COMPLIANCE: Unreliable Narrators

Unreliable Narrators

The dotcom bust in 2000-01 should have been taken as a warning that systemic risk was unduly increasing.

OECD Yearbook 2012, “The Evolving Paradigm”


Hefting a silver ingot as he spoke, Ron Paul looked Fed Chairman Bernanke in the eye and asked the question the Chairman had been dreading: “Do you do your own shopping?”


That was but one high point in this week’s semiannual Humphrey Hawkins testimony, required under the 1978 Full Employment act.  For folks like Dr. Paul, who believe the Fed is unnecessarily opaque, the Act was designed to create sufficient transparency for Congress to fine tune policy toward the societal goals of full (read: enough to keep things quiet) employment and affordable (ditto) housing.  The Fed Chairman’s monetary policy report summarizes past policy decisions and describes their observed and projected impact on the economy, then contextualizes policy in the light of recent developments.  Some – Congressman Paul among them – believe this process fails to spread sufficiently the disinfectant of sunlight in the dingy recesses of the Fed.  It was not until Dr. Paul’s point-blank question that we learned Chairman Bernanke has first-hand knowledge of the price of tomatoes.


Maestro Greenspan used famously to sift through scads of prices furnished by armies of shoppers – the price of a tin of sardines in Chagrin Falls, OH; the price of a pair of nylons in Azusa, CA; the price of a tube of toothpaste in the Bronx – the Fed’s understanding of what drives America’s economy is based on a statistical edifice as massive as the Great Pyramid, and grounded in an understanding of every grain of sand that lies beneath.  What good does all this data do if we arrive at the wrong policy decisions?  You may well ask. 


Dr. Paul was getting at the real definition of Inflation – not, what does your regression analysis show, but a week-over-week comparison of how heavy your pocketbook is when you enter the supermarket, and how light it is when you leave.  A Princeton PhD will define Inflation with a series of algorithms derived from the data set of prices, as massively granular, as eternally shifting as desert dunes.  To the average non-PhD, Inflation is an emotional state: that feeling when the paycheck  that used to go for two tanks of gas, two weeks’ worth of groceries, movies on a Saturday night and the payment on the house, now goes for one tank of gas, two weeks’ worth of pasta and hamburger helper, a six pack and television on a Saturday night, and your younger son wearing his older sister’s sneakers for the junior high school track team.


The literary device of the “unreliable narrator” was first noted by Wayne Booth, professor of literature at the University of Chicago (which, it may interest you to know, does other stuff in addition to economics).  The unreliable narrator draws the reader into a narrative compromised by their own inability to see reality – or by deliberate obfuscation.  Readers of the novels of Chuck Palahniuk will recognize the phenomenon, as will fans of the movie “The Usual Suspects,” with its final-scene reversal of the central character’s identity.  Today, Unreliable Narrators dominate political discourse.  It is not clear whether the relentless pushing of fallacious policy is pure cynical manipulation, or whether our political leaders are really as stupid as they appear.


In his assault on the Fed, Dr. Paul made passing reference to “the old CPI” – a line of argument we wish he had followed.  Government accounts are the ultimate in unreliable narration, and the way our government measures inflation has been manipulated to an extent that even an SEC examiner would be able to detect.  It reminds us of the story the archer who shoots an arrow into the side of a barn, then paints the bull’s-eye around it.  And while it takes a Princeton PhD in economics to come up with the formula for painting the target around the arrow, anyone fourth-grader can tell you it’s wrong.


Two items came out this week from narrators who have a presumption of reliability.  The first was a transparent discussion of the risks of money market funds from the pen of Sallie Krawcheck, former head of wealth management at Bank of America (WSJ, 29 February, “Money-Market Funds Aren’t What You Think”).  The SEC is “finishing a proposal to increase regulation on money-market funds, the $2.7 trillion industry” whose primary purpose is to provide short-term funding for corporations.  To attain that goal, it provides investors with what has always been seen as a safe parking lot for their cash.  Krawcheck tells it like it is: money-market funds are not risk-free investments.  We hope the SEC will prevail on the matter of complete transparency, but Hope is not a regulatory oversight process.


