The Risk Biggest Source: Government

The perpetual bailouts are wrong on many levels. Today I'll focus on just one. The government has become the single biggest risk in financial markets.

What will the next bailout do? Is it going to wipe out common equity? Preferreds? If so, will it be the C-series? S-series? Or will they screw the junior debt? Senior? Or are they going to let it fail? Or maybe they'll just keep on pumping money in?

With the perpetual, arbitrary, ever-shifting bailouts and interference in the market, the government has paralyzed the already-disfunctional financial market machinery. Regulatory and policy risks are scaring a lot of players to the sidelines, and at the same time creating huge arbitrage opportunities that could turn out to be equally lethal traps.

Take Citi (C) for example. One possible explanation for C's precipitous fall last week is the perceived arbitrage between preferred and common shares, which called for going long preferreds and shorting common. But is it an arbitrage or a trap? The answer depends on how each series of the preferreds will be converted, which was very unclear when the bailout was first announced. It's an arbitrage if you assume all preferreds get the same treatment; otherwise it depends on the conversion formula, which preferred you bought and at what price (you can only buy the publicly traded preferreds, not those held by Uncle Sam, Prince Talal, or Sanford Weill), and at what price you shorted the common stock. The latest report, last updated on 3/3, was that the discrimination against publicly traded preferreds would not be "so bad". But still, the language is vague and non-committal.

Such confusion is much more common, and deeper, in fixed income and other areas of capital market. Which JPM bond is backed by the government? How strongly? But really? I mean, are you sure? Will Uncle Sam really tear through the veil of secrecy of Swiss banking or is it just a show? Who gets paid through the conduit called Assured Income from Government? What will happen when AIG loses another $100B next quarter? Will GS still get it or will the conduit be shut down finally? Will somebody high in Washington say/do something that pushes the Chinese over the edge and pricks the treasuries bubble? Who will take how much loss in forced mortgage mod? Or could it be a windfall in disguise in the fantacy land of modern accounting? Will they help European banks when the Eastern Europe Crisis of 2009 hits, or will there be another round of global meltdown?

It's uncertain enough without the government messing around. But if they have to mess around, can't they at least make up their mind and show some consistency?

Stock position: None.

Comments

[Allan Frain:]

A brief reflection of the Big Picture (which tends to be overlooked in the analysis if minutia) which is quite accurate.

Mar 08 09:03 AM

[Asbytec:]

Biggest Risk Source: unregulated AIG Financial Products Division. Any questions?

Mar 08 11:35 AM

[samwise:]

excellent article--and amazingly this is tax-payer dollars so who is the government trying to protect because certainly any use of taxpayer money demands accountability? very interesting that market particpants seem "surprised" by Barak Obama. In other words all the people NY City and certainly all the financial elites vote for Democrats. So what is the source of the precipitous decline? Clearly you have hit on one major malfunction.

Mar 08 01:43 PM

[Econ 101:]

Great article, right on the money.

If the Chinese do decide to stop funding treasuries what will they do with all that cash? Why not buy C and BAC for chump change? Then forclose on all the houses in default? It would get rid of all that useless cash they have and they would have useful assets.

Land - they arent making any more of it!

Mar 08 03:04 PM

[hpcooperjon:]

THEY WILL BUY PRECIOUS METALS AND OIL RESOURCES. THEY WILL ATTEMPT TO STIMULATE THEIR OWN ECONOMY. THEY DON'T WANT ANY FAILED INSTITUTIONS FOR "CHUMP CHANGE" OR ANY OTHER "CHANGE" U.S. INVESTMENTS WERE GOOD FOR CHINA AS LONG AS THEY HAD A NET TRADE SURPLUS BUT THAT IS CHANGING AS AMERICAN CONSUMERS REIN IN SPENDING AND BEGIN SAVING. RIGHT NOW THEY ARE PURCHASING SHORT TERM TREASURIES RATHER THAN LONG TERM. SOON THEY WILL CUT BACK ON THAT. OUR FRIENDS, THE JAPANESE, HAVE NO CHOICE. IT'S SINK OR SWIM WITH THE U.S.


On Mar 08 03:04 PM Econ 101 wrote:

> Great article, right on the money.
>
> If the Chinese do decide to stop funding treasuries what will they
> do with all that cash? Why not buy C and BAC for chump change? Then
> forclose on all the houses in default? It would get rid of all that
> useless cash they have and they would have useful assets.
>
> Land - they arent making any more of it!

Mar 08 06:25 PM

[Bo Peng:]

Yeah, kill the chinks.

Unfortunately, I'm not sure your Japanese "friends" will jump in joy about the fate you designated to them.

Call somebody stupid, evil, or different. It always rallies the ignorant in time of crisis.

Mar 08 09:31 PM

[Econ 101:]

Bo Peng,

I dont understand where your "Yeah, kill the chinks" comment comes from? If you are aiming it at me, then I would advise you to read more of what i write. My targets are congress and our own corrupt politicians. The Chinese are smarter than almost anyone in congress and have had these ideas long before I wrote about them.

Certainly the Chinese have a bunch of dollars and nothing todo with them. The dollars are falling in value making C and BAC cheaper each day. Why not use them to buy real assets for the long term ? That isnt bashing the Chinese, but the deralict fools in our own government and business.

Mar 09 08:57 PM

[Bo Peng:]

Sorry if I misread you, Econ101. As I said in the previous post, I don't think the relative stability of Chinese economy amidst this crisis has much to do with the Chinese government's wisdom or foresight. But I do find it troubling that some in the west are blaming Chinese savings for this crisis. Global imbalance is a real problem that must be addressed but this kind of finger-pointing, which borders on shameless, is definitely not a solution. US and China are more inter-dependent than many people in either side of the pond would care to admit, especially during this crisis. I wish we could own up to the facts and work together.

Mar 11 02:26 AM

[Econ 101:]

I dont thnk the Chinese situation is calm. They face more turmoil than we do. What they need is real value for the dollars they have, a way to convert it to something to off set the value of the Yuan.

If I were the Chinese I dont see why I would trust the US government, what has it done to instill that kind of confidence? Each exchange needs something for both parties, what is in this for the Chinese?

You sound like Rodney King, "Cant we just all get along?" The world isnt nice like that and as Americans we hog 25% of the worlds resources and they have a population that wants their fair share.

This world has resources that might support a billion people, maybe. That was the population in 1859 when we started using oil to suppliment animal energy. Over the next 50 to 100 years that is the power supply we will revert to in all liklyhood.

To lose 84% of the population will require war, fammon and destruction - nothing pretty. I encourage you to read James Kunstler, he is an optimist in my opinion.

And I hope I am wrong!


On Mar 11 02:26 AM Bo Peng wrote:

> Sorry if I misread you, Econ101. As I said in the previous post,
> I don't think the relative stability of Chinese economy amidst this
> crisis has much to do with the Chinese government's wisdom or foresight.
> But I do find it troubling that some in the west are blaming Chinese
> savings for this crisis. Global imbalance is a real problem that
> must be addressed but this kind of finger-pointing, which borders
> on shameless, is definitely not a solution. US and China are more
> inter-dependent than many people in either side of the pond would
> care to admit, especially during this crisis. I wish we could own
> up to the facts and work together.

Mar 12 02:28 AM