Category Archives: Finance

Mark to “Markit” Manipulation

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From Deep Capture:

“Another line of inquiry has not been pursued, however, though it is of equal, and perhaps greater, significance. That line of inquiry concerns the way in which the prices of credit default swaps effect [sic] the perceived value of all forms of debt — corporate bonds, commercial mortgages, home mortgages, and collateralized debt obligations — and as a result, the ability of hedge funds manipulators to use credit default swaps to enhance their bear raids on public companies.

If short sellers can manipulate the price of credit default swaps, they can disrupt those companies whose debt is insured by the credit default swaps whose prices are manipulated.  The game plan runs as follows: find a company that relies on a layer of debt that is both permanent, and which rolls over frequently (most financial firms fit this description). Short sell that company’s stock. Then manipulate the price of the CDS upwards, preferably into a spike, as you spread the news of the skyrocketing CDS price (perhaps with the cooperation of compliant journalists at, say, CNBC).

Because the CDS is, in essence, an insurance policy on the debt of the company, the spiking CDS pricing will cause the company’s lenders to panic and cut off access to credit. As this happens, the company’s stock will nosedive, thereby cutting off access to equity capital. Thus suddenly deprived of credit and equity, the firm collapses, and the hedge fund collects on its short bets.

Moreover, credit default swap prices are the primary inputs for important indices (such as the CMBX and the ABX) measuring the movement of the overall market for commercial and home mortgages.  In the months leading up to the financial crisis of 2008, short sellers pointed to these indices in order to argue  that investment banks – most notably Bear Stearns and Lehman Brothers – had overvalued the mortgage debt and property on their books. Meanwhile, several hedge funds made billions in profits betting that those indexes would drop.

It should therefore be a matter of some concern that credit default swap “prices” and the indexes derived from them are determined almost entirely by a little company with zero transparency and, it appears probable, a high exposure to influence from market manipulators. The company is called Markit Group, and there is every reason to believe that its CDS-driven indices (the CMBX, the ABX, and several others) are inaccurate, while the credit default swap “prices” that they publish  and which rock the market are in fact  nowhere close to the prices at which credit default swaps actually trade.

Last year, the media reported that New York Attorney General Andrew Cuomo had sent subpoenas to Markit Group as part of an investigation into possible manipulation of credit default swap prices by short sellers. This investigation, like Mr. Cuomo’s other investigations into market manipulation, have yielded no prosecutions.

The Department of Justice is reportedly investigating Markit Group for anti-trust violations. This investigation (which is reportedly focused on how Markit Group packages and sells its information) seems to acknowledge that Market Group has near-monopolistic control of information about credit default swap prices. However, if the press reports are correct, the DOJ has not considered the possible appeal of this monopolistic control to market manipulation.

“

My Comment

This isn’t the first time that Markit has been fingered.  Pam Martens wrote a detailed piece last year at Counterpunch called “How Wall Street Blew Itself Up” that blew Markit´s cover.

Now I´ve always suspected the indices (including Libor) are manipulated.  The fundamental problem in our markets is corruption..and that´s directly related to size and monopoly. That´s why you do need certain kinds of  “level playing field” or procedural types of regulation (not substantive regulation) to take care of the problem. I think this should also take care of Olagues’ caveat. The Deep Capture team isn’t confining its investigation to simply naked shortselling in the technical sense, but is expanding its work to the entire range of strategies involved in rigging the markets – insider trading, short-selling of all kinds, and the manipulation of indices. (Correction: I am referring to uncovered short sales, where there is no intent to deliver)

Deadbeat Expats Flee Sharia Crackdown on Debtors

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Foreign workers lured by the promise of easy living and credit are turning tail and choosing to leg it, rather than face Dubai´s tough Sharia law which mandates prison for debtors [not a bad idea in some cases…]:

“Now, faced with crippling debts as a result of their high living and Dubai’s fading fortunes, many expatriates are abandoning their cars at the airport and fleeing home rather than risk jail for defaulting on loans.

Police have found more than 3,000 cars outside Dubai’s international airport in recent months. Most of the cars – four-wheel drives, saloons and “a few” Mercedes – had keys left in the ignition.

