Archive for the ‘Financial Markets’ Category.
Today's entry: "shareholder rights plan." Example usage:
Less than a week after activist investor Carl Icahn announced a 10 percent stake in Netflix, the online video company is moving to protect itself against hostile takeovers.
The Los Gatos, Calif., company said Monday that it has adopted a shareholder rights plan.
Icahn disclosed his stake in Netflix Wednesday.
Under the plan, rights are exercisable if a person or group acquires 10 percent of Netflix, or 20 percent in the case of institutional investors, in a deal not approved by the board.
This is basically a poison pill that can be triggered by the Board that can dilute the value of a hostile investor's share of the company. What it does is force investors to negotiate with management for takeover of the company, rather than directly with shareholders. As such, it is actually a "management rights plan" as it empowers management at the expense of shareholders (as evidence of this, in a rising market today Netflix stock fell on this news -- shareholders know that such moves have nothing to do with their well-being). Managements use it either to protect their jobs (by disallowing hostile takeovers their shareholders would otherwise support) or at least to get a nice payoff on the way out the door as the price for agreeing to the deal.
I have been a stock market bear for some months now. I don't really think the US economy is going to double dip on its own, but I felt like Europe and Asia would bring us down. Well, I simply underestimated both the Fed's and the ECB's willingness to goose financial assets. If the Fed and ECB are going to inflate our way out of, uh, whatever it is we are in, then I certainly don't want to be holding bonds, particularly at these absurdly low interest rates. Stocks are not as good of an inflation hedge as some hard assets, but they are a hell of a lot better than most bonds. I'm certainly not going to buy back in the current euphoric highs, but I am giving up on trying to predict that market based on fundamentals. It seems that fundamentals are a suckers game, and you better not be timing the market unless you have an inside line to government policy, because that seems to be what drives the train.
PS- I wish Milton Friedman were still around. QE was as much his idea as anyone else's. I wonder what he would have thought of the results, or of this particular implementation.
So far, I have mainly been concerned about inflationary risks from quantitative easing, which is effectively a fancy term for substituting printed money for government debt (I know there are folks out there that swear up and down that QE does not involve printing (electronically of course) money, but it simply has to. Operation Twist, the more recent Fed action, is different, and does not involve printing money but essentially involves the Fed taking on longer-term debt in exchange for putting more shorter term debt on the market.
Scott Minder in the Financial Times highlights another potential problem:
In 2008, just before the first of two rounds of quantitative easing, the Federal Reserve had $41bn in capital and roughly $872bn in liabilities, resulting in a debt to equity ratio of roughly 21-to-one. The Federal Reserve’s portfolio had $480bn in Treasury securities with an asset duration of about 2.5 years. Therefore, a 100 basis point increase in interest rates would have caused the value of its portfolio to fall by 2.5 per cent, or $12bn. A loss of that magnitude would have been severe but not devastating.
By 2011, the Fed’s portfolio consisted of more than $2.6tn in Treasury and agency securities, mortgage bonds and other fixed income assets, and its debt-to-equity ratio had dramatically increased to 51-to-one. Under Operation Twist, the Fed swapped its short-term securities holdings for longer-term ones, thereby extending the duration of its portfolio to more than eight years. Now, a 100 basis point increase in interest rates would cause the market value of the Federal Reserve’s assets to fall by about 8 per cent, or $200bn, leaving it insolvent, with a capital deficit of about $150bn. Hypothetically, a 5 per cent rise in interest rates could cause a trillion dollar decline in the value of the Federal Reserve’s assets.
As the economy continues to expand, the Federal Reserve will eventually seek to normalise monetary policy, resulting in higher interest rates. In this scenario, the central bank could find that the market value of its portfolio has declined to the point where it no longer has enough sellable assets to adequately reduce the money supply and maintain the purchasing power of the dollar. Given US dependence on foreign capital flows, if the stability of the dollar is drawn into question, the ability of the US to finance its deficits may falter. The Federal Reserve could then find itself the buyer of last resort for Treasury securities. In doing so, the government would become hostage to its printing press, and a currency crisis or runaway inflation could take hold.
