Phorgy Phynance

Archive for the ‘Sovereign Wealth Funds’ Category

Another word for hedged… leveraged

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Market turmoil is still quite fascinating to me and I still believe the current environment will be one for the history books and I’m still trying to take as much as I can from this learning experience.

My professional work experience is in fixed income. For two years, I was very “plugged in” to the markets and was meeting regularly with some of the greatest thinkers out there, but now I’m more of a pure “quant” and most of my news comes from blogs, web news, etc. Unfortunately, I’m not yet spending as much time with the traders as I’d like (but that should change soon I hope). Most of the major news sources, e.g. Bloomberg, seem to concentrate more on equity markets than credit and fixed income. I pay more attention to the Dow now than ever before. That is why I am so perplexed by the stock market. I thought stocks were supposed to be easier than bonds, i.e all the smart guys are in fixed income, right?

So while the credit markets seem to be imploding, stocks are doing just dandy. Maybe people are taking cues from the market cheat sheet?

Anyway, I’ve blabbered quite a bit on this blog (and at my former employer) expressing my opinion of CDOs. I even managed to upset quite a few people while expressing my opinions as well. No regrets though. I’m happy to have this hugely public diary, both here and on NP, to later look back and see how I did in regards to thinking events through. Occasionally, I still like to poke my nose in over at NP and I see kr is still giving out the occasional nugget. Here is one of his latest:

A few thoughts:
– If you took all the writedowns at a single med-to-large bank rather than seeing them across the street, you could have reduced that entity’s equity to ZERO. For instance, MER has only something like USD54bn of mkt cap and USD39bn of book equity.
– If the view is that there will be another round of writedowns in the same amount as Q3 then you will have banks desperate to raise equity (i.e. it is not just the monolines). Who would buy that equity right now? Prince Alwaleed for example has floated his own holdings so I see him more as seller than buyer for example. I don’t see guys like JC Flowers or Cerberus well positioned for this job – in retrospect, even Barclays/RBS have not been with respect to ABN, as can be seen by the action in their share price and cost of jr capital.
– Another possibility would be the downgrade to BBB like the Japanese banks, with all the implications that brings with it. I.e. serious change in business model. That has contagion and macro effects. One example is that flow trading of financials has cost people a lot.
– I think investors will call foul on the FAS157 Level-3 assets, and it will hit guys like GS seriously as their L3 reporteds are a big multiple of their mkt cap.
– There was a funny comment in this month’s BBG mag about “nobody really knows how desks are hedging the CDO assets.” That is bull – the answer is that most people were NOT HEDGING AT ALL, BECAUSE THEY COULDN’T. Stuff was originated to sell, and the exit has vanished, or, it was originated to live forever on a trading book even though people tried to avoid saying that, and there is no decent MTM approach so instead banks are showing huge volatility, mostly to the downside.
– Implications of SIV / CDO / CP demise are pretty vast. There seem to be an increasing amount of trade receivables on the market, b/c there are no conduits to fund them… means corp cost of cap is going up in unexpected areas.

My hunch is that the fed cuts on the 11th b/c liquidity is dropping again, especially with year-end. It is out of control – specifically Ben’s control. It looks like political support for the various subprime fixes has stalled. What I think is that liquidity of all things financial (i.e. non-corporate) is going to get weaker and cause a full-on crisis for a market-traded institution. The talk about Citi cutting their div is one tremor, trading activity in Barclays is another, and the fact that even AFTER all the reported loss numbers, people still don’t feel comfortable, is yet another.

I think vols are still cheap, maybe looking to buy some.

All the while I was complaining about CDOs, I was coming at it from the angle of a “quant”, i.e. thinking about how to model CDOs and how those models are used in risk management, asset allocation, etc. Too bad I didn’t understand more about the legal/accounting aspects of CDOs. The term everyone has now heard of is SIV. I was blabbering about off balance sheet leverage and fair value accounting, but didn’t realize that the entire CDO market was (to a jaded eye) a big play on accounting in addition to the obvious play on ratings agencies. If I had known about SIVs, I might have been able to do more to help some who may have now lost a lot of money. Maybe not. That’s all in hindsight. But what am I missing now? Where is the next weakest link? How are corporations hiding off balance sheet debt? Has anyone looked at “Level 3” assets in corporate, i.e. non-financial, balance sheets? Are they as scary as the big banks?

I’ll say it again… this is not a subprime issue. Subprime contagion does not explain the current environment. Subprime was just the first to blow. We are experiencing the blowup of a global fixed income bubble. In fact, some would say we’re experiencing a general global asset bubble.

Who’s going to get hurt? Financial institutions for sure. Anyone who depends directly on the value of paper assets.

Who’s going to win? People whose wealth depends on physical assets.

