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Wednesday, April 25, 2012

Gas Prices

In a past life I spent some time trading derivatives on Wall Street. It was a highly lucrative, and a very eye opening experience. Wall Street was meant to help companies raise funds, go public through IPOs, and help us John Qs with our investments and retirements. Over time, that business model expanded into a few higher margin areas - mortgage securitization, risk management, aka hedging risk, proprietary trading, private equity investing, and prime brokerage services.

We are all to aware of how the Securitization business wreaked havoc - the US housing and financial crisis - personal bankruptcies, foreclosures, blighted communities , among its side-effects (makes securitization look like was a dangerous, new social Rx medicine). But Wall Street's lust for originating, buying, and securitizing low documentation, low documentation, no income proof - collectively known as Liar Loans - into Mortgage Backed Securities, and selling them around the world also led to Wall Street being (temporarily) brought to its knees.

As mortgage payment default rates soared, starting mid 2006, greed kept the Street from paying attention. Fraught with inertia, and the propensity to worship money making, Wall Street kept amassing raw inventory of "Alt-A" liar loans, until our marked to market regime blew the cover off the House. Among the many high profile people, and investment banks, that lost the shirt off their backs were several bank CEOs, Bear Stearns, Lehman Brothers, Wachovia Bank, Washington Mutual Bank, and Merrill Lynch. All were iconic companies in the US. Gone, over a period of 12 months. 100s of billions of Dollars of shareholder capital lost. 10s of thousands of low and mid level jobs lost (I have no sympathy for the highly paid superstars of Wall Street who lost their jobs too).

The attentive reader may, by now, be thinking that this rant has nothing to do with Gas Prices! It does. I just have a fondness for the scenic route.

Prop Trading, as in trading for the House, on Wall Street is very large. There are no sane, internal leverage limits for money spinning businesses. Prop traders can take extremely large positions (buy and sell) in anything they want. Prop trading is pure speculation at its core (I wanted to say heart, but they don't have one).

Prime Brokerage was meant to settle and clear trades for independent traders. Then, Hedge Funds got involved, and Wall Street was more than happy to provide the leverage and liquidity to Hedge Funds. Most hedge funds are pure speculators. Some readers may remember the spectacular demise of LTCM (Long Term Capital Management), in 1997, which was the largest hedge fund of its time. Ironic how short the Long Term was. John Merriwether, and his band of traders at LTCM, including the Nobel Laureate Myron Scholes (of the Black-Scholes option pricing model fame), leveraged their fund in excess of 100:1 ($100 of borrowed money, for each $ of capital) to bet on World Convergence. Then, Russia defaulted on its debt obligations, and that default set off a chain reaction of World Divergence that blew LTCM out of the world!

Starting in the mid 2000s, economists and researchers started predicting a major future shortage in global oil supply. A large factor in these projections - the astonishing and continuing growth in Brazil, Russia, India, and China (the BRIC group). Wall Street Prop Traders and Hedge Funds pounced on this as an opportunity to make a lot of money for themselves. The logic actually may have some merit.

Hedge Funds do not disclose their holdings of crude oil, or the size of the open positions in the crude futures prices. Investment Banks do, but in a convoluted manner, buried on page 900 something of their annual disclosure filings. The obfuscation is startling.

It has been reported, elsewhere, that Wall Street owns several hundred million barrels of crude oil, sitting in tankers off the US coast. One report I saw claimed 120 million barrels. That would roughly be 4 days of US's total consumption of oil.

Found an interesting graphic to make my case: http://goo.gl/MyDWC

It shows that crude oil prices collapsed, starting in September 2008. Remember that the weekend of 9/15/2008 was when Lehman Brother failed, and Merrill Lynch was forced into the arms of Bank of America. Within 3 months, gas prices hit $1.60 per gallon in the US. The Bush (junior) Administration bailed out our dear Investment Banks in October 2008.

See a trend in gas prices since then? It is not a coincidence. The cost of producing a barrel of gas has not risen by 100% in the last 4 years. It is Wall Street that is back at its GAME - pump (pun unintended) and dump. In their Prop books, and alongside their Hedge Fund customers!

With unemployment in the high 8%s, and stagnant relative incomes, the John Qs of America are being taken to the cleaners. By Wall Street. And our Congress, including the Administration can do NOTHING about it. Frank Dodd Act, and CFTC's amended powers could have put the brakes on such naked speculative hoarding and trading, BUT the Republican controlled House has effectively blocked Frank Dodd Act, and may infact entirely repeal it. The CFTC meanwhile had its budget severly cut, so the amended powers to monitor and regulate oil speculators was dead on arrival.

America's next NIGHTMARE - Romney @ 1600, combined with John Boehner as Speaker of the House, and a GOP majority, or a close tie in the Senate. If that happens, we are all SCREWED.


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