Monday, November 30, 2009

Seriously - These are Real Stories

As if Foreign Policy naming Ben Bernanke their top Global Thinker wasn't absurd/ironic/laughable enough, Zerohedge brings us the announcement out of Rochdale Securities that they will be restricting access to Dick Bove's research reports:

"Research by prolific banking analyst Dick Bove won't be as widely available for at least the rest of the year and possibly longer, as his employer aims to preserve its value."

PRESERVE ITS VALUE!  The irony is impossible to express in mere words...  If you don't understand why, check out an old post from Karl Denninger regarding Bove's history of calls on the stocks in his sector.

Bove comments, today:

"The information is getting to [people] who are not paying," Bove, of Rochdale Securities, told Dow Jones Newswires by phone Monday. "It's weakening our whole approach to how we want to price the product."

I guess Rochedale only wants Bove to blow up their official paying clients - not to poison the whole investment world with his reports.


Mind Boggling - The Top Global Thinker ?!?!!?

From Michael Panzner, writing on The Big Picture comes a post he titled simply "Say What?":

"Foreign Policy has just published a list of its “top 100 global thinkers” and the winner is…
1. Ben Bernanke
for staving off a new Great Depression.
Chairman, Federal Reserve | Washington
The Zen-like chairman of the U.S. Federal Reserve might not have topped the list solely for turning his superb academic career into a blueprint for action, for single-handedly reinventing the role of a central bank, or for preventing the collapse of the U.S. economy. But to have done all of these within the span of a few months is certainly one of the greatest intellectual feats of recent years. Not long ago a Princeton University professor writing paper after paper on the Great Depression, “Helicopter Ben” spent 2009 dropping hundreds of billions in bailouts seemingly from the skies, vigilantly tracking interest rates, and coordinating with counterparts across the globe. His key insight? The need for massive, damn-the-torpedoes intervention in financial markets. Winning over critics who have since praised his “radical” moves (including Nouriel Roubini, No. 4 on this list), he now faces an uphill battle in his bid for permanently expanded Fed powers. The radicalism is far from over.

For those who still ask "hey - what was Bernanke supposed to do?  Come on - the guy prevented another Great Depression."  The answer is simple:  Bernanke cannot and should not be exalted for his response to the crisis which HE failed to prevent. The accolade from Foreign Policy is mind boggling to me. To bring back an old analogy: it's like commending the captain of the Titanic for getting people out on lifeboats after he steered the ship into an iceberg.  If Bernanke were the top global thinker, he would have acknowledged the reality in the economy - the bubbles that were forming throughout the 2000-2007 years as a result of the free money policy enacted by the Fed.

Also make sure you read MISH's point by point response to Bernanke's op-ed this weekend defending the Fed's policies.

Finally, I assume most people have seen this video of Bernanke's past errors in evaluating our economic situation.  While it may be unfair to selectively cherry-pick each prediction Bernanke has made which has proven to be downright wrong, the point is that he is far from infallible, and that we shouldn't assume that he has the solution for our problems.


If You Were Stranded On a Desert Island

If you were stranded on a desert island it would probably suck. However, if there were other desert islands nearby, and if you were somehow able to fly over this man made archipelago of islands in a plane, and could see that together they seemed to form a map of the globe, well then, you'd have the excess/bubble that is Dubai.  If you heard that David Beckham (I don't think Becks actually owns one of these - although it seems he did buy at the Palms Dubai) or Madonna lived (disclaimer - she doesn't!) on an adjacent island, you might even be talked into paying more than twenty million bucks for your island, even though Becks and Madge probably won't spend more than a few weekends a year at their island pad - it's the middle of the freakin desert, after all.

Although Dubai World's imminent debt default may not have catastrophic global financial consequences, Dubai's woes are symbolic and indicative of potential future shocks in the financial space.  After all - even these wealthiest of wealthy projects were funded largely with debt, and perhaps conceived with less than robust business plans and lack the ability to weather economic storms.

In an effort to one-up their own excess, Dubai was planning to again build the worlds tallest building - a KILOMETER tall structure at a cost of $38Billion over the next 10 years.    As a point of reference, Las Vegas's Bellagio cost under $2B to build when it opened in 1998.  The coup de grace was a comment out of Dubai a year ago, revisited by Jeff Matthews: along the lines of how the 1KM tall tower was still going to be built (good luck!) because it will take 10 years to complete and thus will be facing a different  (read: better) economic world when it is done.

"I'm sure most of you are asking why we're launching this, and you'd be mad not to question it," Nakheel's chief executive Chris O'Donnell said. He added, "The project will be built over 10 years, and we'll have many more [economic] cycles before then...the world will be a different place by the time it's built."

Jeff Matthews: "Mad" is, we think, the exact word for O’Donnell's assurances, as reported by the Wall Street Journal, that the speculation in Dubai will survive whatever cycles the world will throw at it."

Ah yes... more hope and prayer that everything will be ok if we wait long enough.  This time it only took a year for reality to hit Dubai.


Sunday, November 29, 2009

Capital Depreciation Fund - Nice Trades!

"Almost 10 years ago, in January, 2000, America Online CEO Steve Case announced one of the boldest, craziest ideas in modern business history: a $182 billion stock-and-debt deal to buy mighty Time Warner, creating an Internet and media colossus with a combined market cap of $350 billion. It was the largest takeover ever, and a symbol of the turn-of-the-millennium power of the Internet. "Together, they represent an unprecedented powerhouse," Bear Stearns analyst Scott Ehrens told CNNfn at the time. "If their mantra is content, this alliance is unbeatable."

Well, as it turned out, that wasn't even close to true. Almost a decade later, Bear Stearns is gone, and so is CNNfn. Steve Case quit as AOL Time Warner chairman in January 2003, and left the board for good in 2005. A few weeks ago, he sold a company called Revolution Money to American Express. Gerald Levin, the former Time Warner CEO who engineered the deal with Case, now helps his wife run a holistic health center in Los Angeles. And in less than two weeks, the great and terrible combination of AOL and Time Warner, mighty destroyer of careers and shareholder wealth, and vivid reminder of the excesses of the Internet bubble, finally will be undone.

On Dec. 9, Time Warner will spin AOL back out to the public, issuing one share of its stock to Time Warner holders for every 11 shares of the parent company. The shares began trading on a "when-issued" basis on the New York Stock Exchange last Tuesday -- and the debut wasn't pretty. Trading started at 27, but the price dropped to 23 the day after Thanksgiving. At that price, the new AOL had a stock-market value under $2.4 billion. Having swallowed a whale, it has in the end been transformed into a minnow."

If you're calculating a cumulative return, Time Warner's purchase of AOL for $182B and subsequent spinout at $2.4B works out to a loss of 98.68% over almost 10 years.  Nice trade Time Warner!

Not to be outdone, the City of Detroit sold the Pontiac Silverdome last week for pennies on their cost basis dollar:

"Nearly 35 years after taxpayers spent $55.7 million building the Pontiac Silverdome and a year after a $20 million sale fell through, city officials have sold the arena once called the most desirable property in Oakland County.

The price: $583,000."

