We're standing by our opinion that the current Morgan Stanley investigation will eventually lead to the bank's downfall. Morgan is the weakest of the remaining Wall Street institutions. It barely escaped collapse and/or a takeover by a healthier bank during the crisis. Today, it serves as an easy target for the government to "send a message" that it won't tolerate fraud and deceit (ironic, we know). The news out today surrounding Morgan's bond dealings isn't helping the case…
In addition to the "Dead Presidents" deals we already covered, Morgan Stanley created collateralized debt obligations (CDOs), named Baldwin and ABSpoke, during 2005-2006. Investors in these CDOs would lose money even if subprime defaults stayed near their historical averages. Investors in one of the Baldwin deals would lose money if only $235 million of the $2.3 billion mortgage portfolio went bad. They'd get wiped out after only $18 million more of losses. As Thomas Adams, former executive at bond insurer Ambac, told Bloomberg, "I can't imagine anybody would take that bet knowingly."
Morgan Stanley knew everything about these CDOs. It underwrote them. And at the same time it was selling them to clients, records show Morgan was buying credit default swaps (CDSs) against the same securities (CDSs pay off when the underlying security declines in value). Morgan Stanley created pools of mortgages it knew were garbage, sold them to clients, and bet against the same securities it was peddling. That's fraud, plain and simple.
In addition to Wall Street banks, the government is also dipping its grubby fingers into the credit-rating agencies. From the Journal:
The 64-35 vote Thursday represents one of the strongest moves yet by Congress to change how business is done on Wall Street. The amendment aims to resolve what's considered one of the thorniest problems in financial markets: Bond issuers choose ratings agencies and pay for ratings, meaning raters' revenues depend on the very firms whose bonds they are asked to judge.
Under the new proposal, the SEC would play middleman between the company seeking the ratings and the rating agencies. A government board would select – through lottery or rotation – the firm to rate the debt. This oversight committee would only apply to structured securities – like packaged mortgage bonds or credit-card loans.
There's no doubt the current ratings-agency system is flawed. The company issuing the debt should not be paying the ratings agency to rate it – an obvious conflict of interest. Nor should the burden be placed on the company investing in the debt. It could just as easily pressure the rating agencies for advantageous ratings. In short, you can't have interested parties influencing these transactions with payments. Period. As hedge-fund manager and rating-agency critic Bill Ackman told Bloomberg, Moody's and S&P effectively acted as "underwriters" of the debt offering. A company couldn't sell debt without an opinion from one of these companies. These opinions are too powerful to be potentially corrupted.
While the government's proposal addresses the principal conflict of interests, government intervention is not the answer.
The best solution we can think of is independent publishers, like Egan-Jones, tackling ratings. Egan-Jones sells its information on a subscription basis, just like we do. Customers only renew if they're pleased with the information they receive. And we think Egan-Jones' opinions are far superior to those of Moody's and Standard & Poor's. If an investor isn't happy with the coverage he receives from Egan-Jones, he can switch services.
The answer is more competition and free markets… Not a government-sponsored lottery where every rating agency will get their turn.
We wrote it, did you short it?
I expect the euro will rally. With the size of the bets against the euro, it could be a powerful rally. We have a difficult decision to make... Do we take our profits now? Or do we hunker down and risk giving back some profits with the goal of bigger profits down the road? I think we choose the second option. The trend in the euro is incredibly powerful... Even with the large number of investors who have joined us in betting against the euro, it is STILL falling... Now that is a REAL bear market. – Steve Sjuggerud, May 2010 True Wealth
Steve's decision to stay short the euro produced a 32% return for his readers since December. The trend for the currency has been straight down. Today, the euro broke below $1.25, a 19-month low. And everyone thinks it's going lower.
Former Fed Chairman Paul Volcker told a group in London yesterday, we have the "great problem of a potential disintegration of the euro." Earlier this week, Jim Rogers said the EU bailout was the "nail in the coffin" for the euro. He believes the EU has "given up" on their currency. Deutsche Bank CEO Josef Ackermann, in a surprisingly honest moment for a bank CEO, said the Greek situation could cause "a type of meltdown." Even French President Nicolas Sarkozy took a stand… He threatened to pull France out of the euro zone.
Institutional investors are piling into short-euro trades. We think the euro is toast, but the sentiment is awful right now. We wouldn't be surprised to see an intermediate-term rally in the euro… It's already bounced off today's low to around $1.27.
Matt Badiali recently released a new report to S&A Resource Report subscribers describing his favorite way to play gold. In it, Matt describes a special gold investment he calls a "gold bank." This investment isn't a mining stock, gold bullion, or even an ETF. If you had purchased this investment in 2001, you would have earned 1,667%… Buying 10 years earlier would have increased your returns to 9,700%. And it still has much farther to go.
I can't share too many details in the Digest, for fear of giving away the investment. But this opportunity is one of the best and easiest ways to invest in gold. It's low-risk, and it has huge upside from here – even if gold doesn't rise any higher. To read Matt's full report, click here…
New highs: PowerShares UltraShort Euro (EUO), St. Mary Land (SM), Keyera Facilities (KEY-UN.TO), Portfolio Recovery Associates (PRAA), AuEx Ventures (XAU.TO), Inter-Citic Minerals (ICI.TO).
One of the most-oft asked feedback question rears its ugly head again. You've got a question? We've got an answer… feedback@stansberryresearch.com.
"How can you say that SVM had a new high today, when it closed at $8.36, down 60 cents from yesterday's close? The 52 week high is $9.02." – Paid-up subscriber George Fordham
Goldsmith comment: We probably get this question once a week. The new highs you see in every Digest are based on the closing price of the security from the previous day. We use previous day's pricing because we write the Digest during market hours.
"What is EBITDA as mentioned in the Inbev article in Extreme Value?" – Paid-up subscriber PE Haiges
Goldsmith comment: EBITDA stands for "Earnings Before Interest, Taxes, Depreciation, and Amortization." It's just net income with the "ITDA" added back in. Using this measure of earnings, as opposed to net income, allows you to compare companies' true earnings without focusing on finance and accounting measures (which can vary widely between firms). It's useful to measure how well a company can service its debt.
Regards,
Sean Goldsmith
Baltimore, Maryland
May 14, 2010