Fin/Inv

Andy Kroll at Mother Jones discusses problems with the Home Affordable Modification Program (HAMP): The Foreclosure Rescue Mirage

Industry experts are now questioning how many of the program’s estimated 235,000 modifications will actually benefit homeowners in the long term, and say that homeowners clamoring to participate in HAMP have created an industrywide logjam for mortgage servicers, resulting in substantial delays and backed-up customer service support. The Treasury’s first servicer performance report (PDF), covering March to July 2009, found that servicers had offered modifications to just 15 percent of eligible delinquent homeowners, and initiated them for just 9 percent of that group.

I've heard from servicers who've said they are just overwhelmed and are staffing up to meet the demand. And it appears the administration is trying to make improvements:

Despite its flaws, HAMP is a good-faith effort by the government to address the foreclosure crisis, and there are signs of improvement. In June, HAMP officials began conducting much more rigorous reviews of servicers, and have started a "second look" program, in which servicers’ decisions to approve or deny HAMP modifications are scrutinized. Compliance officials are also analyzing samples of HAMP-modified loans to track error rates with servicers. And government officials have on several occasions tried to light a fire under HAMP servicers to speed up the modification process.

Some believe HAMP will fall far short of the goals:

The Treasury has set a target of modifying 4 million mortgages by 2012, but Moody's estimates HAMP will in fact modify only 1.5 to 2 million.

The Treasury disagrees:

More than 400,000 modification offers have been extended and more than 230,000 trial modifications have begun. This pace of modifications puts the program on track to offer assistance to up to 3 to 4 million homeowners over the next three years, our target on February 18.

Actually the original press release stated the program "will help up to 3 to 4 million at-risk homeowners avoid foreclosure" and the new press release says "offer assistance to up to 3 to 4 million homeowners". A few word changes makes a significant difference.

The Treasury's current target is 500,000 cumulative trial modifications started by November 1st, up from the 235,000 cumulative at the end of July. At that pace (about 90 thousand trials started per month), the cumulative trial modifications started will be close to 3.0 million by early 2012 - however many of those borrowers will probably redefault. Anyone who redefaults will have been "offered assistance", but probably will not "avoid foreclosure".

The article has a few interesting anecdotes of the struggles of borrowers in dealing with their servicers. My best wishes to Kristina Page. Thanks for mentioning CR!

And this is just the beginning. Chairman Ben has yet to be fully unleashed.

Courtesy of Sean Malone at Mises Institute

 

Submitted by Linus Wilson, Assistant Professor Of Finance, University of Louisiana At Lafayette

 

Attachment	Size
Madoff Profits To JPM.pdf	67.16 KB

The chart above tracks the number of NYSE, NASDAQ, and ASE stocks making fresh 20-day highs minus the number making new 20-day lows (red line).

Note that new highs peaked in late July in what appears to be a momentum high. At the recent price highs (SPY; blue line), we are seeing fewer stocks participating in the new highs. If this candidate transition pattern holds, we should eventually take out the August lows in SPY. (Note: I follow this and other indicators each morning before the market open via Twitter; follow/subscribe here).

.

One of the key headlines these days has been the unmasking of what has been dubbed the biggest identity theft and credit card fraud case in history, allegedly spearheaded by one Albert Gonzalez, who in 2003 was involved in a comparable scheme however upon being caught, promptly became an informant for the Secret Service and turned over 30 of his hacking buddies. Six years later it is he this time who is in the hot seat, together with most of his associates, including one 25 year old Stephen Watt, who supposedly was the creator of the credit card sniffer software used to hack into over 130 million of various credit cards for merchants such as TJX, Dave And Busters and 7-Eleven, which numbers were subsequently sold for hefty sums to Eastern European purchasers. What is peculiar in all this is that apparently for the entire duration of this operation, Stephen was working in "Application infrastructure development and in house security toolkit development" at Morgan Stanley (earning $99,000 a year as a 21-23 year old programmer in 2004-2007), and subsequently took a brief position with Imagine Software, where he developed "real-time computer trading programs for financial firms." Did Stephen learn the tools of the trading game at MS, while at the same time hacking millions of credit cards, only to take what he learned from both ventures into a new operation, one that counts among its clients the Who's Who of Wall Street? Or, alternatively, did he use his packet sniffing skills at Morgan Stanley? The questions grow...

While the case against Gonzalez is rather clear cut, with him apparently being a recidivist, who should have been taken down the first time around the Secret Service got involved in his deal, that of Watt is less conclusive. According to Wired magazine, "[Gonzalez] spent $75,000 on a birthday party for himself and once complained that he had to manually count $340,000 in pilfered $20 bills because his counting machine broke. But while Gonzalez apparently lived high off ill-gotten gains, [Watt] sits broke and unemployed, his career in shambles, while awaiting sentencing for a piece of software he crafted for his friend."

To be sure Watt's involvement in the hacking industry has its roots in his past:

Though it’s unacknowledged by the prosecution and defense, Watt was once known in hacker circles as “Jim Jones” and “Unix Terrorist.” In the late 1990s and early 2000s, that hacker was part of a band of self-proclaimed black hats that opposed the publication of security vulnerabilities and resisted the hacking scene’s shift from recreational network intrusions to legitimate security research.

“I figured out his name years ago, Stephen Huntley Watt, and then the guy wound up getting indicted on the TJ Maxx thing,” says former hacker Kevin Mitnick.

Under the rubric Project Mayhem, the gang managed to hack into the accounts of a number of prominent “white hat” hackers and publish their private files and e-mails. At the 2002 DefCon hacker conference, Watt took the stage with two friends to personally share some of the hacked e-mails.

What exactly is the prosecution's case against Watt:

The Information alleges that WATT was a member of a conspiracy which, between 2003 and 2008, unlawfully gained electronic access to corporate computer networks using various techniques, downloaded customers’ credit and debit card information, and fraudulently used that information and sold the information to others for fraudulent use. The Information further alleges that WATT modified and provided a “sniffer” program used by the conspirators to monitor and capture the data crossing corporate computer networks.

The full sentencing memorandum against Watt is presented below (trust the United States Of America to be unable to even get the name of the only defendant correct, one would imagine the SEC is somehow involved here):

 

For a more humane representation of Stephen Watt's actions we recommend reading the Sentencing Memorandum prepared by Watt's lawyer, Michael Farkas, presented below:

 

 

Yet, while Zero Hedge will not make any determinations with regard to a justification of Stephen's actions (although there is a certain soft spot for an individual who used a Project Mayhem moniker in his transgressions) what is a major issue here is what if anything did Watt do while he was employed as a "software engineer" at Morgan Stanley, especially since the primary action against him by the government is that he created an (illegal) packet sniffer dubbed "blabla", and what skills did he learn there (and possibly abuse) to take to his next employer Imagine Software where, as the memorandum reveals, he worked on "software such as real-time computer trading programs for financial firms."

Notable is that the entire case against Watt revolves around his creation of a packet sniffer: a program that, by its simplest definition, allows the interception or capture of IP traffic. From the Watt Memorandum:

A program known as a "sniffer" refers to a class of application that captures any type of data that travels across a communications network. "Packet sniffers" are the most commonly referenced, which are used to capture and often store data that travel across a local network or the Internet. Sniffers serve a wide variety of purposes and can be used in many sorts of legitimate research, diagnostics, and security-related scenarios, in addition to illegal data gathering... and from the footnote: Sniffers can also be appropriated for malicious activity, as they can also be used to capture information that travels across networks such as logins and passwords, transmitted files, and various forms of electronic conversations.

