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.
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?
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.
For some reason the market doesn’t seem to want to admit that the housing market is on a continually downward trajectory and this will continue to impact the broader economy.
I guess it is hard to admit that things got way out of hand and now the economy and those benefiting from the ride will have to suffer a bit.
So on a day when the Dow was down over 275 pts, it seems appropriate to reflect on individuals who have been proactive about finding investment opportunities – on the short side – ahead of and during the current unwinding.
I stumbled upon an interview with Mark Cuban where he discussed a number of topics, including how “the internet is dead”.
But what jumped out at me was the criticism surrounding www.shareslueth.com described as:
A site Cuban “launched [in July 2006] with veteran business journalist Christopher Carey, with the stated goal of uncovering waste, fraud, and abuse in publicly traded companies”
Apparently the goal of the company is to uncover publicly traded companies who have misled or otherwise defrauded shareholders, while Cuban and others short these stocks in the mean time.
Some other heavy hitters in the finance industry were recently called out on Bloomberg.com and accused of hiring a “hit man” to investigate improprieties in a stock that they were shorting: Hedge Fund Hit Man Hired by Cohen, Loeb, Sender, Says Insurer
Both Cuban and these hedge fund investors have been accused of proactively seeking to profit from uncovering wrong doing – a type of event-driven arbitrage, where the investor in these cases create the event.
It is unclear exactly what the facts are surrounding these situations; however, even assuming the accusations are true (for what its worth I am skeptical of the Bloomberg piece in particular) the question remains:
Is proactive investigation of impropriety a bad thing?
It seems to me that having highly intelligent and sophisticated investigators out there searching for companies who have been guilty of fraud or otherwise manipulating their financial statements to the detriment of their shareholders is a good thing. Not only are potential perpetrators caught and exposed, but just as CEO’s are inventivized to be more honest through the deterrent example of Skilling, so too potential manipulators might think twice next time after seeing these other companies caught in their lies.
And if on a day like today, when the market gets hammered, these guys are strategically positioned because of this hard work – more power too them. That, in my mind, is really alpha.
Yesterday afternoon I experienced the irrationality of the markets first hand both as an onlooker and an emotional participant.
As most of you have probably seen, Bank of America injected $2b of capital into Countrywide, ending a week of speculation about a possible takeover of the company only a week following Countrywide’s tapping of its $12b credit facility as rumors swarmed that it was going under.
As the headline hit my blackberry via Pownce – Bank of America Invests $2 Billion In Countrywide – I initially panicked. Although I have almost completely closed my short position in CFC I still had a bit of exposure, and more than the pittance of capital at risk, I was worried that I had been wrong: for me a shot to the ego can be more painful more than a shot to the pocket book and it is even worse when they correlate.
After digesting that reaction and seeing that the stock was up over 20% in after hours trading, I decided to delve in a little further.
As it turns out, BofA basically bought a junky piece of preferred equity with a conversion price at a significant discount to the after-hours trading price of $26/share at $18/share. The math isn’t complicated, and as this article explains, the deal was smart for BofA as, they were able to mark-to-market a huge gain and also make a strategic expansion while a major player has their backs to the wall:
Countrywide Gives Bank of America $447 Million Gain
Even with this headline on Bloomberg screens across Wall Street, Countrywide’s stock opened up the day up almost 10% (down from its peak of an almost 20% increase overnight)…
But by the end of the day, the luster had worn off and CFC ended flat with the previous day’s close.
Even this result seems somewhat irrational mathematically, as the company just gave away 20% of its equity value for a discount to the current stock price – but perhaps different return requirements or something could begin to explain some divergence in the two securities.
In any event, the reactions – both my initial gulp and the market’s initial pop – were driven by emotion, rather than reason. And even now the volatility surrounding it makes reluctant to go near this situation…
So the next time someone tells you that markets are “efficient” invite them to play poker and feel confident that at least for that day, you won’t have to worry about that saying about the sucker at the table being you…
On Friday, the Fed finally did an about face and openly admitted what the entire world had already figured and priced into the global securities markets by suggesting that the “subprime” crisis was not simply relegated to one basket of securities, but rather – it is part of a larger problem growing out of the aggressive lending policies surrounding the boom in the real estate markets over the last half-decade.
