Being of Dubious Talent

Good morning. It has been a couple of weeks since I have written, primarily due to the effort required to start the Internet show – “Stocks and Jocks”. For those who may have missed Sarah’s announcements the show airs live on every day from 11am-12pm CST and is available afterwards by archive – for on demand listening or download. Dr. J is with me, and we have a great and growing group of guests as the show gains momentum. I would encourage you to listen and participate, there is a lot going on affecting the market that we should all be understanding and talking about.

Last week the market continued its run to the upside, defying a lot of the experts with the extent of the rally. For the week the SPY was up 1.9% to close at 106.72, up a fairly incredible 59% from that dark day on March 6 when the SPY traded 67.10. That rapid of a rally can cause a problem with any sort of a covered writing program, and the Protected Index Program has been no exception. Those in the Program have noticed that it was necessary for me to put a long call spread on above the market (at the time) to maintain some long deltas, but it is surely a market anomaly to have both the sell-off we saw early in the year and the rally since. Although certainly possible, it would be even more historically unusual for the market to maintain this pace, and we plan on continuing to try and capture some call premium and provide some income in the remainder of 2009. It should be noted that in the period from October 1, 2008 thru August 31, 2009, the SPY was still down 10.2 % while those in the basic PIP Program were down only 2.3%. We have had a continuing rally since August 31, and we will report how September compared as soon as those numbers are available. It also should be remembered that in a hedged position, like the PIP, we never had the losses (and possible panic) that probably would have been an issue when the market was selling off.

Those who may have listened to the show on Friday probably heard that Dan Haugh and I were in Washington D.C. last week for the Mesirow Financial Conference. As attendees we were treated to Mesirow’s Chief Economist Diane Swonk and Illinois Congresswoman Melissa Bean as speakers (I was a speaker as well). Diane gave a very solid and enlightening history of what had actually happened the weekend (one year ago) that Lehman essentially went under. It is her view that those in power (Bernanke, Geithner, and a luke warm view of Paulson) really stepped up with some necessary innovation at the last minute and saved the financial world as we know it. Actually the biggest danger, and one that was not anticipated, was a tremendous run on money market accounts the following Monday which actually caused some of those funds to stop withdrawals, and a couple to actually fail that were heavily invested in Lehman short-term commercial paper. For a very detailed story on how this happened please refer to a story in Bloomberg entitled Sleep-At-Night-Money Lost in Lehman Lesson Missing $63 Billion. I do think that Diane Swonk, and Melissa Bean to a large extent, have really bought the idea that the Bernankes and Geithners of the world were really the solution to the problem and not at all the causes of the problem, a view (in my opinion) not necessarily shared by a lot of investors or citizens.

Melissa Bean gave a very spirited talk about current happenings in Congress, and I was actually very impressed by her energy, candor, and seeming willingness to get the right things done. The issue is whether the “average” legislator really has a handle on what is going on, and any idea on how to improve the system. As readers on this column and listeners know, by biggest fear (assuming legislators are trying to get things right) is the very obvious disconnect between the voters, the elected officials, and the governmental staff/lobbyist group. For example, I asked Congresswoman Bean how it appeared to me that a significant majority of those elected (Senators and Representatives on both sides) are stunned at the too-big-to-fail thing and wonder how it was allowed to happen, and want it fixed going forward. Yet in the last year, since the height of the crisis, these Banks have gotten significantly larger, not smaller, as the obvious policy of the FDIC Staff is to continue to combine failing banks into the old ones with a pattern of seemingly sweetheart deals. My question was, simply “Who controls these people?’ “Who are they directly accountable to, and why can’t that person say this is not what we want?” I went on to detail the incredible deal (in my opinion) given to MB Bank last week in their takeover of Corus Bank. I asked “That deal involved an estimated $1.7 B in taxpayer money, and seemed to me to be remarkably one sided, is there some sub-committee somewhere who will go over it?” She really had no answer, other than the new and improved regulatory world that someone somewhere is writing will solve all these problems and answer all these questions. I think the system is totally out of control, I do not think our elected officials have any real idea how a lot of these deals are being made, and if the prices are anywhere near fair. The only thing they know about regulation is that we need more of it, but you would think they would stop for a minute to consider whether the regulation we do have is part of the problem or part of the solution.

At the risk of being the person everyone in class hates because he or she asks too many questions (especially at the end of class extending the time in class) I could not resist one more to the Congresswoman. I even prefaced the question by saying “You are going to think I am a grumpy old guy.” But I did have to say, “You, and obviously Diane Swonk, are really sold on the talent of those regulators (Bernanke, Geithner, Shapiro, etc.) that you feel stopped us from going over the edge last year. I have to say that a real lot of other people feel that it was their inattention that had us at the edge in the first place, and that they are more the cause of the problem than the solution.” Again, I was sort of lectured on the incredible new laws that were forthcoming, and the party line seems to be that any mistakes that were made were really the lack of legislation giving the Regulators the power to do what needed to be done, not their inattention. You know what, Bull Bleep!! These people (meaning Regulators), with the probably help of meddling legislators and self-serving lobbyists, made all the stupid decisions allowing the six largest Investment Banks to have less net capital, and allowed large Commercial Banks to have capital as low as 6-7% of assets. The rest of the people at the Conference also asked questions regarding how they are convinced that Regulation going forward will do nothing more than make it harder and more expensive to do business for firms that were never guilty of anything, and it appears they are correct. I suspect we can all agree that will be the outcome, harassment of the innocent.

As you can probably surmise, I am not too sold on the ability of the young administration to do an effective job regulating the financial markets (or anything, for that matter). The fact is that most regulation has failed over time, and more is not necessarily better. I suppose it is a natural reaction to any crisis to say the somehow the government should have done something to stop it, and it certainly is a natural reaction for those regulators ineffectively in place at the time to say that if they only had more people and funding they would have done the job right. They (the regulators in place) are really not going to respond with “We really were useless, in fact we probably added to the crisis by our inattention, stupidity, and coziness with those we are supposed to be watching.” I also think that, in addition to being of dubious talent, they are virtually unsupervised. The deal given MB Bank, where they paid essentially $14 M for $7 B in customer deposits is nothing short of astonishing. How much do you think it would cost for the marketing, staff, physical branches, and etc. to raise $7 B in customer deposits? I am thinking way more than $14 M, where can we sign up for that deal?

Is the market going to continue to run and play havoc with anyone with a short call? I have had phone calls from people virtually conceding the market another 15-20% rally before years end, and some thinking this is the biggest bull trap rally of all time. Not a problem to get a difference of opinion. What is true is that the combination of decreasing volatility (hurting any long puts) and a market rising rapidly through any formerly reasonable call strike has caused the PIP to under perform the market to a large degree. During the course of the Program this has happened on two other occasions, the Long-Term Capital/Russian Currency issue in 1998 and the market run up 2 years ago. The first time we essentially caught the market advance in roughly six months by continuing to roll up calls and capture premium. The second time the market turned around and went down hard, making us very happy we had the position we had. The outcome this time is still to be determined, but I think we all need to take a look at the very unusual market moves of the last two years, both to the upside and downside. Having a hedged position essentially takes out a lot of those swings, both the bad swings and the good ones. Right now we are in one of those markets when being hedged seems like crazed conservatism, but last March was not that long ago to where people have totally forgotten. We will certainly make every effort to “catch” the returns the market has made the last couple of months, while not leaving us vulnerable if the market were to decide that the rally is all a mirage.

Have a great week, folks, and be sure to listen to Dr. J and I on!