Friday, May 07, 2010


Quite the interesting remote boxing match this morning on CNBC between the heads of the NYSE and NASDAQ.

Distilled to its essence, the mudslinging between the two chiefs consisted of Duncan Niederauer claiming that the "other exchange," i.e., NASDAQ, had insufficient liquidity to support market orders, while NASDAQ's Bob Greifield accused the NYSE's specialists of, once again, stepping away from filling orders for 90 seconds in an already-plunging market.

Who's right?

It matters, because the NYSE is voiding many trades which rewarded buyers at the very-low prices available once the NYSE's specialists abdicated their role.

Worse, as various pundits noted, many of the institutional buyers brave enough to step in at the bottom and buy, sold out before 4PM for nice gains. Now, they entered this morning short and had to cover.

Whether retail or institutional, investors don't need this sort of game being played. I'm not talking about the plunge in prices, but the arbitrary post-hoc decision to void selective trades. The most profitable, of course.

Funny how that worked, isn't it?

My feeling is that Niederauer's NYSE is the culprit here, not Greifield's NASDAQ. People want to trade, and often allow existing routing systems to "find" the best price. If the NYSE is effectively taking a break, those orders will go to the NASDAQ. If that means lower volume, and automated programs are stepping away lower with bids to buy as sell volume builds, so be it.

Whether it's 1987 or now, using a "market order" during a panic is an invitation to disaster. You have knowingly surrendered to uncontrollable market pricing forces.

If anything, this shows, again, for the zillionth time, that NYSE specialists will violate their duty and step away rather than do their job and provide market liquidity when it goes against them.

Some Eye-Opening Data On Fannie Mae

On Wednesday, I wrote this post comparing Fannie Mae and Freddie Mac to the Second Bank of the United States of the early 1800s.

Yesterday, two sources provided some absolutely eye-opening numbers on Fannie.

On CNBC, a reporter noted that the last eleven quarters resulted in, I believe, a $30B loss, which was itself equivalent to the GSE's profit of the prior 30 years. The occasion of this report was yesterday's "earnings," meaning loss announcement by Fannie, of $8B for the first quarter of 2010.

The Wall Street Journal noted, in its lead staff editorial, that Fannie and Freddie were leveraged twice as highly as Bear Stearns.

The Journal piece also stated,

"By concealing how much they (Fannie and Freddie) were gambling on risky subprime and Alt-A mortgages, these companies sent bogus signals on the size of these markets and distorted decision-making throughout the system. Their implicit government guarantee also let them sell mortgage-backed securities around the world, attracting capital to U.S. housing and thus turbocharging the mania."

No private company could sustain this behavior. It would have been bankrupt several years ago, if it looked remotely like either GSE now does.

Of course, it's also evidence of what happens when a government-underwritten entity "competes" in the economy. It drives out all private sector competitors. In the case of mortgage conduits, no private conduit could remain in the broad, mid-market space occupied by the GSEs. Only the jumbo-loan high end could support private conduits, and they dried up in the mortgage meltdown.

As it now stands, Fannie and Freddie have lost $126.9B through the end of last year, and have no limit on the amount of losses we, the taxpayers, will subsidize going forward.

It's a stunning account of horrible management being propped up, and a money-losing strategy being bankrolled with no limit.

How can any economy prosper with business models like these funded in perpetuity?

Thursday, May 06, 2010

Bear Stearns' James Cayne Declares He Was Innocent

I didn't see all of yesterday's FCIC hearings, but I did hear/see the beginning of former Bear Stearns Chairman James Cayne's testimony.

This morning, I read the Wall Street Journal's recap of his remarks. It makes for rather sad reading, as the article noted that not one of the defunct investment bank's five former executives admitted responsibility for the firm's demise.

According to the Journal, Cayne said,

"Bear Stearns's collapse was not the result of any actions or decisions unique to Bear Stearns. Instead, it was due to overwhelming market forces that Bear Stearns, as the smallest of the independent investment banks, could not resist."

So, after admitting that Bear's 42:1 leverage was "too high," Cayne never the less avoided and evaded taking any blame for knowing that, and allowing it.

Instead, he and his crew of former high-fliers at the firm blamed the market.

It reminds me of a lesson I learned years ago at Chase Manhattan Bank.

We were investigating, at the direction of our CEO, the productivity and profitability of the bank's securities trading business. This necessitated a few meetings with the unit's manager, an SVP. At the time, this was a fairly lofty and unassailable position at the bank.

My partner and I asked what were evidently off-putting and potentially embarrassing questions of the SVP in question, who, for this post, shall remain nameless.

