The Pin That Pricked The Bubble

One need not look hard to find any number of articles talking about how student debt in the U.S. recently reached the $1 trillion threshold.  Regardless of what it means to our nation in general, and more specifically, the individuals who graduate with no salient marketable skills to show for their debt, it has been my opinion for quite sometime that the generally accepted annual 6% inflation modeled into virtually all future cost of higher education projections could not go on forever. As is the case in every corner of the business world I can think of, it takes disruptive innovation to bring about a real paradigm shift. It began a few years back, but it seems that we are finally on the cusp of what I believe will be the disruptive innovation that pricks the high cost of education bubble.

NY Times article: Harvard and M.I.T. Team Up to Offer Free Online Courses

 One could argue that only schools with billion dollar endowments such as Harvard, Stanford, M.I.T. and their peers have the luxury of offering free non-credit courses precisely because they have benefited in the past from the high cost of education, but that misses the point. In a digital world, where it becomes faster and easier to connect to the internet every day, "what you know" will become more important than "who you know" or where you went to school. In the end, results matter. If somebody sitting on a dirt floor in Tanzania can absorb, digest and implement an idea derived from the same course content as somebody sitting in a mahogany-lined classroom in New England, what does it mean for the local economy in Tanzania, and to the bigger picture, the world in general?

College is not for every one; never has been and never will be. I think one of the greatest shams pulled on our nation's youth has been to inculcate them with the belief that if they just go through the motions and do whatever it takes to graduate with a 4 year degree regardless of the discipline, they would be entitled to a life of privilege. Ivy League course content, offered for free, to basically anybody with an internet connection, is the death blow to this notion. In the end, the world will be better for it.

What Really Happened to the MF Global Money

Re-hypothecation on steroids.

(Business Law Currents) A legal loophole in international brokerage regulations means that few, if any, clients of MF Global are likely to get their money back. Although details of the drama are still unfolding, it appears that MF Global and some of its Wall Street counterparts have been actively and aggressively circumventing U.S. securities rules at the expense (quite literally) of their clients.
MF Global's bankruptcy revelations concerning missing client money suggest that funds were not inadvertently misplaced or gobbled up in MF’s dying hours, but were instead appropriated as part of a mass Wall St manipulation of brokerage rules that allowed for the wholesale acquisition and sale of client funds through re-hypothecation. A loophole appears to have allowed MF Global, and many others, to use its own clients’ funds to finance an enormous $6.2 billion Eurozone repo bet.
If anyone thought that you couldn’t have your cake and eat it too in the world of finance, MF Global shows how you can have your cake, eat it, eat someone else’s cake and then let your clients pick up the bill. Hard cheese for many as their dough goes missing.

Read the whole thing.

Value Destruction on Steroids

What would you think if you bought, say a Bugatti Veyron supercar at what you thought was a screaming deal of $250,000. Shortly thereafter, not only did you realize that what you thought was an exotic sports car was actually a Yugo, but that it was going to cost you an additional $850,000 just to get rid of it.

Now we know what it must have felt like to be Bank of America after they bought Countrywide Financial in 2008. But instead of talking about relative pocket change in the hundreds of thousands of dollars, add a couple of orders of magnitude and make the numbers $2.5bil and $8.5bil respectively.

BofA Agrees to $8.5 Billion Settlement, Sees Quarterly Loss

Bank of America (BAC) has confirmed it will pay $8.5B to large investors who lost money on mortgage-backed securities. The settlement is the largest in U.S. banking history and covers securities issued by Countrywide Financial, which BofA bought in 2008 for $2.5B. The bank will also record an additional $5.5B provision in Q2 2011 for representations and warranties exposure. Bank of America now expects to report a Q2 loss of $0.88-$0.93 a share, including a goodwill impairment charge of $2.6B. The investors include Pacific Investment Management, BlackRock (BLK) and the New York Fed. BofA rose 4.4% in premarket trading after news of the deal, with some estimates having put its liability at much higher than $8.5B. The deal could embolden investors to seek similar settlements with other major U.S. banks such as Wells Fargo (WFC) and JPMorgan (JPM). 

 *sigh*...

