Dissing Decoupling

A great little nugget from Ambrose Evans-Pritchard discussing the long lauded idea of decoupling in Europe and abroad. (For those of you who don't know what decoupling is, its the idea that even though the U.S. is heading towards a recession, everywhere outside of the us will continue to grow). A very sobering review of the current situation:

http://blogs.telegraph.co.uk/business/ambrosevanspritchard/april2008/thisbeargrowlson.htm

Level 3 Profits! Hooray For Creative Accounting!

Courtesy of Bloomberg and Johnathan Weil:

April 23 (Bloomberg) -- Here's Rule No. 1 from Wall Street's public-relations
playbook: If the company you run has big losses on hard-to-value assets, scream
your head off about the accounting rules.
And what if the squishy values
result in huge gains instead, as they have in the not-so-distant past? Rule No.
2: Stay mum about it for as long as the rules allow.

There you have it folks. A cliff notes version of how to run a Wall Street firm, when you make bad decsions complain about the accounting rules that force you to admit your mistakes. Then make sure you take all that crap sitting on your balance sheet that has no market and claim that you profited immensely from it:

There has been no commensurate outrage about fuzzy mark-to- market
accounting that lets companies post unrealized gains on illiquid balance-sheet
items. Yet if it weren't for large non- cash profits on hard-to-value holdings, Goldman Sachs Group
Inc. wouldn't have had much profit last quarter. Lehman Brothers Holdings
Inc. would have had significantly less. And Morgan Stanley wouldn't
have had any.
You wouldn't have known those things from the earnings press
releases the three investment banks issued in mid-March. Investors had to wait
until a few weeks later to find out. That's when the banks filed their quarterly
financial statements, including footnotes showing changes in their so-called
Level 3 assets and liabilities.
The rules allow such delays. What's amazing
is that the banks' investors aren't demanding to get this information sooner.

So lets try and get everyone to understand the hierarchy of Level 1, 2, and 3 assets.

1. Level 1: Mark-To-Market Go look up any stock, bond, option, mutual fund on your investment brokerage account. Very easy to value and all gains and losses are reported each quarter on your earnings.
2. Level 2: Mark-To-Model Prices don't exist, so you create a computer program to create a synthenic value for your illiquid product based on price inputs observable in a liquid market.
3. Level 3: Mark-To-Make Believe Essentially a level 2 asset however one of your inputs doesn't have an observable liquid market so you make your own assumptions about its pricing, essentially imagining a market for this input.

Weil Continues:

There isn't anything necessarily wrong with Level 3 measurements. By
definition, though, they are less certain and more prone to bias. There's
nothing new about Level 3 gains and losses either. They just weren't called
Level 3 before FAS 157, which the major investment banks adopted last year, and
didn't have to be disclosed.
Break Down
Here's how the numbers break
down. For the quarter ended Feb. 29, Morgan Stanley reported $4.24 billion of
net unrealized gains on Level 3 assets and liabilities. That was almost twice
the company's $2.21 billion of pretax income.
Those figures included $8.39
billion of net gains on Level 3 derivative contracts, driven in large part by
adjustments on credit-default swaps, which Morgan Stanley used to buy protection
against declines in the creditworthiness of various holdings.
Morgan Stanley
included the $8.39 billion on its income statement as part of trading revenue,
which was $3.39 billion last quarter. So, without those items, Morgan Stanley's
trading revenue would have been negative $5 billion. (Yes, negative.)
At
Goldman, net unrealized Level 3 gains were $2.07 billion for the quarter ended
Feb. 29, equivalent to 96 percent of the company's $2.14 billion of pretax
income.

Please read the rest of his piece here:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a0ZGtAQHLpiA

More Inflation Shenanigans

It just amazes me that Regan and Clinton had the foresight to understand the mess that social security would become and thereby created new methods of calculating inflation so as to tame the exponential growth of social security. I mean why actually try an address a problem when you can mathematically brush it under the rug? Must really be hard for those old folks whose standard of living has dropped precipitously over the last decade or so as their real cost of living has run up while their social security cheques have meagerly risen.

