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HomeDoes AIG’s Self-Dealing Pose Systemic Risk?
Posted by Larry Doyle on July 31st, 2009 8:04 AM |
While our equity markets are making new highs for the year, I cautioned readers the other day “No Time for Complaceny on Insurance and Money Fund Exposures.” On the insurance front, I specifically highlighted:
Experts Call for Fed Involvement in Insurance Industry — but to Different Degrees; InvestmentNews, July 29, 2009
Members of Congress are being urged to create — at a minimum — a new regulatory body within the federal government to focus on the insurance industry. “There is some systemic risk in insurance requiring a regulator,” said Travis Plunkett, legislative director of the Washington-based Consumer Federation of America, who was part of a panel of experts testifying today at a Senate Banking Committee hearing on modernizing insurance regulation.
“In order to fully understand and control systemic risk in this very complex industry, the federal government should take over solvency and prudential regulation of insurance as well.
Where may this systemic risk within the insurance industry originate? None other than our ward of the state, AIG. We are reminded of the massive systemic risk, if not potential illegal business dealings, occurring at AIG in this morning’s New York Times, which reports After Rescue, New Weakness Seen at AIG:
The dozens of insurance companies that make up the American International Group show signs of considerable weakness even after their corporate parent got the biggest bailout in history, a review of state regulatory filings shows.
Over time, the weaknesses could mean trouble for A.I.G.’s policyholders, and they raise difficult questions for regulators, who normally step in when an insurer gets into trouble. State commissioners are supposed to keep insurers from writing new policies if there is any doubt that they can cover their claims. But in A.I.G.’s case, regulators are eager for the insurers to keep writing new business, because they see it as the best hope of paying back taxpayers.
While insurance in general is a pure statistical risk management business, in AIG’s case writing new business and collecting new premiums to pay off current outstanding liabilities amounts to a Ponzi scheme orchestrated by Uncle Sam. (more…)
Obama’s Lessened Popularity Is Helping the Market
Posted by Larry Doyle on July 30th, 2009 5:12 PM |
What is driving the equity markets higher?
1. an end to the recession?
2. green shoots?
3. better than expected earnings?
4. excess liquidity?
5. all of the above?
How about President Obama’s decline in popularity? In a perverse way, is a lessened approval rating for President Obama, in fact, supporting our markets?
Has the decline been statistically significant? What has caused the decline? Given that we are living in the Sense on Cents designated Uncle Sam Economy, we would be foolhardy to neglect what political polls are saying.
Gallup reports, Obama Approval Slips Three Points in Past Week:
Amidst President Obama’s push in July to revamp the nation’s healthcare system, Gallup finds his average job approval rating registering 56% for the seven-day period ending Sunday, down from 59% the previous week. This three percentage point drop is the largest week-to-week decline seen in Obama’s job approval thus far in his presidency, and punctuates a gradual descent from his 66% rating in early May.
The current week is starting off no better for Obama than the previous one. His job approval score in Gallup Poll Daily tracking, conducted July 25-27, is 54%; this is his lowest individual reading to date. Thirty-seven percent of Americans currently disapprove of the job he is doing and 9% have no opinion. (more…)
Wall Street Compensation Collusion
Posted by Larry Doyle on July 30th, 2009 2:44 PM |
Gaining market intelligence is one thing. Colluding with market participants in business practices is an entirely different issue. The Wall Street compensation process has always operated dangerously close to that line, and would appear to have gone over it in 2008.
This potentially collusive practice is easily disguised in the midst of excessive profitability, but is blatantly obvious when revenues disappear. The Wall Street Journal highlights this practice in writing Banks Paid Big Bonuses as Profits Slid:
Several of the banks hit hardest by the economic downturn and those that got the most U.S. government aid nonetheless handed out huge bonuses to hundreds of employees last year, according to New York Attorney General Andrew Cuomo.
Many of the banks that took money from the U.S. Treasury Department’s Troubled Asset Relief Program had been saying they wanted to pay it back as soon as possible, largely because of restrictions put on compensation that came with the funds.
Many of the banks have already paid the money back, but some, such as Bank of America Corp. and Citigroup Inc., haven’t yet done so. Mr. Cuomo said his office has been investigating compensation at many of the banks, including the original nine banks that took TARP funds, over the past nine months. The study refers to 2008 bonuses — those that would have been paid before any of the banks repaid their government bailout money. (more…)
Don’t Fight the Fed
Posted by Larry Doyle on July 30th, 2009 12:37 PM |
“Cover all your Treasury shorts!!”
I will never forget that mandate put forth by Tom Kirch, then head of Fixed Income at First Boston, as the stock market was crashing in October 1987. As a young trader, moments like that are not soon forgotten. Why? Mr. Kirch through dint of experience knew that you “don’t fight the Fed.”
