Tag Archives: Markets

About This Space…

I might as well say it here, even though it has been on Twitter while I was on vacation. My macroeconomic goodness is moving to The Davian Letter and Minyanville.  So I guess I know who my two readers were: an investment newsletter and a financial infotainment website. Thanks for all the pageviews, guys.

But I don’t want to give up this space. I enjoy using it and I want to see what else can be done. Maybe I’ll turn it into a photoblogging site. Doubt it, though. I mean, I may be the only person on Twitter that actually admits I have mental diarrhea. There’s no way I’m going to comply with a STHU memo that easily. Plus, I fear my mental diarrhea is just getting worse and no amount of mental Maalox or Phillips Milk of Magnesia is going to help.

So I’ll just have to figure out what to do with the space in the meantime…

So stay tuned.

And thanks for stopping by, San Diego…

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Going Coastal

I just wanted to take a brief moment and inform all three of my readers (myself included) I am going to be taking a break from the normal financial and macro-related fare you find on this piece of blog.  I’ll be at the beach with my family for the rest of the month, taking a well-deserved and long overdue reprieve.

I’ll still have some posts, but they’ll be a different kind.  Perhaps a bit more personal, maybe even a bit more poignant.  There’s bound to be more photos.  Maybe even a video or two.  I haven’t thought that far ahead.

But it’s good to get away.  The ongoing nightmare known as European interbank lending isn’t going anywhere.  Neither is the debate on FinReg.  Nor the bigger macro backdrop complete with de-leveraging and debates about fiscal stimulus and whether or not central banks drove the macroeconomic bus off the proverbial cliff.  If all of that changed on a dime simply because I wasn’t blogging it, well, I guess I’ll shut up and let everything turn for the better.

But I know it won’t and you know it won’t.  These issues and the debate about how we respond to them will rage on, regardless of what any one of us might think or feel.

So in the meantime I’m going to take the opportunity to listen more attentively to my wife when she asks me to do something (an area I’m sure I have constant room to improve on), to play a bit more with my son and in general, let some of this stuff fade into the background…

And find something else to talk about for a little while…

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A Rant About Xenophobia Run Amuck

This is getting quite ridiculous, really.  No more than a week ago, I had a post about the idiotic comments coming from Europe on “wolfpacks” and “wolfpack behaviors” that were “rampant in the marketplace.”  Those comments about wolfpacks elicited a reaction from me:

It’s amazing what folks in his position do in reaction to market events. To me, it’s very clear that the market isn’t looking to take the Euro down, or as he put it “tear the weaker countries apart.” What the market wants is for Brussels to show they have some guts and draw a line in the sand with respect to their mantras of fiscal responsibility. Not just pay it lip service.

via Comments on “Wolfpack” Behavior Epitomize Idiotic Behavior « Deep Thoughts by Professor Pinch.

Now we have comments in the Financial Times from Wolfgang Schauble, Germany’s finance minister, who thinks markets are “really out of control.”  He also thinks “the ratio of financial transactions to the real exchange of goods and services” needs to be regulated.

Really?!

I guess my first question is define “out of control.”  Are prices only supposed to go one way, depending on the prevailing political winds (up for stocks, down for commodities)?  Puhleeze.  That will get you just as far as a kid gets complaining about a dog eating their homework.  Markets are a product of the people/institutions that participate in them, the products/services that are bought/sold/traded there and the rules that they can operate under.  Rules that are made by people.  So is he really saying people screwed up in setting up markets?  Or that people screwed up in the enforcement of those rules?  If that’s what he means, I’d buy it.  Sadly, I don’t think that’s what he meant.

Which leads me to this asinine idea of regulating “the ratio of financial transactions to the real exchange of goods and services.”  Who sets that ratio?  And who says they know better than me?  Or that they know better than you for that matter?