Some had used-to-the-limit credit cards in the glove box. Others had notes of apology attached to the windscreen.”

Abu Dhabi Agrees to Selective Bail Out

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“We will look at Dubai’s commitments and approach them on a case-by-case basis,” the official told the Reuters news agency by telephone, adding: “It does not mean that Abu Dhabi will underwrite all of their debt.”  Al Jazeera, November 28, 2009

An unnamed Abu Dhabi official has said that the rich UAE [United Arab Republic] emirate will help its spendthrift neigbour Dubai on a case by case basis.

This gets pretty interesting for all the other countries out there with sovereign debt problems .. even though, as I blogged earlier, Dubai´s is not a sovereign debt problem. It´s a problem for Dubai World.

However, there seems to be a perception issue involved, which is causing credit default swaps for Irish banks to rise dramatically.

What´s going on?

This isn´t the first time the Dubai story has caused jitters in the market. Ten months ago, Dubai CDS´s rose to record levels on fears that neighboring and much richer Abu Dhabi wouldn¨t ride in to the rescue.
But that was Dubai CDS. Now it´s Irish CDS´s that are up.

Over at the Baseline Scenario, Simon Johnson has an explanation. He says the Irish tremors are caused by the perception that as Dubai goes, so go the other sovereign debt crises around the world:

1. If Dubai can effectively default or reschedule its debts without disrupting the global economy, then others can do the same.
2. If Abu Dhabi takes a tough line and doesn’t destabilize markets, others (e.g., the EU) will be tempted to do the same (i.e., for Ireland and Greece). “No more unconditional bailouts” is an appealing refrain in many capitals.
3. If the US supports some creditor losses for Dubai (e.g., because of its connections with Iran), this makes it easier to impose losses on creditors elsewhere (even perhaps where IMF programs are in place, such as Eastern Europe).

I´m not sure I follow this reasoning at all. Nor do I understand why Mr. Johnson seems to think this adds up to strengthening Ben Bernanke´s hand…..

Let´s see. Is Mr. Johnson saying that if picking and choosing whom to rescue is OK for an Arab sheikh, it should be good  enough for Ben Bernanke?

Frankly, that sounds less like an explanation and more like advance PR for the Fed to engage in arbitrary treatment – bailouts – of banks and other companies..

[Update:  And lo, it turns out that Ben Bernanke does need all the help he can get. He wants his power, dammit…see this oped at the Washington Post, hat tip to EconomicPolicyJournal]

A more convincing explanation of the Irish reaction than Johnson´s is Irish exposure via investment and employment to the Dubai economy.

“The Emirate was a Mecca for the Irish glitterati during the Celtic Tiger years, with many would-be investors taking a gamble. Ireland captain O’Driscoll bought an apartment in the e389million Tiara Residence in 2006 off the plans. However, the property may now be worth much less than the €500,000 he paid for it.

But thousands of Irish investors are facing the prospect of their Dubai prop-erties plunging in price. Price drops in Dubai have been severe. According to Knight Frank Global House Price Survey, prices dropped by 40%.

It’s all a long way from the glittering heights of the middle of the decade – and from the 1980s, before the ruling Al-Maktoum family decided to turn their dusty emirates into a leading city.

The Irish have shaped the landscape of Dubai like few other nationalities, with Irish builders, engineers and architects prominent in building up the city state.

But now, question marks hang over the fate of hundreds of Irish who escaped the slump at home for jobs with companies under Dubai’s control.”

More here.

John Olagues on Naked Short Selling

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John Olagues, the options market-maker who first analyzed the collapse of Bear Stearns and Lehman as the result of a concerted attack, has a new piece at Investopedia criticizing the ¨naked short selling¨critics:

Naked short selling is often in the news today, and is criticized by journalists and other pundits who claim that naked short sellers allied with “rumor mongers” caused the collapse of Bear Stearns and Lehman Brothers. They cite the large “failure to deliver” for a stock as evidence of naked short sales days after the stock had dropped. Although the naked short sales happened after the collapse event, they still hold onto the idea that those after-the-event naked short sales caused the collapses. (To learn more, see Case Study: The Collapse Of Lehman Brothers.)

