We're all smart now... Bonds hit the brakes... Smith's letter... Dimon responds... Apple hits $600!... The credit bubble... The MBIA saga continues...
Don't you feel smart now? I always feel smarter when the market is up. The S&P 500 is up more than 30% in less than six months. It's over 1,400 as I type this, hitting its highest levels since June 2008, a new four-year high. And at the same time, unemployment claims slid by 14,000 for the week of March 10, approaching a new four-year low.
Gee... it's almost like there's a real recovery going on, one nobody wants to acknowledge... except the stock market.
You'd think the Fed would embrace the notion of a real recovery... But a Wall Street Journal article yesterday suggested the Fed is reluctant to do so. The Fed's most recent statement only makes small changes to the language from a previous statement in January. The Fed had to acknowledge falling unemployment claims and deleted the previous statement's warning about slowing global economic growth.
The Journal warned, too, that if the Fed were caught by a better-and-faster-than-expected recovery, it could wind up hitting the brakes too hard, meaning it'll stop monetary easing too abruptly... causing the recovery to stall.
I don't know about the Fed, but the bond market sure hit the brakes the last couple days. The idea is that if the economy is recovering and growing, inflation is increasing, too. Yields on 30-year Treasury bonds jumped from 3.27% Tuesday to as high as 3.43% yesterday.
As we noted in today's DailyWealth Trader, that's putting the trend in favor of one of Porter's favorite ideas...
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The chart below displays the past year's trading in the big government-bond fund (TLT). When interest rates are falling, bond prices – and TLT – rise. When interest rates are rising, bond prices – and TLT – fall. |
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As you can see, bonds just staged a major downside breakout. Remember, a "breakout" is simply a price at which an asset "breaks" into fresh price territory. A breakout can come on the downside or the upside. But whatever the direction, no trend can start without one. They act as a sort of "starter's pistol" for rallies and declines. And the pistol just fired in Porter's direction... |
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In the January issue of Stansberry's Investment Advisory, Porter wrote, "A collapse in the U.S. Treasury market is 100% certain, in my view. If the Treasury market doesn't tank this year... I'll eat my hat." |
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Porter has a long history of getting "big picture" calls like this one right. If you agree that interest rates will rise, the trend is now in your favor. |
Alliance members can access Porter's suggestions on how to make this bet in the latest issue of DailyWealth Trader. (Please note: For now, DailyWealth Trader is still in beta mode. We're planning on releasing it to the public soon. In the meantime, you can learn more about the service here.)
By now, you've heard about the scathing letter, printed in yesterday's New York Times, by former Goldman Sachs Vice President Greg Smith on why he left the company. Smith said the culture of Goldman is toxic and that the firm is much more interested in making money by ripping off its clients than by serving them fairly. He claims the firm's employees refer to clients as "muppets."
It's an odd accusation for two reasons. First, it's not news. You don't get nicknamed the "vampire squid of Wall Street" for nothing. Everybody thinks Goldman Sachs is ripping everyone off. We've gotten in on the fun ourselves, repeatedly characterizing the company as mysteriously finding itself on the right side of every trade (eventually, at least).
But Smith's accusation is odd for another reason. Goldman's clients have certainly helped make it the tremendous success that it is. It strains credibility that a significant number of them are being ripped off every day, year in and year out. I'm not a great fan of Goldman's. But I know people who've been clients for years... and they say they've never been ripped off.
Smith's letter is also a little too self-congratulatory. It's like he was putting his résumé (which wasn't very impressive) in the New York Times. I have to wonder... who'd hire him after this public display of what, for we know, might be sour grapes?
Regardless, Goldman's top executives are taking Smith's letter seriously. Chief Executive Officer Lloyd Blankfein and Chief Operating Officer Gary Cohn penned a response (published in the Wall Street Journal) that said they were disappointed in the letter, but that a survey showed that 89% of Goldman's employees felt the firm was serving its clients very well.
JPMorgan Chase CEO Jamie Dimon chimed in with a short response (also published by the Wall Street Journal) to Greg Smith's letter, too. Dimon said he didn't want anyone at his company trying to take advantage of his "competitor's alleged issues or hearsay – ever."
Dimon says he doesn't do business that way. I wonder if we'll ever see a letter like Smith's from one of JPM's 260,000-plus employees. Dimon has a stellar reputation. Warren Buffett calls Dimon's shareholder letter the best one in corporate America. Then again, Buffett has always had a high opinion of Goldman Sachs. He met the CEO when he was 10 years old and has liked the company ever since.
Apple hitting a new high of $590 yesterday has attracted even more big money into the stock today... The stock gapped up this morning to trade for more than $600 a share for the first time in history. Then, it fell back to $591. Looks like some big money is unloading...
