July, 2009 | Sense on Cents - Part 3 Sense on Cents

Archive for July, 2009

High Frequency Trading Debate: Mano a Mano

Posted by Larry Doyle on July 24th, 2009 5:42 PM |

In the spirit of continuing the dialogue on high frequency program trading, please view this ‘mano a mano’ debate on CNBC.

In one corner is Joe Saluzzi of Themis Trading. In the other is Irene Aldrige, Managing Partner of Able Alpha Trading.

Mr. Saluzzi initially exposed this activity to the public in late June. Irene views this trading activity as a natural evolution of modern technology.

Please let me know how you score “the fight.”

Wall Street Supercop

Posted by Larry Doyle on July 24th, 2009 9:55 AM |

Regulating Wall Street is not a job for mere mortals. This is a job for Supercop!!

Pardon my lighthearted manner to a truly serious issue, but certain topics just lend themselves to breaking out my Irish wit and this is one of them.

Recall that under President Obama’s initial plans to revamp the financial regulatory structure, the Federal Reserve was to be designated as the uber-regulator or Supercop for Wall Street. Well, the best laid plans do not necessarily play out that way, as the Associated Press reports SEC, FDIC Heads Want New Council to Be Supercop:

Key regulators on Thursday broke with the Obama administration, reaffirming their belief that some new powers to monitor big institutions against financial threats should go to an interagency council, not the Federal Reserve.

Some Republican lawmakers also continued to warn against endowing the Fed with new powers in an overhauled system as Congress slogs through a complex deliberation that could reshape the financial landscape in the wake of a historic crisis.

Under the administration’s financial overhaul proposal, the central bank as “systemic risk regulator” would be able to duplicate and even overrule other regulators.

But Securities and Exchange Commission Chairman Mary Schapiro and Sheila Bair, head of the Federal Deposit Insurance Corp., stressed to the Senate Banking Committee that crucial role should be played by the new stability oversight council. The body would include the Treasury Department, the Fed, and the two independent agencies headed by Bair and Schapiro.

I am not necessarily for more government bureaucracy and I hope this supercop council is not merely a layer of red tape. I would be very concerned if the Federal Reserve were designated as the sole supercop. Why? I think it would likely hinder the Fed’s ability to be viewed as totally independent. I already believe the Fed has a credibility issue on that front. Being designated as Wall Street’s supercop would only further jeopardize the Fed’s claim of independence.

Make no mistake about it, though, the efficacy of a proposed supercop is ultimately a question of transparency and integrity. I addressed these points in writing “Future Financial Regulation: Not A Question of Sufficiency, But of Transparency and Integrity.”

I am heartened by the fact that the FDIC under Sheila Bair would be able to play a prominent role in this supercop council. I hold Ms. Bair in high regard. As the AP reports:

Bair testified that an interagency council with strong and extensive authorities “will provide for an appropriate system of checks and balances.” A council “with real teeth … would be highly effective,” Bair said. It would be “tremendous” power to invest in a sole regulator, she said.

Bair also endorsed the proposed creation under the Obama plan of a consumer finance protection agency to oversee areas such as mortgages and credit cards — an idea fiercely opposed by the financial industry.

How will this play out? Sense on Cents will be monitoring developments. Regulating Wall Street is not a job for mere mortals. This is a job for Supercop!!

Related Commentary

Don’t Call the Fed Independent; June 17, 2009

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Posted in General, regulation | 2 Comments »

Wall Street Has a Problem as High Frequency Trading Moves to Main Street

Posted by Larry Doyle on July 24th, 2009 6:54 AM |

I am not here to rain on the parade, but I do think developments overnight have the potential to dramatically change the nature of our markets if not our economy. I am referring to issues surrounding high frequency program trading.

Until now, the debate over high frequency trading has largely been relegated to Wall Street periodicals, financial news outlets, and blogs, including Sense on Cents.

Well, this morning America awakens to see this high frequency debate course across the front page of The New York Times, Traders Profit With Computers Set at High Speed:

It is the hot new thing on Wall Street, a way for a handful of traders to master the stock market, peek at investors’ orders and, critics say, even subtly manipulate share prices.