To me, this is clearly an outgrowth of some things I highlighted in another post.  Let’s take what I said about CDS for example.  There’s a huge disparity between inter-dealer trading volumes and client-based flow trading:

First, I have to say the volume differences between inter-dealer trading and non-dealer trading is staggering. But it leads me to some questions. Questions that need answers…

  • What are the dealers doing? Is this how they are trying to make the market appear “liquid?”
  • Is there another explanation? I’ve been toying around with this idea that there may be another reason completely unrelated to trading and market-making. The volumes are such to support the headcount in those departments – so this could be bureaucracy and bloat. It may be totally wrong, and a sign my medication needs to be upped dramatically, but I’m just saying there may be an alternative explanation.

via Quick Hits on Credit & Liquidity « Deep Thoughts by Professor Pinch

I’m just trying to come up with ideas as to explain what’s going on, I don’t assume for a minute I’ve hit on anything.  But sticking with CDS for a second, I picked this instrument strictly because it is, to borrow the words of Baudrillard (courtesy of  Kevin Depew), a manifestation of the simulacra.  CDS are a synthetic of an organic/cash instrument.  But yet, we talk more about CDS than cash bonds.  It’s like we talk more about Super Bowl bets than the actual game.

But there’s a point there.  Sports betting is a derivative of the event: an event occurs, people are betting on its outcome.  The same can be said of the markets.  The issue is not in the market action, it’s that the market has become so concentrated – so cartel-like and oligopolistic – that when we need true liquidity to facilitate things like “Flash Crashes” or massive carry unwinds, it’s not there to be had.  People have failed in their regulation of markets and in how regulations should be enforced.

So if Herr Schauble wants to talk about how to fix markets through better policy, fine.  If it’s to punish market participants for participating in the market, like what he said here, the only words that come to mind come courtesy of Gordon Ramsay:

“You!  Over there.  Shut it!  Now!”

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What the Past 3 Years Have Taught Me

Was sitting here watching my tweets, looking at data, and reading the news flow this morning when I started thinking about what the last three years have shown me. So I thought I’d pen them and share them with the 2 (maybe 3? hoping for 3?) readers of this bog. I don’t think these are profound or earth-shattering, but since folks seem to be commemorating things today (We’ve sunk to commemorating over-liquefied 50%+ retracements? Really?), figured I might as well chime in before the real Professor Pinch posts something unrelated and mucks up my abysmal SEO.

A String of Events That “Couldn’t Happen,” “Shouldn’t Happen”, or “Can’t Happen” Can Indeed, Happen

Call it my paraphrasing of Taleb. But the truth is, we started seeing tremors in mortgage origination back around this time, three years ago. Which is where I start the clock on the crisis, not the NBER’s definition. And the truth be told, I don’t even think it’s true. I think our methods for estimating likelihoods and severities of events are flawed. They’re far from perfect. Gaussian distributions matter little to me, unless I’m reading something that has been stylized to show me, the dear reader, how it should work. Yet our literature in finance and economics is filled with Gaussian assumptions. I don’t offer this up in a “destroy the models and lynch the quants” sort of manner, far from it. I think we need that thinking and the benefits of data visibility/transparency (we can’t analyze it until we record it/store it), but the mold needs to be broken in terms of what we do with it and how we do it. I tend to think we’re a lot more infantile in this realm than we believe we are. We need to focus on building mousetraps and metrics more.

Also, there were tell-tale clues all along the way to this point, but they were collectively ignored, forgotten, or disputed. I have a lot more to say about this, but away from this post. The “hindsight is always 20/20” rebuttal usually comes out of this, but frankly, I don’t buy that. I think you could’ve seen a bunch of this if you chose to look.

Never Underestimate a Political Hack’s Desire to Clean Things Up Over a Weekend

Just read “Too Big to Fail” to see what I mean. That desire has had a lot of manifestations over the past few years. From mortgage mods to unorthodox Fed policy to stimulus largesse, the desire to just make pain stop is one I frankly underestimated. And the lengths they’ve went to are simply fantastic. This acts as a lead-in of sorts for my next learning.

