Traders,Well, I start off with an interesting story. Having moved to Florida from San Francisco, well one might assume that I am not where the action is anymore (in financial terms) and that maybe true – until this Friday. I had left work with my partner for a drink down at the marina, when about 7pmish I received a call from my friend who manages the building I work in (a rather large building – note it has several financial institutions in it, one being – the latest casualty. “The Police and FDIC are at the building – they are shutting down First Priority!” – I was close by, I asked do you need me to do anything? He said they were having a couple of issues, if I could swing by until he could get there it would be a help. I got to the building – there was the typical Blacked-OUT SUV and a couple of cop cars. I knocked on the door, introduced myself, and they let me in. The FDIC were there – getting the place organized – along with several employees. Police were located at the exits and in front of the vault. It was a little surreal. The head gentlemen running the FDIC operation was well informed and it seem that things were running smoothly, he indicated that SUNTRUST would be taking over the deposits (insured) and the FDIC would be running the operation. In the background you could hear the constant “ripping sound” of those bill counters – as the FDIC watched over the employees taking inventory. I had heard the employees were pretty much unaware – as the FDIC tapped on the door with the police at 6pm. It all seemed that things were running smoothly and the officers told me they would be standing watch throughout the weekend. Interesting side note, the last time I saw that many guns in a bank when I was traveling in Central America and stopped in a bank (they would only let in a few people at a time as several military looking people stood around with machine guns.) The good news – they all seemed prepared, calm, and that they had everything in order.
It’s early Monday morning – and I haven’t seen anyone outside the bank – however I did take the back garage entrance so I couldn’t see the front. The police cars are still hear. I hope it doesn’t turn into a IndyMac situation – this is a smaller regional bank – but I heard there were over 800 people locally with this bank that had deposits in excess of 100k.
It was interesting seeing this unfold from inside the bank.
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Citigroup shutting down more funds
Citi is shutting down another fund, part of the $2 billion investment group. The fund had been hurt with investor redemptions (withdrawing funds). This is the second large fund to be shut down by Citi, the first being the Old Lane fund, which ironically the new CEO, Pandit, had sold to them last year for a billion dollars. While the fund’s returns were not off drastically (down about 5% this year) – the problem was holding large scale illiquid positions and the need for capital to hold these positions to term – coupled with investor withdraws. It would seem, regardless of returns, that anything and everything that Citi “touches” remains semi-risky because of the entire firms massive comingled conglomerate. The problem with a big company with many different departments – it only takes one big disaster to trickle across the firm and squeeze other departments that traditionally might doing well. Remember, Citi has their hand in many pies – credit cards, mortgages, insurance, hedge funds, CDOs, SIVs, you name it. It might be better for them to break the company up – so that those sections that are doing well are not brought down by the ones that are taking huge hits. However – I have a bad feeling that the departments struggling are being floated by the ones that are not – making a breakup all the more difficult.
Risk remains at Citi – simply because it is so big and the right hand really has no idea what the left hand is doing, and the left probably is relying on the right to stay in business. A mess of the epic kind to be sure.
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Chasing Yield – Treasuries?
According to a Bloomberg report – the network of security firms that make markets (buy and sell)
U.S. Treasuries has dropped to the fewest since the 1960s. The number of dealers declined to 19 last month. As the government takes on more debt, loans more money via the Discount Window, and now is in massive bailout with Freddie and Fannie – the need to sell treasuries (in order to print more money) is in need of MORE dealers – not less. The problem is simple, the underlying asset has dropped in value (exchange value and buying power inflation) – thus the risk is higher to hold dollars, with interest rate very low (2%) and the government data (CPI) reporting inflation above 4% - who really wants to buy treasuries? It’s a losing bet and the security of that bet is becoming more concerning. Back in the beginning of 2007 there was a report that China was going to not renew a major portion of their U.S. Treasuries that came due, the story wasn’t really picked up in the U.S. news except Bloomberg and Economist. The Economist pointed out the severity of that issues, since China was one of the biggest holders of U.S. Treasuries (or Debt) - you could say that China was one of our largest creditors. Well – if the largest creditors is not renewing their credit lines and our debt increases – that means inflation is just around the corner. China and other countries are not incentivized to purchase Treasuries simply because the value of the dollar has dropped and a dropping (rising inflation) means they require to be paid HIGHER interest rates – not lower. Isn’t the whole function of interest rates is to raise them when the risk of the underlying asset has more risk? China is not the only one that has put the brakes on – more large firms have also looked elsewhere for their investments. Swiss and Euro bonds had seen an increase of foreign investments, since their currency is stronger and the interest rates are more than double that of the U.S.
