RCM Editorial: Believing in The Gold Bull Market. Does it Take Faith or Simply Common Sense?

I feel compelled today to discuss what I am hearing is the eminent demise of the Gold bull market. I have been forced to field emails, phone calls and, yes, even a text message on this topic over the last couple of weeks. To say the least, I am disappointed with some in our flock. Over the last 3 years we have painstakingly laid out the road map to perhaps one of the best bull markets in history. Gold prices have out performed all major asset classes in the last 5 years and in 2008 increased 5% while the rest of the financial world was imploding. In the midst of this financial desert, our commitment to Gold last year led to profits for the limited partners of Fortune's Favor I and Fortune's Favor Precious Metals. Gold had a wonderful start to 2009 and in the last 6 weeks has pulled back roughly 10% from the highs. A well deserved rest and a necessary coiling for the 3rd assault on the $1,000 mark that will take prices to new bull market highs.

I am loath to get biblical, but I imagine my discouragement may be akin to that of Moses and his experience with the Ten Commandments. Indulge me for a moment before you roll your eyes at what you perceive to be a bombastic statement. I have basically come down from the mountain with the tablets to investing success and in a few short weeks some of our followers are dancing around a fire built by the heathens of the oft manipulated news media. In an ironic twist, instead of worshipping gold these nonbelievers have been led astray by price weakness (10% off the top would be considered small in any circle), supposed IMF gold sales and a general misguided belief that if the markets go up Gold goes down as the fear trade subsides.

Of course, this is where the juxtaposition with Moses ends. You see, believing in G-d takes faith, but believing in the Gold bull market simply takes common sense.

Has anything really changed the picture in the last 6 weeks? Let's review:

-The tsunami of fiat currency creation around the world is perhaps the single biggest supporting factor for the Gold bull market. Have we witnessed a miraculous about face of governments around the world in the last 6 weeks indicating a tightening of credit and fiscal responsibility? I don't think so. In the U.S., the Fed's balance sheet has more than doubled in size since August. If you think that expansion is coming to an end you are sadly mistaken. During the last 6 weeks, instead of planning fiscal responsibility, the Fed completed an internal study condoning - in fact, encouraging - further balance sheet ballooning. And I'm not talking about the balloons on the back of a birthday chair. I'm talking about the kind that fills with hot air and carries a basket. Want details? Read this story, you will not believe it:

Fed study puts ideal US interest rate at -5% - FT reports the ideal interest rate for the US economy in current conditions would be minus 5%, according to internal analysis prepared for the Federal Reserve's last policy meeting. The analysis was based on a so-called Taylor-rule approach that estimates an appropriate interest rate based on unemployment and inflation. A central bank cannot cut interest rates below zero. However, the staff research suggests the Fed should maintain unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5%. Fed staff separately estimated what size and type of unconventional operations, including asset purchases, might provide this level of stimulus. They suggested that the Fed should expand its asset purchases by even more than the $1,150 bln increase policymakers authorized at the last meeting, which included $300 bln of Treasury purchases. The assessment that the US central bank needs to provide stimulus equivalent to a substantially negative interest rate is unlikely to have changed ahead of this week's policy meeting. (In order to achieve a rate of -5% interest this implies the Fed is targeting an inflation rate of at least 5% with the Fed funds rate at 0%. We are frankly surprised the study was actually made public. This policy suggests the Fed is deliberately targeting a decline in the US$, which is contrary to the government's public rhetoric.)

-Some misguided souls have argued the fear trade is leaving the market. Apparently, the world is a safer place and that's why gold is trading down 10%. This is such a ridiculous supposition that I find it difficult to address. During the last 6 weeks North Korea has sent a missile over Japan, the Taliban are enforcing Islamic rule in parts of Pakistan as war brews and meanwhile, our President is bowing to kings in the Middle East and forming a rather dubious book club with dictators in South America. I think the real reason for the 10% swing in Gold is really rather boring. No market goes up in a straight line. Corrections are necessary to shake out the weak holders and build a base to launch new assaults on the old highs. Since this is a mundane answer it would never work on CNBC. The news media needs to sensationalize in order to captivate. Beware, sometimes market volatility creates news, which can be misleading.

