Friday, August 22, 2008

Must Read

Karl Denninger's blog Market Ticket is an excellent daily read. He has been out in front of the shenanigans going on in Washington and Wall St. His writing is straightforward as he pulls no punches and calls it likes it is. His piece today entitled PIMCO, The New Face of Our Financial System, is absolutely spot on sensational and yet sickening at the same time in its implications and reflections on us and our capital markets

I wish I could say I wrote it, it is that good. I rarely post others work, as this is my blog, and only do so when it is something that is just too good not to share. In this regard, I have lifted his entire piece and posted it here for you. Please take some time to read it as it is well worth it.

Here is the link to his site Market Ticker which you should make a part of your regular reading list.

Thanks again Karl !

PIMCO, The New Face Of Our Financial System

You would have thought that PIMCO's McCulley was a 2-year old yesterday.

He was running his mouth all day long, along with Cramer and everyone else on CNBC, and the message was along the lines of:

  • Paulson has to "show the color of his money" in bailing out Fannie and Freddie (why McCulley? Are you getting nervous?)
  • "Its only going to get worse" (if Paulson doesn't act now)
  • "Agencies (Fannie/Freddie) need to be privatized" (I thought your problem with them is that they already are, they did unsound things, and now you're screaming for a bailout?)
  • "The situation is worse than a year ago" (no kidding? Who'd a thunk? You don't read The Ticker, do you?)

Now let's digest all of this, in light of the facts.

See, just a few months ago, PIMCO disclosed that it had gone on an incredible Fannie and Freddie paper buying spree over the previous few months!

That's right, into the eye of the hurricane PIMCO went out and intentionally bought debt they knew was distressed, issued by a company that might fail.

This was not done "blind". It was done by a couple of very intelligent men who have been investing in the debt markets for a very long time and are experts.

So what's all this really about?

Simple - its about twisting the arm of the government and robbing the taxpayer.

Not because they were bamboozled, not because an unexpected calamity struck these firms, not because of an error.

No, this was a calculated act from the top down - buy a boatload of this debt at distressed prices after the threat has been identified by THEM, then WHINE at the United States Treasury and demand a bailout "or the end of the world will happen while Paulson sits and watches Rome burn."

In truth if Paulson doesn't do what PIMCO wants PIMCO will be the one who burns and PIMCO directly bought into a known distress situation!

See, this is where we've come to. We are now beyond "moral hazard" and "too big to fail"; we've now transmorphed the entire financial system into a mechanism to literally rob the people as institutions intentionally place themselves in harms way and then demand that the government cover a bet they knew was bad when they placed it.

It is one thing to argue that someone is "too big to fail" and that they pose "systemic risk." We've heard that countless times over the last year, and it seems to be the justification for every bailout and proposal that is put on the table - and has been since LTCM collapsed.

But now we've seen institutions take it one step further, and intentionally purchase securities issued by firms that they allege are "too big to fail" yet in dire trouble, then scream for the government to come in and bail them out!

Do you understand what's going on here?

Fannie and Freddie have been running one gigantic hedge fund for the last couple of years. They bought about $500 billion worth of trash ALT-A paper in the 2005-2007 time frame between them, with a goodly amount of "Option ARM" and "Interest Only" loans included. In addition they took in over a hundred billion dollars more from Countrywide and Indymac, most of which was done using "automated approvals" and are in fact stated income loans, although they're called prime paper.

Institutions like PIMCO, The Chinese and Japanese Central Banks, and others all knew this. This is NOT a surprise to any of them.

They all invested knowing full well that these firms were running with leverage ratios far in excess of anything that could be reasonably called safe. In addition they knew these purchases of garbage mortgages had nothing to do with "sustainable housing" or any such claptrap. Fannie and Freddie were "levering up" and "chasing yield" just like the rest of these market participants and the buyers of their paper knew it.

But the award for "truly outrageous" is reserved for those firms like PIMCO that have bought increasing amounts of this debt since the beginning of the year, knowing full well that it is impaired and that the firms behind it are at risk of failure, purchasing it on the back of being able to FORCE the government to do that which the black print on the front cover of EVERY prospectus says won't happen.

Why do we put up with this nonsense?

As for Paulson, were I him I would do what I recommended over the weekend - order up full audits, document that there is no possible way they can survive with the losses that are both being hidden and the projected future path for credit quality, place the firms in conservatorship, and run down the portfolios.

Guarantee nothing of the present debt.

But - provide a funding path going forward that is guaranteed for new security issue, with the strict stipulation that, as noted, only true prime paper can be underwritten, and no "hedge-fund" like activities are permissible. And again, that's 20% cash down payments, 36% DTI, and 15 or 30 year fixed terms. I suggest using Ginnie Mae, which already exists, but if the government wants to re-jigger Fannie and Freddie, once they've run down their portfolios, the equity has been wiped out, and can be sold back off to the public, that's fine too.