With fewer dealers making markets (19 down from 46 its peak in the late 80s) means price discovery and depth will be weaker. As the deficit rises, consumer credit has shrunk, and the dollar risk has increased – banks and firms are looking for safety and restructuring . Dealer firms have seen the spread between the pre-auction market and in some cases has inverted. It is also interesting to note that four of the five firms that are reporting the biggest credit-market losses (Citi, Merrill, UBS, and Bank of America) are also dealers in the Treasury markets. Chasing yields also means that the yield has fallen – the 10-year note fell 17bps last week to 3.93% - below the CPI. I have to ask myself – why bother! It’s a losing bet no matter how you slice it – even using government data. I think real buying power losses on that trade are closer to 5-6%. However – where are people to go – chasing yield in safe heaven means you might have more FACE value – but that doesn’t mean more buying power!
The real problem – if the numbers of dealers gets to low (typically take down 70% of the paper – which has fallen to 40%) – well let’s just say the Fed and Treasury are getting a little nervous – cause someone has to underwrite that debt. While true, fewer dealers means fatter spreads (less competition) it also means less paper the Treasury can be guaranteed to lean on.
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Futures Pre-Market
The futures are getting hit pre-market and the spreads are fairly narrow. Expect a small gap to the downside. I am sure having another bank fail (even though small) is not something that we want to see on the front page of any newspaper. For now expect a small drop if the spread remains.
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Support / Resistance
We pulled back some in the indices - but the RUT remains in the middle.
INDU 11,000-11,250 / 11,500 (We back down in the middle range of probably the biggest volatile week we have seen in a long time – 200 to 300 point moves up and down. 11,250 is not an area to get long – but rather flatten out deltas. Expect more volatility.)
NDX 1800 / 1850 (Back off to the middle of the range – means more uncertainty. We are moving daily on perception – since fundamentals are cloudy at best. There is to many variables to make any rational decisions. Keep gamma on your sheets and watch hard deltas.)
SPX 1250 / 1275 (This narrow range is NOT going to last long – a visit to 1300 or 1200 is seriously in the cards – sooner than later. If we do visit these levels – it doesn’t meant that everything has be resolved – it only means more volatility.)
RUT 700 / 720 (While the rest of the indices are seeing huge volatility the broadest based index is seeing some narrowing – I think we may see it breakout of the 700/720 range this week – that means have gamma on your sheets because you’re going to need it. We have been hammering on the resistance up at 720 – but so far have not gotten through. If the yields in treasuries start to rally it could mean more money flowing into the broader market. Keep an eye on the 720 line – we have been knocking at that door – let’s see if it opens. If it does expect the rest of the indices to break through resistances. If not – we could be back to 700 quickly.)
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Conclusion
Volatility is the only thing we can rely on – it also seems that more banks are crumbling under the weight of this credit crunch. I don’t think First Priority will be the last of the banks (specially in the south-east) to fail – more are to come. I was rather shocked to hear that Sun Flush, sorry Sun Trust, was taking their deposits – but when you step back and think about it – it’s smart – they need money and they are NOT taking any of the liabilities. Maybe Sun Trust taking on the deposit accounts – is an indication how badly they need that money, they did out bid everyone for those accounts – probably at a loss. Hey – it’s deposits right?
I think we should expect more volatility this week and we could break out of these ranges – even if just a short knee jerk up or down. I don’t expect any trends to be set in the near-term and I think volatility will only increase going into September. While August may not be calm – it will not see (IMHO) the kind of volatility to come.
Hedge hard deltas and use gamma!
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