-I will conclude with a comment about the IMF Gold sales and a friendly wager. First, let me be clear, the proposed sale by the IMF is not new information and therefore was not a shock to Gold market participants. The G20 communique read, “…Additional resources from agreed sales of IMF gold…” will go to support developing countries. This is not a declaration of new sales agreements. Second, the communique read, "…To provide $6 billion…over the next 2 to 3 years…” Let's breakdown the numbers shall we?


IMF holds 103.4 million ounces
Current value of holdings at $900/ounce = $93.6 billion
Proposed sale as per communique = $6 billion roughly 6.6 million ounces
Avg. daily ounces traded on the London Bullion Market as of Feb. 2009 = 23.8 million ounces
6.6 million ounces sold will have virtually no impact on the Gold market today let alone over the next 2 -3 years.

And here comes the wager: Western central banks scoff at the importance of Gold and attempt to manipulate the metal lower with well-timed comments and outright sales in order to continue the farce of fiat currency creation. Meanwhile, the East is buying with ever increasing vigor. If the IMF wanted to sell this 6.6 million ounces all at once China could very well be the buyer. We will wager that the day this deal is announced Gold prices will end higher not lower. In fact, we would not be surprised to see the Chinese bid a premium for the entire IMF Gold position. Curious about the Mandarin metal mandate? Look no further:

China reveals it has 1,054 tons of gold - Reuters Reuters reports China revealed on Friday that it had quietly raised its gold reserves by three-quarters since 2003, increasing its holdings to 1,054 tons and confirming years of speculation it had been buying. Hu Xiaolian, head of the State Administration of Foreign Exchange, told Xinhua news agency in an interview that the country's reserves had risen by 454 tons from 600 tons since 2003, when China last adjusted its state gold reserves figure. The world gold market has been buzzing with talk about China buying gold for years as the country's foreign exchange reserves have rocketed, and speculation has picked up since the global economic crisis threatened to weaken the value of those reserves. Gold prices jumped on the news and were up 1% on the day at $910.80 an ounce at 0540 GMT. By a Reuters calculation, China's holding of gold would be worth $30.9 bln at current prices.

News that Moves: Wells Fargo Mark to Fantasy Revealed

RCM Comment: I have been writing at length about the creative "better than expected" EPS coming from the banking sector. Today, I offer the analysis of Dave, a colleague on gata.org who really nails the Wells Fargo fraud, enjoy.

"So far — and especially in Q1 — Wells/Wachovia benefited from gov’t and bank-specific foreclosure prevention and moratorium. This kept Q1 foreclosures at a year low but pushes them down stream. Meanwhile, Q1 defaults surged which will lead to a surge in foreclosures in Q2 and beyond. "

More from Dave on WFC...

Right as the CFO of Wells Fargo was on CNBC spouting out that WFC has a better loan portfolio than others, this piece of data hit the newswire showing that in California mortgage defaults hit a new record during the first 3 months of 2009:
http://www.calculatedriskblog.com/2009/04/dataquick-mortgage-defaults-hit-record.html
Two points of note: 2009 will probably be a record year for notices of default AND "defaults are movin' on up into the mid and high priced areas." This is the "better loan portfolio" of Wells Fargo: 41% of WFC's mortgage portfolio is based in California AND 50% of WFC's portfolio is comprised of pay-option ARM mortgages, which are entering into a "bulge" period of resets and are widely considered to be the most toxic of the 1st lien mortgages. Anyone want to believe the statement made by the CFO of WFC? The comment uttered by this guy is about as credible as O.J. Simpson's claims of innocence.