This does all of the following:

  • Those who intentionally bought securities "in distress" thinking they were going to be able to blackmail or jawbone the Treasury into making them a profit will get it in both holes, as they should. Let their shareholders come after those clowns for their obvious and transparently bankrupt strategy. We must not let "moral hazard" morph into intentional acts of placing one's self in harms way so you can whine for a bailout!
  • Similarly, idiots like Bill Miller who have been buying GSE common stock of late on the very same premise - that they'd be "saved" by the government - will also take it in both holes. Again, we cannot allow firms to intentionally place themselves in harm's way and then scream for help.
  • It places the responsibility for the bad debt where it belongs - in the GSEs and those who knowingly and willingly bought it. Note that most of this debt is perfectly sound and as run down both coupon and principal payments will be made. For some of the more risky paper, there will be losses. This is as it should be.
  • It insures that going forward we will have mortgage liquidity for those loans that are made under sustainable guidelines, with an explicit guarantee, but only for soundly-underwritten paper.

The "new" paper will be marketable folks. It will have an explicit guarantee and be underwritten to sound standards. That is, indeed, the "gold standard" when it comes to debt sold into the market - that it represents loans made to qualified borrowers with collateral valued at or above the amount of the loan written.

Those who are screaming for bailouts of the existing paper and firms are not interested in mortgage liquidity or a healthy housing market.

Oh, and one of the screamers? China. Again:

"``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. ``If it is not the end of the world, it is the end of the current international financial system.''"

You lying sack of dogsqueeze.

You bought these securities knowing full well that they were not guaranteed, and like everyone else who did so, you were simply "reaching for yield." You, along with the rest of your cronies over in China, Japan and elsewhere, were fully aware that the GSEs were buying ALT-A paper stuffed full of liar loans made to hairdressers on $500,000 houses in California and Florida. YOU DESERVE WHAT YOU GET from such a purchase and, if this "is the end of the current international financial system", then IT NEEDS TO END RIGHT NOW, because that "current international financial system" has turned into one gigantic SCAM and YOU ARE THE WORST OF THE SCAMMERS!

These folks are ALL simply trying to force the government to cover a bet they knew was bad at the time they made it, in a raw act of arm-twisting.

Henry Paulson MUST SAY NO.

There is a fly in this ointment however - its that a tremendous number of banks have bought GSE Preferred and are holding it as part of their risk-based capital!

What? You mean to tell me that banks are holding stock as part of risk-based assets?! How the hell did that happen?

Oh, it happened because once again:

"Banks bought Freddie and Fannie preferred stock because they can be used as capital that regulators require to cushion against losses on loans. Banks also get a tax break on 70 percent of the securities, making them attractive to own, said Midwest's Wiest."

And guess what - those are the only two firms' preferred that this applies to.

What sort of criminally stupid "regulators" do we have in this nation when banks are allowed to hold risk-based capital in the preferred stock of firms that are levered up at 60:1 or more?

This whole mess is one gigantic scam from the top down.

We the people need to run all of these people - every last one of them, from Bernanke to OTS to OCC to Treasury - out of town on a rail. They have intentionally allowed banks and institutions to not only lever up to insane levels but also then allowed banks to buy and hold preferred stock, which is THIRD IN PRIORITY in liquidation, as part of their risk-based capital!

Oh, one more thing. Has Henry Paulson shot off his Bazooka pointed at Fannie and Freddie themselves? One has to wonder, given this:

"In July, Congress gave the Treasury authority to lend money to or acquire equity in the companies if needed to prop them up. That helped reassure buyers of Fannie and Freddie debt that the government would stand behind them in a crisis.

But the Treasury's authority may make it harder for them to sell equity because of uncertainty over how the Treasury would treat private shareholders if a bailout is needed."

You have to love unintended consequences.

Wouldn't it be ironic if Paulson's "Bazooka" turns out to be what kills the GSEs?

The next obvious question is was that Paulson's intended outcome all along?

Things that make you go "hmmmmm..


Anonymous said...

Very nice - a new blog to add to my top ten.

Someone should send a link to Paulson!

Shawn said...

Hi Harleydog,

Thanks for your great blog.

Also, great call on the SP500 short positions today... Would you consider those trades to be lay-ups or a dunks?

Anyway - I follow Bill Gross and M El-Erian daily via google alerts and they are both very academic. Most of all, I applaud them for being transparent and as open as they are - and.. they sometimes talk against their book (that cost me dough with TBT).

I checked my Vanguard and Fidelity Trading "clearing" accounts a few weeks ago (where I park money while I wait to trade) - They both are holding "lots of" short-term G.S.E. debt (as if it was U.S. treasuries).

What do we call the point beyond "too big to fail"???

I think El-Erian and Gross are trying to get laid on their wedding night.

Guys, you will "get laid" on your wedding night and the US govt will "rescue" F & F.

You guys in who used to be in the high school chess club can stop begging .... it will happen.

The only question is whether she will ask for something more?????????????


Harleydog said...


thx for reading and your kind words. Still early on the S&P short but that's what stops are for.

Pimco does a lot of homework, we have to hope or heaven help us all if guys like this are just throwing darts, and for them to buy this GSE paper knowing what was going on, and now CNBC provides a weekly soap box for them to bully the Fed and Treasury into bailing them out of the crap is just beyond comprehension.

As Fleckenstein says, crybaby capitalists, which is putting is politely.

They say that strange things happen when temperatures approach absolute zero. We are about to witness many of these strange things.


Harleydog said...


yes Karl's blog is good, glad you like it. thx for stopping by to read mine.


Anonymous said...

Karl is a very smart man. Unfortunately his wisdom is tarnished by racism.

Go to TF and do a search for the "N" word. He's built quite a following of fellow racists as well.

Not the best way to try to start a movement.