townncountry

Hussman Gets It

Months ago, I felt that what Hussman suggested in his March 9 newsletter ("taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date") was exactly what should have been done to such firms as AIG, Lehman, and Merrill.

Why the Treasury didn't do this is beyond me. Perhaps there are legal reasons not to? Or was it fear that China and other sovereign investors in these companies would choose not to return to the capital markets as investors if they were to get burned by the collapse of the firms in whose bonds they invested so much?

I can understand the fear that losing bond investors money could have domino effect repercussions, but is that what led to the decision to buy toxic assets? Seems to my humble mind that shareholders who elected bad boards and invested in poorly run companies should bear the brunt of the fall. And that boards adn management should be replaced as quickly as possible. If there are assets at the end of the day to return to bondholders, great. What may be a better idea is to guarantee bondholders 50 cents on the dollar for their bonds, and then issue them contingent rights to invest in new shares of the reconstituted firms once they are ready to be taken out of receivership.

IMHO. Can anyone explain why this wouldn't work? Can they justify saddeling the non investing public and our kids & grand kids with the tab instead?


It just seems

Hussman Gets It

I liked the comments and actually long believed that doing what Hussman suggested in his March 9 letter ("taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date") was how institutions should be unwound -- including perhaps AIG and Lehman (and Merrill, had the Treasury not convinced BoA to acquire Merrill).

As events unfolded, I'd like to know why the officials involved could not have gone the receivership route? I am aware that China and other sovereign entities and most pension funds and insurers are HUGE investors in the debts of these in the crapper and technically insolvent companies. It seems that the "rescue" of the asset base, however, is the wrong way to go about saving the bond holders. In fact, I am sure the bond holders would be more than happy to have the option to receive either: (a) 50% return of capital invested on their bonds to these troubled companies; or (b) shares or warrants in the new iteration of the received institutions, which will become effective upon repair of the received firms; or some combination of the above.

In my naive understanding of our pension and investing markets, this would be a big shock to insurance companies, pension funds and other bondholders, but the risk of poorly run companies should morally be carried by the investors in those companies, not the taxpayers and not my kids.

Profit from the Housing Mess with ETFs

Interesting article. Compelling reasoning.

Proposed Solution for Toxic Assets Plaguing Banks

Tom -- Basically a good idea, but what about the bank's "bad liabilities" -- those swap liabilities that are explosively dangerous? You need to come up with a solution for that. Those are what blew up AIG's financial products subsidiary, which in turn blew up AIG.

I have 2 ammendments to your suggestion.

1. For any toxic asset a governemnt resolution trust buys from a bank, the bank should sweeten the pot by giving a fractional number of warrants or options that won't expire for some time (say 5 years), and which the trust can sell. Sure it would dilute shareholder value, but the rescur from bad management decisions should cost shareholders something.

2. For the banks being driven to perdition by bad liabilities, the resolution trust ought to evaluate the case by case situation, and then either (a) buy a special class of preferred shares which will help recapitalize the bank, or (b) change the bank's current operating mode to rehabilitation, thereby making bank shares essentially worthless, then giving each shareholders warrants in the post-rehabilitation institution. Certainly the warrants equal to the number of shares (1:1 old shares for new warrants) held by the now zeroed out shares outstanding would have an option value that could be traded immediately. Once the rehabilitated "Humongo Jumbo Big Bank" got back on its feet, the warrants would act like a new issue in a healthy huge interstate money-center bank and the warrants would provide additional primary capital to the rehabilitated monster!

What do you think?

Proposed Solution for Toxic Assets Plaguing Banks

Tom -- Sure the government could do as you suggest, and put them into a resolution trust company for later disposal, but a big part of the bank's problems are it's contingent off-balance sheet liabilities; the toxic swaps that they created for counterparties or traded with other financial institutions. Those might just sink a bank (or insurance company, like AIG).

I'd like to add an amendment to your suggestion, and it is to get (for free, for the good deed of purchasing these toxic assets) long term (say 5-7ears in term) warrants or options on a bank's equity. Sure that would dilute the bank's capital, but it would be needed now. And if the bank does become profitable, the government or resolution trust could sell the warrants or options (or exercise them), thereby increasing the bank's capital.

Dow's Ratio to S&P 500: What Does It Mean?

Possibly that SPY has become more volatile than DIA? If SPY's beta is increasing, that would suggest either that some new components of SPY are causing the beta to (artifically) change, or that something in the economy is being captured by the larger basket of stocks than in the Dow.

The Worst Bear Market in Modern History?

JL, Much better, but the Dow didn't go anywhere really after 1996. The boom was nearly entirely tech. And as I recall, the PE of the Dow was already pretty high in '96 -- about 17x, 18x, or 19x or so, if memory serves well -- right? And p/b was approaching 3x., So if you guessed hey were undervalued at the time, what stocks were you looking at, and what metrics were you using.

(In fact, given the relatively lower low p/es of European and emerging market companies in 2006 and the falling dollar, one could say that a good analyst would have concluded that more foreign stocks were undervalued in 2006 than US stocks were in 1996.)

But then these impressions are from memory, and not from data. Just wondering if my memory serves me right?


On Nov 27 09:41 PM jlounsbury59 wrote:

> One more correction : " I came to the conclusion that, in February,
> 2006, U.S. stocks were undervalued." should read
>
> I came to the conclusion that, in February, 1996, U.S. stocks were
> undervalued.

Which Portfolio Would You Prefer?

Don't know where the worst year stats come from, but it would seem that A's is now -40+% and that B's is now -22%. And the other ratios would have to be adjusted accordingly. Wonder if you can project this out through the timeframe ending 11/30/08?

Also, Harvard's endowment is managed by a team of professionals with their time dedicated to nothing but managing the endowment, and with an allocation strategy based on an expected time frame of infinity. The average individual investor has only him or herself to depend on, and has an -ver decreasing investment time horizon.

The Humility of Realism

Pretty depressing. It's starting to feel like 1932 all over again. I'm beginning to think that if I can hedge for the next 2 years and spend 2%-4% paying for the hedge, then I'll be much better ahead than going all cash. Probably because going all cash is capitulation, while hedging isn't?