Mark to fantasy and Wells Fargo's earnings

... is nothing more than legalized accounting fraud being presented to the world in the form of Wells Fargo's 1st Qtr 2009 earnings release. As suspected, the infamous "record profits" preannounced 2 weeks ago by Wells Fargo are nothing more than a result of our Wall Street-financed Government, including our President, forcing the FASB to change the way big banks account for toxic assets. As per WFC's earnings release today:

"The net unrealized loss on securities available for sale declined to $4.7 billion at March 31, 2009, from $9.9 billion at December 31, 2008. Approximately $850 million of the improvement was due to declining interest rates and narrower credit spreads. The remainder was due to the early adoption of FAS FSP 157-4, which clarified the use of trading prices in determining fair value for distressed securities in illiquid markets, thus moderating the need to use excessively distressed prices in valuing these securities in illiquid markets as we had done in prior periods."

Essentially, what WFC did was post $5.2 billion mark to fantasy gains, which were then added into its revenues, by reversing out previous charges expensed against their securities and loans held for sale. Without this gain, Wells Fargo loses a couple billion.

In looking at WFC's balance sheet, I see that their "securities held for sale" miraculously jumped to 27% of their net loans vs. being only 21% of loans at the end 2008. This is obviously WFC taking full advantage of the new mark to fantasy accounting standard and piling as much toxic waste into this category and marking the price levels up substantially. Be really interesting to see what kind of worthless crap was conveniently moved into this category.

I'm sure there's several billion worth of further indiscretions and outright fraudulent accounting that was incurred during WFC's record-breaking 1st Qtr. For those interested, here's the press release:
http://finance.yahoo.com/news/Wells-Fargo-Earns-Record-305-bw-14995023.html?.v=1
Now we wait for the 10-Q to be filed so we can determine just how much smoke the crooks running Wells Fargo....

News that Moves: Volcker Takes on the Fed, Obama and the IMF, TARP Exit Debate

RCM Comment: IT'S ABOUT TIME!!
By Timothy R. Homan Bloomberg News Saturday, April 18, 2009
Former Federal Reserve Chairman Paul Volcker said Congress will probably review the authority granted to the Fed following emergency credit programs doubling the central bank's balance sheet to $2.19 trillion. "I don't think the political system will tolerate the degree of activity that the Federal Reserve, in conjunction with the Treasury, has taken," Volcker, head of President Barack Obama's Economic Recovery Advisory Board, said today at a conference at Vanderbilt University in Nashville, Tennessee. U.S. lawmakers from both political parties have expressed concern in recent months that the central bank has overstepped its authority by creating several emergency credit programs aimed at reviving lending and ending the recession.
"I think for better or for worse we are at a point where the Federal Reserve Act, after all that has been happening in the last year or more, is going to be reviewed," Volcker said…

Obama proposes $100 bln loan for IMF - Reuters reports President Barack Obama Monday proposed a $100 bln U.S. loan to the IMF to boost the IMF's war chest and urged a bigger stake in the IMF for emerging powers like China and India. In a letter sent to Democrat and Republican leaders in the U.S. Congress, Obama said the U.S. funding "does not represent a budgetary expenditure or any increase in the deficit since it effectively represents an exchange of assets." RCM Comment: If you have yet to be offended by a number of nefarious comments coming out of the mouth of our president then this should do the trick. After reading this comment I was confronted with two equally uncomfortable questions: How dumb does Obama think we are? Or, how dumb is Obama? If Obama really believes this statement then he must also believe (and want us to believe) that the $700 billion+ bailout of US banks "does not represent a budgetary expenditure..." because assets were exchanged. Have we fallen down a rabbit hole? I suspect if this Carrolleusque thinking continues on Capital Hill we are days away from a headline applauding the Mad Hatter's (Obama, for those of you not paying attention) ability to reduce the budget deficit through his brilliant plan of spending.

