The Crash Without Flash

While regulators and investors are still scratching their heads over what on earth happened May 6th that caused what is now being dubbed the "Flash Crash," the market has gone about its merry way steadily marching lower. We are now sitting within a hair of the "horrifying" lows hit on that day when markets plunged unexpectedly on extremely heavy volume, only to rip higher within minutes. Oh my God! What could've caused stocks to hit such extreme and unbelievably cheap levels? The SEC still has no idea, but they've introduced circuit breakers, so that should fix the problem. Any market crash that's going to happen on the SEC's watch is gonna take some time. Sort of like any good ponzi scheme. After all, it wouldn't have been right to catch the Madoff fraud early, better to let it snowball for a few years into a $65 billion fraud so it can ensnare everybody.

Now that equities are legitimately lower, and not the result of some fat finger or HFT trading malfunction, we have to think of an explanation. Because it's just inconceivable to think that maybe investors are bailing because the volatility scares them and a near 80% rally straight to the moon was good enough for them after 2008's drubbing. The WSJ pins the blame for the recent selloff on a highly leveraged pro-growth trade that is currently being unwound by the various hedge funds that profited it from it all year. The trade was based on the view that global economies would recover strongly and commodities and high yielding currencies and stocks would continue to rise. Hedge funds piled into the trade, which was pedaled by, you're never going to believe this, Goldman Sachs. Seems like the folks at GS really are to blame for everything.

In any event, it is expiration Friday. Everybody get their Dow 10,000 hats out AGAIN. Although it's not nearly as fun watching the computers wear them.

US Housing After the Tax Credit Expiration

The MBA has released two troubling updates on the state of the housing market. A record 14.69% of mortgage loans were either one payment delinquent or in the foreclosure process in the first quarter of 2010. As if that weren't enough to send you to the ledge, mortgage purchase applications plummeted to a 13-year low. Purchase applications fell 27% last week and have declined nearly 20% over the past month, this despite very low interest rates. Clearly the expiration of the tax credit has had a significant impact on would-be purchasers. With the administration's HAMP program stalling, somebody's going to have to come up with some more creative ways to pump up housing. The alternative? Face the inevitable economic outcome that the only way to a market clearing price is through supply and demand.

Germany to Ban Short-Selling of Stocks and Euro Government Bonds

Via FT Alphaville, Germany is banning short-selling of stocks and Euro government bonds, including CDS on bonds. How is it that the world's trusty regulators are so gosh darn predictable? See below in my last post about what European regulators might do for an encore to stem the bleeding: "They could always go after the shorts again, because that worked for like a minute in 2008." Just as I was confused (and admittedly angry) back in 2008 when governments around the world banned short-selling to resolve the completely unrelated issue of our globally insolvent banking system, I am perplexed by this action. I mean, since 2008, many of the financial institutions that we weren't allowed to short for a brief period of time eventually went bust, or were bailed out. Furthermore, the short-sale ban only hastened the stocks' plunges into the abyss. The stupid ban worked for all of a day, which just happened to be an expiration Friday, when stocks experienced unbelievable volatility, ripping through through call strikes already given up for dead by options traders that either raked it in, or experienced massive pain. And yet, once again, government manipulation of the market is being floated around as a solution by the Germans. And since all of our regulators like to coordinate their actions, even really dumb ones, I fully expect everyone to follow suit.

What's the Euro Going to Do For an Encore?

Because if a trillion dollar bailout package, plus ECB buying bonds, plus a vow to defend the currency isn't going to keep the wolf pack at bay, then they have to come up with something bigger and better over the weekend. Otherwise, it's Greek riots and mass pandemonium all over again on Monday. They could go after the shorts again, because that worked so well in 2008 for like a minute. Speaking of which, I find it interesting that nobody has tried to pin the blame on the shorts for last week's mysterious mid-day market rout (and then rally) in the US. Maybe that's because the uptick rule is back in force, and "naked shorting" has been banned, thanks to all those boobs that kept insisting that if we squeezed out the shorts, the market would never be volatile again. So now what? The only sensible step at this point, if you want to keep the market up, is to ban selling. Outright. That should do the trick.

