Ilenne's Blog

Self-Help Lawyer

ilenne — Sun, 24 May 2009 17:57:06 +0000

This site is undergoing a change in plans. If you’ve stumbled upon me due to searches related to the markets and financial articles, please check out my updated blog, at Phil’s Favorites. There, we have the newest commentary on the markets by some of the greatest writers out there in internet-land.

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Fraud in the desert and the “Disabler”

ilenne — Sat, 28 Mar 2009 19:05:17 +0000

Note: the wordpress backup site is back, with apologies, so now there are two more Favorites sites. The original one has the blogroll, which can’t be exported/imported.

Below, Tim Iacono reports on the cat and mouse game in the auto sales industry… fraud and arson, meet the "Disabler." – Ilene

Fraud in the desert and the "Disabler"

Courtesy of Tim Iacono at The Mess That Greenspan Made

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Two reports in the Wall Street Journal tell the tale of how automobile ownership is hitting the skids in the U.S. in an eerie parallel to home ownership – people are walking away from what they promised to pay for and lenders are taking steps to assure they are repaid.

In Signs of Stress, Fraud on Roadside, Las Vegans are abandoning their cars in record numbers to get out from under the monthly payment – if you don’t want to take it out to the desert and torch it yourself, the going rate is only $500 for someone else to do it.

Police detective Mark Menzie drove 55 miles into the desert Sunday to inspect the charred remains of a formerly silver Ford Expedition.

Later, he sat in a kitchen on the city’s south side where a 19-year-old man confessed to torching his girlfriend’s Chrysler PT Cruiser.

At noon Monday, Mr. Menzie was picking through the smashed windshield of a 2008 Land Rover in a desert canyon. His police radio crackled as he worked; another car was spotted burning southwest of the city.

Years of no-money-down car loans followed by sinking home values and rising unemployment has made many people desperate over car payments they can no longer afford. For some, the answer is to ditch the car, report it stolen and collect the insurance money to pay it off without hurting their credit.

Well, at least their intentions are good – to preserve their credit in order to borrow another day. The fact that they are committing a crime is apparently less important.

On the bright side, this is one more growth area for our new economy – more jobs in insurance fraud investigation and vehicle storage.

Tow yards in Las Vegas are filled with the blackened hulls of Mercedes sedans and Cadillac Escalades. The wrecks were pulled from desert hills and city streets by the department’s eight-member auto-theft unit, which responds to calls around the clock. Over one weekend this month, Mr. Menzie investigated eight car fires in 36 hours.

"This is a money town," says Lt. Robert Duvall, who reorganized the auto-theft unit to include insurance arson fraud. "Where else can you lose a paycheck in a night?"

The cops hunt suspected arsonists by SUV and helicopter, trying to identify registered owners as quickly as possible. "We see people with singed eyebrows and hands," said Sgt. Will Hutchings, Mr. Menzie’s boss. "Some of them still smell like gas."

The trend began to surface in 2007 when gas prices spiked and the number of auto arson claims jumped. In 2008 claims climbed nationally by 6%, said Dick Luedke, a spokesman for State Farm Insurance. In hotspots like Indiana, Michigan and New York the numbers rose 13% to 18%.

Traditionally, such insurance fraud rarely leads to arrests, falling through the cracks between police and fire department jurisdictions. After Las Vegas became the nation’s leader in auto theft in 2006, Lt. Duvall decided to tackle the problem more aggressively.

In Late on a Car Loan? Meet the Disabler, word comes that there may be a little less work for repo men since used car dealers are installing an increasing number of devices that disable the vehicles of delinquent borrowers.

Jamie De Lisle’s Buick had been warning her for days, first with a flashing yellow light, then a flashing red light. But the 31-year-old mother of two from Collinsville, Ill., was too busy to heed the distress signals. It was only when Mrs. De Lisle began hearing an incessant beeping that she took notice: If she didn’t make her car payment that day, the vehicle wouldn’t start the next day.

The repo man has found a new hiding place — inside your car. Increasingly, used-car dealers are installing remote disabling devices that keep the cars from starting if the buyer gets too far behind on payments.

These so-called disablers, palm-sized devices that are placed under dashboards and wired into ignitions, once were limited to what industry insiders call the "buy here — pay here" segment: the kinds of small used-car lots that line state highways, strung with lights and multicolored pennants. But as the economic downturn deepens, larger, more mainstream dealerships are using the devices as a condition of financing.

