Monday Night Links From The Country

Walking along the side of our rural road yesterday I found a PIECE of a porcupine - like, a little piece of fur  the size of my open palm, with spines on it.  What can rip off a piece of a porcupine, aside from a bear?  Today my wife, Oscar and I walked in the woods wearing our neon orange "don't shoot me" vests, and met our first hunters - two large men each driving their own off road vehicle, with guns strapped to the back.  Live Free or Die!

"Would it have been uncouth for me to request that they don't shoot us on our way back?"  I asked Mrs. Dynamite, who merely frowned at me.

I also saw a little bat - the flying rodent kind - flying around today and landing on my barn.  We knew that there were some bats living in the barn, but I was surprised to see one flying around at 2pm.  I saw him try to snipe a flying bug, but the bat merely banged against it, failing to catch it.  Perhaps it was a baby bat, just getting out for the first time - which might explain the afternoon flight.

Here are some worthy reads:

NYC is virtually bankrupt.

Via Clusterstock:  Edward Pinto - How did Paul Krugman get it so wrong about Fannie and Freddie?

Via Calculated Risk:  Walmart Quote of the Night

 "There are families not eating at the end of the month,” said Stephen Quinn, executive vice president and chief marketing officer at Wal-Mart Stores, and “literally lining up at midnight” at Wal-Mart stores waiting to buy food when paychecks or government checks land in their accounts."

MISH tore apart the Unemployment Report from last week

My CDS post, republished on SeekingAlpha generated some intelligent comments, some of which are similar to the comments left on my blog.  

-KD

Abstract Thoughts on CDS and the Fallacy of Insuring Your Neighbor's House

warning: this post will require you to be able to intelligently ponder philosophical concepts and theories, and perhaps try to forget some assumptions you may already have.   I failed in my attempt to explain the concepts below in a comment thread on NakedCapitalism, so here's the full thought process:

Let's have a quick CDS tutorial:  Credit Default Swaps are insurance on the credit of an underlying company.  An investor who buys CDS on company XYZ will pay a fixed fee (ie, 1% of the notional he is purchasing) every year, and in exchange, the seller of the CDS will owe the buyer money if there is a default event at the company.

The biggest problem with the CDS market was that sellers of CDS - ie, sellers of insurance, wrote checks their bodies couldn't cash.  They ended up with liabilities they couldn't possibly make good on, and you know the rest of the story - government bailout to avoid Armageddon.

There is another problem with CDS, though, and that's the fact that there are many more CDS outstanding on some companies than the actual underlying debt that the CDS are supposed to be insuring.  Let's consider a hypothetical example:  Company XYZ has $100MM in debt outstanding.  JoeHedgeFund owns it all.  JoeHedgeFund goes out to the Street - the sell side broker dealers, AIG, etc, and purchases protection - CDS - for his bonds.  However, JoeHedgeFund takes it one step further - he manages to buy  $500MM worth of CDS - because when you buy CDS, no one asks you how much of the underlying bond you own.   Why is this a problem?  Because, when company XYZ runs into trouble, and goes to negotiate a restructuring, a prepackaged bankruptcy, or a reorganization, JoeHedgeFund now has no incentive to negotiate in favor of the debt he owns - in fact, he's DIS-incented from helping XYZ restructure their debt, because he's essentially overhedged by a ratio of 5-1.  He doesn't care if he takes a loss on the $100MM in bonds by refusing to compromise on any sort of restructuring and forces the company into bankrutpcy, because he gets paid on $500MM of CDS.

This is what's known as "perverse incentive."  Opponents of CDS sometimes say that we shouldn't allow people to buy "naked" CDS, because they don't have an "insurable interest," and thus are exposed to perverse incentives.  A commonly cited example is that you can't buy insurance on your neighbor's house, because you could then burn the house down and collect on the insurance policy.  You also can't buy life insurance on your neighbor, because you'd have perverse incentive to murder him to collect the payout.

Now, here's why it's fallacious logic to apply this reasoning to CDS.  If I buy CDS on a company without owning any of the underlying debt, I cannot effect the health of the company.  Note that I don't have an insurable interest, but it doesn't matter - the "perverse incentive" is a pipe dream, because I can't act on it.  It doesn't matter how much CDS I buy - I could own a gazillion dollars worth of insurance on the debt of a given company - but that still doesn't give me any say, any seat at the table in a restructuring negotiation scenario.  There is a similar analogy with short selling stocks, and it's the reason why people who blame short sellers for the demise of companies are generally nutjobs:  short sellers cannot and do not effect the health of a company.  Similarly, CDS levels do not effect the health of a company - they REFLECT the health of a company, or at least the market's interpretation of that health.  Some companies will see the value of their CDS widen when people fear for the company's financial health.  The CDS is a reflection of the fear, and not the cause of the company's problems.  To suggest that panic from widening CDS levels causes companies to collapse is like saying that avoiding marking assets to market makes them worth whatever we want them to be worth - limiting CDS trading would not alter the underlying health of the company, it would only mask it.

So, since one cannot effect the health of the company by owning CDS - since one cannot murder the company (or burn it down) via a CDS position, the "burning down your neighbor's house" analogy goes up in smoke as a straw man fallacy.  If you're philosophically inclined, you can imagine a world where I could buy life insurance on my neighbor's house, but the insurance company would give me a magic pill that would prevent me from being able to harm the house in any way - it would essentially eliminate the perverse incentive I had.  In this scenario, obviously, there is no reason why I can't buy insurance on my neighbor's house.  Similarly, with CDS, I can't effect default events by owning CDS alone, so the perverse incentive is a straw man.

However - once one DOES own some of the underlying bonds in a company, like JoeHedgeFund in our example, he certainly can effect the outcomes, and thus we need to propose some rules for how much CDS one can own.   Now, these rules are theoretical - I don't have a suggestion for how to enforce them, so if you don't have the capacity for regulatory philosophy, you can click away now.  Also note,  that these rules address ONLY the "perverse incentive" concept - they don't cure the problem of the AIG's of the world writing too much insurance (CDS).

It's actually simple, and it's actually only one rule:  SINCE a debtholder can effect the future health of a company, IF you own debt in a company, you cannot own CDS notional greater than your debt position.  Following logically from that, if you own CDS in a company, you cannot buy debt in the company unless the notional value of the debt is at least at large as the notional value of the CDS.

That's it - just one rule.  Note that under this rule, there is no prohibition on buying "naked" CDS in a company whose debt I don't own - because naked CDS buying does not cause the collapse of companies.

The real problem with CDS, apart from the perverse incentive effects which we've now solved with a simple rule, are not with the buyers of CDS - but with the sellers.  Sellers of CDS historically underestimate the likelihood of default, and issued much more insurance than they could cover if things went sour.    Regulating exposure of the sellers of CDS is a topic for another post - but one that will be covered amply in the news over the next 12 months, I'm sure.

-KD

A Sit Down With Senior Treasury Officials - Part II

In Part One of the recap of my trip to the Treasury, I outlined the questions and answers related to variations on the concept of "extend and pretend" - the refusal to acknowledge bad debts and instead attempt to stick our proverbial policy finger in the dyke and hope that the water will stop spraying out.   Most of the attendees have written recaps of the event, and I found Steve Waldman's piece today to be quite well done, as is David Merkel's ongoing recap.

Later in the meeting, I had the chance to ask a Senior Treasury Official (STO) a question related to this testimony last week from Treasury Secretary Geithner (note - Ritholtz has the location wrong - it's actually from the House Financial Services Committee, I believe):

To summarize the video testimony in the link above: Geithner outlined 5 key points to the Administration's proposed regulatory reform bill:

1) The government has to have the ability to resolve failing firms, with losses absorbed not by the taxpayers, but by the unsecured creditors and equity holders.

