Richard Suttmeier is the Chief Market Strategist at www.ValuEngine.com.

ValuEngine is a fundamentally-based quant research firm in Princeton, NJ. ValuEngine

covers over 5,000 stocks every day.

A variety of newsletters and portfolios containing Suttmeier's detailed research, stock picks,
and commentary can be found HERE.

April 29, 2010 – Financial Reform – Communications Snafu

In watching several hours of the Senate grilling of executives at Goldman Sachs on Tuesday,
my overall take-away is that the Senate does not understand how an investment bank operates,
and those who work at one are poor communicators with regard to operational procedures. This
communication snafu makes Financial Reform extremely difficult to determine and next to
impossible to implement.
On Tuesday I explained how I operated as a market-maker for a primary dealer in US Treasuries and
how long and short positions are managed with a market bias. In conducting business on behalf of my
firm, I had to trade and take positions in my trading book in anticipation of, in reaction to, or to facilitate
an expected flow of business from our clients.
The US Treasury market is an over-the-counter market, but several intra-dealer brokers help provide
liquidity. One of these customer / dealer platforms is Cantor Fitzgerald, who I used to help manage my
trading book and enter orders to buy (bid) or enter orders to sell (offer). Through this facility called an
intra-dealer market I would buy and sell securities to adjust my positions proactively to express position
opinion to be long or short and to facilitate the customer flow of business.
At times I would have bids and offers on the screen in hopes that another contra-party of Cantor would
sell to me at the bid, or buy from me at the offer. This was a way not only to manage risk positions, but
also to judge the pulse of market flows. Trading on a primary dealer desk is both an air and a
science.
What Goldman Sachs allegedly did was repackage subprime mortgages into derivative mortgage
structures that they thought would fail resulting in the price depreciation of the securities over time. To
market the long side of the deal to clients the Goldman Sachs sales force had to tell a positive story of
about the potential performance of the structure. This explanation if done properly explains the risk /
reward of the security to the sophisticated clients who would decide whether or not to buy or to sell the
product. In the case in question the Goldman sales force may or may not have known that the Paulson
Hedge Fund, who had a hand in mortgage selection pre-decided that they wanted to sell the deal short.
In my judgment Goldman did not commit fraud based upon the information I am aware of. In anything
they may have knowingly oversold the long side so that they could be short the structure. They had no
responsibility to disclose to buyers that Paulson was shorting, or that Goldman was joining the short
side as well. What may be unethical is establishing a structure with the high probability that it was not
suitable for investors to own. I know that in my career as a market-maker I would at times use customer
flow to go long or go short, but I never created an investment structure designed to decline in price.
I hope Congress can understand how trading and market-making is done in the fixed income
markets as this is a key to Financial Reform.
• You cannot eliminate market-making or position trading to facilitate customer business.
• You can eliminate proprietary trading in FDIC-insured financial institutions, as their priority is
customer service. By definition Prop Trading is a Risk Book that the company takes on making a
bet on market direction or structure. Without clients as contra-parties these trades are usually
done through the inter-dealer market such as Cantor Fitzgerald, which I previously described.
Prop Trading puts firm capital at risk, which is fine in financial institutions that do not hold
deposits of customer funds.
• Derivatives that cannot be marked to market, or that reside in off balance sheet trusts should be
banned. These are just too risky and will continue to be financial weapons of mass destruction.
• Financial Reform should enforce FASB accounting rules that require mark-to-market accounting
and eliminate off balance sheet trusts. There should be no hidden assets or accounting
schemes to temporarily remove assets at quarters’ end.
• Eliminating “too big to fail” is a difficult issue because those that were bailed out by TARP or
involved in massive takeovers of other large institutions in 2008 are now even bigger. Ways to
mitigate the risks are to raise capital requirements, raise margin requirements, de-lever the
Pension Fund Commodity Asset class. Limit financial institutions to a maximum of 10% of total
assets as measured by the FDIC. This would require Bank of America and JP Morgan to spin off
business units.
• For community and regional banks, the FDIC and other financial regulators need to establish a
program that encourages mergers so that no FDIC insured financial institution is overexposed
to Construction & Development Loans or Commercial Real Estate Loans. This will also require
that many institutions must raise capital from the public.
• I have suggested a Primary Banker designation for strong community and regional banks as
FDIC consolidation institutions.
• I have suggested REHAB – Real Estate & Housing Asset Bank to take over OREO, facilitate
short sales and foreclosure sales even if eminent domain is required for the good of a
community.
We do not need a new Super Regulator, we need to consolidate regulators to eliminate finger-pointing.
• The US Treasury regulates the mortgage market including transferring new mortgage origination
to Ginnie Mae, as Fannie Mae and Freddie Mac are unwound.
• The Federal Reserve becomes the regulator for the “too big to fail” institutions and primary
dealers.
• The FDIC becomes the only regulator of insured community and regional banks.
These regulatory steps would control Wall Street excesses and creates a long term platform to repair
the damages among the banks that serve Main Street USA.
US Treasury Auctions
• On Tuesday the US Treasury sold $44 billion in 2-Year notes at a yield of 1.024. The bid-to-cover
was 3.03 times the auction size. The Indirect Bid at 31% is at the low end of the 30% to 40%
neutral range I have talked about many times in this blog.
• On Wednesday the US Treasury sold $42 billion in 5-Year notes at a yield of 2.54. the bid-to-
cover was 2.75 times and the Indirect Bid was a strong 49%.
• Today the US Treasury sells $32 billion in 7-Year notes.
The Weekly Chart for the Dow: The Dow ended last week above its 200-week simple moving average
at 11,134 with the 61.8% Fibonacci Retracement of the October 2007 to March 2009 low at 11,246.
This level was tested on Monday with a new high for the year at 11,258. MOJO has become even
more overbought. The weekly chart remains positive but overbought on a close this week above
its 5-week modified moving average at 10,886. My annual pivot is 11,235 with semiannual and
weekly resistances at 11,442 and 11,483. I still predict Dow 8,500 before Dow 11,500.

Courtesy of Thomson / Reuters

That’s today’s Four in Four. Have a great day.

Richard Suttmeier
Chief Market Strategist
www.ValuEngine.com
(800) 381-5576
As Chief Market Strategist at ValuEngine Inc, my research is published regularly on the website www.ValuEngine.com. I
have daily, weekly, monthly, and quarterly newsletters available that track a variety of equity and other data parameters as
well as my most up-to-date analysis of world markets. My newest products include a weekly ETF newsletter as well as the
ValuTrader Model Portfolio newsletter. I hope that you will go to www.ValuEngine.com and review some of the sample
issues of my research.

“I Hold No Positions in the Stocks I Cover.”