MichaelSchmichael

Seven Uncomfortable Predictions for the Economy

I find mildly entertaining that the author can not only dish out juicy macroeconomic spin, but can also give you the low-down on fashion, dating and relationships (including the need to "Get A Life THEN Get A Man") (www.jenniferbawden.com...). But I have to admit that the author clearly excels at self-promotion and marketing, giving the public exactly what it wants (gloom and doom) to drive interest in her firm.

Jstratt -- Claim reserves and reinsurance are irrelevant to the insurer problems the author references (liquidity crunch created when csv demands on life policies exceed current cash, requiring the sale of illiquid assets at so-called fire sale prices).

Geithner: A Fool with a Plan? And Is That a Bad Thing?

Since nobody else has started on the vast "potential for manipulation" topic here, I'll re-post a prior post. It seems as if any bank that is currently holding a mark below 93 cents can presumably "buy" the legacy assets at or near 100 cents (most likely indirectly through a hedge fund capitalized with bank money), mark a gain on the "sale" and basically just walk away from its equity stake (leaving the taxpayers with the loss, of course, when the assets prove to be less than that). Stated differently, if the mark is already below 93 cents, the bank has already lost the 7 cents it would take to buy the legacy assets at 100 cents. Why wouldn't the banks do this? Does the False Claims Act provide a mechanism for potential taxpayer recourse?

How Treasury's Bank Bailout Could Make Things Worse

Further to digilante's comment, it seems as if any bank that is currently holding a mark below 93 cents can presumably "buy" the legacy assets at or near 100 cents (most likely indirectly through a hedge fund capitalized with bank money), mark a gain on the "sale" and basically just walk away from its equity stake (leaving, of course, the taxpayers with the loss). Stated differently, if the mark is already below 93 cents, the bank has already lost the 7 cents it would take to have someone buy the legacy assets at 1. Why wouldn't the banks do this? Does the False Claims Act provide a method for potential taxpayer recourse?

And I thought the cronyism under Bush was bad . . . .

"I don't see this as a problem at all. In fact I see the opposite problem:

Let's say I'm a bank with a $100 face value "Legacy" pool that I have dilligently and painfully written down to $50, even though the best tire-kicker bids I have received are at $30. I haven't accepted because I don't want to take another $20 haircut.

The FDIC decides I can get 6:1 debt:equity on this stuff. So I set up a PPIF and fund it with $5.00. Treasury throws in $5 and the PPIF issues $50 non-recourse debt guaranteed by the FDIC. The PPIF then buys my pool for $60 and presto! I have turned $30 worth of crap into $10 cash ($5 net) and $50 of FDIC guaranteed paper- I don't really care what happens to the PPIF. In the fullness of time it may or may not make money. If it does, I'll get 1/2 of the profits. But it probably won't, so the taxpayer will pick up the tab.

So what's to stop me from putting, say, $8 into the PPIF and bidding $96 for the pool? Treasury is in for $8 and the taxpayer is on the hook for $80 courtesy the FDIC. My bank ends up with $16 in cash ($8 net) and $80 worth of FDIC guaranteed paper and the PPIF can go get stuffed for all I care.

I'm laughing all the way to the bank. Wait, I AM the bank."

Choice Hotels: Outperforming Its Peers

You write that "CHH has a quality balance sheet . . . ." I don't see it that way. CHH's most recent financials showed that the company had, as of December 31, 2008, about $328 million in total assets and about $465 million in total liabilities. Total current assets were about $120 million while total current liabilities were $135 million. In other words, the company is insolvent by most tests for insolvency. The company might have decent revenues and be generating cash for the time being, but a quality balance sheet? It looks pretty ugly to me, which is why I am short.

19 'Bathwater Babies' for This Week

Further to my comment above, FGP announced today that it would issue 4.5 million new common units to raise cash ostensibly to pay down debt. At best, this means a ~7% decrease in the dividend via dilution. But I am betting that it is further evidence of a company in a death spiral. To me it seems pretty clear from this latest news that the company is having a difficult time rolling over its debt on favorable terms and is looking to tap the equity markets while pricing is still somewhat favorable. It also seems pretty clear from this that the company is heading down the path of either more debt, more dilution or a dividend cut.

Revisiting Insurable Interest

From a policy perspective there seems to be a pretty clear difference between murder and corporate defaults. Granted, the requirement that an insured retain an insurable interest extends beyond life insurance policies and applies to most traditional insurance products. Even then, in all policies for which there is an insurable interest requirement (e.g., life and property policies are the simplest to think about), there is an element of control over the insured event that simply is not present with CDS -- it is relatively easy to kill someone else or burn down a house, but it is far more difficult for an unrelated third-party to cause a corporate default or other credit event. The tools available to even the most nefarious and wealthy short are blunt and indirect -- while they may exacerbate a weak company's problems, intentional spreading of misinformation, naked short-selling and bidding up the cost of protection never caused a bond default. Too much debt relative to cash, generally poor planning over the business cycle, liquidity imbalances -- i.e., factors controlled by management, not third-parties -- are the cause of corporate defaults.

