Mullooly Asset Management » Wall Street

Bank Stocks Point and Figure Analysis January 2012

Thomas Mullooly — Mon, 30 Jan 2012 21:08:23 +0000

How healthy are the big banks? No one knows the details, but we can get a pretty good idea of what investors think of banks, by simply looking at the point and figure charts in this sector. In fact, we can look at the entire banking sector, the entire financial sector (not just banks) — and the relative strength of these sectors. It’s a worthwhile look!

We close this video with the grand-daddy of all financial sector charts: Lehman Brothers from 2008.

If you’ve got a mutual fund, exchange traded fund or a stock you would like us to ANALYZE, get in touch w/us! You can find Mullooly Asset on the web, or you can call us at 732-223-9000. We would be happy to review a chart for you and maybe even make a video of it. I would also add the following:

Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment or investment strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions, or withdrawals may materially alter the performance of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for an investor’s portfolio.

If you are relying on a blog post for specific investment advice, you are making a huge mistake. Please speak with an investment adviser before making ANY investment decisions.

If you do not have an investment adviser, we encourage you to contact Mullooly Asset Management at 732-223-9000, or through our website. Under no circumstances should the content discussed here to be considered specific investment advice.

Positive Trend Can Be Your Friend

Thomas Mullooly — Tue, 01 Nov 2011 16:53:41 +0000

After a good run in late October, the last day of October AND now the first day of November are off to a thud. What’s happening?

There is a significant difference between the market action in late July – early August and now. The drop in August was enough to break support lines. But at the present time, we are operating in a positive trend… a big difference. While the market carries a long-term negative (bearish) outlook, there will be times where the short and intermediate term is positive.

If you are relying on a blog post for specific investment advice, you are making a huge mistake. Please speak with an investment adviser before making ANY investment decisions.
If you do not have an investment adviser, we encourage you to contact Mullooly Asset Management at 732-223-9000, or through our website. Under no circumstances should the content discussed here to be considered specific investment advice.

For example, in 2008, we had similar long term bearish market tones, but yet we had a sustained three month rally starting in late spring that made (guys like me) scratch our heads. I would also add the following:

All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions, or withdrawals may materially alter the performance of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for an investor’s portfolio.

Here is a snapshot of what is happening right now:

Be sure to get in touch with us if you questions regarding the overall game plan.

Mullooly Asset Management Podcast for March 30, 2011

Thomas Mullooly — Wed, 30 Mar 2011 18:12:25 +0000

We encourage our readers and listeners to our podcast to consult with their investment adviser before making a decision to buy or sell any investment.

And if you are relying on a podcast for specific investment advice, you are making a huge mistake. Please speak with an investment adviser before making ANY investment decisions.

If you do not have an investment adviser in the New Jersey or New York area, we encourage you to contact Mullooly Asset Management at 732-223-9000 or through our website.

Under no circumstances should any of the content discussed on this podcast be considered investment advice.

In this week’s podcast, we talk about John Dorfman’s article in which he discusses the old Wall Street saying “the market climbs a wall of worry.”
But…when stocks (and stock markets) collapse, no one really cares about old stories or sayings. What investors want to know is

Market Drop: Could We Have Seen This Coming?
What Could We Have Done To Possibly Get Out Of Harm’s Way?

Very few (in my profession) have any answer for these questions.

Part of the reason is because so many are conditioned to be “perma-bulls:” they are pre-disposed to staying optimistically bullish, and keeping you invested in some far-off fantasy where everything works out great. Hey, life is not all purple pansies, sometimes things get messy. And sadly, some folks in my line of work get defensive/bearish AFTER the fact, when it is too late. Then they miss the next move.

In repeated conversations with clients, we hear the same phrases:

“Tom, we do not like the news/the headlines…”
“The economy worries me…”
“Tom, I do not like this stock market”

And, as soon as they mention those phrases, they get in a defensive posture. They are conditioned to hear their adviser tell them “you have to look long term.”

We will not be optimistically bullish 100% of the time.
There are times we want to be IN the market.
There are times we want to be OUT of the market.

The Mullooly Asset Management Podcast can be found below. The Podcast can also be found on iTunes. Go to the iTunes Store and simply search for “mullooly.” Under no circumstances should the information contained in this blog or podcast be considered investment advice.

Thank you for listening. We welcome your comments and questions.

Mullooly Asset Management Podcast for March 17, 2011

Thomas Mullooly — Fri, 18 Mar 2011 07:31:50 +0000

“Never make predictions, especially about the future.” — Casey Stengel

We encourage our readers and listeners to our podcast to consult with their investment adviser before making a decision to buy or sell any investment.

