Today's key economic events include weekly claims, productivity revisions, retail chain store reports, pending home sales, factory orders, and the Fed’s weekly report on its own balance sheet, plus testimony from Chairman Bernanke and some other FOMC speakers.
 
8:30: Unemployment insurance claims….back in the old range?  Last week’s report showed initial claims returning to the upper end of the 425k-475k range in which they had fluctuated during most of 2010 before some elevated readings in late July and early August.  The median forecast shows little change in either initial claims or continuing claims (those receiving payments under regular programs).  The overall number of claimants has risen sharply since the renewal of emergency benefits in late July.
For initial claims, median forecast (of 40): 475k, ranging from 460k to 485k; last 473k.
For continuing claims, median forecast (of 11): 4.45 million, ranging from 4.4 million to 4.5 million; last 4.456mm.
 
8:30: Productivity and costs for Q2 (revised)…a bigger setback.  The downward revision to Q2 real GDP growth included a 1-point markdown in the growth rate of nonfarm output; this should show through to the productivity data.  The impact on unit labor costs is slightly smaller, as the Q2 revisions also showed a slightly smaller increase in labor compensation.  First-quarter data for unit labor costs are apt to be revised down.
For productivity, median forecast (of 56) -1.9%, ranging from -2.4% to -0.5%; last (Q2 prelim) -0.9%.
For unit labor costs, median forecast (of 54) +1.2%, ranging from +0.3% to +2.0%; last (Q2 prelim) +0.2%.
 
9:00: Boston Fed President Eric Rosengren and Cleveland Fed President Sandra Pianalto deliver opening remarks…at a summit looking at the effects of foreclosures and vacancies on neighborhoods.  Both are voting members of the FOMC this year, though the specialized nature of this session makes it unlikely they will make market-moving comments.
 
c. 9:15: GS Retail Index for Aug…Our retail analysts are looking for a slowing in this index of same-store sales gains, to 2.7% from 3.7% in June and 3.9% in July.
 
10:00: Federal Reserve Chairman Ben Bernanke testifies….at a hearing of the Financial Crisis Inquiry Commission (FCIC), which is charged with examining the causes of the 2007-2008 financial meltdown.
 
10:00: Pending home sales index for July....further weakness?  That’s the bias of forecasts for July.  This index plunged nearly 30% in May, as activity to take advantage of the homebuyer tax credit was winding down, and it was off another 2.6% in June.  Although we do not forecast this index, there’s a reasonable case for a rebound, as these declines were much deeper than the increases that preceded them.
Median forecast (of 37): -1.0%, ranging from -5% to +4%; last -2.6%.
 
10:00: Factory orders for July….a small increase?  As it usually the case, we expect this report to mimic – in subdued fashion – the patterns drop already reported for durable goods bookings.  For July, this means roughly no change in overall orders (durable goods orders were up 0.3%) but a significant decline in those outside transportation (this component of durable goods orders fell 3.8%).  Revisions to the durable goods data are always possible, and the inventory data bear some attention, as the durable goods component has risen significantly for six months running.
Median forecast (of 59) +0.2%, ranging from -1.2% to +2.5%; last -1.2%.
 
16:30: Federal Reserve balance sheet….We will highlight this report again as the reinvestment of principal repayments of MBS and agency debt begins to alter the asset composition.  This actually started to show up in last week’s data.  The overall size of the balance sheet should stay approximately the same, at $2.3trn.

From Goldman Sachs

Back in September of 2007 when I was preparing to launch a hedge fund, I came up with this interesting name for a blog. It was BoomBustBlog. What made it interesting is that I can literally blog ad infinitum on the synthetically crafted booms and busts of the global economy, for the method of shepherding the economy in this day and age is actually predicated on the existence and/or creation of Booms and Busts. Of course, from my common sense perspective, one would think that the job of a central banker would be to ameliorate the effects of, and in time eliminate booms and busts… Apparently, that doesn’t appear to be the flavor du jour. As a matter of fact, it appears as if central bankers are doing the exact opposite. Of course, attempting to cure a bust with a boom, or worse yet attempting to prevent a boom from busting with another boom is a recipe for disaster, and worse yet the probability of success is close to nil, yet central bankers try anyway. This leads to overt and explicit policy errors, which leads to outsized profit opportunities to those who pay attention. Enter “The Great Global Macro Experiment, Revisited“, from which I will excerpt below. Please keep in mind that this article was written in October of 2008, and turned out to be quite prescient, I will annotate in bold parentheticals the portions of particularly prescient relevance. The original macro experiment piece was posted on my blog in September of 2007… For those that are interested, I plan on discussing this topic live on Bloomberg TV today: “Street Smart” with Matt Miller & Carol Massar at 3:30 pm.

As the US real estate market (residential, and soon commercial) is tanking (see BoomBustBlog.com’s answer to GGP’s latest press release and Another GGP update coming), the opaque derivative structures that allowed banks to write loans bigger than their balance sheets follow (see Is this the Breaking of the Bear? among many others). This will ripple throughout the world as speculative real estate and exotic financing vehicles follow the same paths in Europe (see the Pan-European Sovereign Debt Crisis series), Africa (reference Dubai’s solvency issues), Asia (see Chubble (The Unmistakeable, Yet Thoroughly Argued Chinese Bubble), Unemployed/Deleveraging Shopaholics Pushing Retail Stocks & Other News and What Are the Odds That China Will Follow 1920’s US and 1980’s Japan?), and South America. Spain’s residential real estate market is currently on fire and 92% of the mortgages issued are ARMs, most of which are concentrated to the lower income buyers (see “The Spanish Inquisition is About to Begin…“ and Spain Reports 20%+ Unemployment, a Structural Problem That May Persist For Some Time). Sound familiar? Similar scenes in Brazil. UK residential prices have soared (see Osborne Seems to Have Read the BoomBustBlog UK Finances Analysis, His U.K. Deficit Cuts May Rattle Coalition as well as the near collapse of several large UK banks), Australia up nearly 3 times (relative) (see Australia: The Land Down Under(water in mortgage debt), China homebuilders and contractors or roaring, condos in Dubai everywhere… Add in the US exported structured products… Practically all of the popularized risky assets are destined to follow suit, not just real estate – expect pressure in the emerging market debt markets as a follow-through…

Understanding my proprietary investment style

My own, personal and discretionary investment style leverages long and short positions in any traditional or alternative asset class, in any instrument, in any market around the world with the goal of profiting from macroeconomic trends. Put most simply, I attempt to employ the tried and true adage: buy low and sell high – I simply aim to do it during all phases of the market cycle. The often used, but seldomly recognized as meaningless, investment style classifications of value investing, growth company investing, etc. are silly, to say the least. Everybody is a value investor. We all buy something with the understanding that we will be able to sell it for more, thus the implication that it is undervalued at the time of purchase. The reason why we feel we can sell it for more is the impetus behind these nonsensical monikers of value, growth, Amy, Cindy and Karen! At the end of the day, we all want to buy low and sell high. The key is, how do we successfully go about doing it.

Now, in reading the now historical missive above which references debacle after debacle that policy makers retort “were impossible to see coming” (yeah, uh huh!), it could conceivably be argued that a) I had a crystal ball, b) I’m just smart as hell, or c) I simply pay attention and adhere to basic math, i.e., 2 + 2 = 4, all day, everyday – you know, realism. I’ll let you decide which answer is most appropriate. I go through this exercise because while reading through Bloomberg at 2 am in the morning (yeah, I know I should have better things to do,  but how else will this blog get written), I came across a statement from some professionals that reinforced my thesis that some investors literally cannot possibly fathom that we are still in a bubble despite 40% drops in commercial real estate prices. Take a look at the chart above, the cycle goes up and down, and has been doing so for centuries. Despite the fact that nothing has really changed for over a 1,000 years, it is amazing that so very few have learned their lesson. Or to put it another way, just because something is cheap doesn’t mean it can’t get a whole lot cheaper. Wait a minute, I’ve got another one… I fall out of a 10 story window, and drop 60 feet in a matter of seconds…. Does this really mean that my fall is over just because I fell 60 feet so fast, or do I really have another 100 feet to go, then a very hard impact before all is said and done???

Bloomberg writes: Real Estate Premium to U.S. Bonds Signal Time to Buy Property

Sept. 1 (Bloomberg) — U.S. commercial real estate yields are near the highest level relative to Treasury bonds on record, a signal to some investors it’s time to buy property. Capitalization rates, a measure of real estate yields, averaged 7.22 percent in the second quarter, based on an index calculated by the National Council of Real Estate Investment Fiduciaries. That was 429 basis points, or 4.29 percentage points, higher than the yield on 10-year government bonds as of June 30, according to data compiled by Bloomberg. It’s about 475 basis points higher than Treasury yields as of yesterday.

That spread is near the record 539 basis points in the first quarter of 2009, when the U.S. was mired in the worst of the financial crisis and property prices sank. Risk-averse investors are seeking the highest-quality office towers, hotels and apartments as the gap widens, according to Nori Gerardo Lietz, partner and chief strategist for private real estate at Partners Group AG in San Francisco.

“The data indicate that real estate is poised for a rebound,” said Gerardo Lietz, who advises pension funds on property investments.

Well, I have several problems with the statement above. For one, it is very difficult to “time” real estate markets due to their illiquid nature and a lack of a crystal ball, but if one were a market timer the strategy above makes sense right? Actually, no it doesn’t. For one, we are not in any better an economic or fundamental position now than we were in 2009, its just that the government and the fed have spent so many trillions of dollars to create the illusion that we are under the umbrella of attempting to reinflate the bubbles of 2000 to 2007. With that being said, of course spreads are similar, the situations are similar save the government has less ammunition to fight the battle this time around.

Chart sourced from CREconsole.com

The strategy above appears to be borne from the long only asset management mantra of always buying an asset. Sometimes its best just to say “No!”. For instance, the story clearly states that spreads are almost as wide as they were in the first quarter of 2009, the height of the financial malaise. So, if one were to use the logic inherent and bought at those even wider blowout spreads (the argument for the thesis was stronger back then), take a look at what would  have happened to your hard earned (or your client’s hard earned) money…

The Moodys/REAL commercial property index (CPPI) is a periodic same-property round-trip investment price change index of the U.S. commercial investment property market based on data from MIT Center for Real Estate industry partner Real Capital Analytics, Inc (RCA). The index has been developed with the objective of supporting the trading of commercial property price derivatives. The index is designed to track same-property realized round-trip price changes based purely on the documented prices in completed, contemporary property transactions. The index uses no appraisal valuations. The set of indices developed so far includes a national all-property index at the monthly frequency, national quarterly indices for each of the four major property type sectors (office, apartment, industrial, retail), selected annual-frequency indices for specific property sectors in specific metropolitan areas, and primary markets quarterly indices for the top 10 metropolitan areas in the major property types.

The biggest hole (and there are a few) in this “spread” thesis is the gross reliance of the spread to Treasuries without recognition and appreciation that Treasuries themselves are most likely in a bubble. This is why it is best to take a truly fundamental look at your investments. Back to the story…

Some buyers already are acquiring buildings at lower cap rates, which move inversely to price. In June, a group of South Korean pension fund investors bought the 33-story Wells Fargo Building in San Francisco for $333 million from Principal Financial Group Inc. in one of the largest transactions in the second quarter, according to Real Capital Analytics Inc., a property research firm. The office tower sold at a cap rate of about 7 percent, said Goodwin Gaw, the developer who helped broker on the deal.

My question is, why not just wait until there is a discernible trend in the stability of CRE? Why must everyone rush in to be first? Do rental rates look to be going much higher in the near to medium term due to materially firmer business fundamentals or lessened supply? Do interest rates look to be dropping considerably in the near to medium term? Are the fundamentals of the renters firm and strong? How does supply vs demand look after rampant, bubblicious overbuilding (which is still going on, may I add)? How does the financing and credit landscape look? How about the credit metrics of existing buildings? Do we have low LTVs or are these things thoroughly underwater (see the Macerich excerpt below). Let’s take a few pages out of my CRE 2010 Outlook report for subscribers (click here to subscribe). Be aware that this 47 page report was written nearly 10 months ago…

Are US Treasuries In A Bubble?

Well, if they are, not only does that debunk the “spread only” thesis to CRE investing but it will devastate those who employed said thesis when the bubble pops. As treasury yields spike, the cap rates on said buildings will have to spike to maintain said spread or the spread will have to lessen making the CRE that much more expensive relative to the safer treasuries. Either way, the CRE investor would have wished they waited! Let’s take a look at the NYSE US 10 yr index…

Whoa!!! Looks pretty bubblicious to me! Herein lies the problem. I don’t think that many investors truly understand the predicament that the US, much Europe and those big boys in Asia are in. Pray thee tell me, how is the US going to pay back its massive debt? Taking this from the beginning, many of us were told that the Federal Reserve’s mandate was to management inflation and unemployment rates. I lost a lot of profit and messed up a 7 year record of investing in the 2nd quarter of 2009 when the federal reserve performed a stealth mandate change, which in essence was to reinflate and maintain the credit and risky asset bubbles of the new millenium. This bubble blowing has been funded by the tax payer through the US Treasury. I challenge anybody to prove that the Fed’s objective has been anything but. The government and the CB has literally pulled out all stops to prevent the “Bust” portion of the Boom/Bust cycle. They have bought trillions in MBS, toxic assets directly off of private companies balance sheets, insured and indemnified private transaction, nationalized failed private financial institutions, purchased treasuries and MBS directly in a bid to artificially lower market interest rates -this is a move which is in and of itself by definition, unsustainable and guarantees a rate spike.

To make a long story short, nearly all of the biggest private sector problems have effectively been nationalized and made public sector problems without forcing the private sector to right its wrongs. Since nothing has really changed in the private sector and we are not marking bad assets to market but rather letting whatever we couldn’t goose the government into buying and converting into treasuries remain as they were while cash generating from the faux recovery was paid out as bonuses – the banks still have a shit load of trash on their balance sheets amid a worsening macro environment, the most indebted government of our lifetime and crumbling fundamentals. I pray thee tell me, exactly how are rates not going to spike? US Treasures are the new CDOs, wherein back in 2007 private banks scooped the trash they couldn’t convince suckers clients into buying directly, said trash was aggregated and repackaged with a AAA moniker and then sold to suckers clients. So, what is the difference between what Lehman, Goldman, Merrill and Bear Steans did and what out Central Bank is doing – that is picking up the garbage that nobody wants, recycling it into treasuries with a AAA moniker and then reselling them? The biggest difference is that one of the biggest suckers clients buying these repackaged toxic assets cum treasuries is the Federal Reserve, itself. Talk about a Ponzi scheme that is unsustainable. Again, how is it that treasuries are not in a bubble? How will rates stay low enough to justify buying CRE based upon the spread over treasuries at historic lows that are virtually guaranteed to go higher before the fundamentals of CRE improve significantly? I haven’t even touched upon the situation of our friends over there in Europe  – see .Pan-European Sovereign Debt Crisis series, where several nations are skirting default or restructuring (de facto default, you don’t get your money as promised) which will most likely cause some serious interest rate volatility, of which some banks are not prepared to withstand – See The Next Step in the Bank Implosion Cycle???). Since banks lend to CRE investors…. Oh well, back to the article…

Comparing Yields

Investors compare property yields with Treasuries to determine how much potential profit real estate offers relative to an investment that’s considered low-risk. The spread shrank to less than 80 basis points, the narrowest in 16 years, when commercial real estate prices peaked in 2007. Property values have dropped more than 40 percent since the October 2007 top of the market, according to Moody’s Investors Service.

The gap’s widening follows a plunge in bond yields after the global financial crisis spurred a flight to safety and the Federal Reserve slashed interest rates to a record low. Treasury bonds yesterday completed the biggest monthly rally since the end of 2008 amid signs economic growth is faltering, with the benchmark 10-year note yielding 2.47 percent.

“Property is attractively priced versus the fixed-income market,” said Ritson Ferguson, chief investment officer of ING Clarion Real Estate Securities in Radnor, Pennsylvania, which manages about $12 billion.

Yes, he’s right. Then again, 2 day old oysters smell attractive versus 3 day old oysters as well. Does that mean that 2 day old oysters smell good? The primary mantra of investing should be return of capital over return on capital!

The wide spread carries a warning signal to some investors because the economy remains weak, hurting commercial rents and occupancy. To contact the reporter on this story: Hui-yong Yu in Seattle at hyu@bloomberg.net

Those would be the more prudent investors they are referring to, at least in my oh so humble opinion.

The Amount of Underwater Properties is Nothing to Sneeze At

In December of 2009, I posted an article and accompanying research titled, “A Granular Look Into a $6 Billion REIT: Is This the Next GGP?” The following are excerpts from it:

More on commercial real estate:

• Even With Clawbacks, the House Always Wins in Private Equity Funds
• Commercial Real Estate Continues to Dropped into Foreclosure as the Landlords of Said Properties Enjoy Skyrocketing Share Prices? Yep, Makes Plenty of Sense
• The Conundrum of Commercial Real Estate Stocks: In a CRE “Near Depression”, Why Are REIT Shares Still So High and Which Ones to Short?
• The Shortlist of the Shortlisted “Stocks to Short for 2010″: What We See as the Most Profitable Bear Postions for 2010
• Developing Implications on Loan Accounting Law: Mark to Market, Mark to Model, or Mark to Market Crash?

More on residential real estate:

• I Told You Housing Was Going to Take a Downturn for the Worse. I’ll Tell You Something Else, We Are in a Housing Depression! It’ll Get Worse Until Market Forces Rule Over Government Bubble Blowing!
• Anecdotal Evidence That Banks Are Hiding Depressed High End Real Estate
• As I Made Very Clear In March, US Housing Has a Way to Fall
• Australia: The Land Down Under(water in mortgage debt)
• Australia: The Land Down Under(water in mortgage debt), pt. Deux: Which Banks to Short?
• Aussi Bubble Video to Go With You Aussie Bubble Speculation?
• Recent Mortgage Loss and Credit Performance Commentary

A weak seasonally adjusted PMI number out of China did nothing, as expected, for Chinese stocks, but was enough to push US futures up an entire point overnight, as any data now is enough to send the computers into a feeding frenzy. Additionally the trend of declining European data continues, with an even starker contrast between core and the periphery: EU PMI came in at 55.1 compared to 56.7 previously and the lowest since February 2010, yet what is interesting is that German PMI came on top of expectations (and again the lowest since february at 58.2), while Italy missed by a mile at 52.8 on expectations of some growth from the previous print of 54.5. As for Greece - forget about it: its PMI was 43, compared to 45.3 in July, on steep falls in output and new orders, as austerity continues to extract its pound of flesh. Yet it is all about the AUDJPY, which at least up until the completely worthless and irrelevant ADP report came in at -10,000 on expectations of +17,000 (and, gee, the previous was again revised lower from 42k to 37k, hopefully this is not an indicator of what to expect this Friday, as this was the first decrease in private payrolls since January 2010) was up by about 150 pips. So why is the AUDJPY flying? In addition to some better than expected Aussie GDP data, which is nothing but a second derivative on the Chinese economy, one should actually ask the forward looking question: what is really going on in China? And here is Goldman explaining why the Chinese PMI number, despite what Doug Kass would like to tweet, actually confirms an ongoing slow down in mainland China.

From Goldman Sachs Global ECS Research:

China’s official Purchasing Managers’ Index (PMI), co-compiled by the National Bureau of Statistics (NBS) and the China Federation of Logistics and Purchasing (CFLP), rose to 51.7% in August from 51.2% in July.

Despite the fact that it is claimed to be seasonally adjusted, historical headline PMI data showed clear seasonality. Its August readings tend to be higher than its July readings. After adjusting for this seasonality, the PMI was largely flat in August (down by less than 0.1 percentage point).

Among the sub-indices of the PMI (data mentioned below are after re-adjustment for seasonality, see Exhibit 3 for full breakdowns):

• The production sub-index fell to 54.8% in August from 55.4% in July.
• The new orders index rose to 55.0% in August from 53.9% in July.
• The new export orders index remained unchanged at 51.6%.
• The imports index was down to 49.1% in August from 50.9% in July.
• The employment sub-index went down to 50.8% in August from 51.5% in July.
• The input price sub-index continued to rise to 57.8% in August from 49.4% in July.
• The raw materials inventory index fell to 47.7% in August from 48.1% in July.
• The finished goods inventory index, which is a reverse index that tends to fall when the growth accelerates, fell by 1.4 percentage point.

Takeaways:

The August PMI headline reading suggests manufacturing activity growth remains significantly below its trend level (though there is no major further slowdown like the one that happened in late-2008). The further moderation in the production and imports sub-indices also suggesting actual growth continued to be weak in August. However, 1) the seasonality of the official PMI is not necessarily consistent which means we cannot fully rely on the PMI in judging the strength of activity growth. Other more anecdotal information seems to be more encouraging (e.g., the pace of investments especially in inland provinces probably accelerated. Though this information need to be treated with a big grain of salt too). We need to see industrial production (IP) data, which is due September 13, to get a better sense about actual growth in August. If IP data does confirm the continued weakness as suggested by today’s PMI data, we see more downside risks to our 10.1% 2010 GDP growth forecast. 2) The new orders sub-index started to improve modestly which may signal a rebound in activity growth in the near future. Interestingly, despite heightened concerns about growth in many parts of the world, the export new orders sub-index has not shown any clear downward trend since March.

Also worthwhile noting is the dramatic rebound in the input price index in August. This rebound is consistent with the rise in domestic commodity prices in recent weeks, especially in terms of steel prices, and may translate into a rebound in sequential PPI inflation with a short lag (typically a month). Higher inflation (CPI is also expected rise in August judging from the high frequency food price data compiled by the ministries of agriculture and commerce) may further complicate policy making as policy makers may feel it is difficult to loosen policy to stimulate growth. However, we expect the strength in inflation data to be temporary and by 4Q2010 the growth-inflation combination will likely to be one with lower yoy growth and falling inflation which will push policy makers to (quietly) loosen policy further. If a more-thanexpected slowdown in exports growth occurs in the coming months, a more decisive stimulus package will be needed and likely adopted.

Buried in the recently passed Dodd-Frank financial reform bill are massive financial rewards for turning in your boss. The SEC is hoping that multimillion dollar rewards amounting to 10%-30% of sanction amounts will drive a stampede of whistleblowers to their doors with evidence of malfeasance and fraud by their employers.

