Rolfe Winkler

This afternoon CFTC announced three prosecutions for fraud.  No doubt they’d like to avoid catching egg on their face à la SEC post L’Affaire Madoff.

#1

“CFTC Charges California Man Patrick Dailey and His Texas Company with Fraud in Connection with a Multi-Million Dollar Commodity Pool.  Dailey and Strongbow Investments Allegedly Solicited at least $17 Million from Investors; Court Order Freezes Defendants’ Assets and Protects Books and Records.”

#2

“CFTC Charges Georgia Man with Operating a Multi-Million Dollar Forex Ponzi Scheme.    Eldon A. Gresham Targeted Persons of the Christian Faith, Soliciting More Than $15 Million; Court Freezes Assets.”

#3

“CFTC Charges California Man and His Company with Commodity Options Fraud.   David M. Kogan and First Capital Futures Group Allegedly Defrauded 58 Customers of More Than $3 Million.”

NEW YORK, July 9 (Reuters) - Why are free marketers so afraid of rules? As regulators take a fresh look at the commodity markets, Wall Street and its defenders are again panicked that regulators will overreach.

No doubt regulation, when excessive, can be problematic. But energy markets are so totally unfettered, they can benefit from tougher rules, especially when it comes to transparency and excessive speculation.

Free markets are great, don’t get me wrong. As a product of the University of Chicago economics department, I’m not exactly keen on central planning. But excessively free markets can be dangerous, as the financial crisis has taught us only too well.

With few rules to control how and where it could profit, Wall Street facilitated any and all transactions that could generate a fee, regardless of systemic risk. In energy markets, speculation is largely unchecked, and the spillover effects to the real economy last summer were very painful.

The problem with my free-market-loving brethren is their obeisance to the concept above all others. Few realize they’ve forsaken a far more fundamental aspect of successful capitalist economies: the division of labor.

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Bailouts let banks carry loans at values that are too high (NYT)  This is a very important to understand.  A big way banks avoid writedowns is by expressing “intent and ability” to hold toxic loans to maturity.  They don’t want to sell at market prices, so they have intent.  And they have an implicit government guarantee against failure, so they have ability.

Lenny Dykstra files for bankruptcy (Inquirer)  Another Schadenfreude alert.  Dykstra reminds one of Donald Trump: great at self-promotion, not so great at substance.  Yeah, he was a good ballplayer.  But a lot of his “talent” was likely due to steroid abuse.  I remember Jim Cramer being interviewed for HBO profile of Dykstra called him one of the smartest guys he knew.

Sorry, not everything can be hedged (David Merkel)  “…often the amount of CDS created exceeds the amount of debt covered….I call this a gambling market, because there are parties where the transaction takes place where neither has a relationship to the underlying assets.  There is no risk transfer, but only a bet.  My view is such gambling should be illegal…”

Buffett backs second stimulus (ABC News)  We’re not going to clean up our mess of debt folks; we’re just going to blow another credit bubble.  Count on it.

Historical unemployment data (Northern Trust)  An interesting report from Paul Kasriel, but I wonder: How have the ways we measure unemployment changed?  Is it fair to compare today’s data with data from 80 years ago?  Maybe it is.  I don’t know.

Breaking down June retail sales (Real Time Econ)  A helpful interactive table.  The box of text to the right makes the presentation a little kluge, but the text is helpful for those interested in detail.

Slump visists summer hideaway for the rich (NYT)  The top of the market is also buckling substantially.

Treasury announces first PPIP investments (Reuters)  The numbers are far smaller than initially anticipated, thank goodness.  Every dollar spent as part of this program is a dollar wasted to bail out bank creditors.

Swiss workers want 2 more weeks vacation (Swiss Info)  Four weeks isn’t enough.

Real-life Captcha….

John Meriwether is famous for nearly detonating the world financial system when his hedge fund Long-Term Capital Management went belly up in 1998.  A year later, he started another hedge fund, JWM Partners.

LTCM lasted five years before blowing up.  This time ’round, Meriwether managed to stay in business for ten.  Bloomberg:

John Meriwether, who roiled global markets when Long-Term Capital Management LP collapsed in 1998, plans to shut his current hedge fund, according to a person familiar with the matter.

JWM Partners LLC is closing its main Relative Value Opportunity II fund after losing 44 percent from September 2007 to February 2009. Meriwether, credited with generating billions of dollars of revenue at the former Salomon Brothers in the 1980s through so-called relative value trades, returned an average of 1.46 percent a year with his new fund since opening in 1999, compared with 2.4 percent for the Credit Suisse/Tremont Hedge Fixed-Income Arbitrage Index.

