The following is an addition to the In Session thread made today (available to all enrolled members).
I want to comment on the notion of market manipulation, which I have hinted at recently. What does this mean, "manipulation?" For me, the definition is "moving markets in a given direction for overt political or financial gain for a relative few in opposition to basic fundamentals."
There’s lots of evidence, both direct and indirect, to support the notion that our "markets" are not really markets at all, but rather subject to non-economic forces producing something other than "orderly price discovery."
Here’s a prime example from yesterday:
S&P flip-flop sows confusion in CMBS market
By Aline van Duyn in New York
Published: July 23 2009 00:23 | Last updated: July 23 2009 00:23
Confidence in the dysfunctional market for securities backed by commercial mortgages has been further dented after a rating flip-flop by Standard & Poor’s caused confusion.
The rating agency, which recently changed its criteria for large numbers of bonds backed by loans for shopping malls, office towers and other commercial property, upgraded bonds to triple A just days after those same bonds had been sharply downgraded.
My comments: Hmmmmmm, that’s kind of strange, don’t you think? AAA bonds had been downgraded not just ‘sharply’ as the article says, but all the way to BBB-, which is right down there at the very edge of deep junkdom. From triple-A to triple-B and back again. In a few days. What could the reason for this be? Whatever the reason, we can certainly strike "economic" from our list of considerations. Let’s see if the article provides any further clues.
The reversal on the rating of some commercial mortgage-backed securities (CMBS) came late on Tuesday, the same day that the US administration proposed legislation that would force a raft of new disclosure rules and restrictions on agencies such as S&P, Moody’s Investors Service and Fitch.
My comments: Okay, that’s one potential reason – new restrictive legislation is being considered and S&P suddenly decides to make drastic changes to one of its recent ratings. So we might surmise that there was somebody in power that was unhappy at the downgrade and applied some pressure via the threat of new disclosure rules, with the message being, "Either you change your rating, or we’re going to occupy some of your offices and look over your shoulder forever and ever." However, I consider this angle to be unlikely. It simply takes too long to get proposed rule changes in place, and this seems to be a mere happenstance. We can safely ignore this reason.
Let’s keep reading.
The decision not to downgrade some of the CMBS after all was made after S&P realised that bonds with a shorter lifespan were less risky than other bonds in similar structures with longer lifespans. Assessing risks of securities backed by loans stems largely from analysing which bonds get repaid first from interest payments and loan repayments.
Alan Todd, head of CMBS research at JPMorgan, said the mistake appeared to be a basic misunderstanding of the way cash flows are distributed across a mortgage-backed security and it was an error that should not have been made.
My comments: Here it is suggested that there was a legitimate economic reason for ping-ponging between AAA and BBB-, but even though they dutifully trotted out a JPMorgan flack to provide some cover for this ‘explanation,’ let’s be honest: There’s no way this is the reason. The difference in cash flows and risk across AAA and BBB- is simply too large for this to be a legitimate explanation. If S&P had maybe bounced the rating back up to BB or even B I would have grudgingly said "Okay, maybe…." but all the way back up to AAA? No, sorry, nope.
Let’s keep reading…the real reason is buried near the bottom of the article (as they often are).
The Federal Reserve is seeking to reignite the market for CMBS, in part by financing purchases of the securities, as long as they are rated triple A.
Ding! Ding! Ding! We have a winner!! It turns out that the market for CMBS is still in a deep funk, and the Federal Reserve wants to step in here with its thin-air money program and start buying them up. But they are restricted to buying AAA securities. Which means that the ones that S&P downgraded could no longer be purchased by the Fed under the rules of the game as they currently stand.
Clearly the Fed wanted to buy the particular issues involved, and of the two things that could be done, forcing S&P to change its rating was deemed to be easier than changing the rules at the Fed. So S&P took another hit to its already shredded credibility (which had to gall them terribly) and made a major and embarrassing revision to a recent downgrade.
This upgrade had nothing to do with fundamentals and everything to do with the Fed’s desire to buy these particular issues at full price. If bought at BBB-, these CMBS products would have been bought at perhaps 60 cents on the dollar, but then the bank that was holding them would have had to record a steep loss. Instead, buying these as a AAA issue allows the full mistake of the big bank involved to be completely covered up by the Fed.
This is nothing less than a deliberate program of monetizing bad debt by printing money out of thin air to exchange for bad debts on the books of one or more large, well-connected banks. Small investors, your 401K, and taxpayers need not apply.
This raises a number of troubling issues and conclusions:
- Ratings are not worth anything, because where they were subject to market forces making them too high during the formation of the credit bubble, they are now too high due to political pressure and manipulation on the way down. Ratings are worthless.
- Political pressure is being overtly used to effect specific market outcomes. Where else is it being used? Does any of this explain the recent stock market behavior and GS’s outlandishly good ‘trading returns’? If so, then we are in trouble, because false prices lead to bad investments and therefore serve to enable, not cure, the particular pathology that afflicts us.
- There are still enough bad debts on the books of large banks to require this sort of skullduggery. The notion of a rebounding economy and green shoots are entirely inconsistent with this sort of desperate maneuvering. It is this sort of manipulation that leads me to be especially skeptical of the notion that the economy is on the mend. If it were, then this bizarre action would not have been required.
There are a number of other troubling issues for me here, but I think that’s a sufficient list for now. Because I can see such manipulation here in the CMBS market, I assume that manipulation is happening elsewhere, where there is perhaps less transparency. I make this assumption because in every financial crisis there are two components: the actual financial damage and the associated loss of confidence.
Of the two, the crisis in confidence is the part most addressable by politicians using their power to effect specific market behaviors. During the Great Depression, FDR used government power to directly target higher agricultural prices by openly destroying crops and livestock. The idea was that once people regained their confidence, they were supposed to begin buying and selling with their former vigor.
Under the very best of circumstances, the confidence-building efforts of the politicians will also provide outlandish returns to well-connected financial elite, who will therefore not put up any opposition to the actions.
Here we have large banks getting full price compensation from the Fed for a pile of ruined debt, in an action designed to "restore confidence" to the CMBS markets so that market participants will resume buying and selling with their former vigor. That’s a win-win-win as far as everyone is concerned.
Well, everyone except the taxpayers, of course.
by davos