Exchange Ideas
From The Northwest QuadrantContinuing the ongoing commentary about how insurers can go beyond the business as usual approach to risk and investments and improve their financial results July 07, 2010 "Obscure Deleveraging" and Your PortfolioSoon after I wrote about the 'Restructuring Dance' helping to maintain the climate of greed in financial markets, the cycle swiftly turned. The 'Dance' ended quickly as none of the dancers requiring restructuring took to the floor. Neither Greece, nor other highly levered sovereign credits, nor Wall Street, nor the rating agencies went the restructuring route. With no other good solution posed and no restructuring in the offing, the markets quickly entered fear mode. But, it was deep concern more than fear that emanated from the participants at our company's recent Insurer Investment Forum X. Although some saw opportunity within the growing clouds in financial markets, many indicated concern for what may occur in the months ahead. It is quickly becoming apparent that although the 'lifeguards' (governments) have rescued the banking sector to some degree, the major issue now is 'who will rescue the lifeguards?' At IIF VIII (March, 2008), I noted that we should expect, "The Greatest Deleveraging in the History of the World." Then, at IIF IX (March, 2009), I observed that the governments have followed the greatest deleveraging with the greatest re-leveraging. Fully understanding the amount and timing of the 'Obscure Deleveraging' at the governmental level and its impact on their close cousin – the banking system - will be a key tool in understanding the future of the global economy. And, I do mean global economy. As the US economy has recovered from recession, its respite from recession may be limited in size due to a global slowdown. The Economic Cycle Research Institute’s latest Weekly Leading Index tells us to expect materially slower growth towards the end of this year. Economic slowdowns in the U.S. have usually been accompanied with rather specific trends in equities, credit spreads, etc., as noted by this chart. Meanwhile, one of the best overviews of what is happening in Europe, can be found on Naked Capitalism. The picture isn’t pretty with Spain, among others, a large potential problem – if not the Euro banks due to their sovereign holdings. But, what of China? Our final speaker of the day, Professor Patrick Chovanec spoke to us live from Beijing, and outlined the problems facing the soon to be second largest economy in the world. A real estate bubble similar to the US bubble but mostly accomplished without large amounts of debt; and an overheating economy that received a 1/3 increase in money supply to offset the Great Recession outside its borders are just the start. Stability is important to the ruling Communist Party, and stability is quite difficult when trying to rein in runaway real estate prices and banks following 'extend and pretend' to the n-th degree. Other speakers at the conference provided a glimpse of what to expect from the regulators, AM Best and the auditors (yes, we discussed mark to market and the move to IFRS - look out). But, we also heard about silver linings to be found in many insurer's commercial mortgage portfolios (versus those found at banks where underwriting standards slipped materially) and in opportunities (albeit a few basis points) in short term investments. But the issues of what to expect in the uncertain times of ‘Obscure Deleveraging’ remain. We ALSO should not forget the deleveraging being forced upon state and municipal governments in the US – we now tax bottled water, candy and gum in WA. Nor, should we be surprised by increasing civil protests and violence related to cuts in government services. Financial populism will undoubtedly rear its head in short order, as we noted over a year ago. For insurers, “Obscure Deleveraging” raises several issues, including: What should our equity v fixed income allocation be? A slowing economy, coupled with disinflation and/or the threat of deflation, should mean downward pressure on rates, perhaps offset by rising spreads. But, such a scenario may wreak havoc on expected equity returns. If deleveraging lasts a long time, that may impinge on future expected equity returns for some time. And, if we are concerned about ‘obscure deleveraging’, should we not try to avoid or materially reduce investments in those sectors facing such activities? First in line, of course, would be deleveraging governmental entities, but next, in line, I believe, would be large financials – owners of those government bonds and obfuscators of sufficient disclosure of their financial risks. This becomes a more important issue with the highly likely passage of ‘financial industry reform’ in the US Congress. As I understand it, the likelihood is that there will be no protection afforded investors in these financials’ debt, such as we saw in the last major bailout by the government. That means, the financials must stand on their own…but on what ground? It is difficult to understand their ability to do so when there is way too little disclosure of the risks and way too much obfuscation of off balance sheet and contingent exposures. This new law, coupled with continued obfuscation on financial reports, will undoubtedly make investment in the financial sector’s bonds or equities an increasingly dicey proposition. Of course, all is not 'doom and gloom'. Right now, we've noted a US slowdown, not a recession, despite global issues. However, in a world of ‘Obscure Deleveraging’, we must simultaneously plan for the most likely - low, slow growth in the US. while considering a reasonable 'worst case' scenario. Our ability to do that was perhaps best challenged by F. Scott Fitzgerald. Writing in 1936, as the U.S. and the world struggled to exit the icy grip of the Great Recession, he correctly provided the backdrop for portfolio management today: "The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function." Posted by Alton Cogert at 04:50 PM | Comments (0) April 21, 2010 Goldman Sachs: Caveat Emptor, Indeed