RCM Comment: These next two stories disturb me as it would appear the government wants to retain control of the banks even if they are healthy enough to repay the TARP loans. This is not a healthy development for the banks. We are witnessing a battle between nationalization fears vs. recovery cheers. The equity market rally has been in part a result of recovery cheers gaining momentum. This new developing story may quiet the crowd.
Geithner weighs bank repayments - WSJ The Wall Street Journal reports Timothy Geithner indicated that the health of individual banks won't be the sole criterion for whether financial firms will be allowed to repay bailout funds, a position that might complicate their efforts to give back the cash. In an interview, Mr. Geithner laid out some broad principles, including the need to consider the overall health of the financial system and the flow of credit in judging whether banks can repay their government investment. Among large banks, Goldman Sachs (GS) and JP Morgan (JPM) have both said they want to repay the government. "We want to make sure that the financial system is not just stable, but also not inducing a deeper contraction in economic activity. We want to have enough capital that it's going to be able to support a recovery," Mr. Geithner said. Mr. Geithner also said he plans to discuss signs of improvement in the U.S. economy with his counterparts at the coming Group of Seven finance-ministers meeting. But he said a "dramatic" mobilization of resources is still needed across the world to avert a deeper global recession. "We're trying...to make sure there's as strong and broad a global consensus on stimulus, financial repair and quick deployment of resources to emerging economies so that we can avert risks of a deeper downturn world-wide."

Financial firms lobby to cut cost of TARP exit - WSJ
The Wall Street Journal reports the banking industry is aggressively lobbying the Treasury Dept. to make it less costly for financial institutions to get out of TARP. The move could prove controversial for the banking industry, which is busy deflecting criticism about higher fees it is charging consumers for credit cards and other products and services. At issue are "warrants" the government received when it bought preferred stock in roughly 500 banks over the past six months as part of TARP. The warrants allow the government to buy common stock in the banks at a later date so taxpayers can receive more of a return on their investment when the banking industry recovers. Many banks want to return their TARP money and, as part of that effort, want to expunge the warrants. To do that, banks must either buy them back from the government or allow the Treasury to sell them to private investors. Today, most of the warrants are essentially worthless, because their exercise price is higher than where most banks' stocks are trading. But the government believes the warrants still have value, since they give the Treasury the right to buy common stock at a set price for 10 years. Bankers say it is unfair to charge what amounts to a "prepayment penalty," which makes it additionally onerous to escape TARP. Bank representatives say the cost of buying back the warrants could be equivalent to paying 60% annual interest on short-term loans. That, they argue, would exacerbate banks' existing problems.

RCM Editorial: Banks' Earnings Scorecard

Big banks with government support VS. Smaller banks operating in the real world

"Better than expected" EPS (the big banks)

Wells Fargo (WFC)

Goldman Sachs (GS)

J P Morgan (JPM)

Bank of America (BAC)

Worse than expect EPS (the smaller banks)

Keycorp (KEY)

Pacwest Bancorp (PACW)

SVB Financial (SIVB)

US Bancorp (USB)

Zion Bancorp (ZION)

State Street (STT)

Bank of New York Mellon (BK)

Comerica (CMA)

Huntington Bancshares (HBAN)

Northern Trust (NTRS)

ETC. (Too many to list, but you get the idea)

So the jury is back and the results were as expected for those of you who follow this blog. Over the previous few blogs the banking analyst at Rosenthal Capital Management (that would be yours truly) presented a case for a rather egregious dichotomy developing in the banking space at the behest of our government. In a desperate attempt to reverse investor sentiment and create an environment for banks to raise capital, the government changed rules and gave support to the biggest banks. The last 5 weeks have been rife with "positive" announcements from the big banks that led to a spirited stock market rally. Companies like GS have jumped at the opportunity to raise capital. GS issued new stock at $123 / share, raised $5 billion and the stock has not traded above $123 since even though we were told the deal was dramatically oversubscribed (the stock trades between $113-$115 as I write this).

Week 6 of the stock market rally is underway and reality can no longer be avoided or covered up. The smaller regional banks are announcing earnings and without the help of government the numbers can only be described as macabre.

Important Rule: The reaction to the news is more important than the news.

The direction of the market in the coming weeks can certainly be debated. Yes, we were right on the news, but often it takes time for the herd to respond to reality. Cracks in the foundation of this market rally have formed. Momentum is waning as the market moves higher and volume signals are flashing yellow. However, a market responding to government manipulation can be hard to predict short term so caution is the word of the day.

