Wednesday, January 28, 2009

Treasury Discloses Secret TARP Documents

Tim Geithner is moving fast. In this addition to the US Treasury's website made available literally hours ago, he discloses a variety of TARP-related documents that had not been publicly available previously, most notable among them being this disclosure about the Targeted investment program that the Treasury has established w/r/t keeping Citi alive.

The following statement is Geithner's justification to maintain a "transparent" view of the financial system "In the coming weeks, we will unveil a series of reforms to help stabilize the nation's financial system and get credit flowing again to families and businesses. Included in those reforms will be a commitment to increase transparency and oversight. Today, we are taking a step toward increased transparency by committing to place all of our TARP investment agreements on the Internet so that taxpayers can see how their money is being spent and the terms these institutions must agree to before we invest taxpayer money."

Enjoy the reading. Sphere: Related Content

Late Wednesday Headlines

  • Ruble rubble - currency crashes Wednesday by record 2.5% (Moscow Times)
  • Latest "reflexivity" ruminations by George Soros (FT)
  • House passes stimulus bill; not one republican votes for (Brutally Honest)
  • Doom and gloom: economic pain to be "worst for 60 years" (FT)
  • UBS slashes bonus pool by 80%, Swiss citizens still cry foul (Bloomberg)
  • The private jet backlash continues (as we expected, NYT)
  • Geithner's Yuan comment dismissed as "Horrible Advice" (Bloomberg)
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Weekly CDS Change Update Per DTCC - Technical Recommendations

New DTCC weekly change numbers released for week ended January 23. Most notable is the huge gross notional and contractual amount of full terminations of consumer services CDS. Looks like funds are fully covering overhanging shorts. As this has been the most profitable position over the past 3 months it is not too surprising. Based on this technical data, we would recommend establishing short positions in the space due to the diminishing risk of a mass squeeze. Other data indicate that aside from consumer services, risking action has been roughly equally split with derisking in basic materials, consumer goods, health care, tech/telecom, utilities, and other, and only sovereigns have seen a marked rerisking. Today's market action indicates that equities are again chasing credit.


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Whither Hyperinflation

It seems there are two sorts of people out there right now: those who say that no matter how much money the government throws at every problem it will never result in hyperinflation, and those that say that hyperinflation is now an inevitability regardless of what actions are taken from here on out. It is likely futile to attempt to reconcile the two groups, but we have decided to present some facts, as well as some statistical data culled by Morgan Stanley.

Before that though, we do want to point out the amusing fact that the general media rarely will touch the question of hyperinflation, just like the whole question of are we in a recession or depression - usually the subject is brought up unsolicited. A tangential and rhetorical question is why everyone in this society is so terrified to discuss the real issues that face the economy, and most just opt to skirt around the periphery?

What is hyperinflation and can it occur to the U.S.? The classical, Philip Cagan definition assumes monthly inflation higher than 50%, and the most recent examples include post World War I Europe (Austria, Russia, Poland, Hungary and Germany, of which the latter recorded over 3,000,000% monthly inflation), as well as Argentina (89-90), Peru ('90), Ukraine ('91-94) and Zimbabwe (past several years).

Hyperinflation is caused by uncurbed money supply growth, usually mandated by central banks which are forced to meet excessive fiscal deficits or finance untenable expenditure programs (sound familiar?), and traditionally occurs in a context of adverse economic and political shocks. Ultimately, it has a psychological manifestation - a loss of confidence in the value of money, a flight into real assets and hard currencies, increase in bartering, a shrinkage in financial intermediation initially and the banking system overall, subsequently.

Empirically, hyperinflationary periods are marked by high correlations of money supply growth and inflation rates as seen below.


The correlation can also be seen in episodes of high, but not quite hyper, inflation as were the historical cases of the UK and Mexico:

While in low-inflation environments, the money growth correlation is weaker, there is obviously a high statistical inference with higher money growth rates always resulting in above normal inflation rates.


So where are we now? According to Haver analytics we are rapidly approaching a point of no return, if we haven't passed it already. Concerted efforts by the Fed, Treasury, the ECB and the BOE have resulted in an explosion of money growth. The critical question is has this wholesale pumping of M1 funneled into downstream monetary aggregates (M2, "M3", etc) and the general public.


Clearly M1 levels are gaining momentum and we have yet to feel the impact of the $825 billion + stimulus package. Furthermore, the government seems hell bent on breaking the dam of money supply at all costs by forcing banks to increase lending, reducing taxes, and generally encouraging currency transfers to the end public. How will the government finance all this increase in money supply: options include central bank loans to the government, buying of government bonds at auction, purchases of government bonds in the open market and additional lending to banks against government collateral.

