Martin Kronicle

The NYT Magazine ran an article Sunday about Harry Markopolos, the Madoff whistle blower called Math Is Hard.

According to the article, Markopolos discusses what’s wrong with the SEC – it’s the attorneys and their way of thinking.

That got me thinking about how horrible Chuck Prince did at running Citi. Insight from Markopolos and the Chuck Prince meltdown might provide for an interesting case study in why you’d want a very successful trader – someone with excellent skills at risk management – to run a large trading firm as well as a regulatory body and exchanges.

From the NYT Magazine:

Are you saying the S.E.C. under Schapiro is about to catch fraud on Wall Street?

She has the wrong staff. They’re a bunch of idiots there.

What do you mean?

The five commissioners of the S.E.C. are securities lawyers. Securities lawyers never understand finance. They don’t have the math background. If you can’t do math and if you can’t take apart the investment products of the 21st century backward and forward and put them together in your sleep, you’ll never find the frauds on Wall Street.

Along with Greenspan and Robert Rubin, Obama’s current Council of Economic Advisors Chair Summers formed the Committee to Save the World, according to a Time magazine cover.

The three of them, with Tim Geithner, ran interference to disrupt and frustrate Brooksley Born, then the CFTC Chair, from taking effective action to avert the derivatives morass.

It did not however, stop Born from sounding the alarm enough to get everyone’s attention. Sadly for the US taxpayers, Greenspan, Rubin, Geithner, and especially Summers – who has had issues with women, and maybe a Napoleonic complex to compliment it – did everything he could to politically muscle her around after taking cues from the bank lobby and President Obama and the White House.

Greenspan, Rubin, Geithner, Summers, the bank lobby, former President Clinton, and President Obama are as culpable as any other player involved. They aren’t concerned with Americans. They They will revert to politics before practicality.

This PBS Documentary, The Warning, is one of the best I’ve seen on the government’s role in non-intervention.

Michael Covel’s movie, Broke: The New American Dream does a great job of showing us not only the the politics, but the role of personal responsibility.

For the record, I am for price and volume transparency, standardized margins, and centralized clearing for OTC derivatives.

The spreads between Greece/German bunds and California/30-yr Treasuries are widening. Investors are demanding more for carrying the risk. The downgrade in CA paper yesterday will give the Greek bonds are run for their Drachmas…

According to a Reuters report, the spread between 10-year Greek government bonds and the benchmark Euro zone German bunds has risen to an 11-month high of 298 bps, up from 265 the day before. The high is 300 bps set about a year ago. The equivalent for Spanish bonds is trading at 81 bps premium over German bunds.

According to an article in Bloomberg, the spreads between CA debt and the 30-year Bond are also widening and PIMCO was quoted as saying that the CA debt crisis is headed back to disaster levels.

Bloomberg: “A taxable California bond that matures in 2039 traded today for an average yield of 7.79 percent in blocks of more than $1 million, the highest since Dec. 28, according to Municipal Securities Rulemaking Board data. That opened a gap of 3.15 percentage points between California’s bond and 30-year Treasuries, according to Bloomberg data.”

Yikes…!

Add to that the fact that S&P downgraded California’s debt rating to AA- from AA…not that I hold S&P in any esteem – I don’t. But the fact is, that CA will now have to pay higher coupon payments on the issuance of new debt thanks to the downgrade. They deserved it.

A reader asked a great question about how or why Soros would choose gold futures over bullion or vice-versa?

Yesterday, I wrote two posts about George Soros and his recent gold purchase. One was how he did it, the other why he might have done it.

By owning the bullion via the SPDR Gold Trust (GLD), Soros owns bullion as the underlying asset – this is an investment, not a trade. He owns it outright and there is no margin requirement. If his prime broker settles the transaction in a margin account, Soros can lend the GLD shares to another entity that wants to sell short and exact a rebate for doing so (he’d never let the PB keep it all, if they get to keep any of it). This enhances his yield to own the GLD shares.

If he’d owned the same exposure in the COMEX futures market, he’d need to post margin, which he’d undoubtedly be able to do as it would be between 5% – 10% of the over $600 MM position he has. However, he may run up against a few other hurdles by doing so. One, he’d be right up against the maximum position limit in that one can hold in futures. Two, there may not be sufficient liquidity to move the type of size he might want to at a specific time.

In both investments he’d be able to stand for delivery and accept gold if he wanted to.

I think the main reasons Soros bought the bullion are as follows:

-he can hedge all/part of his position using futures in the short-term by selling futures against his long GLD
-he can lend the GLD to a short seller and capture incremental income via rebate, whereas GLD has no dividend yield
-he can very reasonably enhance his long position by purchasing COMEX gold futures in addition to his GLD
-no margin calls for GLD
-no carry charges for GLD, but has Trust expenses
-he most likely can accept the physical gold bullion against his GLD ( b/c of his size)
-tax treatment is more favorable with GLD (28% capital gains tax rate in taxable accounts)*

You, the retail investor, can buy GLD though a regular brokerage account – you don’t need to be approved for commodity futures trading, which may be a barrier for some given the financial litmus test that you must pass. Soros can pass the test.

*Gains/losses from the purchase and sale of commodity futures are subject to a blended tax rate: 60% is considered a long-term gain or loss, and 40% is considered a short-term gain or loss.

August Comex Gold - No Bubble Here

One thing that was not covered in the BusinessWeek article was the overall size of Soros’ stake in gold wrt the marketplace. By adding another $421 MM to his gold position, he took his entire SPDR Gold Trust corpus to $631 MM.

At today’s price of $1,100 per ounce, that would put the Soros stake at approximately 5,975 contracts had he been trading futures. But since he’s owned his initial stake for quite some time, it’s pretty safe to say that he’s at or over the equivalent of 6,000 contracts – and I stress equivalent because his firm owns shares of the SPDR Trust.

The Position Limit for COMEX Gold futures is 6,000 contracts, with no more than 3,000 contracts being in the expiration month. The 13F that investors with over $100 must file does not include futures contracts. Soros may hold COMEX Gold futures in addition to his SPDR Trust holdings, and if he did, he’d be getting around the position limit guideline.

Soros may not be the risk lover he once was when he and Jim Rogers ran the Quantum Fund. At that time, according to my most recent Jim Rogers podcast interview, Jim said they used excessive leverage to generate their gains.