Felix Salmon

Chart of the Day: Fed Funds

Posted on August 15, 2007 by Felix

Who says that the Fed hasn’t cut the Fed funds rate between meetings?

(Source)

Posted in charts, fiscal and monetary policy | Comments Off

Goldman’s Hedge-Fund Sweetener Revealed

Posted on August 15, 2007 by Felix

We bloggers like to speculate, and on Monday I hazarded

a guess that the don’t-call-it-a-rescue injection of liquidity into Goldman

Sachs’s Global Equity Opportunities hedge fund would reward investors with lower

fees than would normally be available to them. Specifically, I guessed that

Goldman wouldn’t charge a performance fee until the fund hit its high-water

mark.

was half right.

Bloomberg’s Christine Harper reports today that the fund’s

2% management fee is being waived entirely, and that the performance fee is

being cut in half, to 10%. On top of that, the performance fee doesn’t kick

in for the first 10% of appreciation – essentially the high-water-mark

trick that I was talking about.

In fact, this deal could end up being significantly sweeter for investors than

the deal I guessed they were being offered. It’s not clear from the Bloomberg

article, but it seems the 2% management fee is being waived entirely, not just

for the initial period of appreciation but for as long as the investment is

kept in the hedge fund. That’s huge.

Posted in hedge funds | Comments Off

Stocks: The Long View

Posted on August 15, 2007 by Felix

David Leonhardt looks

at p/e ratios today – but not the p/e ratios we know and love, where

the denominator is this year’s (or last year’s, or next year’s) earnings. Rather,

he tries to even out the business cycle by looking at earnings over the past

ten years. And by that measure, p/e ratios look high, by historical

standards.

For years, John Y. Campbell and Robert J. Shiller have been calculating long-term

P/E ratios. When they were invited to a make a presentation to Alan Greenspan

in 1996, they used the statistic to argue that stocks were badly overvalued.

A few days later, Mr. Greenspan touched off a brief worldwide sell-off by

wondering aloud whether “irrational exuberance” was infecting

the markets…

Today, the Graham-Dodd approach produces a very different picture from the

one that Wall Street has been offering. Based on average profits over the

last 10 years, the P/E ratio has been hovering around 27 recently. That’s

higher than it has been at any other point over the last 130 years, save the

great bubbles of the 1920s and the 1990s. The stock run-up of the 1990s was

so big, in other words, that the market may still not have fully worked it

off.

As we all remember, the "worldwide sell-off" in the wake of Greenspan’s

"irrational exuberance" comments was followed by the biggest stock-market

bubble of all time. But have a look at Leonhardt’s chart – it turns out

that even after the bubble burst, long-term p/e ratios still remained

at or above the "irrationally exuberant" levels of 1996. Greenspan’s

ideas of what was overpriced seem, in retrospect, to have been something of

a floor in terms of how far the market could drop.

And I simply don’t understand what Leonhardt is talking about when he refers

to the market "working off" its bubble. Bubbles aren’t "worked

off". They burst. Dramatically. And the market, according to all economic

received wisdom, tends to overshoot, not undershoot, in such a scenario –

in other words, far from falling too little, it tends to fall too much.

Maybe there’s some kind of meta-bubble explanation. Stocks in general got bubbly

in the early 90s, and then a tech bubble grew out of the more mainstream bubble.

The tech bubble burst, but the mainstream bubble didn’t. But I don’t buy it

myself.

Or maybe, as Leonhardt himself proposes, there really has been a secular change:

Over the last few years, corporate profits have soared. Economies around

the world have been growing, new technologies have made companies more efficient

and for a variety of reasons — globalization and automation chief among

them — workers have not been able to demand big pay increases. In just

three years, from 2003 to 2006, inflation-adjusted corporate profits jumped

more than 30 percent, according to the Commerce Department. This profit boom

has allowed standard, one-year P/E ratios to remain fairly low.

Going forward, one possibility is that the boom will continue. In this case,

the Graham-Dodd P/E ratio doesn’t really matter. It is capturing a reality

that no longer exists, and stocks could do well over the next few years.

Dean Baker doesn’t

buy it.

Leonhardt felt the need to say that maybe stocks aren’t over-valued if profits

keep growing rapidly (sounds like Alan Greenspan in the 90s). Well don’t hold

your breath on that one. Profits peaked in the 3rd quarter of 2006 and were

down sharply in the 4th quarter of 2006 and the first quarter of 2007. It’s

always possible that they will bounce back, just like it’s possible that President

Bush will sign the Kyoto agreement, but I don’t know anyone who will bet on

either event.

I’m more sanguine than Baker on this one. Leonhardt isn’t talking about quarter-to-quarter

fluctuations in corporate profitability, and he’s certainly not saying

that the business cycle has been repealed. He’s just saying that maybe there’s

been a permanent move whereby capital gets a larger share of the total economic

pie, relative to labor, than it has done historically. If that were the case,

then it would indeed be silly to compare stock prices today to those companies’

earnings ten years ago, before that change really kicked in.

Remember that Leonhardt is looking at the price of stocks today, divided by

average earnings over the past ten years. Given that recent years have seen

much higher profits than those recorded a decade ago, the denominator

of that ratio is going to increase steadily even if quarterly earnings do decline

over the next year or two.

Posted in stocks | Comments Off

They’re Both Green, As Well

Posted on August 15, 2007 by Felix

The new issue of Portfolio

is now online! The lead

story is all about measuring – and thereby improving – the

amount of good that microfinance institutions do in poor countries. I wonder

what Si Newhouse will make of it.

