What I learned today are "the market liquid" and "the psychology of unexpected s-t PT".
Remember today~
2008年10月10日 星期五
Denmark Offers a Model Mortgage Market There is a safe way to securitize home loans. By GEORGE SOROS from WSJ.com
The American system of mortgage financing is broken and needs a total overhaul. Until there is a realistic prospect of stabilizing housing prices, the value of mortgage-related securities will erode and Treasury Secretary Henry Paulson's efforts will come to naught.
There are four fundamental problems with our current system of mortgage financing.
First, the business model of Government Sponsored Entities (GSEs) in which profits accrue to the private sector but risks are underwritten by the public has proven unworkable. It would be a grave mistake to preserve the GSEs in anything resembling their current form.
Second, the American style of mortgage securitization is rife with conflicts where entities that originate, securitize and service mortgages are generally not the same as those that invest in mortgage securities. As a result, the incentives to originate sound mortgages and to service them well are inadequate. No wonder that the quality of mortgages degenerated so rapidly.
Third, mortgage-backed securitizations, which were meant to reduce risk by creating geographically diversified pools of mortgages, actually increased risk by creating complex capital structures that impede the modification of mortgages in the case of default.
Finally, and most fundamentally, the American mortgages market is asymmetric. When interest rates fall and house prices rise, mortgages can be refinanced at par value, generating the mortgage equity withdrawals that fueled the housing bubble. However, when interest rates rise and house prices fall, mortgages can only be refinanced at par value even though the market price of the securitized mortgage has fallen.
To reconstruct our mortgage system on a sounder basis, we ought to look to the Danish model, which has withstood many tests since it was brought into existence after the great fire of Copenhagen in 1795. It remains the best performing in Europe during the current crisis. First, it is an open system in which all mortgage originators can participate on equal terms as long as they meet the rigorous regulatory requirements. There are no GSEs enjoying a quasimonopolistic position.
Second, mortgage originators are required to retain credit risk and to perform the servicing functions, thereby properly aligning the incentives. Third, the mortgage is funded by the issuance of standardized bonds, creating a large and liquid market. Indeed, the spread on Danish mortgage bonds is similar to the option-adjusted spread on bonds issued by the GSEs, although they carry no implicit government guarantees.
Finally, the asymmetric nature of American mortgages is replaced by what the Danes call the Principle of Balance. Every mortgage is instantly converted into a security of the same amount and the two remain interchangeable at all times. Homeowners can retire mortgages not only by paying them off, but also by buying an equivalent face amount of bonds at market price. Because the value of homes and the associated mortgage bonds tend to move in the same direction, homeowners should not end up with negative equity in their homes. To state it more clearly, as home prices decline, the amount that a homeowner must spend to retire his mortgage decreases because he can buy the bonds at lower prices.
The U.S. can emulate the Danish system with surprisingly few modifications from our current practices. What is required is transparent, standardized securities which create large and fungible pools. Today in the U.S., over half of all mortgages are securitized by Ginnie Mae, which issues standardized securities. All that is missing is allowing the borrowers to redeem their mortgages at the lower of par or market.
Because of the current havoc in the mortgage market, there is no confidence in the origination and securitization process. As a result, a government guarantee is indispensable at this time, and may be needed for the next few years. As the private sector regains its strength, the government guarantees could, and should, be gradually phased out.
How to get there from here? It will involve modifying the existing stock of mortgages, so that the principal does not exceed the current market value of the houses, and refinancing them with Danish-style loans. The modification will have to be done by servicing companies that need to be properly incentivized. Modifying mortgages that have been sliced and diced into securitizations may require legislative authorization. The virtual monopoly of the GSEs would be terminated and they would be liquidated over time.
A plan to reorganize the mortgage industry along these lines would inspire the confidence that would allow a successful recapitalization of the banking system with the help of the $700 billion package approved last week.
Mr. Soros is chairman of Soros Fund Management and the author of "The New Paradigm for Financial Markets" (Public Affairs, 2008).
There are four fundamental problems with our current system of mortgage financing.
First, the business model of Government Sponsored Entities (GSEs) in which profits accrue to the private sector but risks are underwritten by the public has proven unworkable. It would be a grave mistake to preserve the GSEs in anything resembling their current form.
Second, the American style of mortgage securitization is rife with conflicts where entities that originate, securitize and service mortgages are generally not the same as those that invest in mortgage securities. As a result, the incentives to originate sound mortgages and to service them well are inadequate. No wonder that the quality of mortgages degenerated so rapidly.
Third, mortgage-backed securitizations, which were meant to reduce risk by creating geographically diversified pools of mortgages, actually increased risk by creating complex capital structures that impede the modification of mortgages in the case of default.
Finally, and most fundamentally, the American mortgages market is asymmetric. When interest rates fall and house prices rise, mortgages can be refinanced at par value, generating the mortgage equity withdrawals that fueled the housing bubble. However, when interest rates rise and house prices fall, mortgages can only be refinanced at par value even though the market price of the securitized mortgage has fallen.