And if you are relying on a podcast for specific investment advice, you are making a huge mistake. Please speak with an investment adviser before making investment decisions.

If you do not have an investment adviser in the New Jersey or New York area, we encourage you to contact Mullooly Asset Management at 732-223-9000 or through our website.

Under no circumstances should any of the content discussed on this podcast be considered investment advice.

Since last week’s podcast, a lot has happened: earthquakes, a tsunami, and nuclear chaos. The VIX index (the volatility index) has skyrocketed – we can continue to expect plenty of volatility in the upcoming weeks. Tuesday the market was down 200 points; we saw the same on Wednesday, Thursday the market was up 160.

Strap on your seat-belts, get ready for plenty of volatility.

As a reminder to our regular listeners and to inform our newer listeners: the media makes money by selling advertising. Because of this, the news tends to be more sensational in an attempt to keep you watching (or reading).

We have been saying for a while the market has been over-bought and in need of a pullback. What’s happening now in the market is…not a surprise. The long term charts are still positive. Although it’s been rough, what we’re going through now may ultimately just be a correction, and not a re-run of 2008.

The thing that really gets me is we can spend months watching the market climb up inch by inch, only to give it all back in a week’s time.

The downside tends to happen a lot faster than the upside.

The biggest difference between now and 2008 is this: In late 2007, the relative strength chart measuring “cash vs. the stock market” actually flipped over, and started to favor cash.

Look, this chart doesn’t change like very often, so when it does flip over, it is a very big deal.

This chart answers the question, “which is currently stronger?” Putting money into cash, or putting money into the stock market? This is why we prefer to focus on what is happening now – instead of trying to predict what will happen next. Like we said last week, the big picture backdrop is still positive, but the short term is very, very sloppy.

Let’s take a side-bar and talk about the events in Japan in the last week:

1. Terrible 9.0 Earthquake
2. A 30-foot Tsunami Wave
3. Nuclear Reactor “issues”

I’m stunned at the political posturing and rhetoric thrown around regarding nuclear power here in the United States.

Let’s be clear: this nuclear power station has been online for 40 years and survived a 9.0 earthquake. The station was still working after the earthquake – it was the tsunami that knocked out the power.

Are any of the nuclear power plants in the US in danger of being hit by a tsunami? I don’t believe so.

But you won’t hear that on the news. As usual, the media drums up emotions.

It is this reason why we rely on point and figure charts when managing your money here at Mullooly Asset Management. These charts do not show any events, or points where you can add in emotion. Emotion is an ingredient you don’t need in this recipe.

These charts simply show the ongoing relationship between supply and demand. And again, that’s not a theory- it’s an economic law.

Thank you for listening. We welcome your comments and questions.

Big Changes Ahead for Oil?

Thomas Mullooly — Sat, 27 Mar 2010 13:23:52 +0000

We saw a pretty significant signal recently from the oil sector. A relative strength sell signal.

This does not mean oil immediately becomes a terrible place to have money at work in March or April 2010.

But longer term, it suggests oil will (likely) under-perform the overall markets. And, it’s possible the sector could significantly under-perform.

This is really important, in more than one way.

First, let me walk you through another example where a sector gave a relative strength sell signal. The Financial sector gave a relative strength sell signal in April 2007. Think about that. That signal came before any of the mortgage stocks melted, well before Bear Stearns imploded (like nearly a year before that event) and significantly (18 months) before Lehman Brothers collapsed. And long before things like “sub-prime mortgages” and “TARP” became household terms.

And since “financial companies” were the largest component of the S&P 500 (at the time), it was a pretty serious signal for the whole market.

What was even MORE significant was that April 2007 was the first time that chart had flashed a relative strength sell signal…period.

Sure, some financial stocks rallied – and were even good trades AFTER the relative strength sell signal in April 2007. But those gains were fleeting, and most were only short term trades. You were trying to swim upstream in downward environment.

What relative strength charts can tell us is which areas will out-perform (or under-perform) their peers (or the whole market). And relative strength signals tend to last (on average) about two years.

Relative strength is not a trading tool.

So, oil, as a sector, has now given a relative strength sell signal. This is important because as the market has improved over the past year we’ve seen some common characteristics: as oil prices climbed, the dollar fell. Are these two actions mutually exclusive? Probably not. However, in some ways, in the last twelve months oil became a proxy for inflation – and for the markets overall. We saw areas rich in natural resources (like Latin America) perform really well over the past 12 months.

And now, in the last few weeks, we’ve seen the dollar strengthen (somewhat), we’ve seen emerging markets slow down (again, somewhat) and the price per barrel of oil has leveled off around the high 70′s-low 80′s area.

