The Big Picture | Hedge Funds

Who is to Blame for Bear Stearn's Demise?

Friday, March 21, 2008 | 09:12 AM

From our Things that make you go Hmmmm department:

There is a meme going around about the death of Bear Stearns (BSC). According to some people (mostly current and ex-employees) the collapse of the fifth largest investment bank in the US is the fault of many people, none of whom happen to be the management of Bear Stearns itself.

Let's review some of the reasons why this was "not" Bear Stearn's fault:

1) Various clients -- like Renaissance Technologies Jim Simons, who pulled his prime brokerage account from Bear a few weeks earlier, as well as short sellers spreading rumors -- caused a run on the bank.

2) The Greenspan Fed, for not giving iBanks a seat at the discount window when Glass-Steagall Act was repealed (K & Co, March 16).

3) The Ben Bernanke Fed, for failing to raise rates more rapidly.

These excuses are a steaming pile of organic, enzyme-free donkey fazoo. One in particular stands out as more manure laden than the rest. I wish to draw your attention to the third excuse, as it was penned earlier this week by, of all people, three Bear Stearns economists. Its titled "Apart From That, Mrs. Lincoln, How Was The Play?" You see, it turns out that because the Fed kept rates so low, we ended up with all this bad paper, which ultimately led to the increase in foreclosures, then a sub-prime implosion, a housing debacle, derivative collapse, counter-party risk, recession, etc. If only the Fed raised rates more rapidly, their argument goes none of this would have happened.

Um, sure it is, if you say so. Now, put the ~~gun~~ keyboard down, and back away from the laptop.

To me, this is the equivalent of blaming McDonalds (MCD) for your being obese. Why-oh-why must they make the Quarter Pounder (with cheese) so delicious? Who amongst us can possibly resist its mouthwatering sesame seed buns, its delectable, fat-laden goodness? Hmmmmm, so scrumptious!

Not everyone else gorged at the trough of mortgage backed securities the way Bear did: They were the most aggressive player in the mortgage backed underwriting arena, their internal hedge funds were amongst the most heavily leveraged to the junk. Indeed, of all the banks on Wall Street, one in particular stands out for how heavily tied they were to mortgage securitization industry: Bear Stearns. Of course, this obviously had nothing to do with Bears' current predicament.

Then there is the small matter of, shall we call it, a lack of diplomacy on Bear's part. Back in 1998, when Long Term Capital Management was going down, the major banks were brought together by the New York Fed President. The only party who refused to participate in the $3 billion bailout (which turned out to be profitable for asl involved) was Long Term's prime broker, Bear Stearns. That's the sort of poor Wall Street corporate citizenry which can make you quite a few enemies. If revenge is a dish best served cold, you can be sure plenty of people were thrilled on Sunday to announce Supper's Ready.

Finally, there seems to be this tendency amongst Bear economists of playing the role of imperfect messenger. Recall that just as the credit crunch was unfolding, it was Bear (of all people!) who advised everyone: Don't Panic About the Credit Market. Ironically, part of Bear's current criticism consists of blaming the Fed today for, well, not panicking back then -- even as they were telling everyone to calm down. Sorry, but you don't get to have it both ways.

The bottom line is that Bear went under because of the poor judgment of their management: their aggressive risk taking, their positions in the mortgage back market, their apparent lack of risk controls, their leverage, lack of liquidity and reserves, and the enemies they made over the years. Sorry to be so blunt, but get real: It was nobody's fault but their own.

Previously:
The "Chutzpah" of Bear Stearns http://bigpicture.typepad.com/comments/2007/08/the-chutzpah-of.html

Sources:
Apart From That, Mrs. Lincoln, How Was The Play? .pdf
John Ryding, Conrad DeQuadros, Meghna Mittal
Across the Curve: Bear Stearns Economics, March 18, 2008

Bear Economists Snipe at Bernanke
Andrew Ross Sorkin
NYT Dealbook, MARCH 19, 2008, 1:32 PM http://dealbook.blogs.nytimes.com/2008/03/19/bear-economists-snipe-at-bernanke/

Wall Street Ponders Extent Of the Woes At Other Firms
SERENA NG and JENNY STRASBURG
WSJ, March 15, 2008; Page B1
http://tinyurl.com/2dyv4s

New Project(s)

Wednesday, September 19, 2007 | 06:00 PM

in Digital Media | Hedge Funds | M&A | Video | Weblogs

What a crazy week -- and the market is the least of it!

We moved from our old space on Park Avenue & 49th (across from the Waldorf) to larger quarters a few blocks over on 5th Avenue. I have been switching back and forth between Starbux and Bryant Park for internet access (and posting less because I have been out of the office more than in). The furniture is in, the phones are hooked up, and tomorrow, rumor has it Verizon will light us up with a big fat pipe, connecting us to that series of tubes.

But what's been really odd is that a dozen seperate projects I have been working on for a few years now -- some big, some small, all eclectic -- have practically all-at-once, simultaneously, lurched towards fruition.

These include:

A major media project

I may join a new BoD

A fun little web project (its potentially very, very funny)

A significant quant application (this is a very powerful tool)

A brand new video venture

Two fascinating blog related advertising concepts

An expansion of an earlier book blogging idea

A new private equity fund

And that was just this week!