Krawcheck writes that the rule as proposed would end the “convention of reporting assets at a fixed $1 net asset value – instead having it float to represent the funds’ underlying value.”  That underlying value is more diverse than it once was, and while Diversification is taught as part of Modern Portfolio Theory, your money-market fund is a case where diversification may not be a clear benefit.  The money market is a marketplace where buyers (corporations) purchase short-term cash from sellers (you), offering as inducements a rate of interest (today, nil) and the ability to sleep at night, in the form of a fixed $1 net asset value.  We were dismayed last year when we moved our retirement money out of a number of stock funds and found there is no option to hold funds in cash.  “But a money fund is cash” we were told.  No, we answered, it is an investment with a degree of risk associated with it.  Our account manager was incredulous, a situation that was only made worse when we explained that FINRA actually requires stockbrokers to be fully licensed (Series 7 registration, enabling securities professionals to sell risky investments to customers) in order to hold customer assets in a money market fund.  Even FINRA gets it right once in a while.


It is rare that we get such forthright disclosure of the risks facing our investments, and from such a credible source.  Krawcheck cites “hundreds of conversations” with money-fund investors, and from her professional background you may be most were with institutional money managers.  These investors – retail and professional alike – do not know “that as recently as last summer, the largest money funds averaged 45% of their investments in European bank paper, with one major player at just under 70%.”  She goes on to say that “half of the top 10 money-fund providers” are likely not well enough capitalized to guarantee the safety or liquidity of your assets.  In other words: your money market fund may hold German, French, Portuguese, Irish and Greek government debt, is not FDIC insured, and may not have enough money on hand for an overcast morning, leave alone a rainy day.  In short: it ain’t cash.  Which makes that “$1 net asset value” on your brokerage statement about as unreliable as a narrative can be.


Better yet, your broker is actually required to lie to you about the market value and recoverability of your holdings, because they must report the pricing as reported by the mutual fund.  Until this reported SEC proposal, no one has challenged the money fund convention of pricing all holdings at $1. 


We give this proposal little chance of implementation, because we think it would send a tremendous shock through the entire customer base of the US financial system.  It reveals that the value of our currency is further removed from reality than we thought: money fund valuation is a fiat on top of a fiat.  The proposal is receiving a firestorm of predictable opposition from the fund industry, but also from professional money managers – because it would demonstrate their own ignorance about the portfolio values they report to their investors and expose them to retroactive questions about levels of risk in their portfolios.  A money manager who heavily uses a less well capitalized money market fund should expect inquiries from investors and regulators alike.


From the corporate perspective, cutting money fund valuations loose from the one dollar benchmark would likely be disastrous.  The commercial paper market relies on the approximately $2.7 trillion money market sector for corporate liquidity.  Little did we know that the Europeans are also taking a sizeable bite out of our apple.  For all their shortcomings – perhaps because of them, if we place venality and lack of transparency atop the list – the Fortune 500 companies to whom you lend your dollars are planning to return the money in time, in order to be able to return to the world’s cheapest and most liquid trough.  Europe, in contrast, appears to be consciously steering itself into the greatest, most predictable slow-motion train wreck in modern history.  Would you lend 10% of your portfolio to the Euro zone?  How about 45% - or in some cases 70%?


In addition to the integrity of the commercial paper market, there is a further argument for holding firm on the one dollar valuation.  It creates a firm expectation – not a legally binding one, not even (we can hear you chortle at the term) a “moral obligation” of the fund.  But it creates a market standard that all participants must target.  It holds the managers to a level expectation and sets a clear benchmark for failure.  Indeed, we might go so far as to suggest that doing away with the $1 convention is an invitation to risky behavior.  Rather than cut the price free from its moorings, we suggest the regulators take a hard look at the composition of the portfolios of various managers, and at their risk management processes.  We recognize this is a more difficult task – but that’s what the SEC is paid to do.  Ultimately, this could even result in a two-tiered money fund marketplace: the firm one-dollar NAV funds, all managed to a conservative standard, and the speculative money funds – which would be free to float their NAV, but would have to pay a higher yield, charged to the issuers of the short-term paper.  Which raises a further question: are the money fund operators actually charging a higher rate for riskier paper, and not passing it through to the investors?  We only work here.


