Market Talk

It’s starting already:

WASHINGTON—Rep. Spencer Bachus, the Republican expected to take the gavel of the House Financial Services Committee next year, said he plans to rewrite the derivatives provisions of the Dodd-Frank financial overhaul law.

“That’s one of the job-killing provisions of Dodd-Frank that needs to be addressed,” the Alabama Republican said in an interview Wednesday morning, calling the provisions “overly expansive.”

Oh, that’s rich, arguing you need to amend the derivatives laws because they’re “job killers.” Hey, what about all the jobs that’ll be creating by the exchanges to handle the new business coming their way? Won’t that create jobs? One job, maybe? Anything?

The finance boys have once again done their job well. Look at this Bachus page on opensecrets.org. Who is Bachus’ biggest contributor through his career? Commercial banks. Insurance and real estate come in next, with securities next and finance companies after that. And now they’ve got a friendly voice taking over the financial services committee, one who already wants to rewrite the finreg rules. How convenient.

I can’t wait to see how far backwards John “don’t let those little punk staffers take advantage of you” Boehner’s House is going to bend for the banking lobby. David Weidner pegged it last night during the election show. The banks don’t necessarily want to buy elections, they want to buy influence. They don’t care if a Republican or a Democrat holds a seat in Congress, so long as they vote in favor of the banks.

They’ve got a very piable audience in DC. Both parties.

- Soon it might not be so easy to walk away. “It seems some banks have realized that they have made it too easy for borrowers to wash their hands of a bad home purchase, and they are pushing back,” FusionIQ CEO Barry Ritholtz says. “Don’t be surprised if this becomes a national trend. The next leg down in housing is upon us, and banks do not want to take the full hit for the losses.”

- Housing starts and new building permits last month show the recovery’s next phase won’t be a walk in the park. “The post-snapback period in the economy is history, replaced by the harder work of keeping the rebound in positive territory,” James Picerno writes at The Capital Spectator. “The numbers in May remind that the task ahead isn’t going to be easy.”

- “I will simply say this: free market capitalism hasn’t been allowed to dictate the process of price discovery for a long time as policymakers have attempted to engineer the business cycle,” Minyanville’s Todd Harrison says. “As we’ve learned before and as we’ll again see, it’s never wise to mess with Mother Nature.

- Ongoing chatter of a bailout for Spain is causing euro-zone debt worries to fester again. But even as the latest rumors look suspect, their mere existence is a cause for concern, FT’s Alphaville says. “The fact that the rumor is out there shows how vulnerable Spain is on the market at the moment,” blog says. Escalating bailout rumors amid repeated denials prompts the old saying: where there’s smoke, there’s fire.

- TechCrunch founding editor Michael Arrington may be ready to sell his blogging empire. According to TechFlash, Arrington hinted at an event yesterday that he was burned out and possibly looking to sell. “It has been five years, and I can tell you, I am ready,” he said.

- Twitter says the month of June has been its “worst month” since last October, based on a site stability and service outage perspective, and this will likely be a “rocky few weeks” amid increased web traffic due to the World Cup.

- “We are setting ourselves up, without question, for another boom based on excessive and reckless risk-taking at the heart of the world’s financial system,” Simon Johnson writes. “This can end only one way: badly.”

- S&P 500 broke above its 200-day moving average amid yesterday’s rally, Bespoke Investment Group notes, and the percentage of S&P 500 stocks trading above their 50-DMAs sits at 39%. “While not great, this reading indicates that the market has at least picked itself up out of the doldrums.”

- Citi’s halting certain foreclosures near the Gulf spill, WSJ reports. Citi announces a three-month suspension of foreclosure sales and notifications, effective from Thursday through Sept. 17. Citi expects about 1,000 borrowers to participate initially, but that number might increase.

- Rick Bookstaber sheds light on OTC derivatives and new financial legislation.

Wall Street plots out its strategy.

