User241885/(FAMCO)

BofA's 10 Investment Themes for 2010

David Van K's sentiments about investors having to so their own thinking is right on track. Like him, I also realize that the investment division is not involved in day to day corporate management.

"But still" you have to wonder about the message the corporate culture sends to all of its divisions regarding its fiduciary role to its depositors and investors when you consider this track record of the last decade where most of the management is still in place who were responsible for the following :

a) Columbia Funds market timing and after hours mutual fund pricing violations;

b) US Trust Private Banking Group's decimation;,

c) Record Federal and state fines for marketing unsuitable annuity contracts and investments;

c) CountryWide purchase without any renegotiation even though it it occured almost one year after HSBC reported 10BB loss on disaster mortgage results from Househould FInance Division;

d) Merril deal with legacy problems that management maintains they knew nothing about and bonus payments where they feigned complete ignorance of, in spite of approvals signed by CEO Lewis.

e) Unlike any other major us financial intermediary, absolutely no clear succession plan in place.

The list of investment themes could possibly represent the best ideas of the decade, but when I stop to review their other ideas of the same decade, I have to say "no thank you."

Closed-End Funds: How to Buy Stocks at 20% Discount from Current Price

These last two comments contribute absolutely no value whatsoever to the conversation. One brags about his own unsubstantiated prowess, the other recites well known fact.

Why did they even bother showing up, as most readers are, after all, seeking alpha.

Correct?

Closed-End Funds: How to Buy Stocks at 20% Discount from Current Price

TBill,

Addressing the reason for the discounts to NAV is a good starting point for a discussion as it looks as if the writer of this article
identified CEF with discounts but did not delve into any particular reasons for the high discounts to NAV.

While there is ample data to suggest, as you have, that high fees contribute to the discount to NAV, even closer research will show also that when the funds show an inordinately high return of capital every year, they merit a steep discount.

It only makes sense in that the investors "discount" the price of the stock in anticipation of further asset value erosion when dividend payments comprise of high levels of return of capital. In the case of BLU, the ROC approaches nearly 80% of the dividend.

Many of the option writing funds also have steep discounts which result from the eroding asset aspect of a "buy-write" or covered call selling strategy. During a strong market, as we have seen this year, the underlying securities are called away usually at what is now below market prices. The option selling manager cannot not go out and replace the index his contract forced him to sell for X when the market now values it at X plus 50%.

In the case of the muni bond funds, the fact that municipal credits may be approaching unchartered territory has started to appear in the form of steeper discounts as investors become conflicted between selling high yeilding federal tax free CEF's or holding on to them in the face of down grades and potential bankruptcies.

Finally, while many CEF's have cut back on leverage over the last two years, many income funds still are within single digit percentage points of breaching their loan to value covenants, which in turn would create a need to sell off underlying assets to pay off the leverage. For the last two years many of the asset sales created capital gains so again a large part of the dividend was in fact return of capital, not just juiced up levered returns.

If interest rates truly start to rise at some point, then these funds will experience more violations of their loan-to-value covenants, forcing more sales of underlying securities, but this time with the result of capital losses not capital gains, especially in the bond markets where much of the demand has occured. Under this scenario, the universe of CEF's designed to appeal to income investor would not seem to carry the greatest risk going forward.

FAMCO

JPMorgan and the Alabama Swaps

This isn't just about two crooked bankers. If you know the background facts, you see this falls squarely into the slippery slope category.

First, the feds put an unfunded mandate on the county to take on one of the biggest sewer projects in US history, something close to th Big Dig in Boston, except without the feds pitching in one cent.

Then the Alabama legislators refused to back the proposed bond issue with the full faith and credit of the state. You tell me what that means when your own elected officials won't get behind the biggest bond deal in your state's history?

Since the county, the most populus in the state as the writer noted, does not have the same high credit rating as the state, the project was faced with paying higher interest rates. Enter the bankers. One of the orginal hoped for utilities of the derivative product was to offer a low rate where credit enhancement otherwise would have done the job.

