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John Dalt
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John Dalt is a retired small business owner who is now operates galtstock.com for stock investors and traders.
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  • Debt Hypothecation and Greece
    Hypothecation is when a borrower pledges collateral to secure a debt. The borrower retains ownership of the collateral, but it is “hypothetically” controlled by the creditor in that he has the right to seize possession if the borrower defaults.
    Why would anyone hypothecate a loan rather than borrow the money? Because if you pawn an asset, you have to leave it with the pawn shop. If you hypothecate an asset, you get to keep the asset. Evidently Big Banks have learned a few things from pawn shops. Big bank A will hypothecate their assets to Big bank B for a loan, and everyone continues doing business like nothing ever happened.
    Except if something happens, Bank B gets to claim the cash assets without going through bankruptcy court. You might think “No they can’t!” But, they can and the FED and FDIC know it.
    ZeroHedge had a story last October detailing how Bank of America (BAC) moved $53 billion worth of derivatives from its Merrill Lynch unit to the retail bank unit. The holding company had been downgraded by Moody’s (MCO) and Merrill's derivative customers wanted more collateral. By moving them out of the Merrill Lynch unit and into the retail bank the derivative customers had $1.04 trillion in deposits as a backstop.
    Bloomberg reported the Federal Reserve signaled that it favored moving the derivatives while the FDIC objected because they would have to pay off depositors in case of a bank failure. The bank’s stance was that regulatory approval was not needed.
    Section 23A of the Federal Reserve Act limits moving derivatives contracts between business units of a bank holding company to prevent Holding Company business units other than the regulated bank from benefiting from the federally guaranteed FDIC insurance and to protect the bank from excessive risk originating at non-bank units. Bank of America was given an exemption to Section 23A in September of 2010.
    Re-hypothecation is fractional reserve banking, except on steroids. Bank B loaned money to Bank A against Bank A’s assets. Let’s suppose that Bank B wants to borrow some money, so it goes to Bank C and uses Bank A’s assets that are hypothecated in its loan to Bank A as collateral for a loan from Bank C. And you see how Bank A’s assets could be guaranteeing a loan downstream to Bank C,D,E or F.
    What happens if Bank A defaults to Bank B? Does Bank B line up in bankruptcy court and detail how much it is owed, with all the other creditors? NO. Are Bank B’s claims secondary to bondholders? NO In 2005 the U.S. Congress passed and President Bush signed the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA).
    An amendment was inserted in the BAPCPA that exempted derivative counterparties. The U.S. Financial Inquiry Commission investigated the credit crisis of 2008. Their report observes “derivative counterparties were given the advantage over other creditors of being able to immediately terminate their contracts and seize collateral at the time of bankruptcy.”
    One unintended consequence of the derivative exemption in the BAPCPA is the attitude of creditors. When someone owes you money under normal circumstances, you don’t want to force them into bankruptcy. You would be thrown in with all other creditors and have to wait on the bankruptcy trustee to report to the bankruptcy court. Then a judge would allocate the remaining capital according to seniority of the debt.
    If you have a hypothecation on bankrupt assets (or other derivative like a re-po) why do you care? In fact, you can get your hands on their assets immediately if they declare bankruptcy.
    The minute Bank B loses confidence in Bank A; Bank B will apply pressure to push Bank A into bankruptcy so they can collect the assets before a bankruptcy trustee is even assigned. Bankruptcy lawyers may argue that Bank A’s customer’s cash does not belong to Bank B, but possession is 9/10’s of the law. Lawyers can string this out for months or years while the bank uses the assets to make a profit.
    The European Union adapted similar exemptions for derivatives as BAPCPA’s.
    As we watch the drama in Greece, remember every creditor does not have the same interest. Some have sovereign debt from Greece. These creditors want to help Greece become solvent and collect what they can. Some have derivatives that guarantee the value of the Greek bonds. These investors/traders will take nothing less than 100% of face value on Greek debt. If Greece defaults they will be able to collect on their Credit Default Swaps (CDS).
    Some parties have hypothecated loans to eurozone banks that will allow them to seize bank assets in front of other creditors if they cannot be repaid within terms. If turbulence creates uncertainty, these traders can demand payment. They have no risk if firms are pushed into bankruptcy. A Greek default would create a fire-sale mentality as banks try to liquidate eurozone bonds and other assets to avoid bankruptcy. One way or another, the hypothecated lender gets paid.
    Greece must negotiate "haircuts" or write-downs with bondholders of their existing debt or face default.  The derivative owners with CDS against their debt and hypothecated lenders to eurozone banks could win the most if talks fail.


