Rebel Traders – Analysis Without The Hype

Last July, Meredith Whitney, whom many had come to consider as a “bear angel” ever since she recognized first that Citigroup would cut its dividend in 2007, had trumpeted the doom of the last pack of bears that were resisting to the bullish onslaught. She had then made GS her only “buy” based on some light considerations on the money booked by selling corporate and government debt.

Will she be today the “Angel of Apocalypse” for the bullish crowds? She actually downgraded GS from “buy” to “neutral”, just as other analysts were making (a tad bit lately) GS their “buy”. The sanction was immediate: GS slided 3 $ lower.

I had heavily put Meredith under fire for her July “buy”, and I can again reaffirm that such switches in ratings have little to do with “real” analysis. If Meredith Whitney is basing herself on fundamentals, the situation has hardly changed between July and October. If anything, the economy has gotten better looking at the stats. However, losses in CRE are continuing to be an issue for most (if not all) banks and hence the analysts’ expectations that the profit would “triple” seem a bit unrealistic (unless of course, trading has been more profitable than usual). But these elements were already visible back in July to any analyst.

I talked then of “fallen angels”, but today, Meredith would excell as a partner of the “devil” GS in her uncanny ability to pull off such reversals.

Goldman Sachs Group Inc., the biggest U.S. securities firm before converting to a bank last year, was cut to “neutral” by Meredith Whitney, as the analyst dropped her only “buy” recommendation.

Whitney, who correctly predicted in 2007 that Citigroup Inc. would cut its dividend, didn’t update her price estimate on the shares in a summary note distributed to investors today. Further details on the downgrade weren’t immediately available.

The New York-based analyst upgraded Goldman Sachs to “buy” on July 13, since when the stock has risen 34 percent, compared with a 29 percent increase for the Standard & Poor’s 500 Investment Banking & Brokerage Index. The founder of Meredith Whitney Advisory Group LLC said on Sept. 10 that Goldman Sachs “still has a lot of gas in its tank.”

Goldman Sachs shares dropped 0.9 percent to $188.46 in German trading as of 10 a.m. in Frankfurt.

Goldman Sachs, which is due to report third-quarter results on Oct. 15, may say it earned $4.46 a share in the period, according to the report. The New York-based bank posted record earnings in the second quarter.

Goldman Sachs’s profit probably almost tripled to $2.3 billion, according to the average estimate of analysts surveyed by Bloomberg. Revenue from trading has surged to a record as competitors including Morgan Stanley scaled back their riskiest bets.

Goldman Sachs has climbed 125 percent this year on the New York Stock Exchange, the largest increase among the biggest U.S. banks. The bank repaid $10 billion to the U.S. Treasury in June.

Goldman Sachs on Oct. 7 was rated “buy” in new coverage at Deutsche Bank AG, which said the firm may boost market share in investment banking and trading. A day earlier, the bank was upgraded to “outperform” from “underperform” by CLSA analyst Mike Mayo, who also said it may be a “long-term market-share winner.”

The lender for small and medium-sized business is having increasingly more difficulties in reaching an agreement on restructuring its debt. Just as it emerged a few weeks ago that GS had an interest in CIT’s bankruptcy, it would appear today that most bondholders are not following either on refinancing its debt or approving a prepackaged bankruptcy.

The main reason being that many “vultures” attracted by the huge portfolio of CIT and the perspective of splitting it up are playing hardball, considering that they have more to earn from a bankruptcy (particularly if they have securitized loans guaranteed by collaterals). Of course, one of these is the ominous GS.

For those who rant about bailouts, CIT has received about 2.3 Bn $ in TARP funds, all of which would most likely be lost for the taxpayer in the event of a bankruptcy of CIT. In terms of market efficiency, this is one case where letting “pure capitalism” play would end up with a disastrous result on many levels.