To reconstruct our mortgage system on a sounder basis, we ought to look to the Danish model, which has withstood many tests since it was brought into existence after the great fire of Copenhagen in 1795. It remains the best performing in Europe during the current crisis. First, it is an open system in which all mortgage originators can participate on equal terms as long as they meet the rigorous regulatory requirements. There are no GSEs enjoying a quasimonopolistic position.
Second, mortgage originators are required to retain credit risk and to perform the servicing functions, thereby properly aligning the incentives. Third, the mortgage is funded by the issuance of standardized bonds, creating a large and liquid market. Indeed, the spread on Danish mortgage bonds is similar to the option-adjusted spread on bonds issued by the GSEs, although they carry no implicit government guarantees.
Finally, the asymmetric nature of American mortgages is replaced by what the Danes call the Principle of Balance. Every mortgage is instantly converted into a security of the same amount and the two remain interchangeable at all times. Homeowners can retire mortgages not only by paying them off, but also by buying an equivalent face amount of bonds at market price. Because the value of homes and the associated mortgage bonds tend to move in the same direction, homeowners should not end up with negative equity in their homes. To state it more clearly, as home prices decline, the amount that a homeowner must spend to retire his mortgage decreases because he can buy the bonds at lower prices.
The U.S. can emulate the Danish system with surprisingly few modifications from our current practices. What is required is transparent, standardized securities which create large and fungible pools. Today in the U.S., over half of all mortgages are securitized by Ginnie Mae, which issues standardized securities. All that is missing is allowing the borrowers to redeem their mortgages at the lower of par or market.
Because of the current havoc in the mortgage market, there is no confidence in the origination and securitization process. As a result, a government guarantee is indispensable at this time, and may be needed for the next few years. As the private sector regains its strength, the government guarantees could, and should, be gradually phased out.
How to get there from here? It will involve modifying the existing stock of mortgages, so that the principal does not exceed the current market value of the houses, and refinancing them with Danish-style loans. The modification will have to be done by servicing companies that need to be properly incentivized. Modifying mortgages that have been sliced and diced into securitizations may require legislative authorization. The virtual monopoly of the GSEs would be terminated and they would be liquidated over time.
A plan to reorganize the mortgage industry along these lines would inspire the confidence that would allow a successful recapitalization of the banking system with the help of the $700 billion package approved last week.
Mr. Soros is chairman of Soros Fund Management and the author of "The New Paradigm for Financial Markets" (Public Affairs, 2008).
2008年10月7日 星期二
We're Not Headed for a Depression ~By GARY S. BECKER from WSJ.com
In order to promote a much smoother functioning of the financial system, it is paramount to distinguish between the immediate steps needed to cope with the present crisis and the long-run reforms needed to reduce the likelihood of future crises. Let's start with the short-run fixes.
First of all, the magnitude of this financial disturbance should be placed in perspective. Although it is the most severe financial crisis since the Great Depression of the 1930s, it is a far smaller crisis, especially in terms of the effects on output and employment. The United States had about 25% unemployment during most of the decade from 1931 until 1941, and sharp falls in GDP. Other countries experienced economic difficulties of a similar magnitude. So far, American GDP has not yet fallen, and unemployment has reached only a little over 6%. Both figures are likely to get quite a bit worse, but they will nowhere approach those of the 1930s.
The Treasury's announced insurance of all money-market funds, and the full insurance of bank deposits, carry considerable moral hazard risks, but they have not aroused much controversy. The main thrust of the new banking law allows the Treasury secretary to purchase bank assets up to $700 billion in order to increase the liquidity of the banking system. These assets are of uncertain worth since there is essentially no market for many of them, and hence they have no market price. The government hopes to create this market partly through using auctions, where banks would offer their assets at particular prices, and the government would decide whether to buy them. I would have preferred starting with a smaller dollar value of purchases, and up the amount if the situation deteriorates further.
Partly because many consumers are repelled by the intention to bail out companies and their executives who made decisions that got the companies into trouble, the new law includes income and severance pay limits for executives whose firms seek government help. Even though one cannot think much of executives who led their banks into such a mess, that is a bad precedent since it involves too much micromanagement of bank operations. Moreover, such salary controls can be evaded by very generous fringe benefits.
The moral-hazard consequences for banks receiving a bailout now is worrisome since they may expect to get rescued again by the government if their future investments turn sour. Yet while I find helping these banks highly distasteful, moral-hazard concerns should be temporarily relaxed when the whole short-term credit system is close to collapse. Still, the bank bill with its huge bailout does suggest that the $29 billion bailout of the bondholders of Bear Stearns in March was a mistake. It seemed to have a moral-hazard effect by encouraging Lehman Brothers and other investment banks to delay in raising more capital because they too might have expected the government to come to their rescue if times got much worse. Although the government was apparently concerned that foreign central banks were major holders of the bonds, it was unwise to give them and other bondholders such full protection.
One troubling provision is that the government can take an equity stake in banks it helps. Some economists have proposed a similar role for government equity in these banks. I believe it is unwise to give governments equity in private companies, even if the government does not have voting rights in company policies. Many examples in recent history, such as the current Alitalia fiasco, show that political interests outweigh economic ones when governments have some ownership of private companies. This is likely to happen in this bailout if some banks that are helped decide to sharply cut employment in the districts of some congressmen, or to transfer many jobs overseas.