The Things Political Hacks Do Are Great at Creating Cross Currents and Choppiness

What do I mean by that? Simple. Throughout ’06 in the run-up to the mortgage meltdown that started in ’07, 2s/10s on the yield curve was inverted, which meant 10yr funding was cheaper than 2yr – not typical. But as the Fed aggressively cut rates, sparking a rally in short-term money, the curve started to normalize. And with the Fed purchasing MBS and starting up its alphabet soup of liquidity facilities, the effects were amplified.

All of which was supposed to spark a run to risky assets, which it did. Frankly I was shocked at how well it worked, because I just assumed people would’ve learned to exhibit a little more restraint, and been a little less willing to play along with the Fed. But, mea culpa, I can admit that. While it has made a great run-up thus far, it’s not something that looks like it can be sustained. Well, at least to me, it doesn’t.

So I look around and question what’s real and what isn’t, kind of like Neo spending night after night trying to figure out what The Matrix is. Because I want to find relatively clean data and observations to help me price risk/return. Not data points that feel like they’ve been dampened, scrubbed, massaged, and filtered to give the appearance of normalcy, which is what I feel like has been done. But if you start with that premise, you arrive at some conclusions you would never arrive at otherwise.

It kind of reminds me of the first day I tried to surf. Nasty on-shore wind, beach break thrown out of whack by a tropical storm somewhere near Bermuda, in short, a mess. But I went out, managed to catch a few good ones and had a good time, mostly for the friends I went out there with – not the waves. In hindsight, I was probably better off staying out of the water. All the starts and false starts in spotting waves made it tough. So as a result, I’ve become a bigger fan of keeping dry powder and working on stripping away noise. I feel like I spend a lot more time on this now than I used to.

Cross Currents, Seasonal/Cyclical/Secular Trends

This is where things have been tricky, if not treacherous. I’ve become a lot less enamored with government statistics on the economy, because frankly, I don’t think last year’s seasonal effects can capture seasonality one year forward. Maybe it’s climate change and the cyclical nature of weather that does it. I don’t know, but I find myself yawning a lot more when retail sales, NFP, housing starts data come out during the winter months. It just seems like putting a lot of weight on observations skewed by cold temperatures, Eastern Standard Time, snowfall, and holiday shortened months just doesn’t make sense. It’s just noise to me. That means I’m essentially using the months March through October as my barometer of economic health, and I’m OK with that.

So when I think of the jobs data, as easy as it is to be bearish/cynical about it, there are legitimate reasons we can see some things turn around. A lot of work that has to be done simply doesn’t halt because we’re in the Great Recession. Sure, construction and real estate related work isn’t going to be what it once was, financial services work won’t be either. But time still marches on and there will still be some work that has to get done. Governments still need people, hospitals, hotels, and other places need to hire too. My wife and I are still going to have to do/provide plenty of things for our son, so we need goods and services for that and somebody to provide them to us. And we’re not the only ones who need them, there are plenty of others in the same boat. We can argue about how much and at what wage, but the market should be able to sort that out. Trees don’t grow to the sky and they don’t crash straight to hell, either. Call it Zen and the Art of Bearishness if you want, but it’s a struggle to find balance.

I guess I’m trying to say there’s a certain rhythm that all of these things keep, regardless of what any one person or group(s) of people may think or do. What got me thinking about that the most was the weather. You go out, you talk to people, and you’re bound to run across some who act like winter is never going to end and we’re destined to a cursed life of nothing but cold and snow. Next thing you know it’s almost 70 degrees, sunny, and we’re in the second full week of March. The days are getting longer, you actually see and hear birds, and you realize some things are the same as they ever were. Psychology is one of those things that’s so powerful, yet its influence is often misjudged and misunderstood. Folks seem to get way too high and way too low these days.

At any rate, Happy Anniversary…

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Wordless Wednesday 3-3-10

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The Man You Don’t Want in the Foxhole Next to You

The SIGTARP’s latest audit report is out, the New York Times article is here.  Reaction has been swift, and definitely one-sided – against Treasury Secretary Geithner.