If such rules were in place at the time of the settlement with Goldman Sachs (GS), the bonus, in theory, could have been worth up to $500 million. Wall Street firms are bracing themselves for an onslaught of claims, legitimate and otherwise, by droves of hungry gold diggers looking for an early retirement.

Don’t count on this as a get rich quick scheme. Government hurdles to meet the requirement of a true stoolie can be daunting. The standard of evidence demanded is high, and must be matched with the violation of specific federal laws. Idle chit chat at the water cooler won’t do. Litigation can stretch out over five years, involve substantial legal costs, and often lead to a non financial settlement with no reward.

Having “rat” on your resume doesn’t exactly look good either. Just ask Sherron Watkins, the in house CPA who turned in energy giant Enron’s Ken Lay, Andy Fastow, and Jeffrey Skilling just before it crashed in flames. Nearly a decade later, Sherron earns a modest living on the lecture circuit warning of the risks of false accounting, and whistleblowing.

To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.

“Wall Street insiders this year have undertaken more than five times the number of stock sales of their corporate shares as they have purchases”

That one line in a recent article written by Kate Kelly, (with reporting by Jesse Bergman and Jennifer Dwork) of CNBC is enough to make you get the idea of what has been going on with this stock market. Not even corporate insiders want to stick around holding their stock in this “healthy” stock market.  According to the piece;

• Year to date, Goldman Sachs CEO Lloyd Blankfein, President Gary Cohn, and Chief Financial Officer David Viniar have sold a combined $64 million worth of shares.
• J.P. Morgan insiders, including treasury and securities services head  Michael Cavanagh and vice chairman Steven Black, have sold about $16 million.
• Citi executives, including institutional client group head John Havens and Asia Pacific region head Stephen Bird, have sold about $5 million.
• Wells Fargo CEO John Stumpf recently sold nearly $6 million worth of shares, following wealth-management head David Carroll, who sold roughly $5 million in stock this past March.

This graphic shows where Goldman Sachs insiders sold their positions.

And how lucky do you have to be if your the folks over at JP Morgan?  Can they have timed their sales any better?

SOURCE: Wall Street Insiders Want Out, Selling $100 Million in Stock

Much of the monetary actions made by the Federal Reserve and other central banks last year were done under the auspices that they were “trying to save capitalism” or “the free market.”

Setting aside the fact that the US hasn’t been a free market in decades, IF EVER (we’ll address that point in a moment), this statement is so boldly stupid that it’s amazing no one laughed at the powers that be when they claimed it.

“Save capitalism?” what exactly does this statement mean? How does one save a system that by very its nature encompasses failure and collapse for those who mess up? For capitalism, in its purest form, is nothing if not a system through which bad business decisions result in failure and good business decisions result in success.

Indeed, if some financial firm makes a colossal mistake (say, betting trillions of dollars of mortgage backed securities the wrong way for example), and subsequently finds itself insolvent, capitalism dictates that said firm should GO UNDER. End of story. That IS Capitalism. And we have a bankruptcy system in place to hand off the assets to creditors and more capable business people.

However, that’s not the system we have in the US today. Indeed, it’s not clear to me that we ever had that sort of system. As far back as the 1850s the US business game was somewhat rigged as various entities attempted to form monopolies to increase their leverage over their respective industries (John D Rockefeller’s Standard Oil being the most obvious example). To think that these monopolies were formed without some degree of government allowance or even approval is naive.

However, at least Rockefeller’s company actually MADE money.

In today’s Crony capitalist economy, the political system is bought outright by the large multinational corporations via various lobbying efforts/ corporate donations. These multinationals then receive kickbacks in the form of deregulatory policies and other tax loopholes, which permit them to further expand their power and influence.

However, unlike Rockefeller’s Standard Oil, most of these large-scale firms, especially the banks, are in fact insolvent or would be if they did not have unprecedented access to the US Federal Reserve and taxpayer dollars.

These groups aren’t strong pillars of profitability, they’re massively insolvent, unprofitable messes that wouldn’t exist if not for the fact that accounting standards have been suspended or disregarded as a national policy (unless you’re talking about ordinary Americans).

These companies don’t “add value” to the US economy, if anything they are a net drag on US productivity as they simply move capital around, most often from their clients accounts into their own. How many Goldman Sachs clients made fortunes in 2008-2009? Not many. How many Goldman EMPLOYEES made fortunes or took in record bonuses during that time? Quite a few.

Goldman of course is only one example. But the whole US system operates based on the principles of moral hazard, double standards, and crony capitalism.

Which brings me to my final point.

The US is NOT a capitalist country. And is sure as heck ain’t a free market. No, the US is a CRONY capitalist state: a state where one’s position in the socio-economic complex dictates the rules by which one can play. END OF STORY.

Look at the individuals dictating our economic policy: Geithner, Summers, Rubin (to a lesser degree). All of them have either been responsible for massive blow-ups, which should have ended their careers OR have played by a different set of rules their entire lives.

Instead, they’ve been promoted to the most powerful economic positions in the country. Why? Because they understand the part of Crony Capitalism that matters the most: it’s the Cronies… not the Capitalism.

Until we change this, and start leveling the playing field so that individuals with REAL ideas and solutions and STRONG track records can rise to positions of power in public policy, the US as a whole is screwed, or rather, those of us who don’t fall into the “Crony” category (the 300+ million) are.

Good Investing!

Graham Summers

PS. If you’re worried about the future of the stock market and have yet to take steps to prepare for the Second Round of the Financial Crisis… I highly suggest you download my FREE Special Report specifying exactly how to prepare for what’s to come.

I call it The Financial Crisis “Round Two” Survival Kit. And its 17 pages contain a wealth of information about portfolio protection, which investments to own and how to take out Catastrophe Insurance on the stock market (this “insurance” paid out triple digit gains in the Autumn of 2008).

Again, this is all 100% FREE. To pick up your copy today, www.gainspainscapital.com and click on FREE REPORTS.

Submitted by Themis Trading

Bachus Hensarling Letter to Schapiro, and Our Comments.

This morning we awaken to find the Bachus/Hensarling August 24^th 2010 letter to Mary Schapiro in our inbox, which we include as an attachment for you to read. Ever since the HFT industry formed their own lobbying group in Washington DC a few months back, we have expected a letter like this to surface. We certainly have expected it to surface given the recent anti-HFT media attention post May 6^th. Please allow us summarize their letter for you.

“In 2008 markets functioned exceptionally well. High Frequency Trading is beneficial to all. We all benefit from their liquidity. If it goes away we will all suffer.  Spreads have never been narrower. Costs of trading have never been lower. There is no evidence that flash order types are bad. Don’t make any changes unless you have more data. Turning back the clock on innovation will do harm. With our bias in mind, please answer in writing to us by September 10^th, 2010 the following 15 rhetorical questions.”

Had we told you this letter was written by the HFT lobby, you would have shrugged while commenting that such drivel is what you would expect that lobby to say. Perhaps we all should shrug less, and be more alarmed, that it comes from two congressman up for re-election, and written on the Committee on Financial Services letterhead. Incidentally, you can see who contributed to Representative Bachus so far in 2010 here : Open Secrets Bachus, and you can see who contributed to Representative Hensarling so far in 2010 here: Open Secrets Hensarling.

We understand how politics work in the United States. We know there will always be certain groups that have the ear of certain Congressman. However, let us compare this letter, with its open-ended and one-sided blatant bias with the well thought out letter from Senator Kaufman dated August 5^th, where he analyzed our market structure deficiencies and offered up 9 separate potential solutions Kaufman Letter to Schapiro.

The Bachus/Hensarling letter states as fact that the US markets functioned exceptionally well during the financial meltdown of 2008. But did they? Where is the Congressmen’s data to support that claim, aside from comments made by HFT proponents? In addition, their letter wants us all to ignore everything that has happened in 2009 and subsequently regarding HFT. They want us to ignore the arrest of Sergey Aleynikov, who stole code from Goldman Sachs that could be used to manipulate markets. They want us to ignore the studies by brokerage firms and TCA firms that demonstrate the negative and predatory effects of HFT. They want you to pretend you never heard of quote stuffing.

The Bachus/ Hensarling letter also states as fact that our markets remain efficient, transparent, and accessible to all investors. They obviously do not understand that our markets have become tiered, based on the degree of co-location paid to the exchanges. They also don’t understand that 20% of trading volumes are executed in the dark, which is less than transparent, shall we say. They also don’t understand that our markets have altered their focus from investing and towards ultra-short term hyper trading, collateral damage and capital formation be damned.

The Bachus/Hensarling letter states that, as we all do not know what caused the events of May 6^th, we should refrain from using terms like “Flash Crash”, as it presumes flash order types were the culprit. To this point, we say the following: not only is the “re-naming and spin management” game a silly one for the civil servants, whose salaries we pay, to play, but their argument demonstrates the lack of knowledge by these two Congressmen. The May 6^th Flash Crash is aptly named, because the events of that day took place in flash-like speed. The May 6^th Flash Crash was never named because of any reference to flash order types. The Congressmen know precious little of the issue they are attempting to address! Given the other portions of this letter that specifically address the SEC’s focus on flash order types, we easily see the real purpose of this letter, which is to advocate the position of those who wish to utilize these order types in equities and options.

We suggest that the Congressmen listen to what the real owners of our market have been saying.  They may want to read the letters recently written from Iridian Asset, Southeastern Asset, and Baron Asset.  Or listen to the words of Invesco and Principal Global.   These large institutional players have become frustrated with our fragmented market structure and they are now demanding change. Most of them have warned that unless significant changes are made then we should expect more flash crashes to happen. They may also want to listen to the legions of retail investors who have totally lost confidence in our equity market and are withdrawing their funds every month.   So, who are we to believe?   Two up-for-reelection Congressmen who appear highly conflicted, or the true owners of this market, as well as the outgoing Senator Kaufman who has clearly demonstrated that he understands what the issues are facing our market structure?

Crains NY ran a happy, go lucky article today:

The stubbornly dismal economy means at least one thing: an extended stay in the spotlight for a handful of star analysts whose defining characteristic is their extraordinary bearishness. And, of course, their accuracy.

There’s Albert Edwards, a London-based analyst from France’s Société Générale, who believes the Standard & Poor’s 500 will sink to 450, a sickening 57% drop from its current level. There’s David Rosenberg, chief economist at Toronto money manager Gluskin Sheff, who warns that deflation is going to pull down the U.S. economy for years.

And then there’s the New York star of this gloomy show: Reggie Middleton, a Brooklyn entrepreneur who turned to analyzing global markets after a stint buying and renovating apartments in Fort Greene and Clinton Hill. (See “Prophet of doom,” April 19.)

Bad as things may be for the economy, Mr. Middleton warns that they’re poised to get much worse. Prices of real estate, stocks and bonds are all headed for serious falls… Wages will decrease, unemployment will increase. Fun, eh?

…

The culprit, Mr. Middleton says, is Washington. The bank bailouts, nationalization of Fannie Mae and Freddie Mac, and other interventions during two presidencies prevented the market from bottoming out in 2009 like it should have, he says. Now that the economy is weakening again and the heavily indebted U.S. government has fewer rescue options, the reckoning is coming. Markets of all kinds in the United States and Europe will get hit—hard.

“In my opinion, the amount of risk in the system is even higher than in 2008,” he says, adding this rare dash of hope: “2013 might be a good time to start taking a look at buying assets again.”

Mr. Middleton has been startlingly accurate in the past. He forecast the collapse of the housing market in 2007, and in early 2008 warned of the demise of Bear Stearns weeks before it happened. Earlier this year, he said that Ireland’s finances were in terrible shape long before Standard & Poor’s got around to downgrading that nation’s credit rating.

For those of you who don’t follow my blog, Mr. Elstein (the article’s author) was referring to:

1. The Housing Market in 2007 (as it turns out, I was actually overoptimistic – and to think that some call me a bear!): Correction, and further thoughts on the topic and How Far Will US Home Prices Drop?
2. Bear Stearns in January 2008 ( 2 months before they popped, while trading in the $180s and still had buy ratings and investment grade AA or better from the ratings agencies, may I add): Is this the Breaking of the Bear? This  was also about the time I got into it with GGP’s CFO for calling out their insolvency. He called me names, and then they filed for bankruptcy. Of course, they had an investment grade and buy ratings from the ratings agencies and the sell side: BoomBustBlog.com’s answer to GGP’s latest press release and Another GGP update coming… (among over 700 pages of analysis, review the January 2008 archives or search for “GGP” for more research).
3. My views on Ireland, austerity, and the disguised sink hole of debt and non-performing assets that is the Irish banking system: I Suggest Those That Dislike Hearing “I Told You So” Divest from Western and Southern European Debt, It’ll Get Worse Before It Get’s Better!

Those of you who follow my blog may remember that Crains ran an article earlier this summer as well (see Prophet of Doom!), wherein I wasn’t very bullish then, either (or even the summer before that, see Forbes, Going short). I want to be crystal clear here. I am not a perma-bear, bull, or anything of the sort. I’m just your typical brother that has a keen nose for BS and seeks the truth. 2+2=4. It always equals 4. If you are in an investment environment where the number after the “=” sign is greater than 4, you are in a bubble. If the number is less than 4, the market has over-discounted the price of assets. The vast majority of the first decade of the new millennium has seen 2+2=16, and sell side analysts, bankers, brokers, and private funds have been trying to tell us that there is a new math in town. No, my friends. Its the same math, the same story, and the eventually, the end result.

1. BOOM: the bubble blows high and wide
2. BUST: the bubble pops and deflates
3. (this is new) Central banker and policy maker re-BOOM: governments around the globe actually try to reinflate the bubbles of yore before they even finish popping.
4. BlOG: I get to blog about my investment adventures in taking advantage of egregious policy errors in the greatest macro experiment of mankind. See “The Great Global Macro Experiment, Revisited” for more on this topic.

So, how has my bearishness empirically driven realism fared? Well, after riding the real estate boom up (I told you I wasn’t a permabear), since the inception of the blog (2007) until the second quarter of 2009 I knocked the ball out of the park with personal returns pushing nearly 500%, while profitably predicting and shorting the downfall of nearly every major financial, insurance, banking and real estate institution during the period in question (I did miss a few, though). I then gave back half of those profits by underestimating the depth, breadth and ferocity of the government blown bubble 2009. I seriously didn’t think our government would attempt to mortgage our collective future to such an extent for the benefit of so few in the present. The losses in the last 3 quarters 2009 hurt, and they hurt a lot! Well, that’s what I get for thinking! See Updated 2008 performance, and 2009 Year End Note to BoomBustBlog Readers and Subscribers. for the full performance story and the numbers behind it.

As for 2010, let’s recap…

Jauuary and February 2010

I warned in explicit detail, the travails coming for Greece, and by both extension and association, much of western, southern, central and eastern Europe as well. A month or two later, the ratings agencies follow suit (as usual, late to the party). See The Beginning of the Endgame is Coming??? Monday, February 22nd, 2010:

So, Fitch finally get’s around to downgrading the Greek banks. The sovereign debt short is probably a bit crowded right now, and may be due for a squeeze, but the fundamentals and the macro situation still stands. As a matter of fact, I really believe that most investors, speculators, pundits and regulators are actually looking at the wrong sets of risks – hence may truly be surprised when the choco-pudding hits the fan blades.

From Fitch:

Fitch Ratings-Barcelona/London-23 February 2010: Fitch Ratings has today downgraded the Long-term and Short-term Issuer Default Ratings (IDR) of Greece’s four largest banks,  National Bank of Greece (NBG), Alpha Bank  (Alpha), Efg Eurobank Ergasias (Eurobank) and Piraeus Bank (Piraeus) to ‘BBB’ from ‘BBB+’ and ‘F3′ from ‘F2′ respectively. The Outlook on the Long-term IDRs is Negative.

• • • Alpha Bank warned about in subscriber reports last week – Check!
    • National Bank of Greece warned about in subscriber report last week – Check!
    • Efg Eurobank Ergasias (Eurobank) warned about in subscriber report last week -Check!
    • Piraeus Bank (Piraeus)  warned about in subscriber report last week -Check

See the entire Pan-European Sovereign Debt Crisis series, for that was (and is) a recurring theme throughout the year. Oh yeah, and for a visual effect…

Practically every stock and bond negatively opined in the entire Pan-European Sovereign Debt Crisis series is down dramatically. I have also included haircut analysis for much of the sovereign debt for this is far from over.

February 2010

I reiterate my warnings about the Golden Boys who, at the time, were believed by the sheeple to be untouchable. See For Those Who Chose Not To Heed My Warning About Buying Products From Name Brand Wall Street Banks, wherein I state explicitly:

This is not a short post, for it is packed with a lot of supporting information, analysis and data. If you are looking for quippy paragraph, soundbyte or quick headline to get an overview of,,, well whatever, click here, or better yet, click here. For everyone else who may be looking for deeper investigative analysis and the unbridled TRUTH for a change, please continue on.

First a little background info. Goldman is supremely overvalued in my opinion. It is even more so considering much of its profit is generated solely from the raping of its clients. I say this holding absolutely no ill will towards Goldman. This is strictly factual. Let’s walk through the evidence, of profit potential, valuation, and the stuff behind some of the value drivers in their business model, like brokerage and investment banking…

Even after the “big Goldman event” pundits held on to that brand name nonsense. See Can You Believe There Are Still Analysts Arguing How Undervalued Goldman Sachs Is? Those July 150 Puts Say Otherwise, Let’s Take a Look

I invite all who may be new to my blog to peruse the plethora of writings and research from the year (or years) past, for I feel that fundamentals are going to return to these markets, and return in a very big way! There is a deluge of useful information on the site for those who are serious about hardcore, forensic analysis. Although BoomBustBlog is a subscription site, we feature tons of free analysis available to the public. Topics covered for this year include commercial real estate, residential real estate, technology (particularly Apple/Google/Microsoft, which was been quite controversial), investment banks, commercial banks, retail stocks, etc.

The archives are available via drop down menu in the lower left hand corner of the site’s left side bar. Directly above the archives is the ability to browse by topic. There is also a search bar in the upper right had corner for textual searching in lieu of browsing.

Submitted by Jim Quinn of The Burning Platform

The Age of Mammon

“Financiers – like bank robbers – do not create wealth. They merely distribute it. While the mob may idolize holdup men in good times, in the bad times it lynches them. What they will do to the new money men when their blood is up, we wait eagerly to find out.”  - Mobs, Messiahs and Markets

As our economy hurtles towards its meeting with destiny, the political class seeks to assign blame on their enemies for this Greater Depression. The Republicans would like you to believe that Bill Clinton, Robert Rubin, Chris Dodd, and Barney Frank and their Community Reinvest Act caused the collapse of our financial system. Democrats want you to believe that George Bush and his band of unregulated free market capitalists created a financial disaster of epic proportions. The truth is that America has been captured by a financial class that makes no distinction between parties. These barbarians have sucked the life out of a once productive nation by raping and pillaging with impunity while enriching only them. They live in 20,000 square foot $10 million mansions in Greenwich, CT and in $3 million dollar penthouses on Central Park West.

These are the robber barons that represent the Age of Mammon. The greed, avarice, gluttony and acute materialism of these American traitors has not been seen in this country since the 1920′s. The hedge fund managers and Wall Street bank executives that occupy the mansions and penthouses evidently don’t find much time to read the bible in their downtime from raping and pillaging the wealth of the middle class. There are cocktail parties and $5,000 a plate political “fundraisers” to attend. You can’t be cheap when buying off your protection in Washington DC.

Lay not up for yourselves treasures upon earth, where moth and rust doth corrupt, and where thieves break through and steal: But lay up for yourselves treasures in heaven, where neither moth nor rust doth corrupt, and where thieves do not break through nor steal: For where your treasure is, there will your heart be also. No one can serve two masters, for either he will hate the one and love the other; or else he will be devoted to one and despise the other. You cannot serve both God and Mammon. – Matthew 6:19-21,24

It seems that Lloyd Blankfein, the CEO of Goldman Sachs, may have been overstating the case in saying his firm doing God’s work. With his $67.9 million compensation in 2007 and payment of $20.2 billion to his co-conspirators, Blankfein appears to be a proverbial camel trying to pass through the eye of a needle. This compensation was paid in the year before the financial collapse brought on by the criminal actions of Lloyd and his fellow henchmen. After having his firm bailed out by the American middle class taxpayer at the behest of his fellow Goldman alumni Hank Paulson, Lloyd practiced his version of austerity by cutting compensation for his flock to only $16.2 billion ($500,000 per employee) in 2009. I’m all for people making as much money as they can for doing a good job. But, I ask you – What benefits have Goldman Sachs, the other Wall Street banks, and hedge funds provided for America?

Never have so few, done so little, and made so much, while screwing so many.

In 2005, the top 25 hedge fund managers “earned” $9 billion, or an average of $360 million. One year after a financial collapse caused by the financial innovations peddled by Wall Street, the top 25 hedge fund managers paid themselves $25 billion, or an average of $1 billion a piece. For some perspective, there were 7 million unemployed Americans in 2006. Today there are 14.6 million unemployed Americans. While the country plunges deeper into Depression, the barbarians pick up the pace of their plundering and looting of the remaining wealth of the nation. Bill Bonner and Lila Rajiva pointed out a basic truth in 2007, before the financial collapse.

“On the Forbes list of rich people, you will find hedge fund managers in droves, but no one who made his money as a hedge fund client.” - Mobs, Messiahs and Markets

Ask the clients of Bernie Madoff how they are doing.

1920′s Redux

The parallels between the period leading up to the Great Depression and our current situation leading to a Greater Depression are revealing. When you examine the facts without looking through the prism of party politics it becomes clear that when the wealth and power of the country are overly concentrated in the clutches of the top 1% wealthiest Americans, financial collapse and depression follow. This concentration of income and wealth did not cause the Stock Market Crash of 1929 or the financial system implosion in 2008, but they were a symptom of a sick system of warped incentives. The top 1% of income earners were raking in 24% of all the income in America in 1928. After World War II until 1980, the top 1% of income earners consistently took home between 9% and 11% of all income in the country. During the 1950′s and 1960′s when Americans made tremendous strides in their standard of living, the top 1% were earning 10% of all income. A hard working high school graduate could rise into the middle class, owning a home and a car.