My handy HP-12C tells me that's a loss of 98.9%, although it took the Silverdome much longer to achieve a similar rate of return as AOL did for Time Warner.


The Fed Fights Back

Fed Chairman Ben Bernanke has an op-ed in the Washington Post today defending the Fed's handling of the crisis (again) and explaining why he thinks proposed changes to the Federal Reserve system could be hazardous to our financial health.  Yves Smith at NakedCapitalism does a nice job rebuffing much of Bernanke's rhetoric.  David Merkel also has a response well worth reading.

For me, the most important thing to remember each time we talk about how the Fed saved us from the brink of collapse (for now) is that the Fed's policies also drove us to the same brink!


Saturday, November 28, 2009

Two Crazy Stories

Something smells funny to me about the story of the Virginia socialites who "crashed" the White House state dinner on Friday.    Really?  You can be a good looking couple, dress up nicely and TALK YOUR WAY INTO THE F'N WHITE HOUSE?  Come on... Something is funky here.  Did Bravo grease the wheels for publicity for the Real Housewives of DC?  Is it really possible to get into the White House and shake hands with the President when you're not on the guest list?

If that story smells funny, then the Tiger Woods story absolutely stinks.  Let's review the facts/claims:  Tiger left his home at 2:25am, and promptly crashed into a fire hydrant and a tree in his neighbor's yard.  Tiger had scratches on his face - from the crash, according to reports.  Reports said alcohol was not involved.   Then his wife, Elin, supposedly smashed the back window of his SUV with a golf club, in an attempt to get him out of the vehicle.

Now, I don't want to jump to conclusions, but come on... If alcohol wasn't involved, and I hope it wasn't, then how did El Tigre crash into two obstacles after pulling out of his driveway?  Where was he going in the middle of the night?  Was Elin trying to pound him with the golf club as he tried to escape?  TMZ's explanation is much more plausible than the official story being propagated.    This story has been spun even harder than the economic news of the past 6 months.


When the Train Leaves the Station, You Have to Be on Board

I don't want to forget about this article from Clusterstock last week which quoted Raymond James' Strategist Jeff Saut.   Over the past several months, Saut has been repeatedly bullish.  What's interesting about Saut's view is that he hasn't been saying "buy stocks because they are cheap,"  he's been saying "buy stocks because everyone else is buying stocks."  In other words, "Don't fight the tape." (note: none of those are direct quotes).

This time, Saut elaborated on this phenomenon, explaining the concept of "career risk" for money managers:

"Nevertheless, we think the upside should continue to be driven by “game theory,” which suggests that the under-invested institutional portfolio managers have to buy stocks into year-end driven by their under-performance, their subsequent “bonus risk,” and ultimately their “job risk.”  Verily, many of the portfolio managers we know remain under extreme pressure to commit their outsized cash positions in an attempt to “catch up” to their benchmarks between now and year-end"

Saut's point is an essential one:  in the money management profession, for some accepted reason, it's one thing to lose 35% when the market is down 35% - you can write it off to a global clusterfuck - "hey - there was nothing I could do - did you SEE what happened to the S&P?!?!?"  But if the market rallies 65% and you're not on board because you're acting rationally and saying "nothing has changed, the banks are still insolvent, we haven't fixed the problem,"  well, you're clients will tear your head off.  Note - I'm in the latter camp here, trying to act prudent, and looking like a fool.  Thankfully, I don't have to answer to any investors - just myself, and I can justify my decisions to my own second guessing conscience, even if I'm missing the rally.  One thing this tells me is that I'm not a spectacular (and maybe not even a good) trader - a great trader has to be able to trade the market and make money even when it's not cooperating with his own thoughts about valuations.

This is related to my anecdote last week on Return Free Risk  - one explanation (although certainly not a valid one, in my opinion) for the behavior of merger arb fund managers who parked money in deals offering returns on par with riskless rates is that these fund managers are not paid to own treasury bills - they are paid to trade merger arb deals - so they buy the deals even if the risk/reward may not be adequately compensating them.


Thursday, November 26, 2009

Happy Turkey Day

As you stuff yourself this Thanksgiving, enjoy these two Saturday Night Live skits - two of my favorites from recent memory.  I don't know what it is about "What Up With That?" that I find so funny - but Keenan Thompson simply OWNS it.


and then the follow up:


Tuesday, November 24, 2009

Ya Think?

From the FOMC minutes:

"Members noted the possibility that some negative side effects might result from the maintenance of very low short-term interest rates for an extended period, including the possibility that such a policy stance could lead to excessive risk-taking in financial markets or an unanchoring of inflation expectations. While members currently saw the likelihood of such effects as relatively low, they would remain alert to these risks."

Hmmm.. deja vu.  The risk is "relatively low?"  Really?  Look at the markets boys!  ALL asset classes!


Monday, November 23, 2009

They Said It

From this week's Barrons, courtesy of my friend, Ted:

"On the equity/fixed-income side, the traditional rule of thumb has been for retirement portfolios to have a 60/40 split between stocks and bonds. But until the Fed starts raising interest rates, retirees should consider curbing the fixed-income portion of their portfolios. Because bond prices fall as rates climb, cheaper fixed-income investments will be available down the road. A 65/35 or even 70/30 tilt might be best now. Warns Jim Marlowe, a 61-year-old retired broker supervisor at Merrill Lynch: "Bond funds are where all the money is going right now, so when the market gets a whiff of higher rates, it'll be 'Katie, bar the door.' "

Ummm... stock prices might fall also when interest rates are raised!   This points out a conundrum faced by retirees right now:  do you keep your money safe, in short term treasuries (let's just ASSUME that short term treasuries are indeed safe -that's a debate for another day) - earning less than 1%, providing almost no income?  Or do you invest your money into another asset class where the prospects for price declines are signficant at the least?

It's return-free-risk all over again.


Back to the FHA

Last week I wrote about the absurdity of the F.H.A's mortgage insurance - requiring only 3.5% down payments and insuring mortgages up to $739k!  CalculatedRisk followed up with a post titled "Possible Changes to FHA Insured Mortgages,"  where they summarize 4 possible changes, as outlined by the San Francisco Chronicle,  that may help shore up the FHA.  Let's focus on this one, emphasis mine:

"Currently, FHA charges an "up-front" mortgage insurance premium of 1.75 percent of the loan amount. Most borrowers roll that into their loan and finance it. FHA also charges an annual premium, paid in monthly installments, of either 0.5 percent or 0.55 percent, depending on the down payment. To rebuild reserves, FHA could ... raise the up-front premium to 2 percent or as high as the current statutory maximum of 2.25 percent. It could also raise the annual fee..."

Ummm  - the first thing the FHA could do, in lieu of raising the up-front premium, is actually CHARGE an up front premium!  There is no way that the lender (the bank) is paying this fee to the FHA up front, right?  If the FHA is charging an insurance fee that gets rolled into the mortgage which it itself is insuring, well then, they aren't going to collect that fee on defaults!  Plug it into Excel and you'll get a circular reference error.  Divide by zero.  Does not compute.   The borrowers are essentially paying the FHA with their own money!   I guess the FHA will make up for it in volume...