And the reason why Watt is in this jam is precisely because he created a sniffer to isolate credit card numbers out of total Internet traffic:

The sniffer "blabla" involved in this case falls into this latter class of sniffers, which blindly logs any type of data. Specifically, it is known as a "raw TCP sniffer," which can be used to "sniff" incoming data to any sort of Internet server as it was not designed with the prescience of any target host computer or network.

For the conspiracy minded, let's recall that packet sniffing was one of Sergey Aleynikov's, of Goldman Sachs "market manipulation" allegation fame, primary background strong suits. One need not think too hard about how having the benefit of non-public data information in the field of High Frequency Trading (ignoring the concept of Flash orders for the purpose of this thought experiment) could provide a massive profitable leg up to the entity that managed to (surreptitiously) control such packet sniffing.

Which raises the question: was Watt, while employed at Morgan Stanley between 2004 and 2007, a time bracketed on both sides by his illegal activities in the 2003-2008 period, using his knowledge of packet sniffers only in the context of his allegedly illegal scheme to capture credit card numbers while working with Gonzalez, or did his expertise render him more valuable to Morgan Stanley than the headlines would make it seem? Alternatively, did an unquestionably bright Watt realize some of the weaknesses in MS' trading infrastructure, and if so, have these been disseminated? After all it took just a hint of potential impropriety in the Aleynikov case to have the Fed's arrest him just days after Goldman's awareness of his activity (not to mention a bail higher than that of "Sir" Alen Stanford).

An indication to this may be provided by by some hacker disclosures on bulletin boards, where n0td3v writes that Watt is best known for "back dooring of the Qualys Vulnerability Scanner." The fact that Watt actually did work at Qualys in 2001-2002 is not lost. Perhaps Watt's MO, is that if his skills were not used directly for the benefit of his current employer, was to discover the weaknesses present in the IT infrastructure with the goal of potential subsequent abuse?

Yet it bears pointing out that the firm that Watt left for after quitting Morgan Stanley, Imagine Software, counts among its clients such names Credit Suisse, Deutsche Bank, Jefferies, Smith Barney, Millennium Management, PNC... and Goldman Sachs JBWere. From Imagine's About Us section:

Imagine’s reputation for delivering tangible competitive advantage is based upon proven innovation that enables users to stay abreast of the market. Imagine Software puts institutional-grade functionality, broad cross-asset instrument support, and the ability to employ any trading strategy in the hands of sell- and buy-side businesses of all sizes.

• Introduced enterprise solution, Imagine Trading System, in 1993, and ASP solution, Derivatives.com, in 2000
• Headquartered in New York with offices in London, Sydney, and Hong Kong
• Thousands of users across major hedge funds, fund-of-funds, pension funds, brokerage firms and banks worldwide
• Significant prime broker relationship with Credit Suisse
• Relationships with other major prime brokers
• Leading provider of on-demand derivative trading analytics, portfolio and risk management solutions
• Winner of two #1 Risk Magazine Awards (equity trading and equity analytics) several years in a row

Whether Watt's potential transgressions include just the creation of the blabla packet sniffer which was used to defraud numerous public companies out of hundreds of millions, or were his unique skills geared for something more, now that the bright 7 foot tall hacker had managed to find his way into the pinnacle of financial society, will likely remain unknown. However, Zero Hedge will follow the case (District Court of Massachusetts, 08-cr-10318) and await eagerly the release of the transcript of the Sentencing Hearing of Watt, which should be made available to the public in mid-September (presumably severely redacted just like the previously filed disclosure by Belopolsky and Volfbeyn againt RenTec: wouldn't want those "trade secrets" leaking now, would we).

In conclusion, this case which seems to have more and more loose ends unravel each and every day, could potentially benefit by the prosecutors focusing not just on the direct actions of Watt while collaborating with Gonzalez, but on whether there was any potential impropriety by the alleged perpetrator while employed in the capacity of a programmer, dealing with what by all counts seems to be very intimate day-trading software at major Wall Street organizations.

An Uncomfortable Choice

August 28, 2009
By John Mauldin

An Uncomfortable Choice

What Were We Thinking?

Frugality is the New Normal

And Then We Face the Real Problem

Argentina, Brazil, Uruguay, New Orleans, Detroit, and More

We have arrived at this particular economic moment in time by the choices we have  made, which now leave us with choices in our future that will be neither easy, convenient, nor comfortable. Sometimes there are just no good choices, only less-bad ones. In this week’s letter we look at what some of those choices might be, and ponder their possible consequences. Are we headed for a double-dip  recession? Read on.

An Uncomfortable Choice

As our family grew, we limited the choices our seven kids could make; but as they  grew into teenagers, they were given more leeway. Not all of their choices were good. How many times did Dad say, “What were you thinking?” and get a mute reply or a mumbled “I don’t know.”

Yet how else do you teach them that bad choices have bad consequences? You can  lecture, you can be a role model; but in the end you have to let them make their own choices. And a lot of them make a lot of bad choices. After having raised six, with one more teenage son at home, I have come to the conclusion that you just breathe a sigh of relief if they grow up and have avoided fatal, life-altering choices. I am lucky. So far. Knock on a lot of wood.

I have watched good kids from good families make bad choices, and kids with no seeming chance make good choices. But one thing I have observed. Very few teenagers make the hard choice without some outside encouragement or help in understanding the known consequences, from some source. They nearly always opt for the choice that involves the most fun and/or the least immediate pain, and then learn later that they now have to make yet another choice as a consequence of the original one. And thus they grow up. So quickly.

But it’s not just teenagers. I am completely capable of making very bad choices as I approach the end of my sixth decade of human experiences and observations. In fact, I have made some rather distressing choices over time. Even in areas where I think I have some expertise I can make appallingly bad choices. Or maybe particularly in those areas, because I have delusions of actually knowing something. In my experience, it takes an expert with a powerful computer to truly foul things up.

Of course, sometimes I get it right. Even I learn, with enough pain. And sometimes I just get lucky. (Although, as my less-than-sainted Dad repeatedly intoned, “The harder I work the luckier I get.”)

Each morning is a new day, but it is a new day impacted by all the choices of the  previous days and years. Tiffani and I have literally interviewed in depth well over a hundred millionaires, and talked anecdotally with hundreds over the years. I am struck by how their lives, and those of their families, come down to a few choices. Sometimes good choices and sometimes lucky choices. Often, difficult ones. But very few were the easy choice.

What Were We Thinking?

As a culture, the current mix of generations, especially in the US, has made some  choices. Choices which, in hindsight, leave the adult in us asking, “What were we thinking?”

In a way, we were like teenagers. We made the easy choice, not thinking of the consequences. We never absorbed the lessons of the Depression from our grandparents. We quickly forgot the sobering malaise of the ’70s as the bull market of the ’80s and ’90s gave us the illusion of wealth and an easy future. Even the crash of Black Friday seemed a mere bump on the path to success, passing so quickly. And as interest rates came down and money became easier,
our propensity to acquire things took over.

And then something really bad happened. Our homes started to rise in value and we
learned through new methods of financial engineering that we could borrow against what seemed like their ever-rising value, to finance consumption today.

We became Blimpie from the Popeye cartoons of our youth: “I will gladly repay you
Tuesday for a hamburger today.”