First, it would shut down one source of financing for small businesses which have been suffering in this recession. Second, it would concentrate into the hands of the bailed out giants the control of the market, thus restricting competition and creating an oligarchic structure. Finally, as could be expected, a whole sector of the lending market would be wiped out or submitted instantaneously to costly conditions. And I have left out the question of the loss to the taxpayer…

CIT Group Inc is seeing little interest from bondholders in a debt exchange offer aimed at repairing its fragile balance sheet, making bankruptcy increasingly likely, sources familiar with the matter said.

The lender to small and medium-sized businesses said earlier this month it was looking for investors to approve a large debt exchange that would reduce its borrowings, or to approve a prepackaged bankruptcy.

CIT is now more likely to try a prepackaged bankruptcy, two people familiar with the matter said. They declined to be identified because the exchange offer is ongoing and information about its progress is private.

But separately, investors in CIT securities said it is possible the company will not find enough debtholder approval for a prepackaged bankruptcy, which requires sufficient support before the company files for protection from creditors. Instead, CIT might have to aim for a prenegotiated bankruptcy, which typically has less support before the actual filing.

CIT spokesman Curt Ritter declined to comment.

CIT has limited time to work out its debt difficulties. It has about $3 billion of debt to repay in the fourth quarter, including both secured and unsecured obligations, according to a CIT quarterly filing with regulators.

CIT has lost access to unsecured debt markets, but has billions to refinance in coming years. In three of the next four years, it will have more debt to repay than cash to pay it back. CIT has roughly 1 million customers and more than $70 billion of assets, but many of its borrowers are struggling amid the worst recession since the Great Depression.

The company’s debt exchange aims to reduce CIT’s borrowings by at least $5.7 billion, with specific targets for lowering the company’s liabilities through 2012. The exchange offer expires on October 29.

AT LEAST TWO WANT MORE

At least two groups of investors are pushing for better terms in a bankruptcy than those suggested by the company earlier this month, one of the sources and investors said.

A subordinated debt holder said last week he was hoping to press for either more equity, or for a promise from the company to pay extra money to current subordinated debt holders if the company’s assets perform well enough.

Separately, investors holding debt that funded CIT business in Canada are pushing for greater consideration in any bankruptcy plan, too. These investors are entitled to recover money from Canadian assets and the parent company in the United States and could therefore get close to 100 cents on the dollar in any bankruptcy.

One investor that would take a hit in a CIT bankruptcy is the U.S. government. The United States’ Troubled Asset Relief Program invested $2.3 billion in CIT in December and much or all of that could be lost if the company files for bankruptcy, analysts said.

But many debt investors are likely to end up with much more than zero if CIT files for bankruptcy. One group of bondholders lent $3 billion to the company in July. That loan is collateralized by an estimated $30 billion of assets, which would ensure that the July loan could likely be paid back in full.

Interesting news that surfaced in the midst of speculations over the survival of the troubled lender to small businesses. Apparently GS would actually stand to gain from a failure of CIT, pursuant to the terms of a credit facility it extended to the lender in June 2008.

In what would appear a leonine agreement, GS obtained that if the company was to go bankrupt or the the credit facility was ended, it would receive about 1 Bn $ over more than ten years. In order to avoid bankruptcy, CIT is trying to negotiate an agreement with its bondholders and sought as well to renegotiate this agreement with GS. Unsurprisingly, these discussions have not been successful so far.

Goldman Sachs Group Inc. is set to earn about $1 billion in the event CIT Group Inc. enters bankruptcy or otherwise ends a $3 billion financing agreement, according to a person familiar with the matter who declined to be identified because the payout hasn’t been disclosed.The payout would cover fees from a 20-year agreement signed June 6, 2008, according to regulatory filings. Under the deal, CIT agreed to pay Goldman 2.85 percent of the maximum amount lent under the facility, or $85.5 million annually for the first decade and then a declining amount after that, the filings show.