From 1980 onward, the top 1% wealthiest Americans have progressively taken home a greater and greater percentage of all income. It peaked at 22% in 1999 at the height of the internet scam. Wall Street peddled IPOs of worthless companies to delusional investors and siphoned off billions in fees and profits. The rich cut back on their embezzling of our national wealth for a year and then resumed despoiling our economic system by taking advantage of the Federal Reserve created housing boom. By 2007, the top 1% again was taking home 24% of the national income, just as they did in 1928. When the wealth of the country is captured by a small group of ruling elite through fraudulent means, collapse and crisis becomes imminent. We have experienced the collapse, while the crisis deepens.

It’s Good To Be the King

The Wall Street oligarchs  were able to accumulate an ever increasing portion of corporate profits by inventing securitization, interest-rate swaps, and credit-default swaps which swelled the volume of transactions that bankers could make money on. These products were originally introduced as a means for corporations to hedge their risks. Wall Street shysters chose to use their “creative” financial products to build the biggest gambling casino in the history of the world. They functioned as the house, siphoning off billions in profits, but then got caught up in the hysteria and placed billions of bets themselves. This resulted in the financial industry generating 41% of all business profits in 2007. From World War II through 1980, financial industry profits ranged between 10% and 15%. Simon Johnson explains the despicable hijacking that has taken place since then.

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007. 

The original robber barons amassed huge personal fortunes, typically through the use of anti-competitive business practices. These well known titans of industry included Henry Ford, Andrew Carnage, John D. Rockefeller, and JP Morgan. They may have practiced questionable business ethics, but they did create wealth while benefitting the country as a whole. They introduced the automobile, provided the nation with steel, produced the oil that powered our economy, and brought order to industrial chaos of the day. It seems their fortunes were built by creating rather than destroying.

The disgustingly rich Wall Street wheeler dealers who live in Greenwich CT and NYC and summer in the Hamptons have created nothing. Their immense wealth has been created through draining the economic system of its lifeblood. Their financial innovations have created no lasting benefit for our society. Wall Street knowingly created no documentation (liar loans) mortgage loans, Option ARM loans, and subprime loans. You do not create products that beg for fraud unless you want fraud. The packaging of these fraudulent mortgages into CDOs and CDSs by Wall Street’s crime machine benefitted Wall Street only. Those who got the loans defaulted, lost the homes, and had their credit ruined. Wall Street financiers have lured the American public into debt with easy credit and a marketing machine geared to convince the average Joe that he could live just like the rich. Simon Johnson explained the phenomena in a recent article.  

You Call This Capitalism?

Capitalism is supposed to be an economic system in which the means of production and distribution are privately owned and operated for profit; decisions regarding supply, demand, price, distribution, and investments are not made by the government; Profit is distributed to owners who invest in businesses, and wages are paid to workers employed by businesses. The American economy is in no way a free market capitalistic system. It has become a oligarchic consumer capitalist society that is manipulated, in a deliberate and coordinated way, on a very large scale, through mass-marketing techniques, to the advantage of Wall Street and mega-corporations.

When you hear the Wall Street class on CNBC argue against tax increases for the rich, they hark to the fact that small businesses would be hurt most by the expiration of the Bush tax cuts. There are 6 million small businesses in the US, with 90% of them employing less than 20 employees. These are not the rich. The vast majority of these businesses earn less than $1 million per year. There are only about 134,000 people in America who make on average $2.5 million per year. There are another 600,000 people who make on average $760,000 per year. Out of a workforce of 150 million, less than 1 million rake in over $750,000 per year. These are not small businesses. They are the Wall Street elite, corporate CEOs and the privileged classes that control the power in NYC and Washington DC.

The following charts clearly show that  perverse incentives in the US financial system have allowed corporate executives to reap ungodly pay packages, while the middle class workers who do the day after day heavy lifting in corporations have been treated like dogs. Considering the S&P 500, which measures the stock returns of the 500 largest companies in the U.S., has returned 0% for the last 12 years, the CEOs of these companies would slightly embarrassed paying themselves 300 times as much as their average workers. Not in the age of mammon. Big time CEOs are rock stars. Outrageous pay packages are a medal of honor in a world where humility and honor don’t exist.

The Depression that currently is engulfing the nation was 30 years in the making. The criminal Wall Street financiers are the modern day John Dilingers. They have mastered the art of stealing from the masses while convincing these same people that they should admire them because they are rich. This is the oddity about Americans as pointed out by Bill Bonner and Lila Rajiva.

“The poor genuinely believe the rich are better than they are. They are smarter and better educated. The poor even support low tax rates for the rich, as long as they have a lurking chance of joining them.” -   Mobs, Messiahs and Markets

The truth is that the poor have no chance of joining the the rich. The game is rigged. The poor have admired the rich for decades. But, hard times have arrived. And they are about to get harder. The rich have armed guards to keep the poor at bay. They will need an army of guards before this crisis subsides.

Leonard Cohen sums it up perfectly in his song Everybody Knows:

Everybody knows that the dice are loaded
Everybody rolls with their fingers crossed
Everybody knows that the war is over
Everybody knows the good guys lost
Everybody knows the fight was fixed
The poor stay poor, the rich get rich
That’s how it goes
Everybody knows
Everybody knows that the boat is leaking
Everybody knows that the captain lied
Everybody got this broken feeling
Like their father or their dog just died

Bloomberg writes, Blackstone Returns Fees to Investors in First Clawback Triggered at Firm, I excerpt below:

Aug. 27 (Bloomberg) — Blackstone Group LP is refunding some performance fees earned during the commercial real estate boom, the first time fund investors have clawed back cash from executives at the world’s largest private-equity company.

Blackstone and some of its managers returned $3 million in carried interest to investors in Blackstone Real Estate Partners International LP during the second quarter, said a person with knowledge of the payments. They may pay back an estimated $15.7 million this quarter to another fund, Blackstone Real Estate Partners IV, according to the person and a regulatory filing.

Blackstone’s property buyout funds recorded performance fees totaling $1.74 billion, some of which was allocated to the firm’s partners, as the market for office towers, hotels and apartments soared from 2004 to 2007. Prices have slumped about 39 percent since then, leaving New York-based Blackstone and its rivals in a position similar to that of venture capital firms about a decade ago, when the collapse of technology stocks forced them to return profits earned on Internet companies during the 1990s.

“The acute situation for clawbacks is when you have had a very successful period of gains and then the remaining deals don’t do well,” said Michael Harrell, co-head of the private funds practice at the New York-based law firm Debevoise & Plimpton LLP. “That is what happened when the Internet bubble burst and there is certainly the potential for that with the sharp downturn in the real estate market.”

Clawback Provisions

Private-equity funds, which raise money from institutions including pensions and endowments, pay a share of profits from investments, usually 20 percent, to the firm and its investment managers. If the fund’s remaining holdings suffer a permanent decline in value, clawback provisions can require the executives to rebate cash distributions in order to prevent their share of profits from exceeding the 20 percent.

Blackstone’s repayments were included in an Aug. 6 regulatory filing that didn’t name the funds.

Blackstone’s $38.7 billion purchase of Sam Zell’s Equity Office Properties Trust in February 2007 marked the pinnacle of a bubble inflated by easy financing. The firm sold $60 billion of real estate assets before the market slumped in 2008, Chief Executive Officer Stephen Schwarzman said during a July 22 conference call with analysts, according to a transcript.

Profits from some of those sales have helped Blackstone’s funds outperform rivals. The carried interest paid on the profits also exposed Blackstone managers to possible clawbacks when the market fell and dragged down the value of the remaining holdings in their funds. Potential clawbacks at the firm’s property funds more than tripled to $299.8 million last year from $77.2 million at the end of 2008, according to regulatory filings. The figure shrank to $280.3 million at the end of June.

…

Equity Office Properties

While Blackstone sold $27 billion in assets acquired in the Equity Office deal, there weren’t any potential clawbacks from gains on those transactions, according to the person familiar with the funds. That’s because Blackstone used the proceeds from those real estate sales to pay down debt rather than make carried interest payments to itself and managers.

…

Property buyout funds raised about $262 billion from 2005 through 2009, more than double the total from the previous five years, according to London-based Preqin Ltd., a research and consulting firm focusing on alternative assets.

Market Sours

In some buyouts, debt reached 95 percent of the price as buyers assumed that rents and cash flow to service the borrowings would rise with the real estate market, said James Corl, a managing director at Siguler Guff & Co. who oversees the New York-based investment firm’s distressed strategies.

Instead, the economy weakened in 2008, leading to defaults among developers such as Harry Macklowe, whose properties were overburdened with debt, Corl said.

Funds that began investing after 2004 have lost money on average, Preqin data show. Funds that entered the market in 2007 have averaged annual declines of 33 percent.

“All of these guys invested in trophy properties at the top of the market,” said Thomas Capasse, a principal at Waterfall Asset Management LLC, a New York firm that invests in high-yield structured debt. “Many of these real estate opportunity funds ended up down 30 to 75 percent.”

In April, Morgan Stanley told investors that the firm expected an $8.8 billion international real estate fund would end up losing about 61 percent of its assets. Whitehall Street International, a property investment fund run by Goldman Sachs Group Inc., lost almost all of its $1.8 billion in equity, CNBC, Reuters and the Financial Times reported the same month.

…

Private-equity firms begin to earn performance fees once their fund’s annual returns exceed a threshold promised to clients, typically 7 percent to 10 percent. Real estate funds record carried interest as they mark up the value of their holdings. The fees don’t get paid until gains are realized through property sales.

Traditional corporate buyout funds wait until their lifespan, usually about 10 years, is completed to make this calculation. Real estate funds sometimes require interim clawbacks, such as those being made by Blackstone.

“Some managers have had to write checks and some managers have had difficulty writing checks,” said Geoffrey Dohrmann, chief executive officer of Institutional Real Estate Inc., a San Ramon, California, publishing and consulting firm that specializes in the commercial real estate market.

I have written extensively on this topic. For one, the CRE bubble was obvious, but funds plowed ahead because they receive fees for deals done as well as performance fees. I warned about Blackstone and the Sam Zell deal blowing up back in 2007 as it was being done (see Doesn’t Morgan Stanley Read My Blog?). It was quite OBVIOUS that the top of the market was there , but it doesn’t matter if you get paid for both success AND failure, does it? They are often in a win-win situation. On April 15th, 2010 I penned “Wall Street Real Estate Funds Lose Between 61% to 98% for Their Investors as They Rake in Fees!” wherein I espoused much of my opinion on market manipulation and the state of CRE. I will excerpt portions below in an attempt to explain how REITs and the bankers that they deal with get to add 2 plus 2 and receive a sum of 6, or worse yet have 4 subtracted from their 6 and get to sell 5!!! Straight up Squid Math!

Oh, yeah! About them Fees!

Last year I felt compelled to comment on Wall Street private fund fees after getting into a debate with a Morgan Stanley employee about the performance of the CRE funds. He had the nerve to brag about the fact that MS made money despite the fact they lost abuot 2/3rds of thier clients money. I though to myself, “Damn, now that’s some bold, hubristic s@$t”. So, I decided to attempt to lay it out for everybody in the blog, see ”Wall Street is Back to Paying Big Bonuses. Are You Sharing in this New Found Prosperity?“. I excerpted a large portion below. Remember, the model used for this article was designed directly from the MSREF V fund. That means the numbers are probably very accurate. Let’s look at what you Morgan Stanely investors lost, and how you lost it:

The example below illustrates the impact of change in the value of real estate investments on the returns of the various stakeholders – lenders, investors (LPs) and fund sponsor (GP), for a real estate fund with an initial investment of $9 billion, 60% leverage and a life of 6 years. The model used to generate this example is freely available for download to prospective Reggie Middleton, LLC clients and BoomBustBlog subscribers by clicking here: Real estate fund illustration. All are invited to run your own scenario analysis using your individual circumstances and metrics.

To depict a varying impact on the potential returns via a change in value of property and operating cash flows in each year, we have constructed three different scenarios. Under our base case assumptions, to emulate the performance of real estate fund floated during the real estate bubble phase,  the purchased property records moderate appreciation in the early years, while the middle years witness steep declines (similar to the current CRE price corrections) with little recovery seen in the later years.  The following table summarizes the assumptions under the base case.

Under the base case assumptions, the steep price declines not only wipes out the positive returns from the operating cash flows but also shaves off a portion of invested capital resulting in negative cumulated total returns earned for the real estate fund over the life of six years. However, owing to 60% leverage, the capital losses are magnified for the equity investors leading to massive erosion of equity capital. However, it is noteworthy that the returns vary substantially for LPs (contributing 90% of equity) and GP (contributing 10% of equity). It can be observed that the money collected in the form of management fees and acquisition fees more than compensates for the lost capital of the GP, eventually emerging with a net positive cash flow. On the other hand, steep declines in the value of real estate investments strip the LPs (investors) of their capital. The huge difference between the returns of GP and LPs and the factors behind this disconnect reinforces the conflict of interest between the fund managers and the investors in the fund.

Under the base case assumptions, the cumulated return of the fund and LPs is -6.75% and -55.86, respectively while the GP manages a positive return of 17.64%. Under a relatively optimistic case where some mild recovery is assumed in the later years (3% annual increase in year 5 and year 6), LP still loses a over a quarter of its capital invested while GP earns a phenomenal return. Under a relatively adverse case with 10% annual decline in year 5 and year 6, the LP loses most of its capital while GP still manages to breakeven by recovering most of the capital losses from the management and acquisition fees..

Anybody who is wondering who these investors are who are getting shafted should look no further than grandma and her pension fund or your local endowment funds…

More on the topic of commercial real estate in the US…

The Conundrum of Commercial Real Estate Stocks: In a CRE “Near Depression”, Why Are REIT Shares Still So High and Which Ones to Short?

Commercial Real Estate Continues to Dropped into Foreclosure as the Landlords of Said Properties Enjoy Skyrocketing Share Prices? Yep, Makes Plenty of Sense

The Shortlist of the Shortlisted “Stocks to Short for 2010″: What We See as the Most Profitable Bear Postions for 2010

Developing Implications on Loan Accounting Law: Mark to Market, Mark to Model, or Mark to Market Crash?

Commercial Real Estate is Pretty Much Doing What We Expected It To Do, Returning to Reality

Commercial Delinquencies Rise Again, Data Goes Ignored

Wall Street Real Estate Funds Lose Between 61% to 98% for Their Investors as They Rake in Fees!

For Those Who Chose Not To Heed My Warning About Buying Products From Name Brand Wall Street Banks,

The Taubman Properties Q4-2009 Earnings Opinion: The CRE Trend Continues as Expected

CALPERs Uses Jingle Mail as a Risk Management Technique

More bearish US data came out today, as July durable goods came in at -3.8% MoM vs 0.5% expected vs a revised 0.2% in May and new home sales drop a record 12.1% in July to 276k vs 300k (0% MoM) vs a revised 315k (12.1% MoM) in May. Home prices also fell 0.3% in July vs an 0.1% expected increase.

The recent string of negative economic news from the United States has led to large downward Q2 GDP revisions from many banks and research houses, ahead of the GDP release on Friday. JPMorgan and Goldman Sachs, for example, have revised their estimates downward to 1.1% and 1-1.5%, respectively. The consensus estimate is 1.4% and with the flurry of negative surprises in economic data lately, traders are probably bracing for another lower-than-expected number, bringing the priced-in estimate to be perhaps closer to 1.2%. This leads me to believe that there will have to be a seriously lower-than-expected GDP print on Friday to make risk materially sell off, because estimates are already quite low and the negative sentiment suggests participants are positioning for the lower end of estimates as well. I expect a 1.1-1.2% print, which is lower than the consensus, but I don’t expect a very sizable negative reaction to it. Of course, this type of aggregate positioning and expectations creates conditions that permit sharp short squeezes to occur, but I also don’t think the data will have a positive surprise to catalyze a strong surge in risk. Unless tomorrow’s initial claims data is very bearish, I don’t think there is a catalyst for another strong selloff in risk until Aug ISM on September 3.

Because of the pervasive negative sentiment (AAII survey for the week ending 8/14 showed a 42.5% bearish print, 12.4 points above the week prior) and technical support levels coming back into play in a number of assets, I have been mentioning my expectation of a small bounce in risk soon. Today, we hit the significant 1040 level in the S&P, which marked February and early June lows, and I was looking for a bid around there. 1039.83 ended up being the LOD and the market rallied from there, with the SPY ending up only 0.39%, but with some volume expansion to boot. Lower highs and lower lows are still intact, as is my bearish outlook, but I think today could be day one of a short term bounce in risk that could take SPY to retest the underside of the channel it broke down from on the 20th.

The bounce in risk definitely got some help from today’s rally in yields, with the 10yr posting a bullish engulfing candlestick with a nice bullish hammer signifying an intraday reversal to the upside. I went long 10yr yields yesterday at 2.5% but got stopped out as my unnecessarily-tight 2.45% stoploss was taken out. But I went long yields again (shorting /ZN), as today showed the highest volume in three months in /ZN.

Zero Hedge had a nice chart today showing how S&P futures are tracking the 2s10s30s butterfly, which I have mentioned in previous pieces as an important correlation to watch.

Another product trading off of yields is the USDJPY cross, which traded up about 50 pips today and is challenging that 84.75 S/R zone it broke down through yesterday. A rally back above this level could send USDJPY shooting up to 86-87, but it is too early to tell if yesterday’s move was a false breakdown or today’s move is just a countertrend bounce to retest the breached support line. If USDJPY continues ticking higher, expect all risk to follow.

The Dollar Index indeed found some selling at its 55d today, as I predicted in last night’s piece, and if it pulls back a little bit more, it should take out the 38.2% Fibo level I’ve been pointing out, which would suggest a near-term correction in USD. When the 55d is taken out however, I expect a strong rally in the dollar.

CADJPY found a bid around the S/R represented by July 2009 lows and bounced more than 50 pips today. Technically, this cross is a helpful proxy for risk because of the overhead 81 S/R level it broke down from yesterday. If this level cannot be breached, any rallies in risk can be considered oversold bounces. A breakout through CADJPY 81 implies a more sustained countertrend rally could be in play, however.

Because of the widespread support levels I’m seeing, as well as the very short bias of my current positions, I went long a couple high-beta go-to equities as tactical bullish bets and strategic hedges for my core positions. BIDU is bouncing off its 55d and if risk continues to be bid, some volume could come in and help it rally back into the mid-80s. CMG posted a nice intraday reversal to the upside today, as it too bounces off its 55d and has a nice three-month base it is working on that could propel it higher if risk is bid, especially after its bullish earnings release late last month. Again, these are short-term trades to buy hedges at technically low levels.

Crude also had a nice bounce today, as it found support near its July lows around $71/bbl, reversing higher after an intraday selloff from higher-than-expected inventories in distillates, crude, and gasoline. A retest of the support trendline of the triangle it broke down from this month could be next if markets extend today’s bounce. I am holding my crude short position but still see a small bounce in oil developing. The USO ETF, which is a poor proxy for crude prices but is a heavily-traded product whose technicals sometimes can be very relevant to oil price fluctuations, also bounced off of a support level today, with strong volume coming in as well. If I were a more short-term trader I’d probably close my crude short today and/or buy some USO or /CL as a hedge, but my market outlooks are for longer-term positions.

Precious metals had a bullish day today and my silver long from yesterday turned out to be a timely purchase as silver rallied over 3% today. A test of its long-term resistance level around $19.65 seems to be up next, and a breakout through there could send the metal flying.

Ireland’s credit rating was downgraded one notch to AA- by S&P overnight last night. Though European sovereign CDS rallied today, they ticked down from their highs later in the day and their recent rally in the last few weeks may have been pricing in the downgrade. It is too early to tell if debt concerns get a bit of a rest, as everyone seems to be watching US data, but if risk is bid in the near-term then EURUSD and EURCHF could rally a bit. I still contend that any rallies in EURUSD and EURCHF should be sold but the technicals are aligned for a possible bounce from current levels. If CHF does sell off a bit, it could also provide an attractive entry point for the CHFHUF long I presented a short thesis for in last night’s piece. Reclaiming the 1.31 handle in EURCHF would signal a short-term bid is in play.

VXX reversed yesterday’s rally today, and could not break out through the $24 level I mentioned last night. If the small ascending triangle VXX has developed in the last 3-4 weeks sees a breakdown, markets could see a continuation of today’s bounce. A breakout through $24 would indicate risk-off, however, and as I’ve said, a breach of VXX’s 55d should lead to more bearish price action in risk assets.

And a quick note on the JCJ—implied corrs sold off today and yesterday’s surge could have marked a short-term peak as today offered no follow-through.

To conclude tonight’s piece, I’d like to respond to reader comments and questions regarding a possible bond bubble in the making. Hawks and vigilantes point to the US’s ballooning debt levels and ratios and the analogues of sovereign debt issues abroad to suggest Tsy yields are way too low and that the recent bond rally is little more than a bubble. It is my opinion that the United States does not suffer from any near-term funding issues and though the bailouts and deficit spending and QE have increased US sovereign credit risk, deflationary risks are much greater and justify a decreasing-yield environment, at least presently. However, a number of technical dynamics are also behind the recent bond surge, including duration-hedging from MBS books ahead of/as a result of the massive refi boom in the spring and QE 1.5 earlier this month, record retail inflows into bond funds as equity funds see consecutive monthly outflows, and positive net convexity still existing in curve flatteners. These factors alone are enough to explain and justify the current rate environment. But beyond internal dynamics, there is the fact that the Fed/Treasury/Congress account for the entire marginal supply and demand of Tsys, as the Treasury issues record supply that Congress is requiring financials to hold increasingly greater ratios of (as a consequence of financial reform’s capital ratio requirements) and that the Fed is buying more amounts of. While the macro and financial environment remains risk-averse, Tsys and other core sov bonds should continue to outperform, allowing countries like USA & Germany to issue debt at very low rates. The increasing government spending also finds justification as a “necessary evil” that will be unwound and reversed as crisis abates. However, when global growth does finally pick up, the structural deficits and debt burdens will be exposed and will be the relevant theme to be watched, and when yields start rising, they could really take off. I see this as a scenario in Japan in 2011-2012 and in the US as early as 2012-2013. However, that is far in the future and right now, the UST is about as safe of a security as one can buy to shelter away from global growth declines, and there’s no use delving into whether UST’s are a bubble until there are some near-term catalysts for Tsy outflows and until growth picks back up.