George Dorgan observes, on the pages of Zero Hedge, that European countries are taking even large balance sheet risks. The most surprising is the Swiss.
It is an open question how long this bailout will plug the dam. I continue to maintain the position that Greece is going to have to be let out of the Euro. Pulling this Band-Aid off a millimeter at a time is delaying any possible recovery of the Greek economy, and really the European economy, indefinitely. All to protect the solvency of a number of private banks (or perhaps more accurately, to protect the solvency of the counter-parties who wrote the CDO's on all that debt).
Anyway, the interesting part for me is that with this bailout, the total cumulative charity sent the Greek's way by other European countries now exceeds Greek GDP, by a lot.
Just six months ago, governments were criticizing ratings agencies for letting threats by debt security issuers cow them into keeping ratings for bad debt higher than they should be (emphasis added)
Moody’s and Standard & Poor’s, Wall Street’s two largest credit rating agencies, were roundly criticized in the Levin-Coburn Senate reportfor betraying investors’ trust and triggering the massive mortgage-backed securities sell-offs that caused the 2008 financial crisis.
Credit rating agencies are supposed to provide independent, third-party credit assessments to help investors understand the risks in buying particular securities, debts and other investment offerings. For example, securities that have earned the highest ‘AAA’ rating from Standard & Poor’s (S&P) should have an “extremely strong capacity to meet financial commitments” or have “a less than 1% probability of incurring defaults.” Investors would use the ratings to help evaluate the securities they’re seeking to buy.
However, the standard practice on Wall Street is fraught with conflicts of interest. In reality, the credit rating agencies have long relied on fees paid by the Wall Street firms seeking ratings for their mortgage-backed securities, collateralized debt obligations (CDOs), or other investment offerings. The Levin-Coburn report found the credit agencies “were vulnerable to threats that the firms would take their business elsewhere if they did not get the ratings they wanted. The ratings agencies weakened their standards as each competed to provide the most favorable rating to win business and greater market share. The result was a race to the bottom.” Between 2004 and 2007, the “issuer pay” business model fostered conflicts of interest that have proven disastrous for investors.
I have no problem with this analysis. But it's ironic in contrast to the very same governments' reactions to their own downgrades over the last 6 months. In fact, the general government reaction from Washington to Paris has to be to ... wait for it ... threaten the agencies in order to keep their ratings up. And these threats go farther than just loss of business - when the government issues threats, they are existential. It's hard to see how the US or French government's behavior vis a vis downgrades has been any different than that of banks or bond issuers that have faced downgrades.
In general, the tone of government officials has been "what gives them the right to do this to us?" The answer to that question is ... the government. These self-same governments were generally responsible for mandating that certain investors could only buy certain securities if they are rated. And not just rated by anyone, but rated by a handful of companies that have been given a quasi-monopoly by the government on this rating business.
As I predicted, the various highly touted European debt and currency interventions last month did squat. This is no surprise. The basic plan currently is to have the ECB give essentially 0% loans to banks with the implied provision that they use the money to buy sovereign debt. Eventually there are provisions for austerity, but I wrote that I don't think it's possible these will be effective. It's a bit unclear where this magic money of the ECB is coming from - either they are printing money (which they refuse to own up to because the Germans fear money printing even more than Soviet tanks in the Fulda Gap) or there is some kind of leverage circle-jerk game going where the ECB is effectively leveraging deposits and a few scraps of funding to the moon.
At this point, short of some fiscal austerity which simply is not going to happen, I can't see how the answer is anything but printing and devaluation. Either the ECB prints, spreading the cost of inflation to all counties on the Euro, or Greece/Spain/Italy exit the Euro and then print for themselves.
The exercise last month, as well as the months before that, are essentially mass hypnosis spectacles, engineered to try to get the markets to forget the underlying fundamentals. And the amazing part is it sort of works, from two days to two weeks. It reminds me of nothing so much as the final chapters of Atlas Shrugged where officials do crazy stuff to put off the reckoning even one more day.
Disclosure: I have never, ever been successful at market timing investments or playing individual stocks, so I generally don't. But the last few months I have had fun shorting European banks and financial assets on the happy-hypnosis news days and covering once everyone wakes up. About the only time in my life I have made actual trading profits.
