Friday, February 27, 2009

ETFs (video)

Voltron says: I still have my SRS position, but I'm not adding any more Ultra Short ETFs to my long term portfolio. Jeff Macke makes an interesting analogy for Ultra Short ETFs in the video embedded below at around the 5 minute mark.

Thursday, February 26, 2009

UPDATED: Voltron's New Strategy

Voltron says: Suppose you believe (as I do) that commercial real estate is going to collapse. Let's explore some different ways to profit from that thesis (in order of complexity) and discuss some of the pros and cons of each strategy.

Short Real Estate Index (IYR): Like all short positions, you have theoretically unlimited liability (suppose IYR goes to the moon) and limited profit potential (IYR cannot go below zero). For every dollar of capital you have, you'll most likely be able to short two dollars worth of IYR so your maximum leverage is 2 to 1.

Buy Put Option on Real Estate Index (IYR): Now you have limited liability (the option cost) and limited potential (again, IYR cannot go below zero). Leverage ratios are typically 4 or 5 to 1. Options expire, so you need to be right on the direction AND the timing. This property of all options is called "Time Dependence".

Buy UltraShort Real Estate Index (SRS): If you are unsure of the timing, the ultra short ETF may seem to be just the ticket. You have limited liability (because you simply buy the ETF), and potentially unlimited profit potential (assuming the price asymptotically approaches zero). You also get two times leverage. The problems with SRS, however, are manyfold. Suppose the you've made a lot of money in the ETF and then suddenly the IYR moves up 49% in one day - SRS would be down double: 98%. You would be unlikely to recover from this loss no matter low the IYR goes subsequently. This property is called "path dependence" and it also makes it difficult to derive a target price for SRS based on a target for IYR. For a more detailed explanation read this.

If you chart the Ultra Short Real Estate ETF (SRS) and it's evil twin, the Ultra Real Estate ETF (URE), you'll see that actually both drift down together and are both negative at times. This is due to the path dependence discussed above and is called "Volatility Drag".

you therefore may reasonably consider the following trade to make the volatility drag work in your favor:

Short Ultra Real Estate Index (URE): You're now taking advantage of the volatility drag; however, since it's a short position, you have unlimited liability.

Buy URE Put Option on Ultra Real Estate Index (URE): You're stll taking advantage of the volatility drag and since it's an option, you have limited liability. Hindsight being 20/20 buying a URE put would have been the optimum strategy. URE puts are currently too expensive to make this worthwhile; however, I am currently implementing this strategy for Oil (up), Gold (up) and S&P500 (down).

Here's a chart summarizing the strategies:

RiskRewardLeverageTime DependencePath DependenceVolatility Drag
Short IYRUnlimitedLimitedUp to DoubleNoNoNone
Buy IYR PutLimitedLimitedHighYesNoNone
Buy SRSLimitedUnlimitedDoubleNoYesBad
Short UREUnlimitedLimitedDoubleNoYesGood
Buy SRS CallLimitedUnlimitedVery HighYesYesBad
Buy URE PutLimitedLimitedVery HighYesYesGood

Wednesday, February 25, 2009

Optimism is one thing, but this is ridiculous

Voltron says: the worst case scenario that the FDIC will use for the bank stress tests is for housing prices to fall to historical norms, with no overshooting and the average unemployment rate next year to be 10.3 percent, basically in-line with forecasts.

The Formula That Killed Wall Street

Voltron says: A well written, readable, article in Wired magazine explains how a mathematical abstraction became the basis for the explosion in credit derivatives.  This particular formulation came about after I left Wall Street, but it falls into many common pitfalls.  One of them is that correlation between two assets is not constant and in a market panic, all assets become completely correlated.  Most books on "quantitative finance" only devote a few pages, at the end, on the model's weaknesses.  In reality, that should be the subject of most of the book, because that's what good traders need to worry about.  When I would interview job candidates, I would never ask them to "derive the model" . . . I'd ask them to list the assumptions of the model and then debate how realistic, risky and problematic those assumptions are.