We will discuss more about these in the coming weeks; Just about all of them have a market/stock/economic component to them. I'll keep you up to speed with these as they develop.

I expect/hope that at least 3 of these 7 close before Halloween. . .

The Fine Line Between Investment Grade and Junk

Thursday, September 13, 2007 | 03:30 PM

I love a capella, and enjoy a good economic parody. So how could I not love the Richter Scales ode to the 2007 credit crunch, sub-prime implosion, and hedge fund blowups on Wall Street?

Lyrics are below:

There's a fine, fine line
between investment grade and junk
There's a fine, fine line
between liquidity and a crunch
And you never know 'til you settle up
if the credit is benign
There's a fine, fine line
between a gain and a painful decline

There's a fine, fine line
between the theories and the facts
And there's a fine, fine line
between what's solid and what cracks
And now my holdings badly misbehave
and my losses aren't confined
'Cause there's a fine, fine line
between a gain and a painful decline

For years I piled on debt
and smiled as my profits soared
(I even bought a solid gold toilet, yeah)
Now I see that I can't
be levered this much any more
(panicking, I'm panicking, I think I've soiled myself)
Bernanke, please save me,
cut rates, oh I implore...
(please, even 50 bps)

There's a fine, fine line
between a bull and a bear
And there's a fine, fine line
between delight and despair
I'm hoping I'll avoid the pain to come
from trades yet to unwind
But there's a fine, fine line
between a gain
and a crippling, crushing,
mortally wounding decline
(help me)

Mixed by Tat Tong

Inspired by Avenue Q

Martin Feldstein on the Housing/Credit/Economic Mess

Wednesday, September 12, 2007 | 10:39 AM

Regular readers know that I am not a fan of the WSJ Op Ed page. In addition to their playing fast and loose with facts, I find their rhetorical tactics intellectually dishonest. I also suspect that excessive usage of the drug exctasy has left most of their editorial staff crispy remnants of their former selves, subject to frequent delusional flashbacks, delirium tremens and incontinence.

But I must put those intellectual reservations aside and direct you to Martin Feldstein's utterly dead on piece in today's Journal. In a straight-forward, no nonsense manner, Feldstein perfectly sums up how we got to where we are today:

"Three separate but related forces are now threatening economic activity: a credit market crisis, a decline in house prices and home building, and a reduction in consumer spending. These developments compound the general weakening of the economy earlier in the year, marked by slowing employment growth and declining real spendable incomes.

The current credit market crisis was started by widespread defaults on subprime mortgages. Borrowers with poor credit histories and uncertain incomes had bought homes with adjustable-rate mortgages characterized by high loan-to-value ratios and very low initial "teaser" interest rates. The mortgage brokers who originated those risky loans sold them quickly to sophisticated buyers who bundled them into large pools and then sold participation in those pools to other investors, typically in the form of tranches with different estimated degrees of risk. Many of the buyers then used these to enhance yields in structured bonds or even money market funds.

Many subprime borrowers eventually had difficulty making their monthly payments, especially when teaser rates rose to market levels. The resulting defaults exceeded what investors in the mortgage pools had expected.

Credit risk in financial markets had been underpriced for years, with low credit spreads on risky bonds and inexpensive credit insurance derivatives provided by investors seeking to raise their portfolio returns. With such underpricing of risk, hedge funds and private equity firms substantially increased their leverage.

The subprime mortgage defaults have triggered a widespread flight from risky assets, with a substantial widening of all credit spreads, and a general freezing of credit markets. Official credit ratings came under suspicion. Investors and lenders became concerned that they did not know how to value complex risky assets.

In some recent weeks credit became unavailable. Loans to support private equity deals could not be syndicated, forcing the banks to hold those loans on their own books. Banks are also being forced to honor credit guarantees to previously off-balance-sheet conduits and other back-up credit lines, further reducing the banks' capital available to support credit of all types."

Feldstein notes what many TBP readers will recognize as big themes: The significance of housing to the prior "boom," the ongoing risk of inflation, the dangers a slowing economy presents, and of course, moral hazard.

We have seen and heard a lot of anti-free market, who-was-Schumpeter-anyway?, begging for a Fed bailout. Unlike that group of socialist whiners, Feldstein makes the most eloquent and persuasive case I have yet to come across . . .

>

Source:
Liquidity Now!
MARTIN FELDSTEIN
WSJ, September 12, 2007; Page A19
http://online.wsj.com/article/SB118955944544924579.html

One Way Days: Are the rules different this time ?

Wednesday, September 12, 2007 | 07:08 AM

That's the intriguing question asked in a recent WSJ article, New Rules For Picking A Bottom?

Don't leap to the wrong conclusion. The phrase "Its different this time," in its most expensive permutation, refers to rationales why an unsustainable trend will continue, despite obvious risks.

The subject presently at hand is somewhat different: Why are usually reliable technical/quantitative signals failing to have much forecasting prescience?

One of the attractions of quantitative decision making is its attempt to bypass our inherent weaknesses. The way Humans developed has led to a great deal of fallible interaction with capital markets. Error prone decision making is hard-wired into our wetware. (See You just ain't built for it). We bring a lot of baggage to investing, courtesy of a few million years of evolution.

