Phorgy Phynance

Archive for the ‘CLO’ Category

Party like it’s 1998… or 2001… or 1987… or 1929… or 1907

with 5 comments

What a week!! I certainly picked a good time to start a new job in structured finance. It’s only my first week and I’ve already had two 16 hour days where I was in the office until after midnight 😮

Actually, I love it! I love the intensity and love pushing myself. Reminds me of grad school 😉

Anyway, the big news from the Fed last week was the lowering of the discount rate. Over on NP, I voiced my opinion in a brief statement:

I think it is a smart move. The first sign that Bernanke isn’t as bad as Greenspan.

I thought it was an innocuous enough statement, but apparently Greenspan has a lot of fans out there. I was immediately greeted with:

[From RRP:]

Care to elaborate on this? I agree that boosting liquidity even modestly right now will be extremely helpful but I’m not sure that G-Span would have acted differently in this circumstance. Sure he was a bit compulsive about inflation but he gave the system liquidity when it really needed it. In 98 after Russia the discount window borrowing rate went from 5 to 4.50. Same magnitude move we are seeing here. You do realize that the target rate isn’t changing, the secured lending rate is?

[From FDAXHunter:]

I’d like to know what IAmEric is going on about as well. Greenspan was adamant about making sure that bubbles didn’t end up as complete disasters. He was well known to provide liquidity in times of crisis. So how is Bernanke better than Greenspan?

[From uranasss:]

I’d also like to hear IAE’s reasoning…

Then, I replied with what I thought was a reasonable succinct explanation:

Greenspan would have already cut the Fed rate by 1% (or more). That kind of behavior is what got us here. Cutting the discount rate while keeping the target rate at 5.25% makes sense. Nothing more nothing less.

This is where I think RRP got a little out of line, but hey, we are all adults, right? No biggie.

Please, don’t let facts get in the way of your hyperbole but a quick check would reveal this to be pretty much untrue. Taking 98 (which was worse than this crisis has been to this point) to be a good comp (an article of faith no doubt, but bear with me) we saw three rate cuts for a total of 75bps by mid november. This is a full 3 months after the default and two months after things started getting extremely nasty. Lo and behold target rates were back to pre crisis levels by mid November 99. It looks like an effective use of policy to get through a crisis to me.

Now you can fall into the camp that will blame the fed policy for the run-up in home prices and ultimately the housing bubble. That’s well and good, but cheap fed funds do not a bubble make. It takes a great deal of complacancy from the whole financial community to ignore the facts which are now so blindingly obvious and had been obvious to most people paying attention for the past 5 years. If you want to make a substantial loan to somebody and require less verification than it would take to get a Sears card be my guest, just don’t cry to me when you get hurt. There’s a lot of pain out there right now and there’s not a single fucking person feeling it who doesn’t deserve it. Idiotic borrowers, opportunistic originators, greedy investors, lax rating agencies, traders with tunnel vision, bankers with short time horizons, every last one of them is getting stomped (including yours truly). It’s their own goddamned fault so don’t put it at old Alan’s doorstep.

And for the record, I’m not in the camp that thinks Greenspan is one step removed from Jesus, I just belive he performed more than adequately in an extremely difficult job.

I’m really not sure what kind of logic it takes to look at the historical funds rate as evidence against my “opinion” that Greenspan would have already dropped rates by a “1% (or more)” in the last 5 months. I replied with:

You are certainly entitled to your opinion. I hope it has served you well. Comparing this to 1998 may be justified, maybe not. I think not.

The data you yourself supplied shows 8 – 50 bp drops and 3 – 25 bps drops in 2001 alone. ABX tanked in Feb-March. I think Greenspan would have thrown in a few 50 basis pointers during the last 5 months. It’s just my opinion and as we all know, that is what this entire industry is built on, i.e. art versus science.

Then energetic chimed in with…

I think Greenspan would have thrown in a few 50 basis pointers during the last 5 months.

Eric, dude … Head against Wall

I could only afford one last comment before being buried in modeling…

Look at the data man! If anyone should be frustrated, it should be me. I don’t blame people for talking their books though.

