Monthly Archives: September 2007

Calling Another Top

This article sounds interesting and kinda true. The point is basically that once the masses have caught on – the jig is up. This one speaks specifically about Hollywood’s latest – an obsession with hedge funds – and the implication that now hedge funds are doomed.

Hedge Funds in Hollywood: TV and movies have rediscovered Wall Street. Time to sell!

Popular culture, which is created by some of the least business-savvy people on the planet, has always been slow to latch onto business and economic trends. The covers of large-circulation magazines are a good contrary indicator. And TV, movies, and books are even worse.

Perhaps a better indication of not so good things to come, a previously cheerful Goldman Sachs economist has apparently determined that things aren’t looking to well after all. Maybe people are finally starting to recognize that the greatest bubble in real estate history is exploding and this is going to have broader ramifications than a bunch of overpriced fake-AAA securities.

Goldman Sachs tiptoeing into the bear camp

Goldman Sachs has abandoned its ultra-bullish view of the world economy, warning of a likely recession in Japan and mounting risks that US property slump could spread to parts of Europe.

And unfortunately for the dollar and the Chinese, they seem to be showing up at the wrong time for the party: China’s $200 Billion Sovereign Fund Begins Operations

But then again, maybe this is a new paradigm. Or not.

Digesting The Cut

I guess it has taken awhile for me to respond to the news about the Fed’s 50 bps cut partially because it is hard to know what the implications of the cut will be beyond the short term pop everyone witnessed over the last week and partially because I was surprised enough to take a step back.

As I mentioned in my response to a comment here not everyone was surprised that the cut was 50 and not 25 bps, and in fact Goldman and Merrill were apparently anticipating such a cut.

I found the earnings announcements last week interesting. I was glad to see Lehman continue to stay ahead of expectations and not just for personal reasons – it is great to see a company that has risen from underdog status among the elites continue to fend off foes. It was also surprising before, but certainly not after, their announcement to see that Goldman outperformed partially by being short subprime and subprime-related credit throughout the summer. I guess it seems obvious that if someone like me can identify that trade that the dudes at GS would be all over it.

I guess part of the reason I am bit surprised that the “put” appears to be alive and kicking is that this means things are really bad out there, and the future opportunity set for our economy does not look good. For all the doomsday lingo I have tossed around here and in person with many of you, I am optimistic that our country will continue to be great – and so it saddens me to see the Fed concede the weakness of the dollar and to openly risk inflation out of what must be perceived as necessity. It seems such a move could only be motivated by a genuine concern that this was necessary to stave off more dislocation in the capital markets.

While the equity markets have flown since, we do not at all appear to be out of the woods on the credit side, and as Bloomberg noted, our neighbors are struggling with the CP market effects even with CAD/USD parity: Subprime Panic Freezes $40 Billion of Canadian Commercial Paper

And there is still a ton of buyout debt out there to be funded. I read something yesterday putting the figure at still over $340B.

Let’s hope that the credit markets are satisfied with the Fed’s liquidity boost…though I would have to guess that the negative press on this front is likely far from over.

Next Up: Commercial Paper, Earnings and Buyouts

The Commercial Paper market is set to roll over a ton of debt over the next couple of weeks. According to this blog quoting newsweek:

The shaky U.S. credit markets will face a critical test over the next few weeks, as companies try to find buyers for hundreds of billions of dollars in short-term debt that is set to expire. Corporate borrowers are expected to struggle in refinancing their debts, and the repercussions may go far beyond the companies in question. …

The tightest squeeze may come in what’s known as the asset-backed commercial paper market. … About $417 billion worth of asset-backed commercial paper is scheduled to come due during the weeks of Sept. 10 and Sept. 17, or about half of the $959 billion market, according to Sherif Hamid, an investment-grade credit strategist at Lehman Brothers.

I think these images from the Fed, speak for themselves.

This in the midst of a week where big banks are trying to market billions of buyout debt and BSC, GS, LEH, and MS all announce earnings.