Taxpayers may be stuck with hundreds of billions of dollars of losses from the various government insurance provisions and government purchases of assets. Although the media has made much of this possibility through headlines like "$700 Billion Bailout," such large losses are highly unlikely except in the low probability event that the economy falls into a sustained major depression. Indeed, with efficient auctions, the government may well make money on its actions, just as the Resolution Trust Corporation that took over many savings-and-loan banks during the 1980s crisis did not lose much, if any, money. By buying assets when they are depressed and waiting out the crisis, the government may have a profit on these assets when they are finally sold back to the private sector. Making money does not mean the government involvement is wise, but the likely losses to taxpayers are being greatly exaggerated.
The temporary banning of short sales is an example of a perennial approach to difficulties in financial markets and elsewhere; namely, "shoot the messenger." Short sales did not cause the crisis, but reflect beliefs about how long the slide will continue. Trying to prevent these beliefs from being expressed suppresses useful information, and also creates serious problems for many hedge funds that use short sales to hedge other risks. Their ban can also cause greater panic in other markets.
The main problem with the modern financial system based on widespread use of derivatives and securitization is that while financial specialists understand how individual assets function, even they have limited understanding of the aggregate risks created by the system. That is, insufficient appreciation of how the whole incredibly complex financial system operates when exposed to various types of stress. In light of such limitations, it is difficult to propose long-term reforms. Still, a few reforms seem reasonably likely to reduce the probability of future financial crises.
- Increase capital requirements. The capital requirements of banks relative to assets should be increased after the crisis is over in order to prevent the highly leveraged ratios of assets to capital in financial institutions during the past several years. Possibly a minimum ratio of capital to assets should be imposed by the Fed on investment banks and money funds. As much as possible, the measure of capital should not be its book value but its market value, such as the market value of publicly traded shares of banks. Book value measures, for example, apparently badly missed the plight of Japanese banks during their decade-long banking crisis of the 1990s.
- Sell Freddie and Fannie. The government should as quickly as possible sell Freddie Mac and Fannie Mae to fully private companies that receive no government insurance or other help. These two giants did not cause the housing mess, but in recent years they surely greatly contributed to it, partly through congressional pressure on them to increase their purchases of subprime loans. They have owned or guaranteed almost half of the $12 trillion in outstanding mortgages while having a small capital base. The housing market already has excessive amounts of government subsidies, such as from the tax exemption of interest on mortgages, and should not have government sponsored enterprises that insure mortgage-backed securities.
- No more bailouts. The "too big to fail" approach to banks and other companies should be abandoned as new long-term financial policies are developed. Such an approach is inconsistent with a free-market economy. It also has caused dubious company bailouts in the past, such as the large government loan years ago to Chrysler, a company that remained weak and should have been allowed to go into bankruptcy. All the American auto companies have asked for and received handouts too since they cannot compete against Japanese, Korean and German car makers, partly because these American companies have been incredibly badly managed. A "too many institutions in trouble to fail principle," as in the present financial crisis, may still be necessary on rare occasions, but failure of badly run large financial and other companies is healthy and indeed necessary for the survival of a robust free-enterprise competitive system.
Is this a final "Crisis of Global Capitalism" -- to borrow the title of a book by George Soros written shortly after the Asian financial crisis of 1997-98? The crisis that kills capitalism has been said to happen during every major recession and financial crisis ever since Karl Marx prophesized the collapse of capitalism in the middle of the 19th century. Although I admit to having greatly underestimated the severity of the current crisis, I am confident that sizable world economic growth will resume before very long under a mainly capitalist world economy.
Consider, for example, that in the decade after various predictions of the collapse of global capitalism following the Asian crisis, both world GDP and world trade experienced unprecedented growth thanks to the power of market competition on a global scale. The South Korean economy, for example, was pummeled during that crisis, but has had significant economic growth since. World economic growth will recover once we are over the present severe financial difficulties.
Mr. Becker, the 1992 Nobel economics laureate, is professor of economics at the University of Chicago and senior fellow at the Hoover Institution. Portions of this article first appeared on his Web site.
First of all, the magnitude of this financial disturbance should be placed in perspective. Although it is the most severe financial crisis since the Great Depression of the 1930s, it is a far smaller crisis, especially in terms of the effects on output and employment. The United States had about 25% unemployment during most of the decade from 1931 until 1941, and sharp falls in GDP. Other countries experienced economic difficulties of a similar magnitude. So far, American GDP has not yet fallen, and unemployment has reached only a little over 6%. Both figures are likely to get quite a bit worse, but they will nowhere approach those of the 1930s.
The Treasury's announced insurance of all money-market funds, and the full insurance of bank deposits, carry considerable moral hazard risks, but they have not aroused much controversy. The main thrust of the new banking law allows the Treasury secretary to purchase bank assets up to $700 billion in order to increase the liquidity of the banking system. These assets are of uncertain worth since there is essentially no market for many of them, and hence they have no market price. The government hopes to create this market partly through using auctions, where banks would offer their assets at particular prices, and the government would decide whether to buy them. I would have preferred starting with a smaller dollar value of purchases, and up the amount if the situation deteriorates further.
