The Long Crisis

Posts Tagged ‘black swans’

Finally the Securities and Exchange Commission [SEC] has filed fraud charges against a Wall Street firm that made billions of dollars while many Americans suffered the consequences of a housing market meltdown largely caused by the reckless and irresponsible actions of Goldman Sachs and other Wall Street firms.

Very likely, this action by the SEC will be one of many such actions as a flock of black swans that have been patiently circling above Wall Street move in for the kill. Surely, Goldman Sachs is one of the most hated financial firms in the world and politicians seeking populist support will pile on in earnest as the politically well-connected Goldman Sachs sees its support melt away under the heat of unleashed voter anger. Many Americans will rejoice as the SEC pursues its case against the arrogant and unrepentant Goldman Sachs.

Today, Friday, April 16, 2010 the Securities and Exchange Commission announced civil fraud charges against the gigantic Wall Street powerhouse and one of its executives. The SEC alleges Goldman failed to disclose that one of its clients helped create — and then bet against — subprime mortgage securities that Goldman sold to investors. In essence, Goldman is accused of pushing a mortgage investment that was fraudulently devised to fail.

The SEC alleges that Goldman Sachs structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). The SEC states that Goldman Sachs misled investors by not disclosing that hedge fund manager John Paulson reportedly made more than one billion dollars betting against the CDO that he helped Goldman Sachs to structure. Paulson’s hedge fund paid Goldman Sachs more than $15 million to structure the deal that his hedge fund then bet against.

SEC Enforcement Director Robert Khuzami said in a statement that “Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party.”

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” finance expert Sylvain R. Raynes told the New York Times about such deals. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

While so far the SEC has brought fraud charges against Goldman for only one of its many CDO deals the SEC has under review a wide range of Goldman Sachs transactions. More than likely, Goldman Sachs is not the only Wall Street bank or firm subject to review.

The charges against Goldman Sachs and the use by the SEC of the word fraud has spooked a stock market that was already set up for a steep correction. At 1:35 PM the Dow Jones industrial averages was down about 150 points. The market immediately began to sell off after the Goldman Sachs, SEC news was released at about 10:30 AM. This could be the black Swan event that ends the bear market rally from the March 2009 lows. Very likely, after the worse financial debacle since the Great Depression there are other shoes to drop and other black Swan events that will occur during the foreseeable future.

At the very least, those long the stock market will have to re-evaluate the risk that being long stocks bears with Goldman Sachs and the entire financial sector once again under severe selling pressure. In my opinion, the current environment is very risky to be long stocks. Technical indicators were already signaling the likelihood of a steep sell off prior to the fraud charges being brought against Goldman Sachs.

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Those never say die Black Swans are on the move again. The Dow lost about 104 points yesterday as a series of downgrades by the ratings services downgraded Greece and a number of Dubui firms with close government ties. Today Spain was added to the negative watch list.

Yesterday stocks, gold and oil all fell while the dollar rallied after Dubai World’s Nakheel PJSC reported losses of $3.65 billion on writedowns, Fitch Ratings downgraded Greece’s credit, and German industrial production unexpectedly dropped. About noon today the Dow is up about 10 points but looking heavy. Over the next few days look for some serious downside action as the Sovereign debt crisis spreads its wings and takes on the look of a Black Swan.

While the recent last Dubai fly by of the Black Swans only caused turmoil in the US stock market for a day or so the news over the past 48 hours was more unsettling.

“Greece is a whole lot more important than Dubai,” said Uri Landesman, New York-based fund manager at ING Investment Management. “There are a lot of banks, in Europe especially, that have exposure to Greece, so if there’s a major problem in Greece, that would be more important than a problem in Dubai.”

Yes, I know that I am using the term “Black Swan” loosely. A true Black Swan event by its very definition is an unexpected disastrous event and debt problems with Dubai, Greece, and Spain are by now widely anticipated. However, the fallout from the Dubai, Greece, and Spain sovereign debt troubles have the potential to trigger true Black Swan events in parts of this interconnected world that are far removed from Dubai, Greek, and Spanish financial centers.

Fitch Ratings also mentioned the the UK and US were on a path that is headed straight for financial trouble, and that unless the present course is somehow corrected it is no longer unthinkable these two spend, spend, spend, nations could lose their Aaa debt ranking.

Now that would lead to a feast of the Black Swans. With Dubai, Greece, and Spain troubles with excessive debt in the spotlight, it looks like many US stock market traders are beginning to question the lofty level of the market after the rally from last March’s lows. After all the US government is creating more debt than any entity in the world. Is the eventual day of reckoning near?

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Judging from recent stock market performance all is well with the US economy and with the world. Our spin masters in Washington seem to have Americans once again believing that we can get along just fine living in a dream land Wall Street centered everything is wonderful world.

It’s really a tribute to the power of trillions of dollars being unleashed upon Wall Street. A few trillion here and a few trillion there and you can move any market. Just ask the plunge protection team.

I’ve never been one to engage in believing conspiracy theories but the action of the stock market over the past few months makes me think I should reconsider. One can certainly speculate that enough funny money has been advanced to Wall Street at about zero interest rates that at least some of it has flooded into the market. I’m pretty sure that when trading firms and the big too big to fail banks are swamped with cheap cash the urge to put it to work with speculative trading activities becomes quite strong.

Actually, that is an understatement. The huge bonuses that Wall Street and the big banks are about to once again pay out are largely based upon spec trading profits.

With home foreclosures still very much with us, with oil prices refusing to decline from around $80 a barrel, with banks still afraid of small business lending (hey, it’s more fun to speculate with taxpayer and Chinese money), and unemployment still climbing, and the Wall Street firms acting like no crisis ever occurred, one has to wonder how long the dream land Wall Street world can go on?

However long it lasts I’m petty darn sure that the end game will not be pretty. I can’t escape having visions of a huge flock of Black Swans about to swoop in for the kill.

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