Tuesday, 27 October 2009 20:00

Deposit Insurance Arbitrage

I'll coin this term in order to explain the travesty that is being allowed in the banking industry. Institutions are literally paying little old ladies' less than a half a percent on their life savings and using said funds to gamble in the risk fraught derivatives market, with the risk being totally underwritten by the government through the:

  1. FDIC (deposit insurance and bond insurance - although to date this expense has been born by the industry, the FDIC is insolvent and may very well have to tap the Treasury, ie. the taxpayer: see I'm going to try not to say I told you so...),
  2. Treasury (via TARP and associate measures, see America, You have been outright lied to! Bamboozled! Swindled! Hoodwinked! The Worst Case Scenario) and
  3. Federal Reserve (ZIRP, QE, and a whole slew of programs I only wish I knew about - see The Fed Believes Secrecy is in Our Best Interests. Here are Some of the Secrets).

A perfect example of how the big banks are carrying this arbitrage out is outlined in "The Next Step in the Bank Implosion Cycle???", but the global economy risking behemoths are not the only one's that arbitrage bank deposit funds via FDIC guarantees. Earlier this year, I featured research on a smaller bank, Bank of Oklahoma, which I found participated in some pretty suspect accounting moves. Despite these "gimmicks" the stock floated higher with the general market and particularly the banking sector. OF course, this does nothing to cure the ills that they have been papering over. Subscribers should reference:

BOK 1Q09 BOK 1Q09 2009-05-07 06:34:52 460.74 Kb

BOK 2Q09 review BOK 2Q09 review 2009-08-01 05:04:06 1.05 Mb

March Actionable Note - Banking Sector BK March Actionable Note - Banking Sector BK 2009-03-03 11:58:22 184.25 Kb

March 2nd Actionable Note Preview - banking March 2nd Actionable Note Preview - banking 2009-03-02 09:44:20 61.88 Kb

Well, one of my subscribers have pointed out another "gimmick" that they are into, and that is the FDIC arbitrage thing. That's right, not the giga-billion dollar Wall Street TARP babies, but the Bank of Oklahoma. Here's how it works:

  1. As a deposit taking institution, CDs and savings accounts are insured by the FDIC. The banks use the funds from these CDs and savings accounts to fund their operations, which use to be primarily loans and checking/cash management services.
  2. The Fed has enabled expanded margins for many of these institutions through ZIRP (zero interest rate policy), but that is not enough to help the truly sick banks. See "The Anatomy of a Sick Bank!".
  3. Thus, many banks have ventured off into the arcane world of derivatives to boost earnings, and avoid having to polish all of those toasters to offer to Grannie! These banks include JP Morgan, Citibank, and Bank of America (see The Next Step in the Bank Implosion Cycle???"), but also much smaller regional and even some local institutions. The Bank of Oklahoma is offering what appears to be option-embedded CDs that sport the FDIC insured moniker on them. These instruments allow the owner to participate in the equity markets while having the federal guarantee on the principal. So, you ask, what's so bad about that? Well, let's walk through what their marketing material has to say, "For discussion purposes only", of course...

Tuesday, 27 October 2009 20:00

Deposit Insurance Arbitrage

I'll coin this term in order to explain the travesty that is being allowed in the banking industry. Institutions are literally paying little old ladies' less than a half a percent on their life savings and using said funds to gamble in the risk fraught derivatives market, with the risk being totally underwritten by the government through the:

  1. FDIC (deposit insurance and bond insurance - although to date this expense has been born by the industry, the FDIC is insolvent and may very well have to tap the Treasury, ie. the taxpayer: see I'm going to try not to say I told you so...),
  2. Treasury (via TARP and associate measures, see America, You have been outright lied to! Bamboozled! Swindled! Hoodwinked! The Worst Case Scenario) and
  3. Federal Reserve (ZIRP, QE, and a whole slew of programs I only wish I knew about - see The Fed Believes Secrecy is in Our Best Interests. Here are Some of the Secrets).