Not for us the lay-away programs of our parents, patiently paying something each week or month until the desired object could be taken home. Come to think of it, I am not sure if my kids (15 through 32) have ever even heard of a lay-away program, not with credit cards so easy to obtain. Next family brunch, I will explain this quaint concept. (Interestingly, I heard about a revival of the concept on CNBC radio, coming back from dropping Trey off at school this morning. Everything old is new again.)

As a banking system, we made choices. We created all sorts of readily available  credit, and packaged it in convenient, irresistible AAA-rated securities and sold them to a gullible world. We created liar loans, no-money-down loans, and no-documentation loans and expected them to act the same way that mortgages had in the past. What were the rating agencies thinking? Where were the adults supervising the sand box?

(Oh, wait a minute. That’s the same group of regulators who now want more power and
money.)

It is not as if all this was done in some back alley by seedy-looking characters.  This was done on TV and in books and advertisements. I remember the first time I saw an ad telling me to call this number to borrow up to 125% of the value of my home, and wondering how this could be a good idea.

Turns out it can be a great idea for the salesmen, if they can package those loans into securities and sell them to foreigners, with everyone making large commissions on the way. The choice was to make a lot of money with no downside consequences to yourself. What
teenager could say no?

Greenspan keeping rates low aided and abetted that process. Starting two wars and pushing through a massive health-care package, along with no spending control from the Republican Party, ran up the fiscal deficits.

Allowing credit default swaps to  trade without an exchange or regulations. A culture that viscerally believed that the McMansions they were buying were an investment and not really debt. Yes, we were adolescents at the party to end all parties.

Not to mention an investment industry that tells their clients that stocks earn 8% a year real returns (the report I mentioned at the beginning goes into detail about this). Even as  stocks have gone nowhere for ten years, we largely believe (or at least hope) that the latest trend is just the beginning of the next bull market.

It was not that there were no warnings. There were many, including from your humble analyst, who wrote about the coming train wreck that we are now trying to clean up. But those warnings were ignored.

Actually, ignored is a nice way to put it. Derision. Scorn. Laughter. And worse, dismissal as a non-serious perpetual perma-bear. My corner of the investment-writing world takes a very
thick skin.

The good times had lasted so long, how could the trend not be correct? It is human nature to believe the current trend, especially a favorable one that helps us, will continue forever.

And just like a teenager who doesn’t think about the consequences of the current fun, we paid no attention. We hadn’t experienced the hard lessons of our elders, who learned them in the depths of the Depression. This time it was different. We were smarter and wouldn’t make
those mistakes. Didn’t we have the research of Bernanke and others, telling us
what to avoid?

In millions of different ways, we all partied on. It wasn’t exclusively a liberal or a conservative, a rich or apoor,  a male or a female addiction. We all borrowed and spent. We did it as  individuals, and we did it as cities and states and countries.

We ran up unfunded pension deficits at many local and state funds, to the tune of several trillion dollars and rising. We have a massive, tens of trillions of dollars, bill coming due for Social Security and Medicare, starting in the next 5-7 years, that makes the current
crisis pale in comparison. We now seemingly want to add to this by passing even
more spending programs that will only make the hole deeper.

Frugality is the New Normal

I could go on and on, but I think
you get the point. The time for good choices was a decade ago. It would have
been more difficult at the time, so that is not what we did. And now we wake up
and are faced with a set of choices, none of them good.

Reality is staring back in the mirror at the American consumer, and especially the Boomer generation. The psyche of the American consumer has been permanently seared. We are watching savings beginning to rise and consumer spending patterns change for the first
time in generations. Even as the authorities try to prod consumers back into  old habits, they are not responding. Borrowing and credit are actually falling. Banks, for whatever reason, now want borrowers to actually be able to pay them back. Go figure.

Frugality is the new normal. We are resetting the underpinnings of a consumer-driven society to a new level. It will require a major overhaul of our economy. The normal drivers of growth – consumer spending, business investment, and  exports – are all weak, and it is only because of massive government spending that the second quarter was not as bad as the two previous quarters and that the coming quarter will be positive.

But what then? How long can we continue with 10%-plus GDP deficits? We have an economy that is in a Statistical Recovery, fueled by government largesse. In the real world, we are
watching unemployment rise, and it is likely to do so through the middle of  next year. Deflation is in the air. Capacity utilization is near all-time lows.  Housing numbers are only bouncing because of the government program of large tax credits for first-time home buyers and lower home prices. It will be years before construction is significant.

We will be faced with a choice this fall and early next year. If you take away the government spending, the potential for falling back into a recession is quite high, given the underlying
weakness in the economy. A few hundred billion for increased and extended unemployment benefits will not be enough to stem the tide. There will be a groundswell for yet another stimulus package. Another 10% of GDP deficit is quite likely for next year.

As I (and Woody Brock) have made very clear in these e-letters, deficits that are higher than nominal GDP cannot continue without dire consequences. Good friend Richard Russell writes today:

“The US national debt is now over $11 trillion dollars. The interest on our national debt is now $340 billion. This is about at 3.04% rate of interest. In ten years the Obama administration admits that they will add $9 trillion to the national debt. That would take it to $20 trillion. Let’s say that by some miracle the interest on the national debt in 10 years will still be 3.09%. That would mean that the interest on the national debt would be $618 billion a year or over one billion a day. No nation can hold up in the face of those kinds of expenses.
Either the dollar would collapse or interest rates would go through the roof.”

That would be at least 30% of the national budget. How would your household do, paying that much as interest? How can you operate when interest payments are 30% or more of the budget? Do you borrow to pay the interest? And the Obama administration openly admits to
deficits of over a trillion a year for the next ten years, under very rosy growth assumptions. Anyone outside of Washington and rosy-eyed economists think we will grow 4% next year? I am not seeing many hands go up.

And Then We Face the Real Problem

If we do not maintain high deficits, it is likely we fall back into recession. Yet if we do not control spending, we risk running up a debt that becomes very difficult to finance by conventional means. Monetizing the debt can only work for a few trillion here or there. At
some point, the bond market will simply fall apart. And it could happen  quickly. Think back to how fast things fell apart in the summer of 2007. When perception of the potential for inflation changes, it changes things fast.

The problem is that we are now in a very deflationary world. Deleveraging, too much capacity, high and rising unemployment, falling real incomes, and more are all the classic pieces of the formula for deflation.

Let’s look at what my friend Nouriel Roubini recently wrote. I think he hit the nail on the head:

“A combination of higher official indebtedness and monetization has the potential to yield the worst of all worlds, pushing up long-term rates and generating increased inflation
expectations before a convincing return to growth takes hold. An early return to higher long-term rates will crowd out private demand, as lending rates on mortgages and personal and corporate loans rise too. It is unlikely that actual inflation will emerge this year or even next, but inflation expectations as reflected in long-term interest rates could well be rising later in 2010. This would represent a serious threat to economic recovery, which is predicated on the idea that the actual borrowing rates that individuals and businesses pay will remain low for an extended period.

“Yet the alternative – the early withdrawal of the stimulus drug that governments have been dispensing so freely – is even more serious. The present administration believes that
deflation is a worse threat than inflation. They are right to think that. Trying to rebuild public finances at a deflationary moment – a time when unemployment is rising, and private demand is still contracting – could be catastrophic, turning recovery into renewed recession.”

There are no good choices. Nouriel, optimist that he is (note sarcasm), suggests that there is a possibility that the government can manage expectations by showing a clear path to fiscal
responsibility that can be believed. And thus the bond markets do not force  rates higher, thereby thwarting recovery.