OPEN TRADES
Short EUR/USD | 1.3120 | stop 1.2915 | +460 pips
Short AUD/USD | 0.9175 | stop 0.9100 | +330 pips
Short GBP/USD | 1.5985 | stop 1.5810 | +520 pips
Short /NG | 4.485 | stop 4.510 | +12.04%
Short /ES | 1113.00 | stop 1100.00 | +5.23%
Short /CL | 76.25 | stop 76.50 | +4.47%
Short FCX | 68.07 | stop 72.50 | +2.07%
Short PCX | 10.85 | stop 12.40 | +2.30%
Long /SI | 18.41 | stop 17.75 | +2.77%

CLOSED TRADES
Sell /TNX | 245bps | -5bps

NEW TRADES
Short /ZN | 126’11 | stop 126’24
Long BIDU | 77.50 | stop 75.60
Long CMG | 145.95 | stop 140.00

If you would like to subscribe to Shadow Capitalism Daily Market Commentary (which include charts with technical studies drawn on them that were not included in this online version), please email me at naufalsanaullah@gmail.com to be added to the mailing list.

A marginally negative day in risk today, as a light day of news and data led to choppy and low-volume markets. FX saw more vol than equity, however, as the hung parliament in Australia and a negative surprise in Germany’s flash manufacturing PMI weighed down on currencies.
SPY finished the day down a fractional 0.38%, while extending its breakdown through its channel support line and finding intraday selling at its 55d. Volume continued to lag, and though it cleared near the LOD, the equity market likely won’t find significant volatility on either side until after Labor Day. I remained positioned short the market, however, and my bearishness is encouraged by the continuous resistance the market is finding at its 55d and channel support trendline.

The US Dollar Index is showing some significant technical developments, as it comes up to test both the 38.2% Fibonacci level from November 2009 lows to June 2010 highs (pictured) and 38.2% Fibonacci level from June highs to August lows. After finding a bid at its 21d, DX has turned back upward in a nice curved pattern and is honing on challenging its declining 55d. A breakout through this MA should send USD flying again and bring back the recoupling trade, as bearishness in risk would breed bullishness in USD. I expect a little bit of a selloff in the dollar at the 55d level, if not sooner, as it is sitting at recent highs, but I expect any selloff to be short-lived, and as open interest is turning upward again, the USD should find some major strength again very soon, particularly against the euro.

Crude continues to selloff as it extends its breakdown through the symmetrical triangle I mentioned a little over a week ago. A combination of a strong USD and weak growth data globally is weighing down on oil prices and the charts suggest a large downside move is just beginning. The $69-71/bbl zone has offered some strong support in the past year and crude may find some bids around there but I expect it to challenge and eventually break the 38.2% Fibo level around $69/bbl, which should trigger some major selling if and when.

German flash manufacturing PMI came in early this morning at 58.2 vs 60.5 consensus, providing a bearish sentiment to the euro. Although services PMI beat for both Germany and the Eurozone, the below-estimates manufacturing PMI for Germany & the Eurozone (as well as composite Eurozone PMI) weighed down on euro crosses, particularly against the carry funders USD & JPY. The EUR-USD LIBOR spread is still wide but in the current risk-averse environment, continued euro funding pressures could be more bearish than bullish, as instead of representing the effective rate hike from EONIA ticking up in a liquid funding environment, it represents the effect of the liquidity extraction in a risk-averse environment focused on growth slowdowns. If USD LIBOR reverses back higher, which I expect if the USD continues to rally, then the LTRO roll, which catalyzed the EONIA and EUR LIBOR rallies, could turn out to be a short-term gain/long-term pain type of event, similar to hawkish Fed policy in summer 2008 catalyzing the contraction in credit that led to the financial crisis (catalyzed, not caused—inevitability was definitely there). EURUSD broke its 55d today, and is still selling off as Asian trade begins, but is approaching its 50% Fibo retracement around the 1.26 handle. I expect a bounce around there in the short term, but a fresh breakdown through that level will most likely trigger me to add to my EURUSD short. Confirmation from a breakout in the US Dollar Index would be welcome, and further support from deteriorating economic data next month would be the icing on the cake.

EURJPY is down huge as well and back to around July lows. If EURJPY holds the 107 level (especially if JPY finds some selling soon—more on that later), it could trigger a short-term bounce in other euro crosses as well. But when this thing breaks down, it could be headed back to summer 2001 lows around 100, almost 800 pips from current rates.

USDJPY sold off on the risk aversion today, showing that the yen still is the king of risk funding. It is still stuck in rangebound trade, but the 30m chart shows a possible descending triangle developing. A breakout (which would also correspond with a 21d breakout) should send it challenging the 87 handle. However, it is currently sitting near 85-handle support and threatening a breach of that level for the millionth time in two weeks. It is still trading off rates and USTs (particularly the 10yr tenor, which has the highest correlation with USDJPY) are very overbought, so I’m looking for a fresh, unstretched pattern to develop in rates before trying to go short USDJPY. 10yr Tsy rates have been plunging more because of MBS market dynamics than deflationary risks necessarily, as the Fed’s MBS purchases lead to massive influx into Tsys from large MBS holders for duration hedging. The first wave down in rates in late spring caused a big refi boom that led to a positive-feedback reaction in rates, as duration hedging led rates even lower, leading mortgage rates lower, requiring further duration hedging, ahead of Fed demand, which required even more hedging. As rates are oversold and the refi boom and QE 1.5 are now priced in, I expect a short-term bounce in rates, though I expect them to test 200-220bps before everything is said and done, as deflationary risks take center stage from MBS dynamics. As far as how this relates to USDJPY, I still stand by my call for a short-term bounce to 87-87.50 before a plunge back to 85 and a breakdown through. No money on the line so take that scenario for what it’s worth.

The hung parliament in Australia led to a large gapdown in the Aussie, which pared its losses quickly, but found some selling pressure after risk turned down later in the morning. AUDUSD remains below its 200d and is perched right at the 0.89 S/R level. No obvious pattern developing on the charts, besides a possible falling wedge on a 30m, so the key level I’m watching is the 0.885 support level. If this gets breached, I expect AUDUSD to sell off pretty sizably. I will probably add to my short on a breach of 0.885, but if risk finds a short-term bid like I expect, it could be a week or longer before we see AUDUSD challenge 0.885.

CADJPY sold off almost a full big fig today on the back of risk aversion and declining oil prices. Not much to say about this cross beyond that as far as today’s action/data, but the longer term picture shows that it is challenging a very significant S/R zone after making three failed trips to the 55d in the last two months. If the 80-81 level gets taken out with volatility, then this cross could sell off big and take crude prices (and many carry trades) with it. Be careful, however, as a sustained bounce in risk could send this cross flying more than almost any other. The key is for CADJPY to remain below its declining 55d—a breakout through that MA could send it soaring. Presently, the market isn’t exhibiting a clear risk appetite/aversion picture, and volumes are low ahead of Labor Day. Once September rolls around, we should probably get a better idea of market dynamics and I may position myself one way or another in this cross (likely bearish).

An interesting chart from Citi is presented below, showing the US 10yr yield vs Citi’s US economic surprise index and the S&P vs Citi’s US earnings revisions index. As expected, the 10yr yield tracks economic surprises and equity market its earnings revisions, quite well.

There is a divergence, however, as companies beat earnings in the face of downside macro surprises. Citi contends that the decoupling is due to high operating leverage allowing firms to turn nominally small but positive growth into significant earnings. However, if the double dip continues to take root, particularly if August ISM has a poor print, the high operating leverage could end up doing more harm than good, just like it killed earnings back in 2008 as growth declined and the leverage amplified it. There is always a Goldilocks situation in between growth and decline, in which equities decouple from bond yields because of leverage juicing marginally positive data to beat the estimates coming from the negative first derivatives hurting bonds. However, this resolves in the decline killing positive earnings surprises as the leverage amplifies the selloff. Goldman Sachs has recently been pushing for defensive strats and recommending positioning toward lower op lev names. It will be interesting to see if leverage ends up hurting after all.

My trades so far have been performing quite well, and so I am raising/lowering my stops on these positions to lock in some gains. Please take note of the modifications to the stop levels in all of these trades. Because the timeframe for these trades is quite long, I don’t expect these stops to be hit and these represent last-ditch position downsizing levels.

OPEN TRADES

Short EUR/USD | 1.3120 | stop 1.2915 | +485 pips
Short AUD/USD | 0.9175 | stop 0.9100 | +275 pips
Short GBP/USD | 1.5985 | stop 1.5810 | +490 pips
Short /NG | 4.485 | stop 4.510 | +8.87%
Short /ES | 1113.00 | stop 1100.00 | +4.45%
Short /CL | 76.25 | stop 76.50 | +4.51%

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DISCLAIMER: Nothing contained anywhere in this commentary, including analysis and trade ideas, constitutes or should be construed as investing or financial advice, suggestion, or recommendation. Please consult a financial professional and do due diligence before engaging in any purchase or sale of securities.

Goldman Sachs has put together a very informative chart, as part of its European chart of the day series, which shows the discrepancy between household accumulation in domestic and foreign denominated debt. While HUF-denominated debt is a mere 12% of GDP, FX-denominated is at almost 50% of GDP. Most of this debt is CHF-based, and with the CHF hitting fresh record highs, the pain for debtors is becoming unsustainable due to the relative FX strength. And while, as Goldman points out, new FX debt accumulation has plunged, the legacy positions will be there for a long time. For this debt to clear out, the Balance of Payments for Hungary and other non-euro countries will enforce a very prudent deleveraging regime, and will require that the economies grow, not contract. The last is something that is very much in question for Hungary, which as we pointed out recently, has decided to go it alone with IMF assistance, and thus without a safety net backstop should things not work out as expected. Either way, the bottom line is that as European countries loaded up on EUR-, and especially CHF-, denominated debt when the currencies were cheap, the current violent swings with a rising bias, will make the pain for the peripheral countries all that much more pronounced.

Here is some further clarification from Goldman:

The crisis has highlighted the dangers of the private sector accumulating substantial foreign debt.  Central Europe, in particular Hungary, suffers from a no less dangerous variation of this problem - namely households borrowing (from domestic banks) in foreign currency, mostly Swiss Frank and the Euro.  After the crisis hit Hungary in the autumn of 2008, the National Bank and MPC started an educational campaign to highlight the dangers of this practice to households, and FX lending regulations were tightened. As a result, new lending in foreign currencies almost ceased, however, households continued to pay the instalments on their FX mortgages, car, and consumer loans - which were now higher in domestic currency terms after the Forint weakened in late 2008 and early 2009. But the problem persists in stock terms.

Today, the MPC meets for the first time since the Hungarian President signed a law to ban FX mortgages altogether. We’ll be listening to the press conference for possible comments on the problem, including recent FX moves and the government’s reluctance to address its part of the imbalance.

Today’s European Chart of the Day illustrates how debt repayments and the debt stock have evolved since late-2008. After a long period of rapid growth, the start of 2009 brought a dramatic turnaround in accumulation of new FX debt. In net terms, and corrected for exchange rate changes, households have been repaying their FX debt at an increasing pace, with 2010Q2 marking the highest net repayment of about 0.7% GDP. However, with the Forint weakening against the Euro and the Swiss Franc (the latter being reinforced by the flight away from the Euro) household FX debt rose back to 40% of GDP, the same as in the beginning of 2009.

This underscores the vulnerable balance sheet position of Hungary (and other countries where household FX debt increased considerably), and the extent of the large balance of payments adjustment needed to reduce FX exposure. While capital continues to flow out through the banking channel, these countries will have to generate sustained trade balances and reduce public sector borrowing needs to allow for an orderly deleveraging process in the household balance sheets. This will be a long and complicated process.

Need a 100 year inflation outlook? The market has spoken, and courtesy of the liquidity glut, it appears the outlook a century down the line, is for a 5.95% inflation give or take (yes, yes, we know this is not scientific: we are hoping the soon to be released 100 Year swap spreads will give a better read). One wonders what happens to this yield if the Fed's trillions in free money sloshing around the markets are eliminated.

Full pricing grid, courtesy of sole manager (and recent deflationist) Goldman Sachs:

Norfolk Southern Corp "NSC" Baa1/BBB+/BBB+ (s/s/s) upsized USD250m (up from $100m) 100y reopening of 6.00% March 2105 sr fixed rate notes launched at 5.95%. GS (sole books). Co-mgrs: Barclays.  UOP: GCP. Pricing today.   Original USD300m issue priced March 7 2005 (6.00% at 100).

More from Dow Jones:

Norfolk Southern Corp .'s (NSC) reopening of its 100-year bond, first issued in March 2005, has launched at 5.95%, inside price talk of 6%, according to a person familiar with the sale. The sale has also been upsized to $250 million from original guidance of around $100 million.

The Norfolk, Va.-based railroad's new senior fixed-rate bonds, which come on top of the existing $300 million sold in 2005 and also maturing in 2105, are expected to be rated Baa1 by Moody's Investors Service and BBB+ by both Standard & Poor's and Fitch Ratings.

Bankers have estimated the issuer will need to pay a premium of roughly 0.75 percentage points more than what it would cost them to sell 30-year debt. The original deal from 2005 sold at par with an interest rate of 6%, and with a spread over Treasurys of 1.37 percentage points. Another 100-year bond the company sold in 1997 for $350 million, which was part of a $4.3 billion deal, had a spread of 0.97 percentage point over Treasurys.

Goldman Sachs is lead bookrunner on Monday's sale, proceeds from which will be used for general corporate purposes, according to the person familiar with the sale.

A spokesman for the issuer said its "decision to reopen the 100-year bonds was based on the current low [interest] rates, coupled with the strong appetite among buyers for them."

Bankers have been pitching century bonds selectively in recent weeks because Treasury rates are so low that issuers can lock in 100-year financing at reasonably attractive rates. At the same time, investors are sitting on piles of cash and looking to put it to work in corporate bonds, where where they are seeking longer-dated assets that give them higher yields.

Investors say that 100-year bonds aren't much more sensitive to interest rate moves than are 30-year bonds.

Century bonds were very popular earlier this decade and in the mid-1990s, but they aren't very liquid in secondary trading, meaning that they only make sense for certain types of investors. Life insurers and pension funds are the likely buyers and market chatter last week suggested there was around $100 million of capacity among these buyers for a 100-year bond. Investors prefer bond issues to be at least $250 million in size so they are eligible for inclusion in the Barclays Capital Aggregate Bond Index, like the Norfolk Southern 2105 bonds are.

Driving more pension fund interest will be the Pension Protection Act of 2006, which Michael Collins, senior investment officer for Prudential Fixed Income, said over time will encourage pension fund managers to minimize risk between their assets and liabilities even more than they do now.

Issuers have been shifting toward the long end of the maturity spectrum, with around 30% more 30-year debt being issued this year than in 2009 and 50% less three-year debt issued this year than last, according to data provider Dealogic.

Only the strongest companies are able to issue century bonds--brands like Coca Cola Enterprises Inc . (CCE) that are expected to be around in 100 years time. While they may have to pay more than they do when selling 30-year debt, some of them are able to stomach that extra cost, especially if they are able to use the proceeds to buy back more expensive debt that they sold when rates were higher.

Ten days ago we posted extended thoughts on the upcoming US demographic crunch, paraphrasing observations by Goldman Sachs, which speculated that with ever more individuals leaving the "prime-savers" demographic bracket, those aged 35-69, the (already meager) temptation to save in the US will decrease substantially going forward. Goldman was primarily focused on the implications this phase shift implies for future US Current Account deficits. Today David Rosenberg begins to tackle the US demographic issues from his own perspective, with his preliminary conclusions, as expected, not validating any optimistic perspectives before the US economy: "starting next year, this key age cohort for both the economy and the markets will begin to decline — according to official forecasts, each and every year to 2021. The last time we saw sustained declines in this part of the population was from 1975-83, which was an awful time for both the economy (except for that very last year when the negative growth rate in this age segment was drawing to a close) as the S&P 500, in real terms, was as flat as pancake and real per capita income barely expanded."

More from David:

Harry Dent is one of the world’s most widely read demographers and market commentators and we saw something in one of his publications that really caught our eye. A focus on one particular part of the Baby Boom population — notably the one that really drives spending, wealth gains and income. It’s the 45-54 year old cohort.

Indeed, we back checked through the assertion by sifting through the Fed’s database (mainly the survey of consumer finances) and found that this cohort does indeed have the lowest savings propensity, the highest earnings level and the greatest increase in net worth compared to other age categories.

From 1984 to 2010, this cohort rose each and every year. That didn’t prevent business cycles from occurring or the odd vicious bear market, but over that period, the stock market, in constant dollar terms, advanced 240%. But starting next year, this key age cohort for both the economy and the markets will begin to decline — according to official forecasts, each and every year to 2021. The last time we saw sustained declines in this part of the population was from 1975-83, which was an awful time for both the economy (except for that very last year when the negative growth rate in this age segment was drawing to a close) as the S&P 500, in real terms, was as flat as pancake and real per capita income barely expanded.

In other words, unless the US finds a way to "refill" this critical bracket, the endogenous headwinds within the economy will continue to strengthen, which is purely a function of the aging US society. And this does not even begin to consider the implications on the various underfunded Trust Funds (like the SSTF) as they begin to see increasingly more use until their official depletion some time in the next 20 years.

And here are some other tangential and as usual, critical, big picture observation from Rosenberg.

Let’s look at what the banks are actually doing, and what we see is that in the August 11th week, they reduced their aggregate loan books by $12.5 billion, the third net reduction in the past three weeks. If they are lending to anyone, it is to Uncle Sam — the banks continue to play the yield curve, belatedly, and were net buyers of government securities to the tune of $15 billion last week on top of the $8 billion net investment the week before. Moreover, the banks are sitting on even more cash, up $35 billion last week, to $1.3 trillion, so there is lots of buying power to take these long-term Treasury yields even lower in the same bull-flattener game the banks played so profitably back during the credit-healing days of 1992 and 1993, which, as long-standing bond bulls, we remember all too well, and quite fondly too.

Investors’ thirst for yield (and duration!) is so intense that there is growing talk of 100-year bonds coming to the fore — see Rethinking the ‘Long’ Bond on page C1 of the WSJ. Everyone focuses on the risks of a renewed uptrend in bond yields. We will likely face recurring spasms; however, it is difficult to see where the cyclical risks are going to come from regarding our ‘safety and income at a reasonable price’ theme — especially since there seems to be another post-Labour day round of job cuts coming (see Hiring Spree Gets Long in the Tooth on page C1 of today’s meaty WSJ). There are still plenty of opportunities out there in the fixed-income universe, which is why the article on page B9 of the WSJ really caught our eye today (Thornburg Seeks ‘Worthy’ Risks in Muni-Bond Market).

If there is a quote of the day, it must surely go the Lex column on page 12 of today’s FT: “For investors, the only thing worse than a low-yielding world is denying that it exists.”

Yes, demand for cash is extremely high, and when this happens, when the cost of capital is as low as it is today, then that must tell you a thing or two about perceived returns on invested capital. But, by definition, they are very low, and the government has run out of traditional policy bullets and the next moves by Bernanke et al, as per his “what if” speech of 2002, will involve more experiments as the Fed chairman probes the outer limits of monetary policy.

Look at the charts below. Despite the most aggressive government efforts in the modern era to kick-start the economic cycle, what we still have on our hands is a broken financial system. We hope this is not lost on the perma-bulls among us, but the pool of credit under the umbrella of private label asset-backed consumer and mortgage asset loans has collapsed by over $5 trillion, or by 60% (!), over the past two years. The private market for securitized credit is back to where it was in 2000 when the economy was two-thirds the size it is today. What few people realize is that 100% of the increase in GDP during that wonderful, though obviously artificial, economic recovery coming out of the tech wreck from 2002 to 2007 was funded by the explosion in the securitized credit market. This market is now, for all intents and purposes, defunct and replaced by Uncle Sam’s family (Fannie, Freddie, Sallie … and the FHA too).

At the same time, who wants to be a lender today — despite the most aggressive intervention efforts ever (and ongoing threats of cramdowns). Whatever improvement we are seeing in default and delinquency rates have actually been rather marginal and in some cases, especially in the home loan market, have not improved at all. (However, people are making sure they are staying current on their cherished credit card — no strategic defaults here!)


As of yet, there is very little impetus in the money multiplier or money velocity even if they have stabilized at depressed levels; the Japanese charts look eerily similar.

The last charts below illustrate how focused households, businesses and banks are in terms of maintaining historically high levels of liquidity despite the fact that interest rates are at microscopic levels. This says something about the desire on the part of economic agents to maintain very high levels of precautionary balances, ostensibly because they understand that recession risks are high and that means an emphasis on survival kits.

But when everyone is building their liquid assets at the cost of not putting the funds to work in the real economy, then what we get is the infamous paradox of thrift. The government is there to help counteract these deflationary excessive savings trends in the private sector, but the problem now is one of high and rising structural deficits and a debt-to-GDP ratio that is a year away from breaking above 90%, which is the Rogoff-Reinhart threshold for when fiscal policy does more harm than good for the broader economy.

There are no quick fixes to a post-bubble credit collapse. Time and shared sacrifice are the only viable solutions and people on this side of the ocean should probably go and ask the folks that endured the Asian collapse and depression back in the late 1990s what it took beyond intestinal fortitude to get to where these “emerged” markets are today (ie, radical economic, financial and political reforms). By letting failed companies and banks survive with the help of government intervention, what the U.S. government decided to do was to avoid further pain after Lehman collapsed — and what you pay for by putting an artificial floor under the “levels” of output, spending, credit etc, is that it becomes difficult to achieve any meaningful “growth rates”. There may be something to be said to rebuild the system from the rubble, which is what Japan never did but what the other Asian countries managed to accomplish as social contacts were rewritten and sacred cows laid to rest. Why is America sending troops into harms way and at the same time finding different ways to subsidize delinquent mortgage borrowers?


One final note before we move on — it is a mystery as to how folks can get away with some of the things they say. For one, we see this article on page B1 of today’s Globe and Mail titled Bumpy Economic Road? Truck Drivers Don’t Think So. But the article shows a chart of the Ceridian-UCLA Pulse of Commerce Index which measures trucking activity. Ed Leamer, one of the architects of the index, is quoted as saying “I don’t think that a double-dip is in the cards.”