“This would not be a windfall payment,” Goldman Sachs said in a statement today. “The make-whole payment, which was publicly disclosed at the time of the financing, is simply the present value of the spread to be earned over the life of the facility.”

CIT Chief Executive Officer Jeffrey Peek is seeking to modify as much as $29 billion in debt, asking bondholders to swap unsecured obligations for new secured debt and preferred shares, in an effort to avoid bankruptcy. The company turned to bondholders in July for $3 billion in rescue financing after failing to win a second U.S. bailout.

CIT is in talks with Goldman to amend the facility, but no agreement has been reached, according to an Oct. 2 CIT filing. The Financial Times reported the payout earlier today, without saying where it got the information.

If the debt exchange fails to win agreement from bondholders, CIT will seek court protection through a pre-packaged bankruptcy, the company said Oct. 1. CIT, which finances about 1 million businesses from Dunkin’ Brands Inc. to Eddie Bauer Holdings Inc., posted a second-quarter loss of $1.62 billion as more customers defaulted on loans.

Credit Agreement

Goldman Sachs provided the credit facility last year after CIT was cut off from the commercial-paper market, its traditional source of funding. The maximum amount of the facility declines by $300 million each year after the first 10, the filings show.

Goldman Sachs spokesman Michael DuVally declined to comment beyond the company’s statement. An e-mail to CIT spokesman Curt Ritter wasn’t immediately returned.

CIT is boosting its board to 13 members from 10, and replacing some directors who may step down, according to an Oct. 2 regulatory filing. A bondholder steering committee will recommend candidates, who must be approved by the Federal Reserve Bank of New York, CIT said.

The plan to expand the board means CIT may be preparing to remove Peek, according to corporate governance experts. Peek, 62, joined CIT in 2003 after being denied the top job at Merrill Lynch & Co.

CIT’s board extended Peek’s employment contract last month, keeping him at the helm until at least Sept. 2, 2010, according to a Sept. 4 filing. Peek earned $800,000 in base salary last year, and stock and option awards helped bring his total compensation to $5.4 million, according to CIT’s proxy statement.

Interesting interview of Lloyd Blankfein, the CEO of Goldman Sachs published in the international edition of Der Spiegel, a reference German magazine. To read the full article in english, go here.

In essence Lloyd Blankfein “admits” some mistakes, but, of course, they are nowhere near the black image everybody has of them:

SPIEGEL: You say that Goldman did things better than many others in advance of the crisis. What was your biggest mistake?

Blankfein: Goldman Sachs has traditionally been strong in business with mergers and acquisitions. We also provide financing for acquisitions by companies …

SPIEGEL: … and through private equity funds, which shortly before the crisis financed corporate takeovers at astronomical prices using almost exclusively borrowed money.

Blankfein: When this market for so-called “leveraged finance” was booming, we wanted to remain competitive and maintain our market share. We extended even larger lines of credit to our clients and did so at the same time as lending terms were getting easier. When companies like Chrysler began to falter, we acted quickly, but we did not act quickly enough, which was a mistake.

Then, about inflation, Blankfein replies that his opinion is that the bankers are doing “exactly what needs to be done”. No I wasn’t paid by GS to write my piece “Eyes Wide Open”!

SPIEGEL: Will we see a significant rise in inflation over the next five years?

Blankfein: The central banks are currently pumping liquidity into the markets, and thus consciously accepting inflationary risks. At the same time, however, they are also bolstering the economy. And, do you know what? It may just be that these people are doing an extraordinarily good job. Still, it is risky. If the surplus liquidity is not siphoned off soon enough, inflation will result. But I would not discount the possibility that that the central bankers are doing exactly what needs to be done.

SPIEGEL: Do you invest in gold?

Blankfein: I am not bullish on gold.

Naturally, Blankfein discounts the theory of “too big to fail”, for him the issue is the same if there are “too many to fail”.

SPIEGEL: Wouldn’t it be much easier to simply limit the size of banks? After all, the danger of systemic contagion is less when the banks are smaller.