Unmentioned in this debate – and here we give particular praise to Ms. Krawcheck – is the responsibility of the consumer.  The investing world – professionals and retail alike – swing forever between panic and complacency.  Without threats looming on the horizon no one bothers to read the prospectus of their money market fund, much less to call the investor relations department and question what this stuff really means.  When things explode, everyone expresses horror at how poorly managed their investments were. 


Star quarterbacks are taught to shake off their shame response when they throw an interception.  The coach cannot have a quarterback feeling gloomy about his last throw: he must focus on being great in the upcoming play.  And so their egos are constantly stroked, they are trained to reinforce their awareness of their own greatness, no matter how badly they just botched that play.  Professional investors and traders are a lot like that.  We chose this week’s opening quote from the newly-issued OECD Yearbook as a classic indicator of how the system keeps failing those who rely on it.  Market participants shake off yesterday’s losses and take a fresh shot at the markets today with insouciance – and with your money.  If that didn’t work, they reason, maybe this will.  Investors must recognize that calm periods in the investment markets mask a host of sins and omissions on the part of managers, and that even the best-managed fund will have trouble if all investors rush to redeem at once.  Somebody did learn from the excesses and exposure of the dot-com collapse.  It was not the regulators, not the central bankers – and probably not the guy managing your investments – but somewhere out there are a few people who recognize that managing risk is the key to prosperity.  Michael Lewis’ book The Big Short is an example of the tremendous profits that can be earned when people focus on risk rather than return.  Finally, it appears the numbers of risk-aware investors may be growing.  There is, finally, no better means of portfolio preservation than risk management, and no better form of consumer protection than consumer education.


Changes in the way the markets are regulated will only come from the consumers.  The perpetual state of disaster we wake up to each morning is the direct result of leaving oversight of the marketplace in the hands of fools (the regulators) and villains (Congress).  Ms. Krawcheck has done the marketplace a tremendous service by delineating in clear and precise terms just how unrealistic the standard $1 valuation is.  Her piece is required reading for anyone who still has a dollar – a shrinking audience these days.  We would propose Sallie Krawcheck for the chairmanship of the SEC, but we would be afraid of offending her.


At Home With Tim And Carole

Q: When is a default not a default?

A: When it’s an ISDA.


Just another quiet evening by the fire in the Geithner home: that white elephant of a house in Larchmont, NY.  Tim pokes the fire lazily, unwinding after a long day of boxing with the Chinese over whose currency is bigger.  On the sofa, his wife Carole rustles the pages of the Wall Street Journal then lets out a sharp exhalation that is half surprise, half scorn in reaction to yet another story about how the Volcker Rule will cut off sovereign nations’ access to the capital markets and undermine the US’ ability to compete globally.  Despite his own very public pronouncements to the contrary, most people in the world think of Geithner as an economist and expect him to advise the President on economic issues.  We refer, of course, to Geithner’s much-parodied reply to David Gregory on “Meet the Press” (18 April 2010).  When asked whether unemployment might not rise again, Geithner replied “No, I’m not an economist, David, but if you see that happen it’ll be because you have more people come back into the work force now because there’s hope again.”  For someone who is not an economist, Geithner’s prediction is right out of Macro 101.


