Skip to comments.Have We Seen the Last of the Bear Raids?
Posted on 03/26/2009 11:13:07 PM PDT by CutePuppy
So is that it? Is the downturn over? After bouncing off of 6500, or more than half its peak value, and with Citigroup briefly breaking $1, the Dow Jones Industrial Average has rallied back more than 1200 points. So, is it safe to go back in the water? Best to figure out what went wrong first -- what I like to call a bear-raid extraordinaire.
The Dow clearly got a boost from Treasury Secretary Tim Geithner's new and improved plan, announced on Monday, to rid our banks of those nasty toxic assets. The idea is to form a "Public-Private Investment Fund" to buy up $500 billion to $1 trillion worth of bad assets -- mostly mortgage backed securities (MBSs) and collateralized debt obligations (CDOs).
While it's true that private interests can conceptually help establish the right market price for these assets, the reality is Mr. Geithner's public-private scheme won't work. Why? Because the pricing paradox remains -- private parties won't overpay, yet banks believe these assets are extremely undervalued by the market. As Edward Yingling, president of the American Bankers Association, said recently on CNBC, "You have to go into the securities, examine the securities, examine the cash flow. I've seen it done, and the market is so far below what they're really worth."
The Treasury can't just keep throwing money at the problem, but needs instead to figure out what's really been going on -- the aforementioned bear-raid extraordinaire that's crushed Citigroup and Bank of America and General Electric, among others. Only then can Mr. Geithner craft a real plan to fight back.
In a typical bear raid, traders short a target stock -- i.e., borrow shares and then sell them, hoping to cover or replace them at a cheaper price. Once short, traders then spread bad news, amplify it, even make it up if they have to, to get a stock to drop so they can cover their short.
This bear raid was different. Wall Street is short-term financed, mostly through overnight and repurchasing agreements, which was fine when banks were just doing IPOs and trading stocks. But as they began to own things for their own account (MBSs, CDOs) there emerged a huge mismatch between the duration of their holdings (10- and 30-year mortgages and the derivatives based on them) and their overnight funding. When this happens a bear can ride in, undercut a bank's short-term funding, and force it to sell a long-term holding.
Since these derivatives were so weird, if you wanted to count them as part of your reserves, regulators demanded that you buy insurance against the derivatives defaulting. And everyone did. The "default insurance" was in the form of credit default swaps (CDSs), often from AIG's now infamous Financial Products unit. Never mind that AIG never bothered reserving for potential payouts or ever had to put up collateral because of its own AAA rating. The whole exercise was stupid, akin to buying insurance from the captain of the Titanic, who put the premiums in the ship's safe and collected a tidy bonus for his efforts.
Because these derivatives were part of the banks' reserve calculations, if you could knock down their value, mark-to-market accounting would force the banks to take more write-offs and scramble for capital to replace it. Remember that Citigroup went so far as to set up off-balance-sheet vehicles to own this stuff. So Wall Street got stuck holding the hot potato making them vulnerable to a bear raid.
You can't just manipulate a $62 trillion market for derivatives. So what did the bears do? They looked and found an asymmetry to exploit in those same credit default swaps. If you bid up the price of swaps, because markets are all linked, the higher likelihood (or at least the perception based on swap prices) of derivative defaults would cause the value of these CDO derivatives to drop, thus triggering banks and financial companies to write off losses and their stocks to plummet.
General Electric CEO Jeff Immelt famously complained that "by spending 25 million bucks in a handful of transactions in an unregulated market" traders in credit default swaps could tank major companies. "I just don't think we should treat credit default swaps as like the Delphic Oracle of any kind," he continued. "It's the most easily manipulated and broadly manipulated market that there is."
Complain all you want, it worked. In early March, Citigroup hit $1 and Bank of America dropped to $3 and GE bottomed at $6.66 from $36 not much more than a year ago. Same for Lloyds Banking Group in the U.K. dropping from 400 to 40. Citi CEO Vikram Pandit recently announced that the bank was profitable in January and February. (How couldn't they be? With short-term rates close to zero, any loan could be profitable). Never mind they still had squished CDOs, it was enough to get some of the pressure off, for now.