So it is always fascinating when decision making processes designed to bypass this weakness suddenly stops working. And we have seen several examples of this as of late:

90/90 Days: When 90% of volume is in the same direction, and 90% of price moves are also, you get a "One Way Day." These usually are very bullish signals.

"When stocks are approaching the end of a decline, investors tend to be in a panic, and their sell orders dominate trading. Then, once the selling runs its course, bullish investors step in with heavy buy orders that dominate trading and, in turn, signal the beginning of a rally.

Lately, that combination of heavy selling followed by heavy buying is exactly what the market has seen -- on steroids.

"We have been getting these days at the rate of one every 3½ days, and that's just crazy," says Paul Desmond, president of research service Lowry's Reports in North Palm Beach, Fla., who has done extensive research on the subject. "We don't have anything like that anywhere in our history" of data, going back to 1933, he says."

Other independent research shops have had related problems. Ned Davis Research tracks a variation which they call nine-to-one days (trading volume only). The problem is that the huge uptick in volatility has wreaked havoc with these signals. Because there were too many nine-to-one days, Ned Davis simply raised their 9-to-one threshhold to 10-to-one days.

This isn't the first time I've seen this: From 2001 thru 2003, the usually reliable Arms Index simply stopped being a good timing signal for buys. Dick Arms re-jiggered it, placing the basic index into an oscillating framework. Like Ned Davis' approach, this eliminated the previously rare but suddenly all too common signals. The weaker "false" signals were eliminated.

What is different this time is that 2 trillion dollars worth of fast money is in the hands of active hedge funds. Failing to adapt to that could be quite expensive for traders . . .

Sources:
New Rules For Picking A Bottom?
E.S. BROWNING
WSJ, September 10, 2007; Page C1
http://online.wsj.com/article/SB118937309413321829.html

Fear the Roller Coaster? Embrace It
DENNIS K. BERMAN
WSJ, September 11, 2007; Page C1 (THE GAME)
http://online.wsj.com/article/SB118947349416123314.html

Investors' View Of Risk Returns To Normal
Justin Lahart
WSJ, September 10, 2007; Page C1
http://online.wsj.com/article/SB118938618650822150.html

You just ain't built for it
Apprenticed Investor: Know Thyself
Barry Ritholtz
RealMoney.com, 5/3/2005 10:20 AM EDT
http://www.thestreet.com/_tscs/comment/barryritholtz/10221284.html

A Demon of Our Own Design

Tuesday, September 04, 2007 | 10:00 AM

I previously mentioned A Demon of Our Own Design in a linkfest a few weeks ago. I enjoyed the book a great deal, and just about finished it over the long weekend.

The opening paragraph just reached out and grabbed me:

"While it is not strictly true that I caused the two great financial crises of the late twentieth century—the 1987 stock market crash and the Long-Term Capital Management (LTCM) hedge fund debacle 11 years later—let’s just say I was in the vicinity. If Wall Street is the economy’s powerhouse, I was definitely one of the guys fiddling with the controls. My actions seemed insignificant at the time, and certainly the consequences were unintended. You don’t deliberately obliterate hundreds of billions of dollars of investor money. And that is at the heart of this book—it is going to happen again. The financial markets that we have constructed are now so complex, and the speed of transactions so fast, that apparently isolated actions and even minor events can have catastrophic consequences."

Terrific stuff.

Indeed, I enjoyed the rest of the book. Bookstaber was on the scene in the early days of many of derivatives now contributing to market turmoil. He rather deftly makes complex issues readily understandable, regardless of how much advanced mathematics you may have under your belt.

And, he names names. LOTS of names. All the usual suspects come under scrutiny, as well as a lot of folks who probably assumed they were not int he public eye. There will be a lot of people not very happy with his blunt, insider descriptions of the analytical errors made by major players -- many of whom are still around today and in positions of authority and power.

He also accepts a lot of responsibility for many costly errors he himself made.

Overall, a fun, very informative read.

I was intrigued enough by the book that I contacted Bookstaber (the author) and Wiley (the publisher), and asked for their permission to reproduce the first chapter. They graciously sent me a pdf and text version, which you will find after the jump: All of chapter one, in both text form and PDF. I also included some mainstream media reviews after the chapter.

I have pretty good relationships with many of the publishing houses -- they all want to get a book or two out of me. Anyway, if it turns out you guys like this idea, perhaps we can offer up a book or two that I am reading every month in this same format. Maybe we can have an online reading group club -- it could be a good place to have a full discussion. Share your thoughts.