The problem is that when you see the chart, two things jump out. First, it looks to be a perfectly coincident index. Actually, it looks to have peaked in early 2008, after the recession actually began. Second, although this index did recover in July, it looks to have already turned in a classic double top.

There’s also a column on page B7 of the Globe and Mail that poses the question: “How can we be entering a double-dip recession if commodities are peaking?” Yet, we see that the CRB Futures index actually already peaked in April at 280 right around the same time the equity market has turned in its highs — and is sitting at 267 today.

By Static Chaos

With Merger and Acquisition really picking up steam in the last month, the question arises whether private equity will be able to complete a major move in the remainder of 2010. This past week Intel acquired software security firm McAfee for $7.7 billion in an all cash deal and the prior week BHP offered $40 Billion to take over Potash Corp. from shareholders.

In contrast, the latest deal involving private equity--Blackstone acquiring Dynergy for $543 million--is a far cry from the heyday of private equity deals back in 2006, when deals such as Harrah`s Entertainment, Hospital Corp. of America, Clear Channel Communications, Kinder Morgan, and Freescale Semiconductor each worth more than $17 Billion dollars took place. In 2007, Blackstone acquiring Equity Office Properties Trust for $38.9 billion, and TXU went for a $42 Billion three way deal with Goldman Sachs, Kohlberg Kravis Roberts, and TPG.

So, all this M&A activity begs the question--where the heck is private equity? Can they still compete with large companies sitting on a pile of cash?

I understand the financing travails and the freezing up of the credit markets in 2008, but this is late 2010 and supposedly private equity has all this money from investors that they have been unable to utilize for deals over the last three years. In short, what could private equity be waiting for?

There are some great bargains out there in undervalued companies that have huge cash flows, little debt, large cash stockpiles, and there is a low cost of capital right now for financing deals. Do you need an engraved invitation to the ever-present M&A party? If you cannot complete a major deal now, then when will you be able to do a major deal?

The cost of capital is only going to go up in the future, in a major way. Frankly, it seems that the private equity community is like the proverbial deer in headlights, and still stuck in the malaise, fear, and uncertainty of the past three years that they are slow to react to the changing landscape of deal making. And this is their core business deal making.

It is apparent that the dynamics have changed in the private equity buyout game, and maybe the firms are waiting for the good old days. But the good old days are long gone, and you have capital to deploy, so you’d better either start adapting to the new environment or start giving your capital back to investors so they can realize a better return on their money.

There is the stigma of all those bad private equity sham deals that have occurred over the last decade that probably makes many banks weary of private equity when they inquire about financing deals. So, yes the days of the sham deals are over where you buyout some garbage company that has a declining business model, uncompetitive business, but little debt, and you take it private, lever up the balance sheet with monstrous debt obligations, pay yourself a huge dividend recapping your original investment, and then taking it back public in a better market with higher multiples. The reason this type of deal is dead is because there will always be a bag holder, and banks have ultimately been caught in the crossfire too many times as the one picking up the pieces in the end.

Most likely, all future private equity deals will involve more of the firm`s own money in the deal. But private equity, by most accounts, has been sitting on large amounts of capital, so the money is there for deals. Furthermore, there are plenty of legitimate value enhancing, highly attractive deals out there, which this cash may be applied to right now, as there are great fundamentals (outlined below) in the marketplace for the private equity model.

• The valuations of many public companies are well below the average of the last 10 years.  
• There are many solid companies that have little debt on their books. 
• Many companies with strong cash flows. 
• The cost of capital is extremely attractive at these rates of financing, providing banks believe that private equity firms have some skin in the game and willing to share the risk. But this should have always been the model, as shared risk inevitably leads to high quality deals and not the sham deals where risks are absorbed by others. 
• The M&A cycle for the next 10 years is just starting, so the best deals are still available.  
• The next cycle will be highly inflationary, which means you are taking assets out of the market at the bottom of a deflationary cycle, and bringing these same assets back to the public markets in three years in the midst of an inflationary cycle where the value of the same assets receives a much higher multiple due to the inflation of asset prices.  
• Banks have recapitalized for the past three years, and they now need to start applying more of their capital base to lending projects with higher returns, they just need the demand component to pick up, and this is where private equity firms come into fill this void.

So, how likely is it that we have a$100 Billion private equity deal in the remainder of this year? Well, at the beginning of this year it would have seemed impossible, but the dynamics are there for a deal to occur. Things really just have to fall into place. With the latest rumblings of M&A activity, there is an increasing chance that we witness a Mega Private Equity deal that really shakes up the current valuation models regarding what public companies are worth.

This is one of my candidates for a Mega Private Equity deal. What are some of the companies that you think will make for great Mega Private Equity Deals for the remainder of 2010?

Static Chaos

Via Pension Pulse.

Mary Williams Walsh of the NYT reports, Pension Fraud in New Jersey Puts Focus on Illinois:

The federal government’s crackdown on the State of New Jersey this week for misrepresenting the condition of its pension funds raises a question: Who else might have pension numbers that could draw regulatory fire?

 

Cities and states are scrambling to make sure their pension disclosures are in order, and investors in distressed debt — who make money off financial trouble — are scrambling too, sensing opportunity.

 

“No one knows exactly how to attack this market yet, but people are going to be watching the New Jersey case and others like it very closely from an investment point of view,” said Jon Kibbe, a lawyer who specializes in distressed debt.

 

Though some advisers are urging caution, New Jersey and other states have continued to issue new debt at reasonable rates as investors clamor for high-grade securities in a low-rate environment.

 

Harry J. Wilson, a Republican candidate for New York State comptroller, said Friday that New York was not compliant with the standard that the Securities and Exchange Commission established in its cease-and-desist order against New Jersey. Dennis Tompkins, a spokesman for the current New York comptroller, Thomas P. DiNapoli, who is running for re-election, said that “it’s ridiculous, it’s wrong and it’s reckless to make those accusations” and added that the state’s financial disclosures were complete and correct.

 

After two prominent S.E.C. pension cases, the American Bar Association’s new

disclosure bible for municipal bond lawyers is selling briskly.

 

“The cease-and-desist order has heightened awareness of the importance of accurate pension disclosure,” said John M. McNally, a partner at the law firm Hawkins Delafield & Wood, and the project coordinator of the newest edition of

 

“Disclosure Roles of Counsel,” a treatise telling municipal bond lawyers what is expected of their clients.

 

Mr. McNally has also been serving as a special disclosure counsel to San Diego, the first government accused of securities fraud by the S.E.C. for faulty pension disclosures. New Jersey was the first state.

 

The S.E.C. and other regulators found that San Diego had numerous pension problems, but in general, regulators said its government did not adequately describe the size of its obligations to retirees. In addition, there were discrepancies between the pension numbers in the official statement distributed to bond buyers and the pension numbers in other documents.

 

Mr. McNally said it was important to give consistent information and to explain the status of the pension fund’s condition in plain English. “One of the critical disclosure points would be, what are the implications for an entity’s annual budget,” he said.

 

Instead of bristling with acronyms, he said, pension documents should tell an investor how much the government must put in the pension fund every year and whether it can afford the payments. At the moment, the municipal bond market’s players — advisers, investors and underwriters — are more concerned about Illinois than any other state. Its credit was downgraded this year, and all the main ratings agencies said the poor condition of its public pension funds was a primary factor.

 

A spokeswoman for Gov. Pat Quinn’s Office of Management and Budget, Kelly Kraft, said Illinois believed its pension disclosures were complete and accurate. The state has not hidden the fact that its pension funds have big shortfalls, she said, and there was no reason to think the S.E.C. might lodge a complaint against it, as it did with New Jersey.

 

She added that investors had been calling with questions in the wake of the S.E.C.’s action against New Jersey, but said that Illinois had been telling them not to worry — the regulator had not contacted state officials.

 

She said the state had no plans to revise any of its financial documents. Still, some actuaries are deeply concerned about Illinois’s pension numbers, particularly because of a pension law enacted earlier this year.

 

State officials claimed the measure had sharply lowered costs by cutting the benefits that will be earned by workers hired in the future. (The current work force will continue to earn the same benefits as before.)

 

When it enacted the reform, Illinois issued a report, explaining in detail how it would work. Actuaries who have reviewed the numbers say that report is at least misleading and appears to be based on a type of calculation not authorized for pension disclosures. The state has not issued new audited financial statements since the law was passed.

 

Numbers in the report show that the state will be able to reduce its contributions to its pension funds, saving the state money, starting with $300 million in its first year and adding up to tens of billions of dollars over time. That’s because Illinois could make smaller pension contributions, on the assumption that its work force would over time consist of people earning smaller pensions.

 

Paradoxically, even though the state will make smaller contributions, the report forecasts that Illinois will get its pension funds back on track to a respectable 90 percent funding level by 2045. It projects that costs will increase slowly and an economic recovery will make cash available for the state to make the contributions it has failed to do in the past.

 

Whether that is even possible is contested by some actuaries who note that its family of pension funds is now only 39 percent funded. (If a company let its pension fund dwindle to that level, the federal government would probably step in, but federal officials have no authority to seize state pension funds.)

Some actuaries who have reviewed the state’s plans said that shrinking contributions would make the pension funds shakier, not stronger.

 

Indeed, one of them, Jeremy Gold, called Illinois’s plan “irresponsible” and said it could drive the pension funds to the brink.

 

Further, Mr. Gold pointed out that Illinois’s official disclosures said that its pension calculations used an actuarial method known as “projected unit credit,” but that the pension reform report used another method, which had not been approved for disclosure.

 

“According to Illinois statute, the prescribed contributions are determined under a method that may not be in compliance with the pertinent actuarial standards of practice,” Mr. Gold said.

 

Actuaries from the two big firms that help Illinois with its pension funds conceded that the report relied on another methodology. Larry Langer of Buck Consultants said that a law allowed the state to use the alternate method outside of bond offering documents. Investors can look at both sets of numbers and draw their own conclusions, he said.

 

He acknowledged that using the latest pension reforms would lead to a lower funding level but said state officials were not concealing the magnitude of the problem. “They almost laud it,” he said.

 

Brian Murphy of Gabriel, Roeder, Smith & Company, another of Illinois’s actuarial consultants, said the numbers were for illustrative purposes only and unlikely to reflect what the state would actually do in coming years.

 

“They’re going to fund it at the proper level,” Mr. Murphy said.

In a separate article, the WSJ wrote an op-ed on the SEC's Jersey Score:

The movement to clean up state pension funds is gaining momentum, and the latest evidence is that even the Securities and Exchange Commission is getting in on the action. In the Wonders Never Cease Department, the SEC has scored the state of New Jersey for lying to bond investors that its state pension funds were adequately funded.

 

In the summer of 2001, legislators in Trenton wanted to raise pension benefits 9% for state and local government employees. But there wasn't enough money in the pension system to fund the benefits and, only months before an election, the pols didn't want to raise taxes. So the legislature cooked the books, valuing the existing assets in the plan as of their market prices on June 30, 1999, before the dot-com bubble burst. Voilà, the two main state pension funds magically had enough cash to pay higher benefits.

 

Rather than disclosing this political fraud to the buyers of its bonds, the state perpetuated it. In 79 offerings from 2001 through 2007, representing $26 billion in bonds, New Jersey "misrepresented and failed to disclose material information" about its underfunding of the pension plans, says the SEC. In a settlement this week, New Jersey neither admitted nor denied wrongdoing but promised not to commit such fraud in the future.

 

The New Jersey case is the SEC's first-ever fraud charge against a state—amazing when you consider that the market for municipal securities, including bonds issued by states, is now roughly the size of the corporate bond market. It's doubly amazing given that accounting by government issuers is "uniformly dishonest," according to a former senior official at the SEC. This particular probe began under former SEC chief Chris Cox, and we hope current Chairman Mary Schapiro keeps it up, notwithstanding her desire to please public employee unions.

 

One obvious target is disclosures to investors about state retiree health and related benefits. According to a recent report from the Pew Center on the States, no fewer than 21 states have funded 0% of their retiree health care and other non-pension benefits. This is the definition of a Ponzi scheme, yet Pew charitably puts these states in a category labeled, "Needs improvement."

 

The last two times Congress has legislated heavy new requirements on private companies that participate in the securities markets—the Sarbanes-Oxley Act in 2002 and this year's Dodd-Frank bill—government issuers received a pass. Private firms that serve these issuers face new rules, and Dodd-Frank authorized a two-year study of the muni market, but the muni-bond issuers still have nowhere near the same disclosure obligations as private firms.

 

And get this: Congressman Barney Frank has been pressuring credit-rating agencies to give better grades to government issuers of securities, based on the fact that they've rarely defaulted in the past. Given the poor disclosure from states and cities, we don't know how Mr. Frank can even guess whether they will perform as well in the future.

 

The SEC can't require governments to disclose anything. It can only prosecute them for fraud after the fact, and while this week's action against New Jersey is a promising first step, the double standard between public and private fraudsters is still alive and well.

 

When Goldman Sachs settled its far more dubious recent case on similar charges to those New Jersey faced, it had to pay $550 million. But New Jersey paid nothing. The SEC is apparently loath to make taxpayers foot the bill for the sins of politicians and bureaucrats. We share that sympathy but wonder why it doesn't extend to shareholders in companies sued by the agency.

 

Beyond simple justice for taxpayers and shareholders, deterrence against bad behavior in business and government will only be effective when the SEC sues people, not institutions. Those people should include politicians who sell bonds under false pretenses.

In a related topic, Janet Morrissey of TIME reports, SEC Now Offering Big Payoffs To Whistle-Blowers:

In what could give new meaning to the phrase — "If you see something, say something" — a clause within the financial reform legislation is offering big cash rewards to whistleblowers who report fraud and other wrongdoing at U.S.-listed companies and Wall Street banks.

 

Under the program, which is already live, anyone who provides a tip that leads to a successful Securities and Exchange Commission action will be able to collect between 10% and 30% of the amount recovered — as long as the total amount exceeds $1 million. This means the minimum payout is $100,000.

 

The whistle-blower could be a company insider or a private investor, if they're able to offer information or analysis that leads to an action. And with potential payoffs netting millions — or even tens of millions — of dollars, experts are bracing for a surge in tipoffs. (See the worst business deals of 2009.)

 

Money can be "extraordinarily effective" in getting people to blow the whistle when they see fraud, says John Phillips, whose law firm Phillips & Cohen LLP specializes in whistleblower cases. The U.S. Government evidently agrees. "We expect the awards will prompt a significantly greater number of insiders to come forward with high-quality evidence of fraud," says SEC spokesman John Nester.

 

In the past, the SEC's whistleblowing program was limited to insider trading cases and offered only small discretionary, rather than mandatory, rewards ranging from 0 to 10% of the money recovered. "It was completely ineffectual, completely discretionary," says Phillips. (Read about a whistleblower case involving ignorance.)

 

The narrow scope and poor cash rewards generated little response: Since the program's launch in 1988, only 14 applications led to actions where a civil penalty was ordered, and only eight cash awards were handed out totaling $1.16 million, according to SEC officials. The largest award came last month when the ex-wife of a hedge fund adviser at Pequot Capital Management was awarded $1 million for her role in providing information that led to Pequot paying $27 million to settle an insider trading case involving Microsoft securities. The ex-wife had discovered a key email on her computer hard drive that led to the action against her ex-husband's former employer. (Read about the new sheriffs of Wall Street.)

 

But this legislation extends the program beyond insider-trading cases to all securities law violations and, most importantly, offers bigger payoffs and therefore bigger incentives to speak out. People can report almost any securities violations, ranging from money laundering, accounting fraud and ponzi schemes to bribery. Also, the SEC will be looking at not only independent knowledge, but even analysis as proof. The means an academic, private investor, or even a journalist or a securities analyst who conducts independent research and uncovers fraud based on that research could collect an award if their information is new and leads to an action.

 

"So you can have people who might have done analysis for academic reasons or personal trading reasons or research that they sell, that they may now, in addition, provide to the SEC with an eye toward getting a bounty," says Paul Leder, a partner at Richards, Kibbe & Orbe LLP and former SEC official for 12 years. He noted how the options backdating scandal in 2006 stemmed from academic articles that described how the option grants to executives and board members were extraordinarily well-timed. The SEC picked up on the analysis and wound up filing dozens of cases against companies and executives. (Comment on this story.)

 

Even a CEO could squeal on his own company as long as he wasn't personally convicted in connection with the fraud. "Yes, to the extent that they themselves are not culpable," says Phillips. "You can't initiate the fraud and then go collect on it."

 

The legislation bars certain people from receiving awards — officers or employees of a regulatory agency, the department of justice, a self-regulatory organization, the Public Company Accounting Oversight Board or a law enforcement organization, as well as company auditors and anyone convicted of a crime related to the securities violation.

 

The program also protects squealers against company retaliation. Any whistleblower who is fired, demoted, suspended, threatened, harassed or discriminated against by a company for providing info or testifying in an SEC investigation, can file an action in the U.S. District Court. If they succeed in proving their case, the legislation guarantees the person's reinstatement, two times the amount of backpay owed, and coverage of all court and attorney fees—so long as the action is filed within a certain time period.

 

The potential payoff is high. The recent judgment against Goldman Sachs resulted in a $550 million penalty. "If you got 10% of that, it's pretty good money," says Leder.

 

Even a mid-cap company could wind up with a consent order or suit in the millions of dollars, says Daniel Karson, executive managing director and counsel at Kroll, a risk consulting company. "So 10% for making a phone call is a pretty good payday," he says.

 

One obvious question overhanging this new lure for whistleblowers is whether the SEC will have the staff to handle it. "The government always has limited resources," says Karson. "I think the SEC is going to be overwhelmed in short order with people bringing these kinds of actions — they're going to have to sort through what has substance and what doesn't." The SEC has indicated it will be opening a whistle-blowing office and chairman Mary Schapiro told a House committee the agency would need to hire 800 new people to fully implement the financial reform bill's changes.

 

"There's real money to be made," says Leder. "I think it's a powerful incentive."

After a lengthy attempt to bail out his pet bank, ShoreBank Chicago, Illinois, which included several alleged armtwisting episodes by the administration, the president has finally let the bank die (with its assets valued at about 50% of face). Yet instead of going to hell, it was immediately resurrected with a bevy of new owners, among them Goldman, Morgan Stanley, and BofA, all of whom received nearly $400 million in taxpayer money for their "generosity" to keep the bank zombified even in the afterlife.

Some details on the bank from the FDIC press release: "As of June 30, 2010, ShoreBank had approximately $2.16 billion in total assets and $1.54 billion in total deposits." In other words, the value of ShoreBank's assets was well below 70% of face, if the bank was undercapitalized at its current deposit level. Continuing: "The FDIC and Urban Partnership Bank entered into a loss-share transaction on $1.41 billion of ShoreBank's assets. Urban Partnership Bank will share in the losses on the asset pools covered under the loss-share agreement. The loss-share transaction is projected to maximize returns on the assets covered by keeping them in the private sector. The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $367.7 million." Netting the incremental cost of taxpayer DIF subsidies, means that the real value of assets was ($1.54 billion - $367.7 million)/$2.16 billion or 54% of face. And this is a bank that Obama wanted to keep alive at all costs? And just who is this "Urban Partnership Bank" that is receiving a taxpayer subsidy of $368 million? Why all the usual suspects of course: "The significant investors in Urban Partnership Bank are American Express Company, Bank of America, Citigroup, Ford Foundation, GE Capital Equity Investments, Inc., Harris Bank, the John D. and Catherine T. MacArthur Foundation, JPMorgan Chase & Co., Key Community Development Corp., Morgan Stanley, Northern Trust Corporation, PNC Investment Corp., State Farm Mutual Automobile, The Goldman Sachs Group, Inc., and Wells Fargo & Company." And so the old "out-of-one-taxpayer-pocket-and-into-another-Wall-Street-pocket" game continues, only this time it includes administration darling banks that should have been liquidated long ago.

By keeping ShoreBank artificially alive for far longer than it deserved, the assets amortized far more than they would have had it been taken into receivership by a non-conflicted bank, and thus the final cost to taxpayers would have been far less.

As it stands, Goldman and 11 other banks are receiving a multimillion dollar gift to conduct a portfolio liquidation run-off of ShoreBank's assets, while merely making sure existing deposits are serviced. At least we now know just how truly angry at Wall Street Obama is.

The funniest bit: this is how efficient the auction process was (from the press release):

FDIC received only one bid, which included an asset discount of $146 million and a 0.5 percent deposit premium. This saved the FDIC’s insurance fund $250 million to $334 million over liquidation.

This also padded the top line of the abovementioned banks by $368 million off the bat, over and above whatever they make as they collect the proceeds from the portfolio run off.

In other words, Wall Street's core banks could have come up with any bid they wanted, and the FDIC would have had no choice but to fund the difference, because the alternative would be, gasp, so much scarier. Hm, where have we heard this before.

Full press release (link) and supplemental information (link) to this latest taxpayer gift to Wall Street's kleptocrats.

As frequent readers will recall, in late April we pointed out that a Moore Capital ploy to "bang the close", which is merely a trading artifice in which the closing price is manipulated by repeated barrages of buy or sell orders to get a closing print that causes a derivative instrument to be in (or out of) the money, resulted in a then near-record fine charged by the SEC to go alongside a settlement of manipulation allegations. We then observed: "As the saying goes, if you look around the table, and you can't figure out who is using illegal manipulative mechanisms to push the market higher or lower, you are an idiot: the answer is all of them." Well, we know the manipulator is Moore, but not who the specific trader was. Today, via the WSJ, we learn that the guilty person is none other than former Moore trader, and recent sole hedge fund manager, Chris Pia, who also happens to be Louis Bacon's right hand man for 18 years running. We also learn that platinum are palladium were merely two of the numerous products that Chris was banging (into the close). And the coolest thing: Mr. Pia is now running his own hedge fund Pia Capital Management, as if nothing happened (although the anchor Swiss gold-refining investors in Pia Capital may soon have to reevaluate their relationship with the PM (no pun intended) at this point). One also wonders if these were the accepted illegal trading practices at Moore (for which they got caught) just what else is the $10 billion hedge fund guilty of doing on a daily basis to attain that ever more elusive alpha (the 7x return that Pia generated in 8 years at Moore sure wasn't from holding T-Bills).

