Health of Banking Industry

Today, I saw the following excerpt on SeekingAlpha:

Banks See Delinquent Loans Rise 23.8% (Inman News, Nov. 28th): "FDIC's Quarterly Banking Survey: The 8,560 institutions it insures
boosted their reserves by 7% during Q3, to $87 billion. It was the largest
quarterly increase in reserves in 18 years, but failed to keep pace with a
"sharp rise" in delinquent loans, the report said. Residential mortgage loans were the focal point of the deterioration in asset quality, said FDIC Chairman Sheila Bair, but delinquency and loss rates were up across all major loan categories. Noncurrent loans were up 23.8% from Q2, to $83B-- the largest increase in 20 years. More than half the increase was attributed to residential real estate loans. Noncurrent residential mortgage loans were up 27.2%, to $35B, while noncurrent home equity lines of credit were up 27.4%, to about $1B."

Bottom line is this score for last quarter:
Delinquency: $16 Billion
Banks: $6 Billion

The banks are falling behind fast. Their reserves are not high enough to cover any additional non-performing loans, and they will have to raise billions every quarter next year precisely when credit is getting most expensive. The outlook for consumer and business credit is not good when the banks have no money to lend. The Fed can try to step in and print money for them to lend, but that money will flow out of the country faster then they can print it. It will only make the situation worse in the long run.

Alea iacta est!

With today's trades, I am now fully invested in the options account. I bought two positions. The first was an MCGC call. The second was Citigroup puts.

Here's my thinkin on the trades. The first was an MCGC Jun'08 12.50 call. It cost 0.75 with MCGC at $10.99. The stock is dirt cheap at this price. It should be trading at $15. I took this position to double down on MCGC.

The second position I just couldn't resist. It is two Citigroup Dec 30.00 puts for 0.65 each. C was at $32.46. This bet translates into a 2% chance of C falling 9% over the next month. I think we will see a repeat of Countrywide getting their bailout from BAC. I think this is an absolute no-brainer.

The market is now gripped by perhaps more fear than on Monday, when the market plunged. The fear comes from short sellers covering. Unfortunately, I didn't cover anything Monday, like I should have. I was thinking about it, but I thought the odds were on more than one day of fear, especially for homebuilders. This week marks the announcement of new and existing home sales. As I expected, existing home sales were below already dismal expectations. No problem, this is an opportunity to short more, and I have taken it.

One more trade (yesterday):

Bought 9 SKF (Powershares Ultrashort Financials) at $106.72 on a 6% fall. It's down again today, but I think that the ABX, CMBX, and CDX bond indexes, as well as the Citigroup bailout, the Fed bailout, and the Shumer probe into CFC and the FHLB are signalling VERY bad news right around the corner.

Bottom line is that I will remain extremely bearish short term. I am looking for the VIX to spike over 35 and probably over it's intraday high of 36.5. It's fallen today from over 28 Monday to almost 24 today, but it hasn't been under 20 since 11/01. That's a powerful base of volatility.

FEAR is back

According to Reuters, today marked

the biggest single day dip in 30-year yields in over three years

The 30-yr treasury bond fell more than 3.5% to yield 4.29% while the 10-yr fell over 4% to yield 3.84%. This means one thing: Fear is back. Throughout the rest of this week, we may see the bond market fear spread to the stock market. Our 200 point drop was only 1.5% off the DOW. We need a 600 point drop to top the fear in the bond market.

Where is this fear coming from? The announcement of more bailouts, liquidity infusions, and relaxing of regulations means that things are worse than they appear. Otherwise, why do anything? The obvious assumption is that the Fed is afraid of something, and if the Fed's afraid, everyone else catches the cold quickly. On top of this comes Chuck Shumer's probe of Fed Home Loan Bank advances to Countrywide. I would be surprised if there isn't any funny business going on there. So would everyone else.