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: BAC, GS, MCO, derivatives, hypothecation, default, macro view
    Feb 01 4:59 PM | Link | Comment!
  • 236 Years of Honor
    Firday was Veteran's Day in the United States. Thursday was the 236th birthday of the founding of the United States Marine Corp. I talked to an old friend who left his leg in Vietnam, and thanked him for his service to our country. He attended lunch in Kansas City Thursday with other Marines. I thanked him for his service, and suggested he puff out his chest. A couple of other calls to “leathernecks” to thank them for their service left me with a lump in my throat. The "Long Line" continues with one of my friends. He fought in Vietnam, his youngest son enlisted in the Marines earlier this year and is scheduled to deploy to Afghanistan in January as a Security Officer.
    Iwo Jima Memorial
    Iwo Jima Memorial in Washington, D.C.
    21,570 Japanese and 6,821 Marines Killed in the Battle of Iwo Jima
    Thinking about my friends and others that gave the last ounce for us makes all the daily work we do in the market seem insignificant. Bob Parsons is the founder and President of GoDaddy. They host our website. Bob Parsons is a Marine. Each year Bob sends out his tribute to the Marine Corp. You mayBelow is the Marine Corp Commandant's 236th Birthday message, Indomitable Spirit.



    I encourage you to make a few calls to anyone you know who served our country, you will be better for it.     The Marine Corp was founded 236 years ago. A committee of the Continental Congress met in Tun Tavern in Philadelphia. They drafted a resolution to form two battalions of Marines to fight for independence at sea and shore.
    The resolution was approved on Nov. 10, 1775, officially forming the Continental Marines. After organizing, the force was ready in early 1776. According to Answers.com the present day Marine Corp consists of 203,000 active duty, and 40,000 in reserve. The Corp motto is Semper Fidelis, Latin for “always faithful.”
    With all of the above, we want to make our annual suggestion to think of using Worcester Wreath Co. for a nice gift for friends or customers. Worcester grows the balsam wood, makes the wreaths and ships them to your address. This Company’s president, Morrill Worcester donates wreaths every year for Arlington National Cemetery. Maybe a little bit of the money you spend with him will help him continue this philanthropy. Morrill started by giving 5,000 wreaths to decorate the graves at Arlington National Cemetery in 1992
    Wreaths at Arlington Cemetery
    Arlington Cemetery with Worcester Wreaths
    This year Wreaths Across America will decorate 330,000 fallen heroes’ graves at Arlington National Cemetery. Wreath laying day is the second Saturday in December, this year falling on the tenth. Wreaths Across America is a 501c3 organization that organizes the wreath ceremonies at 300 locations in the U.S. and 24 foreign cemeteries where our fallen heroes rest. There are few charities more deserving of our support. You can donate at Wreaths Across America. Here is a short video by Karen Worcester explaining the theme for this year, "The Christmas They Never Had."

    My Dad's older brother fought at the Battle of the Bulge in WWII that Karen mentions in this video. He never talked about this to us, but told his children he had never been so cold. He crawled between command posts, stringing wire so officers could talk to each other. He told his kids the spools of wire were tied on his back and he drug his knapsack along because he never knew where he would get to sleep.
    I hope you can make the effort to remember our Veterans, as they gave willingly when called.
    Quote:
    To be killed in war is not the worst that can happen. To be lost in war is not the worst that can happen...to be forgotten is the worst that can happen. - Pierre Claeyssens (1909--2003)


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: war, veteran's day, marines, 236 years, defense, patriotism
    Nov 12 10:05 AM | Link | Comment!
  • Waiting on the Wedge
    We wondered this morning what the day would look like.  Asian markets were down, except for China.  European markets were up early and futures looked positive for U.S. markets.  We were not convinced.  The unrest in Libya sounds like it is getting worse.  Crude oil and precious metals are spiking.  One of our favorite ways to look at the market is a point and finger chart.
    Point and Finger Chart 3/7/11
    It is a simple way to see where we are.  If the S&P drops below 1300, we have a long way to fall.  I noticed the S&P chart this weekend looked like we had a trend line starting to establish itself of lower highs.  Here is a sharpchart.
    S&P 500 3/7/11
    You can draw a line from the top on 2/18 down across the tops of the highs (sloping down from left to right).  Then draw a line from the lows on 2/24 along the bottoms (sloping up from left to right).
    We have a wedge building that comes to a point.  The market has to break one of the trend lines, either moving higher or falling to create a new trend.  Traders would be advised to watch for the break of this wedge.  This will tell us the short term trend of the market.
    The market looks like is going to bounce off the bottom trend line today. Be careful entering trades that may move against you swiftly on violation of these two trend lines.


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: technical analysis, bull market, bear market
    Mar 08 3:42 PM | Link | Comment!
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