2) Firms who cannot survive without government support must face the consequences of that failure.  The government would facilitate the "orderly demise" of the failing firms, not ensure its survival.

3) Taxpayers must not be on the hook - the government will recoup losses by assessing fees on industry peers

4) The FDIC and FED must have limited authorities with respect to these abilities to take over failing firms

5) The Government must have stronger supervisory authority.

Now, the first three points from Geithner's testimony are the main ones, and they are a good idea - they are pretty much saying that we'd never have bailout like we had the last time, where taxpayers were asked to front the capital that the bondholders (in the form of haircuts and debt for equity swaps) and equity holders (in the form of dilution) should have had to pay for.   I think that most of America would agree that these three points are reasonable, and at the very least, a good start.  My question for the STO was how these three new ideals jived with the recently announced imminent THIRD round of bailout money for GMAC.

Back in May, I was stonewalled by Barney Frank when I asked him why bank bondholders and auto bondholders faced such disparate treatment in the bailout proceedings - with the auto bondholders being forced to make concessions as they rightly should have, while the bank bondholders went on their merry way and watched the government commit taxpayer dollars to shore up their balance sheets.

Sadly, I had a similar feeling when the STO responded to my question about GMAC, explaining, basically, that GMAC was different.  The GMAC bailout was part of the Capital Assistance Plan, where the Treasury stood ready to commit capital to any bank that couldn't raise the capital it needed to raise as identified by the stress tests.  GMAC was the only such entity unable to raise its own capital, and the Treasury was making good on its promise.  I was told that the new rules were for the future, which left me raising an eyebrow, as I was complaining about a third round of funding for GMAC that was being announced as we were sitting in that conference room at the Treasury!  It wasn't the future - some as yet unforeseen disaster - it was happening as the Treasury was announcing policies to say that it wouldn't happen!

The STO clearly didn't want to debate this with me, but must have noticed my squirming, wrinkling my nose, and raising my eyebrows as if I'd just walked into a bathroom at Penn Station, because as he was responding to another question, he briefly addressed me, noting that this was another example of how the rules would need to be flexible.

This was even more disturbing, as I basically took it to mean "there will be no bailouts like we had before, UNLESS there needs to be bailouts like we had before."

John Jansen  asked a question regarding the re-opened 3 and 7 year Treasury notes, and the potential saturation of demand due to the massive annualized issuance in these midrange maturities, which he pegged at nearly 1.2 TRILLION dollars a year.   John was similarly stonewalled with a response that basically consisted of "why would you think that?"   A bit perplexed, John replied that this was simply a tremendous amount of issuance, but was told that he'd need to discuss that with a different Treasury official.

One viewpoint I was surprised to hear expressed by a STO, but one that I strenuously agree with, was the dismissal of the notion that investors were duped into buying much of this toxic paper that has inundated our financial system.  It was noted that the products could be understood by those who deigned to actually understand them, and that those who didn't understand what they were buying were responsible for their decisions.  It's pretty clear to me that it's not that the buyers were duped by spurious Wall Street salesmen, but rather by their own greed and relentless hunt for yield in a low interest rate environment.  Interestingly, I tend to have similarly little sympathy for homeowners who claim they didn't understand their mortgages, which leads me to a quick tangent about consumer protection - another topic which was discussed briefly.

I believe some of this is already in the works, but I'd like to see standardized credit card and mortgage documents that have data just like all food products now do - only instead of listing fat content, vitamins, and calories, these docs would list interest rates, loan length and terms.  There should be no fine print - and that goes for television ads too.  A pet peeve of mine are auto ads on tv where there is fine print on the screen that I can't even read if I pause my digital video recorder on my HDTV.  Consumers need to be protected from their own ignorance.

Tyler Cowen asked if the Treasury was worried about the possibility of the economy falling off a cliff, and was greeted with a response that pretty much summed up the Treasury's options:  the response was essentially (and this is not a direct quote) "what else can we do - should we try to pull that potential cliff forward instead of pushing it back?"  Before I could jump out of my chair and shout "BUT PUSHING THE CLIFF BACK MAKES IT TALLER TOO!"  Tyler Cowen uttered almost those exact words.  The STO nodded and pursed his lips - acknowledging the possibility of that reality.

In summary, I think this was an interesting opportunity to gain insights I'd rarely expect access to from senior government officials.  However, one of the bloggers summed it up on the way out, saying "the concept of the meeting was probably cooler than the actual meeting," and I was left feeling similarly unsatisfied, considering the relative brush off of what I thought was a very well reasoned question (GMAC).   I got the impression that the Treasury officials are still very concerned about what the results of their policies will be, and for good reason.  As I've said before, I don't think that continued stimulus or failure to mark to market - the extend and pretend policy - solves anything.  To use an overdone analogy:  you can't give a drunk another drink to help him avoid a hangover.  That hangover is inevitable, and by postponing it with another drink, you're making the eventual reckoning worse, although later!

Unfortunately for the Treasury, much like Tom Cruise's Lt. Daniel Caffy in A Few Good Men, I just don't think America can handle the truth

The truth is that expansion doesn't last forever, even in our economy that seems to rely on expansion (Ponzi?) to run - and that the only way to resume growth is to first acknowledge hundreds of billions, if not trillions of dollars worth of bad debts that need to be washed away.  The Administration, politically, cannot tell this to the people - no Administration can - it's a sad fact of politics.  In times of trouble, politicians who do the right thing and make the tough decisions sign their own political death warrants.  The officials making these policy decisions at the Treasury are clearly not stupid - I think the main realization from this meeting for me was that they really don't feel like they have any other choice but to TRY to resolve the issues in a way that avoids current mass financial pain.   Is it possible that the Fed can simply buy up all the bad debts?  Maybe - I mean, it looks like they are actually trying to do that.  Will the effects of that - potential hyperinflation and pervasive moral hazard be worse than if we "took our medicine" and allowed the system to implode sooner?  That remains to be seen. 

-KD

A Sit Down With Senior Treasury Officials - Part I

I received a mysterious email last week from the Treasury, inviting me to a discussion about the Administration's policies and reactions to the economic crisis.  Although the timing sucked for me - it was the Monday following the weekend of my move out of NYC - it was too rare an opportunity to pass up.

Arriving at the Treasury, I quickly bumped into AccruedInterest along with John Jansen from Across the Curve.   Michael Panzner soon joined us, before we were escorted to the proper conference room, where we found Yves Smith from Naked Capitalism, Steve Waldman of Interfluidity, Tyler Cowen from Marginal Revolution, and David Merkel of Aleph Blog fame.  In all, there were 8 "bloggers" and a handful of senior Treasury officials, who shall remain nameless.  Henceforth, all Treasury views will be attributed to "STO" - Senior Treasury Officials.

STO began the session with a little background regarding the Administration's response to the financial crisis.  The first point that caught my ear was the description of the stress tests as having been designed to restore a level of confidence in the banking system.   The STO mentioned that the focus was now on reducing the footprint of economic intervention cautiously, quickly and prudently.    Michael Panzner jumped right in, addressing a concept I've writted about previously - that of "extend and pretend," or "delay and pray" - the concept of attempting to avoid recognizing actual losses and or insolvencies, and growing out of them after enough time.  Panzner called it "fake it 'till you make it."    I mentioned that I felt like we were undergoing a "Ponzi scheme of confidence" - but that confidence mattered less than ever in the current environment where, contrary to perhaps the prior 10 years, confidence can no longer be "spent."