US Credit Rating Outlook Cut To Negative

Yesterday the big story was that S&P put the US government "on notice" that it risks losing its AAA credit rating unless policy makers agree on a plan by 2013 to reduce budget deficits and the national debt. I love the terminology. Anybody that's sat through a mandatory firm-wide harassment seminar will immediately recognize that when you put somebody on notice it means they've officially crossed the line of comfortable civility that should exist between adults in the workplace. The real question here is why it took so long for S&P to recognize the fact the the government crossed the line? I am of two minds on this one. On one hand they're stating the obvious, but better late than never. On the other hand, given their record of complicity and the very prominent role they played in the housing bubble debacle, why should they have any credibility at all? Nevermind that, why are they still in business?

Consuming ourselves

Bill Gross' most recent investment outlook likens our current fiscal path to the mating ritual of mantises. He has this to say:

The problem is that politicians and citizens alike have no clear vision of the costs of a seemingly perpetual trillion dollar annual deficit. As long as the stock market pulsates upward and job growth continues, there is an abiding conviction that all is well and that “old normal” norms have returned. Not likely. There will be pain aplenty and it’s imperative that we recognize now what the ultimate cost of blueberries will mean for American citizens of tomorrow. Four major factors come to mind:

1. American wages will lag behind CPI and commodity price gains.
2. Dollar depreciation will sap the purchasing power of consumers, as well as the global valuation of dollar denominated assets.
3. One of the consequences of perpetual trillion dollar deficits is the need to finance them, and at attractively low interest rates for as long as possible.
4. Trillion dollar annual deficits add up, and eventually produce a stock of debt that can become unmanageable: witness Greece, Ireland, or a host of Latin American countries of generations past.

Read the whole thing.

Is $250,000 really rich?

 Who knows where the number came from, but whenever the subject of extending the Bush tax cuts comes up, the line between the haves and the have-nots seems to be $250,000. If you make more than $250,000 you can afford more taxes is what many politicians on the left apparently believe. Fortunately, President Obama caved to GOP pressure and went along with the tax-cut extension by saying something along the lines of, "when you're in hostage negotiations, it's best to not harm the hostage. In this case the hostage was the American people." Silly illustrations aside, I think he did right by extending the tax cuts to all tax-paying citizens. As a recent Economist article pointed out, Federal Government spending is 24% of GDP and tax receipts are 15% of GDP this year. If you raise taxes on  those who make more than $250,000 a year and raise capital gains by 5% to 20%, the extra tax revenue will only cover the deficit for 9 days.When it is put in that perspective, one is left with the feeling that $250,000 is an arbitrary number pulled out of thin air; and those that argue people making more than that are "rich" are promoting class warfare whether they realize it or not.

The following article, "Down and out on $250,000 a year"does an excellent job revealing what a family of four making the magical $250,000 really has left at the end of the year. To control for geographical cost and local tax rate differences, the article models 5 different cities across the nation: Huntington, NY, Plano, TX, Pinecrest, FL, Naperville, IL and Glendale, CA.

The results are shocking, but not surprising.

How to Make the Dollar Sound Again

Here's a must read from James Grant, one of the more intelligent and dead-pan humorous guys on the street in my opinion.

In Gold We Trust

A realistic alternative to QE 2

The results of the most recent and much anticipated Fed meeting are out. The Fed is going to purchase $600bil in bonds through June 2011 to help stimulate the economy by flattening out the middle of the yield curve. The hoped for stimulus resulting from this move will be lower mortgage and interest rates which will theoretically make it easier for small businesses to get loans for expansion and eager home buyers to get a piece of the American Dream. Not sure how that will help stimulate employment though. From my vantage point, it doesn't matter how low mortgage rates go if nobody will refinance or lend to you without a job. And with few exceptions, I'll wager not many small businesses are eager to expand in the current political climate. From a saver's point of view, with money market rates already well below 1%,  it's not like anybody is going to go out and buy a Chevy Volt off their earned interest. It's hard not to conclude that if the Fed continues down this path they are going to lose credibility in the not too distant future; at which point, "...backed by the full faith and credit of The United States of America"--the phrase that underpins our debtor nation--will be worth less than a wooden nickel.

QE 2: not just another giant ocean liner

I remember several years ago, before they decided to dismantle her in Dubai, when the Queen Elizabeth II arrived in San Francisco to much fan fare. People lined the bay all the way from the Golden Gate Bridge to her berth over by Pier 29. I happened to be crossing the Bay Bridge after she had berthed and caught a glimpse of her transom. It was massive. It almost dwarfed the impressive west-looking view of the San Francisco skyline. But that was the old QE 2. The new QE 2, even bigger and more impressive than the last, was christened in Southampton earlier this month. Ironically, this is happening at the same time that the markets are widely speculating that the Fed will announce the details of its own version of QE 2 at the conclusion of their meeting on 3-NOV. 