Fed is committed to propping up banks

Voltron says: looks like the government intends to repeat the mistakes of Japan in the 90s.  "Lost Decade" here we come.

Monday, February 23, 2009

Next Crisis: Commercial Real Estate

Word of another wave of mortgage-related pain added to investor unease Monday after a top Fed official warned that American real estate troubles will go commercial this year. Nearly all asset classes took a hit for the day, with only the dollar showing appreciable gains.

Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said he was concerned that U.S. banks remain "pretty heavily exposed" to commercial real estate. "It is the one domestic factor that keeps me up at night," he said.

So far, the U.S. mortgage morass has been largely confined to the residential part of the market, but delinquencies on commercial real estate loans and mortgage-backed securities are expected to increase as businesses suffer the effects of a slowing economy. If 2007 and 2008 can be thought of as the peak of residential real estate issues, Lockhart told the Association for Financial Professionals after a speech, then "it is possible to think of 2009 as the year of commercial real estate."

Commercial values have fallen 16.0% from their peak in October 2007, according to the Moody's ratings agency, which expects further declines over the next 12 to 24 months with delinquencie rising as macroeconomic pressures take a toll on property cash flows.

full article here

Sunday, February 22, 2009

Now It's Official: Stress Test Results Pre-Determined

Voltron says: Economist Yves Smith alleges that the government "stress test" evaluations of the major banks are a sham, and provides some interesting anecdotal evidence of their insolvency.

I explained how commercial real estate loans can be hidden time bombs back in October:

Friday, February 20, 2009

Meredith Whitney trashes banks on her own

Voltron says: Just because nationalization is a bad idea doesn't mean it won't happen.  Meredith Whitney has been prescient, but political analysis carries more weight than financial analysis.

I'm getting out of WFC

Voltron says: I'm getting out of my Wells Fargo short position and put options.  Too much danger of it popping on a rumor.  If it does pop, I may get back in.

SKF at 200

Voltron says:  I don't own any, but if I did I would be getting out because any snap back in financials could wipe out your profits.

Wednesday, February 18, 2009

Greenspan backs bank nationalization

Another $500 Billion into the breach

Voltron says: The Treasury is pumping another $500 Billion into Fannie Mae and Freddie Mac.  This is somewhat sudden and unexpected.

The Insolvency of the Fed

Voltron says: The Federal Reserve Bank is leveraged 50 to 1. If 2% of their assets default . . . the Fed itself is insolvent.

Tuesday, February 17, 2009

Bank Stress Tests

Voltron says: CreditSights made a loss estimate for the major banks.

Potential Loss

Book Value


Wells Fargo

$119 Billion

$35 Billion


Bank of America

$99 Billion

$60 Billion


JP Morgan

$124 Billion

$72 Billion



$101 Billion

$50 Billion


Goldman Sachs

$147 Billion

$37 Billion


Morgan Stanley

$34 Billion

$29 Billion


Source: NYT

Peter Schiff on the Bailout (video)

Bank nationalization gains ground with Republicans

Thursday, February 12, 2009

Treasury Secretary is a debt junkie himself

Voltron says: this is from an Associated Press story that seems to have been buried.

The [Geithners] bought a home in the Washington suburb of Bethesda, Md., in 1992 for $275,000, taking a mortgage of $202,300. Through a series of refinancings and the sale of two properties, they climbed the economic ladder until they bought a house for $1.6 million in Larchmont, N.Y., in 2004.

All of the Geithners' mortgages - from big banks including Nationsbanc, which is now Bank of America; Chase Manhattan, which is now J.P. Morgan Chase; and Wells Fargo - carried adjustable-rate mortgages with the risk that annual rate increases could raise their interest payments to as much as 11.25 percent, though the couple tended to refinance or sell their homes before they faced a rate adjustment.

They also took out second mortgages, now known as home equity lines of credit, borrowing a total of nearly $1 million in 2002 on their second Bethesda home, which they bought a year earlier for $1,085,000.

In 2004, they sold that house for $1.45 million and bought their current house in the New York suburb of Larchmont with a $1 million Wells Fargo mortgage, later adding a $400,000 home equity line of credit, also from Wells Fargo.

