What might have been significant yesterday, the BoE cutting the reference rate, was negated when the ECB did not follow suit…in fact, President Trichet expressed concerns over inflation. This puts even more pressure on the Fed since an easing could imply a lack of concern and strengthen the belief (fact as far as TB is concerned), that an easing won’t stimulate the economy but merely mitigate some of the pain for individuals…certainly not the financial sector! This, along with the Paulson plan makes a double whammy for financials.
…66 years ago today FDR declared Dec. 7, 1941 a day of infamy and united the country to go to war against Japan and ultimately Germany (of course his lend lease to Britain of our old destroyers formed an undying bond with the UK while allowing him to appease the doves and at the same time to build a fleet of destroyers that truly won the war in the Pacific for us). 13 years ago today…hey, this is no time to be superstitious and that was just two sixes above, not three…we learned that Orange County, California had filed for bankruptcy at 5pm the night before, setting off a string of problems. The problem was overleveraging the county investment portfolio thru reverse repurchase agreements…mainly with Merrill Lynch…and once again they make the news…TB thought a friend was referring to Orange County, Florida which is in the Florida fund, but nope it was the real OC! This time with CDS and asset backed paper of SIV’s.
The last OC problem, which TB was intimately involved in knowing every one of the players, and having formerly worked for Merrill and having to testify twice before a Grand Jury as a holder and expert witness, was followed by revelations at San Diego County (which was not leveraged as much but also held a lot of structured debt instruments, and later the pension fund lost money to Amaranth), and San Bernardino County (whose fund was run by a man ran up huge losses at L.A. County and was later who was later convicted of taking bribes there along with the Treasurer). About 10 years earlier San Jose, California was on the hot seat by overleveraging the portfolio. OC’s Treasurer, Bob Citron, was convicted over financial reporting as was his assistant Matthew Rabbe. The point of this is that municipal employees are susceptible to engaging in the same behavior as they deal with the same brokers and talk at their conferences…monkey see, monkey do. This is not to be confused with the pension funds which rely on outside consultants (of course they failed to tell their clients, public and private, to rebalance and reduce stock holdings to 60% of the portfolio during the late ’90’s, which would have mitigated some of their losses). An irony is that OC’s whistleblower, an accountant named John Moorlach, succeeded Citron as Treasurer and used draconian measures to insure the safety of the portfolio. He is no longer treasurer but obviously controls were loosened.
A final irony is that less than a year before the bankruptcy filing Citron told the press they had cured the problem and even if there were losses, they were only on paper as “they hold to maturity”. Similar comments have emerged in the Florida fund problem. When you are leveraged however you do not have the ability to hold to maturity due to margin calls. Moody’s and S&P bought into Citron’s story too, but when the bankruptcy occurred said they did not evaluate the investment portfolio because it was beyond the scope of their expertise! What were they being paid for? Could they not read a balance sheet (albeit in a form that made it difficult to see the extent of the leverage that TB also missed initially)?
The point is that leverage is a double edged sword, whether it is for a hedge fund or a money market fund. Worse yet one has to understand risk and TB has made this point numerous times over the years:
People look at yields or returns on everything…they will stretch to get a higher yield. Mike Milken understood this. But when you are in a money market fund, don’t look at the yield, look at the difference in income of an extra 1%. If you have $100,000 in a mm fund is $6,000 so much better than $5,000 if the manager took significant risk to earn it. Meanwhile 1% more yield on a 10 or 30 year bond amounts to a lot of income over the life of the security, so consider the yield on longer maturities and the dollars on shorter ones, keeping in mind that the object of a money market fund is absence of risk and liquidity while achieving a good rate of return…not the best which compromises the first two objectives. Never be afraid to ask any manager how they achieved those great returns…never take them for granted!
Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and in no way reflect the views of anyone other than himself. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. No fee…nothing to sell…merely observations of events in the marketplace offering a non-mainstream viewpoint…sometimes…usually? Hope you find it useful.
Copyright TBD Capital LLC December 7, 2007