With an increase in monetary supply flooding the consumer now being only a question of time, the psychological element of public confidence will have to be carefully monitored: a surge in inflation would open up a vicious cycle of a loss of confidence by the public and force a reduction in deposits and cash holdings, resulting in purchases of real assets (commodities, select currencies and real estate). At that point the velocity of money and inflation would rise and the central bank would have to keep printing even more money to finance government spending.

Morgan Stanley attributes a low probability to a hyperinflationary outcome as a result of current monetary and fiscal policy, and assigns to it a mere black swan risk, but regardless believes that "buying some insurance against the event of high inflation or even hyperinflation makes sense and is relatively cheap currently."

Our belief is that the worst case outcome is not a fat tail, and is a question not of if but rather when. The ironic situation that the U.S. and the entire Developed world has put itself into is that due to the measures taken at fixing the broken financial system, which one could argue were precipitated by the collapse of Lehman, or alternatively, taking a cue from Soros' book, began when the massive credit bubble started some time after Bretton Woods, the outcome of the current period of financial instability, will be a world of even greater financial distress marked by hyperinflation in most western countries.

As we have argued before, and as evidenced by today's FOMC statement, the Fed is now toothless in its monetary policy (0% rate floor, when it should ostensibly be negative, in order to maintain an appropriate rate of economic expansion and inflation) and, by purchasing treasuries is now commencing its involvement in pseudo-fiscal adjustments. This adds more ice to the slippery slope of M3 exploding in our faces, at a time when the central bank is still fighting to prevent the consequences of 10%+ unemployment and an effective shut down in consumption from impaling U.S. GDP. (there is, of course, the export component of GDP, but I think we are in for a slew of negative surprises on that front as well very very soon).

For monetary policy sticklers, we have provided the most recent version of the Fed's H8 report where one can see the rather violent increase in the M3 proxy (either total assets or total liabilities, opinions differ). It is a safe bet that the total amount will only continue increasing in the coming months.



What can investors do to protect themselves from eventual (hyper) inflation? As specified above, "hard assets" are a safe bet. TIPS, shorting treasuries, purchasing currencies of those countries that are not expected to have huge deficits and/or untenable leverage, commodities (we still like our "risk free" profit idea, although the contango now has collapsed, so if you did it at the time, props to you), others? While the alleged pessimism that we sometimes exhibit may be too much for some readers, we only try to present both sides of the coin, and to help as many people preserve capital. Over the next 2-3 years, this will be a very difficult task, absent amusing days like today when the market is up 3% on patently horrendous news.
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Allstate Earnings: Ooops

The real first black president (David Palmer) couldn't save this one.

*ALLSTATE SUSPENDED SHARE BUYBACK
*ALLSTATE INSURANCE HAS CAPACITY TO PAY DIVIDENDS $1.3B
*ALLSTATE SUSPENDED SHR BUYBACK PLAN
*ALLSTATE HAS $12.6B CAPITAL AT YEAR END 2008
*ALLSTATE 4Q OPER INCOME PER SHARE 97C; ANALYST EST. $1.
*ALLSTATE REMAINS WELL CAPITALIZED
*ALLSTATE 4Q PROPERTY-LIABILITY COMBINED RATIO 91.5
*ALLSTATE 4Q OPER EPS $0.97

Link here. Sphere: Related Content

Expected Market Sector Growth Rates

With almost half the S&P having reported their earnings, we know all too well how bleak the employment picture is with a daily barrage of "streamlining" bullet points in each company's earnings press release. Another interesting factoid is to compare the estimated earnings growth rates of different companies by sector, whether based on company guidance or consensus estimates. What is surprising is the nearly 80% drop in the estimated growth rate for the S&P500 from only 3 months ago. One can accuse sell side analysts (and management teams goaded by ebullient PR firms) of many things, but being realistic is probably not one of them.

On the next graph the relative growth rate estimates for the market by sector are shown. All those people saying the bottom in financials is here and today is the last day to buy at bargain prices, we suggest you take a look at the far right column.

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Republicans Throwing Cog in the Democratic Wheel

Breaking on CNBC: Republicans to present alternative stimulus plan which will "create double the amount of jobs in the currently proposed plan." Enter stage left: partisan wrangling.

And just when you thought the market has enough on its mind to worry about politics. Sphere: Related Content

The Roulette That Is The Massively Disconnected Market Keeps On Spinning

I assume I am not the only one watching the big game of roulette on CNBC right now (i.e. the market). For all those clicking the buy button on E-Trade with the reckless abandon of Gary Busey doing... well, anything he does, we want to point out this interesting analysis on FT Alphaville. Tracy Alloway has looked at capacity utilization in two of Europe's largest economies, France and Italy, and the punchline is :"France utilization fell to 75.8 in January from 82.2 in October - the biggest decline ever seen. In Italy the same - utilization feel to 69.9 from 74.4 in October." However the January number really indicates data only thru the end November. JP Morgan says "on the basis of capacity utilization, output fell very, very dramatically in December and January. Furthermore, this collapse in capacity utilization suggest a big decline in capital spending and inflation in the months ahead."