In my opinion, those who believe that naked short sales caused the collapse of Bear Stearns and Lehman Brothers are misdirecting the attention from the illegal inside traders and their allied manipulators.

The large volumes of “fail to deliver” stock and the naked short sales after the  collapses of Bear Stearns and Lehman Brothers leads me to believe there is an explanation for those large volumes. However, that strategy did not cause the collapse of those companies. (For more, check out our Short Selling Tutorial.)

The Bottom Line

Selling short can be done in a myriad of ways. And, although naked short selling is often given a bad reputation in the media because it is frequently abused, it is not as nefarious as its critics suggest.

My Comment:

I´ve gone back and forth about this with Olagues, as well as with the most prominent figure in the naked short-selling campaign, Patrick Byrne…and it occurs to me that a lot of the problem lies in language – as is the case in other areas of political debate too.

Distinguishing between naked shortselling and other forms of shortselling where the shares fail to deliver seems to the source of the problem. NSS should include within it all forms of shortselling that do not cost the seller.

When the seller does not pay the actual price for his transaction, his activity is no longer adding information to the market. There is no price discovery, because the cost of the shortselling has been arbitrarily shifted elsewhere and in fact miscues the market. So what market-makers do in the course of their legitimate activities and also when they´re trying to exploit their position for their own benefit would come under the NSS rubric..

Aside:
I would go on..but I have had computer problems for the past two weeks…the keys type whatever they want to …I cant use the apostrophe, the parentheses have vanished, and when I type a dash, out comes an equals sign….which is why I keep using dots..and there are no contractions.

Fall-Out from Dubai World (Update)

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I´ll try rounding up the reaction in the market and the punditry to Dubai World´s threat of default.

Two clarifications.

First: Dubai World´s problem is being referred to as a sovereign debt problem, but as far as I can understand, it´s not. The Dubai government is the 100% owner of Dubai World, which is itself a holding company. But, as William Buiter points out in the Financial Times, the Dubai government has only limited liability, just like any other limited liability company.

It wouldn´t have to reach into its pockets to make good any obligation unmet by Dubai World or its subsidiary Nakheel.

Second. The debt crisis is being referred to as a Black Swan. Again, this is inaccurate. A black swan is an unexpected event that doesn´t fit (and in fact upends) the prevailing paradigm. This debt crisis has been on the horizon for a while. And the announcement of the standstill in payment was obviously calculated to roil the markets as little as possible – being made during the Thanksgiving holidays, when the market is partially shut, and also at the start of Eid which lasts until December 6.

Update: With those caveats, I was going to try and list the banks and sectors that might be affected…but I found that Bob Wenzel´s site  had already got a chart of Dubai World´s obligations to Nakheel Holdings from Izabella Kaminska at the Financial Times. You definitely need your coffee before you read this one.

However, the text below the chart, although just as abstruse, does make it clear that investors are not going to be able to get any blood out of the Dubai government.

“Investors should note, however, that the Government of Dubai does not guarantee any indebtedness or any other liability of Dubai World.”

Update: I should add here that while technically the government of Dubai is not responsible for the debt, it is implied everywhere that the safety of the debt derives from its backstopping by the government. The reaction of furious investors that Dubai would never be able to raise a penny again implies that default would taint the government and not simply the company.

Speculation Drives Metal Prices

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Geologist Brent Cook at Mineweb explores the speculative frenzy behind metal prices:

“Now I do not know if Paul’s [Van Eeden] thesis on gold is accurate or not: if it is it could still take many years to play out. Likewise, I do not know how or when the base metal prices will re-equilibrate to the reality of end demand-whatever that is. What is obvious is that gold and now base metals have become speculative investments that in addition to being bought as hedges against inflation and a falling US dollar are the latest get rich quick scheme. The end result is that absent the faith that metals and markets are all headed higher, we here at Exploration Insights are finding it difficult, although not impossible, to find value in junior mining and exploration companies.

Hot money on the other hand is not.

Over the past few months we have witnessed bought-deal equity financings for individual mid- to junior tier gold companies in the 10’s to 100’s of million dollars. These are being bought at nearly the absolute 52-week highs by funds that I know have not looked into the mining, metallurgical, social or political intricacies that make or break a mine. This fearless hot money jumping into the sector worries me. It always precedes a market bubble and correction: sometimes serious, sometimes temporary- sometimes by weeks, sometimes by years.