From the WSJ, we learn that Pia is a perfectly normal, calm, collected, orthodox person, just like most other happily married, responsible, hedge fund managers:

Mr. Pia liked to tell colleagues about his modest upbringing, and that he is a devout Catholic. He complained about hedge-fund managers he considered elitist. On the trading floor, he often twirled a string of rosary beads. Callers to his cellphone heard the Batman theme song.

Yet it is not his character we are interested in, but his precious metals manipulation scheme, which while applicable to platinum and palladium, is perfectly relevant to the daily gyrations, especially prior to Comex close, in gold and silver.

"As you get down the scale to commodities like palladium, futures markets are almost by definition less liquid and more susceptible to this kind of conduct," says Scott Early, a securities lawyer and former general counsel of the Chicago Board of Trade. But it becomes easier for regulators to catch such activity in thinly traded markets, he says.

Closing prices in futures markets are set differently than they are in the stock market, where they are determined by the last trade each day, at 4 p.m. In the futures market, the "settlement," or closing price, is the weighted average of all trades during the last few minutes of trading. For palladium, for example, the "closing period" is from 12:58 to 1 p.m., and for platinum, it is 1:03 to 1:05 p.m.

Traders can push settlement prices around by inundating the market with orders during the last two minutes of trading. Trying to push prices higher in that way—banging the close—is in some cases considered market manipulation under commodities laws. It is loosely akin to an illegal stock-market practice known as "pump and dump," where traders push up the price of thinly traded stocks by disseminating misleading information, then sell shares before the price falls again.

In 2008, several traders complained to the New York Mercantile Exchange about someone entering the market near the close and aggressively buying platinum and palladium futures contracts, two people familiar with the matter say. Around the same time, the CFTC began detecting unusual trading patterns in the two markets. CFTC enforcement lawyers began questioning Mr. Pia about his trading, says one of the two people.

The CFTC complaint against Moore doesn't specify the day or days on which the trades in question took place, nor does it disclose whether Mr. Pia was the trader involved.

Often, at 12:58 p.m., two minutes before the close of the palladium market, the unnamed trader—Mr. Pia, according to people familiar with the matter—or an associate would send instant messages to a trader in that market with "directions that indicated that he wanted to push prices higher," according to the CFTC complaint. That trader waited until the last 10 seconds of trading to relay the high-priced orders to a floor clerk in the trading pit of the New York Mercantile Exchange, the complaint said. Moore sometimes repeated the sequence during the closing period for platinum futures, the complaint said.

Fewer than 10 traders typically participate in the thinly traded market for palladium, the CFTC said, and the Moore trades accounted for most of the volume in the two markets during the closing period.

In a series of interviews, CFTC investigators asked Mr. Pia whether he intended to push prices higher through the trading in question, according to one person familiar with the matter. Mr. Pia denied doing anything wrong. He admitted to waiting until the last minute to place the orders, but said he simply was buying what the floor traders were selling and the market would go up, this person says. Mr. Pia said his last-minute timing was intended to thwart rival traders who often would try and buy ahead of Moore's orders, this person says.

And guess what: the CFTC is likely buying this. We are confident in this because they are actually confused by Pia's apparetn motives:

The ongoing CFTC investigation is looking into whether Mr. Pia tried to boost his compensation through the trades in question, according to a person familiar with the investigation. Among the questions being examined by the CFTC is whether Mr. Pia was trading ahead of Moore's commodities orders through a portfolio he managed within the firm, possibly in an effort to increase his pay, this person says. Such tactics can give traders an unfair advantage because pending orders—which aren't known to the public—can affect prices when executed.

In other words, in addition to manipulating thin volume closes, was also allegedly frontrunning internal (presumably prop although Moore is so big it may well have been flow) trades. One would almost think Pia took a master class in market manipulation at Goldman. Oh wait:

In 2008, for example, Mr. Pia entered into a trade under which Moore would get a $25 million payout if the New Zealand dollar rose to a certain level. Goldman Sachs Group Inc. was on the hook to make the payout. If that level wasn't hit, Moore stood to lose $1 million.

As the trade's expiration date approached, the New Zealand dollar was trading about 25 cents below the price at which the contract would pay out. Mr. Pia got clearance from top Moore officials to spend billions buying New Zealand dollars, hoping the currency would hit the set price, according to the person with knowledge of the trade. Fifteen minutes before the contract expired, Mr. Pia began buying billions of New Zealand dollars, lifting the currency to the price at which Moore was able to collect the $25 million, the person says.

Gary Cohn, Goldman's president, later congratulated Mr. Pia on the trade, the person says.

Yes indeed, to Goldman such practices were not only not worth pursuing legal action against (who needs capital when you have discount window access and are, after all, the squid), but in fact, were laudable and worthy of commendation. Oh yes, and it appears that in addition to platinum and palladium, Pia was guite a close banger of the NZD, and who knows what other currencies. Perhaps the CFTC will tells us that the FX market is as thin as the palladium one, and just 10 people give or take trade carry pairs? (Actually that may be quite true right now that nobody trades any more, but it surely wasn't the case in 2008).

We don't have any bad blood with Mr. Pia: "The new fund, headquartered in Greenwich, Conn., has about $500 million under management, and is down 0.6% for the year." Since it is relatively difficult to be down (or just barely up), if performing alleged illegal market manipulative scams, we are confident he has learned his lesson. Yet for every Pia, there are 1,000 LBMAs, who perform precisely the same act on the Comex all day every day, in an attempt to constantly push down the key Central Banker nemesis: "gold." We are confident that the CFTC and the DOJ will get right on with their investigation of comparable manipulation in the gold and silver markets. Because after all, nobody has anything to hide there... And gold would still be where it was if it weren't for consistently shady PM activity in the market.

We hope Mr Pia will come forth to the media out of his own volution and discuss what else the broader public should be aware about manipulative practices, be they in the FX market, or in commodities. Alas, we are not holding our breath. Nor are we holding our breath that the DOJ, which has now be ruminating for about about 4 months as to whether or not to launch an investigation into silver market manipulation by JPM, will ever come to an affirmative conclusion. After all, they have said on so many occasions there is absolutely nothing wrong with the PM market, how can one possibly not believe them?...

Submitted by Todd Harrison of Minyanville

Seeking Solutions in an Uncertain World

“We used to play for silver, now we play for life; ones for sport and one’s for blood at the point of a knife.” --Grateful Dead

We live in interesting times. During the last two years, a financial virus spawned and infected the economic and social spheres as a matter of course.

This isn’t just about money anymore. Our civil liberties, the foundation of free market capitalism and the quality of life for future generations are dynamically shifting as we traverse our current course. (See: The Short Sale of American Icons)

I once offered that Shock & Awe was a tipping point through a historical lens; as Baghdad blew-up on CNN, I somberly sensed America would never be the same. That’s not a political statement -- we don’t know what would have been if we didn’t invade -- it’s simply an observation. Almost overnight, world empathy turned to global condemnation.

If we’ve learned anything through these years, it’s that unintended consequences tend to come full circle. Whether it’s the moral hazard of bailing out some banks, the gargantuan profits of a chosen few -- Goldman Sachs (GS), JP Morgan (JPM), Bank America (BAC), Morgan Stanley (MS), Wells Fargo (WFC) -- the caveats of percolating protectionism, or the growing chasm of social and geopolitical discord, times they are a-changin’ and it’s freaking people out.

As speculators are vilified and hedge funds are perceived as acceptable casualties of war, financial fatigue will evolve in kind. We’ve already seen the burnout manifest in trading volume -- upwards of 70% of the flow are the robots -- and we’ve witnessed it in financial media, with reported ratings of some of CNBC’s marquee shows down as much as 25% year-over-year. (See: The War on Capitalism)

Sun-tzu once said, “If your enemy is superior, evade him. If angry, irritate him. If equally matched, fight and if not, split and reevaluate.” As we navigate this socioeconomic maelstrom, an increasing number of people are weighing their options -- and some of the smarter folks I know are “going dark.”

What does that mean? They’re selling businesses, unwinding trading operations or otherwise distancing themselves from the capital markets. The thematic reasoning is straight out of an Ayn Rand novel: “I can’t compete and when I do, the rules of engagement change in the middle of the game. I’ll let the powers that be vanquish themselves and return in three to five years to sift through the remains.” (See: The Last Gasp Bubble)

The first time I heard this, I took notice. The second time, it piqued my interest. Now, with four or five savvy seers pulling the plug, I felt compelled to communicate these observations. I’m often early and sometimes wrong but I’ll always put it out there; while few are talking about this, it’s on many people’s mind.

I’ll also share that the most lucid thought I’ve had since offering in 2003 that we should "sell tech and financials, buy energy and metals and open a taco stand in Costa Rica" is to edge away from NYC. While I’m not the panicky type -- heck, some would say I thrive under pressure -- I would be remiss if I didn’t offer the respect of that honesty. I’m unsure of the genesis of this particular vibe -- quality of life or proactive self-preservation -- but the intuition is palpable and ever-present.

As it stands, I'm not in a position to do that -- this is where we are and this is what we do -- but my personal choice doesn’t alleviate the overarching societal shift or the collective tension that seems to be percolating. I speak with a ton of people in an array of industries throughout the world and "business is great" feedback is a rarity.

More often than not with increased frequency, the sentiment skews in the other direction, as do anecdotal data points such as thinning crowds at concerts and excess capacity at high-end restaurants and sporting events. There are of course exceptions -- $10 million plus homes in Manhattan are well-bid, due in large part to Wall Street bonuses -- but they’re an outlier in the broader array of our societal fray.

Last week on Minyanville, we shared the following feedback from someone within our community. And I quote:

I read your exchange on “going dark” and wanted to share some anecdotal evidence. I owned a chemical and manufacturing corporation that employed twelve people. We sold the company in October, 2009 for three reasons: expectations of higher future tax rates (income and cap gains), lack of clarity in regulations and the perceived coming wave of governmental policies.

Looking at that last sentence reminds me of why we decided to take our cards off the table after a successful run; the words EXPECTATION, CLARITY, and PERCEIVED.

All of these lead to one thing -- uncertainty. It was hard enough to make a dime with the relative stability of the previous period. Change the operating environment and in my mind, you change the probability of success. Smart people (being presumptuous there!) don’t wager in that environment!

Now, I’m not suggesting we cower in a corner, buy guns and butter and get all Mel Gibson on each other. Further, I understand most folks aren’t in a position to seize the day and walk away. I’ve written in the past that if we’re not part of the solution, we’re part of the problem and that remains true, now more than ever; society, at the end of the day, is simply a sum of the parts.

As we wrestle with reality and attempt to operate in the best interests of ourselves and those we love, some have chosen to extricate themselves from an increasingly tenuous struggle to focus on the little things in life. I suppose they’re lucky to have that option and their actions are consistent with a widespread reprioritization following the Great Recession. I’ve written about them before; net worth vs. self-worth, having fun vs. being happy and the caveats of looking for validation at the bottom of a bank account. (See: Memoirs of a Minyan)

For those motivated to power through to better days and easier trades, the actions of a few effects the lives of many; we, the people, need motivated, innovative proactive problem-solvers to remain engaged as the second side of the storm approaches. While our financial equation is multi-linear and ever-changing, my sense is that we’ve got four to five years of perseverance and preservation as a precursor to the profound, generational opportunities that will emerge thereafter. (See The Eye of the Financial Storm)

Looking at this emerging trend of “distancing” another way, we know the opposite of love isn’t hate, its apathy. Through that lens, folks walking away from the capital market construct may indeed be another step in the steady migration from what was to what will be. We often say the leaders who emerge from the crisis are rarely the same as those who entered it. At the very least, it should be noted that several former leaders have removed themselves from the running.

By Static Chaos

One of the headline news today was that New Jersey became the first U.S. state sued by the Security Exchange Commission (SEC) for security fraud. Here is the low-down according to WSJ (my summary):

The SEC cited the case involved municipal bonds in 79 separate offerings totaling $26 billion from 2001 to 2007 where the state didn't disclose it had abandoned a five-year plan to fund the pension plans. The filing described NJ used a series of accounting maneuvers to create an illusion that it was funding the two pensions totaling $62 billion, when it actually was just moving money around, and alleged misled investors.

Now, here comes the part about the Irish Luck (my summary based on NYT)

SEC settled its suit with New Jersey by issuing a cease-and-desist order, which the state accepted without admitting or denying the findings. No penalties were imposed. Neither individual, nor the bond underwriters was charged. New Jersey’s largest bond underwriters during the period in question include Citigroup, J. P. Morgan Securities, Morgan Stanley, Bank of America, Merrill Lynch, Goldman Sachs and Barclays Capital.

So basically, New Jersey pulled an Enron accounting trick without any consequences.  Can you imagine any corporations or private citizens would get off this easy? Some fines or penalties have got to be involved, at the minimum, and some employee(s) and the underwriters would be charged as well.

Well, as it happens, SEC currently has authority over companies regarding disclosure, but with munis, all it can do is bring a case if it suspects fraud. Furthermore, no investors appeared to have been harmed, and imposing any sizable fines and/or penalties would probably bankrupt New Jersey. So this most likely explained why NJ got just a little slap on the wrist. (By the way, The SEC has asked Congress for expanded authority.)

However, what's more worrisome is that WSJ noted that

"States as a whole face a trillion-dollar gap between the pensions, health care and other retirement benefits they have promised to public employees, and the money set aside to pay the benefits, according to a report by the Pew Center on the States. The SEC said it is concerned about how these problems are disclosed to investors."

Chart Source: WSJ.com

With New Jersey as a precedent, muni investors probably should not expect too much accountability and protection from the SEC.

A week ago Goldman raised its price target on gold to $1,300/ounce, an action which judging by the firm's historical record of putting its clients' interest in its rightful last place, led us to be skeptical: "The report will likely result in a brief pop in spot as the idiot money rushes into the latest Goldman trap. Alas, it also means that GS is now offloading. Be very wary of market dynamics over the next month." Today we realize our skepticism was perfectly justified: in the latest Perspectives from Goldman Sachs Asset Management (intended FOR BROKER-DEALER, FINANCIAL INSTITUTION, OR INSTITUTIONAL INVESTOR USE ONLY. NOT FOR DISTRIBUTION TO CLIENTS OR THE GENERAL PUBLIC), in addition to summarizing all the other recent actions presented by the firm's key departments, way in the back, in very small print when discussing commodities, the letter author notes: "Shifted our stance on gold after years of being long; see gold as vulnerable to Central Bank inactivity in the face of rising deflation risk." Once again, those who bet that Goldman does precisely the opposite of what it tells clients to do, win.

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By Giordano Bruno, of Neithercorp Press

The Purpose Behind Engineered Economic Collapse

“From now on, depressions will be scientifically created.” — Congressman Charles A. Lindbergh Sr. , 1913

Everyone loves money. Even people like myself who abhor the abuse of money and commerce, who understand the fraudulent nature of the system we live in, still work hard and save so that we might attain a sense of stability within that system. Many people see money as a focal point to their existence. But is it really money that they are after, or is it something else entirely? In truth, money represents ‘security’ in the minds of the masses. Money affords us the ability to survive, and the more of it we have, the safer we all feel. Because we subconsciously associate the extension of our very life with the variable health of the economic structure in which we live, we tend to become unwitting devotees to its continued existence, even if it is corrupt and condemned to failure. We gullibly deny the system or the currency that supports it is doomed to the contrary of all evidence because, even though it has beaten us bloody, we have never known anything else.

In light of this entrenched way of perceiving things, especially in the U.S., it is difficult enough to convince some people that the economy is in fact not providing the security they desire, but is actually destroying their future completely. To explain to them that this is deliberate, that the economy is designed to self-destruct, that is another prospect altogether.

Many people hit a proverbial wall on this issue because they simply cannot fathom that certain groups of men (globalists and central bankers) view money and economy in completely different terms than they do. The average American lives within a tiny box when it comes to the mechanics and motivations of finance. They think that their monetary desires and drives are exactly the same as a globalist’s. But, what they don’t realize is that the box they think in was BUILT by globalists. This is why the actions of big banks and the decisions of our mostly corporate establishment run government seem so insane in the face of common sense. We try to rationalize their behavior as “idiocy”, but the reality is that their goals are highly deliberate and so far outside what we have been taught to expect that some of us lack a point of reference. If you cannot see the endgame, you will not understand the steps taken to reach it until it is too late.

In the past we have covered numerous instances in which global bankers have admitted to fraud on a massive scale, fraud which is now crushing our already fragile economy. We have covered the private Federal Reserve and how it knowingly facilitated the creation of the housing bubble, as well as how it is now inflating a Treasury bubble which is soon to implode. We have covered Goldman Sachs and its efforts to promote and sell toxic derivatives all over the world while at the same time betting against those derivatives on the open market. We have covered the manipulation of gold and silver markets by companies like JP Morgan, which have recently been exposed by whistleblowers and GATA investigations. And, most importantly, we have executed in-depth analysis on the growing weakness of the U.S. dollar in preparation for severe currency devaluation. These revelations raise questions, which is natural, but they also illicit misconceptions and reckless knee-jerk reactions, especially when broaching the fact that the illegal strategies of international banks are part of a greater agenda.

Below, we will examine some of the most common narrow minded responses to the issue of engineered economic collapse, as well as why people think the way they do when the “semi-sacred” subject of money is involved…

1. The economy is too complex to be controlled by just a handful of people…

This response often comes from people who make presumptions on economics, rather than actually educating themselves on how the system works. From the outside looking in, the world of finance appears chaotic; a mixture of mathematical and legal standards swirling in a void of mass psychology. Many Americans are either frightened off by the seemingly complicated field of study, or they find it rather boring and not worth their time. This, however, does not stop them from assuming that they know how money works.

The problem is that just because a person participates in his economy daily, it does not mean he has any understanding of how it operates. Many watch television on a daily basis, but few have any idea how the picture actually gets onto the screen, or how to fix a television once it is broken. Sadly, our egocentric culture has led a substantial portion of the public to imagine that they are experts on EVERYTHING, and thus, true researchers in the fields of economics and globalism get reactions like the one above constantly.

At bottom, once all the quasi-technical biz-babble used by mainstream talking heads is removed from the equation, economics is rather simple. Supply and Demand will always be at the center of any and every economy, regardless of the political atmosphere it exists in. These two fundamental factors can be manipulated to a point, by the creation of artificial supply, or the conjuring of false demand. This is achieved in many ways by global bankers, but primarily through domination of the issuance of currency, the ability to change interest rates at will, as well as the ability to inject or remove incredible sums of money from any market.

A perfect example is the suppression of silver prices by JP Morgan:

http://www.zerohedge.com/article/whistleblower-exposes-jp-morgans-silver-manipulation-scheme

Gold and silver represent competing currencies to the fiat dollars created by the Federal Reserve, and suppressing the value of these commodities helps to ensure that the public will never see them as a viable alternative to paper assets. JP Morgan, who along with other international banks has the ability to throw around massive quantities of capital wherever they please, suppresses the value of physical silver by issuing paper securities for silver that doesn’t actually exist (creating an artificially high supply), and naked short selling silver markets to drive them lower (creating the false impression of low demand).

Another good example of economic manipulation is the private Federal Reserve’s strategy during the 90’s under Alan Greenspan to artificially lower interest rates, allowing banks to issue credit at historical levels for over a decade. Linked below is an article from Ron Paul’s ‘Texas Straight Talk’ dated March, 2007, before the housing market even began its full swan-dive. In it, he discusses the Federal Reserve’s direct role in the creation of the housing bubble:

http://www.house.gov/paul/tst/tst2007/tst031907.htm

Men like Ron Paul, Peter Schiff, Gerald Celente, Jim Rogers, and many others were able to predict long before hand that the Federal Reserve’s actions were creating an explosive mortgage and credit bubble, yet, we are supposed to believe that the Federal Reserve had “no idea” that their actions would result in a debt implosion?

Catherine Austen Fitts, former Assistant Secretary of Housing and Commissioner of the U.S. Department of Housing and Urban Development under the first Bush Administration stated conversely that the mortgage bubble was absolutely not an accident, and that she had witnessed outright and deliberate fraud on the part of the U.S. government and the Federal Reserve Bank in creating the bubble. The fact that disturbed her most, however, was her discovery that only a small handful of international banks were responsible for the perpetuation of toxic mortgage debt, not just in America, but around the world:

http://solari.com/blog/?p=2058

Goldman Sachs (one of the primary globalist banks involved in the igniting of the debt crisis) was caught red-handed selling toxic derivatives to investors and governments all over the planet while at the same time betting against those derivatives on the market. Goldman even bet against mortgage securities the bank itself created!

http://www.businessweek.com/news/2010-04-26/goldman-sachs-bet-against-its-own-deals-senate-s-levin-says.html

This is sort of similar to a car maker selling vehicles without brake lines, then placing bets that their clients will crash and burn. Essentially, it is blatant and sociopathic fraud! Goldman’s actions directly contributed to credit collapses in numerous countries, including Greece, and here in the U.S.

The idea that global banks can turn the economy on and off like a light switch may be a stretch, but the vast majority of evidence shows that they do have the ability to shift the direction of markets to a point, as well as the ability to spur the growth of bubbles that eventually lead to recessions, depressions, and beyond. In fact, if one examines the U.S. economy from the inception of the Federal Reserve in 1913, they would find that the past century has been nothing but a series of engineered equity bubbles designed to slowly hobble, but not completely cripple, our financial system and our currency, at least, until recently. Like a steam locomotive on a collision course with a bottomless canyon, globalist banks can slow or speed up the pace of our descent, but the final destination never changes.

Now that we have established that market collapses can be created by a small handful of bankers and done knowingly, lets move on to the next most common sheeple-like talking point.

2. Yes, international banks triggered the meltdown, but the “greed of Capitalism” is truly to blame (i.e. Its all the Republican Party’s fault)…

First off, if you’re parroting the fiscal debate points of two dimensional socialist gatekeepers like Michael Moore, then you’re already hopelessly lost in the mind warping hedge maze of the false left/right paradigm. You should stay as far away as possible from adult conversions on economics, especially if you plan on associating the “greed” of capitalism and corporatism with the Republican Party alone.

