Ringing a (Tiny) Bell

Early in June the current 3-month/10-year Treasury inversion got a lot of attention.

I opined at the time that 10 BPs wasn’t very much, and I wanted to see it persist or widen before calling it a signal. It did that, lasting through the entire month.

First, let me be clear about what it actually tells us. The investors in Treasuries are the most risk-averse US Dollar investors around. There are just over $60 billion of the current 10-year Note, and $35 billion of the current 3-month Bill. Investors in the 10-year Note are totally aware that they can get 2.15% by investing in the Bill, but they are choosing a 2% return instead to avoid having to reinvest in three months.

Why it is a signal:

When serious investors don’t like the prospect for the next few months or year (in terms of reinvestment options at that time), they are choosing to avoid having to make that decision when they tie up their money for 10 years. If they are right, that investment opportunities are going to really suck in the near future, that would be because they think riskless returns are going to be even lower, and they also think returns on risk assets have a high probability of being negative if you buy into them in that time window.

As Larry Kudlow was fond of pointing out before he got his current gig, the 3-month/10-year curve inversion has an amazing track record — seven for seven in modern times. NBER usually lags reality by two or more quarters when it comes to declaring official recessions, so don’t expect to see “we are in a recession” headlines six or twelve months from now. More likely is that, 19 or 20 months from now we will get the “news” that we have had one.

On the bright side, deficit government spending, especially in military and security, is going up at a pretty good clip, and that adds to GDP, though not with the multiplier effect of other kinds of government spending. And there’s the stock market if you want to be in the “don’t worry, be happy” camp.

Ice Dams and Slo-Mo Promo

After several weeks of chipping roof ice, emptying buckets and trash cans, and moving things out of the attic and three rooms, I can finally see the end of winter (by happenstance, just a couple of hours from now, celestially speaking).  And it’s snowing.

Saving my “stuff” and the house from the depredation of water coming in took priority these last couple of weeks.

I did get to spend part of two days giving an interview to an industry publication called “National Mortgage News.”  The reporter, Bonnie Sinnock, has been on the mortgage “beat” for nearly twenty years, so it was a pleasure to speak with her.  She also read all of Finance Monsters before the interview….

Like others who read it and know the people, Bonnie said she laughed out loud at some of the incidents that show readers how the Finance Monsters think and behave.

Snowbound Reading

I got an email today from a friend that I hadn’t heard from in about a year.  Even though we both live in the same state, it seems like arranging the hour+ drive each way doesn’t happen too often these days, for either of us.

He was congratulating me on publishing Finance Monsters, and letting me know that he downloaded it this morning to have some reading during the blizzard that is now getting its act together to bury us in snow.  I’ve also been preparing for the likely two or three days of isolation, and I realized that none of the “emergency” kits suggest some reading.  Plenty of people are encouraged to get more batteries for their junk drawers, gallons of water, full tanks in their cars, etc., but nobody seems to consider stimulating their minds as a necessity they might want to do, even without power.

Like the guy with the bumper stickers that read “Eat More Kale” who won when defending himself against Chik-Fil-A, I think the time has come for bumper stickers that say “Read More Books.”

take care,

hh

I’ve Seen This Movie Before

When a financial market sector is doing well on Wall Street, you can be sure that it will get exploited until it breaks.

One of the ways this happens is through “ratings shopping.”  If one rating agency holds tougher standards, the dealers will go to the others.  If the product is wanted by enough buyers, the credit and disclosure standards begin to slip for the whole market. Lenders, rating agencies or investors who insist on higher standards are basically forced out of business.

In Finance Monsters, I did give the Rating Agencies a partial defense for their ratings on subprime bonds, but the news this week is indefensible. Today the SEC announced a settlement with Standard & Poor’s regarding their ratings on CMBS (Commercial Mortgage-Backed Securities) in 2011. They will be paying $77 million to the SEC and two state Attorneys General, and will also be suspended from rating the largest part of the CMBS market for a year.

2011?  Are you kidding me? By my recollection, in 2011 the “peasants” were still outside the doors of the Rating Agencies with pitchforks and torches, calling for blood after the global financial crisis.

Render Unto Caesar’s, but Where?

And to Whom?

$26.9 billion in CDS muddy the waters in Caesar’s Casino’s $18.4 billion in debt restructuring.

