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And Hank and Ben Looked at Their Handiwork and They Were Glad

And Hank and Ben Looked at Their Handiwork and They Were Glad

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Published by: api-26094277 on Sep 12, 2008
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Don Coxe Conference Call for 2008-09-05 “And Hank And Ben Looked At Their Handiwork And They Were Glad”BMO Capital Markets Client Conference Call for September 5, 2008Don CoxeChicago“And Hank And Ben Looked At Their Handiwork And They Were Glad”Thank you all for tuning in to the call, which comes to you from Chicago. The chart that wefaxed out was the CRB futures and the tag line is “And Hank And Ben Looked At TheirHandiwork And They Were Glad”.As the chart reveals, we had a fast run up from the first of May to mid-July in the commoditiesand then came the massacre of Sunday the 13th. And we’ve had a plunge to the CRB. And theCRB breaks its uptrend line if we get down to 350. We’re at 374 at the moment.So I don’t have to tell anybody on this call that what’s happened in the last nearly two monthshas been pretty devastating. And it’s been against a backdrop of bear markets in equities aroundthe world. And they aren’t confirmed bear markets in North America unless they break throughlower levels. And the breakdown levels would be 1210 on the S&P and we would get abreakdown on the Dow at 10,850. We get a breakdown in the Transports at 4650. We get abreakdown in the TSE at 12,000. And the FTSE at 5150 and it’s only, not even 200 points abovethat.So, let’s talk about this, what they did, why they did it and how brilliantly they did it, becausethis is the most massive intervention of government into the capital markets or the financialsystem since Roosevelt closed the banks back in 1933, briefly.Well, one of the things that we have to address in this is, first of all, why they did it and then howthey did it. But we have to look at also, what are the chances that their intervention in factchanged the fundamentals enough so that we’ve got the commodity story right off the table foran extended period of time. And in looking at that, I’d like to take you back to where we were inthe first week in July. And that seems like eons ago and that’s why I’m going to take you throughit. Because it’s hard for some people to recall just how much we were up so recently.Back then, gold looked like it was going to break through the 1,000 mark, which it had donebriefly at the time of the Bear Stearns bailout. But this time it was also being fueled by the bigsurges that occurred in CPI from spring. CPI was now in the US – and of course that’s thenominal CPI, not the adjusted CPI or the core – but that’s what all sorts of things are tied to,including Social Security and indexed wage contracts. And we were at a 15 year peak for that.And with a 2% Fed funds rate, this was putting enormous pressure on Ben Bernanke. He’dalready had one or two dissenters on his board. And so he was faced with the fact that he mightbe under pressure to actually raise the rate. Oil was above a hundred and forty bucks a barrel.Corn was at seven and a half and soybeans were above fourteen. And although cost pass
throughs were being resisted in the system, food inflation was threatening to break out really bigtime.The Dollar looked like it was going to break down anew, it was down at 70 on the DX anddespite spreading recessions across the Eurozone, the Euro was threatening to burst upwardsthrough a buck sixty. The bank stock index, the one we use, the BKX had fallen in six monthsfrom 90 to 50. And all those bank equity deals with sovereign wealth funds were way underwater.But Bernanke had another problem, which was that the Fed’s balance sheet was being degradedby the day with this extraordinary policy of swapping Treasuries for CDOs according to thebank’s models for the prices of these ones that they couldn’t sell. And this was a huge change inFed policy from what securities were required up until then, you’d have to use Treasuries for thepurpose.Meanwhile, the policy of course, the problems had spread across the world. The ECB was facingthe same kind of degradation problems on a smaller scale in it’s balance sheet, because banks inthe regions – particularly in Spain, but also smaller German mortgage lending banks – werepacking up their illiquid mortgage products and borrowing from the ECB at rates that once againput the ECB in a position that their balance sheet could be in trouble.But out there also, the screams were coming that…the Wall Street Journal was leading thecharge, saying that $140 oil was due to what was happening to the Dollar and that the Fed had toraise interest rates to protect the Dollar and therefore get oil prices down.Now, the most immediate problem of course was that Fannie and Freddie were on the edge of collapse. And that meant that hundreds of billions worth of their paper held by government fundsabroad, including a hundred billion by Russia, was at risk. And it also meant that the bigexposure that banks have to Fannie preferred stocks and other equity securities was in troubleand the banks didn’t need anything else to go wrong.So what they did – and this is why you want in a crisis like this, you want a Goldman Sachs ex-CEO at work. People sometimes sneer about the fact that Goldman seems to just get all these bigappointments. But what it means is you’ve not only got somebody that really knows the markets,but somebody who’s access to information is terrific and who really understands how you canintervene in the markets successfully. Because if you’re going to do a strategy like this, it’s gotto work.So what they were able to get information on, with help from the Commodity Futures TradingCorporation, was the change in the make up of who was driving this huge rally in thecommodities. And there had been a change since May in the speculative investors had a muchbigger share on the buy side. And these were levered speculators lead by the hedge funds.So what they did was basically said “All right, we’ve got to bail out these over-levered banks,we’ve got to do something to get the bank index rising so that we can create equity in thebanking system that they can do re-financing. So we’ll go from taking all the pressure on
leverage off the banks to putting it on the commodities. And we’re going to focus particularly onoil, gold and the grains.” Because if you could take those out, you would also take out theinflation scare. So you get a psychological effect, plus the real effect of the leverage beingunwound in the private sector in a way that was deemed deleterious to the financial system.And they did it and it worked.And leverage was being unwound dramatically. And of course by doing it Sunday night, that wasbrilliant because the hedge funds who were short the financials and long the commodities werein the position that the commodities were already going down because they trade around theworld. But the available supplies of bank stocks were very small in foreign markets. So that bythe time that New York opened on Monday morning, what you had was massive bids for thebank stocks gapping upwards. And that just reinforced the need of the hedge funds to unwindtheir positions. So we had a true panic.And this was bigger by far than what had happened when the Bank of Japan had made thatmassive adjustment to its balance sheet a couple of years earlier in the merry month of May,which was the quickest downdraft we’d seen in this commodity bull market.Nothing like this had been done efore and they got help from the SEC. In other words, they gotall their troops in line. Chris Cox – no relation to me – came up with an unprecedented ruleagainst short-selling of Fannie, Freddie and of selected bank stocks.So you had a situation where, when these stocks were rallying, it’d be difficult for those whoweren’t caught in a levered position but said “Ah these stocks aren’t worth these prices”, thatthey couldn’t move in and supply the stock to meet the panic short-coverings. That was,therefore, what you had a situation where all the regulatory authorities in effect moved in at thesame time. And it was enough to blow the system apart and to change the game.They also had some…lots of help on their side from deteriorating economic numbers and theywere coming in day after day so they would have undoubtedly talked to their friends at centralbanks abroad and the Bernanke people would have been able to get all sorts of help on that. Andremember that with central bankers, they’re real group, their real collegiality is with other centralbankers. They find themselves regularly in an position of an adversarial relationship to localpoliticians and interest groups, so the people that they can talk to most comfortably are the kindof people that they do social events with and they have meetings during the year around theworld. They know each other. They trust each other. They consider themselves the true globalelite group. And therefore I’m quite sure that they got all the information that they needed aboutpositions around the world and that this intervention was going to work.Well, if, in that kind of situation there was no new source of buyers to stop the descent…and thisis also against a backdrop that we had of bear market conditions for equities generally. And whathappened then just fed on itself. And as oil in particular went down and as gold broke down, thenwhat we had with the grains was that the rain stopped. Terrific weather returned to the plains.And so, the USDA started coming in with better reports about the outlook for grains.

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