Edit: Here is the data for 2001


December 11 – Rate cut 25 bps to 1.75
November 6 – Rate cut 50 bps to 2.00
October 2 – Rate cut 50 bps to 2.50
September 17 – Rate cut 50 bps to 3.00
August 21 – Rate cut 25 bps to 3.50
June 27 – Rate cut 25 bps to 3.75
May 15 – Rate cut 50 bps to 4.00
April 18 – Rate cut 50 bps to 4.50
March 20 – Rate cut 50 bps to 5.00
January 31 – Rate cut 50 bps to 5.50
January 3 – Rate cut 50 bps to 6.00

RRP chose to argue against a Greenspan “1% (or more)” rate cut by pointing at 1998 (as if today somehow resembles 1998). Using similar logic (which admittedly isn’t very sound), I pointed at 2001. That is not to say I think today’s environment resembles 2001, but was simply meant to point out that the Fed Greenspan could have a lead foot when it comes to rate cuts in times of “crisis”, which I think current events count as.

Then the fun started:

[From energetic:]

So, you want to compare the current crisis with the aftermath of .com collapse? AFAIC, this is a bad model, but you would agree, would you not, that there was a considerable delay in Fed reaction even then?

[From kubrick:]

IAE, regarding 2001, comon man… that was a recession with 9/11 thrown on top to boot. Where is the comparison?

[From RRP: (my emphasis in bold)]

It were not best that we should all think alike; it is difference of opinion that makes horse races” – Twain

And I tend to agree with him. But seriously, this is not some random trash bin on the internet where anyone can say whatever pops into their head and not have to defend it.

So in the spirit of fairness here is whyI think that this is more similar to 98 than not (and coincidentally 98% of the people I’ve spoken to on this are in agreement).

  • Seemingly isolated events torching unrelated markets
  • Deals ground to a halt
  • Media panic about shadowy hedge funds toppling the global financial markets
  • Decrying the fed bail out that has yet to materialize
  • The feeling that there is no end in sight
  • Summer totally getting fucked; My drinking is purely therapeutic at this point and not for recreation

Please let me know why you don’t think it’s similar. And just an aside in my youth, some really old dudes informed me that everyone thinks the first market crisis they experience is really new new new when in fact history repeats itself more than we’d like to admit. It’s just better sales to say we’ve never seen anything like this before, making the same mistake twice appears really really dumb for some reason.

As for 2001 and this being similar, or similar enough to compare fed reactions, please elaborate. Seriously, people got what the hell was going on there, equity markets were getting trounced on the heels of the dot com shutdown but fixed income was in fine shape. Business investment dried up very quickly. This whole irrational exuberance drum was getting pounded before the equities collapse(Greenspan 96). Again, not that it matters if you are ultimately right, because if you miss out on the way up you’re not going to keep your job long enough to be vindicated. Also to the point 2001 was a reaction to fundamental economics, 98 was a reaction to a crisis in confidence. Two different animals in my book. Sir Appleby, I don’t necessarily disagree with you on the Drexel thing but 91 was really a recession as well and I think trying to separate the fed motives for liquidity provision vs. managing targets for key economic variables is a little tougher task. Plus I was just getting pubes in 91 so I don’t have a lot of knowledge of it.

The problem I have with second guessers is that they generally are the last to the party and the first to point out how shitty it is. It’s easy to criticize and hard to create, I mean really are you really disappointed with the Greenspan track record en total from 87 to 06? What would you have done differently? Why do you think things would have turned out better?

Wow. What can I say? That is just real %$#^ed up. To be fair, RRP is probably sitting on a portfolio of CDOs and is understandly not in such a great mood these days (even though I did warn him long ago) 😉

It didn’t end there though. Tabris, ironically speaking of jumping on band wagons, had this to say:

Now with regards to the Fed discount rate, we can all speculate on what G-span would have done (my bet on 25bps cut next meeting if G-span still in office) but it is really a moot point. The fact is, Big Ben is beginning to realise the issue they are having in liquidity and is taking pre-cautionary steps in correcting the LIQUIDITY problem. They are not bailing out HFs or mortgage clowns as HFs will still blow up and Mortgage clowns still have to sit on their bed of toxic subprime loans. Nothing more, nothing less…

Now, less bandwagon jumping, and more evident based debate please.

RRP, you have my respect for being one of the few guys trying to bring this debate back from the pits. Drinks on me next time! Chug Beer

Then, last night before hitting the sack after a very long week, I posted the following:

Why is this not like 1998? In 1998, it was a “liquidity” event. As such, pumping liquidity into the markets does make a certain amount of sense. What is unfolding now is a combination of “liquidity event” with a bursting “credit bubble”. It is not a “mortgage” issue that has spread. Rather, it is a general “fixed income bubble” that is bursting. THAT is different and that will not be made better by pumping the system with liquidity. You can argue all you want (and you’re certainly entitled to) that the Fed had nothing to do with inflating the credit bubble since 2000-2001. You’d be in good company. Conversely, if you thought the Fed’s policies encouraged the credit bubble, you’d also be in good company.