Analysts warn of commercial meltdown

Geithner's Bank Plan Led To Hasty Goldman Meeting

Voltron says: Goldman Sachs and Morgan Stanley are the only major financial institutions who are not insolvent and therefore have something to lose.  Goldman was so unimpressed with Treasury Secretary Geithner's vague plan that, according to CNBC, they held an emergency "secret squirrel" meeting to discuss alternatives.

Tuesday, February 10, 2009

The problem with loan securitization

Pelosi Stimulus Casts Shadow Over Obama, America, World

Obama on Nationalization

Voltron says: Interesting article.  The President says that banking system is too big to nationalize.  Economist Nouriel Roubini thinks the current plan is to buy time until nationalization is politically feasible (in 6-12 months).

Economists React: Treasury Announcement Fails to Satisfy

Perhaps the centerpiece of today’s announcement is the commitment up to $1 trillion to revivify the collapsed market for securitized debt that previously allowed unprecedented levels of lending in the home, auto, student, and credit card sectors. Geithner makes the false assumption securitization is a prerequisite for healthy markets. Our nation’s short history with widely securitized debt has simply shown that the process can lead to massive mispricing of assets and risk. But, in the worldview of Geithner and his fellow economists, credit, rather than savings, is central figure in the economic equation. In his mind, anything that eases the process of lending is an end in itself. in so doing this plan guarantees that the U.S. economy will be pushed farther and farther out on a leveraged limb, until no amount of market medicine can prevent a total economic collapse. Peter Schiff, Euro Pacific Capital

It’s really not clear what the plan means; there’s an interpretation that makes it not too bad, but it’s not clear if that’s the right interpretation. The plan deserves praise for what isn’t in it, at least as far as I can tell. There doesn’t seem to be provision for mass purchases of toxic waste at premium prices; there also doesn’t seem to be a massive “ring-fencing” guarantee against private losses on bad assets. In that sense the plan is better than what the last few weeks of leaks led us to expect… So what is the plan? I really don’t know, at least based on what we’ve seen today. But maybe, maybe, it’s a Trojan horse that smuggles the right policy into place. Paul Krugman, Princeton University

Why Obama's new Tarp will fail to rescue the banks

Stimulus: A History of Folly

Government Bonds May Be Last Bubble: Jim Rogers

Electronic run on the banks last September

Voltron says: Rep. Paul Kanjorski (D-PA) Capital Markets Subcommittee Chair, revealed on C-Span exactly what happened last summer that frightened the government into passing the original TARP legislation.  It's pretty scary how close we came to complete collapse of the entire financial system and the government.  For more background on what happened around that time read this :

    Rep Paul Kanjorski [2:02]: They are right to this extent. Why did we do that? We did that because the Secretary [Paulson] …

    Look, I was there when the Secretary and the Chairman of the Federal Reserve came those days and talked with members of Congress about what was going on. It was about September 15th [2008].

    Here’s the facts, and we don’t even talk about these things. On Thursday [that would have been September 11, 2008], at about 11 O’clock in the morning, the Federal Reserve noticed a tremendous draw-down of … money market accounts in the United States. To the tune of $550 billion was being drawn out in a matter of an hour or two. The Treasury opened up its window to help. They pumped $105 billion in the system and quickly realized that they could not stem the tide.

    We were having an electronic run on the banks.

    They decided to close the operation, close down the money accounts, and announce a guarantee of $250,000 per account so there wouldn’t be further panic out there. And that’s what actually happened.

    If they had not done that, their estimation was that by 2 o’clock that afternoon [Sept 11, 2008] $5.5 trillion would have been drawn out of the money market system of the United States would have collapsed the entire economy of the United States, and within 24 hours the world economy would have collapsed.

    Now we talked at that time [around Sept 15th?] about what would happen if that happened. It would have been the end of our economic system and our political system as we know it. And that’s why, when they made the point we’ve got to act and do things quickly we did.

    Now Secretary Paulson said let’s buy out the subprime mortgages. That’s what he came to Congress [with] but he said give us latitude and large authority to do many things as we decide … necessary. And give us $700 billion to do that.