But I’m not going to rehash that.  I’m going to take a look at the report and the assets the New York Fed got in the bargain from AIG – a big slug of CDOs that are practically worthless or soon will be.

First, it’s clear our government officials panicked.  From the SIG TARP report:

Mr. Geithner mobilized a consortium of banks led by representatives from JPMorgan Chase & Co. and Goldman Sachs to arrange private financing for a $75 billion loan to address AIG’s liquidity crisis. The Federal Reserve believed that the bank consortium would provide the liquidity AIG needed.  A JPMorgan Chase vice chairman noted that participants felt a sense of urgency to find an immediate solution to avert a potential downgrade by the credit rating agencies.  The group developed a loan term sheet, but an analysis of AIG’s financial condition revealed that liquidity needs exceeded the valuation of the company’s assets, thus making the private participants unwilling to fund the transaction.  FRBNY officials told SIGTARP that, in their view, the private participants declined to provide funding not because AIG’s assets were insufficient to meet its needs, but because AIG’s liquidity needs quickly mounted in the wake of the Lehman bankruptcy and the other major banks decided they needed to conserve capital to deal with adverse market conditions.

First sign they panicked: that “sense of urgency” to come up with $75 billion to float AIG, even though the assets – which would’ve been pledged as collateral – were insufficient.  When you panic, you still try and do things that you know you shouldn’t do, but you still do them because you’re not prepared to do what you need to do.  The Fed & Treasury needed to be prepared to let AIG go.  But they weren’t.

Second sign from the SIGTARP report:

FRBNY did not develop a contingency plan in the event that the private financing did not go through and did not conduct an independent analysis regarding the appropriate terms for Government assistance to AIG; instead it used in substantial part the economic terms of the private sector deal, albeit for $85 billion instead of the $75 billion prepared by JPMorgan Chase for the unsuccessful private sector solution.

No contingency plan?  They just upped the loan amount by $10 billion, because it’s, well, just another $10 billion.  I saw all of the different asset classes that they got themselves (and us) into, and I can only come away with the thought that they could’ve spun off stuff they weren’t going to support into a subsidiary and let that subsidiary blow up while still backing the commercial paper and other obligations that were attached to the stable value funds and corporate 401k plans.  At least that way you’d do something to ensure employees of Wal-Mart, AT&T, etc. didn’t get wrapped up in this mess but at the same time you didn’t do something stupid.

But that’s what you do when you panic.  You do stupid things.

People have written ad-nauseum about the Fed’s decision to pay par on the CDS contracts when they shouldn’t have, so I won’t spend a lot of time on it.  They could’ve taken door #2 instead of door #3 (p. 12 of the SIGTARP report).  The wind-down process would’ve taken longer but there would’ve been less money at risk & the counterparties would still have to hold on to the CDOs with the NY Fed paying in the event of a CDO default.  The NY Fed would’ve gotten that money from the dismantling of the rest of AIG.

So what are we left with in the Maiden Lane III SPV the NY Fed set up?

Yeah.  That’s a solid portfolio <sarcasm off>.  If you wanted to know what a crap sandwich looked like at somebody else’s expense (that somebody else is the taxpayer), this is it.  There’s no way on Earth this CDO – with these underlying assets – will ever realize face value.  $29.6 billion right there.  We may be lucky to see $14 billion returned to the taxpayer.

At this point, there’s nothing we can do.  Tim Geithner committed our collective butts to this thing.

And he did it in a moment of panic.

So when the bullets are flying, people are dazed and confused, and the battle is being fiercely waged out there on the front, would you want him in the foxhole next to you based on how he handled this?

Factors_Affecting_Efforts_to_Limit_Payments_to_AIG_Counterparties

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Short End of the Stick, er… Curve

Read an article at Bloomberg the other day.  One of those stories that nobody probably pays any attention to until it’s too late.  Well in an attempt to make sure I see all of the trains that can hit me (Note: It’s always the train you don’t see that hits you), I thought I’d say something about it.

First, it starts off rather ominously:

The drop in the premium banks charge for dollar loans above the federal funds rate to pre-financial crisis levels may indicate investors are underestimating risk again, according to Macroeconomic Advisers LLC. 

