The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Durable goods orders, ex non defense aircraft, rock!

Mar Durable Goods headline unexpectedly fell by 1.3% vs a forecasted rise of .2% BUT, ex transports, orders rose a solid 2.8%, well above estimates of a gain of .7%. Non Defense Capital Goods ex Aircraft rose 4% after a 2.1% gain in Feb and is up 12.5% y/o/y. A 67% drop in non defense aircraft weighed on the top line, offsetting the 2.2% gain in vehicles/parts. Helping the core portion were solid gains in computers/electronics, electrical equipment, machinery and primary metals. Inventories rose .2% but the inventory to shipments ratio fell to 1.67 from 1.69 as shipments, which get directly plugged into GDP, rose 1.2%. Bottom line, the figure ex aircraft was solid and gives even more reason for the FOMC next week to alter, whether thru rhetoric or action, their extraordinarily accommodative stance.

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In response to the cnbc report earlier that some Fed members are becoming more vocal about, sooner rather than later, selling some of the MBS they just finished buying, the 30 yr FNMA coupon is up 4 bps to a 2 week high and the spread to the benchmark 10 yr yield is at 70 bps, the widest since March 2nd. It got as tight as 59 bps on March 10th and was as wide as 237 bps in March ’08. The Fed started their purchase program in Nov ’08 in order to not only lower mortgage rates but to compress the spread between MBS and US Treasuries. It was completed at Q1 end.

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March New Home Sales totaled 411k, 86k above expectations as the clock ticks on the expiration of the home buying tax credit and buyers rush to take advantage. It’s the highest since July ’09 and Feb was revised up to 324k from the initial record low reading of 308k. Combining the improved sales with a reduction in the absolute number of homes for sale and the inventory to sales ratio fell to 6.7 from 8.6. While the world changes on May 1st in terms of the action of the first time home buyer, inventory levels of new homes going into it has been trimmed to a good extent but unfortunately the market is still plagued by a still high rate of foreclosures of existing homes.

Not surprisingly, Greece has officially asked for EU/IMF help. The melt down in their bond market this week made it an inevitability. The 45b of euros that will come their way will help in the short term but for the long term financial health of the country, it just bides time for an economy that will highly unlikely be able to grow out of their trouble and will at some point be back for more help. A debt restructuring would have been the best long term option for them, however painful in the short term it would have been. A region of bailouts for profligate countries does not a healthy union make and maybe that’s why the euro is seeing no bounce on the news. Greek bonds are rallying, CDS are narrowing and stocks are higher. Also helping European stocks was the April German IFO business confidence # which was 3 pts above expectations at the highest since May ’08.

US Treasuries are selling off after cnbc is reporting that more members of the Fed are pushing to start selling their $1.25t of MBS at some point soon. The FOMC meets next week and the pressure is clearing building on them to do something, whether thru rhetoric or action, to reverse their emergency monetary policy and QE that has been in place beginning in late ’08. Asset sales will likely be the first step of this process but considering the dovish stance of Bernanke, Kohn and Yellen, it won’t happen imminently.

I have been watching with a mixture of awe and dismay some of the really bad analysis, sloppy reporting, and just unsupported commentary about the GS case.

I put together this list based on what I know as a lawyer, a market observer, a quant and someone with contacts within the SEC. (Note: This represents my opinions, and no one elses).

Ten Things You Don’t Know (or were misinformed by the Media) About the GS Case

1. This is a Weak Case:  Actually, no — its a very strong case. Based upon what is in the SEC complaint, parts of the case are a slam dunk. The claim Paulson & Co. were long $200 million dollars when they were actually short is a material misrepresentation — that’s Rule 10b-5, and its a no brainer. The rest is gravy.

2. Robert Khuzami is a bad ass, no-nonsense, thorough, award winning Prosecutor:  This guy is the real deal — he busted terrorist rings, broke up the mob, took down security frauds. He is now the director of SEC enforcement. He is fearless, and was awarded the Attorney General’s Exceptional Service Award (1996), for “extraordinary courage and voluntary risk of life in performing an act resulting in direct benefits to the Department of Justice or the nation.”

When you prosecute mass murderers who use guns and bombs and threaten your life, and you kick their asses anyway, you ain’t afraid of a group of billionaire bankers and their spreadsheets. He is the shit. My advice to anyone on Wall Street in his crosshairs: If you are indicted in a case by Khuzami, do yourself a big favor: Settle.

3. Goldman lost $90 million dollars, hence, they are innocent:  This is a civil, not a criminal case. Hence, any mens rea — guilty mind — does not matter. Did they or did they not violate the letter of the law? That is all that matters, regardless of what they were thinking — or their P&L.

