Money Markets Show Significant Improvement, Will Volatility Finally Subside?

I am hearing from my sources that money markets are showing significant signs of improvement today.  Three-month Libor has dropped by over 20 basis points from last night's fix and the TED spread is totally cratering (wide=bad, narrow=good.)  For those who are not intimately familiar with the money markets, they are akin to the basic plumbing of the financial markets.  Trillions of dollars of simultaneous stimulation by governments around the world is finally starting to work.  Since stocks tend to lag the credit markets (as evidenced by the fact that it took a year for the stock market to figure out the complete and total debacle occurring in the bond market), I suspect that it may take some time for the news to filter through and the for the panic to subside.  The VIX is still trading over 70 although down from its peak of 80.  These are still incredible levels and I suspect that the VIX will start to decline.  To all of the options traders out there, I wish you a happy expiration Friday.  It's certainly been the most incredible options expiration cycle I have ever witnessed in my life, and if you are an options market maker and you're still standing after this month, Congratulations, you've earned every penny.  In honor of those that made it through the panic, I offer a video for your amusement.  The following is the layman's version of what it must've been like to trade on the floor of any exchange in the past two weeks: 

Lehman Fends Off Nasty Rumors, Lives to Fight Another Day

Yesterday, as Lehman's stock was getting pummeled for the third day in a row, a rumor started circulating that Lehman was borrowing heavily from the discount window because it was having trouble obtaining financing from its lenders. Just as I was about to risk an SEC investigation of rumormongering by posting the rumor, Lehman's treasurer made a statement adamantly denying the rumor, claiming that the firm had not used the discount window since April 16th. The stock rallied back, only to sell off again into the close. However, a far more interesting and insidious rumor, that Lehman was buying its own stock on the dip, turned out to be true. Although many view a stock buyback as a sign of confidence by management, I happen to have a different opinion. Highly leveraged institutions, particularly those who are actively seeking fresh capital should not be buying their own stock. It is a waste of much needed liquidity. Given that Lehman is in a position where it has to defend its liquidity position every day, this move can almost be viewed as desperate. Sure they have $40 billion in liquid assets, but Lehman also had, as of the end of the last quarter $197 billion in repos on the liability side of the balance sheet. In English, Lehman depends on nearly $200 billion in short term financing, some of it overnight to finance its operations. While $40 billion sounds like a nice round number, it's not that much when put in context. If management wants to show confidence, why doesn't Dick Fuld spend his $40 million bonus from last year to buy some "cheap" Lehman stock? Mr. Fuld has always been considered a very shrewd investor, but I hear they don't call him Dick because his first name is Richard.
Needless to say, the action is set to continue for another day, if the options and credit default swap markets are any indication. Although Lehman hasn't tapped the discount window yet, we may be hearing a different story by the end of the week. Bernake will be waiting for them with outstretched arms, but hopefully with an admonishment or two..."yes, we'll give you money but seriously, stop buying back your own stock..."

Lehman to Raise Capital, "Analysts" Fear Steeper Losses

Lehman Brothers may raise $3 - $4 billion in capital, according to "analysts". Those in the know are expecting Lehman to report the capital raising plan in conjunction with an average estimated loss of $300 million the week of June 16th. The generic press releases issued by Reuters and the Wall Street Journal claim that analysts and Wall Street executives don't know the exact amount of capital to be raised, but they fear it is an indication that Lehman will report steeper losses than anticipated. This is interesting indeed. Apparently, analysts are expecting the company to raise significant amounts of capital based on the fact that analysts are underestimating the losses that Lehman will report. Are these two different groups of analysts? Who is really behind this press release? Lehman's stock has taken a dive in the past two weeks and options volatility has spiked again. Although volatility has not returned to levels reached around the Bear Stearns debacle, it is still high enough to wonder why so many investors are loading up on out-of-the-money puts again. David Einhorn of Greenlight Capital, a very vocal and noted shortseller has stepped up his case against Lehman's accounting. His main complaint, among many, is that Lehman has not adequately written down the value of its $6.5 billion CDO portfolio. Apparently, Lehman only marked the securities down by 3% in the last quarter, which is not realistic given that 25% are below investment grade. According to Mr. Einhorn, the CDOs wouldn't get more than ten cents on the dollar in today's market. Lehman dismissed his claims, pointing out that Mr. Einhorn is a short-seller and aims to profit from a drop in the stock. Clearly, the market hasn't brushed his comments off. And that is a very big problem for an investment bank who needs to go to the well every single day to get financed.

Lehman Brothers Options Action: Deja Vu All Over Again?