News that Moves: GS EPS Comes into Question, Neil Barofsky's AIG Investigation, SIVB Worse than Expected EPS

RCM Comment: Goldman Sachs continued...

Cracks in the foundation of the "better than expected" Q1 numbers from GS. The first story below highlights the rather dubious decision by GS to change its fiscal year, which helped reduce the impact of an awful December. The second story is perhaps even more troublesome as it attacks the very root of Goldman's "successful" quarter. We wrote at length on April 1st that "AIG was responsible for banks' profitability" and we explained that this would cast a specious light on the EPS numbers. Well, now the regulators have jumped into the ring. Neil Barofsky, the chief watchdog of the U.S. financial rescue program, has launched an investigation into the AIG unwind.

The Baseline Scenario: "...the quarter-over-quarter comparisons left out December. Because Goldman just changed its fiscal year end, its previous quarter ended in November and its latest quarter ended in March. December was reported separately and - surprise, surprise - Goldman took a net loss of $0.8 billion. So if they had mashed December into Q1, they would have had a four-month “quarter” with $1.0 billion in profits."

ZeroHedge: Legislators want to know if AIG offered less to retire the contracts and whether there was any review about banks’ ability to sustain losses on the derivatives.“To what extent did AIG pay counterparty claims at 100 percent of face value and was any attempt made to renegotiate and close out these claims with ‘haircuts?’” Barofsky wrote. “Questions concerning whether AIG paid more than necessary to counterparties and whether Treasury adequately monitored such payments are clearly relevant.”

RCM Comment: Another piece to the Q1 EPS puzzle has snapped into place. As I explained yesterday, we anticipated "better than expected" EPS numbers from the big banks but worse than expected numbers from the smaller banks. These smaller banks are not involved in the AIG unwind, so will not get the false boost to EPS. They are not privy to select government information, so they cannot set up proprietary positions that benefit from government action. The story below details the EPS pre-announcement of a California bank. Get used to this type of report, you will be reading more like this in the weeks to come.

SVB Financial Group: Color on pre-release (20.89 ) : Friedman Billings notes that yesterday night, SIVB pre-released 1Q09 EPS of ($0.28) to ($0.36), well below the $0.23 consensus est. They note primary drivers of this shortfall are credit deterioration in its Shared National Credit (SNC) portfolio, material NIM compression due to holding new deposits in lower-yielding securities, and valuation declines in its investments in VC funds (held in SVB Financial Group's securities portfolio). They remain cautious near term as they expect similar headwinds at SIVB moving forward in '09, which will likely keep valuation compressed. They believe the discount it trades at is warranted given their near-term concerns surrounding credit quality in its loan portfolio and risks of further securities losses related to its investments in VC funds.

News that Moves: Goldman Sachs Earnings and $5 billion Secondary

RCM Comment: I continue to believe we will see a significant division within the banking sector during earning season. As I have stated, I expect the big banks (GS, WFC, JPM) - who are in cahoots with the government - to post "much better than expected EPS", while the smaller regional banks will not. The first test of this theory has been confirmed as WFC and GS post "surprises".

The story below allows us to dig deeper into the "surprise" and see that "the Goldman numbers were driven by the best FICC (Fixed Income, Currency & Commodities) trading results ever". This is not an area where smaller banks participate. Unfortunately, "illiquid assets...continue to head lower" and commercial real estate "whole loans and CMBS (commercial mortgage backed securities)" continue to suffer. I suspect these areas to hamper the rest of the banking sectors earnings.

Of course, the reaction to the news is more important than theories. Now is the time to watch closely and use the markets' action over the next few weeks as a guide to portfolio management. GS announced and priced their much anticipated $5 billion secondary at $123/share. This price is now the line in the sand. If the stock can hold above $123 and head higher that would have to be viewed as positive for the markets overall while an inability for the syndicate to support $123 may suggest that the rally has stalled. Patience will be key in the coming weeks stay tuned...