Also, couching the debate in terms of "insurable interest" is a little misleading, at least to the extent that the author is equating "insurable interest" with "owning the referenced bond or underlying instrument." Insurable interest is a fairly loose concept, and presumably would be satisfied in the CDS context by having sold protection on the referenced instrument, owning equity in the referenced company (if the CDS is on a company), being short puts/long calls on the equity, etc. Permitting someone to buy protection on a company because they were also short equity puts seems to be the sort of speculation the author suggests is bad. Further, it would be very difficult to develop sensible buyer-side regulations that took into account the various ways in which a protection buyer could have an "insurable interest" in the referenced instrument and even more difficult (and expensive) to enforce.

I agree that regulation of CDS is important and needed, but I think the regulation should be focused on protection sellers not protection buyers.

When Bank of Hawaii Falls Below 52-Week Low, It's Time to Buy

The fundamentals on this stock don't justify its high valuation (it is trading at 2.5X reported book value, which is about twice where most banks are trading). This implies a credit quality I think undeserving in this environment. BOH has about $10B in total assets. $2.6B of that are in investment securities, of which ~$300 million are in non-agency MBS. The non-agency MBS have been written down by less than 10% from cost, so I expect further writedowns here. BOH has about $4B in consumer loans, the majority of such ($2.6B) is in residential mortgages secured by property in Hawaii. A significant portion of Hawaiian homes and condos are second-homes owned by non-residents from the US and Asia. These loans default at a higher rate than those secured by owner-occupied homes. C&I, commercial mortgage and construction make up an additional $2B, and we are just seeing the tip of the iceberg in defaults in those books.

In the end, Hawaii's economy reflects what is happening in the US and Asia, and the signals from both of those markets point strongly down. Those counting on Hawaii's economy being immune from this are akin to those who believed ______________ (fill in market where people in the past have claimed immunity, e.g., Manhattan's real estate market) was immune. It is coming to Hawaii, too, and when it does this stock will be flirting with the lowest of the three Dow downside targets cited by the author.

Long puts.

19 'Bathwater Babies' for This Week

I disagree re Farrell Gas (FGP). The company is highly leveraged, with a simple interest coverage ratio of .39 ($9M in operating income and $17M in interest expense), quick ratio of .38 and debt to capital ratio of 101%. In fairness, these figures can be misleading -- but even when you add back in depreciation of $21M, the company still is not generating sufficient cash to cover both interest payments ($17M) and dividends ($32M). The company's dividend doesn't look sustainable -- it appears to have been relying on debt to fund the dividend in recent quarters. I also don't like the heavy reliance on receivable financing via securitizations, which likely is very expensive right now and could spell trouble when customers stop paying their bills. My bet is on a dividend cut within 2 quarters, which is why I am short FGP.

Altria Has Been Great, Time to Exit

"The decision is a horrible one in that it now opens all businesses to suits that would have ordinarily been funneled to Federal Court to State Court, where we all know nothing good can happen."

This makes little sense. The Altria decision was a narrow decision addressing whether a federal law specific to the tobacco industry preempted state deceptive act statutes. First, the decision has no impact on non-tobacco businesses. Second, it does little to change the overall legal environment for tobacco companies as they are already in litigation in all 50 states, facing common law claims that will almost always be in state as opposed to federal courts (assuming compliance with CAFA). Rather than the chicken little assessment offered here, I see it as more of a "heads we win, tails it takes us longer to win" decision, where tails came up.

Brazil: One of the Best Opportunities in Emerging Markets

I am not so convinced that easing is likely. The problem I see for many EMs, especially those in LatAm is as follows. There is now and presumably will be continued significant downward pressure on their currencies. At a certain point they are going to have to stop using reserves to support the value of their currencies (or risk running out of them -- I haven't heard the latest figures for Argentina's reserve burn rate, but I imagine the controlled slide is costing them dearly), at which point they have to decide whether to let the currency fall or raise interest rates to support the currency. If they let the currency fall, inflationary pressures build (and, more immediately, corporate USD/Euro denominated debt becomes more expensive) and they are back to raising rates. I see easing as a possible outcome only if the fabled soft landing happens.

A Little Known Fact, And Good News, About This Crisis

This article seems to only reinforce the notion that academicians are either out of touch with reality or driven by an unclear agenda. Mr. Kanitz appears to be a very intelligent person, so I am going to opt for the latter.

First, that the author regards the mortgage income tax deduction as "a little known fact" seems odd -- every real estate agent hypes this benefit.

Second, as noted above, the math is wrong -- the total interest paid on a $1M loan would be about $1.15M, not $1.8M as referenced by the author.

Third, the author disregards the economic distortion of the much larger tax subsidy provided by the up to $500,000 exemption on gains from the sale of a qualifying residence (yes, I realize that $500,000 is nominally lower than $1.15M and the applicable rate would be LTCG, not ordinary income, but the tax benefit is available in the current year, not stretched out over 30 years, and has a much larger emotional component (i.e., "I just got $500,000 tax free!!!!")).

