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HomeRetaining Risk on Wall Street: Necessary but Painful
Posted by Larry Doyle on November 5th, 2009 1:03 PM |
How did Wall Street lead the United States economy into the ditch?
The pure ‘originate to distribute’ model employed on Wall Street spelled the death knell for Wall Street and our economy.
I addressed how firms won under that originate to distribute model in a commentary from November 12, 2008, “The Wall Street Model Is Broken….and Won’t Soon Be Fixed!!”:
At the turn of the century, the Wall Street model was a pure “originate to distribute” model with little to no residual risk on behalf of the originators or underwriters. When there is no residual risk, those who “WIN” are the players that can purely process the most volume. Well, how does one get volume? Lower the credit standards, put fewer restrictions on borrowers, little to no covenants (NINA Loans: no income, no asset check). WOW!!! What were we thinking?? Well, Wall St. felt, “let’s worry about it tomorrow or maybe not at all because we are making too much money today.”
Tomorrow has arrived and Wall Street must now deal with the concept of retaining risk in their loan originations. The topic of ‘risk retention’ has been bandied about over the course of the year, but it was ratcheted up dramatically in a recent meeting of the House Financial Services Committee and U.S. Treasury on October 27th.
What came out of that meeting has potentially dramatic implications for the entire spectrum of loan origination, securitization, and distribution businesses on Wall Street and their subsequent impact on Main Street. Let’s navigate. (more…)
October 24, 2009: Month to Date Market Review
Posted by Larry Doyle on October 24th, 2009 7:32 AM |
Did the market merely take a breather this week or is the ‘little engine that could’ getting tired? Are we distinguishing the winners from the laggards? Are the cracks in our economic foundation repairing or are some just too large to hold back the flow of red ink, i.e. embedded losses? Perhaps we are experiencing all of the above as we continue our journey along the new and varied trails of our economy. Let’s review the major economic statistics for the week, along with the month to date returns across a wide array of market segments.
I thank you for reading my work, and now let’s collectively ‘navigate the economic landscape,’ the mission of Sense on Cents. If you have any questions, please do not hesitate to ask.
ECONOMIC DATA
I largely discount positive news on the housing front as I view them largely manipulated by Uncle Sam while delinquencies, defaults, and foreclosures move ever higher. This may be an oversight on my part, but so be it.
Aside from that, I believe the most meaningful news this week was the GDP report from the UK. Please see my Friday morning commentary highlighting how the UK remains mired in recession.
Let’s move along to market performance. The figures I provide are the weekly close and the month-to-date returns on a percentage basis:
U.S. DOLLAR
$/Yen: 92.08 versus 89.68, +2.7%
Euro/Dollar: 1.500 versus 1.4635, +2.5%
U.S. Dollar Index: 75.44 versus 76.72, -1.7%
Commentary: the overall U.S. Dollar Index declined marginally this week. The dollar has improved versus the Japanese yen, but remains decidedly weak versus the Euro. The U.S. Dollar Index did break below 75.00 at one point early Friday. The correlation between the U.S. Dollar Index and the equity markets remains quite high. Both markets ended the week close to unchanged. Have too many people bought equities and commodities while having sold the U.S. greenback? I have been asking that question for the last month so no reason to stop now. The biggest impact of the weak dollar is seen in the commodity markets and long term interest rates. Commodities continue to trade with a firm tone while interest rates move higher.
I reiterate my comment from previous weeks: while I think Washington is not disappointed in a relatively weak dollar, although they should be (“Dollar Devaluation Is a Dangerous Game”), other countries are not overly keen about further dollar weakness. Why? A weak dollar puts those countries in a marginally less competitive position in international trade. On this topic, please read “Brazil Wants A ‘Real’ity Check.”
COMMODITIES
Oil: $79.65/barrel versus $70.39, +13.1% REMAINS VERY FIRM
Gold: $1055/oz. versus $1008.2, +4.6%
DJ-UBS Commodity Index: 137.32 versus 127.683, +7.5%
Commentary: I repeat from last week, unless you grow your own crops or have your own source of energy, you should expect to get increasingly squeezed as prices at the supermarket and gas station are likely to head higher. While Washington will not address this development, these price moves are directly correlated with Washington’s weak dollar policy. The banks and others able to borrow cheap money for trading and investing benefit from the weak dollar. American consumers and savers get stuck with the bill.
