Two and half years removed from the worst financial crisis since the Great Depression, the investing public has grown increasingly frustrated with the lack of criminal prosecutions of, and absence of truly significant fines levied against, the senior executives and companies responsible for igniting the subprime meltdown. Pundits have criticized the Securities and Exchange Commission (the “SEC”) and the Department of Justice (the “DOJ”) as capitulating to the interests of “big finance,” citing SEC settlements that have been characterized as mere “slaps on the wrist” and the DOJ’s failure to convict a single executive responsible for creating the “great recession” despite significant evidence of intentional misconduct.

For decades, the public’s trust in the integrity of U.S. capital markets was a source of economic stability and unparalleled prosperity. To maintain this trust, investors must believe that they compete on a relatively equal playing field and that the laws governing the markets will be strictly enforced. In furtherance of these goals, violators of federal rules face civil penalties from the SEC or criminal prosecution by the DOJ. In connection with previous corporate scandals, the government held a significant number of the principal wrongdoers civilly and criminally accountable for their misconduct. In the wake of the current financial crisis, however, many argue that the lack of such accountability has eroded the public’s faith in U.S. capital markets.

Now, more than ever, private lawsuits are needed to supplement the existing regulatory structure, both to ensure that shareholders are adequately compensated for their losses and to send a strong message that fraudulent conduct will not be tolerated. Indeed, institutional investors continue to vigorously prosecute suits against the companies and executives at the heart of the mortgage crisis, well after the SEC and DOJ have shuttered their civil and criminal investigations. While it remains to be seen whether government regulators will eventually force Wall Street executives to answer for their improprieties, it is clear that sophisticated public pension funds will continue to play an essential role in obtaining compensation for injured investors and deterring future wrongdoing by corporate executives.

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As you know, investor sentiment is bearish, and this is a bull signal.  I am basing this statement on the “dumb money” indicator, which is shown in figure 1, a weekly chart of the SP500.  To make such a statement, I would construct a study where we bought the SP500 when the “dumb money” indicator was below a certain level –  i.e., showing  too many bears — and sold that position when the conditioned no longer existed.  Looking at figure 1, I have placed those buy and sell signals on the price bars.

Figure 1. SP500/ weekly

Looking at this small window of the price cycle, we note that the strategy generated 28 unique trades since August, 1990, and this yielded 892 SP500 points.  By comparison, buy and hold SP500 yielded 935 points.  25 out of 28 trades were winners, and the average trade lasted 6 weeks.  In other words, the strategy was in the market only 15% of the time.  Yet, the strategy earned a return almost equal to buy and hold SP500 but with only 15% market exposure.  Therefore, when the strategy was in the market, you saw your money appreciate at a greater than 40% annualized rate.  This is very high. (Tech Take)

The biggest Elephant, still around, Spain’s troubled Cajas, are reportedly hiding large amounts of Debt. We have written extensively on the Spanish Economy and the problems it faces. Spain next up? Watch those CDS prices. Translated by Google, El Confidencial.

The Spanish savings banks will have to redo the stress test after the European Banking Authority (EBA) on Wednesday announced the postponement of the evidence that the entities referred some data too optimistic. According to industry sources, the Bank of Spain will require greater hardness with exposure to real estate, which can cause suspension testing several entities, which will be published in the second week of July.

As anticipated the Confidential April, the Bank of Spain had sought ways that virtually the entire Spanish financial sector stress tests passed, and one of his victories was the inclusion in computing the capital of the money pledged by the FROB although not ship until September.

However, the EBA has not swallowed the figures sent from Spain and from other European countries. According to a report yesterday by the Wall Street Journal, the reason for the delay is that banks have sent some data too optimistic, which would detract from the credibility of the testing effort, as happened last year.

Therefore, this newly created banking authority has required national central banks to tighten the conditions of the test, described as “unrealistic” in light of the data received. His intention is to publish the results in the second week of July, according to sources, although further delays can not be excluded.

Interestingly, the Spanish banks had complained of the hardness of the evidence excluded from the capital because concepts such as convertibles and prevent you from upgrading the expected benefits for years to come.

Raising the expected loss

Officially, the Bank of Spain has not communicated to the institutions the new requirements, but the sources say, beyond clarification or further segmentation of the information, the supervisor seeks to raise the expected loss on real estate exposure (credit promoter and awarded blocks). This means that the industry takes that in case of crisis, stress tests are to pose adverse scenarios, the losses will be greater than originally estimated.

This will surely make some entities suspension of the test. ”The Bank of Spain’s interest that some do not pass as a matter of credibility, no one would believe the evidence if everyone passes them and would have no validity, as last year”, added the sources.

This hardening is not applied only to banks but also banks, but they are the first ones to suffer most and who are at risk of suspending the test in this new scenario.You will also need to be extended to other European banks, but its real estate exposure is negligible compared to the Spanish. In that case, the main problem is the debt portfolio of peripheral countries, which incidentally will not submit to testing.