This does not imply oil will collapse with absolute certainty. After all, the market generally looks pretty virile. It also does not mean we will absolutely see Lehman-style collapses in the area either. But never say never.

This is the first relative strength sell signal the oil sector has given, dating all the way back into the 1990′s.

This is one big reason why I have stopped buying in the oil patch and the emerging markets. These areas were “hot to trot” a year ago. Now, I am more skeptical about investing in these areas. Too many times, investors will look at “what did the best last year” and blindly stick their 401k money there, or invest in the hot mutual fund of 2009. Last year’s superstars may become this year’s (or next year’s) duds.

Be careful! Again, this signal could foreshadow conditions that may not appear for a few months, or even a year. Or not at all. The sector could just stall. But I’d rather be early, than a minute late.

Back On Offense

Thomas Mullooly — Tue, 12 Jan 2010 06:31:08 +0000

Just what the heck does that mean…”back on offense?”

When I refer to “offense” and “defense” I mean which team currently controls the momentum of the market.

If the defensive team is on the field, then “supply” is in control. If the offensive team is on the field, then “demand” is in control. When the market is on defense, news can be interpreted as either “no news” or “bad news.” Meaning “surprises” (good and bad) usually bring lower prices. Nearly everything can become a reason to sell.

When the offensive team is on the field, “demand” is in control of the football. We don’t know how long we’ll have the ball. It could be “3 and out” or it could be a sustained drive culminating in a touchdown. We don’t know the outcome.

But we know the plays to run when which side is in control.

See, a lot of folks (in my line of work) just run “offensive” plays, all the time. Yes, ALL the time!

And when the things don’t work out, they lament “well, right now the market is bad.”
What kind of _____ answer is that?

I’ve got a fiduciary O-B-L-I-G-A-T-I-O-N to my clients to make sure we invest this money prudently. If we are on defense, the first play in my playbook is to STOP buying. There is an entirely different set of plays I run whether we are on offense or defense.

You should know the market can go UP even when we are on defense. Or markets can just hang around doing nothing. Defense means the risk of losing money is greater.

Here’s an example: in this recent defensive period, the Dow Jones climbed to their highs for the year, but most individual stocks — and most sectors — pulled back and stalled. You probably noticed in the 4th quarter that your accounts stayed flat, while the Dow moved up. Most stocks and most sectors pulled back to the middle of their trading band. So we didn’t get hurt during this defensive period.

Ok, for this time around…defense was on the field and didn’t give much yardage. But we can spend more time talking about defense later.
For the present time, we are back on offense.

Which means the chance of making money is better now than in the recent period (when we were on defense). Yes, the market can (and does, sometimes) go down while on offense. But the odds of making money in the market improves when on offense.

Some areas will out-perform others. My work keeps us in those areas. But the tone on offense is a rising tide. And a rising tide lifts all boats in the harbor…good and bad.

So a lot of lousy investments may go up when we are on offense. When the football goes into defensive hands, the lousy investments will be exposed. Warren Buffet said “It’s only when the tide goes out that you learn who’s been swimming naked.”

We have the football. Let’s get to work.

Equal Weighted vs. Cap Weighted

Thomas Mullooly — Sat, 07 Nov 2009 20:31:08 +0000

Here is a quick video I put together to help explain the difference between equal-weight and cap-weight investment “baskets” like the S&P 500.

Auditors project deeper deficits for Obama budget

Thomas Mullooly — Sun, 22 Mar 2009 10:42:56 +0000

Every time I see headlines about future budget deficits, I keep telling myself “that is a weather forecast!” Most folks read the headline, perhaps scan the first paragraph, proceed to get bummed out and turn on the NCAA Tournament.

Just drill down into this a bit. The forecast is for a $9 trillion deficit to amass between now and the next ten years. Ten years!

Ten years ago, we were all worrying about Y2K. Remember?

Buried in the next-to-last paragraph was this little golden nugget. Read this whopper: “Long-term deficit predictions have proven notoriously fickle — George W. Bush inherited flawed projections of a 10-year, $5.6 trillion surplus and instead produced record deficits — and if the economy outperforms CBO’s expectations, the deficits could prove significantly smaller.”

There is so much ink spilled every day in the financial media that is essentially nothing more than predictions, or a public relations spot for something else. Unfortunately many of the PR and predictions become headlines. Our decisions can be swayed by too many headlines that are merely predictions or opinions. I’ve come to the conclusion everything written by the financial media has an agenda attached to it. Or said another way, everything written by the financial media is intended to make you do precisely the wrong thing.

I cannot help but laugh when I see some “expert” interviewed about the stock market, and the excuses/reasons given why markets went up or down that day. “The market is worried about inflation.” Later the same week “deflationary fears rattled the market.” Look, the market is not that smart — or that “forward-looking.”