The full-court press has started against the portions of the financial-reform bill that deal with the handling of derivatives. Of course, the full-court press usually is employed when one team is losing, badly, and the clock’s running down, so read into this what you will.

Goldman Sachs, its flogging in the public square notwithstanding, has been actively lobbying against the bill’s derivatives features, specifically “section 106,” which would require big banks to sell off their derivatives operations. From the Journal:

Goldman Sachs Group Inc. is lobbying hard to kill a provision in financial industry overhaul legislation requiring big banks to sell off their derivatives-trading businesses, and rival banks are welcoming the help, shrugging off attacks on the firm by lawmakers and securities regulators.

Goldman’s lobbying could put Democrats and the White House, which is lukewarm on the provision, in a difficult position. With congressional elections looming in November, lawmakers don’t want to appear supportive of Goldman or Wall Street.

But Goldman’s leadership is less concerned about politics than the provision itself, known as “section 106.” The nation’s five largest banks together earned $23 billion from derivatives trading in 2009, and are working separately and together to defeat the provision.

See that $23 billion figure? That’s all you need to know about why the Street is fighting this. That’s $23 billion in 2009; what do you think it was in 2007? Or 2006? Derivatives are a golden goose for the Street, a big part of their fixed-income profits, which has been the main part of their overall profits. It hasn’t been lending to consumers, that’s for sure.

That is the sole reason they will oppose any reform efforts. It has nothing to do with their ability to make loans or liquidity or market making or anything. It’s about profits.

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The SEC really walloped Wall Street today. Usually the agency is reduced to proving its worth by circling rinkie-dink Ponzi schemes, or second-rate boiler room operation. But they’re going after Goldman, firing a broadside at the whitest of the white-shoe firms, and at a rather critical moment for the fate of one of their biggest and most successful, and least regulated, cash machines. Derivatives.

Goldman’s shares are getting hammered, as is the wider financial sector, even though the case focuses on a single deal at a single firm. But you can’t view this in a vacuum. The SEC is filing charges related to the marketing of a CDO as the debate is at fever pitch in Washington over whether and how to regulate them. It’s a debate that the Street has thrown a lot of money at, and the GOP has actively played the lackey for, all in an attempt to keep any strings from holding that that cash cow.

Wall Street does not want derivatives to be regulated. And now here comes the SEC, which might as well have Inspector Clouseau running it for all the good it’s done the past decade, pulling off something of a Colombo moment. “Ah, just one more question, Lloyd.”

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The Vampire Squid is in trouble.

Goldman Sachs is getting beat up good this morning, after news broke that the SEC charged them with fraud in structuring and marketing a CDO tied to subprime mortgages. The news is ugly enough in and of itself, but what really captures the imagination are the possible implications and ramifications.

Goldman shares are down 12%, and the entire financial complex is down about 3% on the news. It’s kind of like that scene in “Training Day,” where Ethan Hawke shoots Denzel Washington, after Denzel taunts him, saying he doesn’t the guts to do it. When he finally shoots, Denzel screams in surprise (in a way that only Denzel can convey, too) “you shot me in the @#$!”

The SEC’s charges are straightforward enough: the hedge fund Paulson & Co. paid Goldman $15 million to structure and sell a CDO in 2007, just as the housing market was beginning to crack. Paulson picked the securities to include in the CDO, and then shorted them. Goldman went along, and told investors the securities were picked by an independent third party.

We’ll get all breathless here and suggest to you that this could be the biggest piece of news to hit the financial markets this year. It gets to the heart of the recriminations about Wall Street’s role in the housing bubble, the credit crisis and the financial meltdown. The big Wall Street firms weren’t just providing “liquidity,” as they claimed, they were actively gaming the system to their own benefit. That’s what this allegation says. And it’s Goldman Sachs.

It’s early. These are just allegations. Goldman has not been heard from yet. But another crack in the wall that Wall Street hides behind — that facade that says they’re so successful because they’re just that much smarter than everybody else — has appeared. No telling where it goes or how wide it gets.