And technically he is right. If  there were adults supervising the party, it might be possible. But there are not. . Instead of fiscal discipline, we are hearing  increased demands for more spending. Please note that the very rosy future-deficit assumptions assume the end of the Bush tax cuts at the close of 2010. But raising taxes back to the level of 2000 does not make the projected future budget deficits go away.

I mean, seriously, does anyone think Pelosi or Reid are going to lead us to fiscal constraint? Obama talks a good game, but he has not offered a serious deficit-reduction proposal, other
than further tax increases. And by serious, I mean we need cuts on the order of several hundred billion dollars. The Republicans lost their way and their power (deservedly, in my opinion). Just as at the high school prom, the very few adults are being ignored.

It is the proverbial rock and the hard place. Cut the stimulus too soon and we slide back into a deeper recession. Let the budget spin out of control for a few years and we will see inflation return, with higher rates and a recession. Raise taxes by 1.5-2% of GDP in 2010 and we are shoved back into recession.

There are no good choices. If we do the right thing and cut the deficit, it means very hard choices. Can we keep our commitments to two wars and our massive defense budget? Medicare and Social Security reform are not painless. Education? Research? The “stimulus”? But cutting the deficit by hundreds of billions while raising taxes by even more than is already
in the works, is not the formula for sustainable recovery.

Have we grown up? Are there adults in the room? Sadly, I don’t think there are enough. We are still a nation of teenagers. We will do whatever we can to avoid the pain today. We will kick the can down the road, hoping for a miracle. Will we grow up? Yes, but the lessons
learned will be hard.

There are no statistical signs of an impending recession. We are not going to get an inverted yield curve this time, which made it relatively easy for me to predict recessions in 2000 and
2006. We are in a deflationary, deleveraging world. A far different world than in the past.

I see little room for us to avoid a double-dip recession. It would take the skill and speed of former Cowboys running back Tony Dorsett hitting a very small hole in the line to break us
into the open. I see no running back in our national leadership with such ability. As I have outlined above, recession could be triggered again in any number of very different economic environments. It all depends on the choices we make. But the choices lead to the same consequences, at least in my opinion.

As I wrote in August 2000 and August 2006, I write again in August 2009: there is a recession in our future. I was early both of those times and I am early now, maybe two years early, though I doubt it. And as I pointed out both of those last times, the stock market
drops an average of over 40% during a recession. When I was on Kudlow in October of 2006, I was given a hard time about my recession call and prediction of a bear market. I think it was John Rutherford who dismissed my bearish vision. And he was right for the next three quarters, as the market proceeded to rise another 20%. I looked foolish to many, but I maintained my views.

You have choices. You can buy and hold (buy and hope?) or you can develop a strategic alternative. The next bear market, as I wrote in 2003 and in will likely be the bottom. (It takes at least three of them to really take us to the bottom.) But the next one will change perceptions for a long time. Valuations will drop. Savings will rise even more. And a generation will grow up. The adults will return. Chastened. Scarred. Shaken. But we will Muddle Through. That is what we do. Even my teenagers.

Choose Wisely

Argentina, Brazil, Uruguay, New Orleans, Detroit, and More

Only a month ago my fall schedule looked sur prisingly light. And then reality hit. I will be at the Schwab conference in San Diego on September 15. If you are going to be there, drop me a note. That is my only trip in September. But then it gets interesting. I celebrate my 60th birthday the first weekend of October, then fly to New Orleans to be at the annual New Orleans Conference, October 8-11. The speaker line-up is better than ever. I find this to be one of the best conferences I go to very year. I have been attending on and off for over 25
years. You should think about this one.
http://www.neworleansconference.com/speaker-eblast-JohnMauldin/

Then I will spend the next weekend in Detroit, then probably go to New York, then  Philadelphia for a CMG conference October 20, then down to Houston, over to  Orlando, stop to change clothes and pack at home, and then fly off on a whirlwind trip to Argentina, Brazil, and Uruguay, speaking at a series of CFA conferences. Orlando in mid-November … and nothing else so far. Switzerland and London in January.

I recently did an interview with King World News that was quite frankly one of the best interviews I have ever done. Eric King really got me going. It is in two parts. I give you the link to the first part, and the second is in their archives. There are also interviews with a very serious group of names. I am flattered to be included. Click here.

It is time to hit the send button. I am resisting the temptation to launch into politics, so I need to quit before I do. Suffice it to say, we could see some big changes as we work through our teenage years, back to adulthood.

Speaking of good choices, the wedding last weekend was fabulous. I am delighted with my new son-in-law. Life goes on, even as my kids struggle to get enough hours of work and money. Henry is at UPS, and work hours are way down and they have a new son. Chad finally
got a new job, which may give him enough hours to survive, but not a lot of money. For those of you who think I live in an ivory tower, I do have a view into the lives of seven kids who are very real people, as well as those of lots of friends. I am very well aware of how tough it is out there, and realize how blessed I am.

You have a great week. Tomorrow I get to go the Dallas Cowboys game in the new stadium in a suite, courtesy of a friend who got the seats from Jerry Jones himself. Not sure where, but it
sounds cool. Sometimes life gives you lucky breaks.

