The Bank Stress Tests Are Graded

2.5% of USA GDP Loss Attributed to Changing the Rules

I am posting a comment I read over at Little Green Footballs:

Cato5/08/2009 10:40:16 am PDT

The other day I attended a conference sponsored by a major bank's private banking group for its high net worth clients in the real estate industry. I saw there probably a dozen people and families that at one time or another had a billion dollar net worth. The most recognizable name was Sam Zell, but to me there were a lot more interesting people whose exploits have become the lore of the business in NY. I wanted to share some of the discussion because even I had not appreciated how in 100 days the president had permanently alienated this group.

The conference started with a professor of the Wharton School noting that: "The US is now no different from Russia or Zimbabwe in the eyes of investors since no one can rely on the law anymore."

He said this started with Bush but quickened with Obama. Using some econometric models he demonstrated that 2.5 pct GDP loss was contributed by changing the rules alone.

A variety of other speakers from public and private institutions demonstrated how capital was flying from the US as we speak.

But the most interesting was lunch. There were probably 90 people at lunch. Someone asked a couple of questions and then asked how many people voted for Obama. About 80 pct raised their hands. Then they asked whether they would do it again. No hands.

He asked for volunteers to explain why. In a word, the answer was Chrysler. Knowing the people involved, Israel would be the answer next time.

"The rule of absolute priority has been violated. If the government can change my lien's priority, I won't lend and I won't borrow."

"He's a thug. What president inserts his office into a bankruptcy?"

"I hear that the company doesn't have to pay back the TARP money that Congress voted against giving them. So my tax money went to buy the UAW control."

"Yeah," responded another. "I am not going to pay my taxes to go to the union. I hear Namibia doesn't have extradition laws. Screw the government."

One guy who voted for McCain and who was a lawyer who became a developer said, "I didn't vote for him because he could have done anything out of law school, but instead became a community organizer. It means he wanted remain uneducated about either business or the law. He is purposefully unknowing."

"He has violated his fiduciary duty to the people. He permitted that atrocity of a budget and now he gives tax money to a union"

"I hate the crazy religious republican nuts and I'm forced to give money to them."

Since I never supported the President, I do not feel betrayed. But there was a palpable sense of betrayal by this very, very rich group who largely voted for him.

Black Friday In San Francisco

We were in San Francisco Friday morning, and some of the group were even shopping at the stores that surround Union Square. We thought it was our patriotic duty to ensure Black Friday was a success, and thus help restore confidence in our economic system. But somehow, we missed all the drama.


Actually, this seems in very bad taste given the what was going on in Mumbai, etc.

The End of the Long Boom

I have been wondering how much of the market sell-off is related to the increasing likelihood of the next president being Obama, with the attendant increases in taxes for capital gains. I am thinking that people want to take all their capital gains this year to avoid the higher capital gains tax rates in the Obama years.

So I was interested this morning to see this in Investor's Business Daily:

He wants a 33% increase in the tax rates on capital gains and dividends, an increase of 16% to 32% in the top payroll tax rate, reinstatement of the death tax with a 45% top rate, and a new payroll tax on employers estimated at 7% to help finance his health insurance plan. He's also contending for higher tariffs under his protectionist policies.

Finally, he would increase corporate taxes by 25%, though American businesses already face the second-highest marginal tax rates in the industrialized world, thus directly harming manufacturing and job creation while weakening demand for the dollar.

Obama argues disingenuously that his tax increases would only affect higher-income workers and "corporate fat cats." But it is precisely these top marginal tax rates that control incentives for savings, investment, entrepreneurship, business expansion, jobs and economic growth. While he wants to tax the rich, the burden will fall on the poor and the middle class.

In their new book, "The End of Prosperity," Art Laffer, Steve Moore and Peter Tanous argue that the threat of this tax tsunami is already destabilizing our financial markets and causing capital flight from America.

They write, "Hot capital is escaping over the borders out of the United States and flowing into China, India, Europe, and even Japan. . . Starting in late 2007, foreigners started pulling their money out of the United States, and Americans started investing more abroad. Global investors are losing confidence in the U.S."

I included that last paragraph just because it is so wrong about right now. What is happening right now is the opposite, money is flowing into Japanese Yen and US Dollars. But not into investment in the stock market. And I am thinking the reason for that is the increased taxes mentioned in the editorial.

The value of stocks is based on the expected earnings for shareholders. If the shareholders are going to be hit with a higher capital gains rate, then the expected value of the earnings for shareholders is lowered. That means people are not willing to pay so much for equity investments.

The higher the probability of Obama's election, the greater the sell off.

(I am not in denial of the other factors, e.g., mortgage melt down. Just wanted to mention this one.)

Totally OT: Aggressive Short Selling of S&P Futures

(This is my second totally off topic economic post.)

I've been wondering if the current market collapse is being driven by hedge funds aggressive short selling of S&P Futures in order to hedge their long positions on individual stocks. I was glad to see that someone else has been wondering the same thing:

Beginning last Monday, I began to see a number of big hedge funds in the S&P 500 futures pit, boldly selling futures to hedge their core long holdings. As the market dropped precipitously on both Friday afternoon and Monday afternoon, they got ever more aggressive -- according to my sources, more aggressive today than at almost any point in a decade or more.

If my observation is correct -- and we will get some sense of this on Friday afternoon when the size of the professionally hedged S&P futures positions are released; our thesis will be proven correct if there is a large increase in open interest -- it will be proof positive that those hedge funds are now shorting the hell out of S&P futures in order to hedge their cratering longs. Indeed, some of those hedge funds might now even be overhedged and short S&P futures, as it has been working.

This strategy is a classic tactic one sees at panic/capitulation lows as hedge-hoggers sell short what they can sell easily -- the S&P futures market is deep and liquid -- while they retain what they can't sell easily (i.e., large blocks of individual equities). I have always been concerned about where the marginal buyer would come from, especially with the SEC ban, and, again, if I am correct, the momentum of a rising market into the all-important year-end could now cause a reverse panic to the upside as hedge fund managers that have overhedged their portfolio with futures buy them back and cover their positions just as fast as they sold them short.

Indeed, it is quite possible that those managers could lose both ways -- on the upside on their short futures positions (which some have overhedged because it's been working!) and as their core holdings fail to perform in line with an advancing market.

That's what I see happening recently in the S&P futures pit, and even if I am only half correct, those hedge-hoggers could be on a sinking ship without a life preserver as the stock market might have bottomed under the weight and intensity of their aggressive short selling of S&P futures.

In summary, investors and traders might now be looking for the answer to the market's recent drubbing in all the wrong places. The fundamental news is bad, but this is known and is arguably being cured by public and private sector initiatives. Rather, it could be that the recent behavior of hedge funds -- namely, their imperious and aggressive shorting of S&P futures -- is even worse than the fundamentals and might be a root cause for the precipitous market drop over the past 10 days.

As with Kass, I'm not denying the weak fundamentals. I am just wondering if something else is going on as well.

From Doug Kass on TheStreet.com

The Coming Collapse of the Middle Class

This lecture in which Elizabeth Warren links the rise in bankruptcy to the shift from the one wage earner family to the two wage earner family is worth the time to watch. (Well, you can skip the first six minutes of introduction.)
H/T to Anglican Scotist