Monday, October 31, 2011


When we woke up crying in the wee hours of Thursday morning, Eurozone nannies told us not to be afraid. Reassured, we sold dollars and bought euros in the light of day. Now the scariest of Halloween's goblins, Vampire Debt, is back. Sovereign yields are screaming higher. As for currencies:

Now back under $1.40:
the euro retraces Thursday's "bazooka rally."

[courtesy ZeroHedge]

Sunday, October 30, 2011

Quote for the Week, Oct. 30-Nov. 5, 2011

Tell me what brand of whiskey that Grant drinks. I would like to send a barrel of it to my other generals.
--Abraham Lincoln [U.S. President, 1861-65]

Friday, October 28, 2011

Queue It Up

Dizzying high-altitude photography.
75-year-old mystery solved.
Because it's there.
Trailer here.
Lizbeth Scott's haunting ode here.

Thursday, October 27, 2011

Markets Defer to 'Financial Terrorists'

Global markets are melting up today upon the perception that the Eurozone has effectively solved its debt problem. Do not be misled, advises Max Kaiser, who in this rant [below] likens the Eurocrats responsible for this latest bailout to "financial terrorists." By proposing to leverage the European Financial Stability Fund, unelected ministers are, in Kaiser's words, "mollycoddling banks," undermining national sovereignty, and "guaranteeing economic collapse"--not bad for a long night's work. China, widely assumed to be a guarantor for the EFSF, is merely buying time, says Max, until it can hoard enough gold to immunize itself against the coming contagion.

You must see this:

Meanwhile, ZeroHedge tells us where to look for clues about the creditworthiness of the "ultimate backstoppers" -- Germany and China.

"Note to EU lackeys: there is no free lunch," writes Charles Hugh Smith, who likens the rescue plan to a plutonium life preserver. Heavy and toxic.

[update, 4 p.m.--]

Note to MainePERS: sell the Bazooka rally. BAC has just closed over 7.

[update, morning after--]

The euro-phoria has worn off. Italian ten-year bonds are back over 6%. The risk has not gone away.

Yield on Italian 10-year debt

Monday, October 24, 2011

Quote for the Week, October 23-29, 2011

One must bear in mind that the expansion of federal activity is a form of eating for politicians.
--William F. Buckley, Jr.

Thursday, October 20, 2011

'A Terminal Short'

MainePERS, read this:

"Bank of America equity is worthless."

"BAC is the WorldCom of banking."

" sustainable competitive advantage."

"BAC deserves more downgrades..."

"...a dishonest accounting mess..."

Read the full Value Investors Club commentary here.

[h/t ZeroHedge]

More below. A pro's pro, Gary Shilling, tells Bloomberg why the big banks are such a rotten investment at this time:

BofA Needs Fed Sanctuary More Than Ever

To whom does the Fed pledge allegiance?
[courtesy Bloomberg]

Bank of America knows that the Federal Reserve has its back. But getting such favorable treatment from the courts will not be so easy. BofA has spent the past several months trying to fast-track a settlement over home-mortgage abuses in what is called an Article 77 proceeding. The bank is hoping that a New York court will agree to cap all related liabilities, henceforth and forevermore, at $8.5 billion. Aggrieved parties would not be allowed to opt out of such a settlement.

Yesterday federal judge William Pauley III offered relief to one of said aggrieved parties by ordering the case removed to federal court. In his ruling the judge found that the settlement agreement "implicates core federal interests" and touches on "the integrity of nationally chartered banks." [Reuters scrutinizes the nitty-gritty here.] Those of you playing at home will quickly recognize that "integrity" and "Bank of America" are not a match. So any protracted exploration of BofA's integrity is likely to be inimical to the firm's best interests.

If Pauley's ruling is upheld upon appeal, the price tag for a settlement will likely go up. Way up. Multiply by ten and work your way up from there. This is an iceberg-sized number that could sink the ship. But creditors and investors need not worry. The Fed has their backs, too. By engineering the mergers three years ago of Bank of America with both Countrywide Financial and Merrill Lynch and now migrating the toxic assets of those legacy firms to a federally insured subsidiary of BofA, the Fed has made sure that the only ones ultimately paying will be taxpayers.

The looting continues.

Tuesday, October 18, 2011

Smoke and Mirrors

Breaking: BAC reports phantom earnings.

Market watchers were introduced to a new acronym last week: DVA, which stands for "debit valuation adjustment." In its third-quarter earnings report on Thursday, JP Morgan Chase disclosed that it was booking $1.9 billion in a pre-tax benefit from DVA gains. Unschooled analysts immediately hit up their Bloombergs for a quick refresher in DVA. Turns out that DVAs are an accountant's way of making lemonade out of lemons. A company doing bad can make it look like it is doing good. How does it do it?