Posted in development | Comments Off

When Cheap Bonds Look Attractive

Posted on August 15, 2007 by Felix

Henny Sender gets a

little bit ahead of herself in the WSJ today, although she does pick up

on something important: that as the price of debt falls, it’s starting to become

more attractive, on a relative-value basis, than equity.

The news is that hedge funds and private-equity shops are getting very enticed

by the high yields offered on discounted bonds.

Three weeks ago, with investors increasingly spooked, the banks that arranged

financing for private-equity giant Kohlberg Kravis Roberts & Co.’s buyout

of Goodlettsville, Tenn.-based retailer Dollar General agreed to sell some

of that debt for as little as 87 cents on each dollar owed. Hedge funds led

by TPG-Axon, an affiliate of TPG, swooped in, attracted by returns of close

to 18%.

Indeed, that could turn out to be a better return than what KKR earns as Dollar

General’s new owner, with far less risk, given how much KKR paid to buy the

dollar-store chain.

Of course, TPG hasn’t made any returns at all, yet. Yields are not returns,

and the value of Dollar General’s bonds can go down as well as up. It definitely

seems fair to say, however, that those bonds are less risky than KKR’s equity

in the company – and that there’s a good chance that at these levels they

will prove more lucrative, too. After all, if the bonds rise in price, you get

a nice capital gain on top of your big coupon payments.

Sender also sees more value in default than I do:

If the company encounters even stronger head winds and one day defaults,

the debt holders would wind up owning the firm…

The private-equity firms say that even if their companies have a lot of debt,

these companies are far larger and stronger than in the past and have such

flexible capital that they can withstand any storm. If they are wrong, of

course, debt today that trades at 87 cents on the dollar will obviously fall

much further.

But with current yields above 15% and the possible upside of debt turning

to equity, private-equity firms are increasingly embracing these trades.

When Sender talks about "the possible upside" of converting debt

to equity in default, does she mean that the value of the equity, post-default,

could be higher than the 80 or 90 cents now being paid for the debt? That seems

most improbable to me. There are distressed-debt trades which are designed to

profit from converting debt to equity, but they don’t have entry points at these

sort of levels. Normally, that trade only works when you buy the debt at truly

distressed levels in the mid-30s or so.

Posted in bonds and loans | Comments Off

Keeping Dow Movements in Perspective

Posted on August 15, 2007 by Felix

Kudos to the NYT and WSJ this morning, in the wake of another 200-point drop

in the Dow yesterday. Neither turned the news into a big front-page story, as

they probably would have done a couple of weeks ago. And the NYT, indeed, didn’t

even bother to write its own story on the stock market at all: it just put a

standard AP report on the back page of the business section. It’s heartening

to see stock-market gyrations kept in their proper perspective, for once.

Posted in stocks | Comments Off

The $5,000 iPhone Bill

Posted on August 15, 2007 by Felix

Adam didn’t read my post

about using the iPhone abroad before he used his iPhone in England. Adam

just got his

latest phone bill from AT&T.

The bill is $5,086.66. For one month’s phone usage.

Ouch.

Posted in technology | Comments Off

Private Equity: The Bankruptcies Begin

Posted on August 15, 2007 by Felix

Just how smart is Stephen Feinberg, the principal of Cerberus

Capital? Portfolio’s Daniel Roth tells

us:

On Wall Street, the C.E.O. of Cerberus Capital Management, an investment

firm with $26 billion in assets under management, has long been admired. (“You

probably think you’re smart,” says one former employee. “Now

take your brain and mine, take them to the 28th power, and you have Steve

Feinberg.”)

Wow. A brain to the 28th power? Is that a bit like a 25-standard-deviation

event? I only ask because Mr Feinberg might not be feeling so particularly

clever this morning, after Aegis Mortgage Corporation filed

for bankruptcy, owing more than $600 million to its creditors. Among those

creditors is Madeleine LLC, owed $178 million in unsecured debt and very unlikely

to see any of it.

Madeleine is a part of the Cerberus empire, it turns out, and owns 81% of Aegis.

I don’t know how much money Feinberg paid when he bought Aegis, but all that

is now surely gone as well.

But let’s not concentrate too much on the Feinberg-specific schadenfreude and

miss the bigger story, which is this: companies owned by private-equity shops

are defaulting, now. And those shops include big names like Cerberus.

Lenders have gotten a little starry-eyed in recent years, as private-equity

principals willing to pay eight-figure sums in M&A advisory fees have persuaded

them to fork over billions of dollars to overleveraged companies. I’m sure the

bankers told themselves that these private-equity types make lots and lots of

money – and that the only way they can continue to make money is if their

portfolio companies don’t do things like file for bankruptcy.

Well, so much for that theory.

Posted in private equity | Comments Off

How Tight Are Mortgage Underwriting Standards, Really?

Posted on August 15, 2007 by Felix

The WSJ’s Jonathan Karp wants to tell us "How

the Mortgage Bar Keeps Moving Higher", in the words of his headline.

After all, he says, "mortgage lenders are tightening standards, even for

borrowers with strong credit". We’ve known this for a while, of course,

but cut the chap some slack: he’s writing for the Personal Journal.

Naturally, Mr Karp needs to kick off the story with an anecdotal example of

underwriting standards tightening up. Does he find a hardworking executive with

an embarrassing past which is hurting his FICO score? A young couple with a

good double income who have just blown a bundle on their wedding and therefore

don’t have a lot of money for a downpayment? Not exactly. Rather, he finds Frankie

Van Cleave, a 70-year-old denizen of Marietta, Georgia, who already

lives in her $890,000 riverfront property.

