Earlier this week I interviewed with Benzinga radio discussing my views on the Economic Circle of Life, and the global cartel of central bankers who have conspired to manipulate said cycle, to the detriment of fundamental investors, tax payers and market pricing worldwide! See an excerpt below and click the link to here the full audio of the interview.

Reggie Middleton: Economic Cycle Frozen at Top of the Bubble

 

Benzinga Radio recently had a chance to speak with Reggie Middleton, the founder of boombustblog.com. Mr. Middleton is an investor who guides a small team of independent analysts. His research is widely circulated among banks, hedge funds, and institutional and individual investors. Reggie has appeared on Bloomberg Television, CNBC, BBC World News, and CNN among others, and his prescient investment calls have been detailed in publications such as Fortune and Crain's New York.

The primary topic of Benzinga's discussion with Mr. Middleton centered on the unfolding Eurozone sovereign debt crisis, which continues to hold financial markets hostage. According to Middleton, the term "contagion" or "virus" when describing what is taking place in Europe is misleading. It is less a matter of market distrust and rising sovereign yields in one country spreading to another, and more a problem of a faulty foundation with regard to the entire EU and euro currency.

He said, "the problems were inherent from the beginning - from the inception of the Eurozone and the euro in general." He added, "a building was built upon a faulty foundation." Middleton noted that one of the core problems that is taking place in the EU is the fact that countries such as Greece lack true sovereignty due to the structure of the monetary union.

Follow this link for the full article and the full audio of the interview: http://www.benzinga.com/content/2138614/reggie-middleton-economic-cycle-frozen-at-top-of-the-bubble#ixzz1e4KdG349

The reasoning behind my comments in this interview stemmed from the posts Do Black Swans Really Matter? Not As Much as the Circle of Life and What Happens When That Juggler Gets Clumsy?:  As excerpted...

Actually, it is not the Black Swan events themselves that do the damage but said event do serve as the catalyst that either bust a bubble that was waiting to pop anyway, or break a structure that was hobbling along on one leg as it was  - where we happen to be now in many places of the developed world - sans rampant propaganda, misinformation and disinformation from less than disinterested sources.

I have always been of the contention that the 2008 market crash was cut short by the global machinations of a cadre of central bankers intent on somehow rewriting the rules of economics, investment physics and global finance. They became the buyers of last resort, then consequently the buyers of only resort while at the same time flooding the world with liquidity and guarantees. These central bankers and the countries they allegedly strive to serve took on the debt and nigh worthless assets of the private sector who threw prudence through the window during the "Peak" phase of the circle of economic life, and engaged in rampant speculation. Click to enlarge to print quality...

The result of this "Great Global Macro Experiment" is a market crash that never completed. BoomBustBlog subscribers should reference File Icon The Inevitability of Another Bank Crisis while non-subscribers should see Is Another Banking Crisis Inevitable? as well as The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance.

All four corners of the globe are currently "hobbling along on one leg", under the pretense of a "global recovery".

Simply sit back and look at the (supposed, none of these should truly be considered surprises) Black Swan Catalysts that we now face:

    1. US Housing, you know, the the thing that kicked this all of to begin with - The True Cause Of The 2008 Market Crash Looks Like Its About To Rear Its Ugly Head Again, With A Vengeance Friday, March 11th, 2011
    2. US and/or European Commercial Real Estate - Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate Friday, February 25th, 2011
  1. MENA, the Middle East & North Africa - Egypt’s Social Unrest As A Pan-European Economic and Financial Contagion? It Can Happen!!! Friday, January 28th, 2011  or First Tunisia, Then Egypt, Now Yemen: Will This Reach The Powder Keg That Is The EU & What Will Happen If It Does? Wednesday, February 2nd, 2011
    1. Japan - Can Contagion Be Avoided Considering The Magnitude Of Japan’s Woes? Tuesday, March 15th, 201

The list can go on. The most likely catalyst is described as follows...

The advice coming from both the government agents (ex. central bankers) and those whom these government agents have pledged to rescue at the absolute cost to the average tax payer (the FIRE sector, particularly the banking cartel)  has been absolutely horrendous. First let's take a look at the most respected of these agency protected players - Goldman Sachs. From my missive, Is Another Banking Crisis Inevitable? posted last month, I excerpt the following:

Today, Bloomberg reports that Goldman Sachs Turns Bullish on Europe Banks as Debt Risk Eases.The report goes on to state:

The U.S. bank that makes the most revenue from trading advised investors to take an “overweight” position on banks, raising its previous “neutral” recommendation, according to a group of equity strategists led Peter Oppenheimer. Investors should pay for the trade by lowering holdings of consumer shares, he wrote.

“For financials the narrowing of sovereign spreads in peripheral eurozone, which our economists expect to continue, is a clear positive,” London-based Oppenheimer wrote in the report dated Feb. 3. “Banks are one of the least expensive sectors in the market and the trade-off between their growth prospects and earnings in the next few years looks especially attractive.”

Unfortunately, the risks of this particular trade were not articulated, and I feel that the risks are material. Far be it for me to disagree with the “U.S. bank that makes the most revenue from trading”, but they have been wrong before – many times before. Reference Is It Now Common Knowledge That Goldman’s Investment Advice Sucks??? or Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?for more on this topic.

Attention subscribers: A new subscription document is ready for download File Icon The Inevitability of Another Bank Crisis

So where is the risk?

The impact of the Asset Securitization cum Sovereign Debt Crisis to bank balance sheets should become the market and media focus. The full cost of cleaning up the balance sheets of financial institutions particularly against the backdrop of adverse macro shocks emulating from sovereign defaults is not fully known. Structural weaknesses in sovereign balance sheets could easily spill over to the financial system due to the fact that most banks are stuffed to the gills with sovereign debt – highly leveraged, and marked as risk free assets at par. This can have broad, adverse consequences for growth in the medium term.

Click here for the rest of this entry »

BoomBustBlog has taken the opposite stance: The Inevitable Has Finally Been Admitted In Europe: The Macro Experiment Has Ignited Inflation Without Commensurate Growth & Rates Will Spike. I have queried many times in the past, Is It Now Common Knowledge That Goldman’s Investment Advice Sucks???. Those who follow me regularly know that I have no problem running up against these big investment houses in terms of analytical accuracy and veracity. See Did Reggie Middleton Best Wall Streets Best of the Best? to ascertain who has been most accurate throughout this entire fiasco since 2007. I am not that smart, and I don't have a crystal ball. I simply understand and respect the Circle of Life and I do not need to screw my clients in order to make my profits. Let's see where the news of today puts those Goldman proclamations in reference to my perspective...

Published in BoomBustBlog

BoomBustBlog subscribers, I call you to attention. I have found a bank that literally has more derivatives risk than Citibank, Goldman, Morgan and JP Morgan - COMBINED! That's right, and on top of that if you peek under the covers (and not just follow the fodder in the annual reports) it apparently has the greatest mortgage risk in the industry. In addition to that... Okay, I'm getting ahead of myself. Let's start from the beginning or skip down to the RT Capital Account video if you're the impatient type.

Here are some quick updates before I move on to the latest subscription research (and boy, is this one a doozy!, subscribers download it here - Haircuts, Derivative Risks and Valuation). If you thought that Goldman, Bear, Lehman, BNP & Apple were good contrarian calls, you're going to wet your pants over this one - and thus far I haven't heard a peep about this company from ANYONE. I'm sure that will change forthwith as it shows signs of blowing up on both sides of the Atlantic - opps, I gave a hint. Well, here's some more...

ZeroHedge reports Italian Bonds Plunging: ECB Intervention Imminent: But if Italian bonds are tanking again, doesn't that put France at risk? See French Banks Can Set Off Contagion That'll Make Central Bankers Long For The Good 'Ole Lehman Collapse Days. Hold on, if France is suspect what does that portend for its largest bank? "BoomBust BNP Paribas?" (it is strongly recommended that you review this article if you haven't read it already) I started releasing snippets and tidbits of the proprietary research that led to the BNP short, namely Bank Run Liquidity Candidate Forensic Opinion - A full forensic note for professional and institutional subscribers. Even if we were to disregard BNP's most serious liquidity and ALM mismatch issues, we still need to address the topic of sovereign debt. Now, if you were to employ the free BNP bank run models that I made available in the post "The BoomBustBlog BNP Paribas "Run On The Bank" Model Available for Download"" (click the link to download your own copy of the bank run model, whether your a simple BoomBustBlog follower or a paid subscriber) you would know that the odds are that BNP's bond portfolio would probably take a much bigger hit than that conservatively quoted in the media.  Here I demonstrated what numbers would look like in said model...

image008

 

Okay, so if Italy and Greece cause France to go BOOM and the French banks will get caught in the blast (or vice versa, who can keep up these days), then doesn't that mean that those US banks leveraged into France and Italy will get hit? Oh yeah!!! Just As I Predicted Last Quarter, The World's First FDIC Insured Hedge Fund Takes A Fat Trading Loss

thumb_image001_copy

So, let's get to this big derivatives thing going around the web where Bloomberg blew the Bank of Lynch America Countrywide and JP Morgan spot by reporting they moved over $50 trillion notion of derivative exposure to their FDIC ensured banking arm to placate investors. What does this portend?

If Bank of America did it, and JP Morgan did, you can be rest assured most other big banks did it as well. What you ask? Hide the hot sausage, in a place that will burn... Really bad! As has been reported throughout the MSM and the blogosphere, the US banks have been caught playing hide the hot sausage, the problem is they're hiding it in mom and pop's bank accounts. Needless to say, this is going to burn the average tax payer and savings account holder where the sun don't shine...

Of course, you know I'm going to say "I told you so!" Reference So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't? and then Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored? You see, in said piece, ZeroHedge dutifully reported that Five Banks Account For 96% Of The $250 Trillion In Outstanding US Derivative Exposure- a very interesting refresh of what I called out two years ago through "The Next Step in the Bank Implosion Cycle???":

The amount of bubbliciousness, overvaluation and risk in the market is outrageous, particularly considering the fact that we haven't even come close to deflating the bubble from earlier this year and last year! Even more alarming is some of the largest banks in the world, and some of the most respected (and disrespected) banks are heavily leveraged into this trade one way or the other. The alleged swap hedges that these guys allegedly have will be put to the test, and put to the test relatively soon. As I have alleged in previous posts (As the markets climb on top of one big, incestuous pool of concentrated risk... ), you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks.

Click to expand!

bank_ficc_derivative_trading.png

This concept was further illustrated in An Independent Look into JP Morgan...

Click graph to enlarge (there is a typo in the graphic - billion should trillion)

image001.png

Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet. Both of these companies were rated investment grade at the time, just like "you know who". Now, I am not saying JPM is about to collapse, since it is one of the anointed ones chosen by the government and guaranteed not to fail - unlike Bear Stearns and Lehman Brothers, and it is (after all) investment grade rated. Who would you put your faith in, the big ratings agencies or your favorite blogger? Then again, if it acts like a duck, walks like a duck, and quacks like a duck, is it a chicken??? I'll leave the rest up for my readers to decide.

