Morning Report: Merger mania on Wall Street

Vital Statistics:

	Last	Change	Percent
S&P Futures	1430.2	-2.9	-0.20%
Eurostoxx Index	2654.9	0.2	0.01%
Oil (WTI)	89.7	-0.3	-0.31%
LIBOR	0.31	0.000	0.00%
US Dollar Index (DXY)	79.12	-0.145	-0.18%
10 Year Govt Bond Yield	1.78%	-0.03%
RPX Composite Real Estate Index	191.8	-0.1

Markets are slightly lower after a slew of economic data this morning.  3Q GDP was revised upward to 3.1%.  Initial Jobless Claims came in at 361k. Consumption rose 1.6%.  The November Index of Leading Economic Indicators fell .2%.  Bonds and MBS are flat.

The FHFA House Price Index rose a half of a percent in October.  Sep was revised downward.  Prices are up 5.6% YOY and the index is 15.7% below its peak in April 2007.  We are more or less back to Summer of 2004 levels.

The Intercontinental Exchange (ICE) has agreed to buy NYSE Euronext for $8.2 billion.  It shows just how much the importance of trading equities has fallen.  Who would have thought a 12 year old scrappy upstart from Atlanta would end up buying the New York Stock Exchange, Paris Bourse, and the Amsterdam Exchange?  The floor of the New York Stock Exchange is more or less just a museum these days.  Separately, Knight Capital Group, the Nasdaq market-maker which lost $460 million on a computer glitch earlier this year, agreed to a deal with Getco, the Chicago-based leader in high frequency trading.

On the fiscal cliff front, the House plans to vote on a measure that increases taxes on millionaires.  Obama has already threatened to veto it. The current bid / ask spread is 400 - 1000, meaning that Obama wants the threshold for higher taxes to start at 400k, while Boehner wants it to start at 1 million. Bloomberg has a good backgrounder on the relationship between Obama and Boehner.

KB Home announced their 4th quarter and full year earnings this morning.  Deliveries were up 6% and average selling prices increased 10% sequentially and 23% year-over-year. Backlog is up 35% and that potential revenue would be the highest since Q407. Larger homes were the driver, which accounts for the jump in ASPs.

Morning Report - 12^3 edition

Vital Statistics:

	Last	Change	Percent
S&P Futures	1433.3	1.8	0.13%
Eurostoxx Index	2629.5	5.4	0.21%
Oil (WTI)	86.35	0.6	0.65%
LIBOR	0.31	0.000	0.00%
US Dollar Index (DXY)	79.95	-0.116	-0.14%
10 Year Govt Bond Yield	1.66%	0.00%
RPX Composite Real Estate Index	191.1	0.4

Markets are up slightly this morning ahead of the FOMC statement this afternoon. Mortgage Applications were up 6.2% last week. Right to Work was passed in Michigan. Bonds and MBS are flat.

The FOMC statement is due out at 12:30, and at 2:15, the Bernank begins his press conference. Things to look for:  New Treasury purchase plan to replace Operation Twist, 2013 GDP forecast, any comments on its outlook for housing. The WaPo speculates that the Fed will shift more buying to Treasuries than mortgages, and it looks like Bill Gross concurs, as he is lightening up his MBS position.

Looks like FHFA Acting Director will be out of a job soon. This will undoubtedly pave the way for a mass principal forgiveness / underwater refis on Fannie and Freddie loans. Mortgage-Backed securities will be vulnerable to news of more interventionist policies out of FHFA, so beware as you could have Treasury pricing and MBS pricing diverge.

While individual tax rates are going up as part of the fiscal cliff, corporate tax rates may be going down. Obama earlier this year proposed lowering the corporate tax rate to 28% from its current 35%.  The lower rates would be offset by eliminating some deductions and the net revenue would be the same. I would argue that we are at the point on the Laffer Curve where lowering rates would actually raise revenues as it would eliminate some of the transfer-pricing games companies play to declare as much income as possible overseas. The poster child of these transfer pricing games is GE, which paid no US income taxes in 2010. Or Google, which shifted $9.8 billion in revenues to a Bermuda shell company, which allowed it to avoid paying roughly $2 billion in taxes.

Dodd-Frank implementation could stall for a while after Mary Schapiro steps down as Chairman of the SEC, leaving the commission deadlocked with 2 democrats and 2 republicans.  Politically divisive issues like prop trading and restrictions on executive pay will have to wait until a fifth commissioner is nominated and confirmed.  Fun fact:  The SEC has finalized just 32 of the 95 rules that the 2010 law required.

The Fed has been quietly telling the big banks:  No more mergers. Banks that hold 10% of US deposits are already capped in size, but now it looks like the biggest banks just below that threshold are now prohibited from growing by acquisition. Fed Governor Dan Tarullo gave a speech which discusses the TBTF problem and examines various alternatives (re-instate Glass Steagall, capping non-deposit liabilities, etc.)

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.