Even as the recession has fueled the used-car market, it has made it harder for auto buyers to obtain credit. Eager to book sales, dealers and finance companies are expanding their own financing operations, and the use of disablers helps them prod customers to make timely payments. Satellite-based locators are often built into the remote systems, though some dealerships say they don’t make use of that capability.

Maybe they should install heat sensors in these "Disablers" so, when the car is torched out in the desert, they could immediately scramble a team to arrest the perpetrators.

AIG/Banks: It’s About Time (Cuomo)

ilenne — Fri, 27 Mar 2009 19:17:37 +0000

Andrew Cuomo is asking good questions, and as Karl Denninger points out here, at least someone is. – Ilene

AIG/Banks: It’s About Time (Cuomo)

Courtesy of Karl Denninger at The Market Ticker

My God, there is a cop:

March 26 (Bloomberg) — New York Attorney General Andrew Cuomo subpoened American International Group Inc.’s credit- default swap data to see whether its customers including Goldman Sachs Group Inc., Societe Generale SA and Deutsche Bank AG were improperly compensated with taxpayer dollars.

“Our investigation into corporate bonuses has led us to an investigation of the credit-default swap contracts at AIG,” Cuomo said in a statement. “CDS contracts were at the heart of AIG’s meltdown. The question is whether the contracts are being wound down properly and efficiently or whether they have become a vehicle for funneling billions in taxpayer dollars to capitalize banks all over the world.”

It’s about damn time.

I have some questions, specifically:

Why isn’t the FBI performing this investigation.
Why isn’t US Attorney General spearheading this investigation?
Why isn’t our President, Barack Obama, demanding this investigation?

From the information available in public reports I believe that AIG’s "rescue" is nothing more or less than a thinly-disguised looting operation for certain preferred banks both here and abroad, intended to improperly obtain the full value of credit default swaps when the underlying instrument has not (yet) defaulted. Since AIG does not have the money (nor will they if and when the instruments do default) the company is being used as a conduit to funnel taxpayer money to these creditors who would otherwise be forced to seek their redress for bets that went bad through the bankruptcy court, and in the process would almost certainly take a very singificant loss.

What’s even worse is that AIG’s "installed" CEO, Liddy, was a director at Goldman Sachs before he took the helm of AIG, and Hank Paulson picked him for both roles!

Since Mr. Liddy is allegedly working for a salary of $1, let’s ask the obvious question that immediately comes to mind - exactly who’s interest does he represent as CEO of AIG? Is he a steward of the people’s money that has been injected to this company, or is he in fact a stooge installed by Hank Paulson, former CEO of Goldman Sachs himself, to make sure that Goldman (and perhaps others, if it could be arranged) "got theirs" – at taxpayer expense?

Congratulations to Mr. Cuomo for having the integrity and public interest necessary to go after this matter, send the subpoenas, follow the trail where it leads and get to the bottom of the matter.

It’s about damn time, and puts the lie to Obama’s claim that he came to Washington to "bring change."

Unless, of course, "change" is in fact even more corruption than we had in Washington DC before!

The Other Crime of the Century: 2008’s Short Squeeze in Oil

ilenne — Fri, 27 Mar 2009 16:44:17 +0000

Stock Jockey refers to 2008′s oil price manipulation swindle as the "other crime of the century," but it was also business as usual on Wall Street. The information in this article and those linked within might make you sick. – Ilene

The Other Crime of the Century: 2008’s Short Squeeze in Oil

Courtesy of StockJockey at 1440 Wall Street

There have been some remarkable swindles over the past year – Madoff, AIG etc etc. But the one that ravaged everyone’s pocketbook directly hit last summer.

The spike in oil to nearly $150 last July was breathtaking. And it was a killer blow to consumers around the world – the straw that broke the camel’s back as we moved deeper into a recession, and teetered on the brink disaster. At the time I was going apeshit over the price of crude, smelling a rat while peak oil types wore smug looks on their faces and shadowy industry analysts called for even higher crude prices:

May 21st

An analyst at Goldman Sachs, Mr. Murti has become the talk of the oil market by issuing one sensational forecast after another….Mr. Murti, 39, argues that the world’s seemingly unquenchable thirst for oil means prices will keep rising from here and stay above $100 into 2011. NYT

Yes, last summer Arjun Murti of Goldman Sachs was the Belle of the Ball, a regular Nostradamus living in New Jersey with two hybrid automobiles and an aversion to the media. As Barron’s said in early June of 2008, just as we headed into perhaps the biggest short squeeze in modern Wall Street history:

The 39-year-old analyst doesn’t give many interviews and keeps a low profile, preferring not to be photographed. But his strong views on energy have resonated across the financial markets.