Your amazed to still be writing after all these years

analyst,

John Mauldin

John@frontlinethoughts.com

Copyright 2009 John Mauldin. All Rights Reserved

John Mauldin is the President of Millennium Wave Advisors, LLC (MWA) which is an investment advisory firm registered with multiple states. John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS) an NASD registered broker-dealer. MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB). Millennium Wave Investments is a dba of MWA LLC and MWS LLC. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

~~~~~~

An Important Announcement

But first, I want to make a very important announcement. There are not many
times in a career when you can say that something new has been created in the
financial services industry and that you have been a part of it. But now I can
say that and, I must admit, with a little pride in helping to bring a new
creation into the world.

For years, Steve Blumenthal and I have shared a passion for bringing Absolute Return Strategies to all investors, not just the wealthy and institutional investors.

I want to introduce you to a new mutual fund, one that is different than the typical long-only equity mutual fund. My friends and partners at CMG have created a mutual fund that is comprised of 9 different trading strategies, a “fund of trading strategies,” so to speak; and it’s one that I believe will be strategically suitable for the economic environment that I think we face. And, as a mutual fund, it is open to
all investors.

You can learn more about it by reading a report I have prepared, entitled “How to
Deal with Volatility in Extraordinary Markets – Introducing the CMG
Absolute Return Strategies Fund.” Simply click here.

If you are an investment advisor or broker, you especially should read about this new fund and contact CMG directly for more information and reports. Full disclosure: as a consultant to the Advisor to the fund, my investment advisory firm does participate in the fees.
And be sure and read all the disclosures and risk factors in the document.

Economix points to an interesting study by the Gallup people, which concludes there is no clear relationship between Presidential approval and the Dow.

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As was shown last election (2006), there is a much closer relationship between Presidential approval and gasoline prices:

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Gasoline Prices & Presidential Approval

Source: Big Picture, Pollkatz

Herbie Hancock’s The River: The Joni Letters made my best of list for 2008

... is that they're always trying to sell something.

By the way, Karl Denninger needs a reality check. He does great forensic analysis, but has not produced a single original thought or global hypothesis in memory.

Global hypothesis?  You mean global conspiracy theory, right?  Why bother with those unless you're trying to drive someone toward a paid "newsletter" in which one can push some "alternative" that relies on something that "will happen tomorrow" - and when it doesn't, well, we just got the day wrong, but it will happen tomorrow!

Why do spooky visions of Jim Jones keep flashing before my eyes?

His view of a need for a New Resolution Trust Corp to clean up the mess shows a big blind spot. Any New RTC must be designed to operate as an independent entity, capable of turning a profit in a vast liquidation cycle with fees earned.

Absolute nonsense.  The purpose of an RTC is not to make a profit.  In fact, it will generate a loss - a big one.  Probably as much as a trillion dollars, maybe two trillion when one considers the backstop of depositors that has to be provided  (and which we will do, one way or another, as the alternative - screwing Granny out of her $30 large - means the shotguns come out, and the government knows it.)

The purpose of an RTC is to take out the trash and fix the US credit intermediation system by removing the clog.  We must do so in order to restore sound fundamentals and, on a forward basis, the ability to prosper and clear ordinary commercial credit transactions - a necessity if we are going to participate in the global monetary structure on a full and fair basis.  Since all modern monetary systems are in fact debt-based there is no real alternative to this that does not lead to us being left behind in an economically-crippled state, with the high likelihood of economic depression.

The fact that many individual properties under mortgage are linked to multiple mortgage bond securities hints that the trust would actually lose quite a handy sum of money.

Prove it.  This is simple; while these complex securities are "complex", they are so by obscurity.  That CDROM (or worse, DVD-ROM!) delivered content that lists each "thing" in the security pool does exist.  We also have things called computers, which can analyze and crosslink the data.

I've heard this allegation for years - going back to at least 2003.  That's a hella-long-time for this to be sitting out there without substantiation.  And while there are certainly lots of people who do not want this uncovered, the fact remains that the data is available, it was put on those CDROMs and DVDROMs, and it hasn't been destroyed. 

Hundreds of billions of dollars have been lost by investors worldwide in this collapse, and each of those dollars is a reason for someone to chase this.  I have never in my life subscribed to a conspiracy theory that requires me to buy into the belief that a whole lot of separately-interested parties, specifically lawyers, all of whom earn a fee on contingency, would fail to investigate and rip to shreds any such conspiracy on such a grand scale.

Further, the moment that such a thing was proved hundreds if not thousands of people would wind up in prison.  Yes, some of them would make threats (cf. Keating and what he said with regards to William Black) but that doesn't change the outcome - note that Bill Black's body remains at an elevated temperature compared to the room.

Other mortgage bonds are pure counterfeit, with no property income stream linkage.

Again, prove it.  There are billions of reasons for people to prove this if it is true.  Nobody has.

I look to motivation - the scammers have lots of reasons not to disclose but the harmed have billions of reasons to sue and press discovery if necessary.  It hasn't happened in this light to any material degree.  I don't buy it; this sort of kook-a-berry inspired rant does nothing to advance the debate on how we got here and how we get out.

Some bonds would cost more than they could redeem, while other bonds would not be redeemable at all. Mortgage bond fraud represents the gigantic shoe in the machinery. No meaningful home loan modifications, no New RTC, only top-down solutions favoring the big banks. My clarion call for a New RTC was made in 2007, but stopped in 2008 when that criminal fraud detail was revealed. Denninger must have been asleep back then. He has a great knack for dissecting trees, plants, and ferns, many rotten or acidic, but he misses the forests. Every squirrel has its expertise, but some have limited vision.

Bah.  Willie is great at putting forward what others have said, but of course he has a newsletter to sell.  I don't.

Oh, and what is Willie's prescription for investors?  Here we are again with the same old tired song:

 But real money emerges triumphant after the inevitable crisis that ensues. THAT REAL MONEY IS GOLD, ALONG WITH SILVER, EVEN PLATINUM.

Of course he's been calling for this "huge move" for a while.  I know, I know, gold is "screamingly undervalued" even at $1,000.  Ok.  So when will the big move come, and what's the target?  Willie, like most of these clowns, plays coy - he doesn't want to be caught having to "revise his calendar" when the end of the world does not materialize (or worse, hand you a cup of grape KoolAid) so he merely says this:

The gold breakout will come suddenly, without warning. In my view it could easily come from ENEMIES AT THE GATE, foreign creditors responding to their own stress.

Emphasis his, of course.  But this lack of a means to discern when (or if) the event is coming means that he can never have to say "I blew it"; unlike those of us who put forth an annual forecast with material and objective targets that we can grade a year later, he doesn't.  I wonder why not?

The "rush to junk" is one that I and many other commentators have pointed out on multiple occasions.  This isn't some conspiracy - it is how these sorts of parabolic blow-off movements come.  If you think this isn't a parabolic move, chart the S&P 500's price .vs. P/E over the last six months and tell me if your opinion changes.

As of July 31st we stand at 143.95 for that ratio, with a new update out in a few days.  By any measurement you care to use this is a parabolic move and those always follow the same pattern coming off the base (or bottom):

• First, the strongest firms have a nice, measured, volume-backed move.
• Then their volume and strength on a relative basis starts to weaken.  The middle-tier companies get it next, with their volume supporting their advance, dragging the strong firms along (but on flat to declining volume.)
• Finally, the used dogfood firms like Citibank, AIG, Fannie and Freddie "catch the fever" and their volumes spike to three, four, five, ten, even 100 times their normal volume and they take off like a rocket.  The "drag along" effect gets weaker and weaker as people start to look at the charts and go "heh, wait a second - that's a company that's doubled in three days, represents 10% of the entire NYSE volume, and on any reasonable valuation basis is a zero?

Not long thereafter the move collapses.