The last crisis was exaggerated by the (mis)use of CDS products. This time is no different, except now CDSes will attack the Sovereign countries. Some thoughts by Satyajit.

The European Union’s linguistic gymnastics, redefining default as “restructuring” or “re-profiling” and the structure of any final deal on Greek debt has “real” implications for the arcane workings of the CDS market.

In the film Casablanca, Rick (Humphrey Bogart) tells Captain Renault (Claude Rains) that he came to the city because of his health, to take the waters. Informed that they are in the desert, Rick ironically replies that he was “misinformed”. Investors and banks that purchased Greek sovereign credit default swap (“CDS”) to protect themselves against the risk of default may find that they have been similarly “misinformed”.

The “hedges” may not provide the protection sought. While net outstandings of Greek sovereign CDS is modest (around US$5 billion), the current imbroglio raise important questions about the role and efficacy of CDS contract generally.

Similar to credit insurance, in a CDS, the buyer of protection pays a fee to obtains indemnification against the risk of default of a borrower (Greece) and any resultant loss from a protection seller. Payment is triggered by a “credit event”, technically defined as failure to pay interest or principal, debt moratorium or repudiation or “restructuring”.

“Restructuring” is concerned with a material restructuring of an entity’s payment obligations or a forced substitution of new obligations. Generally restructuring will entail:

Changes in the ranking of the debt, reducing seniority, subordinating the obligation or converting debt into equity.

1. Change in the currency of payment (other than into certain permitted currencies (G-7 currency or OECD member with a local currency long-term debt rating of either AA or higher)).
2. Any reduction in interest or principal payable.
3. Deferral or postponement in the date of payment any interest or principal.
4. Restructuring is not considered to have occurred where it is not directly or indirectly related to deterioration in the creditworthiness or financial condition of the entity.

Voluntary restructuring – entailing lenders agreeing to Greece exchanging existing bonds and loans with one with different terms (longer maturity, different rates) – may not constitute a credit event under the CDS. This is because lenders would be agreeing “voluntarily” to subscribe to new debt which would be used to pay off existing or maturing debt. The original debt may not have been “restructured” in legal terms.

This means that, for Greece, only a “hard” default – a failure to pay, full debt rescheduling or non-voluntary or forced exchange – would allow the CDS protection buyer to trigger the contract.

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Some insight into the World of Algos. HFT algos have totally taken over the trading space, and this trend will just continue, at least until we get another “real” Flash Crash.

The third part of the series on information theoretic methods of analysis for dynamic systems is taking longer than anticipated. Crunching the numbers is killing me. So I’ll take a break from it and look a little farther forward–how we can use the methods I have been describing so far to forensically examine the algorithms used in various high-frequencytrading events of the recent past.

As seen on Nanex and Zero Hedge, there has recently been a lot of strange, algorithmically driven behaviour in the pricing of natural gas and individual stock prices on very short time frames. In an earlier article I pointed out that the apparent simple chaos we observe in the natural gas price appeared to be an emergent property of at least two duelling algorithms.

In this series of articles we will begin analysis of the algorithms involved. Today’s discussion will mostly focus on framing the issues that must be addressed in order to study unknown algorithms on the basis of their time-varying outputs. Future articles will present results from the various analyses.

We begin by looking at the activity in the natural gas price on June 8, 2011:

In both of these examples (many more such examples exist) there are three time series of interest to us–the bid price, the ask price, and the prices of trades. Additional information which may also be of use are such things as volume, size of bids, size of asks, and so on. In principal both the bid and ask prices form continuous series which are prone to instantaneous changes. The actual trades form a discontinuous time series with obsrevations at irregular intervals.

Full article;

Deconstructing Algos, Part1

Interview with Jim Rickards on CDS, Greece and greedy banks. (King World)

What is the risk of having the same people rule and have the power of creating and running a country for generations? Coincidence or in breeding, you judge. Associates Press reports on the many Papps;

ATHENS, Greece (AP) — One family has dominated Greek politics for more than half a century: the Papandreous.

A George Papandreou was in charge in the 1960s at a time of constitutional upheaval. And a George Papandreou rules now amid a financial crisis that threatens the nation with ruin.

The current prime minister’s father, Andreas Papandreou, and his namesake grandfather were larger-than-life leaders credited as reformist architects of modern Greece but also blamed by many for the country’s mountain of debt.

In a historic irony, George Jr. is being forced to dismantle state projects championed by his leftwing father, who poured borrowed billions into job guarantee schemes and expensive development ventures that fostered corruption and helped lay the groundwork for the current crisis.

“The son is paying for his father’s sins,” said author and political commentator Nikos Dimou.

The scion of the Papandreous is the ultimate insider who’s also seen as something of an outsider.

