The Credit Crisis Financial Stocks Short Journal

This FOMC meeting is a tough one, bernanke said a cut is "certainly feasible" so we know they will do it.
25bps would be too little, it would disappoint the market and the fed cares about deflationary expectations/lack of risk taking a lot right now, they keep reminding everybody they have a vast toolbox so to stop the panic

50bps should be the minimum here, now there is something that might tip them to 75bps, the "why wait" hat that central bankers sometime wear. The fact that they increased the meeting shows that they have a bias toward major actions right now so my instinct says they are in 'why wait' mode, if they think the floor should be .25 they will go there this meeting. Heck even 100bps is not off the table. What is off the table is a .50 cut then signaling more to come(although I cant rule this one out) or a .25 and signaling a pause

The arguments against a steep cut are that treasury money market funds will go under, the problem is that treasury market and the effective fed funds will send them under anyway. And if they go under and people are forced to reach for yield in more risky money markets, then whats so bad about that?

Another argument is a too low rate would dimish the income banks have on interest on required reserves, thus removing the capital subsidy, I dont know if this argument has any merit, probably not because this could encourage risk taking by the banks and the TARP is already reparing the capital ratios of banks

I think is a coinflip between 50 and 75, and they stay there at least one year and a half so I'm still long the futures. If they do ZIRP, then I will be glad to be wrong

 

Short Idea: Capital One Financial(NYSE:COF)

This company doesn't have the worst balance sheets out there(5-1 on equity, 10-1 on tangible equity) They have $99b in deposits($10b of that doesnt even pay interest), they claim to have $32b in 'liquitidy' inclusing cash, credit facilities, securities that can be sold. Its possible that they will suffer the 'WB/WM' effect of people reading everyday about their troubles, seeing their stock price go down and then begin to pull their money out

They have $154B in assets(loans) and $13B in tangible equity. $25b of the loans are car loans. $52b are credit cards

Shorting company is a bet on the unemployment rate, bankruptcies and the economy. Since the Fed is now done I gotta play that game another way

On their presentations they claim credit cards are 'different', pabts prime of this forum makes that claim as well. I'm not an expert of on this but credit cards look to be like a gigantic pay option arm as people can make minimum payments and keep increasing their debts, plus its all unsecured

 

Just finished reading most of the book ‘Essays on the Great Depression’ by Ben Bernanke. I found the book very informative, Bernanke expands on Milton Friedman’s and other economist works and reaches the conclusion that adherence of the gold standard had significance statistical correlation with the dept and severity of both deflation and depression. The countries that went off the gold standard first had a better economic performance and rising price level, the book is filled with charts of industrial production, wholesale prices, consumer prices, M1 M2 of both countries that were slow to get off the gold standard(mainly US and France) and countries that went off early(mainly UK, Japan, Canada)

The equivalent of going off the gold standard(removing constraints to increase the money supply) these days is dropping policy rates to 0% and increasing M1 and M2 aggressively. Both of which the Fed is engaged in, another factor was the withdraws of currency from banks dropping the money multiplier, with the existence of FDIC and the bank bailouts, bank runs have been prevented and deflation induced by runs is off the table

Bernanke argues that Friedman was right that declining money supplies played an important role for declining output and the price level but he provides statistical evidence that there was OTHER factors as well.
Mainly he argues that the banking crisis and deflation increased the costs of providing credit, financial intermediation suffered. He found significant statistical correlation between banking panics and industrial production.

 

He argues that the falling money supplies(friedman’s main theory) only explains about 50% of the decline in output and the other component is the decline in velocity that were the result of fearful banks hoarding liquidity fearing runs, the declining number of banks/lenders, bank fears that borrowers were insolvent(as a result of deflation the borrower income/collateral keep declining).

There is this quote from a writer at the time “We see money accumulating at the centers, with difficulty of finding safe investment for it; interest rates dropping lower than ever before; money was available in great plenty for things that are obviously safe but not available for all for things that are in fact safe and which under normal conditions would be entirely safe(and there are a great many such) but which are now viewed with suspicion by lenders”

Bernanke says “And this quote suggests, the idea that low treasury yields or blue chip bonds signaled a general period of ‘easy money’ is mistaken, money was easy for few safe borrowers but difficult for everybody else’.

The difference between Baa bond yields and treasuries rose from 2.5% in 29-30 to 8% in 1932(that ratio never went above 3.5% in the 1920-1922 sharp recession, suggesting deflation played a role on the spread during the 30’s)

There is little doubt that the monetary factor is taken care of this time, the fed will keep M1 and M2 growing at above average levels till they see clear signs deflation has been avoided, FDIC insurance prevents widespread runs and there is no gold exchange standard that had a deflationary bias.