I Guess the Constitution Merely Offers Suggestions

FBI wants widespread monitoring of 'illegal' Internet activity

Posted by Anne Broache | 30 comments

WASHINGTON--The FBI on Wednesday called for new legislation that would allow federal police to monitor the Internet for "illegal activity."

The suggestion from FBI Director Robert Mueller, which came during a House of Representatives Judiciary Committee hearing, appears to go beyond a current plan to monitor traffic on federal-government networks. Mueller seemed to suggest that the bureau should have a broad "omnibus" authority to conduct monitoring and surveillance of private-sector networks as well.

The surveillance should include all Internet traffic, Mueller said, "whether it be .mil, .gov, .com--whichever network you're talking about." (See the transcript of the hearing.)

In response to questions from Rep. Darrell Issa, a California Republican, Mueller said his idea "balances on one hand, the privacy rights of the individual who are receiving the information, but on the other hand, given the technology, the necessity of having some omnibus search capability utilizing filters that would identify the illegal activity as it comes through and give us the ability to preempt that illegal activity where it comes through a choke point."

In response, Issa said: "Can you have someone on your staff designated to work with members of Congress on trying to craft that legislation?"

If any omnibus Internet-monitoring proposal became law, it could implicate the Fourth Amendment's guarantee of freedom from unreasonable searches and seizures. In general, courts have ruled that police need search warrants to obtain the content of communication, and the federal Wiretap Act created "super warrant" wiretap orders that require additional steps and judicial oversight.

In addition, it's unclear whether "illegal activity" would be limited to responding to denial-of-service attacks and botnets, or would also include detecting other illegal activities, such as online gambling, the distribution of "obscene" images of adults engaged in sexual acts, or selling drugs without a license.

Robert Mueller

(Credit: FBI )

To be fair, Wednesday's discussion of the plan was geared toward cybercrime and the Bush administration's classified "cyberinitiative," which includes a shadowy program known as Einstein.

Some politicians have already raised concerns that even Einstein, which is described as dealing only with government networks and not private ones, could infringe upon the privacy rights of American citizens. It's already in place at 15 federal agencies, but Homeland Security has said it's still preparing the necessary privacy impact assessments for a proposed $293 million governmentwide Einstein expansion.

Issa, for his part, referred on Wednesday to malicious attacks being undertaken by foreign and domestic hackers who want to "take control of computers" and harvest the national-security secrets and private information of government agencies, private companies, and individual Americans.

"What authorities do you need to monitor, looking for those illegal activities, and then act on those, both defensively and, either yourselves or certainly other agencies, offensively in order to shut down a crime in process?" Issa asked.

In response, Mueller said he would be happy to have his legislative staff work with members of Issa's committee on creating a bill for a broader-reaching surveillance system.

Issa suggested that perhaps the FBI already has the power to seek voluntary private-sector partners that would like to be "defended" by its agents, provided that they give the FBI their consent. Mueller, however, wasn't so sure, saying, "that's going to require some thought."

[6:00 pm: Updated story with additional quotations from transcript of the hearing.]

CNET News.com's Declan McCullagh contributed to this report.

I Heart Helen Thomas

I would love for someone to try and explain to me how new home sales are at levels last seen in 1991, durable orders were down yet again, there are numerous data points indicating that the consumer is cutting back drastically on spending, CEO opinion believes that we are in a recession, yet the market chooses to ignore everything and continue to flip flop around in a range. over these last couple quarters I have, on numerous occasion, had to refer to my favorite quote by Keynes and today calls for it yet again:

The market can stay irrational longer than you can stay solvent.

sigh.....

My Favorite Data Point of the Week

This summary is not available. Please click here to view the post.

S&P is officially retarded

Yesterday, AMBAC loses 2.5 times their market value and today S&P affirms their AAA (insurance sub entity) claiming that their losses were "within their projections"

I'm simply speechless... when I can actually wrap my head around this lunacy I'll say more.

Yet Another Weak Consumer Data Point

Not surprising in the least.....