Top 10 Things I Hate Most About Trading

On a lighter note, but with a heaping teaspoon of truthiness...
Courtesy of The Dopey Cowboy

DARK POOLS are the one thing that keeps me up scratching my head at night. Regulators in all their genius, decided that your every day Joe Schmo investor was being treated unfairly and needed more market transparency.  So what did we do?  We created “dark pools” of super secret hidden liquidity. So much for transparency and disclosure.

VWAPS also helped to destroy the industry.  Market data that started out as a way to analyze daily stock activity has become a way of life.  How pathetic. Being average has now become the bogie.  There went all the creativity and differentiation amongst market makers, sell-side and buy-side traders.  It’s no longer about getting the best price for your customers or not impacting the tape.  It’s about being within a penny or two from the VWAP.

ALGOS- Screw them too. If I had my way, they’d be plucked off everybody’s desk like chickens. Stretch this! We are traders – not monkeys. We are supposed to prove how good we can trade based on information, levels, conviction and “feel”.  It's not trading when you throw your order in some algo and watch the micro-reports come back.

Flash Crash

Last Friday the SEC released the much anticipated report on the "Flash Crash" that occurred 6-MAY-2010 when the Dow sold off 700 points in a matter of minutes then recouped much of the losses almost as quickly to close down 347 for the day. The report found that a single market sell order of 75,000 SPX e-Mini futures contracts with a notional value of $4.1bil caused the sell off. To put that in perspective, 1 e-mini contract is equal to 500 SPY shares. That's the equivalent of sending 37,500,000 SPY to sell at the mkt with absolutely no regard to price. One can't blame the market for treating a mkt order like a mkt order. That's about 1/6th of the avg daily volume for the SPY. Although not officially named in the report, it has been revealed that a trader at the firm Waddell & Reed Financial in Kansas was responsible for the order. That's not exactly "adding alpha" to performance, which is the end goal of every trader.  

How sausage is made

I recently returned from a three day trip to Washington D.C. where I attended the annual Security Traders Assoc. conference and met with a few of our elected officials as a representative from the board of the San Francisco affiliate of the STA. Generally the convention is in a more exotic location, but this year since Wall St. is everybody's favorite punching bag and with so much pending legislation that will fundamentally alter US equity markets, the organizers thought it would be prudent to really focus on the political end of our existence.

Geithner: unemployment could rise

WASHINGTON (Reuters) - Treasury Secretary Timothy Geithner said the U.S. unemployment rate could rise for two months before it drops, potentially deepening Democrats' problems in the November congressional elections.
"It's possible you're going to have a couple of months where it goes up," Geithner said on ABC's "Good Morning America" interview broadcast on Tuesday and taped a day earlier.
"But what we expect to see ... is an economy that's gradually healing. Of course we want to do what we can to reinforce that process because it's not growing back as quickly as we'd like."

I wish it would rise by one person, Turbo-Tax Timmy to be exact. Everything he says is preempted in my mind by the words "tax cheat." It has the effect of discounting everything else he has to say, even if he has a point. That's not an admirable trait in a Treasury Secretary of the United States.

Keeping track of the TARP

TARP COP: Get tough on banks

The top cop tracking the $700 billion bailout program said Monday that he's concerned federal officials are ignoring his proposals for preventing tax dollars from being wasted or pilfered.

Neil Barofsky, the special inspector general overseeing the Troubled Asset Relief Program, released a 260-page report detailing a long list of concerns about government efforts to prop up hundreds of banks, Wall Street firms and auto companies.

It's like deja vu all over again

It's great to see that Wall St. has gotten over the Great Hiccup of 2008 and it's back to business as usual:

Morgan Stanley Plans to Turn Downgraded Loan CDO Into AAA Bonds

July 8 (Bloomberg) -- Morgan Stanley plans to repackage a downgraded collateralized debt obligation backed by leveraged loans into new securities with AAA ratings in the first transaction of its kind, said two people familiar with the sale.

Morgan Stanley is selling $87.1 million of securities that it expects to receive top AAA ratings and $42.9 million of notes graded Baa2, the second-lowest investment grade by Moody’s Investors Service, according to marketing documents obtained by Bloomberg News. The bonds were created from Greywolf CLO I Ltd., a CDO arranged in January 2007 by Goldman Sachs Group Inc. and managed by Greywolf Capital Management LP, an investment firm based in Purchase, New York.

