Senator Bunning's Office Responds

I received an email on Thursday from Senator Jim Bunning's legislative director, William Henderson.  Unfortunately, it was sent to my secondary account, and I didn't notice it until this evening when I returned home from a weekend trip.  I feel it's only fair to post Mr. Henderson's email in full, as it is a response/clarification/enhancement to the post I wrote last week titled "Emergency Powers."  And oh, Mr. Henderson - if you ever want to contact me, drop me a comment on my blog.  It's a much quicker way to get in touch with me, and I'm happy to provide further input on the policies you guys are looking at.

Without further ado:

KD, I enjoy the blog and am a regular reader. It has been helpful as we have been working on the financial reform bill and, most recently, the stock plunge hearing today.

I wanted to clarify what Sen. Bunning's comments regarding emergency powers at the hearing today. His point was that the SEC and the exchanges have identified some changes they think should be made (the new trading curbs) but those changes are not yet in place and able to be used because the SEC's rule approval process takes a couple weeks. He was inviting Schapiro to ask for the ability to make such changes faster if she thinks that is appropriate. That is what he meant by emergency powers.

Regarding market orders, he agrees with you. I'll paste an exchange that started with Eric Noll of NASDAQ and Larry Leibowitz of NYSE Euronext on breaking trades and ended with a bit on market orders.

Finally, he said at the beginning of the hearing that he was glad to see the curbs are for moves in either direction, and not just down.

Hopefully this will allay your concerns a bit.

W

Mr. Henderson also included the exchange to which he was referring:

"Transcript:

BUNNING:
    It's all right. Thank you.

    Mr. Noll, I'm going to start this question with you, since you talked about it more in your written statement than anyone else. But I would like the others to respond as well.

    As I said in my statement, I am concerned about the way some trades were canceled. Given that everyone seems to agree the system worked the way it was set up to do, how do you justify canceling trades and protecting sellers from their bad decisions?


NOLL:
    I -- I share much of your concerns, Senator Bunning. And it was a very difficult day to make that decision. It was done in coordination with all of the other markets on an ongoing discussion and, quite frankly, lasted many hours trying to decide what the appropriate decision was fair.

    So we were trying to balance the need and requirement of what we would call moral hazard issues, which is making people aware and bear the consequences of their activities in the marketplace for good or for ill, with what was clearly a dysfunctional marketplace that wasn't functioning as it should function.

    So in the absence of any clearly erroneous trade, we looked at the DK of what we would call price discovery and the provision of liquidity.



NOLL:
    And we tried to draw that line -- admittedly somewhat more arbitrarily than I think any of us are comfortable with -- draw that line in an appropriate area where we did not reward anyone for bad behavior, but we did solve the problem of what we considered to be a dearth of liquidity.

    That being said, I think we are very confident that the stock-by- stock circuit-breakers that we're putting into place will prevent a reoccurrence of this kind of situation.


BUNNING:
    Looking back, we all have 20/20.


NOLL:
    I think that's true. So we -- we -- we believe that we'd like to put the stock-by-stock circuit-breakers in place. We think that will prevent this going forward, these kind of events going forward, but more importantly, we endorse Chairman Schapiro's desire that we have transparent, understandable, agreed-upon across all markets trade break clearly erroneous rules that remove the discretion from any one market actor or any group of market actors so that everyone knows visibly and clearly what those -- what those events are and how they will be triggered.


BUNNING:
    Anybody else like to jump in? Go ahead.


LEIBOWITZ:
    Sure. Sure. So I had the fortune of sitting on the Nasdaq Quality of Markets Committee at the time that the first erroneous trade policy went in. And I think, Rick, you were actually...


KETCHUM:
    I was there.


LEIBOWITZ:
    ... the CEO at the time or the COO at the time. And it troubled me then, and it troubles me now. Markets that have to resort to breaking trades as a response to abhorrent (ph) conditions are -- are -- are just not orderly markets, in my mind. It's not the way we should do our business.

    I think, in this case, the big challenge wasn't we had institutional investors who made a mistake. You know what? You're right. They should pay the price.

    The challenge here was that we had retail investors who had submitted market orders that essentially went into a black hole. They had stop-loss orders in high-cap stocks...


BUNNING:
    But -- but I'm sorry, sir. Sophisticated -- even if they're not sophisticated, anybody that puts a market order in knows exactly what's going to happen to a market order.


LEIBOWITZ:
    So I would agree with you that their broker probably does -- and maybe the answer is the broker should have stood up (ph) for that trade -- I would submit to you that a lot of the public does not. And I'll tell you...


BUNNING:
    A lot of the public doesn't know that if you put a market order in, it's executed?


LEIBOWITZ:
    They think, maybe it'll go -- it'll go -- you know, I'll be...

    (CROSSTALK)


BUNNING:
    Rather than a limit order?


LEIBOWITZ:
    Well, they don't realize that, when I trade Accenture, it's going to be down 99 percent when they get now.


BUNNING:
    I agree with that.


LEIBOWITZ:
    And -- and...

    (CROSSTALK)


BUNNING:
    But if you put a market order in, that's your execution.


LEIBOWITZ:
    You're absolutely right in that regard. And I think we have to make sure that it just can't happen in the market. We also need to talk about whether market orders should be allowed at all and how we educate people so these things don't happen.

    But I agree. There should not be the moral hazard of breaking trades. It is not the right way to make a market function properly."

It's good to see that Bunning understands exactly what a market order is, and I agree with Larry Leibowitz that the retail public does NOT understand exactly what a market order is, and that reform is needed to either educate the public so that there is no whining and there are no "victims" after the fact, or to simply protect Joe Retail from himself by preventing him from entering market orders.

-KD

Bloomberg Writes Some Headline Click Bait

How else could you describe this one:

"Strippers Declare Inflation Dead in Zero Coupon Bond Revival"

Nope - the article doesn't contain a single mention of stagnant prices for gentlemen's club dancers - Bloomberg was referring to the process of bond coupon stripping.  Sneaky.

I'll be offline thru Monday night.

-KD

Friday Links

Some of these I sent out on Twitter already:

 - Headline of the week: "18 Orgies Later, Chinese Swinger Gets Prison Bed."

 - Dubious Politician of the week: "Blumenthal's Words on Vietnam Service Differ from History."  Then today, this follow up:  "Another Case of Blumenthal Misstating Service."

 - Not as easy at it seems article of the week: "Padded Pensions Add to New York Fiscal Woes."

I say "not as easy as it seems" because I think the initial reaction is to say "that's f'n crazy."  And yet, I sympathize with the policeman who they talk a lot about in the article, who defended the situation:

"Mr. Tassone said the only reason he joined the police force was the promise of a full pension after just 20 years, and it would have been wrong for the state or city to go back on the promise after using it to recruit him."

