Sunday, May 9, 2010

Europe's Shock and Awe/ European Bank Exposure to PIIGS/ Strategic Defaults/ Markets Failed on Thursday/FANNIE & FREDDIE-Black Holes for Money

I noticed that Vanguard has eliminated commissions for its brokerage customers who buy Vanguard ETFs. It has been some time since I last checked Vanguard's brokerage commissions. There were not competitive with some of the other discount brokers when I last checked several years ago. I checked again over the weekend and found them to be reasonable and better than Fidelity for those with accounts over $500,000. Vanguard - Vanguard Brokerage Services - Commission and fee schedules

I mentioned in a comment to a recent post that Mr. Market was telling Europe that more needed to be done to stabilize the Eurozone and the EURO than the bailout of Greece. Europe needed a "shock and awe" rescue package. (Reply to DutchPerplex: Added 400 ACG at 7.85) The European Finance Ministers have agreed to a 750 billion Euro "defense" package with 250 billion EUROs from the IMF. NYT (almost 1 trillion dollars) Hopefully, this will be enough to calm the markets and turn last week into a temporary squall.

1. The NYSE and Nasdaq Did not Function Properly Last Thursday: Based on some additional reading over the weekend, it is clear that two major exchanges failed investors on Thursday. The account in the WSJ of how quickly the stock of Accenture fell to one penny clearly indicates that our exchanges are not functioning in an way conducive to promoting individual investor confidence. (Other stocks fell quickly to less than a penny including Exelon, Brown & Brown, and Casey General Stores) If it turns out that a large order for Proctor & Gamble set off the chain of events culminating in a 1000 point drop in the DJIA (WSJ), then it is impossible to have any confidence in the two exchanges based primarily on their lack of coordination.

I read that 296 stocks experienced wild and tremendous swings in prices. (list of them are at & story at Many individuals were undoubtedly screwed during the chaotic period who had entered stop loss orders that were hit, followed by a sharp rebound in the stock price. Some of this is discussed in this WSJ. article. Other individuals placing market orders found their orders filled at outrageous prices that failed to reflect anything approaching a fair market price.

It is an farcical for both exchanges to claim that everything worked properly on Thursday. It actually says something about their respective mind sets to even make such an absurd claim. I do not see how any individual investor can have sufficient confidence in the exchanges now to enter a market order, or to place a stop loss order on any exchange traded security. It is one thing for an air pocket to hit for one of the thinly traded stocks. It is quite another for it to happen to the stocks of the largest companies in the U.S. And who could quibble with Alan Abelson's observation in his Barrons column that the exchanges sacrifice protection for the long-term investors in order to serve the interest of hyper-leveraged intraday speculators. It is a market designed to cater to hedge funds and assorted Masters of Disaster.

2. European Banks' Exposure to the PIIGS: The German banks have about a 704 billion exposure to the PIIGS: Banking Systems Most Exposed to PIIGS Nations - CNBC The Netherlands is at 244 billion: CNBC Belgium is higher than Germany and the Netherlands as a percentage of their banking assets with close to 119 billion. France has the highest percentage exposure of the ones that I have listed at 10.4%: CNBC The numbers provided by CNBC do not include the exposure of European insurance companies which would add a lot to the totals.

BNP Paribas put its exposure to Greece at €5 billion. French and German banks have 1.16 trillion at risk in Spain and Italy, including both private and public debt.

Andrew Bary asserted in his Barrons column that the market's reaction to the European sovereign debt issues was overdone last week. I would agree with that opinion. And I would agree with Michael Santoli that the fears "may be overblown", and that comparisons to the market meltdown in 2008 were inappropriate. It is easy to voice such opinions as the saying goes, opinions are a dime a dozen. It is different when you have your own money at stake, where an opinion which turns out to be incorrect can cost the investor a lot of money. Without the Europeans taking aggressive steps before the markets opened on Monday, this could have easily been another bad week.