Enjoy chapter one.

~~~
>
Disclosure: No, I don't accept money for this -- it was my idea, and I approached the publisher and author about this -- not vice versa. Please don't start bombarding me with offers to promote books I am not already reading. They will be unceremoniously deleted without response.

As noted in our disclosure section, we don't do payola here (if you click thru and buy it on Amazon, I do see some scratch).

Continue reading "A Demon of Our Own Design"

CDO Insiders: "We Knew We Were Buying Time Bombs"

Friday, August 24, 2007 | 06:00 AM

in Credit | Derivatives | Hedge Funds | Real Estate

Here's an email I received late yesterday from a friend, "R," who was in the CDO business from way back when to right through the past few years.

"R" writes:

"I've been paying attention to your macro economic call lately and you're right on. Three anecdotal stories for you that you can use on Kudlow. (PLEASE don't mention my name).

1. XXXXXX and I were talking in 2003 about how shaky these low FICO, high LTV, 2/28 ARM's that were being created were. People in the know knew then those loan products were going to be a problem in the future. Way back in 2003, it didn't make sense.

2. In early '05, XXXXXX tried to hook me up with a HF he knew that wanted to play the CDO issuer game. I talked to the guy and told him that at the risk of talking them out of hiring me, I wouldn't do it. I thought that game was topped-out even back then. A bit early, but perhaps the right call.

3. I was talking to CDO managers in mid-'05 that were saying how rich sub-prime MBS was and how wrong everyone was for buying that stuff at the spreads they were. To a man, they all agreed they were paying too much for the risk, they all believed that HPA [ED: home price appreciation] was going negative soon. But, sadly, they had to buy the stuff because they needed to accumulate collateral for their CDO issuance. Fuck, we all knew we were overpaying, even back in 2005. We knew it was essentially a bet that home price appreciation was going to continue at levels that couldn't be sustained. No way that could keep going on.

Everyone was saying the same thing: Home pricing cannot continue appreciating at the same rate, and the second this thing turns, we are FUCKED.

Is it really any surprise to anyone that the mortgage business got too far ahead of itself? To me, the only surprise has been it took so long for all of this to happen."

So what was the prime motivating factor?:

"The answer is quite simple: DEAL FEES. I gotta keep buying collateral, in order to keep issuing these transactions as a CDO manager. Its my job: I gotta keep accumulating collateral, and I gotta issue the liability against that collateral.

In 2005, we all said "I hate the real estate market, I hate the credit spread, but my job is to keep doing this: Buying Collateral and issuing CDOs. Everyone was the buying this shit to do any deal. The greed went thru the whole chain, from the home owner buying a property they couldn't afford right up to the CDO manager buying subprime paper."

Why did these managers keep buying this bad junk?:

"Well, nothing is "bad junk" -- it's just priced wrong. No one believed the under-performance of these MBS loan pools would ever be so severe. Everyone knew in the back of their minds that the possibility existed, as did the possibility that residential real estate prices would move LOWER someday.

But no one wanted to be the first to acknowledge it fearing that they'd miss the opportunity to participate in big fees, big alpha, etc. . . ."

Thanks, R. Great insight from inside the belly of the beast.

UPDATE: August 24, 2007 3:49pm

R asked me to add the following:

"I hate the fact that I'm getting pulled into this, but I'm seeing the need to clear a few things up.

1. To Fred or MS, I "had a spine" by walking away from an opportunity to start up a CDO management business at an established hedge fund company in '05. Everyone was going the same way on that trade, the collateral sucked, and HPA was maxing out. What I told Barry about were my observations from daily interactions with buyers of sub-pime HEL's as collateral for their CDO transactions. My role then was on the sell-side. Minds far smarter than mine were eager to accumulate this collateral. Fraud? Nothing fraudulent at this stage of the proccess. If there was fraud, reading an offering memorandum and monthly remittance reports cover to cover or spending hours of cash flow modelling on Intex wouldn't have shown it. Oh, and where was the fraud? My opinion; mortgage brokers possibly lying about and jamming loans into the wrong people to get fees from the lenders. My view on the relative value of sub-prime HEL's during this time period was not nearly as upbeat as others in a world where EVERYONE else was a buyer.

2. Eclectic, it's not quite as disgusting as you might think. Everyone knew the bet they were making; a combination of HPA and continued positive loan performance would continue sans interruption. It was a market call, similar in concept to the market calls most of you reading this make each day in your chosen financial markets and products. It was a bet that the collateral was going to continue doing what it was supposed to. It's a bit annoying when the "talking heads" claim that institutional investors and HF's buying these products don't know what they own. Bullshit. They know. They own a bet on Average Joe's house staying equal or going up in value and his continued ability to make his loan payments.

3. Stuart got it right, unfortunately. In a capitalist society, one sells what people want. And they wanted sub-prime HEL's with HUGE credit spreads such that the arbitrage was bigger. How is that huge credit spead possible? Lower quality loans; low FICO's, low LTV's.

Thanks Barry. I really want these folks to read this extra detail in an effort to clear up mis-understanding."

"Dear Investor" -- Quant Letters to Clients

Thursday, August 23, 2007 | 07:11 AM

in Hedge Funds | Psychology/Sentiment | Quantitative | Trading

These are floating around anyway, so we might as well offer them all up in one place: (Thanks, Rob!)

Below you will find the various letters written to clients from many of the quant shops which have experienced some "dislocations over the past month or so.

The list includes:

AQR (AQR.pdf)
Barclays Global Investor (Barclays.pdf)
Black Mesa Capital (Black Mesa.pdf)
Highbridge Statistical Opportunities Fund (Highbridge.pdf)
Renaissance Technologies (Renaissance Technologies.pdf)