In fact, simplicity has much to recommend it, particularly in overseeing the financial markets.  Mrs. Geithner seems to share our view.  In his Opinion piece in the Wall Street Journal (2 March, “Financial Crisis Amnesia”) Secretary Geithner lays out a clear picture of what is perhaps most wrong about the regulatory process, and wrong with America’s economic and political nexus today.  Those who complain that America has allowed greed to run rampant are frequently reminded that, with all its failings – from slavery to Fannie Mae – America has created the highest standard of living for the most people in the history of humanity.  Those who keep trumpeting that factoid, though, forget that the biggest booms, the broadest creation of well-being was under a regulatory regime that included Glass Steagall, community banking, and strong labor unions.  The founders intended the political process to lurch forward through progressive points of gridlock, as a way to prevent runaway legislation by any one faction, leading to fiat government (as we go to press, Vladimir Putin looks ready for his coronation.)


No less than the safeguards to our democratic process, the soundness of our economic system is predicated on balancing interests: strong labor unions are a counter to the abuses of unbridled wealth, but also a productive alternative to a welfare state.  Strong bank regulation keeps a cap on bankers’ ability to grow earnings – both institutionally and personally – but protects depositors’ funds from the risks taken on by professional traders.  The community bank is analogous to the money market funds we described above.  When you deposit your $1000 in your local bank, you recognize that it may be lent to Joe’s Deli, Sam’s Shoe Town, or Bess’ Dresses, all local businesses run by people you know and trust.  The risk to your cash is the risk inherent in your community.  When you deposit that same $1000 in Banko Wanko Mundo, you may not realize that they have no interest in helping Bess expand her inventory – because they have been hypnotized to believe that they can earn more money, and pay themselves fat bonuses, if they let Wanko Mundo Securities trade your money in the European CDS market.  Well, you say, Greece is for sure going to default, so I guess I will get a return on my money.  Oops – nobody explained to you that ISDA, the private club that runs most of the world’s CDS business, can unilaterally declare that a default is not a default after all.


Far from being threatened by the Volcker Rule, we wonder why a private club, which is what ISDA is, can exercise a cartel-like influence on market forces by redefining the terms of the very contracts it created.  If private investors do not sue ISDA over abruptly invalidating the myriad CDS contracts that will now be violated over the Greek restructuring, perhaps the SEC and CFTC should.  Oh, we forgot – they are prohibited by Act of Congress from regulating the derivatives markets.


Writes Secretary Geithner, “my wife looks up from the newspaper with bewilderment at another story about people in the financial world or their lobbyists complaining about Wall Street reform.”  He has his finger on it: the conflicted structure of Wall Street is such that professionals are paid on their next transaction, not on how well they handled your money last time.  Washington, too, is caught in this windmill.  Look at the members of Congress who are charged with overseeing the financial markets.  While taking bankers and traders to task, they also must run for re-election every two years – which means they probably spend an average of about six weeks in each electoral term actually working on legislation – and will be visiting many of those same bankers to ask for campaign donations.


Secretary Geithner lays out a clear blow-by-blow of how we have ended up with our heads down the toilet – laced with an admonition that we are likely to remain there unless we consciously reverse course.  Geithner praises President Obama for pushing through financial reform quickly “before the memory of the crisis faded.”  But now, he writes, the weight of dialogue has shifted to criticism of the regulatory reforms and complaints that the costs are too high.  To those critics, the Secretary says the costs are “certainly not too high relative to the costs of another financial crisis.” 


“Amnesia,” writes Geithner, “is what causes financial crises.”  Secretary Geithner may not be much of an economist – perhaps that is why he has written a clear description of the facts, rather than a set of hazy “expectations.”  Maybe it’s time America stopped listening to economists and started listening to common sense.  Just because Tim Geithner says something, doesn’t mean it’s not true.


Growth Slowing: SP500 Levels, Refreshed

POSITIONS: Long Utilities (XLU), Short Consumer Discretionary (XLY)


Soros would say markets are “reflexive.” I agree. Growth Slowing As Inflation Accelerates can be ignored as a fundamental fact only until it is reported as fact. Then, if the market reacts negatively to that fact – I guess it’s a more relevant fact!