Now 70-year-olds are not the kind of people that mortgage lenders naturally

court at the best of times. Their future income is unlikely to go up, and indeed

is highly likely to go down. They’re at very high risk of enormous medical bills,

or death. In other words, their ability to make mortgage payments over the course

of 15 years or more is likely to be limited.

But if the home in question is valuable enough, and the loan in question is

small enough, then banks will still lend the money. So maybe the problem with

Ms Van Cleave is that she was asking for too much money. A bank might be willing

to lend her half the value of her home – $450,000. But if she asked for,

say, 80% of the value – $720,000 – you can see why a lender would

say no.

So how much is Ms Van Cleave asking for? A cool $1 million, or more than 110%

of the appraised value of her home. Never mind the risk that house prices might

drop: in order for any such lender to have the remotest chance of being paid

back in full, Frankie’s house will have to rise, and quite substantially

too, in value. But that’s not the way she sees it, of course:

"A good credit record doesn’t count for anything now," Ms. Van

Cleave says of her futile refinancing effort. "If you don’t have assets,

forget it. If you’re self-employed, you have real problems in this market."

No. If you’re 70 years old, and you have $110,000 of negative equity, then

you have real problems in this market. (Actually, we’re told that the appraisals

on the house came in below $900,000, which means that she has even

more negative equity than that.) The self-employed bit is the least of Van Cleave’s

worries: no lender is going to assume that a 70-year-old is going to stay on

the payroll at any company for very long.

The fact that Frankie Van Cleave can’t get a mortgage is not news. It’s the

fact that "several mortgage brokers" were still courting her not so

long ago which is the more worrying part.

Indeed, I wonder whether underwriting standards have in reality tightened up

nearly as much as we’re constantly being told they have. Look at the most recent

tranche of ABX.HE subprime indices, the 07-02 vintage, containing mortgages

written in the first half of this year, long after systemic problems in subprime

underwriting had been splashed all over the headlines. It turns out that those

subprime loans are trading just as badly as – if not worse than –

the subprime loans of the 2006 vintage. And does this sound like underwriting

standards are tight, or just that they’ve been insanely loose right up until

now?

IndyMac Bancorp is the latest lender to shun 100% financing for borrowers

who want merely to state their income. For Alt-A loans that don’t have third-party

mortgage insurance, IndyMac is insisting on at least a 5% down payment for

"all loan sizes and property types," according to guidelines sent

to mortgage brokers.

IndyMac has been providing, all year, 100% financing for people who won’t even

show them how much money they were making? And it’s still providing 95% financing?

Yikes. This article isn’t showing me how tight underwriting standards are: it’s

showing me how loose they are.

I do think that there’s less outright fraud in loan applications now, compared

to a year ago. But I’m not convinced that there’s been a significant tightening

of underwriting standards more generally – certainly not until the past

couple of weeks, anyway. And if that’s the case, then mortgage lenders have

been acting even more foolishly than we’d heretofore imagined.

Posted in housing | Comments Off

Tuesday Links Yearn for Liquidity

Posted on August 14, 2007 by Felix

Sometimes a blogger finds himself with a vast number of tabs open in his web

browser, some of which are getting decidedly stale. So I apologize for anything

here which is old news.

Greg Mankiw is shocked that Nantucket property is selling

for 30

times gross annual rental income. But I think that’s largely a function

of the fact that the houses only really rent out for three months per year.

Ultrashort bond funds are meant to be safe as houses. Safe

as subprime mortgages, more like. One such fund is down 6.26% in the past

four weeks.

Mike Mandel thinks that liquidity will rotate out of the housing

industry and into

technology and telecoms. A falling tide doesn’t have to sink everyone!

Jeff Matthews doesn’t

seem to understand that Barclays is one of the world’s largest investors,

and, as a big index investor specifically, has huge shareholdings in just about

every company in the US.

(Update: A normally well-informed source

tells me that Matthews is actually on to something here. Given how smart both

Matthews and my informant are, and how little I know about the specifics, I’ll

defer to them on this one. Sorry for doubting you, Jeff.)

Alan Greenspan loves working for Germans: first he signed

an advisory contract with Pimco (owned by Germany’s Allianz); now he’s signed

another with Deutsche Bank. Maybe it has something to do with the strength

of the euro.

Tanta looks at stated-income "liar" loans where

proof of income was provided, but the actual income blacked

out. Astonishing.

James Hamilton gives a very good overview of the mechanics

of a Federal Reserve liquidity

injection.

Are the rouble and the Brazilian real the safest

currencies of all?

Nassim Taleb is walking down the street with $10 burning a

hole in his pocket. Opposite a hot dog vendor, he espies Robert Merton,

drunk, dishevelled, and begging for cash. What

does he do?

Ford CEO Alan Mulally admits

that if it wasn’t for fuel-economy standards, Ford would make even fewer small

cars than it does at present.

New York might not be losing out as a financial center after

all.

A crucial business insight: if you’re selling food to the really rich,

you’re not actually selling to them directly, you’re selling

to their servants.

We’re often told that 75% of portfolio managers underperform the market. But

where

does that number come from?

The

Economist on Nouriel Roubini: his "commentary seems

carefully calibrated to avoid any hint that economic disaster may be avoidable".