Curious timing (he gave two high profile media interviews in three weeks) given what was going on at the time with SemGroup Holdings:

When oil prices spiked last summer to $147 a barrel, the biggest corporate casualty was oil pipeline giant Semgroup Holdings, a $14 billion (sales) private firm in Tulsa, Okla. It had racked up $2.4 billion in trading losses betting that oil prices would go down, including $290 million in accounts personally managed by then chief executive Thomas Kivisto. Its short positions amounted to the equivalent of 20% of the nation’s crude oil inventories. With the credit crunch eliminating any hope of meeting a $500 million margin call, Semgroup filed for bankruptcy on July 22.

But now some of the people involved in cleaning up the financial mess are suggesting that Semgroup’s collapse was more than just bad judgment and worse timing. There is evidence of a malevolent hand at work: oil price manipulation by traders orchestrating a short squeeze to push up the price of West Texas Intermediate crude to the point that it would generate fatal losses in Semgroup’s accounts.

“What transpired at Semgroup was no less than a $500 billion fraud on the people of the world,” says John Catsimatidis, the billionaire grocer turned oil refiner who is attempting to reorganize Semgroup in bankruptcy court. The $500 billion is how much the world would have overpaid for crude had a successful scam pushed up oil prices by $50 a barrel for 100 days. Forbes

Of course the energy markets were full of intrigue at the time, but it appears in retrospect that it was business as usual on Wall Street – boys playing a game of high stakes poker, and one side had marked the cards:

What’s the evidence of this? Much is circumstantial. Proving oil-trading manipulation is difficult. But numerous people familiar with the events insist that Citibank, Merrill Lynch and especially Goldman Sachs had knowledge about Semgroup’s trading positions from their vetting of an ill-fated $1.5 billion private placement deal last spring. “Nothing’s been proven, but if somebody has your book and knows every trade, it would not be difficult to bet against that book and put the company into a tremendous liquidity squeeze,” says John Tucker, who is representing Kivisto.

What’s known for sure is that Goldman Sachs, through J. Aron & Co., its commodities trading arm, was in prime position to use such data–and profited handsomely from Semgroup’s fall. J. Aron was Semgroup’s biggest counterparty, trading both physical oil flowing through pipelines and paper oil, in the form of options and futures.

When crude oil peaked in July, Semgroup ran out of cash to meet margin requirements on options contracts it had with Aron, contracts on which it had paper losses of $350 million. Desperate to survive, Semgroup asked Aron to pony up $430 million it owed on physical oil. Aron said no, declared Semgroup in default on its contracts and demanded immediate payment of losses. Forbes

You can read the gory details at the Forbes website, but clearly something big was going down last spring. I had written a series of pieces on the shenanigans in the oil marts, starting with a nascent CFTC investigation:

Stay tuned, this one could make Brian Hunter’s escapade look like amateur hour and Syriana merely a window to the real world machinations in the energy markets.

Alas, the investigation ultimately produced only the usual suspects – small time traders who had no powerful connections. The head of the NYMEX made a victory lap on CNBC’s Fast Money July 24th, crowing about the CFTC busting a group of odd-lot energy traders who made a few shekels while simultaneously SemGroup was neutered by powerful interests who had seen their trading book and shot against it, ultimately bleeding consumers of billions of dollars and tipping the economy into an ever deeper death spiral:

July 24th

Of course, while the CFTC busted a small Dutch energy prop trading firm today, accusing several principals of “banging” the market, in a fairly inept fashion, to make $1 million, there are clearly bigger hijinks going on.

And while pointing your finger at Morgan Stanley and Goldman Sachs might not be fair, the futures marts are a zero sum game, and chances are part of SEMGroup’s $3.2 billion loss might have ended up in the hands of the Wall Street titans, who have enough clout to intimidate regulators, and keep them at bay.

The energy markets are the biggest casino’s in the world, and the regulators are clueless, and somewhat powerless, to stop the shenanigans. The CEO of the NYMEX was on Fast Money tonight crowing about the bust, but nailing a couple of Dutch prop traders, who are clearly without any well placed friends, is not that impressive to me. 1440 Wall Street

Too, it seems the Feds were on the verge of something big on June 6th:

The chairman of a Congressional energy panel said Thursday that oil and products markets were being “manipulated” by the biggest trading houses in the futures markets, though he said a probe hasn’t uncovered illegal activity.