The foundational error that Willie and most other so-called analysts (AND "degreed economists") make is that they fail to properly recognize what the monetary base is in a debt-based monetary system.  Most will cite M1, M' or some other similar stupidity.  This is false and a bit of cogitation will lead you to the right answer, if you think about it for a while.  Consider the facts of all such modern systems: Your $100 bill spends identically to your VISA card.  What is the "monetary base" of your VISA card?  Now consider what, on a population-wide basis, this means for the monetary base of a nation's currency and credit system and the light should come on.  If it doesn't please check your cranium for the presence of a functioning set of neurons and if you have an economics degree make sure you turn it in to the university that issued it as it should clearly be revoked.

PS: At least the "bio" on FSN says this about Jim's intentions - in tiny, small print at the bottom, of course:

 Articles in this series are promotional, an unabashed gesture to induce readers to subscribe.

To which I reply: No, really?

The Census Bureau has released the "Quarterly Starts and Completions by Purpose and Design" report for Q2 2009 a few days ago.

Monthly housing starts (even single family starts) cannot be compared directly to new home sales, because the monthly housing starts report from the Census Bureau includes apartments, owner built units and condos that are not included in the new home sales report.

However it is possible to compare "Single Family Starts, Built for Sale" to New Home sales on a quarterly basis. The quarterly report shows that there were 82,000 single family starts, built for sale, in Q2 2009 and that is less than the 102,000 new homes sold for the same period. This data is Not Seasonally Adjusted (NSA). This suggests homebuilders are selling more homes than they are starting.

Note: new home sales are reported when contracts are signed, so it is appropriate to compare sales to starts (as opposed to completions). This is not perfect because homebuilders were stuck with “unintentional spec homes” during the housing bust because of the high cancellation rates, but cancellation rates are now much closer to normal.

Click on graph for larger image in new window.

This graph provides a quarterly comparison of housing starts and new home sales. In 2005, and most of 2006, starts were higher than sales, and inventories of new homes rose sharply. For the last seven quarters, starts have been below sales – and new home inventories have been falling.

The second graph shows the NSA quarterly starts intent for four categories since 1975: single family built for sale, owner built (includes contractor built for owner), starts built for rent, and condos built for sale.

Condo starts in Q2 tied the all time record low for Condos built for sale set in Q1 (5,000); the previous record was 8,000 set in Q1 1991 (data started in 1975).

Owner built units are above the record low set last quarter (38,000 units compared to 24,000 units in Q1 2009), however the pickup in starts was probably mostly seasonal (this is NSA data).

And single family units built for sale were also above the record low set last quarter (82,000 compared to 53,000 in Q1 2009).

Last night, I updated my list of trading rules, and I'd like to explain why.

8/29/2009 amendment: I will add that a major concern I have is that our government, which has become quite accustomed to extreme interference with the markets, will step in to "rescue" everyone during the resumption of the tumble. As a person who hopes to profit handsomely from the downturn, my concern is that the government is going to specifically target the bears in a show of populist activism.

I put nothing past them. Some ideas that spring to mind are outlawing options (or at least outlawing put options), assessing a 95% tax on profits from short sales, and making short-selling on any securities illegal. So I plan to take most of my profits before I believe the final low is in place if I get the impression that the lawmakers are about to step in and save everyone from the bears who "caused" this calamity.

Two interesting front page articles this morning expand on several of our favorite themes.

The first, the NYT’s A Reluctance to Spend May Be a Legacy of the Recession, treads over some well worn ground with anecdotes and data.  The anecdotal stuff is the usual mix of sad tales, and psychology, some signs of improvement and recovery.

Two data points worth noting are:

“Between 2003 and 2007 — prime years of the housing boom — the net worth of an American household expanded to about $540,000, from about $400,000, according to an analysis of federal data by Moody’s Economy.com.

Now, the wealth effect is working in reverse: by the first three months of this year, household net worth had dropped to $421,000 . . .

As recently as the middle of 2007, Americans saved less than 2 percent of their income, according to the Bureau of Economic Analysis. In recent months, the rate has exceeded 4 percent.”

What is omitted from the article is the why:  3 asset class collapses (Stocks, Housing, then Stocks again) will wreak havoc with yor psychology. Add to it shrinking Real Income, and voila! Consumers find frugality to be their new mantra.

The WSJ takes a different tack, looking at the advantages of larger versus smaller firms — but using the same anecdotal hooks to tell the story (I omit anecdotes for the obvious reasons):

The U.S. recovery is a tale of two economies. At one extreme of Corporate America is a cadre of companies and banks, mostly big, united by an enviable access to credit. At the other end are firms, chiefly small, with slumping sales that can’t borrow or are facing stiff terms to do so.

On Main Street, there are consumers with rock-solid jobs — but also legions of debt-strapped individuals struggling to keep their noses above water.

This split helps explain the patchiness of the recovery that appears to be taking hold after the worst recession in a half-century . . .”

Both of these are well worth your Saturday morning reading time . . .

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Sources:

A Reluctance to Spend May Be a Legacy of the Recession
PETER S. GOODMAN
NYT, August 28, 2009
http://www.nytimes.com/2009/08/29/business/economy/29consumer.html

Halting Recovery Divides America in Two
CARI TUNA, LIZ RAPPAPORT and JULIE JARGON
WSJ, August 29, 2009
http://online.wsj.com/article/SB125150649639668499.html

As a companion to the August 28 Problem Bank List (unofficial), below is a list of failed banks since Jan 2007.

The FDIC released the Q2 Quarterly Banking Profile this week. The report showed that the Deposit Insurance Fund (DIF) balance had fallen to $10.4 billion or 0.22% of insured deposits.

Click on graph for larger image in new window.

The graph shows the cumulative estimated losses to the FDIC Deposit Insurance Fund (DIF) and the quarterly assets of the DIF (as reported by the FDIC). Note that the FDIC takes reserves against future losses in the DIF, and collects fees and special assessments - so you can't just subtract estimated losses from assets to determine the assets remaining in the DIF.

The cumulative estimated losses for the DIF are now over $40 billion.

In this Dick Bove interview with CNNMoney, the interviewer Poppy Harlow said:

"When we look at that list though - we don't get the names from the FDIC obviously - only about 13% of the bank on that list actually end up failing".

The 13% number is historically accurate, but that is over the entire cycle - and this down cycle will probably be worse than most. So during this down period, the percentage will probably be much higher. As far as the names of the banks on the "list", most of them are on the Unofficial Problem Bank list.

The FDIC closed three more banks on Friday, and that brings the total FDIC bank failures to 84 in 2009.

Failed Bank List

Deposits, assets and estimated losses are all in thousands of dollars.

Losses for failed banks in 2009 are the initial FDIC estimates. The percent losses are as a percent of assets.

See description below table for Class and Cert (and a link to FDIC ID system).

The table is wide - use scroll bars to see all information!

Click here for a full screen version.

NOTE: Columns are sortable - click on column header (Assets, State, Bank Name, Date, etc.)




Class: from FDIC

The FDIC assigns classification codes indicating an institution's charter type (commercial bank, savings bank, or savings association), its chartering agent (state or federal government), its Federal Reserve membership status (member or nonmember), and its primary federal regulator (state-chartered institutions are subject to both federal and state supervision). These codes are:

N National chartered commercial bank supervised by the Office of the Comptroller of the Currency

SM State charter Fed member commercial bank supervised by the Federal Reserve

NM State charter Fed nonmember commercial bank supervised by the FDIC

SA State or federal charter savings association supervised by the Office of Thrift Supervision

SB State charter savings bank supervised by the FDIC

Cert: This is the certificate number assigned by the FDIC used to identify institutions and for the issuance of insurance certificates. You can click on the number and see "the last demographic and financial data filed by the selected institution".

by Bruce Webb

That is the subtitle of the new Center for Budget and Policy Priorities (CBPP) analysis of the Aug 25th CBO and OMB Reports on projected budget deficits that is being injected into the health care debate as a reason for non-action. The CBPP analysis can be read here: New OMB and CBO Reports Show Continuing Current Policies Would Produce Large Deficits. The authors' introduction:

