Toomre Capital Markets LLC

@ltoomre @mrkwpalmer @ltabb @johnjcoulter @kw2dio The #SIFMA edition:

Since March, I’ve been posting #FollowFriday posts on my blog, highlighting people that I find interesting. Often, these posts focus on specific groups of people; friends from Connecticut, Connecticut news outlets, political activists, people doing interesting stuff in online marketing, and so on. This week, I’m highlighting a few people doing saying interesting things about financial markets.

As is my standard, I write it as a blog post, so people can get additional information on why I am following these people, and TwitterFeed sends the key part to Twitter.

Treasury yields soared and prices correspondingly plunged on June 10th, 2009. The benchmark 10-year note briefly touched the four percent level after the United States Treasury sold $19 billion of 10-year notes and Russia said it would further reduce its share of U.S. debt. This was the highest yield for the benchmark since October 15, 2008 when the credit markets were in the throes of seizure.

During the past few months, Toomre Capital Markets LLC ("TCM") has been quite busy tending to other matters (like client engagements). Hence, Lars Toomre in particular has had limited time to write for this website. However, as often happens behind the scenes, a client contact called to pick Lars' brain about what might be his macro perspective on yesterday's events. That I shared with the client and I also told him a few ways that I would be positioning investment portfolios if I were responsible for the management of fixed-income or equity assets. This client also strongly urged that I also share with the readership of this website a brief write-up about my first statement, which was "It is all about convexity!"

The bond market in general is having fits because of the large amount of Treasury supply that is needed to fund the stimulus package as well as what some regard as the profligate spending of the new Obama administration and Democratic Congress. Hence, Treasury interest rates in general have backed up from the excessively low levels they reached while investors of all types fled to the relative safety of Treasuries. The reader might well remember just a few short months ago that no one wanted to own any type of risky asset.

Both the Treasury and major equity markets are back to levels roughly about where they stood as the events around the bankruptcy of Lehman Brothers and the rescue of AIG took place. Eight months have elapsed during that period. During that period, both equities and bond yields have been much lower. The United States Federal Reserve stepped in with various alphabet soup programs in attempt to maintain some amount of liquidity and to prevent an absolute seizure in the money and credit markets. Hence, the Federal Reserve balance sheet has expanded massively and quite quickly.

While this expansion has occurred, there has been a major move to get consumers with troubled mortgage debt to refinance into more traditional mortgage instruments. Much of that origination occurred at lower interest rates. The resulting securities are now held in large part by either FNMA/FHLM or the Federal Reserve under one of the purchase programs introduced in the last year. Also many of such recently originated mortgage-backed securities are now "under water" or below the origination/purchase cost.

People sometimes forget how much negative convexity there are in mortgage-backed securities, particularly when yields shift by about 150 basis points or more. What start out as securities near par with a duration slightly in excess of four, now become discount securities with durations around six years. (Remember longer durations imply that for a given amount of yield increase, there will be a bigger price drop for a longer duration bond.) The refinance option still residing with the homeowner keeps is far out of the money, and hence the effective duration of the mortgage pool is now much longer. The question is how much longer and what is the over-all consensus in the market about how long that option is going to remain out of the money.

For about a dozen years now, late-night TV has frequently had advertisements from a financial firm known as J.G. Wentworth. On June 1st 2009, that firm, formally known as JGW Holdco LLC, and two of its subsidiaries, J.G. Wentworth LLC and J.G. Wentworth Inc., entered Chapter 11 bankruptcy protection after the company allegedly "encountered liquidity problems amid a tightening credit market".

This relatively-small financial firm repeatedly pitched the concept that one could sell insurance contracts known as structured settlements "to raise cash now". Rather than receive a stream of payments in future years as specified in an annuity insurance contract that is part and parcel to a structured settlement, the beneficiary of that structured settlement could receive a sum of cash from J.G. Wentworth "now". In exchange, the beneficiary would give up all future claims to the annuity cash flows and the funder, J.G. Wentworth, would receive them instead.

Many individuals and firms have long avoided the structured settlement sector of the financial markets, particularly on the purchase side of the transactions. Most sellers of structured settlements are what one would call "retail" customers. Frequently, these customers are less sophisticated in one way or another. Often the customer is at least middle-aged, if not older; is in a diminished physical state; and has encountered some type of financial stress that is leading to the consideration of the sale of the structured settlement annuity contract.

In such a condition, it often is not clear to a seller whether a proposed transaction price is fair or not, especially when potentially pressured by an aggressive broker who promises to get the seller cash now. As with all retail-oriented businesses, the "downsides" (risks) of entering into the transaction are rarely well-explained. Further the total fees to be paid to the broker and/or principal are often concealed or less than completely disclosed.

The Microsoft Internet Explorer browser in its various implementations is so frustrating to deal with, especially in its various non-standard ways of rendering XHTML elements and CSS mark-up. Working with Internet Explorer version 7 during the past few days, I am reminded well why we here at Toomre Capital Markets LLC ("TCM") fled first to Firefox and then more recently to Google's Chrome as our web browser of choice. Unfortunately, though, slightly more than sixty percent of this site's visitors still use Microsoft IE for browsing content here. Hence, website changes still need to be correctly rendered with IE as well.

Over the past few weeks, we have been doing quite a bit of working on the plumbing so to speak that enables this website to function. At its core, the public side of this website relies on the excellent Content Management System known as Drupal. The core software was upgraded to the most recent Drupal release 6.12 and all of the more than sixty or so modules were upgraded as well. We also have begun implementing a number of new features like the ability to print content in a printer friendly format, an ability to e-mail content to professional contacts and the ability to share content with various social network sites.

As part of that overhaul, we also have rewritten the core Drupal theme that will be used to display various website pages to the user. That new theme is working really well in both the Chrome and Firefox browsers. However, of course, the Microsoft IE browser has other thoughts. It appears not to recognize some CSS selectors or maybe not implement them at all. Other CSS selectors seem to have padding and/or margin issues that are throwing neat rows of graphical elements out of whack.

Hopefully, it will only take a short while to track down solutions to each of these Microsoft IE specific issues. Until then, we will hold off on putting the new theme into daily production. Thank you for bearing with us during this upgrade and redesign process. We are off to find some tools that might assist with the debugging of what is going on with the IE rendering engine.

Toomre Capital Markets LLC ("TCM") first wrote about the use of credit default swaps ("CDS") as a means of insider-trading back in October 2006 in the post Possible Insider Trading Using Credit-Default Swaps?? On May 5th 2009, the Securities and Exchange Commission finally filed its first case alleging that credit-default swaps were used to facilitate illegal insider-trading activities. Hopefully, this will be just the first of many such cases filed involving the abuse of insider information and the credit default swap market.

According to this story on Bloomberg News written by David Scheer, the SEC has now alleged that a Deutsche Bank AG salesman, one Jon-Paul Rorech, 36, passed on information about a pending bond sale to a now former Millennium Partners LP money manager, one Renato Negrin, 45, who then bought credit default swaps that resulted in profits of $1.2 million once the VNU high-yield bond transaction was formally announced. The securities market regulator wants these two individuals to forfeit "unlawful trading profits" and pay unspecified fines. “Rorech and Negrin checked their integrity at the door and schemed to engage in insider trading of CDS to the detriment of investors and our markets,” Scott Friestad, the SEC’s deputy enforcement director, said in the statement announcing the lawsuit.