A perfect example of how the big banks are carrying this arbitrage out is outlined in "The Next Step in the Bank Implosion Cycle???", but the global economy risking behemoths are not the only one's that arbitrage bank deposit funds via FDIC guarantees. Earlier this year, I featured research on a smaller bank, Bank of Oklahoma, which I found participated in some pretty suspect accounting moves. Despite these "gimmicks" the stock floated higher with the general market and particularly the banking sector. OF course, this does nothing to cure the ills that they have been papering over. Subscribers should reference:

BOK 1Q09 BOK 1Q09 2009-05-07 06:34:52 460.74 Kb

BOK 2Q09 review BOK 2Q09 review 2009-08-01 05:04:06 1.05 Mb

March Actionable Note - Banking Sector BK March Actionable Note - Banking Sector BK 2009-03-03 11:58:22 184.25 Kb

March 2nd Actionable Note Preview - banking March 2nd Actionable Note Preview - banking 2009-03-02 09:44:20 61.88 Kb

Well, one of my subscribers have pointed out another "gimmick" that they are into, and that is the FDIC arbitrage thing. That's right, not the giga-billion dollar Wall Street TARP babies, but the Bank of Oklahoma. Here's how it works:

  1. As a deposit taking institution, CDs and savings accounts are insured by the FDIC. The banks use the funds from these CDs and savings accounts to fund their operations, which use to be primarily loans and checking/cash management services.
  2. The Fed has enabled expanded margins for many of these institutions through ZIRP (zero interest rate policy), but that is not enough to help the truly sick banks. See "The Anatomy of a Sick Bank!".
  3. Thus, many banks have ventured off into the arcane world of derivatives to boost earnings, and avoid having to polish all of those toasters to offer to Grannie! These banks include JP Morgan, Citibank, and Bank of America (see The Next Step in the Bank Implosion Cycle???"), but also much smaller regional and even some local institutions. The Bank of Oklahoma is offering what appears to be option-embedded CDs that sport the FDIC insured moniker on them. These instruments allow the owner to participate in the equity markets while having the federal guarantee on the principal. So, you ask, what's so bad about that? Well, let's walk through what their marketing material has to say, "For discussion purposes only", of course...

I was having lunch with a portfolio manager at a big $16 billion hedge fund the other day, trading ideas and chewing the fat. She said that she, and her whole fund, were not buying any equities. They were paid well on their legacy assets, which they dumping into the rally, though.

As a matter of fact, I really don't know anybody who is buying - save those guys that CNBC always seems to find - that are buying, not  to mention buying in volume.

If I am not mistaken, this rally (the biggest since the great depression) has been the only rally that has occurred on DIMINISHING volume. That's right! Less people are buying the assets, yet the assets are going higher in price. That, my friend, is the inverse of supply and demand that you learned in econ 101. To move from the realm of undergrad econ to financial analysis, the prospects of many companies are looking relatively dim. Revenues are trending down, macro growth is forecast to be weak, coming out of the greatest recession there ever was, there aren't many stock buyers on reduced volume, yet stocks double in price. There is no wonder that so many conspiracy theories are floating around. It certainly debunks the theory of the massive liquidity from the Fed and the Treasury driving up stock prices because if that were the case, volume, and the amount of purchases would increase, not decrease. Liquidity is obviously not the driver in this case.

I would love to switch into bull mode and go net long, but unlike many in the talking head pundits camp, I need solid fundamental reasons to do so. I simply can't prudently justify chasing a stock because it traded higher.

With these thoughts in mind, let's look at what the largest providers of long exposure have been doing over the last year (hint: reducing exposure, which should push down on prices), as per Bloomberg:

I was having lunch with a portfolio manager at a big $16 billion hedge fund the other day, trading ideas and chewing the fat. She said that she, and her whole fund, were not buying any equities. They were paid well on their legacy assets, which they dumping into the rally, though.

As a matter of fact, I really don't know anybody who is buying - save those guys that CNBC always seems to find - that are buying, not  to mention buying in volume.