Given the focus on Europe's deterioration, it's been a while since we've revisited our own mortgage crisis. After the subprime crisis hit, the government printed trillions of dollars to boost markets. With the immediate problems – failing banks, plunging markets, etc. – solved, the financial institutions then started pointing fingers... And due to the nature of the mortgage markets (where mortgages are underwritten by one firm, then sold to a bank, which subsequently chops the mortgage up into small pieces, packages them with thousands of other mortgages, and sells them to investors across the globe), it proved difficult to place the blame.
We wrote about the issue in an August 2010 Digest...
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Speaking of the credit bubble... here's an important trend worth watching: the battle over "reps and warranties." One of the primary reasons the housing bubble got so out of control and why so many bad loans were made during the 2003-2007 period is because securitization allowed mortgage originators to sell bad loans to other financial institutions. Originators didn't care about credit quality. They didn't hold the loans; they sold them. To protect the buyers of mortgage securities from fraud, originators had to agree to a series of legal representations ("reps") and provide a warranty against default for some period of time. So... what's happening now with all of these bad loans, nearly all of which violated the representations made about their underwriting? |
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Most of these loans ended up on the books at Freddie and Fannie, which bought something like $400 billion in nonprime mortgages during 2005 and 2006. (As usual, the government agencies found a way to buy the worst mortgages at the worst time...) As these two firms sort through the paper trails on all of their bad loans, they first contact the mortgage insurance firms – typically either MBIA or Ambac – to make a claim. The insurance companies then prove that the mortgage was fraudulently underwritten and deny coverage – something called rescission. At that point, Fannie and Freddie send a claim back to the originators, firms like Wachovia and Countrywide, which the surviving banks, Wells Fargo and Bank of America, now own. |
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As you can imagine, the whole process is like a game of hot potato. No one wants the liability for the potential losses on a defaulted mortgage. The underwriter denies any claim of fraud and argues the mortgage was properly insured. The insurance companies claim fraud. And Fannie and Freddie say it's not their fault, it's the underwriter's responsibility. Things were pretty much at a legal standstill until Fannie and Freddie's newest regulator got involved and sent subpoenas to 64 mortgage underwriters. That's when the proverbial "stuff" hit the fan. Analysis by Chris Gamaitoni of Compass Point Research & Trading predicts massive additional undisclosed losses at Bank of America, Wells Fargo, JPMorgan and Citigroup – led by $7 billion at Wells Fargo. Total losses (both disclosed and undisclosed) due to reps and warranties could be as high as $17 billion at Bank of America. |
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There's a flip side to these losses, however – the matching decline of liabilities at the mortgage insurance companies. Check out MBIA, for example. It's a $2 billion market cap mortgage and municipal bond insurance company. It holds almost $35 billion in assets, including about $3 billion in cash. On the other side of its balance sheet, however, are more than $20 billion insured losses, mostly mortgage insurance claims. Every dollar of insured losses that MBIA is able to rescind because of reps and warranties is probably worth $5 or $6 in market cap. If you were able to rescind half of the $20 billion in mortgage losses, you'd probably see the stock trading closer to $60 than $6. |
On January 3, New York State Supreme Court Justice Eileen Bransten made it easier for MBIA to seek damages from Bank of America... The judge said MBIA only needs to show Countrywide (now owned by BofA) made misrepresentations about the loans, instead of also proving they caused the losses. Bank of America is appealing the ruling.
Then, on January 11, four banks suing MBIA over the firm's 2009 restructuring renewed a request to have a "qualified" expert review its financial condition. The banks claim they have data that "clearly demonstrates" MBIA "cannot satisfy its policyholder claims in full," according to Robert Guiffra, the banks' lead counsel and partner at Sullivan & Cromwell.
In response, MBIA spokesman Kevin Brown said, "Although the banks have been predicting MBIA Insurance Corp.'s imminent demise for almost three years, it remains solvent and fully capable of meeting all of its expected obligations." He added Bank of America owes MBIA about $3 billion in mortgage put-back claims.
And today, UBS disclosed in its annual report that it has reached an agreement with MBIA... UBS agreed to reduce certain credit-default swaps in exchange for a cash payment. The agreement reduced UBS's 2011 net trading income by 167 million Swiss francs. And if the settlement goes through, both firms will release their claims. Shares of MBIA increased as much as 5% today, trading at $10.20.
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New 52-week highs (as of 3/14/12): ProShares Ultra Technology Fund (ROM), Abbott Labs (ABT), Exact Sciences (EXAS), Prestige Brands Holdings (PBH), Calpine (CPN), BLADEX (BLX), Target (TGT), and Microsoft (MSFT).
If you've ever worked for Goldman Sachs, we'd love to hear about your experience with the company. Do you agree with Greg Smith? Write us at feedback@stansberryresearch.com.
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Sean Goldsmith and Dan Ferris
New York, New York and Medford, Oregon
March 15, 2012