Don’t get hung up on the Dow Jones. The Dow Jones may not be a “relevant” yardstick for you to use. After all, it’s only 30 stocks…and you might not own ANY of them. And avoid predictions and projections. It’s just a waste of time.

Charles Schwab Advertisements are Great. Here’s why…

Thomas Mullooly — Sat, 21 Mar 2009 18:20:33 +0000

Have you seen the ads that Charles Schwab has been running on TV?
You probably have seen them. They sound like real people, but they’re actually cartoon/colorized images.

These may be the best ads for financial services ever created. Here’s why:

You’re probably not aware of this, but in the financial services industry, firms and advisors are strictly prohibited from running testimonials of any sort. Think about it… how powerful would an ad be if some firm could get a few of their clients on TV and have them say: “You know, at so-and-so brokerage firm, they told all of us to get out of the stock market last summer!”

Too bad we can’t do that.

I would love nothing better than to have one client after another — in print, audio or video — in their actual voices — splattered all over my website.

See, I can expend tons and tons of hot air (or spill a lot of ink) telling you how great I am. But it becomes much more believable when you see an image of someone who looks like you, or someone who looks like someone you know, or who talks like you, or has the same problems as you, and is seeking a similar solution as you.

Which is why referrals are the strongest kind of recommendation/testimonial I can get. You told your “story” in person to someone else, and told it in such a compelling way that it moved the other person to pick up the phone and say “I want that too!” I sincerely appreciate the countless referrals I have received from you. It tells me you appreciate the work I am doing for you, and also tells me you care enough to refer your friends and co-workers. How terrific is that?

Testimonials are great — they are real people telling you real things that are important, or, at least matter to them. Maybe their advisor or brokerage firm didn’t get them out of the market, but perhaps they provide a valuable service, like — “he clearly explained everything to me like no one else had ever done before…” or even something like “he’s the first advisor I’ve worked with who actually returns phone calls!”

Can you believe we are not even permitted to run testimonials saying “we were happy just to get a phone call back, that’s never happened before!”?

By the way, if you happen to spot a financial advisor or brokerage firm with testimonials on their website, run!

This is why brokerage firms usually resort to running only “branding” advertisements. Not that there’s anything wrong with branding advertisements, in fact, they’re usually very effective over time. It’s easier for them to say “we are bullish on America” (what precisely does that mean?), than to get their lawyers to approve an ad that says “well, my broker did not steal my money and basically did an okay job.”

This is precisely why these ads from Charles Schwab are excellent. They are not real people — they’re illustrated images of real people. Their voices are real, their situations are real — the woman on the street, the guy standing over the barbecue, the older couple. People you and I could know very well.

More than that — Schwab really captures the essence of what’s going on. You know, that conversation going on in the back of your mind. These stories they tell are dead-on, bull’s-eye perfect. I can tell you that every single one of these analogies they use in their commercials, I have also heard from new clients over the last few months. Schwab has nailed it.

These are real people that really need help.

Of course, the next time you are with a friend or co-worker, listen. Listen hard to what they are saying. The main theme I have heard lately borders somewhere between worry and hopelessness, which is a terrible neighborhood. The situation today is NOT hopeless, and worry never got anyone, anywhere. Do THEM a favor, send them over to me.

Citigroup Considering Reverse Stock Split

Thomas Mullooly — Sat, 21 Mar 2009 01:00:39 +0000

One of top questions I’ve heard (over and over) lately has been:

What about buying Citibank down here?

As little as two weeks ago, the financial services giant was trading at one dollar (in fact it dipped briefly to 97 cents).

So? How can we miss, right?

Well, I can think of few reasons why this may not be such a hot deal. But before we get to that, did you ever read the first post I wrote about Citibank? It was back in November 2007.

First, “word on the street” is the uptick rule may be reinstated.

If you were relentlessly selling short Citibank, the announcement of the return of the uptick rule ought to be enough to get you to cover your short (buy back the stock you sold short). And while it’s impossible to tell, it’s my guess we saw a lot of short covering this week.

Next, the CEO of Citibank, Vikram Pandit, circulated an internal memo to employees that stated Citi actually made a profit in January and February. That’s good, right?

Maybe.

After all, the same company managed to lose $28 billion in the previous quarter. Twenty-eight-billion-dollars! How can a company manage (mis-manage?) to do that — in just a 3-month period? Mark-to-market had much to do with the write-downs they took in the previous quarter. And that rule is still in place, it has not been suspended. So, the company may still lose money for the entire quarter. Yikes.