Sowood Capital Management (Sowood.pdf)
TYKHE (GS) (Tykhe.pdf)

I found it particularly interesting that very few managers took real responsibility for what occurred. Only Jim Simons of Renaissance Technologies actually blamed their own system ("the principal culprit was our Basic System") for the recent performance issues.

QuantlettersAug07.pdf

Did I miss any? If so, forward a PDF to me for posting . . .

Update: August 23, 2007 10:23am

An amusing variation of these letters comes to us courtesy of Long or Short Capital blog via fund manager Scott Frew:

Long or Short Capital "Dear Valued Client"
"Dear valued client".pdf

Update 2: August 23, 2007 3:09pm

I see that most of these ran earlier this month in the WSJ:

Dear Investors, We're...

Hedge Funds Strain To Find Words to Say 'Sorry' for Your Losses
GREGORY ZUCKERMAN
August 16, 2007; Page C1
http://online.wsj.com/article/SB118720257346298683.html

The Quants Explain Disaster

Saturday, August 18, 2007 | 06:00 AM

in Credit | Derivatives | Hedge Funds | Psychology/Sentiment | Trading

Floyd Norris posted a fabulous take down of the report from Goldman Sachs entitled “The Quant Liquidity Crunch."

The annotations are by a hedge fund manager who sent me a copy of the report to Norris. The Goldman quotes from the report are in italics, while the fund manager's commentary is on regular type.

a) “we do not believe that current prices reflect fundamental values” — based on what? The very models that failed you last week?

b) “No one, however, could possibly have forecast the extent of deleveraging or the magnitude of last week’s factor returns.” Bullshit. Buffett and Munger have been warning about the dangers of excessive leverage combined with crowded trades for quite some time.

c) “what the market experienced in recent days has been completely unprecedented” More baloney. 100-year storms happen every few years in financial markets. Always have, always will (though every storm’s a little bit different — maybe that’s what they mean). The only completely unprecedented thing was the LACK of any 100-year storms for the past few years.

d) “Going forward, we believe that successful quant managers will have to rely more on unique factors.” Given that you don’t seem to have come up with any, why should anyone believe that you will now? And given that every quant manager on the planet is trying to do the same thing, what makes you think that everyone else won’t come up with the same “more unique factors”?

e) “to protect our investors, we will need to make more of an effort to make sure that our proprietary factors remain proprietary” Yeah, that’s the problem: other quant managers stealing your highly proprietary factors of buying stocks with momentum or companies trading at low multiples of cash flow.

f) “In the coming weeks, we will continue to analyze this extraordinary period. We will also re-evaluate and re-prioritize our research agenda in light of recent events. Stay tuned. As we continue to study these events, we hope to gain additional insights that will help us avoid similar problems in the future.” Translation: we don’t know what happened to us or what we’re going to do about it, but we really, really, really don’t want to admit that the fundamental premise of our business is fatally flawed and shut down, so we’ll come up with something.

g) “we remain confident that stocks with better valuations, higher profitability, better earnings quality, shareholder-friendly management, strong momentum and improving analyst sentiment will outperform” I think they just about covered every single investing cliche here…

h) “our process should continue to add value under normal market conditions” Finally, in the last sentence, they perhaps inadvertently reveal the truth: their success depends on NORMAL MARKET CONDITIONS! In other words, what they do works 99% of the time, but the other 1% of the time they blow up — especially since they insist on using a ton of leverage because their brilliant models tell them that what happened last week was a 28-standard deviation event. Hint: IT WASN’T!

Fantastic stuff . . .

Source:
The Quants Explain Disaster
Floyd Norris
Notions on High and Low Finance
NYT, August 15, 2007, 6:16 pm
http://norris.blogs.nytimes.com/?p=244

See Also:

The Shareholder Letter You Should, But Won’t, Be Reading Next Spring
Jeffmatthewsisnotmakingthisup
Wednesday, August 08, 2007
http://tinyurl.com/yuu7jf

Dear Investors, We're...
Hedge Funds Strain To Find Words to Say 'Sorry' for Your Losses
GREGORY ZUCKERMAN
WSJ, August 16, 2007; Page C1
http://online.wsj.com/article/SB118720257346298683.html

Open Thread: A Stealth Fed Rate Cut?

Thursday, August 16, 2007 | 07:30 PM

in Credit | Derivatives | Federal Reserve | Hedge Funds | Psychology/Sentiment

Today's absurdity was this rumor circulating that the Fed was arranging a secret meeting.

Than the rumor came that they were going to cut next week.

But my favorite rumor du jour was passed along by the WSJ: You see, according to some of the more cleverer ~~Horse~~ Central bank Whisperers out there, the FED HAS ALREADY CUT RATES.

"The Fed's primary weapon is its influence over the federal-funds interest rate, at which banks with excess reserves lend to banks that are short reserves. When demand soared last week and the market interest rate rose above the target, the Fed pumped in extra cash. But in times of turmoil, it can be difficult for the Federal Reserve Bank of New York to fine-tune its interventions. In recent days, the rate has traded well below the Fed's target at some points of the day -- even coming close to zero at times. That has prompted some in the markets to deem this "a stealth Fed easing."

That was the reason given for the comeback today. Not that we had sold down 1,500 Dow points in less than a month, but (shhhhh!) whisper after me: "Fed cut."

Stealth cut, or absurd rumor?

What say ye?

Update: August 17, 2007 9:38am

Whoopsadaisy!

FOMC statement

Federal Reserve Board discount rate action

Source:
Has the Fed Secretly Cut U.S. Interest Rates?
Markets Wonder As Federal-Funds Rate Lingers Below Target
DAVID WESSEL in Washington, LAURENCE NORMAN in New York, ENDA CURRAN in Sydney and MICHAEL S. ARNOLD in Tokyo
WSJ, August 16, 2007 2:25 p.m.
http://online.wsj.com/article/SB118726976751399608.html

Subprime Credit Rot

Thursday, August 16, 2007 | 03:30 PM

in Credit | Derivatives | Hedge Funds | Psychology/Sentiment