Posted in remainders | Comments Off

Cramer’s Meltdown Spills Into Print

Posted on August 14, 2007 by Felix

There’s a school of thought that Jim Cramer just plays a screaming

nutcase on

TV, that in reality he’s actually quite smart and knows his onions.

On the other hand, he’s also capable of using his column in New York magazine

to write something

like this:

This spring, as many homeowners stopped paying, the mortgage bonds—for

the first time—starting losing value. Hundreds of billions in bonds

that were thought to be worth more or less the price they were sold at, it

turns out, are worthless.

Bonds are almost never worthless. Even in cases of enormous and outright

fraud, like WorldCom, bonds aren’t worthless. Cuba stopped paying its debt decades

ago, and its bonds aren’t worthless. And mortgage-backed bonds, of

course, are backed by mortgages, which in turn are backed by houses. The minimum

recovery value on a defaulted mortgage is about 50%.

And this isn’t some kind of Cramer slip. He repeats himself later on, and even

says that he’s smarter than Bear Stearns’ Warren Spector:

Spector, maybe one of the best minds in the bond business, genuinely believed

that these mortgage-backed bonds still had substantial value. If someone as

savvy as Spector thought these bonds were still good when they were actually

worthless, that tells you that thousands of other managers are simply dreaming

if they think their portfolios are worth anything near what they claim they’re

worth.

The thing is, Spector was right when he saw a certain amount of value

in mortgage-backed bonds. If Cramer really thinks that mortgage-backed bonds

are worthless, he should be shorting them all like crazy right now. But I don’t

think he is. The AAA-rated tranche of the ABX subprime index has already started

to rally in price – it’s now back up to 92.5, from a low just below 90.

Now to be charitable to Cramer, it’s possible for a mortgage-backed bond to

be worthless even if the underlying mortgage still has value. The first-loss

tranches in a waterfall structure can be wiped out entirely, leaving the value

for the holders of the higher-rated bonds. Although it’s worth noting that even

the lowest, BBB- tranche of the ABX index is still trading in the high 30s:

a long way yet from zero.

In any case, most of the losses at subprime-exposed hedge funds have not been

due to holding low-rated tranches which might be wiped out; instead, they’ve

been due to leveraged exposure to high-rated tranches which have merely dropped

in value.

There are some very nasty things going on in the mortgage-backed market right

now, so there’s really no need for this kind of hyperbole. Cramer’s meltdown

has been something of a hit on YouTube, so maybe he’s just trying to milk the

last drops out of it. But he’s wrong

about housing, and he’s wrong about the value of mortgage-backed bonds,

as well.

Posted in housing, Media | Comments Off

One Question for David Viniar

Posted on August 14, 2007 by Felix

Goldman Sachs CFO David Viniar is a man who, one can assume,

is reasonably au fait with numbers. So what on earth was he thinking

when he said

this?

“We were seeing things that were 25-standard deviation moves, several

days in a row,” said David Viniar, Goldman’s chief financial officer.

“There have been issues in some of the other quantitative spaces. But

nothing like what we saw last week.”

For one thing, 25-standard-deviation moves just don’t happen. Or, in Brad

DeLong’s words,

"the universe isn’t old enough for even one sixteen-standard-deviation

event to have ever happened".

But more to the point, the markets were volatile, but they weren’t that

volatile. To the untotored eye, there was nothing outrageously unprecedented

going on. So my one question for David Viniar is this:

What, exactly, was it that saw a 25 standard deviation move?

A chart would be nice. But just the name of whatever it is that Viniar had

in mind would help. Because I’ve certainly never seen such an animal

before, and if one has been caught in the wild, as it were, it would be nice

of Goldman to let the rest of us see it.

(Via Yves

Smith)

Posted in banking, hedge funds | Comments Off

New York City Gets Federal Congestion Pricing Funds

Posted on August 14, 2007 by Felix

Great news today: despite the city missing the application deadline, the federal

government has awarded

New York City $354 million for its congestion pricing plan. Transportation

secretary Mary Peters was positively gushing at her press conference:

The average New York commuter now spends 49 hours stuck in traffic every

year, up from 18 hours in 1982. While some may be content to accept growing

gridlock as a way of life, Mayor Bloomberg is not going to let traffic rob

the Big Apple. He has stepped forward with a plan as brass and bold as New

York City itself.

The department of transportation has now explicitly said that building more

roads doesn’t reduce congestion. Let’s hope that New York’s legislature comes

around to that point of view and accepts this large gift with grace.

Posted in cities | Comments Off

Dissecting Hedge Funds

Posted on August 14, 2007 by Felix

Blessed with the genius of hindsight, Veryan Allen has decreed

that "the recent stat arb problems were almost inevitable". He’s talking

about the losses in quant funds at places like Goldman Sachs, Renaissance, and

DE Shaw, and his reasons all ring true to me.

Interestingly, however, Allen’s departing a little from his usual script. Normally,

when a hedge fund loses money, he says that it’s not a proper hedge fund at

all. This time around, he’s saying that "contagion affects all strategies,"

and that "everyone loses money sometimes".

And he’s also moved decidedly into the bearish camp, it would seem. Yes, there

are opportunities in this market – you can hardly have this much volatility

without creating opportunities for the fast and the smart. But the rest of us,

he says, should sell, now.

Good fund managers are taking action and reducing risk during this storm.

I find this stay in for the long haul, ride out the volatility "advice"

ludicrous. Ships do their best to get to the nearest port and aeroplanes avoid

hurricanes but sell-side strategists are mostly recommending staying invested

and they claim stocks are "cheap"!