But, what you have probably not read about yet is much more interesting. Continue reading "Goldman Sachs: Caveat Emptor, Indeed" Posted by Alton Cogert at 11:49 AM | Comments (0) November 29, 2009 Dubai the Current Concern, But Not the Most ImportantContinue reading "Dubai the Current Concern, But Not the Most Important" Posted by Alton Cogert at 06:39 PM | Comments (0) November 25, 2009 Happy Thanksgiving - from the NAIC and PIMCOThey say if you want to get out ‘bad’ news, the best time is on a Friday evening. Even better is on the day before a major holiday, like Thanksgiving. Well, Happy Thanksgiving! It seems our friends at the NAIC have been reading the public relations playbook and just released an outline of the new non-agency RMBS modelling performed by PIMCO. I have been assured that this will be used for determining risk based capital (RBC) factors only. And that issues such as impairment, will not be addressed by this methodology. However, let’s put that in perspective. You have valued a bond at 85 - no review for impairment necessary per policy as it does not impinge on the typical ‘below 80% for more than six months’ standard. PIMCO, in the infinite wisdom of their arbitrary model (see below for more on this), decides that valuation is 70. The reasonable news on this: If you want to carry it at 85, you will have to allocate more RBC than a company holding the same bond and valuing it at 70. The problemmatic news: Your auditor sees the valuation and says, ‘This should probably be impaired since that’s what the NAIC (PIMCO) says. In fact our audit firm audits both your company and the one holdling the bond at 70, so take the write down…but atleast you won’t have to maintain as much RBC.’ As noted in my prior post, if you are a large, leveraged life insurer, RBC is more important than the earnings hit. Adequate RBC is tied to survival, while earnings is more transitory. However, across the entire insurance industry, the earnings hit and subsequent disclosure is much worse than holding more RBC, since capital is usually not as large an issue as earnings. As noted previously, score one for the large life insurers. Those hefty dues to the American Council of Life Insurance sure look like a good deal for them. But, what of PIMCO’s model? It looks like a relatively common approach to modeling non-agency RMBS. And many of the details ‘under the hood’ still appear hidden in the latest memorandum from the NAIC. However, one item not hidden is a very key assumption, Expected home price depreciation or, peak to trough HPA, is assumed to range from -33% to -61% depending upon the scenario (most aggressive to most conservative). This deserves a few comments: 1- This assumes geography has zero to do with HPA declines. More sophisticated models tend to use this very significant factor when using HPA as a driver in determining incidence and severity of loss. 2 - Recent readings of Case-Shiller indices show a slowing in HPA declines to a leveling in some areas. Is it reasonable to assume further declines? I do not know the answer to this, but it is a very difficult and important point tied to the ‘most likely’ case of slow economic growth versus a double dip recession in the future. Besides my nagging feeling about ‘conflicts of interest’ when an investment manager of assets, including RMBS, is called upon to value such assets for regulatory purposes, I remain concerned about the use of these arbitrary valuations. Will they produce ‘more accurate’ RBC than the ratings? Perhaps, perhaps not. Remember, we all got into this mess relying upon inadequate models. Who is to say that PIMCO’s modeling for the NAIC will not prove just as inadequate? Will they produce problems when auditors notice your company’s valuation, based upon perhaps more strenuous modeling than PIMCO’s, has a higher value than PIMCO’s valuation, prompting concerns about impairment? I don’t see how they won’t. Will your voice be heard in the deliberations on this? Probably not, unless your company is a large life insurer. However, there is a public meeting and open conference call scheduled for next Monday (so soon) at 11am ET. If you would like to participate, please contact Chorus Call (866-332-4905), the NAIC conference call coordinator, in advance and ask for the Evangel Call (there is a fee for participation). And if you cannot participate via telephone, it has been requested that your comments be made in written to Bob Carcano (RCarcano@naic.org). Posted by Alton Cogert at 10:16 AM | Comments (0) January 20, 2009 The Next Weakest Link - ChinaWith the Obama Administration rightly proposing a major fiscal stimulus - and probably not enough - analysts are expecting well over a $1 trillion deficit in this fiscal year...and probably higher in the succeeding year. The government can print money to fund these deficits, but it would much rather borrow (primarily from Japan and China). But, can we keep borrowing from the Chinese if they need to keep their savings at home to support their own troublesome economy. How troublesome? Below is a forecast from the OECD (not exactly a very incendiary group) and it is not pretty:
If you're in the leadership class in China, this graph is quite scary, as economic growth below something like 7-8% probably means insufficient jobs for the hordes coming from the country to the city looking for jobs. And, history tells us that angry hordes can pose severe problems for social, economic and governmental stability. Thus, one can make a reasonable case for China being very careful in its purchases of securities offshore. In fact, this has probably already happened in some fashion, as noted in the Treasury's January 15 press release detailing November data (December data won't be available until mid-February): "Net foreign purchases of long-term U.S. securities were negative $56.0 billion. Of this, net purchases by private foreign investors were negative $18.9 billion, and net purchases by foreign official institutions were negative $37.1 billion." With apologies to economists much smarter than me, the math is really quite simple: Large deficits = borrow or print money. Borrowings = Domestic Savings + International Savings (i.e. Purchases of Treasuries) If domestic savings is something we don't want to encourage in order to recover from a recession, we must borrow from abroad. However, if one of our largest creditors faces a large economic downturn, it will not have the desire to extend credit at current rates. The results: (1) higher US Treasury rates in the U.S. and/or (2) dollar devaluation (express or implied) and/or (3) inflation. Should China have the problems noted in the OECD study, we could expect some combination of one or more there. Of course, if foreign interest in Treasuries wanes, the Fed could always buy the securities. But isn't that just borrowing from one pocket to pay the other? And, to do so would most likely result in more dollars injected into the economic system (inflation). Perhaps inflation is not so bad in an economy suffering a slight bout of deflation...but at what long term cost? Posted by Alton Cogert at 11:35 AM | Comments (0) September 09, 2008 FNMA and FHLMC: The Hitchhiker's Guide Meets GodzillaFour months left for the Administration and the Goldman Sachs-US Treasury department. The Greatest Deleveraging in the History of the World has destabilized financial markets and threatens to drag one developed economy after another into a recession. In the latest move to have this occur, the US Treasury has basically taken over the largest single sources of mortgage finance in the world: FNMA and FHLMC. In our prior post, we said: "However, it (the mortgage market) will eventually recover, although with significant changes. FNMA, FHLMC and GNMA (and the US Government) will continue, in some form or other, to be the cornerstone of the market. And, where there is money to be made, Wall Street will find a way to securitize mortgages - more transparency, more risk sharing, improved ratings methodologies, etc - but I believe it will happen. Meanwhile, we should all follow the guidance from the Hitchhiker’s Guide to the Galaxy: Don’t Panic" As expected, the result of that "some other form" has been conservatorship...a nice legal word for bankruptcy. Every day it seems like the US economy is starting to look more like (take your pick) the US in the 1930s or Japan in the late 1980s/early 1990s. We prefer the later, since the former brings about results we know that the Fed can successfully deter. As the economy slowly moves into this Godzilla-like stage of slow growth/recession coupled with asset deflation due primarily to the credit excesses of the past, we must carefully view government responses to determine if we bordering the eastern Pacific have learned anything from our friends bordering the western Pacific. One error that the academics say Japan made was to prop up banks and other credit sources too long and not let the capitalist system wash away the bad apples and start afresh as soon as possible. With the UST's four point plan, it appears that some of these errors may indeed occur unless the federal government can successfully think like an entrepreneur. Although no one doubts Mr. Paulson's entrepreneurial capabilities (a minimum requirement for a "master of the financial universe"), one must severaly doubt if the next administration and Treasury secretary will have a similar bent. And those doubts can easily be placed at the feet of both Presidential candidates, too busy to talk about mindless topics than the core of our financial system, which indirectly and directly supports all potential voters. The four point plan will undoubtedly be viewed with glee by troubled financial markets: (1) an unlimited commitment to buy convertible preferred stock, (2) a 60+% reduction in their mortgage holdings over time, (3) a senior lending credit facility to provide virtually unlimited liquidity, (4) UST commitment to buy an unspecified amount of GSE mortgages. However, such glee should also be tempered. Note the message it is sending. "We are the government and we are here to run the mortgage business for an indefinite period of time." Although this plan may solve short term problems, it does not give comfort that the government will eventually let the capitalist system wash away the bad apples and start afresh as soon as possible. And therein lies the troubling comparison with Japan in the late 1980s/early 1990s. Four months to go, and the Administration and Goldman Sachs-UST has delivered us into a Godzilla like moment. They think they have tamed the beast. But, until there is assurance