I then posted the following series, which eventually led to me finally breaking down and performing a full forensic analysis of JP Morgan, instead of piece-mealing it with anecdotal analysis.

  1. The Fed Believes Secrecy is in Our Best Interests. Here are Some of the Secrets
  2. Why Doesn't the Media Take a Truly Independent, Unbiased Look at the Big Banks in the US?
  3. As the markets climb on top of one big, incestuous pool of concentrated risk...
  4. Any objective review shows that the big banks are simply too big for the safety of this country
  5. Why hasn't anybody questioned those rosy stress test results now that the facts have played out?

You can download the public preview here. If you find it to be of interest or insightful, feel free to distribute it (intact) as you wish.

JPM Public Excerpt of Forensic Analysis Subscription JPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb

Reggie Middleton on CNBC's Squawk on the Street - 10/19/2010, discusses JP Morgan and concentrated derivative bank risk.

If you think that's scary (and you really should) check out Is Goldmans Sachs Derivative Exposure the Squid in the Coal Mine?

The notional amount of derivatives held by insured U.S. commercial banks have increased at a CAGR of 22% since 2005, which naturally begs the question “Has the value or the economic quantity of the underlying increased at a similar pace, and if not does this indicate that everyone on the street has doubled and tripled up their ‘bets’ on the SAME HORSE?”

Think about what happens if (or more aptly put, "when") that horse loses! Would there be anybody around to pay up?

Sequentially, the derivatives have increased every quarter since Q1-05 except for Q4-07, Q3-08 (Lehman crisis) and Q4-10 while on a YoY basis the growth has been positive throughout recorded history.  In Q2-2011, the notional value of derivative contracts increased 2% sequentially to $249 trillion. The notional value of derivatives was 12% higher than a year ago. The notional amount of a derivative contract is a reference amount from which contractual payments will be derived, but it is generally not an amount at risk. However, the changes in notional volumes can provide insight into potential revenue, and operational issues and potentially the contagion risk that banks and financial institutions poses to the wider economy – particularly in the form of counterparty risk delta. The top four banks with the most derivatives activity hold 94% of all derivatives, while the largest 25 banks account for nearly 100% of all contracts.  Overall, the US banks derivative exposure is $249 trillion and is more than four folds of World’s GDP at $58 trillion.

In absolute terms, JPM leads this list with total notional value of derivative contracts at $78 trillion, or 1.3x times the Wolds GDP. However, in relative terms, Goldman Sachs leads the list with total value of notional derivatives at 537 times is total assets compared with 44x for JPM, 46x for Citi and 23x for US Banks (average).

So, what does this mean? Well, it should be assumed that Goldman is well hedged for its exposure, at least on academic basis. The problem is its academic. AIG has taught as that bilateral netting is tantamount to bullshit at this level without government bailout intervention. If there is any entity at risk of counterparty default or who is at the behest of a government bailout if the proverbial feces hits the fan blades… Ladies and gentlemen, that entity would be known as Goldman Sachs.

As excerpted from Goldmans Sachs Derivative Exposure: The Squid in the Coal Mine?, pages 2 and 3...

GS__Banks_Derivatives_exposure_temp_work_Page_2

Goldman is much more highly leveraged into the derivatives trade than ANY and ALL of its peers as to actually be difficult to chart. That stalk representing Goldman's risk relative to EVERY OTHER banks is damn near phallic in stature!

GS__Banks_Derivatives_exposure_temp_work_Page_3

As opined earlier through the links "The Next Step in the Bank Implosion Cycle???"and As the markets climb on top of one big, incestuous pool of concentrated risk... , this is not a new phenomenon. Quite to the contrary, it has been a constant trend through the bubble, and amazingly enough even through the crash as banks have actually ratcheted up risk and assets in a blind race to become TBTF (to big to fail), under the auspices of the regulatory capture (see Lehman Dies While Getting Away With Murder: Introducing Regulatory Capture). So, what is the logical conclusion? More phallic looking charts of blatant, unbridled, and from a realistic perspective, unhedged RISK starring none other than Goldman Sachs...

And to think, many thought that JPM exposure vs World GDP chart was provocative. I query thee, exactly how will GS put a real workable hedge, a counterparty risk mitigating prophylactic if you will, over that big green stalk that is representative of Total Credit Exposure to Risk Based Capital? Short answer, Goldman may very well be to big for a counterparty condom. If that's truly the case, all of you pretty, brand name Goldman counterparties out there (and yes, there are a lot of y'all - GS really gets around), expect to get burned at the culmination of that French banking party I've been talking about for the last few quarters. Oh yeah, that perpetually printing clinic also known as the Federal Reserve just might be running a little low on that cheap liquidity antibiotic... Just giving y'all a heads up ahead of time...

image009

 

As you read exactly how precarios the situation is in France (and Belgium, through Dexia, et. al.) keep in mind that although this is definitely not good news for Goldman's numbers, historically since the beginning of this crisis, GS has actually correlated more with coke laced, red bull juice powered mo-mo trader patterns than actual book value - reference The Squid Is A Federally (Tax Payer) Insured Hedge Fund Paying Fat Bonuses That Can't Trade In Volatile Markets? Who's Gonna Tell The Shareholders and Tax Payer??? from just last reporting period...

... I'd like to announce to the release of a blockbuster document describing the true nature of Goldman Sachs, a description that you will find no where else. It's chocked full of many interesting tidbits, and for those who found "The French Government Creates A Bank Run? Here I Prove A Run On A French Bank Is Justified And Likely" to be an iteresting read, you're gonna just love this! Subscribers can access the document here:

As is customary, I am including free samples for those who don't subscribe, so you can get a taste of the forensic flavor.


Interested parties should click here to subscribe, cause next up we walk through several other American banks to see who's up for re-enacting 2008-9 put parade - and historically we have usually if not always been ahead of the curve, particularly when compared to Wall Street and the sells side - see Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?


So, in case you have yet to hear anything new (which could be the case if you're a BoomBustblog regular), try this on for size - taken off of the very first page of today's BoomBustBlog subscriber update - Banks Haircuts, Derivative Risks and Valuation.

Colossal Derivative exposure

According to the latest quarterly report from the Office Of the Currency Comptroller the top 4 banks in the US now account for a massively disproportionate amount of the derivative risk in the financial system. Although the [subject bank] with the xth largest derivative exposure stands a significant distance behind JPM, Citi, Bank of America and Goldman Sachs (the four largest players); the exposure quoted in OCC report is only for the US entity. Overall, [subject bank]’s group derivative exposure in its balance sheet is 220% of its tangible equity, far higher in both absolute and relative terms when compared to its peers. [Subject bank]’s on balance sheet derivative exposure is higher than the combined share of Goldman Sachs ($74bn, or 115% of TEC), JP Morgan ($78bn, or 62% of TEC) and Morgan Stanley ($46bn, or 114% of TEC).  What is more worrying is the quality of these derivative assets. Of the total notional value of credit derivatives (over half trillion $US bn), nearly 60% are non-investment grade. [Subject bank] has the highest proportion of non-investment grade credit derivatives followed by Citi Group (55%), GS (52%), Bank of America (37%) and JP Morgan (32%). The tables below as well as on the following page compare [subject bank]’s on-balance sheet derivative exposure...

Well, there you go. If things were to kick off and the bovine excrement hits the fan blades, look for [subject bank] to stink worse than most! This is exactly how we isolated Bear and Lehman back in 2008! More importantly, just imagine [subject bank] stuffing all of those high quality, leveraged, about to implode liabilities into your Aunt Gertrude's CD and retirement savings! Yep, if Bank of American and JP Morgan did it, is anybody truly naive enough to believe that nobody else is doing it as well? As my Aunt Eva used to tell me, there is never just one roach!

I can be reached via the following channels, or directly via email:

  • Follow us on Blogger
  • Follow us on Facebook
  • Follow us on LinkedIn
  • Follow us on Twitter
  • Follow us on Youtube
I will be releasing the date (probably this week), location and time of the NYC meet and greet within the next 24 hours or so, so we can chat, drink, debate, argue and fraternize with pretty woman together in a trendy spot in the Meat Packing District or the Bowery (I apologize in advance to all of my female readers/subscribers). Those who are interested in attending should email customer support. There has been strong interest in the London meeting, enough to warrant the venue - I simply need to get the travel and venue organized due to a change of plans.
For those that are new to the blog, these are pics of previous meet and greets...

  

47b8d631b3127cce98548a67f7f900000047100Abs2TFi2ZsWWg.jpg

DSC06310.jpg

 

buddhakahn2.jpg

Published in BoomBustBlog

image018_copy

I have received SO MUCH flack over the last year for pointing out the obvious FACT that Apple's phenomenal growth will be hit by Android's extra-phenomenal growth, it has been borderline disheartening. Well, the time is hear folks, and as is usual, logic. common sense and rational thinking rule the day once again. The results should be interesting, if not immediate, for many Apple investors and consumers are beyond loyal and ede to borderline fanatic. This portends much more irrational emotion in decision making and potentially unnecessarily drastic actions in the end. What do I mean? Well, Apple is purportedly just under 7% of the NASDAQ. If the Apple religion falls out of fad... Well, look out below! This may not happen immediately, for the love affair is truly torrid, and all sorts of excuses will be made. At the end of the day (or fiscal year, to be more accurate) the reality is bound to hit that Apple is a C corporation like everyone else and is subject to market pressures and competition, and truly does not fart fairy dust.

Of course, logic would dictate that the (literally) hundreds of hate mails I received should be replaced with hundreds of "Hey, Reg, you were right" mails, but it won't happen due to the fact that the nature of those that generated the hate mails forbids them from examining fact and instead allows them to be guided by a bisection of corporate marketing, brand loyalty and emotion. It should be quite interesting to see what the responses to this article will be in the comments section. This is a long post, but more than worth you time. I urge you to read in its entirety, or at least up until the part that reminisces:

"In our analysis of Apple, we are using real world assumptions of future performance derived from backing in to the low balling this company is prone to. If you look at its history carefully you can gauge what management is comfortable with, hence what they may be capable of on the margin. Using these more realistic numbers, it is much more likely Apple will deliver a miss in the upcoming quarters in its battle with the Android! The following is the reason why..."

Early last year, I started tracking the rapid ascent of ultra mobile computing in my Mobile Computing Wars series. At that time, I didn't have a favored winner, but as I researched more and dug deeper, clear patterns started to emerge. These patterns simply got clearer and stronger as time progressed, and it ended in my putting out highly contrarian research on Google in public - Google’s Q1 2011 Review: Part 2 Of My Comments On The Gross Misvaluation of Google and in substantially more detail in private -the subscriber forensic analysis (63 pg Google Forensic Valuation, to plug in your own assumptions see Google Valuation Model (pro and institutional).

I also issued similarly contrarian research on Apple: File Icon Apple – Competition and Cost Structure).