On August 25, both the Office of Management and Budget (OMB) and the Congressional Budget Office (CBO) released updated budget projections. Some observers, comparing OMB’s estimate of the deficit over the next ten years under the President’s proposed policies ($9.1 trillion) to CBO’s “baseline” estimate of the deficit under current law ($7.1 trillion), jumped to the conclusion that the President proposes to increase the deficit dramatically. In fact, the opposite is true. The President’s proposals would produce significantly lower deficits over the next ten years than continuing current policies.
This and other confusions have occurred because both the OMB and CBO reports are chock-full of numbers that are hard for even seasoned budget-watchers — and almost impossible for ordinary citizens — to interpret. This brief analysis explains what some of the numbers mean, how CBO’s official baseline must be adjusted to show what CBO’s estimate of deficits would be if it assumed current policies are continued, and why even that adjusted baseline should not be compared with OMB’s estimate of deficits under the President’s policies.

The whole document is five pages long and should be read in full. But one lesson to take away is that you cannot directly compare CBO and OMB numbers, the former being bound by current law and the latter by current and proposed policy, two different things. To see the explanations from CBO and OMB try these links:
Orszag Press Release Mid-Session Review
OMB Mid-Session Review Mid-Session Review Web-Page with link to PDF of full report.
CBO Director's Blog Comparing CBO's and OMB's Projections of the Federal Budget Deficit with link to PDF.
A table below the fold .


Kevin Drum who pointed me to this has an annotated version of this table at MJ: http://www.motherjones.com/kevin-drum/2009/08/chart-day-0 where he totals the bottom line to get $10.556 trillion which is actually $574 billion below the figure CBPP comes up for an adjusted CBO number.

So before people jump to conclusions about how these new OMB and CBO numbers show Obama is breaking the bank be sure you know whether you are dealing with apples and oranges both with the initial and revised numbers.

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The Jewish Buddha says:

If there is no self, whose arthritis is this?

Be here now. Be someplace else later. Is that so complicated?

Drink tea and nourish life; with the first sip, joy; with the second sip, satisfaction; with the third sip, peace; with the fourth, a Danish.

Wherever you go, there you are. Your luggage is another story.

Accept misfortune as a blessing. Do not wish for perfect health, or a life without problems. What would you talk about?

The journey of a thousand miles begins with a single Oy.

There is no escaping karma. In a previous life, you never called, you never wrote, you never visited. And whose fault was that?

Zen is not easy. It takes effort to attain nothingness. And then what do you have? Bupkis.

The Tao does not speak. The Tao does not blame. The Tao does not take sides. The Tao has no expectations. The Tao demands nothing of others. The Tao is not Jewish.

Breathe in. Breathe out. Breathe in. Breathe out. Forget this and attaining Enlightenment will be the least of your problems.

Let your mind be as a floating cloud. Let your stillness be as a wooded glen. And sit up straight. You’ll never meet the Buddha with such rounded shoulders.

Deep inside you are ten thousand flowers.  Each flower blossoms ten thousand times. Each blossom has ten thousand petals.  You might want to see a specialist.

Be aware of your body. Be aware of your perceptions.  Keep in mind that not every physical sensation is a symptom of a terminal illness.

The Torah says, Love your neighbor as yourself.  The Buddha says, There is no self.  So … maybe we’re off the hook?

I just wanted to add some color to my recent post regarding why the NYSE TRIN indicator might be broken. Reader Brian adds a very interesting perspective, indicating that he's watched TRIN and C side by side and has seen a very strong correlation. When C flips from up to down (or vice versa), there is a corresponding huge move in TRIN. This could only be the case if a stock like C comprised a large share of total NYSE volume, which indeed seems to be the case, as noted by The Big Picture blog.

Above I took C, FNM, and FRE and expressed their *composite* volumes (e.g., the volumes transacted across all exchanges) as a fraction of NYSE volume. What we see is that, early in 2007, those three stocks accounted for only 1-3% of NYSE volume. During the financial crisis of late 2008 and again as the market was bottoming in early 2009, that ratio skyrocked to well over 50%.

Recently, however, the volume in these three stocks has hit astronomical levels relative to total NYSE trading, as all three have made phenomenal percentage gains during August. Indeed, the composite volume of these three stocks alone has recently doubled total NYSE volume. If we look at just the NYSE trading of these firms, they are accounting for about 40% of NYSE volume. It is not surprising that Brian would notice TRIN flipping up and down as these stocks change direction.

Again, the question is what all this means. There is no way that mom and pop trader and investor are involved in any meaningful way in generating these kind of daily trading volumes. Nor are proprietary trading shops capable of generating volumes that exceed those of the entire New York Stock Exchange. While I have no doubt that the algorithmic trade close to the market is participating in this movement, the directionality of the involvement suggests that large financial institutions are systematically buying the beaten-up shares of the poster children for TARP: C, FNM, FRE, AIG, and the like.

It is worth noting in this regard that other major (healthy) financial firms, such as GS and JPM, have seen no such surge in their volume or their trading prices.

My best guess? We're seeing a massive infusion of capital into very troubled financial institutions, no doubt aided by short covering and the participation of program traders and proprietary daytrading firms. Where is the capital coming from? Why has it poured in so suddenly (the really large infusions began in early August)? Why is it coming in at such a pace that it is dominating NYSE volume? Zero Hedge rightly wonders why this hasn't triggered alarms at the exchange. And why is it happening with only the weakest financial institutions?

If you were the government and you saw that these institutions were on the verge of a major fail, with billions of taxpayer dollars at risk, I'm not sure you'd announce that to the world. Nor, at this point politically, could you ask for yet another bailout package. But you would only pour money into those stocks at a frantic pace (capable of detection) if you perceived a dire need for the capital.

I'm not inclined toward conspiracy theories, but it's difficult to imagine a scenario in which this is not a (frighteningly necessary) coordinated capital infusion, with taxpayer dollars ultimately at work in financial markets.
.

Es gibt inzwischen verschiedene Schätzungen der Kosten der globalen Krise. Nun hat sich die Commerzbank daran versucht und kommt auf insgesamt 10,5 Billionen Dollar oder 7,3 Billionen Euro. Das wäre drei Viertel der jährlichen Wirtschaftsleistung der USA und fast das Dreifache der deutschen (Abb. 16003). Pro Erdenbewohner wären es etwas mehr als 1500 Dollar.

Hi All

Here is a quick video that I thought you would enjoy:



My Take:

What's a government to do? Spend money that they don't have or stop and let people starve?

1.5 million desperate Americans are facing the reality of losing their last lifeline of income by the end of the year. How many more people have to suffer before we finally suck it up and take our medicine?

Let's face it folks. We need to face the music and force many banks and every other bad company that's bankrupt to take their losses. Our nation will burn to the ground if we continue to bailout the favored elite.

The economy if NOT functioning. The government has spent trillions on bailing out America and its done nothing to help the little guy. The jobless still remain unemployed and they are about to lose their last option.

I am all for a few social programs that help people in dire situations. However, like the gentleman said above, we must stop spending money that we don't have in other areas of the economy in order to prevent our deficits from deepening.

I think its time the stimulus filters down to the people that actually need it versus bailing out the millionaires on Wall St.

We need change folks before we lose our country.

These days a surprising number of people have sprung up to defend the integrity and the role of High Frequency Trading in maintaining an orderly and efficient market (some of these are legitimate and bring good ideas to the table, many of them alas are simply deplorable, arising from the frontal cortex of tabloid journalists who have never seen a VWAP algo in action yet staunchly repeat whatever the mantra de jour is with the steadfast determination of a kamikaze bomber). Yet, for one reason or another, two former employees of multi billion quant fund Renaissance had other ideas when in the summer of 2007 they filed a lawsuit against the East Setauket purveyor of 2600 processing cores, alleging major fraud and illegal market activity related to various of RenTec's trading strategies. While the market in 2007 was, ironically, much more rational (if just a "little" overvalued), now that HFT has crept to dominate virtually every vertical of trading, it bears recalling some of the details presented by Alexander Belopolsky and Pavel Volfbeyn, at the time employed by yet another quant fund in all but name (which has and always will compete with Stevie Cohen's SAC for the fund with the fastest revolving door policy), Israel Englander's (he of 740 Park fame) Millennium Partners.