Briefing:
GS Goldman Sachs Conference Call Summary -Update-
GS says that the altered competitive landscape was a helpful component behind its strong performance Trading margins are robust... cautious about the near term outlook; remain focused on core strategy... Says there was nothing in reversal in marks on illiquid assets, they continue to head lower... virtually all cash flows with AIG (value for value) to part at the end of the year, most were unwound before the end of the year; P&L regarding AIG in Q1 amounted to zero... had $800 mln in losses related to Commercial real estate; combination of whole loans and CMBS; hedging in this area amounted to a $100 mln profit... Revenues in FICC were broad based; benefitted from higher spreads and less competition but also suffered a little from lack of volume... is not able to say they will have $6.6 bln in FICC every quarter but states that outside of the writedowns in Q4, they have performed well in every type of environment... says they are not putting a lot of weight on linearity in the quarter; believes performance was well spread out... CRE have market value of $8.5 bln (was $10 bln last quarter), about $1.5 bln was CMBS; Real estate portion of that was approx $7 bln and that was marked at 50 cents on the dollar... residential real estate they have approx $4.5 bln split evenly between prime, Alt-A, and subprime; says that amount is a trading amount that will fluctuate and would not even refer to them as legacy assets...

Gross leverage on the balance sheet was 14.7x (was approx 18x last quarter)... leverage loans from the $52 billion of legacy loans that they had at end of 3Q07 were down to a market value of about $2.3 billion so the exposure there is pretty minimal at this point and the average mark on that $2.3 billion is in the range of $.50.... security services revenue remains tight with the reduction in hedge fund assets; growth should be slower in this business... there was not a lot of new lending commitments made in Q1; says they are a corporate lender not a consumer lender and the requests were not there this quarter... says there is still headwinds for asset values which keeps them cautious; does not believe they have as many assets as some of its competitors; says that its economist are more optimistic (or less pessimistic) about 2H09...

Asked about TARP: says stress test should be completed at the end of this month; says after the completion of the stress assessment they would like to redeem the TARP capital if allowed... Asked about Private Equity commitment fund: says the announcement yesterday on the $5.5 bln fund (Vintage Fund V) was 'old news'; says this is to buy secondary interest in the private equity fund... expects private equity investing to be slow as there is not a lot of leverage available... continue to see opportunity in the very illiquid products; notes they have a good history in investing in distressed assets; says sellers and buyers prices have not come in line but expect that to happen in the next few months; expects to see opportunity and believes the BRIC countries will be great opportunities in the next five years...

Says they are seeing 'a pretty big pick up' in Capital Markets activity; can not say if this will be sustained... expects the merger business to take more time to recover; need to see a sustained pick up in the economy to generate the enthusiasm behind this area... Tier 1 ratio under Basel I improved to 16% from 15.6% (notes this is its first quarter as a bank holding company so prior comparisons are difficult)... excess liquidity pool is a drag on earnings and ROE; believes in this environment it is prudent to park assets there; would make the trade off of slightly lower earnings and ROE for the prudence of having the higher liquidity... would like to continue to issue unguaranteed debt; believes spreads will come in and allow them to do that... virtually all of the revenue was from very liquid products, very little in anything that was illiquid... first time since the Summer they have seen two IPOs in the same week so the Capital Market are picking up...

In FICC there was very little write up or reversal of prior marks on assets... had a loss of about $200 million on own debt because credit spreads tightened across the quarter... Asked why VAR was higher: just volatility and movements in credit spreads that drove it...

Asked about TARP vs FDIC's TGLP Program: does not believe they are tied together; notes there are participants in the FDIC guarantee program who did not have TARP capital today and think that Congress has made it pretty clear that they are interested in the equity investments in the firms that have received TARP capital and those things are not tied together; still have some capacity under the FDIC guarantee at pretty attractive spreads so will continue to use that when it's available but expect to continue to raise unguaranteed that once available as well.

RCM Editorial: Is This Rally Sustainable? Goldman Sachs Gives Hints & Meredith Whitney Weighs In

The cause and durability of this equity market rally continues to be a hotly contested debate. I would like to throw my hat in the proverbial ring and offer some thoughts on durability.