Of course, the mainstream media and the Sell Side of Wall Street took the opposite sides of these bets, to wit: Goldman’s $430 Target, Screaming Buy On Apple At Its All Time High Is In Direct Contravention To Reggie Middleton’s Logic – Who’s Right? Well, Who Has Been More Right In The Past? and Reggie Middleton Takes The Challenge To Goldman Sach’s Apple Proclamation One Step Farther, Apple’s Closed System Risks Failure!”. Realize that It Should Now Be Common Knowledge That Goldman’s Investment Advice Sucks. Of course, that doesn't necessarily mean that there is any credibility in said proclamations, though. Reference this priceless nugget in light of the links above... Goldman Sells Nearly Half $Billion Of Apple Stock Directly Into Their Client’s Conviction Buy Recommendation: Guess Who Really Agrees With Reggie Now!I'd also like to reiterate, I've Told You Before, And I'll Tell You Again - Goldman Sachs Investment Advice Sucks!!!

Well, as luck would have it, the Street was wrong on Google, see Did A Blog Best Wall Street's Best of the Best In Guaging The True Value of Google? We Have To Think More Like An Entrepeneur & Less Like A Wall Street Analyst July 19th, 2011.

There were wrong on Apple, and to be absolutely honest, they are wrong in general - reference Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best? Not that this tidbit of fact and simple math will stop the sheeple from shoveling over billions upon billions of dollars to this industry to be recycled back into the bonus pool, versus supporting truly independent research such as BoomBustBlog, no matter HOW many times I'm right and they are proven wrong - and it has been a lot, trust me.

We also had pundits in private equity who I would have normally assumed should have know better jump on the Apple wagon, as excerpted from My Thoughts on Roger McNamee's View of Google and Mobile Computing...

Of note, pundit recommended long Apple and short Google for guaranteed profits. Google blew out numbers this quarter (Our Uber Growth Thesis For Google Is Intact and Performing Well) and Apple missed, all the while Google is strategically positioned to do much, much more damage. As for the comment about nobody makes money from Android, well those entities that make money from Android disagree. I have outlined this in the first quarter, reference Apple Gears Up To Combat The Margin Compression That Apparently Only It, Google & Reggie Middleton Sees Coming Monday, February 14th, 2011.

On this point, I must give props to Herb Greenberg for allowing me to espouse my contrarian, yet highly accurate mantra concerning Apple as well as US banks' derivative exposure through the mainstream, namely CNBC. The derivate issues have recently reported by Bloomberg and ZeroHedge, reinforcing my many warnings, ex. So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't?

Of course, as timing would have it, I predicted that Apple would miss 4 to 6 quarters after the pronouncement I made on international TV exactly 1 year ago via CNBC on the eve of Apple's earnings (3:40 into the video). Exactly 4 quarters later.... Hmmm!

Simple math, simple business logic, simply common sense, yet the Apple hordes attacked relentlessly. Listen, what Google has created to compete with Apple, RIM, MSFT and Nokia, was not a new technology - but a new way of doing business. Less than free was their new business model and it proved to be pretty damn effective.

Margin compression follows a slip in sales due to competition. You see, in order for Apple to maintain its unit growth, it wiill have invest more into the product, cut costs, or both. Any scenario leads to margin compression. Since I have written so much on this topic, I will not rehash, but simply point to the prophetic post I made two weeks ago in calling for what I considered to be the obvious: Sliced Apple Margins For Dinner?

In the meantime, let's parse today's news event: Apple Misses Big on Earnings, Revenue; Shares Tumble

Apple posted a rare miss on both earnings and revenue as far fewer iPhones were sold during the quarter than expected. Shares tumbled after-hours.

Again, it's Apple's expectations that will be the eventual undoing of this company as an investment. They are simply unrealistic, as I will get to in a moment, but first I'd like to point out the extreme favoritism that is still given to this company by the MSM.

Bloomberg reports: Apple Misses Estimates on Delayed Sales

Apple Inc. (AAPL) fell in German trading after profit missed analysts’ predictions for the first time in at least six years, evidence that customers delayed iPhone purchases before the release of the latest model.

This statement is bullshit. Customers delay purchases right before the release of every new model, yet that somehow didn't cause a miss for the iPhone 3G, the iPhone 3GS and the iPhone 4, did it? iPhone's sales dissappointed for one reason, and one reason only!!!


Profit was $6.62 billion, or $7.05 a share in the fiscal fourth quarter, compared with $4.31 billion, or $4.64 a share, a year earlier, Cupertino, California-based Apple said yesterday in a statement. That missed analysts’ predicted profit of $7.31 a share, the first disappointment from Apple in at least 26 quarters.

Apple sold 17.07 million iPhones, less than the 20 million projected by analysts surveyed by Bloomberg, as consumers held out for the iPhone 4S, released after the close of the period that ended Sept. 24. The shortfall underscores the growing importance to Apple for the iPhone, which was introduced in 2007 and accounted for 39 percent of revenue last quarter.

“The market was expecting very strong iPhone sales going into the product launch,” said Giri Cherukuri, head trader at Oakbrook Investments LLC, which holds Apple shares. “It stands to reason that a lot of people were waiting for the new iPhone to come out.”

Again, Bullshit! Why didn't this phenomena occur during the last three product launches? Oh yeah, that's right, because Android wasn't up to speed by then.

Apple shares dropped as much as 7.3 percent to the equivalent of $391.75 in German trading and were down 6.4 percent as of 9:03 a.m. in Frankfurt. Yesterday, the stock fell 6.3 percent to $395.50 in extended U.S. trading. The stock had closed at $422.24 in New York.

Sales of the smartphone are rebounding this quarter, and the decline in Apple shares represents a “buying opportunity,” said Cherukuri, whose firm is based in Lisle, Illinois.

Yeah, and thereing lies the problem, shares of Apple are always a buying opporutunity, no matter what the facts or circumstances are, right?

As excerpted from Apple on the Margin:

Writing about Apple is like writing about gold, despite the fact that there is a strong fundamental argument for or against it, the emotional response and lack of empirical outlook clouds the fundamentals, ex. Apple  and the iPhone vs Android or Gold and fiat currencies/inflation. I am not a Apple hater, and I am probably one of the most advanced iPad users you know of. Apple has its pluses and minuses, but people (including many professionals) are failing to look at the facts and instead are joining their respective "fanboi" clubs. Thus, in continuing with my attempt to educate my readers on the folly of believing Apple's position to be unassailable, I am illustrating exactly how vulnerable Apple is to either a compression of margin on the iPhone or a slow down in sales. Apple is just penetrating the market and has a fertile field to conquer, it is just that it will not be able to pursue that field devoid of competition as it has over the past 3 years. This should dictate an adjustment to the highly optimistic aura attached to the multiples used in forecasting economic results.

The graph below illustrates the importance the iPhone represents to Apple's franchise. Believe it or not, this graph actually understates the importance of the iPhone to Apple for while it brings in 45% of the revenues, it is responsible for about 70% of the profits. Apple has become too reliant on one product, although that reliance was borne from the fabulous success of said product. While Apple will probably derive some much needed revenue diversification from iPad sales, the iPad will face the same hurdles that the iPhone is coming up against - and that is competition from Android-based devices and potentially even Windows Mobile 7 8 (albeit this is an admittedly much more speculative statement).

Breaking the argument down even further, you see how the iPod and the iPhone have literally transformed this company. While I am sure it will continue to be fantastic company with cool products, I doubt very seriously that it will be able to grow in the future as it has in during the last 7 years.

The saving grace is that the smart phone and portable computing market will grow quite quickly, allowing companies with dwindling market share to still capture increasing revenues. The ugly reality is that those revenues will have to be burdened with increasing R&D, marketing and distribution costs since the amount of competition will probably scale faster than the market itself. That, my friends, is a very good thing for you and I, the consumer!

All paying subscribers are welcome to download the mini-model which shows Apple's earnings sensitivity to margin compression through competition. This is the very crux of determining the extent of Apple's success or lack thereof, in the near to medium term. Click here to download (File Icon Apple iPhone Profit Margin Scenario Analysis Model), and click here to subscribe.

... Apple said that while iPhone sales fell off last quarter, the holiday quarter will be its best yet. First-quarter per- share earnings will be about $9.30 on sales of about $37 billion, Apple said in the statement.

That surpassed analysts’ projections, suggesting that iPhone sales are bouncing back with the release of the iPhone 4S, which set a record with debut-weekend sales of 4 million.

“In our wildest dreams, we couldn’t have gotten off to as great a start as we did with the iPhone 4S,” Cook said on the call. The drop in demand for iPhones in the second half of last quarter was “substantial,” said Cook.

This may very well be the case. I don't doubt it, but it also doesn't negate the generally stagnating growth trend - see Google's Android Now Leads In Market Share, Growth Rate and Potential Buyer Preference. Apple released a new product on two new carriers, which at best matches (and that's at best, I believe it falls far short) the Android flaghip device from 6 months ago! This much wider distribution network coupled with the iPhone popularity is bound to boost sales, but the popularity of Android (now the number 1 OS, globally and domestically, with the highest growth rate, to boot) make it unliekly Apple can regain the growth crown through marketing alone. It is now quickly becoming common knowledge that high end Android phones such as the Samsumg Galaxy S II series handily outperform anything from Apple thus far. As a result, the sales are becoming more fad generated and less technology/usability driven. We all know what happens to very fad, don't we? Apple will have to invest heavily into the tech, and that ain't free nor is it a guarantee for success. Hence the margin compression thesis. Look to my writings from last summer to determine the common sense reasons why Apple is at risk despite the lovefest that the media, the sell side of Wall Street and the equity markets have for it: . After nearly a year of showing nearly incontrovertible evidence that Apple has seen its heyday, the mainstream media is catching on. First a quick overview of my thoughts...

    1. Look & Listen Closely As The Solitary Margin Compression Theory Slowly Bears Fruit: Apple to Drop Flagship iPad Prices?
    2. Steve Jobs Calls End Of the PC, We Call The End Of The Fat Margin Tablet – Including The Pretty iPad, With Proof! 
    3. Is The Evidence For An Apple Margin Collapse Now Incontrovertible? 
    4. I Absolutely Dare Anyone To Read This And Still Not Consider The Probability (Not Possibility) Of Apple Suffering From Margin Compression

Smartphone Rivals

The new touchscreen handset is vying with new smartphones from companies including Samsung Electronics Co. and HTC Corp. (2498), which use Google Inc.’s Android operating system.

As excerpted from "Is The Evidence For An Apple Margin Collapse Now Incontrovertible?" 5/19/11:

This is going to be a much tougher fight for Apple than even that of the smartphone market, and you see how well Android did in that category as the current market leader in both footprint and growth rate. Literally98% more competition is coming down the pike this year, and products are already widely reviewed as at parity or superior in Apple's chief diversification segment (remember, derives ~70%  of its profits from the iPhone). With that, even the iPhone is supremely challenged by Apple's own parts vendors, Reference :

Apple's biggest suppliers (the most important parts vendors for the products that contributes about 75% of Apple's profits) and the companies that Apples is currently embroiled in global litigation with (no wonder why) also produce similar products, ex. the LG Optimus 3D and the Samsung Galaxy S II.