Bart Stupak, D-Mich., named Goldman Sachs (GS) and Morgan Stanley (MS) as two of the trading houses. He said the U.S. House Energy Oversight Committee hasn’t subpoenaed the banks and is basing its findings on data from the Commodity Futures Trading Commission.

Stupak said initial results of his committee’s investigation into skyrocketing oil and product prices had found loopholes in current laws were allowing the biggest traders in the futures market to “game the system.” He said the committee would hold a hearing to announce full results of the investigation on June 23.

“As our investigation goes further, we are really starting to unravel quite a web of – I am trying to say collusion, but I wouldn’t quite go that far – but you can certainly see manipulation of the price in places we’ve never seen before,” he said.

Asked if the biggest trading houses were Morgan Stanley and Goldman Sachs, Stupak said: “Yes, it’s them,” again stressing the lack of any evidence of illegal behavior.

“It’s not that they are doing anything criminally illegal…they are taking advantage where no one has ever looked before and when someone does take a look, there may be something illegal.” (DJ, cited in 1440 Wall Street)

But somebody muzzled Stupak – he changed his tune a few hours later and was never heard from again on the subject, as far as I know.

Of course these new allegations could not come at a worse time for Goldman, given that packs of anarchists are roaming the Streets with pitchforks.

But when it rains, it pours, and the shitstorm hanging over 85 Broad continues to intensify.

And if you are looking for someone to blame over the near $5 gas you saw at the pump last summer, you probably have your answer.

___________________________________________________

Did Goldman Goose Oil?
Forbes, by Christopher Helman and Liz Moyer,
Forbes Magazine dated April 13, 2009

May 21st
An Oracle of Oil Predicts $200-a-Barrel Crude
NYT

June 9th
What Mr. Crude Oil Sees Ahead
Barron’s

June 5th
Crude Oil Rips After Regulators Show Their Hand
1440 Wall Street

June 7th
Why Oil Spiked
1440 Wall Street

June 10th
CFTC Forms Interagency Task Force To Probe Commodity, Energy Trading
1440 Wall Street

July 24, 2008
SEMGroup Roils Oil Market But Questions Linger
1440 Wall Street

Aug 6, 2008
CFTC/NYMEX Come Clean and Revise Data on Oil Speculators
1440 Wall Street

Kass: SELL! SELL!

ilenne — Fri, 27 Mar 2009 15:08:36 +0000

Recall a post by Stock Jockey earlier this month called "Kass Digs In While Bears Continue to Feast"? It started off "Doug Kass is not afraid of the spotlight, and that is what he has at the moment thanks to his high profile calls that it is time to get more constructive on this market… but can the market be really be bought here?" Well now after the March run up, Doug is saying it’s time to exit. Read on. - Ilene

Kass: SELL! SELL!

Courtesy of Henry Blodget at ClusterStock

Doug Kass is sticking with his call about the generational market low a few weeks ago. But now that everyone else is finally realizing that this may just be the start of a huge new bull market, he’s also running for the hills.

(We love Doug’s instincts. We thank goodness we don’t have to worry about getting all these little short-term bulls and bears right, though. And we’d still put at least 50% odds on the fact that we have not yet seen that generational low.)

Too Many Booyahs Now?

I am going to stay true to what brought me here… and suggest that it is now an appropriate time to raise some cash.

Within the context of the greatest political circus ever televised, stocks have not improved because of the government; they are improving despite the government. And in the face of an unprecedented five up 90% days in March, the current rally is clearly different this time and more durable than others that preceded it.

Even though market internals have been steadily improving, the Nouriel Roubini Stock Market Bottom is in and a generational low has likely been reached (and will not be breached), so the move now seems stretched as the fear of being out has been replaced the early March fear of being in.

The gloom and doom that permeated the investment scene in early March is now disappearing. My sense is that, not unexpectedly, investor optimism is now on the rise and that sentiment indicators will exhibit that heightened optimism as they are released in the days ahead. This coupled with overbought technical indicators lead me to a more cautious view now.

More Doug Kass here >

What the IMF Would Tell the United States, If It Could

ilenne — Fri, 27 Mar 2009 01:00:50 +0000

Here’s an introduction to and excerpt from The Quiet Coup, courtesy of Simon Johnson and James Kwak, at The Baseline Scenario.

What the IMF Would Tell the United States, If It Could

From 1945 until around 1980, the financial sector was one industry among many in the United States. Then something happened.