In other words, 5 years ago, the economy could be kept churning along if consumers were convinced that things were going to be ok - they could go and borrow more and spend more.  They could take out another mortgage on their home.  Today, on the other hand, that credit bubble has popped - we're broke, both as a consumer, and a nation - and we can no longer simply "spend" confidence by levering up our personal balance sheets any more.    I challenged the STO that he had a poor choice of words in describing the stress tests as designed to restore a level of confidence, rather than to determine which banks were healthy and which were insolvent.

This drew a chorus of "whoa whoa's" and a murmur from a number of STO's present in the room, who quickly banded together to clarify that no one knew the results of the stress tests before they happened, and that they were designed to restore confidence by identifying the levels of capital needed by the banks, and requiring them to raise such capital.  I said that if they wanted to restore confidence, they should require banks to mark assets to market, and depict the true financial situation.

The response was that banks don't mark to market because, well, that's just not what they do - since they hold assets to maturity.  It was also pointed out that if banks had been required to mark to market, the system would have been insolvent multiple times in the past 50 years.  I almost laughed - that was my whole point - just because you pretend that the system is not insolvent doesn't mean that it's not insolvent!  Holding assets to maturity does not mean you'll receive your principal back, obviously.  I also noted that I understood that my background in equities gave me a slightly different perspective, since our (equity) assets were much more liquid and had to be marked to market daily - but I took umbrage with the recent decision by the FDIC to allow banks to recognize commercial real estate loans which were clearly impaired as "performing" and avoid taking writedowns.  I referenced David Einhorn, who wrote an entire book on Allied Capital - whose accounting shenanigans attempted to hide the health of their loan book in exactly this manner.  Loans which were certain to default, but had not yet defaulted were still recorded on the books at full price, and as "performing."

I failed to draw an analogy to the local Washington Redskins, which I think would have been a good one:  the Redskins are technically in the NFC East playoff race - they haven't been mathematically eliminated yet - but in reality, they are not a contender.  Similarly, many of these CRE loans are technically "performing" - the payments are currently being made - but the values of the properties are down massively, rents are falling,  and it's widely recognized as a mere matter of time before the loans default in one form or another.

David Merkel jumped in with the suggestion that even if loans are not marked to market prices, there still has to be an increase in capital requirements held against loans that have seen their market values impaired.

Steve Waldman was a harsh critic of the policy of "Prompt Corrective Action," and was credited (by me) with the quote of the day when he addressed one STO on the regulatory reform plan: "I've read your bill, and it's terrible - no offense," and followed with "too big to fail is too stupid a criteria."    This led to a discussion of how capital ratios were not the problem - although I do think they are a part of the problem.  The buzzword issue was really "interconnectedness," aka, "counterparty risk."

There had been suggestions as far back as a year ago, I believe, about having a central counterparty risk identifier, like the Federal Reserve, monitor the net counterparty risk of each firm, and quantify it systematically.  I mentioned that the problem was that even if we had a "Counterparty Risk Czar" who somehow managed to magically quantify the exposures of each firm (which may be quite a difficult task in itself), we'd see the same problems we saw when the government went to give out the TARP funds. The government didn't want to "bail out" select firms (ie, BAC and CITI) because they feared that the stigma attached to such assistance would create panic and runs on the bank - so they asked a large pool of financial institutions to take the money to hide the truly sick cows.  The Counterparty Risk Czar would have the same issue - if he were to somehow miraculously identify that Firm A had too much exposure to Firm B, the very announcement of such extreme exposure would become a self fulfilling prophecy and result in panic by investors in Firm B, which would in turn spread like wildfire to Firm A.  Is the solution to move the trading of every product onto a clearing house centered exchange?  Perhaps, although that would eliminate an immeasurable amount of OTC trading that the system seems to need to keep churning at its current size, and hamper the economic growth fueled by it (with "it" being financial engineering, in some sense).

I made another point that, although I was not going to presume to lecture a room full of economists and pseudo-economists (as one STO described himself) on economic theory, it was clear to me that they needed to throw away their old economic playbooks.  The thing that bothers me most about economic history is that it's based on a relatively small number of samples.  Furthermore, the inputs in each scenario are vastly different.  Today, for example, we have record length of time the government will provide unemployment benefits, record length of time people spend receiving unemployment benefits, and yet still a record number of people exhausting unemployment benefits.  I cautioned the economists in the room that there is no rule about what "usually" happens when GDP rebounds from -3% to +3% - or when unemployment goes from 5% to 10% - because it's the INPUTS that determine the rationale for the response.  In other words, a +3% GDP print from government spending (which I maintain is what we just saw) is very different from a +3% GDP print from organic economic growth.  The stimulus induced GDP growth will revert when the stimulus stops.

Stay tuned for Part II - where I"ll talk about some unsatisfying answers to questions asked by myself and others, and attempt to synthesize my interpretation of the Treasury's stance on policies.

-KD 

Kid Dynamite Goes to Washington

I was fortunate enough to be included in a group of bloggers who were invited to Washington DC to sit down with senior Treasury officials for a discussion on current policies and future regulatory reform. I just got home, and I will be writing up the event as best I can ASAP, given the constraints that I cannot name specific Treasury officials, or even anonymously quote directly from the meeting.

Still, I expect the recap to be a quality post, and urge you to check back here for it.

Here's a little warmup story: I had a few minutes to kill before the Treasury meeting, so I ambled into a tour at the Bureau of Engraving and Printing (BEP), which actually prints US currency. I had laughed earlier, looking at their website, when I read "You'll see millions of dollars being printed during a tour of the BEP." Millions? That's so 1998.  Millions don't bail out GMAC, bay-bee! Anyway, the tour starts with a little video about the BEP, including a line about how the employees show up every day to "print money and ensure that the U.S. economy remains strong." I chuckled out loud - drawing glances from the Joe and Joan SixPacks that made up the rest of the tour. I thought it was a joke - even the BEP can't think that printing money equates to a strong economy can they? The ironies didn't stop though - the tour guide explained how they were testing out a new printing press that could print even larger sheets of bills (I think the new press does sheets of 50, compares to sheets of 32 for the old press) - so that the BEP can print even MORE money, FASTER! They are printing so much f'n money that they need a newer higher tech press! AIYAHHHH!

The guide then claimed that 95% of the money printed was to replace old and damaged money taken out of circulation, and that only 5% was new money. This seems like a dubious stat to me, but hey - what can I say.

Looking down over the room where the bills are stacked before being fed into the cutting machine, there is a sign that says "Have you ever been this close, and yet so far?" Impressive that the BEP actually TAUNTS the poor American schlubs who will never see stacks of money like this again. One worker jokingly pulled an uncut sheet of hundy's off the stack and pretended to hand it to one of the tour guests - who was of course secured behind a closed in glass catwalk.   He had good intentions, though, drawing wide eyes from the little girl on the rail.

next up:  The Treasury

-KD

Who Are These People

According to a NY Times article on digital video recorders (aka:  TIVO-esque modern day digital VCR's), nearly half of all DVR users watch the commercials on the programs they record!

The Dynamite family has moved into our new New Hampshire home.  We've met the neighbors, and donned orange hunting blazes to avoid getting shot while walking in the woods with Oscar.  Strangely, although we live in an area nearly bereft of houses, we have seen no wildlife aside from an occasional squirrel, chipmunk, blue jay or bat.  Not a fox/deer/moose/bear/bobcat/yeti to be heard from.  I guess these animals are smarter than I thought - they know it's hunting season, and they must be in deep cover.  We do hear frequent shotgun blasts, though, so someone is finding something.

I'm off to the Nation's Capital tomorrow for a big opportunity which I will discuss when I return.

-KD

Hasta La Vista NYC

Today was my last day in New York City.  Mrs. Dynamite and I visited a friend of mine on the floor of the NYSE where I was surprised to see exactly how the floor's landscape has changed in the 10 years since I was last down there.  Obviously, the vast majority of trading is now electronic, and crowds at the specialist posts are a rarity where they were once a staple.  I was surprised, however, at how many agency brokers (aka, two dollar brokers) populated the perimeter of the floor.  The rise of the direct access business is an interesting shift.

Leaving the NYSE, we rode the famous J Train for the first time, up to Katz's Deli, where we enjoyed the finest pastrami sandwich available on Earth.  Not bad for a farewell tour.

So anyway, I'll be away from the Interwebs for a few days as I move and get my new setup wired.  In the meantime, make sure you check out the two pieces I wrote on dark pools this weeks:

1) You Don't Need to Be Scared of Dark Pools
2) Calling out Matt Taibbi on Dark Pools

After that, check out these links:

-Arnold Schwarzenegger says "FUCK YOU" to the California Legislature.  Top Notch.

- Institutional Risk Analyst's Chris Whalen on the the absurdity of the GMAC bailouts - the third of which was just announced.  "Zombie Love."

 - MISH's "Twelve Reasons For A Job Loss Recovery"

Live free or die!  NH here we come.

-KD

Calling Out Matt Taibbi on Dark Pools

So, I wrote this explanation of the reality of dark pools earlier today.    Then, after having a few going away drinks with some friends, I read Taibbi's piece "Goldman Lobbies Senate, Says Full Transparency Sucks," which pretty much proved my point - that people railing against dark pools almost certainly don't understand what they are angry about.  Goldman Sachs put out a presentation attempting to explain to the ignorant masses on the internet how the markets actually work.  It's a pretty decent presentation, which ZeroHedge has an even better version of here.   

Now, let's get to Taibbi's analysis:  "One friend of mine put it this way: say Goldman buys a big block of stock from a pension fund in a dark pool. Now they have shares they want to get out of and flatten out their risk. So where do they sell? Well, a big chunk of it might go to the retail schmuck who has no idea what’s going on. He’s buying 1000 shares of whatever at $28, not knowing that Goldman has another 50,000 shares to go. Next thing you know, the schmuck’s shares are at $27."

You don't have to be a professional trader to understand why Taibbi's "friend's"  logic is batshit crazy.  In fact, I'd expect any intelligent journalist who endeavors to write financial articles with impact to understand this simple concept:  If you're Goldman Sachs, your business model is not, has never been, and never will be to buy large blocks of stock from pension funds in dark pools and then unload them on unsuspecting retail "schmucks" at lower prices.   Buying at $28, selling at $27.  Sounds like a barnburner business plan - sign me up! (/sarcsm).

There's an old allegory about the farmer who bought watermelons for $10 and sold them at market for $9.  His friend asked him, "How will you make money doing that?"  "VOLUME!"  He replied.

That's basically what Taibbi's suggestion is:  that Goldman Sachs is buying large blocks of stock from pension funds, and turning around and selling small pieces of these blocks to poor innocent retail investors, thus driving the price down.  Somehow, I guess Taibbi believes, GS will make up for it in volume! By the way - there is almost no reason for any retail investor to use dark pools - since retail investors don't need to worry about other traders acting on their visible supply and demand - because it's so small.

I went back and pulled another Taibbi quote on high frequency trading, just for the fun of it:

"The people who are actively innovating on Wall Street are all involved in the business of gaming the system to take advantage of short-term price swings. The people who invest money for the long-term and stick with their investments are punished in this environment."

Hey Taibbi - guess what - that was my point:  you've been complaining about high frequency traders scalping visible supply and demand, and now you're complaining about the antidote to such high frequency traders.  It  may make for good click bait among the ignorati (I just coined that word, and I love it) - but it doesn't make sense in the real world.  Pick your battle - hate one or the other - or even neither - but as long as you hate both, you're proving your ignorance.

-KD

ps - usual disclosures - I do not, and have never worked for or received any compensation from Goldman Sachs.

Dark Pools Are Not Scary Shady Places That Rip Off Average Investors

The next step in the discussion about high frequency trading leads logically to the topic of dark pools.  I'm constantly mind-boggled to see the same people who were railing against high frequency trading proceed to dark pools as their next target.  Why is this so surprising to me?  It's simple:  dark pools are the antidote to high frequency trading.  They're where you go to hide from the computer algorithms who are making lightening fast trades in reaction to the bids and offers you post in the marketplace.

Let's take a quick step back.  One component of high frequency trading is what I'll call "pattern mappers" - algorithms that try to deduce how stock prices are going to move based on the bids and offers that are lining up in the marketplace on open books.  For example, if XYZ normally trades one million shares a day, and there is a bid posted for 100,000 shares, it might be reasonable for a high frequency trading algorithm, or any other market participant for that matter, to assume that there is more demand for shares than there is supply, and that the price of XYZ will go higher.  Of course, there is no guarantee that this will happen, and the person buying 100,000 XYZ may not ever change his limit.  So, the algorithm, we'll call her Patty Pattern Mapper, buys stock in XYZ hoping to sell it to the buyer at a higher price.  The big buyer, we'll call him Donnie Dark Pool, has other options though.  Instead of exposing his bid to Patty's pattern mapping algo on the NYSE, he can enter his order in a dark pool, where no one can see the order.  If, and only if, there is someone on the other side of his trade willing to sell shares to Donnie, the stock will trade.

Now, there are some key facts about dark pool trades that lots of people either ignore or fail to understand.   First, all dark pool trades, like any other trades, are required to be reported to the tape within 90 seconds.   Second, all dark pool trades, like any other trades, in accordance with Reg NMS, are required to take place within the inside market - the NBBO - national best bid/offer.  So, no matter how much Karl Denninger would like to construct an example where a stock is trading at $10 on the "open exchange" and there is a seller in a dark pool willing to sell shares at 9.90, which are instantly snatched up by Goldman Sachs  for $9.90 to resell to the open market at $10 - that simply does not happen.  The dark pool either routs the seller's order to the open $10 bid, the stock trades at $10 or better in the dark pool,  or no trade takes place.

Third, and most importantly, trades in a dark pool, or in any other marketplace, only happen when there are matching supply and demand for shares at a given price.  One misconception is that dark pools somehow unfairly allow buyers to buy large blocks of stock without moving the price.  Huh?  Yeah - they can buy large blocks of stock if there is someone willing to sell large blocks of stock.  Otherwise, they can either raise their bid in the dark pool until they find liquidity, or not buy shares.  It's impossible to buy "large volumes of shares" at "small volume prices."

An erroneous critique related to this third point is that "large supply of stock should make prices go lower in an open market."  David Weidner's column on Marketwatch gives an example of this common thought error:

"The problem, of course, is that bulky trades move markets. If I'm at Merrill Lynch and I need to unload 500,000 shares of XYZ, I can place the order in dribs and drabs -- through the multiple public markets out there including the Nasdaq, EDGE and Arca. But that order still is going to pressure XYZ's share price. Also, I'm going to be giving myself away. It also means that XYZ's share price should be lower because there are more shares for sale than buyers. That's how free markets are supposed to work, right?"