Speaking of the Samsung Galaxy, this newest refresh is nearly universally thought of to be the best smartphone available, including the Apple iPhone. I haven't found a single review yet that has said otherwise. This is an impressive feat considering how "Apple-centric" the media currently is. Reference this snippet from Endgadget:

For a handset with such a broad range of standout features and specs, the Galaxy S II is remarkably easy to summarize. It's the best Android smartphone yet, but more importantly, it might well be the best smartphone, period. Of course, a 4.3-inch screen size won't suit everyone, no matter how stupendously thin the device that carries it may be, and we also can't say for sure that the Galaxy S II would justify a long-term iOS user foresaking his investment into one ecosystem and making the leap to another. Nonetheless, if you're asking us what smartphone to buy today, unconstrained by such externalities, the Galaxy S II would be the clear choice. Sometimes it's just as simple as that.

Endgadget is not the only reviewer to go head over heals over Android super-powered phones. Check it out, courtesy of onlinesocialmedia.net:

    1. Dan Sung of Pocket-Lint rates the phone with 4.5 out of 5 stars and calls it a “cracking experience” and like Engadget, “better than any other Android smartphone.” Very minor complaints included the 1080p DLNA streaming, which was noted could be better, plus minor quibbles with the camera lens but overall the conclusion is that “no one buying this superphone will have anything to complain about.
    2. Chris Davies over on Slash Gear. Guess what, Davies also says, “this could well be the best Android smartphone on the market today” and noted that iPhone users that were shown the Galaxy S II said they could have their heads turned by it. There were minor criticisms, such as the keyboard, but these were said to “pale in comparison to the Samsung’s strengths.” In conclusion Davies says “we’re running out of reasons not to buy the Galaxy S II.”
    3. Electric Pig by Ben Sillis, who gave the phone a staggering 5 out of 5 star rating and says “Samsung has triumphed again with theSamsung Galaxy S 2.” There are some quibbles about software in this review but not enough to get in the way of it being a “surefire contender for phone of the year,” and again the superb display gets a special mention.

... Apple’s fourth-quarter revenue was $28.3 billion, below the $29.6 billion predicted by analysts. Missing expectations caught investors by surprise since the company has so consistently beaten predictions. During the previous 19 quarters, Apple had exceeded profit estimates by an average 28 percent, according to Piper Jaffray Cos.

‘Clueless’

“Shame on me and other investors who got lulled into complacency based on how much they’ve beaten estimates in the past,” said David Rolfe, chief investment officer at Apple investor at Wedgewood Partners Inc.

Apple had said in July that it expected sales and profit to fall because of changes to its product lineup.

“It’s not the company that missed, it’s the people who follow Apple that are clueless,” said Trip Chowdhry, an analyst at Global Equities Research in San Francisco.

Analysts may revisit projections that Apple will continue to grow at a record rate and exceed estimates, said Michael Obuchowski, chief investment officer at First Empire Asset Management.

“That the company can maintain the growth rate that some of the analysts envision is not very realistic,” he said. “There will be a reevaluation of the analysts’ expectations.”

"Clueless"! “Shame on me and other investors who got lulled into complacency"!

Taken right out of the Reggie Middleton playbook! Refereince Apple Once Again Surprises The Unsurprisingly Inept Analyst Estimates: When Will Investors Catch On To The Earnings Management Game?: I will repost (for the 6th time) the earnings guidance snippet and challenge readers to possibility that we may have a very valid point.

In the meantime, sheeple-like investors are being hoodwinked by quarter after quarter of Apple blow out earnings. Don't get me wrong. I feel and fully acknowledge that Apple is executing on all 8 cylinders of a 6 cylinder engine, but it still has its real world limitations. Apple will start to bump up against these limitation over the next 4 quarters, and the signs of this bump are already apparent. Of course, the signs are being handily masked by the games that Apple management and the sell side analysts of Wall Street play, with the "Sheeple" retail and the lazier component of the institutional investors being put out to take the eventual bullet.

Riddle me this - If Apple can consistently beat the estimates of your favorite analysts quarter after quarter, after quarter - for 11 quarters straight, shouldn't you fire said analysts for incompetency in lieu of celebrating Apple's ability to surprise? After all, it is no longer a surprise after the 11th consecutive occurrence, is it? I would be surprised if my readers were surprised by an Apple surprise. Seriously! Apple management consistently lowballs guidance to such an extent that it can easily manage, no - actually create outperformance. This has has a very positive effect on their valuation. Of course, I do not blame Apple management for this, of they are charged with maximizing shareholder return. The analytical community and the (sheeple) investors which they serve is another matter though. Subscribers can download the data that shows the blatant game being played between Apple and the Sell Side here: File Icon Apple Earnings Guidance Analysis. Those who need to subscribe can do so here.

Below, I drilled down on the date and used a percentage difference view to illustrate the improvement in P/E stemming from the earnings beats.

In our analysis of Apple, we are using real world assumptions of future performance derived from backing in to the low balling this company is prone to. If you look at its history carefully you can gauge what management is comfortable with, hence what they may be capable of on the margin. Using these more realistic numbers, it is much more likely Apple will deliver a miss in the upcoming quarters in its battle with the Android! The following is the reason why...

In the meantime, more inaccurate and uncalled for Apple bias in the media that will do naught but cause losses for investors that bother to pay it any attention... Bloomberg reports Google, Samsung Announce Updated Android Phone:

“Ice Cream Sandwich could provide the critical push in the race to catch Apple,” said Mark Newman, an analyst at Sanford C. Bernstein & Co., who is based in Hong Kong. “Apple’s software is still on the cutting edge.”

This is outright nonsense! Apple's most recent OS5 release simply brings iOS up to par with what Androids are currently running since the beginning of this year. As a matter of fact, as of today, Apple's tech is still behind since Google just released an OS update (Ice Cream Sandwich) that again puts it leaps and bounds above the Apple OS. 

Apple’s new iPhone was unveiled earlier this month with Siri technology, which lets users ask for weather updates, make calendar appointments or send messages without tapping on the keyboard. The iPhone is the company’s best-selling product.

The article fails to mention that this feature was available in Android from the beginning of the year, at least. Again Apple is playing catch up, but it has not yet caught up!

The latest Android incarnation also offers easier multitasking and a new People app, which helps check status updates from Google+ and other social networks.... Android controlled 43.4 percent of the global smartphone market in the second quarter, while Apple’s iOS had an 18.2 percent share, according to researcher Gartner Inc.

This is up from zero hust three or so years ago, reference:

  1. More of the Android Onslaught: Increasing Handset Revenues and Growth
  2. The Complete, 63 pg Google Forensic Valuation is Available for Download

For tablets, Apple’s iOS dominated with 61.3 percent market share in the second quarter, according to research company Strategy Analytics. Android accounted for 30.1 percent of the tablet market.

Take note that the the tablet market is taking a very similar path to the phone market where Apple started with ~90% share and dropped very, very quickly with no explicit recognition of such from the media or the sell side. Reference:

 

Archived 2010 posts on the Creatively Destructive Pace of Technology Innovation and the Paradigm Shift known as the Mobile Computing Wars!

  1. There Is Another Paradigm Shift Coming in Technology and Media: Apple, Microsoft and Google Know its Winner Takes All
  2. The Mobile Computing and Content Wars: Part 2, the Google Response to the Paradigm Shift
  3. An Introduction to How Apple Apple Will Compete With the Google/Android Onslaught
  4. This article should drive the point home: 
  5. A First in the Mainstream Media: Apple’s Flagship Product Loses In a Comparison Review to HTC’s Google-Powered Phone
  6. After Getting a Glimpse of the New Windows Phone 7 Functionality, RIMM is Looking More Like a Short Play
  7. RIM Smart Phone Market Share, RIP?
  8. Android is gaining preference as the long-term choice of application developers
  9. A Glimpse of the BoomBustBlog Internal Discussion Concerning the Fate of Apple
  10. Math and the Pace of Smart Phone Innovation May Take a Byte Out of Apple’s (Short-lived?) Dominance
  11. Apple on the Margin
  12. RIM Smart Phone Market Share, RIP?
  13. Motorola, the Company That INVENTED the Cellphone is Trying to Uninvent the iPad With Android
  14. Android Now Outselling iOS? Explaining the Game of Chess That Google Plays in the Smart Phone Space
  15. More of the Android Onslaught: Increasing Handset Revenues and Growth
  16. The BoomBustBlog Multivariate Research in Motion Valuation Model: Ready for Download
  17. The Complete, 63 pg Google Forensic Valuation is Available for Download
  18. iSuppli Continues to Validate BoomBustBlog’s Original Thesis: Android as the Viral Game Changer!
  19. BoomBustBlog Research Hits Another One Out the Park! Google up nearly 10% after hours, true blowout earnings unlike JPM
  20. As I Warned in June, DO NOT DISCOUNT Microsoft in This Mobile Computing War! Their Marketing Campaign is PURE GENIUS! and it Appears as if the Phone Ain’t Bad Either
  21. Reggie Middleton Wasn’t the ONLY Openly Apple Bear in the Blogoshpere, Was He?
Published in BoomBustBlog

The graphic below pretty much sums up Goldman's most recent quarter...

thumb_image001_copy

An unmitigated disaster, and worse than practically everybody on the Street anticipated, save that brash-ass blogging dude brandishing those old fashioned analytical weapons of choice... Two months or so ago (Monday, 22 August 2011), I penned the public blog post that also relased my most recent research on Goldman Sachs - The Squid Is A Federally (Tax Payer) Insured Hedge Fund Paying Fat Bonuses That Can't Trade In Volatile Markets? Who's Gonna Tell The Shareholders and Tax Payer??? -  as excerpted:

The chart below demonstrates how the volatility of the revenues from the trading and principal investments trickles down into volatility of the total revenues and profits of Goldman Sachs. I don’t call Goldman the world’s most expensive federally insured hedge fund for nothing!

And for those who haven't been following my Squid Hunting series, there's a lot more to come from those boys at 200 West Street. If you want to know what will happen next, just look at the first few pages of the lastest Goldman subscription docs (click here to subscribe):

After all, eventually someone must query, So, When Does 3+5=4? When You Aggregate A Bunch Of Risky Banks & Then Pretend That You Didn't?

 

 I'm Hunting Big Game Today:The Squid On The Spear Tip, Part 1 & Introduction

 

I'm Hunting Big Game Today: The Squid On A Spear Tip

Summary: This is the first in a series of articles to be released this weekend concerning Goldman Sachs, the Squid! In this introduction (for those who do not regularly follow me) I demonstrate how the market, the sell side, and most investors are missing one of the biggest bastions of risk in the US investment banking industry. I will also...

 Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?  

Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?

Welcome to part two of my series on Hunting the Squid, the overvaluation and under-appreciation of the risks that is Goldman Sachs. Since this highly analytical, but poignant diatribe covers a lot of material, it's imperative that those who have not done so review part 1 of this series, I'm Hunting Big Game Today:The Squid On The Spear Tip, Part...