Wednesday, April 23, 2008 - 2:05 PM PDT

Starbucks paints bleak Q2 picture

Puget Sound Business Journal (Seattle)

Citing a gloomy economic picture, Starbucks Corp. warned that its second-quarter earnings and fiscal 2008 will fall short of last year's earnings.

"The current economic environment is the weakest in our company's history, marked by lower home values, and rising costs for energy, food and other products that are directly impacting our customers," said Howard Schultz, chairman, president and CEO, in a statement.

The Seattle coffee giant (NASDAQ: SBUX) said it expects second-quarter earnings of 15 cents per share, down from 19 cents a year earlier and less than the 21 cents that analysts polled by Thomson Financial Network expect. For fiscal 2008, Starbucks said it expects earnings lower than the 87 cents reported in fiscal 2007, and less than 97 cents expected by analysts.

The company said it's been hit really hard in California and Florida markets, which account for 32 percent of its U.S. retail revenues. Those two states are "where consumers have been especially impacted by the effects of the downturn in the housing market," company officials said in a statement.

In after-hours trading Wednesday, shares in Starbucks had fallen more than 10 percent, dropping $1.85 to $16.

Now what I'm trying to wrap my head around is that we've had all these different instances showing that consumer demand is weakening and getting worse... yet we have anything beta related rallying (which mind you is mostly consumer oriented tech crap). The sad thing is that the next domino to fall is reduction in corporate spending not acceleration (which would have helped bolster this "Goldilocks" lunacy) we are heading for a depression and it is blatantly apparent the stock market is oblivious to this inevitability.

A NYT Piece everyone should read

Roger Lowenstein's Piece on the snafu's of the ratings agencies. There are some classic quotes by agency executives. Most notable is an S&P executive claiming that this whole mess started due to "ahistorical behavioral modes"by buyers of homes. Riiight.... yet another example of America: the land devoid of personal responsibility.

Lowenstein on Mortgage Ratings Agencies

Ed Wallace Telling it Like it is

Definitely worth reading. It seems to me that Oil is becoming a better inflation proxy than gold... which is very puzzling to me.

Ed Wallce on Energy

Interesting Data Point

Courtesy of Bloomberg:

The S&P 500 dropped almost 10 percent in the first quarter, the worst start to a year since 2001, as increasing unemployment, record mortgage delinquencies and a retreat in consumer confidence signaled that the economy is falling into a recession.

Even with the decline, analysts' recommendations to ``buy'' or ``hold'' U.S. shares climbed to 94.5 percent, the highest rate in more than five years.

If that isn't a contrary indicator I certainly don't know what one is.....

A differing View

I'm more than happy to entertain those whose views differ from mine so long as they are somewhat grounded in reality and accruedinterest has a great post today explaining how we've probably seen the last of the large swings and width of spreads.

Its against my programming to call bottoms

Friday's discussion on bearish market sentiment was really great. Thanks for all who commented.

Most of the comments seemed to focus on stock prices. As a bond pro, I spend my time thinking more about yield spreads, both in credit and other sectors. As discussed many times (many, many, many times), there were two elements causing spreads to widen: poor liquidity and weaker economics.

Liquidity has improved dramatically since the Bear Stearns bailout. The feeling is totally different than in some of the other false rallies (in credit) we've experienced since September. Previously, any hiccup would cause spreads to move drastically wider. There were times when we moved a bit tighter, then some writedown would be announced, and it would all go to hell again. It isn't as though we haven't had hiccups the last couple weeks. The 200 point sell-off on GE's earnings is an example (I wrote about this here). Or Wachovia's need for more cash. Or Bank of America's weak earnings report. Now these events are taken in stride. Spreads have moved wider on certain days, but its controlled, more reasonable. Not panicky. I won't say that spreads (especially in CDS) aren't still volatile. The massive amount of shorts in CDS that have been or are being covered is seeing to that.

Plus the correlation of spreads has broken down. Now it isn't necessarily true that agency debt, MBS, and credit all move the same direction on any given day. Hell municipals had become highly correlated with credit spreads. Now it seems that these spreads are moving on their own supply and demand conditions, not on liquidity fear.

