Australia is in recession

Apparently Australia is in recession, and has been since the start of the year. And here I was thinking Australia was strong...

In real news, major US banks have been making profits - but by less than the markup on their own debt. This is a piece of accounting genius: Suppose company XYZ sells $15 Billion of debt due in 5 years for a total of $10 Billion. Next, the market realises that there's a real risk that XYZ will not last 5 years and the debt is going to be paid only partially and only through bankruptcy proceedings, so the debt falls in value to $7.5 Billion. XYZ records a profit of $2.5 Billion because the present value of their outstanding debt has fallen.

In theory, XYZ could buy its debt back for $7.5 Billion - but there were any way it could do this, the market would not have discounted the debt quite so harshly. This windfall profit comes with the catch that it is guaranteed to go away over time - firstly, if the health of the company improves, an equal amount of loss is incurred, and secondly, as the debt matures the present value approaches the face value, making an equal amount of loss.

And on the dangerous side, let's take a look at CDS rates. Rio Tinto is currently around 7.25%, while Macquarie Bank managed to hit 12.65% at the market bottom. Loosely speaking,
CDS rate = Risk of bankruptcy per year * Expected recovery on debt after bankruptcy
At a recovery rate of 2/3rds (probably low for Rio, high for Macq Bank unless they're telling the truth), this gives a market expectation of over a 20% chance on Rio bankruptcy this year and briefly rated almost 40% on Macquarie Bank.

Disclosure: Currently short Macquarie Bank and Rio Tinto in a variety of ways.

Futures spreads

One thing that is fantastic about derivatives is the ability to bet on just about any aspect of the future, so long as there is someone willing to bet against you. The end result of this is that you can get odds on many things, and a consensus bias on many more.

On the way down, the futures spread on the ASX 200 index (both March and June) were around 1% below the index, indicating a consensus of "falling". At the bottom it flipped around, with a spread of 0.5% above the market (June only - March had expired), indicating a consensus of rising, something I bet against to my great detriment. In the last week, the June contract has slipped to between 0.1-0.2% above the market, indicating an expectation of a very mildly upward drifting market until June, however the September contract is trading 1% below the index. After September, the bets get less precise, but imply no recovery even through to June 2010.

To complicate this further, there is an activity called arbitrage. A big player could make bets against all stocks now and buy futures for a guaranteed profit, which will move the market down and the futures up. I believe this results in around 1% being the maximum possible difference between futures and the market while the market is open - otherwise financial institutions with nifty maths and powerful programs will step in and take free money.

In summary, the futures market is predicting a massive market fall between June and September. Bet against it at your own risk.

Earnings & Bankruptcy

Wells Fargo pre-announced that it was going to have massively successful earnings - of course, they're not real. The timing was a surprise. Goldman Sachs had good earnings, which were meant to come out in the morning but came out the evening before - again a surprise impact on the market - but then they flipped into capital raising mode before the market knew what hit it. Good earnings, but still need more money somehow. JP Morgan's earnings were decent, and were also released on time. None of this should really be a surprise given the previous posts here.

At the same time, we have the US's largest commercial real estate bankruptcy - GGP. It appears that the company was worth $18 Billion at the peak in April 2007. The CEO mantains they were fine, simply couldn't roll over debt, and stories appear to indicate how this is positive for Commercial Real Estate because of the opportunity to acquire assets at firesale prices. This is true, if the large CRE companies are cashed up and the economy is poised for recovery...

April recovery #2

Another thing that should not be underestimated in the "profits" for the first quarter this year is the effect of bailing out AIG. The money was drained into the global financial system, which was tallied for a few of the larger recipients by Yahoo News as follows:

Through three separate types of transactions, Goldman received an aggregate $12.9 billion. Among European banks, SocGen was the biggest recipient at $11.9 billion, Deutsche got $11.8 billion and Barclays was paid $8.5 billion.

Additionally, many states were bailed out through AIG, with the largest recipient, California, receiving over $1 billion.

Beware of April

April has many "surprises" in store, though a few of them have been telegraphed:

• Goldman Sachs and Morgan Stanley delayed their earnings announcements from mid-March to mid-April - it is currently still possible to find them referenced as earlier in old calendars.
• These delays shortly happened before the Mark to Market relaxing legislation in the US, affecting financial reports delivered after April 2nd. This change will allow banks to decide how much their assets are worth - a ball of string could be declared as worth $2 Billion after this if the bank so chose. The expectation is that the US banks will change their books to produce massive "write-ups" (accounting only profits) on their investments in things now worth not more than said ball of string.
• The "uptick" rule is expected to come out of the April 8th SEC meeting. This is supposed to be some magical rule that will ensure the market doesn't go down, or something, it's not entirely clear what chain of causation would result in an improvement in anything.
• The Federal Reserve is now buying longer term US government debt - $300 Billion happening right now. This is meant to keep interest rates down, which in turn is meant to stimulate the economy.
• There's plans for the Treasury and the FDIC to provide speculators money to buy the toxic assets from the banks. The most likely end result of this is that the banks speculate on their own toxic assets and transfer all future losses to the taxpayer.
  

There's 2 possible causes for this confluence. Either there's something truly awful coming out in April that they're trying to offset, or it's a coordinated attempt to force the stock market higher so the looting can continue just a little longer.

IMF: Iceland on the road to recovery

I'm not sure what they mean by "road to recovery". To a certain degree, having recently lost the 4th of their big four banks, they can't lose any more of them. The real content of this statement may be as little as is found in "we're heading in to the future".

Babcock and Brown down and out

Babcock and Brown found that leverage upon leverage and the practice of funding dividends from the money provided by new investors (aka a Ponzi Scheme) results inevitably in bankruptcy. While only $3 billion of debt was directly impacted, it should be remembered that all of its children, who are now running for cover, have a total debt load of over $50 billion. The question that has to be asked at this point is: Why was Babcock & Brown terminated this soon, and why before Centro?