If you can’t or won’t invest in good hedge funds or go short, the safe haven

is CASH. It is not as though "common sense" traditional stock and

bond funds are immune from all this. There has been little selling by long

only and long biased funds so far but if it comes the effects will be worse…

Dig your well before you are thirsty and DEFINITELY before everyone else gets

thirsty.thirsty for the safety of cash.

Allen even lifts his kimono a tiny bit and gives us the name of one hedge fund

he considers to be a good investment:

Renaissance Technologies remains the best quant firm currently operating.

It is worth noting that their core fund Medallion is positive for this year

and is where the managers keep their own money.

On the other hand, never mind 2-and-20; Medallion charges 5-and-44, even if

you’re invited to invest in it, which you’re not. As Greg Newton

notes,

"Medallion is today a purely ‘friends and family’ operation, managing the

assets of Renaissance employees, former employees, and their families".

Maybe that cash is looking more attractive after all, at least with overnight

interest rates still relatively high.

Posted in hedge funds | Comments Off

Revisiting Green Dimes

Posted on August 14, 2007 by Felix

Last month I wrote about junk-mail reduction company Green

Dimes, calling

it a VC-backed for-profit philanthropy. I met with the CEO, Pankaj

Shah, on Saturday, and he was hesitant to go that far: his company

was "socially responsible," he said, but he wouldn’t necessarily call

it a philanthropy.

One clarification he did make, which hasn’t been well reported: the $20 million

in venture capital he received went not to Green Dimes per se, but

rather to Tonic, the parent company. Shah has revamped the Green Dimes business

model, and says that he doesn’t see it making much money: in fact, he’d love

the company to go out of business, if it succeeds in establishing a do-not-junk

list analagous to the wildly successful do-not-call list. Tonic, meanwhile,

is more profit-focused; Shah wouldn’t divulge much in the way of its business

ideas, but did say it was going to sell limited-edition t-shirts, some proceeds

from which would go to good causes.

A large part of the Green Dimes business is now spent pushing its do-not-junk

petition.

If the petition is successful, then indeed Green Dimes will no longer be a viable

business. But whether it’s successful or not, everybody who signs the petition

gets automatically added to Tonic’s mailing list. There’s no way of signing

the petition while at the same time saying that you don’t want to be contacted

in relation to Tonic’s other business ventures, and in fact there’s no indication

when you sign the petition that your details will be used for any other purpose.

It’s all a little bit sneaky: Tonic seems to be cutting other people’s unsolicited

snail mail, while adding to the world’s stock of unsolicited email.

In any case, the main thing I wanted to clear up with Shah is what has happened

to Green Dimes. When I last wrote about it, customers paid $3 a month to reduce

their junk mail. "We’ve researched dozens of direct mailers and literally

thousands of catalog publishers. We contact them on your behalf and make sure

that you STAY off of their mailing lists," said the FAQ

at the time. "We have a team of dedicated people working around the

clock to make sure that you receive the best possible service." It continued:

Are there other companies that do this?

Yes. The only similarity is that we’re all for-profit companies (some have

a .org domain name but are not non-profits) that reduce junk mail. The difference

is how much we do for you. Most one-time fee services are part time operations

that charge $20-$41 to send some postcards for you to fill out and mail and

that’s it. We have a complete full-time staff, contact dozens of direct mailers

and know how to unsubscribe you from thousands of catalogs. And if we don’t

know how to stop something, our team will find out.

Now, Green Dimes has become a one-time-fee service itself, with a cost of $15.

The FAQ

is much shorter, and says nothing about a full-time staff; the How

it Works page is even less enlightening, and mentions only the things that

the customer does, like regsitering with the Direct Marketing Association and

sending off postcards. Has Green Dimes become exactly the kind of company it

was so rude about so recently?

Shah says it hasn’t, and that the company has invested a lot of money in automated

systems which successfully replicate the work which used to be done by humans.

Although it’s now a one-time fee service, he says, that one-time fee buys you

a lifetime membership, and Green Dimes will continue to work to eradicate your

junk mail even as and when it reappears in the future.

We’ll see. I’m not completely convinced, if only because the Green Dimes website

doesn’t seem to be trumpeting the changes very loudly (or, indeed, at all).

If the new business model is better and cheaper than the old one, you’d think

that Green Dimes would make the effort to tell us that; instead, the change

happened very quietly indeed, without so much as a mention on the official

blog.

Still, I’ve signed up. There’s nothing more depressing than coming back from

holiday to find an enormous pile of mail, the overwhelming majority of which

is wasteful junk. I’ll happily pay $15 to see that pile get seriously reduced.

Posted in climate change | Comments Off

The Travails of Johnson & Johnson

Posted on August 14, 2007 by Felix

If there was one corner of the debt market immune from present credit woes,

one would imagine it to be the market in unsecured, "natural" AAA-rated

securities. And indeed Johnson & Johnson, one of those precious natural

AAA credits, saw

enormous demand for its $2.6 billion bond offering yesterday.

But it paid a steep price, all the same.

J&J issued

three tranches of debt. The five-year bonds came at 62bp over Treasuries;

the 10-years at 77bp over; and the 30-years at an eye-popping 96bp over.

In comparison, the last time that J&J came to market, its 10-year bonds

were issued at 38bp over, while the 30-year bonds came at 50bp over Treasuries.

And looking at yesterday’s closing levels for the Embi emerging-market bond

index, we can see that Egypt is trading at 65bp over Treasuries, while Poland

is trading at 70bp over. Poland has a single-A rating, while Egypt is not even

investment grade.