Reggie Middleton Serves Up Fried Calamari From Raw Squid: Goldman Sachs and Market Perception of Real Risks!

Hunting the Squid Part 3: Reggie Middleton Serves Up Fried Calamari From Raw Squid

For those who don't subscribe to BoomBustblog, or haven't read I'm Hunting Big Game Today:The Squid On The Spear Tip, Part 1 & Introduction and Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?, not only have you missed out on some unique artwork, you've potentially missed out on 300%...
 Hunting the Squid, part 4: So, What Else Can Go Wrong With The Squid? Plenty!!!  

Hunting the Squid, part 4: So, What Else Can Go Wrong With Goldman Sachs? Plenty!

Yes, this more of the hardest hitting investment banking research available focusing on Goldman Sachs (the Squid), but before you go on, be sure you have read parts 1.2. and 3:  I'm Hunting Big Game Today:The Squid On A Spear Tip, Part 1 & Introduction Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To...

I actually show up in person!

Hunting the Squid, Part 5: Sometimes Your Local Superhero Doesn't Look Like What They Show You In The Movies

My next post should also include research on the next bank that we have found that has been (again) overlooked by the market, the media and the sell side. Can we expect the same that we saw in BNP, Bear, Lehman, etc.? Well, paying subscribers shall find out forthwith.

I can be reached via the following channels, or directly via email:

  • Follow us on Blogger
  • Follow us on Facebook
  • Follow us on LinkedIn
  • Follow us on Twitter
  • Follow us on Youtube
I will be releasing the date (probably this week), location and time of the NYC meet and greet within the next 24 hours or so, so we can chat, drink, debate, argue and fraternize with pretty woman together in a trendy spot in the Meat Packing District or the Bowery (I apologize in advance to all of my female readers/subscribers). Those who are interested in attending should email customer support. There has been strong interest in the London meeting, enough to warrant the venue - I simply need to get the travel and venue organized due to a change of plans.
For those that are new to the blog, these are pics of previous meet and greets...

The Motherland on the Atlantic Ocean, just outside NYC

The Motherland on the Hudson, NYC

47b8d631b3127cce98548a67f7f900000047100Abs2TFi2ZsWWg.jpg

79st Boat Basin, NYC

DSC06310.jpg

79st Boat Basin, NYC

buddhakahn2.jpg

BuddhaKahn, NYC

Published in BoomBustBlog

image001

I took the weekend off and all types of nonsense occurs in my wake. Well, I'm back with some fresh research. Subscribers, we have found another bank at risk (and you know how well the other banks that we targeted fared in the past - Bear, Lehman, the entire French banking system, etc.) and will be releasing the research in the next 24 hours. In the meantime, I would like to address the massive bear market rally/short squeeze that probably created many a draw down. First, a little misdirection and disinformation as reported by CNBC: Greek 'Haircut' No Threat to French Banks: Noyer 

French banks could cope with a significant Greek "haircut"—a private sector writedown of Greek bonds—but it is still possible that the country's financial institutions may have to be recapitalized, Christian Noyer, governor of the Bank of France, told CNBC.

"Greece is not a problem for the French banks," Noyer said. "The total (exposure) of the French banks to Greek sovereign debt is significantly smaller than the first half of profits for the French banking system."

That exposure amounts to roughly 8 billion euros, while French banks' first-half profits totaled about 11 billion euros.

Still, Noyer would not rule out recapitalization for banks in France, given that all of Europe's banks' could face mandatory increases to their required capital base, depending on a decision by the European Bank Authority (EBA), the European Union's banking regulator.

Where shall I begin? Well, Reuters reports German Finance Minister Insists Greek Debt Haircut Should Be At Least 50-60%, as excerpted:

Greece's debt crisis cannot be solved without larger write downs on Greek debt and governments are trying to persuade banks to accept this, German Finance Minister Wolfgang Schaeuble said on Sunday, just days ahead of a key EU summit.

Asked in the interview with ARD whether there could be a Greek debt write-down of as much as 50-60 percent, Schaeuble said: "A lasting solution for Greece is not possible without a debt write-down, and this will likely have to be higher than that considered in the summer."

In July, private creditors agreed to a voluntary write-down of 21 percent on their Greek debt, a figure which now looks insufficient. Euro zone officials said last week losses are now likely to be between 30 and 50 percent.

"Of course we would like, if possible, to agree together with the banks. That is why we will be discussing things with them. But it is clear, there must be a level of participation which is enough to bring about a lasting solution for Greece. That is enormously difficult," Schaeuble said.

The market has an even higher implied actual haircut! Analysis - Greek debt enters Argentina-style twilight zone

Reuters - Even that would be a better deal than levels of a 60 to 70 percent haircut currently priced into Greek debt. Most Greek bonds are trading at around 35 cents on the euro. For emerging market players with experience of Argentina, which defaulted on $100 ...

Of course, a little useless financial engineering can make things all good right? Yeah, right! You see, what looked like a bad deal just a week ago... EU Officials: Private Sector Bondholders Could Expect 30-50% Haircut Business Insider - ‎Eurozone officials told Reuters today that the private sector will likely see a 30-50% haircut on holdings of Greek bonds if they participate in a debt swap deal. That's far more than the 21% that had been expected under the initial terms of the July ...

Looks like a hell of a bargain today... Greek Bond Deal: Too Good to Last

Wall Street Journal (blog) - Reason 2: As we have pointed out before, a sharp fall in Greek bond prices since July 21 makes the bond swap look like an even better deal to bondholders. The new bonds they would receive through the exchange have other benefits to investors—they ...

Pointless Greek bond swap dead — long live pointless Greek bond swap

FT Alphaville (blog) - For all we know, the terms of the current bond swap may simply be tweaked to get the “new” haircuts, for example by lengthening the maturities of the new bonds or cutting the coupons paid by Greece, while keeping other things (like collateral) much the ...

Contrary to Noyer's opinion above, both Reggie Middleton and other disinterested yet objective sources state Greek banks can withstand haircut of up to 30 percent - sources
Reuters UK - ATHENS (Reuters) - Greek banks could endure a loss of up to 30 percent on their Greek government bonds but could not stand significantly bigger haircuts, Greek banking sources said on Thursday. "Banks can withstand a haircut of up to 30 percent but a ...

Of course, those loyal BoomBustBlog readers knew this to be the case a year and a half ago!
Subscription analysis from early 2010 shows Greece was nearly guaranteed to default as its banks were stuffed with trash:

File Icon Greece Public Finances Projections
File Icon Greek Banking Fundamental Tear Sheet

Online Spreadsheets (professional and institutional subscribers only) showed that haircuts were to be multiples of the originally proposed 21% if Greece were to even have a chance of digging itself out of the hole!!!

I also explained the situation in public, and for free, early in 2010: Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! The situation with the Greek banks is the same situation with the French, German, etc. banks. Leverage piled upon depreciating assets simply wipes out equity. Period! How Greece Killed Its Own Banks!

...These downgrades are going to cause people to increase their risk weightings,” Yelvington said.

Well, the answer is.... Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)...

image001image001

The same hypothetical leveraged positions expressed as a percentage gain or loss...

image003

I even went so far as to compare Greece to Argentina, complete with online models. No matter which way you slice it, a 50% haircut would be akin to a snowy Christmas in the summer of a devout Muslim country - highly unlikely! A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina

Now, referencing the bond price charts below as well as the spreadsheet data containing sovereign debt restructuring in Argentina, we get...

Price of the bond that went under restructuring and was exchanged for the Par bond in 2005

image001

Price of the bond that went under restructuring and was exchanged for the Discount bond

image003

On that note, ZeroHedge has come out with a blockbuster explanatory article: Credit Suisse Buries European Banks, Sees Deutsche Bank And 65 Other Bank Failing Latest Stress Test, €400 Billion Capital Shortfall

A day after Credit Suisse killed the Chinese bank sector saying that the equity of virtually the entire space may be worthless if NPLs double, as they expect they will to about 10%, the Swiss bank proceeds to kill European banks next. Based on the latest farce out of Europe in the form of the third stress test, which is supposed to restore some confidence, it appears that what it will do is simply accelerate the flight out of everything bank related, but certainly out of anything RBS, Deutsche Bank, BNP, SocGen and Barclays related.

I'd like to add that I've ridiculed all of these stress tests, US and European, although the European stress tests were by far the biggest joke. Dexia passed with a grade of A (or so), and will be nationalized momentarily. 'Nuff said!

To wit: "In our estimation of what could be the “new EBA stress test” there would be 66 failures, with RBS, Deutsche Bank, and BNP needing the most capital – at €19bn, €14bn and €14bn respectively. Among the banks with the highest capital shortfalls, SocGen and Barclays would need roughly €13bn with Unicredit and Commerzbank respectively at €12bn and €11bn. In the figure below we present the stated results. We note RBS appears to be the most vulnerable although the company has said that the methodology, especially the calculation of trading income, is especially harsh for them, negatively impacting the results by c.80bps." Oops. Perhaps it is not too late for the EBA to back out of this latest process and say they were only kidding. And it gets even worse: "We present in this section an overview of the analysis which we published in our report ‘The lost decade’ – 15-Sep 2011. One of our conclusions was that the overall European banking sector is facing a €400bn capital shortfall which compares to a current market cap of €541bn." Said otherwise, we can now see why the FT reported yesterday that banks will be forced to go ahead and proceed with asset firesales: the mere thought of European banks raising new cash amounting to 75% of the entire industry's market cap, is beyond ridiculous. So good luck with those sales: just remember - he who sells first, sells best.

And the scary charts:

1. Capital Shortfalls under Stress Test part Trois (9% min. CET1 ratio)

If anyone over there has two synapses to spark together, I would fully expect them to take my research over much of the anecdotal drivel passed around the Street as research. For instance, from the outside looking in, the Greek writedowns (yes, even the mark to myth Greek writedowns) will most likely wipe RBS profit for the year. Now, try applying what the real losses will be... Okay, after you do that, try realizing that no Greek default will occur in a vacuum and all peripheral assets will suffer in solidarity, not to mention their own solvency issues. Then add to that that RBS is an insolvent ward of the state to begin with, after passing stress tests itself then being nationalized. Okay, now that we've dispensed with the most of the optimism and good news (I'm going to skip over DB, since much of the market appears to be doing in assuming that Germany cannot be touched despite the fact that it is already very much "touched") and head on to the bank that I warned my paying subscribers about in late August - in time to see its share price halved despite not a damn peep of a warning from the sell side of the pop media. May I please be allowed reminisce, as excerpted from Small Independent, Bombastic Financial News Show Dramatically Scoops the Financial Times On French Bank Run Story :

 Post Note: BNP management is now shopping around for capital investment.