What else? There are millions of new shares coming onto the market. Citibank is converting many of their preferreds into common stock. This dilutes the value of common shares already in the market.

Anything else? Well, yes, maybe the worst of all. The company announced they are contemplating a reverse stock split. A study completed in 2008 showed companies that did reverse splits found these reverse splits underperformed the market by 50% (on a risk-adjusted basis) during the three-year period after the action. “Reverse stock splits are a strong indicator the company is going to be a significant underperformer during the near future,” says Jim Rosenfeld, co-author of the study and an associate professor of finance at Emory University’s Goizueta Business School in Atlanta.

Many companies consider pulling a reverse stock split to avoid getting delisted. But many wind up taking that path eventually anyway. Can you imagine Citibank getting delisted from the New York Stock Exchange?

Jim Cramer: Exposed

Thomas Mullooly — Fri, 13 Mar 2009 15:06:47 +0000

I am not a big fan of Comedy Central or Jon Stewart, I’ve watched the show a few times. But on Thursday March 13, 2009 Stewart interviewed Jim Cramer on his show. And for the first time (at least that I can remember), someone actually tried to hold Cramer responsible for some of the advice he has given, and also for the fact that CNBC has “morphed” into an entertainment channel. The thrust of the conversation was more toward exposing CNBC (and to some extent Cramer) as shills for Wall Street and no investigative work is done on that channel.

Bravo. It is truly an excellent piece to watch and encourage you to do so now.

I expect Yahoo and Hulu will chop up this video shortly. So, don’t delay, see this video as soon as possible. It’s nearly 20 minutes, so take some time and watch this, it will be worth it. Here is the link: http://tv.yahoo.com/blog/stewart-vs-cramer-winner-take-all–183

Stewart said “CNBC could be this great financial tool…especially for people who believe there are two financial markets…the people who are told to invest in 401ks and just leave it there…invest for the long term…don’t worry about it.” And the other market — that occurs in a back room. Where giant piles of money are going in and out…” “But you go on TV and pretend (that market) isn’t happening.”

By the way, if you have not checked out Hulu (http://www.hulu.com) you really should. Full-length TV shows (and even some movies) are shown online. Free. Since they have no business plan to make money, I don’t expect them to be around very long. But worth a look.

Mark to Market Accounting: a basic analogy

Thomas Mullooly — Thu, 12 Mar 2009 15:02:49 +0000

How mark to the market accounting helped kill Wall Street

Mark-to-market accounting is what’s used in your brokerage account — your margin account at a Wall Street firm. To understand mark to market accounting, let’s look at what happens in a retail brokerage account that trades on margin:

Suppose you invest $80,000 in cash in a brokerage account. You sign up for margin capability. Before you place a trade in your account, you have the ability to buy up to $160,000 worth of securities with only $80,000. You will pay margin interest on any outstanding balances, and your “margin maintenance” is recalculated every night – based on the gain or loss in value of the securities in the account. This is how a margin account works.

Using the above illustration, you have 50% equity in the account, and have an outstanding margin (or debit) balance of $80,000.

Suppose the value of the assets in the account drop from $160,000 to $145,000. You now have 45% equity in your account. You still have buying power and seem to be in no imminent danger of a margin call. Remember, you still owe $80,000. If you were to close the account now, you would sell the assets for $145,000. The margin debit balance of $80,000 would be paid (margin interest would also be included). The securities dropped almost 10% in value (from $160,000 down to $145,000) but you lost nearly twice that percentage, because you leveraged the trade. You would be left with the remainder… approximately $65,000.

But suppose the value of the assets in the account dropped from $160,000 to $100,000. You now have 20% equity in your account. Remember, you still owe $80,000. At this stage, you have no more “buying power.” This means you cannot take money from the account, nor can you buy any additional investments. In fact, at 20% equity you have a “margin call” and your broker would be contacting you requiring you to deposit more money (or other securities) to boost the equity in the account.

Margin works wonderfully when the assets in your account are rising in value. But margin will wipe you out when the assets in your account are falling in value.

The assets in the account are repriced every single night in a margin account. And the equity is calculated every day and the amount needed for “margin maintenance” is also calculated every day. And when your account gets upside down, you have a margin call, and it needs to be rectified right away.

Margin accounts are calculated using mark to the market accounting.

Banks (and brokerage firms) that own mortgage backed securities have been required — since November 2007 — to use mark to market accounting on these securities. Coincidentally, this was just around the time these mortgage securities started dropping precipitously in value. 2007 saw many mortgage firms get wiped out, and brokerage firms and banks holding these assets started realizing the volatility of these assets.

