I recently delivered a keynote speech in New York city focused on valuable risk management and corporate governance lessons, as well as the future of Financial Reform and its impact on the economy, the capital markets and investors.
Over two dozen institutional investors came up to me after the presentation and were shocked at how little transparency there is coming out of Washington on Financial Reform. The questions were; almost three years after Lehman Brothers what's been accomplished? Do "too big to fail banks" still have the Federal Reserve and US Treasury held hostage? After all of the stimulus, quantitative easing and experimental drugs, would another Lehman Brothers bankrupt America?
In the last several weeks, I've met with two US Senators and two US Congressmen and I don't like what I'm hearing. These 4 members of Congress are all very high ranking members of the House Financial Services Committee and the Senate Banking Committee. Here's my color on what's really happening.
Land of the Low Hanging Fruit
To me, fixing the mortgage market and preventing the the next Lehman Brothers are the two most important things we can accomplish in Financial Reform. In 2007, 25% of US GDP was housing related. GDP was 5.5% that year in the USA vs. a Goldman Sachs recently revised 2.5% trend for 2011. Falling home prices puts a cap on GDP, economic growth and job creation. A robust housing market led the US economy out of the last 3 recessions. Yet, our leaders in Washington are spending a lot more time addressing bank swipe fees on credit cards? They're going after the easy targets and kicking the most important challenges down the road.
From 2000-2006 the housing boom in the USA was fueled by 3 giant engines. The lending power of Fannie and Freddie, the commercial banks and investors (colossal buyers of RMBS -- residential mortgage backed securities and CDOs -- collateralized debt obligations). Today, one third of this formerly easy money machine is on strike. The investors in mortgage backed securities are not being treated fairly in the financial reform process and they're on the sidelines. Who can blame them?
Here's the rub. After the great depression in the USA, following the crash of 1929, the corporate bond market was a mess. Investors just didn't trust corporations and trusted bankers less. Like the mortgage backed securities market today, back then the corporate bond market had its fair share of robo-signing like scandals in the sense that almost every bond indenture was different. It was an unmitigated confusing mess. No transparency. And as I said in my book, A Colossal Failure of Common Sense, "Capitalism Does Not Work Without Transparency of Risk."
Do We Need a Trust Indenture Act of 1939 for the Mortgage Backed Securities Market in 2011?
The Trust Indenture Act of 1939 brought a dramatic cure to the US corporate bond market in the USA. It simplified bond indentures and shined a beautiful bright light of transparency on to the corporate leaning market. Trust was back, lending flourished and then the 1950s roared. Yet today, our well paid public servants in Washington are NOT addressing the deep dysfunction in the mortgage backed securities MBS market. I've read dozens of indentures in MBS structures. Everyone of them is different. There's no simplified standardization. Reps and Warranties have little meaning. And investors remain on strike. In other markets, Collateralized Loan Obligation (leveraged loans) issuance is coming back. Commercial Mortgage Backed Securities are right there with them. In the Junk bond market there's easy money for some of the worst corporate credits. And MBS issuance? An important backbone of the US housing market, is a deadly fraction of 2005 levels.
"Way out there" Warren?
In my opinion we have a serious constitutional challenge developing. On September 10th, 2010 President Obama named Elizabeth Warren as his "assistant" and "special advisor" to the Secretary of the Treasury on the Consumer Financial Protection Bureau CFPB. Why these odd roles? Because many Washington Policy experts believe Ms. Warren was "borkable." A colorful tribute to Robert Heron Bork. In 1987 he was nominated to the Supreme Court of the United States by President Ronald Reagan, but the Senate rejected his nomination. So instead of putting her up for official nomination and a potentially nasty Congressional approval process the President punted and created a role for her. Some would say he skirted a crucially important intent of the law?
"Way out there" Warren has been operating in limbo land for months now and from what I understand taking aggressive liberties with her job duties. The speculated $20 billion settlement between the banks and the State Attorneys Generals is a classic case of the ever encroaching "Warren waltz."
Ms. Warren is an unelected, unappointed power player who has not been approved by Congress. We're coming up on the one year anniversary of Dodd Frank and we have no Congressionally approved head of the CFPB. The legislation mandates an "approved" head of the bureau must be filled by the one year anniversary. With the latest budget battle and and a busy legislative agenda, I'm hearing Congress will not be able to approve a head of the CFPB on time.
