Sunday, April 6, 2008

Are the bears prepared for new highs?

They are not. And neither are the longs.

Friday, we lost 80,000 jobs and the market rallied. Where were the sellers? They were already beaten into submission by the bears.

And the market rallied on the bogus governmental figures, that included the estimated 142,000 jobs that the BLS included in their birth/death model, where these government statisticians said we even "gained" 28,000 jobs in construction!

The 5.1% unemployment rate gets headlines, but the 9.1% rate that includes the "marginally attached" and the part timers who can't get a full time job is approaching the average unemployment rate of 9.7% rate of the 1981-82 recession!

The Bear Stearns bankruptcy scared out the last long, and the hedge funds smelled blood hoping for a systemic collapse. But the demise of Bear Stearns also left the shorts without their dirtiest clearing firm in the "naked" shorting of stocks.

When it was Patrick Byrne complaining, no-one cared. He was just "nuts." Read his work. And then see if he is nuts.

But when they started the rumours on the banks, they fought back. First we had the Telegraph expose on HBOS:

Britain's biggest mortgage lender, HBOS, falls victim to larceny on the grand scale when dealers spread malicious rumours about its liquidity and then bet on the falling share price. One speculator is thought to have made as much as £100 million - which would make this the biggest single act of theft in British criminal history, for theft it is. The response of the City's regulator, the Financial Services Authority? It issues a statement saying it will "not tolerate" such criminal activity. As they pocket their ill-gotten gains, the rogue traders must be trembling in their boots.

And then more:

A hedge fund based in London set up a "dirty-tricks unit" to manipulate share prices and get illicit information on companies in an attempt to make millions on the stock market, an insider has revealed...

Front companies were set up to allow the hedge fund traders to pose as independent researchers or journalists.

Negative information on companies was then distributed to leading investment banks in the hope that rumours would spread and some share prices would fall.

Now we have Cramer on television wanting to re-establish the uptick rule since it was abolished in July 2007. It's his next "they know nothing" campaign.

You know when you have a lost cause? When you are the only one championing it out loud except for a few fringe players whom you may not want to make common cause with.

I am talking about the combination of shorting without upticks -- perfectly legal -- coupled with rumor-mongering -- legal if you believe it so really hard to prove -- and failing to deliver after you raid down a stock...

I am saying that it is easier to knock down stocks if you don't bother to find stock to sell and don't have to worry about delivering, which is how the current system has devolved.

I am saying that without the uptick rule to slow things down, it is much easier than ever to take a stock and crush it.

I am saying that it is easier than ever to rumor a stock down, simply make up stuff, and spread it, especially to the traders who help you get the trade on, particularly options trades.

When Lehman said they would forensically look at all the trading in it's stock and options, we started the April Fool's rally!

Lehman Brothers on Tuesday said it had sent information to the Securities and Exchange Commission about possible abusive short-selling in its shares in recent days.

Erin Callan, Lehman chief financial officer, said the SEC was examining whether hedge funds acted in concert to drive down the bank’s share price in the days following the near collapse of Bear Stearns. Such behaviour could constitute market manipulation, subject to civil and criminal sanctions.

Now prices are recovering in bonds and spreads. Look at the ranges here!

Investopedia has this to say:
The introduction of indexes like the CMBX has led to massive growth in the structured finance market, which includes credit default swaps, commercial mortgage-backed securities, collateralized debt obligations and other collateralized securities. Trading in the CMBX tranches is done over the counter, and liquidity is provided by a syndicate of large investment banks.

While the average investor cannot participate in the CMBX indexes directly, they can view current spreads for a given risk class to assess how the market is digesting current market conditions, making it a potentially valuable research tool.

How about sub-prime?

You can get a rough overview here:

What happened to the 2008 index?

"The new series, the Markit ABX.HE 08-1, was scheduled to launch on 19 January 2008. The decision to postpone its launch was taken following extensive consultation with the dealer community. It follows a lack of RMBS deals issued in the second half of 2007 and eligible for inclusion in the forthcoming Markit ABX.HE roll. The Markit ABX.HE 07-2 remains the on-the-run series until further notice."

What happened to securitized auto loans? It didn't happen.

Why? Here's a great read on it:

The market is only going to efficiently price a security when there is reasonable two-way flow. In other words, when a price is reached where there is a reasonable number of traders on both the short and long side. Is this what's been happening with the ABX index? No. Whatever you think of where actual value is on various ABX contracts, it certainly isn't a two-way market. Buyers of protection have dominated that market for about a year now. Of course there has to be a seller if there is a buyer, but I've persistently heard that sellers of protection have overwhelmingly been either paired trades along the capital structure (e.g., long the 2007-1 BBB and short 2007-2 BBB) or short covering.

Now one can look at any of the specific structures in the ABX library and make a case that the price should be higher or lower. That isn't the point. The point is that the ABX never developed natural buyers of risk. Once home equity structures became distressed, there were some buyers of cash bonds. But these are the kinds of buyers who want to comb through the structures and carefully analyze every dollar of cash flow. That kind of buyer is looking for a cash-flow diamond in the rough. Selling protection on the ABX is a bet on home equity spreads in general tightening. That's not the kind of bet distressed buyers like to make.

Meanwhile, with so few home equity bonds actually trading, the ABX became the only means of estimating a market value on home loan bonds. So right or wrong, the ABX became the "mark to market" for pricing many different types of mortgage-related paper. Buyers who were careful to buy higher quality home equity paper complained, as they believed they had better structures than those on which the ABX is based. But it didn't matter since there were no new deals with which to compare, the ABX is all auditors had to use as a base.

The negative feedback was severe. (Notice I didn't say it was a "loop") Any real money buyer who tried buying high quality home equity paper saw their marks based on the lower-quality ABX. Portfolio managers are hard-pressed to buy bonds, regardless of the fundamental value, if the mark is going to be substantially lower. With no real money buyers and liquidity very poor, it became impossible to securitize any mortgage-related paper.

What would have been better for all involved is if the market had been allowed to price bonds individually based on individual risk characteristics. Perhaps the dislocation in the mortgage market was too severe for that to have realistically happened. But the ABX caused everything to be priced on a lowest-common-denominator basis. That really didn't help anyone other than the shorts.

So given all this, it seems obvious why various market participants aren't too eager to create another ABX monster. Its true that default rates on auto loans are likely to rise significantly, both due to normal recessionary pressure as well as the weak housing market.

As we have huge shorts in stocks, we have even bigger shorts in credit. Knock down an index, and then get your mark, and then take 20% of the "phantom" profit that you can't realize for the year end or the quarter, since your position, and every other hedge fund, cannot be monetized because you have the same playbook and positions bigger than the index that you're getting your phantom mark!

But if this was the case, you'd then have a huge rally starting on the first day of the next quarter as the shorts in stocks and credit try and scramble and cover their positions, where they got paid on, of which they didn't monetize!

They are just like the homeowner who cashed out on their HELOC before the house fell in value. How ironic is that?

And you just thought it was just April's fools rally!

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