In particular, when we examined the relationship between the unit's trading volumes, bonuses, profits and operations costs and requirements, it became clear what was going on. The unit required expensive facilities capacity from its IT group, but felt it should pay the lowest estimated IT costs in the industry for that type of trading.

When comparing volumes and profits, it was clear that the unit's traders and managers enjoyed outsized bonuses, but didn't take any serious losses in calm or unprofitable markets.

The SVP's response was, laughably, that in good markets, he and his traders added a lot of value but, when markets were bearish, well, that was not something they could control, so losses weren't their fault.

Sound familiar? It's like all of these large bank trading execs read the same business management manual full of aphorisms designed to let them share in gains but always avoid 'market-related losses.'

This is neither a new, nor surprising contention. It's just that Cayne's and his fellow former Bear Stearns executives' explicit statement of it is particularly nauseating, in light of events.

Berkshire's Burlington Northern Deal Finally Gets Scrutiny

Last November, I wrote this post concerning Berkshire Hathaway's offer to purchase Burlington Northern railroad.

Among my observations were these,

"First, because Berkshire already owned 22% of BNI, Buffett was able to secure a private screening of the recent board presentation. As an effective insider, then, Buffett had special knowledge that you or I don't about the company's recent and prospective performance.

I don't believe such knowledge made the ultimate difference in Buffett's offer, but it does show how and why Buffett can get deals you cannot. And won't be hauled into court, either, for doing them. Like, oh, say a Sri Lankan-born hedge fund manager?

It also explains why Buffett doesn't want competition in this bid. If he had approached the BNI management publicly, and/or with an investment bank, he may have had one or more hedge funds quickly raise the price through arbitrage.

But right now is a good time to buy. While liquidity is high, M&A activity hasn't re-ignited yet on a large scale. There probably isn't a single business competitor who is positioned to take BNI without anti-trust issues. And it would take some time for even a few private equity groups to collaborate on a bid for BNI. Plus, they tend to want quicker returns than Buffett will accept.

Again, here is where Buffett gets opportunities others do not. How many investors would sit still for being told that a $44B acquisition is carrying a 30% premium and may not pay off for a decade? Most would redeem at the next quarterly window."

Well, it seems I wasn't the only one who noticed this latent unfairness. The Wall Street Journal reported this morning that the SEC is looking into Berkshire's/Buffett's possible violation of "13D," a regulation governing how and when large shareholders must inform other shareholders of the former's "plans or proposals" to take control of the firm.

In the Burlington Northern case, one could argue that Buffett triggered that when he made his oral offer to buy the shares of the firm that Berkshire didn't already own.

The Journal goes on to note that this informal, quiet approach, which Buffett so often uses, tends to depress the acquisition prices he must pay for his targets.

Hmmm....sounds sort of, well, illegal and cronyistic, doesn't it? A large firm's wealthy, influential CEO being allowed liberties with SEC regulations that ordinary investors don't get?

The Journal piece notes that enforcement of 13D

" has long fallen into a gray area. Potential buyers are loath to disclose a potential deal, fearing that it could upset their ability to complete the transaction. The SEC, meanwhile, has shown only spotty attention to this area of the law over the years, say securities attorneys."

According to one attorney quoted in the Journal article,

"Once the large shareholder decides that it plans to make an offer, that is a material change. You have a duty to amend your 13D filing promptly. There is no real dispute on this."

This would, of course, have affected several of Buffett's prior deals, but, most significantly, the recent BNI caper.

It's no doubt wildly naive and optimistic to believe that Buffett will be vigorously pursued and charged in this matter. The guy has managed to so ingratiate himself with Congress and the current administration that it would be like sending your own grandfather to jail if Buffett were appropriately dealt with in this matter.

How's that for crony capitalism?

Wednesday, May 05, 2010

Congress Remains Silent On The Modern Bank of The United States- Fannie & Freddie

Robert Wilmers, CEO of M&T Bank Corporation, wrote a hard-hitting editorial in yesterday's Wall Street Journal entitled, bluntly, "What About Fan and Fred Reform?"

In the past few weeks, much has occurred in Congress and the administration which smacks of trying to supercharge the rush to poorly-thought, badly-drafted finance so-called "reform."

The Dodd bill is, of course, quite far from real, effective reform. And that's if we actually believed that the Congressional panel formed to investigate the recent financial crisis had completed its job. And various pundits and officials had contributed credible, objective testimony, while meaningful, measurable criteria were advanced and adopted for assessing the US financial system's health and effectiveness.

Mr. Wilmers is the CEO of a rather quotidian commercial bank. It's not a former investment bank now reborn as a commercial bank. It's not a money center bank in New York.

Thus, Mr. Wilmers' observations have some credibility and a lack of obvious bias.

