Friday, June 22, 2012 – Something About Mary – by Sinclair Noe

DOW + 67 = 12,640
SPX + 9 = 1335
NAS + 33 = 2892
10 YR YLD+.05 = 1.67%
OIL + 13.92 = 92.12
GOLD + 7.10 = 1573.30
SILV +.02 = 27.00
PLAT – 4.00 = 1441.00

Over the past couple of weeks, we’ve paid attention to Jamie Dimon’s testimony on Capitol Hill. You might not have noticed the testimony of Mary Schapiro before the Senate before the Committee on Banking, Housing, and Urban Affairs. Schapiro is the Chairwoman of the SEC. Her testimony was a frank warning on the vulnerabilities of the money market fund system. You may remember that in September 2008, money market funds broke the buck; there was a run on funds held in money market accounts that was only staunched by a $3 trillion dollar guarantee from the Treasury and the Federal Reserve. Breaking the buck was a key part of the financial crisis. There were profound implications for a reputedly rock solid investment. The effects rippled throughout the economy as investors were shortchanged and sponsors were squeezed as they were forced to shore up valuations. 

Could we see another run on money market funds? We already have. It happened one year ago, a small scale run. And yes, it could happen again. And just because the run was stopped in 2008 and 2011, it is no guarantee another run could be contained in the future. There has basically been no reforms to prevent or control a future money market fund run. Here’s part of Schapiro’s testimony:

“Given the role money market funds play in providing short-term funding to companies in the short-term markets, a run presents not simply an investment risk to the fund’s shareholders, but significant systemic risk. No one can predict what will cause the next crisis, or what will cause the next money market fund to break the buck. But we all know unexpected events will happen in the future. If that stress affects a money market fund whose sponsor is unable or unwilling to bail it out, it could lead to the next destabilizing run. To be clear, I am not suggesting that any fund breaking the buck will cause a destabilizing run on other money market funds—it is possible that an individual fund could have a credit event that is specific to it and not trigger a broad run—only that policymakers should recognize that the risk of a destabilizing run remains. Money market funds remain large, and continue to invest in securities subject to interest rate and credit risk. They continue, for example, to have considerable exposure to European banks, with, as of May 31, 2012, approximately 30% of prime fund assets invested in debt issued by banks based in Europe generally and approximately 14% of prime fund assets invested in debt issued by banks located in the Eurozone.”

Schapiro talked about possible solutions, at least solutions for the institutions; such as allowing the funds to float and not requiring a hard peg to the dollar on Net Asset Value, requiring more cash as a buffer, and limiting redemptions. Of course, limiting redemptions destroys the meaning of money market funds as a safe place to park cash. And while Schapiro is to be commended for issuing a stark, honest warning; the idea that it is acceptable to limit redemptions is unacceptable; it is a sign of the times; it just isn’t acceptable. And while we’ve heard warnings about Europe being a major trading partner and any Euro-slowdown could hurt the US economy, the greater danger may be from this kind of credit freezing threat.

Rep. Darrell Issa of California, of the House Oversight and Government Reform Committee (yes, the same guy who holds AG Holder in contempt); Issa wrote a 15 page letter to Mary Schapiro at the SEC,  demanding the SEC address how egg got on the face of our capital markets thanks to Facebook’s underwriters fleecing unsuspecting retail investors who bought the IPO.  The oversight committee expressed fears of a crumbling capital markets system if laws continue “to protect, over-regulate, and coddle our financial institutions.” Financial institutions are screwing up everything because they’re being protected and coddled. 

Which is a long way of getting around to a correction. The other day I said 88% of all Americans held Congress in contempt. That is not correct. I was referring to the disapproval rating, and you can disapprove of Congress without going all the way to the harsher feeling of contempt, also the number was incorrect, it is not 88%; actually, 91% of all American’s disapprove of Congress.

We always hear there’s too much regulation and too many taxes; maybe for small businesses, but the big companies don’t seem to be suffering. Corporate profit margins  have hit an all time high. One reason for the profitability might be that corporations are not employing as many people as they used to. As a percentage of the population, fewer Americans (less than 59%) are working than at any time in the past 30 years; also, wages as a percent of the economy are at an all time low. Seems to me this divergence might be problematic in the future. I’m just not seeing the long term wisdom in destroying your market. 

That brings us to our next story, also involving Capitol Hill and Mary Schapiro. NYSE Euronext and Nasdaq OMX Group – the corporate parents of the New York Stock Exchange and the Nasdaq – headed to Capitol Hill this week to lobby regulators about dark pools. Dark pools are off-exchange forums where traders can buy and sell securities privately, without reporting to the broader market as the exchanges are required to do. Retail investors almost never trade through dark pools, but the big institutional investors such as pension funds, hedge funds, and mutual funds do quite a bit of business off exchange; up to 40% of all trades now take place off exchange. The  NYSE and Nasdaq sent lobbyists to Capitol Hill because they just want to cut out their competition. 

