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

My morning reading material:

• Explaining the JPM trade that blew up: Whale-Watching Tour: Too Big To Hedge (FT.com) see also The unconventional hedge, redux (FT.com)
• The Case for Global Accounting (NYT)
• Gas prices: Down and headed lower (CNN Money)
• Goldman Hoards Italy’s Debt (WSJ)
• Twitter Rent Surge Makes San Francisco Best Office Market (Bloomberg)
• Attain presents Why Alternatives?: Global Debt Panel at CFA (Attain Capital Management)
• Bartlett: How the Rich Make Us All Better Off (The Fiscal Times)
• The Washington Post Co.’s Self-Destructive Course (Columbia Journalism Review)
• Leaked DHS memo: Pornoscanners don’t work (BoingBoing)
• Gay marriage, Obama and the fierce urgency of now: Why did he do it this week? (Yahoo News)

What are you reading?

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Polarised prospects


Source: The Economist

The disclosure by once future Treasury Secretary and current JP Morgan CEO Jamie Dimon of a sudden and previously undisclosed $2 billion dollar derivative loss should be a wake up call. It unwittingly reveals much about the present state of finance:

• The inherent tension between traders using leveraged risk with Other People’s Money in the pursuit of enormous bonuses is still weighed heavily towards excess risk taking;

• There is no bank in the United States that has demonstrated the ability to manage proprietary trading risks — if they use derivatives and/or leverage;

• It took less than 3 years after the financial crisis peaked for traders to engage in the same sorts of highly leveraged reckless speculative bets that helped crash the economy last time. Imagine the sorts of risks these mis-incentivized desks will be doing when the memories of the crisis fade 10 years after.

• Trades that are so enormous as to be “credit index distorting” are not hedges, but pure speculation. Within banks, apparently the word “Hedging” loosely translates as “speculation.” Actual hedging of existing positions appears to be nonexistent.

• VaR remains a mostly useless concept as applied by banks today. It is a false model of reality whose deviations have devastating consequences. (Call it physics envy)

• At these size trades, the asymmetrical preference for bonuses over risk management is such that even clawbacks won’t work;

• Jamie Dimon, formerly praised as the Capo di tutti capi of bank CEOs, apparently has been more lucky than brilliant. This quarter, his luck ran out.

• Derivatives, because of their enormous built in leverage, are inherently dangerous. They are still financial weapons of mass destruction;

• Too big to fail banks remain a threat to the stability of the global economy.

While this was “only” a $2 billion loss it easily could have been much greater. That banks such as JPM are still putting on trades that distort indices is quite bluntly, astonishing.

The solution to this risk is very very simple: The USA should reinstate Glass Steagall, and repeal the Commodity Futures Modernization  Act.

Until that occurs, the risk of catastrophic failure remains present in the financial system.

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Disclosure: Long JPM

Abstruse Goose: Fill it up with unregulated:

Abstruse Goose

Following up on a previous matter, Karl Denninger  posted what is supposed to pass for a rebuttal to my recent post on government spending. To my eyes, as Jay Bookman so aptly put it, it looks like “the octopus trick, squirting black ink to cloud your retreat.” True enough. Anyway, done with that discussion.

Paul Krugman presents a chart in his new book, End This Depression Now, that just screamed at me for replication and a bit of enhancement, so here it is. Professor Krugman wrote about the ongoing cries of the bond vigilantes, who have been warning for about three years running that we were on the cusp of runaway inflation and skyrocketing interest rates any day now. I have documented this a bit myself over the past three years (in response to Bowyer and Laffer  here in July 2009, and again here last year), but Professor Krugman’s chart inspired me to revisit this topic.

Below is a chart of the US 10-year Treasury, including clearly marked points in time at which we heard from various vigilantes (including, regrettably, President Obama). The 10-year yield at the time of the comment is indicated.

Source: St. Louis Fed, Series DGS10. Markers placed on a best efforts basis.

In chronological order:

May 2009, The Wall Street Journal, The Bond Vigilantes. 3.67 10-year. Money shot:

It’s not going too far to say we are watching a showdown between Fed Chairman Ben Bernanke and bond investors, otherwise known as the financial markets. When in doubt, bet on the markets. [Ed. note: Assuming the Journal still believes an investor's best bet is "on the markets," what would be its advice now with a ~1.84 (May 8 close) 10-year?]

June 2009, Arthur Laffer in The Wall Street Journal, Get Ready for Inflation & Higher Interest Rates. 3.81 10-year. Money shot:

Reduced demand for money combined with rapid growth in money is a surefire recipe for inflation and higher interest rates. The higher interest rates themselves will also further reduce the demand for money, thereby exacerbating inflationary pressures. It’s a catch-22. It’s difficult to estimate the magnitude of the inflationary and interest-rate consequences of the Fed’s actions because, frankly, we haven’t ever seen anything like this in the U.S.

July 2009, Jerry Bowyer, in National Review Online, We’re All Inflation Hawks Now. 3.63 10-year. Money shot:

But what happens when the [monetary] floodgates open? At some point the banks will have to release a river of liquidity. Consumers are demanding it, Congress is demanding it, and even President Obama is demanding it. (That last one may well be the clincher.)

November 2009, President Obama, Interview with Fox News. 3.33 10-year. Money shot:

“I think it is important, though, to recognize if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the U.S. economy in a way that could actually lead to a double-dip recession.”