Last week’s call was to down-shift your beta. Hopefully you did some of that. Small Cap and Basics Materials beta is getting smoked now that the US Dollar is attempting to solidify its stance above $79.03 TREND support.


Across all of my risk management durations, here are the lines that currently matter most: 

  1. Immediate-term TRADE resistance (was support) = 1366
  2. Immediate-term TRADE support = 1356
  3. Intermediate-term TREND support = 1283 

In other words, there is plenty of bullish support for this market – just from lower prices. We have not seen my immediate-term TRADE line (1366 today) snap and stay there (below the line) since December. So, stay tuned…


Our markets are addicted to inflation. So this, like mostly everything in markets, is going to be a process, not a point.




Keith R. McCullough
Chief Executive Officer


Growth Slowing: SP500 Levels, Refreshed - SPX


March GGR estimate up 23-33% YoY



It’s only 4 days so not much read through yet but we’ll tell you what we have.  Average daily table revenues were HK$748MM which is down from February’s surprisingly strong HK$779MM.  We would have expected better since two out of the four days were weekend days.  On a full month basis, the calendar is favorable with one extra weekend days.  Some people are saying two extra weekend days but the Macau government counts one day in arrears.  Overall for the full March including slots, we are estimating GGR at HK$24-26 billion, up 23-33% YoY.  Last year in March, VIP hold was percentage was the lowest of the year.   




Market share is irrelevant at this stage of the month so we have little commentary other than to say Galaxy looks like it is taking one on the chin in terms of hold.  Galaxy has been struggling with share recently and we expect that trend to continue, particularly with the opening of Sands Cotai Central next month.  Wynn and MPEL are off to strong starts.



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European Banking Monitor: Interbank Risk Throws Off Mixed Signals

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .


Key Takeaways:

*Interbank risk throws off mixed signals. Last week the Euribor-OIS spread tightened by 4 bps to 61 bps while the TED spread rose 1.6 bps over the same period to 41 bps. What's interesting here is the emerging divergence between the two series. Euribor-OIS continues to improve at a consistent rate, as it has done since the start of the year. The TED spread, however, has flattened out since mid-February and is essentially just moving sideways now. Last week's round two of LTRO was the short-term catalyst the markets had their sights set on. While interbank risk was among the most significant factors at the start of the year, the amount of renormalization that has occurred in Euribor-OIS (we estimate ~60% complete) leaves far less room for improvement today than there was back just two months ago.


Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 4 bps to 61 bps.


 European Banking Monitor: Interbank Risk Throws Off Mixed Signals - 1. Euribor


ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  Friday made a new high of €820.8 Billion.


European Banking Monitor: Interbank Risk Throws Off Mixed Signals - 1. ECB overnight


European Financials CDS Monitor – Bank swaps were tighter in Europe last week for 38 of the 40 reference entities. The average tightening was 8.2% and the median tightening was 8.8%.


European Banking Monitor: Interbank Risk Throws Off Mixed Signals - 1. banken


Security Market Program – The ECB's secondary sovereign bond purchasing program did not buy any paper in the week ended 3/2, which equates to three straight weeks of no purchasing and a mere €183 Million in the first two weeks of February, versus €2.2 BILLION in the week ended 1/20 and €3.8 BILLION in the week 1/12, and a total program of €219.5 Billion. Interesting, and despite ECB purchases, last week saw solid bond demand and lower yields across auctions from Italy, Spain, and France. Who is taking down this paper?  Is the ECB just on hold? Is the ECB winding down the SMP?  Is the ECB making up the numbers? How much further can yields fall despite only marginal changes to the sovereign debt and deficit levels across much of the region, weakness in the banking system, and a tight credit environment?   We continue to scratch our heads….