Morgan Stanley In CDO Probe

Federal prosecutors are investigating whether Morgan Stanley misled investors about its crappy CDO deals. You're never going to believe this, but apparently MS arranged and marketed CDOs to its investors while simultaneously betting against them! I mean that sounds like something that only Goldman Sachs would do! Yet who is Morgan Stanley really? Oh that's right: a less profitable Goldmans Sachs. I've even heard that Morgan Stanley's strategy is replicating Goldman Sachs, once it actually figures out what the hell those stupid vampire squids are doing over there to make so much G-ddamned money! In any event, the probe is on.

EU Likes to Bail Out Its Bankers Too

If you were checking the headlines all day yesterday in anticipation of the news of Europe's rescue package for its banks, you too might have been amused by the escalation of the size of the rescue package. It went something like this:

• EU agrees to rescue package. Details to come (Can we get some details please?)
• How's $500 billion?
• Ok, we'll try $700 billion?
• No. No, let's do a trillion. The market should love that.

In an effort to prove that it too loves its bankers, the European Union managed to cobble together a massive bailout package comprised of 440 billion euros in loans from euro-zone governments, 60 billion euros from an EU emergency fund, and 250 billion euros from the IMF. Furthermore, the ECB is buying euro-zone government and private bonds "to ensure depth and liquidity" in markets, a move it recently swore it wouldn't resort to. The US Fed jumped into the foray as well by reopening its swap lines with other central banks to make sure they had enough access to dollars. Nothing like global coordinated government love to juice recently beaten down equity markets around the globe. Yet another transference of risk from the private to the public sector to embolden bankers to take more risk. As for how we're going to pay for all this? Um, we'll figure that one out later.

On Unemployment, Fat Fingers, and Market Plunges

If you happened to step out for a post-lunch latte in the middle of the trading day yesterday, you might have missed the near 1,000 point plunge in the Dow. If you were long, that would've been a good thing, as you definitely would've lost your lunch at the lows. Although the market rallied back from its lows, all major indices closed down some 3% on the day. The WSJ declares "Market Plunge Baffles Wall Street" as traders and pundits scramble to figure out what on earth would cause our predictable and rational markets that never have large price swings for no apparent reason to whipsaw the BeJesus out of equity players. 1987, 1989, 2000, 2002, 2008 don't count because the market had its reasons. Oh, and the developing Greek crisis, credit spread blowout, and fears of another banking meltdown don't count either because the fundamentals for US stocks are just so peachy.

From what I hear, electronic market makers (high frequency traders etc.) pulled their quotes when a wave of selling triggered stops. With no bids below, stocks plummeted, some to as low as a penny a share before ripping back. While everyone is wondering what fat finger triggered the stops, I'm sort of wondering why anyone would want to buy stocks in a market where the liquidity is so thin that bids disappear right when you might want to sell.

Meanwhile, in economic headlines, nonfarm payrolls were up 290,000, a bit more than economists were expecting. However the unemployment rate jumped to 9.9%. This is somehow being painted as a positive as apparently a bunch of happy unemployed people are choosing to reenter the workforce. That's just fine and dandy that they are no longer discouraged and depressed. But let's just hope they can all find jobs.

Geithner Says Can't Take All Risks Out of Banking and He Should Know

Treasury Secretary Tim Geithner in his prepared statements to the Financial Crisis Inquiry Commission says that it would be a mistake to take all the risks out of banking. "The lesson of the crisis...is that we cannot make the economy safe by taking functions central to the business of banking, functions necessary to help raise capital for business and help businesses hedge risk, and move them outside banks, and outside the reach of strong regulation."

Funny, I thought the main lesson of the crisis was that regulators should actually pay attention to what our banking system is doing before the system blows itself up, takes the economy with it, and requires massive government bailouts and subsidies. Another takeaway from the crisis? That massive bailouts and subsidies to the banking sector essentially remove risk from the banking sector and cause them to do really stupid things that will eventually blow up the system anyway. Except now the government is paying for the clean up. Want a good example? Check out what's happening in Europe right now. European banks are absolutely browning themselves over a Greek default. Why do they own Greek debt given the risks, you might ask? Because the ECB allowed them to pledge Greek debt as collateral into its term repos at extremely low rates. So banks bought up loads of Greek debt at high rates and pledged it to the ECB to make huge "risk-free" spreads, something they certainly would not have done if they had nowhere to go with the debt and had to finance it at market rates. In retrospect, the trade was maybe not such a great idea. Although if the European bailout of the Greeks actually works, it was a great idea. Yet another way of removing financial risk from the banks and passing it on to the public sector.