Every market rally - whether it be a bull market or bear market bounce - has a group that leads the move. By studying this group we can get some insight into the strength of the overall move. In this case, the financial sector clearly led the markets off the bottom and an examination of the ability for this group to continue its rise may be helpful. The rise off the bottom for the financials can be attributed to a few main reasons:

1)Dramatically oversold conditions led to a much needed reprieve
2)Launch of TALF
3)Launch of PPIP
4)Fed monetizing of debt (announces $300 billion program to buy U.S. Treasuries)
5)Real estate numbers released by the government are "sold" as positive. (Only a sucker would buy this idea. Please see the 3/25/09 blog for more details.)

The question remains: can the financials continue their rocketesque launch off the lows and make it to orbit, or will they fall back into the ocean like a failed North Korean missile launch? I will offer up the following thoughts and let you be the judge:

1)Government initiatives can create near term excitement but historically cannot change the long term direction
2)Real estate reality will return and continue to be an issue that is hard to ignore. Read the story on U.S office vacancies before you debate this idea with me.
3)Earning season is starting and the numbers will highlight a glaring bifurcation in the financial sector. Those banks working with the government to unwind AIG will show "better than expected" numbers. Those banks on the periphery will not. I suspect this schism will lead to a selloff on the news and create a mistrust of the numbers.
4)Banks need capital and will use this recent rally to raise it at the expense of current holders

I offer the following two stories as support for the thoughts above:

Goldman Sachs considers share sale to payback govt loan - Daily Telegraph
Daily Telegraph reports the co, which will report its first-quarter results on April 14, is expected to announce on the same day that it is to submit a formal application to repay the sum given to it as soon as it passes the formal "stress test" being conducted by govt officials on all major US financial institutions. People close to the bank say that its management, led by chairman and chief executive Lloyd Blankfein, is assessing a range of options for repaying the money loaned to it as part of the US Treasury's Troubled Asset Relief Programme. These include orchestrating a new share sale or funding the repayment from existing capital resources, and it may still decide to pursue the latter route. Goldman, along with a number of its rivals, is understood to have enjoyed a spectacular first three months of the year in terms of its trading performance, according to insiders. The bank would not require additional capital to repay the Tarp money, having raised $11 bln from investors including Warren Buffett, the so-called "Sage of Omaha", last autumn. Some senior Goldman officials believe, however, that the ongoing banking turmoil means that it should continue to take a conservative view of its balance sheet and exploit further opportunities to raise additional capital if it is accessible on reasonable terms.

Meredith Whitney - Meredith says shes not bullish by any case, but would be very careful pressing shorts here. She says all rules are subject to change once you bring in the government into the picture. She says the reality is tangible book values will go higher in the near term. When asked if she would commit capital to the financials she says this qtr is going to look stronger, perhaps private capital comes in to support some of these financials. Co says the new housing data is the "head fakes of all headfakes". When asked about earnings in the financial sector she says several technical and one time factors will lead to Q1 profits and capital creation. Meredith says some investors may buy into earnings and react the way they reacted to Friday's NFP number and think the worst is over. She believes these investors are incorrect and after the stress test findings come out, she says some decent size banks will not pass the stress test. She says be careful at the end of the month when the stress test findings come out, it will be another grim period for financials

News that Moves: FAS 157 Changes, Commercial Real Estate Collapse

RCM Comment: Update on the FASB decision:

Where impaired assets losses are concerned, FASB has caved in and is not requiring immediate write offs for the full amount. Instead, banks must write off the part that is impaired because it was a bad asset, but the rest that is impaired because of market conditions (as determined by the bank) is allowed to stay on the books under a different balance sheet item.

Where valuation of portfolios is concerned, the rule REMAINS fair market value. However (and here is the rub) if a bank can prove there is not an active market for an asset, then said bank may use a model that is supposed to approximate the "hypothetical active trading price based on today's environment."