Oddly, with the new Treasury plan, these same bear raiders are still incentivized to manipulate the price of swaps to depress toxic derivative prices, especially so with the government's help to get hedge funds to turn around and buy them. Perversely, they may get rewarded for their own shenanigans.
This week's Treasury announcement of private buyers isn't going to magically change the depressed prices of these toxic derivatives. The Treasury needs to fight fire with fire. If I were Mr. Geithner, I'd pull off a bull run -- i.e., pile into the CDS market and sell as many swaps as I could, the opposite of a bear raid. If the bears are buying, I'd be selling, using the same asymmetry against them. Sensing the deep pockets of Uncle Sam, the bears will back off. Worst case, the Fed is on the hook for defaults, which they are anyway!
With the pressure of default assumptions easing, prices of CDOs should rise, which not only gives breathing room to banks, but may actually get these derivatives to a price where banks would be willing to sell them, replacing toxic assets in their reserves with cash or short term Treasurys, which ought to stimulate lending.
So are hedge funds villains? Not especially. The bear raid probably saved us five to 10 years' of bank earning disappointments as they worked off these bad loans. Those that mismatched duration set themselves up to be clawed. Under cover of a Treasury bull run, banks should raise whatever capital they can and dump as many bad loans before the bear raiders come back. Let the bears find others to feast on, like autos, cellular, cable and California.
Andy Kessler (born 1958) was co-founder and President of Velocity Capital Management, an investment firm based in Palo Alto, California. He is an author of several books on business, technology, and the health field and has also contributed to The Wall Street Journal.
Books by Andy Kessler:
The End of Medicine: How Silicon Valley (and Naked Mice) Will Reboot Your Doctor - 2006 - 354 pages
Running money: hedge fund honchos, monster markets and my hunt for the big score - 2004 - 312 pages
How We Got Here: A Slightly Irreverent History of Technology and Markets - 2005 - 272 pages
Wall Street Meat: My Narrow Escape from the Stock Market Grinder - 2004 - 272 pages
I can’t even understand Contract Bridge.
Private public funding of hedge funds to leverage money to buy toxic assets. If economy recovers, hedge fund keeps all the profits, and if economy falters and the funds lose money, taxpayer eats the losses. Wall Street via politicians have hijacked Wash DC and made arrangements where only the taxpayers will be screwed when everything goes wrong again.
That's because they are.
The details of the asset plan make sense. Basically they are going to put the FDIC on the hook for debt written against these assets, up to 6 to 1 leverage or so. That means the "carry" on them will be huge, because debt can be issued against them at insured CD rates.
Do some vulture investors want 30 cents on the dollar when the things are really worth 60? Sure, they'd like to freely double their money. But if you can borrow most of the price, you can double your *equity* paying 50, if they are really worth 60. It is a perfectly sensible plan, and all the "it won't work" nonsense is based on the same old puritanical market-perfection belief that the lowest quotes to date are the "true value". Which is nonsense, and the banks know it is nonsense. So will the new players who take these deals. PIMCO isn't going to hold out for 30 when they can do the math and see they can double their money paying 50.
Pols are enamored with pseudo public-private “partnerships” (aka Third Way) because it’s a no-lose game for them.
Heads - they win, tails - you lose. Handy scapegoats are usually on hand, and hardly any accountability as most recent experience with GSEs (Fannie, Freddie and others) has shown.
Opening up that ability to the bond funds is a new incentive that can indeed get this stuff out of the banking system and into long term buy-and-hold hands. And the only risk the government is running in that, is one it is already running through its existing guarantees.
They simply know what they are doing, and everyone else is pretending the government can somehow get off the hook by blaming somebody else or letting somebody or other fail. They can't. Grok already, the treasury *already* owns all the downside. F. D. I. C.
Which is exactly what Citi and BoA are doing now. It's an easy way to get really profitable really fast, using leverage, and pay off TARP loans (which is in everybody's interest) if / when financial system is stabilized and bear raids or run on the bank are no longer in the picture. That would unclog the credit facilities of the banks, which have been already thawing due to lower spreads and LIBOR rates.