The Baltic Dry Index once again moved higher and got back above the 3000 level. Is the improvement in the non-Japan Asian economic bloc for real? Certainly the economies in Europe and North American remain decidedly challenged.
I continue to believe these commodity tea leaves are an indication of inflationary expectations in these ‘inputs,’ while we encounter deflationary pressures in wages and real estate. (more…)
The Wall Street Oligopoly Rails on Compensation Controls
Posted by Larry Doyle on October 22nd, 2009 3:48 PM |
Is there a hotter topic currently on Wall Street than compensation? I have to admit, I have a range of emotions on this issue.
I pride myself on being a proponent of free market capitalism. As such, while the government needs to be actively involved in regulating the marketplace, beyond that I would just as soon see Uncle Sam stay out of the way. One may think I would be vehemently against the Wall Street pay czar Ken Feinberg getting involved in compensation on Wall Street. The Wall Street Journal reports on the far-reaching net cast by Uncle Sam on this issue and writes, U.S. Unveils New Rules on Banker’s Pay. Rest assured, the crowd on Wall Street right now is seething. Let’s navigate.
As I think more and more on the compensation topic, I have come to the following conclusions: (more…)
David Einhorn Provides Sense on Cents
Posted by Larry Doyle on October 21st, 2009 11:52 AM |
David Einhorn of Greenlight Capital
In the midst of my ‘navigating the economic landscape,’ I thoroughly enjoy reading the work of intelligent people. While I certainly never agree with all that I read, intelligent people force me to think and review my own opinions and beliefs. That process is always healthy. I also enjoy sharing the insights and perspectives of these people with those who read Sense on Cents. High five to KD of 12th Street Capital for bringing just such an individual to my attention.
David Einhorn runs Greenlight Capital, an investment management firm. He recently delivered an address entitled “Liquor Before Beer…In the Clear.” For those interested in an overview of David’s thoughts, I will clip those points I found most informative. For those with a keen interest in the economy and markets, the linked nine page document is a ‘must read.’ I agree with David’s views and welcome highlighting some of his points. Here are excerpts from David Einhorn’s speech:
1. The lesson that I have learned is that it isn’t reasonable to be agnostic about the big picture. For years I had believed that I didn’t need to take a view on the market or the economy because I considered myself to be a “bottom up” investor. Having my eyes open to the big picture doesn’t mean abandoning stock picking, but it does mean managing the long-short exposure ratio more actively, worrying about what may be brewing in certain industries, and when appropriate, buying some just-in-case insurance for foreseeable macro risks even if they are hard to time.
2. As I see it, there are two basic problems in how we have designed our government. The first is that officials favor policies with short-term impact over those in our long-term interest because they need to be popular while they are in office and they want to be reelected. In recent times, opinion tracking polls, the immediate reactions of focus groups, the 24/7 news cycle, the constant campaign, and the moment-to-moment obsession with the Dow Jones Industrial Average have magnified the political pressures to favor short-term solutions.
3. The second weakness in our government is “concentrated benefit versus diffuse harm” also known as the problem of special interests. Decision makers help small groups who care about narrow issues and whose “special interests” invest substantial resources to be better heard through lobbying, public relations and campaign support. The special interests benefit while the associated costs and consequences are spread broadly through the rest of the population.
4. Americans understand that the Washington-Wall Street relationship has rewarded the least deserving people and institutions at the expense of the prudent.
5. The proper way to deal with too-big-to-fail, or too inter-connected to fail, is to make sure that no institution is too big or inter-connected to fail. The test ought to be that no institution should ever be of individual importance such that if we were faced with its demise the government would be forced to intervene. The real solution is to break up anything that fails that test. (more…)
It’s the Economy, Stupid!!
Posted by Larry Doyle on October 16th, 2009 9:05 AM |
The American public is becoming increasingly wise to the ways of Wall Street and Washington.
Many Americans were duped by financial practices and products emanating from Wall Street. Where was Washington? I would assess Washington’s involvement and responses in the following fashion:
1. At worst, Washington was complicit given a wide array of failed public policy programs, especially in housing. These public policies were largely ‘greased’ by lobbying dollars and campaign contributions.
