Author Archives: Lila

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.”

Psychic Income Versus Real Income (Updated)

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John Mauldin in Frontline Thoughts on one off balance sheet vehicle that might get us out of this crisis faster than we think: psychic income, our dreams for our future…

“Every night we go to sleep on our psychic income, and every day we get up and try to figure out how to turn it into real income……The future is never easy for all but a few of us, at least not for long. But we figure it out. And that is why in 20 years we will be better off than we are today. Each of us, all over the world, by working out our own visions of psychic income, will make the real world a better place.”

My Comment:

In response to RobertinDC, my loyal reader, who politely calls this a “crock,” I should add the context of Mauldin´s note, which is technological change.

Mauldin argues that even if the market stays flat or depressed in real terms, even if unemployment increases and the standard of living falls, none of us can know for sure what the future holds. In ten years time, the world may very well be a better place.. in terms of possibilities… than it is today because of technological innovation.

Is this implausibly “feel good” stuff?

Well, yes.

Of course.

It takes no great courage or imagination to imagine plausible scenarios.

Imagination is the ability…the very creative and fundamentally life-giving ability..to imagine implausible..even unbelievable scenarios and then make them not only plausible but inevitable.

And, again in a fundamental sense, that is how creativity in all fields works. Focusing solely on the negative is itself a form of delusion.

I don´t mean by this that you can wish yourself into any outcome you want. There are also physical laws at work that you have to accept. You cannot wish away a contraction of the economy because of overspending, for instance.  The economy has to correct.

But the effects of the contraction, the extent, and its resolution can in fact be ameliorated by a change in attitude.

And by staying alert to every possibilty, we can also sense when deterministic interpretations – such as, “this is the way capitalism is”  — are being used to cover up what is in truth a very manipulated reality.

In that case, what we should focus on is an imagined ideal, the way capitalism should be, which may be implausible or even a crock, in some views, but is our only true guide to a way out of this debacle.

This is why I wrote, in 2007, that the economy didn´t have to crash. It was in a PR piece for the book.This wasn´t because I lacked a healthy sense of reality. But reality in the sense that physicists understand it is a very different thing from the “common sense” understanding of reality. The physicists´view is actually closer to what might be called implausible or even unbelievable. But it´s none theless true. The same divergence between common sense perception and underying reality exists in the economy.  Cynicism is often right. But not always. Pessimism is often warranted. But not always.

There were fundamental problems in the economy in 2006-2007, but the way the crash occured struck me then as very strange.

I suspected at the time that some of the indices were manipulated…and now the deepcapture team (and others like Pam Martens) have shown how they could have been (see prior posts).

In time, you are going to find that this is true of many of the indicators we use to read the mood of the investing public. Markets are driven by emotions. And smart crooks with the ability to manipulate that emotion can make big money from the manipulation….

And if they can, it stands to reason they will.

What is surprising is only why it took so long for supposedly tough minded financial reporters to figure that out.

In any case, whether manipulation is proved or not, what ordinary people can do is to take for their model the good trader. Good traders are people who can “keep their heads when all around you are losing theirs and blaming it on you”..as Kipling said.

The hall mark of expert trading is to control the emotions and rein them in from succumbing to mass moods. What does that mean in practical terms?

It means when everyone is panicking, look for silver linings, and when everyone is complacent, learn to worry…

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.”

Israeli National Airline a Front for Israeli Secret Police?

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Jonathan Cook in Dissident Voice:

“South Africa deported an Israeli airline official last week following allegations that Israel’s secret police, the Shin Bet, had infiltrated Johannesburg international airport in an effort to gather information on South African citizens, particularly black and Muslim travellers.

The move by the South African government followed an investigation by local TV showing an undercover reporter being illegally interrogated by an official with El Al, Israel’s national carrier, in a public area of Johannesburg’s OR Tambo airport.

The programme also featured testimony from Jonathan Garb, a former El Al guard, who claimed that the airline company had been a front for the Shin Bet in South Africa for many years.

Of the footage of the undercover reporter’s questioning, he commented: “Here is a secret service operating above the law in South Africa. We pull the wool over everyone’s eyes. We do exactly what we want. The local authorities do not know what we are doing.”