Saturday, January 26, 2008

The Melting Dollar - Best Speculation I've Seen to Date

From John Maudlin's Frontline Newsletter

In The Financial Times today the inside headline is "Markets ask if the Fed was duped?" It seems that a rogue trader (interesting how a lone trader who loses a lot of bank money is always a rogue) lost Societe Generale $7.1 million (4.9 million euros). Seems he knew how to override the risk control systems, had other employees' passwords, and built up a massive long position which was down about $2.2 billion by the time SocGen management found out. He produced the losses in just a few weeks. SocGen started selling everything to cover the loss on Monday morning, and the markets moved away from them, growing the loss to the $7.1. That constitutes a bad day at the trading desk. (As an aside, I have worked with SocGen from time to time over the years, and have always been impressed.)

Some suggest that it was the very selling by SocGen, which was 10% of the market trades, which caused the downside volatility. It seems the European Central Bank knew early on about the problems at SocGen, but the Fed got caught by surprise. The Fed holds an emergency FOMC meeting ahead of the scheduled meeting this week, and makes a shock and awe 75-basis-point cut. I can tell you that shocked a lot of very sophisticated traders and managers that I talked with here in Europe.

Everywhere I went I was asked, "Why an inter-meeting cut?" The Financial Times wrote, "The question being asked now by some in the markets is: was the Fed duped into a clumsy and panicked move by the clean-up operation for Jerome Kerviel's [AKA rogue trader at SocGen] mammoth losses for the French bank?"

My very good friend Barry Ritholtz seems to agree with that position. He was on CNBC with Steve Lissman and Rick Santoli and they suggested that the Fed responded to the volatility in the stock markets with the rate cut and that the Fed is now responding to the traders in the S&P futures pit.

Let's read Barry's take when he finds out that the volatility may have been the result of our rogue trader, in a blog entitled "Fed's Folly: Fooled by Flawed Futures?": "Was it a misunderstanding of their mandate, inexperience, or just plain hubris? Regardless, it took only 2 days to learn just how ill-considered the Fed's emergency market rescue plan was: To wit, a fraudulent series of losses led to a major European bank unwinding a huge trade: Societe Generale Reports EU4.9 Billion Trading Loss.

SG's $7.1Billion dollar unwinding led to panicked futures selling on Monday and Tuesday. "Hence, we quickly learn what sheer folly and utter irresponsibility it is for the Fed to use its limited ammunition to intervene in equity prices. Their panicky rate cut was not to insure the smooth functioning of the markets, but rather, to guarantee prices.

As we have been saying for the past two days, this is not the Fed's charge. They are supposed to be maintaining price stability (fighting inflation) and maximizing employment (supporting growth) -- NOT guaranteeing stock prices.

"I guess the European Central Bank has it easier: Their only charge is to fight inflation: 'maintain price stability, safeguarding the value of the euro.' Tuesday's panicked 75 basis cut will prove to be an historical embarrassment, a blot on the Fed for all its days. Failing to understand what their responsibilities are is bad enough; allowing themselves to be bossed around by futures traders is inexcusable.

And, having been rewarded for their past tantrums, the market will now be screaming for another 75 bps next week. As Rick Santelli appropriately observed, the Pavlonian training is now complete."

I don't agree with that assessment, and Barry is not so thin-skinned that he will worry about my having a different view. So, let me throw out another scenario.

First, for years one of my central premises has been that we have to remember that when a normal human being is elected to the board of the Fed, he is taken into a secret room where his DNA is altered. Certain characteristics are imprinted. Now, he does not like inflation and hates deflation even more. He sees his role as making sure the financial market functions smoothly. He does not care about stock prices when thinking about rate cuts.

Then what was the reason for the cut if not stock prices? Why an inter-meeting cut much larger than the market was expecting next week, just seven days later? What was so urgent that we needed a shock and awe rate cut a week early?

I am not sure if panic is the right word, but I think very deep concern is also a little understated. It has to be something serious for an inter-meeting cut. Looking around for problems I came up with the following thoughts that I shared with investors and managers while here in Europe.
What Does the Fed Really Know? I believe the monoline insurance companies like Ambac and MBIA are in worse shape than most realize, the counter-party risk in the $45 trillion Credit Default Swap market is much worse than we realize, and the exposure by various banks to their problems is much larger than currently understood. The Fed understands this, and realizes that they have been behind the curve but need to catch up. Let's go back and look at this quote from my letter just last week: "If you are a bank or regulated entity, and you have mortgage-backed securities that have been written by a AAA monocline company, you can carry that debt on your books as AAA. But as the companies get downgraded, you have to write down the potential loss. Quoting from a recent note from Michael Lewitt:

" 'MBIA's total exposure to bonds backed by mortgages and CDOs was disclosed to be $30.6 billion, including $8.14 billion of holdings of CDO-squareds (CDOs that own other CDOs, or mortgages piled on top of mortgages, or, to quote Jeff Goldblum's character in Jurassic Park again, 'a big pile of s&*^'). MBIA was being priced as a weak CCC-rated credit when it issued its bonds last week; it is now being priced for a bankruptcy. MBIA's stock, which traded just under $68 per share last October, dropped another $3.50 this morning to under $10.00 per share. " 'The bond insurers' business model is irreparably broken. In HCM's view, it will be all but impossible for these companies to raise capital at economic levels for the foreseeable future and certainly in enough time to work out of their current difficulties. The performance of MBIA's 14 percent bond issue will prove to have been the death knell for this business. The market needs to come to the realization that the so-called insurance that these companies were offering is not going to be there if it is needed. The fact that these companies were rated AAA in the first place will remain one of the great puzzles of modern finance for years to come.' "You can bet that the $8 billion in CDO-squareds is gone. It is a matter of time. MBIA's market cap is about $1 billion [it is now at $1.74]. Current shareholders will be lucky if they only get diluted 75%."

Think this through. MBIA is still rated AAA. Ratings downgrades are just a matter of time. Banks that raised $72 billion to shore up capital depleted by subprime-related losses may require another $143 billion should credit rating firms downgrade bond insurers, according to analysts at Barclays Capital.

(to read the rest of the article, click here - you have to register your email address but then you'll get the word directly.)

John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore

Thursday, January 24, 2008

Sunday, January 20, 2008

You Can't Say You Weren't Warned


The Panic Starts

Author: Jim Sinclair
Thursday, January 17, 2008, 5:45:00 PM EST

Dear CIGAs,

There is no doubt the Fed and the PPT are meeting right now. A drop of over 300 points on the Dow after the Chairman of the Federal Reserve speaks publicly presages a 1000 point break in the Dow Jones Industrial Average coming quite quickly, if not tomorrow.

Unless the equity markets can be calmed, a panic is about to happen, making the statement "This is it" a horrible reality.

If the equity markets cannot be calmed then:

  • Recognize this is the Formula happening like everything else much sooner and much bigger in its implications than anticipated.
  • Gold will rise to $1650 as an almost immediate effect of what will be done to attempt to fend off a total panic starting to take place in general equities, therein threatening to be followed by all credit markets of all kinds.
  • The funds and hotshot short term traders in gold shares will be killed by the upward explosion of the gold price about to occur.
  • The PPT and the Fed will step out of gold’s way because gold is one of the tools used in 1930 by Roosevelt and in 2000 by Bush. It will be used again now on the upside.
  • Gold is the only insurance there is against what all this means because a panic in equities will blow the financial system, already coming apart, to smithereens.
  • All country funds would shut down on any further investments in "at the wall" financial institutions.
  • The rollover in credit and default derivatives would exceed the entire foreign debt of the USA.
  • The rest of the $450 trillion dollar mountain of derivatives would start a disintegration like nothing you have every seen in your lifetime.
  • Consumer demand would slam shut.
  • The auto industry might as well go into liquidation this coming Monday, avoiding the June 2008 rush.
  • The US dollar would burn a hole in the floor going directly to .5200 or lower.
  • As the dollar disintegrates gold would rocket to and through $1650 in days.
  • The markets for general equities would all have to institute total trading halts every 100 points on the downside for 30 minutes each.
  • All commercial call loans would be called.
  • All debtors one day late on any payment, lacking grace period, would be liquidated. All debtors over one day of the grace period would be liquidated.
  • It is clearly visible to anyone with eyes or a mind to think that the PPT has lost all semblance of control in the equity markets and will soon in all remaining markets.
  • The commercial paper credit market which is almost dead will die totally.
  • Should no emergency action take place soon, you will see an old fashioned panic of the 1929 variety.
  • Just as emotional fools sell gold and gold shares, be assured that more emotional general equity fools will unload and bring the averages down more than ever in history in one day.
  • Recognize this is the Formula happening like everything else much sooner and much bigger in its implications than anticipated.
  • Emergency action will be all splash and theatrics but truthfully the cat is out of the bag. It buys some time but corrects nothing. It makes the Formula 100% correct.
  • There now must be EMERGENCY ACTION because the Chairman of the Fed has BOMBED OUT PUBLICLY and a PANIC is about to occur. Expect EMERGENCY ACTION in days, not weeks.


If you have not protected yourself, you may only have days to do so now.

Tuesday, January 01, 2008