It seems to me both of these rule changes are akin to allowing the lunatics to run the asylum. The reaction to the EPS news from banks over the next few weeks will be very telling. The financials have experienced a big rally into the news, so a sell off on the news would not be unexpected. Beware, if these banks announce "better than expected" EPS and the stocks sell off this will be a no confidence vote in the new FASB rules and a major crack in the foundation of this market rally.

RCM Comment: Another shoe has dropped with a bang and yet there is a dearth of news coverage. The commercial real estate market is staring into the abyss and yet, I'm constantly hearing about the bottoming of markets and the possibility of economic recovery. I humbly submit that without a stabilization of the commercial market there will be no recovery. I can concoct many possible scenarios to explain the stock market rally over the last month, but the explanation of the commercial real estate collapse is devoid of creativity. The collapse is plain and simply a reflection of the crumbling economic situation. We must monitor this situation closely and use our findings as a litmus test for any "recovery" scenarios.

U.S. office vacancies hit 15.2% and are rising - WSJ
WSJ reports cos, struggling to cut costs, dumped a near-record 25 million square feet of office space in the first quarter, driving vacancy up and rents down, according to data to be released today by Reis. Businesses that needed to lease space took advantage of the market weakness to extract concessions from landlords. But the trends exacerbated financial woes for owners, especially those who owe more on their mortgages than their properties' current value. The office vacancy rate nationwide rose to 15.2% from 14.5% in the previous quarter, and likely will surpass 19.3% over the next year, according to Reis. That would put the vacancy rate above the level during the real-estate bust of the early 1990s, the worst on record. Effective rents, which include free rent and other landlord concessions, fell 2% in the first quarter to a national average of $24.16, the largest drop since the first quarter of 2002, according to Reis. Sublet space, on average, is going for between 10% and 15% less than what landlords are charging. The weakening commercial real-estate market is posing yet another threat to the ailing economy because it is causing the value of buildings to plummet, often to less than the amount of their mortgages. In one closely watched transaction earlier this week, the marquee John Hancock Tower in Boston was valued at $660.6 million in a foreclosure auction, less than half of its $1.3 billion price in 2006. Washington policy makers are scrambling to extend bailout programs to help shore up commercial real estate.

News that Moves: Nassim Taleb & Mark to Mark Rules / AIG Responsible for Banks' Profitability

Nassim Taleb: A brilliant analogy explaining the absurd and fraudulent idea of changing the mark to mark (MtoM) rules for banks.

As the theory goes, under the MtoM rules of today banks are forced to use current prices to value assets they intend to hold long term. The proponents of a rule change blubber that this is unfair because the assets will be worth more in the future (how they know this is spurious, but I digress), so they should be valued more today. Nassim Taleb, author of Black Swan a 2006 book predicting the banking crisis, made the following analogy that I will paraphrase:

Allowing banks to change the MtoM rules would be the same as allowing homeowners to change the value of their homes. A homeowner who "intends" to live in the house for a number of years should be allowed, under new MtoM rules, to value the house at a much higher price than where it is valued today. Housing prices historically double every X amount of years. Why not let the homeowner value his house at double today's price, which would mend his financial situation?

The farcical nature of this example sheds some much needed light on the fungus-like ideas growing in the back rooms of government.

As long as we are discussing farce and exposing fraud, let's address the "strong" January and February banking announcements that led to the March stock market rally. One of our respected colleagues explains it best:

Zero Hedge: AIG was Responsible for the Banks' January and February Profitability

...During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent - these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were "we have never done as big or as profitable trades - ever".

>...AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.

In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner's (and thus the administration's) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.

For banks to proclaim their profitability in January and February is about as close to criminal hypocrisy as is possible. And again, the taxpayers fund this "one time profit", which causes a market rally, thus allowing the banks to promptly turn around and start selling more expensive equity (soon coming to a prospectus near you), also funded by taxpayers' money flows into the market. If the administration is truly aware of all these events (and if Zero Hedge knows about it, it is safe to say Tim Geithner also got the memo), then the potential fallout would be staggering once this information makes the light of day.