that the private sector will be allowed to devise new ways to securitize and sell securities without stifling competition from the federales, there is the risk that we may follow in the footsteps of our friends in Japan. Posted by Alton Cogert at 05:17 PM | Comments (0) July 15, 2008 FNMA and FHLMC: Guidance from the Hitchhiker's Guide to the GalaxyDon't Panic is a phrase used in the book The Hitchhiker's Guide to the Galaxy by Douglas Adams. It comes from the fictional intergalactic travel guide The Hitchhiker's Guide To the Galaxy, that theoretically served to show planet-hoppers how to see the Universe on less than thirty Altairian dollars a day. Now to FNMA and FHLMC - both insolvent from a mark to market perspective, and both deeply strugglling (depending upon your definition of capital) with the problems in the mortgage markets. The Bush administration just opened a new chapter in their figurative Hitchhiker's Guide by announcing a plan to save these GSE's by extending a $300 billion line of credit. Since this will require an act of Congress, it is expected that the Fed will provide the financing in the interim. But wait, the Fed already has about 1/2 of its assets (about $400 out of $878 billion) tied up in non-US Treasuries and their existing 'short term' credit facilities for banks and brokers. The Fed reports its balance sheet weekly. Click here for the most recent numbers. No wonder the old saying is "If you owe the bank $1 million and can't pay, you're in trouble, but if you owe the bank $1 billion and can't pay, the bank's in trouble." Just add a few zeros (in the contingent liability column) in this case. It has always been my impression that FNMA and FHLMC underwriting standards were superior and tighter as compared to other lenders, especially many of those in the private label securitization game. Thus, we will probably learn that the market's latest concerns are overblown. In fact, this may get back to the value of the mortgages held by the GSE's. With Friday's FDIC takeover of the very aggressive lender - IndyMac Bank - there should be no worries for depositors with less than $100,000 at the bank. However, the real worry will be what the FDIC will be able to receive when it goes to liquidate IndyMac's assets in an already tight mortgage market. Thankfully, one would assume that: (1) Most mortgages held by these GSE's are better underwritten than those held by IndyMac, or Countrywide, or Washington Mutual, or.. (2) The U.S. government will continue to make good on any of these GSE's problems, since debt and MBS issued by them are held not just by domestic investors, but foreign investors consider them to be as good as US government debt. And, those investors hold trillions of dollars of US securities. (3) FNMA and FHLMC now make up a large majority of mortgages being originated today. Thus, they must continue in business in order for the mortgage market to begin to recover and, with it, the valuation of residential properites. An interesting article in Barron's this week has Chip Case, of Case/Shiller Index fame, making a case for the residential market turning around. And, I would add that ARM repricings (the fire starter of the subprime mess) are projected to peak next month. Back to the Hitchhiker's Guide: The words 'Don't Panic' are printed on the cover of the Guide (always capitalized) "in large friendly letters". The novel explains that this was partly because the device "looked insanely complicated" to operate, and partly to keep intergalactic travelers from, well, panicking. The mortgage market today does look a bit 'insanely complicated' to operate, probably even from the standpont of an intergalactic traveler. However, it will eventually recover, although with significant changes. FNMA, FHLMC and GNMA (and the US Government) will continue, in some form or other, to be the cornerstone of the market. And, where there is money to be made, Wall Street will find a way to securitize mortgages - more transparency, more risk sharing, improved ratings methodologies, etc - but I believe it will happen. Meanwhile, we should all follow the guidance from the Hitchhiker's Guide to the Galaxy: Don't Panic We would, however, recommend discussions with your investment manager about the FNMA and FHLMC securities your company owns. Posted by Alton Cogert at 01:59 PM | Comments (0) June 12, 2008 Shocking, Just Shocking: Performance Measurement at the Rating AgenciesThe SEC has just release for comment (within an aggressive 30 day period), their proposal for improving the process at credit rating agencies (NRSROs). One suggested change is: Require credit rating agencies to publish performance statistics for 1, 3 and 10 years within each rating category, in a way that faciliates comparison with their competitors in the industry. Shockingly, this adds a hint of competition to an industry that is an oligopoly. It is a slow move towards the word most hated and feared by Moody's, S&P and Fitch - COMPETITION. In a capitalist economy, lack of competition can lead to inefficient and ineffective markets....something that is still endemic in the NRSRO industry today. We firmly believe this disclosure is a step in the right direction. It might even get investors to realize how truly imperfect credit ratings are, and how important independent credit research is. It should also be a stark reminder to investors that ALL portfolios with credit risk are subject to losses which can indeed be anticipated and analyzed in advance. Unsurprisingly, we are called upon to provide such quantitative analyses for our client