Partly because many consumers are repelled by the intention to bail out companies and their executives who made decisions that got the companies into trouble, the new law includes income and severance pay limits for executives whose firms seek government help. Even though one cannot think much of executives who led their banks into such a mess, that is a bad precedent since it involves too much micromanagement of bank operations. Moreover, such salary controls can be evaded by very generous fringe benefits.
The moral-hazard consequences for banks receiving a bailout now is worrisome since they may expect to get rescued again by the government if their future investments turn sour. Yet while I find helping these banks highly distasteful, moral-hazard concerns should be temporarily relaxed when the whole short-term credit system is close to collapse. Still, the bank bill with its huge bailout does suggest that the $29 billion bailout of the bondholders of Bear Stearns in March was a mistake. It seemed to have a moral-hazard effect by encouraging Lehman Brothers and other investment banks to delay in raising more capital because they too might have expected the government to come to their rescue if times got much worse. Although the government was apparently concerned that foreign central banks were major holders of the bonds, it was unwise to give them and other bondholders such full protection.
One troubling provision is that the government can take an equity stake in banks it helps. Some economists have proposed a similar role for government equity in these banks. I believe it is unwise to give governments equity in private companies, even if the government does not have voting rights in company policies. Many examples in recent history, such as the current Alitalia fiasco, show that political interests outweigh economic ones when governments have some ownership of private companies. This is likely to happen in this bailout if some banks that are helped decide to sharply cut employment in the districts of some congressmen, or to transfer many jobs overseas.
Taxpayers may be stuck with hundreds of billions of dollars of losses from the various government insurance provisions and government purchases of assets. Although the media has made much of this possibility through headlines like "$700 Billion Bailout," such large losses are highly unlikely except in the low probability event that the economy falls into a sustained major depression. Indeed, with efficient auctions, the government may well make money on its actions, just as the Resolution Trust Corporation that took over many savings-and-loan banks during the 1980s crisis did not lose much, if any, money. By buying assets when they are depressed and waiting out the crisis, the government may have a profit on these assets when they are finally sold back to the private sector. Making money does not mean the government involvement is wise, but the likely losses to taxpayers are being greatly exaggerated.
The temporary banning of short sales is an example of a perennial approach to difficulties in financial markets and elsewhere; namely, "shoot the messenger." Short sales did not cause the crisis, but reflect beliefs about how long the slide will continue. Trying to prevent these beliefs from being expressed suppresses useful information, and also creates serious problems for many hedge funds that use short sales to hedge other risks. Their ban can also cause greater panic in other markets.
The main problem with the modern financial system based on widespread use of derivatives and securitization is that while financial specialists understand how individual assets function, even they have limited understanding of the aggregate risks created by the system. That is, insufficient appreciation of how the whole incredibly complex financial system operates when exposed to various types of stress. In light of such limitations, it is difficult to propose long-term reforms. Still, a few reforms seem reasonably likely to reduce the probability of future financial crises.
- Increase capital requirements. The capital requirements of banks relative to assets should be increased after the crisis is over in order to prevent the highly leveraged ratios of assets to capital in financial institutions during the past several years. Possibly a minimum ratio of capital to assets should be imposed by the Fed on investment banks and money funds. As much as possible, the measure of capital should not be its book value but its market value, such as the market value of publicly traded shares of banks. Book value measures, for example, apparently badly missed the plight of Japanese banks during their decade-long banking crisis of the 1990s.
- Sell Freddie and Fannie. The government should as quickly as possible sell Freddie Mac and Fannie Mae to fully private companies that receive no government insurance or other help. These two giants did not cause the housing mess, but in recent years they surely greatly contributed to it, partly through congressional pressure on them to increase their purchases of subprime loans. They have owned or guaranteed almost half of the $12 trillion in outstanding mortgages while having a small capital base. The housing market already has excessive amounts of government subsidies, such as from the tax exemption of interest on mortgages, and should not have government sponsored enterprises that insure mortgage-backed securities.
- No more bailouts. The "too big to fail" approach to banks and other companies should be abandoned as new long-term financial policies are developed. Such an approach is inconsistent with a free-market economy. It also has caused dubious company bailouts in the past, such as the large government loan years ago to Chrysler, a company that remained weak and should have been allowed to go into bankruptcy. All the American auto companies have asked for and received handouts too since they cannot compete against Japanese, Korean and German car makers, partly because these American companies have been incredibly badly managed. A "too many institutions in trouble to fail principle," as in the present financial crisis, may still be necessary on rare occasions, but failure of badly run large financial and other companies is healthy and indeed necessary for the survival of a robust free-enterprise competitive system.