That is the kind of conversation that can be potentially interesting. One where you have super sharp and experienced people on both sides of the aisle with completely opposite views on things. As I’ve said before, I subscribe to the concept of “economic Darwinism” and that a recession now and then is a good thing for long term growth. I am in good company on that one. I particularly enjoyed Andy Xie’s recent piece:

Market Insight: Time to end central bank bailouts of markets

If central banks try to bail out Wall Street, it would lead to high inflation for years. The inflationary effect of loose monetary policy of the past was offset by the deflationary effect of globalisation. Now China and other developing countries are experiencing high and rising inflation. Loose money will go straight into inflation. The vicious cycle of the wage-price spiral of the 1970s has not occurred as both labour and capital still believe in the inflation- fighting credibility of the central banks. If they loosen up again to bail out Wall Street, this credibility may be squandered. The ensuing wage-price spiral could ruin the global economy for years to come.

What is occurring is an opportunity for central banks to restore their credibility. Markets have been taking more risk than they should because they believe that central banks will come to their aid during times of crisis, like now. The penchant of Alan Greenspan, former US Federal Reserve chairman, to flood the market with liquidity during financial instability is the genesis of this “central bank put”. As long as this expectation remains, financial bubbles will occur again and again. Now is the time to act. Let the crooks go bankrupt. Central banks should bury the Greenspan “put” for good.

Band wagon? There certainly may be a lot of that going on these days, but I hope you don’t put me in that category. Just read what I’ve said over the last couple of months. Private equity? LBOs? CLOs? Structured finance in general? High yield? Those might be headlines now, but they certainly weren’t back when I first began blabbering about them (Maybe it was incoherent blabbering, but blabbering all the same). The first time I began publicly voicing my opinion about Bernanke and Greenspan was on July 3 in the “Liquidity Liquidity Everywhere” thread (and no, I am not running around in glee Puke ).

Greenspan and Bernanke are both wankers. I call it “forest fire monetary policy” (there is probably a better academic name). It is better to let the forest burn once in a while in a controlled blaze then to let timber build up over years and years. That situation can only end in inferno.

Believe me, I had been arguing with economists and other analysts about the point far earlier than that. [Sidenote: If you are a noob to monetary policy, but would like to a know a bit about what its all about, I highly recommend A Term at the Fed.] Not that any of that matters, I just felt like debunking the “band wagon” statement, which is a bit like setting up a straw man, don’t you think?

And I’m certainly not criticizing in bad times and chearleading in good. I’ve been warning anybody who would listen about CDOs since the moment I learned about them (and have the well-received research reports to prove it). And now that the sheah has hit the fan, I’ve joined a structured finance group. One reason being that I know there are some great opportunities and working through this time will be a killer learning experience. Having said that, I still wouldn’t touch a CDO with a 10 foot pole, but there is more to structured finance than toxic voodoo magic.


Anyway, it seems that jumping on “IAmEric” has become an increasingly popular recreation sport on NP these days, and since I value the community there, I still want to avoid senseless rants or jibes against my comments which just distracts from the conversation (and decreases the likelihood of having an actual valuable contribution from kr or Bachelier etc). So… I recreated the relevant parts of the conversation here. Have at it! That is what blogs are for. Give me what you got 😉

Written by Eric

August 18, 2007 at 7:31 am

More on CLOs and private equity

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The discussion over at Nuclear Phynance continues.

This morning, we are talking a bit about high yield spreads, CLOs, LBOs, and private equity. Here is my latest contribution

See? It is much more fun to have opinions on the future rather than the past. We will ultimately be able to see who is right rather than looking in the rear view mirror and say what idiots others have been.

Private equity is awash with cash, no doubt, so what are they going to do with it? My opinion is that it is not the intention of private equity to make current shareholders rich (duh!). They’ll only execute an LBO if they think there is profit to be made. Generally, you might think lower equity values would make a company an attractive LBO candidate, but what if the low equity value is because the company’s actual value is decreasing due to deteriorating economic and market conditions? PE will not be catching falling daggers. That coupled with increased financing costs will give PE limited options for investing the cash they are sitting on. If they don’t invest, pension funds and endowments that have gorged them with cash will begin extracting that cash to invest elsewhere. Why pay PE fees for treasury-like (or worse) returns?

The IPO rip cord worked for the partners at Blackstone, but the subsequent tanking will make other PE’s going public more difficult.

Time will tell

Written by Eric

July 25, 2007 at 8:27 am

Posted in CLO, Private Equity