Adding to the absence of fear and proper due diligence in the market, my recent discussions with corporate financiers confirm that both large and mid-sized gold companies are being offered substantial unsolicited bought-deal financings-no questions asked. At the same time, some of the very same companies being offered the quick money are being hit with heavy selling when a fund manager becomes “concerned” because there has been no news for a couple of weeks or gold backed off $15.

Hand in hand with heavy fund demand for new metals investment ideas most of the major research firms have increased their commodity price assumptions to reflect the “new reality”. The primary advantage afforded by the commodity price revisions is that previously overvalued mining companies can instantly become “Buys”. Recall that the last major upward revisions from many of these same research firms came as the new reality of higher prices set in 2008.

The problem is that greed is driving the market and so any small hiccup or change in sentiment and the hot money tends to bolt. As last year taught us (remember last year?) when the fast money going in is the liquidity, there ain’t no liquidity getting out.

I remain cautious and somewhat concerned by what appears to be hot and fickle money jumping into a sector that is apparently taking its cue from pig farmers”.

Secy of IMF – Siddharth Tiwari

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On November 21 an Indian was named Secretary of the IMF, according to Press Trust of India:

“With a proven track record in managing complex work programmes, Indian economist Siddharth Tiwari has been named as the Secretary of the IMF by its Managing Director Dominique Strauss-Kahn.

Tiwari, currently Director of the Office of Budget and Planning, is set to assume the position, which was held by Shailendra Anjaria before his retirement from the IMF earlier this year.

“Mr Tiwari has the experience and skills” to promote consensus building, which is a critical goal of the IMF Board and Management, Strauss-Kahn said in a statement.”

Billionaire Nabbed In Largest Hedge Insider Scheme

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In the news (:http://www.bloomberg.com/apps/news?pid=20601087&sid=asliefsvW5Zc)

“Oct. 16 (Bloomberg) — Raj Rajaratnam, the billionaire founder of Galleon Group, and ex-directors at a Bear Stearns Cos. hedge fund were among six people charged in a $20 million insider trading scheme federal prosecutors called the biggest ever involving hedge funds.

Also accused were Rajiv Goel, who worked at Intel Capital as a director in strategic investments, Anil Kumar, who worked as a director at McKinsey & Co., and IBM Corp. executive Robert Moffat. The former officials at Bear Stearns Asset Management are Danielle Chiesi and Mark Kurland, who were affiliated with the firm’s New Castle Partners, which managed about $1 billion.

“The defendants operated in a world of, you scratch my back, I’ll scratch your back,” U.S. Attorney Preet Bharara in Manhattan said at a press conference today. “Greed, sometimes, is not good.”

My Comment

The biggest hedge scam – there you go. Anything Westerners can do, Easterners can do better. We’re not going to settle for any penny-ante crime anymore.  Now you know how at least one South Asian billionaire got rich so fast. Nothing like having an edge…

What’s interesting is that this is the first time that the Fed’s used wire-tapping to target insider trading on Wall Street. Until now that tool has been the reserve of organized crime and drug cases.

Fraud On the Run: Goldman Cop On SEC Beat (ROTFLOL)

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In the news, to be filed under – What parallel universe does New York live in?:

“Oct. 16 (Bloomberg) — The U.S. Securities and Exchange Commission named Adam Storch, a 29-year-old from Goldman Sachs Group Inc.’s business intelligence unit, as the enforcement division’s first chief operating officer.

Storch, who joined the SEC Oct. 13, was named to the newly created post of managing executive in the enforcement unit, charged with making the division more efficient, the SEC said today in a statement. At New York-based Goldman Sachs, he had worked since 2004 in a unit at that reviewed contracts and transactions for signs of fraud.”

My Comment:

Personally, I’ve come to nurse a kind of contemptuous respect for, an appalled amusement at Goldman Sachs. It’s the contrarian in me.

In-your-face-corrupt, shameless, self-promoting, out-of-touch, sanctimonious, and bottomlessly greedy –  It’s a firm made for our times…

If Goldman Sachs didn’t exist, we’d have to invent it.