It is called high-frequency trading — and it is suddenly one of the most talked-about and mysterious forces in the markets.

Powerful computers, some housed right next to the machines that drive marketplaces like the New York Stock Exchange, enable high-frequency traders to transmit millions of orders at lightning speed and, their detractors contend, reap billions at everyone else’s expense.

These systems are so fast they can outsmart or outrun other investors, humans and computers alike. And after growing in the shadows for years, they are generating lots of talk.

Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency trading is one answer.

This article is likely sweeping the globe at this very minute and, in my opinion, is particularly devastating in its tone and delivery . . . and justifiably so.

I can only imagine the commentary this evening at the local Rotary Club, Knights of Columbus, Lions Club, town carnivals, and church fairs. Probably something along these lines:

“Have you heard how Wall Street is screwing us?”

“I knew that game was never on the up and up.”

“What a bunch of thieves.”

Without entering into a debate over the merits or lack thereof of this high frequency program trading, I think Wall Street has a huge problem on its hands. Why? A question of fundamental fairness. With the publication and dissemination of this article, try to explain to the average Joe looking to buy 50 shares of IBM how he is being treated equitably.

As the New York Times reports:

“You want to encourage innovation, and you want to reward companies that have invested in technology and ideas that make the markets more efficient,” said Andrew M. Brooks, head of United States equity trading at T. Rowe Price, a mutual fund and investment company that often competes with and uses high-frequency techniques. “But we’re moving toward a two-tiered marketplace of the high-frequency arbitrage guys, and everyone else. People want to know they have a legitimate shot at getting a fair deal. Otherwise, the markets lose their integrity.” (LD’s highlight)

What do you think? Please share your thoughts and opinions.

Related Commentary

Is Uncle Sam Manipulating the Markets? July 1, 2009

Is Uncle Sam Manipulating the Markets? Part II July 6, 2009

Is Uncle Sam Manipulating the Markets? Part III July 8, 2009

Why High Frequency Program Trading Smells July 14, 2009

High Frequency Trading: Point-Counterpoint July 17, 2009

Daily Market Discipline

Posted by Larry Doyle on July 23rd, 2009 5:29 PM |

The markets, the economy, and life itself are all marathons. As such, everyday we have to put on our shoes and do our roadwork. Without the discipline of that process, how can we ever expect to achieve our long term goals?

Promoting discipline and its practice is not exactly an approach that sells easily, but I know of no other approach for achieving real progress.

In my opinion, America in general and Wall Street specifically have long been far too focused on the short term, that is, one quarter’s earnings, one month’s sales figures, one week’s data, or one day’s stock returns. If we manage our businesses and our lives to achieve those short term results, are we laying the foundation to withstand challenges and hurdles for long term success?

The reason I broach this topic is the ebullience I view from the overwhelming numbers of financial commentators on up days in the market relative to their mood on down days.

I know they are in the ‘sales’ business, but if we are going to adapt to a new economy, then I think we need to adapt a new approach to trading, investing, and business – if not life itself.

I have exposure to different sectors of the market and obviously like to see investments increase in value just like anybody else. I always respect the market and the price action even if I have different opinions about values. However, if my mood is changing appreciably based upon daily market swings then my investments are controlling me rather than vice versa.

I will allow others to lead the cheers. I merely want to make slow and steady progress everyday, and hopefully help others do the same via Sense on Cents.

Do not mean to be overly philosophical, so . . . it’s time for me to go get back on that elliptical.

Tags: daily market discipline, do not focus on short term, life is a marathon, long term goals, need to focus on the long term, not too high, not too low
Posted in General | No Comments »

The Relaxation of Mark-to-Market May be Stiffening

Posted by Larry Doyle on July 23rd, 2009 2:07 PM |

I have always thought the relaxation of the mark-to-market accounting standard by the Federal Accounting Standards Board (FASB) was nothing more than a vehicle for banks to ‘cook their books.’