portfolios. Each portfolio exhibits a different expected loss distribution, but all portfolios' credit loss distributions tend not to be 'normal' and are subject to severe negative spikes in losses in certain 'unusual' cases. Given the current and expected state of the economy, perhaps it is time for analysis of expected loss distributions in your company's portfolio? Posted by Alton Cogert at 12:25 PM | Comments (0) June 11, 2008 The Rising Tide of Credit RiskLast December, in a blog entry entitled, "Credit Risk: Prepare for What Will Come Next" we warned of focusing on the 'headlines' of sub prime problems without considering "good old fashhioned credit risk". We noted: "What's the next shoe to fall in the credit risk arena?" may not be the correct question. Perhaps "What and how many shoes?" is a better question. Now, Moody's has confirmed our thoughts with a recent report, as noted by Reuters: A record $772 billion of U.S. corporate debt may be put on review for downgrade this quarter as financial firms stumble and rising commodity prices take a toll on industrial companies, according to Moody's Investors Service. The previous record for downgrade reviews was $543 billion in the third quarter of 2001, a year of massive bankruptcies as accounting scandals and recession toppled corporate giants. Downgrade reviews for this quarter are on pace to top the $593 billion reported for all of last year, according to a report released late on Wednesday. We've been in recent meetings with some investment managers who see value in the investment grade corporate market because spreads are predicting defaults in excess of those seen back in 2001. Alas, these managers may be too sanguine if Moody's predictions, which are pointing to worse credit conditions than 2001, come to pass. The report goes on to say: "Three clear trends have stood out among U.S. issuers subject to recent downgrade reviews: financial firms hurt by holdings of toxic structured financial products, industrial firms squeezed by rising commodity prices, and firms with direct exposure to the discretionary spending of the U.S. consumer," according to Moody's statistical economist Benjamin Garber. In the case of financial firms, the reliance on leverage is endemic; and for firms with direct exposure to discretionary consumer spending, leverage has been a strong contributing reason for revenue gains. The rising tide of credit risk will make your investment managers' tasks more difficult. However, it is incumbent upon insurers to carefully question, understand and monitor the process or credit risk management at those investment management firms. And, as noted in our earlier blog: Although life insurers do allocate surplus in the form of asset valuation reserves for credit risk, PC insurers do not have such a valuation reserve. We highly recommend that all insurers review the potential for credit losses and Other Than Temporary Impairment write downs over the next year (both expected values and probabilistic distribution of those values) in order to get a better idea of future portfolio performance. There are many different ways to perform such an analysis. However, using credit rating transition matrices, credit default swap spreads, long term credit default performance as well as stress testing that performance is a good start. It is much better to be prepared now than surprised later. Posted by Alton Cogert at 10:52 AM | Comments (0) June 06, 2008 Mark to Market is Just An Implementation ProblemThat's not our quote, but it was Bob Herz, FASB head who noted this at the recent CFA Institute Annual Conference in Vancouver, B.C, as he laid out a plan for convergence of FASB and IFRS (international accounting) standards. There are several areas that need to be addressed before this occurs, and mark to market (now required by IFRS) is one of these areas. We're all for mark to market of assets AND liabilities...when it makes good sense. Please remember that accounting is basically sociology...what we group of humans think is the best way to report financial results of enterprises, etc...and these are always subject to change. And, as we tell all of our clients, when it comes to their investment process, everything starts with what you are trying to accomplish (your company's key goals and objectives, key performance indicators, etc.). And, the same holds for accounting...it still comes down to what you are trying to accomplish. If the goal is to provide a snapshot of balance sheet market values without regard to why those assets and liabilities are on the balance sheet, it's full speed ahead on MTM -- and any problems are indeed implementation problems, per the esteemed Mr. Herz. However, if the goal is to accurately convey the financial condition of a firm within its unique goals and objectives, MTM only applies where those assets and liabilities are subject to conversion at those values. For example, insurers typically purchase equities for long term capital appreciation. When preparing a balance sheet as of a certain date, there is good reason to mark these assets to market, because we all want to know how far along that capital appreciation path those investments are hopefully on. However, if an insurer puchases a bond to hold for a long period of time (whether for maturity or not) in order to provide investment income (assuming no credit risk), it makes little sense to mark the bond to market, since the bond is being held to support the business/income statement of the company and not to produce outsized total returns. Conversely, if an insurer