2. To a large extent, Washington was negligent in terms of oversight, especially on the financial regulatory front.
3. At best, Washington was naive given a general lack of understanding of markets and finance.
The American public is now responding in appropriate fashion. How so? In increasing numbers, they are choosing not to play the Wall Street game. What game is that? Active trading and investing. While the numbers of pure day traders may have increased, the American population at large is focused elsewhere. Where is that focus? On the economy at large and on their individual pocket books.
Washington’s focus on Wall Street and its selling of the market rebound as reflective of a return towards prosperity is a product that will not fly . . . try as they might. Why?
It’s the economy, stupid! Reports this morning indicate that wages will likely show the greatest decline since 1991. Even in the face of declining wages, consumers’ purchasing power is being further eroded by the continuing decline in the value of the dollar. That decline is inflationary which hurts consumers but it continues to present a very cheap funding vehicle for those who want to use the greenback to employ leverage in the markets. Who has the advantage in that process? The large banks. Do they spread that wealth in terms of increased credit and higher savings rates? Now why would they do that?
The American saver and consumer shouldered the cost of the bank bailouts in 2008. They are now shouldering the cost of the wealth transfer to the banks in 2009. While Washington would like to sell this dynamic differently, the American public gets it.
Washington will continue to sell this dynamic at its peril.
LD
October 10, 2009: Month to Date Market Review
Posted by Larry Doyle on October 10th, 2009 10:12 AM |
We are reaching a point in our new “Uncle Sam” economy where rhetoric from Wall Street, Washington, and global financial centers seems to be having greater impact than true market and economic fundamentals. Why? Our financial and political ‘wizards’ are working overtime to reconnect the great ‘disconnect’ between Wall Street and Main Street. While we receive glimmers of hope in certain economic statistics, the dark clouds in employment and housing remain daunting.
Are the ‘Washington wizards’ (Bernanke, Geithner, Summers) providing hints of support for our greenback while truly hoping for a manageable decline? I believe they are, and I believe this financial engineering is a very dangerous game.
I thank you for reading my work, and now let’s collectively ‘navigate the economic landscape,’ the mission of Sense on Cents.
ECONOMIC DATA
> Non-manufacturing Institute of Supply Management: this report rose above 50 (an indication of growth) with a positive development in new orders (this is clearly good), but with no signs of improvement in employment and pricing power by manufacturers.
> Redbook: indications of slight improvement in same store sales although next week’s Retail Sales report will likely look exceptionally weak as it incorporates an end to the ‘Cash for Clunkers’ program. Overall signs point to what is expected to be a weak holiday retail season.
> Jobless Claims: overall claims declined, which presents a sign of stability within employment. That said, it is hard to be optimistic on the employment front on the heels of the employment report released on October 2nd (embedded within the Equity section of this commentary).
> Trade Deficit: this deficit surprisingly narrowed, with a slight increase in exports combined with a slight decrease in imports. All other things being equal, this report would be positive for our dollar but the noise surrounding our currency is overwhelming the focus within this one month reading.
I would typically lead my review with focus on the equity and bond markets, but those sectors are actually following developments in the currency and commodity markets so let’s shift our focus accordingly.
How did the markets handle the Fed-speak, the data, and technical flows? Let’s continue navigating. The figures I provide are the weekly close and the month-to-date returns on a percentage basis.
U.S. DOLLAR
$/Yen: 89.78 vs. 89.68
Euro/Dollar: 1.4709 vs. 1.4635
U.S. Dollar Index: 76.35 vs. 76.72
Commentary: the overall U.S. Dollar Index has declined by approximately .5% this month, but the volatility and focus on movements in this space have been tremendous. Precipitated by an increase in rates by the Australian Central Bank midweek, the U.S. Dollar Index plunged below 76 which represents multi-year lows. The dollar weakness led to a move higher in global equities as traders, investors, and speculators were emboldened to enter into more ‘positive dollar carry trades.’