Despite all the recent chirping among Wall Street big wigs proclaiming the credit crisis to be almost over, a decidedly bearish tone has returned to the markets. Witness the drubbing of Lehman's stock and the significant increase in put buying in Lehman's options today. While the volumes and volatility are not near the levels they reached during the height of the panic around mid-March, they are still notable. Lehman has worked very hard to dispel the rumors of liquidity problems, and it seemed to have convinced the investing public that it would not face Bear's fate. An interesting article in the Heard on the Street column in the Wall Street Journal this morning discussed how some investment banks were losing money on hedges used to offset losses on CMBS investments. Apparently, banks had shorted the CMBX index as a hedge against their commercial real estate holdings. The index has rallied significantly, while the securities have in some cases declined. Lehman was cited as the biggest loser with analysts expecting write-downs in the $1.5 - $2 billion range on the CMBS portfolio including hedges. Erin Callan, Lehman's CFO, recently called some of the firm's hedges "counterproductive." That's a very creative way of saying Lehman just flushed some of its newly raised equity down the toilet.
Analysts are once again slashing their estimates for investment banks earnings two weeks before the banks are set to report. It is very generous and helpful of them to reduce their overly optimistic projections right before we get the actual news. As I pointed out several months ago the last time we were going through the same ridiculous exercise, it is nearly impossible to project investment banking earnings due to the opacity of their trading positions. Despite horrible news amid unprecedented strains in the credit markets, analysts were gleefully predicting huge hockey stick revenue rebounds by the middle of the year due to the Fed's aggressive liquidity injections. Banking activity would once again surge and everybody would be making money again. Except they aren't. What we're faced with is further uncertainty in the real economy. The probability of soaring defaults on residential real estate, commercial real estate, home equity, auto, and credit card loans as well as soured private equity deals completed at the highs, is increasing by the minute. Consumers are facing record high prices on food and energy coupled with declining equity in their homes. Now the Fed is signaling that it may be finished cutting rates due to inflation fears.
Investors were happy to snap up equity and debt issuance after issuance of the banks and brokers in the past month thinking they were getting a great deal. They aren't so sure anymore. Can Lehman survive another crisis of confidence? If fear exceeds the levels reached in mid-March, it may not. It is a highly levered financial institution that relies on debt to stay alive. Any levered institution can go belly up from one day to the next. Investors who didn't know that before, learned their lesson in March. The parade of broker earnings in the next few weeks will offer some real insight into how investment banks are weathering the storm. Assuming, of course, that you trust the marks on their portfolios...

Google and Citi, A Tale of Two Economies

Google posted a 31% jump in profits for the first quarter, dispelling the rumors that had been circulating about the slow-down in the economy affecting the company's ability to continue to grow at a torrid pace. If you happened to check the stock after hours yesterday, you may have thought for a moment that you had stepped through a portal in time and traveled back to 1999. It's rare to see a $75 surge in a stock's price these days, although on a percentage basis a 17% move isn't that hard to believe. What is interesting is how mispriced the options on Google were relative to the jump in the stock price. The options market is generally good at jacking up the implied volatility in the options to anticipate a stock's move on earnings news. But given that Google reported the day before options expiration, getting the pricing right was particularly difficult this time. If you were a betting fool and felt like taking some serious one-day risk, you could've purchase the april at-the-money straddle for roughly $30 yesterday and printed cash today. It's rare to see a stock blow through eight strikes on an expiration friday. In any event, there are some fairly significant profits and losses out there today, which should make for interesting trading.

Citigroup, on the other hand, lost $5 billion in the first quarter on a massive $15 billion in write-downs. Revenues, although down by 50%, did not decline as much as analysts expected, which got the market very excited. Why does this also remind me of 1999? Because back then internet companies with negative margins would claim "we're losing money on every product we sell, but we'll make it up on volume." And the stocks would rally. Once again, the chorus of "the worst is behind us" continues. I still don't believe it given how the overhang in the credit market persists and Citi remains an owner of $2 trillion in assets, but it's tough to fight a market that loves to rally on such dismal news.

Citi Defends Lehman, TSLF a success, No News Out of TMA

An analyst at Citi upgraded Lehman this morning. Just to show how much stock investors put into analyst upgrades from banks that are having their own issues, Lehman's stock reacted with a resounding $.35 rally on the news. I don't have a clue what is going on at Lehman or if any of the liquidity rumors are true. The options market seems to believe them. And given how rumors can become a self-fulfilling prophecy, I'd be very nervous about betting against them.
The TSLF auction seemed to go well yesterday indicating that the pressures in the money markets may not be as bad as everyone believed. The stock market reacted with a sell-off in financials, which I found somewhat perplexing.
We're still waiting for news on whether TMA is going to make it. No announcements were made on the results of the private placement, so I'm guessing it's not going to happen. In any event, I still contend that private placement or no private placement, owning the common stock is a bad idea.