News Flash! Barack Obama received far more in corporate campaign donations (including donations from BP and Exxon) than McCain did. Both Bush Jr. and Obama increased government spending to record levels meaning Neo-Conservatives are in no way “conservative” (as a true Republican is supposed to be). Obama has consistently surrounded himself with banksters and corporate lobbyists, including various hobgoblins from the bowels of Goldman Sachs. BOTH major parties are owned and operated by global banks. This is a cold hard undeniable truth of our political system. There is no way around it. Learn it, accept it as reality, and stop trying to blame one side or the other for problems that both sides created! If you cannot do this, your view of our cultural state of affairs will always be horribly skewed and your insights on our social problems will be utterly worthless.

While wannabe socialists desperately clamor to point fingers at the free market ideology as the cause of all our ills, the fact is that none of us have ever lived in a truly free market system. Since the inception of the Federal Reserve in 1913, all markets and even our own currency have become more and more vulnerable to manipulation by the banking elite. We have lived our entire lives in a rigged market, not a free market. To blame the very concept of Capitalism for our current dire circumstances is not only naïve, it is dangerous. Globalists would like nothing better than to promote the illusion that “too much freedom” led us to this disaster, and that severe controls must be put into place to ensure that it “never happens again”.

3. Global banks would never engineer the collapse of the U.S. economy or the Dollar. It makes them too much money…

This often heard song and dance ties in with the number two comment above. Again, the assumption is that the globalists only do what they do out of an “uncontrollable greed for money”. This perpetuates a couple fallacies. First, it encourages the false belief that the end concern for the Elite is the accumulation of riches. Central bankers have the ability to PRINT all the money they want from thin air! Remember, the Federal Reserve has never been subjected to a full audit, meaning they could easily create billions if not trillions without any oversight whatsoever. Greed for money, to them, is surely an absurd notion. What they do want, more than anything else, is social power. They want control over every living human being without question. All other concerns are secondary.

The next fallacy underlying the above argument is the conjecture that the U.S. economy is somehow indispensable to global banks. This is simply not so. Where we see the economy as an extension of our culture and ourselves, the Elites see financial systems as mere tools in the pursuit of a greater goal: World Government. Imagine you are building a house. Once your saw has fulfilled its intended role of cutting the wood, do you cling to it, or do you throw it aside and pick up a hammer? This is how globalists look at financial systems. They are perfectly willing to cast off the U.S. economy like a snake shedding skin if it brings them closer to attaining their ultimate aim.

The same goes for the Dollar. The Greenback may be the premier world reserve currency now, but that can and likely will change very quickly over the next couple years. The Dollar is a device that has outlived its usefulness as far as global bankers are concerned. The IMF has on several occasions made it clear that they eventually intend for the SDR (Special Drawing Rights) to replace the Dollar as the world reserve currency, and they have openly admitted that it will one day be established as a global currency. IMF press releases make this development sound far off and away, but SDR accumulations by countries around the world have risen dramatically in the past year. This along with other factors we will cover (namely China’s preparations to dump their U.S. T-bond holdings) show that IMF actions indicate they are preparing for a collapse of the Dollar now!

4. China would never dump U.S. Treasuries because it would hurt them as much as it hurts us…

The theory that China is somehow fused to the U.S. in a kind of symbiotic seesaw relationship that can never be broken is so ingrained among mainstream American financial analysts it simply will not die, regardless of how much contradictory evidence you show them. It really is like a mental disease which causes MSM pundits to go into involuntary Tourettic convulsions every time you mention the words “Treasury bond dump”. America and China are not conjoined twins, and one can survive without the other. We have covered the China issue over and over again, and I will not rehash all that evidence here. To lay it out simply: China has re-engineered its economy towards consumption and importation rather than relying on exports. The IMF has talked about this on many occasions with apparent excitement:

http://www.imf.org/external/np/tr/2010/tr072910c.htm

China has also finalized the ASEAN trading bloc which has combined export markets at least equal to that of the U.S. Meaning, China already has another place to send its exports besides America.

Most importantly, China must increase their currency’s value if their new consumer based system is to survive. Allowing the Yuan to rise sharply in value will revitalize the buying power of the Chinese populace making greater consumption possible. Indeed, China MUST dump their Treasury holdings and pump up the Yuan if they are to hold their economy together. And, the Federal Reserve has given China every reason to turn its back on Treasuries through never ending liquidity injections. This is not to say that a U.S. collapse will not affect them, it would negatively affect the entire world. However, China has positioned itself to survive, and perhaps even thrive with their economic expansions into Africa, and their new financial agreements with Germany.

Finally, the Chinese have been very forthcoming over the past week about plans to drop Treasuries. China has dumped over 7.7% of their U.S. T-Bond holdings since January, including the biggest T-bond dump on record this month. They have openly admitted to a plan to diversify away from the Dollar:

http://www.bloomberg.com/news/2010-08-17/china-cuts-long-term-treasury-holdings-by-most-ever-as-u-s-yields-decline.html

I’m always fascinated by those economists who vehemently deny China will ever turn away from the U.S. Dollar while they are doing so right in plain view. Are MSM analysts simply crazy? I don’t know, but it would explain a lot…

5. Sure, bankers took advantage, but it’s really the American people’s fault for getting suckered…

Yes, a sizable portion of the American public can be gut wrenchingly stupid. It hurts my head and my feelings to see people act so idiotic, it really does. The problem with this argument though is that when it is taken too far it becomes an attempt to divert blame away from the criminals and place it on the victims. If you knowingly leave your front door unlocked in a bad neighborhood and you find your home ransacked the next day, then you are partly responsible. But, we cannot forget that the neighborhood is “bad” in the first place because of the criminals, not the people who don’t lock their doors.

Just because global banks can sucker the public doesn’t mean they should, or that they cannot be judged for it. The crime ultimately rests on those men who made the conscious effort to destroy this country, and the blame rests with them as well. I see the attempt to parlay the economic collapse into the lap of the American people very often lately, especially from bankers who now claim that it’s the American public’s fault entirely. Why? Because they will not spend more, they will not take on more debt, they will not take on more risk, and they will not believe hard enough in the recovery that never was. Imagine a serial rapist behind a podium admonishing women for carrying pepper spray. It’s eerily similar…

6. Ok, maybe the banks are causing a collapse, but to say the government is helping them is just crazy conspiracy theory…

Why is it that the Federal Reserve has never been fully audited? Why is it that when Ron Paul tried to pass HR 1207 Federal Reserve Transparency Bill, it was muddled in committees and then eventually derailed? Why is it that banks like Goldman Sachs have been caught, yes caught, setting the stage for an economic implosion in this country, yet no government indictments have been formed to criminally prosecute them? Why are these men still roaming free like locusts to continue pillaging at will? Are we supposed to feel lucky that we get table scraps like Bernie Madoff behind bars while the Federal Reserve commits Ponzi fraud on a scale that dwarfs his?

Our government, both major parties, is owned lock stock and barrel. This is why there are no satisfactory answers for the questions posed above. Elements of the U.S. Government including almost every president since 1912 have not only turned a blind eye to Globalist activities, they have offered their full support to the bankers.

Nixon removed the Dollar from the gold standard in 1971 giving the Fed free reign to print as much fiat as they wished without limitations. In 1980 the Depository Institutions Deregulation and Monetary Control Act was passed placing all banks essentially under the rules of the Federal Reserve. The Glass-Steagall Act which kept investment banks and depository banks separate was repealed under a Republican majority in the Senate, and then finalized by Democratic President Bill Clinton in 1999. 30 years ago, banks that held your home mortgage were for the most part required to keep that mortgage until it was finally paid. But, a series of government decisions spanning that period and influenced by global banks allowed for the “securitization” of mortgages, leading to the creation of “derivatives”, which were then used by corporate mobsters like Goldman Sachs to destroy our financial system. Last, but certainly not least, both the Bush and Obama Administrations pressured Congress into passing highly unpopular bailout legislation which basically rewarded the same banks that created the credit crisis with trillions in taxpayer dollars (yes, the bailouts are now actually in the trillions, not billions). This led to the coining of the term “too big to fail” (or “too big to jail”). Our Government has been nothing but complicit in the banker takeover of this country. To debate otherwise is to invite embarrassment.

I haven’t even scratched the surface of government involvement in the collapse of our economy. Cases like the Savings and Loan crisis of the 1980’s led to serious prosecutions and jail time for more than 1100 criminal bankers, but this only caused the government to respond by changing investigation rules to make it even more difficult to catch the high level fraudsters in the act! Linked below is an interview between Max Keiser and bank regulator Prof. William K Black who outlines our government’s complicity in the breakdown of the country it is mandated to protect:

http://www.youtube.com/watch?v=5Bf5Frx1lZk

Elites destroy cultures to make way for new philosophies; their philosophies. Its not so much “conspiracy theory” as it is a widely admitted methodology. Corporate globalists believe in global government on their terms and they barely try to hide it. If someone thinks this sounds “fantastical” then they haven’t been paying the slightest attention. When one understands how Elites view economy, and realizes their primary motivations, the fact that they purposely triggered a collapse is perfectly logical. Nothing besides all out war inspires more fear and desperation in a society than a financial upheaval. Such elements on a mass scale allow changes in our collective psychology that were never possible before. Most people tend to falter under such an overwhelming threat and turn towards any authority (or fake authority) to save them from harm. Some people scoff at this idea, but it is likely they have never actually been in the wake of a real national catastrophe before. Men, especially those who know little of themselves, can change quickly in the face of calamity. The Elites recognize this, engineer tragedy, then waltz into the aftermath to merrily lord over the rubble.

Will their plan work? I think not, but I’m an optimist (no, really). The pursuit of total control and total power seems rather infantile to me, be it on an impressively psychotic level. Although, if we are made to forget who the real enemy is, then I think they do have a chance at success. That is how they have remained successful to this point. Only now does the average man have such immense knowledge at his fingertips, the knowledge to bring down a line despots and tyrants that have reigned for centuries. If only the average man was not so easily deterred by WMD’s (Weapons of Mass Distraction). The Elites will likely ignite some wars, tempt us into in-fighting, and fabricate enemies like Al Qaeda out of the ether. As the slogan goes, “Order Out Of Chaos”. Whatever happens, our eyes must remain fixed on the root of the problem; the bankers, and nothing else.

Globalists are not invincible, they are not untouchable, they are not even all that brilliant. They are human, and they have made many mistakes. The engineering of an economic meltdown really changes nothing. Hired thugs, useful idiots, corrupt officials, even hyperinflation, all tiny obstacles when considering the world we could have if the Elites were finally made to face the reckoning they deserve. Americans once took on the greatest empire on Earth. We once took a feared king to task. Are a bunch of frothing corporate bankers really so daunting? All that is needed is a principled movement with the will to see justice done, and I believe we have that already.

You can contact Giordano Bruno at: giordano@neithercorp.us

Commentary courtesy of www.fmxconnect.com

Gold is following Monday’s buying through this morning and is up 2-3 dollars after yesterday’s solid gain of over $9.00. Stocks and the rest of commodity complex are broadly higher so far today.  The USDX is weaker as well. Soros made some comments that investors should buy gold  and Goldman Sachs made a buy recommendation last week. The market has behaved strongly since that recommendation, despite the concerns that GS may be creating an exit strategy for itself and/or some clients. But that would be the point wouldn’t it? I mean who takes the cover of Barron’s touting a stock he hasn’t already bought, right? The question remains, is there enough interest and discretionary capital left to spur another buying spree?

So as a trader, lean into the move or surf the wave, your call.

Technical Look

One of the few technical tools I use on the options side are Bollinger bands. I use Bollinger bands to indicate whether to hedge Gamma systematically (take profits aggressively), or to let the Gamma run ( ride the trend). Right now, the daily bands  are saying stay long and the weekly bands are saying do nothing.  So for the moment we are long with wide trailing stops to get out.

BBands say go with the trend- Stochs say don’t be shy about taking profits

When the weekly bands widen, then we will pick a more aggressive direction. Weekly BBand widening offer tremendous risk reward scenarios as volatility breakouts have much less noise in their signals then do flat price moves.

-Elizabeth Thawne

Via Pension Pulse.

Quarterly filings were released on Monday and all eyes are on star hedge fund managers. The WSJ reports, Paulson Adds Goldman Sachs, Other Financial Stakes:

Hedge fund manager John Paulson continued to add to his holdings in the U.S. financial services industry with new stakes in Goldman Sachs Group Inc. (GS), mortgage insurer PMI Group Inc. (PMI) and regional bank Popular Inc. (BPOP).

 

Paulson, who runs Paulson & Co., reported in a quarterly filing with the Securities and Exchange Commission that he added a new position with 30 million Bank of America Corp. (BAC) warrants, increased his holdings in common stock of Wells Fargo & Co. (WFC) by 4.5 million shares to 17.5 million, and raised his holdings in Hartford Financial Services Group Inc. (HIG) by more than 31 million shares to 44 million.

 

But Paulson reported reducing its stake in CIT Group Inc. (CIT) by just over one million shares, to 3.3 million.

 

Paulson was among the first big hedge fund managers to build a stake in banks late last year, reversing course after winning big in betting against subprime mortgages during the financial meltdown. Last year, for example, he bought Citigroup Inc. (C) stock and continues to hold more than 500 million shares.

 

Over the last three months, Paulson bought 1.1 million Goldman Sachs shares, more than 66 million shares in Puerto Rico bank Popular, and 5 million shares in PMI.

 

Paulson maintained his holdings in gold companies, and added a variety of sectors to his portfolio, including 5 million shares in McClatchy Co. (MNI) and 8 million shares in Strategic Hotels & Resorts Inc. (BEE). He increased his stake in large drug maker Pfizer Inc. (PFE) by 7.2 million shares, to 22.8 million, but reduced his holdings in Boston Scientific Corp. (BSX) by more than 19 million shares, to 80 million.

 

Paulson added several other companies in healthcare and technology, including stakes in inVentiv Health Inc. (VTIV), Mylan Inc. (MYL) and Odyssey Healthcare Inc. (ODSY).

But not everyone is bullish on financials. Reuters reports Lampert fund trims stakes in financials:

Billionaire hedge fund manager Edward Lampert further trimmed stakes he owned in major U.S. financial companies during the second quarter, a securities filing showed on Monday.

 

As of June 30, Lampert's ESL Investments' RBS Partners fund reduced the stakes it owned in Capital One Financial Corp, Citigroup Inc and CIT Group Inc, the filing showed, compared with holdings on March 31.

 

The filings also showed no holdings in two financial companies in which RBS previously listed stakes -- Wells Fargo & Co and student lender SLM Corp.

 

ESL tends to take concentrated positions in a few stocks and, in the first quarter, had already trimmed shares in Wells Fargo and Bank of America Corp.

 

Lampert himself is best-known for putting together retailers Sears Holdings Corp and Kmart five years ago. He remains chairman of Sears.

 

The RBS filing showed it had 3.6 million shares in CIT Group as of June 30, down from 4.5 million shares as of March 31. It had 24.6 million shares of Citigroup, down from 31 million in March. And it had 7.1 million shares of Capital One, down from 9.1 million.

 

RBS did raise its stake in Genworth Financial Inc to 9.1 million shares from 8.1 million shares, however.

 

Large investors such as Lampert are required to report their holdings of U.S.-listed securities at the end of each quarter.

 

They are not required to show short positions or holdings of other securities such as bonds and over-the-counter derivatives contracts. Investors may also exclude stocks they are trading or have moved to other funds.

 

The filing also showed lower stakes held by RBS in Sears and two other companies in which ESL is involved, AutoZone Inc and AutoNation Inc , compared with the previous quarter.

 

Recent regulatory filings show RBS distributed shares of those companies to various general and limited partners during the quarter.

In other activity, Bloomberg reports that billionaire Nelson Peltz disclosed that his hedge-fund group sold a $132 million stake in Kraft Foods Inc. that it bought earlier this year:

Trian Fund Management LP’s investment funds held no Kraft shares as of June 30, compared with 4.47 million shares on March 31, according to filings with the U.S. Securities and Exchange Commission on Friday. The New York-based hedge-fund group had owned as many as 34.6 million Kraft shares at the end of 2008.

New Zealand's Stuff reports from Reuters, Hedge funds find oil bargains:

Top hedge fund managers went bargain hunting in the oil patch in the second quarter, buying shares whose prices had fallen because of BP's Gulf of Mexico well disaster and lower oil prices.

 

Top managers including billionaire Carl Icahn, Eric Mindich and Dinakar Singh, whose stock picks are closely watched in investment circles, added energy stocks to their holdings as billions of gallons of oil gushed into the Gulf, according to quarterly securities reports filed on Monday.

 

Others buying energy shares included David Einhorn, former Fidelity Investments star Jeff Vinik and the US$22 billion ($31 billlion) Boston-based fund Adage Capital.

 

Fund managers must say what US listed equities they owned within 45 days after the quarter ends.

 

While energy stocks ranked among the worst performers during a quarter that also featured a still unexplained flash-crash and fresh fears that the US economy would recover more slowly, hedge fund managers staked out the sector much like they had with financial firms earlier in the year.

 

After building his energy holdings slowly at the beginning of the year, Icahn picked up the pace in April, May and June by committing nearly US$1 billion to the sector after the Deepwater Horizon drilling platform at BP's Macondo well exploded and sank in the Gulf of Mexico.

 

The purchases included 2 million shares of oil and gas producer Anadarko Petroleum and 240,000 shares of offshore drilling specialist Ensco PLC's sponsored American Depository Receipts, according to documents submitted to the Securities and Exchange Commission on Monday.

 

Icahn also added 2.4 million shares of NRG Energy, a big power utility.

 

Dinakar Singh's hedge fund TPG-Axon bought 1.4 million shares of Anadarko, while adding 2.1 million shares of drilling services specialist Baker Hughes and 3.5 million shares of Halliburton, another major oil services player.

 

Mindich, whose skills at Goldman Sachs helped him raise a record US$3 billion when he started his fund in 2004, bought 1.3 million shares of BP and call options to buy 1 million more.

 

Mindich's US$13 billion Eton Park Capital also bought 168,000 shares of Baker Hughes, 165,000 shares of Diamond Offshore Drilling, 300,000 shares of Forest Oil, 256,000 shares of Marathon Oil, 420,000 shares of Plains Exploration & Production and 237,000 shares of Suncor Energy.

 

Vinik added 3.1 million shares of Exxon Mobil, 11,000 shares of Ensco and 2 million shares of the Oil Services HOLDRS Trust, which owns a basket of 15 stocks in the sector.

 

Einhorn's Greenlight Capital bought 7.4 million shares of Ensco, just over 5 percent of the company's shares. Ensco "was not involved in the horrible accident, which should not materially impact the company's long-term potential," Einhorn wrote in a letter to his investors last month.

 

Adage, run by former managers from Harvard University's endowment, owned 3.4 million shares of BP at the end of the quarter, up from 124,000 three months earlier. The firm added to existing positions in Anadarko, Ensco and Halliburton.

 

The bets mark a dramatic change in their portfolios, coming as many other investors pulled their money out. BP's stock price fell over weeks until its value had fallen by half.

 

Even prominent mutual fund manager Fidelity Investments, where millions of Americans hold their college savings and retirement accounts, appears to have joined the trend.

 

Fidelity managers added 24.2 million shares of Exxon, leaving it with 74.9 million shares, making it the fifth biggest holding for Fidelity. It also added 10.9 million shares of BP.

 

The forms managers filed on Monday include only US-listed equity securities and related derivatives. Bonds, other securities and short positions are typically not disclosed. Managers may also omit US-listed equities under certain circumstances or file some holdings on confidential filings.

Earlier this month, FINalternatives reported that hedge funds opened the first half with modest gains, but some of the industry’s biggest players did substantially better:

Citadel Investment Group’s flagship hedge funds roared back into the black in July. The Kensington and Wellington funds each rose about 4% on the month, Dow Jones Newswires reports. The funds are now up about 1% on the year.

 

Kenneth Griffin wasn’t the only hedge fund mogul smiling in July. Lone Pine Capital added 5.5% on the month and is up 2% on the year, while SAC Capital Advisors’ flagship added 3.7% last month, Reuters reports.

 

Bridgewater Associates’ eponymous fund rose 3.5% in July to bring its year-to-date return to nearly 20%, according to The Wall Street Journal. Ellington Management’s mortgage funds rose 2% in July and are up about 11% on the year. Och-Ziff Capital Management’s flagship added 1.46%.

 

The (somewhat) rising tide even lifted one perennially-battered boat: Clarium Capital Management, which had been down as much as 10% this year, rose 5% in July, one month after it decided to shut down its New York office and relocate back to the San Francisco Bay Area. And Harbinger Capital Partners, whose flagship dropped nearly 11% in the first two weeks of last month, saw its newly-launched Credit Distressed Blue Line Fund edge up 0.5% on the month.

 

Of course, where there are winners, there are losers. RAB Capital’s flagship Special Situations Fund hit a serious bump in its road to recovery, plummeting 12.1% in July to leave it down 8.2% on the year. D.E. Shaw Group’s flagship dropped 2.7% on the month, while Brevan Howard Asset Management fell 2.3%.

Finally, FINalternatives also reported that Goldman added Millennium, Citadel High Frequency Trader:

You can learn more on "high frequency trading" and how it distorts market prices and volume by reading this article and especially by reading Zero Hedge's excellent comments on high-frequency trading (they were the first to cover this activity in detail). Alpha is a tough business and the top hedge funds are always looking for an "edge" to compete with each other.

I track hedge funds' quarterly filings very closely and pay particular attention to small and mid cap holdings. But I'm also cognizant that these big hedge funds can churn their portfolios many times in quarter, and if you're not careful, you can be left holding the bag.

Eton Park, the hedge fund founded and ran by Goldman's youngest partner, Eric Mindich, has just joined Paulson and Soros in making GLD his largest common stock position at $800 million (in addition to owning calls and puts on GLD for another $1.1 billion in gross notional). The fund also owns puts for almost $900 million gross in the MSCI Emerging Markets index, but without having any detail on the strike and duration, this position could be equivalent to a net notional of anything (not to mention possible arbs with non-disclosable CDS and other OTC products). Either way, as Eton Park had no GLD common holdings at March 31, it is now clear where a substantial buying interest in the ETF came from in Q2.