Thought problem: I wish I understood the incentives facing European banks. It seems like right now to be almost a reverse cartel, where the cartel holds tightly because there is a large punishment for cheating. Specifically, any large bank that jumps off the merry-go-round described above likely starts the whole thing collapsing and does in its own balance sheet (along with everyone else's). The problem is that every day they hang on, the stakes get higher and their balance sheets get stuffed with more of this crap. Ironically, everyone would have been better getting off a year ago and taking the reckoning then, and certainly everyone would be better taking the hit now rather than later, but no one is willing to jump off. One added element that makes the game interesting is that the first bank to jump off likely earns the ire of the central bankers, perhaps making that bank the one bank that is not bailed out when everything crashes. It's a little like the bidding game where the highest bidder wins but the two highest bidders have to pay. Anyone want to equate this with a defined economics game please do so in the comments.
From Edward Pinto at the American
Fannie and Freddie entered into agreements accepting responsibility for misleading conduct discovered by the SEC, including:
1. As of June 30, 2008, Freddie had $244 billion in subprime loans, while investors were told it had only $6 billion in subprime exposure.
a. Freddie knew it was inadequately compensated for the risks it was taking. For example, it was taking on “subprime-like loans to help achieve [its] HUD goals” that were similar to private fixed-rate subprime, but the latter typically received “returns five to six times as great,” says the complaint.
b. Freddie had concerns about risk layering on loans with an LTV >90% and a FICO <680. (Yet, in Freddie’s disclosures it only noted risk layering concerns on loans with an LTV >90% and a FICO <620. This is a major difference since only 10 percent of its loans fell into the LTV >90% and a FICO <620 category, while nearly half fell into the LTV >90% and a FICO <680 one.)
2. As of June 30, 2008, Fannie had $641 billion in Alt-A loans (23 percent of its single-family loan guaranty portfolio), while investors were told it had less than half that amount ($306 billion, or 11 percent of its single-family loan guaranty portfolio).
3. The SEC complaint disclosed that Freddie had a coding system to track “subprime,” “other-wise subprime,” and “subprime-like” loans in its loan guaranty portfolio even as it denied having any significant subprime exposure.
These suits are important because they demonstrate that Fannie and Freddie “told the world their subprime exposure was substantially smaller than it really was … and mislead the market about the amount of risk on the companies’ books,” said Robert Khuzami, director of the SEC’s Enforcement Division.
Nice tax refund you have coming .... we think we'll keep it
The [Greek] government has decided to stop tax returns and other obligation payments to enterprises, salary workers and pensioners as it sees the budget deficit soaring to over 10 percent of gross domestic product for 2011.
For all the supposed austerity, the budget situation is worse in Greece. Germany and other countries will soon have to accept they have poured tens of billions of euros down a rathole, and that they will have to do what they should have done over a year ago - let Greece move out of the Euro.
Government workers and pensioners simply will not accept any cuts without rioting in the street. And the banks will all go under with a default on government debt. And no one will pay any more taxes. And Germany is not going to keep funding a 10% of GDP deficit. The only way out seems to be to print money (to pay the debt) and devalue the currency (to effectively reduce fixed pensions and salaries). And the only way to do all that is outside of the Euro. From an economic standpoint, the inflation approach is probably not the best, but it is the politically easiest to implement.
For a while now, a few authors have been quipping at Zero Hedge that the best investment strategy is to do the opposite of what Goldman Sachs is telling is retail customers. The theory is that if Goldman tells the public to buy, it means that they are selling like crazy for their own account.
This seemed a bit cynical, but on Friday Zero Hedge observed that Goldman was telling its retail customers to buy European banks. This advice seemed so crazy -- the European agreement last weekly explicitly did not contain anything to help banks in the near term with over-leveraged bets on shaky sovereign debt -- that for the fun of it I played along. I shorted a couple hundred shares of EUFN, a US traded fund of European financial firms (took a bit of work to find the shares to borrow).
Made 6% in one day. Thanks Goldman.