Sense on Cents

Let’s Listen to Trust Company of the West’s Jeff Gundlach

Posted by Larry Doyle on May 22nd, 2009 5:06 PM |

Jeff Gundlach, Chief Investment Officer of TCW (Trust Company of the West) is widely considered to be one of the sharpest, if not THE sharpest, bond manager on Wall Street.

Let’s listen to him address the dynamics of the bond market, in general, and the mortgage market, specifically:

Let’s also listen to Mr. Gundlach address the dynamics within the housing market:

Glad to bring the best in the business to you here at Sense on Cents.

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Obama Isn’t Concerned About Change In Credit Rating

Posted by Larry Doyle on May 22nd, 2009 1:58 PM |

White House Press Secretary, Robert Gibbs

Bloomberg reports, Gibbs Says He Doesn’t Believe U.S. Credit Rating Will Be Cut:

White House Press Secretary Robert Gibbs said he doesn’t believe the U.S.’s AAA credit rating will be cut.

In response to questions at his regular briefing, Gibbs said President Barack Obama isn’t concerned about “a change in our credit rating.” Asked if he expects a cut, he said, “I don’t believe they will be cut.”

Investors sent U.S. bond and currency markets lower amid concern for the AAA rating after Standard & Poor’s lowered its outlook yesterday on the U.K.’s AAA rating to “negative” from “stable.”

A few comments and questions . . .

1. Gibbs should know better than to make a casual comment about our sovereign credit rating. The market listens to every word emanating from an administration to detect the level of seriousness and “risk management” being employed.

2. Is Gibbs indicating that President Obama isn’t concerned in that he does not believe the rating will be cut, or does not really care if it is cut? There is an enormous difference in those interpretations. Gibbs should not be vague.

3. When asked his own opinion, Gibbs provides a glib response without substance. He does not inspire confidence!

The Press Secretary needs to understand that the markets listen, monitor, study, and react to each and every word from the Administration. I, and others, want greater clarity from our financial leaders in Washington. Ben Bernanke and Tim Geithner pick and choose their words very carefully knowing that Wall Street picks up on every nuance. Gibbs should take a lesson on addressing economic and financial topics.

Wall Street and every other financial center in the world detests an official who dismissively passes off a topic of very serious substance.

Why and how do things like this happen? Inexperience and little market knowledge.

For what it is worth, from the time of this news release, long term interest rates increased another 3 basis points.

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What Does A Declining Dollar Mean?

Posted by Larry Doyle on May 22nd, 2009 11:21 AM |

On the heels of comments yesterday by Bill Gross of Pimco that the implied AAA credit rating of the United States will eventually be downgraded, our dollar is being hit hard again today. Let’s address some questions about a weaker dollar:

1. What are the implications of a weaker dollar?

– more expensive to travel overseas

– higher inflation here at home

– perceived greater risk of holding the currency and dollar denominated assets

– given the greater perceived risk, investors will demand a higher rate of return. In other words, interest rates will head up (and are currently, especially longer maturities).

2. What are the risks?

– significant exit of foreign capital from our market. Can you imagine the conversations going on around the world, but especially in China and Japan the two largest foreign holders of our debt?

– as our economy is forced to pay higher rates to attract capital, the economy slows as the cost of debt service increases.

3. Are there benefits?

– in a perverse way, I think our political leaders actually want a somewhat weaker dollar. Why?

– A weakened dollar will help domestic production of goods relative to our continued reliance on imports.

– generating some inflation is a de facto means of devaluing our outstandng massive amount of debt. Whomever is in debt currently can actually pay back those debts in future dollars that are worth less.

– however, having the dollar decline in value marginally is akin to getting a little bit pregnant.

4. How do you stem the decline in the value of the dollar?

– increase short term interest rates, that is, the Federal Funds Rate (currently sitting at 0-.25%) will have to go higher. What does that mean? Higher rates lead to a slowing economy. Although given the current economic turmoil, the Fed may have to increase the Fed Funds rate even sooner than they desire and we could suffer through a nasty bout of STAGFLATION.

Playing with the valuation of the currency and not defending it is a VERY dangerous game.