With two main classes of debt, the senior bondholders have agreed to terms and filed Chapter 11 together with the private equity owners of the company in bankruptcy court in Chicago. But holders of the junior debt are suing, and also filed for Chapter 11 bankruptcy, but in Delaware.

And then there’s the Credit Default Swap (CDS) position, roughly one and a half times the size of the debt issues.

The junior debt holders didn’t get their interest payment in December, a deferral the company points out is allowed in the subordinated bond offering documents. Still, the holders of the much larger CDS position went to the International Swap Dealers’ Association (ISDA) to ask for a payoff. In the parlance of the Association, they wanted the missed payment declared a “credit event.”

Does Santa Take Side Bets?

Coal in some stockings, treats in others, but who’s been naughty and who’s been nice? In the world of big-time financial side bets (Credit Default Swaps), it isn’t exactly clear.

When I heard about the unusual happenings that kept Radio Shack open for at least one more Christmas season, my thoughts went to the decision process for the traders on each side of a massive CDS trade. Making money is the primary reason they play, but there is something else going on.

Senior people on Wall Street have their own version of Black Friday – the day after Thanksgiving that some retailers need to push their full year into the black. It’s not the same day at every Street firm or hedge fund, but it’s just as manic as the mall scenes with people trampling each other to get enormous televisions. On one day each year, everybody gets their “number” – their bonus for the year.

This year, as every year, people are trying their best to book big profits while the bosses are deciding who gets how much of the bonus pool.

From the glossary of Finance Monsters, here’s the definition of the Bonus Pool: 

Lowering Threat Level to Orange

That doesn’t mean we can’t have a crisis, but the threat is less than it might be.

There’s been quite a reaction to the posts from two weeks ago about the potential that our next financial meltdown might be quietly germinating in the dark recesses of the credit derivative market, and rightly so. There are still people linking to the second in the series today.

After the break, I’ll follow some clues we can look at to see whether another mega-mushroom of risk is growing in the dark basement of finance, the way it was in Finance Monsters….

Financial Love Canal

How to make a startling headline if you’re a financial reporter:  just look for owners of junk bonds that might be in trouble, and make that your story.

Remember SIVs?

Not many people seem to remember that the very first bailout proposed by Treasury Sec. Paulson wasn’t for mortgages. It was for Structured Investment Vehicles (SIVs), and he proposed it in late 2007.  He wanted the government to sponsor a $100 billion “super-SIV” to buy performing assets from bank-sponsored SIVs if they had a problem selling the paper that they relied on for funding.

What a Weekend!

Over the weekend, MindonMoney and Finance Monsters both picked up a larger circle of readers, and they weren’t all the usual suspects. For example, blogs in Sweden, China and Malaysia linked to the post Three Conditions and Three Warning Signs. Since I don’t read Swedish or Chinese, I can’t say what those blogs focus on, but as they say, “There’s no such thing as bad publicity.”

National Memo carried an excerpt of the book from the chapter Contagion as its featured “Weekend Reader” that was especially timely, given the unknown secondary effects of the collapse in oil prices. FWIW, energy high yield spreads are now above 1,000 basis points for the first time ever.

Finance Monsters even flirted with the most fleeting of all honors – Amazon bestseller – that is, if you count being the bestseller in a quiet category like bond investing e-books. The rankings are recalculated every hour, so I’m not quite ready to run a press release claiming bestseller status. What would it say? Six hours on the Amazon (bond category) bestseller list? It does make me wonder how many books it would take to get to the top of the main list, at least long enough to take a screen shot of that exalted status.

The biggest effect had to be from Zero Hedge, the blog/rant/gossip/research site that’s wildly popular on trading desks around the Street. By late Sunday the copy of the Three Conditions post that “Tyler Durden” put up on Saturday had over 30,000 readings. After the break, a tip of the hat to a dozen other blogs and sites that linked over the weekend…

Not a Lone Voice Any More

Mainstream commentators finally noticed.

It’s been a bit lonely sounding the alarm that the next crisis and bailout was on the runway waiting to take off.

That all changed this week as Congress debated whether to extend funding for the “discretionary” chunk of government. You know, stuff like defense department contractors, highway construction and repair, national parks, food stamps, scientific research, border patrols and so on.

Much to my surprise, the long-time policy that derivatives trading is a “Heads – we win; Tales – taxpayers lose” business became an issue that bubbled up to general consciousness.