On that note, let's review my post last week, "BoomBust BNP Paribas?" (it is strongly recommended that you review this article if you haven't read it already) I started releasing snippets and tidbits of the proprietary research that led to the BNP short, namely File Icon Bank Run Liquidity Candidate Forensic Opinion - A full forensic note for professional and institutional subscribers. It outlined some very telling reasons why BNP's share price appears to be spillunking, namely:

    1. Management is lying being less than forthcoming with the valuation of toxic assets on its books.
    2. The sheer amount of these assets on the books and the leverage employed to attain them are devastating
    3. BNP has employed the proven self destructive financing methodology of borrow short, invest in depreciating assets long!
    4. BNP management lying being less than forthcoming about reliance on said funding maturity mismatch, despite the fact it handily dispatched Bear Stearns and Lehman Brothers in less than a weekend!

Another BIG Reason Why BNP Paribas Is Still Ripe For Implosion!

As excerpted from our professional series File Icon Bank Run Liquidity Candidate Forensic Opinion:

BNP_Paribus_First_Thoughts_4_Page_01BNP_Paribus_First_Thoughts_4_Page_01

This is how that document started off. Even if we were to disregard BNP's most serious liquidity and ALM mismatch issues, we still need to address the topic above. Now, if you were to employ the free BNP bank run models that I made available in the post "The BoomBustBlog BNP Paribas "Run On The Bank" Model Available for Download"" (click the link to download your own copy of the bank run model, whether your a simple BoomBustBlog follower or a paid subscriber) you would know that the odds are that BNP's bond portfolio would probably take a much bigger hit than that conservatively quoted above.  Here I demonstrated what more realistic numbers would look like in said model... image008image008

To note page 9 of that very same document addresses how this train of thought can not only be accelerated, but taken much further...

BNP_Paribus_First_Thoughts_4_Page_09BNP_Paribus_First_Thoughts_4_Page_09

So, how bad could this faux accounting thing be? You know, there were two American banks that abused this FAS 157 cum Topic 820 loophole as well. There names were Bear Stearns and Lehman Brothers. I warned my readers well ahead of time with them as well - well before anybody else apparently had a clue (Is this the Breaking of the Bear? and Is Lehman really a lemming in disguise?). Well, at least in the case of BNP, it's a potential tangible equity wipe out, or is it? On to page 10 of said subscription document...

BNP_Paribus_First_Thoughts_4_Page_10BNP_Paribus_First_Thoughts_4_Page_10

Yo, watch those level 2s! Of course there is more to BNP besides overpriced, over leveraged sovereign debt, liquidity issues and ALM mismatch, and lying about stretching Topic 820 rules, but I think that's enough for right now. Is all of this already priced into the free falling stock? Are these the ingredients for a European bank run? I'll let you decide, but BoomBustBloggers Saw this coming midsummer when this stock was at $50. Those who wish to subscribe to my research and services should click here. Those who don't subscribe can still benefit from the chronology that led up to the BIG BNP short (at least those who have come across my research for the first time)...

Thursday, 28 July 2011  The Mechanics Behind Setting Up A Potential European Bank Run Trastde and European Bank Run Trading Supplement

I identify specific bank run candidates and offer illustrative trade setups to capture alpha from such an event. The options quoted were unfortunately unavailable to American investors, and enjoyed a literal explosion in gamma and implied volatility. Not to fear, fruits of those juicy premiums were able to be tasted elsewhere as plain vanilla shorts and even single stock futures threw off insane profits.

Wednesday, 03 August 2011 France, As Most Susceptble To Contagion, Will See Its Banks Suffer

In case the hint was strong enough, I explicitly state that although the sell side and the media are looking at Greece sparking Italy, it is France and french banks in particular that risk bringing the Franco-Italia make-believe capitalism session, aka the French leveraged Italian sector of the Euro ponzi scheme down, on its head.

I then provide a deep dive of the French bank we feel is most at risk. Let it be known that every banked remotely referenced by this research has been halved (at a mininal) in share price! Most are down ~10% of more today, alone!

So, What's the Next Shoe To Drop? Read on...

For those who claim I may be Euro bashing, rest assured - I am not. Just a week or two later, I released research on a big US bank that will quite possibly catch Franco-Italiano Ponzi Collapse fever, with the pro document containing all types of juicy details. This is the next big thing, for when (not if, but when) European banks blow up, it WILL affect us stateside! Subscribers, be sure to be prepared. Puts are already quite costly, but there are other methods if you haven't taken your positions when the research was first released. For those who wish to subscribe, click here.

Now, let's refresh the output from And The European Bank Run Continues...and more importantly BoomBustBlog BNP Paribas "Run On The Bank" Models (they range from free up to institutional, I strongly urge those who haven't to click upon said link and download your intellectual weapon of choice!) where I modeled Greek losses on BNP.  Below is sample output from the professional level model (BNP Exposures - Professional Subscriber Download Version) that simulates the bank run that the news clippings below appear to be describing in detail...(Click to enlarge to printer quality)This scenario was run BEFORE the Greek bonds dropped even further in price...

image014

Using more recent market inputs (you know, assuming this stuff was Level 1), we get the following...

bnp_haircut_exposure

Notice here the base case TEC impairment is now approaching the adverse case from just a few weeks ago - and this is using market pricing, not some pie in the sky model!

I have not recalculated the adverse scenario in this example, but you can simply use your imagination, or download the model and run it for yourself.

A Greek default with haircuts somewhat inline with market prices will wipe out 13% of BNP TEC, with a more severe cut (quite likely) taking out nearly 20%. This is not even glancing upon the many problems we discussed in our forensice reports (File Icon French Bank Run Forensic Thoughts - Retail Valuation Note - For retail subscribers,File Icon Bank Run Liquidity Candidate Forensic Opinion - A full forensic note for professional and institutional subscribers).

Now, if the ZH referenced report above is accurate (and I believe it is) the banks are going to try to delever by selling assets in the open markets (all at the same time, selling the same assets to the same pool of potential buyers at the same bad times). This means that the prices used to populate this model are probably still too optmistic. Even if they weren't, look at the capital short fall the Greek default will leave BNP with assuming our institutional bank run thesis holds true and they see a slight withdrawal of liquidity of 10% this year and 15% next (knowing full well the numbers for Lehmand and Bear were much, much higher than that before they collapsed). First, a refesher on our European bank run theory expoused 5 months ago...

  1. Let's Walk The Path Of A Potential Pan-European Bank Run, Then Construct Trades To Profit From Such
  2. Greece Is Fulfilling Our Predictions Of Default Precisely As Predicted This Time Last Year
  3. The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
  4. The Fuel Behind Institutional “Runs on the Bank” Burns Through Europe, Lehman-Style!

And the BNP results????

bnp_haircut_exposure_bank_run

Half trillion euros here, half trillion euros there... Sooner or later, we'll be talking about some real money! Since the problems have not been cured, they're literally guaranteed to come back and bite ass. Guaranteed! So, as suggested earlier on, download your appropriate BoomBustBlog BNP Paribas "Run On The Bank" Models (they range from free up to institutional).

My next post should also include research on the next bank that we have found that has been (again) overlooked by the market, the media and the sell side. Can we expect the same that we saw in BNP, Bear, Lehman, etc.? Well, paying subscribers shall find out forthwith.

I can be reached via the following channels, or directly via email:

  • Follow us on Blogger
  • Follow us on Facebook
  • Follow us on LinkedIn
  • Follow us on Twitter
  • Follow us on Youtube
I will be releasing the date (probably this week), location and time of the NYC meet and greet within the next 24 hours or so, so we can chat, drink, debate, argue and fraternize with pretty woman together in a trendy spot in the Meat Packing District or the Bowery (I apologize in advance to all of my female readers/subscribers). Those who are interested in attending should email customer support. There has been strong interest in the London meeting, enough to warrant the venue - I simply need to get the travel and venue organized due to a change of plans.
For those that are new to the blog, these are pics of previous meet and greets...

  

47b8d631b3127cce98548a67f7f900000047100Abs2TFi2ZsWWg.jpg

DSC06310.jpg

buddhakahn2.jpg

Published in BoomBustBlog
Friday, 07 October 2011 11:17

Subscribers, Look To The Discussion Forums

All paying subscribers, please make more use of our private discussion forums. I've left a not there about my position in Apple to get the discussion started.

Published in BoomBustBlog

I recieved this in the mail from a connected media editor regarding Goldman's very recent investment advisories...

Buy calls for a likely relief rally on earnings (Oct 20th)

We see the potential for a rebound in MS shares on earnings, but the event is not without risk. We believe concerns regarding its European swap and loan exposures appear overdone, as the firm signaled its net exposures to France and the periphery are modest if not immaterial. Uncertainty generated by press reports, as well as difficult markets have driven shares below levels reached when the market was at its March 2009 lows.

Balance sheet strengthened; sell short-dated CDS as fear falls

We believe the recent widening in MS CDS spreads does not reflect actual credit fundamentals. MS appears to have enough capital and liquidity

($182 bn in global liquidity pool + its bank status) to withstand significant market duress. Its 14.6% Tier 1 common ratio is at the high end of the industry. We expect the market focus to remain on European sovereign exposures and liquidity levels, and expect management to discuss this, highlighting the strength of its cash position, hedging and collateral, and progress in reaching its strategic goals, somewhat calming fears.

I responded with the rant below...

A)     Goldman’s investment advice sucks, big time – see Is It Now Common Knowledge That Goldman's Investment Advice Sucks?

B)      The term “net” exposures is misleading and in many cases, make believe. The offsetting hedges used to “alledgedly” hedge the gross exposure were written off of counterparties in the same businesses, trading the same products in the same markets as Morgan. When the feces hits the cooling machine blades, everyone’s liquidity will move in the same direction – downward. There is no true diversity, hence there is no true hedge – only academic hedges written, and traded, in paper form.

a.     I have addressed this ad nauseum on the blog, but the answer to that questions has been put best by Tyler Durden, at ZeroHedge put it best: ...Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else who on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky. The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd's bank "resolution" provision would do absolutely nothing to prevent an epic systemic collapse.

C)    There is evidence that corroborates bullet point “B” in Goldman’s own missive, and I quote “Balance sheet strengthened; sell short-dated CDS as fear falls.” Are we to believe that Goldman is only giving this advice to those clients large enough, liquid enough, solvent enough and adequately diversified from the financial services, asset management and investment industry (this can be read as absolutely no hedge funds, HNW, pension funds and family offices – Yeah, right!) so as to ensure the ability to pay out these CDS in a fat tailed event? Or is Goldman peddling this advice that is not paid for to incentivize clients act in a fashion that Goldman is paid for, ex. Market maker/broker/principal/agent in the CDS market? As Goldman pushes CDS sales onto any willy nilly who’s willing to wright them, Goldman compounds the risks already inherent in a much less than perfect system. Isn’t that why AIG had to be bailed out to the tune of over a fifth a TRILLION US dollars?