Is the grill getting ready to be turned down, if not totally turned off? Kudos again to Bloomberg’s Jonathan Weil for his cutting edge review and analysis of major accounting issues and their impact on our financial industry. Weil reports, Accountants Gain Courage to Stand Up to Bankers:

The Financial Accounting Standards Board is girding for another brawl with the banking industry over mark-to-market accounting. And this time, it’s the FASB that has come out swinging.

It was only last April that the FASB caved to congressional pressure by passing emergency rule changes so that banks and insurance companies could keep long-term losses from crummy debt securities off their income statements.

Now the FASB says it may expand the use of fair-market values on corporate income statements and balance sheets in ways it never has before. Even loans would have to be carried on the balance sheet at fair value, under a preliminary decision reached July 15. The board might decide whether to issue a formal proposal on the matter as soon as next month.

I am truly heartened (yet simultaneously shocked) that the FASB would choose to pick this fight with the financial industry and their Congressional counterparts at this time. Washington has unequivocally laid out a plan to ‘buy time’ for financial institutions, and in turn the economy, to recover. This proposal, Financial Instruments: Improvements to Recognition and Measurement, would certainly promote transparency while likely exposing real problems within financial institutions.

Weil provides further piercing insights:

“They know they screwed up, and they took action to correct for it,” says Adam Hurwich, a partner at New York investment manager Jupiter Advisors LLC and a member of the FASB’s Investors Technical Advisory Committee. “The more pushback there’s going to be, the more their credibility is going to be established.”

The scope of the FASB’s initiative, which has received almost no attention in the press, is massive. All financial assets would have to be recorded at fair value on the balance sheet each quarter, under the board’s tentative plan.

This would mean an end to asset classifications such as held for investment, held to maturity and held for sale, along with their differing balance-sheet treatments. Most loans, for example, probably would be presented on the balance sheet at cost, with a line item below showing accumulated change in fair value, and then a net fair-value figure below that. For lenders, rule changes could mean faster recognition of loan losses, resulting in lower earnings and book values.

What would this rule change have meant for CIT?

The commercial lender, which is struggling to stay out of bankruptcy, said in a footnote to its last annual report that its loans as of Dec. 31 were worth $8.3 billion less than its balance sheet showed. The difference was greater than CIT’s reported shareholder equity. That tells you the company probably was insolvent months ago, only its book value didn’t show it.

What does the banking lobby think of this proposed rule change?

“I guess the nicest thing I can say is it’s difficult to find the good in this,” Donna Fisher, the American Bankers Association’s tax and accounting director in Washington, told me.

Weil concludes:

If the bankers don’t like it, that’s probably a good sign the FASB is doing something right.

Sense on Cents concurs and will be monitoring developments very closely. Thank you Mr. Weil.

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Posted in General | 1 Comment »

Uncle Sam’s Dirty Little Secret Is Revealed

Posted by Larry Doyle on July 23rd, 2009 11:15 AM |

Uncle Sam may think he can keep losses of tens of billions of dollars somewhat secretive, but when those losses cross into the hundreds of billions the dirt is much harder to keep under the rug.

What is the nature and size of this dirt? The losses assocated with those dastardly large twins, Fannie and Freddie. I lifted the rug on this dirt on June 18th in writing, Uncle Sam’s Dirty Little Secret.

Fannie and Freddie hold 50% of the mortgages in our country. These entities are most likely sitting on hundreds of billions in embedded losses currently with limited prospects to generate real revenue. They have no viable business model at this point in time.

CNN reports today, Fannie and Freddie: The Most Expensive Bailout

When Congress was debating the bailout of Fannie and Freddie last July, the official estimate from the Congressional Budget Office was that a bailout would most likely cost taxpayers $25 billion, with only a 5% chance of the price tag reaching $100 billion between them.

In addition, both Fannie and Freddie are likely to need billions of dollars more after they report second quarter results in the coming weeks. Experts believe the cost will only continue to rise in the next year.

“We’re assuming they each will cross the $100 billion mark fairly soon. They could be hitting the $200 billion barrier by the end of next year,” said Bose George, mortgage analyst at Keefe, Bruyette & Woods, an investment bank specializing in financial services firms.

The fact remains that these two wards of the state are no longer for profit entities but rather vehicles for promoting Obama’s housing plans and redistribution of wealth.