Remember banks and brokerage firms were required to employ mark to market accounting beginning in November 2007 for mortgage backed securities. As real estate values collapsed, and foreclosures began to rise, banks and brokerage firms no longer wanted to hold the securities as investments on their books. It is no wonder then, that six months later (March 2008) that one of the biggest holders of mortgage backed securities — Bear Stearns — was caught in a massive credit squeeze. The assets that they regularly borrowed against were no longer “borrow-able.”

Bear Stearns — which had traded at well over $100 per share months before, agreed to sell themselves to J.P. Morgan Chase for two dollars per share. This figure was ultimately increased to $10 per share.

By mid– 2008, Merrill Lynch had decided to unload a $31 billion pool of mortgage backed securities that they owned, and essentially announced they would take the best offer. These mortgage backed securities had been held on the books (it’s estimated) at $.80 on the dollar. This pool was sold for $.22 on the dollar in July, only after Merrill Lynch agreed to subsidize part of the losses that might be incurred by the buyer.

These are anecdotes and examples using vast over-simplification and are being used to illustrate how mark-to-market accounting works.
While not directly connected, mark to market accounting required that other banks and brokers investing in similar type investments market their own similar assets down to similar levels. Thus, the entire mortgage backed market froze. Trades were no longer taking place, because every time a trade would take place, it would require the values of similar securities to be repriced everywhere. These securities could no longer find a value and could not be borrowed against, hampering most lending capabilities at these firms.

Mark-to-Market Hearings Today

Thomas Mullooly — Thu, 12 Mar 2009 14:13:07 +0000

If you haven’t been able to make heads or tails of the credit crisis, read this.

Thursday, March 12, 2009 is the day the House Securities Subcommittee will hold a hearing on mark-to-market. The chairman of the committee, Paul Kanjorski (from Pennsylvania) seems to agree with us — mark to market standards have proven “problematic” for banks.

Mark to market (also known as fair value rules) has been only one of the contributing factors in the recent credit crunch.

Many mortgage and bond-related assets, many of which had been AAA rated previously, have been experiencing a mandatory write down in value, because of these accounting rules. Many of these assets needed to be “re-priced” nearly every day. This is how Citibank could lose $28 billion in the last quarter. Think about that number. A quarter is only 90 days long — and not all of them are business days. And yet, for a bank (or any business) to lose $28 billion is hard to conceive. That’s over $300 million lost on a daily basis during the quarter.

How can that be?

Mark to market accounting rules required that banks write down the value of assets on their books — nearly every day. Even though these assets were not bought and sold (they couldn’t be sold — the trading market for asset backed securities has been frozen for nearly a year), they still needed to be marked down.

What I expect we will hear from these hearings on Thursday is something along the lines of “there should be an exemption from a need to repriced these assets on a daily basis since there is no liquid market for these securities presently.” I also expect we will hear a proposal to improve the situation these banks are facing. It would not be a big surprise to hear testimony proposing “mark to the model” instead of “mark to market.”

Mark To A Model

“Mark-to-a-model” is a proposal that has been gaining speed. Many have argued it is not realistic to carry these securities at the full face value of the underlying security, nor is it realistic to carry these securities at zero value either (like now). What might be a better — temporary — solution is a financial “model” that can gauge the average holding period of the securities, the average duration of the portfolio and a model of the credit composition of the portfolio. At least with a model, minimal (floor) values can be placed on the securities.

What would be the result of a change in mark-to-market, or instituting mark-to-a-model?

The first benefit would be a drastic increase in the book value in market value of the securities on hand at banks. No one is trying to game the system. By re-inflating the value of many securities on hand at banks, this will automatically raise the capital ratios at these banks.

So what?

Raising the capital ratios at these banks removes the need for bailout money.

You may have read recently that banks are “hoarding cash.”

Why would the banks hoard cash — especially when lending is needed to restart the economy?

Well, the banks have been required to maintain certain capital ratios, or be declared insolvent and run the risk of being taken over by the government, or closed. So, although the banks have received capital injections, with the purpose of lending, the same banks have been “hamstrung” because they need to maintain a certain amount of cash on their books to meet capital ratios.

These capital ratios will be met if they suspend mark to market accounting, at least on a temporary basis.

It may also help to re-ignite trading in these asset backed securities. This helps improve liquidity and lending capabilities. Put another way, you cannot borrow against securities that don’t have a liquid market and do not trade. While the “marginability” of these securities is severely hampered, just re-establishing a market for these securities is a step in the right direction.

Let’s hope they don’t screw it up.

Bank Nationalization and Mark to the Market

Thomas Mullooly — Tue, 03 Mar 2009 06:06:31 +0000

Mark to Market is a topic I have written about previously.