Yes - they did promise it to him, and it's hard to just tear up that obligation...   I don't think it's reasonable to expect that Mr. Tassone could have reasonably assessed the likelihood of the City of Yonkers running out of money in the future when he took this job.  HOWEVER, the article also talks a lot about the manipulations used to increase pension payments ("Hugo Tassone, retired at 44 with a base pay of about $74,000 a year. His pension is now $101,333 a year,") which can certainly be cracked down on.  

 - early 90's crank calling comedy group reference of the week: "Greece & The Jerky Boys." Yeah - that's my own link - it didn't get enough love! RESPECT!

-least repentant accounting of the market's function during the Flash Crash:  Taste_Arbitrage @ Stone Street Advisors.

"I keep hearing how terrible this event was, and if nothing is changed it could happen again. Oh no, what ever shall we do?! Here’s a thought, if you think the price of a security is too low and you think it’s insane that it doesn’t seem to have a bid, you should just go ahead and bid. That’s it. If the price is too low, pay it and make money."

- David Merkel : "Two Experiments."

"The Fed always delays trouble in the modern era.  Slow to tighten, quick to loosen.  No wonder that we built up a mountain of debt, because the Fed would always ride to the rescue of crises, but never let the pain settle in that would liquidate poor investments.

We need fewer banks, fewer homebuilders, and fewer auto companies.  But guess what we bailed out?  We bailed out the very things that were the least productive in our economy, and taxed those more productive to do so.  Monstrously dumb.

So when the market corrects because there has been no effective change in economic policy that would allow for elimination of bad debts, and shrinkage of bloated industries, we should not be surprised.  Government stimulus can only do so much.  The markets incorporate the stimulus, and they move on.  Those stimulated gain, and taxpayers/moneyholders lose, but the markets move on."

 - Gold conspiracy theorists won't like this one:  "Seriously, GLD is Not a Scam, but PHYS Might Be."  I think the author has a factual error in her post which doesn't really alter the point:  she claims PHYS cannot issue additional shares  - I believe that is false, and a reading of the PHYS prospectus backs up my thought.

- Michael Panzner:  The Fed and Treasury Can't Get Their Stories Straight

-KD

Emergency Powers!!??!

From the NY Times' Dealbook:

"Federal market regulators are still unsure about the cause of the sharp stock market drop two weeks ago, and that worries Senator Jim Bunning."

Let me interrupt here - I'll tell you the cause of the sharp drop:  more sellers than buyers! If we're talking about the aberrant prints, like 1c in ACN, you don't need Sherlock Holmes for that one either:  sellers came in to sell stock regardless of price, and there were no buyers. 

"Mr. Bunning, Republican of Kentucky, told Mary L. Schapiro, the chairwoman of the Securities and Exchange Commission, that she should request emergency powers from the Senate to do whatever is necessary to prevent another market plunge until the cause of the May 6 flash crash can be determined. 

“If we get bad news out of the I.M.F. or Greece or Portugal or something that could have an adverse affect on our markets, we could see the exact same recurrence and we haven’t done anything,” Mr. Bunning said at a Senate hearing on Thursday."

Senator Bunning - there's an easy fix for this:  make sure that retail traders know that "market order" means "regardless of price."  Make sure that retail traders know that "stop orders" become "market orders" when their stops are triggered.  Once you protect the retail traders, no one care if the professionals shoot themselves in the foot with bad order types.  Yet, Bunning wants the SEC to have "EMERGENCY POWERS!"  Bunning:

“I think there comes a time you take emergency actions and if we are in that situation that we need emergency powers, all you have to do is come here and ask,” Mr. Bunning added.” We don’t want a recurrence, and we surely don’t want to arbitrarily break up trades that were legitimately done under a set of rules, and I would urge you to come and ask this committee for emergency powers.”

I can only hope that the literal translation of what Bunning means is NOT "If it looks like stock prices are going to go a lot lower, and there's nothing that can be done to prolong the Ponzi scheme, please let us know and we'll put regulations in place to prop up stock prices."

Cause that's what it sounds like to me, but maybe I'm just being cynical...

My favorite part of the article sounded like a little cynicism from the author:

"It is unclear as to what emergency powers the Senate could grant the S.E.C. to hold off another flash crash, given that the origins of the first disruption has yet to be determined."

-KD

It's So Easy In Hindsight

My friend Ted sent me this story yesterday - a flashback from November, 2007.  All you really need to know is the headline: "Rappers join models in insisting on Euros as Greenbacks fall further out of fashion."  In hindsight, I can only facepalm myself, and wonder how I didn't recognize one of the greatest contrarian signals of my generation.  Rappers & models....

-KD

note: to be fair, the Euro (vs USD)  is only now trending below the Nov 2007 level, so if the rappers & models were quick and nimble with their FX trading, they could have made out great on the trade.

The Fed on Housing

Mr. Griffey got neutered today.  We picked him up at 5pm, and he's been staggering around like a drunk all night, feeling the after-effects of the anesthesia.   Hopefully he'll feel better tomorrow and won't need to wear the cone on his head...

Anyway, one thing I found worth mentioning today:  the FOMC's minutes, re: housing, via CalculatedRisk:

"Moreover, the recovery in the housing market appeared to have stalled in recent months despite various forms of government support. Although residential real estate values seemed to be stabilizing and in some areas had reportedly moved higher, housing sales and starts had leveled off in recent months at depressed levels. Some participants saw the possibility of elevated foreclosures adding to the already very large inventory of vacant homes as posing a downside risk to home prices, thereby limiting the extent of the pickup in residential investment for a while"

Key word:  "DESPITE."  Just imagine what happens when the "various forms of government support" stop...

-KD

Ban Market Orders!

The SEC, in their 150 page report on the May 6th crash, has section (around page 75) on "potential regulatory responses".  I found this interesting, since I've been constantly repeating that we should ban market orders if we want to protect people from themselves:

"We are considering ways to address the risks of market orders, and their potential to contribute to sudden price moves. Areas under consideration include: (1) requiring market order “collars,” thereby effectively converting market orders into limit orders; (2) prohibiting or limiting the use of market orders; (3) requiring broker-dealers to specifically warn retail customers about the risks of market orders, particularly in volatile markets; and (4) pursuing investor education initiatives as to the risks of market orders."

I'd be shocked if they implemented #2, but it's the simplest and most effective solution, and removes any and all potential excuses from the execution side of things.  I've specifically discussed all four of the potential changes the SEC detailed in that paragraph above.    Mary Schapiro - you could at least give me a hat tip...

-KD

SEC: Comment Period for Individual Stock Circuit Breakers

I gave you this story last week.  Today, it's official.

"Under the proposed rules, which are subject to Commission approval following the completion of the comment period, trading in a stock would pause across U.S. equity markets for a five-minute period in the event that the stock experiences a 10 percent change in price over the preceding five minutes. The pause would give the markets the opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion."