D)    As for the last comment “MS appears to have enough capital and liquidity ($182 bn in global liquidity pool + its bank status) to withstand significant market duress. Its 14.6% Tier 1 common ratio is at the high end of the industry. We expect the market focus to remain on European sovereign exposures and liquidity levels, and expect management to discuss this, highlighting the strength of its cash position, hedging and collateral, and progress in reaching its strategic goals, somewhat calming fears.” I direct you to my latest post on what Superheroes may look like in real life –  Hunting the Squid, Part 5: Sometimes You…

Published in BoomBustBlog

Yes, this more of the hardest hitting investment banking research available focusing on Goldman Sachs (the Squid), but before you go on, be sure you have read parts 1.2. and 3: 

  1. I'm Hunting Big Game Today:The Squid On A Spear Tip, Part 1 & Introduction
  2. Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?"
  3. Reggie Middleton Serves Up Fried Calamari From Raw Squid: Market Perceptions of Real Risk in Goldman Sachs

So, what else can go wrong with the Squid? 

Plenty! In Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?" I included a graphic that illustrated Goldman's raw credit exposure...

So, what is the logical conclusion? More phallic looking charts of blatant, unbridled, and from a realistic perspective, unhedged RISK starring none other than Goldman Sachs...

 image006

And to think, many thought that JPM exposure vs World GDP chart was provocative. I query thee, exactly how will GS put a real workable hedge, a counterparty risk mitigating prophylactic if you will, over that big green stalk that is representative of Total Credit Exposure to Risk Based Capital? Short answer, Goldman may very well be to big for a counterparty condom. If that's truly the case, all of you pretty, brand name Goldman counterparties out there (and yes, there are a lot of y'all - GS really gets around), expect to get burned at the culmination of that French banking party
I've been talking about for the last few quarters. Oh yeah, that perpetually printing clinic also known as the Federal Reserve just might be running a little low on that cheap liquidity antibiotic... Just
giving y'all a heads up ahead of time...

And for those who may not be sure of the significance, please review my presenation as the Keynote Speaker at the ING Real Estate Valuation Seminar in Amsterdam, below. After all, for all intents and purposes, Dexia has officially collapsed - [CNBC] France, Belgium Pledge Aid for Struggling Dexia... and its a good chance that it's a matter of time before BNP follows suit - exactly as BoomBustBlog predicted for paying subsccribers way back in July.

A step by step tutorial on exactly how it will happen....

 The European banking debacle was predicted at the start of 2010, a full year and a half before this has come to a head. If I could have seen it so clearly, why couldn't the banking industry and its regulators?

Now, back to GS, and considering all of the European falllout coming down the pike, of which Goldman is heavily leveraged into, particulary France (say BNP/Dexia/etc.)...

image009

Let's go over exactly how GS is exposed following the logic outlined in the graphic before this series of videos, as excerpted from subscriber document Goldmans Sachs Derivative Exposure: The Squid in the Coal Mine?, pages 3,4 and 5.

GS__Banks_Derivatives_exposure_temp_work_Page_3

GS__Banks_Derivatives_exposure_temp_work_Page_4

GS__Banks_Derivatives_exposure_temp_work_Page_5

Booyah!

There you go. The markets and the media have concentrated on Morgan Stanely because Goldman has successfully hid much of its risk from those who didn't subscribe to BoomBustBlog. Of course, those who did subscribe picked up those puts ridiculosuly cheap, and are/will reap the benefits as the TRUTH goes VIRAL!

Those who wish to jump on the gravy train of our next US bank analysis featuring those susceptible to this malaise can subcribe here and now!

The many ways to reach Reggie Middleton:

  • Follow us on Blogger
  • Follow us on Facebook
  • Follow us on LinkedIn
  • Follow us on Twitter
  • Follow us on Youtube

Or simply email me.

Meet Reggie Middleton in person in NYC and London!

I will be hosting two BoomBustBlog meet and greets, for those who aren't too put off by my truthful, fact-based style. One in the next couple of weeks in a swank, pretty people laden lounge in downtown Manhattan, and the other potentially in London in mid-November - both wherein we sit down and chew the fat about things financial, global macro and socio-economic over drinks and heated debate. I will have plenty of gratis BoomBustBlog research there as well. Those who are interested should email the blog Customer Support for info.

Published in BoomBustBlog

For those who don't subscribe to BoomBustblog, or haven't read I'm Hunting Big Game Today:The Squid On The Spear Tip, Part 1 & Introduction and Hunting the Squid, Part2: Since When Is Enough Derivative Exposure To Blow Up The World Something To Be Ignored?, not only have you missed out on some unique artwork, you've potentially missed out on 300% to 500% investment gains as well (as of the posting of this message from the beginning of the month)...

image019

Goldman's share price went down to nearly $50 during the 2009 crisis, and I believe things are worse this time around. Of course BoomBustBlogger, you shouldn't be greedy, subscribers. Cash in your fried calamari chips now, or at the very least hedge them - while you have them and prepare for the next opportunity. There will be plenty, rest assured. Remember how Goldman's stock actually trades...

.. I'd like to announce to the release of a blockbuster document describing the true nature of Goldman Sachs, a description that you will find no where else. It's chocked full of many interesting tidbits, and for those who found "The French Government Creates A Bank Run? Here I Prove A Run On A French Bank Is Justified And Likely" to be an iteresting read, you're gonna just love this! Subscribers can access the document here:

As is customary, I am including free samples for those who don't subscribe, so you can get a taste of the forensic flavor. Here are the first 2 pages of the 19

page professional edition, with illustrative option trade setups soon to follow.

 Goldman_Sachs_Q3_Forensic_Review_Page_01Goldman_Sachs_Q3_Forensic_Review_Page_01Goldman_Sachs_Q3_Forensic_Review_Page_01

Is Goldman Sachs stock really the front running, Mo-Mo traders wet dream?

Goldman_Sachs_Q3_Forensic_Review_Page_02Goldman_Sachs_Q3_Forensic_Review_Page_02Goldman_Sachs_Q3_Forensic_Review_Page_02

 

Published in BoomBustBlog
ZeroHedge dutifully reports: Five Banks Account For 96% Of The $250 Trillion In Outstanding US Derivative Exposure; Is Morgan Stanley Sitting On An FX Derivative Time Bomb?

The latest quarterly report from the Office Of the Currency Comptroller is out and as usual it presents in a crisp, clear and very much glaring format the fact that the top 4 banks in the US now account for a massively disproportionate amount of the derivative risk in the financial system. Specifically, of the $250 trillion in gross notional amount of derivative contracts outstanding (consisting of Interest Rate, FX, Equity Contracts, Commodity and CDS) among the Top 25 commercial banks (a number that swells to $333 trillion when looking at the Top 25 Bank Holding Companies), a mere 5 banks (and really 4) account for 95.9% of all derivative exposure (HSBC replaced Wells as the Top 5th bank, which at $3.9 trillion in derivative exposure is a distant place from #4 Goldman with $47.7 trillion). The top 4 banks: JPM with $78.1 trillion in exposure, Citi with $56 trillion, Bank of America with $53 trillion and Goldman with $48 trillion, account for 94.4% of total exposure. As historically has been the case, the bulk of consolidated exposure is in Interest Rate swaps ($204.6 trillion), followed by FX ($26.5TR), CDS ($15.2 trillion), and Equity and Commodity with $1.6 and $1.4 trillion, respectively. And that's your definition of Too Big To Fail right there: the biggest banks are not only getting bigger, but their risk exposure is now at a new all time high and up $5.3 trillion from Q1 as they have to risk ever more in the derivatives market to generate that incremental penny of return.

At this point the economist PhD readers will scream: "this is total BS - after all you have bilateral netting which eliminates net bank exposure almost entirely." True: that is precisely what the OCC will say too. As the chart below shows, according to the chief regulator of the derivative space in Q2 netting benefits amounted to an almost record 90.8% of gross exposure, so while seemingly massive, those XXX trillion numbers are really quite, quite small... Right?

...Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else who on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky.

The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd's bank "resolution" provision would do absolutely nothing to prevent an epic systemic collapse. 

...

Lastly, and tangentially on a topic that recently has gotten much prominent attention in the media, we present the exposure by product for the biggest commercial banks. Of particular note is that while virtually every single bank has a preponderance of its derivative exposure in the form of plain vanilla IR swaps (on average accounting for more than 80% of total), Morgan Stanley, and specifically its Utah-based commercial bank Morgan Stanley Bank NA, has almost exclusively all of its exposure tied in with the far riskier FX contracts, or 98.3% of the total $1.793 trillion. For a bank with no deposit buffer, and which has massive exposure to European banks regardless of how hard management and various other banks scramble to defend Morgan Stanley, the fact that it has such an abnormal amount of exposure (but, but, it is "bilaterally netted" we can just hear Dick Bove screaming on Monday) to the ridiculously volatile FX space should perhaps raise some further eyebrows...

 Let Me Post This Paragraph ONE MORE TIME!

...Wrong. The problem with bilateral netting is that it is based on one massively flawed assumption, namely that in an orderly collapse all derivative contracts will be honored by the issuing bank (in this case the company that has sold the protection, and which the buyer of protection hopes will offset the protection it in turn has sold). The best example of how the flaw behind bilateral netting almost destroyed the system is AIG: the insurance company was hours away from making trillions of derivative contracts worthless if it were to implode, leaving all those who had bought protection from the firm worthless, a contingency only Goldman hedged by buying protection on AIG. And while the argument can further be extended that in bankruptcy a perfectly netted bankrupt entity would make someone else who on claims they have written, this is not true, as the bankrupt estate will pursue 100 cent recovery on its claims even under Chapter 11, while claims the estate had written end up as General Unsecured Claims which as Lehman has demonstrated will collect 20 cents on the dollar if they are lucky.

The point of this detour being that if any of these four banks fails, the repercussions would be disastrous. And no, Frank Dodd's bank "resolution" provision would do absolutely nothing to prevent an epic systemic collapse.

Super, Duper, B-I-N-G-0!!! It is so relieving to hear someone else espouse what really should be common damn sense, yet happens to be one of the uncommon commodities to be found on the Isle of Manhattan.

Reggie Middleton on CNBC's Squawk on the Street - 10/19/2010

Mr. Middleton discusses JP Morgan and concentrated bank risk.

Hey, there ain't no concentration risk in US banks, and any blogger with two synapses to spark together should know this...

An Independent Look into JP Morgan.

Click graph to enlarge

 image001.pngimage001.pngimage001.png

Cute graphic above, eh? There is plenty of this in the public preview. When considering the staggering level of derivatives employed by JPM, it is frightening to even consider the fact that the quality of JPM's derivative exposure is even worse than Bear Stearns and Lehman‘s derivative portfolio just prior to their fall. Total net derivative exposure rated below BBB and below for JP Morgan currently stands at 35.4% while the same stood at 17.0% for Bear Stearns (February 2008) and 9.2% for Lehman (May 2008). We all know what happened to Bear Stearns and Lehman Brothers, don't we??? I warned all about Bear Stearns (Is this the Breaking of the Bear?: On Sunday, 27 January 2008) and Lehman ("Is Lehman really a lemming in disguise?": On February 20th, 2008) months before their collapse by taking a close, unbiased look at their balance sheet. Both of these companies were rated investment grade at the time, just like "you know who". Now, I am not saying JPM is about to collapse, since it is one of the anointed ones chosen by the government and guaranteed not to fail - unlike Bear Stearns and Lehman Brothers, and it is (after all) investment grade rated. Who would you put your faith in, the big ratings agencies or your favorite blogger? Then again, if it acts like a duck, walks like a duck, and quacks like a duck, is it a chicken??? I'll leave the rest up for my readers to decide.

