The Morning After ...

MS and GS to become bank holding companies and submit to regulation by the Federal Reserve.. The WB+MS merger is off. I suspect both will try to buy high quality banks over time. That's the end of an era - now there are none. No independent full service investment banks - just boutique firms doing pure M&A, advisory, etc., and perhaps some small players.

Australia, Taiwan and Netherlands ban short selling.

Remarkably, the SEC staff still acts as if it's in the pocket of Wall Street and the beefers. I saw a Financial Times story over the weekend that they recommend exempting market makers from the short selling rule. Sheesh … what a huge loophole they want to create ! A beefer could bid for a huge position in “in the money” put options on bank stock B which the market maker could short to fill the order, hence completely circumventing the “no short sales” temporary rule. Such incredible open knavery or stupidity boggles the mind.

A fact for comparison: in the RTC crisis of the early 1990s, about 1000 S&L failed. So far in this crisis, 12 banks or S&Ls have failed. And it’s rather far along for that number to be off by more than an order of magnitude. [For Gen X-Y-Zers, that a multiple of 10]. So all should take comfort that the increased regulation created then really has helped a lot.

But since then the hedge fund industry exploded in size and its tentacles have wound through the large banks and brokerage firms. That is the source of this mess. That is the cause of and the location of much of the excess leverage about which pundits screech. That plus credit default swaps, a “market” that should be tightly regulated, too.

You might think, "OK, Bunkerman, what would you do to regulate those markets and firms ?" So here's my rough thinking.

Derivatives

As pointed out last Wednesday, no credit default market can “insure” against systematic risk in the entire economy. And writers of those policies actually have committed effective fraud if they do not have rock solid collateral against any “net” CDS positions. By rock solid collateral, I mean T-bills. By net positions, I mean any net exposure when swaps are binned into subgroups by insured credit and counterparty – long and short exposure in each individual bin can be netted within the bin only. That’s all. Any net short exposure of any individual bin must have T-bill backup for the full notional amount. Anything less is not enough and is effective fraud. Calendar spreads of CDS in any bin will require scaled collateral. New CDS regulation should require this.

Equity derivatives and other derivatives shall require margin posted in the same amount as the underlying security. No second tier derivatives (a derivative on a derivative) shall be permitted except for designated broad based indices such as the S&P 500. A broad based equity index shall has at least 100 stocks with suitable anti-concentration limits. Hence kiss your “VIX” derivatives goodbye.

Hedge Funds

Any hedge fund with assets over $1 billion and which is leveraged should be regulated as a bank. Any hedge fund without leverage with assets over $1 billion should be required to submit to the Investment Company Act. Appropriate rules should apply to anyone managing actively assets for separate accounts which assets exceed $1 billion. The antics of these whales must be stopped.

Proprietary trading books of any broker-dealer or bank shall be segregated from its other activities and regulated as a hedge fund.

This damage cause by these financial Vikings must be stopped forever.

Short Selling

The uptick rule on short sales should be reinstated and applied to ETFs, also. Short selling shall be permitted otherwise but the SEC shall be given express power to ban or otherwise restrict it for any or all securities in times of any market stress. This power shall apply to any derivative also. Market circuit breakers on program trading shall be reviewed for appropriate ranges.

Other

CFTC shall regulate energy swaps and any swap connected to or related to any product traded on commodity futures markets. Swap positions shall be disclosed as are futures positions and require similar collateral. The only persons considered "hedgers" or "commercials" shall be true business hedgers such as oil companies, farmers and airlines, for examples. Trading companies shall not be deemed "hedgers" or "commercials". Position limits shall be tightened and aggregated across all related commodities and strictly enforces.

Pension funds shall be prohibited from taking positions in futures or swaps in commodities.

Congress should include some support for GM and the US auto industry as part of this market support plan. And I have no problem with some money to help homeowners stay in their homes by buying down their mortgage balances and re-writing the loans to affordable levels. In fact, if Treasury can buy those loans directly, then part of the plan could be to do that, and them refinance those loans with FHA loans. I proposed that before.

By the way, it is a good thing this crisis occurred in the US and not the EU. There is no ability for the EU to move this fast as no EU really exists as a unified government.

Markets

I checked my Krypto Fund allocations and the model wants me to sell some of the real estate class and buy foreign stocks – mostly emerging markets and a bit in Europe. I will defer this as when Mrs. B deploys her substantial cash in her Sky Fund ( a subset of Krypto Fund ), those adjustments might be nullified. Rather than bounce money around excessively, I will be patient. I know she plans to make investments in foreign stocks / mutual funds and municipal bonds, and also cannot effectively buy real estate in her fund. So her investments when made might solve the imbalance.

Travel: I go to NYC this mornings and return Tuesday evening. No blog post tomorrow.

Word of the Day

"Recondite" - adjective [$10]
Recondite means 1. hidden from sight; concealed; 2. incomprehensible to one of ordinary understanding or knowledge; deep; 3. of, relating to, or dealing with something little known or obscure.
Sentence: The recondite swaps markets in everything - all swaps of any kind - need to be regulated and forced into a futures market strcuture where offsets are automatic, contract terms in time and size are fixed and collateral requiremements are clear and mandatory.