The spread between corporates and treasuries simply was and is the crisis. If the Fed wanted to address it directly they'd just arb that spread directly. Instead they continue to do it indirectly, wanting private actors to take the lead. That is delaying things, but sooner or later it turns.
The original losses have all been written off long since. All the big banks have been cash flow positive throughout - the "losses" are all marks and additions to loss reserves, not cash going out the door.
I will wait for the treasury market to reflect your confidence in this scheme. If the Chinese start to buy 10+ year treasuries, then they must have analyzed the toxic asset plan and came to the same conclusion that you have, it will work, thus the US will be able to back their treasuries and eventually pay their debts. On the other hand if they do not, we got problems.
Also true is that credit thaw started right after TARP liquidity injection (despite all the political theatre) and had nothing to do with latter developments or lack thereof. Market prices also had reacted to clear anti-business bias and huge deficit spending of incoming Obama administration.
All the big banks have been cash flow positive throughout - the "losses" are all marks and additions to loss reserves, not cash going out the door.
Also correct. Most people don't distinguish between cash flow, free cash flow, operating losses and non-cash goodwill / write-offs losses, especially of the "kitchen sink" variety. All they see are more scary headlines with the largest losses ever. Media (including financial media) is only too happy to amplify it without understanding or explaining any of it to the public, which erodes confidence and creates or amplifies panic. It's a negative feedback loop, which only plays into the hands of politicians who crave the crisis - to exploit for their own purposes.
The rules of bridge are easy, the most complicating factor is the partner.
Ping for later reading...
Your scenario is true if the banks are willing to sell at 50 with a true value of 60.
But what about all of the banks that have most of their toxic assets still marked around 92-95 and won't budge downwards unless it's them buying their own debt?
There are still a lot of banks carrying their commercial loans at 100.
This is why the PPIP won't work. The 84 that the FDIC uses as an "example" auction is a dream. Very few banks will touch that.
Citi and BAC are buying all of the Alt-A and ARM that they can get their hands on. They're about to game the system - at the taxpayers expense.
By anything in particular?
It's not really clear here , but if you look carefully you'll see some rallies on the long slow decline. Then imagine all the wise saying that we've hit bottom. That only has to happen a few times for a lot of people to lose every dime they've got.
Only one sentence needs to be read:
“Those that mismatched duration set themselves up to be clawed. “
We will see DOW 5,000 before we see DOW 10,000 again.
Good post as usual, but I’ve got a couple of questions.
Is there any equitable way to price these assets? As the overall economy still continues to tank, won’t these sub prime based assets continue to lose value as foreclosures and real estate deflation continue?
Is this program large enough in scope to make a difference? Most estimates I have seen put the toxic assets in the 4-5 trillion range...this program is in the 1 trillion range.
I guess my real question is this....is this a fix or just kicking the can down the road?
This was a classic short squeeze and nothing else. The insiders bought up bunches and bunches of stocks to drive the prices up, and make shorts cover. This HS designed to get you to put your money in to buy the shares these guys just marked up 12% and take them off their hands.
None of this has anything to do with reducing the horrendous debt loads that the American public is holding.
PS. Stocks are not undervalued. They have been overvalued for about 20 years.
These assetts need to be sold before the full effects of Obama’s tax and regulation policies are seen , then even the holders of these securities will be glad to get $0.30 for them when the payments stop coming in.
We don't want folks trading CDS. They shouldn't even exist.
We "little people" don't want Geitner bailing out their asses. We want them tarred and feathered and their so-called banks sown under with salt.
PS the country is still head over heals in debt, at multiples of GNP that would have made your predecessor shills in 1929 mad with envy.
This is about the funniest piece of idiocy I have read all week long.
Short sellers in the market serve a purpose. They sniff out over valued stock and help prevent bubbles from being created. Generally, it is a good thing, when done legally.