Is this a final "Crisis of Global Capitalism" -- to borrow the title of a book by George Soros written shortly after the Asian financial crisis of 1997-98? The crisis that kills capitalism has been said to happen during every major recession and financial crisis ever since Karl Marx prophesized the collapse of capitalism in the middle of the 19th century. Although I admit to having greatly underestimated the severity of the current crisis, I am confident that sizable world economic growth will resume before very long under a mainly capitalist world economy.
Consider, for example, that in the decade after various predictions of the collapse of global capitalism following the Asian crisis, both world GDP and world trade experienced unprecedented growth thanks to the power of market competition on a global scale. The South Korean economy, for example, was pummeled during that crisis, but has had significant economic growth since. World economic growth will recover once we are over the present severe financial difficulties.
Mr. Becker, the 1992 Nobel economics laureate, is professor of economics at the University of Chicago and senior fellow at the Hoover Institution. Portions of this article first appeared on his Web site.
2008年8月25日 星期一
Dead Man Walking~
Dead Men Walking ~ From Bennet, the president of Atlantic Advisors in Winter Park, Florida.
Dead Man Walking - Originally, a phrase in a poem by Thomas Hardy in 1909, but later in a work of non-fiction by Sister Helen Prejean, A Roman catholic nun and one of the Sisters of Saint Joseph of Medaille. Prejean later wrote 'Dead Man Walking', which became a hit movie in 1995. The title comes from the traditional exclamation "dead man walking, dead man walking here" used by prison guards as the condemned are led to their execution.
Death Row - A term that refers to the section of a prison that houses individuals awaiting execution. It is also used to refer to the state of awaiting execution, even in places where a special section does not exist. As of 2008, there were 3,263 prisoners awaiting execution in the United States.
The Last Mile - "I guess sometimes the past just catches up to you, whether you want it to or not. Usually death row is called 'The Last Mile'. We call ours 'The Green Mile'-the floor was the color of faded limes." - Tom Hanks as Paul Edgecomb in 'The Green Mile'.
Are There Corporations that are "Dead Men Walking"?
The title of this piece sums up how I feel about the current credit markets. When I first started in the industry in 1981 we were worried, but only about one company -the Chrysler Corporation. Prior to that, Continental Illinois was in the forefront. Later in my career, in 1998, it was Long Term Capital Management, the hedge fund founded by John Meriwether that captured our attention. Then we had Enron/WorldCom, and by early 2008 Bear Stearns became a worry and then a problem that needed fixing.
All of these events were isolated, dealt with, often with either direct assistance from Uncle Sam or an effort coordinated by our benevolent/socialist government financial authorities. Markets would become unnerved, fear would grow, and then the Government would step in to make sure that the systemic risk that had finally come to the surface didn't melt the entire planet.
But this is where it is "different this time". Not only is it different, I think it may be unprecedented in nature. When I look at my Bloomberg monitor each day that contains my 100 most important indices, companies, commodities, bonds, bond spreads, preferred shares, etc, I shudder. The reason I shudder is that my screen doesn't have just one "problem child". It looks like a screen that contains many "dead men walking".
The Failed Fannie Mae/Freddie Mac Experiment
I recently wrote a piece entitled The Tale of Two Markets, where I talked about the "Fannie Mae/Freddie Mac Experiment". That experiment has now clearly failed and a bailout/privatization/nationalization of Fannie and Freddie is now being planned. While I have been expecting nationalization for quite a while, I am intrigued along with my peers and colleagues as to why the bailout is taking so long to accomplish. This is where it gets interesting and dangerous from a systemic point of view. My hunch is that the reason for the delay is that the Treasury Department is "peeling back the onion" on Fannie/Freddie and finding out just how much of a mess the two of them are in.
At last count, Freddie had Level 3 Assets of $151 billion while Fannie had $65 billion, for a not-so-paltry sum of $216 billion. When Freddie announced their results a couple of quarters back, they disclosed that most of their Level 3 Assets were of the "sub-prime" variety (the type of assets that started the whole Credit Crisis in the first place). They are also littered with Alt-A mortgages and are leveraged to the hilt.
Just how bad is the news at Fannie/Freddie? On Friday morning, Moody's downgraded their outstanding preferred stock 5 notches from A1 to Baa3 (a slight gradation above junk) and their Bank Financial Strength Ratings (BSFR) to D+ from B- (one/half notch above D, which is reserved for companies in default). According to Moody's, "the downgrade of the BFSR reflects Moody's view that Fannie Mae and Freddie Mac's financial flexibility to manage potential volatility in its mortgage risk exposures is constricted.....in particular, given recent market movement, Moody's believe these companies currently have limited access to common and preferred equity capital at economically attractive terms." "Dead men walking" defined.
Moody's went on to say, "The GSE's more limited financial flexibility also restricts their ability to pursue their public mission of providing liquidity, stability and affordability to the US housing Market. Fannie Mae and Freddie Mac currently make up approximately 75% of the mortgage market in the US. A reduction in the capacity of these companies to support the US mortgage market could have significant repercussions for the US economy. In an effort to thwart broader economic effects, Moody's believes the likelihood of direct support from the United States Treasury has increased."