The losses within Fannie and Freddie will accrue as long as housing delinquencies and defaults increase. No credible analyst can truly predict when those statistics may peak. They can guess but given the runup in home prices along with the growth in housing, that is all they can do.

In fact, the argument can be made that the very policies being utilized to forestall delinquencies and defaults will ultimately exacerbate and extend the pressure on the housing market, and in turn, Fannie’s and Freddie’s losses.

Will the American taxpayer ever see a return on the funds being pumped into Fannie and Freddie? Don’t hold your breath.

CNN continues,

Neither firm has given an estimate as to how high losses will reach. But the original limit of $100 billion in losses set in place when the government put Fannie and Freddie into conservatorship, essentially a form of bankruptcy, last September was quickly raised early this year to $200 billion each because of concerns about looming losses.

In return for pumping taxpayer dollars into the two firms, Treasury received preferred stock, which is designed to give the government a healthy 10% to 12% dividend. But few expect that Fannie or Freddie will be able to pay that dividend, let alone return the money handed to the firms to cover their losses..

Even James Lockhart, director of the Federal Housing Finance Agency, the government body that has overseen the two firms since they were placed into conservatorship, said it will be a challenge for Fannie and Freddie to make their scheduled payments.

Let’s be honest, Fannie and Freddie have become financial intermediaries used to promote a form of socialized housing.

With Uncle Sam’s dirty little secret now revealed, break out the industrial strength vacuums!

Related Commentary

Freddie Mac, Fannie Mae Deja Vu? ; May 28, 2009
If you think Fannie and Freddie are alone amidst this dirt, they have sizable company in the form of the Federal Home Loan Bank system.

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Posted in Fannie Mae, Federal Home Loan Banks, Freddie Mac, General, Housing Crisis | 2 Comments »

Are We in the Early Stages of a Depression?

Posted by Larry Doyle on July 23rd, 2009 8:48 AM |

At the request of a reader (hat tip to kbdabear), I have been asked to comment on a report produced by Sprott Asset Management of Toronto, Ontario entitled It’s the Real Economy, Stupid. The writers, Eric Sprott and David Franklin, believe:

We are now in the early stages of a depression. The economic indicators we follow to track real economic activity are all signaling a slowdown of massive proportions. You wouldn’t know it reading the mainstream papers of course – they all focus on the relative decline in the slowdown’s intensity. Reading about the slowdown ‘slowing down’ is not the same as growth however, and does not warrant excitement in our opinion.

Are we in the early stages of a depression or are we merely experiencing the worst recession since the 1930s? Let’s define these two economic terms.

Recession? Depression? What’s the Difference?

The standard newspaper definition of a recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters.This definition is unpopular with most economists for two main reasons. First, this definition does not take into consideration changes in other variables. For example this definition ignores any changes in the unemployment rate or consumer confidence. Second, by using quarterly data this definition makes it difficult to pinpoint when a recession begins or ends. This means that a recession that lasts ten months or less may go undetected.

Recession: The BCDC Definition

The Business Cycle Dating Committee at the National Bureau of Economic Research (NBER) provides a better way to find out if there is a recession is taking place. This committee determines the amount of business activity in the economy by looking at things like employment, industrial production, real income and wholesale-retail sales. They define a recession as the time when business activity has reached its peak and starts to fall until the time when business activity bottoms out. When the business activity starts to rise again it is called an expansionary period. By this definition, the average recession lasts about a year.

And how is a widely feared depression defined?

Before the Great Depression of the 1930s any downturn in economic activity was referred to as a depression. The term recession was developed in this period to differentiate periods like the 1930s from smaller economic declines that occurred in 1910 and 1913. This leads to the simple definition of a depression as a recession that lasts longer and has a larger decline in business activity.

The Difference

So how can we tell the difference between a recession and a depression? A good rule of thumb for determining the difference between a recession and a depression is to look at the changes in GNP. A depression is any economic downturn where real GDP declines by more than 10 percent. A recession is an economic downturn that is less severe.