Elsewhere, Soros posted an update on his own holdings, which dropped by over 40%, from $8.8 billion to $5.1 billion, signifying the Hungarian manager may be getting more bearish on the economy. Further confirming his departure from stocks, aside from his top GLD position at 5.2 million shares, Soros' other key top 10 positions were convertible bond positions in Linear (3.125% 2027), Lawson (2.5% 2012), Flextronics (1% 2010), RF Micro (0.75% 2012), Epicor (2.375% 2027), RF Micro (1% 2014), Diodes (2.25% 2026), Cadence (1.375% 2011), Blackboard (1.5% 2027), JDS (1% 2026), and Ceradyne (2035), in order of size.

The problem is that now that most funds have blown their easy money on accumulating GLD stakes, any incremental purchases in GLD will likely not be as easy on the margin. And with some of the biggest hedge funds in the world having made GLD their top position, and the likelihood that at least some of them have made wrong bets in their other holdings, a potential drop in the market, which could incite a flash round of margin calls, will likely see liquidations in GLD which is now liquidity of first resort for many of the top 10 worldwide hedge funds. This indeed foots with Goldman's recent upgrade on gold (PT of $1,300), which we took very skeptically. Our concern was subsequently validated by Robbin Griffiths in the following King World News interview:

Eric King:  "I wanted to ask you about gold Robbin. I know you believe that this is a secular bull market in gold.  At the same time Goldman Sachs put out a bullish report as reported by ZeroHedge and from a contrarian perspective they were looking at that as quite negative.  I wanted to get your comments on that."

Robbin Griffiths:  "Yeah I'm absolutely with them, that's a contra-indicator.  I'm personally out of my gold at the moment.  I do think that the ten year secular uptrend is still in place and it will eventually go to at least two and a half thousand, probably more than that.  That's simply the old all-time high adjusted for inflation...And I just think it's one of the assets that people have profits on, so as the equities melt down, people realize they need cash, they will sell whatever they've got profits on and that will include gold."

We see gold going much higher in the long run. That's strategy. The tactics, however, may not be quite as simplistic as there are far too many variables suddenly involved to make a smooth prediction on how one gets from point A to point B. To quote Art Cashin: stay nimble.

John Paulson who has recently not had much P&L success in his bullish bet on the economy, released his 13-F for Q2. It appears JP went hog wild adding to existing and new positions in Q2, increasing total positions outstanding from 60 to 78. During the quarter, in addition to adding billions to existing positions (most notably increasing his Hartford position by 31.3 million share to 44 million for a total value of $973 million at June 30, making this a top 5 position, below Anglogold and above Comcast), Paulson added 19 new positions worth $2.4 billion, particularly in Exxon, for 9.2 million shares, or over half a billion as of 6/30, 7 million shares of Sybase, 10 million shares of Mariner Energy, 43.7 million shares in American Capital, 66.7 million shares in Popular, and, lo and behold, a 1.1 million share position in former darling, and CDO portfolio creator extraordinaire, Goldman Sachs (as well as a bunch of other positions). In the meantime, Paulson divested of his positions in XTO, 3 Com and First Midwest. Yet of the top positions in Paulson's portfolio, which tonie to be GLD, Bank of America, and Citigroup, the manager has seen a substantial drop in value, with BofA declining by over a dollar per share between June 30 and currently, and Citi dropping by $0.50, resulting in a loss of $400 million in just these two names in the period since the 13F. Add a $3 drop in GLD, and the top three positions alone have caused a half a billion loss in Paulson's portfolio since June 30. 

Full portfolio breakdown below (green shading indicates new positions).

A look at the key economic events in the relatively quiet week ahead from the perspective (and benchmarks) of Goldman Sachs.

Week Ahead

European developments As mentioned, the better than expected 2Q Eurozone GDP numbers on Friday failed to lift EUR/$, which ended the week 4% lower. As highlighted in Friday’s Daily, we do see near term risks for the EUR--one of the reasons we incorporated downside risks to our EUR/$ forecast (1.22 in 3-months), to reflect the potential for rising political tension again. We are again seeing some noise on this front in recent days with the EUR being weighed upon with news headlines such as possible Spanish deviation from fiscal austerity measures. It is interesting also to note that sovereign CDS spreads in the European periphery have also started to creep back up. This is something that we will be paying close attention to in coming weeks and months.

US manufacturing data This week’s Empire, Philly Fed, industrial production and advanced GLI reading are important as usual in gauging the pace of slowing industrial momentum in the US. Consensus expects a slight improvement in both the Empire and Philly Fed readings. We do not forecast the Empire survey, but on the more representative Philly Fed (which is also a component of our GLI), we are expecting a decline.

TICs We get the June TIC s release which will allow us to gauge the latest US Q2 BBoP picture. The US trade deficit has been widening out, especially stark in last week’s June release, which widened out to almost $50bn from $42bn. We’ll see what the upcoming TICs release shows but overall, the underlying flows picture is likely to remain USD negative still.

Central Banks We’ll see some central bank news in the form of the RBA and BOE minutes as well as meetings in Turkey and Mexico. We expect the RBA minutes to make it clearer that the Board is in no rush to move rates higher (even if a subtle tightening bias remains). Our Australian economists continue to expect rates on hold till November. For the BOE MPC minutes, we are not expecting much incremental information, coming right after the last Inflation Report. For the meetings in Turkey and Mexico, we are expecting rates to be left unchanged, in-line with consensus.

Monday 16th

Japan 2Q GDP We expect 2Q GDP data to show that the growth underpinned by government stimulus is losing momentum. We forecast a slowdown in real GDP growth to a sequential, annualized rate of +2.1% in 2Q from +5.0% in 1Q, with notable weakness concentrated in personal consumption. [this has just come out at a very disappointing annualized 0.4%, which can only mean the night shift at Liberty 33 is working overtime]

Eurozone CPI (Jul) The flash estimate put the headline inflation rate in the Euro-zone at 1.7% in July after 1.4% in June. There are few details on core inflation, but in Germany it continued to ease, and given that this is the strongest-performing Euro-zone economy at the moment, resource underutilization in the remaining member states is likely even higher, suggesting further easing of core inflation in those countries as well.

Empire Manufacturing (Aug) Consensus expects an improvement here to +8.25 from +5.1.

TIC data (Jun) This will allow us to gauge the latest US Q2 BBoP picture. The underlying flows picture is likely to paint a picture that is fundamentally unsupportive for the USD outlook still.

Tuesday 17th

RBA minutes In our view, the statement accompanying the last decision suggested that the Board spent little time seriously contemplating a decision to move rates in either direction in August - reinforcing our forecast that rates are firmly on hold until November. We expect that they will make it clearer that they are in no rush to move rates higher (even if a subtle tightening bias remains).

UK CPI (Jul) A small drop in petrol prices is likely to have depressed the headline inflation rate a little further to 3.1% yoy after 3.2% in June, we are in line with consensus.

US housing starts (Jul) We are expecting a bounce to +4%mom after last month’s -5% decline. Consensus is at +2%.

US PPI (Jul) We are expecting core PPI at +0.2% mom vs consensus at +0.1%

US Industrial production (Jul) We are forecasting a +0.6% mom gain versus consensus at +0.5%.

Wednesday 18th

UK MPC Minutes The minutes in mid-quarter months are usually pretty uninformative, coming just a week after the much more exhaustive analysis in the Inflation Report. The August Report referred to “particularly large” degree of uncertainty about inflation but we doubt there'll have been any change in the voting pattern, except for one more (from new member Martin Weale) in favour of unchanged interest rates.

Thursday 19th

UK retail sales (Jul) Our forecast assumes unchanged nominal growth of 3%yoy, implying a monthly rise in volume terms of +0.5%; consensus is at+0.2%.

US jobless claims Consensus is expecting a slight moderation to 480k in initial claims, after last week’s higher than expected 485k.

Philly Fed (Aug) We are expecting a decline to +3.0 from +5.1 previously. Consensus is expecting a gain to +7.5

Advanced GLI reading We continue to stay focused on our proprietary leading indicator of global industrial cycle momentum. The last read suggests that momentum has turned slightly negative and it will be critical to see if this trend continues.

Friday 20th

Turkey central bank meeting No change in rates expected, in-line with consensus.

Canada CPI (Jul) Consensus expects a +0.1% mom gain from -0.1% previously.

Mexico central bank meeting We are expecting no change to rates at 4.5%, in-line with consensus

From The Daily Capitalist

Until I began to examine the Dodd-Frank financial overhaul bill I had no idea that it would so significantly change the direction of the United States. It's scope is so vast and pervasive that it is difficult to grasp its totality. I wrote this article to try to explain this and why I believe it is so important for us to understand it. Because of its complexity it was not possible to do this briefly, so I wrote this major "white paper" and divided it into four parts to make it easier to digest. Please stick with me for the next few days; your eyes will be opened.

Part 3

We continue to look at the Act's provisions.

Regulation of Derivatives and ABS

Recall that one of the major themes behind the Act is that the “murky” world of “exotic” instruments such as credit default swaps and asset backed securities (ABS) added unacceptable risk to the financial system. The goal of the Act is to provide “transparency” and “accountability” for those engaged in such instruments.

The SEC and Commodity Futures Trading Commission (CFTC) will regulate derivative markets. The CFTC is involved because they regulate the futures and options markets which are included within definition of “derivatives.”

The new rules:

• Require securitizers of ABS to maintain 5% of the credit risk in assets transferred, sold, or conveyed through the issuance of ABS ... The new rules must allocate the risk retention obligation between securitizers and originators. The retained risk may not be hedged. [The “skin in the game” rule.]
• Banks must spin off "riskier" swaps dealing activities but can still conduct such activities through separately capitalized affiliates.
• All standardized swaps must be cleared and exchange-traded.
• End users [i.e., those who use derivatives for actual commercial hedging purposes] are exempt from the clearing requirement ...
• The banking regulators, the SEC and the CFTC, will set margin and capital requirements for uncleared swaps.
• Security-based swap dealers and major security-based swap participants will be required to comply with SEC-prescribed business conduct standards. … [They] will have a duty to communicate with counterparties in a fair and balanced manner based on principles of fair dealing and good faith and other standards and requirements prescribed by the SEC. [If you read The Big Short, you might say that this is the “Goldman Sachs Rule.”]
• It imposes new liability on securitizers for the underlying mortgages originated by third parties.

The Wall Street Journal ran an article exploring the world of farmers and futures contracts. Farmers rely on forward contracts to hedge their risks. What was interesting is the conclusion of the article: “There is no real understanding if the Act will exempt, say farmers who use futures as a hedge, or make it more difficult for them to hedge.”

Office of Credit Ratings

To regulate credit rating agencies, a new Office of Credit Ratings is established. The most significant outcome of the Act is that investors are allowed to sue the rating agencies. They are now treated like other “experts” such as lawyers and accountants and are subject to the same liabilities.

There are basically only three credit rating agencies, Standard & Poor’s, Moody’s Investor Service, and Fitch Ratings. They are referred to as Nationally Recognized Statistical Rating Organizations (NRSROs) under the Act. These private companies are sanctioned by the SEC and the Treasury to give credit ratings. A kind of monopoly if you will. Basically you can’t sell a security to the public without a rating from one of these companies.

When the rating agencies figured out what the legislation was doing to them, they promptly notified their clients that they couldn’t use their ratings in ABS securities registrations. That apparently put a halt to the ABS market and caused Ford to pull a pending offering. This caused the SEC to postpone the rules for six months until they figure out what to do.

This rule is actually a good thing in my opinion within the current regulatory structure. The failures of the rating agencies were part of the problem with the mortgage backed securities market. It is apparent that it wasn’t just that they didn’t understand the risk involved, rather they ignored it. If a lawyer gave an opinion that caused investors to lose money because of the lawyer’s negligence, the lawyer gets sued. Why not the rating agencies?

Office of Investor Advocate

A new Office of Investor Advocate is set up within SEC; plus there is an Investor Advisory Committee.

There are a number of provisions promoting “corporate democracy” such as allowing shareholders to nominated directors, to vote a non-binding resolution on executive pay and retirement packages, and establishes new rules governing corporate compensation committees. One of the aims of the legislation was to discourage corporations from paying “excessive” compensation to their executives, in the belief that it encouraged short-term thinking while sacrificing long-term stability.

The most significant rule is that the SEC is granted discretionary rule making authority to establish new standards of conduct for broker-dealers and investment advisers when providing personalized investment advice to retail customers. The concept is that the broker must act in the ”best interest of the customer without regard to the financial or other interest of the broker-dealer or investment adviser providing the advice.” This gets close to making broker-dealers act in a fiduciary capacity to its retail customers.

Bureau of Consumer Financial Protection

A new agency, the Bureau of Consumer Financial Protection, has the task of regulating consumer financial products such as, checking accounts, private student loans and mortgages. The agency will have the authority to "deal with unfair, abusive and deceptive practices.”

The new bureau will set standards for credit cards. Certain penalties are eliminated, reducing bank profits, which will raise costs for consumers in other areas. This has nothing to do with the bust, but rather is an exercise of power by the Democratic majority to impose politically popular “consumer friendly” rules that limit penalties that upset credit card users and borrowers.

New mortgage lending rules are established: prepayment penalties are limited, banks must lend on the basis of the borrower’s ability to repay, borrowers must submit more data showing they have the ability to pay, loan brokers and loan officers can’t be compensated for steering customers to a particular type of loan or rate, and new appraisal regulations establish rules on appraiser compensation.

A new Office of Housing Counseling is established within HUD. This new agency is described as follows:

The [Office] establishes rules necessary for counseling procedures, contributing to the distribution of home buying information booklets, carrying out functions regarding abusive lending practices relating to residential mortgages, providing for operation of the advisory committee, collaborating with community-based organizations with expertise in the field of housing counseling and providing for the building capacity to provide housing counseling services in areas that lack sufficient services

The creation of this agency is not encouraging. It is yet another wasteful bureaucracy within a vast federal structure.

The Act increases the requirement to qualify as an "accredited investor," the kind of investor one must have to avoid SEC registration for private placements. Accredited investors must now have a $1 million net worth excluding the value of their primary residence, whereas the old rule was simply a $1 million net worth.

Federal Insurance Office

This is new. Generally insurance companies are regulated by the states. The reason many insurance companies incorporate separate entities in each state is to avoid federal regulation. But, while most regulation is still relegated to the states, a new Federal Insurance Office can step in and take over a company if it threatens “financial stability”:

The Act creates the Federal Insurance Office (FIO), the primary task of which will be to monitor insurance issues of national importance and give reports to the Secretary of the Treasury and Congress on such issues. The FIO also will advise the Secretary on major domestic and international insurance issues. …

 

The Act gives the FIO the authority to supervise … an insurance company, if material financial distress at the company or the activities of the company could pose a threat to the financial stability of the United States. An insurance company subject to the FIO’s supervision will be required to meet certain “prudential standards” concerning its operation. The prudential standards will be more stringent than those applicable to other nonbank financial companies that do not present similar risks to the nation’s financial stability.

 

The Act provides for the orderly liquidation of companies under the FIO’s supervision if it is determined that they should be put into receivership. The prudential standards concerning the operations of insurers under supervision will be in addition to, or instead of, state insurance regulations. The prudential standards may limit the ability of subject insurance companies to operate with the same level of freedom they now enjoy under the state-based regulatory regime. Overall, the states’ ability to regulate insurance companies under the FIO’s supervision may be more limited as a result of the Act.

Remember AIG? Nothing, it appears, is beyond the reach of federal control. Like other powers granted by the Act, the new FIO can basically regulate any insurance company it finds to be a threat to financial stability.

Regulation of Investment Advisors

Formerly mildly regulated private investment advisors are now required to file a statement with the SEC describing their activities. The law applies only to those advisers with $150 million under management. Private family offices are exempt.

Hedge Fund Regulation

Large hedge funds and fund advisers ($150 million plus) must “register” with the SEC. Many large funds already register so this will only affect the smaller funds.

Extraterritoriality of the Act

This is one of the aspects of the Act that seems to be passed over by commentators, but the Act grants the regulators the power to extend control over economic activity normally beyond the jurisdiction of the federal government. Gibson Dunn explains the new extraterritorial provisions of the Act as follows:

Securities markets are increasingly global with multinational companies listing securities for trading in the United States and with trading in U.S. securities occurring in overseas markets. At the end of its most recent term, however, the Supreme Court ruled that Section 10(b) of the Securities Exchange Act prohibited fraud only in connection with the purchase or sale of securities listed for trading on a domestic, United States exchange and did not extend to securities listed abroad but traded in the United States through American Depositary Receipts. Morrison v. National Australia Bank, N.A. ___ U.S. ___, No. 08-1191 (June 24, 2010).

 

Congress added provisions to the Act which restored the authority of the SEC and of the Department of Justice. In particular, the Act amended Section 22 of the Securities Act, Section 27 of the Securities Exchange Act, and Section 214 of the Investment Advisers Act to confer U.S. court jurisdiction over violations of the three anti-fraud provisions involving (i) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors, or (ii) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.

I am sure this new authority will be tested in the courts, and perhaps the Morrison case may give us hope these vague powers will be deemed unconstitutional, but the intent of the Act is to allow no foreign refuge.

The federal government’s extraterritoriality push is part of a larger move toward supranational regulation of financial companies. Since the 2008 crash, countries have been meeting under the auspices of the Bank of International Settlements to discuss international financial stability. One of the outcomes of these efforts will be the new Basel III requirements regarding bank capital and liquidity structures. For example, the minimum Tier 1 leverage ratio for banks worldwide will be 3%.

Is Your Gold Conflict Free?

The Act condemns ‘conflict’ minerals from the Democratic Republic of the Congo, and as such the SEC will draft rules to assure a conflict free chain of custody to prove they are not from sources deemed exploitative such as local warlords. The minerals include gold which is produced by artisanal miners in certain areas. The SEC will produce a map of Congo to aid buyers.

For Part 1, see here. For Part 2, see here.

Monday, the final Part 4: a look at the consequences of the Act.
After Part 4 is published, I will post a link for a downloadable PDF version of the complete white paper.

In a surprising act of lucidity, David Kostin recently reduced his 2010 S&P target from 1,250 to 1,200. Now, the Goldman strategist has penned his own version of David Rosenberg's SIRP (Safety and Income at A Reasonable Price), by introducing two strategies for a low GDP environment: Low Operating Leverage And Dividend Growth (LOL-DG - yes, we prefer Rosenberg's acronym).Hopefully, this means that the GARP abortion is finally dead and buried.

Kostin clarifies this new recommendation, after various client meetings:

Clients were most interested in discussing our recommendation to buy stocks with low operating leverage and sell firms with high operating leverage. The weak US GDP growth forecast and specter of deflation means top-line sales increases will be hard to achieve. Firms with low operating leverage should benefit from stable margins and less risk of negative EPS revisions and should outperform companies with high operating leverage. We suggest buying a basket of 25 stocks with low operating leverage (Bloomberg ticker: <GSTHOPLO>) and selling a sector neutral basket of 25 companies with high operating leverage (Bloomberg: <GSTHOPHI>). The long/short trade has returned 1.6% since initiation at the start of the week.

The intuition behind our low vs. high operating leverage trade has two components: First, Goldman Sachs Economics forecasts US GDP will post average annual growth of 1.9% in 2011, near the low of the 51 economists surveyed by the Blue Chip Economic Forecast. Consensus growth forecast averages 2.8%. The earnings models that equity analysts use to forecast EPS estimates incorporate a GDP growth rate assumption. If consensus 2011 GDP growth (2.8%) falls towards the Goldman Sachs estimate (1.9%), then consensus sales projections will have to be slashed because GDP and sales are correlated. As a result, earnings estimates will also have to be reduced. Negative EPS revisions should be more modest for firms with low operating leverage compared with companies with high operating leverage. EPS revision differential should drive relative share price performance.

Second, profit margins have already returned to near-record levels for the overall market (2Q reached 96% of prior peak). The prospect that profit margins will continue to rise meaningfully from already elevated levels is becoming more difficult to embrace given a weak US economy will retard top-line revenue growth. Significant cost savings have been realized during the past year but incremental margin improvement will be more challenging.

Buy High Dividend Growth: Lower potential upside to the US equity market favors buying stocks offering a combination of both high initial dividend yield and strong dividend growth. Our basket of 40 S&P 500 stocks have an estimated cash-return-on-cashinvested of 3.9%, more than 200 bp higher than the equal weighted S&P 500. The stocks have a larger market cap, higher current annualized dividend yield, and faster expected dividend growth than the equal-weighted S&P 500.

Essential beach reading: Our 2Q 2010 S&P 500 Beige Book

We included verbatim excerpts from 56 company conference call transcripts in our quarterly S&P 500 Beige Book. We highlighted 5 key themes:

Theme 1: Uncertain economic outlook but Europe better-than-feared. Managements were positive on 2H outlook but tempered it with caution around the consumer. Views differ across sectors, with Industrials and Materials generally more positive and Health Care more conservative. Examples: F, MCD, NKE, KMB, JPM, MS, UNH, JNJ, ETN, FDX, GE, BA, V, XRX, FCX, OI.

Theme 2: Focus on margin improvement. Corporate margins continue to benefit from 2009 cost cuts and lean hiring. Many firms guided to flat or slightly higher sequential margins in 2H and seem to be placing a higher priority on margin levels than other performance metrics. Managements indicated that much of the previous cost cuts will remain “permanent”. sExamples: NKE, CL, COP, MHS, CMI, GE, LMT, WM, XRX.

Theme 3: Disciplined hiring practices. Corporations remained tentative in their hiring practices, waiting for stronger signs of stabilization. Many firms cited high unemployment and weak sentiment as reasons for caution. Lean payrolls may help companies protect their margins in a slowing economy. Examples: AMZN, KMB, MMM, UPS, PAYX, AKS, ETN.

Theme 4: Use of large cash balances. Corporate cash balances remain high and companies continued to pay down debt, raise dividends, and buyback stock in 2Q. The desire to expand margins and capture limited growth opportunities has curtailed investment spending. Examples: F, CAT, GE, UPS, AMZN, PEP, MMM, X.

Theme 5: Mitigated impact from currency moves. Many firms hedge their near-term FX exposure. Managers noted that a persistently strong USD could be a headwind. If the USD weakens against the Euro it could be a mild positive for profits as hedges roll off. Examples: KO, FDX, UPS, MCD, NKE.