You can read about them here. I don’t like changing the rules of the game in mid-stream, but something drastic needs to be done. A terrific opinion piece was written in the Wall Street Journal recently by Peter Wallison. If you click on his name, you can see his very impressive resume. Graduate of Harvard Law, adviser to Nelson Rockefeller, adviser to President Reagan, General Counsel to the US Treasury, Wallison has the credentials.

The Obama Administration has still not come up with a plan to remove troubled assets from the balance sheets at banks. Therefore, their solution appears to be “semi-nationalization,” as evidenced recently when the US Government and Citigroup agreed to convert the preferred shares held by the government into common shares. The US Government will soon own approximately 36% of Citigroup, which is about as aclose as you can get to nationalizing a bank without coming right out and saying it.

Wallison asks a very important question as the thesis of his article. Accounting rules are very important, and should not be bent. This situation appears exceptional, but that does not mean there will be other exceptions in the future. It is a dangerous precedent. What most commentators and other media are missing is this important twist. Wallison writes:

What happens, then, when there is virtually no market for these assets — as has been true for at least a year? In that case, accounting rules require the banks use whatever market indicators are available.

What will this imply for other banks that are in trouble, or soon fall into trouble? How endless is the money supply?

I agree with Wallison’s approach…nationalizing the banks is a terrible solution. Revisiting mark to the market needs to become a priority. And Wallison writes:

…Both taxpayers and banks could come out well — and so would our economy — if the government were to buy the assets at their “net realizable value,” which is based on an assessment of their current cash flows, discounted by their expected credit losses over time.

Take a look at the article here (printed in the Wall Street Journal February 25, 2009). Additionally, suspending mark to market can effectively replace another cash infusion from the Government. It is worthy of consideration.

Mark to the Market

Thomas Mullooly — Wed, 25 Feb 2009 02:46:06 +0000

Throwing good money after bad into these banks is not the answer.

Now, I don’t like changing the rules in the middle of the game. But I still believe the almost-immediate fix for this entire mess is suspending “mark to the market” regulations.

Read this statement from news sources today: Citigroup declined to comment on talks with the government, but in an email said its capital base is very strong, despite $28.5 billion of losses in the last five quarters.

How could Citigroup lose $28 billion — and say they are very strong?
Believe it or not, it is TRUE.

They HAVE to book these losses due to “mark to the market.” This is really important! When a competitor has to mark down the value of bonds, mark-to-the-market means you must do the same thing on your books…whether you sell or not!

OK, true, these same banks made profits hand-over-fist when real estate was going up and they leveraged like crazy off it. So, if you run your business that way, it’s going to be painful…no…near suicidal…when things are bad.

And that’s precisely whats happening now.

Now, a capitalist society says the weak will be extinguished. OK.

So weak auto stocks should be wiped out.

Weak homebuilders have to go.

Weak retailers, see ya.

But banks provide the grease for the entire economy. They should NOT be bailed out with cash.

Suspend mark-to-the-market. Now.

Retention Bonuses

Thomas Mullooly — Sat, 21 Feb 2009 15:47:02 +0000

There have been several articles written recently regarding stockbrokers and retention bonuses.

If you are outside the industry you may not know when brokerage firms are merged or acquired, the brokers (the salesforce) are sometimes awarded bonuses merely for staying. The reason behind the bonus is the broker/salesperson may face a drop-off in business, the bonus may help smooth the transition period.

Often times, the retention bonus requires a broker to stay at the firm for a long period of time. That’s usually good for his or her business, showing they are stable while the sign outside the building may be changing.

Larger producers may get these retention bonuses, while lower-end producers may see a significantly smaller bonus, or perhaps nothing. Some of these deals, in my opinion, carry staggering, eye-popping numbers.

This has been getting attention lately because many of these same firms that planned retention bonuses also received TARP money from the government.

It’s hard to justify (in my opinion) handing out retention bonuses as a worthwhile use of taxpayer bailout money.

Others apparently agree.

On February 20, 2009, it was reported Wells Fargo has decided NOT to pay retention bonuses to the Wachovia brokers they recently acquired. “With the environment we’re in, with all the attention we’re under — all the firms are under — and with clients down 20%, 30% and 40 % … a [retention] bonus didn’t seem to be the appropriate approach,” said Wachovia Securities spokesman Tony Mattera. You can read more about it here.

And also here.

Also, on February 11, 2009, retention bonuses were also picked up by the Huffington Post (and other news outlets). In that article, it discusses how some brokers were informed “There will be a retention award. Please do not call it a bonus” The Huffington Post article also contains an audio clip from the conference call for Smith Barney and Morgan Stanley.