actively trades those same bonds, with a philosophy of looking for total return advantages through relative value decisions, etc., than the insurer should indeed mark those bonds to market, because they are less interested in providing income to support the business and more interested in that long term capital appreciation, similar to the investment in equities noted earlier. It all comes down to something similar to the 'cash flow statement' required of companies -- trying to determine what the sources and uses of cash flows are. Of course, market illiquidity has caused getting good market values to be problemmatical, but if one is actively trading, one should know those values or else how could one trade effectively...and if one could not trade effectively, it brings up much more serious issues than what is shown on a financial statement. Meanwhile, our friends at the CFA Institute, without considering all of their consituencies such as insurance company investment professionals, continue down the path of blindly supporting MTM: “Putting the blame on fair value for current market conditions is misguided,” said Georgene Palacky, director of the CFA Institute Centre’s financial reporting group. “Fair value is the most transparent method of measuring financial instruments, such as derivatives, and is widely favored by investors. Recent finger pointing seems merely an attempt to shift the focus from the real causes of the financial crises involving sub-prime lending practices and lack of market discipline. Indeed, fair value accounting and disclosures, which provide investors with information about market conditions as well as forward-looking analyses, does not create losses but rather reflects a firm’s present condition.” Market value disclosures are always a good idea...the more transparency the better is a generally good rule to follow. However, forcing MTM on investors that use investment grade bonds as a source of income, not total return, is completely missing why those investments are being held. Alas, MTM is not just an 'implementation problem' when you look at insurers. Posted by Alton Cogert at 09:39 AM | Comments (0) May 06, 2008 SEC Unveils 'Cloaking Device' to Hide ProblemsThe writers of the sci-fi franchise Star Trek long ago realized the importance of plot devices to keep the viewer interested and make problems more intractable. Thus, they had the bad guys use a technology that the good guys did not have: a 'cloaking device' that would hide the existence of their starships despite being in proximity of the good guys' Enterprise. With the good guys (?) at financial firms being pummeled by write downs due to marking securities down to values that are, themselves, pummeled by a market low in liquidity and high in fear, the writers of the non-fiction franchise SEC have come up with their own 'cloaking device': www.sec.gov/divisions/corpfin/guidance/fairvalueltr0308.htm It grants all publicly listed companies the ability to use unobservable inputs for pricing securities (Level 3 under FAS 157) when those securities are being observably priced in a 'forced liquidation or distressed sale'. It does not appear to define what is meant by such distress, but does require significantly more disclosure about how securities found their way into Level 3 and how they were priced using those unobservable inputs. This appears to be the SEC's attempt to temporarily derail their inexorable march to mark to market, while allowing the markets to return to 'normalcy' (more normal liquidity and less fear). The theory here may be that time heals all wounds. However, as all Star Trek fans know, the 'cloaking device' does have unintended consequences. How will investors be able to fully trust the earnings reported at companies holding many Level 3 securities? And, how will that impact the very markets the SEC is attempting to calm? And, will those firms using this 'cloaking device' be able to more as adroitly as those that do not? This starts to appear very similar to what happened under 'regulatory accounting' at thrifts in the early 1980s. That accounting treatment kept many thrifts in business despite a 'mark to market' problem. The government reacted by loosening many regulations on thrifts. Developers/promoters stepped in and took advantage of those regulations and many of those thrifts were later taken over or merged by the Resolution Trust Corp in the late 1980s and early 1990s. The ultimate cost being borne by the US taxpayer. One would think that policymakers would have learned about the perils of using the 'cloaking device' to hide or delay the resolution of problems. But, perhaps that only happens in science fiction. Posted by Alton Cogert at 11:53 AM | Comments (0) March 20, 2008 Greatest Deleveraging in the History of the World