Fourth, although it is often suggested that the tax tail always wags the economic dog, but -- as many of the comments above suggest -- tax implications are but one (often small) factor in determining whether a particular deal makes sense (the prevalence of the rent versus buy calculators available on the internet suggest that people are actually doing the math) -- factors such as equivalent rent and expectations of future asset appreciation or depreciation or rent increases or decreases are far more important.

Fifth, the economic value of the mortgage deduction tax benefit decreases every year as the annual interest paid decreases and inflation increases the spread between the fixed tax benefit and inflation adjusted taxable income (e.g., in 2038, the final year of the hypothetical 30 year mortgage, the borrower would pay only $2000 in interest but presumably (hopefully) would have income far greater than $200,000 -- the deduction would only be worth $800 that year assuming a 40% marginal bracket).

There are many good reasons to buy a house, but anyone who does so based solely on the mortgage interest deduction (to the exclusion of other, more important, factors) is in my view misguided.

Also, in reference to a comment above, mortgage interest isn't a preference item for purposes of the AMT.

What Obama Needs to Know about Tim Geithner, the AIG Fiasco and Citigroup

Kinabalu -- You're right, the math is wrong. But I am not sure it matters all that much -- whatever the number is, it is huge. Even if you used 50% of the numbers you questioned ($25T instead of $50T outstanding; 20% instead of 40% in the money), you would still have over $1T. Whatever it is, we are all guessing at this point, but it is likely very large.

I think the point of the article goes more to the implications of the policy decisions being made and the potential motivations behind those decisions, not whether the specific numbers cited end up being correct or even reasonable. It would be short sighted to dismiss the article out of hand based on an unfortunate and presumably very embarassing arithmetical error.

How Will Arbitron Fare in This Market?

Arbitron is down over 50% since this article was posted. The question is whether, at $14-ish, there is still potential for large moves to the downside. I tend to think so, and recently opened a larger position to the south.

In its 10-Q filed November 5, 2008, the company listed $162M in total assets and $171M in total liabilities as of September 2008. The company is therefore technically insolvent by its own admission. Backing out $38M in goodwill and $1M in intangibles, the company's total liabilities exceed by almost $50M its tangible assets. This apparently has not impacted the company's ability to tap its credit lines, as Arbitron issued $125M in new LTD while paying off only $67M in existing LTD (net increase of $58M in LTD for Q3). The company is still paying its dividend, but it is not clear how much longer its lenders will keep feeding the pig.

In addition to what appears to me to be considerable balance sheet issues, Arbitron also recently lost contracts with Cumulus and Clear Channel to Neilsen. The revenue loss for this is estimated by the company as $7M in 2009 and $10M annualized. Not that big of a deal by itself, but could be indicative that the company faces individualized revenue generating headwinds on top of general market malaise.

Long puts.

Argentina: Sinking

The analysis about this latest bout of Argentina/Kirchner wierdness is almost uniformly half-baked and the commentators seem pre-disposed to jump to the conclusion that the country will default. But this is not new -- every adverse event in Argentina since 2001 has been interpreted as a signal that it will default again. The differences between 2001 and now are stark: Argentina has a floating currency; the most recent expansion was fueled by exports, not debt; it has much less external, dollar-denominated debt; it had over USD $40B in reserves; and it had significant budget and current account surpluses. I do not buy the argument that the proposed privatization (it still needs to pass the legislature, which is not entirely friendly to Kirchner) was needed to fund next year's budget or as a way to extinguish a big chunk of sovereign debt (AFJP accounts reportedly hold USD $15B of it). It seems to be more reflective of nationalism, a distrust of international banks and finance and a desire to unwind the "neo-liberal" mechanisms put in place by Menem. But, whatever the reason, it shows the Kirchners' fundamental misunderstanding of or indifference to conventional economic and market wisdom. And, sadly, the erratic behavior of the government itself, even though I don't think it signaled a default, might actually cause a default: There is now a run on the Peso, in response to which the Central Bank appears likely to burn through its currency reserves, which will back it into a corner and leave it few alternatives but to default. But I don't think all is lost, at least not yet.

How Good are RiskMetrics' Tools?

Looking post hoc at the loss incurred versus premium collected with respect to a single loss is not a reasonable or fair way to determine the propriety of the premium. Almost any single insured loss will look improperly priced when viewed in that way. Only in the context of an entire portfolio, probably over an entire cycle, can the propriety of premium be fairly evaluated.

Actuarial analysis works reasonably well with life insurance, property loss, auto and a few other lines in which you have large, diverse pools of insureds and excellent long-term data. It is less than reliable when it comes to complex types of financial risk (D&O, E&O, surety), especially when the degree to which the individual insured risks will correlate is unknown. That said, and in the perspective of actual insurance (not CDS, which aren't technically "insurance"), $1.5M in premium for up to $1.3B in risk looks very low compared to how other types of complex risk is priced.