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Tuesday, February 5, 2008

Bank Troubles, This Bounce Looks Exhausted

Rumors from Europe about Royal Bank of Scotland are giving equity futures the willies this morning. Apparently RBS has a $12.5 Euro funding gap and clearing problems. RBS is said to have gone to the ECB discount window.

Also, rumors are making the rounds of a ‘muni arb’ hedge fund getting into trouble.

No matter. The iTraxx index has been sneaking higher since late last week. Yesterday we took note of 1 and 3 month LIBOR also sneaking higher. Stress is creeping back into the system. It would appear that this bounce may have exhausted itself.

Yesterday morning the S&P 500 couldn’t tag the psychologically significant 1400 mark on the open. Prices opened lower and never closed the gap. That was the signal to close out any remaining ‘bounce’ longs and to get net short.

Some of the more interesting short positions I put on early yesterday are:

XLF (Puts)
BAC (Puts)
C (Puts)
XLB (Puts)
ES (Futures)

Tread carefully and make damn sure you’re flat or net short. To get you in the mood I present the following headlines for today:

Company Default Risk Jumps as Banks Toughen Lending Standards: “The risk of companies defaulting rose to the highest in two weeks on concern borrowers will find it tougher to raise cash after the Federal Reserve said banks are tightening lending standards.”

CDO Ratings to Fall as Losses Trigger Fitch Overhaul (Update1): “Collateralized debt obligations may be downgraded as many as five levels as mortgage-related losses force Fitch Ratings to review its criteria.

The biggest cuts will be to AAA rated CDOs that are based on credit-default swaps and aren't actively managed, according to ratings guidelines proposed by Fitch today. CDOs that package high-yield assets may be cut as many as three levels for the portions first in line for losses.”

Those SWEET SWEET AAA tranches weren’t those the invincible ones? Oh wait. Never mind. >grin<

European Services Growth Slows, Retail Sales Tumble (Update1): “Europe's service industries grew at the slowest pace in more than four years and retail sales dropped the most since 1995 after stock markets slumped, the U.S. economy faltered and inflation accelerated.”

Not pretty. Nuff said.


Anonymous said...


RBS and many, many other banks are in serious trouble. Why? Its very simple. Banks loaned money to people that can't pay it back. Lots and lots of money to lots and lots of people who can't pay it back.

Prior to the realization that the loans couldn't be paid back, the banks booked the loans as assets. Each round of new lending magically increased the value of previous loans thereby encouraging more lending and even more glorious " bank asset" inflation. Perpetual motion it seemed. Charles Ponzi was a piker compared to wall street bankers.

Worse still, acting in their own self interests, banks spent lavishly on their employees based on the ponzi valuations of their assets. Defaults were at all time lows. So were reserves.

The fed had no clue. They viewed these fictional bank assets as proof of America's burgeoning wealth. Declining incomes were ignored. So was the fact that America's trade deficit showed America was shipping 1.3% of total household wealth over seas each year, at interest no less.

The TAF was institued so troubled banks could wash their dirty laundry in private. Massive, inter-meeting rate cuts are resesved for bank solvency, not consumers. Fears of Northern Rock style bank runs made the TAF a necessity.

To me, the stock market started bouncing downward in 2000 after the dot-com bust. Today, we are still bouncing downard. Buy and hold has become a very long term proposition.

Anonymous said...

Simply great analysis FN; thank you.

I do have a question though. What are your thoughts on consumer discretionary/services? It seems the consumer crunch is now upon us (or, at least, finally showing up in data). Or do you think the consumer troubles will unfold more gradually?

Thanks in advance, and thanks again.

Anonymous said...

FN....great post, solid analysis, unambiguous commentary.

Thank you!



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