Since all this happened my understanding is that the state legislators have come back in and backed the deal but only after the county nearly bankrupted when the swap higher payment terms were triggered.

You really do have to wonder why the state did not act earlier as this has been a major municipal finance event going on two years. Had they acted in the interest of their constituents, there would have been no need for derivates in the first place.

As much as I would like to fault a lot on amoral business people, there is plenty of blame to spread around.


FAMCO

Misplaced Fiduciary Duty: Why BofA's Lewis Failed

The issue here is not whether Lewis was under pressure from the feds or what the particular deal was that he had with them. The issue here is what Ken Lewis did or did not do once he had the information about how badly the Merrill financials were once he knew about it.

To say that Ken Lewis had no choices simply disregards the entire field of fiduciary law, disclosure under the SEC 33 and 34 Acts and sound practices of good corporate management. No one forced Ken Lewis to do anything but Ken Lewis himself.

If the government threatened him by giving him the ultimatum either to lie to shareholders or lose his job, then Lewis had only course of action and that was to resign. If he was not willing to make a full and fair disclosure to the shareholders, which is a fundamental responsibilty of the office, then he had no place holding the title as CEO.

Instead, he chose to mislead investors. And it was most certainly a choice. Paulson and all may have subjected him to all sorts of pressures, but Lewis still had choices.

To say that Lewis thought he was acting in the best interest of the financial industry is second guessing at best and revisionist history at worst. It is the best interest of the finance industry to have the trust of the investors and depositors through the highest levels of management.

It was clear by Lewis' own testamony months ago on capital hill that he knew he had "mislead" investors. When it comes from his own mouth, I don't know how it could be any clearer.
.

Has a MERShole Opened Up?

As the author points out, one has to commend the judge in this case for actually applying the law rather than legislating from the bench. The story of the last year seems to have been various departments of the federal government deciding that it was easier to rewrite established corporate jurisprudence than to uphold it. One need only look at mortgage modification as a prime example of a complete disregard for contract law, a substantive right that only each state can modify, not each federal regulator.

But to attribute the motivation of MERS to fraud is a stretch (to quote the author: "I believe that a large part of the root cause of these "lost" documents is to cover up blatant and in many cases outrageous fraud"). First of all, it gives the mortgage brokers, real estate lenders, investment bankers and the securitizing agencies way too much credit for possessing the necessary intelligence required to plan a conspiracy.

More to the point, however, the assignment clause in every mortgage mortgage deed and every promissory note assigns only the financial and security interests in those documents. They do not require the assignor or assignee to attest to any amount of due dilligence about credit quality, verifiable income and assets. NINJA (No Job, No Income or Assets) mortgage pools, while astonishing for their stupidity, are not illegal.

This is an important distinction because the case of Landmark National Bank v. Kesler is simply about "perfecting security interests". The issue here is that for the income stream and other rights like foreclosure to be assignable, you have to record the assignment. It's pretty straightforward. Apparently MERS thought they had a better system than one that has been used over the last three or four hundred years.

No doubt there is fraud on many levels. It seems to be part of the fabric of corporate banking the last decade. The examination of BofA's memos regarding the obligation to disclose Merrill's financials will be a new low in that regard (I just heard that instead of complying with the AG's order to produce relevant documents, they supplied instead e-mails to employees about discounts at Wal-Mart. Nice).

The fraud the author describes will be outed in time but this is not the where the fraud happened. This is where incredible stupidity happened. MERS believed they had a better solution than centuries old established legal precedent. If this was their idea of adapting to the environment, then good luck to them in circumventing the law of evolution.

TARP: Why The Media Doesn't Need Every Detail

Anyone who survived reading the post above can be assured that mine will not do anything more than address the basic issue raised by this article: is any company too-anything-to fail?

The recent activist movement in our government is an end-run on well established rules from both capitalist values and corporate jurisprudence which have already dealt with the concept of giving the flailing entity a second chance.