December 2009, Morgan Stanley Sees 5.5% Note as U.S. Faces Deficits. 3.69 10-year. Money shot:

The surge will push interest rates on 30-year fixed mortgages to 7.5 percent to 8 percent, almost the highest in a decade, Greenlaw said.

March 2010, Wall Street Journal (as a news story, not an editorial), Debt Fears Send Rates Up. 3.84 10-year. Money shot:

And some argue that the bond market has been too confident about these longer-term rates remaining low, at a time when the economy is slowly improving and the government is running huge budget deficits.

April 2011, Bond King Bill Gross, LA Times, Gross Boosts Bet That Treasury Bond Yields Will Surge. Even the best and brightest make mistakes. 3.52 10-year. Money shot:

As the U.S. Treasury gets set to issue another $66 billion in notes and bonds this week, Pimco bond guru Bill Gross has a message for potential buyers: Stay away.

August 2011, Standard & Poor’s downgrades the credit rating of the United States. ~2.50 10-year.

Now, there’s getting it wrong because you modeled it wrong, and getting it wrong because you’re a political operative first and economist or market pundit second. Both are on display above. The political operatives, who to this day are still making noise about Weimar in the United States tomorrow, simply refuse to acknowledge the mechanics of a liquidity trap. I know Gross, to his great credit,  has done some very public navel-gazing on this matter. Too bad the same can’t be said for the likes of Bowyer, Laffer, or the Journal.

@TBPInvictus

My afternoon train reading:

• WTF? Bernanke Gets 75% Approval From Investors in Global Poll (Bloomberg)
• Gold Losing Its Luster (WSJ)
• Avoiding the Next Big Bailout (WSJ) see also Breaking Up Four Big Banks (Economix)
• Still time to make money in Treasury bonds (Market Watch)
• SEC Disagrees with Supreme Court’s Anti-U.S. Investor Morrison Decision (Angry Bear)
• Technology Industry Seen Growing Fastest in New York (NYT)
• Two brilliant moves that helped create the Apple iOS powerhouse (Dalton) see also What retail is hired to do: Apple vs. IKEA (Asymco)
• America’s War on Tourists (Slate)
• Solar Installers Offer Deals, Gaining Converts (NYT)
• Gamma-Ray Bending Opens New Door for Optics (Science Mag)

What are you reading?

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For every $1 Google spends lobbying, Apple spends 10¢

Source: CNN Fortune

Hey! I’m a source for this:

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click for full graphic

Read the rest of this entry »

via The Chart Store:

Click to enlarge:

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My morning reading material:

• What Makes a Great Stock Analyst? (WSJ)
• Swedish Banks Pummel EU Peers Wallowing in Laxer Rules (Bloomberg)
• Spain nationalises Bankia as euro crisis escalates (The Telegraph) see also Greeks May Hold $510 Billion Trump Card in Renegotiation (Bloomberg)
• It’s All About the Fraud: Madoff, MF Global & Antonin Scalia (Institutional Risk Analyst)
• The ascent of the shadow economy (FT.com) see also Growth of the shadow economy, charted (FT.com)
• Gross Talks His Books, Says (Asks for) QE3 Getting Closer (Bloomberg)
• Post-Financial Crisis – How do the Major Economic Players Stack Up? (Northern Trust)
• You Hate Taxes, but You Ain’t Moving to Nashville (Bloomberg)
• Facebook IPO: Investors should wait (Market Watch)
• The False Truths of Social Finance (Phil Pearlman)

What are you reading?

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Two annoying problems

Source: Indexed

Doug Kass on Donald Luskin:

Many are concerned that a combination of higher tax rates and lower spending puts the U.S. on a fiscal cliff at year-end. (CNBC’s Maria Bartiromo has been particularly vocal about the subject.)

On the tax point, Don Luskin wrote an op-ed in The Wall Street Journal over the weekend, entitled “The 2013 Fiscal Cliff Could Crush Stocks.”

The essence of Don’s view is, “Do the math on dividend taxes. Yields lower, stock prices lower—maybe by 30%.”

My reaction to the article is that it is hyperbolic and that the analysis (that the dividend tax rate will rise from 15% to 43.4%) is wrong-footed.

Most significantly, the author assumes that 100% of all dividends received by investors are taxed.

This is plain wrong.

Most industry observers calculate that less than one quarter of dividends (between 20% to 25%) are paid out to taxable investors. The balance, or 75% to 80%, are paid to non-taxable investors such as IRAs, pension plans, charitable institutions, etc.

If we make the above adjustment to reality, Don Luskin’s vulnerability of stock prices drop to only 7% (22.5% of a 30% hit).

As well, it is highly unlikely that the tax rate on dividends will triple as the Obama administration has already signaled that this item is open to debate. (And obviously, if Mitt Romney is elected, he will oppose the increase and, at the very least, limit the tax rate rise on dividends to probably something close to the capital gains rate of 20% to 25%.)

Net-net, if the dividend tax rate is increased to the capital gains rate, the calculus is that the potential or theoretical hit to stock prices is closer to 2%, not the 30% that Don Luskin suggests.

Finally, if the dividend tax rate is hiked, corporations will react by substituting some portion of their dividend payments with broader share repurchase programs. (When the dividend tax rate was initially cut to 15%, corporations more aggressively raised dividends and cut back share repurchase activity.)

At James Montier‘s CFA presentation, he used one of my favorite quotes:

“Science advances one funeral at a time.”

-Max Planck

I would add to that:

If only economics were so fortunate . . .