Last we checked, credit spreads on the big banks were widening, indicating an emerging suspicion among speculators that one or more of these babies might actually default. For any bank, that's BAD. Bonds previously issued by an at-risk bank start trading at a discount as investors begin to worry about possibly losing their principal. The debt shows up on the bank's balance sheet as a liability, which must be paid down over time.

Here is where it gets interesting. The Financial Accounting Standards Board (FASB) has given the banks the green light to mark their debt liabilities to market, viz. "at the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date" (ASC 820). For the issuing bank, that is GOOD. It means that the liability on the company's books can be discounted as the bonds lose value. The company is allowed to book a profit commensurate to the difference between the bond's face value and its market price.

The "profit" is pure fantasy. The company has not actually engaged in a real-time transaction to buy back any of its debt. It is still on the hook for full payment of principal plus interest. The debt is still a lemon. But, as Boston Globe sportswriter Bob Ryan points out, "corporations often employ bookkeepers who can do with numbers what Rajon Rondo can do with a basketball." He means something magical. In the bank's case, the debt liability is simply revalued on the shaky assumption that the company could, if it wanted to, buy back all its debt, all at once, at a momentary price in a thin secondary market fraught with huge friction costs. Not gonna happen.

Even JPM's CEO, Jamie Dimon, confesses to the gimmickry. "The DVA gain," explained Dimon on Thursday, "reflects an adjustment for the widening of the Firm's credit spreads which could reverse in future periods and does not relate to the underlying operations of the company" [emphasis mine]. Yesterday another of the mega-banks, Citigroup, showed that it uses the same cookbook, announcing a third-quarter pre-tax DVA gain of, you guessed it, $1.9 billion. What a coinkydink!

Enter Bank of America, a veritable warehouse of lemons. For its quarterly earnings (announced this morning), BofA squeezed out a DVA gain of $1.7 billion, not quite up to JPM and Citi's level of performance, but still not bad for worst-of-breed. BofA did not stop there. It also recorded a "fair value adjustment on structured liabilities" of $4.5 billion, another phantom gain (see page 5 here). Back out those two accounting treatments, and you get zero dollars of net income. Then back out the proceeds ($3.6 billion) from a one-time asset sale. You are left with a core business that is still losing money hand over fist.

So why invest in any of these behemoths? It is a question that I have put to officials at the Maine State Retirement Fund (MainePERS), which continues to hold substantial stakes in both BAC and JPM, top-ten holdings as recently as fifteen months ago. The reason they fell out of the top ten is not because portfolio managers sold when the selling was good, but because the share prices have collapsed. As of September 30, we (i.e. MainePERS beneficiaries and guarantors) still hold over 2.6 million shares of BAC and over a million shares of JPM. In the third quarter alone, those BAC shares were down 44%, or more than $12.6 million.

I advised to sell the Santa Claus rally, which raised the stock to over $13 a share. Then, eight months later, I said sell the Saint Warren rally, which saw $8 a share. Today BAC has a six-handle, and it is difficult to see from the company's latest earnings report any possible catalyst for a rally from here. Rather, looming bank failures in Europe could be the catalyst for further downside.

[update, 2 p.m.--]

Bloomberg is just out with the explosive revelation that Bank of America has shifted derivatives from its Merrill Lynch unit to a federally insured subsidiary. This has essentially exposed U.S. taxpayers to the risk that these derivatives might blow up, in which event counterparties would have first claims to the firm's assets (including $1.04 trillion in cash deposits) prior to any bankruptcy resolution. William Black, a federal bank regulator during the Savings & Loan crisis of the early '90s, is quoted as saying that BofA has succumbed to the "enormous temptation to dump the losers on the insured institution. We should have fairly tight restrictions on that."

The safe harbor for derivatives counterparties is a legacy of the George W. Bush Administration, which in 2005 championed passage by Congress of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), a misnomer if ever there was one, as the ones being protected were reckless lenders and speculators. Consumers, far from being protected, were further subjugated.

Yves Smith at explains BofA's move this way:

Remember the effect of the 2005 bankruptcy law revisions: derivatives counterparties are first in line, they get to grab assets first and leave everyone else to scramble for crumbs. So this move amounts to a direct transfer from derivatives counterparties of Merrill to the taxpayer, via the FDIC, which would have to make depositors whole after derivatives counterparties grabbed collateral. It’s well nigh impossible to have an orderly wind down in this scenario. You have a derivatives counterparty land grab and an abrupt insolvency...This move paves the way for another TARP-style shakedown of taxpayers, this time to save depositors. No Congressman would dare vote against that. This move is Machiavellian, and just plain evil.