As for why capacity utilization is important - some theory from David Mackie of JP Morgan:

"Capacity utilization plays a critical role in our thinking about the Euro area.
Given the lags in the production of the official output data, it influences our view of high frequency developments in production.

Because the denominator is influenced by the capital stock, the level of capacity utilization seems to play an important role in capital spending decisions.

It is a key determinant of pricing power and thus it is very significant in our Phillips curve for the region which drives our core inflation forecast.

And, last but not least, it plays an important role in our ECB forecasting tool, as it influences the appropriate policy rate."

However, it seems nobody cares what the underlying economic metrics are anywhere in the world anymore as long as the government is buying treasuries, mortgages, toxic assets, banks, oreos, California's IOUs and everything else... Bottom line is investors are convinced the only way to make money in this market is to keep front-running the Treasury and Fed until both of them hit double zero. Sphere: Related Content

Fed Rate Kept at 0%; FOMC Full Statement; Vague On Treasury Purchases

Release Date: January 28, 2009

For immediate release

The Federal Open Market Committee decided today to keep its target range for the federal funds rate at 0 to 1/4 percent. The Committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

Information received since the Committee met in December suggests that the economy has weakened further. Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending. Furthermore, global demand appears to be slowing significantly. Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight. The Committee anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant.

In light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, the Committee expects that inflation pressures will remain subdued in coming quarters. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. The focus of the Committee's policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level. The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant. The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets. The Federal Reserve will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Committee will continue to monitor carefully the size and composition of the Federal Reserve's balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Dennis P. Lockhart; Kevin M. Warsh; and Janet L. Yellen. Voting against was Jeffrey M. Lacker, who preferred to expand the monetary base at this time by purchasing U.S. Treasury securities rather than through targeted credit programs.

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Private Equity Firms About To Get In Line For TARP Handouts

It The Boston Consulting Group and Nassim Taleb are right, and the latter has been right over the past 2 years where everyone else has been massively wrong, then private equity firms are about to get in line for government bail outs.

In a study by BCG, as many as 40% of the biggest 100 buyout firms may collapse over the next 2 years "as their debt-strapped assets default." We are trying to get some more color on whether any specific firms were actually named (some potential guesses here).

Taleb, who is known for memorable quotes, said "banks are being bailed out, and private-equity firms are going to go next. These people in a bull market look like geniuses. And now they don’t look that intelligent, and it’s going to get a lot worse for them. If the S&P goes down 20 percent from here, what will happen to private equity firms? They’re all under water.”

A PE bailout may be a tough sell to taxpayers, who did not take the news of Thain's taxpayer funded office renovations or Vikram's French private jet too kindly. In the meantime, everyone is fundraising to run with the crowd investing in the phenomenal opportunities of whatever the current asset bubble may be. If everyone is so aggressively looking for distressed opportunities, who don't the healthier PE firms just purchase the equity of the more "troubled" ones - no better distressed asset out there in our opinion. Sphere: Related Content

Ari Kiev On CNBC Right Now, Providing Profound Psych Insight For Free

"Don't focus on the drawdown... The market will rebound...Look for the ephemeral truth."
This stuff is priceless.


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More about Wall Street's Deluded Distressed Investing Crowd

Overpriced, rumormongerous tabloid Debtwire (just kidding, we love our competition) apparently had a little extra free time and did a survey in which it polled "100 hedge fund managers, prop desk traders and other asset managers" to forecast how they perceived distressed debt opportunities in 2009 (we were not aware there are 100 specimens of this endangered species left out in the wild...it might make sense to put them all in zoos before they become extinct). Among the major findings of the glorified census were the following:

- Financial services sector is expected to offer the most opportunities for distressed investors. Auto manufacturers and suppliers may be the most lucrative sector for investors in 2009. Opportunities are expected to be spread relatively evenly throughout other sectors, reflecting the breadth of the recession.

- 73 percent of respondents predict an overall decrease of the liquidity in distressed debt trading. As the consolidation among banks and fund closures in 2008 are expected to carry over into 2009, competition for positions will be cut, allowing new funds to push into the market. Investors likely will continue to see a buyers' market in 2009, allowing them to be more selective with where they commit their capital.

- 2008 saw a 23 percent increase from 2007 in respondents who did not use hedging strategies. With significant declines across all markets in 2008, most hedging strategies proved ineffectual, with 34 percent of respondents not using any hedging strategies. The use of credit default swaps as a preferred strategy dropped 6 percent in 2008 from 2007.

Furthermore:

- Fewer respondents used leverage to manage their fund in 2008 compared to 2007. Out of those who did, 49 percent plan to use less in 2009.

- More than half of the survey respondents believe the recession will stretch through at least the first half of 2009, while 35 percent think it will extend through the end of 2009, making it the longest on record since 1933.