If the FHA doesn't want to actually charge this fee up front, then they will likely have to raise the insurance fee - as buyers who default will not end up paying the full fee.   Who am I kidding - they'll likely have to raise the insurance fee anyway, as their actual default results cannot be in line with what they expected!


Sunday, November 22, 2009

China Wants Their Money Back

Is it funny cause it's true?  or sad?

SnL nails it with this one.  "I like to be kissed when someone is doing sex to me!"



Friday, November 20, 2009

The Magic of the F.H.A.

Thanks to Calculated Risk for pointing out this remarkable NYT story about FHA insured loans in California.   Now, obviously, we have to be careful drawing conclusions and condemning a program based on one example - but this is not a one of a kind story.    Let me summarize my view up front, in the paraphrased words of Mike Shedlock: "You cannot keep home prices from falling by selling homes to people who cannot afford them."  Some excerpts from the NYT article:

"In January, Mike Rowland was so broke that he had to raid his retirement savings to move here from Boston.  A week ago, he and a couple of buddies bought a two-unit apartment building for nearly a million dollars. They had only a little cash to bring to the table but, with the federal government insuring the transaction, a large down payment was not necessary.

“It was kind of crazy we could get this big a loan,” said Mr. Rowland, 27. “If a government official came out here, I would slap him a high-five.”

In its efforts to prop up a shattered housing market, the government is greatly extending its traditional support of real estate, including guaranteeing the mortgages of middle-class and even upper-class buyers against default."

High five!  Sold to you SUCKA!

"Some F.H.A. borrowers here say they have the cash for a full down payment but would rather invest it in the stock market or use it for remodeling. Others, like Mr. Rowland and his friends, simply do not have the money required by private lenders — which would have been nearly $200,000, in their case.

“We were resigned to waiting another year,” said a second partner, Michael Bedar, 31. “Then we read about the F.H.A. I had never heard of it before, and couldn’t quite believe it. But it was the answer to our problems.” They put down about $33,000, split among the three of them."

Lever it up, bayyyy-beee!  Of course, with a 3.5% down payment, they could be underwater in no time, and then disincented from actually having to pay back their mortgage.    Wait a second - isn't this what caused the housing crisis in the first place?  Banks making reckless, highly levered loans to individuals who couldn't afford the homes?   Now, it's possible that these three gentlemen each make hundreds of thousands of dollars a year, but the article makes it sound unlikely, explaining "Mr. Kurland and Mr. Bedar, who are employed full time, are the buyers of record. Mr. Rowland, a freelancer, will have his interests protected by a legal agreement."   Note - I clearly cannot judge the ability of these three 3 guys to cover the mortgage - but my point is that it's irrelevant  - 3.5% down mortgages are like playing with nitroglycerin.  If borrowers can afford a real downpayment, they shouldn't be given government sponsored leverage, and if they can't afford the downpayment, they shouldn't be given government sponsored leverage!  

"“Is this going to be the next wave of the housing downturn?” asked Eileen Bermingham, an agent with Pacific Union. “With such a minimal down payment, how do we make sure people don’t get in over their heads?”"

Good question, Eileen - almost by definition, anyone who can only put down 3.5% is already in over their heads.

"The F.H.A. commissioner, David H. Stevens, said recently that its loans were relatively safe because the buyer was required to live in the property. They “are for shelter. They aren’t speculative-type investments,” Mr. Stevens said.

But the idea of a house as an investment dies hard. Mr. Bedar, Mr. Rowland and the third partner in their property, Jordan Kurland, are all in the technology field, but their dreams of wealth do not feature stock options.

“We’re banking on real estate,” said Mr. Kurland, 24. “Everyone expects prices to keep going up.”

Aiyahhhhhhhhhh!!!! The bubble is still alive!

"A few weeks ago, Congress extended the higher lending limits for another year. Representative Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee, said in an interview that he planned to introduce legislation next year raising the maximum F.H.A. loan by $100,000, to $839,750."

Oy vey.  And when the real estate market crashes again as a result of this attempted double down strategy (MARTINGALE!), Barney Frank will say that he was against giving these loans, and blame the Bush Administration.   I mean - really - why do we need to have the F.H.A insure $800,000 mortgages?!?!?  Isn't the point of the F.H.A to help poor buyers who can't afford a down payment - maybe we should have them buy MORE AFFORDABLE homes!  As the article notes: "F.H.A. insurance was created for minority and low-income families who could not come up with the traditional down payment of 20 percent required by private lenders. Buyers receive loans from government-approved lenders and are required to document their income and assets."     The F.H.A. limits should be LOWERED, not RAISED!

MISH also touched on the subject last week, exposing the lunacy in Frank's thinking:

First, MISH quoted a Richmond newspaper article:

"Exactly who made Bernadine Shimon think that she could buy a new house shortly after declaring bankruptcy and losing another home to foreclosure? The American taxpayer, that’s who.

Without a Federal Housing Administration willing to guarantee a $125,000-plus mortgage, this Denver-area schoolteacher’s recurring “dream of homeownership” could not come to pass. Shimon’s down payment was a tiny 3.5 percent.

This single mother is so strapped that she had to cash in her retirement savings to come up with the 3.5 percent. Her case was cited in a New York Times article about, not surprisingly, the sad shape the FHA finds itself in."

"With nearly a quarter of FHA loans insured in the last two years now in trouble, you’d think that the agency would show more discretion in deciding which homebuyers to help. And you’d think that Democrats running the House Financial Services Committee would be more upset over the way the FHA still hands out taxpayer guarantees.

But committee Chairman Barney Frank of Massachusetts insists that these mortgages are needed to “keep prices from falling too fast.”

Then he explained the absurdity:

"Home prices are falling precisely because houses people bought homes they could not afford.

Note however, the thought process of Barney Frank: We have to keep selling houses to people who cannot afford them in order to keep home prices from falling.

That mentality all but assures a bailout of the FHA is coming"

This is proof to me that we have not seen the bottom in housing.


full disclosure - I just bought a house - which is FURTHER evidence (based on my contrary indicator nature) that we have not seen the bottom in housing

Thursday, November 19, 2009

Return Free Risk - A Merger Arb Anecdote

Most people are familiar with the concept of risk free return.  Today I want to tell my personal anecdote about return free risk and how I should have seen the liquidity bubble forming back in 2006.  Don't be alarmed by the mention of arbitrage spreads, cost of capital, and short rebates - the concepts are simple.

When I was on the buy side of the business - working for an internal hedge fund at a major sell side firm - we ran a large merger arbitrage portfolio. Merger arb is simple in theory:  when a cash acquisition is announced (ie, ORCL buys JAVA for $9.50 per share), you buy the shares in the target company if the risk vs reward payout being priced by the market is favorable (in your opinion).  If and when the deal closes, you make the spread between where you bought the stock and the acquisition price.  If the acquisition is an offer for shares in the acquiring company instead of cash (ABC is buying XYZ, and giving XYZ shareholders 2 shares of ABC stock for every share of XYZ that they own), you buy shares of the target (XYZ)  and short 2 shares of the acquirer (ABC) for each XYZ share that you've bought.  If and when the deal closes, your long XYZ will be converted into an ABC position that will cover your short hedge, and you'll have captured the spread, and be left with no stock positions.