If I am not mistaken, this rally (the biggest since the great depression) has been the only rally that has occurred on DIMINISHING volume. That's right! Less people are buying the assets, yet the assets are going higher in price. That, my friend, is the inverse of supply and demand that you learned in econ 101. To move from the realm of undergrad econ to financial analysis, the prospects of many companies are looking relatively dim. Revenues are trending down, macro growth is forecast to be weak, coming out of the greatest recession there ever was, there aren't many stock buyers on reduced volume, yet stocks double in price. There is no wonder that so many conspiracy theories are floating around. It certainly debunks the theory of the massive liquidity from the Fed and the Treasury driving up stock prices because if that were the case, volume, and the amount of purchases would increase, not decrease. Liquidity is obviously not the driver in this case.

I would love to switch into bull mode and go net long, but unlike many in the talking head pundits camp, I need solid fundamental reasons to do so. I simply can't prudently justify chasing a stock because it traded higher.

With these thoughts in mind, let's look at what the largest providers of long exposure have been doing over the last year (hint: reducing exposure, which should push down on prices), as per Bloomberg:

As mentioned in my previous post, an empirical backtesting of strategies that I have used and/or are contemplating using is available for download.

Direction Neutral Strategy - S&P 500 Direction Neutral Strategy - S&P 500 2009-08-04 10:14:35 1.38 Mb

As mentioned in my previous post, an empirical backtesting of strategies that I have used and/or are contemplating using is available for download.

Direction Neutral Strategy - S&P 500 Direction Neutral Strategy - S&P 500 2009-08-04 10:14:35 1.38 Mb

Tuesday, 26 May 2009 20:00

What's coming next for the blog...

For those who have been wondering, I have been rehashing previous research since the market had moved so aggressively against what I consider the fundamentals. I have to be sure that I am correct in my stance. The last thing I want to be guilty of is hubristic investing. In addition, many of the companies have increased so much in price that they represent a new opportunity to profit, as long as the investment thesis is still valid, hence the rehash of the previous research.

There is also a new crop of short candidates coming up (the short list is currently being whittled down), and for the firt time on the blog I will be releasing long candidates as well.

Tuesday, 26 May 2009 20:00

What's coming next for the blog...

For those who have been wondering, I have been rehashing previous research since the market had moved so aggressively against what I consider the fundamentals. I have to be sure that I am correct in my stance. The last thing I want to be guilty of is hubristic investing. In addition, many of the companies have increased so much in price that they represent a new opportunity to profit, as long as the investment thesis is still valid, hence the rehash of the previous research.

There is also a new crop of short candidates coming up (the short list is currently being whittled down), and for the firt time on the blog I will be releasing long candidates as well.

From Bloomberg: Stock Valuations Highest in Europe Since 2004 After April's Record Rally

May 5 (Bloomberg) -- April’s record rally in European stocks pushed market valuations to the highest level in more than four years as investors bet the first global recession since World War II is easing.

The 13 percent advance in the Dow Jones Stoxx 600 Index last month sent the measure to 16.2 times its companies’ earnings, according to data compiled by Bloomberg. Forecasts for 2009 profit growth in the gauge fell to 18 percent on May 1 from 22 percent a month earlier, the biggest drop this year, after earnings declined 40 percent in 2008, according to data and analysts’ estimates compiled by Bloomberg.

From Bloomberg: Stock Valuations Highest in Europe Since 2004 After April's Record Rally

May 5 (Bloomberg) -- April’s record rally in European stocks pushed market valuations to the highest level in more than four years as investors bet the first global recession since World War II is easing.

The 13 percent advance in the Dow Jones Stoxx 600 Index last month sent the measure to 16.2 times its companies’ earnings, according to data compiled by Bloomberg. Forecasts for 2009 profit growth in the gauge fell to 18 percent on May 1 from 22 percent a month earlier, the biggest drop this year, after earnings declined 40 percent in 2008, according to data and analysts’ estimates compiled by Bloomberg.

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