European Banking Monitor: Interbank Risk Throws Off Mixed Signals - 1. SMP


Matthew Hedrick

Senior Analyst






Comments from CEO Keith McCullough


Got Growth Slowing? The #1 Most Read finally has nothing to do w/ Greece or Apple – it’s all China this morning:

  1. CHINA – Growth Slowing has been plainly obvious in just about every high frequency economic data point in Jan-Feb – plenty shrugged that off as being all about the Lunar calendar, but this morning’s Services PMI print out of China is a 48 and that’s more inline w/ what Wen’s guiding to in a 7.5% GDP Growth rate (vs the 9-12% China has been tracking since 2009)
  2. YEN – President of Japan’s Credit Rating Agency Inc said the BOJ is “damned if they do, damned if they don’t” (buy bonds) w/ this massive debt maturity spike in 2012. Them be fighting words in Japan as the Yen continues to be in a Bearish Formation (bearish TRADE, TREND, and TAIL) w/ an immediate-term oversold level of $81.96 USD/JPY.
  3. USD – after a +1.3% week, finally attempting to stabilize above critical $79.03 support – Romney solidifying the Republican base has had a high correlation to a more stable dollar than the Newt/Santorum thing. Super Tuesday could be another bullish USD catalyst inasmuch as winning Michigan was.

Dollar up would Deflate The Inflation and get me more bullish on Equities broadly (again). But there’s a time/price bridge to pass over called beta in between these Growth Slowing Expectations falling and stocks addicted to down dollar doing the same.







THE HBM: SBUX, DNKN, CMG, PZZA - subsector





SBUX: Starbucks topped the Restaurant Social Media Index for 4Q11 once again.  The complete rankings are below.


THE HBM: SBUX, DNKN, CMG, PZZA - restaurant social media index



DNKN: Dunkin’ Brands is planning to open another 100 stores in China over the next two to three years and will use LeBron James to promote its image in Asia, having announced a multi-year marketing agreement with the NBA star today.


CMG: During the month of March, Chipotle is offering a free order of chips and salsa to entrée-purchasing customers that “check in” at Chipotle on foursquare.


PZZA: Papa John’s has been holding the line on discounting, instead sticking with its long-held premium-products-at-premium-prices message, according to a story on


THI, YUM, DPZ, CMG, WEN, SONC, JACK: All speaking at conferences this week.




BAGL: Einstein Noah traded higher on accelerating volume following stronger-than-expected earnings.





DIN, TXRH, RRGB, CAKE, RUTH, EAT, PFCB, RT, BOBE: All speaking at conferences this week.




DIN: Dine Equity traded down -5.6% on accelerating volume Friday following disappointing earnings.  





Howard Penney

Managing Director


Rory Green




The Macau Metro Monitor, March 5, 2012




Sands China CEO Edward Tracy said the second phase of Sands Cotai Central is planned to open in October.  He also reconfirmed that Sands Cotai Central’s first phase will open in April, which includes the Conrad and Holiday Inn hotels and the casino.  The property’s casino is to include about 140 VIP gaming tables, as well as 200 mass market gaming tables. Sands China plans to add 200 mass market gaming tables by 3Q 2012, Mr Tracy said.



Junket operator Neptune Group Ltd. announced a profit of MOP229.7MM for the six month period ended December 2011. The company’s board says this will be a challenging year and that revenue growth may slow down depending on the mainland’s economic performance.  “Importantly we will continue to invest in our business, continuing to acquire more VIP room operators’ business in Macau and in other Asian countries,” says Neptune.  Previous media reports have stated that Neptune promotes nearly 200 VIP tables across 10 venues in Macau.


Amax Holdings shareholders voted last week in favor of an IPO of its associate company Greek Mythology (Macau) Entertainment Group Corp Ltd. that controls Macau's Greek Mythology casino.  A new holding company, Greek Mythology Holdings Ltd., is to be listed in Hong Kong within two years.  Amax Holdings will control a minimum 49.9% interest in the new holding company.  The IPO was the course decided on by the board of Amax Holdings in order to recover a disputed stake in Greek Mythology (Macau) Entertainment Group Corp Ltd.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.52%
  • SHORT SIGNALS 78.70%