What the author fails to explore here is illegal naked shorting. Traders selling shares that don't exist and that have no intention or ability to deliver. Trades that never settle. In effect, stealing shareholder value right in plain sight.
“banks believe these assets are extremely undervalued”
......That’s because they are......
The collateral is good, the paper is bad. The solution requires separating the assets from the broke holders of the paper. The banks need to be able to eliminate the middle guy holding title and directly own the asset.
The poor must go back to renting. The property must be forclosed or title given to the Bank and the former owner becomes a renter
What the author fails to explore here is illegal naked shorting. Traders selling shares that don't exist and that have no intention or ability to deliver. Trades that never settle. In effect, stealing shareholder value right in plain sight.
Correct. Any crook would love to be able to sell a non-existent item, receive payment for it, fail to produce it, and yet go unpunished for the act. This goes on thousands of times a day on Wall Street.
A short seller doesn't get paid anything until he delivers the stock.
Technically, the trade remains open. In fact, the naked short sellers are increasing the value of their already established short positions, and so each naked short sale that helps to depress the price of the stock pays off for the crook.
Only when they finally deliver the shares.
The market way to do all that is for operators with capital to buy up all tranches cheap, paying only cents for the subordinate ones to be sure, and then do deals with the senior class to recreate the original loan portfolio. Next step, triage that portfolio, all the performers repackaged and sold. All the non-performers go to workout people who can expedite all the collateral churn side of things, where right now the banks are swamped and securitization hair gums everything up.
If there were only one lender and the pols would stop monkeying with the foreclosure laws thinking they can make it all go away by just not letting anyone at the collateral, then it'd be RTC easy. But neither is true. That being the case, it may wind up that it has to be Fannie and Freddie doing the first step of the above, with public backing. Hopefully indirectly (Fed buying their debt etc).
At last.... a reasoned, succinct analysis that I can understand describing a solution.
.....The right thing is to first recreate whole loans....
Does this mean to separate out the individual loans from the tranches? Or, does it mean that the original loan has been somehow split and needs to be reassembled?
CEOs like Jeffrey Immelt like to blame market manipulators, in another era it would have been "the Jews", but the damning truth is that he used his shareholders' money to overpay for assets and assume risk for insufficient premiums. He is blaming speculators for his mismanagement, or worse.
What really happened was that over a decade, credit was extended and risks were assumed with other people's money without any underwriting standards, creating $10 trillion or so (that's everything) of unrecognized losses. Certain events exacerbated this, such as an extra trillion when Spitzer took Greenberg off the case so that Cassano could run wild.
There is nothing wrong with an unregulated CDS market. The root of the problem is other people's money. A case in point is that Wall Street firms somehow managed to survive, or morph, for a century or so until they went public. No sooner did that happen than somehow they became dens of bad underwriting and became supplicants to the public purse.
The market was exacting its own solution until government started to meddle. Stupid government action can be played by free market actors, and that is what is happening. No outrage here.
My solution? Let nature take its course. However, post Bear Stearns, post AIG, post reason, that is not going to happen. All we can do is nip at the heels of the demagogues.
SO I'm not sure now if we've made it to the 1932 moment or if the current gyrations are more like those of 1930-1931.
Also, while I agree that it is not YET anything like the Great Depression, I fear that Obummer and Co. are doing their level best to recreate the 1930s. They certainly are bringing the same big government we're the brightest and best attitude to the problem.
Um, not according to the Goldman Sachs report that flew across my desk few days ago. Banks are not carrying their debt on their balance sheets marked at 50. None of them.
Banks could still sell their toxics assets at 50 like you describe, but they won't. That would require them to take huge write-downs that they're not willing to suffer. They'll just sit on it instead - or buy their own debt and stiff the taxpayer throught the FDIC's non-recourse loan.
How would buying their own debt "stiff the taxpayer"?