By this yardstick, the last depression in the United States was from May 1937 to June 1938, where real GDP declined by 18.2 percent. If we use this method then the Great Depression of the 1930s can be seen as two separate events: an incredibly severe depression lasting from August 1929 to March 1933 where real GDP declined by almost 33 percent, a period of recovery, then another less severe depression of 1937-38. The United States hasn’t had anything even close to a depression in the post-war period. The worst recession in the last 60 years was from November 1973 to March 1975, where real GDP fell by 4.9 percent. Countries such as Finland and Indonesia have suffered depressions in recent memory using this definition.

In reading Sprott’s and Franklin’s review, they focus on the negative assessments of the following economic data: (more…)

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Posted in Economy, General | 15 Comments »

Financial Literacy Is the First Step to Financial Independence

Posted by Larry Doyle on July 22nd, 2009 3:12 PM |

Financial literacy does not guarantee financial independence but it is a necessary first step.

In a society which has undervalued thrift and prudent financial management, is it any wonder our country is woefully unprepared to help future generations become financially literate?

The goal of Sense on Cents is to help people navigate the economic landscape, from whatever point of departure on that landscape they may currently occupy.

The Medill Washington Program recently reported on challenges to improve financial literacy. From the article Financial Literacy Programs Face Uphill Climb:

“The economic crisis was caused by the fact that a lot of Americans lack basic financial literacy skills, which makes it difficult to make wise credit decisions, as was evidenced by the mortgage crisis and other areas of the overall economic crisis,” said Levine. “However, with the advent of the new presidency, also comes a new approach when it comes to undertaking the goal of increasing national financial literacy in schools. And the transition to this new approach takes time.”

Everett Hoffman, 22, of Staten Island, N.Y., wishes he had taken the elective of a personal financial education course in high school. He thinks it would have helped him make wiser spending choices.

“I think it might have been good because I’m learning a lot of things the hard way now being a young adult,” said Hoffman. “But I really do think taking that class might have helped me avoid some minor debit card issues I’ve been having lately, you know basics, like balancing a checkbook.”

Allison Joseph, 21, of Chesapeake, Va., also interviewed on the National Mall, said that her parents still shelter her from having to take care of her finances. She took a macroeconomics course in high school that did not cover personal finance.

“When I went to college, I started getting my own credit card statements, but my parents have always helped me out, so I’m not totally independent in that sense.”

Up to now, only three states require at least a one-semester course devoted to personal finance – Utah, Missouri and Tennessee. Eighteen other states require personal finance instruction to be incorporated into other subject matter. The rest have no requirements, but leave individual schools the choice to implement personal finance education programs in their curricula.

According to JumpStart, a personal financial education course would give students a head start at being less debt-prone by teaching them how to manage checkbooks, how mortgages work, and other basic financial life skills.

I will readily admit that the tone and tenor of my writing at Sense on Cents is not geared toward high school students, but certainly the Financial Primers in the right sidebar (Debt Management, Financial Aid, Insurance, Investing, Mortgage Finance) provide a wealth of information for anybody embarking down a financial path.

By the same token, I am heartened by the number of college students and recent college grads who have informed me how much they have learned and are learning from Sense on Cents.

Please spread the word and do not be bashful about asking me anything.

Financial literacy is the first step in becoming financially educated which is the path to becoming financially independent.

I am happy to help you navigate along the way.

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Posted in financial literacy, General | 3 Comments »

CIT Gets ‘Don Corleone Financing’

Posted by Larry Doyle on July 22nd, 2009 12:11 PM |

Desperate companies, just like desperate individuals, will take desperate measures when pushed to the brink.

We clearly see this as the terms of the CIT financing arranged over the weekend are released. Bloomberg exposes this loan sharking in reporting, CIT Hit With Interest Rate More Than 25 Times Libor:

CIT, the 101-year-old commercial lender struggling to retire $1 billion of debt maturing next month, agreed to pay a 5 percent fee to the creditors and annual interest of at least 13 percent. On top of that, the New York-based company pledged assets worth more than five times the amount of the loan as collateral.