While I think Washington is not disappointed in a relatively weak dollar, although they should be (“Dollar Devaluation Is a Dangerous Game”), other countries are not overly keen about further dollar weakness. Why? A weak dollar puts those countries in a marginally less competitive position in international trade. ECB President Jean-Claude Trichet voiced his concerns on this topic. Rest assured, the Asian nations feel the same way although they are careful in their comments. Adding further fuel to dollar weakness was speculation that the trading of oil and a basket of other commodities, which are currently transacted in U.S. dollars, would shift trading away from being dollar-based. On that note, let’s review the action in commodities.
COMMODITIES
Oil: $72.29/barrel vs. $70.39
Gold: $1050.1/oz. vs. $1008.2 !!!! THE BIG WINNER !!!!
DJ-UBS Commodity Index: 129.177 vs. 127.683
Commentary: I view this segment of the market to be the STRONGEST indicator of the global economic pulse. Additionally, the price action in commodities is likely a strong indication of the ‘positive carry’ trade put on by hedge funds and other traders.
The overall commodity index has moved higher by approximately 1.2% on the month, but the movements within specific commodities is gaining the real focus. Gold specifically has soared by over 4% this month. Why? Market speculation about a potential further slide in the greenback would be inflationary. Oil and other commodities also benefited from the story I referenced above. The conundrum I find in this space revolves around overall levels of international trade. Are these commodities moving higher truly because of an increase in demand or merely because of speculative investing and trading? Where do we go to get a pulse on that? The Baltic Dry Index. How is our friendly indicator of global shipping activity doing?
The Baltic Dry Index continues to move marginally lower. Can global equities in general and commodities specifically increase in value if the major indicator of global trade, that being the BDI (Baltic Dry Index), is in a downtrend? I think not for the long haul, but for a period of time a cheap funding vehicle, that is the U.S. dollar, can override market fundamentals.
I read these commodity tea leaves as sign of inflationary expectations in these ‘inputs’ while we encounter deflationary pressures in wages and real estate. What a world.
EQUITIES
DJIA: 9865, +1.6%
Nasdaq: 2139, +0.8%
S&P 500: 1071, +1.3%
MSCI Emerging Mkt Index: 946, +3.6%
DJ Global ex U.S.: 197.6, +1.5%
Commentary: equities regained momentum after last week’s selloff. Recall how just one week ago, we faced a remarkably weak and disappointing Unemployment Report which culminated a week in which equities had given up approximately 2%. Well, we not only recaptured that decline but rallied further by another 1-2%. This past week accounted for the strongest advancement in equities since early July. Are we poised for a breakout past 10,000 on the Dow? Well, we need to remain focused on what is driving the market . . . and that is the weak greenback.
Indications of economic strength in Australia compelled the Australian Central Bank to raise rates which drove the Aussie higher and the dollar to new lows. In the process, the ‘dollar carry trade’ gained momentum propelling global equities higher.
The initial earnings reports released continue to show no real signs of improvement in top line revenue generated by increased sales while the bottom lines have improved given ongoing cost cutting progams. If a company cuts ALL its costs, will its stock still go higher? Rising stock values ultimately need to be driven by ‘growth.’
BONDS/INTEREST RATES
2yr Treasury: .97%, an increase of 2 basis points or .01%
10yr Treasury: 3.39%, an increase of 9 basis points
The yield curve steepened (longer maturities underperformed shorter maturities) under the weight of another Treasury refunding (3yr, 10yr, and 30yr). The 30yr auction on Thursday was disappointing which precipitated the selloff. The bond market has been trading in sync with equities for the last few months. That price action is an anomaly as typically bonds will trade in an inverse relationship with equities. Comments by Bernanke in the latter part of the week about an eventual and timely increase in rates by the Fed did take the wind out of the bond market’s sails.
COY (High Yield ETF): 6.64, +3.8%
FMY (Mortgage ETF): 17.85, +0.3%
ITE (Government ETF): 57.77, -0.3%
NXR (Municipal ETF): 14.46, +0.1%
Commentary: while interest rates did move marginally higher over the week, overall they remain at remarkably low levels. The high-yield market remains on fire as that sector is benefiting from a lot of hedge funds allocating capital via the ‘dollar carry trade’ referenced previously.