Blankfein: So what is “too big to fail”?

SPIEGEL: When a bank is so large that in the event of insolvency, it could take the entire financial and the entire economic system along with it into the abyss. The state would then rescue the financial institution with taxpayer money.

Blankfein: The size of the bank is not the most important factor. Whether a certain risk is bundled at a single bank or spread across several is completely irrelevant. That doesn’t diminish the size of the risk. In fact, this would only change the problem from “too big to fail” to “too many to fail.”

And finally Blankfein’s explanation for the crisis puts, of course, the responsibility on people who had taken loans they could not repay. Don’t see any fault in the derivatives! In short, the whole interview can be resumed in one sentence: not our fault.

Blankfein: No, I think you are assuming that this crisis was caused solely by highly complex derivative products. It wasn’t. Just look at a typical bank balance sheet. Most banks value their loans at the price at which they were issued. This applies to corporate and consumer loans, mortgages and credit card debt. All seemingly bread-and-butter transactions. And then there are a few derivatives and some more complex products.

SPIEGEL: What are you trying to say with that?

Blankfein: This crisis was not just caused by complex derivatives.

SPIEGEL: What caused it, then?

Blankfein: Too much money was lent to people who had bitten off more than they could chew. When the bubble burst and recession hit, default rates went through the roof.

This post is more for the newbies in trading or economic analysis. It might be difficult understanding why so much attention is being paid to several different economic statistics and how they move the markets. Hence the interest of giving some explanation on the functioning and the impact of these statistics.

And who better to provide the explanation than the nemesis of the US public, Goldman Sachs?

GS publishes since several years, a small manuel called “Understanding US Economic Statistics”.

I have to tip my hat off to GS for that manual because it explains in an accessible and interesting manner the content of these economic stats and the precautions you have to take to interpret it (or at least how they would interpret it). You may download the full document here. A (very) simplified “recipe book” for economic stats can be found here.

More evidence surfaced of Hank Paulson’s suspicious dealings in the wake of the bailout of AIG.

According to evidence uncovered by the New York Times, Hank Paulson who was then Treasury Secretary, spoke “two dozen times” with Lloyd Blankfein, the GS CEO on the week the bailout was granted to AIG, in September 2008.

During the week of the A.I.G. bailout alone, Mr. Paulson and Mr. Blankfein spoke two dozen times, the calendars show, far more frequently than Mr. Paulson did with other Wall Street executives.

On Sept. 17, the day Mr. Paulson secured his waivers, he and Mr. Blankfein spoke five times. Two of the calls occurred before Mr. Paulson’s waivers were granted.

Michele Davis, a spokeswoman for Mr. Paulson, said that the former Treasury secretary was busy writing his memoirs and that his publisher had barred him from granting interviews until his manuscript was done. She pointed out that the ethics agreement Mr. Paulson agreed to when he joined the Treasury did not prevent him from talking to Goldman executives like Mr. Blankfein in order to keep abreast of market developments.

Ms. Davis also said that Federal Reserve officials, not Mr. Paulson, played the lead role in shaping and financing the A.I.G. bailout.

But Mr. Paulson was closely involved in decisions to rescue A.I.G., according to two senior government officials who requested anonymity because the negotiations were supposed to be confidential.

And government ethics specialists say that the timing of Mr. Paulson’s waivers, and the circumstances surrounding it, are troubling.

The fact that many decisions taken by the US Treasury under Hank Paulson’s mandate appear to have directly or indirectly benefitted GS has been the subject of much controversy until now. For instance, the decision to let Lehman Brothers or Bear Stearns fail, but to bail out both GS and AIG, not only eliminated two of the most dangerous rivals of GS, but ensured a flow of 12 Bn USD of taxpayer money into GS, allowing it thus to profit of its CDS and its “intelligent” risky hedging strategy.