The question is how much coddling is necessary before we let the patient's diagnosis run its course? The USA has nearly 4,000 banks. Does each and every one have a constitional right to survive a financial crisis, especially where their own actions contributed to bring about their current problems? Canada has less than 50 banks, none of which are experiencing the problems to the extent ours are. Maybe 4000 banks is too many in this environment.

And what is the price we pay for this coddling? Each and every tax dollar is just the tip of the iceberg in terms of the real money needed to fund that relief. A recent SA article pegged the $8,000 first time home buyer tax credit at $43,000 per house. My guess is that the mortgage modifications also carry a similiar math, not the kind of multiplier effect one typically associates with banking.

Cash for clunkers is another good example of unfortunate activism. Take a ride through a dealership and go to the area of the parking lot where all the cars have the word "Clunker" grease-painted in the window. Some of these cars are only three or four years old. They are waiting to have their oil lines flushed with solvents at which point the engines are to be run until they sieze up and are made worthless.

So for the sake of pumping up sales for manufacturers and dealers, who were already on the terminally ill list, we take away business from the local independant repair shop, the second hand parts guy, and the engine rebuilder, all sustainable businesses that are even more successful in recessionary times.

Why should banks be any different? Paulson gave them a life-line when things looked their bleakest, but now we need to let the barely marginal firms meet their fate instead of siphoning off our funds that should have been put to our future through investment. I would not invest in a failing fiinancial company that had little or no chance of surviving what promises to be a challenging environment for financials going forward. Why should we all be so forced?

Maybe the Treasury SHOULD publish the list of banks that did not get TARP funding. We have gone too far protecting every business that benefitted from the easy credit, massive liquidity and slight whiff of fraud perpetuated by both business and politics.

We don't need any more new and innovative approaches to dealing with the problems of recessions and business failures. We have the laws already that were properly drawn the last time we had to craft a solution for failed companies. We just have to enforce them rather than needlessly providing these tortured life support solutions to critically ill firms. We do this for no other reason than the fact they are making the healthy firms sick as well.


FAMCO

Lessons from the Fall of Lehman

While it is hard to disagree with the observation that the Lehman's demise marked "the moment at which the financial crisis became a severe economic crisis", the later comment that the systemic risk was "little seen" is hard to support. There was an abundance of evidence and all of it as clearly visible as could be.

Going in reverse order, the Lehman problems were visited much earlier in the March 2008 bankrupcy filing of Bear. Well before that, in July 2007, two Bear hedge funds, whose strategy was to lever prime and sub-prime mortgage pools, filed for protection. If the concentration of risk in the mortgage market was not openly apparent at that point, go back two years earlier when Freddie and Fannie both brought in new CEO's to clean up valuation disorders of their derivate holdings and "insurance" liabilities due to defaults nearly two years earlier.

Dick Syron (who certainly possessed the required critical faculties during his tenure the Boston Fed and the American Stock exchange before assuming the role of CEO at Freddie) was in August of 2004 unable to file quartlery earnings as a result of massive accounting discrepencies caused by the hedging programs used to "manage risk" in Freddie's massive mortgage portfolio.

Each and every one of these instances involved the most major governmental and financial intermediary in the mortgage securitization process. As such they each had the best possible insights into the quality of the underwriting, the default data, the use of credit enhancements, the leverage and most importantly the hedging of each and every issue. The head of the NY Fed who oversaw settlements for the credit default swaps during this time is now our Secretary of Treasury.

These were not some obscure "unseen" event, that people are now seeing clearly through the rear view mirror but rather brilliantly flashing warnings that no one chose to pay attention to at the time the trouble began to foment. For whatever reason, be it financial or political, if people choose not to act when the warnings signs are self-evident, no amount or regulation is going to change the outcome.

FAMCO

Addressing the Lehman Myth

Let's go one step further than Anarchist's post and say that the real wake up call should have been the two Bear hedge funds that went bankrupt nine months ahead of Bear's own filing. The funds, High Grade Structured Credit Strategies Master Fund and High Grade Enhanced Leverage Master Fund filed for protection in July of 2007, well before Bear own March 2008 filing.