Rather than respond to the various cheerleaders and pollyannas (Ben Stein, Brian Wesbury, David Malpass, et. al.) who have been telling us how great things are even as recently as this week, I prefer to respond via some humor, culled from around the web.

First up: Long or Short Capital:

The Jitters
by Johnny Debacle

Guy #1: Subprime?
Guy #2: Subprime?
Guy #1: Subprime.
Guy #2: Jitters.
Guy #1: Exposure?
Guy #2: Subprime Jitters.
Guy #1: INFLATION.
Guy #2: No, CONTAGION.
Guy #1: But the expected loss on all residential subprime loans is de minimis to the greater economy.
Guy #2: Liquidity. And contagion.
Guy #1: Oh. Fuck.
Guy #2: Commercial paper.
Guy #1: The end.

And I love their tag line: "Let us think for you, since we're better at it."

And, the always amusing Ben Sargent:

via Yahoo!

How To Speak Hedgie

Wednesday, August 15, 2007 | 11:30 AM

in Hedge Funds

Amusing linguistic observations from Slate's Dan Gross:

Hedge-Fund Phrase: Challenging
Translation: Run for the hills!

Hedge-Fund Phrase: Unprecedented, unique circumstances
Translation: Stuff happens. But we had no clue.

Hedge-Fund Phrase: Market volatility has produced unfair, unrealistic prices.
Translation: The market is efficient only when it works in our favor.

Hedge-Fund Phrase: Our results were affected by the selling behavior of other firms.
Translation: We made the same dumb trades as everyone else.

Hedge-Fund Phrase: We just want to protect investors.
Translation: We just want to cover our butts.

Hedge-Fund Phrase: This isn't a rescue.
Translation: THIS IS TOTALLY A RESCUE!!!!!!!

Great stuff! The full article is here:

Source:
How To Speak Hedgie
What hedge-fund managers mean when they talk about challenges.
Daniel Gross
Posted Tuesday, Aug. 14, 2007, at 4:16 PM ET
http://www.slate.com/id/2172224/

Ratings Agencies 2007 = Equity Analysts 2000 ?

Wednesday, August 15, 2007 | 06:34 AM

in Credit | Derivatives | Hedge Funds | Psychology/Sentiment | Real Estate

Way back in the late 1990s into the early 2000s, a previously well regarded group -- stock analysts -- subtly shifted the objectives of their work. Previously, they plied their skills looking for stocks their clients and trading desks could make money buying and selling.

But things change, commissions shrunk from 10 cents per share to 6 to 3 to mere half pennies today. The old business model no longer applied. What rose in its place was a new model that emphasized not the trading of equities, but the investment banking fees that accompanied IPOs. Many analysts compromised their objectivity on the altar of banking fees. This was especially true in the Internet/Technology/Telecom space.

Thus, they went from being somewhat valued allies of the investor class to the guys helping to dump the dogs into an unknowing public's portfolios. Since then, many of this crowd has been vilified (Jack Grubman, Henry Blodgett, etc.), and the securities industry got Spitzerized to the tune of some $$1,387.5 Million dollars in fines (a deal I suspect they would do all over again if they could).

Fast forward to the early 2000s. Interest rates are at 46 year lows, and this time around, another group of ~~shameless whores~~ analysts are following the same playbook: The ratings agencies that gave their AAA blessings to the now defaulting alphabet soup of RMBS, CDOs, CLOs, ABX structured products that has so recently seized up the credit markets.

It was a simple case of pay-to-play to get rated. Portfolio's Jesse Eisinger goes into the ugly details of a surprisingly familiar story:

"Moody’s and S&P dominated for decades, and their business model was straightforward: Investors bought a subscription to receive the ratings, which they used to make decisions. That changed in the 1970s, when the agencies’ opinions were deemed a “public good.” The Securities and Exchange Commission codified the agencies’ status as self-regulatory entities. The agencies also changed their business model. No longer could information so vital to the markets be available solely by subscription. Instead, companies would pay to be rated. “That was the beginning of the end,” says Rosner.

It might come as a surprise, but rating credit is a heck of a business to be in. In fact, Moody’s has been the third-most-profitable company in the S&P 500-stock index for the past five years, based on pretax margins. That’s higher than Microsoft and Google. Little wonder that Warren Buffett’s Berkshire Hathaway is the No. 1 holder of Moody’s stock.

McGraw-Hill’s most recent financial report shows that S&P has profit margins that would put it in the top 10. Fitch Ratings, owned by the French firm Fimalac, is a distant third in market share but nevertheless has an operating margin above 30 percent, about double the average for companies in the S&P 500.

In 2006, nearly $850 million, more than 40 percent of Moody’s total revenue, came from the rarefied business known as structured finance. In 1995, its revenue from such transactions was a paltry $50 million. . ."

The entire article is well worth your time to read in full.

Yes, Moody's, S&P, and Fitch were complicit in what is slowly coming to be viewed as widespread fraud. However, there is more than enough blame for the failure of the credit markets to spread around. The ratings agencies fraudulent ratings -- I won't even bother with the word alleged -- are merely the tip of the iceberg.

As much as the ~~whores~~ credit agencies have a large share of responsibility in this mess, do not forget to save some blame for an even greater ethically challenged industry: those clever folks who work at Wall Street's biggest iBanks. As related by Reuter's Patrick Rucker, it seems that Wall Street often shelved damaging subprime reports. (Sweet!) Here are the details:

"Investment banks that bundle and sell home mortgages often commissioned reports showing growing risks in sub-prime loans to less credit-worthy borrowers but did not pass on much of the information to credit rating agencies or investors, according to some of those who prepared the reports.

The mortgage consultants, known as due-diligence firms, were hired by investment banks to make sure blocks of mortgages conformed to the mortgage seller's own standards. The studies provided a first glimpse of loan quality for ratings agencies and investors who do not normally see the full reports.

As the U.S. housing boom reached its crescendo in 2006 and investors showed a strong appetite for mortgages, lenders relaxed their underwriting standards, and millions of borrowers with poor credit records were able to obtain subprime mortgages as a result.