Today's movement in T-Bonds will put the dollar under intense pressure this week. I expect gold and oil to bounce back very strongly. It would not be surprising to see oil hit $100.

Decoupling

This article from Bloomberg prompted me to tirade against the pop econ notion of "decoupling." As the article points out, Asian financial markets have never been more tied to American markets. Rather than decoupling, Asian markets are more closely tied to American and European demand and economies than ever before. As the article quotes Citigroup's Markus Rosgen " 'The ratio of consumption in Asian nations' gross domestic product,' he says, 'has declined over the last five years.' " This is absolute proof, in my opinion, that Asia is more dependent on Western demand than ever before in history. In fact, I expect that when the U.S. plunges into recession in the first quarter of next year, the rest of the world will not be more than six months behind. Not only that, but I think they will fall harder as well.

It may look like we have a bigger problem with our trade deficit. However, what is not often considered is what the nature of our imports and exports is. China imports raw materials and exports manufactured (mostly) low-tech goods. America imports cheap manufacturing and exports technology, pharmaceuticals, software, high tech manufacturing assembly, and food. When it comes right down to it, we can feed ourselves, and China can't. The Soviet Union started to fall from the moment it couldn't feed itself. I believe that China is dependent on us to feed them. As long as this remains the case, there will be no decoupling. We can do without the cheap goods from China. If our economy goes south, we can call capital back home by placing tariffs on imports and creating jobs at home. If we stop buying Chinese products, what will they do? They can't lower their prices enough to generate their own demand. They will be forced to revalue their currency upwards to afford imports of necessities (like food) which will further pressure their manufacturing industry just when it's under pressure from slackening demand. This is not a good combination. Sometime towards the end of next year, their whole economy will be exposed as just as much a bubble (and just as fake) an industry as housing was in America. Here's my prediction: sometime between now and the middle of 2009, the Shanghai Index will rewind its value to what it was five years ago. FXI will drop to about $60 (from a high of $220). Time to keep watching those FXI puts.

bond markets

In Europe, they closed them. In the US, the ABX indexes are spiking like Jack's magic beanstalk. Protection costs more than the bonds yield. CMBX index spreads have jumped as much as from 3.66 to a 90+ point spread. These moves make the 23 standard deviation moves in August look like everyday occurrences. Here's the chart:

All I can say is, uh, oh......

market sentiment

This quote from Bloomberg just about sums it up:

``It's a very panicky market,'' said John Kattar, who oversees $2 billion as chief investment officer at Eastern Investment Advisors in Boston. ``There's a growing feeling that the problems are unknowable and unquantifiable, and that there's no way of dealing with it except through the passage of time.''

It's official. The market is depressed. It could very easily slide into a bear market for the next few months.

thoughts

It seems that the market is suffering more from depression than panic lately. As a result of this, I will hang on to my shorts. I bought MCGC yesterday because it was at its yearly low, yielding 14%. Unlike ALD, they announced strong earnings last quarter and they use less leverage. Their dividend should be safe.

I think another “scare” is imminent given that the ABX index led the Aug 16th plunge by ~6 weeks. We're at about 7 weeks of downslide now. Overall levels are much lower. I expect something big to break soon. Actually, we got it today with Fannie and Freddie, but the broad market expressed no fear. When the next panic comes, the dollar will rally, the DOW will nosedive, and there might even be some bargains out there. This will be a great chance to get out of the dollar. If the market just stays depressed, I will look to rotate out of homebuilder shorts into as yet undamaged financials when BV's approach 50%. Other than that, I can just wait. I am very happy with my portfolio.

The Dollar

The US is following a course of dollar devaluation. Given the massive dollar outflows recently, this seems a puzzling course of action. Won't foreign central banks dump their dollar holdings? Won't this cause capital to exit the US at a time when it is most needed? This danger is indeed more real than the spector of foreign banks dumping the dollar. FCB's won't dump the dollar, but they may diversify out of the dollar. Capital flight cannot be avoided. The US standard of living will be dropped in order to pay off our debts. Interest rates will be lowered as much as is needed to make debts easier to pay off. In the meantime, the US is trying to take China down with us. By devaluing the dollar, we've gotten the European Central Bank on our side. Now they know that they cannot match it because we've got the head start, but they can put pressure on China to revalue their currency upwards.