Mr. Geither says you can't take all the risks out of banking and yet that is exactly what he has done in his handling of the crisis. Here's a list of the many ways that Mr. Geithner, in cahoots with Mr. Bernanke, was responsible for taking all the risk out of banking:

• Bailing out Bear, AIG, Fannie, Freddie, [insert all your favorites here.] By the way, bailing all these companies out was primarily a bailout to debt-holders, which were generally banks.
• Creating a variety of Fed facilities to help banks finance their inventories.
• Allowing banks to borrow at cheap rates via FDIC's government-guarantee program.
• Zero interest rates. Really does this need any elaboration?
• Quantitative easing. Ditto.
• Capital injections, in some cases repeated capital injections, into the largest banks.

I mean, could we possibly take any more of the risk out of banking? I have a better idea. Let's return all the risk to banking, regulate our financial firms, and let the losers actually take the fall the next time they screw up.

In Other News 5/5/2010

• The UK's Prudential PLC has been forced to delay the rights offering that was supposed to finance the purchase of AIG's Asian insurance arm. It seems the FSA is having some issues with the capital position of the combined group if the merger were to go through. Let's hope Prudential works it out, otherwise we'll have to find another sucker to pay $35 billion for the unit.
• One of the problems with crafting a solution to our healthcare woes is that everyone agrees that costs are spiraling out of control, nobody seems to understand why, so everyone sort of makes up reasons that match their political agendas. So isn't it nice to hear that one of the largest health insurers, WellPoint, has been jacking up its premiums to customers around the country because of a likely mathematical error? Score one for the insurance company haters.
• BP is cleaning up its oil spill with a detergent-like chemical. I'm sure the fish will really appreciate that.
• A Picasso sold for $106.5 million, an auction record. It's either a sign that confidence is back, or that people are hoarding hard assets because they don't want to own fiat money. I'll let you decide. In any event, I'll be covering the upcoming auctions of contemporary art as they will be a better barometer of how low investors are willing to stoop for hard assets. Giant stuffed shark bathed in formaldehyde? Anyone? Anyone?
• Spreads on MBS reached their widest levels in months. The bozos interviewed for Bloomberg's story attribute it to the Greek contagion. Yet maybe it has something to do with the fact that the Fed is no longer spending trillions to prop up the market? Just maybe?
• Oh yeah, and Jimmy Cayne doesn't think that Bear Stearns' collapse had anything to do with his failure to pay attention to what the hell was going to at the firm he was in charge of. After all, he was at a bridge tournament. Remember? It was that unforeseeable credit crisis that got them.

Could the Euro Debacle Get Any Worse?

While the Greeks are busy burning buildings to protest the austerity measures included in the bailouts offered by their generous and more solvent European neighbors, investors are fleeing European stock and bond markets. The Euro is plummeting and the ratings agencies cannot downgrade the PIIGs fast enough. It seems the folks at Moody's have no interest in being hauled before Congress to get yelled at for not warning investors that Portugal, or Spain, or Italy, or whoever might be next. At least the subprime debacle taught them the right lesson, eh?

Over here in the US, our economic data seems to be pointing to a respectable, although not spectacular, recovery. So why on earth do we care if the EU implodes? Can't we just go about our own business issuing piles of government debt to finance our various bailouts of banks, car companies, insurance companies, mortgage lenders, and anything else our legislators decide to throw into the mix? I mean, all of this chaos in European markets is forcing investors into US Treasuries because we remain the safe haven so that helps us finance our bloated deficit a bit cheaper. If it weren't for that nagging suspicion that the US was doing exactly the same thing as some of our less solvent friends across the pond (because it's really all relative,) I'd be running around in circles waving the American flag. The problem is: when investors stop being kind enough to finance our government's excesses, there's nobody big enough to bail us out.