-KD

History Repeats Itself

Cliche:  History repeats itself because no one was listening the first time.

This morning's Bloomberg story of interest involved the continued acceleration of ignorance of risk and potential pitfalls, even though we just went through this scenario.

"Two years after suffering $213.2 billion of losses when debt markets froze, investors in junk bonds are accepting what Moody’s Investors Service calls the weakest creditor protections since 2007. 

Even with housing starts hovering at their lowest levels on record, Beazer Homes USA Inc. managed to sell bonds this month on terms that allow it to add more debt. The Atlanta-based builder couldn’t even do that when it issued debentures at the height of the housing bubble in 2006 and its credit rating was seven levels higher. In a report last week Moody’s singled out CF Industries Inc., Standard Pacific Corp., AK Steel Corp. as borrowers offering debt on terms historically available only to higher-rated companies.

“We got ourselves in trouble with that in the past and here it is again,” James Kochan, the chief fixed-income strategist at Wells Fargo Fund Management in Menomonee Falls, Wisconsin, said of the trend toward looser debt covenants. “It’s not that surprising, but it is disturbing,” said Kochan, who helps oversee $179 billion. "

Beazer Homes is issuing debt with investor-unfriendly covenants that it couldn't even issue at the peak of the bubble!  Shocking.  I mean - ignorance of risk is one thing, but ignorance of risk in a home builder?  Really?  I must be living on another planet.  

"Lenders are letting down their guard just as worsening government finances raise doubts about the sustainability of the global economic recovery. Money managers say they have little choice but to go along. They need to find a home for the record $29.4 billion that has flowed into high-yield bond mutual funds the past 16 months from retail investors seeking to join in a rally that has produced an average 69 percent return since the market bottom in March 2009."

Oy vey.   And THIS is why I blame the Federal Reserve's zero interest rate policy (ZIRP) for the current situation, folks - the bastardization of risk pricing and asset prices.  "Money managers say they have little choice but to go along" ??? Really?  And if/when it goes bad, what happens?  We blame the banks who underwrote it, right?  (that's where I need my SARCASM font!)   This is also what I meant when I explained to a commenter on a  previous thread that the Fed can indeed effect the entire corporate risk curve, not just the treasury curve - ZIRP forces investment, even where rational investment wouldn't be made.

It's a well known fact that there are cycles of risk appetite and avoidance on Wall Street - I'm just shocked at how short those cycles have become.  We JUST concluded the biggest orgy of debt consumption in our nation's history, which I'd dare to say ended badly,  and it's almost like it never happened.  Even though we saw the results of covenant-lite loans, they're back with a vengeance already!

“This trend represents more than an episode of ‘back to the future,’” Moody’s analysts including Alex Dill, the firm’s senior covenant officer, wrote in their report. “It reflects a weakening in covenant protections even below those existing at the peak of the market, in 2006 and 2007.” 

Weaker covenants than at the peak - the peak of the bubble of all debt bubbles!  WTF?

Well, at least we can offer on explanation, after we get to the details:

"Beazer sold $300 million of 9.125 percent bonds due in 2018 on May 4 that carry lighter restrictions than its 2006 issue on the amount of debt the builder can add and how it can use money raised from selling assets. The terms also allow Beazer to double its capacity to pay dividends to shareholders even after a 90 percent drop in its stock, according to Covenant Review."

"The company’s senior unsecured bonds are rated Caa2, which Moody’s defines as “judged to be of poor standing and are subject to very high credit risk.” Beazer was rated Ba1, one step below investment grade, in June 2006, when it issued $275 million of 8.125 percent 10-year notes."

Ok - so Beazer's credit rating is lower, and they're paying a higher interest rate than they did at the peak of the bubble - that much makes sense.  Why, though, are buyers of the debt making concessions?  The buyers should be the ones in control.  Ah - but it gets back to the Fed and ZIRP, and should give us an idea of exactly how powerful the Fed's effects are:  there is so much capital out there looking for a positive yielding home that even companies like Beazer, a troubled company in a troubled industry, can get investors to make concessions.

Capital re-deployment is precisely what the Fed wanted - I'm guessing ignorance of risk is NOT what the Fed wanted, but it's a side effect nonetheless, and will bring me back to the word I've often used to describe the situation:  PONZI.

A closing quote:

“In 2008, all the companies that we said would screw the bondholders did it,” said Cohen of Covenant Review. “Now, it feels like 2007 to me. We’re telling them they’re going to get screwed and they’re not paying attention.”

Note: related, via Paul Kedrosky:  "The Triumph Of the Stupidly Optimistic."

-KD

Beaten To the Starting Line on Another Business Plan

One of my best business ideas that would have been relatively easy to do was to create a sarcasm font.  We all know that sometimes sarcasm can get lost in emails or on the internet, but if we put it in a special font, it would be easy to recognize.  Unfortunately, I didn't move quickly enough on this one, so I'm not the one who gets to give out the sarcasm denoter for free download - here is: The SarcMark. Strangely, they have a video ad which purports to demonstrate uses of sarcasm, but uses several examples which are not at all good demonstrations of sarcasm...

-KD

Quotable: John Hussman

From John Hussman's weekly piece:

"ECB President Jean-Claude Trichet has been quick to deny concerns that the move by the ECB will be inflationary, emphasizing that the intervention will be "sterilized" in order to prevent a major increase in the amount of euros outstanding. This is "totally different," he argued last week, from the massive increase in monetary base that has occurred as the U.S. Federal Reserve has bought up over $1.25 trillion in debt obligations of Fannie Mae and Freddie Mac. A "sterilized intervention" is one where the euros created through the purchase of distressed Euro-area debt will also be absorbed by selling other assets from the ECB's balance sheet, in order to take those euros back in. 

In order to evaluate the arguments being made, it's helpful to understand the balance sheet of a typical central bank. Whether in the U.S., Europe, or elsewhere, the basic structure is the same. On the asset side, the central bank has government debt that it has purchased over time. A small proportion of total assets might be held in "hard" assets such as gold, but primarily, the assets of each central bank has traditionally represented government debt - mostly of its own nation (or in the case of the ECB, euro-area governments). As a central bank purchases these securities, it creates an equal amount of liabilities, in the form of "monetary base" (currency and bank reserves). 

Notice, for example, that the pieces of paper in your wallet have the words "Federal Reserve Note" inscribed at the top. Currency is a liability of the Federal Reserve, against which it has traditionally held assets such as Treasury securities, and prior to 1971, at least fractional backing in gold."

but this is the part I really liked, emphasis mine:

"In this context, consider the ECB's proposed 750 billion euro line of defense. Essentially the ECB is saying "We stand ready to buy as much as 750 billion euros of distressed Euro-area debt in order to defend the euro." Simultaneously, despite the fact that Euro area countries are running large fiscal deficits, the worst being in Greece, Portugal and Spain, the ECB is saying "However, we intend to sterilize this intervention, which will ultimately require that we sell Euro-area debt into the market in order to absorb the euros we create." The only way that both statements can be true is for the ECB to admit "Therefore, we are fundamentally promising to debase the quality of our balance sheet, by exchanging higher quality Euro-area debt with lower-quality debt of countries that are ultimately likely to default." 

Far from being "totally different" from what the U.S. Federal Reserve has done, the ECB is essentially promising exactly the same thing - to corrupt its balance sheet and debase its currency in order to protect the worst stewards of capital from the consequences of bad lending and poor investment."

-KD

Sarcasm - MGM - Paulson

I just found out that John Paulson is on the other side of my trade.  I'm short MGM, and he filed his latest 13-Fs today, showing ownership of 40MM shares. WTF?!?!?  This is so unfair. If I knew Paulson was on the other side of the trade, I never would have shorted the stock.  I'm going to sue Etrade for not telling me about this.

-KD

note: this post is sarcasm - I even put it in the title to avoid confusion. if you don't get the reference, don't sweat it - it's not worth your trouble.  also, it's important to note, despite mainstream media confusion to the contrary,  that the suit against Goldman Sachs isn't about the fact that Paulson was on the other side of the trade, but that the person on the other side of the trade (who happened to be Paulson) may have played a larger-than-stated role in the design of the portfolio.  Anyway...

note 2:  Paulson's purchase of MGM actually surprised me. I understand his purchase of the banks (which I'm also short!) - he's playing the "shake hands with the government" card, but MGM had me scratching my head.  I was wondering if it was possible that he might somehow be short their recent convert and long stock against it, but that's about 6 sigmas.  He also bought BYD, so I guess he's just bullish on Vegas, which I can't fathom.   Dirty Dave chimed in with a suggestion: "Hedging his upcoming stay at Aria's baccarat salon?"  As usual with Dirty Dave's inimitable wit, if you get it, you love it.  If not, well, on to the next post...

GM Wants More Subprime Buyers

Last week I linked to a story about how GM wanted to get back into the  financing business.

Today's AP headline had me tilting my head and raising my eyebrows in surprise:

"GM Wants More Subprime Buyers"

"GM's top North American executive Mark Reuss, under pressure to quickly sell more cars and boost GM's value as it gets ready to sell stock to the public, said a shortage of subprime lending is holding back sales in the U.S.

But the automaker's main lender, Ally Financial Inc., has little appetite for risky loans, having spent the last few years cleaning up its own financial mess caused mainly by its failing mortgage lending business. Both companies are majority-owned by the U.S. government.

For decades, GM owned Ally, writing its own loans through the so-called captive finance arm. Nearly every automaker makes loans in such a fashion. But a cash-starved GM sold most of Ally -- formerly known as GMAC -- in 2006.

GM and Ally now have a loose partnership that gives Ally control over who gets a car loan. If GM returned to auto lending -- either through buying Ally's auto business or starting its own in-house lending unit -- it could set lending standards itself. That could benefit the automaker by allowing it to extend loans to people with weaker credit and to more lease customers."

Amazing, right?  GM's business plan to sell more cars is to give loans to less creditworthy customers.  Wow.

The article notes:

"For example, Honda Motor Co. gets 20 percent of its sales and leases from subprime buyers, he said. GM, on the other hand, gets only 1 percent because it can't access the money to loan to those customers."

and then:

"Ally has been less than eager to resume lending to risky customers."

That damn Ally and their prudent lending practices!!! (/SARCASM!)

Now, to be fair, subprime auto loans are not quite as devastating as subprime home loans:

"Subprime lending for cars is generally considered less risky than mortgages. During the recession, borrowers didn't default on car loans as much as they did on homes because the value of cars never became overinflated. Also, if a car buyer defaults, the lender can quickly repossess the vehicle and resell it, recouping at least part of the lender's investment."

I'm not sure that the reason buyers didn't default is because "the value of cars never became overinflated" - if buyers can't pay, it doesn't matter what the value is.  The reason buyers didn't default probably has much more to do with the fact that the car payments are much lower than the house payments!

"Ally would appear to have little to gain, though, from selling its auto lending operation, by far its most profitable line of business. Writing auto loans made Ally $846 million in pretax profit in the first quarter -- the division's fifth straight quarterly profit -- up 28 percent from a year earlier."

So, if subprime auto loans are so profitable, why isn't Ally making more of them? From earlier in the article:

"After GM sold a majority stake in Ally, the lender became heavily involved in the subprime mortgage boom, a move that nearly bankrupted the company when the housing market collapsed. Ultimately, the federal government has spent $16.3 billion to bail out the lender, leaving taxpayers with a 56 percent stake in the former GMAC.

Ally has spent the last year trying to clean up its mess, diversifying its customer base beyond just GM buyers, launching a highly profitable online banking service and working to sell what remains of its mortgage lending business. Earlier in May, the company posted its first quarterly profit in more than a year and rebranded itself as Ally."

If Ally, having now found "religion" doesn't like the risk-reward of subprime auto loans, it implies to me that either subprime auto isn't the bonanza that GM thinks it is, or that Ally still has balance sheet issues and is sticking only to solid, low risk loans for now, until they can completely clean up their mortgage lending biz. 

-KD

Vegas & Detroit - A Tale of Two (Not So Different) Housing Markets

There's definitely an interesting comparison between Detroit and Vegas - both of whom have housing markets which I think could accurately be described as "languishing."

First, Detroit, courtesy of the WSJ:

Detroit is finally chipping away at a glut of abandoned homes that has been piling up for decades, and intends to take advantage of warm weather and new federal funding to demolish some 3,000 buildings by the end of September.  

Mayor Dave Bing has pledged to knock down 10,000 structures in his first term as part of a nascent plan to "right-size" Detroit, or reconfigure the city to reflect its shrinking population.

When it's all over, said Karla Henderson, director of the Detroit Building Department, "There's going to be a lot of empty space."

Mr. Bing hasn't yet fully articulated his ultimate vision for what comes after demolition, but he has said entire areas will have to be rebuilt from the ground up. For now, his plan calls for the tracts to be converted to other uses, such as parks or farms. 

Pretty amazing.  Not really totally crazy, if you think about it - they'll get Federal funds, and create jobs, to knock down houses no one wants, which will also help values of remaining homes hold steadier.  Then, in a few years, they'll (probably - assumption on my part!) get more Federal funds and create more jobs when they rebuild these homes - if the situation recovers.  Creation by destruction.  Bizarre at the core, perhaps - or maybe bizarre on the surface and totally logical at the core.

Also amazing is the situation in Las Vegas, courtesy of the NY Times:

"The chance to make money on the next housing boom “is like it’s never been,” Mr. Lee, a real estate promoter, assured a crowd of agents, investors and bankers. “We’re going to come back like you’ve never seen us before.” 

Home prices in Las Vegas are down by 60 percent from 2006 in one of the steepest descents in modern times. There are 9,517 spanking new houses sitting empty. An additional 5,600 homes were repossessed by lenders in the first three months of this year and could soon be for sale. 

Yet builders here are putting up 1,100 homes, and they are frantically buying lots for even more. 

Las Vegas is trying to recover by building what it does not need. It is an unlikely pattern being repeated in many of the areas where the housing crash was most severe."

Never mind the talk of "the next housing boom" when you live in one of the worst real estate markets in the country (yeah - SEVENTY percent of Nevada mortgage holders owe more than their homes are worth!)... Contrary to what my friend Yangabanga emailed me, I explained that this was the same plan as Detroit, just in a different order.  While Detroit is demolishing unwanted inventory now, and will rebuild in the future, Vegas is doing the rebuilding without first disposing of the excess inventory, and they'll have to get rid of the excess inventory later - barring a miracle recovery to peak bubble levels.  I'm surprised, as I'd think that the Detroit model would be easier to pull off, logistically. 

A Vegas builder elborated on the phenomenon in the NYT article:

“We’re building them because we’re selling them,” Mr. Anderson said. “Our customers wouldn’t care if there were 50 homes in an established neighborhood of 1980 or 1990 vintage, all foreclosed, empty and for sale at $10,000 less. They want new. And what are we going to do, let someone else build it?”

So Vegas simultaneously has a surplus of supply and a surplus of demand.  Again, amazing.

-KD

Greek Prank Calls? Punitive Damages

This morning's Bloomberg story to talk about is "Greece Considering Legal Actions Against U.S. Banks for Crisis."

"Greece is considering taking legal action against U.S. investment banks that might have contributed to the country’s debt crisis, Prime Minister George Papandreou said."

Now, how can you NOT think of the classic Jerky Boys clip, "punitive damages?" (wait a few seconds for the embedded sound clip to load)

Sue You People sound bite  The Jerky Boys sound bites

If you're not familiar with the Jerky Boys, the full clip is here:

Sue everybody!  Punitive damages!

-KD

Doubling Down

"I just had my first KFC Double Down Chicken Sandwich.  I feel like I doubled down and lost." - Kid Dynamite, May 14th, 2010

I'm not a big fast food guy.  I like the Wendy's Junior CheeseBurger Deluxe and Spicy Chicken Sandwich, but I've eaten at Burger King less than 5 times in my entire life, and at McDonalds only when stopping at rest stops when I'm driving between NYC and Boston.  I think I went to Taco Bell once about 8 years ago, and  I had Popeye's a few times a year when I was in New York, but I can't remember the last time I was at KFC.

So, it was relatively unusual that I found myself making a special trip to KFC to sample their new Double Down Chicken Sandwich.  You know that feeling you get when you're playing blackjack and you get dealt an eleven against the dealer's six?  Excitement... anticipation... DOUBLE DOWN!!!  That's how I felt as I drove to KFC in Concord today.  The result, however, was just like spiking a deuce on your doubled down eleven and then watching as the dealer snaps himself off a 4 card 19 - disappointment.  Pain.  Stomach ache.

This sandwich isn't much like the one you see in the commercial, which shows two long, thin, golden brown crisp chicken patties.  Mine was a soggy, pale yellow specimen, which was short and stubby.  If you watch the commercial clip above, you'll be fooled by the few inches of foil wrapper that the guys are holding the sandwich in.  Guess what - if you push the sandwich to the bottom of the foil wrapper, it barely sticks out above the opening.  Which isn't to say that you won't be getting your calories worth with this baby -  I was actually somewhat surprised to find that it contains "only" 540 calories and 32 grams of fat.  Of course, I washed it down with a DIET Pepsi.

I'll leave you with a few reviews from other sources about this sandwich:

"The chicken is watery within its soft casing of "crust," the cheese familiar to anyone who has eaten food prepared by the United States government, the bacon chemical in its smokiness, the mayonnaise sauce tangy, salty, and sweet, all at once...It is, in all, a disgusting meal, a must-to-avoid. -- Diner's Journal, New York Times"

"God clearly did not mean for humans to eat chicken, bacon, and low-quality, gelatinous cheese at the same time...Each bite became a grueling endurance test, as the cheese and grease began to override the chicken breasts, and the sandwich grew more revolting-looking with each bite. -- The AV Club"

Amen to that.  At least KFC's potato wedges were an excellent side dish...

-KD

You Be The Judge

Can you pick the real headline(s) out of the list of headlines below?

1) BN  16:00  GEITHNER SAYS EUROPE'S RESPONSE TO CRISIS IS "VERY STRONG"

2) BN 16:00  GEITHNER SAYS EU DEBT CRISIS UNLIKELY TO HURT US ECONOMY

3) BN 16:00 GEITHNER SAYS "HELICOPTER BEN IS STANDING BY WITH A WHOLE FLEET OF HUEYS READY TO BOMBARD THE HEARTLAND WITH A STORM OF $100 BILLS SIX INCHES THICK"

4) BN 16:00 GEITHNER SAYS "EUROPE HAS THE CAPACITY TO MANAGE THROUGH THIS"

5) BN 16:00 GEITHNER SAYS WILL MOVE QUICKLY ON FANNIE, FREDDIE CHANGES

6) BN  16:00 GEITHNER SAYS NEW FINANCIAL RULES HELP "FIX WHAT'S BROKEN"

7) BN  16:00 GEITHNER SAYS U.S. ECONOMY "GETTING STRONGER," CONFIDENCE UP"

8) BN  16:00 GEITHNER PRAISES "VERY STRONG" FINANCIAL OVERHAUL LEGISLATION

My friend Ted inspired this post by sending me headline number 2, which outraged him.  Ted is a U.S. bull, but he thinks it's totally irresponsible for Geithner to throw out phrases like "unlikely" without quantifying them, and that this can only come back to bite Geithner in the ass like Hank Paulson's "subprime is largely contained" from quote October of 2008.

In case it wasn't obvious, all of the headlines are real, except for number 3, which is nevertheless probably as accurate as any of the other headlines.

-KD

A Succinct Enunciation of "The Problem"

On my prior post about the real problem evident in the big banks' perfect trading quarters, commenter "HT" weighed in with some thoughts that I thought were worthy of their own post.  I could probably write about 1500 words in response to this comment alone, but I think I'll just let it simmer for now, because it can stand on it's own:

"Sorry KD, I know you're working hard to understand the mechanics of the situation here, but isn't the real problem the inappropriately low Fed interest rate, not the banks that are able to benefit from a unusually tilted FICC environment?

And the low Fed interest rates are primarily due to the political desire to dampen the socio-economic impacts from many years of accumulated bad consumer borrowing behavior.

And that Tim and Ben know this policy is just giving money to the banks, even if that may not their direct intent? They might even be as troubled about this as you are?