Maybe this is why MainePERS considers BAC a safe investment. If the bank should fail, taxpayers will be picking up the tab.

[update, 9 p.m.--]

Karl Denninger at uses italics, bolding, AND underlining to reinforce his view:

[T]his sort of movement of liabilities should be flatly prohibited...That the firm's ratings have deteriorated and thus it may be required to post additional capital against these positions by those counterparties does not justify shifting the risk to depositors simply so the bank can avoid posting collateral against a deteriorating credit picture, which for all intents and purposes shifts the risk to the taxpayer since the FDIC has a line of credit at Treasury.

And John Hussman, in his weekly market commentary, has this:

[T]he transfer is clearly driven by the intent to get around capital adequacy regulations, and runs precisely opposite to the right way to create a good bank and a bad bank. It saddles the good bank - the taxpayer insured one - with the questionable liabilities, while "giving relief" to the holding company. This is really preposterous.

Monday, October 17, 2011

Quote for the Week, Oct. 16-22, 2011

If you want to know what God thinks of money, just look at the people he gave it to.
--Dorothy Parker

Friday, October 14, 2011

Queue It Up

Georgian earth-tones in autumn.
Robert Duvall sticks it.
And Alison Krauss too?
Trailer here.

Thursday, October 13, 2011

Be There Or Be Square

Red Sox Nation Reeling

Dan Shaughnessy: "Chaos"

[excerpt from today's Boston Globe:]

"There are so many things wrong with the Sox at this hour, it’s difficult to know where to start. The manager is gone, the general manager is gone, the owners are in hiding, and the players are a loathsome lot totally unworthy of the money and adulation they receive...

Put down the long-necks and the Double Down sandwiches and tell the fans you are sorry."

Sunday, October 9, 2011

Quote for the Week, Oct. 9-15, 2011

In many years I have come to the conclusion that one useless man is a shame, two is a law firm and three or more is a congress.
--John Adams (U.S. President, 1797-1801)

Thursday, October 6, 2011

Visionary Passes

Steve Jobs

"Your time is limited, so don't waste it living someone else's life. Don't be trapped by dogma -- which is living with the results of other people's thinking. Don't let the noise of others' opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary." [Stanford Commencement Address, 2005]

Tuesday, October 4, 2011

Something's Up with the Banks

BAC, 5-year CDS spread

Default insurance for Bank of America debt continues to get more expensive. We'll know shortly whether MainePERS continued to hold BAC bonds and stock through the third quarter.

Meanwhile, BofA further endeared itself to its customers by announcing last week that it would charge debit-card users $5 a month just because. Ever since the announcement, the firm's online banking site has been overwhelmed by traffic. Those attempting to log on to do business are greeted with this:

[click to enlarge]

Could it be that the run on deposits has finally started?

CDS spreads for Morgan Stanley are even wider (by over 100 bps) because of that bank's perceived exposure to European banks, which in turn have heavy exposure to the shaky sovereign debt of countries like Greece. The whole system is stacked like dominoes. When they start falling....

Monday, October 3, 2011

Today's Markets Are Seized, Not Free

by John Hussman, Ph.D.


"We are headed toward a new recession because our policy makers never addressed the underlying problem in the first place, which was, and remains, the need for debt restructuring...'[F]ailing' institutions can be restructured without any loss to depositors or counterparties...[B]ondholder and shareholder capital of these institutions are more than sufficient to absorb any losses without the need for public funds, provided that the objective of government policy is to protect the people and the long-term viability of the economy, rather than defending the existing owners, bondholders, and managements of these institutions....

We shouldn't blame what is happening here on capitalism or free markets. We really have only a caricature of those here. We have a system that is constantly eager to abandon the proper role of government in the markets - which is effective regulation of risk - and to substitute it with the worst role of government in the markets - which is absorbing losses for those whose losses should not be absorbed, and pursuing policies tilted toward the constant creation of speculative bubbles and the avoidance of required economic adjustments, rather than the productive allocation of capital.

Free markets work - provided that they operate within a framework of government policy that enforces property rights, provides reasonable regulation, coordinates objectives that cannot be achieved privately (e.g. certain infrastructure, insurance coverage for pre-existing conditions - which otherwise creates an adverse selection problem even for companies that would like to offer it), and maintains reasonable consumer protection...."

Complete commentary viewable here.

Sunday, October 2, 2011

Quote for the Week, Oct. 2-8, 2011

Violence results from policies that create black markets, not from the characteristics of the good or activity in question.
--Jeffrey Miron