They were your basic leveraged mortgage pools using prime and sub-prime mortgages. This was front page news on the Journal at a time when all the financial intermediaries were praising alternative investments like mortgage-backed pools levered by hedge funds and the CNBC talking head empty suits were extolling the virtues of liquitidy.

If we aren't intelligent enough to see the sign of a pending disaster when it flashes brilliantly in front of us, then we deserve what ever happens next.

FAMCO

A Poor Craftsman Blames Others’ Tools

Jeff,

A terrific analysis of the "me-centric" attitude of so many writers who care more about seeing their name on the by-line than practicising and perfecting the craft of writing.

As a contributor, editor and publisher in a past life, I wish I could have sent the staff writers to your classes. The preponderance of "first-person authority" in their writing seems to have dominated the industry. To this day, I am just incredulous about the number of stories that are published which seem to be mostly about the writer, his or her tastes and preference, impressions and conclusions.

Years ago, I asked my staff at our weekly meeting to read the stories the other writers had submitted to analyze them for any particular biases or blind spots. This seemed like a good exercise to explore our capability for obsersvation and objectivity. It might have even allowed for further self-examination, except that no one had done any of the reading!

A generation of two later, we are now living with the results. Forgive my negativity but to your point about Twitterand the use of new tools to help the journalist as the servant of the news, too many journalists believe they are the news.

Thank you again for an insightful story.

Unfair Advantages of the Shadow Banking System

Having just read the post above, I want to withdraw my earlier post.

Vernon Hill made excellent observations in his blog. As a result, I expected that the responses would include intelligent rebuttals written by well-informed contributors.

Apparently I was mistaken.

Unfair Advantages of the Shadow Banking System

The laws are clear that if you are a depositor at a commercial bank and trust company, your money market fund, like any other deposit, is insured up to certain limits. If you bought a money market fund from a brokerage, mutual fund, investment bank or any other SEC 34 Act Company, the laws are also clear that you are an investor who has no insurance against the risk of the MMF share breaking a buck.

If the idea is to legislate consumer protection that insures every money market fund (MMF) will never break the buck, then it probably makes sense to put all money market funds under the regulatory umbrella of the commercial bank and trust industry. It is only fair that if your deposits are going to be insured that you, the MMF issuing bank, pay the premium, just as all the other MMF issuing commercial banks do.

It goes without saying, however, the consumer is also paying for that insurance. What if he or she prefers to self-insure? Shouldn't the consumer be given the choice as to whether they want a fixed or floating share value? There is no shortage of regulation that distinsguishes whether you want to be a "depositor" at a commerical bank and trust company or an "investor" at a brokerage/ investment bank. SA recently reported that DB has a floating price share MMF in registration. That makes sense and certainly complies with the appropriate regulatory framework.

Let's talk about that for a moment. The entire purpose of Glass Steagal was to separate commercial banking (and its insured deposits) from investment banking (and its unisured or self-insured risk).

Some aspects of Glass Steagal have been repealed, most noteably in regards to security underwriting and distribution, which should be noted favored commercial banks, not investment banks. But the chief aspect of Glass Steagal is the qualitative distinction based upon enjoying deposit insurance versus accepting investment risk, which is still very much with us. It is the fundamental distinction between the two financial intermediaries.

The consumer still gets to decide whether they want the protections of being a depositor at a commercial bank or whether he or she assumes the risk of being an investor at the the brokerage/mutual fund/ investment bank. The SEC Act of 1934 made the prospectus the tool of full and fair disclosure for determining whether the consumer wishes to be a depositor or an investor. That body of regulation is also still very much with us.

With all due respect to Chairman Voclker, the idea that all money market funds should be soley under the jurisdiction of the banks sounds like more heavy handed lobbying by big corporate and big government self interests (sorry I can't narrow it down to one only but I can't tell the two apart anymore). Furthermore, the idea that commercial paper should never have been made available by investment banks really oversteps the bounds of how our financial markets work.