People in finance started making more money, jobs in finance became more desirable, financial institutions became more influential, and the linkages between the financial sector and the political establishment became stronger. At the same time that our financial sector became more leveraged and more risky, it also became more powerful. The result was a confluence of interests between Wall Street and Washington – one more normally found behind the scenes of emerging market crises, the kind the IMF is called on to resolve.

Simon and I tell this story – and the story of what happened next – in “The Quiet Coup,” an article in the May issue of The Atlantic. (Many thanks to The Atlantic for putting the online copy up as early as they did.) The working title of the article was, “What the IMF Would Tell the United States, If It Could.” Enjoy. – By James Kwak.

Excerpt from The Quiet Coup:

In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts, like the ones we saw in February with Citigroup and AIG. The administration will try to muddle through, and confusion will reign.

Boris Fyodorov, the late finance minister of Russia, struggled for much of the past 20 years against oligarchs, corruption, and abuse of authority in all its forms. He liked to say that confusion and chaos were very much in the interests of the powerful—letting them take things, legally and illegally, with impunity. When inflation is high, who can say what a piece of property is really worth? When the credit system is supported by byzantine government arrangements and backroom deals, how do you know that you aren’t being fleeced?

Our future could be one in which continued tumult feeds the looting of the financial system, and we talk more and more about exactly how our oligarchs became bandits and how the economy just can’t seem to get into gear.

The second scenario begins more bleakly, and might end that way too. But it does provide at least some hope that we’ll be shaken out of our torpor. It goes like this: the global economy continues to deteriorate, the banking system in east-central Europe collapses, and—because eastern Europe’s banks are mostly owned by western European banks—justifiable fears of government insolvency spread throughout the Continent. Creditors take further hits and confidence falls further. The Asian economies that export manufactured goods are devastated, and the commodity producers in Latin America and Africa are not much better off. A dramatic worsening of the global environment forces the U.S. economy, already staggering, down onto both knees. The baseline growth rates used in the administration’s current budget are increasingly seen as unrealistic, and the rosy “stress scenario” that the U.S. Treasury is currently using to evaluate banks’ balance sheets becomes a source of great embarrassment.

Under this kind of pressure, and faced with the prospect of a national and global collapse, minds may become more concentrated…

Look Before You Buy LEAPS

ilenne — Thu, 26 Mar 2009 19:31:36 +0000

Condor Options discusses LEAPs, calls, and options in buying options.

Look Before You Buy LEAPS

Courtesy of Condor Options

Long-term Equity Anticipation Securities (LEAPS) are a class of options with expiration dates longer than a year. Their purpose is to allow investors who would otherwise hold shares of an underlying equity to buy an option instead, and thereby participate in expected price movement without tying up as much capital. However, we caution investors against using LEAPS as stock substitutes without first taking volatility considerations into account.

Let’s say you want to buy 1000 shares of Cisco Systems (CSCO). At $15.91, you’ll tie up $15,910 to hold those shares. If you were comfortable trading LEAPS, you could instead buy 10 January 2010 CSCO 12.50 calls for $4.85, tying up just $4,850 to own those options. You’ll participate in most of the upside should the stock rally over the next year: if CSCO is at $23 by January 2010 expiration, you will have gained $7,020 on the stock position, or about $6,000 on your LEAPS (at .77 delta, the calls will mimic about three fourths the movement of the stock). And as with any long call, your losses are limited to the premium paid – in this case, owning the LEAPS would reduce your exposure by $11,060 should the stock collapse. Of course, if you wanted the option position to track stock movement more closely, you could choose a contract further in the money with higher delta, though the usefulness of the LEAPS as a capital-freeing stock replacement would decrease accordingly.

But delta isn’t the only greek worth attending to when it comes to LEAPS. Those January 2010 calls also carry a vega of .04, which means the option will lose four cents in value for every 1% decline in implied volatility. The current implied volatility in this series is about 53%, which, like most stocks these days, is well below the recent highs but is still historically quite rich. That means anyone buying LEAP calls today may be setting themselves up to lose either way on the volatility front: if the stock rallies, the consequent decline in implied volatility will punish call holders, and at these levels a steady decline will have already been priced into the options, such that a gradual selloff will also be consistent with declining volatility levels. Either way, traders paying up for premium could lose out relative to those holding shares.

sIFR_callback_4_DoFSCommand(info, args);Options Are Not On Sale

As a matter of fact, a scan across a number of equities suggests that this may be one of the worst times in recent history to pay up for long-dated call options. Again: a sharp rally in the near term would suck the volatility premium out of the contracts purchased, while the downside ranges assumed in many option prices are unrealistic, causing investors to pay for protection they won’t need. In our CSCO example, the Jan 2010 calls are priced assuming a 43% chance that the stock will be somewhere between its current price ($15.91) and $9 by expiration. While there are undoubtedly some stocks that still have a further 40% decline in their immediate future, unless you think that most stocks will share this fate, buying long-dated calls looks like an especially expensive proposition right now.