Default rates on many of those subprime mortgages are now rising, some borrowers face foreclosure on their homes, and investors in the mortgages face losses." (emphasis added)

At this point, we should expect to see a flurry of investigations into the rating agencies and the same slew of Wall Street firms that were involved in the last analyst scandal.

The saving grace for Wall Street maybe (emphasis maybe) that this was less of a "systemic fraud" than the 1998-2002 scandal. They may perhaps escape by merely jettisoning these bad actors, throwing them under the bus to save their own skins. Perhaps.

We will also find out if the S.E.C. has developed the cojones to go after their own, a shortcoming sadly lacking last go round.

Finally, if the S.E.C. fumbles, we may learn if NYS Attorney General Andrew Cuomo is willing to do what his predecessor, Eliot Spitzer did: challenge Wall Street's God given right to do anything it can regardless of consequences to earn banking fees.

I suspect the next 24 months are going to be quite intriguing . . .

UPDATE: August 15, 2007 7:15am

The WSJ also has a page 1 column on the subject: How Rating Firms' Calls Fueled Subprime Mess >

Sources:
Overrated
The subprime-mortgage meltdown could— finally—end the credit-ratings racket.
Jesse Eisinger
Portfolio, August 14, 2007 (September 2007 Print Issue)
http://www.portfolio.com/news-markets/national-news/portfolio/2007/08/13/Moody-Ratings-Fiasco

Wall Street often shelved damaging subprime reports
Patrick Rucker
Reuters, July 27, 2007
http://www.iht.com/articles/2007/08/01/bloomberg/sub.php
Mirror (IHT)
http://www.boston.com/business/articles/2007/07/27/
wall_street_often_shelved_damaging_subprime_reports/

How Rating Firms' Calls Fueled Subprime Mess Benign View of Loans Helped Create Bonds, Led to More Lending
AARON LUCCHETTI and SERENA NG
WSJ, August 15, 2007; Page A1
http://online.wsj.com/article/SB118714461352698015.html

Goldman Sachs Conference Call Highlights

Tuesday, August 14, 2007 | 01:30 PM

in Corporate Management | Derivatives | Earnings | Hedge Funds

Paul has the full scoop: Highlights from Goldman Sachs' Conf Call Today

(Is it so wrong to find this terribly amusing?)

Quote of the Day: "the stunning failure of responsibility"

Wednesday, August 01, 2007 | 05:00 AM

From the author of The Long Emergency, comes this just about perfect summation as to the present situation:

"Last week's stock market meltdown suggested that a financial sector rigged for the falsification of reality eventually enters a danger zone where reality implacably reasserts itself, expectations dissolve, and all that remains is the sour odor of fraud.

This long episode of market mania, running for seven years, was based on the idea that non-performing loans could be turned into money by removing them from their point of origin and dressing them up in respectable clothes -- like taking all the winos in downtown Los Angeles, putting them in Prada suits, and passing them off as the faculty of the Harvard Business School. It was a transparently ludicrous racket and the wonder is that America proved to be so utterly bereft of regulating authority -- not to mention plain decency and self-restraint -- at every stage.

It's really hard to account for the stunning failure of responsibility. What you had was a whole industry that surrendered the standards and norms that brought it into being and enabled it to function in the first place. Mortgage lenders stopped requiring house-buyers to qualify for loans; bankers stopped caring what stood behind the paper they issued; dubious loans were bundled and resold like barrels of rotten anchovies -- in such numbers that no individual stinking minnow would stand out -- and the barrels were traded up the line, leveraged, hedged, fudged, fobbed, and fiddled until, abracadabra, they were transformed into so many Tribeca lofts, Hampton villas, Piaget wristwatches, million-dollar birthday parties, and Gulfstream jets.

It worked for the Goldman Sachs bonus babies, and the private equity scammers, and for the corporate CEOs and their board members, and for the politicians who parlayed their votes into cushy lobbying jobs, and even for the miserable quants in the federal government's termite mounds of statistical reportage. It even worked for about 18 months for millions of feckless US citizens gulled into contracts for houses they could never hope to pay for, under arrantly false and ruinous terms . . ."

Ouch!

Source:
Vanishing Point
Jim Kunstler
Clusterfuck Nation, July 30, 2007
http://jameshowardkunstler.typepad.com/clusterfuck_nation/2007/07/vanishing-point.html

Brief Foreclosure History & Mortgage Delinquency Maps

Thursday, July 19, 2007 | 06:15 AM

in Credit | Derivatives | Hedge Funds | Real Estate

A very short history of how we got here:

All of the turmoil in the CDO, hedge fund, and subprime space has come about due to a very simple reason: An inordinate number of recent home buyers have been defaulting on their mortgages.

The why of this is rather simple: These are the folks who historically have not been home owners due to their debt obligations, low income, and/or poor credit. In the past, they were known as renters.

The ultra-low rates that Easy Al put into place when he dropped the Fed Funds to 1% started an entire chain reaction of events: If high rates keep home prices down, well you can guess what ultra-low rates do. Home prices rose due to the lower monthly carrying costs, and we were off to the races..

But the boom begat a feeding frenzy, and corruption soon followed. The appraisers faked values to get loans approved (making a 100% LTV look like a 80%). Mortgage brokers quickly learned how to get nearly anyone approved through no doc/no income check loans, AKA liar loans. A bunch-o-new mortgage products came out -- Interest only ARMs, LIBOR based, etc. I am not sure what legitimate purposes these very profitable products served, but we know what they accomplished: They got people into homes THEY COULD NOT AFFORD.

Hence, when rates ticked up, when prices stopped rising, when people could no longer bootstrap paying their mortgages by taking out more home equity loans, the foreclosure rate began to rise.

When this happens, the RMBS/CDOs that have been sliced and diced and resold by iBanks to funds start to devalue. Since so many of these funds use huge leverage, the problem gets magnified.

Hence, the recent Bear Stearns and other fund problems.