Could be a choppy week indeed. I am investigating SKF and IAI as a way to express a view.

The Power of Numbers

To tip my hand and show, contrary to what the previous post may indicate, that I believe numbers have power – if nothing more they add content to our intuitions and reason.

This is truly one of the coolest displays of statistical data I have ever seen. It also reveals some unintuitive but right-sounding observations about the development of the “Third-World” over the last few decades.

If you have a few minutes, give it a watch:

But don’t take it too seriously:

Statistically Speaking

It may be the fault of my Econometrics professor in undergrad who talked about how he enjoyed single malts and parties in his undergraduate days while laughing about “statistical significance.” He introduced me to, and the glint in his eye as he emphasized the latter half of the site’s name coupled with the ease with which I always been able to “massage” the data likely both contributed to my skepticism.

So when I saw this article today, I couldn’t help but smile:

Most Science Studies Appear to Be Tainted By Sloppy Analysis

The point of the article is clear from the title – those of us who groan every time someone says “they have proven _____” fill in the blank – are now not only backed by Taleb-like Fooled By Randomness talk, but also an article in the Wall Street Journal about research by a serious scientist.

The irony is of course obvious. Statistically proving that scientists are statistically irresponsible is just kind of funny to me for some reason.

I guess I just feel like more often than not we – scientists, economists, investors, researchers, theorizers – are wrong more often than we are right. Its just really hard to predict the future or come upon anything like the “truth”.

That doesn’t mean we should give up trying. But when Goldman’s Global Alpha gets hammered a few months in a row and Greenspan admits that he saw the Subprime risk but couldn’t translate it to a market reaction, it makes one wonder how much we really know about stuff as simple as the capital markets – much less important stuff like science.

Batter up for predicting the next move in the markets…my guess is we have only heard the first of a many shoes (or statistical gaffes) to drop.

America The Beautiful

I have always been patriotic. And I am from Texas.

Those two facts are probably correlative and maybe even indicative of causation, but like so many things it is hard to know whether causation exists.

The reason I bring it up is that sometimes I think my pessimism about the markets can get muddled with the rest of the anti-American crap bouncing around out there in cyber-space and the media.

Let me be clear, quoting Taleb’s recent article: The Birth of Stochastic Science.

I am convinced that the future of America is rosier than people claim…

It fosters entrepreneurs and creators, not exam takers, bureaucrats or, worse, deluded economists. So the perceived weakness of the American pupil in conventional and theoretical studies is where it very strength lies — it produces “doers”, Black Swan hunting, dream-chasing entrepreneurs, or others with a tolerance for risk-taking which attracts aggressive tinkering foreigners.

I think this country is in the process of a splintering dichotomy. On the left-coast (and in cyberspace throughout) the country and innovation is booming at an ever increasing clip. This is primarily being driven by the increased capacity for the consumption and distribution of content that is now mainstream through the internet and mobile devices.

This amped-up connectivity has spurred a whole army of innovators and creators, from simple blog-applications like the one I am writing on, to cool connectivity sites like: Or the regulars like: the I-phone and the Blackberry.

These sites/devices/applications are allowing people to come together to collaborate and share in ways that were never before possible, and this will allow better coordination, experimentation, and ultimately creation.

And of course…on the other side of the country:

The credit markets and the developed financial systems are reeling. They will continue to reel as the ripple effects of too much capital deployed too cheaply on the levered backs of normal Americans continues to play out. I am continually amazed that people even react to mortgage company layoffs like those announced by CFC over the weekend or the worst home sales since 2001.

Mozilo himself (the CFC CEO who literally made more than $700 mm from selling his shares over the last year) has said that he doesn’t see a bottom before late 2008. So if the guy who has made so much money from the game and is most incentivized to keep the thing afloat publicly says there is no bottom until late 2008, my money is that it will be at LEAST that long.

I hope he is wrong, but I would be surprised if he is.

But as Taleb says: most of it is random anyway.

