Traderbill's Financial Markets Weblog

 …why aren’t we outraged? Is it because the Secretary of the Treasury is former Chairman and CEO of Goldman Sachs, the most powerful investment house on the planet?…certainly he doesn’t want to go after his cronies who are only a part of the problem but they were the most significant as they allowed the subprime debacle to spread globally while hedging their own positions. Talk about loyalty among thieves: they paid themselves huge bonuses on record earnings (except for the bottom 10% that got zip), then, despite the fact that the entire derivatives market was unwinding, seemed shocked when they took some writedowns and lowered forecasts. Listening to Mr. Paulson it is hard to see him as a CEO. One can bet he never stammered like he has in recent press conferences in a presentation to clients or before the board of directors. He is thoroughly confused and despite the tone so far TB cannot blame him. Not only are there no easy answers, there are no answers and he knows it. This ‘thing’ has morphed beyond the power of all the central banks and governments and is built on fraud, ignorance, and deception at all levels. So instead, we are content to watch one bailout plan after another fail while the true culprits are banking their ill-gotten gains, many with some very nice tax preferences…game, set, match?

But signs of weakness for them are also emerging. The decline for private equity firm Blackstone (BX), headed by a cry baby who did more damage than anyone, started right after the IPO…it had a new low close yesterday; BX was also an advisor to Fortress (FIG), a hedge fund manager on their IPO which also peaked on its debut day and is just inches above the low. Even the esteemed Black Rock (not to be confused with Blackstone or Northern Rock…here is a name for a new fund: Northern Stone!), is having problems with the private equity commitments they made, they all are, and because the buyouts they recently completed didn’t pan out will have to rebate fees to investors. It’s called a cycle…a vicious one.

Aside from a smattering of CEO’s, most of the blame has been put on the department heads or entire derivative asset backed departments (notably BofA where CEO Ken Lewis wasn’t responsible for anything, or in the case of Merrill, new CEO Thane cutting bonuses for the entire fixed income group), who has had to pay? How about the investors…holders of the crap that emanated from them, or the shareholders themselves as we cheer lowballing investors injecting capital at the expense of dilution? Dilution…now there is a concept…much like stock buybacks do not equal dividends…especially when you issue preferred stock to accomplish the buybacks like Fannie, Freddie and others did.

We rewrote the rules of finance and now we must rescind them and start over. Until greed reared its ugly head the concept of securitization and derivatives made sense…we couldn’t have grown the global economy like we did. But that will prove illusory, much like startup companies who predict 25% or even higher returns forever. Without derivatives, investing is a zero sum game…for every winner there is a loser, but through the magic of financial engineering we produced incredible returns over the past 25 years only to give them back in a quarter or two…round trip to a zero sum game…well almost.

Go back to Enron, Tyco, and the other scams of the dotcom era. A few people went to jail, firms were destroyed of severely cut back, and one of the top CPA firms bit the dust…that’s it. The SEC failed us and instead got concessions to put money into a fund to educate investors on risks…much like the tobacco settlements where they advertise that smoking is bad for you. No sir, the SEC and all the other regulators including the esteemed Federal Reserve and its esteemed Chairman Sir Alan of Greenspan. Oh, there was another winner, Elliot Spitzer who parlayed being Attorney General of the Great State of New York by lining the coffers of the state with the spoils of his investigations. Of course he also went after a hedge fund manager (Bill Ackman) to see that his comments on monoline insurers were not just to move the market…of course they were but they were true…doesn’t PIMCO’s Bill Gross and every manager that appears on CNBC do the same thing? So what did Spitzer do after he investigated Ackman? Dropped it…didn’t look at the monoline insurers or tell them to clean up their act…didn’t get the Insurance Commission on the case…nope, he became Governor and that folks, is as close as we got to a white knight. Now we have a monoline mess and the Insurance Commission is wringing it’s hands and Spitzer says break it up or we will fix it.   