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Turbo-Tim Gets Defensive About Deficit

Posted by Larry Doyle on May 22nd, 2009 6:00 AM |

After the biggest one day selloff in U.S. government debt in a long time, U.S. Secretary of the Treasury, Tim Geithner, got very defensive this afternoon about the explosive growth in the U.S. deficit. Bloomberg reported, Geithner Pledges to Cut Deficit Amid Rating Concern.

Well, perhaps Secretary Geithner could help Barack and team find more than .5% of his $3.5 trillion budget to cut as a start if he is serious about his pledge. Over and above that, Tim asserted:

that the rise in yields on Treasury securities this year “is a sign that things are improving” and that “there is a little less acute concern about the depth of the recession.”

Benchmark 10-year Treasury yields jumped 17 basis points to 3.37 percent at 4:53 p.m. in New York.

With all due respect to the Secretary, perhaps he may want to review the fact that the overall Treasury funding needs in calendar 2009 will likely exceed the funding needs of 2006, 2007, and 2008 COMBINED. Additionally, he may want to have a chat with the governors of the Federal Reserve. In the minutes of the most recent Fed meeting, the consensus forecast for growth, unemployment, and inflation is worse than what the governors foresaw in January. Perhaps the Secretary may want to reconcile his statement with those forecasts.

Tim did hedge his bets and cover his flank by commenting that:

it’s still “possible” that the unemployment rate may reach 10 percent or higher, cautioning that the economic recovery is still in the “early stages.”

I do not pretend to think that Geithner has an easy job, but ultimately the market and investors will more value a secretary, spokesman, or analyst who is truly credible than merely an administrative mouthpiece. In my opinion, Tim has a lot of work to do on this front.

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Congress Establishing Financial Crisis Inquiry Commission

Posted by Larry Doyle on May 21st, 2009 5:18 PM |

The law firm of Wilmer Hale recently released the following statement:

CONGRESS TO ESTABLISH FINANCIAL CRISIS INQUIRY COMMISSION
May 7, 2009

By Reginald J. Brown, Jamie Gorelick, Anne Harkavy, Randolph D. Moss, William R. McLucas, Howard M. Shapiro, Michael J. Sharp,Matthew A. Chambers

Yesterday, the House of Representatives passed S. 386, the Fraud Enforcement and Recovery Act of 2009, by a 367-59 vote. Among other things, S. 386 establishes a Financial Crisis Inquiry Commission (the “Commission”), with broad authority to examine the domestic and global causes of the current U.S. financial and economic crisis. The Senate passed a similar bill in late April and final passage, most likely of the House version, is expected soon.

Under both versions of the bill, the Commission will have roughly 18 months to investigate the circumstances that led to the financial crisis and issue a report to Congress with its findings and recommendations. The Commission will have broad investigative authority, including subpoena power, and the ability to refer any evidence of criminal activity to the U.S. Attorney General and state attorneys general. Other key provisions, as described in the House bill, include the following:

Membership:

The Commission will have ten members, who must be private citizens and may not be employed by any government entity. [§ 5(b)(2)(B)] Commission members will be appointed as follows: Three each appointed by the Speaker and Senate Majority Leader; two each appointed by the minority leaders in the House and Senate. [§ 5(b)(1)(A-D)] The Chair and Vice Chair must be from different parties and will be selected jointly by the respective leaders. [§ 5(b)(3)] Members are expected to be prominent U.S. citizens with national recognition and depth of experience in fields such as banking, regulation of markets, taxation, finance, economics, consumer protection and housing. [§ 5(b)(2)(A)] Read the rest »

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Is The Government Bond Bubble Getting Ready To Burst? UPDATE #2 >>

Posted by Larry Doyle on May 21st, 2009 2:41 PM |

With equities down 2-2.5% on the day, one might think the safety of U.S. Treasury debt would be in vogue. Well, not so. In fact, the Treasury market is BREAKING down as I write this. The 10yr U.S. Treasury note has backed up to a 3.36% rate, which is a full 16 basis points higher on the day. This is a very significant move. What’s happening?

Well, let’s revisit my original commentary on April 30th and my subsequent update on May 7th.