Let me put it this way. "We the people" are about to become owners in Fannie and Freddie, whether we like it or not. The capital markets have shut on them both as their stocks trade in the $2-5 range, down from the $70-80 level just a year ago. And the yield on the outstanding preferred shares hovers in the 18-23% range, quite the bargain if they keep paying, but also it is the market's way of saying "beware the value trap", as the preferred shares may pay another dividend or two, but that is about it.
When the Treasury peels back the onion, I believe they will find a hornet's nest. I think we will see an initial bailout of $100 billion or so, with 2/3-3/4 going to Fannie (as it is a larger organization). The scenario I foresee however, just as happened at Merrill Lynch, Lehman Brothers and Morgan Stanley, is that they came to the financing window expecting to have borrowed enough, but then find they have to keep coming back repeatedly until the buyers go away or until "We The People" have thrown at least $500 billion at Fannie/Freddie to get them back on their feet again. This will also likely take an Act of Congress to raise the Treasury's Debt ceiling quite dramatically.
I will now identify who might be the other "Dead Men Walking".
More Dead Men Walking-Is There a Pattern?
What strikes me the most about impaired companies, whether they are automakers, airline companies, banks, brokers or GSE's, is that they seem to sing the same tune, or have the same pattern of behavior. This is how I have attempted in the past to identify what would be in trouble in the future (whether that was just to avoid their stocks and bonds from the long side or to try to profit from their missteps on the short side). It is a pattern that is not terribly dissimilar from the emotion charts I like to focus on so much. In the graphic below, I will offer my "recipe for disaster" for a bank or brokerage firm. I would like this cycle to be called, "The Dead Man Walking Cycle".
The first tip-off or "tell" is when a company releases earnings or some sort of positive announcement and the stock falls. Another important tell is the credit spreads of the debt as the company begins to widen. Then, the company will usually announce that "all is well" and is so great that they will buy back stock and not "cut the common dividend". After this comes the "acceptance" phase and write-offs/write-downs are announced and then some Sovereign Wealth Fund or Private Equity firm will inject capital or that a company within the same group will buy a "strategic stake". After a brief pop in the stock and short covering rally, the stock begins to fall further and credit spreads begin to blow out and preferred shares get hammered. Then, uh-oh, more write-downs and more write-offs and yes, another capital raise and finally a dividend cut to 'preserve capital'.
Sound familiar yet...?
All of this goes on for quite some time, until your stock price is so low that you would have to issue so many shares in a secondary offering that you dilute your shareholder base until it is unrecognizable. With this new share offering your credit, while still rated investment grade, trades like junk, and your preferred shares rise to double digit yields. Further, the former strategic buyers, Sovereign Wealth Funds and Private Equity firms have taken such a beating that there are no further buyers.
Yet the write-downs and write-offs continue unmercifully as the economy slows and credit is all but cut off. Eventually, dividends go to zero and you are a "Dead Man Walking".
There are only a few things that can happen to the companies that are walking "The Green Mile". Either you make it to the electric chair (in the movie "The Green Mile" it was called "Old Sparky") and cease to exist or you are eventually forced into the arms of a better capitalized institution. Over time, I expect a bit of both but mostly of the latter.
Keep in mind that if too many are allowed into the arms of Big Sparky", it will have a systemic effect as all the institutions are so intertwined because when one group of institutions are forced to mark their bonds to market, others are forced to do the same, ending in an ugly daisy chain. I think the chain has formed and that many are about to "walk the mile".
In the end, perhaps years from now, many banks and brokers will be merged into an international list of "good banks" or "Live Men Walking". Who are the Live Men Walking? They are likely Bank of America, Bank of New York, JP Morgan Chase, Northern Trust, State Street, US Bancorp, ABN Amro, Deutsche Bank, BNP Paribas, Royal Bank of Scotland, Barclays, Allianz and a few others. The following cycle is how the cycle goes from good bank to 'Dead Man Walking'.
Who Are the Dead Men Walking?
Above, the cycle begins with denial, and ultimately ends up in despair. At first, the company denounces that anything is wrong, but Mr. Market has a way of sniffing out who is imitating Pinocchio. Ultimately, the company ends up in despair when they need/want to raise capital to just be able to function normally, but alas, they cannot because the window of opportunity to raise capital has shut.
Let's use Lehman Brothers as the poster child of this sort of behavior. I wrote a piece last week that singled out National City, Washington Mutual and Lehman Brothers. Before the credit crisis started, Lehman, at the time known for its savvy timing, suddenly came to market for $5 billion of long-term bonds when they didn't need capital-or did they know something was awry as I suspect? Last year, with the Credit Crisis in its infancy, Lehman announced a $100,000,000 stock buyback. The shares, as you would expect, popped on the news, but of course no stock was ever re-purchased. As the stock began to sell off, they kept saying that capital was not needed.
Then, on June 9, 2008 they sold 143,000,000 shares at $28 per share. As hedge fund manager David Einhorn said, "They've raised billions of dollars they said they didn't need to replace losses they said they didn't have." In between was an enormous preferred stock deal-75,900,000 shares at $25 per share at a rate of 7.95%. Those shares now change hands at $15 per share for a yield of 13.1%. Its pretty hard to turn a profit when your cost of capital is greater than 10%.