4. ACA is a victim in this case: Not exactly, they were an active participant in ratings gaming. Look at the back and forth between Paulson’s selection and ACAs management. 55 items in the synthetic CDO were added and removed. Why?

What ACA was doing was gaming the ratings agencies for their investment grade, Triple AAA ratings approval. Their expertise (if you can call it that) was knowing exactly how much junk they could include in the CDO to raise yield, yet still get investment grade from Moody’s or S&P. They are hardly an innocent party in this.

5. This was only one incident: The Market sure as hell doesn’t think so — it whacked 15% off of Goldman’s Market cap. The aggressive SEC posture, the huge reaction from Goldie, and the short term market verdict all suggest there is more coming.

If it were only this one case, and there was nothing else worrisome behind it, GS would have written a check and quietly settled this. Their reaction (some say over-reaction) belies that theory. I suspect this is a tip of the iceberg, with lots more problematic synthetics behind it.

And not just at GS. I suspect the kids over at Deutsche bank, Merrill and Morgan are working furiously to review their various CDOs deals.

6. The Timing of this case is suspect. More coincidental, really. The Wells notice (notification from the SEC they intend to recommend enforcement) was over 8 months ago. The White House is not involved in the timing of the suit itself, it is a lower level staff decision.

7. This is a Complex Case:  Again, no. Parts of it are a little more sophisticated than others, but this is a simple case of fraud/misrepresentation. The most difficult part of this case is likely to turn on what is a “material omission.” Paulson’s role in selecting mortgages may or may not be material — that is an issue of fact for a jury to determine.  But complex? Not even close.

8. The case looks thin: What we see in the complaint is the bare minimum the prosecutor has to reveal to make their case. What you don’t see are all the emails, depositions, interrogations, phone taps, etc. that the prosecutors know about and GS does not. During the litigation discovery process, this material slowly gets turned over (some is held back if there are other pending investigations into GS).

Going back to who the prosecutor in this case is: His legal reputation is he is very thorough, very precise, meticulous litigator. If he decided to recommend bringing a case against the biggest baddest investment house on Wall Street bank, I assure you he has a major arsenal of additional evidence you don’t know about. Yet.

Typically, at a certain point the lawyers will tell their client that the evidence is overwhelming and advise settling. That is around 6-12 months after the suit has begun.

9. This case is Political: I keep hearing that phrase, due to the SEC party vote. It is incorrect. What that means is the case is not political, it means it has been politicized as a defense tactic. There is a huge difference between the two.

10. I’m not a lawyer, but . . . Then you should not be ignorantly commenting on securities litigation. Why don’t you pour yourself a tall glass of STF up and go sit quietly in the corner.

I have $1,000 against any and all comers that GS does not win — they settle or lose in court. Any takers? My money is already in escrow — waiting for yours to join it. Winnings go to the charity of the winners choice.

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Previously:
Questions Surrounding the SEC’s Litigation vs Goldman (April 17th, 2010)
http://www.ritholtz.com/blog/2010/04/questions-sec-litigation-vs-goldman-sachs/

PBS: ‘Strategic Defaulters’ Skip Mortgage Payments as Home Values Tumble

AIR DATE: April 20, 2010

As part of his continuing series of reports making sense of economic news, Paul Solman tells the story of some homeowners who have stopped paying their mortgages even though they can still afford them.

Hat tip Tim Iacono

Top Ten Goldman Sachs Excuses from April 20, 2010.

Hat tip Paul

Quite an interesting reading list today:

• Take apart Goldmans SEC defense line by line, and it does not look pretty for GS: Fisking Goldman’s latest rebuttal (FT Alphaville)

• Mark Hulbert: A rare buy signal with a good record (Marketwatch)

• The Fed Is All Wrong About Inflation (Yahoo Tech Ticker)

• Why Technical Analysis Matters  (AAII)

• Michael Lewis: Bond Market Will Never Be the Same After Goldman (Bloomberg)

• Some “Inside Baseball” On The Goldman Case (Bianco Research)

•  Paid off? GM Still Owes Us $43B (Forbes)

• Changes in the $100 bill since 1860 (Chicago Tribune)

• MarijuanAmerica  (Rolling Stone)

• I’m in deep trouble:  New speed cameras trap motorists from space (Telegraph)

What are you reading ?

Another good infographic, via the WSJ:
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Source:
The Busted Homes Behind a Big Bet
CARRICK MOLLENKAMP , MARK WHITEHOUSE And ANTON TROIANOVSKI
WSJ, April 22, 2010   
http://online.wsj.com/article/SB10001424052748704133804575198120387721724.html

In the post below we said that the Goldman case is a game changer. We said that based on two assumptions. One was that Goldman loses its case.