Summary/Conclusion
The game continues. The disconnect between the overall domestic economy and the price action in the markets presents what one noted investor described as ‘the greatest experiment’ in modern finance. To the extent that people are putting money to work, I would focus on buying quality and utilizing ‘dollar cost averaging’ techniques.
Thanks for your support. If you like what you see here, please subscribe via e-mail, Twitter, Facebook, or an RSS feed.
Thoughts, comments, questions always appreciated.
Have a great day and weekend.
LD
Mary Schapiro Has Some ‘Splainin To Do…
Posted by Larry Doyle on October 8th, 2009 4:03 PM |
Mary Schapiro
Big money makes for a very strange bedfellow. Is FINRA sleeping well these days? A pending lawsuit against FINRA would like to pull back the covers and check to see if the money in the FINRA mattress was allocated appropriately. Let’s enter the sitting room and take a peek into this corner of the FINRA household.
In the process of consolidating the NASD with NYSE Regulation to form FINRA, the NASD allocated capital proceeds to its member firms. This capital was generated via the initial public offering of the Nasdaq. Did the NASD, now known as FINRA, significantly underallocate capital proceeds to its member firms? This alleged underallocation, known as being ‘picked off’ on Wall Street, is the basis for a lawsuit brought by two FINRA member firms, Benchmark and Standard Investment Chartered.
Why am I concerned about the arcane inner workings and legal issues of a Wall Street self-regulatory organization? For the very same reason that I’m concerned about that regulator’s internal investment portfolio activities. Transparency or the lack thereof and the resulting confidence or lack thereof that the American public has in our entire financial regulatory system. Those goals strike me as worthy especially in light of the systemic risks embedded in an array of organizations which this regulator was charged to oversee. Yes, a large amount of exposure and transparency is badly needed at this point in our economic history. Against this backdrop, let’s navigate and see what we can learn about this lawsuit.
The law firms of Cuneo, Gilbert & LaDuca along with Greenfield and Goodman are representing the plaintiffs. From the former’s website we learn:
Along with our co-counsel Greenfield & Goodman, LLC, we currently represent members of the Financial Industry Regulatory Authority (“FINRA”) (formerly known as the National Association of Securities Dealers or “NASD”) in United States District Court and Court of Appeals litigation. The complaints, which are based on state law, allege that defendants, among other things, obtained the NASD members’ vote in support of the consolidation of NASD and NYSE Regulation through an inaccurate and deceptive proxy statement and solicitation process. (LD’s highlight) At issue in the suit is whether NASD could have distributed to its members a larger share of the approximately $1.5 billion of NASD members’ equity. As members will recall, NASD repeatedly asserted that the IRS imposed a $35,000 “hard cap” on what the NASD could pay its members.
Wow. With a $1.5 billion pie, we are talking big money. In light of that, a charge labeled as ‘inaccurate and deceptive proxy statement and solicitation process’ is aggressive especially for an industry’s regulatory organization. Whatever happened to embracing accuracy and clarity? Let’s continue.
Some documents from the litigation that shed light on the truth of these statements are now public. However, FINRA has insisted that the key fact – the amount the Internal Revenue Service (“IRS”) told NASD it could distribute – remain secret, that is, under seal.
Secret? Under seal? Those terms aren’t synonymous with transparent. I thought under the ‘change’ being promoted by the Obama administration transparency would be embraced. What this looks like is more ‘business as usual’ on Wall Street. Navigating further we learn,
>The IRS did not limit the payment to member firms to $35,000 as NASD and its officials insisted.
>The IRS did not issue a formal ruling on the payment to members until March 13, 2007 – approximately two months after the member vote on the bylaws occurred.November 21, 2006.
>NASD Board Minutes demonstrate that the NASD Board discussed the $35,000 limit stating, “regardless of the amount agreed upon, it was paramount that the figure not be subject to negotiation.”
At this juncture, if I could be so bold as to steal a line from Ricky Ricardo in engaging Lucy, I would say to Mary Schapiro who headed FINRA, “you got some ‘splainin to do.”
For any legal beagles and overachievers in the audience, I am happy to submit the following legal documents pertaining to this case:
Communications between NASD and the IRS
Communications Between NASD and NYSE
Rest assured, I will be monitoring developments in this case closely.
LD