“The terms are egregious,” said Dwayne Moyers, the chief investment officer at Fort Worth, Texas-based SMH Capital Advisors, which oversees $1.4 billion, including more than $70 million of CIT bonds. “They ripped the faces off everyone with these terms.” (LD’s highlighting)

The rate on the financing was initially released as 10.5%. That level looks downright cheap compared to these terms.

The question begs, though, whether even under these terms CIT will survive:

CIT, led by Chairman and Chief Executive Officer Jeffrey Peek, said in a regulatory filing yesterday that the loan doesn’t solve the funding challenges and it may be forced to seek bankruptcy protection unless holders of $1 billion in floating-rate notes due Aug. 17 accept 82.5 cents on the dollar for the debt.

I addressed the concerns CIT immediately faces in writing yesterday “CIT-go Into Bankruptcy?” A question I raised:

> Were certain unsecured creditors just abused by this transaction?

Though neither CIT nor the creditors providing the $3 billion in new capital will publicize it, these lenders hold secured debt and as such they just stepped in front of a wide array of unsecured creditors in a likely bankruptcy. Who are some of these unsecured creditors? Small and mid-sized retail outlets and franchises which pledged receivables for future credit. CIT will pay 10.5% and pledged $30 billion in face value of assets/receivables as collateral for the $3 billion loan. Will the small and mid-sized companies be able to tap their credit lines? Great question.

I obviously stand corrected in terms of the rate on the loan.

The outlook for unsecured creditors (customers who have pledged assets/receivables and other bondholders) remains decidedly challenged as Bloomberg asserts:

The company has said its bankruptcy would put 760 manufacturing clients at risk of failure and “precipitate a crisis” for as many as 300,000 retailers, according to internal documents.

“As a CIT unsecured bondholder you’re better off than you were on Friday, but if they go into bankruptcy you’re not going to be too happy other holders jumped ahead of you,” Cohen said.

Bondholders that didn’t participate in the rescue financing may fare worse in a CIT bankruptcy because so much of the assets are pledged as collateral, said Adam Cohen, founder of debt research firm Covenant Review LLC in New York.

In regard to the secured creditors involved in this specific $3 billion financing, they are going to do just fine. Make no mistake, this financing was no mission of mercy, nor should it be, but as Bloomberg highlights:

“This is called Don Corleone financing,” Egan said, referring to the patriarch in the organized-crime family depicted in the 1972 film, “The Godfather.” “You can’t lose money on this deal.”

Outside of the “urban underworld,” Egan, 52, said he couldn’t recall seeing a loan backed by as much collateral that paid interest rates so high. “These terms would make a pawn- shop operator blush.”

What will this loan shark financing do for lending to small and medium sized companies? Well, do you know any businesses which can afford to pay 14% so CIT can make .50% on this financing?

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Posted in CIT, General | 4 Comments »

The King of Wall Street Takes on the Casinos

Posted by Larry Doyle on July 22nd, 2009 7:08 AM |

Kings like control. Control drives revenue and profits.

Revenues and profits are a function of volumes and margins.

Any businessman worth his salt works tirelessly at increasing his own volume and margin while necessarily narrowing those of his competition.

Larry Fink

I see a classic case of these competitive forces at work this morning in a report from the Financial Times, BlackRock Chief Attacks Wall Street Earnings:

Larry Fink, BlackRock’s founder and chief executive, on Tuesday took aim at the “luxurious” trading profits enjoyed by Wall Street banks, saying that they have taken advantage of reduced competition to charge their customers more for even basic trades.

“There are fewer players. There is very little capital being committed by these dealers,” Mr Fink said

Little doubt The King of Wall Street, Larry Fink is irked by the ransom being charged by those running the Wall street ‘casinos.’ The king says as much in stating:

“They’re just taking the spread between the bid and the ask [the price gap between buyers and sellers] and they are making very luxurious returns,” he added.

In layman’s terms, the King is denigrating those working the Wall Street ‘casinos’ as the equivalent of toll takers on the Triborough Bridge. Who likes paying increased tolls? Nobody, and especially not a king.

What is a king to do to reinstitute some order in his kingdom? (more…)

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Posted in General | 1 Comment »