I am not inclined to agree with Cramer who suggested waiting for DJIA 9000 to buy. CNBC The kind of fear, nervousness and anxiety which is manifested in the VIX surge last week is not conducive to the start of a new long term bull market. But, a fall to that level in the DJIA may be wishful thinking for anyone hoping to time the next buying opportunity.

The point that I would emphasize is that the S & P 500 closed on April 9, 1998 at 1110.67:^GSPC: Historical Prices for S&P 500 INDEX It closed at 1110.88 last Friday, May 7, 2010. This is what I define to be a long term secular bear market, a lot of up and down motion but ending up going nowhere for well over a decade. Eventually, this will come to an end and a new long term secular bull market will be born. I am sticking to my assessment for now that this will not be for another two or three years however. (see Posts from September 2009: t 1974 or 1982: Start of Cyclical Bull in a Long Term Secular Bear Market or the Start of Secular Bull Market? & More on 1982 or 1974 and the recent assessment made in Item # 2 from the April 2010 post-Problems Brewing for Stocks and Bonds? ). In this kind of market, the trigger has to be pulled more often, on both the buy and sell side, and cash has to be available in order to take advantage of opportunities as they arise. Cash is an important allocation category in a long term secular bear market.

The S & P 500 closed Friday just above its 200 day moving average. S&P 500 INDEX,RTH Index Chart

3. Fannie and Freddie-Money Black Holes: Gretchen Morgenson had some interesting observations about Freddie Mac's first quarter report. NYT I am accustomed in these posts to introduce a summary of these reports with the phrase "earnings report" or similar phrases. Needless to say, neither Fannie nor Freddie are reporting earnings. Maybe it would be better to refer to these reports in the same way that I would reference a summary of the damages caused by Katrina. As noted by Ms. Morgenson, Freddie reported a loss of 6.7 billion for its 1st quarter, and requested an additional 10.6 billion from the government on top of the 52 billion previously received by it. This is not really the focus of her article. For those who believe the housing market has made a turn for the better, the report from Freddie is an eye opener.

Delinquencies in Freddie's Alt-A loans (referred to as liar loans and viewed as superior to subprime for some reason) rose to 12.4%. One of the many abominations hatched during the housing bubble, the interest only mortgage, rose to a 18.5% delinquency rate. The delinquencies in the single family residential loans increased to 4.13% from 2.41% in the 1st quarter of 2009. When Freddie sells a property, it loses on average 39 percent.

A good chunk of the money received by Freddie from the government is returned to government as preferred stock dividends, which is what the government receives in exchange for its funds. This creates the appearance of the government receiving something for its money, when Freddie and Fannie are just recycling government funds to make the payments. The dividend now is around 6.2 billion annually for what has been received to date, more than Freddie earned "in most periods". Both Fannie and Freddie are doing excellent imitations of money black holes.

The enormous losses of both Fannie and Freddie are basically being absorbed by the U.S. government.

Freddie's 10-Q filing for the 1st quarter can be found at the SEC's web site.

4. Strategic Defaults: Sixty Minutes had a story about homeowners, who are capable of making their mortgage payments, walking away from their contractual obligations and allowing the bank to foreclose on their homes. 60 Minutes This is becoming a serious problem in states that do not permit a lender to secure a default judgment against the borrower and then collect any deficiency judgment against the borrower's other assets. According to this report, it is estimated that there have been 1 million strategic defaults in the past year which is undoubtedly making the housing crisis worse. In Arizona and nine other states, the lender is not able to collect a deficiency judgment from the borrower's other assets. A deficiency judgment would be the difference between the balance on the loan (plus the lender's expenses related to the foreclosure) and the proceeds received by the lender upon resale value after foreclosure. If the borrower had other assets beside the home, the borrower would have to think twice about a strategic default. There would also be tax implications for a cancellation of mortgage debt where there is recourse to other assets. Home Foreclosure and Debt Cancellation

In those ten states, prudent lenders would need to be far more circumspect about lending money on homes in the future, requiring the borrowers to have more skin the game. This would also cut down on parabolic increases in home prices, as in Arizona which was the focus of the the Sixty Minutes story, since credit would not be available in such a way as to fuel substantial increases in home prices.

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