So am I calling a bottom? Well, I don't really invest that way, so if I didn't have a blog, I wouldn't really think about a "bottom" very much. I try to stick to fundamentals and spend only a little time on technicals. Liquidity is part of any fundamental analysis of a bond, so indeed it became tough to value many different bonds in recent months. And deep fundamental investors tend to be a little early, seeing the fundamentals shift and/or pricing (un)attractive before the market actually shifts.

But yeah, if you stick a gun to my head, I'd say we've seen the wides in credit spreads. Not because the economic problems are solved, but because liquidity has improved to the point that people are willing to be opportunistic. That will put a lid on how far investment-grade names will move before yield hungry investors come in. Issuers will be able to come to market with new issues, and the wheels of the credit market will continue to churn.

I personally think he may be right for the next couple quarters, however liquidity is a coward and when the economy as a whole starts to deteriorate I do believe we'll find far less people willing to "be opportunistic". I think that we are more in a wait and see approach an the bond market reflects this.

Now thats a pricey Meat-a-ball

just found this article and I'm stupefied that someone would actually pay that much... I guess absurd valuations are not a thing of the past when it comes to the web.

Updated: Bebo's Revenue Numbers: Not So Big; AOL Paid 160 Times EBITDA: Report

By Rafat Ali - Thu 13 Mar 2008 09:28 AM PST

So we reported on the return the investors got, but not on Bebo's actual revenue numbers. Kara digs in and reports on some of the real revenue numbers: Bebo's revenues for 2006 were only $7 million with $3 million in EBITDA...In 2007, the results are still small, with $20 million in revenues and $5 million in EBITDA. Based on these numbers, AOL (NYSE: TWX) paid a huge 42.5 times revenues and 160 times EBITDA.

Even looking at projected numbers (which of course may or may not materialize)--$50 million in revenue and $10 million in EBITDA in 2008; $117 million in revenue and $48 million in revenue in 2009 and $193 million in revenue and $92 million in EBITDA in 2010-- it is a very rich deal, for the founders and investors.

Kara says that the high asking price (around $1 billion) and smaller U.S. presence (big in UK and Europe) made others like News Corp (NYSE: NWS). MSFT and others pass on the deal. Allen and Co was hawking the firm.

Updated: comScore (NSDQ: SCOR) also reports Bebo's increase in total unique visitors in 2008 compared to 2007:

-- In January 2008, Bebo had 22.4 million unique visitors worldwide with visitors averaging more than 3 hours and 30 minutes on the site during the month.
-- In February 2008, Bebo had 4.8 million unique U.S. visitors with visitors averaging 1 hour and 40 minutes on the site during the month.
-- In January 2008, 60 percent of Bebo's traffic came from Europe, followed by North America with 22 percent, and Asia-Pacific with 16 percent.
-- In January 2008, there were 11.4 million unique visitors from the United Kingdom to Bebo, representing the largest proportion of the site's worldwide traffic.

I heart John Williams

M3 is something that everyone should be conscious about. It was what Volcker based his entire regime on yet Bernanke decided it was the first thing he'd get rid of.




You can enjoy all of John's commentary at his site
www.shadowstats.com

Friday April 18, 2008

Well as it turns out I'm not very good at posting with any real regularity as my almost 8 week absence has shown. Very long procrastination and short relevant information aggregation (shout out to LOS Capital on that last sentence). So with that said I'll make a more conscious effort to at least put together a bunch of posts relevant to what I've learned today.

ES up 15.75 on a very easy money day and I only managed to make 1.75 points.
(Spent too much time attempting to study my CFA books rather than watching the market)

Mulling current Ideas...

Short Consumer monthlies (eg subscription content as well as other services)

Best Working Idea (Short Public Storage PSA)

Risk is appx 5.25%
1st buying support is 85-80 (Reward of 10.53%-15.78%)
2nd support is around 70-65 (Reward of 26.32%-31.58%)