- “It’s looking like more individual investors just can’t stand being on the sidelines anymore as the stock market continues to rally,” Tom Petruno writes.

- Bullish sentiment is on the rise in recent weeks. But keep in mind “as quick as [investors] have been to embrace rallies, they have been just as quick to abandon them,” Bespoke says.

- As good as recent economic data has been, high unemployment levels should keep investors “very hesitant to erupt in full-throated rejoicing at the turnaround in the American economy,” Free Exchange says.

- Is Newsweek’s cover story touting the economy’s “remarkable turnaround” a contrary indicator, or just plain contrary?

- Europe appears to be heading down a slippery slope.

- Initial jobless claims jumping for a second consecutive week shows the labor market hasn’t quite joined the recovery fiesta.

- Yesterday’s strong retail sales report shows the consumer is finally showing real signs of life. “Even a relative pessimist like me has to admit that recent trends look pretty good,” Tim Duy writes.

- Requiring commercial banks to separate derivatives operations from commercial banking activities looks nice on paper, but Yves Smith at naked capitalism remains skeptical it will solve the systemic risk posed by OTC businesses.

- AAR reports rail traffic rose 7.5% in March compared to a year earlier, which Calculated Risk notes is the first year-over-year increase since July 2008. Sure, it’s a step in the right direction, but recovery in rail traffic still has a long way to go.

- Harbinger Capital discloses it’s purchased 16M shares of Palm. “Somebody, somewhere is going to buy Palm. And they’ll end up paying more for it than the market thinks it’s worth today. That’s the thinking behind hedge fund Harbinger Capital’s bet,” Peter Kafka says.

- Here’s a new one. Obama administration approaches Microsoft (MSFT) about creating a video game about balancing US budget. Erskine Bowles, leader of Obama’s 18-member budget-balancing commission, says the game “would enable anyone with a computer to take a stab at balancing the budget” and would definitely “go viral.”

Dow Jones Newswires columnist and News Hub host Simon Constable reports:

I always worry when regulators start meddling in financial markets: Their efforts tend to backfire.

That’s why last week’s public meeting of the Commodity Futures Trading Commission concerns me so much. Attendees at the gathering discussed curbing speculators in the metals markets.

The problem is that attempts to limit the role of speculators are misguided and will be counterproductive.

Or to put it another way: it would be an “own-goal” for the CFTC. “Own-goal” is a soccer term that refers to scoring a point for the opposing team. In this case, the opposing team would be the enemies of efficient markets and the opponents of capitalism.

Craig Thomas, senior economist at PNC Financial Services in Pittsburgh, hits the nub of the matter: “The underlying theme for financial markets is that markets are perfect but that information in imperfect,” he says. “So you can try to fix the market or fix the information.”

And there’s the rub: Attempting to fix the market by pushing away speculators will ultimately chase away the information, hurting the market even further.

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FusionIQ CEO Barry Ritholtz says it’s time to regulate derivatives just like all other financial instruments.

In order to reduce the systemic risk that derivatives present, he says Commodity Futures Act of 2000 needs to be repealed, derivatives need to be treated like all other financial products and CFTC needs “full oversight and teeth to enforce the rules,” he argues.

Wall Street and the banks will fight this tooth and nail, as they are reaping billions in derivative trading profits. Never mind that whole 2008-09 meltdown thingie — that’s ancient history.

This is simple, folks: Derivatives should not receive special treatment — they need to be regulated the way most other financial products in the world are.

Roger Ehrenberg, managing partner of IA Venture Strategies, offers a different argument. In a blog post published last month, he wonders whether derivatives are the real problem. Derivatives are a hot-button issue these days, but reactive policy-making isn’t the answer, he says.

