Bad Banks, Short Selling and Financial Terrorism

We said yesterday that now was the time to be trading, but we never had an inkling of the news that hit the markets last night. A possy of US financial glitterati announced last night the US government is to stage a monumental bail-out of the hundreds of billions of dollars of 'toxic' mortgages.

This move is aimed at being the silver bullet that finally brings the credit crisis to an end.

The idea appears to be the creation of what is being called a 'bad bank' which would act as a massive fund designed to suck bad debt out of the system with the US government holding this debt until maturity.

News of the plan, was greeted with cheers on the floor of the New York Stock Exchange. The Dow Jones index traded in a 617-point range, eventually closing up 410.03 points, or 3.86pc, at 11019.7, its best one-day percentage gain in six years.

Markets across Europe are being called up vastly with the FTSE, CAC 40, and the DAX all expected to make 200 point + gains. This bail-out and with the news that the FSA has banned short selling on financial stocks for 120 days is sure to make today's session an interesting one.

The FSA made the short selling move on fears that other banks could follow HBOS in being targeted by short-sellers.

Outgoing FSA chairman Sir Callum McCarthy said: "There is a danger in a trading system which allows financial institutions to be targeted and subject to extreme short-selling pressures."

The ban covers all new short-selling of financial stocks. Also, by next Tuesday, investors must disclose short positions of more than 0.25pc of a company's total value.

Traders though are none to impress, one said "This is an utter joke. There is now even less liquidity in a poor liquid market. How are the institutions going to sell?"

Short sellers are being viewed with suspicion all over the world. Jim Cramer, CNBC commentator and ex-hedgie was discussing the short selling measures in the US and even made reference to 911 and the belief in some quarters that airlines were being shorted by Bin Laden and other terrorist groups and the same could be happening with financials.

Cramer’s been talking to the short sellers he knows, and that’s the theory they’ve been putting forward. His sources said that it’s doubtful that the market’s traditional short sellers are behind the negative action we’ve seen lately.

Cramer, who was merely relaying what he heard, did say that, given the fact that the U.S. is in a “financial nationally emergency,” the “financial terrorism thing, to me, has to be put on the table just because the regular short sellers are not doing this.”

Calls to investigate who is behind short selling are coming, not just from Cramer, but from others in the financial markets. One trader who we spoke to said "Banning short selling is just madness, long term. If the FSA suspect that there is something going on other than legitimate shorting, then we will wear it until the deadline but if this becomes a permanent thing, forget it, the days of the free market are over".

The FSA have said that they believe short selling to be a legitimate tool so we believe it's unlikely that this ban will be extended indefinitely, but as we have said many, many times before, prepare for a massive tidal wave of regulation in 2009/2010.

Source: HF Markets - Online Trading

ARS Boys Under The Hammer

The auction-rate securities farce continues at a pace with more indictments, but this time it involves individuals in trouble rather than entire banks.

Federal prosecutors in Brooklyn filed charges against two former Credit Suisse brokers, Julian Tzolov and Eric Butler, for fraud in the sale of auction-rate securities to CSFB customers. Meanwhile, the SEC followed up with its own civil suit against the duo. Click here for the DOJ’s press release; here for the indictment; and here for the SEC’s complaint.

The indictment alleges that Tzolov and Butler schemed to obtain higher sales commissions by selling auction rate securities backed by mortgages to Credit Suisse clients who, in fact, had placed orders to buy ARS backed by student loans.

The defendant are said to have lied to clients and their employer by falsifying the names of the ARS the clients bought and otherwise misleading the clients into believing they had bought ARS backed by student loans. When the mortgage-backed ARS market failed, say prosecutors, the clients lost their money.

Looks like Tzolov, however, is not hanging around for the result as he is suspected of fleeing back to his native Bulgaria.

FBI Assistant Director-in-Charge Mark Mershon stated, “Investors who were told they were purchasing relatively low-risk securities backed by student loans were unwittingly purchasing high-risk mortgage-backed securities. For a nearly three-year period, what Tzolov and Butler sold their clients was a bill of goods. The FBI remains committed to policing the securities industry to protect investors from all forms of unscrupulous and illegal conduct.”