On the morning of Sept. 16, 2008, the day the A.I.G. rescue was announced, Mr. Paulson’s calendars show that he took a call from Mr. Blankfein at 9:40 a.m. Mr. Paulson received the ethics waiver regarding contacts with Goldman between 2:30 and 3 the next afternoon. According to his calendar, he called Mr. Blankfein five times that day. The first call was placed at 9:10 a.m.; the second at 12:15 p.m.; and there were two more calls later that day. That evening, after taking a call from President Bush, Mr. Paulson called Mr. Blankfein again.

When the Treasury secretary reached his office the next day, on Sept. 18, his first call, at 6:55 a.m., went to Mr. Blankfein. That was followed by a call from Mr. Blankfein. All told, from Sept. 16 to Sept. 21, 2008, Mr. Paulson and Mr. Blankfein spoke 24 times.

At the height of the financial crisis, Mr. Paulson spoke far more often with Mr. Blankfein than any other executive, according to entries in his calendars.

The calls between Mr. Paulson and Mr. Blankfein, especially those surrounding the A.I.G. bailout, are disturbing to Samuel L. Hayes, a professor emeritus at Harvard Business School and a consultant in the past for government agencies, including the Treasury Department.

“We don’t know what they talked about,” Mr. Hayes said. “Obviously there was an enormous amount at stake for Goldman in whether or not the A.I.G. contracts would be made whole. So I think the burden is now on Mr. Paulson to demonstrate that there was no exchange of information one way or the other that influenced the ultimate decision of the government to essentially provide a blank check for A.I.G.’s contracts.”

For those who would think that it is necessary for the  Secretary of the Treasury to consult so often with one of the leading banks of the US, here is a recap of the phone calls to other important bank CEO’s.

By contrast, Mr. Paulson spoke six times that August with Richard S. Fuld Jr. of Lehman, four times with Jamie Dimon of JPMorgan Chase and only twice with John Thain of Merrill Lynch.

So prospers the GS connection in the US government.  There is not much to say anymore about it. Just remains to wait and hope that their crazy risk-taking will ultimately be the cause of the downfall of GS, just as it might have been the case in September 2008, had it not been for the helping hand of Hank Paulson.

Two charts to highlight this morning. The first is a multi year daily chart of GS, the second is an hourly chart.

On the daily chart observe the gray box. This area represents a long price support/resistance level which is rather strong. Currently GS is sitting right at the ‘gray’ resistance zone now.

On the hourly chart we have what may be multiple rising wedges (bearish outcome prediction) on the shorter term chart. Observe where the top of the wedge is taking place, right at the long term resistance price region (gray box).

Thanks to Free Mind for his work on the hourly chart.

(click images for larger view)

Goldman Sachs reports quarterly earnings losses..

REPORTS Q4 -$4.97 V -$3.50E, REV -$1.58B V $931.6ME, TIER 1 CAPITAL RATIO 15.6%
- Q4 ROE 5.5%
- Q4 Securities Services $799M +19% y/y
- FY08 Compensation costs $10.93B -48% y/y
- Q4 Financial advisory revenue $M  % y/y
- Q4 Trading Revenues -$4.36B v $6.93B y/y y/y
- Q4 Asset Management Revenues $945M -19% y/y
- Q4 AUM $779B  -$90B during quarter
- Operating expenses $2.51B +4% y/y
- Level 3 assets $66B v $68B

And then soon afterwards…

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For me today’s most interesting aspect of the market was the action in the treasuries market. I was watching very closely the yield of the 10 year ($TNX) which established another new low today. The chart of the 10 year yield shows a break out of the lower channel line. The question that can’t be answered yet is if this is a trend change (further declines), or a whipsaw event in which the channel violation is temporary and yields will recover back into the channel.