Now, there are other costs and considerations as well - dividends you will pay (on short positions) and receive (on long positions), and more importantly, the cost of carry.  The cost of carry is the opportunity cost on your money - the risk free rate that you could otherwise be earning, or your "cost" of borrowing money.  At my "fund,"  we had access to a large amount of capital courtesy of the bank's balance sheet.   The catch was, each dollar we used we paid for.  In other words, I could buy $100MM in stock, and they'd charge me for that money - say, 5% annualized.

Thus, when calculating the return on merger arb deals, I had to back out the cost of capital.  For cash deals, this meant basically subtracting 5% from the annualized return that the market was pricing in.  For stock deals, it's a little more complicated, but don't fret, it's not rocket science:  when you short stock, you usually earn a "rebate" on your short position.  This is a fancy way of saying that the proceeds from the short sale earn interest for you - although not quite as much interest as you have to pay on your long position.  Thus, in calculating my cost of carry I need to add the cost of buying the long position, and deduct the rebate that I earn on my short position.   In stock for stock deals where the company I'm shorting (the acquirer) is an easy to short, top rebate level stock, the impact on the cost of carry will be small - since the rebate on the short stock will be very close to the cost of funds for the long stock.

Anyway, fast forward to "ideas dinners" where a bunch of merger arb hedge funds get together and talk about their best ideas in the field.  We'd have 20 supposedly smart guys from different firms sitting around a table, and talking about arb spreads.  "the ABC-XYZ spread is 5% - it's a layup,"  one guy would say, and I'd raise my eyebrow.

"It's not 5%, it's 0%.  You have to adjust for the cost of your funds,"  I'd say.

"We don't pay for funds," he'd respond, as others in the room nodded.  See, most hedge funds just have a pool of client money that they're investing - they don't have to pay to borrow it from their firm.

Now my other eyebrow would go up, and I'd say "Are you guys serious?  Even if you don't actually get charged for the funds, you still need to deduct the risk free rate from your return profile."   I mean - this is finance 101.

Amazingly, most of these traditional hedge fund traders didn't look at it this way - they way they looked at it was that they had $100MM to invest, so if a deal returned 5%, they were making 5%.  Never mind the fact that US Treasuries returned 5% also - they were earning their 5% of RETURN FREE RISK.  ZERO excess return (above the risk free rate) with risk included!  Where do I sign up!  Of course, it's not entiely return free, as there were a number of merger deals in 2005 and 2006 that saw bumps or increases in the bid price to a higher price.

Shockingly,  in stock for stock deals, these same guys would add back in the rebate they earned on their short position to make their "return" look even higher - STILL without accounting for the cost of capital on the long side!   In a room full of twenty people, there were maybe 2 others in the same boat I was who approached me after the events to explain that they understood my point. 

I'd return from the events and explain to my boss that the Street was batshit crazy, and that they were absolutely mispricing the risk in these deals.  Every time a broker called us and said "Check out XYZ-ABC - it's 5% annualized,"  my boss would just mutter "don't educate them,"  and we'd say "thank you," and hang up the phone.  Obviously, you know how this story ends:  the merger arb world blew up in 2007, and guys who were recklessly putting on every spread at rates which didn't compensate them for the risk they were taking on got wiped out.

How does this relate to today?  If you read Bill Gross's monthly piece today, he talks about the Fed's efforts to reflate the market by keeping rates so low that investors are almost FORCED to plow their funds into riskier asset classes to avoid earning a near 0% return on their money - which is what the risk free rate is now paying.

"The Fed is trying to reflate the U.S. economy. The process of reflation involves lowering short-term rates to such a painful level that investors are forced or enticed to term out their short-term cash into higher-risk bonds or stocks. Once your cash has recapitalized and revitalized corporate America and homeowners, well, then the Fed will start to be concerned about inflation – not until."

If you're wondering why the stock market (not to mention the government bond market, oil market, gold market,  corporate bond market, junk bond market) seems to be rising without logic, it's because of all this liquidity that is MANDATING the devouring of risk assets.  In my opinion, this can only end one way... badly.


Wednesday, November 18, 2009

Misusing Statistics - Distorting Tax Statistics

Look, I'm a fiscal conservative.  I hate the idea of solving all of our problems by taxing the rich.  I admit that I would normally spout a statistic like I quoted yesterday such as "the top 3.5% of earners pay over 60% of the tax dollars," to illustrate the iniquities in the tax code.    Unfortunately, there's a big problem with that stat  - it's a red herring designed to misdirect the reader, and I'm shocked that every time it's mentioned people don't shoot it down.  I am ashamed to admit that, despite my math background and statistical prowess, it wasn't until AsphaltJesus's comment yeterday on my post that I realized how inane/insane that stat is.

The point is that we need to know what percentage of the income the top 3.5% of earners earns!  If they earn 60% of the income, and pay 60% of the taxes, well then, that seems pretty darn fair.  According to,  the top 5% of earners earn roughly 37% of the income and pay roughly 60% of the taxes.   So, phrasing it as "the top 5% of earners pay 60% of the taxes," while comparing apples to oranges, sounds a lot more "unfair" to the wealthy than "the group that earns 37% of the income pays roughly 60% of the taxes."

Yeah, of course the rich still pay a higher relative share of the tax pool, but it's not quite as absurd as misleading or irrelevant statistics can make it seem.


Tuesday, November 17, 2009

Quality Readings Link Dump

I was honored to be included in the Reformed Broker's Periodic Table of Finance Bloggers under the category of "rogues gallery." 

Paul Kedrosky's chart of the price of gold, in gold, is good for a laugh.

Howard Lindzon'z New New NASDAQ is worth a read.

Peter Boockvar on how the Fed has done in its goal to maintain the purchasing power of the dollar (hint:  not very well!)

MISH on the jobs outlook - even with assumptions about job creation, we're going to have very high unemployment for a very long time.

Calculated Risk:  record mortgage delinquency

Barry Ritholtz with a graphic from  Who Pays Taxes in the USA?  (the top 3.5% of earners pay over 60% of the tax dollars)


Nothing to See Here - Everything is Fine.

I really thought/hoped that this report was lifted from The Onion:

"During the best of the times, Miguel Salcedo’s son, an illegal immigrant in San Diego, would be sending home hundreds of dollars a month to support his struggling family in Mexico. But at times like these, with the American economy out of whack and his son out of work, Mr. Salcedo finds himself doing what he never imagined he would have to do: wiring pesos north."

I mean - come on - things are so bad in the US that Mexican families are wiring money TO their relatives in the US?  That has to be a joke - I've been reading the financial press every day and I've been told that the recession is over and that everything is fine. 

Then, this:

"In other cases, the migrants are returning home, as the many passengers who hop off the bus that runs regularly from northern California to a gas station in Miahuatl├ín make clear. “There’s nothing up there,” said a young man with an overflowing suitcase who returned one recent night."