I’ve already lost all hope in Bernanke. He is not going to let his monicker “Helicopter Ben” go by the wayside in a “time of need”. Bernanke is going to lower rates and weaken the USD until oil exporters are forced to break the peg to the USD and inflation skyrockets. I predict that all these gloom mongers about home prices dropping by 30% will turn out to be wrong in nominal terms even if they are correct in real terms. In other words, home owners are going to be saved by the dropping value of the USD. All those on Wall Street who were so gleeful every time rates dropped are suddenly going to feel the pain when the value of their paper securities go up in smoke.

Watch out for the “happy stage of inflation”, i.e. wage increases. It will be interesting to see what the world will look like when oil is priced in EUR and the USD is no longer the world currency. Fortunately, I still have faith that we’ll come out of the current mess stronger as a country, but there will certainly be pain felt at the higher end of the wealth spectrum.

I’m actually ironically optimistic about the outlook for suburban and rural economic development. A weaker dollar will make outsourcing less attractive. That will bring manufacturing jobs back home. I can imagine a boon in suburban and rural development. Just imagine if communities developed decent broadband via fiber-to-the-home/business. Suddenly, there will be attractive jobs and living standards in affordable places.

Maybe a weak dollar is what this country needs, i.e. a good kick in the pants. Pain is the best teacher, right?

[Edit: PS, the title of the post was inspired by a great article on Financial Armageddon, but I never got around to explaining why, but have a look and it might be obvious.]

Real money M&A

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Way way back a long time ago (in August), I clarified a semantic issue regarding one of my market forecasts (more like voodoo analysis) I made on July 24 here:

Non-Leveraged M&As versus LBOs

Here is a snippet:

But regarding that quote above from my last post, there is something I wanted to clarify. Particular the chain of events that I outlined, i.e.

subprime CDO imploding -> HY repricing -> CLO slowing -> LBO stopping -> private equity choking -> equities tanking -> M&A increasing -> ???

At the time I wrote that, we were only on step two, i.e. subprime had imploded and HY had repriced (a bit). I think their is still long way down to go for credit, but at the time I wrote that CLOs hadn’t been hit yet, LBOs were not on the radar screen (of most anyway), and the idea that private equity was in trouble seemed ludicrous. How about now?

Now, everything has occurred except “M&A increasing”. At the time I wrote that I was distinguishing LBOs from M&A, but have since learned that many people include LBOs under the M&A umbrella, so I thought I would clarify what I meant by that last item before the “???”.

LBO activity was driven by (at least) two factors: easy credit and value in acquiring companies. The first factor is now gone, which is why private equity is hurting. The second factor remains. Easy credit made it difficult for real-money people to take advantage of the value in acquiring companies because of competition from private equity. With easy credit gone and private equity struggling to get LBOs done, now people/corporations with real money on hand can take advantage of the situation.

By “M&A increasing” I meant that mergers and acquisitions that are not dependent on leverage, i.e. by people/corporations with “real money”, would increase. This, I thought, would prop up equities for a while longer. For example, on July 25, I said:

Since I expect LBO activiate to be significantly hampered, if not halted, and since there is value in stripping some of the companies, I expect more M&A activity to replace LBO activity.

I meant “non-leveraged” M&A. So watch for this. The first sign of this happening that I’ve seen comes from Bloomberg in regard to Warren Buffett. Certainly a “real money” guy.

Buffett’s $46 Billion in Cash Could Buy Kohl’s, Nucor

Here’s an excerpt:

Berkshire Hathaway Inc. Chairman Warren Buffett is ready to spend $40 billion to $60 billion on an acquisition, and his opportunities are expanding as stocks fall and leveraged buyouts dry up.

Shares of health insurers, steelmakers and department stores are as much as 22 percent cheaper than in May, when Buffett said he would “figure out a way” to come up with $60 billion for the right deal. WellPoint Inc., Nucor Corp., Kohl’s Corp. and dozens more companies are now closer to meeting his investment criteria.

It seems we are approaching the faintest regions of that earlier “prediction”. Real money seems to be stepping up and it is not necessarily from the obvious candidates. Watch out for sovereign wealth funds to keep things propped up for a while longer.

A bit dated due to my reduced blogging pace:

Gulf Counters M&A Slowdown With $25 Billion of Deals

and a bit more recent via a guest appearance on Brad Setser’s blog

Soverign wealth funds

Michael Pettis seems to think sovereign wealth funds can prop up the market for years to come. I tend to agree with him (but not sure if the time span is years… or months). By the way, as a sidenote, when I asked someone at work about the possible positive influence of sovereign wealth funds on structured finance, I was shot down pretty publicly. It was brutal. Friendly new colleagues seemed to get a kick out of it and still rib me about it to this day. Pick on the new guy! 🙂 Oh well. I’ve decided to keep my mouth shut about markets and economies during high-profile meetings. After all, I’m not an economist or even a market analyst. I’m a quant. As a quant, I am quite competent and should just stick with what I know when it comes to my actual career. On the “quant” front, however, I’ve recently developed some massively cool technique for rapidly producing analytics, e.g. OAS, OA duration, etc for a large pool of securities. In the “privacy” of my own blog, I can say whatever I want though 😉

Written by Eric

September 23, 2007 at 11:28 pm

Bye bye dollar

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Needless to say, after my comment on August 28

PS: I’ve been ignorantly harsh on both Greenspan and Bernanke, but I have to say that I am quite impressed with Bernanke’s recent performance maneuvering through the current credit crisis. I expect him to hold the target rate at 5.25% on September 18. If he does, I’ll gladly apologize for anything less-than-flattering I’ve ever said about him. If he lowers rates, I’ll lose respect and throw him back in the Greenspan “save my Wall Street buddies” bucket.

