The Toxic Assets Avenger
March 24, 2009
Good morning. Last week the market had some volatile moves on a daily, or hourly, basis, but closed the week with a gain of only .8%, with the SPY moving from $76.09 the week before to close at $76.70. Be mindful, however, that the $.72 dividend in the SPY did come out as it went ex on Friday, meaning that it was actually up another $.72. The big news, however, came on Wednesday, when the Federal Reserve announced a long rumored plan to buy some long-term treasury securities. That brought about a significant rally in stocks and the largest ever short-term move in the 30-year Treasury Futures, with the initial upward move over seven full points (the old limits used to be 3 points). Almost all of those gains were lost, however, in very lackluster and negative trade on Thursday and Friday. This morning, so far, we are in the midst of a big rally greeting the new Treasury plan to remove toxic assets from bank balance sheets. It also seems that existing home sales in February were much better than expected, even though sales of distressed properties were 45% of transactions.
I think a lot of people were caught off guard by the Fed’s announcement to buy treasury securities. The Fed has been very vigilant, due to Mr. Bernanke’s knowledge of the Great Depression, to not let the money supply fall in the midst of all this market turmoil. Most, if not all, economists feel that the root cause of the depression was the Fed allowing the money supply to sink dramatically, as much as 24%, in the months following the stock market crash. He has not allowed that, in fact M2 grew by 9.7% in the last 12 months, and has grown at a 15% rate in the last 3 months. The plan to buy treasuries means that the Fed wants that growth rate even higher, really jolting the economy but certainly inviting inflation later.
Is this the start of a new bull market? It sure looked like maybe that view was the right one last Wednesday after the Treasury announcement, only to be greeted by some negative sentiment Thursday and Friday, and now today’s wild to the upside with a new plan. Just this past weekend people were calling on Treasury Secretary Tim Geithner to resign, today the market is toasting him (or someone) with both hands. It seems like the new plan will strip the big, in trouble banks, of those assets that are toxic, meaning those that have been written down, need to be written down, don’t know what to do with, etc. Current holders, banks and others, have already written down most of these groups of assets to some level, varying between 20-80 cents on the dollar. It seems now that the Fed is going to be insightful enough to remove these assets from the banks at a price that is at least equal (and preferably higher) than the value currently carried (otherwise you would put the bank out of business and put in serious jeopardy the huge amounts the government has already loaned the banks). The price also has to be less than someone else would want to pay (even using borrowed money from the government) and a price that the people on the receiving end can profit greatly as the loans mature.
The question is, and it is the same question that has existed through countless plans and talking heads, can there be such a price? It does no good to pay less than the banks now carry them, you just cause future write-offs, now of government equity. If someone is willing to pay more, then the banks have less of a problem than they think and they should be able to work out of it on their own. I ask again, why is it necessary to move these assets to another whole layer of institutions and who comes up with this magical price? I think because Bill Gross and countless hedge fund carpetbaggers are beating on elected officials through lobbyists, TV, in person, to “Let me help you and take some of these ‘toxic’ assets off your hands for 20 cents on the dollar, provided you lend me the money and guarantee I don’t lose too much.” Nice, if it works for you and have the connections to get the “good stuff.”
The other question is the continuing fervor regarding the AIG bonuses, and the amazing fixation of the public on this one piece of the news. I read this morning that AIG is averaging 15,000 pieces of hate mail a day, and now tour buses in NYC are including the AIG office building on the tours, where people on the bus are pointing to (sometimes vertically) people leaving the building. Of course it should make no difference that no one in that building had anything to do with the financial contracts in question. Can anyone explain to me why people are more upset with these bonuses than with the banks that took huge amounts of taxpayer money and are now raising credit rates on those same taxpayers? Or should we be more concerned with the billions given AIG that went right out to Goldman, Deutsche Bank, and others. When Mr. Dick Fuld (not a sympathetic figure) testified before Congress that his required collateral deposits were being increased at the same time people were breaking every rule about naked selling his companies’ stock, and at the same time some were gobbling up credit default swaps on his company (betting it was going under), did anyone other than me think it could all have been coordinated by the same people or institutions? What if someone was doing all of these things at once, should we be giving money to AIG to pay them off or should we be bringing them to the noose? I have no real evidence, but something sure smells if you use any imagination to connect the dots.
So how do we make money with all this volatile trading, going from one announcement to the next on at least a bi-weekly basis? I think you do just like we have been doing for our clients. We have some cash in reserve, we have significant amounts in the market (but protected by at least put spreads), we have a long-term bullish position on the financials and the energies at these levels, and for our more aggressive clients we are short the very high premium levels in a small and careful way. I have thought about committing more cash, but the puts and put spreads are still high. I am also somewhat concerned that some of these huge governmental plans will not work as quickly as hoped. The government is making a huge bet (probably exceeding all other programs like this in all of history combined) that the economy will turn around quickly enough for these companies to, at least, survive and maybe actually pay them back. If they are wrong we will have stagflation on steroids. Right now I am more inclined to do some bullish spreads, taking advantage of the high volatilities, to get more involved than I am to burn up our excess cash. Today I wish we were more invested, tomorrow, I might feel just the opposite.