- Heading into 2009 the appetite for primary deals has shrunk, with approximately 10 percent of respondents planning to allocate 10 percent or less to the primary.

Perhaps the words of Michael Bruder of Macquarie sum it up best "[we are in a distressed investing cycle that] may be remembered for the exceptional buying opportunities for those astute distressed investors that are able to navigate these volatile markets." Truly insightful. Sphere: Related Content

New York Times To Cease Providing Monthly Revenue Updates

In a quest to "improve" transparency into its business, the New York Times will cease providing monthly sales updates beginning this month, and only give clarity on a quarterly basis said the CEO on a phone call this morning... Next quarter we assume this practice will be adjusted to providing any sorts of updates to once a decade.

Also, in much more troubling news, NYT announced its pension is currently underfunded by $625 million. We hope Andrew Ross Sorkin has been saving up. The silver lining, Capex will drop in 2009... I guess the plan for another exoskeletal skyscraping monstrosity on top of Port Authority will be put in hold for now.
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All Business Trips Cancelled for Merrill Brokers

We wrote about what we think the implications for the private jetting industry would be after Falcon-gate, but did not expect this. The Post reports that Bank of Countrywide Lynch has banned all broker trips after an internal unit-wide television broadcast by Dan Sontag, the new head of Merrill's brokerage unit. The ban is expected to last through 2009. While star brokers didn't shed too many tears after all rookie brokers (who make 1/2 to 2/3 of what Thain's carpet cost) were recently let go, the news that all trips will have to commence at Port Authority is the final straw and will likely cause all brokers to depart for the greener pastures of... um... maybe they will just stay put. Sphere: Related Content

Jefferies Tries to Rebuild Its Restructuring Group

Jefferies, the self proclaimed "largest investment bank left out there" today announced that it has hired 2 managing directors to replace the massive defections in its restructuring group, which for all intents and purposes, picked up and left to join Moelis & Co. The new additions are Hal Kennedy who was previously at Credit Suisse, and Leon Szlezinger who worked at Mesirow previously and was listed in Bankruptcy Insider as a top creditor advisor, and in Turnaround & Workouts' People to Watch 2007: Hot! Sphere: Related Content

New Issuance Fever Hits Market

The primary debt market has taken advantage of people throwing money into the TARP pit, with two high yield energy companies on deck to raise capital over the next few hours (or as long as there is an uptick to the market): Chesapeake, in the form of $500 million 6 year notes, and Inergy, raising $200 million 6 year notes, both to refinance existing debt. As mattress are overflowing with worthless pieces of paper, it is likely that both these issues will be quickly digested by the market... The desire to price these asap makes sense due to the high likelihood that tomorrow the market will crash and burn based on recently trading patterns (ed. this is not a recommendation to buy SPUs) Sphere: Related Content

No Tax Refund for Californians, Now Official

In what is likely the last step before officially declaring insolvency, California has halted the processing of state tax refunds. Per California State Controller John Chiang's office, "Unfortunately, we have asked the California Franchise Tax Board not to send over tax refund claims beginning today because we will not be able to process them and have them out the door by Feb. 1 when a 30-day delay in tax refunds goes into effect." Can taxpayers ask the IRS not to have to pay taxes?

2.74 million individuals and businesses will have a tax refund delayed and the delay in their processing should free up $1.99 billion over the next month to pay for "education, debt service, and other payments that legally have first claims to state funds." As this money is essentially a debt to its residents, some could interpret this action as a forced 30 day grace period before Cali has to retain Lazard and some overpaid bankruptcy lawyers. Sphere: Related Content

Major CDS Last Day Movers


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Breaking News: IMF Estimates Toxic Asset Losses To Raise By $800 Billion to $2.2 Trillion

*IMF SAYS U.S. ECONOMY TO SHRINK 1.6%, EURO AREA DOWN 2% IN '09
*IMF RAISES ESTIMATE OF BANK LOSSES FROM $1.4 TRILLION IN OCT.
*IMF: GLOBAL GROWTH TO BE 0.5% IN '09 VS 2.2% PRIOR ESTIMATE
*IMF SEES LOSSES FROM TOXIC U.S. ASSETS TOTALING $2.2 TRILLION Sphere: Related Content

Porsche About to Get Gestapo-Lite Treatment

After costing most US hedge funds huge losses last year and Adolf Merkle his life, German prosecutors have finally opened an investigation into activities by "responsible people" at Porsche that have led to trading manipulations in VOW shares. The German regulators, who based on their speed and efficiency one would assume were the Berlin branch of the SEC, said “we have to open a file if we get such a complaint, but we will take further action only if BaFin’s findings indicate any wrongdoing may have taken place.”

So Perry and Greenlight don't hold your breath you will be recouping those crazy stop losses any time soon.
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