This leaves a $400 million budget for the CFPB and all its power in murky hands. According to my friends at DC Tripwire, unlike the Securities Exchange Commission SEC and the Commodity Futures Trading Commission, the funds supporting the CFPB don't need congressional approval. Congress can slow down Dodd Frank's progression by holding back funding for the SEC and CFTC. The CFPB is another animal and the Federal Reserve has control their funding.
2002 vs. 2011?
Coming out of the 2002 recession you had powerful distrust of corporate balance sheets in the wake of the Enron, Tyco and Worldcom scandals. It was very difficult for corporations to raise money in the capital markets by selling stocks and bonds. Yet, the US housing market was awash with cash. The securitization market, supported by investors, provided trillions of lending dollars through the shadow banking system (Countrywide, Own It, Rescap Mortgage...).
Today we have the complete opposite. In my conversations this week with high yield, leveraged loans, convertible securities and equity trading desks the message is the same. The capital markets have never been more open to companies raising money. Covenant lite deals are back juicing the LBO (Leveraged Buy Out) market. CCC junk rated paper issued with easy. We're back to the land of crummy coupons on crummy credits. It's very clear, massive issuance in the investment grade/high yield corporate bond markets are funding the M&A boom, just like '07. Per my friends at Barclays, globally announced M&A activity is on a tear. Highest level of first- quarter M&A activity since 1Q07.
Party Like It's 2007 in the Equity and Debt Markets?
Everyone's a a good mood, Sentiment Alert? According to Investors Intelligence latest report the bulls are on the rise to 57.3%, while the bears hibernate @ 15.7%. The spread is close to levels @ Oct '07 peak.
Corporations are feeling the love as well. The S&P 500 announced stock buybacks just touched its highest quarterly volume since 4Q07, a cool $100 billion-ish.
The shorts are definitely on the run. As of March 30th, the value of stocks on loan to short sellers was a paltry $273 bln, lowest in 5 years per my fiends at Data Explorers in London.
First quarter performance shows the financial sector have dominated YTD spread tightening (improvement) with REITS, Banks, Insurance leading the way. Yet bank credit spreads are well off their 2007 tights by about 80 bps if you look at 5 year CDS (credit default swaps). While industrials and consumer related companies are on top of or through 2007 tights. In other words, McDonald and IBM can borrow at 2007 levels (pay less interest) and CitiGroup, JP Morgan, Bank of America cannot.
They're dancing across the pond as well. Over the last 10 days cash corporate spreads (easy credit) in Europe have continued to rally, reaching levels last seen in May 2010.
It's not as rosy in sovereign land as Ireland's 5 year government bonds have increased 210 bps in yield since early February to 10.5%, 10 yr paper + 90 bps to 9.8%. Winston Churchill once said, when you're going through hell keep going. My sympathy is with the people of Ireland, something like $30 billion in annual tax revenue vs. $22 billion in interest costs on their mountain of debt.
My Meeting with the Governor of the Central Bank of Ireland
I have a meeting with the Governor of the Central Bank of Ireland, Patrick Honohan while I'm in Dublin on June 2nd. I look forward to learning more.
Listening to the loud chorus of recent Fedspeak (comments by Federal Reserve board members) here in the USA you might have to cover your ears. Not because of content but volume. There's a growing view among traders that Washington sent out some memo to coordinate everyone to start talking hawkishly?
In fact, going into this week, 13 Fed officials have spoken publicly in the last two weeks at 23 speaking engagements all over the globe.
It's working as well. The 10 year US Treasury is ripping wider, with a yield at last night close of 3.58%, that's 36 basis points higher yield over the last 3 weeks.
Of course the raging doves on the Fed like Bill Dudley are still singing the same tune about how tame "core" inflation (ex food and energy) is. This may be true but Mr. Dudley you can't eat an iPad. A single bottle of Chateau Lafite recently sold for record $34,316. "Wine History was made today," said a VP at Sotheby's International. Not to mention with the Easter holiday approaching Hershey announced it's raising wholesale candy prices by a big bite, 9.7%.
According to the website Zerohedge, the Federal Reserve has printed $2.5 trillion to create 1,492,000 jobs from recession bottom; that's $1.7 million per job. How many dollars is that per DOW point from the March 2009 lows?
All cheap money did was get us into this mess in 2007. And now we're heading towards those same waters without a functional financial reform process. We must fix Dodd-Frank now, we cannot afford another Lehman Brothers.