The article also cites some comments describing the retention bonuses/awards as a “gratuitous expense” and even quotes a former chief economist at the U.S. International Trade Commission as saying “They are putting lipstick on a pig,” said Peter Morici, a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission. “Very often, retention bonuses are paid to undeserving executives who helped drive their enterprises into the ground…”

You can read the entire article (along with the audio portion) here.

And also here.

Revisiting Mark to the Market

Thomas Mullooly — Sun, 15 Feb 2009 11:36:38 +0000

What is left in the governments bag of tricks to get the banks back on track? One topic that I wrote about — 5 months ago — has popped up this past week with more and more frequency. We are finally starting to hear more and more chatter about relaxing “Mark to the market” regulations.

What is mark to the market?

Suppose a house on your street went into foreclosure. Previously, that home — and every other home on the street had a value of $600,000. But the foreclosed property went through a sheriff’s sale and was sold for $250,000. Does it mean every home on the street must suffer the same price cut? Events like this can “dent” prices up and down the street. But following market to the market regulations, every home on that street would now be worth $250,000.

Is that fair, or even realistic?

This is what banks and brokerage firms have been dealing with. It’s absolutely glorious when prices are moving up. But it is a nasty, vicious, life threatening downward spiral when prices are going down. Let me explain:

In summer of 2008, Merrill Lynch desperately wanted to get out of a large investment ($31 billion) of mortgage backed securities. Merrill, and many other brokerage firms were still carrying these bonds on their books at approximately $.80 on the dollar (80% of the face amount). They received an offer of $.22 on the dollar, only a fraction of what they were carrying them on their books. When Merrill completed the sale, all other similar investments — at Merrill Lynch and every other firm — had to be marked down to those kind of levels.

Here’s where bad news gets worse. Most banks and brokerage firms were choking on debt like this. After all, Standard & Poor’s and Moody’s had rated these mortgage backed securities as high-quality investments. This allowed banks and brokerage firms to hold these investments instead of treasury bonds (which had much lower interest rates), and these high credit ratings also gave them the opportunity to borrow against them. The benefit to the banks was easy to see. But everyone else benefited too: somewhat higher rates were paid on CD’s and bonds, loans were available to many, and mortgages were created at lower rates. We all drank from the well. Some more than others.

Here’s where worse news becomes a catastrophe. Many banks and brokerage firms were leveraged 30:1 or 40:1. Meaning, if the value of these bonds dropped by 5%, they had a serious problem. This is why they started creating, buying and selling these additional “bets” or “side contracts” known as credit default swaps. Most of these mortgage backed investments had already been marked down to about 80%. But the bar was brought down to 22 with that Merrill deal. Yikes.

I am completely against bailing out incompetent management. Wall Street and the banks have taken some really dumb risks and made terrible decisions. Indeed, some of these executives need to be shot. But the problem is that the banks provide “the grease” that keeps the economy moving. So something needs to be done. Mark to the market needs to be modified. Yes, it means changing the rules in the middle of the game, which really isn’t fair.

There’s more (much more), but that’s enough for now.

Rep retention awards may face scrutiny on Hill

Thomas Mullooly — Sun, 25 Jan 2009 22:23:14 +0000

Brokers and TARP Money

Looks like others are starting to learn the story. Your individual stock broker — getting TARP money — is just plain wrong. And the size of these retention bonuses is extreme.

But believe it. It is happening right now. Merrill brokers are getting their TARP money right now.

What’s even more outlandish is the fact that industry executives (who created the very concept of paying these retention bonuses) refuse to call them bonuses. In the Investment News article (link is below), a spokesman for Morgan Stanley states these are “not bonuses.”

Let’s clear this up, since many folks outside the business don’t seem to understand how these retention bonuses work.

The structure of a retention bonus works like this: 100% (or more) of the stockbrokers trailing 12 months gross commission is handed to the broker. So a broker generating $750,000 in commissions the last 12 months could be handed a check for $750,000 (or perhaps $1,000,000) in TARP money. Your money.

In exchange for the TARP money (retention bonus), the broker signs an agreement to stay at the firm for a period of time (several years). This money is also structured as a “forgivable loan” or “forgivable note.” What this means is, if the length of the deal is 5 years, then 20% (one-fifth) of the loan is written off (forgiven). So every year, the stockbroker in this example would have “phantom income” for each of the five years of his deal. So the stockbroker would have to make allowances to cover his income taxes.

But the money is real. Very real.

Think this is a small group of stockbrokers? Think again. Brokers generating less than $500,000 are being shown the door at many large firms, or seeing their payouts chopped.

Stockbrokers are being handed money to sit at their desks. TARP money.

Your money. Completely wrong.

Here is the link to the article in Investment News.