But our larger point is that LEAPS are always a little more expensive than they might appear, because more of the premium is attributable to implied volatility than is the case with shorter term options. One of the ways investors attempt to offset this cost is by selling short term out of the money options against their longer dated holdings. In our example, you could sell the April 18 calls for $0.13, and keep the premium assuming the stock is below that level 27 days from now. But this is hardly a solution to the problem of overpaying for the LEAPS: the options being sold have an implied volatility of 41%, not 53%, and with a vega of .01 are much less sensitive to changes in implied volatility. So the bulk of the volatility exposure remains; and while savvy options traders may be comfortable with or even amenable to risks associated with volatility, this is clearly not an area that most stock investors are prepared to navigate. In other words, investors using LEAPS strictly for stock replacement purposes are getting more (and paying for more) than they may have bargained for.

As an alternative to buying LEAPS, we suggest looking at series three or four months out when purchasing calls: while some volatility exposure remains, it is less significant, and rolling the long contracts forward every month or so will prevent time decay from having too much of an impact.

Elliott Wave Update – Possible Count for March 26

ilenne — Thu, 26 Mar 2009 18:41:51 +0000

Here’s Corey’s latest Elliott Wave Count Update.

Elliott Wave Update – Possible Count for March 26

Courtesy of Corey Rosenbloom at Afraid To Trade

Here’s an update and comments to the possible Elliott Wave Scenario playing out on the S&P 500 – this is just one possible count – a very bullish interpretation – which hints that we’ve bottomed and are now in a corrective or perhaps even impulse phase.

(You’ll need to click for a larger chart)

Let me first state that price breaking above 805 in the S&P ‘messed up’ the obvious count, which is that the current rally was a fractal Wave 4 of the final Wave (5) … or alternately of final 5 of Wave (3), but we’ll side-step that discussion for the moment.

According to one of only 3 basic Elliott Wave Rules (that’s right – as complicated as Elliott Theory is, it only has three hard rules)…

“Wave 4 Can Not Enter the Price Territory of Wave 1″

That’s why so many traders were watching the 800/805 level so intently on the S&P, and why it had so much trouble breaking above it, and that when it finally did break, we got a surge off that level because so many stop-losses (from the short sellers) were being covered.

Because this happened, it forced Elliotticians to defer to their alternate counts. The count I have posted above is one of those alternate counts which implies that we achieved a full, five-wave count in the prior downswing from 950 to 665 on the S&P 500 Index.

IF this count is correct, it implies one of two things:

1) If we accept the count at face value, it would imply we have bottomed out here and that we are perhaps beginning a primary new impulse up – that is extremely hard to believe given the current negative economic environment, and that’s not necessarily an implication I’m willing to make right here.

2) If we assume that Primary Wave 3 has not yet completed, and that the down-move here just officially completed Wave 3, then we will be launching into a strong ABC (perhaps even Zig-Zag) Primary Wave 4 that could take us as high as 1,200 (but more realistically, 1,000/1,100). This ABC pattern could last months.

Let’s look at Scenario 2, which implies that we just completed (or are completing) Primary Wave 3:

I tend to lean more bullish at this time because other indicators hint at least an intermediate bottom is in place – for example, the lengthy positive momentum divergence, the “Three Push” Pattern, and the Government’s willingness to print money at will (which will perhaps catch up to us later… but not right now), and record low sentiment readings that came just prior to the absolute 665 low.

As much as it might ‘feel’ like we need to put in a final leg lower, that view may have officially changed with price breaking 805. Nothing’s to say we don’t come down and make new lows, but it just seems that the odds have shifted more bullishly for the time being. A solid break beneath 800 might challenge that assumption, but it just seems the winds are changing for whatever reason.

I’ll keep you posted with alternate scenarios and counts as needed and as more data (price) is revealed to us.

WSJ: Have We Seen the Last of the Bear Raids?

ilenne — Thu, 26 Mar 2009 15:38:54 +0000

Andy Kessler explains the "bear-raid extraordinaire." Read this article, maybe twice.