No comment has come from the defendants or their lawyers at this stage.

This, we are sure, is not the last we will have heard on the whole ARS thing nor on the hedge fund blow ups.

We wrote previously here about hedge fund rules and how they do not represent sanity when approaching this market. Although the ARS situation is a little different we do believe that reforms on hedge fund advertising and access rules could go a long way to preventing fraudulent situations occurring.

If hedge funds were able to advertise (therefore have informative web sites and information) clients would be able to evaluate those funds that perform well, those that don’t and those that are a scam. In 2007 hedge fund manager Phillip Goldstein sent the performance of his fund to a client who never actually invested. He was indicted under the hedge fund advertising rules but won his case against the SEC.

We hope the regulators will look at the various frauds and misleading situations that have happened over the last few years and look inward to assess whether the rules now need to be overhauled and brought into some semblance of sanity.

UBS Face $25bn Bite In The ARS.

If all wasn't already bad enough for the beleaguered UBS, things are now starting to get serious. Facing prosecution in the US for various charges of aiding tax fraud the US authorities also threw in a charge of fraudulently selling auction-rate securities.

UBS is close to resolving those claims and may make a promise to retail and institutional clients to buy back the securities, valued at $25 billion by regulators.

On Thursday, Citigroup agreed to buy back about $7.5 billion of the debt, as part of settlements with New York Attorney General Andrew Cuomo and the U.S. Securities and Exchange Commission.

Zurich-based UBS, the target of three state complaints over auction-rate sales, has been in talks this week with Massachusetts, Texas, New York and the Securities and Exchange Commission in an effort to settle the claims.

"We are consistently working with regulators towards a comprehensive solution for all auction-rate securities investors," UBS spokeswoman Sabine Woessner told Reuters, but declined to comment on the report.

(Definition - Wikipedia) An auction rate security (ARS) typically refers to a debt instrument (corporate or municipal bonds) with a long-term nominal maturity for which the interest rate is regularly reset through a dutch auction.

It could also refer to a preferred stock for which the dividend is reset through the same process. In the dutch auction, broker-dealers submit bids on behalf of potential buyers and sellers of the bond. Based on the submitted bids, the auction agent will set the next interest rate as the lowest rate to match supply and demand. Since ARS holders do not have the right to put their securities back to the issuer, no bank liquidity facility is required

The market started to fall apart Beginning on Thursday, February 7th, 2008. Auctions for these securities began to fail when investors declined to bid on the securities. The four largest investment banks who make a market in these securities (Citigroup, UBS AG, Morgan Stanley and Merrill Lynch) declined to act as bidders of last resort, as they had in the past. This was a result of the scope and size of the market failure, combined with these own firm's need to protect their capital during the 2008 financial crisis.

On February 13 (2008) 80% of auctions failed. On February 20th, 62% failed (395 out of 641 auctions). As a comparison, from 1984 until the end of 2007, there were a total of 44 failed auctions.

On March 28th, 2008, UBS AG said it was marking down the value of auction-rate securities in brokerage accounts from a few percentage points to more than 20%. The markdowns reflect the estimated drop in value of the securities that the market has seized up, while UBS wasn't offering to buy the securities at the new lower prices.

Beginning in March 2008, several class action lawsuits had been filed against several of the large banks. The lawsuits were filed in federal court in Manhattan alleging that these investment banks deceptively marketed auction-rate securities as cash alternatives.

On July 17th a National Task Force, be made up of officials from several states including Missouri, began investigating at the St. Louis, MO Headquarters of Wachovia Securities. Some in the media were calling it a raid and officials called it a "Special Investigation" at the St. Louis offices. Media reports also said that Wachovia Securities part of Wachovia Corp based in Charlotte, NC did not comply with request by officials which prompted the "Special Investigation".
It is also stated that other Securities Firms are also a part of the investigation. The Missouri State action was prompted by complaints to the state and total of more than $40 million of investments that were frozen.

Citi then announced it would be buying back these securities and now UBS looks to be negotiating a similar situation.

It is a tough time to be a banker, especially one with UBS, we just hope that certain commentators, who have been calling the bottom in the banking sector, are right!