I believe that the only way to save the US banking system is to devalue the dollar until the banks can be made whole. We will see very low interest rates over the next year or two.

Where are we in the credit crunch? (2)

This article from Bloomberg prompts me to ask this question again. Where are we? Well, according to Goldman Sachs, losses may reach $400 billion. I remember seeing a figure of about $70 billion in already announced losses. However, I have seen much higher estimates in Barron's. The estimate was $1-1.5 trillion out of the $30 trillion in outstanding mortgages. Unfortunately, I believe that this estimate is also inadequate. How could $1-1.5 trillion in losses stay "contained" in the mortgage sector? I believe that the truth will prove to be even harsher. However, let's take $1.5 trillion as a good estimate and see where that puts us in the ole ball game. Hmmm... We're at two outs in the top of the first. It's going to be a looooong game.

Gold

Just bought an ABX Jan'09 70 call for 1.60. Here's the thinking: since the low on 8/16, gold has risen to a high of 850 (33%) and given back 11%. ABX has risen twice as fast as gold and has given up 15% since gold hit 850. I think that gold will go over $1,000 next year for a 28% gain, and ABX will rise at double that rate to at least $63. I think that's close enough to make my calls worth about $7.00.

Trade & thoughts for today

I bought a Dec Bank of America $40 put for 0.90 yesterday. My thinking is that with the Super SIV asset reshuffler now in action, and BAC one of the big names in it, they are in some serious trouble. Today they announced $3 billion in losses and they were up. Oh, well. We'll see how long that lasts.





Here's a nice chart that speaks for itself:

Current price: $33.88.

Well, with the Vix dropping down to under 25, I need to look for some puts, and maybe some retail or financial bouncebacks to short. I don't think this bounce will last long.

Where are we in the credit crunch?

Maybe a collection of golden nuggets will give us some clues.

Merrill included for the first time $5.7 billion of subprime exposure at Merrill Lynch Bank USA and Merrill Lynch Bank & Trust, while also upping by about $600 million its exposure to CDOs after an insurance policy Merrill had taken out against losses was terminated following a dispute with the unnamed seller.- Reuters

Hmmm.... I wonder how much is "insured" that isn't counted yet.

Merrill Lynch (MER.N: Quote, Profile, Research) upped its tally of exposure to risky subprime and structured credits by $6.3 billion, to $27.2 billion - Reuters

Hmmm.... Sounds like it's just coming out of the woodwork.

Meanwhile, Moody's cut ratings on $33 billion of debt of structured investment vehicles (SIVs). SIVs, off-balance sheet bank affiliated structured financings, total more than $300 billion, and are a threat to find
their way back on to bank balance sheets - Reuters

Hmmm.... Every time ratings are cut, that's another ticking time bomb just waiting to go off. Sooner or later, the losses will show up.

The October Federal Reserve Senior Loan officer survey showed tightening conditions almost across the board, and notably for loans to "prime" home borrowers

The survey has been around since 1966 and has proved to be highly predictive of future economic growth. - Reuters

Hmmmm.... Again, another future indicator of more trouble coming down the road.

Standard & Poor's said a collateralized debt obligation managed by State Street Corp. began liquidating its assets, prompting the ratings firm to slice the investment vehicle's ratings as much as 18 levels.