He’s known as “George the American” because he was born in St. Paul, Minnesota, where his father taught at university. He studied at Amherst College and Harvard University, among other prestigious overseas educational institutions. During anti-government rallies, protesters have chanted “George, Go Home!”

Papandreou now faces the near impossible task of sweeping away graft, party patronage and corruption, while fixing wrecked national finances.

He is under immense pressure from just about everyone: European and IMF lenders, hostile opposition parties and the protesting public, even one-time staunch supporters of his Socialist party, including powerful unions and civil servants’ groups.

A failure by Greece to pay back its debts could plunge many other EU countries into financial turmoil and threaten the fragile global economic recovery. At the same time, Papandreou has to manage the anger of a public hit by savage budget cuts and spiraling unemployment.

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China inflation on, off, on, off. This morning Mr Wen seems to be out saying China will have a hard time in keeping the inflation below 4%, a somewhat different tone than earlier this weekend. Growth will still be around those “always perfect” 8-9%.

Chinese Premier Wen Jiabao signaled for the first time that China would struggle to meet its 4 percent inflation target this year, underlining expectations that interest rates will rise further even as economic growth slows down.

Wen, who is traveling in Europe, was quoted by Hong Kong media on Monday as saying that while he sees the Chinese economy growing above 8-9 percent this year, it was hard for China to keep inflation under 4 percent in 2011.

“China’s financial situation will still be among the best in the world this year, with economic growth kept above 8-9 percent, and CPI controlled under 5 percent,” Wen told Hong Kong television media during the England leg of his Europe tour.

Wen’s latest comments sounded somewhat less sanguine than his remarks on Friday, when he said China’s inflation was firmly under control this year and should cool steadily. However, they may not alter investors’ thinking about monetary policy.

Many economists had assumed China would overshoot its 4 percent target given that the inflation rate has stayed well above that mark since January, and is expected to peak at 6 percent in June or July.

Inflation rose in May to a 34-month high of 5.5 percent.

Economists polled by Reuters in June predicted China would stay in a tightening mode, raising its benchmark lending rate by one-quarter of a percentage point and its deposit rate by a half-point this year. (Reuters)

On the other hand we had short maturity SHIBOR rates falling sharply overnight.

	O/N	6.1117		93.85
	1W	7.2617		140.83
	2W	7.0592		24.76
	1M	7.9225		3.68
	3M	6.4302		4.09
	6M	5.1832		0.97
	9M	5.0751		1.26
	1Y	5.1071		0.47

This week’s essentials from the Things that make you go hmmmmm.

First some interesting charts for interesting times.

Currently, the Fed, the BoE, the ECB and the BoJ (to name but a few) are practicing the art of manipulation as they desperately try to keep various plates spinning but every time ‘Sabre Dance’ starts to fade in the background it not only starts up again with renewed gusto, but yet anoth er pole is added to the end of the line, topped with a new, spinning disc. The line is getting longer and longer and consequently, the mad dash up and down its length to attend to the various plates which seem to be about to crash to earth is getting more and more frenzied. Generally speaking, when one plate falls from its pole, several others are never far behind.

It will come as no surprise to anyone familiar with the art of plate spinning that ‘Spinning plates are sometimes gimmicked, to help keep the plates on the poles’ – after all, if you’re going to keep the masses entertained, it makes perfect sense to tilt the odds in your favour in whatever way possible to ensure a more impressive show. In plate spinning, that is achieved through ‘gimmicking’ the plates. But what exactly IS ‘gimmicking’?

According to the Webster’s English Dictionary a gimmick is:

i. a mechanical device for secretly and dishonestly controlling gambling apparatus

ii. an important feature that is not immediately apparent

iii. an ingenious and usually new scheme or angle

So – a manipulation that contains features that are not immediately apparent, mechanical devices for secretly and dishonestly exerting control or ingenious schemes or angles. We know a song about that, don’t we boys and girls?

Full report,

Hmmm Jun 25 2011

Europe’s white knight, China, is sticking to it’s guns, and promises to buy more European debt. With already averaging down on the PIIGS debt, China cannot abandon the already initiated trade, and will end up import bad debt, but that is a later problem. For now enjoy the rhetoric from Mr Wen;

He also repeated his assurance that China would remain a long-term investor in European sovereign debt, saying China would lend to those countries experiencing difficulty borrowing.

“China has no intention to pursue a trade surplus,” he told BBC television through a translator.

“What we want is to have balanced and sustainable growth of trade. At home we are going to further stimulate domestic demand and we are going to reduce our foreign trade surplus and our reliance on exports,” he said.

During his visit to Hungary Saturday, Wen said he was willing to buy a “certain amount” of Hungarian government bonds.

When asked if he planned to lend to others, Wen said: “We have done this for Hungary and we will do the same thing for other European countries.”