 Ah, yes complacency.  Where have you been my long, lost friend?  Winter of ’07 seems so far away now.  You all remember then, right?  That was the around the time this place got started.

Plus, who are these know-nothing guys at Macroeconomic Advisers?  Umm, wait.  Oops!  These guys probably know something and if they don’t know, then we’re all screwed.  Anyway, let’s jump down a ways.

The Libor-OIS spread has narrowed to the least since 2007, prior to the collapse of the subprime-mortgage market and the global credit rout, amid government support to the banking sector, the firm headed by former Federal Reserve Governor Laurence Meyer wrote. Investors may be under-pricing risk if the gap doesn’t widen as government support wanes, said former Fed economist Antulio Bomfim, who co-wrote the report.

“We’ve seen a decline in risk premiums larger than we would expect for this stage of the cycle,” Meyer, vice-chairman of Macroeconomic Advisers, said in a Nov. 9 interview. “We have to appreciate the signal from these spreads that suggests that the prevailing level is unsustainable. While we don’t think that suggests a dangerous reversal, certainly some reversal will be likely.”

That’s pretty much a shot across the bow, folks.  Or at least as much of a warning you’re going to get from a guy who used to be a central banker.  But to illustrate what he’s saying, I have a chart for a reasonable proxy of the LIBOR-OIS spread below.  The spread is calculated by taking the difference between the 3-month LIBOR rate and the nearby 30-day Fed Funds futures rate, which shows the market’s expectations for Fed Funds.

LIBOR-OIS-1

Notice the spike starting in the ’07 timeframe. That was during the August of 2007. You know, when all hell started to break loose.  But there’s another way we can examine what happened by looking at where Fed Funds were trading themselves.

To paraphrase the Apple commercial, there’s a  chart for that.  And I have it right here.  This is a daily chart of the daily standard deviation in Fed Funds trading at the New York Fed.  You’ll see the same pattern as the chart above, but the chart only goes back 2 1/2 years. But you should still get the idea.

Fed Funds - std deviation

One thing I notice is this: volatility – as measured by standard deviation – is way lower now than even before August ’07.  Why? Part of it has to be due to the Fed Funds target is now a range – not a rate.  My theory is by allowing Fed Funds to trade in a target range, volatility is being dampened because you’ve changed what/how you will calculate a difference.  If you target a specific number, any number which is different from that target is in and of itself a variance.  But if you target a range, you will only measure moves that are outside of that target range.

Of course, there’s this whole other thing you have to deal called the Fed balance sheet.  Take a look at the following chart:

Fed Balance Sheet 10-09

A pretty graphic, stunning, and grotesque view of the balance sheet expansion the Fed has undergone to try and unfreeze markets.  I’m going to tell you right now I don’t think it’s worked one bit.  The Fed is essentially the only provider of liquidity right now, volatility is lower but that’s because interbank lending is still dysfunctional and banks still have billions waiting for them in charge-offs.  And given what the Fed said as they embarked on quantitative easing…

The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level.  As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.  The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.  Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.  The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

I’m not sure a rate hike is going to be needed to raise rates.  Rather, I’m leaving the possibility we can see a rate increase merely as a function of a less-liquid Fed.  One that’s beginning to wind down purchases of Treasuries (I for one don’t see their purchases as being as big an issue as others.  Because the Fed had a huge outflow of Treasuries last year to ensure the market had ample supply to meet margin calls.  Treasuries are considered high quality collateral for margin loans), MBS, ABS, and other securities.  If I’m right, we could see Fed Funds and short-term rates in general move higher.  That will compress returns you can earn by borrowing short-term money to invest in longer-term assets.

If that happens, the market is not ready for that sort of outcome.  With a lot of investors borrowing short to invest long and earn the carry on the duration mismatch, a sudden move higher at the short end of the curve could leave them feeling like they got hit by a truck that they didn’t see coming.  Just like these guys in the armored truck:

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