Meriwether’s second collapse didn’t pose the same systemic risks.  JWM Partners was nowhere near as large, or as overlevered, as LTCM.  The only losers this time are his investors.

Meriwether has made one great contribution to humanity, providing fantastic subject matter for, quite possibly, the two best business books of the last 20 years: Liar’s Poker, about his days trading bonds at Salomon Bros; and When Genius Failed, about the LTCM collapse.

In his colorful piece blaming Goldman Sachs for blowing every major financial bubble of our time, Matt Taibbi actually left out a rather big one: the Penn Central commercial paper debacle in 1970.  WSJ:

Goldman was nearly driven out of business…when the Penn Central railroad went bankrupt in 1970. Because it was Penn Central’s commercial-paper dealer, Goldman was sued not only for losing investors’ money but also for not informing clients that its privileged information had caused the firm itself to dump Penn Central’s paper. Goldman was censured by the Securities and Exchange Commission and lost tens of millions of dollars in the aftermath.

Eerily similar to the subprime implosion, no? In 2007, Goldman was a chief underwriter of CDOs, the most toxic of assets. And it profited substantially in the early stages of the crisis by shorting same. James Grant has much more on the Penn Central Affair in a short chapter of his book, Money of the Mind, beginning on page 290. A great line:

All in all, it was a spectacle that called to mind the truth that progress in financial affairs is cyclical, not cumulative. Putting a man on the moon, scientists had stood on the shoulders of giants. Overlending to Penn Central, bankers had re-created the [Depression-era] errors of their fathers.

It’s unfortunate that we’re talking about a Consumer Financial Protection Agency, as if regulators in Washington can somehow control how dangerous financial products (think Option ARMs) are marketed and sold. Seems to me it would be better if we had more stringent suitability standards and/or fiduciary requirements for financial advisors, mortgage lenders, et al. We should hold them legally accountable if they sell financial products they know aren’t appropriate for particular clients.

Giving trial lawyers another issue to litigate isn’t a preferred solution. It would be better if finance types had the integrity to forgo quick profits, to not sell (even better: not create) complicated financial products unsuitable for clients. But that will never happen.

(Send links, pics, vids to optionarmageddon at gmail.com)

Who’s in charge of global health spending (Aid Watch)  One third of the money spent by the U.S. government on health-related development aid has vanished without a trace.  Perhaps it was spent on something useful, but who knows?

Lo-Fi (Nick Gogerty)  Methinks Nick would be a big fan of narrow banking…

Hybrid securities doomed six IL banks (WSJ)  Details about the IL banks that collapsed last week.  Agnes has some thoughtful comments.  BTW, narrow banking would also solve this problem.

In search of dignity (David Brooks)  George Washington lived by a code of dignified living that was lost long ago.  Brooks thinks Obama might resurrect it.

Tell Americans what they’re really paying for their food (Atlantic)  Food subsidies waste money.  That’s not a new argument.  But as long as we keep flushing money down that toilet, it’s not old either…

Is job retraining a waste of money? (NYT)  An interesting Labor Dept. study says yes.

An overview of the housing crisis and why there is more pain to come (T2 Partners)  An updated slide presentation.  I particularly like slide #20, Tilson’s “immutable laws of the universe.” (ht M. Winks)

Amenity: Giant Lizards (HeraldTribune)   “If you’re looking for a silver lining to the home-foreclosure story — and who isn’t? — the good news is that 8-foot-long Nile monitor lizards are taking over our abandoned properties.”

Cartesian personal ad (Craigslist)  Brilliant.

The best insults in Cricket (Independent)  #11: Ian Botham could always give as good as he got. When he came to the crease Aussie ‘keeper Rod Marsh said cheerfully: ‘How’s your wife and my kids?’ Botham is said to have replied: “The wife’s fine. The kids are retarded.”

In his morning note today, Gluskin Sheff’s David Rosenberg argues not only that stocks aren’t cheap today, but that the lows we hit back in March weren’t, well, very low.

…This notion that we had moved to Armageddon lows in equities [back in March] does not seem to hold water. After all, the forward P/E multiple on the S&P 500 at the lows was 11.7x. That was not a multi-decade low or some massive standard-deviation figure — we were actually lower than that at the October 1990 lows when the multiple was 10.5x and frankly, coming off the 1987 collapse, the forward P/E had compressed to 9.8x. As it now stands, the multiple is back very close to where it was at the October 2007 market high, when the multiple had expanded to 15.0x. The range on the forward P/E over the last quarter-century is between 9.8x and 21.8x (excluding the tech bubble), so at 14.5x currently, it is hardly the case that this market can be viewed as a bargain.