Come on - are you kidding me?  Sadly - no - that's the truth of the economic situation in our country.  The ponzi scheme of confidence doesn't solve our problems - telling people that things are better does not make things better.  

"There's nothing up there."   That should be the headline in the mainstream media - not "recession over" or "jobless claims data improves."

Things are so bad here that 1) Mexican workers who came to the US to earn money to send home to their families in Mexico are now having to receive money from their families instead, and 2) Mexican migrant workers are going back to Mexico. 

I mean - what more do I need to say?



The NY Times writes an article about bloggers going to the Treasury without nary a mention of Kid Dynamite's throrough, detailed recaps?  WTF?  DYKWTFIA?  


ps - Mrs. Dynamite spotted a possum in our yard last night.  More wildlife updates to follow as necessary.

Monday, November 16, 2009

Monday Morning Quarterback

Last night's Patriots-Colts game ended in spectacular fashion, with the majority of the sports world coming down hard on Bill Belichick's decision to go for it on 4th and 2 from his own 28 yard line with just over two minutes remaining.  The Patriots led by 6, and Indy had 1 timeout remaining.  The Colts had fought back from deficits of 17 points to start the 4th quarter, and 13 points with only 4 minutes remaining.

After watching Indy put together two quick 79 yard touchdown drives, each taking roughly two minutes (5 and 6 plays respectively), Belichick didn't want to give Indy QB Peyton Manning a chance to win the game, and elected to try to convert a first down, which would have sealed the game for the Patriots.

Obviously, when Belichick's gamble failed, the entire Monday Morning QB universe came down on him for his "horrendous decision."  Advanced NFL Stats, however, attempts to quantify the expected value of the decision to go for it instead of punting:

"With 2:00 left and the Colts with only one timeout, a successful conversion wins the game for all practical purposes. A 4th and 2 conversion would be successful 60% of the time. Historically, in a situation with 2:00 left and needing a TD to either win or tie, teams get the TD 53% of the time from that field position. The total WP for the 4th down conversion attempt would therefore be:

(0.60 * 1) + (0.40 * (1-0.53)) = 0.79 WP

A punt from the 28 typically nets 38 yards, starting the Colts at their own 34. Teams historically get the TD 30% of the time in that situation. So the punt gives the Pats about a 0.70 WP.

Statistically, the better decision would be to go for it, and by a good amount. However, these numbers are baselines for the league as a whole. You'd have to expect the Colts had a better than a 30% chance of scoring from their 34, and an accordingly higher chance to score from the Pats' 28. But any adjustment in their likelihood of scoring from either field position increases the advantage of going for it. You can play with the numbers any way you like, but it's pretty hard to come up with a realistic combination of numbers that make punting the better option. At best, you could make it a wash."

What seems like an asinine decision is actually probably pretty close when you run the numbers.  Obviously, the probabilities are not exact - Indy may be more likely (maybe 70%)  to score from the Patriots 30 yard line, and less likely to score from their own 35 yard line with 2 minutes and one timeout.  New England may be closer to 70% to convert the first down attempt.  Indy also may get better field position if New England punts - or they may fumble the punt (like Buffalo fumbled the Pats' kickoff with 2 minutes remaining in week 1!) - it's not an exact science.  The point is that perhaps Belichick's apparently insane decision wasn't quite as crazy as it seemed.  I'd use the estimates of 70% for New England to convert the first down, 70% for Indy to score if the Patriots failed to get the first down, and 30% for Indy to score if they got the ball inside their own 35 yard line.  Those assumptions yield a win percentage of 79% for "going for it" and 70% for "punting."  I think we actually need to DECREASE the win percentage for "punting" though, because Indy may get better field position.

Now, what I have a problem with is the strategy change the Pats made in the fourth quarter - playing a softer defense - not quite a prevent D, but one that allowed Manning to pick them apart for two quick scoring drives.  Against many teams, when you're up by 17, this strategy is ok - but against Peyton Manning and the Colts, who run a precision no huddle offense, taking less than 12 seconds to re-snap the ball after each completion, time just doesn't become an issue for them.    Similarly, when the Patriots had the ball on their final two drives, they shouldn't have tried to kill the clock - they should have kept up the offensive pressure that Indy couldn't stop all game long.

Anyway, this was a gutwrenching loss for Pats fans - it will be interesting to see if the anger at Belichick is tempered over the next week as fans try to understand his likely considerations - or if they will view him as having jumped the shark and become a crazy old man.


Thursday, November 12, 2009

Stat of the Day

Via CalculatedRisk:

"86 percent of homebuyers relying upon FHA mortgage insurance in FY 2009 had downpayments of less than five percent."



Wednesday, November 11, 2009

Veteran's Day

Thanks to all the past, present and future members of the United States Armed Forces.

I have two links today, both from Tyler Cowen of Marginal Revolution:

1) Who knew you could tell so much about a person by the way they phrased a Google search?  This is a fascinating look (Cowen didn't do the research, he just linked to a few different projects) at how beginning your search with a phrase like "how 2" will result in an entirely different class of suggestions than if you begin your search with "how one might."  Cowen's blurb links to this piece and this piece and this piece - both are well worth a click.

"If you believed all the talk from Chrysler about how our tax dollars would help finance its fast-track electric-vehicle future, you're in for a big disappointment.

Chrysler has disbanded the engineering team that was trying to bring three electric models to market as a rush job, Automotive News reports today. Chrysler cited its devotion to electric vehicles as one of the key reasons why the Obama administration and Congress needed to give it $12.5 billion in bailout money, the News points out."


Monday, November 09, 2009

Monday Night Links From The Country

Walking along the side of our rural road yesterday I found a PIECE of a porcupine - like, a little piece of fur  the size of my open palm, with spines on it.  What can rip off a piece of a porcupine, aside from a bear?  Today my wife, Oscar and I walked in the woods wearing our neon orange "don't shoot me" vests, and met our first hunters - two large men each driving their own off road vehicle, with guns strapped to the back.  Live Free or Die!

"Would it have been uncouth for me to request that they don't shoot us on our way back?"  I asked Mrs. Dynamite, who merely frowned at me.

I also saw a little bat - the flying rodent kind - flying around today and landing on my barn.  We knew that there were some bats living in the barn, but I was surprised to see one flying around at 2pm.  I saw him try to snipe a flying bug, but the bat merely banged against it, failing to catch it.  Perhaps it was a baby bat, just getting out for the first time - which might explain the afternoon flight.

Here are some worthy reads:

Via Calculated Risk:  Walmart Quote of the Night
 "There are families not eating at the end of the month,” said Stephen Quinn, executive vice president and chief marketing officer at Wal-Mart Stores, and “literally lining up at midnight” at Wal-Mart stores waiting to buy food when paychecks or government checks land in their accounts."

My CDS post, republished on SeekingAlpha generated some intelligent comments, some of which are similar to the comments left on my blog.  