    Shortly after we enacted our bill with those very broad powers, the UK came out and said: No we don’t have enough money to buy toxic assets. Instead we’re going to put our [UK's] money into banks so that their equity grows and they’re not bankrupt. And so the UK started that process and that’s true. It was much cheaper to put more money in banks as equity investments than to start buying their bad assets. Because it became early determined that we’d probably have to spend $3 or $4 trillion of taxpayers’ money to buy these bad assets. And we didn’t have we only had $700 billion.

    So Paulson made a complete switch, went in and started putting money [into] buying securities and reinvesting into banks in the United States.

    Why? Because if you don’t have a banking system you don’t have an economy … [4:49]

    YouTube video of the interview  

Voltron says:  If you watch the whole video, you'll here a nutty caller berate Rep Kanjorski on the bailout, and the congressman admits that the government has no idea what it is doing and sincerely suggests that perhaps the (crazy) caller might have a better idea.  

Sunday, February 8, 2009

Wednesday, February 4, 2009

CNBC's Cramer requests SEC ban SKF

Voltron says: be sure to watch the video

The slippery slope

Voltron says:  People are understandably upset that executives at companies receiving taxpayer bailout money are getting large bonuses.  Many of the companies in question were FORCED by the government to take bailout money because if only some companies were seen taking the money that would be seen as confirmation that they are weak and they would be targeted for destruction by speculators.  Goldman Sachs is looking to pay their bailout back immediately in order to cut the strings.  Bankers are gamblers and if you set up a situation where they can get an extra couple million in pay if they reject the bailout and manage to survive, they'll take their chances - slim as they may be.  It's fair to question why the government should be bailing anyone out, but keep in mind that as credit conditions worsened and banks wanted to stop lending their precious capital, the government twisted their arms into making loans that their better judgment told them not to make.  So now the government, by improperly exerting undue influence,  is morally obligated to help.

Real Unemployment

Meredith Whitney Discusses Bad Banks (VIDEO)

Monday, February 2, 2009

Use tax cuts to ignite incentives

Voltron says: It'll never happen, but it's a good idea.

From NPR Marketplace:

Todd Buchholz: There's a scene in "The Godfather" when hot-headed Sonny Corleone gets whacked by two thugs. The senior thug turns to the younger and says, "Leave the gun, take the cannoli."

Our hot-headed housing and banking sectors have been whacked, and now we wonder: What firms do we rescue? Which do we leave for the undertaker? The free market is not a pain-free market. Some live and some die.

Preventing failure is like trying to put the economy in a lockbox -- safe from damage, but unable to move ahead.

The end of the Cold War left thousands of aerospace engineers jobless. Now many work at Cisco and Apple.

Thank goodness Theodore Roosevelt didn't put the economy in a lockbox -- or we'd never have driven a car, flown on an airplane, or expected to live past age 50.

Neither Republican nor Democrat leaders have even a rule-of-thumb for rescuing firms. Lehman dies, AIG limps on. Heck, Larry Flynt is lobbying for a bailout of the porn industry. Great, even our national libido needs a stimulus package.

Now Congress wants to contort President Obama's $825 billion fiscal plan. Congressmen can't wait to put their names on bridges, tunnels, roller skating rinks for senior citizens. Lobbying in Washington is so crowded, corporate jets can't get landing slots.

This is a mess.

Rather than bailing out those who've failed, rather than tax rebates where we all just send checks to each other, rather than paving every road with gold-plated blacktop, let's ignite new incentives. Cut taxes for companies that hire new employees. Cut taxes for jobless workers who take a new job. Cut taxes for companies that buy new equipment. Cut taxes for tech firms that add to their R&D budgets. This is not tax-cutting gone foolishly wild.

Foolish is when you waste money giving it away to make up for past blunders. Foolish is when you give in because some CEO puts a gun to your head and says, "The whole world will end unless you give me money."

Enough foolishness. Leave the gun. Take the cannoli. Bet on the future

Wells Fargo funny business