But maybe they've played the scenarios and this is the best of the possible outcomes. That raising interest rates and increasing socio-economic stress at this moment would possibly result in public and congressional outrage directed at the Fed. That a congress that has not been strong in demonstrating its competency in understanding complexities of modern financial markets or macroeconomics may then take legislative action to cut back Fed independence and enact further restrictive policy measures on the US financial system.

And this endgame may be more damaging to the US in the long run than allowing the dynamic that you're appropriately critical of to just play out?

The banks are capitalizing on an unusual situation, but one that is rooted in the American citizen that is still relatively ignorant of their own role in causing the economic environment that's been created, and still has not faced up to their own personal accountability in taking on the pain required to restore health to our financial system. "

If I were going to sum that up in one sentence, I'd say that we're trading moral hazard for real economic pain. (We're gobbling a huge helping of moral hazard, in exchange for trying to avoid greater economic pain.)  Ponder that...

Thanks, "HT"

-KD

Breaking News: What the SEC's New Individual Stock Curbs Might Look Like

This isn't cast in stone yet, but I'm told that starting Monday, a pilot program will be filed requiring all exchanges to apply new rules to S&P 500 stocks and select active ETFs, designed to prevent a rehash of Thursday May 6th's extreme price action.

Trading in each stock will be monitored by the exchange it's listed on.  Curbs will be triggered when there is a 10% decline (or advance) in any rolling 5 minute period between 9:45am and 3:30pm.  If the curb is triggered, the listing exchange will send out a message, and trading will be "paused" for 5 minutes, during which time no trading would occur - quoting only. Once the listing exchange prints a new trade, the pause would be lifted.  This is similar to the way that stocks come out of breaking news trading halts currently.

The plan will likely be implemented in 30 days.

EDIT:  in case it's not clear, it seems that the goals of this plan are to 1) allow for "circuit breakers" during times of large price movement and 2) to put the onus of responsibility back on the listing exchange - under these rules, the listing exchange is the one who controls the "re-opening" of a stock.

-KD

Quick Links

If you didn't like my take on the perfect trading quarter, try The Reformed Broker with a humorous take on how to have a perfect trading quarter:

"Step 1.  Be yourself! (only if 'yourself' happens to be a trader at one of the anointed banks.)

Step 1a:  Don't forget to smile.  And to convince the government that without an unlimited supply of interest-free capital to 'get you on your feet', western civilization might end.

Step 2:  Diet and exercise are crucial.  Also, you should take that interest-free capital and put it to work across all interest-bearing asset classes.  Profit margins begin at 100% and work higher from there..."

There's more on his site.

I'd love to see an update of Paul Kedrosky's CDS chart, smartly titled, "What a sovereign heart attack looks like."  This is from May 3rd... Looks like an EKG, right?

Speaking of EKGs, I found this NY Times article interesting: "Lifesaving Devices Can Cause Havoc at Life's End"

"When her father’s cancer became terminal, Carol Filak realized that making his final days comfortable involved something she had never thought about — turning off his heart defibrillator.

A doctor friend told Ms. Filak about horrible scenes he had witnessed in which a defibrillator had shocked a dying patient, causing pain and terrifying family members gathered at the bedside.  "

-KD

Big Bank Perfect Trading Quarters - The Real Story

disclaimer/disclosure: 1) I am not an expert in bank balance sheets.  These 10Qs are not for the faint of heart, and yet I'm quite sure that there are readers in my audience who will be able to add value to this discussion and have more expertise in dissecting these than I do.   There is a mammoth story here, and I am probably not the guy to get to the bottom of it, but I hope to open up Pandora's box for others to dive into.  2) I am short XLF

You've probably heard by now that four of the biggest banks racked up "perfect quarters" in their trading businesses. Bloomberg:

"Bank of America, JP Morgan, and Goldman Sachs, the first, second and fifth-biggest U.S. banks by assets, all said in regulatory filings that they had zero days of trading losses in the first quarter. Citigroup,  the third-largest, doesn’t break out its daily trading revenue by quarter. It recorded a profit on each trading day, two people with knowledge of the results said"

From Dealbreaker: on JPM:

"JPMorgan had average daily trading revenue of $118 million for the quarter and never ended a day with a net loss, according to a filing on Monday. JPMorgan posted gains of between $60 million and $90 million on most trading days of the quarter with about half the days bringing in at least $90 million. On 10 days, Jamie & Co. had more than $180 million in net trading revenue."

on BAC:

"Bank of America scored positive net revenue on its trades every single day last quarter. Here’s the breakdown: Revenue was more than $25 million 95 percent of the trading days in the first quarter, with the firm chalking up gains of over $125 million on 16 trading days between $75 million and $100 million on another 16 days. BofA said the gains were due to “more effective positioning” and “market conditions.”

on GS:

"Goldman Sachs just revealed in an SEC filing that its traders made money on every single trading day last quarter, a record for the firm. Net revenue for trading was $25 million or higher in all of the first quarter’s 63 trading days with 35 of those days bringing in more $100 million, according to the filing."

The numbers reported by the banks are incredible indeed - amazing in both size and consistency, but I can't recall a story of more importance that the blogosphere has done a more miserable job of covering than this one.  While the financial blogosphere has put itself on the map by doing the analysis that mainstream media couldn't or wouldn't do, the lack of in depth analysis on this one has been striking.  Perhaps its because trying to navigate the 10Qs which were released, each nearly 200 pages, is extremely difficult and tedious. 

Still, its disappointing that the analysis to come out thus far has focused on irrelevant demonstrations of how impossible it is to have 63 consecutive winning days if your probability of winning on each day is 50%.  Or on how this means that the big boys must be "cheating" "fixing the game" or "frontrunning all of their orders."   See, the probability of winning when your cost of funds is near zero and you can invest at positive interest rates at assets which are already being supported by the Government is probably closer to 100% than 50%.  As for the complete misunderstanding of "frontrunning" and all that crap:  people have no clue that only roughly TWENTY PERCENT of these earnings that we're talking about are coming from equities businesses!  By focusing the anger on the wrong "causes," we guarantee that we won't change the patterns.  People have a right to be angry about these earnings - but not because of banks manipulating equity markets - it's because the Fed is feeding them with free money and asset price support.

The second paragraph of the Bloomberg article gets closer to the truth than anything else:

“The trading profits of the Street is just another way of measuring the subsidy the Fed is giving to the banks,” said Christopher Whalen, managing director of Torrance, California- based Institutional Risk Analytics. “It’s a transfer from savers to banks.”

See, there's a much larger travesty going on here.  Exactly as the Fed designed, the goal is to recapitalize the banks by allowing them, encouraging them, to earn back the losses they are "extending and pretending" away for now.  In fact, it's the only way extend and pretend works:  banks print money now by leveraging zero cost funds, which will then cover the writedowns they are presently avoiding taking.  By the time they take the writedowns, they'll have already "earned" back the capital they need.    Borrow from the Fed at zero or near zero, invest in positive yielding securities --> profit.  I could use some help quantifying that, though - which is where you bank balance sheet experts come in.