…With the U.S. government now putting its fingers into more than one-third of the economy (health, finance, autos, energy, housing), one would expect that the fair-value multiple in the future will be lower than it has been — given the implications for productivity and the potential non-inflationary growth potential.

Folks can subscribe to Rosenberg’s commentary here.

Over the weekend, Felix stole a bit of my thunder, arguing preemptively that insurance commissioners shouldn’t regulate CDS, that CDS aren’t insurance in the first place.  (A similar argument was made on Economics of Contempt.)  Personally, I like the idea of a little internecine warfare here at Reuters.  I think that means Felix and I are doing our jobs.  In fact, he makes some good points in his post, but his chief argument is fatally flawed.  I can’t let him get away with it.  (Oh, and I’ll explain the title of the post in a second)

Here’s Felix’s argument:

First, credit default swaps are not insurance, they’re swaps. A lot of journalists talk about them being “like an insurance contract” when they try to explain what they are, and that’s true, as far as it goes — they do share certain characteristics with insurance. But that doesn’t mean they are insurance. It doesn’t mean that some foolish law should be passed forcing buyers of protection to have an “insurable interest” in some underlying debt instrument, and it certainly doesn’t mean that all CDS should be regulated by some insurance commissioner somewhere.

Let’s be clear, I didn’t say CDS are “like” insurance.  I said they are insurance.  The fact that “insure” is the only verb capable of describing their function settles that argument pretty quickly.  The insurable interest argument, which is the same one made by Economics of Contempt, is totally circular.  Insurable interest isn’t a feature of insurance, it’s a feature of insurance law.  All that needs to happen to make the insurable interest doctrine apply to CDS is for legislators to pass a law requiring it, which is essentially what Assemblyman Morelle would like to do.

The question is whether that makes sense.  I argue it does.  The reason we require buyers of insurance to demonstrate an interest in the insured property is to eliminate incentives to destroy that property.

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Goldman, Barclays marketing “insurance” products to cut banks capital requirements (FT)  The financial innovators who develop these products are just trying to find ways for client’s to dodge regulatory capital requirements in order to boost leverage.  Great idea guys.  Brilliant.  Comment from a source: “Credit rating agencies and banks are collaborating to hide risk, using the same broken diversification models that got us into this mess.  And nobody will do anything about it anytime soon.”

U.S. lurching toward debt explosion with long-term interest rates on course to double (Telegraph)  Another take on the “stimulus won’t stimulate” argument made here.  Exploding deficits should, eventually, lead to much higher interest rates.  This will more than offset any positive impact from stimulus spending. (ht Aaron Krowne)

Wells Fargo to beef up securities business (WSJ)  Now that trading profits are up for Wall Street, another bank wants to set up as a dealer in the casino.

Get ready for 14% unemployment (RealClearMarkets)  Extrapolating from stats for private business investment, the author argues the unemployment rate is going much higher.

India says world economy too reliant on dollar (Reuters)  Previously India had avoided Chinese/Russian calls to move away from the dollar.  Can you blame them for chaning their mind, especially now that we’re talking about a third debt-financed stimulus package?

Court ruling clears path for GM to restructure (NYT)  Chrysler was in and out of bankruptcy in 42 days.  GM may be able to keep to just as tight a schedule.

Ryanair wants to make passengers stand (Telegraph)  Imagine riding a plane while strapped to a bar stool.  That’s what the Irish airline is considering…

Why incompetence spreads through big organizations (MIT Tech Review)  “All new members in a hierarchical organization climb the hierarchy until they reach their level of maximum incompetence.” (Did I already link to this?  Apologies to readers if so)

We Rent Movies, so why not textbooks? (NYT)

– Rolfe Winkler is a Reuters columnist. The views expressed are his own –

By Rolfe Winkler

NEW YORK, July 6 (Reuters) - Credit default swaps nearly brought down the world financial system last fall when it was discovered that AIG Financial Products had written hundreds of billions of dollars worth of credit protection without setting aside sufficient reserves. Yet since then, pathetically little has been done to get this corner of the derivatives market under control. There’s a simple way to fix the problem. Regulate CDS as insurance. That could happen if some state insurance legislators get their way.

Treating these financial weapons of mass destruction as insurance instead of as merely swaps would subject them to sensible regulation. But Wall Street is fighting the idea because it would hammer profits and, more importantly, force them to reduce leverage.

Are credit default swaps insurance? As with insurance contracts, the seller of credit protection promises to reimburse the buyer’s losses in case his creditor defaults. If that sounds like an insurance policy, that’s because it is.

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