He wrote, at length, about how huge and problematic Congress has allowed the two GSEs to become,

"Congress may be making progress crafting new regulations for the financial-services industry, but it has yet to begin reforming two institutions that played a key role in the 2008 credit crisis—Fannie Mae and Freddie Mac.

We cannot reform these government-sponsored enterprises unless we fully confront the extent to which their outrageous behavior and reckless business practices have affected the entire commercial banking sector and the U.S. economy as a whole.

At the end of 2009, their total debt outstanding—either held directly on their balance sheets or as guarantees on mortgage securities they'd sold to investors—was $8.1 trillion. That compares to $7.8 trillion in total marketable debt outstanding for the entire U.S. government. The debt has the implicit guarantee of the federal government but is not reflected on the national balance sheet.

To date, the federal government has been forced to pump $126 billion into Fannie and Freddie. That's far more than AIG, which absorbed $70 billion of government largess, and General Motors and Chrysler, which shared $77 billion. Banks received $205 billion, of which $136 billion has been repaid.

Fannie and Freddie continue to operate deeply in the red, with no end in sight. The Congressional Budget Office estimated that if their operating costs and subsidies were included in our accounting of the overall federal deficit—as properly they should be—the 2009 deficit would be greater by $291 billion."

Does anyone seriously doubt that any attempt at effective regulatory change of this sector will fail without addressing- and fixing- Fannie and Freddie?

Then Mr. Wilmers concludes with this knockout blow,

"According to a 2004 Congressional Budget Office study, the two GSEs enjoyed $23 billion in subsidies in 2003—primarily in the form of lower borrowing costs and exemption from state and local taxation. But they passed on only $13 billion to home buyers. Nevertheless, one former Fannie Mae CEO, Franklin Raines, received $91 million in compensation from 1998 through 2003. In 2006, the top five Fannie Mae executives shared $34 million in compensation, while their counterparts at Freddie Mac shared $35 million. In 2009, even after the financial crash and as these two GSEs fell deeper into the red, the top five executives at Fannie Mae received $19 million in compensation and the CEO earned $6 million.

This is not private enterprise—it's crony capitalism, in which public subsidies are turned into private riches. From 2001 through 2006, Fannie and Freddie spent $123 million to lobby Congress—the second-highest lobbying total (after the U.S. Chamber of Commerce) in the country. That lobbying was complemented by sizable direct political contributions to members of Congress.

Changing this terrible situation will not be easy. The mortgage market has come to be structured around Fannie and Freddie and powerful interests are allied with the status quo. I recall a personal conversation with a member of Congress who, despite saying he understood my concerns about the two GSEs, admitted he would never push for significant change because "they've done so much for me, my colleagues and my staff." "

When I read these last three paragraphs, I was instantly reminded of President Andrew Jackson's campaign against Nicholas Biddle's Second Bank of the US. A quasi-governmental entity so entwined with the federal government's officials and Congress that the two could not wean themselves from the Bank.

Biddle contributed to many Congressional campaigns, calling to mind Wilmers' reference to his member of Congress friend.

The Second Bank of the US dominated politics for four years. Fannie and Freddie could do so, now. They are that powerful, corrupt, and entangled with the nation's financial troubles and system.

Tuesday, May 04, 2010

Just What Is "Proprietary Trading" Anyway?

Much has been made recently of the belief that "proprietary trading" did not actually cause the demise of Bear Stearns or Lehman Brothers, and, thus, is of no consequence in the evolving FINREG bill.

I believe this is wrong. It takes too narrow a view of just what proprietary trading actually entails.

To me, proprietary trading may technically define or describe only those as-principal activities on an investment or commercial bank's trading desks which risk the firm's own capital.

However, the broader notion meant by people like Paul Volcker, in articulating his Volcker Rule is, I believe, that of the risking of a bank's capital on any underwriting, long term investments or high-frequency trading for its own account.

The key common element isn't the duration, which could rule out proprietary trading as the culprit of some now-defunct banks' woes, but, rather, the risking of the bank's own capital in market-valued instruments and activities.

When banks which do this are also in the business of taking insured deposits, then they are implicitly being backed by the FDIC and, ultimately, taxpayers.

Lehman was brought low, in part, by the poor quality of the commercial mortgage assets it chose to hold on its books. That was proprietary investment.

Bear Stearns was believed, by its commercial bank lenders, to have asset quality problems which made those overnight loans too risky.

Were the assets the result of trading, or underwriting, or investment? Doesn't really matter.

They were owned by the firm, and lost more value than there was equity to back them.

Trading...investment.....really, what's in a word, in this case? The time dimension isn't what is important when considering the reform of financial regulations and structure regarding a bank's risk exposure while also taking insured deposits.

