Tuesday, November 16, 2010

Memo to MainePERS: It's Not Too Late To Sell

Market-Ticker's Karl Denninger

"potential wipe-out" for TBTF banks

If you are a beneficiary, now or in the future, of Maine's Public Employees Retirement System, you may want to click away from this page. Go somewhere else, anywhere else. Keep having your nice day. Nothing to see here.

With that up-chuck alert out of the way, let's get down to business. You already know that the State of Maine's pension fund is over-exposed to stocks generally, and to bank stocks specifically. As discussed earlier, the MainePERS portfolio has lost $20 million since mid-April in share-price depreciation for two of its largest holdings, JPMorgan Chase and Bank of America. Our "passive" fund managers continue to hold one million shares of the former and 2.5 million shares of the latter, apparently under the assumption that what goes down must go back up.

Karl Denninger is here to remind you that what goes down in the stock market can go not up, but to zero. Denninger, in a radio interview with the Mad Hedge Fund Trader, John Thomas, points out that there are still real-estate losses out there, over $2.5 trillion worth, looking for a home. They will find one in the Too Big To Fail banks (aka JPMorgan, Bank of America, and others of their ilk). The banks' exposure to "put-backs" of defective mortgages and fraudulent securities is estimated at $200 billion. And their exposure to second mortgages (typically home-equity lines of credit, or HELOCs) may be even greater. So far the banks have been able to hide their exposure through creative accounting. Denninger gives them another three to six months "before it becomes impossible to hide anymore."

[If you cannot catch the whole 40-minute interview, slide ahead to the 12:00 mark and listen to the next eight minutes. All you need to know, right there.]

Other fund managers are bailing on the banks. Why not MainePERS? Listen to David Tepper, the hedge-fund manager who famously declared on CNBC in late September that the Fed's latest round of quantitative easing is a "win-win" for stock investors. Better yet, watch what he does. As of June 30, 2010, Bank of America was his largest holding, 27.3 million shares valued at over $360 million. At the same time that he was pumping equities on TV, he was dumping 18% of his BofA.

Ditto the legendary John Paulson. As of September 30, 2010, Paulson had nearly 8% of his $23 billion portfolio in Bank of America, his third largest holding. That was after trimming 18% of his BofA in the third quarter. A year ago Paulson had a 2012 price target of $30 a share for the stock. Now he's selling it in the low teens. What does he know that MainePERS managers do not?

In Denninger's view, 2011 will be a case of sugar-hits-fan. You've heard of 30/30 players in baseball. How about this one? Denninger is looking for a stock-market meltdown that takes the S&P 500 average to 300 and the Dow to 3,000. Those valuations, which are 75% lower than where we are today, will reveal the "embedded pension fund damage" that is already in place, though not yet recognized. Eventually the federal government will step in and try to stop the bleeding. Public pension funds will be allowed to redeem their beaten-down stocks for 30-year Treasuries yielding 2%. In Denninger's words, it will be "the ultimate screw job."

But if you have clicked away like I told you to, you are still having a nice day.

[update, 11-17-10:]

Christopher Whalen of Institutional Risk Analytics explains in this five-minute interview why the big banks are a Sell. To quote, "a lot of losses in the system investors haven't seen yet...we have a distressed sale going on with some of these larger banks."

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