During this time, in January, the company actually raised its common dividend by 15% year-over-year. They have written off north of $8 billion since the Credit Crisis began and when they release earnings (or lack thereof) next month, estimates are for another round of $2-4 billion of write-downs. They have reportedly been trying to shop $40 billion of impaired real estate and they are mired in all sorts of Alt A, sub-prime, CMBS and CDO's and CLO's.
The best part is that they said they "shrank their balance sheet" when in fact they were sold to an "off balance sheet subsidiary" that they own part of. The bonds weren't sold, they were just "relocated". I sure wish I could do that when I make a mistake. And lets not forget that the Federal Reserve opened up the discount window to primary/dealers so that they could off-load a bunch of nuclear waste on to the Fed's balance sheet, which now looks like one big hedge fund in drag. And then the SEC temporarily changed short selling rules for 'the Group of 19' (the GSE's and Primary Dealers) for a few weeks, resulting in a short squeeze, but their shares still hobble along at recent lows.
On Friday, there was a rumor that the Korean Development Bank would buy Lehman, but again that turned out to be hogwash. And if they wanted to raise debt, like they say, "lotsa luck". Their bonds trade around +500 basis points to treasuries but my guess is that even if they could get deal done, they would have to come in the 10% range, again, uneconomic.
So now we have the recipe and an example for "Dead Men Walking":
* Common stock too low to issue new shares.
* Preferred stock yield too high to issue new shares economically.
* Issuing debt is uneconomic.
* More write-offs coming in days to come.
* Business trends are awful.
* Denial.
Now that we have identified the "poster child", let's find a few more... Or sadly, more than a few.
Zions Bancorp
* Equity has traded down from $75 to $25.
* Tried to issue a $200 million preferred stock offering at 9.5% but only was able to sell $47 million.
* Their debt trades in the open market approximately 1,000 basis points above Treasuries, IF you can sell them, or 13 14%.
* They are geographically in Utah, but spread out to Florida, Nevada and Arizona at the top of housing to take advantage of great opportunities.
* They say they need $200-300 million capital. Good luck.
* They maintained their common dividend.
KeyCorp
* Common Stock has traded down from $40 to $11.
* Preferred Stock trades at 13%.
* Debt trades in the market at 10-11% dividend.
* Cut dividend in half in July, still yields 6.5% even while they lose money.
Fifth Third Bank
* Equity has traded down from $60 to $14.
* There are no preferred issues outstanding.
* Debt trades in 10-11% range if you can sell it.
* Cut dividend by 75%.
Washington Mutual
* Equity has traded from $40 to $3.
* No preferred outstanding except convertible preferred.
* Debt trades in the 20-25% range.
* Cut the dividend to $0.01 per share in April.
* Has admitted they will lose money for the next several years.
National City
* Equity has traded from $40 to $5.
* Preferred stock trades at 13-15%.
* Sold a huge amount of shares at $5 per share in April.
* Cut dividend to $0.01 per share in April.
Regions Financial
* Equity down from $40 to $8.
* Preferred Stock Trading at 10%.
* Debt trades in the 10-11% range, if you can sell it.
* Cut dividend by 75% in June.
* Needs to raise $2 billion, according to Sanford Bernstein.
General Motor/GMAC
* Equity has traded from $80 to $10.
* Preferred stock trades in 18% area.
* Short-term debt trades in 25-30% range.
* Long-term debt trades in 17% range.
* Eliminated common dividend in July.
Ford/Ford Motor Credit Co
* Equity has traded from $60 to $4.
* Preferred stock trades in 16-17% range.
* Long term debt trades in the 18-20% range.
* Eliminated common dividend in September.
Wachovia
* Equity has traded from $60 to $14.
* Issued a $3.5 billion "hybrid security" in February that now trades at 11%.
* S&P has stated they cannot issue any more hybrids.
* Sold 92,000,000 shars of a preferred stock in December at 8% that now trades $18 or 11%.
* Cut common dividend twice since February to $.05 a share or 90%.
* Debt trades at 9.5-10.5%.
CitiGroup
* Equity has traded from 60 to 9.
* Preferred Stock trades in 12% range.
* Outstanding debt trades in 12-14% range.
* Cut common dividend by 66%.
* Sold 91,000,000 shares of common at $11 in April 2008.
Who are in the "Limping but Not Dead Man Walking Crowd"?
These companies would include those that may be 'too big to fail', have enough quality assets to sell, a franchise that is worth something to an acquirer or could just be broken up into pieces. They include:
* Citi
* Merrill Lynch
* Morgan Stanley
* Suntrust
* Legg Mason
* Capital One
* AIG
* MetLife
* Prudential
Summary - This is NOT Shaping Up to be a Pretty Couple of Years
I am certain that I have missed a bunch of names on the "Dead man Walking List", but the pattern is rather easy to discern. As I stated early on, when we have one or two firms in trouble, we can deal with it. But when we add rising unemployment, explosive debt growth in recent years and non-performing assets to many hobbled financial institutions with trillions of dollars of exposure, it is hard not to be concerned.
