Saturday, April 25, 2009

It's Like a Nightmare...

"It just keeps getting worse and worse." Vincent Lauria (Tom Cruise), repeating the line that was said to him in The Color of Money.

What we're seeing now are the biggest crimes committed in the history of our world, financially speaking. What continues to elude me is how they continue to be perpetrated without penalty.

Let's start with Ken Lewis, CEO of Bank of America. He revealed this week that Henry Paulson had "bullied" him into taking Merrill onto their books on Bernanke's orders to avoid another Lehman meltdown at the risk of his whole board being fired if he refused. First, Bernanke and Paulson should go to jail for circumventing the SEC in this whole process. Second, Ken Lewis should join them in the cell next door for knowingly taking on a company that would lose $15 billion in the 4th quarter without telling his shareholders. Not exactly the kind of leadership you would expect from your CEO.

MERS. Sounds like some sort of respiratory virus, but in actuality, is a private company that owns about 60 million loans. "Created by lenders seeking to save millions of dollars on paperwork and public recording fees every time a loan changes hands, MERS is a confidential computer registry for trading mortgage loans. From an office in the Washington suburbs, it played an integral, if unsung, role in the proliferation of mortgage-backed securities that fueled the housing boom. But with the collapse of the housing market, the name of MERS has been popping up on foreclosure notices and on court dockets across the country, raising many questions about the way this controversial but legal process obscures the tortuous paths of mortgage ownership." “I’m convinced that part of the scheme here is to exhaust the resources of consumers and their advocates,” said Marie McDonnell, a mortgage analyst in Orleans, Mass., who is a consultant for lawyers suing lenders. “This system removes transparency over what’s happening to these mortgage obligations and sows confusion, which can only benefit the banks.”

We'll see how this plays out as judges seem obliged to tell MERS lawyers to produce the note on the mortgage since they never loaned a penny, something that will make collection quite a bit harder.

And the "White Paper." The Fed's supposed explanation of how they are going to apply the stress tests, even with their new worst case scenario of -3.3% GDP this year and unemployment of over 10% in 2010. Well, the details can be summed up with the following quote. “The anticipation over the white paper appears to be much ado about nothing,” said Josh Rosner, an analyst at independent research firm Graham Fisher & Co. in New York. “The most significant numbers provided by the Fed in the paper appear to be the page numbers.”

The paper basically doesn't explain anything, avoiding what numbers they would consider significant enough to trigger a need to raise capital. "Yesterday’s report was “completely worthless,” said David Trone (of Fox- Pitt Kelton) in an interview. “We were looking or the translation of the economic forecasts to loan losses and we didn’t get that.”

This can't come as any surprise. It's clear that our government plan, even upon realizing the mistake of allowing a stress test, is to hide the horror that is our financial system. Upon seeing the markets drop 100 points in the first minute after the details were released, they were quick to provide the following. "The Fed says the 19 companies that hold one-half of the loans in the U.S. banking system won't be allowed to fail — even if they fared poorly on the stress tests."

Well, I for one, am tired of getting screwed by not only government but market manipulation. I propose the following to get some payback. None of the banks will be allowed to fail. It's not even likely that any of the 19 will be painted in a poor light. Two scenarios unfold. One, all banks rise like a rocket after the May 4th release of results. Two, most banks rise but a few with the poorest capital base are punished on fears of nationalization (not bankruptcy). The three most likely to fit part 2 are Citi, Fifth Third, and Regions Financial. All 3 are candidates for a strangle, but I think Citi provides the best leverage at $3.19.

As of close yesterday, May $2 puts were .10, $4 calls .17. Leaning towards the calls and the continued charade of bank profitability, I would buy the out-of-the-money calls to puts in a 3 or 4-1 ratio, with the puts really just being breakeven protection. Citi has traded between $2 and $4 just in the last 3 weeks, so to think a move this strong could take place post announcement is very reasonable. The other banks offer cheap options as well, but not as cheap as Citi. However, I do think Fifth Third and Regions are much more likely sacrificial lamb candidates than Citi, so you might want to distribute your put-to-call ratio more evenly.

Oh, and 4 more banks failed last night.


Tiger Coach said...

The notion of bank profitability is still a sham.

Note the moratorium on foreclosures will be expiring. Unless there is a move to extend teh deadline, that mean banks will need to reconcile their balance sheets... and toxic assets again become the 800 pound gorilla. And ignoring the gorilla despite popular belief does not mean the gorilla is not there...

AX said...

I agree, can't ignore forever, but with suspension of mark-to-market, it's just a guessing game as to what's being hidden. The plunge will come, just might not be in the next few weeks. Remember, we still have no-shorting rules pending.

Nancy Boulicault said...

Could you explain the strategy for taking advantage of the 'new rules' to make a profit on bank shares?
Sorry, new to this - lured in by the incredible events. I've never before witnessed mass daylight robbery.

AX said...

Nancy, thanks for reading. My thoughts are this for the impending events of the next few weeks. I'd like to employ what's called a "strangle," which is buying out-of-the-money options in both directions, calls and puts. The theory behind a strangle is that you expect a large move in either direction, you're just not quite sure which.

Well, in this case, I'm pretty sure it will be to the upside as market sentiment has made it such that any perceived news that isn't awful will shoot stocks, and banks, even higher. That is why I recommend the 4-1 ratio of calls to puts. We know that Citi will not be allowed to fail, but if it's clear that they still need billions to stay afloat, they may plummet near $1 again. On the upside, the charade could continue and if it reaches even $5, you have a great trade. I would also consider employing this trade with Fifth Third Bank, as they may be a sacrificial lamb in this process. I would use a more even ratio of calls to puts with this strangle.

I also forgot to mention that GDP numbers come out on Wed. If they are suitably doctored by the goverment (4th Q GDP initially came in 40% below final reading), you might see 2 pops in banks stocks in the next week. So this trade needs to be executed in the next 2 days. High reward, medium risk. Good luck and thanks.

Anonymous said...


Love the strangle idea. Looks like citi will need 10 billion, so those puts should skyrocket. Anyway, it is nice to see people like Nancy reading your blog. Nancy "mass daylight robbery" I could not have said it better myself!