Is that how free markets are supposed to work?  If I want to sell stock at $15, large amounts of it, then the stock should trade lower?  No - I don't think that's a requirement of good, free, efficient markets at all.   Although, it is one area of market inefficiencies that the high frequency pattern mappers are experts at implementing.  The truth is that if I want to sell 1mm shares of stock at $15, the price need not go down at all.  The price goes down only when there is no one willing to pay $15 and I lower my limit to $14.95.  Then, when I exhaust the demand at $14.95, the price goes down again when I lower my price to $14.90.  Supply of stock at a given price (say $15) does not make a stock go lower.  Supply of stock at increasingly lower prices without a corresponding match in demand makes a stock go lower - this is a key point, and is not semantic nitpicking.  We're so accustomed to trading off of what we think other traders are going to do that it requires some philosophical forethought to understand this concept.   

In the ideal market, I believe that the entire marketplace would be dark - we need not even see bid and ask prices - just one last price.  Everyone can enter their bids and offers - their supply and demand - into this one big dark pool, and trades would print as matches were made, with no one worrying about being out-traded by Patty Pattern Mapper.

I believe it's totally consistent to have the view that both dark pools and  high frequency trading algorithms which exploit the bids and offers they see on open exchanges are ok.  However, I think it's logically impossible to be against both these pattern mappers and the dark pools which enable other traders to hide from them.  Furthermore, I believe its clear that individual investors are not disadvantaged by dark pools, and elimination of dark pools would result in higher execution costs.

-KD

Two Bands You Need to See

One of the things I'm going to miss most about NYC is the easy access to quality live music.  There are a number of venues within walking distance from my apartment where I can go on almost any random Saturday night and be quite confident that I'm going to see more than one band that will make me say "wow - that was well worth the $8 cover charge."

I actually pulled my wedding band out of the Lion's Den on Sullivan Street (now renamed Sullivan Hall) many years ago after seeing them randomly on a Thursday night, and recognizing their awesome talent.  My favorite band from the past few years, though, has been Leroy Justice, who I've had the privilege of seeing somewhere in the neighborhood of 20 times at venues varying from the Bitter End to Mercury Lounge.    Leroy Justice's Southern inspired rock is reminiscent of the Black Crowes, with a touch of Led Zeppelin and maybe some Jet thrown in for good measure.

The band is playing the Bitter End on Halloween, where they will perform 2 sets of music, including a full cover of the Steve Miller Band's greatest hits.   You will not regret making them a part of your evening.

The other band you absolutely cannot miss seeing right now is Sirsy - a duet who plays more than 200 live shows a year.   Melanie Krahmer plays a drum set standing up, while wailing on vocals, and occasionally picking up a flute as she continues to stomp on her base drum, as Rich Libutti accompanies mostly on bass guitar, sometimes adding piano or playing the snare with his feet.    Krahmer also wields her drumsticks like weapons - swinging them aggressively, like Sharon Stone in Basic Instinct might have.  To compare them to the White Stripes or the Ting Tings would be a total sin - as Sirsy is similar to those bands only in that they are all two piece bands.  Sirsy flat out rocks - with pure talent, and Krahmer's searing raspy voice  evokes reminders of Alannis Morissette, Janis Joplin, Pink and Pat Benatar.

Sirsy dominates the NorthEast, giving you ample opportunity to see them when they come to a town near you - don't miss them.

-KD

How Easy Is It to Transfer Credit Card Debt?

I forgot to talk about another MISH post that was interesting, regarding Citibank's decision to jack credit card rates to 29.99% on a number of customers.   My first thought is one of adverse selection - Citi's decision would force any sane person who has the ability to pay down their balance to find another card instead of paying Citi's usurious rates.  Citi would then be left with nothing but a steaming pile of customers who cannot pay their bills, and who would presumably get disenchanted with their prospects of ever being able to cover 29.99% APR's, and try to find a way to walk away from their debts to Citi.

But then I had an epiphany - what if Citi is brilliant?  What if they know that they have hundreds of thousands, if not millions, of customers who will be racking up increased defaults in the next 24 months, and thus increased losses for Citibank.  The solution?  Raise your rates so high that the customers are FORCED to transfer their balances to another bank's credit card! 

Now, in order for this to be their brilliant plan, these customers would have to have the ability to transfer their debt elsewhere.  I'm sure that 2 years ago this wouldn't have been a problem - but I have no idea how hard it currently is for someone who carries $5k to $20k in revolving credit card debt, while always making on time payments of at least the minimum, to transfer a balance to another bank's card.

Anyone?  Thoughts?  Is this a brilliant plan by Citi to force their at-risk cardholders into some other bank's arms like a hot potato?

-KD

Double Shot from MISH, and Other Links

Mike Shedlock is a blogger who writes frequently, with in depth and accurate assessments of economic policies and talking points.  Over the past few days, he posted two pieces I want to mention here.  The first is about government subsidies for pork bellies.  I found this one especially interesting because I had a very similar debate with my in-laws just a week before, over the topic of milk prices.  My wife's family grew up on a dairy farm, and my father in-law was complaining that milk prices are too low right now.  I responded that it's impossible for milk prices to be too low, because they are a commodity, and if they are too low, then farmers should stop making milk.  Now, milk is slightly different, because there is a long lead time, but we agreed that the problem was government intervention in milk prices (with subsidies to compensate farmers when prices fall)  which keeps weak farms in business, and maintains the status quo of OVERsupply of milk, surpressing prices.  On to Mish's thoughts on hogs, emphasis mine:

"It is absurd to think the government or anyone else owes farmers a profit anymore than computer consulting corporations or real estate agencies are owed a profit.

Yes farmers have a rough life. But everyone unemployed or underemployed has a rough life now. Farmers are raising too many hogs and prices are low. The solution is to raise fewer hogs, either voluntarily or involuntarily via bankruptcy.

When government steps in and offers price supports it keeps weak producers alive when they should go out of business, it encourages more production of unwanted goods, those goods stockpile up and then finally the US government dumps the excesses on foreign markets at whatever price it can get. The latter is an enormous source of aggravation for struggling emerging market countries."

MISH also had a nice piece on the effect of government stimulus.  Of course stimulus results in an increase in spending - the problem is that it results in temporary spikes which last as long as the stimulus does.  We saw this with CashForClunkers, and we'll see it when the Homebuyer Tax Credit finally ends.  To use an old analogy:  it's like giving another shot of alcohol to a drunk.  It postpones the eventual hangover, but cannot elminate it.

A related view of the same topic was expressed by David Einhorn in his remarks last week at the Value Investing Conference.  Some economists say the problem following the great depression was that the Fed withdrew its stimulative/accomodative monetary policy too soon, which resulted in a double dip recession in the late 1930's.  Einhorn notes:

"An alternative lesson from the double dip the economy took in 1938 is that the GDP created by massive fiscal stimulus is artificial. So whenever it is eventually removed, there will be significant economic fall out. Our choice may be either to maintain large annual deficits until our creditors refuse to finance them or tolerate another leg down in our economy by accepting some measure of fiscal discipline."

Finally, via ZeroHedge, Damen Hoffman of Wall Street Cheat Sheet goes head to head with Jim Cramer.

-KD

The Truth Behind the Data

The NAR is not a government agency. It's the National Association of Realtors - a trade group. Their entire mission objective is to ensure that the real estate market is healthy, and thus they, well, they basically lie about data to try to depict a rosier situation than actually exists.

The recent September home sales data contained a massive seasonal adjustment which resulted in the NAR trumpeting a "SURGE" in home sales. I'll let Barry Ritholtz take it from here:

This year, the fall was 5.3%. Hmmm, that was highly aberrational — I wonder why? We (and the NAR) know the reason: Due to ZIRP and the soon to be expiring 1st time home buyers $8,000 Tax credit, the drop was minor – much smaller than it usually is when we go from August to September in EHS.

The tax credit very likely extended the selling season by at least a month. It pulled some sales forward, and perhaps created other sales where there might not have been.