For this reason, we remain cautious towards credit, expect a hard sell-off in stocks into 2010, consolidation in the financial services industry and some pain, like it or not. I am just not sure where the capital will come from to bail everyone out simultaneously. And even if the capital showed up, it would likely come at a cost that is uneconomic and would likely be dilutive for many years to come.
It is why we expect much lower than consensus earnings across the board and lower stock prices ahead. In the meantime, we sit with our historically cheap GNMA's at the widest spreads in 20 years and continue to add to that position. In the meantime we position our portfolios so that if we are wrong, the most we can lose is opportunity, not precious capital.
2008年8月19日 星期二
Carry and Roll-Down
Read from someone's blog (http://volcurve.blogspot.com/), very great concepts!
Carry and Roll-Down: back to the basics
Interest Rate Traders and salespeople talk about carry and roll-down all the time. It is useful to remember what they are talking about.
1. Upfront Carry:
1. For a 10-year receive fixed swap, the 1 year carry is the net present value of a 10-year swap less the net present value of a 9-year swap starting 1 year from now.
2. Upfront roll-down:
1. For a 10-year receive fixed swap, the 1 year roll-down is the net present value of a 10-year swap and less net present value of a 9-year swap today.
2. Typical documentation will have carry and roll-down for various swap lengths: 1M, 2M, 3M and so on. So a 1 year carry can be provided as 0.45 $ per 100 $ of notional or some other dollar convention.
3. Running Carry:
1. the Upfront Carry divided by the PV01 of the forward starting 9-year swap.
4. Running roll-down:
1. the Upfront roll-down divided by the 9-year swap starting today.
5. Actual Vol-adjusted Running Carry & Running Roll-down:
1. 1Y Running Carry divided by the actual volatility of the 1Y rate over the past 1 year.
How to Read the Quotes:
6. Notional Neutral Switch:
1. Typically quoted as where one receives fixed for the shorter rate and pays fixed for the longer rate.
2. If the expected carry and roll-down is 180bps on a 5s/30s – one should read this as follows. For an investor, who receives fixed on a 5 year swap 1mn notional and pays fixed on a 30 year swap 1mn notional -- expected profit is 180,000.
7. Duration Neutral Switch:
1. Typically quoted where one receives a short dated swap, and pays a long dated swap.
2. The notionals can vary here – such that the durations cancel out.
8. Butterfly:
1. Quoted as 2bps on a 3s/4s/15s. Read this as expected roll-down and carry as pay fixed on the 3yr and the 15yr, and receive the 4yr fixed rate.
Carry and Roll-Down: back to the basics
Interest Rate Traders and salespeople talk about carry and roll-down all the time. It is useful to remember what they are talking about.
1. Upfront Carry:
1. For a 10-year receive fixed swap, the 1 year carry is the net present value of a 10-year swap less the net present value of a 9-year swap starting 1 year from now.
2. Upfront roll-down:
1. For a 10-year receive fixed swap, the 1 year roll-down is the net present value of a 10-year swap and less net present value of a 9-year swap today.
2. Typical documentation will have carry and roll-down for various swap lengths: 1M, 2M, 3M and so on. So a 1 year carry can be provided as 0.45 $ per 100 $ of notional or some other dollar convention.
3. Running Carry:
1. the Upfront Carry divided by the PV01 of the forward starting 9-year swap.
4. Running roll-down:
1. the Upfront roll-down divided by the 9-year swap starting today.
5. Actual Vol-adjusted Running Carry & Running Roll-down:
1. 1Y Running Carry divided by the actual volatility of the 1Y rate over the past 1 year.
How to Read the Quotes:
6. Notional Neutral Switch:
1. Typically quoted as where one receives fixed for the shorter rate and pays fixed for the longer rate.
2. If the expected carry and roll-down is 180bps on a 5s/30s – one should read this as follows. For an investor, who receives fixed on a 5 year swap 1mn notional and pays fixed on a 30 year swap 1mn notional -- expected profit is 180,000.
7. Duration Neutral Switch:
1. Typically quoted where one receives a short dated swap, and pays a long dated swap.
2. The notionals can vary here – such that the durations cancel out.
8. Butterfly:
1. Quoted as 2bps on a 3s/4s/15s. Read this as expected roll-down and carry as pay fixed on the 3yr and the 15yr, and receive the 4yr fixed rate.
2008年7月29日 星期二
Hyperinflation~
From Economist.com~
HYPERINFLATION requires a good head for figures and a sturdy wallet to hold wads of low-value paper money. Governments have attempted to keep pace with hyperinflation by issuing ever-higher denomination banknotes to replace worthless notes that might as well serve as wallpaper. Last week Zimbabwe's central bank unveiled a 100 billion dollar banknote to cope with inflation running at 2.2m%. On Sunday July 27th the bank changed tack and announced it would be lopping off a string of zeros on replacement notes, in what passes for economic reform in stricken Zimbabwe. But Robert Mugabe has some way to go before he can claim for his country the accolade of printing the highest-denomination banknote. A note issued in post-war Hungary came with a mind-boggling 19 digits.
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