly as lobby dollars flowed in? Nothing. So if we are to provide aid to banks and lenders under the guise of helping the economy and preventing losses how are we fixing the problem? We inject capital into a system that is still controlled by the same decision makers and regulators that let it break in the first place.
To me this is asinine. We are here because of people that were unscrupulous with the rules and enforcers who were willing to be bribed. These are fundamental flaws of leadership. Capitalism works because it gives people the freedom to succeed and the freedom to fail. This is the very essence of Adam Smith's Invisible Hand. Any scenario that does not provide for full reconciliation of all the players prevents failure and thus enables inefficiency and instability. Capitalism needs consequences. There needs to be a wolf at the door in case something slips or gets out line. The wolf prevents excess and greed, he punishes irrationality by destroying capital. A free market system cannot survive without a wolf. The whole point of this bail out seems to be to feed one group to the wolf while insulating another.
As Macabre as it might be, I think we should let the dam break. There will be pain, but just as a forest must occasionally burn in order to survive so must capital be destroyed in order to preserve a free market's opportunity for prosperity."
Yes Orange Section, in 'protecting the economy' Congress is covering its collective ass, covering the lack of oversight and regulation that should have been in place all along and which probably would have prevented a lot of this mess.
The problem with Adam Smith's Invisible hand is that it swings so wildly that the Average Joe gets smacked by it coming and going. The whole goal of naked raw capitalism is not a level playing field, but the avoidance of one in the first place or the destruction of one if one already exists. Pure capitalism, I will state again, results not in a panacea, but in five guys owning everything, absolutely everything: your house, your clothes, your car, the air you breathe, the water you drink. Pure unfettered capitalism is the destruction of creativity and innovation.
The deregulators in my party (the Republicans) got their way, and that is how we got to this place. What we got with deregulation is opacity in place of clarity, the inability of anyone to price certain securities. With deregulation we got the Shadow Mortgage Industry which behaved with predictable irresponsibility and which grew to tremendous size and influence in a short time. Who thought (You and I certainly did not) it was a good idea to allow this level of gambling to go on with what is the American family's biggest financial asset: its home? And why was it a good idea to allow the Shadow Mortgage industry to exist in the first place?
The other thing Congress is doing, with the bailout (and it is a bailout - make no mistake) is saving themselves from having to explain to voters why it is that we slipped into a '29 kind of Depression with the DJIA somewhere south of 3000 and virtually everyone's pension plan wiped out. I think that is what the consequence would be of the bailout's failure.
Even with the bailout there is going to be pain. It is going to be drawn out longer. But banks are still going to have to do a lot of write offs and write downs. We are still in a recession and the economy is still slowing and joblessness is still going to keep rising.
So now what?
Here are some things I would like to see:
AND LAST - BUT NOT LEAST
October 1, 2008
Here is a link to 'Recession now certain, economists say', by Rex Nutting of MarketWatch.Com. I quote the article extensively below.
'The recent data were deteriorating sharply' even before factoring in the latest impact of the credit squeeze.
Global Insight doesn't think the recovery will be quick or powerful. The economy will likely contract for three quarters and then show weak growth in the second quarter next year.
If the recession lasts from December 2007 until April 2009, as Gault suspects it will, it would be the longest since the Great Depression. And the recovery, when it comes, won't feel anything like a boom.
...In the past year, most of the GDP growth has come from increased exports and a reduced appetite by Americans for foreign-made goods. Consumer spending, which typically accounts for 70% of the economy, has contributed only about 40% of the growth over the past year.
And consumer spending seems almost certain to decline in the third quarter, which ended Tuesday. We won't see September consumption data for another month, but the trend through August was horrible. With auto sales dropping to a 16-year low and chain-store sales weak, September may have been even worse."
September 30, 2008
Red and White D sends these links from The Guardian:
http://www.guardian.co.uk/world/2008/oct/01/japan.japan
'Crap sandwiches on Capitol Hill by Simon Tisdall', I quote this one below.
Eminent reputations lie in ruins; the august institutions of Congress, the Treasury and the Federal Reserve tremble; the presidency itself is shaken. From America's year of living dangerously, few will emerge unscathed.
The consensus view, if there is one in so divided a nation, is that the US has suffered a calamitous, across-the-board failure of leadership. The bankruptcy is political as well as economic. This conclusion is widely held among both supporters and opponents of the bail-out."
I will share this note from Rich Kolon
Back in June I asked the rhetorical question: 'What is a rational observer suppose to think about this? The situation is getting worse for the banks in trouble. They are getting more desparate for cash.'
At that time the loans were 'just' 75 billion every two weeks for 28-day loans.
Well now they will be getting even more.
http://www.federalreserve.gov/ newsevents/press/monetary/20080929a.htm
And there's the talk of a $700 billion bailout package we all heard about.
The problem with the short term loans is that they don't solve long term problems. It's like the borrowing banks are addicted to maxing out their credit cards with the government.
With individuals, the solution is to minimize future credit. Or there is bankruptcy.
The right thing is no different for banks who tried to screw everyone else and even their own stockholders to enrich a few executives using phony baloney statistics and false ratings.
Rich"