The first idea is that we are witnessing the Greatest Deleveraging in the History of the World. When you think about it, that is not as forceful a statement as it seems on the surface, since we have just witnessed over the last few years (until about August, 2007), the Greatest Leveraging in the History of the World. The largest single country economy ever used expanding leverage to grow in excess of the rate it would if it did not so use as much leverage. As we all know, leverage is a two sided sword: great when things are going well, and dangerous when they are not. We are now in the dangerous stage. Perhaps the Fed, by working with JP Morgan and salvaging Bear Stearns,will control the impacts of this deleveraging today. And, perhaps there will be other large institutions ('too big to fail') for which the Fed or other government agency will have to do the same. And that brings me to the second idea from our conference. Mr. Sloan was quite entertaining and witty, as he is within his column in Fortune. However, he said that this was only the second time he can remember that a break down in the financial system is impacting the 'real economy' towards what looks like a recession. (Usually, it is the 'real economy' that has problems that cause a recession that then impacts the financial system to some degree.) The other time Mr. Sloan could remember that the financial system caused problems for the 'real economy' and not vice versa: the great depression. If credit continues to contract and if market liquidity continues to be under assault, the problem in the U.S. will be falling, not rising prices. And, therein lies a truly problemmatical scenario. In that case, when would those helicopters aluded to by Chairman Bernanke start dropping suitcases full of cash? In May, 2007, Chairman Bernanke said he did not expect 'significant spillovers' from the subprime market to the rest of the economy or financial system. The Fed's latest moves, including significant rate cuts, opening up the discount window, setting auction market lending facilities and now working on a Bear of a problem proves that not only does he 'get it', but he is quite concerned about the Greatest Deleveraging in the History of the World. There are still many other monetary and fiscal policy solutions that can and probably will be used to tackle this deleveraging. Unlike during the depression, we have those tools at our disposal. In addition, the occassionally maligned Mr. Bernanke could be the most educated person on this topic. Our conference was really quite positive in many ways, but those two rather interesting and troubling ideas were my personal 'take aways' Posted by Alton Cogert at 03:04 PM | Comments (0) February 07, 2008 As January Goes, So Goes The Year?According to the old saw, "As January goes, so goes the year." Let's hope that is only partially true this year, as shown in the statistics below: Listed: Beginning/High/Low/End/% Chg/(HL)Beg%)
Despite the press' consistent harping about stock market volatility, the SP500 was only a fraction as volatile (measured by the high minus low for the month divided by the beginning value) as the 3 month T-Bill and the spread between LIBOR and the Bill. Yes, we can thank the Fed for this, but more likely this was an indication of money moving to the sidelines (cash like instruments) awaiting the right time to reenter...putting further pressure on the Fed. And, as all fixed income managers know, January was exceedingly volatile in terms of spreads to Treasuries, as the yield curve continued its move toward a more 'normal' shape. So, let's not take our eyes off the ball. Significant valuation changes continue to occur in the fixed income markets and some of them are a negative result for insurers (who typically hold 'spread' product). If you didn't like your manager's performance in Q4, you may not be too happy about Jan 08 either. Can investment grade managers truly add risk adjusted value with 'active management'? During Q4 and, undoubtedly in January, the jury returned a 'no' vote for many. Posted by Alton Cogert at 12:13 PM | Comments (0) December 18, 2007 Paulson and Sisyphus: Strange Bedfellows
As a reminder, as punishment from the gods for his trickery, Sisyphus was compelled to roll a huge rock up a steep hill, but before he reached the top of the hill, the rock always escaped him and he had to begin again. The maddening nature of this punishment was reserved for Sisyphus due to his hubris and belief that his cleverness surpassed that of Zeus. Perhaps the markets are playing the role of Zeus. Of course, as an the former Chairman and CEO of Goldman Sachs, it is hard to imagine a lack of some degree of hubris. With Citgroup's and other banks' recent action to add SIVs to their balance sheet, it is increasingly looking like the US Treasury's plan for a master conduit of SIVs to rescue that market may go by the wayside. (Of course, SIV's must still face the burgeoning roll over of their Medium Term Notes -- an event that will start in earnest in January.) And, now the announcement of a sub prime mortgage rescue appears to have a similar approach to the Treasury engineered SIV plan. When originally announced two weeks ago, I could not resist the impulse to answer the Wall Street Journal's forum question: "Will Bush's mortgage plan have an impact on the housing crisis?" Here's what I noted then, and I would echo those thoughts today:
I don't know what this does other than give servicers the legal wiggle room to delay repricing for five years and make it possible for folks to stay in their home for now. However, the ARMs will reprice and the rate is tied to short term rates which may be higher five years from now. This is starting to look like another Sisyphean effort. The markets (Zeus) want transparency so that it can begin the process of correcting prior excesses. This may mean mergers of large financial players. It may mean further reorganizations of others. And, it may mean other consequences which we all must face (including further declines of the value of the US Dollar). To put the onus solely on the Fed (and their new liquidity auctions) for solving this problem is like fighting with one hand behind your back. If you want Zeus to solve the problem, you will have to give him what he wants (transparency) and not a plan that will result in another Sisyphean result.