The ratings on the most senior class of Carina CDO Ltd. were lowered to BB, two levels below investment grade, from AAA, while another AAA class was slashed 18 steps to CCC-. The chance of material losses to noteholders is high, New York-based S&P said

Carina is the first CDO to begin unwinding after a slump in the credit worthiness of the underlying assets, S&P said. Thirteen others have informed S&P of an event of default, a precursor to liquidation. A widespread fire sale by CDOs, which package asset-backed securities and resell them in pieces, may further exacerbate declines in subprime-mortgage securities.

Hmmmm.... AAA to BB. According to the ABX indexes, AAA is trading from 75-95 cents on the dollar. BBB runs from 18 to 38 cents on the dollar. BB is not even on the chart. I pity the investors liquidating into this market. I wonder whether any banks own any of this. If they do, you can bet it will come up again.

Events of default, triggered by ratings cuts to holdings of the CDOs, can
force the transactions to liquidate, S&P said last week. Alternatively, the
events would result in all payments being diverted to the most senior classes, whose owners may vote on whether to liquidate, S&P said.

It all comes down to the ratings. Ratings gave this derivatives monster life, and ratings will cause its death.

sign of things to come...

is this story from Marketwatch.

Hurt by unseasonably warm weather, record high oil prices and concerns about the housing and credit markets, retailers posted a 1.6% rise in October sales, the International Council of Shopping Centers said, making it the worst October in 12 year

"Worst October in 12 years." Yes. Must be the weather's fault.

Time to short Underarmour, Deckers Outdoor (makers of UGGs) and other overpriced consumer discretionary companies. They will get creamed this Christmas.

One final word today. Yesterday, Helicopter Ben, or Uncle Chopper, as I have started to call him, predicted a rebound in the economy by middle of next year. That's how I know it's going to get bad soon. SOON! THAT MEANS WITHIN THE NEXT THREE MONTHS!

trade

I sold VWIMD.X today. It is the Jan. 2009 $20 Washington Mutual put. I wanted $6.00 for it and I got it. If I didn't, I would have sold it at the close today. WaMu had plunged from $30 to $20 the past couple of weeks, and today fell as much as 20% to as low as $19.72. WaMu would have to fall under $14.00 to increase my profit. While it may, I think that the reward outweighed the risk, so I took it off the table. This gives me some ammo for the options account, and I will try to use it wisely.

Uh Oh.....

The Governator just ordered California state departments to slash 10% from all spending, according to the LA Times. Here are a few of the meat and potatoes quotes:

State officials have warned the governor that the likely deficit for next year has jumped from a few billion dollars to as much as $10 billion

Recently, administration officials acknowledged that receipts through September -- just three months into the fiscal year -- were about $1.5 billion below projections.

Hmmmm..... Put these two quotes together and the numbers just don't add up. Reporters aren't known for their math skills, but $1.5 billion short per month = $18 billion. Heck, let's just round that up to $20 billion. Ouch! Doesn't look like health care for all Californians is going to fly.

In the past two months, I've noticed "For Lease" signs at commercial space sprouting up everywhere, like mushrooms after a nice rain. My friend Al noticed the same thing. California is a proxy for the U.S. economy. It was the frontrunner for the dot.com boom and bust, and is not the leading indicator for the housing bust.

In more vague news, the ABX and CMBX indexes are disintegrating. If we follow the same pattern as in August, before the end of the month, we will have another major panic, and there will be some golden opportunities to cover shorts and rotate into some dollar weakness plays. I would not be surprised to see gold fall to about $750, and then finish the year close to $1000.

I think that Treasury rates will test their 2002 lows of 1% in 2009. Also, China has reached the ridiculous stage. Petrochina listed on the Shanghai exchange and promptly tripled to a $1 Trillion market cap. That's bigger than Exxon and G.E. combined, and it's not even in the top 50 global companies in revenue. I suspect a nasty crash in 6-12 months. The Olympics next year could be very interesting. The Shanghai market is completely out of control, and out of all proportion to the GDP of China. Look at Exxon compared to the US economy, and then look at Petrochina compared to China's economy. If their stock market crashes, then they will lose an immense fortune.