Faith-Based Investing: Let Us Pray Congress Comes Through
Disdain for the bailout plan floated by Paulnenke was evident at the Senate Banking Committee meeting. Many questions regarding moral hazard, oversight and effectiveness were asked. Importantly, senators showed some significant resistance to the idea that this plan needed to be approved pronto and implemented yesterday. (Maybe they need time to attach a bunch of pork and giveaways to it?)
So why did Paulnanke announce the need for an immediate $700 billion bailout? It was the markets' loss of faith. Why were Congressman non-plused by the plan?....loss of faith. What has turned this debacle into a threatening implosion has been the slow but steady erosion of investor confidence in the functioning of markets and the ultimate losses being hidden by opaque financial companies. Of course, the more arcane, complex and opaque the issues are, the greater the loss of faith. Even Paulnanke have lost faith. They lost faith in the credit default swap markets ability to continue functioning under the failure of a major dealer - that was evident in the Bear Stearns bailout and again in the AIG LBO.
Merrill Lynch leaping into the arms of Bank of America was the ultimate statement regarding investor confidence. Here is a firm that potentially took the ultimate low water mark haircut on its questionable assets, and stayed solvent, yet they still ran to safety due to the fear of investor flight from leverage.
Goldman Sachs and Morgan Stanley lost faith that investors wouldn't pull the plug on their levered balance sheets. Frankly, I don't think it was a statement about the quality of the assets on their books, although no one really knows.
A recent quote from the New Yorker underscores how this crisis has moved from a residential mortgage meltdown to a flight from leverage and loss of faith.
“Lehman’s assets were not significantly more toxic last Monday, when the company filed for bankruptcy protection, than they had been a week earlier. And, technically speaking, the bank may not even have run out of money, since it had access to an emergency liquidity line from the Federal Reserve. What Lehman did run out of was credibility. It couldn’t remain a going concern because creditors and customers no longer trusted it. Why would they, when its stock price had fallen nearly 80% in the previous week? The less faith the market had in the possibility of Lehman’s survival, the more remote that possibility became.”
The biggest blow to faith and confidence came with last week's run on money market funds, and I would still not rule out a run on banks, if faith is not restored, before some of the larger impending bank failures hit.
What the market needs now is a big confidence booster shot. So far in this crisis we have received some small ones:
Jeffrey Gundlach, CIO of Trust Company of the West was reportedly buying beaten up Alt A mortgages back in April. He recently made a conference call presentation for fund holders and potential fund buyers in which he avers that he has continued to buy severely discounted paper that he believes will pay off handsomely, even with extremely dire loss assumptions, saying "I am not terribly concerned that we might have a short-term negative performance movement from the non-agency positions we have bought because they are way below fundamental value. They are very very likely to deliver very high returns even under a draconian pessimistic case."
Jim Tisch, CEO of Loews Corp. (the investment holding co. - not the hardware stores) recently reported that his company started buying select sub prime assets back in July, through its CNA Financial insurance and surety unit.
Distressed investor/private equity firm Lone Star Funds bought Merrill's toxic portfolio, in July but, hey, they paid cents on the dollar when financing is taken into consideration.
Bank and savings & loan insiders were buying more stock in their own institutions over the summer than at any time in 20 years. However, there's no denying the fact that some of these guys are the same dumb-asses that got us into this mess.
John Paulson of Paulson & Co. (not related to Treasury Secretary Henry), whose hedge fund made billions shorting sub prime, has been raising a fund to invest in battered banks. The fund was expected to be open by year-end.
Rockefeller & Co. is also raising a fund to invest in insurers, banks and brokers under the moniker Rockefeller Global Financial Services Recovery Fund LLC.
As of today Warren Buffet is investing $5 billion in Goldman Sachs - on an IQ or Ivy League degrees per dollar basis, probably one of the all-time great value buys. Plus Warren negotiates his usual, no one gets as good a deal as the Wizard, preferred stock structures.