So while the old-coast is crumbling, the new-coast is bubbling with innovation, and that makes me proud to be an American.

CP Market Vol Uncovered

I wonder if this helps to explain some of the ridiculous Vol/illiquidity/drying up in the CP markets over the last few weeks:

Citigroup reportedly has $100 billion in SIVs

Apparantly Citi (and I would be shocked if they were the only dudes who utilized this type of trade) used off-balance sheet structured vehicles to create a kind of carry-trade. They used CP funding sources (with low yields) to buy higher yielding stuff…like maybe CDO’s? hmm. nah. Prolly something better than that. I hope.

More Greenspan Banter

This article is awesome. Basically now that Greenspan is out of office, he can hop into the mainstream and be honest.

In his own words from the article: Greenspan Says Turmoil Fits Pattern

“The behavior in what we are observing in the last seven weeks is identical in many respects to what we saw in 1998, what we saw in the stock-market crash of 1987, I suspect what we saw in the land-boom collapse of 1837 and certainly [the bank panic of] 1907,” Mr. Greenspan told a group of academic economists in Washington, D.C., last night at an event organized by the Brookings Papers on Economic Activity, an academic journal.

Unfortunately the difference, at least as compared to 1998, is that this crisis is driven by an unwinding of fundamentals across an entire asset-class – real estate finance – that is related to the entire economy. Real estate impacts individuals directly through their homes, businesses through their rents, companies through their office buildings, investors through their holdings, and everyone above through the increased lending rates coming from bank’s losses as a result of the implosion continuing in the ABS/CDO/CLO markets.

Next interesting tidbit on the horizon: Some big LBO’s are awaiting closing over the next month or so. Big question: Will the banks just take it for the team?

What’s Wrong With A Greenspan/Bernanke Put

I am sitting in the bathroom of a hotel room that I paid way too much for at 3 am, because the air conditioning sounds like a garbage disposal and the walls are thinner than vietnemese rice paper rendering the neighbor’s conversation a just audible accompaniment to the clang of the window unit.

And for this I blame Greenspan, and whether this madness continues now lies in the hands of his successor.

I am still amazed – shocked and awed if you will – that people are surprised that the credit markets are where they are today. To me this conclusion is as evident as the good looking guy getting the good looking girl in a Hollywood tentpole conclusion.

Following the excesses of the last few years, and in line with history, we are entering a correctionary period.

Blaming Greenspan fully for this result is of course a slight over simplification. Of course Adam Smith and other economists as well as free market advocates like Milton Friedman should get some credit too, but I digress…

Back to this overpriced room and how it and I got here.

In late 2001 and 2002, following the most demoralizing and evil attack that modern cultures have witnessed, the US Economy was in a sorry state and in desparate need of boosting (I mean 9-11 though Enron and its cohorts were also huge downers). So Greenspan did what any good economist would do to rectify the situation – he threw money at the problem and let the invisible hand, through incentives, sort the whole thing out…and sort it, it did.

Over the next few years, as the Bank of Japan used a similar strategy, the Fed dumped a ton of capital into the system, and as any good free market participant is bound to do, financial engineers from NYC to HK jumped into action trying to make those incentives turn into personal profit.

It took a bit of time but within a couple of years a few exciting, and I think predictable, results emerged.

Through fancy deregulated vehicles called Hedge Funds and Private Equity funds, the rich got richer. These investment vehicles were the perfect avenue through which people with money and credit were able to tap into the cheap debt provided by the government. Sure the path wasn’t direct, but at base the idea is simple: borrow money for less than you should be able to – pay really smart dudes to figure out a way to “invest” that money (or take advantage of the inherent discount to fair value provided by the fed) – and count on incentives and Math to sort out the rest. And unsurprisingly, it worked. Anyone who reads the business section of the Wichita Times will tell you that hedge fund managers are the new robber barons, but remember, these dudes were always managing and making money for other Qualified Investors (aka dudes who were already rich).