The problem, however, isn’t exclusive to derivatives; it’s the underlying “business purpose” of transactions. Hedging has a legitimate business purpose. Making markets, speculation, and financing projects have solid business foundations as well. But entering into transactions that serve to hide or obfuscate economic reality work against this principle. And this lack of business purpose is not confined to the derivatives markets, but frequently takes place in the cash markets as well.

So to blame derivatives, and derivatives alone, isn’t the answer. “Let’s be clear. The issue isn’t derivatives; it’s all financial transactions whose objective is to deceive or to weaken financial transparency,” he says.

Satyajit Das, author of “Traders, Guns & Money, in a long-but-worth-your-time guest post at naked capitalism, lays out the depressing, albeit likely, route that derivatives regulation is likely to take (which at one point I recall was estimated to be a $62 trillion market. Not sure where it is now, or, given Das’ post, how anybody could even know.) He explains in detail the extreme granular complexity of the market, which itself is a formidable obstacle to regulation.

Keep in mind here, the banking lobby is a very well-oiled machine, and will throw whatever needs to be thrown in the path of any new rules that might crimp profits. Given everything that has happened, it’s beyond me that strong regulation of the derivatives market would not be a cornerstone of any reform plan that comes out of Congress, but this isn’t the sharpest Congress we’ve ever had.

From Das:

Debate over regulation of financial services has taken on a frenzied tone. Regulators and think tanks are producing voluminous, overlapping and (sometimes) contradictory proposals. Regulatory agencies are jockeying for position, sometimes forming unlikely coalitions to preserve or expand territory. In the U.S. Congress, multiple bills and several committees are jostling to make sense and harmonise complex and irreconcilable draft legislation. Activity and achievement are confused.

Banks and their lobbyists do not believe that there is a case for regulation. In William Davenant’s words: “Had laws not been, we never had been blam’d; For not to know we sinn’d is innocence.”Banks argue that the complex nature of derivative trading dictates that self-regulation is the only feasible approach. If that fails, then banks seek to minimise scrutiny of major issues, such as the size of the market, speculative activity, pricing issues, complexity and mis-selling of derivatives to unsuitable clients. They argue that existing regulations already adequately cover some issues. Proposed regulations will be masterfully narrowed to minimise impediments to profitable activities.

There will be a familiar threat. Lack of international agreement and regulatory uniformity makes compliance impractical. Banks and derivative activity will relocate with losses of jobs and taxes to the host country. Familiar arguments will be heard regarding the loss of competitive advantage, diminished financial innovation, slower capital formation and higher cost of capital. Each is a well-known step in the familiar “regulatory tango”.The complexity of the issues means that ultimately no laws may be truly effective. As one famous law maker, Adlai Stevenson, observed “Laws are never as effective as habits.”Groucho Marx observed that “[government] is the art of looking for trouble, finding it, misdiagnosing it and then misapplying the wrong remedies.” Legislators and regulators are likely to discover the truth of that proposition in their attempts to regulate the derivative market.

Yves Smith over at naked capitalism points out one more failure of the financial-reform movement: the failure to address in any capacity the uses of credit default swaps. “Credit default swaps played a much more central role in the financial crisis than is widely understood, and they continue to get a free pass in financial reform proposals that they do not deserve,” she writes today.

Unlike real derivatives, CDS are subject to massive price moves (”jump to default’) when a reference entity (the entity on which the CDS is written) defaults or goes into bankruptcy. That large price movement, means that the margin already posted will be insufficient, and there is no guarantee that the counterparty will be able to pony up the amount now due. But perhaps more important, the idea that CDS have legitimate uses is questionable.

If there’s been three words uttered on this subject in Congress, I’ve missed them. Just think about the whole range of subjects that need to be address regarding the financial markets, and then think about this consumer protection agency, which is what Congress is offering as its solution. And they can’t even agree on that.

Why don’t they just outsource the work to Consumer Reports, and let Congress get on to things they can handle, like kissing babies or counting campaign contributions. This crew isn’t really cut out for anything more complicated.