In the last 90 minutes we came across some “inside baseball” reporting that can help investors determine whether or not the SEC will win its case.

• Bloomberg.com – Goldman SEC Case May Hinge on Meaning of ‘Selected’
  The case against Goldman Sachs Group Inc. may turn on the meaning of the word “selected.” The Securities and Exchange Commission must prove that the most profitable company in Wall Street history defrauded investors by failing to disclose that a hedge-fund firm betting against them played a role in creating what they bought. It must also counter Goldman Sachs’s assertion that an independent asset manager, which the SEC said rejected more than half of the securities initially proposed by Paulson & Co. for a collateralized debt obligation, signed off on the selections. “The question is whether Paulson’s undisclosed role in portfolio selection was material,” said Larry Ribstein, a law professor at the University of Illinois in Champaign who has written about 140 articles and 10 books on topics including securities law and professional ethics. “There’s no clear and well-defined definition of what you have to disclose in this type of transaction.” The SEC case signals the regulator could eventually target other banks over how much they told investors about at least $40 billion of CDOs that turned toxic as mortgage defaults soared to the highest level since the 1930s. Robert Khuzami, the SEC enforcement chief, said last week that the agency will aggressively pursue deals “that share similar profiles.”

Comment
This story above is a rather long story and does a good job of laying out all the legal issues in this case as they are known based on a detailed reading of the SEC complaint.
Is Abacus 2007-AC1 Unique?

• CNBC – Goldman Only Did One Deal With Hedge Fund: Paulson AideAccording to sources who have read Paolo Pellegrini’s deposition in the Goldman fraud case and spoken with him, the former Paulson hedge fund manager told government attorneys that the mortgage securities deal—called Abacus—was the only one Paulson arranged with Goldman Sachs that had a neutral third party selecting the securities. The revelation raises questions about how widespread the alleged fraud is on Wall Street. While reports suggest the government is looking into other such deals, Pellegrini’s testimony suggests this particular transaction was limited. The SEC filed a civil suit against Goldman on Friday, accusing the Wall Street investment bank of misleading investors by not disclosing that Paulson’s hedge fund picked securities for the deal and then shorted—or bet against—them. Goldman denied the allegations. Paulson and Pelligrini have not been accused of any wrongdoing. In fact, according to Pellegrini, Paulson was only able to suggest what securities would go into Abacus. Instead, ACA Management—a unit of financial insurer ACA Financial Guaranty—was the primary agent in deciding what securities were included in the deal, as Goldman claims.

Comment
The story above is based on the video below, it appears that Steve Liesman of CNBC has access to deposition or other facts in the SEC case. Perhaps he has been talking to Paolo Pellegrini, Paulson’s former head trader who is believed to be a key witness for the SEC. We have found no one else that is reporting on case specifics beyond what was in the SEC complaint.

Liesman reports that the Abacus 2007-AC1 deal (pitchbook) was somewhat unique in that it was Paulson’s only CDO that used a neutral third party manager to select collateral (ACA management) or “bespoke” deal. Pauslon did other CDO deals where they picked the collateral directly and it was disclosed as such. What is not clear is if Paulson’s economic interest in those deals failing was also properly disclosed.

The implication is if Goldman loses this case it will not lead to a precedent that will spread to many other CDOs.

Liesman is also reporting on the collateral selection for Abacus 2007-AC1. Paulson originally proposed 123 deals be included. ACA rejected 55 of them. Then Paulson expanded his criteria to find more deals. ACA and Pauslon went back and forth until enough deals were included to satisfy rating agency criteria to get the desired ratings for the CDO.

As we interpret Liesman’s words (feel free to disagree), ACA was not tossing out deals because they thought they were bad for CDO buyers, but ACA was using its expertise to game the rating agencies to make sure the deal got the desired credit ratings to make it work.

Liesman also reports that “someone close to Pellegrini” says that ACA selection criteria “stacked the deck” against Paulson’s short position therefore implying that this deal is not as fraudulent as it appears. They also point out that ACA “took down” (we believe he means wrote protection against) $840 million of the $1.1 billion deal. What is not clear is if ACA did this to get the deal done and then “re-insured” this exposure with a firm like AIG right after it closed.

If you are interested in the “inside baseball” of this case, this four minute interview is worth a look.

Finally, the following video is a conversation with Josh Rosner, managing director of Graham Fisher, and Jesse Eisinger, a reporter with Propublica. It was one of the better and more informed conversations about this case.