Call the Treasury's Bluff 24 comments
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Twice in 2002, and once in 2001, I engaged in a risky form of financial behavior. I was an investment grade corporate bond manager, and I was focused on financial names. In 2001, post 9/11, we bought all of the out-of-favor sectors from September to November. (I remember being at a conference for insurance CIOs in October, and seeing the horrified looks on the face of the other CIOs in a closed door session, when I said we were expanding our exposure to BBBs and junk, and hotels, Airplane EETCs, etc. What topped it all was the representative from Conseco telling me how irresponsible I was. Coming from Conseco, that made me blink.)
But we sold them all in the second quarter of 2002, when the hunger for yield was growing. We happily sold our bonds that were now in favor for higher prices. Then, with the accounting disasters at mid-year, on July 27th, two of my best brokers called me and said, “The market is offered without bid. We’ve never seen it this bad. What do you want to do?” I kept a supply of liquidity on hand for situations like this, so with the S&P falling, and the VIX over 50, I put out a series of lowball bids for BBB assets that our analysts liked. By noon, I had used up all of my liquidity, but the market was turning. On October 9th, the same thing happened, but this time I had a larger war chest, and made more bids, with largely the same result.
At that point, I noted that the market was behaving differently. Most of the troubled names were either dead or cleaned up, so I continued to buy yieldy long-duration financial bonds as the rally continued. Aside from a hiccup as the Iraq war started, the rally that started October 9th persisted for a long while in equities and corporates.
Why am I telling this story? Partly because the case for panic conditions in the fixed income markets, and with the banks is thin. By the time we were in mid-2002, the equity markets were down far more from the peak, and implied volatilities were a lot higher.
Now, what is different at present is that the losses in this market are being led by financials, because in 2002 housing was not overvalued like it is today, and in 2002, the commercial and investment banks were not so highly levered.
So, looking at the two periods, I would rate the economic stress as pretty even across the worst of 2001-2002 and now. We bounced back from 2002 without any bailouts. Could it get worse from here in this present era of stress? Yes, it could. But at some level, enterprising investors come in without the aid of the government and begin buying assets where the downside is adequately discounted, and the upside ignored. We are close to that now, with mortgage opportunity funds starting up. Those won’t see the light of day if there is a bailout.
So, I’m not sure we need any bailout. As Yves Smith at Naked Capitalism notes, the calls from average people to Capitol Hill are having an impact. Keep making them. Call the Treasury’s bluff. If we prove wrong, well, the next administration will craft its own measures, rather than a bunch of unaccountable lame ducks who are unaccountable even when not lame ducks. (Did I say that? Sigh. Repeat after me: This is not a political blog, this is not a political blog… and I voted for Bush twice, not that it matters much in Maryland.) I agree with Naked Capitalism again — there may not be a true crisis.
But, I can look at it from another angle. If I had $700 billion to spend as a clever investor (versus $30 billion for Buffett, earning 17% lending to Goldman Sachs), what would I do? I would adopt the same approach that I did in 2002 (where my war chests were hundreds of millions), and get my analysts to percolate up their best ideas, and do rough estimates of what fair value is at a number of different discount rates. I would start small, and offer lowball bids for hundreds of millions of seemingly mispriced securities. I would adjust my bids as I found no takers or many takers. Price discovery in illiquid bond markets is tough, but it is something I was good at in 2001-2003. I would also leave markets where there is no rationality… I can invest anywhere, why should I limit my reach? If Buffett can earn 16-17% off of Goldman Sachs, why should I look for much less?
Today, Bernanke suggested the use of reverse auctions to deploy bailout money at hold-to-maturity pricing levels. My dear naive professor, markets avoid equilibrium, they do not seek equilibrium. When the markets are in trouble, most players are in trouble, and there is not enough liquidity to bring the markets to long-run equilibrium levels in the short run. The fundamental value of an asset is a relative concept, and depends on factors like the yield curve, implied volatility/credit spreads, etc.
The danger with the Treasury bailout proposals is that they will waste money by buying assets at levels above what the market will bear. The danger with Dodd’s proposal is that they will drive companies into the ground through dilution from hasty asset sales.
Looking at it from a static standpoint, perhaps $5 Trillion would solve the crisis. I think that would fill every hole, definitely. But on a dynamic basis, you don’t need as much to move markets. Once a buyer of size comes in, other players adjust their bids and asks. So, if I had $700 billion of cash, I would have a hard time disguising my moves. I would expect to send unused cash back to my funders.
Also, the difficulty of reverse auctions when you have so many disparate securities with small sizes is tough. So, I look at this crisis, and think that if we wait for four months, the situation might be better, and no bailout will be needed. If not, the next administration, not lame duck, would face the consequences.
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This article has 24 comments:
The thieves should get nothing. I would like someone to show us the profits that the companies involved in the bailout made from 2005 through 2007. I would also like to know the bonuses that their employees made during that same time.
Buffet is using his vast amount of money to make more money for his stakeholders. Why shouldn't the federal government do the same for its stakeholders - the taxpayers?
(Adapted from William Shakespeare's Hamlet)
(WilliamBanzai7)
To Bail, or not to Bail, that is the question:
Whether 'tis nobler in the mind to suffer
The slings and arrows of outrageous loss of fortune,
Or to take arms against a sea of financial troubles
And by opposing end them. To die—to sleep,
No more; and by a sleep to say we end
The heart-ache and the billion market shocks
That investor hubris is heir to: 'tis a consummation
Devoutly to be wish'd. To die, to sleep;
To sleep, perchance to dream—ay, there's the rub:
For in that sleep of death what dreams may come,
When we have shuffled off this market coil,
Must give us pause—there's the respect
That makes calamity of so long life.
For who would bear the whips and scorns of time,
The CEO banker's wrong, the proud man's contumely,
The pangs of write offs, the law's delay,
The insolence of office, and the spurns
That patient merit of th'unworthy takes,
When he himself might his quietus make
With a bare quill? Who would Federal oversight bear,
To grunt and sweat under an ordinary life,
But that the dread of something after death,
The undiscovere'd country, from whose bourn
No traveller returns, puzzles the will,
And makes us rather bear those ills we have
Than fly to others that we know not of?
Thus conscience does make cowards of us all,
And thus the familiar hue of resolution trust
Is sicklied o'er with the pale cast of thought,
And enterprises of great pitch and moment
With this regard their currents turn awry
And lose the name of action.
Does the phrase "opposition party" have any meaning? Where is there ANY COURAGE?
I am still going to vote for Obama, because he is the most obvious leader by intelligence and energy hands-down, but this all so sobering.
What’s going to happen next week?
They threw Enron’s Jeffrey Schilling in prison for what again? These are infinitely worse crimes. These perverted companies purposely, by very clever design, hid the true value of what they were peddling. Buyer beware should be replaced by prison beware.
Leave wall st alone.
let the market sort out the mess.
this is just a grab for money / power based on scare tactics / fear.
Historically, very common.
If intervention is justified, there are a lot better ways to implement it.
Paulson / Bernanke have demonstrated a level of market twitchiness not compatible with their jobs.
and US households will get the scrap... what a deal !
As miclone83 said structure the taxpayer bailout the same as Buffet's purchase of Goldman. Why shouldn't the US taxpayers get as good a deal?
Kill the Treasury Plan and Don't Settle For Congress Limiting Executive Compensation (Lipstick On A Pig)
There is only one way to make the crooks pay on Wall Street and Washington DC.
Pay no taxes
After all we do pay their wages and they are rotten employees.
We can fire them all.
No more taxes.
As to not paying taxes, let's all take our example from Charlie Rangel and just "forget" to pay them.