But the seasonal adjustment does not know that; The math PRESUMES THE AUGUST/SEPTEMBER DECLINE IS OF TYPICAL MAGNITUDE OF THE PRIOR 10 YEARS.

That creates a misleading — lets even say false — appearance when the seasonally adjustments are performed.

Again, someone trying NOT to mislead will inform the reader of that directly. But calling it a SURGE? Only if you are innumerate — or a liar. Any honest statistician who worked on these numbers KNOWS that the seasonal adjustment was going to create a big bump, a misleading number, based on the historical data.

And thats the whole point. The NAR knows that calling this a surge will mislead readers, but they report the data — DOWN 5.3% — as a “SURGE.” What else might their goal be BUT TO MISLEAD THE PUBLIC?

I refuse to facilitate that. And I will call anyone an unprofessional liar, a distorter of the data who claims this was surge. THIS MEANS YOU, NAR !

The folks who are unfamiliar with seasonal adjustments will get caught in the scam. This was not an ordinary seasonal adjustment — it was highly misrepresentative.

I know better. And now, you know better. Unfortunately, most folks do not.

-KD

Blogger Help!

So, I've upgraded my old template on Blogger.  I have a simple question for you wizards out there, since I'm not a master code monkey.  How do I get the main body of my posts to be WIDER, rather than 2 inches wide???

At the recommendation of an anonymous commenter, I also installed APTURE, which I will be experimenting with.  Unfortunately, it is useless until i figure out how to get the new Blogger template to work, which I am unable to do


-KD

Don't Payze Me Bro

A story I didn't comment on this week was that of the "Pay Czar" Kenneth Feinberg, who is going to limit executive pay for the top 25 employees at the biggest TARP teat sucklers: BankAmerica, Citi, AIG, GM, GMAC, Chrysler and Chrysler Financial. Even for a free markets capitalist like me, it's hard to complain about this - I mean, these firms have received oodles of government cheese, and I dare say that all of them would be up a creek without a paddle if not for the generosity of the taxpayer. Hence, the public's anger gets appeased with this symbolic offering: you certainly won't see the CEO's of any of these firms receive hundred million dollar bonuses this year. One problem is that especially at BAC, C and AIG, the top 25 titular ranked employees may not be the highest earning ones.

Marla @ ZeroHedge had an interesting post a few days ago on the subject - which I found especially intriguing because her readership generally disagreed with her.

"Citizens of the United States do not need a "special master" to deliver them a spanking for losing money. Nor do they need a handout from government coffers. It's time for enterprise in the United States to leave the nest and forgo both the extra bedroom that Mom will keep just like you left it "in case," and the time out room Dad will send you to if you blow it again. Punishing firms that accepted government funds, effectively under duress, and who have managed to actually pay those funds back (at a gain to the taxpayer, you might also notice) is a dangerous act. It is a clear sign that political whim and "sensitivity to public outrage" is driving economic policy. Again, this will all end in tears."

I strongly agree that firms who paid the funds, which were given without foresight of potential consequences (like public outrage over GS's massive bonuses) cannot be held liable forever. Also, I think the government meddling in the compensation of employees at non-government owned firms is an atrocious idea. However, the 7 firms in this case are not your average companies - they are the top of the pyramid of government largess, and I think that with these 7 companies, it's hard to disagree with limited compensation. Marla notes that populist policies can never be a good trend, which I agree with wholeheartedly.

Marla also explains:

"The proper way to have dealt with executive pay (which is a tiny fraction of corporate cost in any event) would have been to permit these institutions to fail. Period. You might notice that no one needs to modify Dick Fuld's pay today."

I agree 100% with this - but what do we do now that the horse is out of the barn? That's why I find it hard to argue with restricting comp at the worst offending firms.

Yves at NakedCapitalism also attacked the topic:

"The point is that the collection of these scalps will do nothing to comp levels ex these firms. The companies that also enjoy implicit government guarantees are free to do the “heads I win, tails you lose” game of privatized gains and socialized losses. And Ken Lewis is the poster child of why these measures are completely meaningless. He sacrificed his 2009 pay, but will still collect $125 million when he departs Bank of America. If the government is going to backstop the industry (and this isn’t an “if” anymore), it needs to limit those firm’s activities to what is socially valuable and regulate them heavily to contain risk taking."

I happen to very much disagree with that last sentence about ensuring that activities are "socially valuable." On the contrary - the key is to make sure that the activities are NOT socially DESTRUCTIVE. Those two conjectures are not equivalent. If the government is going to backstop an industry, like banking, it needs to make sure that none of the firms have the ability to take risks which have the ability to blow up our financial landscape. The government's job is NOT to make sure that banks are saving puppies and kittens and painting their offices in pretty pastel colors, or other "socially valuable" initiatives.


-KD
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Fool Me Thrice, Shame on Both of Us

We've all heard the old idiom "Fool me once, shame on you. Fool me twice, shame on me." In the words of GW Bush, channeling his inner "The Who" in the form of "Won't Get Fooled Again:"



Can anyone explain to me how John Meriwether is managing to launch a third hedge fund? For the uninformed, Meriwether was one of the principals behind Long Term Capital Management- the hedge fund which put the term "Too Big To Fail" on the map when it imploded in 1998 and necessitated a bailout orchestrated by the Federal Reserve. Somehow, Meriwether managed to start a new fund, JWM Partners, shortly after LTCM's blowup. JWM Partners closed last year after losing 44% amidst the market turmoil of 2008. Hedge funds typically have "high water marks" which means that investors don't pay performance fees to the fund manager in subsequent years unless the fund surpasses its highest point. Thus, the solution for fund managers whenever they have a bad year is to liquidate, wait a bit, and form a new fund?!?! Anyone who was invested in the old fund and the new fund thus pays fees twice: you paid when JWM Partners reached its high water mark, and now you'll pay again if/when Meriweather Cubed (not the real name) manages to make money - the same money JWM Partners effectively lost after reaching its high water mark.

Fool me once, shame on you. Fool me twice, shame on me. Fool me three times? Well, I guess we'll just go begging to the government for help when that happens...

-KD

Paradigm Shift - Live Free or Die!

The Dude chastised me for not posting enough again today. "Buddy - people want to read stuff every day - they don't want to go back every 5 days and have to scroll down for your posts, or find nothing new at all." Yes, yes, but sometimes worthwhile content doesn't jump up and throw itself on my screen every day. Stick with me, folks - you will not be disappointed.

There is big news in the Kid Dynamite household: we are leaving New York City. The change from a duplex townhouse garden apartment in the West Village to a massive house on multiple acres in the outskirts of Concord, New Hampshire will be a paradigm shift, to be sure, but Mrs. Dynamite and I are ready for it. She's been dying to get out of the city for a while, and I would rather try this new avenue than go back to work on the Street in NYC, so, that's the story. Live Free Or Die!

The most popular question is, "What are you going to do?" Well, same thing I've been doing: keep my chiseled physique in peak condition, devour massive amounts of financial information on the internet, act as the financial blogging community's ombudsman/fact checker, and switch to online poker. I hope to eventually start some sort of business - maybe a bar, microbrewery, coffee shop, or indoor soccer arena. Who knows. Oscar is almost certain to appreciate the change of scenery.



We will need a new car - we're looking at small SUV's that will be good in the snow. My mother-in-law raves about her Honda CR-V's handling in the snow, so that's a top contender, along with the Toyota Rav-4, the Subaru Forrester, the Nissan Rogue, and maybe the Hyundai Tuscon. If anyone has experience with any of these cars, please let me know your thoughts. Also, I've found TrueCar as a great source on new car pricing, and Edmunds as an excellent research resource. Are there other must-visit sites when shopping for a car?