This public preview is the culmination of several investigative posts that I have made that have led me to look more closely into the big money center banks. It all started with a hunch that JPM wasn't marking their WaMu portfolio acquisition accurately to market prices (see Is JP Morgan Taking Realistic Marks on its WaMu Portfolio Purchase? Doubtful! ), which would very well have rendered them insolvent - particularly if that was the practice for the balance of their portfolio as well (see Re: JP Morgan, when I say insolvent, I really mean insolvent). I then posted the following series, which eventually led to me finally breaking down and performing a full forensic analysis of JP Morgan, instead of piece-mealing it with anecdotal analysis.

  1. The Fed Believes Secrecy is in Our Best Interests. Here are Some of the Secrets
  2. Why Doesn't the Media Take a Truly Independent, Unbiased Look at the Big Banks in the US?
  3. As the markets climb on top of one big, incestuous pool of concentrated risk...
  4. Any objective review shows that the big banks are simply too big for the safety of this country
  5. Why hasn't anybody questioned those rosy stress test results now that the facts have played out?

You can download the public preview here. If you find it to be of interest or insightful, feel free to distribute it (intact) as you wish.

JPM Public Excerpt of Forensic Analysis Subscription JPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb

 

Oh yeah, and while we're at it, this Morgan Stanley thing has been a concern of mine for well over a year now. The interest rate storm is coming, that is unless Europe can maintain historically low rates as several countries default. Then again, they never default, right...

Don't belive me, let's look at history...

image022

image021_copy

image034

So, as I was saying...

Check this out, from "On Morgan Stanley's Latest Quarterly Earnings - More Than Meets the Eye???" Monday, 24 May 2010:

Those who don't subscribe should reference my warnings of the concentration and reliance on FICC revenues (foreign exchange, currencies, and fixed income trading).  Morgan Stanley's exposure to this as well as what I have illustrated in full detail via the  the Pan-European Sovereign Debt Crisis series, has increased materially. As excerpted from "The Next Step in the Bank Implosion Cycle???":

The amount of bubbliciousness, overvaluation and risk in the market is outrageous, particularly considering the fact that we haven't even come close to deflating the bubble from earlier this year and last year! Even more alarming is some of the largest banks in the world, and some of the most respected (and disrespected) banks are heavily leveraged into this trade one way or the other. The alleged swap hedges that these guys allegedly have will be put to the test, and put to the test relatively soon. As I have alleged in previous posts (As the markets climb on top of one big, incestuous pool of concentrated risk... ), you cannot truly hedge multi-billion risks in a closed circle of only 4 counterparties, all of whom are in the same businesses taking the same risks.

Click to expand!

bank_ficc_derivative_trading.png

So, How are Banks Entangled in the Mother of All Carry Trades?

Trading revenues for U.S Commercial banks have witnessed robust growth since 4Q08 on back of higher (although of late declining) bid-ask spreads and fewer write-downs on investment portfolios. According to the Office of the Comptroller of the Currency, commercial banks' reported trading revenues rose to a record $5.2 bn in 2Q09, which is extreme (to say the least) compared to $1.6 bn in 2Q08 and average of $802 mn in past 8 quarters.

bank_trading_revenue.png

High dependency on Forex and interest rate contracts

Continued growth in trading revenues on back of growth in overall derivative contracts, (especially for interest rate and foreign exchange contracts) has raised doubt on the sustainability of revenues over hear at the BoomBustBlog analyst lab. According to the Office of the Comptroller of the Currency, notional amount of derivatives contracts of U.S Commercial banks grew at a CAGR of 20.5% to $203 trillion by 2Q-09 from $87.9 trillion in 2004 with interest rate contracts and foreign exchange contracts comprising a substantial 84.5% and 7.5% of total notional value of derivatives, respectively. Interest rate contracts have grown at a CAGR of 20.1% to $171.9 trillion between 4Q-04 to 2Q-09 while Forex contracts have grown at a CAGR of 13.4% to $15.2 trillion between 4Q-04 to 2Q-09.

In terms of absolute dollar exposure, JP Morgan has the largest exposure towards both Interest rate and Forex contracts with notional value of interest rate contracts at $64.6 trillion and Forex contracts at $6.2 trillion exposing itself to volatile changes in both interest rates and currency movements (non-subscribers should reference An Independent Look into JP Morgan, while subscribers should referenceFile Icon JPM Report (Subscription-only) Final - Professional, and File Icon JPM Forensic Report (Subscription-only) Final- Retail). However, Goldman Sachs with interest rate contracts to total assets at 318.x and Forex contracts to total assets at 11.2x has the largest relative exposure (see Goldman Sachs Q2 2009 Pre-announcement opinion Goldman Sachs Q2 2009 Pre-announcement opinion 2009-07-13 00:08:57 920.92 KbGoldman Sachs Stress Test Professional Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb, Goldman Sachs Stress Test Retail Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb,). As subscribers can see from the afore-linked analysis, Goldman is trading at an extreme premium from a risk adjusted book value perspective.

bank_forex_exposure.png

As a result of a surge in interest rate and Forex contracts, dependency on revenues from these products has increased substantially and has in turn been a source of considerable volatility to total revenues. As of 2Q-09 combined trading revenues (cash and off balance sheet exposure) from Interest rate and Forex for JP Morgan stood at $2.4 trillion, or 9.5% of the total revenues while the same for GS and BAC (subscribers, see BAC Swap exposure_011009 BAC Swap exposure_011009 2009-10-15 01:02:21 279.76 Kb) stood at $(196) million and $433 million, respectively. As can be seen, Goldman's trading teams are not nearly as infallible as urban myth makes them out to be.

bank_ficc_trading_revenue.png

Although JP Morgan's exposure to interest rate contracts has declined to $64.5 trillion as of 2Q09 from $75.2 trillion as of 3Q07, trading revenues from Interest rate contracts (cash and off balance sheet position) have witnessed a significant volatility spike and have increased marginally to $1,512 in 2Q09 compared with $1,496 in 3Q07. Although JPM's Forex exposure has decreased from its peak of $8.2 trillion in 3Q08, at $3.2 trillion in 2Q09 the exposure is still is higher than 3Q07 levels. Even for Bank of America and Citi , the revenues from Interest rate and forex products have been volatile despite a moderate reduction in overall exposure. With top 5 banks having about 97% market share of the total banking industry notional amounts as of June 30, 2009, the revenues from trading activities for these banks are practically guaranteed to be highly volatile in the event of significant market disruption - a disruption aptly described by the esteemed Professor Roubini as a rush to the exit in the "Mother of All Carry Trades" as the largest macro experiment in the history of this country starts to unwind, or even if the participants in this carry trade think it is about to start to unwind.

The table below shows the trend in trading revenues from Interest rate and Forex positions for top banks in U.S.

Click to enlarge...

bank_ficc_exposure.png

Banks exposure to interest rate and foreign exchange contracts

With volatility in currency markets exploding to astounding levels (with average EUR-USD volatility of 16.5% over the past year (September 2008-09) compared to 8.9%  over the previous year), commercial and investment banks trading revenues are expected to remain highly unpredictable. This, coupled with huge Forex and Interest rate derivative exposure for major commercial banks, could trigger a wave of losses in the event of significant market disruptions - or a race to the exit door of this speculative carry trade. Additionally most of these Forex and Interest rate contracts are over-the-contract (OTC) contracts with 96.2% of total derivative contracts being traded as OTC. This means no central clearing, no standardization in contracts, the potential for extreme opacity in pricing, diversity in valuation as well as a dearth of liquidity when it is most needed - at the time when everyone is looking to exit. Goldman Sachs has the largest OTC traded contracts with 98.5% of its derivative contracts traded over the counter. With the 5 largest banks representing 97% of the total banking industry notional amount of derivatives and most of these contracts being traded off exchange, the effectiveness of derivatives as a hedging instrument raises serious questions since most of these banks are counterparty to one another in one very small, very tight circle (see the free article, "As the markets climb on top of one big, incestuous pool of concentrated risk... ").

bank_ficc_otc_exposure_and_currency_volatility.png

The table below compares interest rate contracts and foreign exchange contracts for JPM, GS, Citi, BAC and WFC.

JP Morgan has the largest exposure in terms of notional value with $64,604 trillion of notional value of interest rate contracts and $6,977 trillion of notional value of foreign exchange contracts. In terms of actual risk exposure measured by gross derivative exposure before netting of counterparties, JP Morgan with $1,798 bn of gross derivative receivable, or 21.7x of tangible equity, has the largest gross derivative risk exposure followed by Bank of America ($1,760 bn, or 18.1x). Bank of America with $1,393 bn of gross derivatives relating to interest rate has the highest exposure towards interest rate sensitivity while JP Morgan with $154 bn of Foreign exchange contracts has the highest exposure from currency volatility. We have explored this in forensic detail for subscribers, and have offered a free preview for visitors to the blog: (JPM Public Excerpt of Forensic Analysis SubscriptionJPM Public Excerpt of Forensic Analysis Subscription 2009-09-18 00:56:22 488.64 Kb), which is free to download, and File Icon JPM Report (Subscription-only) Final - Professional, orFile Icon JPM Forensic Report (Subscription-only) Final- Retail as well as a free blog article on BAC off balance sheet exposure If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 3 - BAC).

bank_ficc_otc_exposure_jpm.png

bank_ficc_otc_exposure_bac_and_gs.png

Subscribers, see WFC Research Note Sep 2009 WFC Research Note Sep 2009 2009-09-30 13:01:30 281.29 Kb, ~ WFC Off Balance Sheet Exposure WFC Off Balance Sheet Exposure 2009-10-19 04:25:53 258.77 Kb ~ WFC Investment Note 22 May 09 - Retail WFC Investment Note 22 May 09 - Retail 2009-05-27 01:55:50 554.15 Kb ~ WFC Investment Note 22 May 09 - Pro WFC Investment Note 22 May 09 - Pro 2009-05-27 01:56:54 853.53 Kb ~ Wells Fargo ABS Inventory Wells Fargo ABS Inventory 2008-08-30 06:40:27 798.22 Kb to expound on our opinions of Wells Fargo, below.

bank_ficc_otc_exposure_wfc_and_c.png

bank_ficc_otc_exposure_ms.png

Subscribers, see MS Simulated Government Stress Test MS Simulated Government Stress Test 2009-05-05 11:36:25 2.49 Mb and MS Stess Test Model Assumptions and Stress Test Valuation MS Stess Test Model Assumptions and Stress Test Valuation 2009-04-22 07:55:17 339.99 Kb

Published in BoomBustBlog