The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Sundays are a good time to look at some of the academic literature out there. Reader Mike R. sends along this study from Q1 2009 — revised January 29, 2010 — that looked at the “asset-backed commercial paper conduits” a/k/a securitized paper.

Recall the basic idea behind securitization structured finance: It is supposed to distribute risk by aggregating various debt instruments into a large pool, which is then sliced and diced into various tranches of different risk quality (and yield). Risk is supposed to be spread amongst investors, who purchase the tranches they desire based on the degree of risk (relative to return) they want to undertake.

This assumes, however, that there is an honest attempt to structure these securities in order to spread the risk. It is quite possible to create a structure that willfully aims at more nefarious goals.

But that is precisely what occurred during the run up to the financial collapse: Securitization was used to accomplish the opposite goal — namely, to concentrate (rather than disperse) risk. These structures did so by lowering capital requirements.

That is the conclusion of several NYU and Federal Reserve Board researchers who studied the issue. According to Viral V. Acharya, Philipp Schnabl and Gustavo Suarez, that is precisely what occurred:

We analyze asset-backed commercial paper conduits which played a central role in the early phase of the financial crisis of 2007-09. We document that commercial banks set up conduits to securitize assets while insuring the newly securitized assets using credit guarantees. The credit guarantees were structured to reduce bank capital requirements, while providing recourse to bank balance sheets for outside investors.

Consistent with such recourse, we find that banks with more exposure to conduits had lower stock returns at the start of the financial crisis; that during the first year of the crisis, asset-backed commercial paper spreads increased and issuance fell, especially for conduits with weaker credit guarantees and riskier banks; and that losses from conduits mostly remained with banks rather than outside investors.

These results suggest that banks used this form of securitization to concentrate, rather than disperse, financial risks in the banking sector while reducing their capital requirements.

A few interesting charts in the paper are worth exploring:

The first is a comparison of Modern Banking – with and without risk transfer during Securitization:

Modern Banking – Securitization with/without risk transfer

The second looks at what happened to Commercial Paper after new accounting rules (The Enron Capital Rule) for “liquidity enhancement provided to conduits” went into  effect April 2004.

Total Asset-backed Commercial Paper Oustanding

Quite fascinating.

You can download the full paper here.

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Source:
Securitization Without Risk Transfer
Viral V. Acharya (London Business School – Institute of Finance and Accounting; Stern School of Business; Centre for Economic Policy Research (CEPR))
Philipp Schnabl (New York University, Stern School of Business)
Gustavo Suarez (Federal Reserve Board)
Date originally posted: March 22, 2009
AFA 2010 Atlanta Meetings Paper
http://ssrn.com/abstract=1364525
http://ideas.repec.org/p/nbr/nberwo/15730.html

See also:
Recent Policy Issues Regarding Credit Risk Transfer
Federal Reserve Bank of San Francisco
Number 2005-34, December 2, 2005
http://www.frbsf.org/publications/economics/letter/2005/el2005-34.html

In the wake of the highest unemployment rate in 25 years, the Roosevelt Institute asked historians, economists and other public thinkers to reflect on the lessons of the New Deal and explore new, big ideas for how to get America back to work. Marshall Auerback calls for government to step in as employer of last resort.

At 10.2%, unemployment is now at its highest level since 1983. Nearly 16 million people can’t find jobs even, though we are constantly being told that the worst recession since the Great Depression has officially ended. Yet instead of trying to revive the productive economy, most of the Obama Administration’s recovery efforts still remain focused on cardio-shock treatment for Wall Street. The President still seems curiously hamstrung by his Herbert Hoover-like devotion to fiscal rectitude: he wants to spend but not add “one dime to the deficit,” as he announced at his Congressional address on health care in September. He does this even though deficits are a natural consequence of slowing economic growth, falling tax revenues and higher social welfare payments.

To all of the “Chicken Littles” (including the president), who fret about “excessive” government spending, we would simply point out that it is far better to deploy government spending in a way that reduces unemployment instead of settling for having it rise as a consequence of this spending.

We therefore suggest a new approach: Government as Employer of Last Resort (ELR). The U.S. Government can proceed directly to zero unemployment by hiring all of the labor that cannot find private sector employment. Furthermore, by fixing the wage paid under this ELR program at a level that does not disrupt existing labor markets, i.e., a wage level close to the existing minimum wage, substantive price stability can be expected. A sizable benefits package should be provided, including vacation and sick leave, contributions to Social Security and, most importantly, health care benefits, providing scope for a bottom-up reform of the current patchwork health care system.

Government as ELR would not be introducing another element of intrusive bureaucracy into our economy, but simply better utilizing the existing stock of unemployed, who are now dependent on the public purse — especially the chronically long-term unemployed. The current system we have relies on unemployed labor and excess capacity to try to dampen wage and price increases; however, it pays unemployed labor for not working and allows that labor to depreciate and develop behaviors that act as barriers to future private-sector employment. Social spending on the unemployed prevents aggregate demand from collapsing into a depression-like state, but little is done to enhance future growth and demand, which can be done via the ELR by providing the currently unemployed with jobs, greater education and higher skill levels.