With the crash of the stock market, the Fed cut interest rates and flooded the system with liquidity. In the process, the U.S. Treasury market had a massive rally. Kirch knew what was going to happen and saved the firm millions in the process. You can rest assured I immediately broke out some ‘Buy’ tickets and covered my Treasury shorts in a heartbeat.
“Don’t fight the Fed” is a tried and true rule of trading on Wall Street. While the bond market can often get overbought or oversold in the midst of a Fed easing or tightening scenario, ultimately if the Fed wants to move rates in one direction or another, it will make it happen.
Fast forward to the Brave New World of the Uncle Sam Economy 2009. How are market participants supposed to view the Fed currently? Dare I say, as challenging as it may be for market participants, myself included, “don’t fight the Fed” is still very much applicable. How so?
(more…)
A Fresh New Perspective on Technology and Electronic Trading
Posted by Larry Doyle on July 30th, 2009 9:14 AM |
Is high frequency program trading inherently unfair? Does it improperly utilize technological advances? Does it allow front-running at point of execution? So many great questions, but to this point, the debate on this topic has completely focused on the equity markets.
Well, let’s shift the focus of this debate to the debt markets, commonly regarded as the bond or fixed income markets. What can we learn by comparison? Do the fixed income markets represent a fair comparison? As with any comparative analysis, do we have sufficient data to analyze and compare these markets? Non-financial people may be surprised, but the debt market across all sectors totally dwarfs the equity market in terms of size. Let’s frame the debate.
I view technological developments on the investment superhighway as having three lanes: analytics, risk management, and trade execution.
Whether in fixed income or equities, technology which can more efficiently and productively provide robust analytics is a great advantage and should be embraced. As a case in point, when I traded mortgage securities throughout the ’80s and ’90s, Bear Stearns invested in and utilized tremendous analytics. The Bear system was so advanced that it could literally analyze the mortgages in a mortgage-backed security to the level of the underlying zip code. No other dealer had those capabilities and it was a boon to Bear’s business. This technology was utilized to run a wide array of customer portfolio optimizations and helped Bear become the top mortgage shop on Wall Street. Bear’s downfall is a story for another time. The point being, technology which can more thoroughly review an investment product promotes competition and capitalism. There should be no speed limit on this technology lane of the investment superhighway. (more…)
Economy and Markets: Improving, Declining, or Adapting?
Posted by Larry Doyle on July 29th, 2009 3:35 PM |
While the dark economic storm clouds of 2008 may have passed, the economic outlook and landscape remain decidedly mixed as evidenced by the recently released Federal Reserve Beige Book. The key takeaways in this report include:
>> slower pace of overall economic decline
>> expectations of a moderate recovery in manufacturing in 6-12 months
>> extended soft labor market
>> sluggish retail sales
>> commercial real estate weakened in most regions
>> some pockets of strength in technology and health care
>> credit conditions remained extremely tight. Loan demand experienced a downturn, particularly from the household sector. Credit standards continue to tighten as delinquency rates are steady to higher.
>> a pickup in used car sales (don’t think this is a positive)
Bloomberg reports Fed Says Most Districts Report Slower Pace Decline:
The Beige Book provided few signs of outright growth. Retail demand was “sluggish” in most areas, with “mixed” auto sales. Non-financial services were “largely negative” with “a few bright spots,” and manufacturing was “subdued” yet “slightly more positive” than in the previous report, the Fed said.
Lending in most regions “was stable or weakened further” in most loan categories, and banks tightened credit standards in seven districts, the report said.
While most economists and market analysts are looking at statistics and data to determine whether the economy and consumers are improving or rolling over, my take is different. I view the economy and consumers as adapting to the new dynamic at work in our country. The color about consumers purchasing more used vehicles is a perfect case in point.
Automotive companies aren’t going to prosper with consumers purchasing more used vehicles, but consumers will continually look for means to save money and keep expenses down.
In regard to market news, this morning I addressed concerns in a post, “What is China Saying? Sustainability and Indirect Bidding,” regarding the level of indirect bidders in our Treasury auctions. I wrote of yesterday’s 2 yr note:
While Chinese officials made these strong statements regarding our deficit, the U.S. Treasury auctioned $42 billion in 2 yr notes. How were these notes received? Not very well. In fact, the indirect bidders only purchased 33% versus close to 69% a month ago.
Today’s $39 billion 5 yr note was not well received, either. Indirect bidders purchased 37% versus 63% a month ago.
As we continue to navigate our economic landscape, I remain convinced that those who are able to most effectively adapt to the dynamic changes will be in the best position to thrive as we move forward.
What do I mean by adapting? Continue to work to keep expenses down, be judicious and disciplined in your investments, and be voracious in terms of absorbing data on the economy, markets, and companies.