It seems that triple-A rating is good for generating demand; it’s just not

so good at bringing down spreads.

Incidentally, I have a lot of sympathy for J&J in its suit

against the American Red Cross. The two organizations have happily coexisted

with the same trademark for many years: J&J, which had the trademark first,

uses it for commercial purposes, while the Red Cross uses it for charitable

purposes.

It’s not like the Red Cross is ignorant of trademark issues – quite

the opposite. And J&J even looked the other way as the Red Cross slapped

its name and logo on all manner of commercial products, including this

one. But there comes a point when J&J simply can’t allow its direct

competitors to use its own trademark. And that point arrived when the Red Cross

started licensing out J&J’s own trademark to J&J’s own competitors.

It seems that the Red Cross, in typical high-handed fashion, simply refused

to talk to J&J, or address the company’s concerns, despite the fact that

J&J is a major donor. When you behave like that, you run the risk of a lawsuit,

and that’s what they ended up being slapped with. The Red Cross is trying to

bully

J&J into stepping down; I hope the company has the cojones not to.

(Via)

Posted in bonds and loans | 2 Comments

Why a Goldman Sachs Hedge Fund Investment Might Look Attractive

Posted on August 13, 2007 by Felix

Commenter tinbox has an

interesting take on the news that Goldman Sachs is injecting liquidity into

its own hedge funds:

It’s wildly implausible that anyone looked at Goldman’s fund and suddenly

decided it is the best investment opportunity on the planet. That simply didn’t

happen. Funds down 15%+ do not attract new investors for a whole variety of

reasons and this self-serving announcement addresses none of them.

Well, there’s at least one good reason why a fund down 15%+ should address

new investors, and it’s called the high-water

mark. If you think that hedge funds are a good investment, you think that

they’re a good investment after they’ve taken out their 20%-of-the-profits

performance fee. Which means that they’re a really good investment

if you don’t have to pay that fee for the first 35% that your investment goes

up.

If the Goldman funds are down 26% from their high-water mark, then they will

have to rise more than 35% from their present levels just to get back to it

and start earning performance fees again. Which makes investments in these funds

some of the cheapest hedge-fund investments available right now.

I reckon there’s a very good chance that the $3 billion of liquidity being

injected into Goldman’s funds won’t pay any performance fees unless and until

those funds reach their high-water mark. If that’s the case, I imagine that

quite a few hedge-fund investors would be extremely interested in buying cheap

exposure to what has historically been a very high-performance fund.

Posted in hedge funds | Comments Off

Chart of the Day: West African Trucking Obstacles

Posted on August 13, 2007 by Felix

Charles Kenny points me to a study

of the obstacles to trucking on West African roads, which includes this wonderful

chart.

The methodology certainly seems solid to me:

Trained IRTG agents distribute data-collection sheets to drivers in ports

(or inland ports). They choose only drivers with trucks in good condition

(according to legal standards) and with paperwork in order. Their counterparts

at the other end of the corridor collect the completed data-collection sheets

from drivers completing their journeys. If the agents judge the data reliable,

they computerize it and send it to the Information Technology Department of

the UEMOA Commission for analysis.

The road from Bamako to the nearest port is 1,900km long, and the stops delay

truck drivers for between 15 and 38 minutes every 100km (62 miles) – which

would be bad enough even if it weren’t for all the bribes which have to be paid.

This kind of study is crucial to understanding real trade barriers,

as opposed to just the ones which get fought over at international fora such

as the WTO. Here’s

another, from Indonesia.

Posted in development | Comments Off

Counterparty Risk in the CDS Market

Posted on August 13, 2007 by Felix

Yves Smith is worried

about counterparty risk in the credit default swap (CDS) market. A CDS is

basically an insurance contract, and anybody who buys insurance wants to know

that their insurance company is definitely going to be there, with the money,

if the thing they’re insuring against ever happens. So if there really is a

lot of counterparty risk which hasn’t been priced in to the CDS market, that’s

worrying.

Now I’m no expert in the mechanics of the CDS market, but it does strike me

that almost no one will buy credit protection from a seller they’re not completely

sure about. It defeats the purpose of buying the protection in the first place:

why pay money to protect yourself against a default, if that default would bankrupt

your counterparty and leave you with no money anyway?

Which means that in practice, anybody wanting to buy protection is going to

buy it from a big broker-dealer, and quite possibly from a special-purpose bankruptcy-remote

vehicle set up by that broker-dealer for specifically that purpose.

But what about the broker-dealers themselves? They make a market in this stuff,

and therefore should be willing to buy protection from just about anybody. So

it’s the big CDS broker-dealers, like Deutsche Bank and JP Morgan, which should

be most worried about counterparty risk in the CDS market. But they’re also

the players who are most likely to know what they’re doing, and to have elaborate

risk controls set up to address exactly this problem.

Many of their counterparties, of course, they don’t need to worry about. When

a bond fund plays in the CDS market instead of the bond market, or when AIG

writes credit protection, the chances of either entity blowing up as a result

of paying out on a credit default swap is minimal.

But big bond funds and insurance companies aren’t the only writers of protection

in the CDS market. There’s also hedge funds, who are much more prone to blowing

up, and who can use CDS as a source of leverage. Essentially, writing credit

protection is free money: you collect your insurance premiums and have to pay

out nothing unless and until there’s a default.

And broker-dealers are desperate for hedge funds’ business, because it’s very

profitable. So they might well end up with non-negligible counterparty exposure

to a fund which turns out to be a big net writer of credit protection.