I have some quality links today:

1) Dikshit sells most of his stake in Partygaming: I'm a Party shareholder, and this can't be good news. If Barney Frank were making any progress in getting online poker legalized in the US, why would Dikshit abandon ship? The logic in the article that the company needed him to sell his shares because the government doesn't like criminal shareholders is bunk - since his crime was running PartyGaming! Bones liked how the article pointed out the proper pronunciation of Dikshit's name: "Dikshit (pronounced Dix-it)"... yeah sure...

2) Fantastic Esquire article on the magic of the "$20 trick" - an entertaining account of the perks you can obtain by spraying $20's around to the right people

3) John Hussman's weekly note: "The stock market has never been this (intermediate term) overbought"

4) David Einhorn's comments from the Value Investing Conference: straight talk from one of the smartest guys out there, who also expresses himself very well in writing.

-KD

First, We'll Kill all the Bloggers

This NY Times article about the FTC requiring increased disclosure by bloggers, Twitterers, and others receiving free products in exchange for publicity absolutely shocks me. It's not that I'm against increased disclosure - I generally think more disclosure is usually better - but that the FTC - the Federal Fucking TRADE COMMISSION is going after BLOGGERS and TWITTERERS, as opposed to the mainstream media who, as I've discussed at length, has a MEGA agenda of their own...

"Some think it will help establish more professional standards, policing the kind of bloggers that Amber Katz, the founder of Beauty Blogging Junkie, calls “cloggers,” or bloggers who use their Web sites as platforms for soliciting the latest perfumes or garnering invitations to fashion industry events. “Cloggers will tweet about how they’d just love a free garment or accessory directly to a brand’s Twitter account,” she said. “They brazenly insist on tons of samples even though they haven’t been blogging long enough to build up any sort of readership.”"

Wait - so Ms. Amber Katz is angry that some beauty bloggers (cloggers!?!?!?) who she views as less worth are "brazenly" insisting on free samples that they don't deserve!??!?! STOP THE PRESSES!

Is the FTC going to require CNBC to publish a disclaimer mentioning that they are majorly incentivized to continually pump the markets with absurd spreading of ignorance, such as the importance of the "MYTHICAL" DOW 10,000 level (actual quote today on CNBC - MYTHICAL)? Is the FTC going to require every speaker on CNBC to mention that they have major incentive to talk people into buying stocks so that stocks continue to go up so that more people get talked into buying stocks (PONZI-RINSE-REPEAT) ???

No - the FTC has decided that some girl receiving free perfume and GAP jeans, and blogging about how much she likes the product, is violating the sanctity of American commerce if she doesn't disclose that she received a freebie.

Amazing.

In other news - this CNBC piece on the absurdity of the Las Vegas housing market is a must read. Excerpt:

"We went to a home that had been on the market for one day, and the key was stolen out of the lock box. Our Realtor said immediately, 'You want this home.' She told us another Realtor had stolen the key because they wanted their client to get it. So what did my Realtor do? She broke in. And sure enough this was the home we fell in love with. It was on for $132,000 so we decided to be really aggressive and offered $160,000, plus we had government backing on our loan. Well our Realtor called that night and said, 'You're not going to get the home. They got 30 offers and half are cash offers, so the bank is not even going to look at you.' The banks just want the cash to unload these places."

-KD

full disclosure: SHORT the stock market in general.

Using High Frequency Trading as a Scapegoat Has Jumped the Shark

Matthew Goldstein at Reuters wrote an article about what can go wrong when investors use stop-loss orders. A stop loss order is an order to sell your stock when it reaches a certain level to the downside - ie, if GE is trading at $16, and you want to lock in profits if it starts to fall, you can enter a stop-loss order to sell at $15. Then, if GE hits $15, your order will be entered into the marketplace. The catch is that if GE is plummeting and there isn't a lot of liquidity, you could sell your stock much lower than $15.

So, Goldstein describes a few investors who didn't understand that their stop-loss order doesn't guarantee them execution at their stop price. They were trading a lightening fast moving highly speculative biotech stock called Dendreon, around the time that Dendreon had news imminent regarding a potential cancer treatment drug. The stock started to fall, stop loss orders were triggered, stock was sold at a low price, and the stock quickly rebounded.

There are two real stories here: one is that the stock may have plummeted because a trader entered a "fat fingers" order in error - perhaps typing an extra zero onto the end of the order, and the other story is that someone intentionally may have leaked misleading information about the drug trial results in order to manipulate the stock. There's actually another story, and that's the danger of "market" orders, and how investors should never used them. Goldstein, however, decided to jump on the populist bandwagon, and blame high frequency trading for the price action in Dendreon's shares. He even titled his post "The Victims of High Frequency Trading." Talk about jumping the shark!

Goldstein's hack piece prompted Zero Hedge to write a post titled "Was HFT Responsible For Investor's Massive Dendreon Losses?" I think that even the guys at Zero Hedge know that the answer is "no," but they are in the business of generating page views, hence, the post.

I'm going to address some other concerns that the uninitiated may have about damage done by high frequency trading (HFT):

Did HFT kill Michael Jackson? NO

Did HFT cause the breakup between Jon & Kate Gosselin? NO

Was HFT responsible for Obama winning the Nobel Peace Prize? NO

Did HFT get Kourtney Karsdashian pregnant? NO

Is HFT helping Osama Bin Laden hide in the mountains of Afghanistan? NO

Did Jonathan Paplebon allow 3 ninth inning runs on Sunday against the Angels, resulting in the end of the season for the Boston Red Sox because of HFT? NO

Can HFT spread swine flu (H1N1) ? NO

Could HFT beat George St. Pierre in the octagon? NO

Can the dominance of the NY Yankees be explained by HFT? NO

Did HFT cause the tsunami in Samoa? NO

Did HFT help Iran obtain nuclear facilities? NO

Does HFT hate health care reform? NO

Put. Down. The. Pitchforks.

-KD

Weekend Reading

Here's what caught my eye over the past few days:

Accrued Interest on the Fed's purchases of agency paper and interpreting the facts rather than sensationalizing them.

The U.S. States suffer "unbelievable" revenue shortages.

NY Times: Congressional Panel Says Obama Plan Will Not Slow Foreclosures.

"On Thursday, Treasury announced that 500,000 homeowners had since had their payments lowered on a trial basis, celebrating this as a milestone.

But the report from the oversight panel directly challenged the administration’s characterizations.

Most prominently, the panel had grave uncertainty about whether large numbers of the trial loan modifications — which typically run for three months — would successfully be converted to permanent terms.

As of the beginning of September, only 1.26 percent of trial modifications that had made it through the three-month trial period had become permanent, the report found. Of course, very few of those trial loans had reached their three-month expiration because the program only recently began processing large numbers of applications. As of Sept. 1, the Obama plan had produced 1,711 permanent loan modifications.

Some homeowners complain they have received trial modifications only to have them canceled for what seem dubious reasons — checks sent but supposedly never received, documents once in the file but suddenly missing."

Naked Capitalism on the FHA:

"My objection is that the article implies that low down payment loans are a bad idea. They aren’t necessarily. Low down payment loans can be a viable business, but lenders need to screen borrowers much more carefully than when they have a much bigger loss cushion.

And using low down payment loans as a way to prop up the housing market IS a bad idea. The fact that the FHA is cranking so many loans through more or less the same administrative platform is strong evidence that its lending standards have gone out the window."

Calculated Risk on the FHA:

"“I don’t think it’s a bad thing that the bad loans occurred. It was an effort to keep prices from falling too fast. That’s a policy.”
Barney Frank, chairman of the House Financial Services Committee on recent FHA lending."