What has changed today from then? Very little aside from S&P putting U.K government debt on watch for potential downgrade. Can the U.S. be far behind?

The demand for credit by global governments is swamping the market. If equities go up, down or sideways, I think U.S. Treasury 10 year notes are headed to at least a 4% rate and potentially much higher. (They started the year at approximately 2%, so they have already gotten pummeled).

Please recall that U.S. Treasury funding needs this year will very likely exceed the debt issued in 2006, 2007, and 2008 combined!! As I see it, the overall delevering process – in which individuals, corporations, and governments need to pay down debt via asset sales or refinance the debt – continues unabated. On May 7th, I wrote:

I have tried to highlight my concerns on interest rates for the entire year. Despite the Federal Reserve “cutting checks” to buy hundreds of billions in U.S. Treasury bonds and mortgage-backed securities, the global demand for credit (meaning global governments, companies, and municipalities issuing MASSIVE supply of bonds) is driving rates higher.

As I wrote in my post from April 30th, the U.S. Treasury market has been faced with underwriting tens and now hundreds of billions in government debt on a regular basis. The 30yr government bond auction today was not well received and interest rates have moved higher by 10-20 basis points (.10 to .20%).

What are the implications of higher rates?
1. Increased cost of financing the deficit.
2. Upward pressure on other rates, primarily mortgage rates.
3. Longer time for economy to improve given higher interest costs.
4. Given the massive global government deficits, the access to credit for private enterprise is negatively impacted. This is known as crowding out.

As I referenced the other day, “We Still Have To Pay The Bill.”

Bloomberg reports, Treasuries Tumble as Bond Sale Draws Higher Than Forecast Yield.

From my piece at the end of April:

The equity markets have rebounded significantly over the last seven weeks. The Dow and S&P are now down approximately 4-6% on the year. The tech heavy Nasdaq has distinguished itself and is up approximately 10% on the year.

At this juncture, if the equity markets are implying that the economy will not slip into Depression, then the bill for the stability in equities is being transferred to participants in the bond market. Government bonds are facing an almost weekly avalanche of tremendous supply. This week the market is absorbing over $100 billion in 2yr, 5yr, and 7yr Treasury securites. Take a deep breath and next week the market is faced with over $75 billion in 3yr, 10yr, and 30yr government securities. The Treasury is likely going to sell 30yr government debt on a monthly basis!!

The Federal Reserve has been the biggest buyer of Treasury and mortgage-backed securities. The Fed’s balance sheet may be large but it is not endless. What have 10 yr. Treasury securities done on the year? Even in the face of massive buying of these securities by the Fed, the 10yr has backed up almost 1% to a current level of 3.1%. That rise in rates is very significant.

I have maintained and continue to maintain that interest rates will move higher given the overwhelming demand for funds by global governments to pay for deficit spending. Central banks around the world may try to hold the respective bond markets up and interest rates down but investors will continue to demand a higher rate of interest in the process.

As government rates move higher, mortgage rates, and other corporate rates will likely move higher as well. If we get a whiff of early signs of inflation which I believe is coming these rates could ratchet higher and the bubble in the government market would not merely burst but would actually explode.

Having fewer banks on Wall Street means larger slices of the profit pie for those still standing. However, having fewer banks also means lessened liquidity and risk-taking overall. Bigger deficits mean higher rates which lead to a slower economy and longer recovery period. Turbo-Tim, Big Ben, and Barack need to factor that dynamic into their economic equations. Principles of Economics 101.

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U.S. Attorney and SEC Investigating Lehman’s Auction Rate Securities Sales; They Should Also Investigate FINRA’s

Posted by Larry Doyle on May 21st, 2009 11:34 AM |

The Wall Street Journal reports this morning Lehman Role Probed in Selling Securities:

The Justice Department has questioned several former executives at Lehman Brothers Holdings Inc. as part of its criminal investigation into whether they sold supposedly safe, liquid securities to clients while knowing that the market for the securities was drying up.

Prosecutors from the U.S. attorney’s office in Brooklyn and lawyers from the Securities and Exchange Commission in recent weeks interviewed several former executives who ran Lehman’s auction-rate-securities business, these people said. Auction-rate securities are short-term debt instruments in which the interest rates reset at periodic auctions.