Sunday, November 08, 2009

Abstract Thoughts on CDS and the Fallacy of Insuring Your Neighbor's House

warning: this post will require you to be able to intelligently ponder philosophical concepts and theories, and perhaps try to forget some assumptions you may already have.   I failed in my attempt to explain the concepts below in a comment thread on NakedCapitalism, so here's the full thought process:

Let's have a quick CDS tutorial:  Credit Default Swaps are insurance on the credit of an underlying company.  An investor who buys CDS on company XYZ will pay a fixed fee (ie, 1% of the notional he is purchasing) every year, and in exchange, the seller of the CDS will owe the buyer money if there is a default event at the company.

The biggest problem with the CDS market was that sellers of CDS - ie, sellers of insurance, wrote checks their bodies couldn't cash.  They ended up with liabilities they couldn't possibly make good on, and you know the rest of the story - government bailout to avoid Armageddon.

There is another problem with CDS, though, and that's the fact that there are many more CDS outstanding on some companies than the actual underlying debt that the CDS are supposed to be insuring.  Let's consider a hypothetical example:  Company XYZ has $100MM in debt outstanding.  JoeHedgeFund owns it all.  JoeHedgeFund goes out to the Street - the sell side broker dealers, AIG, etc, and purchases protection - CDS - for his bonds.  However, JoeHedgeFund takes it one step further - he manages to buy  $500MM worth of CDS - because when you buy CDS, no one asks you how much of the underlying bond you own.   Why is this a problem?  Because, when company XYZ runs into trouble, and goes to negotiate a restructuring, a prepackaged bankruptcy, or a reorganization, JoeHedgeFund now has no incentive to negotiate in favor of the debt he owns - in fact, he's DIS-incented from helping XYZ restructure their debt, because he's essentially overhedged by a ratio of 5-1.  He doesn't care if he takes a loss on the $100MM in bonds by refusing to compromise on any sort of restructuring and forces the company into bankrutpcy, because he gets paid on $500MM of CDS.

This is what's known as "perverse incentive."  Opponents of CDS sometimes say that we shouldn't allow people to buy "naked" CDS, because they don't have an "insurable interest," and thus are exposed to perverse incentives.  A commonly cited example is that you can't buy insurance on your neighbor's house, because you could then burn the house down and collect on the insurance policy.  You also can't buy life insurance on your neighbor, because you'd have perverse incentive to murder him to collect the payout.

Now, here's why it's fallacious logic to apply this reasoning to CDS.  If I buy CDS on a company without owning any of the underlying debt, I cannot effect the health of the company.  Note that I don't have an insurable interest, but it doesn't matter - the "perverse incentive" is a pipe dream, because I can't act on it.  It doesn't matter how much CDS I buy - I could own a gazillion dollars worth of insurance on the debt of a given company - but that still doesn't give me any say, any seat at the table in a restructuring negotiation scenario.  There is a similar analogy with short selling stocks, and it's the reason why people who blame short sellers for the demise of companies are generally nutjobs:  short sellers cannot and do not effect the health of a company.  Similarly, CDS levels do not effect the health of a company - they REFLECT the health of a company, or at least the market's interpretation of that health.  Some companies will see the value of their CDS widen when people fear for the company's financial health.  The CDS is a reflection of the fear, and not the cause of the company's problems.  To suggest that panic from widening CDS levels causes companies to collapse is like saying that avoiding marking assets to market makes them worth whatever we want them to be worth - limiting CDS trading would not alter the underlying health of the company, it would only mask it.

So, since one cannot effect the health of the company by owning CDS - since one cannot murder the company (or burn it down) via a CDS position, the "burning down your neighbor's house" analogy goes up in smoke as a straw man fallacy.  If you're philosophically inclined, you can imagine a world where I could buy life insurance on my neighbor's house, but the insurance company would give me a magic pill that would prevent me from being able to harm the house in any way - it would essentially eliminate the perverse incentive I had.  In this scenario, obviously, there is no reason why I can't buy insurance on my neighbor's house.  Similarly, with CDS, I can't effect default events by owning CDS alone, so the perverse incentive is a straw man.

However - once one DOES own some of the underlying bonds in a company, like JoeHedgeFund in our example, he certainly can effect the outcomes, and thus we need to propose some rules for how much CDS one can own.   Now, these rules are theoretical - I don't have a suggestion for how to enforce them, so if you don't have the capacity for regulatory philosophy, you can click away now.  Also note,  that these rules address ONLY the "perverse incentive" concept - they don't cure the problem of the AIG's of the world writing too much insurance (CDS).

It's actually simple, and it's actually only one rule:  SINCE a debtholder can effect the future health of a company, IF you own debt in a company, you cannot own CDS notional greater than your debt position.  Following logically from that, if you own CDS in a company, you cannot buy debt in the company unless the notional value of the debt is at least at large as the notional value of the CDS.

That's it - just one rule.  Note that under this rule, there is no prohibition on buying "naked" CDS in a company whose debt I don't own - because naked CDS buying does not cause the collapse of companies.

The real problem with CDS, apart from the perverse incentive effects which we've now solved with a simple rule, are not with the buyers of CDS - but with the sellers.  Sellers of CDS historically underestimate the likelihood of default, and issued much more insurance than they could cover if things went sour.    Regulating exposure of the sellers of CDS is a topic for another post - but one that will be covered amply in the news over the next 12 months, I'm sure.


Thursday, November 05, 2009

A Sit Down With Senior Treasury Officials - Part II

In Part One of the recap of my trip to the Treasury, I outlined the questions and answers related to variations on the concept of "extend and pretend" - the refusal to acknowledge bad debts and instead attempt to stick our proverbial policy finger in the dyke and hope that the water will stop spraying out.   Most of the attendees have written recaps of the event, and I found Steve Waldman's piece today to be quite well done, as is David Merkel's ongoing recap.

Later in the meeting, I had the chance to ask a Senior Treasury Official (STO) a question related to this testimony last week from Treasury Secretary Geithner (note - Ritholtz has the location wrong - it's actually from the House Financial Services Committee, I believe):

To summarize the video testimony in the link above: Geithner outlined 5 key points to the Administration's proposed regulatory reform bill:

1) The government has to have the ability to resolve failing firms, with losses absorbed not by the taxpayers, but by the unsecured creditors and equity holders.
2) Firms who cannot survive without government support must face the consequences of that failure.  The government would facilitate the "orderly demise" of the failing firms, not ensure its survival.
3) Taxpayers must not be on the hook - the government will recoup losses by assessing fees on industry peers
4) The FDIC and FED must have limited authorities with respect to these abilities to take over failing firms
5) The Government must have stronger supervisory authority.

Now, the first three points from Geithner's testimony are the main ones, and they are a good idea - they are pretty much saying that we'd never have bailout like we had the last time, where taxpayers were asked to front the capital that the bondholders (in the form of haircuts and debt for equity swaps) and equity holders (in the form of dilution) should have had to pay for.   I think that most of America would agree that these three points are reasonable, and at the very least, a good start.  My question for the STO was how these three new ideals jived with the recently announced imminent THIRD round of bailout money for GMAC.

Back in May, I was stonewalled by Barney Frank when I asked him why bank bondholders and auto bondholders faced such disparate treatment in the bailout proceedings - with the auto bondholders being forced to make concessions as they rightly should have, while the bank bondholders went on their merry way and watched the government commit taxpayer dollars to shore up their balance sheets.