The source of the risk capital is.

Monday, May 03, 2010

The Demonization Of Goldman Sachs & The Profit Motive

One of the apparent casualties of last week's unprincipled bullying of Goldman Sachs personnel by a handful of Senators was the legitimacy of the profit motive in trading and investment banking.

Once you wade through the political posturing of the Senators, and their general inability to understand that which they excoriated, you are left with a Congressional disposition against professional investors in the capital markets making money by risking capital on positions over any timeframe.

To my recollection, nobody ever believed Salomon Brothers' original CMO activities, arranged between professional investors, were altruistic. Salomon was a hard-charging, take-no-prisoners investment bank. Nobody who traded with them as a principal, or bought their underwritings, thought the fixed-income titan was doing them a favor.

Simply put, trading with investment banks isn't a sport and it's not for naive or non-professional investors. And by "trading," I mean buying from an investment bank for the purpose of holding the security.

Every professional investor, including investment committees of unions and such, knows, or should know, that no investment bank underwrites or trades securities as a principal solely for the investor's benefit. The banks do these activities to make money. So that means they expect what they sell to fall in price, or rise less than what they buy, and what they buy to rise in price, or fall less than what they sell.

What is so hard to understand about this?

Unlike selling food, cars, or vacuum cleaners, the buying and selling of securities involves making judgements on the future performance of said securities. You buy food to eat. You buy securities as a store of value.

Thus, by definition, the seller of that store of value, if it is an investment bank acting for its own account, is implicitly telling you they have better options for their own money than holding that which they sell to you.

If the Abacus deal and subsequent witch hunts into Goldman Sachs' behavior by the SEC and Justice Department demonize the business of trading, as principals, by investment banks, we have a major disconnect between our elected and appointed dummies in Washington and the realities of capital markets.

Warren Buffett Dances Around Conflict of Interest Questions On CNBC This Morning

I've been watching/listening to Warren Buffett on CNBC this morning. It's pretty sickening to watch the network's anchors venerate Buffett and treat him with kid gloves, while he does his grandfatherly chortling act.

Nauseating. It's just nauseating and disgusting what major business media lets this guy get away with.

This weekend, of course, was the Berkshire Hathaway annual meeting. As usual, CNBC and the Wall Street Journal covered it as the carnival it has become, with Buffett as the center of all adulation and worship.

This morning, in one of her annual personal interviews with Buffett, Becky Quick managed to at least ask Buffett if backing Goldman, as he so strongly has, is not "talking his book?"

In response, Warren employed his now-famous 'as shucks' guffaw, and only said, to paraphrase,

'I'm answering because you asked me a question.'

In effect, actually ducking the key question.

Quick, of course, declined to pursue with a tougher follow up, and let Warren skate away looking magisterial as well as simple.

The truth is, of course, that Buffett was talking his book.

The Wall Street Journal article discussing Buffett's sudden interest in derivatives regulation and defense of Goldman only noted that "to an extent" Buffett could be expected to protect his investment.

My God!

Can't even the Journal just come out and say Buffett is stumping for his investments by backing Goldman Sachs and Lloyd Blankfein to the hilt? After all, if I'm not mistaken, Buffett got warrants along with a nice coupon rate on that big loan to Goldman.

When CNBC's Joe Kernen asked Buffett if the Senate crucifixion of Goldman Sachs' personnel this past week wasn't over the top, Buffett let loose with "the chuckle," then went on to 'aw shucks they're only bein' Senators, by gum' it past any serious remarks about the unseemly spectacle.


Well, that FINREG bill isn't finished yet. Buffett isn't about to enrage all those powerful Democratic Senators who could cost Berkshire so much money in constantly-marked-to-market derivatives. So Buffett is staying the hell away from any criticism of Congress. Or the administration, for that matter.

Then there was Buffett's defense, both in the Journal and on CNBC, again, this morning, of the Moodys and S&P ratings agencies. A blind man could see these firms were atrociously derelict in the execution of their Congressionally-granted franchise. Possibly even fraudulent, as they rated some mortgage-backed issues AAA way too early, in light of subsequent performance.

Why Buffett is defending these firms is harder to understand. Perhaps it's because he is worried that, if the ratings agencies are seriously impacted by regulation changes, a lot else in Buffett's world could change- and for the worse.

Honestly, it's sickening to see all the major business media treat Buffett like this. They all want access and advertising, so nobody will call Buffett on his double standards, special treatment, use of the country boy image to deflect hard, meaningful, potentially damaging questions.

Isn't anyone ever going to expose this guy for gaming the system while getting away with actions which would get others hauled before Congress?