The inquiry centers on whether Lehman employees defrauded customers as the market for these securities broke down in 2007. Authorities want to know if Lehman executives got these auction-rate securities off the firm’s books and into client accounts at a time in which the securities were becoming hard to sell, according to the people with knowledge of the matter.

Authorities also want to know if executives knew the market was in trouble and sold their own personal holdings of auction-rate securities, which could constitute insider trading, according to the people. (LD’s highlight)

I wrote on January 16th, “Let’s Really Question Ms. Schapiro.” In that post, I was raising the same questions about FINRA that the U.S. Attorney is now raising about the Lehman executives. I wrote:

Additionally, as of the end of 2006, FINRA acknowledged that the assumed portfolio held a cool $647 million dollars in Auction Rate Securities!!!

For those not familiar with Auction Rate Securities, this sector of the market totally imploded last Spring leaving institutional and individual investors holding the bag. While many institutional investors were made somewhat whole via settlements from the larger broker-dealers, many individual investors remain holding the bag as smaller broker-dealers, who did not necessarily underwrite these securities but did distribute them, have not been forced to make clients whole. WOW!!!

Are you kidding me!!?? The main regulator of the financial industry happens to be an investor in securities which virtually every Attorney General in the country is going after every Wall Street institution for improper marketing and distribution!! Are we looking at gross negligence, ignorance, incompetence or all of the above?? The question that MUST be answered is what has FINRA done with these Auction Rate Securities. Do they still own them? Did they liquidate them? If so, when and at what price? How was the sale negotiated? So many questions.

Over and above that, given that Ms. Schapiro is the chief executive of FINRA, don’t you think it would have been appropriate for her to address which hedge funds, fund of funds, and private equity shops were in FINRA’s portfolio? FINRA’s Annual Report categorically states its’ investment committee addresses any potential conflicts of interest. The public deserved to have this topic openly addressed during Ms. Schapiro’s hearing. WHY? For the simple reason that FINRA is feeding from the very same trough it is supposed to be regulating.

I followed this post up with numerous other posts raising the same questions. On March 31st, I wrote “Before Any Fraud Ensued,” in which I aggressively put forth:

Given that there is public acknowledgement by a federal judge that a fraud had ensued in the marketing and distribution of ARPS, let us return to the case Sense on Cents has been highlighting. FINRA’s Annual Report for 2007 publicy records that FINRA owned $647 million ARPS at year end 2006.

The questions that need to be answered:

1. Was FINRA defrauded in the purchase and sale of their bonds?

Note from LD: I have subsequently unearthed, in reading NASD Annual Reports from 2003-2005, that FINRA assumed the ownership of their ARS holdings from NASD. I highlighted as much in my post, “NASD Knew Auction Rate Securities Weren’t Cash”

2. If FINRA has sold their bonds subsequent to the publishing of that report in April 2008, to whom did they sell them? at what price? on what date?

Note from LD: The Bloomberg article from April 30th, FINRA Oversees Auction-Rate Arbitrations After Exit offered the following color addressing FINRA’s sale of their ARS holdings:

Finra, responsible for educating and protecting investors, owned as much as $862.2 million of the debt before exiting the market in the spring of 2007, less than six months before auctions began to fail, according to spokesman Herb Perone.

3. Did FINRA have material non-public information at the time of sale, if in fact they sold them? Did they act on that information?

Note from LD: Today’s WSJ article is further acknowledgment that the Auction Rate Securities market was failing in 2007. FINRA first apprised investors of concerns in the ARS sector in Spring 2008. If in fact the ARS market was failing in 2007, the pressure on FINRA needs to increase. FINRA must release the trade information on their sale of ARS. Without that information, how can the investing public have any confidence in the integrity of FINRA and its procedures. Returning to my March 31st post:

Let’s put this into layman’s terms. FINRA was supposed to be overseeing and regulating the casino on Wall Street. In the process of regulating the casino, it appears that they put some of their own chips into one of the games. That game, ARPS, turned out to be a fraud, as publicly acknowledged by U.S. District Judge Lawrence McKenna in this case with UBS.