WSJ: Have We Seen the Last of the Bear Raids?

Courtesy of Andy Kessler

So is that it? Is the downturn over? After bouncing off of 6500, or more than half its peak value, and with Citigroup briefly breaking $1, the Dow Jones Industrial Average has rallied back more than 1200 points. So, is it safe to go back in the water? Best to figure out what went wrong first — what I like to call a bear-raid extraordinaire.

The Dow clearly got a boost from Treasury Secretary Tim Geithner’s new and improved plan, announced on Monday, to rid our banks of those nasty toxic assets. The idea is to form a "Public-Private Investment Fund" to buy up $500 billion to $1 trillion worth of bad assets — mostly mortgage backed securities (MBSs) and collateralized debt obligations (CDOs).

While it’s true that private interests can conceptually help establish the right market price for these assets, the reality is Mr. Geithner’s public-private scheme won’t work. Why? Because the pricing paradox remains — private parties won’t overpay, yet banks believe these assets are extremely undervalued by the market. As Edward Yingling, president of the American Bankers Association, said recently on CNBC, "You have to go into the securities, examine the securities, examine the cash flow. I’ve seen it done, and the market is so far below what they’re really worth."

The Treasury can’t just keep throwing money at the problem, but needs instead to figure out what’s really been going on — the aforementioned bear-raid extraordinaire that’s crushed Citigroup and Bank of America and General Electric, among others. Only then can Mr. Geithner craft a real plan to fight back.

In a typical bear raid, traders short a target stock — i.e., borrow shares and then sell them, hoping to cover or replace them at a cheaper price. Once short, traders then spread bad news, amplify it, even make it up if they have to, to get a stock to drop so they can cover their short.

This bear raid was different. Wall Street is short-term financed, mostly through overnight and repurchasing agreements, which was fine when banks were just doing IPOs and trading stocks. But as they began to own things for their own account (MBSs, CDOs) there emerged a huge mismatch between the duration of their holdings (10- and 30-year mortgages and the derivatives based on them) and their overnight funding. When this happens a bear can ride in, undercut a bank’s short-term funding, and force it to sell a long-term holding.

Since these derivatives were so weird, if you wanted to count them as part of your reserves, regulators demanded that you buy insurance against the derivatives defaulting. And everyone did. The "default insurance" was in the form of credit default swaps (CDSs), often from AIG’s now infamous Financial Products unit. Never mind that AIG never bothered reserving for potential payouts or ever had to put up collateral because of its own AAA rating. The whole exercise was stupid, akin to buying insurance from the captain of the Titanic, who put the premiums in the ship’s safe and collected a tidy bonus for his efforts.

Because these derivatives were part of the banks’ reserve calculations, if you could knock down their value, mark-to-market accounting would force the banks to take more write-offs and scramble for capital to replace it. Remember that Citigroup went so far as to set up off-balance-sheet vehicles to own this stuff. So Wall Street got stuck holding the hot potato making them vulnerable to a bear raid.

You can’t just manipulate a $62 trillion market for derivatives. So what did the bears do? They looked and found an asymmetry to exploit in those same credit default swaps. If you bid up the price of swaps, because markets are all linked, the higher likelihood (or at least the perception based on swap prices) of derivative defaults would cause the value of these CDO derivatives to drop, thus triggering banks and financial companies to write off losses and their stocks to plummet.

General Electric CEO Jeff Immelt famously complained that "by spending 25 million bucks in a handful of transactions in an unregulated market" traders in credit default swaps could tank major companies. "I just don’t think we should treat credit default swaps as like the Delphic Oracle of any kind," he continued. "It’s the most easily manipulated and broadly manipulated market that there is."

Complain all you want, it worked. In early March, Citigroup hit $1 and Bank of America dropped to $3 and GE bottomed at $6.66 from $36 not much more than a year ago. Same for Lloyds Banking Group in the U.K. dropping from 400 to 40. Citi CEO Vikram Pandit recently announced that the bank was profitable in January and February. (How couldn’t they be? With short-term rates close to zero, any loan could be profitable). Never mind they still had squished CDOs, it was enough to get some of the pressure off, for now.

Oddly, with the new Treasury plan, these same bear raiders are still incentivized to manipulate the price of swaps to depress toxic derivative prices, especially so with the government’s help to get hedge funds to turn around and buy them. Perversely, they may get rewarded for their own shenanigans.