And it all gets funneled through Fannie and Freddie.  How much agency mortgage backed securities does JP Morgan hold?  Take a guess...  on  page 97 of their 10Q, you can see $30.6 Billion in the trading account, and another $160 Billion classified as "available for sale."  And you wonder why Fannie and Freddie are getting a bottomless pit of Government aid?  Oh - in case you were wondering, Bank of America owns $153 Billion of Agency MBS classified as available for sale, and another $43Billion of agency collateralized mortgage obligations (BAC 10q, page 21). {I do want to clarify that I don't think these available for sale securities are impacting the income statement, though - at least not in terms of the change in their fair value. I'm not sure about any interest revenue they are throwing off.}

The real bank subsidy is sneaking around the corner largely unnoticed, while the angry mob in the street rants and raves about equity markets, which are a relative odd-lot in the profit numbers.  The 10Qs are here:  GS, C, JPM, BAC, and I've pulled out the trading revenues for each:

Goldman (page 106):

FICC (Fixed Income, Currency, Commodities): $ 7.386Billion

Equity Trading:  $1.473 Billion

Equity Commissions:  $881MM

Citigroup (page 100):

Interest Rates: $1.309Billion

FX: $241MM

Equity: $565MM

Commodity: $109MM

Credit Derivatives: $1.827 Billion

BankAmerica (page 108)

FICC: $5.515 Billion

Equities:  $1.530 Billion

JPMorgan (pg 18)

Fixed Income: $5.464 Billion

Equities: $1.462 Billion

So there you go - we've proved that these profits are not largely derived from computerized trading frontrunning equity orders - and now we can get down to the real nitty gritty. 

Remember what happened at the end of Q1 2010 - the quarter in question?  The Fed wrapped up its purchases of $1.25 TRILLION dollars of Agency MBS.  There very well may have been some "frontrunning" involved in those outsized profits - but it wasn't the banks frontrunning your purchase of 500 AAPL - it may have been frontrunning of the Fed's purchases of assets.    Load up on the stuff you know the Fed is going to be buying, sit back, wait, collect coupon as the Treasury continues to funnel money into the bankrupt entities, and rack up trading gains as the Fed drives the prices higher.  Bill Gross at PIMCO even gave us this playbook last year - he advised, "Shake hands with the Government."

What, then, is the exit plan?  I guess for the Agency paper it's easy - the Government has your back anyway, so you can't lose.  But are the banks really borrowing short (from the Fed, and in the CP market) and lending long (buying treasuries, and Agency paper) ?  If so, the Fed won't be raising rates to substantial levels anytime in the foreseeable future - they CAN'T - or the banks would get hosed by their funding maturity gap (see: CIT!)...  Perhaps some bank balance sheet experts can weigh in here.

Finally, there's a simple explanation for a chunk of the trading profits:  values on the paper held by the big banks continues to improve.  Now, it's my opinion that a large reason that these values are improving is again a direct result of the Fed's policies of mandating re-risking: (yeah, this is where you can throw the word PONZI in)  forcing re-investment into risky assets by offering the alternative of zero returns in cash accounts - but we will have to wait and see on that one...

Anyway, there is a big, deep, story here (which I've barely scratched the surface of in this post), but it's sad to watch commentators divert attention from the real problem - knowing that they already have an easy target which the public is confused and angry about:  electronic trading.  This post is in no means a defense of electronic trading (although I've made my position clear on that in the past) - the point is that inciting people to ignorantly scream and yell about the wrong thing does nothing except guarantee that the REAL problem won't get recognized and solved.

-KD

EDIT:  interestingly, a former colleague of mine told me after reading this that I sounded "like a socialist," which I thought was interesting, since I think my views are pretty purely capitalistic.  I countered that my point was that these hidden subsidies ARE socialistic in nature, and on the contrary, being against them is the opposite of socialist... 

Feminine Hygiene Products and Dog Butts

There you go - I laid it all out there right in the subject line.  If you're expecting thoughtful economic commentary, you will be disappointed with this post.  However, I have to admit that the GB in this post is more fun to write about than other GBs:  Goldman's Blankfein, Greece Bailouts, Gold Bubble... They all pail in comparison to Griffey's Bum!

I'm guessing that if I polled my audience, I'd find that I'm not the only man who has purchased maxi-pads.  However, I'd wager that I'm the only one who has purchased maxi pads for his dog!  That's what I did today, as our diaper wearing foster pup, Mr. Griffey, is running out of maxi pad liners for his "belly band." 

Griffey with his new haircut, sans diaper

We've learned a few things in the past few weeks with Mr. Griffey:  1) I'm pretty sure he doesn't speak any German at all, contrary to what we were told.  2) he hasn't tried to mark at all either, but has peed in his diaper a few times - I think it's mostly because he's scared. 3) he doesn't like me.  He's terrified of me - you'd think that I'd abused him.  It's unreal.  Interestingly enough, my wife took Griffey home with her over Mother's Day Weekend, while I took Oscar home with me.  When we all reunited back in New Hampshire, Griffey was more receptive to me. He even sat on my lap this morning while we watched SnL.  That was a first!  4) Griffey only poops on grass.

Last week we went to the vet to get Griffey checked out - we thought he had the same abscessed anal gland problem that had proven to be an ordeal with Oscar over the winter.   Strangely, when we got to the vet, we could no longer see the abscess, and the vet couldn't find anything wrong. Unfortunately, Griffey was diagnosed with lyme disease and an ear infection - so he's taking antibiotics (for the Lyme) and getting ear drops, which Oscar subsequently tries to lick out of his ears. 

Yesterday, 5 days later, Griffey got groomed.  We told the groomer we wanted a "sanitary cut."  In NYC, this was a standard cut - it basically meant to shave the dog's groin and bum. 

The groomer hesitated, and confirmed, "sanitary cut... you mean...?"

"Doggie Brazilian," I quickly replied, and she nodded, "Gotcha - I just wanted to make sure."

When we picked Griffey up with his new stylish Brazilian cut, it was clear that he has a major tuchus problem.  The groomer confirmed it, and said we needed to take him in to the vet immediately.   So, now it's back to another round of cute little dogs with infected dookers.  Sweet.

Today, we took Griffey back to the vet, who checked the abscessed anal gland and said it was fine and healing on its own, partly due to the antibiotics that Griffey is already taking for the Lyme Disease.  It was a little confusing for us, since we'd gone through a whole ordeal with Oscar having the same problem, which resulted in our seeking out this new vet.  Additionally, the old vet had told us that Oscar would repeatedly need the glands drained, while the new vet said that once it abscessed, it wouldn't be a problem anymore, as it kinda stops functioning (which is basically contrary to what we've read and heard).  Mr. Griffey is getting neutered next week, so we'll keep an eye on his abscess, and hopefully it won't flare up again and become an issue.  We'll also be able to get it re-checked while he's under anesthesia for the neutering.