Still, the broker-dealers are big boys, and I’m not going to get too worried

on their behalf. I’m more interested in Smith’s conclusion:

If enough financial players are distrusted as counterparties for routine

transactions, one would think at a certain point those worries have to infect

the CDS market.

If enough financial players are distrusted as counterparties, then there will

be fewer counterparties able to write credit protection – in other words,

the supply of that protection will go down. When supply goes down, the price

goes up, and implied yields in the CDS market could rise. But that’s nothing

which hasn’t happened quite dramatically over the past week or two.

And what would happen to the CDS market if there was a big corporate default

and a hedge fund found itself unable to pay out on all the protection it had

written? Answer: the broker-dealers who bought the protection from that hedge

fund would essentially take over all the rest of its assets. I don’t think it

would be the end of the world.

Posted in derivatives | Comments Off

Floating Art for Rich Rubes

Posted on August 13, 2007 by Felix

Are you worth a few million bucks? Do you live near the ocean in a large and

ostentatious house with a lot of walls? Do you not know much about art but you

know what you like? Then welcome aboard the Grande Luxe!

Alexandra Wolfe introduces

us to the Grande Luxe, and its owner, David Lester,

in the September issue of Portfolio. It’s a 228-foot yacht with 28 different

gallery spaces, each of them rented out to a second-tier gallery that most art

world sophisticates would never step into.

Anyone who wants to visit SeaFair has to apply online and answer questions

about his or her collection. But most of the art-related questions are merely

a formality, Lester admits. “Their collection doesn’t really matter,”

he says. “Preference goes to the person with the most money.”

If anything, I suspect that serious collectors are precisely the people Lester

doesn’t want. If you own a Tuymans or a Kippenberger or a Mehretu, SeaFair,

as his peripatetic floating art fair has been named, is not for you. Rather,

the idea is to take the stratospheric valuations of those art-world stars, and

use them to justify ridiculously high prices for artists who will never find

themselves in an evening sale at Sotheby’s. The target audience, not to put

too fine a point on it, is rich rubes, not the art-world insiders who flock

to Art Basel and other international fairs.

Can the seven- and eight-figure price tags from Art Basel trickle down into

big profits from SeaFair? I’m not sure. On the one hand, one can never underestimate

the amount of money that rich people are willing to spend on just about anything.

On the other hand, these are people who would never dream of spending more money

on paintings than they did on buying their house in the first place.

Can the small galleries on the yacht make a steady profit selling paintings

in the $10,000 to $40,000 range? Apparently they’re paying about $80,000 a month

in rent, which means they’re going to have to move quite a lot of product in

order to make a profit. But just think about all those empty walls in those

brand-new McMansions. They’re crying out for art, and SeaFair’s exhibitors

will bring it straight to your door. How easy is that?

Posted in art | Comments Off

Mortgages go Messianic

Posted on August 13, 2007 by Felix

We know that CEOs tend to have big egos – sometimes even delusions of

grandeur. But it seems that Patrick Flood, the former CEO of

Christian mortgage lender HomeBanc, has a fully fledged Messianic

Complex. The WSJ’s Valerie Bauerlein spoke

to him in the wake of HomeBanc’s implosion:

Mr. Flood, the former CEO whose January severance package was $5 million,

plans to start another faith-based mortgage company. He says HomeBanc employees

and customers will take what they learned and plant the seeds wherever they

land. "When Jesus got on the cross, people at the time thought that he

failed because he died and the ministry ended," he said. "But people

around him have cascaded it into the greatest movement in history. The company

being a financial failure doesn’t mean that the work has ended."

Bauerlein’s article paints HomeBanc to be a cult which locked employees into

three-year contracts and hired them only if they were willing to push the company’s

products to their friends and family. I sincerely hope that Flood’s new company

never gets off the ground. Right now, what mortgage lending needs is less in

the way of charismatic leaders, and more in the way of reality-based underwriting.

Posted in housing | Comments Off

Conflicts of Interest at the Ratings Agencies

Posted on August 13, 2007 by Felix

Jesse Eisinger looks

at ratings agencies in the September issue of Portfolio, and spends a lot

of time making the distinction between active and passive involvement on their

part. Active involvement, it seems, is "one of the dirtiest open secrets

in the mortgage-ratings world," and constitutes a conflict of interest

on the part of the ratings agencies which sullies their precious purity.

I don’t want to come across as being overly sarcastic here. If you’re a ratings

agency, your reputation for bestowing ratings without fear or favor is the most

valuable thing you have. Even the impression of impropriety in such matters

can be very damaging indeed.

And while ratings agencies exist for the benefit of investors, they’re paid

by issuers. That is most definitely a conflict of interest – although

it’s one that’s not confined to the world of structured credit.

I just wonder whether investors would really prefer the ratings agencies to

be less actively involved in bestowing ratings. Active involvement does, after

all, inevitably bestow a deeper and more sophisticated understanding of a deal’s

structure than simply being shown the structure and asked to provide a rating.

The key issue, I think, is not that active involvement is bad – in many

cases, it can be a good thing. (Although it’s certainly weird that the ratings

agencies seem to be so keen to deny that they have any active involvement in

deals.) The problem comes when a ratings agency, after having worked closely

with an issuer for a long time, gets lazy about asking tough questions, or assumes

that the answers to those questions a few years ago are the same as the answers

to those questions today.