It goes without saying a healthy dose of Sense on Cents as part of your daily diet is also strongly recommended!!
LD
No Time for Complacency on Insurance and Money Fund Exposures
Posted by Larry Doyle on July 29th, 2009 1:02 PM |
Despite the rise in the equity markets and supposed hints of stability in the economy, this is no time to get complacent about your investments. The transition we are experiencing in the economy and the markets will present real opportunities, but also real risks.
On the topic of risks, it is of paramount importance that all investors get full information from your brokers and financial planners across all your exposures. Do not allow those managing your money to indicate ‘the market feels OK here’ and leave it at that. Why? Significant underlying fundamental risks remain in the market. I am reminded of two of them this morning as I read the following about insurance companies and money market funds:
1. Experts Call for Fed Involvement in Insurance Industry — but to Different Degrees; InvestmentNews, July 29, 2009
Members of Congress are being urged to create — at a minimum — a new regulatory body within the federal government to focus on the insurance industry. “There is some systemic risk in insurance requiring a regulator,” said Travis Plunkett, legislative director of the Washington-based Consumer Federation of America, who was part of a panel of experts testifying today at a Senate Banking Committee hearing on modernizing insurance regulation.
“In order to fully understand and control systemic risk in this very complex industry, the federal government should take over solvency and prudential regulation of insurance as well.
This shift in regulatory oversight of the insurance industry would be a massive undertaking. Recall that all insurance companies are currently regulated at the state level; however, state insurance reserves to protect policyholders against defaults are woefully deficient.
The Wall Street Journal touches upon this as well, in writing Syntax Error? Life Insurers and Earnings:
Some life insurers used the recent market upturn to raise more than $10 billion in combined capital. Hartford Financial Services Group and Lincoln National, which report after the market closes Wednesday, accepted Treasury Department money. The injections have scaled back doomsday scenarios, as well as liquidity concerns that made a few insurers short-selling favorites.
At Hartford and Lincoln, analysts are watching closely to see if the government bailouts may be tainting the insurers in consumers’ eyes.
While certain banks were forced to take TARP money, for Hartford and Lincoln taking TARP became a necessity. If I had exposure to these institutions, I’d be monitoring them very closely. I’d do the same with all my insurance exposures.
2. Money Funds Are Ripe for ‘Radical Surgery’; Bloomberg News; Jane Bryant Quinn writes:
I’m among the last people standing who think that Paul Volcker is right about money-market mutual funds. They pose a systemic risk to the financial system and need a radical fix.
When a central banker of Volcker’s magnitude raises a concern of systemic risk, I am all ears. Virtually the entire money market industry is currently backstopped by Uncle Sam. How many of these money funds may ‘break the buck‘ without some form of assistance? Bryant asserts:
In most cases, money-fund sponsors have come to the rescue of their funds if any question arose about the $1 value of their shares. Peter Crane, president and founder of Crane Data LLC in Westboro, Massachusetts, says as many as one-third of the funds will have needed support by the time this global financial squeeze abates.
But you can’t be sure that sponsors will always be willing or able to bail out their shareholders, says Jack Winters of Hingham, Massachusetts, an expert who worked in the industry from 1976 to 2008 and commented on the SEC proposals.
“Dealers supported auction-rate securities for 25 years until their financial situation precluded it,” Winters says.
We know all too well how the ARS debacle unfolded.
No time for complacency!!
LD
Related Commentary
Got Insurance? 529 Plans? Financial Aid? Read On…
What is China Saying? Sustainability and Indirect Bidding
Posted by Larry Doyle on July 29th, 2009 9:47 AM |
Reading through the financial tea leaves this morning, I am struck by two developments yesterday. In the midst of the U.S.-Chinese economic summit in Washington, little surprise that Chinese diplomats voiced concern about the U.S. fiscal deficit. The Wall Street Journal highlighted this topic in reporting Chinese Convey Concern on Growing U.S. Debt:
A show of unity from the U.S. and China at the end of a high-profile two-day conference was overshadowed by continuing Chinese concerns about the U.S.’s growing pile of debt.
The U.S.-China Strategic and Economic Dialogue, a forum designed to foster closer cooperation, closed on a similar note to that set at the start by President Barack Obama, who stressed the countries'”mutual interests.”
The two powers vowed to maintain efforts to pull the global economy out of recession and shore up financial markets. They also agreed on a plan to create more-balanced global growth in the future.
But like a banker visiting an overextended borrower, Chinese economic leaders repeatedly conveyed to their U.S. hosts the importance of managing the U.S. debt. Chinese Vice Premier Wang Qishan, in talks with Treasury Secretary Timothy Geithner and other officials, urged the U.S. to protect the value of the dollar.