The consumers of those products know well in advance whether they bought an insured product or not simply by virtue of who they bought it from. If the risks is realized at the commercial bank, the insured depositor enjoys the benefit of his bargain: protection. When the brokerage/mutual fund realizes the risk, since neither paid for the insurance, neither the investment bank does nor the customer gets any protection.

The only thing unfortunate about this system is not the lack of regulation but the lack of enforcement of the regulation. Both the republican and democrat administrations failed to observe and uphold those laws. It is not the shadow banking system that failed, but the polticians who interferred with it.


FAMCO

David Merkel on Life Settlements

The doctrine of insurable interests should be as fundamental to every insurance transaction as compounding is to every financial transaction. Without it, the process does not exist.

Had the credit default swap market had this, there would be little or no issues today as the number of counter-parties and leverage would have been greatly reduced.

Think about it. A pension fund manager buys a bond issue. As owner of the debt, he has an insurable interest in that he wants to see that bond issue performs fully and be repaid at maturity.

Does the hedge fund manager betting against the issuing corporation have an insurable interest? Of course not, he is short the stock and now, thanks to the dimunition of the legal concept of insurable interest, he can effectively short the bonds as well through a CDS contract.

Under this scenario, AIG now is on the hook for a $100MM benefit to every counterparty who bet against the issuing corporation, only one of whom had an insurable interest to begin with, the bond owner.

The concept of an insurable interest should be enforced through out the industry. The whole idea of insurance is to manage risk, not multiply it.

FAMCO

Wall Street Securitizing Life Insurance Policies. Seriously.

While moral outrage on the nature of life settlements makes for good headlines and sells papers, the NYT article was trying to raise the spector of another crisis created by "toxic financial products." And while the article over-reached the conclusions and under-mined the data, the one important but absent observation part was a discussion about how to avoid creating a new set of disasterous outcomes as insurance providers seek out new opporunities for profit.

The simple step that could have mitigated a substantial part of the credit default swap market fall out would have been to require that the beneficiaries of those contracts have "an insurable interest". this is a common sense legal necessity in life insurance and it is what keeps the life insurance industry able to pay its liabilities. That is also why the counter-parties to the secutized debt and credit defaul swap markets could not.

The pension manager who just bought $100MM corporate bond issue has a fiduciary obligation to protect his investment, so having an insurable interest, he or she can buy insurance in the form of a CDS. The hedge fund manager who is betting against the issuing corporation has no insurable interest. Had the insurable interest legal requirement been in place, there would have only been one credit default insurance policy issued on the entire bond issue, not several thousand policies, as the world learned too late from AIG's financial products group.

This is such a basic concept to the insurance industry, like compounding in finance, you have to have it in order for the process to work. I understand that many of the writers in the chain above are from the insurance industry, so it is a little dissapointing to see most of them going on the defensive about this line of business rather than providing insight into how to avoid similiar problems from happening again.

Isn't that what risk managers are supposed to do?

FAMCO

Life Settlements: Still No Dice

The New York Times article provided a great illustration of just how clueless the "mainstream" media really is. As this article and many of the posts note, the custom of funding a claim ahead of the death of the owner has been around for over 30 years as a result of long protracted terminal illnesses, as one post mentions specfically in regards to AIDS. The insured could recieve much needed funds before death and the insurer could either factor the policy or sell it outright by assigning the death benefit to a third party.

What is really disgraceful about the NYT article is how the headline "New Toxic etc etc...." sells the fear of another financial meltdown without having a grasp of the facts, and does so as if to say that for once the mainstream media knows what's going on and is acting in the best interest of the readers, which has never been the case the last twelve months.

What could have been interesting, but unfortunately well outside the skill set of the NYT writer, would have been to make the case the insurance problems related to the credit derivatives (or if we want to humor the NYT writer, the life settlements for that matter) could have been mostly prevented, and still can be, by using the same legal underpinnings that most fundamental insurance products have required for hundreds of years: all beneficiaries of the contract must meet the standard of having an "insurable interest."