Posted by Alton Cogert at 12:21 PM | Comments (0) November 20, 2007 Transparency: The Lubricant for Loosening the Grip of FearMarkets are notorious for moving between the states of fear and greed. For a number of years, we were living within the greed state. Low corporate bond spreads...no problem. Low credit capability for mortgage borrowers...no problem. The great amounts of liquidity in the global financial markets assured that more dollars would be chasing financial assets, looking for a home, any home, even a subprime home, that could provide a yield or return of some kind. However, first the bond market and now the equity market have shifted gears to the state of fear. The US economy is slowing and may move into recession by the end of next year. The equity markets await the salve of Fed easing, but Mr. Bernanke must be careful not to tip his hand, lest the dollar will fall swifter than few of us can imagine. Any corner of the financial or real economy subject to the use of credit has been and will continue to be impacted by what we called over a year ago "Deleveraging". (Those that simply refer to this as a credit crunch are missing the fact that financial institutions will probably be forced to delever to some degree to meet their capital requirements; while we have already seen this occuring in other areas like hedge funds.) What can be done to alleviate the grip of fear? Let's start by getting at the truth. It may not set us free, but it sure would give us all a better idea of how pervasive subprime and other credit related problems are. What if, instead of, slowly leaking out credit related write downs, banks and brokerages actually had to list the securities subject to write down? Transparency in our time. Shocking? Not really. Here in the world of US insurance companies, annual statement filings must list all investment holdings along with significant data, including cusip, book value, market value, yield, credit rating, etc. Quarterly, insurers file statements that include their investment transactions. And the NAIC (National Association of Insurance Commissioners) is even considering going further with a proposal to add an annual statement disclosure outlining all subprime exposure (direct and indirect), including MBS, CDO's, other structured securities, debt and equity securities of companies with 'signficant subprime exposure', and the always perplexing 'other assets'. Would it be a violation of trade secrets or trading strategies? No, because such disclosure would only apply to a portion of the overall investment portfolio. And, I'm not sure what partial disclosure of a portfolio really tells us about overall strategy. Would it let others know what they might be trying to 'unload' in the future? Possibly, but once the securities are written down, the rush to unload may not be so great as the 'pain' should already be felt. Or, would it allow banks and brokerages to hide the extent of the 'damage' from bad investment decisions, hoping markets would reverse before they have to revise their write downs at a later date? Such banks are acting like the two year old boy who doesn't want to tell his parents he unloaded in his pants...until he positively had to do so. We've read talk of a 'super' regulator being established with authority to require such disclosures. However, I believe that existing regulators have the ability to do so (and the last thing we need is another regulatory bureaucracy). In the US, the SEC, promoters of the 'disclose but caveat emptor' approach to regulation, should require this transparency. The accountants are indeed trying sometimes, but they are trying to be quasi-regulator (tough to do when the institutions 'quasi-regulated' pay your audit fees) by forcing public companies to show how they obtain valuations on securities and allowing them to choose mark to market. Please, no new regulator, just a requirement for transparency. Once we know how bad these credit related problems, the market will swiftly adjust. And, like members of Alcoholics Anonymous, the banks and brokerage firms, after admitting they have a problem and how large it is, can begin taking steps to improve. Transparency is the lubricant that can loosen the grip of fear in the markets. The tools are there. We only have to use them. Posted by Alton Cogert at 02:47 PM | Comments (0) |
 CategoriesArchives
Recent Entries
|