Financial Headlines 5/4/2010

• The Dow is down 147 in early morning trading on - you're never going to believe this but - "European debt fears" AGAIN. I mean, how many more times are we going to do the Greece-is-imploding/Europe-is-bailing it out dance, before everyone wakes up and realizes that we're all overextended and need to restructure? Apparently, many.
• At least people are buying cars again. Car sales were up 20% in April year-over-year, which is good if you forget about the fact that sales hit multi-decade lows in April of last year. April's annualized sales pace was about 11.21 million vehicles, slower than the rate of 11.78 million in March, supporting the theory that we're experiencing a nice bounce but nowhere near the 16 million pace of the bubble years.
• The Lehman bankruptcy estate started presenting evidence last week in an attempt to prove that Barclays gouged its eyes out after the investment bank's bankruptcy filing. The evidence? $11 billion or so that Barclays made immediately after it cherry picked some assets. The estate plans to go after other banks - you've heard of a few of them - that it claims picked its carcass clean in the confusion following Lehman's implosion.
• Lending standards remained tight and even got tighter at US banks, but you already knew that. I mean how many ways can your bank say "No. No. I said No! Go away!" before you get the message. A few categories showed improvement, industrial and commercial loans for large businesses, but otherwise, hope you're doing fine living off your unemployment check.
• Curiously, one of the only stocks showing green today on my screens is BP. Apparently, if you cause a major environmental disaster that will cost billions to clean up, it's no biggie. It just means your stock is now viewed as "defensive." According to the FT, the US is raising pressure on BP over spill costs. Apparently, after the 1989 Exxon Valdez spill, landmark legislation was passed to ensure that these types of oil spills are paid for by the "responsible" party. Included in the legislation, however, was a $75 million liability cap, because that was apparently the best that the jokers in office at the time could do to pass something. But fear not, our savvy lawmakers are just now getting around to trying to raise that cap to $10 billion, which will likely get whittled down to $100 million by the time the oil lobby has done its work.

Pressure Mounts on Goldman

The folks at Goldman might still believe they are doing God's work, yet the regulators believe otherwise, as the news of a possible criminal probe by federal prosecutors hit the tape last week and sent the investment bank's stock reeling. Add that to the SEC charges filed last month, and it's not looking so good for the world's most lovable vampire squid. Sure there's enough money to settle charges with everyone, but criminal charges? Not good, and generally not survivable. Time to crank up the PR machine and work on convincing everyone that they're really sorry, they're nothing to change and stuff like this is never going to happen again, at least not for another seven years or so.

The FT reports this morning that GS is planning to "change some of its practices in dealing with institutional clients, a step that could help it settle charges filed last month by US securities regulators." The thing is, even though the designation of "institutional client" implies that said client actually understands what it's investing in, that has proved not to be the case. In fact, many clients gladly purchased billions upon billions of complicated structured products from GS without knowing that they would likely be worthless in a matter of months. So, what to do to address the issue of GS's clients being boobs for assuming that the bank actually cared that it was selling worthless garbage to book monster profits? Hmmm, let's see... Oh, here's a great idea! Make them state that they understand the risks associated with any given security before doing a transaction with the bank. Creates a bunch of needless paperwork. Protects the bank from lawsuits in the future. Keeps the lawyers busy. Problem solved.

Might I suggest the following format for the new documents:

"Dear Valued Customer,

Please be advised that when our salesmen call you, they are attempting to sell securities that Goldman no longer wishes to own in its inventory. If we actually believed the securities were going to rise in value, we would keep them. In fact, it is highly likely that we believe the securities will lose value immediately. Furthermore, please be aware that we have likely front-run you before calling you in order to bid up the price of the securities we want you to purchase. In fact, if the securities are actively traded and you see bids on the screens reflecting certain prices, please be aware that it might just be our trader trying to paint the screens to coerce you into paying an inflated price. The minute you place your order, the trader might pull his bids in order to make you look and feel like a jackass. If the securities are less liquid products without tradeable prices, products in fact that we have created, please be aware that you are paying WAY more for the securities than we actually believe they are worth. It's what we at Goldman refer to as "customer service." As a profit making enterprise, it is our job to rip you off until you feel it in your keister. If you haven't thought of your keister today, might I recommend that you give your GS salesman a call. Have a nice day!"