While much of the details of the original lawsuit are shrouded in secrecy due to "trade secret disclosure", the redacted, public version still contains some very curious pieces of information, which some of our more astute readers may be able to pick up and connect an occasional dot.

The lawsuit, which was essentially a response to a prior lawsuit filed by RenTec for trade secret porting by the two MIT Physics Ph.D's into Millennium, in some ways almost reads like a smear campaign. We will ignore any substantive conclusive claims (as these events were likely settled quite amicably), and instead will focus on the snapshot of time afforded by this one unique filing.

Curiously, some of the names and concepts touched upon back in 2007, which incidentally refer to a time when the two MIT grads were still employed by RenTec, a period between 2001 and 2003, read like the who is who of the Flash, HFT, and program trading funny pages in the Mainstream Media nowadays.

The facts.

From the filing:

130. While employed by Renaissance, Dr. Volfbeyn's superiors repeatedly asked him to assist Renaissance in conducting securities transaction that Dr. Volfbeyn believed to be illegal.

The illegality of these activites touched upon three main topical areas:

ITG-POSIT (The Dark Pool angle)

131. In particular, Dr. Volfbeyn was instructed to devise a strategy to defraud investors trading through the Portfolio System for Institutional Trading ("POSIT"). POSIT is an electronic trading system operating by Investment Technology Group ("ITG" ). POSIT collects buy and sell orders from large traders and attempts to match them.

132. On information and belief, POSIT is completely confidential. It does not reveal information about orders to anyone. For its customers, this confidentiality is an essential aspect of the system.

133. Renaissance asked Dr. Volfbeyn to create a computer algorithm to reveal information that POSIT intended to keep confidential [REDACTED]

134. Renaissance intended to, and did, use this trading strategy [the POSIT strategy] to profit [REDACTED]

135. Dr. Volfbeyn believed that [REDACTED] [the POSIT strategy] violated securities laws. He expressed his opinion to his superiors at Renaissance and refused to build the computer algorithm as they requested.

Limit Order Strategy [Stealing Liquidity]

139. Renaissance asked Dr. Volfbeyn to develop a computer algorithm [REDACTED] [the "limit order strategy"]

140. A limit order is an instruction to trade at the best price available, but only if the price is no worse that a "limit price" specified by the trader. Standing limit orders are placed in a file, called a limit-order book. Limit-order books on the New York Stock Exchange and NASDAQ are available to be viewed by anyone.

141. By [REDACTED], Renaissance intended to profit illegally.

142. Dr. Volfbeyn refused to participate in such activities. He explained that his refusal was based on his belief that the proposed transactions violated securities laws [2nd time RenTec allegedly used an illegel strategy]

143. Senior Renaissance personnel, including Executive Vice President Peter Brown and Vice President Mark Silber, attempted to persuade Dr. Volfbeyn to engage in the [REDACTED] limit order strategy, despite his objections. Mark Silber is the compliance officer for Renaissance, responsible for implementing systems to ensure that Renaissance does not violate the securities laws, and for protecting employees who complain about potentially illegal conduct.

144. On information and belief, Renaissance did not implement the [REDACTED] limit order strategy prior to Dr. Volfbeyn's termination. [What about after?]

Swap Transactions [The Naked Short Scam]

145. At all times relevant to this action, Rule 3350 of the NASD, prohibited NASD members, with certain exceptions from effecting short sales in any Nasdaq security at or below the current national best (inside) bid when the current national best (inside) bid is below the preceding national best (inside) bid in the security.

146. At all times relevant to this action, Rule 10a-1 under the Securities Exchange Act of 1934 provided that, subject to certain exceptions, an exchange-listed security could only be sold short at a price above the immediately preceding reported price or at the last sale price if it is higher than the last different reported price.

147. During the period when Dr. Volfbeyn and Dr. Belopolsky were employed at Renaissance, plaintiff engaged in a massive scam [REDACTED] [the "swap transaction strategy"]

148. [REDACTED]

149. [REDACTED]

150. Renaissance conducted [REDACTED] in violation of Rule 3350 and Rule 10a-1. Renaissance also intentionally [REDACTED] in violation of SEC and NASD rules. [REDACTED] Renaissance profited from the strategy [REDACTED].

151. Researchers at Renaissance expressed their concern to Executive Vice President Peter Brown and other officials of Renaissance about the legality of these swap transactions, including concerns that the transactions violated the tax laws and securities laws. Renaissance failed to halt the transactions. On information and belief, the swap transactions are continuing and generate substantial profits for Renaissance.

Zero Hedge makes no claim to the validity of any of these claims: we merely report what a former employee  of Renaissance claimed the quant fund was doing in violation of a variety of securities laws. Keep in mind, that while Renaissance is the undoubted master of controlling market liquidity (presumably legally, however this filing indicates extensive premeditated illegality), all this was occurring back in 2001, when HFT, PT, Flash, etc. were still fledgling strategies, accounting for far below 20% of total market volume, compared to the current 70% [ref: AITE Group]. As more attention focuses on potential abuse by HFT players and strategies, it is critical to keep in mind that contrary to what proponents may claim repeatedly in various venues, HFT is rife with potential abuse, which in many times likely crosses the threshold of what is considered legal, all at the expense of less sophisticated institutional and, by implication retail, investors. 

Once again: one can hope that the SEC, so focused on substantiating an increase in its "meager" budget, will follow up on such and many other cases, and maybe even preempt them, so that employees don't have to actually come forth first and disclose alleged illegal activities by their market making employers.

The full filing from the Supreme Court Of New York is presented below (and attached)

PS. Has anybody seen Millennium's monthly P&L? One would imagine it may make for a captivating read.

 

Attachment	Size
Quant Case.pdf	1.45 MB

Included in today’s FDIC closings were: Affinity Bank – Cost to the FDIC $254 million Bradford Bank  - Cost to the FDIC: $97 million Mainstreet Bank Cost to the FDIC - $95 million It almost appears that these closures are “controlled” to avoid having to shut down 20 or more that deserve to be closed immediately. With the current problem in the Banks, investors continue

From Rolfe Winkler at Reuters: Judge puts Fed's bailout revelations on hold

Chief Judge Loretta Preska of the U.S. District Court in Manhattan stayed her August 24 order in favor of Bloomberg News, which had sought [the names of the banks that have participated in the Federal Reserve's emergency lending programs] under the federal Freedom of Information Act, so that the central bank could appeal.

This case might go on and on. Perhaps Barney Frank and Ron Paul will pass new legislation requiring auditing the Fed before this FOIA case makes it through the courts.

UPDATE: Mish says Ron Paul RonPaul.com makes clear in an email to Mish that Frank is not talking HR1207, but an overall regulation.

"[W]e will subject [the Federal Reserve] to a complete audit. I have been working with Ron Paul, who is the main sponsor of that bill. He agrees that we don't want to have the audit appear as if it is influencing monetary policy, because that would be inflationary. And Ron and I agree on that.

One of the things the audit will show you is what the Federal Reserve buys and sells. And that will be made public, but not instantly, because if that was made instantly you would have a lot people trading off of that and you would have too much impact the market - and again Ron agrees with that. So we will publicly have that data released after a time period of several months, enough time so it wouldn't be market sensitive. That will be part of the overall Federal regulation that we are redacting.

The House will pass [the bill] probably in October."

The West setting sun
Affinity burned brightly
Extinguished today
by Soylent Green is People
From the FDIC: Pacific Western Bank, San Diego, California, Assumes All of the Deposits of Affinity Bank, Ventura, California

Affinity Bank, Ventura, California, was closed today by the California Department of Financial Institutions, which appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. ...

As of July 10, 2009, Affinity Bank had total assets of $1 billion and total deposits of approximately $922 million. ...

The FDIC and Pacific Western Bank entered into a loss-share transaction on approximately $934 million of Affinity Bank's assets. ...

The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $254 million. ... Affinity Bank is the 84th FDIC-insured institution to fail in the nation this year, and the ninth in California. The last FDIC-insured institution closed in the state was Vineyard Bank, National Association, Rancho Cucamonga, on July 17, 2009.

A quarter of billion here, a quarter of a billion there ...