At this point it would be helpful if the government could come up with a plan addressing several key issues. The first is mark-to-market accounting's failure in yielding good data on solvency. The second is the lack of oversight by bank and securities regulators and an indication that these guys are on the job, but not set to make things worse by forcing asset sales willy nilly. The third, a backstopping plan for saving banks that just need time to ride through high but manageable loan losses. Lastly, an orderly liquidation plan for those zombie institutions that are just dead men walking.
So in the unforgettable words of the Jerky Boys "Say yer prayers" that Washington will get er' done in short order.
Posted by Colgin
Wed Sep 24th, 2008 03:11 PM
Jeff,
Great post as always. This is slightly OT but would to get your input on the following.
A friend of mine (assume for purposes of this post that we are both right-wing free market nutjobs, although I think that does not quite fit me) and I are having a dispute over whether or not there was market manipulation or a "bear raid" in last week's thrashing of Goldman Stanley after the LEH and AIG news. (FWIW, we are both vehemently against the recent short sell ban.) He thought the bears were out to (unfairly) destroy MS and GS and picked them out and notwithstanding great business models (again, in his opinion) for both caused them to be on the verge of going to zero. My view was that while shorts certainly piled into that trade, there had been a loss of confidence in those stocks in light of Bear, LEH and AIG for many of the reasons outlined in your post. He claimed market manipulation as evidenced by short-selling levels, CDS spreads and option trading. To me he attributed causality to the "shorts" that was inappropriate.
Yes, CDS spreads widended terribly, but how do we know that shorts manipulated this. You know this stuff better than I do. I am just wondering how shorts could manipulate and blow out CDS spreads to help them with their short positions on equity. I would think spreads widened because of the very lack of trust/transparency that, again, you have detailed above.
The one idea for manipulation I had is that the "evil shorts" could overwhelm the CDS market with bids for protections in Goldman Stanley thus causing premiums to rise. My problem with this is that they would be the very ones paying these increasing premiums. So, they would pay more and more for CDS "protection" in order for their equity short bets to come in big time. This seems far fetched to me, but perhaps I am too naive (or do not understand these markets well enough). Your thoughts on this would be appreciated.
Posted by jeff
Wed Sep 24th, 2008 03:51 PM
I am not one for believing that speculators break the bank too often. But George Soros wrote about this concept in "The Alchemy of Finance" years ago after he basically broke the Pound and the Bank of England had to step in. So yes I guess it can happen, but their is always an underlying big vulnerability. As to your question on the long CDS, short equity trade. I actually think it may have been at work. It's really a spin on capital structure arbitrage, except your short both the stock and the bonds. But you can make out big time on the stock, while the bonds may only get beat up...or potentially you catalize a situation where lines of credit are called and the debt collapses as well. I would peronally be wary of paying up too much for the CDS leg of the trade, but if you got in early you probably could benefit from bond owners jumping in to buy insurance as the stock fell. You could also theoretically hedge by buying some of the bonds as they traded off. Not my field, but I bet some guys did do these trades.
Posted by chris
Wed Sep 24th, 2008 04:10 PM
Your comment about John Paulson is a bit off ... Paulson Credit Opportunities Fund (invests in distressed mortgages, etc.), which was closed to investors since last year, has now re-opened to investors. The firm is also launching Paulson Recovery Fund (invests in equities of busted financials) will open to investors on Oct 1, 2008, not year-end. The minimum investment is $5 million - not bad at all, considering his track record and his broad institutional client base. Frankly, I'd rather give this guy $5 million than invest this in an overrated crappy ccop apartment on the upperwestside, that is poised to decline at least 40% in value when the valuations are on par again when the long term affordability index ...
Posted by jeff
Wed Sep 24th, 2008 08:22 PM
Chris,
With all the opportunity to pick up distressed mortgages on the cheap, I guess they will be getting the fund open prior to previous expectations in press reports. Thanks for the fresh info. I'm with you on the relative opportunity in distressed debt today vs. NYC real estate....I would add commercial properties of all types to your concerns about coops.