In April, Moody’s said it would start doing what it should have done

long ago: more aggressively scrutinizing new mortgage loans. The company acknowledged

that its models, created in 2002, were out-of-date. “Since then, the

mortgage market has evolved considerably, with the introduction of many new

products and an expansion of risks associated with them,” a Moody’s

report said. In hindsight, it seems astounding that the most influential rater

of mortgage bonds wouldn’t be upgrading its models regularly to account

for the growth in exotic mortgages.

Did the constant stream of money flowing from mortgage-backed issuers to Moody’s

bottom line encourage the company to forget to reconfigure its models? It’s

possible. But I reckon that the same thing would have happened if Moody’s had

been purely passive in its ratings, and got the money with even less work. Perhaps

then people would be complaining that the ratings agencies hadn’t been active

enough when bestowing their much-coveted triple-As.

Posted in bonds and loans | Comments Off

AQR Also Hopes To Put More Money Into Quant Funds

Posted on August 13, 2007 by Felix

Bess Levin of Dealbreaker has

the letter

that AQR principal Cliff Asness sent to investors worried about losses in his

quant-based hedge funds. It seems that the losses are significant, and that

AQR is moving money out of that strategy – but at the same time moving

money in to that strategy. See if it makes any more sense to you:

In the face of this dramatically increased risk profile, we have temporarily

been managing a reduction of our notional exposure to these strategies in

the several hedge funds where they are utilized. Despite this reduction, we

strongly view that the exit of many others from this style of stock picking

represents a striking opportunity for future gains, which we fully intend

to capitalize on for our clients. To that end, we’ve already seen increased

client demand for our aggressive market-neutral equity fund.

Why is it that hedge fund managers seem incapable of using the word "selling"

when they can talk about "a reduction of our notional exposure" instead?

And is there any meaning at all to the word "notional" in that sentence?

In any event, with the Goldman

liquidity injection, it’s clear that AQR isn’t alone in this "lightning

won’t strike twice" play.

Posted in hedge funds | Comments Off

Mark-to-Market vs Mark-to-Model in the Insurance Industry

Posted on August 13, 2007 by Felix

How do you turn low-rated mortgages into high-rated bonds? There are basically

two ways: overcollateralization and insurance. The spotlight has been on the

former of late, as people wonder whether the overcollateralization models reflect

the reality of the subprime market over the past year or two. And now the other

shoe is dropping: David Reilly, today, wonders

what the exposure of insurers in general, and AIG in particular, might be to

the subprime meltdown.

AIG, of course, has its own models of how much it stands to lose on insurance

it’s written against subprime losses. But models, as we’ve seen, don’t always

match with market reality.

The company also said it didn’t see problems related to a kind of insurance

contract, or derivative, it has written against financial instruments that

include some subprime debt. AIG based its all-clear signal for those derivatives

on the fact that its internal models show that losses are extremely remote

in the portions of the investment vehicles it’s insuring. No likely losses

means no reason to worry, the company reasoned.

Yet the company’s valuation models seem to ignore the fact that those derivatives

would likely take a haircut if sold in today’s depressed market. "There’s

no way these aren’t showing a loss," says Janet Tavakoli, president of

Tavakoli Structured Finance Inc., a Chicago research firm. That’s simply a

market reality, she adds, that should be showing up in AIG’s results.

This raises an interesting question. Increasingly, there are market-based alternatives

to insurance products: you can issue catastrophe bonds in the market, for instance,

rather than insuring against a catastrophic event. In this case, AIG’s insurance

is pretty much identical to the credit default swaps that are being traded in

the market and which have seen huge price volatility of late.

But when insurance companies have been in their business for decades or longer,

while the open market in such things is very young, does it really make sense

for insurance companies to use market valuations rather than their in-house

models? Yes, models can be wrong – but so can the market, especially,

as now, when there’s a lot of stress and volatility.

Posted in insurance | Comments Off

Nice Work If You Can Get It

Posted on August 13, 2007 by Felix

My favorite datapoint from Daniel Roth’s cover

story on Stephen Feinberg’s Cerberus Capital:

Squeezing money out of firms that weren’t in distress required different

skills. Feinberg went out and bought them. He hired 150 C.E.O.’s and

other top executives to form an active brain trust—paying them, according

to a competitor, around $500,000 a year—to field calls from Cerberus

employees, find and weigh in on deals, and open up their Rolodexes.

Half a mil a year to answer phone calls. Ya gotta love the private-equity bubble.

Posted in private equity | Comments Off

Chart of the Day: Fed Funds

Goldman’s Hedge-Fund Sweetener Revealed

Stocks: The Long View

They’re Both Green, As Well

When Cheap Bonds Look Attractive

Keeping Dow Movements in Perspective

The $5,000 iPhone Bill

Private Equity: The Bankruptcies Begin

How Tight Are Mortgage Underwriting Standards, Really?

Tuesday Links Yearn for Liquidity

Cramer’s Meltdown Spills Into Print

One Question for David Viniar

New York City Gets Federal Congestion Pricing Funds

Dissecting Hedge Funds

Revisiting Green Dimes

The Travails of Johnson & Johnson

Why a Goldman Sachs Hedge Fund Investment Might Look Attractive

Chart of the Day: West African Trucking Obstacles

Counterparty Risk in the CDS Market

Floating Art for Rich Rubes

Mortgages go Messianic

Conflicts of Interest at the Ratings Agencies

AQR Also Hopes To Put More Money Into Quant Funds

Mark-to-Market vs Mark-to-Model in the Insurance Industry

Nice Work If You Can Get It

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