Sadly, I had a similar feeling when the STO responded to my question about GMAC, explaining, basically, that GMAC was different.  The GMAC bailout was part of the Capital Assistance Plan, where the Treasury stood ready to commit capital to any bank that couldn't raise the capital it needed to raise as identified by the stress tests.  GMAC was the only such entity unable to raise its own capital, and the Treasury was making good on its promise.  I was told that the new rules were for the future, which left me raising an eyebrow, as I was complaining about a third round of funding for GMAC that was being announced as we were sitting in that conference room at the Treasury!  It wasn't the future - some as yet unforeseen disaster - it was happening as the Treasury was announcing policies to say that it wouldn't happen!

The STO clearly didn't want to debate this with me, but must have noticed my squirming, wrinkling my nose, and raising my eyebrows as if I'd just walked into a bathroom at Penn Station, because as he was responding to another question, he briefly addressed me, noting that this was another example of how the rules would need to be flexible.

This was even more disturbing, as I basically took it to mean "there will be no bailouts like we had before, UNLESS there needs to be bailouts like we had before."

John Jansen  asked a question regarding the re-opened 3 and 7 year Treasury notes, and the potential saturation of demand due to the massive annualized issuance in these midrange maturities, which he pegged at nearly 1.2 TRILLION dollars a year.   John was similarly stonewalled with a response that basically consisted of "why would you think that?"   A bit perplexed, John replied that this was simply a tremendous amount of issuance, but was told that he'd need to discuss that with a different Treasury official.

One viewpoint I was surprised to hear expressed by a STO, but one that I strenuously agree with, was the dismissal of the notion that investors were duped into buying much of this toxic paper that has inundated our financial system.  It was noted that the products could be understood by those who deigned to actually understand them, and that those who didn't understand what they were buying were responsible for their decisions.  It's pretty clear to me that it's not that the buyers were duped by spurious Wall Street salesmen, but rather by their own greed and relentless hunt for yield in a low interest rate environment.  Interestingly, I tend to have similarly little sympathy for homeowners who claim they didn't understand their mortgages, which leads me to a quick tangent about consumer protection - another topic which was discussed briefly.

I believe some of this is already in the works, but I'd like to see standardized credit card and mortgage documents that have data just like all food products now do - only instead of listing fat content, vitamins, and calories, these docs would list interest rates, loan length and terms.  There should be no fine print - and that goes for television ads too.  A pet peeve of mine are auto ads on tv where there is fine print on the screen that I can't even read if I pause my digital video recorder on my HDTV.  Consumers need to be protected from their own ignorance.

Tyler Cowen asked if the Treasury was worried about the possibility of the economy falling off a cliff, and was greeted with a response that pretty much summed up the Treasury's options:  the response was essentially (and this is not a direct quote) "what else can we do - should we try to pull that potential cliff forward instead of pushing it back?"  Before I could jump out of my chair and shout "BUT PUSHING THE CLIFF BACK MAKES IT TALLER TOO!"  Tyler Cowen uttered almost those exact words.  The STO nodded and pursed his lips - acknowledging the possibility of that reality.

In summary, I think this was an interesting opportunity to gain insights I'd rarely expect access to from senior government officials.  However, one of the bloggers summed it up on the way out, saying "the concept of the meeting was probably cooler than the actual meeting," and I was left feeling similarly unsatisfied, considering the relative brush off of what I thought was a very well reasoned question (GMAC).   I got the impression that the Treasury officials are still very concerned about what the results of their policies will be, and for good reason.  As I've said before, I don't think that continued stimulus or failure to mark to market - the extend and pretend policy - solves anything.  To use an overdone analogy:  you can't give a drunk another drink to help him avoid a hangover.  That hangover is inevitable, and by postponing it with another drink, you're making the eventual reckoning worse, although later!

Unfortunately for the Treasury, much like Tom Cruise's Lt. Daniel Caffy in A Few Good Men, I just don't think America can handle the truth

The truth is that expansion doesn't last forever, even in our economy that seems to rely on expansion (Ponzi?) to run - and that the only way to resume growth is to first acknowledge hundreds of billions, if not trillions of dollars worth of bad debts that need to be washed away.  The Administration, politically, cannot tell this to the people - no Administration can - it's a sad fact of politics.  In times of trouble, politicians who do the right thing and make the tough decisions sign their own political death warrants.  The officials making these policy decisions at the Treasury are clearly not stupid - I think the main realization from this meeting for me was that they really don't feel like they have any other choice but to TRY to resolve the issues in a way that avoids current mass financial pain.   Is it possible that the Fed can simply buy up all the bad debts?  Maybe - I mean, it looks like they are actually trying to do that.  Will the effects of that - potential hyperinflation and pervasive moral hazard be worse than if we "took our medicine" and allowed the system to implode sooner?  That remains to be seen. 


Wednesday, November 04, 2009

A Sit Down With Senior Treasury Officials - Part I

I received a mysterious email last week from the Treasury, inviting me to a discussion about the Administration's policies and reactions to the economic crisis.  Although the timing sucked for me - it was the Monday following the weekend of my move out of NYC - it was too rare an opportunity to pass up.

Arriving at the Treasury, I quickly bumped into AccruedInterest along with John Jansen from Across the Curve.   Michael Panzner soon joined us, before we were escorted to the proper conference room, where we found Yves Smith from Naked Capitalism, Steve Waldman of Interfluidity, Tyler Cowen from Marginal Revolution, and David Merkel of Aleph Blog fame.  In all, there were 8 "bloggers" and a handful of senior Treasury officials, who shall remain nameless.  Henceforth, all Treasury views will be attributed to "STO" - Senior Treasury Officials.

STO began the session with a little background regarding the Administration's response to the financial crisis.  The first point that caught my ear was the description of the stress tests as having been designed to restore a level of confidence in the banking system.   The STO mentioned that the focus was now on reducing the footprint of economic intervention cautiously, quickly and prudently.    Michael Panzner jumped right in, addressing a concept I've writted about previously - that of "extend and pretend," or "delay and pray" - the concept of attempting to avoid recognizing actual losses and or insolvencies, and growing out of them after enough time.  Panzner called it "fake it 'till you make it."    I mentioned that I felt like we were undergoing a "Ponzi scheme of confidence" - but that confidence mattered less than ever in the current environment where, contrary to perhaps the prior 10 years, confidence can no longer be "spent."

In other words, 5 years ago, the economy could be kept churning along if consumers were convinced that things were going to be ok - they could go and borrow more and spend more.  They could take out another mortgage on their home.  Today, on the other hand, that credit bubble has popped - we're broke, both as a consumer, and a nation - and we can no longer simply "spend" confidence by levering up our personal balance sheets any more.    I challenged the STO that he had a poor choice of words in describing the stress tests as designed to restore a level of confidence, rather than to determine which banks were healthy and which were insolvent.