DID THE SECURITY GUARD, FINRA, PROTECT THE OTHER PATRONS AS REQUIRED OR DID THE SECURITY GUARD PROTECT HIS OWN INTERESTS TO THE DETRIMENT OF THE OTHER PATRONS?

Now here we are on May 21st, 2009. The questions that the U.S. Attorney is looking to get answered by Lehman executives are the EXACT questions that FINRA executives also should be compelled to answer.

Do you think representatives from the U.S. Attorney’s Office, the SEC, and defense counsel may also want to know the answers to these questions as well?

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Mary Schapiro Still Not Being Questioned; Independent Investigation Still Required

Posted by Larry Doyle on May 21st, 2009 5:45 AM |

When you are the head of the SEC and you do not get invited to a dinner to discuss investor protections and financial oversight, you know you have a problem.

As the Wall Street Journal reports, SEC Objects to Idea of Shifting Oversight:

SEC officials have expressed concern that the administration’s plans are proceeding without much SEC input. Some top Obama officials, including Treasury Secretary Timothy Geithner, National Economic Council Director Lawrence Summers and former Fed Chairman Paul Volcker met Tuesday night over dinner to discuss the regulatory revamp.

Is this a power play by “the boys?” Was Ms. Schapiro merely a figurehead in the first place? Her confirmation process was the highway equivalent of an E-Z pass. The Wall Street investment banking model was laid to waste in 2008 and Ms. Schapiro was treated with kid gloves during her confirmation. On January 16, 2009 I wrote, Let’s Really Question Ms. Schapiro:

The WSJ did yeoman work yesterday in highlighting that under Ms. Schapiro, the number of cases and collection of fines by FINRA has diminished by 30% and 36% respectively. The WSJ did not expose any info, though, from FINRA’s financials. The $2.1 billion in equity in this tax exempt entity that paid Ms. Schapiro $3 million dollars is invested in a variety of sectors, including common equities, fixed income, private equity, hedge funds, and fund of funds!!! Additionally, as of the end of 2006, FINRA acknowledged that the assumed portfolio held a cool $647 million dollars in Auction Rate Securities!!!

Perhaps Ms. Schapiro knows too much information or is too close to the financial industry as many maintain. That said, she has not distinguished herself in her first few months at the SEC. She has held a series of perfunctory meetings and is seemingly involved in an internal turf war with the DEA in regard to the Stanford Financial investigation.

Add it all up and in the space of 4 months, Mary Schapiro has effectively been relegated to a figurehead.

While Ms. Schapiro has clearly been frozen out, the SEC as a whole is also shown no respect. As the WSJ reported:

The SEC is one of the federal agencies most at risk in the regulatory revamp under study by the administration and Congress. Its reputation suffered a blow from its failure to catch money manager Bernard Madoff’s Ponzi scheme and its light regulation of Wall Street investment banks during the boom.

Closed door sessions without full representation does not engender confidence as to the motivations of those involved. I am not a Mary Schapiro fan, but for Obama and team to comport themselves in such a fashion smacks of “insider dealing” and “Chicago-style” politics. We need total transparency and integrity in our regulatory review. I have been calling for that, as evidenced in my piece Future Financial Regulation: Not A Question of Sufficiency, But of Transparency and Integrity.

In fact, let’s go one step further with our review process and fast track to what we really need, an Independent Investigation Required.

For those who have read this review, I hope you find it further insightful in light of current developments. For those reading it for the first time, I hope it makes you ponder as to what is really going on behind the closed doors at Finra, the SEC, on Wall Street and Washington.

How does our economy and country move forward after having experienced rampant abuses throughout our financial industry? It is disheartening that we have not already seen an aggressive pursuit and prosecution of many involved in these financial improprieties. Bloomberg releases a story today indicating House Speaker Pelosi Wall Street Probe Modeled on Pecora After Wall Street Crash.

While a thorough investigation is critically important to improve the health and well being of our markets and economy, I would propose we employ an independent investigation. Why?