This week’s Treasury announcement of private buyers isn’t going to magically change the depressed prices of these toxic derivatives. The Treasury needs to fight fire with fire. If I were Mr. Geithner, I’d pull off a bull run — i.e., pile into the CDS market and sell as many swaps as I could, the opposite of a bear raid. If the bears are buying, I’d be selling, using the same asymmetry against them. Sensing the deep pockets of Uncle Sam, the bears will back off. Worst case, the Fed is on the hook for defaults, which they are anyway!

With the pressure of default assumptions easing, prices of CDOs should rise, which not only gives breathing room to banks, but may actually get these derivatives to a price where banks would be willing to sell them, replacing toxic assets in their reserves with cash or short term Treasurys, which ought to stimulate lending.

So are hedge funds villains? Not especially. The bear raid probably saved us five to 10 years’ of bank earning disappointments as they worked off these bad loans. Those that mismatched duration set themselves up to be clawed. Under cover of a Treasury bull run, banks should raise whatever capital they can and dump as many bad loans before the bear raiders come back. Let the bears find others to feast on, like autos, cellular, cable and California.

Mr. Kessler, a former hedge-fund manager, is the author of "How We Got Here" (Collins, 2005).

Is the worst behind us?

ilenne — Thu, 26 Mar 2009 03:14:03 +0000

James Hamilton is watching the housing market — as long as prices are falling, concerns about the value of mortgage backed securities and financial instruments constructed from them will persist.

Is the worst behind us?

Courtesy of James Hamilton at Econbrowser

A couple of weeks ago we received the encouraging news that retail sales for both January and February were 1.8% above December. On Monday the National Association of Realtors reported that February sales of existing homes were 5.1% above January levels on a seasonally adjusted basis. Today the Census Bureau reported that new orders for manufactured durable goods rose 3.4% in February, with new orders for nondefense capital goods up 7.4%. And also today the Census Bureau reported that new home sales in February were up 4.7% (on a seasonally adjusted basis) relative to January. Is the tide starting to turn?

Note: graph does not include today’s new home sales data. Source: Calculated Risk.

The new home sales figure is particularly relevant. Calculated Risk has been emphasizing the discrepancy between the possible turnaround in sales of existing homes and what had up until today been an ongoing slide in new home sales. Much of the strength in existing home sales has come from foreclosure resales. Large numbers of foreclosures coupled with falling sales of new homes do not paint a picture of a healthy housing market. Although the February bump in seasonally adjusted new home sales is encouraging, on a seasonally unadjusted basis, we’d usually expect February sales to be 25% above the seasonal low in December. But the seasonally unadjusted February 2009 number was about the same as was reported for a very weak December and 44% below February 2008.

Seasonally unadjusted new home sales. Source: Calculated Risk.

Despite the increase in sales of existing homes, the inventory of unsold existing homes unfortunately also increased in February. But the good news is that this inventory remains below the levels seen for most of 2008.

Source: Calculated Risk.

Here is Calculated Risk’s take on the earlier existing home sales report:

Inventory levels increased sharply in 2006 and 2007, but have been below the year ago level for the last seven months. This might indicate that inventory levels are close to the peak for this cycle. Note: there is probably a substantial shadow inventory– homeowners wanting to sell, but waiting for a better market– so existing home inventory levels will probably stay elevated for some time. There is also the possibility of some REOs [real estate owned] being held off the market.

It is important to watch inventory levels very carefully. If you look at the 2005 inventory data, instead of staying flat for most of the year (like the previous bubble years), inventory continued to increase all year. That was one of the key signs that led me to call the top in the housing market!

If the trend of declining year-over-year inventory levels continues in 2009 that will be a positive for the housing market. Prices will probably continue to fall until the months of supply reaches more normal levels (in the 6 to 8 month range), and that might take some time.

As long as house prices continue to fall, concerns about the true value of mortgage-backed securities and financial instruments constructed from them will still be with us. But a lower bound on how much farther house prices will fall would help significantly to resolve the status of trillions of dollars in these "troubled assets".

On Monday CR wrote:

I think the keys to watch for the housing market are declining inventory levels, a bottom in new home sales, and the gap between new and existing home sales closing.

CR was right on target about the housing peak, so I trust his judgment in calling the bottom. But I take some encouragement in the news of the last two weeks.

Ilenne's Blog

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WSJ: Have We Seen the Last of the Bear Raids?

Is the worst behind us?

Note: graph does not include today’s new home sales data. Source: Calculated Risk.

Seasonally unadjusted new home sales. Source: Calculated Risk.

Source: Calculated Risk.