Testing the waters

One of my current concerns as I voiced in a previous post is that the Obama administration may try to take over the Federal Reserve by using the strong arm of a Democratic Congress. Looks like they may be testing the waters:

Bloomberg article: Fed Said to Retreat From Seeking Power to Sell Its Own Bills

At the House Budget hearing, a lawmaker brought up the idea of making Fed district-bank presidents subject to Senate confirmation. Currently the presidents are nominated by the banks’ boards of directors and approved by the U.S.-appointed Fed governors in Washington.

It's official: Congress and the SEC are insane

Insanity has been defined as the repetition of the same task with the expectation of a different result. If that's the case, then the SEC and Congress offer a text book example:

US Lawmakers Push Short-Selling Changes Following Report

A bipartisan group of U.S. senators said the SEC needs to consider new restrictions to help quell naked short selling, including a possible requirement that short sellers borrow shares before they try and sell a stock short. Naked short selling occurs when a trader sells shares that are not actually in their possession, potentially creating downward pressure on the price of shares.
"Unless the SEC can develop an appropriate alternative, a strict pre-borrow requirement may be the only way to adequately protect shareholders' rights," Sen. Charles Grassley, R-Iowa said in a joint release with Sen. Carl Leving, D- Mich., and Sen. Arlen Specter, D-Penn.

Observing the weathervane

This quote summarizes this week’s sentiment rather succinctly: "There will likely be a growing steady recognition that in trying to prevent a Depression, the transfer of risk has been shifted from the private sector to the public purses and this may create a longer, more drawn out problem."

• Geithner admits overnight that the US credit rating is in jeopardy in light of our heavy issuance
• PIMCO's Bill Gross said the U.S. will eventually lose its AAA rating
  
• Moody's did say Thursday it is comfortable with the triple-A sovereign rating on the United States, but it is not guaranteed forever
• Goldman Sachs said the hike in oil prices this week was due to real oil market fundamentals and not just hedging against a weak dollar and equity market rallies. "The oil market was shocked by disruptions in Nigeria, refinery problems in the U.S. and a strong gasoline market," Goldman said in a research note. (Not sure why they think they have any credibility. Last year when oil was at $140/bbl they were calling for $200/bbl by year end. Their prop desk was probably getting short on the call, but I digress...--Ed)
• US Treasury was getting hit hard at the end of the day yesterday as the market was getting ready for big new supply coming next week - $101B of fresh Treasuries to be auctioned
• WAPO reported that the Obama administration is preparing to send GM into bankruptcy as early as the end of next week under a plan that would give the auto maker tens of billions of dollars more in public financing
• Mastercard will lose more than half of a $59B portfolio of debit-card users after JPMorgan Chase & Co. decided to shift more business to Visa
  
• The FDIC seized BKUNA, the 34th bank failure of the year, with $12.8B in assets, $8.6B in deposits and 85 branches
• AIG announced that Chairman and CEO Edward Liddy will step down and also proposed a 1-for-20 reverse stock split

I think that at some point in the not too distant future the Obama Administration, with the help of Congress, will attempt to take over the Fed. I bet the majority of Americans will see nothing wrong with that, at least the ones who have no idea (and don't care to have one) what the Federal Reserve system is and why it was created in the first place.

The elephant in the room

Bruce Bartlett at Forbes does a good job of quantifying exactly what it would take to fully fund all of our upcoming Social Security and Medicare liabilities.

The 81% Tax Increase

Most Americans believe that the Social Security trust fund contains a pot of money that is sitting somewhere earning interest to pay their benefits when they retire. On paper this is true; somewhere in a Treasury Department ledger there are $2.4 trillion worth of assets labeled "Social Security trust fund."

The problem is that by law 100% of these "assets" are invested in Treasury securities. Therefore, the trust fund does not have any actual resources with which to pay Social Security benefits. It's as if you wrote an IOU to yourself; no matter how large the IOU is it doesn't increase your net worth.

Ask me no questions, I'll tell you no lies

Greenmail: Money paid by a company (or allied company or individual) to acquire its own shares of stock from a shareholder who is threatening to take control of, or unwanted influence over, the company. The term is a neologism combining the terms greenback and blackmail, invented by journalists and commentators who saw the practices of corporate raiders as a form of blackmail. The target company is financially held hostage, and is legally forced to pay the greenmailer to go away.

Jonathon Weil makes some interesting observations about a recent unsolicited payment from Goldman Sachs to the Commonwealth of Massachusetts: