Madoff, Mark-To-Market (again) And More

Let's start with Madoff.

150 years in jail; an effective life sentence:

NEW YORK - In a courtroom surprise, it was revealed Tuesday that Bernard Madoff will plead guilty Thursday to securities fraud, perjury and other crimes, knowing that he could face up to 150 years in prison for one of the largest frauds in history.

The revelation came as prosecutors unveiled an 11-count charging document against the 70-year-old former Nasdaq chairman, and as his lawyer, Ira Sorkin, told a judge that Madoff planned to plead guilty this week without a plea deal.

Let's dissect this - this is a good deal, right, even if they only really give him 20 or so.  He'll still die in prison, one way or another.

Not so fast.  Good as far as it goes, without a doubt, but where are the other co-conspirators?

Provided that this does not "close the case" I'm cheering.  My fear is that this will "satisfy" the public thirst for blood and the other hundred co-conspirators (and if you think there are fewer than that you're simply delusional) will walk off free.  That, if it happens, is flatly unacceptable.

Oh, and what of Stanford?  Where did that one go?

My call for a temporary suspension of mark-to-market set off a shizstorm of controversy, characterized by this sort of idiot savant comment over at The Automatic Earth:

Moreover, the drive to change fair value rules (were they ever executed?) gets so strong that blogger Karl Denninger, who's spent months clamoring for fair value and mark-to-market, today does a 180 and argues for a suspension of the all-too-rational principle. Thinking of a career in politics? Any idea of the damage a suspension would do? I think you do, Karl.

Bah.

For the intellectually-challenged (a group that is ballooning by the minute) let me put things in stark relief for you, hopefully this time in plain enough English that you can understand it.

First, we have today "mark to fantasy" or rather, "mark to lie."  It is called Level Three with its cousin "off-balance sheet."

The predecessor Mark To Model was the law prior to Enron; MTM was put into place after Enron due to the outrageous abuses in modeling that Enron exposed.  The problem is that lack of regulatory oversight and enforcement, along with enough holes to drive a truck through, led the game-playing to be squeezed into different forms but it did not disappear.

It is essential that we get this part of The Bezzle out of the system if we hope to restore trust and have a lasting recovery, 15% rally in the XLF yesterday notwithstanding.

So exactly how do we do this?

We must kill both "Level Three" and the SIV/Off-balance-sheet games.

But if you do that right now, you are forcing marks in a market that for all intents and purposes does not exist, because the government's interference with the market, continually implying that it will intentionally overpay on one hand while at the same time threatening to destroy more value on the other has driven spreads to nutty, even insane levels, and without agreement on price no trade takes place.

This has to be fixed but we must fix it in the correct order or we detonate the entire financial system at once.

So let's fix it.

We'll give the banks six months.  This stops them being forced to take a mark off some hedge fund's fire sale bid list on a Level 3 asset, which stops the unpredictable asset devaluation.

At the same time we make clear that (1) your forbearance ends in six months, date certain, (2) you better start trading these things now, openly, on an exchange (go get those CUSIPs gents) or at least where people can see them and (3) six months hence anything you don't have marked to the market you're going to have to sell 10% of and take that mark.  And finally we do the same thing for the CDS marketplace.  Issue that executive order, bar collection of non-exchange-traded CDS where there is no central counterparty, force 'em all onto that exchange and get margin supervision established and maintained.

No exceptions, no ifs, ands or buts.  No Level 3, no SIVs, no nothing.

Everything is consolidated and trading is effectively forced so prices can be established under pain of having marks forced upon you six months hence.

What prevents rigging the process?  Simple - there's more than banks out there with this stuff.  If banks start trying to play "I'll buy yours for $1 and you buy mine for $1" suddenly Sir Hedgie who has them marked at 20 cents says SOLD TO YOU!

The Prisoner Dilemma works really well when there are hundreds of billions on the table.  Nobody's going to get away with trying to game this for very long - if they attempt it someone will come hit that bid HARD to unload their trash into that bid and off you go - now Sir Hedgie has all his money and Sir Bank has twice as much overvalued trash as he wanted!

While we're at it close the dark pools - no published bid, offer, size and last, no operation.  Period.

Transparent markets must include all of the above - volume is just as essential as price, as any technician will tell you - myself included.

If you still don't get that I'm doing my damnedest to drain the swamp with my recommendations, not add water to cover stinking bodies, I can't help you - but I can recommend the local high school's summer program for remedial reading.

Next, let's take on the uptick rule, as claimed to be under consideration here:

The uptick rule, adopted after the 1929 stock market crash, allowed short sales only when the last sale price was higher than the previous price. The SEC abolished the rule in 2007, after concluding that advances in trading strategies rendered it ineffective.

Senate Banking Committee Chairman Christopher Dodd said he backed the SEC reinstating the uptick rule "I wish they'd do it quickly," the Connecticut Democrat told reporters.

The SEC abolished it in 2007 because with "penny spreads" it was and is meaningless.  But heh, if it builds confidence, why not?  It will do nothing, but doing nothing and making people think you are doing something is a time-honored tradition in Washington DC, and so long as you don't do harm, if it helps confidence, I'm for it.

Just don't think it will stop a collapse in prices, because it won't. 

"No bid" is far more powerful in terms of a collapse than an entire army of short-sellers, and there have been plenty of bid collapses in the last few months.

Indeed, let's look at the short interest on BAC; as of 10 February (the last date I have data for) it was 2.2% of the "float", or public shares available for trading.  That's nothing!  The short ratio (or shares short .vs. average daily volume) is only 0.3 - that is, you could cover ALL the short shares in 1/3rd of one day's average volume.

Now let's look at Amazon, a stock that has held up quite well.  Its short interest is 9.6% of the float, with a ratio of 2.1 - that is, it would take a bit more than 2 days of trading to cover all the shorts. 

That's six times the short interest by the numbers as Bank America, yet Amazon has held up well in relative terms.

Short sales kill stock prices eh?  Uh, no - the absence of bids kills stock prices, and you can't manufacture a bid where none exists.

Nonetheless, "reinstating the uptick rule" works for me as a confidence builder.  No harm, no foul, no problem.  Let's do it.

Oh, and on that alleged AIG "the world will blow up if you don't give us more money" document that one can now find on the net?  I got a suggestion for firms that play that card too - any firm or individual that, in effect, tries to extort (more) bailout money with what can be construed as a thinly-veiled threat to destroy the financial system (and I would argue the last paragraph on page 3 qualifies, not to mention the next few pages) should be treated as having made a terrorist threat against The United States and thus be exposed to criminal indictment, both as a company and individually by all officers, directors and others involved in the preparation and dissemination of same.  Send DHS over there to start the proctological examinations toot-sweet - and make sure your DHS agents have BIG HANDS.