Next result, and this one is the sad and perhaps less predictable one, the poor got poorer. At first this struck me as unintuitive, but with a little thought it started to make more sense. Basically, poverty, or more importantly relative poverty, is measured on a – you guessed it- relative basis. So it isn’t so much that the poor got poorer per se, as much as they didn’t get as rich as the rest of us. And that makes sense if you think about it. In order to partake in the partay of cheap and free money, you gotta understand how the whole financial game works, and this game is kinda complicated…so unless you have education, I mean money, I mean education…I think you get the rest.

And driving this giant wedge was not only financial juggernautdom, but the good ole US real estate market. Because cheap money not only drives up returns on big bets, but also on small ones, like buying a 19th century house in Nantucket and slapping a sign on the front and calling it a B+B, people all across the country jumped aboard the gravy train.

This one deserves a bit of elaboration because this is where the mess hits home, literally.

Basically, here is how dudes get rich in real estate: borrow money to buy a property, rent that property out, pay back the loan with the proceeds, sell the property hopefully for more than you paid for it originally.

This game is old and frankly simple, which is why lots of not so bright dudes make money in the “real estate business” (full disclosure: I worked in real estate investing a couple of yrs back).

Well what happened when the financial engineers looking to put that massive amount of free money to work intersected with the concept of the American Dream of homeownership would have brought a year to ole Mr. Smith’s eye. The engineers enginered a way to structure products in such a way as to make lending to people who wanted to own a home easier. This process, called securitization, has actually been going on long before the current boom, but what happened when money got super cheap was the amount of capital that needed to be “put to work” got to be too big for the traditional structures. And at the other end of the process, the mirage of the American Dream (and the cool trick of DIY real estate investing) became super-duper-alluring-er to people across the country.

So…along came, I know it is getting old but I will just say it once, Subprime Lending! Well, this is a couple of steps removed, but the gist is super incentivized investor dudes paid incentivized engineer dudes for complicated instruments that kinda incentivized dudes said would pay back money from a bunch of incentivized by dream dudes who were lent money by incentivized to lie dudes. Or, hedge fund and other funds invested in CDO’s sold by investment banks that were rated by credit rating agencies and basically consisted of a bunch of promises to pay which at base were made by people who bought a house that they could barely afford and were told which loan to take by a mortgage broker who got paid, not for doing credit analysis on the borrower, but rather by convincing said borrower to take whichever loan paid him the highest commission and which loan, as it turns out often had fancy crazy features like “reset rates” or “prepayment penalties” likely because the rich dudes who were investing the money to fund this whole thing had done well to hire smart dudes who knew that such features made the loans more valuable – on paper.

Whew, that is a mouthful, and lots of stuff is going on in there. The point is: people acted as they should be expected to act in a capitalist economy and stuff got out of hand as the structured finance products fueled a real estate boom that dwarfs all other booms in comparison.

And now…

Dudes who bought on a dream that housing prices would continue to rise are screwed.

Dudes who borrowed money with terms in their loans that they did not understand are screwed.

Dudes who structured the products to sell the loans to fund the dreams and the homes are screwed.

…I don’t know why she swallowed the fly…(couldn’t resist)…

Anyway, you get the point.

But the problem, or at least the one that is getting Bernanke’s attention, is that this what I will call “screwed effect” is now threatening to impact the rich dudes, and they don’t like that too much.

But unlike the past, before the real estate boom, there is no clearly obvious place for a new flood of capital to go even if Big B were to pull out the Greenspan Card (way to many ironies in that name to call out) and give the rich and super incentivized dudes their “put” with another rate cut.

Will he do it? I don’t know. Will it help if he does? Maybe for some but probably not for dreaming dudes and other fringe real estate players – there is only so much someone can pay for a shitty piece of property, even in Nantucket.

All I know is that if he does cut by more than a hundred bps, I am going to buy as many domain names and property that I can in SecondLife and in Wii-land ahead of Adam Smith’s invisible hand and the next tidal wave of incentives finding ways to play with free money.