Trader’s Narrative

The US financial system was resuscitated by the largess of the taxpayer. Without any real quid pro quo, transparency nor discussion, they were made whole. Their losses made public while their profits were guaranteed to remain private (as the recent obscene bonuses attest).

So now that the US economy is still on the ropes, fighting for its very survival and in dire need of a liquidity transfusion of its own via the credit markets, where are the banks?

Surely they are pumping the lifeblood they received from the US treasury and the Fed back into large and small businesses that are the engines of growth to allow the economy the same recovery they enjoyed. Right? right? Well, no. In fact, if you assumed that you couldn’t be more wrong.

As you can see from the chart above, bank lending in the US has contracted to an unprecedented degree. You may notice that a contraction of some shape or form happens each time we have a recession (the dark bars). And you would be right. But we are not taking a random walk down Wall Street these days. These are extraordinary times, which required extraordinary measures - whether rightly or wrongly.

So what are the banks doing with all the cash they received from the hard working American Joe and Jane Sixpack?

Hoarding it like a miser:

So we have banks flush with cash, not lending to those who need it and deserve it, but rather sitting on the cash or in Goldman’s case, using it to generate billions of dollars in profit which then is promptly cut in half to be paid as bonuses.

As David Rosenberg of the Toronto boutique firm, Gluskin Sheff posits, this may be why the US government bond market is so subdued:

The banks are deploying the cash in the government bond market, buying a net
$27 billion in the latest week and $130 billion in the past 18 weeks. Meanwhile, cash reserves keep piling up and just reached an all-time high of $1.2 trillion — enough to finance the entire U.S. fiscal deficit. This is a nice back-of-the-door mechanism for how the Fed is monetizing the government’s endless need for money: bolster reserves at the big commercial banks and have these banks buy the bonds that Uncle Sam sells in order to raise the capital needed to fund all the government’s fiscal stimulus measures.

Here is a very long term chart of the US 30 year bond yield:

The Chinese have a saying: ‘May you live in interesting times.‘ All I dare hope is that things don’t get any more interesting than this.

By the way, here is an almost too good to be true offer for my US readers. For a limited time, you can get a complimentary subscription (aka FREE) to SFO magazine (Stocks, Futures, and Options).

It takes less than a minute to sign up and you need to provide some basic information. But as I mentioned, you need to be a resident of the US (because you need to provide a US address). Enjoy!

Executive compensation is one of the glaring issues at the heart of the financial crisis. We haven’t even come close to dealing with it in a meaningful way as the powerful Wall St. lobby moved quickly to throw obstacles in the path of any regulation or even discussion of the matter.

The most common argument that is trotted out to defend the obscenely disproportionate compensation packages on Wall St. is that the bonuses, salaries and stock options are needed to keep ‘talent’. But no one is able to ask how ‘talent’ that nukes the global financial system and brings down once mighty investment banks is worth even a shiny dime.

A look at the global bank CEO compensation also throws cold water on this non-sequitur:

Source: Reuters

The only non-US bank that approaches lofty compensation levels is Santander. Since the graph above shows the compensation and the market capitalization of each bank, I thought it would be interesting to show the relative compensation, so here is a graph of that:

There is incredible variation in executive compensation around the world with many very large banks being run by CEOs who are paid next to nothing (compared to US counterparts). So are they stupid to stick around? or is the North American mindset wrong?

I’m not really in favor of a government cap on compensation. But regulation is needed to bring salaries and bonuses in line with performance. And they clearly are not right now. The industry itself nor the market is going to deal with the agency issue at the heart of the matter. Shareholders theoretically are in control but in reality, there is so many layers of bureaucracy insulating them and the compensation committees appointed by the CEOs that no one really believes in this free market fairy tale anymore. A third objective party needs to step in and rescue Wall St. from themselves for the good of all.

Well, that didn’t take long! We’re back to the status quo faster than you can say Government Sachs. Crisis wasted? or crisis averted?

For economic and market news and to see what interesting reading you may have missed last week, check out the list below. To see it all go to news.tradersnarrative.com:

• Count Your Money, Not Blessings
• Michael Lewis Thinks Bashing Goldman Sachs Is a Game for Fools
• Benefits Abound For Active Traders Who Incorporate
• Five Firms Hold 80% of Derivatives Risk
• Get a FREE Subscription to Financial Magazines
• How to Understand High Frequency Trading
• The Perils of Trading as a Victim
• An Arrrrgh!-conomic Analysis of the Somali Pirate Business Model
• Inside Goldman Sachs
• Get the “Best of Trader’s Classroom” eBook for FREE (limited time)
• The $100 Million Bonus Man
• A Critical Look at the Baltic Dry Index
• The psychology of overconfidence

For the complete list, follow the graphic below:

And remember to check back regularly since there are interesting links added throughout the week.

Week Ahead:

Book Giveaway
If you haven’t already, throw your name into the hat for a giveaway of:
Hedge Fund Operational Due Diligence (follow link and submit comment)

While you were watching the news about the AIG bonus dustup, hope you didn’t miss on AIG the ticker symbol. It is still kicking around on the NYSE and as a penny stock, it put in an impressive wide range day:

I have no idea why it jumped on Monday since there wasn’t really any news (other than the bonus fiasco). But a 66% jump (from last week’s close) is juicy and as a daytrader, even if you can catch a fraction of it, you’re set.

Even if we ignore Friday’s close and only take it from the gap up open on Monday to the close, it was a 36%. Not too shabby. The intraday high at the magical, round number $1.00 - something really special about round numbers that acts almost like a magnet. The more you watch it, the more you see this stuff.

You don’t want to chase a runaway train so watching for an entry point is crucial. A great, low risk entry point was available at around 10:20 AM (green arrow). Price action paused and then retraced slightly with volume dropping off. If you notice, there was some resistance at $0.60, which was then broken to the upside. This then would have acted as support. So placing a stop under it would have allowed you to define your risk levels intelligently.

No one really knew, of course, that this would turn out to be a huge wide range, trending day. But the tip-off was the incredible volume, as well as the large gap up open. AIG had already put in a bottom last week and rallied impressively already from its low of $0.33 so there was something afoot.

Book Giveaway
If you haven’t already, throw your name into the hat for a giveaway of:
Hedge Fund Operational Due Diligence (follow link and submit comment)

The insistence of AIG to pay $450 million in bonuses dominated the news today. There are a few things that can unite Republicans, Democrats and even libertarians. Well, pretty much every sentient carbon based lifeform in the US is seething.

While the villains of the hour are clear, it is important to remember that at this critical junction in US history, we also have quite a few heroes. Take for example, Beth Israel Deaconess Medical Center. While we want to (rightfully) vilify AIG, we also should to celebrate the heroes.

So how can the Obama administration prevent AIG from awarding taxpayer funded “bonuses” to a handful of AIG executives and traders for nuking the global economy?

Before AIG can be held accountable, the US government needs to grow a pair. Or as the Italians call it coglioni quadrati - literally, square balls. Here are just a few humble suggestions for the Obama administration:

• use the government’s 80% ownership stake to force executives to “voluntarily” give up the bonuses
• introduce a very special tax that would target the bonuses - they get paid but they are then taxed 100% right back to the taxpayer
• buy out remaining 20% - in effect, nationalize it temporarily, then clean house before flipping it
• “leak” the names of all the executives that are clawing for bonuses
• give AIG immunity from any lawsuits that may result by withholding bonuses
• hire some Wall St. type corporate lawyers to find loop-holes
• as a last resort, or just for shits and giggles, send Dick Cheney’s death squad after the lot of them

I’m sure there are other, more creative solutions, so let me know yours.