This is my life...

-KD

I Have Finally Made It

Although I'd been hoping that I could get William Shatner to read my blog posts aloud as performance art, I guess I'll have to settle for The Modern Mystic.  How on Earth did I find this, you wonder?  Well, via Statcounter, I can see how people arrive at my blog, both via searches and via clickthroughs.  This morning I had several clickthroughs from The Modern Mystic's Youtube video, which I found odd, until I checked out the video:

In case it's not clear to everyone - NO - I am NOT The Modern Mystic.  I do appreciate his use of a French voice for the ECB's quote, and the Hannibal Lecter voice to read the Bernanke quote.

SHATNER!  WHERE ARE YOU!   You have an open invite.  If you ignore me, I'll have to pursue Christopher Walken!   (Great idea - courtesy of Mrs. Dynamite, who couldn't think of Walken's name... "You should get that guy from Pulp Fiction whose dad shoves the watch up his ass," she suggested."

-KD

The Little Guy Has Nothing to Complain About

I see a lot of comments about how the "little guy" feels like the system is stacked against him. Who are we talking about here?   The small investor?  Au Contraire:   There has never been a better time in history to be a small investor in the United States.  Note - there is a difference between investors and traders, which I'll get to in a minute.

-We've had a veritable FLOOD of new ETFs created, which allow investors to easily and with granularity select exactly what kind of exposures they want.   Small retail investors can now get customized exposure to almost every sector and industry, as well as fixed income strategies, developed markets, emerging markets, international indices, commodities and even currencies.

- Technology has allowed brokerage firms to provide speedier access and cheaper commissions.  One can now trade for $9.99 or less, and customize executions to decide which exchange to send orders to, as well as use advanced tools for research, charting, and rapid market access via front ends (I use Etrade's Power Etrade, personally, and it's decent).

- Bid/ask spreads have decreased from quarters 10 years ago to pennies today.  That's a good thing - no matter how you slice it.

- Individuals can easily get access to after hours trading sessions, should they so desire.

 - Access to information:  the individual investor has ample access to an insane amount of information:  SEC filings, news, research reports, rumors.  When I first got interested in stocks as a mere pup of about 15 years old (and this is less than twenty years ago), I would read the earnings reports in IBD looking for companies with increasing earnings.  Then, I'd call my broker, speak to an actual person, and get the phone numbers for the companies I was interested.  THEN, I'd call the companies themselves and ask them to send me their latest annual reports, 10k, 10q, and if I was lucky, I could begin doing some analysis a week later!

In my opinion, the most important items for an investor are selection of products, availability of information,  ease of access, and costs of trading.   I don't know how anyone could argue that we're at unprecedented "bests" in all four of those categories.

Now, how about the small "trader?"  Well - that's a different story, and it should be.  Our markets aren't  constructed (nor should they be) so that any monkey sitting at home can turn on a computer and print money by easily navigating our capital markets.  If you want to trade with the big boys, who are faster than you, smarter than you, more experienced than you, and have more technology than you, you're going to lose.  The important thing is that this "big boys" club isn't an exclusive club - anyone with the resources can develop their own trading systems and gain equal access to the same "privileges."

So if you're a small trader and you're disillusioned with the markets and are throwing in the towel - good for you!  That's your prerogative - no one said trading was easy - but I don't think anyone needs to weep for you.   No one has the right to demand to be able to make profits trading their personal account! Take a longer term view, do some real research, and invest in companies at prices which you like.  If you're right, you'll make money in the long run.  THAT is the important feature of our markets. (If you want to talk about how markets are rigged, I think they are actually rigged in one way: against the prudent short positions.  Markets are rigged to go higher.  We need them to - our society's spending habits depend on it, because we have come to think  of the value of our portfolios as synonymous with our wealth.  If you're positioning yourself from the short side, you may also eventually be proven right, but you frequently have to endure a lot more pain in the process)

The most important point, though, is that all of this fancy trading stuff doesn't hurt the little average Joe Investor!  It doesn't hurt you when someone or some electronic thing crushes your beloved ACN down to a penny and then it rebounds in a matter of seconds.  Other people's mistakes are YOUR opportunities.  If you're really the investor you claim to be, you don't care about short term price movements, and need not lose faith in markets because of the short term aberrations.  Of course, I already wrote a whole post about this:  don't lose faith in markets, lose faith in market orders.

Everyone, investors and traders alike, should certainly understand one important thing, though: The Market doesn't owe you any price for your stock.  If you use a market order, you are saying "I want to be filled, regardless of the price, even if the price on my sell order is 1c."  Now, I'm guessing that people don't really mean that.  Ever.  I've said it before, and I"ll say it again:  in my opinion, you should NEVER use a market order.

Liquidity is not a right, and should not be assumed.  Expecting it to be there is a mistake.  Liquidity gaps have happened throughout the history of trading markets, and they will continue to happen.

John Hussman provided some great old quotes in his most recent piece

"Of all the mysteries of the stock exchange there is none so impenetrable as why there should be a buyer for everyone who seeks to sell. October 24, 1929 showed that what is mysterious is not inevitable. Often there were no buyers, and only after wide vertical declines could anyone be induced to bid ... Repeatedly and in many issues there was a plethora of selling orders and no buyers at all. The stock of White Sewing Machine Company, which had reached a high of 48 in the months preceding, had closed at 11 on the night before. During the day someone had the happy idea of entering a bid for a block of stock at a dollar a share. In the absence of any other bid he got it."

John Kenneth Galbraith, 1955, The Great Crash

Hussman, in his own words:

"If you spend a good portion of your time studying price-volume behavior, "air pockets" of the type we observed last week become familiar parts of the landscape (though they are typically not so distilled into a single intra-day move). Robust demand is the only thing that holds prices from falling vertically in the face of eager selling. Overvalued, overbought, overbullish markets are often already spent of that demand. As investors suddenly became aware of that reality on Thursday, all I could think was "welcome to my world.""

I've grown fond of another expression I coined, which I think accurately describes the market action of last Thursday, May 6th: Markets aren't efficient, but they are efficient enough!  Was is crazy that ACN and other stocks traded down to 1c?  Of course it was, and we will probably modify our market structure to try to prevent it from happening again - but note this: the aberration was quickly corrected by The Market, and the lasting damage for the small individual INVESTOR was nil.  In fact, it was an opportunity to pick up some stock at fire sale prices!

There's no need to weep for the Joe SixPack American Retail Investor.  There has never been a better or more rewarding time for individual investors who do their homework to be able to quickly, cheaply and easily invest in the companies they choose to.

-KD