~~~
To put this into a geographic context, here is where the foreclosures are coming from:

2007 Q2 Delinquencies:
click for larger maps

Source:
Mortgage Delinquencies
WSJ, July 19, 2007
http://online.wsj.com/article/SB118481288641971250.html

The Bear Facts: Mortgage Woes Are Apt to Worsen
RANDALL W. FORSYTH
Barron's JULY 18, 2007 10:45 a.m. EDT
http://online.barrons.com/article/SB118470690240369216.html

Efficient Market/Random Walk Joke

Monday, July 09, 2007 | 09:58 AM

Here's my variation on the classic EMH joke:

Two Economics professors are walking back to their offices after giving a lecture on the Random Walk of stock prices.

"Look!" says one of the academics, "There's $1.7 billion dollars!"

"Nonsense!" says the other. "The market efficiency hypothesis states that security prices fully reflect all available information. That money is impossible."

"Schmucks!" laughs Jim Simmons of Renaissance Technologies. He picks up the money and goes back to his office.

You may now return to your previously scheduled belief system.

10 Questions About CDOs

Saturday, June 30, 2007 | 11:11 AM

in Credit | Derivatives | Hedge Funds | Investing | Psychology/Sentiment

James Hamilton at Econbrowser asks the remarkably sanguine question: CDOs: what's the big deal?

He does a nice job looking at many of the issues this topic raises. However, I still have some unanswered questions about CDOs:

Thus, I will respond to the Prof in true Socratic method by asking more questions. These raise the possibility that not only CDOs may be a big deal, but we don't have a clue how big a deal it may be -- Modest? Gargantuan? Ginormous?

Here are my 10 questions:

1. What would have happened had Bear Stearns simply let their two funds, High-Grade Structured Credit Strategies Fund and High-Grade Structured Credit Strategies Enhanced Leverage Fund, dissolve?

2. If CDOs are not priced to market, what are the actual values of these holdings?

3. How levered up are the funds that own the bulk of the CDOs? 10-to-1? 20-to-1? More?

4. How many Hedge funds are or have been taking quarterly or annual performance profits, based in whole or in part, on hoildings that have been marked to a theoretical value ("Mark-to-Model") versus an actual value ("Mark-to-Market")?

5. Liquidity has been a driving force behind M&A activity, share buybacks, and leveraged buyouts. Might the CDO situation somehow impact liquidity?

6. Might a liquidation in a CDO/illiquid derivative fund spread to other asset classes?

7. How widely held are the toxic CDO tranches in funds that are self-decribed as "conservative" or "risk averse?"

8. How accurate are the major ratings firms (Moodys, Standard & Poors, Fitch) assessment of these products. Are these outfits arm's length objective raters, or are they merely corporate whores who play for pay?

9. After the final chapter is written on CDOs, what might the total losses on the $250 Billion in quarterly CDOs that Wall Street has created actually be? 10 Billion? 100 Billion? 1 Trillion?

10. How much will systemic confidence be impacted if there is a series of large fund failures due to CDOs? What impact might that have on the rest of the markets?

The big deal is that we simply know so little about these issues. Wall Street has gotten better, for the most part, about managing risk. But these CDOs are increasingly looking like unknown factors, with an unknown set of risk parameters.

Hence, that is what the big deal is . . .

Saturday, June 30, 2007 | 11:11 AM | Permalink | Comments (25) |