“As a major reserve currency-issuing country in the world, the U.S. should balance and properly handle the impact of the dollar’s supply,” Mr. Wang said through an interpreter Tuesday.
China’s Finance Minister Xie Xuren said the delegation “expressed the view that credible steps should be taken to prevent fiscal risks and to ensure sustainability” and that “high attention should be given to fiscal deficits.” He said Mr. Geithner “stated clearly” that the U.S. is placing “a lot of importance” on the deficit.
What exactly do the Chinese mean by sustainability? Clearly, they are emphasizing the need for America to lessen its deficit, which will likely surpass $2 trillion this year alone. (more…)
Sense on Cents Interviews Joe Saluzzi Regarding High Frequency Program Trading
Posted by Larry Doyle on July 29th, 2009 7:07 AM |
High frequency program trading is the single hottest topic on Wall Street today. No individual has generated greater focus on this topic than Joe Saluzzi of Themis Trading.
I look forward to interviewing Mr. Saluzzi this Sunday evening, August 2nd from 8-9pm on NoQuarter Radio’s Sense on Cents with Larry Doyle.
This show will comprehensively cover the gamut of issues and topics involved in this highly controversial trading activity. Does high frequency program trading engage in front-running? Are retail and institutional investors disadvantaged? Are the exchanges and regulators looking the other way? What were the developments in the marketplace which brought us to this point?
NQR’s Sense on Cents with Larry Doyle will address these questions and more with the man ‘in the arena’ and at the center of the debate, Joe Saluzzi.
The show is available as a podcast on iTunes, and also archived in an audio player right here at Sense on Cents so it should serve as a tremendous informational resource as we continue to navigate the economic landscape.
Please share with friends and colleagues.
LD
Editor’s Note, 8.03.09: For a full review of this broadcast, please visit Review of Sense on Cents Interview with Joe Saluzzi on High Frequency Trading.
Related Sense on Cents Commentary:
High Frequency Trading Debate: Mano a Mano (July 24, 2009)
Is Uncle Sam Manipulating the Equity Markets? (July 1, 2009)
TARP Warrants a Review
Posted by Larry Doyle on July 28th, 2009 5:09 PM |
How is Uncle Sam doing with his TARP investments? Recall that there are two components of the TARP (Troubled Asset Relief Program):
1. Straight capital injections
Treasury would have us believe that we are doing fine on these disbursements given returns from a select few institutions. Neither Treasury, other government officials, nor the media choose to highlight that as of June 30th, the TARP disbursements had a $159 billion loss. Although Treasury defines this ‘loss’ as a ‘subsidy,’ Sense on Cents classifies the negative difference in dollars allocated versus market value of investments as a ‘loss.’
Read my full review: “The TARP Has a $159 Billion Loss”
2. Purchase of warrants
What is a warrant? From our trusty Investing primer, we learn a warrant is:
A derivative security that gives the holder the right to purchase securities (usually equity) from the issuer at a specific price within a certain time frame. Warrants are often included in a new debt issue as a “sweetener” to entice investors.
These warrants were purchased last Fall at the time of allocating capital to a wide array of financial institutions. How is Uncle Sam doing? Should he exercise these warrants? Are they ‘in the money,’ meaning the current price of the stock is higher than the ‘strike price?’ Warrants also have time value. That is, the amount of time until the warrant expires. TARP warrants were generally 10 year warrants. That is a long time and represents a lot of value for the taxpayer.
Let’s check Subsidyscope, our fabulous link in the right sidebar here at Sense on Cents, to monitor a whole host of developments going on in Washington with OUR tax dollars. In regard to the TARP warrants, we learn:
Based on the closing prices on July 27, 2009, only 37 of the 234 warrant transactions listed on Subsidyscope are in the money. Some of the biggest recipients of TARP funding are in the most difficult financial situations. For example, the closing stock price for AIG was $13.00 on July 27, which is 420 percent below the strike price of $2.50 of the warrants that the government received on November 25, 2008; and Citigroup’s closing stock price of $2.69 on July 27 is 85 percent below the strike price of $17.85 of the warrants the government received on October 28, 2008.
While AIG’s stock valuation may appear to be in the money, please be aware that AIG recently executed a reverse stock split.
Readers can regularly check these TARP warrants at Subsidyscope’s Monitoring the Value of the TARP-Funded Warrants.
Additionally, not unlike many brokers who tout their winners while disregarding their losers, please do not allow Secretary Geithner or any other government official to ‘blow smoke’ about how well we are doing with our TARP investments.
A $159 billion loss combined with only 37 of 234 warrants being in the money after an enormous rally in our equity markets is not exactly a stellar performance.
Please utilize the tools at Sense on Cents and Subsidyscope to keep Uncle Sam honest as we all navigate the economic landscape.
LD