This drew a chorus of "whoa whoa's" and a murmur from a number of STO's present in the room, who quickly banded together to clarify that no one knew the results of the stress tests before they happened, and that they were designed to restore confidence by identifying the levels of capital needed by the banks, and requiring them to raise such capital.  I said that if they wanted to restore confidence, they should require banks to mark assets to market, and depict the true financial situation.

The response was that banks don't mark to market because, well, that's just not what they do - since they hold assets to maturity.  It was also pointed out that if banks had been required to mark to market, the system would have been insolvent multiple times in the past 50 years.  I almost laughed - that was my whole point - just because you pretend that the system is not insolvent doesn't mean that it's not insolvent!  Holding assets to maturity does not mean you'll receive your principal back, obviously.  I also noted that I understood that my background in equities gave me a slightly different perspective, since our (equity) assets were much more liquid and had to be marked to market daily - but I took umbrage with the recent decision by the FDIC to allow banks to recognize commercial real estate loans which were clearly impaired as "performing" and avoid taking writedowns.  I referenced David Einhorn, who wrote an entire book on Allied Capital - whose accounting shenanigans attempted to hide the health of their loan book in exactly this manner.  Loans which were certain to default, but had not yet defaulted were still recorded on the books at full price, and as "performing."

I failed to draw an analogy to the local Washington Redskins, which I think would have been a good one:  the Redskins are technically in the NFC East playoff race - they haven't been mathematically eliminated yet - but in reality, they are not a contender.  Similarly, many of these CRE loans are technically "performing" - the payments are currently being made - but the values of the properties are down massively, rents are falling,  and it's widely recognized as a mere matter of time before the loans default in one form or another.

David Merkel jumped in with the suggestion that even if loans are not marked to market prices, there still has to be an increase in capital requirements held against loans that have seen their market values impaired.

Steve Waldman was a harsh critic of the policy of "Prompt Corrective Action," and was credited (by me) with the quote of the day when he addressed one STO on the regulatory reform plan: "I've read your bill, and it's terrible - no offense," and followed with "too big to fail is too stupid a criteria."    This led to a discussion of how capital ratios were not the problem - although I do think they are a part of the problem.  The buzzword issue was really "interconnectedness," aka, "counterparty risk."

There had been suggestions as far back as a year ago, I believe, about having a central counterparty risk identifier, like the Federal Reserve, monitor the net counterparty risk of each firm, and quantify it systematically.  I mentioned that the problem was that even if we had a "Counterparty Risk Czar" who somehow managed to magically quantify the exposures of each firm (which may be quite a difficult task in itself), we'd see the same problems we saw when the government went to give out the TARP funds. The government didn't want to "bail out" select firms (ie, BAC and CITI) because they feared that the stigma attached to such assistance would create panic and runs on the bank - so they asked a large pool of financial institutions to take the money to hide the truly sick cows.  The Counterparty Risk Czar would have the same issue - if he were to somehow miraculously identify that Firm A had too much exposure to Firm B, the very announcement of such extreme exposure would become a self fulfilling prophecy and result in panic by investors in Firm B, which would in turn spread like wildfire to Firm A.  Is the solution to move the trading of every product onto a clearing house centered exchange?  Perhaps, although that would eliminate an immeasurable amount of OTC trading that the system seems to need to keep churning at its current size, and hamper the economic growth fueled by it (with "it" being financial engineering, in some sense).

I made another point that, although I was not going to presume to lecture a room full of economists and pseudo-economists (as one STO described himself) on economic theory, it was clear to me that they needed to throw away their old economic playbooks.  The thing that bothers me most about economic history is that it's based on a relatively small number of samples.  Furthermore, the inputs in each scenario are vastly different.  Today, for example, we have record length of time the government will provide unemployment benefits, record length of time people spend receiving unemployment benefits, and yet still a record number of people exhausting unemployment benefits.  I cautioned the economists in the room that there is no rule about what "usually" happens when GDP rebounds from -3% to +3% - or when unemployment goes from 5% to 10% - because it's the INPUTS that determine the rationale for the response.  In other words, a +3% GDP print from government spending (which I maintain is what we just saw) is very different from a +3% GDP print from organic economic growth.  The stimulus induced GDP growth will revert when the stimulus stops.

Stay tuned for Part II - where I"ll talk about some unsatisfying answers to questions asked by myself and others, and attempt to synthesize my interpretation of the Treasury's stance on policies.


Tuesday, November 03, 2009

Kid Dynamite Goes to Washington

I was fortunate enough to be included in a group of bloggers who were invited to Washington DC to sit down with senior Treasury officials for a discussion on current policies and future regulatory reform. I just got home, and I will be writing up the event as best I can ASAP, given the constraints that I cannot name specific Treasury officials, or even anonymously quote directly from the meeting.

Still, I expect the recap to be a quality post, and urge you to check back here for it.

Here's a little warmup story: I had a few minutes to kill before the Treasury meeting, so I ambled into a tour at the Bureau of Engraving and Printing (BEP), which actually prints US currency. I had laughed earlier, looking at their website, when I read "You'll see millions of dollars being printed during a tour of the BEP." Millions? That's so 1998.  Millions don't bail out GMAC, bay-bee! Anyway, the tour starts with a little video about the BEP, including a line about how the employees show up every day to "print money and ensure that the U.S. economy remains strong." I chuckled out loud - drawing glances from the Joe and Joan SixPacks that made up the rest of the tour. I thought it was a joke - even the BEP can't think that printing money equates to a strong economy can they? The ironies didn't stop though - the tour guide explained how they were testing out a new printing press that could print even larger sheets of bills (I think the new press does sheets of 50, compares to sheets of 32 for the old press) - so that the BEP can print even MORE money, FASTER! They are printing so much f'n money that they need a newer higher tech press! AIYAHHHH!

The guide then claimed that 95% of the money printed was to replace old and damaged money taken out of circulation, and that only 5% was new money. This seems like a dubious stat to me, but hey - what can I say.

Looking down over the room where the bills are stacked before being fed into the cutting machine, there is a sign that says "Have you ever been this close, and yet so far?" Impressive that the BEP actually TAUNTS the poor American schlubs who will never see stacks of money like this again. One worker jokingly pulled an uncut sheet of hundy's off the stack and pretended to hand it to one of the tour guests - who was of course secured behind a closed in glass catwalk.   He had good intentions, though, drawing wide eyes from the little girl on the rail.

next up:  The Treasury


Sunday, November 01, 2009

Who Are These People

According to a NY Times article on digital video recorders (aka:  TIVO-esque modern day digital VCR's), nearly half of all DVR users watch the commercials on the programs they record!

The Dynamite family has moved into our new New Hampshire home.  We've met the neighbors, and donned orange hunting blazes to avoid getting shot while walking in the woods with Oscar.  Strangely, although we live in an area nearly bereft of houses, we have seen no wildlife aside from an occasional squirrel, chipmunk, blue jay or bat.  Not a fox/deer/moose/bear/bobcat/yeti to be heard from.  I guess these animals are smarter than I thought - they know it's hunting season, and they must be in deep cover.  We do hear frequent shotgun blasts, though, so someone is finding something.

I'm off to the Nation's Capital tomorrow for a big opportunity which I will discuss when I return.