There hasn’t been any updates to regulations on dark pools for 13 years, back before high frequency trades and flash crashes. Back in 2009, SEC Chairwoman Mary Schapiro said: “We should never underestimate or take for granted the wide spectrum of benefits that come from transparency, which plays a vital role in promoting public confidence in the honesty and integrity of financial markets.” That was three years ago, and we have even less transparency. 

Regular retail investors don’t have access to price discovery of trades on the dark pool exchanges, however high frequency and algorithmic traders have been granted access to many broker-dealer owned pools and they are able to lock in price differences between exchanges and dark pools. The perception today, and in fact the reality, is that the retail investor comes in at a disadvantage.

The big institutional investors should not be given preferential treatment to hide trading activity. When you don’t know the price you can’t even begin to claim that you have capitalism; you can’t have honest markets; you only have rigged markets. It’s not a matter of competing with the NYSE and the Nasdaq; competition is good; it’s a matter of transparency. If they can’t stand the light of day, they shouldn’t make the trade, and just because they are institutional investors doesn’t mean they should have a license to screw over the retail investor. They do. But it shouldn’t be that way. But it is. 

And that brings us round to yesterday afternoon’s big bank rating downgrade. Moody’s cut ratings on 15 big international banks. Low ratings can be detrimental for banks with large capital markets operations because they can reduce the number of counterparties willing to trade with the firm and also increase the amount of collateral banks need to back trades.

Not only will funding costs rise for the worst-rated banks, but trading partners are bound to ask for more collateral – and steer business to those perceived to be financially stronger. The big get bigger (maybe too big to fail). The weak get smaller.

The ratings cut also gave a competitive advantage to “safe-haven” banks that fund themselves with stable, low-cost customer deposits, while worsening the outlook for weaker banks that rely more on capital markets for their funding. Morgan Stanley figured it out a while back; starting in March 2011, Morgan Stanley started transferring derivatives into its higher-rated bank unit to reduce the impact of ratings downgrades. 

The bank increased its notional derivatives positions at its bank unit to $2.5 trillion at the end of March from $1.7 trillion at the end of December. The portfolio has increased from $1.2 trillion at the end of March 2011. So, I know the ratings downgrade made people nervous. Can we trust Morgan Stanley?   Their risky trades in the derivative markets are now insured by the FDIC and just as soon as those bets are paid off, your deposits would also be paid off, if there’s anything left.

The leaders of the euro zone’s four largest economies vowed on Friday to defend the common currency with all means necessary. They just haven’t figured out how to do it. They’ll hold another key summit meeting in Brussels next week.   In a news conference with German Chancellor  Merkel, President François Hollande of France and the Italian prime minister, Mario Monti, Spain’s new prime minister, Mariano Rajoy said: “There was an agreement among all of us to use any necessary mechanism to obtain financial stability in the euro zone.” Mr. Monti said: “The euro is here to stay, and we all mean it,” but he added that while much had been done to stem the euro crisis, it was still insufficient. The whole euro-crisis is turning into the never-ending nightmare.

Bank of America’s Merrill Lynch wealth-management unit was fined $2.8 million by the Financial Industry Regulatory Authority for overbilling customers by $32.2 million over an eight-year period. Merrill Lynch charged the fees to about 95,000 accounts between April 2003 and December 2011. The average amount pilfered per customer was under $400. BofA says it was just a mistake, you know, or maybe it was just 95,000 mistakes. There is no question that BofA and Merrill Lynch are guilty, even though the settlement does not require an admission of guilt, but seriously, FINRA has got to stop giving out sweetheart deals to the banksters. Steal $32 million, keep 90 cents on the dollar, no admission of guilt. It is a brilliant business model, at least if you’ve abandoned morality.

Wells Fargo was the one major US bank to escape a ratings cut by Moody’s Investors Service this week. Wells is a little ahead of the pack; ten years ago they were a big player in subprime mortgages but they got out of the subprime game in 2004. They got out of subprime mortgages but they still remained active in payday loans, but they were largely out of the subprime mortgage game before the housing crash. That move, and the bank’s lack of exposure to investment banking and Europe is why they avoided a ratings cut. 

Wells ramped its mortgage business in 2008; their timing seems good. Now, they are ramping up even more. Wells  is sticking to traditional commercial and consumer banking while de-emphasizing riskier undertakings like credit derivatives trading. Delinquency and foreclosure rates are half what they are at Bank of America. That should really make you nervous about BofA, but what about Wells Fargo?

If the economy strengthens and rates suddenly rise, mortgages will suffer more than most other loans and the bank’s income could be clobbered. Another recession would also hurt the bank, because defaults would rise. For now, it just looks like they’re trying to corner the market for mortgages. 

You may have heard that Larry Ellison is buying the island of Lanai, the sixth largest island in Hawaii. For an estimated price of $500 to $600 million, Ellison will hold a 98% stake of the tropical 141-square mile island nine miles off the coast of Maui. $500 million might sound like a lot but Ellison has net worth estimated at $36 billion and so for him it’s like a typical family buying a bicycle. 

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