Naked Capitalism wonders why no one is talking about how 34 banks missed their TARP dividend payments:

"Of the 34 miscreants, two are pretty large, namely AIG and CIT, But the next on the list is First Bancorp, which received a mere $400 million from the TARP. Probably more important than the number is the trend, since the number of institutions that skipped dividends nearly doubled. In a supposedly improving economy and with a steep yield curve (at least until very recently), things appear to be getting worse rather than better.

I didn’t post on this because I assumed the MSM would be all over it. So I am pretty surprised to see it has gotten very little coverage. The usual suspects (Bloomberg, Financial Times, Wall Street Journal, New York Times) were silent."

Howard Marks in NY Times Dealbook:

"I think the crisis came about primarily because people of all stripes did novel, complex and dangerous things, in greater amounts than ever before. In the world of investing, for instance, people made excessive use of borrowed money — “leverage” — and committed too much capital to illiquid investments. It all happened because people believed too much, worried too little and thus took too much risk.

Worry and its relatives, distrust, skepticism and risk aversion, are the essential ingredients for a safe financial system. To paraphrase a saying about the usefulness of bankruptcy, I think fear of loss is to capitalism as fear of hell is to Catholicism. Worry keeps risky loans from being made, companies from taking on more debt than they can service, portfolios from becoming overly concentrated, and unproven schemes from turning into popular manias. When worry and risk aversion are present as they should be, investors will question, analyze and act prudently. Risky investments either won’t be undertaken or will be required to provide adequate compensation in terms of anticipated return."

The New Yorker on the madness that is Martin Armstrong (courtesy of Barry Ritholtz)

Vanity Fair's long must read piece on the efforts that were made last year to save MS and GS during the financial crisis. Lost in this excerpt is how incompetent it makes Ken Lewis look again - as the piece illustrates how other CEO's (Dimon of JPM refusing to buy MS) had the balls/integrity/gumption/call it what you will to say no when bullied by Geithner and Paulson.

South Park: Billy Mays pimps Chipotlaway!




-KD

Rampant Mis-Information - and the Responsibility of Financial Bloggers

It's not that I don't like Matt Taibbi. I have a subscription to Men's Journal, and Taibbi's sports-related pieces are always worth reading and usually laugh out loud funny. For example, from his piece several months ago on all-time ugly athletes:

"Then there’s Kevin Youkilis. Youk has only three body parts, all hideously oversized: an enormous set of gnomish, bushy forearms; a massive, casaba melon–size white head; and a cauldronlike belly. He has a truly awesome bristle of thick red chin hair that makes his face look like a cross between a vagina and something out of The Hobbit. At the plate he disgustingly gushes sweat by some means previously unknown to science in which the moisture travels upward along his body, racing in a cascade from his balls and armpits up his neck, over his head, and back down over the bill of his helmet to shower the plate. Whereas a guy like Teixeira was born with a swing so gorgeous you want to paint it, Youkilis fighting a middle reliever to a nine-pitch walk looks like a rhinoceros trying to fuck a washing machine."

See - that's accurate, well written, and funny. If I want to read a lucid comparison of Youk's face to a Hobbit-esque vagina, I'll look for Matt Taibbi's name in the byline. However, if I want to read factual financial articles that demonstrate a solid understanding of what is actually happening, I am knowledgeable enough to know that Taibbi has very little idea what he's talking about. This is the reason I'm bothering to write a post about a little tete-a-tete between Taibbi and Clusterstock's John Carney on the subject of naked short selling. There are few things less rewarding than internet blog post battles - one of them being interfering in other people's internet blog post battles, but I take my self appointed role as "Protector of the Accuracy of Financial Information on the Internet" very seriously, so I'm stepping into the fray. We'll just stick to this week's happenings, and ignore the stuff from last week where Taibbi posted a presentation from GS about market structure and reached the conclusion that GS was using the presentation to lobby congress to allow naked short selling.

First, Taibbi posted a video that purported to show a trader nearly instantly obtaining a locate (which you need to do in order to short stock) on "tens of billions of shares" of a stock that only had 4.5B shares outstanding. Clusterstock's Carney misread Taibbi's post, and responded that Taibbi was a sucker for believing that someone actually shorted tens of billions of shares of said stock, and that some common sense would allow anyone who understands the process to reach the conclusion that there is no way that trade happened.

Matt Taibbi retorted that Carney was an idiot, and that he (Taibbi) never said that the trade happened (although, Taibbi DID say that: ":17 At seventeen seconds, at the bottom, you see that the firm Penson has now approved the trade and” located” the multibillion amount of shares. The trade goes through.") - insisting that he claimed only that the trader was able to quickly obtain a locate which 1) should have been impossible to obtain and 2) should CERTAINLY have been impossible to obtain so quickly, and that the actual trade was for only 100 shares. Taibbi is absolutely right on these two points - the locate should have been impossible to obtain, especially with such speed. But here's the kicker: Taibbi's video shows nothing of the sort. I'm not going to link the video here, because I'm not going to take part in spreading the mis-information - but what is shown in the video is a simple audit trail requirement. Let me explain.

Daily, traders and brokers will obtain a list of easy to borrow stocks, which get loaded into their trading system. If you go to short GE, it's on the "easy to borrow list," and as long as you don't try to short 10,000,000,000 shares, you won't have to call your stock loan department to "borrow" shares to short - everyone knows the stock is readily available. Other stocks, however, like Citi (which is almost certainly the stock in Taibbi's video) can at times be difficult to borrow - like during the summer when they were doing an exchange of preferred stock for common stock, and everyone wanted to be short the common (and long the preferred) to arbitrage the spread between the two share classes.

So, if you try to short Citibank (a few months ago), any good execution system will check its easy to borrow list, see that Citi is not on the list, and ask you where your "locate" is from - in other words, which broker agreed to lend you the stock. There are also many electronic systems where you can request a stock locate electronically - but this is not what's in Taibbi's video! What the video clearly shows is that the stock in question (let's call it C) is on the hard to borrow list. The trader gets a warning message saying that the stock needs to be borrowed, and asking for the trader to either submit the borrow information or elect not to submit the trade.

The trader in the video is NOT submitting a request for the stock to be borrowed - he's entering information into an audit trail point asking WHO the stock was borrowed from, HOW MUCH was borrowed, and WHEN it was borrowed - exactly to prevent problems related to naked short selling! This way, if the seller fails to deliver shares, the broker can easily pull the exact reference that was used for the short sale. Of course, just because I say that I was able to obtain a locate for a gajillion shares of C doesn't mean that I actually was able to - and that's why especially hard to borrow stocks should have another level of compliance checking embedded in them. If this trading system in the video allowed a trader to claim a locate that was clearly impossible, then that's a condemnation of the inadequacy of this trading system - not of the borrow market and the legitimacy of short selling. Fortunately, there was no naked short sale of tens of billions of shares of C on this trade, and Taibbi's post is a gigantic misunderstanding of what was actually going on. Of course, it's especially scary when people jump to his defence (in the comments of both his posts and of Carney's posts) and thank him for highlighting such injustices - never failing to mention how Goldman Sachs is stealing money from poor old grandmothers at the same time.

Journalists with the clout of Matt Taibbi need to take special care to ensure that their reporting is accurate, especially when dealing with topics that the general public clearly doesn't understand. It is essential that we provide MORE clarity to the uninformed, rather than misinterpreting the facts and stirring up a hornets nest of anger when none is warranted.

-KD

disclosures: I am not currently, and have never previously received any type of compensation from C, GS, Men's Journal, Matt Taibbi, John Carney, or Clusterstock.