Our financial industry is intertwined with the regulatory and political oversight which is supposed to monitor it. If we employ a currently sitting legislative body to investigate Wall Street, can or will we receive a truly unbiased analysis? Do we recall Franklin Raines of Fannie Mae being questioned by members of Congress who had received significant campaign contributions from Fannie? The “investigation” of Freddie and Fannie was certainly more theatre than true investigation. Will we get the same with Ms. Pelosi’s probe? Bloomberg offers:

House Speaker Nancy Pelosi plans to push for a comprehensive inquiry, saying that three-quarters of Americans want to know what led to the bankruptcy of Lehman Brothers Holdings Inc. and the collapse of Bear Stearns Cos. and Merrill Lynch & Co. She favors one patterned after Senate Banking Committee hearings led by Ferdinand Pecora starting in 1933, according to her spokesman, Nadeam Elshami.

The Pecora review “was probably the single most important congressional investigation in the history of our country, except perhaps the Watergate hearings,” Donald Ritchie, associate historian for the U.S. Senate, said in an interview. Read the rest »

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Review of the Federal Reserve’s Minutes: ‘Where Are Those Green Shoots?’

Posted by Larry Doyle on May 20th, 2009 8:00 PM |

The Fed released the minutes from their April 28-29 meeting. Let’s dive right in straight from the Fed’s own website. Minutes of the Federal Open Market Committee:

Almost all participants viewed the near-term outlook for economic activity as having weakened relative to the projections they made at the time of the January FOMC meeting, but they continued to expect a recovery in sales and production to begin during the second half of 2009. With the strong adverse forces that have been acting on the economy likely to abate only slowly, participants generally expected a gradual recovery: All anticipated that unemployment, though declining in coming years, would remain well above its longer-run sustainable rate at the end of 2011; most indicated they expected the economy to take five or six years to converge to a longer-run path characterized by a sustainable rate of output growth and by rates of unemployment and inflation consistent with the Federal Reserve’s dual objectives, but several said full convergence would take longer.

Call me cynical, but where are the ‘green shoots’ in that review? In my opinion, this review is akin to a CYA analysis, as in things are going to get worse before they get better . . . I hope.

By every measure, the Fed governors are revising their calls on unemployment, output, and inflation to worsen in 2009 relative to their call in January. Were they merely being overly optimistic in January? Perhaps these minutes are similar to the regular revisions provided each and every month depicting the economy to be in tougher shape than previously advertised.

I did find it very interesting to see the assessment targeting a 5 to 6 year time horizon–and perhaps longer–for the economy to regain the trajectory consistent with Fed objectives.

Given that these minutes are aggregated in a closed door session, they may actually more accurately embody a sense of veracity and integrity. How ’bout that!!

How did the equity market respond to these minutes? The DJIA reversed course from being up 100+ points in the morning to close down 52 points.

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Hotel California Revisited: Prisoners Here of Our Own Device

Posted by Larry Doyle on May 20th, 2009 4:30 PM |

“Tonight we have heard from the voters and I respect the will of the people who are frustrated with the dysfunction in our budget system,” Gov. Arnold Schwarzenegger said.

The Wall Street Journal provides full coverage, “California Voters Reject Budget Measures.”

What does California’s budget nightmare mean? The state will be forced to cut upwards of $20 billion from an $82 billion budget. How and why? In the face of the the massive recession, California’s tax revenues are insufficient to meet the state’s fiscal needs.

In years past, California and other states would tap the municipal bond market with bond insurance provided by a monoline insurer, such as MBIA or Ambac. Given the enormous losses suffered by these monolines, primarily on structured mortgage deals, they are no longer strong enough to provide insurance sufficient for California to raise funding. In a similar vein, California can no longer source a letter of credit provided by a large money center bank.

Where is California looking for a backstop to its financial woes? Well, much like the United Auto Workers, the strongly Democratic constituencies in California will look toward Washington for a backstop/bailout.

California’s representatives are downplaying the severity of the situation. California Treasurer Bill Lockyer, much like Barney Frank, condescendingly comments on the historically low level of defaults in municipal finance. Do I have to remind Bill and Barney that historical analysis was also highlighted in providing AAA ratings to sub-prime mortgage deals? Read the rest »

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