That's the standard philosophy, but in reality, the existence of so many major market bubbles has pretty much disproved it. There is another side of this coin - since logically "smart" shortselling would (and does) tend to occur near the supposed top of the market, the short squeezes actually move the market higher and create larger and longer tops than anyone expects, with more money moving from the sidelines into the market, not the other way around. You often hear short sellers warning about the "market's irrational exuberance" years before the parabolic ascent and crash occur - that's a lot of money thrown at the market just when it's most expensive to do so and when "this time it's different" euphoria just starts to set in and people throw money at the market. In other words, The market can stay irrational longer than you can stay solvent. - John Maynard Keynes.
Bears and Bulls get mauled because short selling often extends and prolongs the market (or stock's) top, and what could have resulted in reasonable and quiet deflation of the market often results in a crash that is significantly harder and destroys more of the capital than otherwise would.
Something to think about... And, no, I am not in favor of "banning" short selling, or derivatives etc. They are just useful financial tools and can be used conservatively or aggressively, without all the damage that all too often we see they can and have been used to cause. To paraphrase, "financial instruments don't destroy capital; people, who are abusing them, do". We should see to it that they cannot. The same way we do not ban aviation or car travel, but try and take measures to prevent them from being used as guided missiles or weapons of mass destruction.
Here's a scenario:
"Megabank" had $100 billion (par value) of toxic assets.
Over time, they wrote down $5 billion on those assets and they now sit on the balance sheet at $95 bllion (marked at 95).
The FDIC holds an auction for those toxic assets.
Megabank either directly (or indirectly through a third party in order to obfuscate) bids the whole $95 billion.
The FDIC guarantees a loan for 80% of the auction price - $95 billion x 80% = approx. $75 billion.
The US Treasury puts up 1/2 of the remaining equity needed - $20 billion x 50% = $10 billion.
MegaBank puts up the remaining equity that is needed - $10 billion (they might even use TARP bailout money to fund it - wouldn't that be ironic).
Now, here's where it gets interesting. Megabank KNEW going in that the toxic assets were actually only worth 50 cents on the dollar (I'm being EXTREMELY generous with that number).
Megabank faced a write-down of an additional $45 billion on their toxic assets if they were forced to price them accurately.
Instead, Megabank now has cash instead of toxic assets, and only had to put up $10 billion in equity to get it.
Megabank fully intends to let the deal go south since everything is set up as a non-recourse loan. The MOST that they stand to lose is their equity - $10 billion. So what - that's better than the $45 billion that they were staring in the face.
Meanwhile, the US Treasury (taxpayer) also loses its equity - $10 billion.
The 80% loan goes into default and the FDIC has to cover. The original loan was $75 billion. The true price of the toxic assets is $50 billion, for a $25 billion loss (taxpayer).
Therefore, between the US Treasury and the FDIC loan guarantee, the US taxpayer ends up losing $35 billion dollars on the deal.
Megabank only loses $10 billion - and maybe even less if they take out CDS contracts on the whole deal.
When you said, "their own debt", I thought you meant bonds they issued, not bad bonds they bought from someone else.
Comparing blaming "manipulators" (notice, not "speculators", which would be trite and unfair) of the market (and providing specfic examples of how it's done) is not the same as comparing themn to "Jews" (as in Merchant of Venice and Nazi Germany and other places at other times). As a matter of fact, when the mob on Capitol Hill singled out AIG people who received "bonuses" it made me think of them being used as "Jews". And when the ACORN mob started riding a bus around those AIG employees' houses, it made me think how close are we to Kristallnacht or pogroms?
Re "short selling forced writedowns quickly rather than being papered over for 5 to 10 years," I'd much prefer the latter since it would only affect and orderly deflate the value of banks (along with their assets on the books) instead of creating a major crisis and massive destruction of capital and near destruction of capitalist financial system (which may yet happen, depending on how much "change" our new government "hopes" to inflict on us)
Good comments on OPM and most governments' (not just ours) "solutions" that extend and prolong the problems that market itself would solve (with enough temporary liquidity, necessary to quell panics).
The problem with socialism is that you eventually run out of other people's money.
To cure the British disease with socialism was like trying to cure leukaemia with leeches.
- Margaret Thatcher
DemRats equivalent of the Reichstag fire.
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