However a version of the quantity formula is Prices = Money * Velocity / Real Output
While the banking system has experienced few failures, the shadow banking system is dropping like flies, mortgage lenders, hedge funds, SIVs and the securitization market has shutdown by and large, this means Velocity is in a downtrend, animal spirits is also playing a role and dropping further as banks hoard liquidity, don’t lend, consumers raise their savings rate and corporations cut back on investment

The question then becomes where is the bottom in Velocity, will the money supply growth offset the decline in V before there is widespread deflation? This is a difficult problem to solve and I don’t believe I have enough information to have a strong opinion one way or the other. The government seem committed to increase Velocity(through public spending, restoring borrowers solvency, low fed funds to encourage risk taking) however I believe I will need to study this issue further as I there seem to exist sophisticated investors in both sides of the argument(taleb’s ‘massive deflation coming’ pimco’s ‘risk of stagflation are now higher, government will reflate’).

We had a bubble in the financial sector, which means Velocity was too high, this complicates the soft landing scenario for the prices as it makes more likely the consequences will be far more complex than what the Value At Risk oriented economists looking at the hear view mirror think. In the other hand commodity shortages could lead to inflation expectations and higher spending

 

The argument doesn't stop with the Fed succeeding in reflating. The real question is "what", as inflating asset prices (their goal I assume) will lead to a completely different outcome than if reflation were to occur in goods and services (more likely in my view), specially if as you say we are faced with numerous commodities supply shocks. The wild card is also how foreign creditors will respond to all of this, the limiting factor.

Thank you for sharing.

 

I posted about low testing a while back, JPMorgan has a study showing the low gets tested 86% of the time
http://www.bloomberg.com/apps/news?pid=20601087&sid=ak7FQQWIAF5k&refer=home

It takes at the most 100 days for that to happen, this suggests by the end of March 09 we will have tested the 08 Nov lows. If in that process the sp500 gets support at 700, SPY puts look very attractive

I put 1% of my networth on SPY puts yesterday, will probably buy more. I'm bought half MAR 31 75.00 and half JUN 77.00 puts. I beginning to think the JUN look more attractive since by the time the lows get tested we should see a double whammy effect of the IV of the puts and Vol going through the roof and you also get more time, of course your pay off is worse but a VIX at 60 could hand you a nice profit to take

 

I agree that its likely the inflation(if it comes) will likely happen in the goods and services area. the Fed monetizing part of the $800b stimulus is giving a green light to congress to keep passing tax cuts till the economy comes back
There is an article that I think points out some of the problem the USD and treasury funding might happen when the safe haven bid goes away
http://www.contraryinvestor.com/2008archives/mooct08.htm

Had a pretty nice rally in the C 2014 bonds I bought. the Investment grade bonds area put a +20% move and I feel the need to sell the bonds as I dont think I'm being compensated to lend to C at 6%, who knows a forced debt to equity swap could come down the pipe. since there is no liquidity to sell the bonds I'm forced to short C stock in a 2-1 bond-equity ratio. Meredith Whitney says the stock hasn't seen the worst of it and since I'm still bearish in stocks I think the hedge leg could make some money

 

Just found a HUGE hedge for anyone whos short financials or the stock market. The 2009 depression intrade contract!

The apparently retail crowd has bid up the contract to 42-43% chance GDP will decline 10% for 4 consecutive quarters. Roubini and Shilling are talking about a total decline in GDP of 5% and they are supposed to be the leading bears. I dont think there is much chance of the 10% decline over 4 Qs because the $300b tax cut and stimulus will boost some of the GDP like it did in the last year, the contract doesnt have a whole lot of liquidity which is a good sign as it might indicate its really retail investors reading too many newspapers and exaggerating the % of a decline of that size instead of more informed investors

I was having a tough time to balance my bets as I couldn't find many bullish trades , but I think fading a depression to balance short stock long put fed easing positions look like a nobrainer, if I'm wrong and the retailers take my money then I will kill in fed futures, shorts, puts. Just waiting for my wire to hit intrade now
One problem could be how to build a big position there

 

Congrats on the WFC trade. Keep it up.

 

thks. I'm hearing some shortsellers are saying JPM is insolvent and could plunge big time

But I got to say I'm worried about the Paulson Put, he is removing tail risk of bank assets at a cheap prices. I just hope the bailout policy of wiping shares out come back once private capital dries up