I wasn’t particularly excited about the surprise 50 bps cut in both target and discount rates for the general long-term prospects of the US economy, although on a selfish level it was certainly good for my career stability. As far as I’m concerned, it is open season for Bernanke bashing. Greenspan bashing has been accelerating as well. Besides, if things really get bad with the USD, we’ll just move to Hong Kong or something 🙂

One of the things that I learned from Al Wojnilower was that the US economy could certainly keep chugging along for as long as the USD was the world currency. As he liked to repeat often, having the USD as the dominant world currency is like having an “American Express card with no limit”. One of the things that keeps the USD as the world’s currency is its position in sovereign reserves as well as the fact that oil is priced in USD. As far as I can see, both of these factors are beginning a worrisome decline.

With sovereign reserves continuing to diversify away from USD and Saudi Arabia refusing to cut rates in lock step with the US marks a real turn in the outlook for the USD dollar, and consequently the ability of the US economy to continue chugging along.

Written by Eric

September 22, 2007 at 7:28 am

Flight to non-USD quality revisited

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Historically, sovereign reserves were (from my understanding) ultra conservative and consisted of mostly US treasuries. Increasingly, these sovereign reserves have been managed more actively and we are hearing more and more about the growth in sovereign wealth funds. When 40% of all US debt is held OUTSIDE the US, what is going to happen in a turning credit cycle?

On July 25, I stated my opinion on the subject in the post

Flight to non-USD quality

I also suspect that a “sovereign” flight to quality will not be a flight to US treasuries and in fact may be a flight away from US treasuries into EUR denominated government bonds. So as the credit market turns, the typical safe haven will not be available as even treasuries get whacked from sovereign sellers.

I may have been wrong about the EUR (or maybe I was right… time will tell), but it made sense to me then as it does now that sovereign wealth managers will not necessary flee to the “quality” of US treasuries as the credit cycle turns. In fact, it made sense to me then as it makes sense to me now that sovereign funds will turn their backs on US treasuries causing treasury yields to rise. This would hurt US investors who typically considered the US treasury to be safe during times of crisis.

Don’t get me wrong. It is not that I WANT bad things to happen. I am an optimist after all 😉 If I do manage to get one or two things right, rest assured I am not running around in glee with my t-shirt over my head.

Mostly, my comments on this blog are driven by two things. On the one hand, I am hoping to maximize my personal learning experience so that I will ultimately become a better investor. I expect to one day to have people put their faith in me with hard earned savings. I take that responsibility very seriously and want to be the best investor I can be. For both my own sake as well as those who place their trust in me. On the other hand, I hope that something I say may help others more experienced who currently are responsible for investing other people’s money to see things in a different light. I generally have unique or unorthodox ways of interpreting things and that has often benefited me as well as those who have worked with me. If something I say manages to generate a good investment idea, I will be happy.

With all that said, I found today’s BBG article to be very interesting.

Treasury Gain May Falter; Foreign Holders Flee Dollar

Treasury investors basking in the biggest rally in four years have reason to fear for their profits: The largest owners of U.S. government debt are heading for the exit.


U.S. long-term interest rates would be about 90 basis points, or 0.90 percentage point, higher without foreign government and central bank buyers, according to a 2006 study for the Fed by Professors Francis and Veronica Warnock at the University of Virginia in Charlottesville.


Government and central bank holdings of U.S. government debt at the Fed fell by $46.1 billion from the week ended July 25 to the week ended Sept. 5. They climbed to a record $1.25 trillion in July from $574 billion in June 2001.


Asian central banks also reduced Treasuries last month in an effort to curb dollar gains against their currencies. Taiwan’s central bank cut its currency reserves by $4.9 billion in August, mostly by selling U.S. bonds, George Chou, a deputy governor of Central Bank of the Republic of China (Taiwan), said in an interview.

Even before the flurry of sales, more nations were starting to shift foreign-exchange reserves away from U.S. government bonds.


China will likely, and appropriately, “reduce its holdings of dollar assets to get higher returns,” said Ha Jiming, chief economist in Beijing at China International Capital Corp., the nation’s largest securities firm. Ha attends central bank Governor Zhou Xiaochuan’s quarterly meeting with the nation’s lenders.

The $50 billion Qatar Investment Authority said on Sept. 4 it is looking for options in Asia to counter a weak dollar.

Makes perfect sense to me. A little common sense seems like it can go a long way these days.

Written by Eric

September 9, 2007 at 9:49 pm