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Of Duty And Doodie


I can now add to the long list of reasons I won’t let my kids watch C-SPAN the following: those Senators are nasty!

Carl Levin chose to emphasize the fact that Goldman traders referred to the Abacus deal in internal emails as a “sh*tty deal,” hammering that phrase over and over. I suppose you can do that on cable TV. The Goldman guys sat there looking cool under pressure (well, they should, they’re traders and they’ve heard lots worse on the Goldman floor I assure you), but I suspect that those folks who wondered whether the SEC really had a case against Goldman are now wondering how many other emails like that there are. Part of what drove the post-equity-bubble research settlements after 2000 was the discovery of internal emails showing that research was saying one thing when they really felt another.

Of course, these are traders, and while they bowed to the Committee and said they had a duty to their clients, that’s not technically true of the market-makers. Goldman as a firm has a duty to clients to not defraud them and not misrepresent the facts (or their opinions), but especially with institutional customers their legal duty is to maximize value for the shareholders (within the rules). Enlightened traders understand that you maximize long-term value for your shareholders by cultivating good relationships with customers, but that isn’t the same as the legal duty to clients. I remember very clearly one customer who wanted me to add a “synthetic AAA CDO tranche” to juice up the returns of an inflation strategy I was talking to them about. But the end client was a municipality with a post-retirement benefit (OPEB) plan. I made clear in every way that I could, orally and in writing, being sure to have witnesses present, that the yield of that “AAA CDO” clearly indicated that it shouldn’t be considered “AAA” in safety and was in my opinion not a suitable investment. I lost the deal. It was one of my finest hours (especially considering what happened to synthetic “AAA” CDOs.

Now, I am not a lawyer, and perhaps these Goldman guys pushed the envelope just exactly to where they could justify it. I suspect, though, that they did not anticipate how the law might be interpreted in the middle of a populist backlash against Wall Street. This is one of the problems when you let activist judges interpret the law: the law probably means something a little different today than it did three years ago, especially if the judge lost a bundle in his IRA. Even if Goldman has a rock-solid case by the letter of the law, I suspect they are already realizing that this is gaining momentum faster than they’d like.

Speaking of gaining momentum faster than anyone would like, European bourses took a pounding today as the implications of the Greek unraveling began to dawn on people, and for that matter on some rating agencies. S&P downgraded Greece to junk, which I think means that Greek bonds can no longer be hypothecated as collateral at the ECB; moreover, they downgraded Portugal as well with a negative outlook. Usually, when the ratings agencies finally get out in front of a problem, that problem is almost past…but in this case, I think S&P moved a lot earlier than I (and many other people) expected them to.

Stocks here in the U.S. dropped in sympathy, -2.3%. That’s still not a “plunge,” but closer to being worth worrying about. Bonds rallied on a flight-to-quality bid, with TYM0 up 1-02+ and the 10y yield down to 3.69%. Whatever my reasons for being bearish on fixed-income, a collapse in European markets wasn’t one of them, and I’ll wait until that plays out before getting bearish again. I don’t think getting long is a great idea, because when the situation settles the flight-from-quality will be even faster than the flight-to-quality. As traders and investors, we don’t have to make a bet until we feel the odds are in our favor. The pot odds don’t favor any bet right now.

And while this is happening, the Federal Reserve is wrapping up its 2-day meeting tomorrow (the post-meeting statement is the only important economic announcement of the day). Whatever their plans were prior to this, I think it is pretty unlikely that they will choose this meeting to remove the “extended period” language and throwing gasoline on the fire – although, having said that, there is some argument to be made that making such a change when bonds are bid, rather than offered, makes some sense. I think it would be foolish, since any significant turmoil in Europe will raise questions about the impact on our economy, and preserving options here should be the Fed’s modus operandi. There is little upside, and much potential downside, to sounding hawkish at this meeting. But sometimes, they do stupid things.

The Committee might be forgiven if they are cheered by the Consumer Confidence figures, which jumped today to 57.9, much higher than expected. Most of that rise, however, was in the expectations component. That doesn’t mean the rise in confidence doesn’t matter, but expectations are probably enhanced by the stock market’s performance so I would put a lower value on that than the “current conditions” subcomponent (which is some 50 points worse than the expectations component). Moreover, the “Jobs Hard to Get” response to the employment situation question declined but only to 45.0. As the chart below (Source: Bloomberg) illustrates, this is better…but probably not enough to be confident yet that the job market is on a medium-term healing path.

Looks toppy, but hard to say for sure yet. Not exactly strong improvement.

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