The monolines have totally destroyed the auction rates securities market where hundreds of 7, 28, and 35 day auctions have failed (no bidders but sellers and the underwriter refusing to take down the securities). As reported yesterday some are good fails as the rate can go to 5%, 6%, or even 20% tax free, so as long as the underlying credit is OK you are fine…can even borrow to pay your taxes and make money. We have even had failed auctions on AAA rated securities…it is not about credit, it is about covenants and restrictions on bonded indebtedness and loans. Also, some of the risker auctions that failed have actually seen the rates fall. That is because the indenture sets the reset in the event of a failed auction and many of those are resetting at 1-2%…the worst case of all. Many of those, such as the Nuveen issues are being used to fund long bond positions and a spokesman said that the low rate proves they are fine…wait till it clears up and you will have yet another problem: an unwinding of leverage and as these closed end funds have issues put back to them they will not be able to do this again  …they can play dirty and leave them out there for as long as they want though…this will mean they have to sell bonds which will mean lower returns and capital gains to shareholders. As for the issues resetting at attractive rates, they will be ‘relinked’ over the next few months. This will mean the state and local issuers will have to then issue 30 yr bonds or whatever the original maturity was at a higher rate. How high is a question ass there will be more supply than demand presenting buying opportunities but whereas with the stock market the question is how low is low, for muni’s it will be how high a yield is high? This is because with any security the longer the maturity the fewer buyers…which is why we split up mortgages into CMO tranches in the first place. The other end of the curve will see more cash chasing fewer securities, such as agency discount notes which are already yielding less than 2% and of course treasury bills.

It will be interesting and one thing we know is things will not go back to normal. Deleveraging will continue at all levels…hedge funds are going out of business again and one new fund is now charging a 1-1/2% flat fee for all expenses…a year ago you would have no interest in any fund that didn’t charge at least 2% plus 20% of the profits. Other hedge funds are doing just fine of course while still others are freezing withdrawals…although some have pulled out their own money and let some of their big investors do likewise  …which is why transparency is so important. TB read where some funds that are refusing withdrawals may be forced into bankruptcy which as we have seen from the two Bear Stearns funds doesn’t do anyone any good.

Lastly, is our white knight, Warren Buffett, who, aside from his ill-conceived (by his own account) $22 billion bet in foreign exchange just because he didn’t like the dollar due to Bush’s deficit spending, would be a guru. TB cannot make this point strong enough: there are smart people out there but no guru’s! To believe you are one is to set yourself up for failure as sure as becoming TIME’s Person of the Year, or the cover of Sports Illustrated…Swimsuit Edition excepted, but those aren’t guru’s anyway. So Buffett makes an offer to any and all monoline insurers to take the safe municipal insurance off their hands for 1.5x the premiums they are being paid…after all his insurer commands a premium. TB would have borrowed and set up a syndicate to do this…a layup! JP Morgan is chuckling in his grave as that is right out of 1907 when the National Bank backed his takeover of other ailing banks. Also out of it is Spitzer and the NY State Insurance Commission threatening the insurers if they don’t accept it or similar…no matter what happens don’t buy these stocks…OK? But wait…another of the culprits is the rating agencies who get paid fees and don’t even fully understand what they are rating! Buffett happens to be the largest shareholder in Moody’s (17%), and he now has a conflict of interest since they are threatening all the monolines with rate reductions…a mere AA is enough to destroy them. Also, as TB reported even IF Buffett takes over the monolines the rating is on the monolines so the rating agencies get paid for yet another rating…you go, Warren!

Hopefully, TB has identified some of the culprits, but sadly he cannot find a hero…where are the heroes? They are in Iraq and Afghanistan…remember? Also, you cannot be a hero if it is purely for monetary gain. Perhaps then, TB can declare himself a mini-hero (but you have to be anointed, you can’t claim it). He has done the research and presented it to readers in an attempt to educate for no personal gain. Monetary gain only, though as like the professor, he his the one who learned the most. The question is: when will we ever learn?

Hey, at least it was shorter today…and all structured around the same topic.Have a great day!

TB