Merrill Downgraded Again, But Real Story is Lehman

Although Merrill is set to report earnings in April, and analysts persist in making up numbers to show that they slashed earnings before the earnings release, the real story in the options market is Lehman. Much like the bets in the options market that predicted Bear's demise (please refer to my prior posts that pointed these out before the institution's near collapse), traders are betting that Lehman may be facing the same situation soon, in the next 22 days. Nearly every out of the money put has traded furiously today, with a particular emphasis on the ap 20's, which have changed hands nearly 10,000 times today with several hours remaining in the trading day. What's the story? Rumors must be flying around about Lehman's liquidity. Are the rumors true? Will the rumors be so persistent that they will kill Lehman just like they did Bear?

For Those Who Used to Have a Strong Stomach...

Anyone betting that the takeover of CCU would actually be completed this week, despite previous delays, is having a lousy day. However, according to the options market the deal isn't dead yet. A significant amount of options activity is screaming, much like the peasant from underneath the pile of dead bodies in Monty Python's "Holy Grail", "I'm not dead yet!" Implied volatility is high (I call anything over 100 high), and some are arguing that the Wall Street Journal's report that the buyout was on the brink was inaccurate. I remain a skeptic on this deal, unless the terms are changed. The last thing any bank wants to do right now is pile more leveraged loans that they agreed to many moons ago on the heap that they already have to mark down. The last thing any private equity player wants to do is pay far too much for a company, despite being incredibly willing to do so a mere six months ago. Needless to say, the results will be interesting.

What We Really Need is an Investigation or Two...

The SEC has decided to open an investigation into possible manipulation of Bear Stearns' stock by evil traders during the crazy events of the past week that ultimately led to the demise of the firm.


SEC investigation


Furthermore, New York City's Comptroller, who oversees the city's pension funds, will investigate if there was any deception by Bear Stearns or if the bank failed due to sheer stupidity. Apparently, the city's pension funds owned some Bear stock and they want their money back.

NYC Comptroller Investigation

So which is it? Was the firm manipulated and ruined by a bunch of traders as the SEC suspects? Or did Bear mislead investors and mismanage itself into bankruptcy within two days as the NYC Comptroller alleges? Because it can't be both, can it? In any case, if I had to guess, I'd bet that the SEC may be on to something. The amount of Bearish activity (the pun is intended) in the options at the beginning of the week was very suspicious (please refer to previous posts). Significant bets were placed on the stock dropping over 50% before options expiration (March 21st). You just don't see that kind of trading in options unless a biotech company is waiting for the results of a phase III trial which will determine if the company ever makes money. Or a company with significant intellectual property is waiting for a ruling on a patent dispute. In any case, it just doesn't happen during the normal course of trading. If I were the SEC, I would start in the credit default swap market. Apparently buyers of credit default swaps drove the spreads wider, and the sellers of the swaps went to the options market to buy puts to hedge their risk. So if the options buyers were just hedging, then the CDS buyers were really speculating that the company would default on its debt. The irony is that the CDS buyers may have gotten scorched as JP and the Fed are now backing Bear's debt, which means the spreads have narrowed significantly. It's the CDS sellers who hedged with options that printed cash. At any rate, there's a great story in here somewhere of who was behind the rumors, because the rumors were incredible. As much as Alan Schwartz, Bear's CEO, tried to quell them, he couldn't keep the rumors from destroying the firm.

Will Bear Stearns Rise From the Ashes?

My "inside sources" are pointing out that the Bear Stearns trade may not be over.  Now, the speculation goes something like this:  Bear Stearns shareholders hate this deal, for obvious reasons.  They still have to vote to approve it.  They are going to vote no, and give the Fed the middle finger.  Out of spite, they'd rather get $0 than $2 a share, and let the Fed deal with the aftermath of trying to get the money back on the $30 billion in illiquid securities that it guaranteed so that JP Morgan would agree to purchase Bear.  Also, maybe the shareholders assume that after the Fed eases and the new $200 Billion dollar Treasury/MBS swap with the broker dealer community commences on March 27th, spreads will have improved so much that they will be able to get a better deal on their portfolio.  In fact, spreads in the agency markets have narrowed considerably so maybe they have a point.  In any case, crazy volatility persists in the options market.  The april 20 calls are .40 bid.  That kind of crazy bullishness on a broker we haven't seen in a long time...  

Is Bear Stearns Going Bankrupt?

Anyone?  Anyone?  After unbelievably bearish option activity yesterday (supposedly spurred by rumors the firm is having liquidity problems that cased severe widening in Bear's credit default swaps,) the stock had a nice recovery this morning on news of the Fed's liquidity injection.  However, it has now given up its gains and is down on the day.  This does not bode well for the investment bank.  If I had to guess which investment bank was going bankrupt, I would certainly pick Bear given its lack of diversification from fixed income, particularly mortgages.  However, I do believe that if Bear goes bankrupt before march options expiration, the other brokers should take it on the chin as well.  I guess I'd rather short a 160 stock (hint hint) on its way to 50 rather than a 58 stock on its way to zero.  Call me crazy...