As investors scramble to assess just how far this contagion will “spread”, typically-savvy fixed-income brainiacs are dumping securities across the board and driving up prices (and down yields) on the only surely safe thing left in the market – US T-Bills: Tough love on Wall Street
As lenders hunt for bad loans, Pimco founder and Fortune columnist Bill Gross says the Street is learning hard lessons about disclosure.
This report does an excellent job walking through the economic indicators that show that the housing market has been both the weight driving the pendulum of the markets up and now down again over the last few years.
Anyone with 20 minutes on their hands who wants some insight into where we are and where we might be headed should give this a read:
Midsummer Meltdown Prospects for the Stock and Housing Markets
“This paper examines the factors that have led to the recent instability in financial markets, specifically the housing bubble and the recent run-up in stock prices. Prices in both the housing market and the stock market are often moved by psychological factors that have little to do with fundamentals.
The paper notes that the economists and analysts who give advice to the public and policymakers are often caught up in the psychology of financial bubbles along with everyone else. “
It has been awhile since I posted the beautiful (read: scary) charts of the ABX indices that were the start of all of this trouble:
These reflect the reality that has been driving the crisis in the credit markets.
This article does a great job walking through a summary of what has been going on in the underlying real estate mortgage markets. It is a great refresher or intro for anyone:
In a Credit Crisis, Large Mortgages Grow Costly
“When an investment banker set out to buy a $1.5 million home on Long Island last month, his mortgage broker quoted an interest rate of 8 percent. Three days later, when the buyer said he would take the loan, the mortgage banker had bad news: the new rate was 13 percent.”
I also discovered these CDX indices for the first time tonight. They show how the woes that started with mortgages have now spread literally across the spectrum of the credit markets (and the equity markets of late):
Notice this Emerging Markets chart in particular:
The cost of protecting emerging market debt has almost doubled in the last week or two…one can only speculate about what is driving this particular factor, but I would imagine the “flight to quality” and “unwinding” of positions is to blame.
And the Asian markets continued their tumble overnight. Stay tuned.
The weather analogies continue as the first storm to hit land dissipated much like the huge drop in the market mid-day today.
Now another storm, this time a hurricane, looms on the horizon, and I can’t help but press the weather metaphor to the breaking point.
Just as forecasters struggled with fear anticipating the worst hurricane season in history only to see the second consecutive weak season to date, so too doomsdayers (myself included) anticipated a major correction heading into late 2006 and 2007 only to see the Dow hit a record high mid-summer…
Now as the markets seem to be showing sure signs of the crisis we have feared, a hurricane is finally brewing in the tropics – both bring threats of disaster, but hope remains.
Predicting which way it will turn is hard, and as it turns out, apparently even Einstein can be mistaken…as the speed of light may not always predictable according to German Scientists who recently stated: ‘We have broken speed of light’
Good luck over the next few weeks…let’s hope the storm stalls over cool waters.
Irony can be ironic: the same day that the first tropical storm of the season made landfall in Texas, the markets have been pouring down on investors across the board.
One of the greatest challenges when trying to understand the financial markets is recognizing that the “price” or “value” of a security is driven by what people are willing to pay for it above all else. This value is driven by 2 primary factors: 1) how the company/asset underlying the security has performed in the past and 2) what investors expect out of the asset/company in the future.
Although the first factor can sometimes be complicated and hard to pin down, it is the second factor that drives price appreciation and today, depreciation.
As the uncertainty of the implications of our over-indulgence in the credit markets looms overhead, investors around the globe are increasing the discount rate of their future expectations – which by definition reduces valuations.
The VIX continues to spike and speculation is running rampant that the Fed is talking out of both sides of its mouth…all of this is like a deluge on the expected values of securities across almost every market.
Predicting the future is hard…especially when it comes to weather and people.