Morning Report

Vital Statistics:

	Last	Change	Percent
S&P Futures	1319.1	3.4	0.26%
Eurostoxx Index	2181.4	31.3	1.45%
Oil (WTI)	92.34	-0.2	-0.25%
LIBOR	0.467	0.000	0.00%
US Dollar Index (DXY)	81.2	0.119	0.15%
10 Year Govt Bond Yield	1.78%	0.04%
RPX Composite Real Estate Index	175.7	0.1

Markets are generally firmer this morning on hopes of further stimulus out of China and Europe. Euro sovereign yields are lower. US bond futures are down a point and MBS are down slightly.  MBS underperformed bonds in the rally, so they should outperform as bonds retrace.

Richmond Fed came in below expectations. This survey looks at the service sector for Richmond, Baltimore and Charlotte. Revenues actually contracted in May. They note that service providers expect stronger customer demand over the next six months, while retailers do not.

Existing Home Sales came in at 4.62MM annualized.  5.5 million is about "average."  The number is up 10% YOY. The lack of distressed sales and the seasonal move towards bigger houses increased the median price 10% from 161,100 to 177,400. Overall, it notes that the headwinds in the real estate sector are abating.

Yesterday we had a number of sizeable mergers, with Eaton buying Cooper Industries for 12.8 billion, DaVita buying Healthcare Partners for 4.5B and Wanda Group buying AMC. Generally speaking, mergers are a good sign for the markets and the economy in general.

Andrew Ross Sorkin has a good column on why Glass Steagall wouldn't have prevented the crisis. The Glass-Steagall issue has become a facile explanation of what went wrong. Elizabeth Warren even acknowledges this - one of the reasons she has been pushing reinstating GS - even if it wouldn't have prevented the financial crisis - is that it is an easy issue for the public to understand and "you can build public attention behind."  And there you have it. Never mind that nobody else in the world (the UK, Europe, Japan, Canada) separates commercial and investment banking, or even draws a distinction between the two.

What was the rationale behind Glass-Steagall in the first place?  Poorly underwritten deals (for example, Facebook).  Facebook was the quintessential poorly underwritten deal.  An underwritten deal means that the investment banks (primarily Morgan Stanley) actually write a check to the company and buy 421MM shares at 38. It then places those shares with institutional investors.  If the deal is handled well, Morgan Stanley sells all the stock, collects its fee and moves on. This deal did not go well, obviously. Institutional investors sold into the market and FB was in danger of breaking price. Morgan Stanley stood in the market and bought everything that the market was willing to sell at the offer price. (If an IPO breaks price on the first day, that is a MAJOR embarrassment to the investment bank). So Morgan Stanley is now lugging millions of Facebook shares that it bought in the market at 38. The stock is trading at 32.65. Huge loss. Pre-Glass Steagall, what would they do?  Sell the stock to their captive commercial bank at 38. (Hey, we bumped up your allocation to 5 million shares)  Institutional investors will pull their money out quickly if they sense an investment bank is in trouble.  Depositors at a sleepy commercial bank?  Not so much.  Note:  This was done more with bond issues than stock issues, but the rationale remains the same. In the Great Depression, commercial banks were failing and it turned out their assets were not home mortgages or commercial loans - they were all the lousy deals their sister investment bank couldn't unload. That is why we had Glass-Steagall - to prevent commercial banks from being repositories for losing positions.

Fast forward to the financial crisis - commercial banks weren't failing because they bought CDO-squared issues from their investment banking divisions. Or because Citi was stuffing its retail bank with LBO paper it couldn't unload. The reason we had a financial crisis is because we had a residential real estate bubble.  Every bank in the US is exposed to residential real estate in some way, shape, or form. And it didn't matter whether you were exposed to residential real estate through a mortgage backed security or through holding whole loans on your balance sheet.  The small community banks who wouldn't know a CDO from a codfish blew up just the same as the big integrated banks.

Probably the single best thing regulators could do to prevent a re-occurrence would be to deal with the cascading counterparty risk from OTC derivatives. They should demand that OTC derivatives become standardized and exchange-traded with a central clearing party, position limits, and open interest disclosure. That would have prevented AIG from taking the positions it did and exposing all of its counterparties when it failed.