If this is a trend break and yields continue to go lower then this becomes almost scary. We are talking about ‘depression‘ types of deflation occurring. I still believe  however that in the long run inflation will reveal its ugly head once again, perhaps even with a vengeance in a few years. I am tempted to short the treasuries with a very small position initially (remember that treasury prices are inverse of the yield). This would not be a quick trade, instead I am considering buying (go long) TBT (Ultrashort Lehman 20+ Year Treasury) for my long term account. If I initiate this trade I will go no higher than 5% of my long term capital for this position initially. I will let you know if I decide to take this trade.

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Producer Price Index (PPI) data reveals inflation still rising…

FEB U.S. PPI TABLE
Table Of PPI Data From Labor Department, In Percent Changes

                                             FEB.     JAN.     DEC.

PPI, Finished Goods           0.3      1.0     -0.3
PPI, Ex. Food, Energy         0.5      0.4      0.2
Energy                                    0.8      1.5     -3.0
Foods                                   -0.5      1.7      1.4
Consumer Goods                0.3      1.1     -0.4
Residential Electricity       -0.4     -1.2      0.6
Residential Gas                 5.7      0.7     -1.5
Gasoline                             2.9      2.9     -7.6
Home Heating Oil            -3.7      8.5     -0.3
Drugs                                  1.3      1.5      0.4
Autos                                  0.8      0.3     -0.5
Tobacco                              0.1     -0.1      0.6
Capital Equipment             0.5      0.4      0.1
Intermediate Goods            0.8      1.4     -0.2
Ex, Food, Energy               0.6      0.8      0.0
Crude Goods                     3.7      2.5      1.1
Ex. Food, Energy              3.3      4.0      0.2

Goldman Sachs (GS) and Lehman (LEH) reported earnings and each has reported a ‘better than expected’. Oh goodie, the crisis is over (if you listen to the talking heads). No need for any rate cuts now… LOL

Today is a wait and watch day. 2:15pm is when we find out what the Federal Reserve will do. I can’t remember a time when the market has been so convinced that the Federal reserve will cut the Fed Funds rate by so much and with so much confidence it will happen. Makes me think of a ’sell the news’ once it happens, if it happens.

The markets closed in the red after a crazy short week.  Next week the big drug makers report earnings and potential market moving economic data will help make next week interesting again.  The XLF (Financial ETF) was unable to break 28.00, closing at 27.20.  Noticed that even Microsoft (MSFT) couldn’t hold that spike up on earnings and closed down 0.93% on the day.

New York City Comptroller is suing 26 financial firms that underwrote Countrywide (CFC) stock and bonds.  Also suing more CFC officers and global accounting firms.  Citigroup (C), JP Morgan (JPM),  Goldman Sachs (GS), KPMG accounting and Grant Thornton are among those named in the class action suit.

Treasury Secretary Paulson says the stimulus package may help create 500,000 jobs this year and that checks may be mailed 2 months after legislation is enacted.  Tax rebate checks are going to help create 500,000 jobs?  Someone want to explain that to me?

Caterpillar’s CEO says he expects to see record results again in 2008 and sees top line sales to be above $50B in 2010.  He expects his company’s softer markets to bottom in 2008 and that any U.S. recession will be short-lived.  Wait a minute!  Isn’t this the same guy that was wailing away last quarter that the U.S. was looking at economic conditions not seen since the Great Depression?  Guess he finally got the memo to knock off all that negative talk.

There will be more commentary and charts later and over the weekend. 

The market continues it’s weakness and mini bounces aren’t holding.  GS had OK earnings, but their conference call wasn’t as positive as most would have liked.  As of this posting, the share price is still dropping, down over 5%.  The European Central Bank injected $500B into banks today to provide liquidity through year end.  That’s $500 Billion, wow!  Again, there were those cheering this event, but man oh man oh man!  That is a bit scary to me.  I sure hope somebody out there knows how to keep this all from unraveling too quickly.  I really do. 

I’m going to jump back into the pit now, because there is money to made no matter what this market is doing.  More updates later, but there isn’t any more economic data slated for the rest of the day.