The ELR program would allow for the elimination of many existing government welfare payments for anyone not specifically targeted for exemption. It would also command greater political legitimacy, as society places a high value on work as the means through which individuals earn a livelihood. Labor would welcome the safety net of a guaranteed job, and business would recognize the benefit of a pool of available labor it could draw from at some spread to the government wage paid to ELR employees. Additionally, the guaranteed public service job would be a counter-cyclical influence, automatically increasing government employment and spending as jobs were lost in the private sector, and decreasing government jobs and spending as the private sector expanded. It would therefore remain a permanent feature of our economy. In effect, it would act as a buffer stock to put a floor under unemployment. The program helps maintain price stability whereby government offers a fixed wage that does not “outbid” the private sector, but simply creates a stabilizing floor and thereby prevents deflation.

A more or less “free market” system does not (and, perhaps, cannot) continuously generate true full employment. And no civilized nation should allow a large portion of its population to go without adequate food, clothing and shelter. One of the best features of the ELR program is that it creates a stock of employed people, rather than a buffered stock of unemployed, where social capital depletes rapidly, and several long-term social pathologies develop.

The way we’re approaching our labor force now isn’t working. It’s time to try something that can put as many Americans as possible into productive employment.

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Marshall Auerback is a Denver, Colorado-based global portfolio strategist for RAB Capital plc and a Fellow with the Economists for Peace and Security (http://www.epsusa.org/). He is a frequent contributor to the blog, Credit Writedowns, and the Japan Policy Research Institute (www.jpri.org) and is a contributor to The Big Picture. Auerback is also a fellow at the Roosevelt Institute.

via New Deal 2.0

Lost amongst the Greeks, the Discount Rate hike, and that unpleasantness with Tiger Woods last week was Dell’s earnings news. It was not particularly good, and the stock fell to near 5 year lows.

Dell’s disastrous stock performance creates a “teachable moment.” That lesson is simply “Do not blindly follow the investing strategies of billionaires.”

Recall a purchase of stock by Michael Dell himself in 2006. That was $70 million worth of stock at $23.99.  This was remarkably Mr. Dell’s first ever purchase of his namesake company’s stock. According to data from Thomson Financial, he had been selling steadily every year since 1988.

At the time, we wrote:

“Like all too many things financial, the headline looks much better than the detailed reality beneath. This much is true: Dell did make the aforementioned $70 million purchase: But lets put this buy into some actual context:In the 2005 publication of the Forbes 400, Dell was listed as the 4th richest man in the United States and the 18th richest person in the world. He has net assets of $ 18.7 billion. Dell reportedly owns the 15th largest home in the world.

Put those figures into context: This $70 million purchase was less than 0.37% of his Mr. Dell’s assets. In terms of relative wealth, it is the equivalent of someone who earns a $100k per year buying 100 shares of Dell stock.

Yet that did not stop many pundits and analysts from looking at the purchase as if it were an enormous vote of confidence.

A year later, we noted:

“Billionaires are different from you and me. To begin with, they have more money. But its more than that — they invest differently, because they have very different goals and objectives. And (shocker thought it may be) they can afford different things than you.

Yet that doesn’t seem to stop people from wanting to “tag along.”

The lesson to be learned is that billionaires invest differently than you and I. They have very different goals and objectives. They are not concerned with saving for retirement. One should consider that before chasing their most recent buys.

These prior posts on the subject are worth a second look . . .

Dell 5 Year Chart

Dell 20 Year Chart (Monthly)

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Previously:
Dell Makes A Purchase (Whoopee!) (June 22nd, 2006)
http://www.ritholtz.com/blog/2006/06/dell-makes-a-purchase-whoopee/

Investing Advice: If you are NOT a billionaire . . . (March 25th, 2007)
http://www.ritholtz.com/blog/2007/03/investing-advice-if-you-are-not-a-billionaire/

Don’t Follow Wealthy Investors, Part 14 (February 17th, 2008)
http://www.ritholtz.com/blog/2008/02/dont-follow-wealthy-investors-part-14/

See also:
Dell shares fall as company’s net slips
Benjamin Pimentel
MarketWatch, February 19, 2010
http://www.marketwatch.com/story/dells-profit-declines-but-sales-rise-2010-02-19

Here are the latest bank closing data:

February 19, 2010
By John Mauldin

Germany, Greece, and Spain
Two Views on the Euro
The Pain in Spain
How Much Is Too Much?
Tampa, Austin, and California

Last week we talked about Greece. But the problems are more than just Greece. We look at two very different views of the euro, and then opposing thoughts on Spain. Is Spain a problem or not? And how can the US keep on spending? Is there a limit? There is a lot to cover in what has been an interesting, if confusing, week.

Before we get into the meat of the letter, I want to give you a chance to register for my 7th (where do the years go?!) annual Strategic Investment Conference, cosponsored with my friends at Altegris Investments. The conference will be held April 22-24 and, as always, in La Jolla, California. The speaker lineup is powerful. Already committed are Dr. Gary Shilling, David Rosenberg, Dr. Lacy Hunt, Dr. Niall Ferguson, and George Friedman, as well as your humble analyst. We are talking with several other equally exciting speakers and expect those to firm up shortly.

Look at that lineup. These are the guys who got the calls right over the past few years. They called the housing crisis, the credit bubble, and the recession. And, in my opinion, these are some of the best in the world at giving us ideas about where we are headed.

Comments from those who attend the annual affair generally run along the lines of, “This is the best conference we have ever been to.” And each year it seems to get better. This year we are going to focus on “The End Game,” that is, on the paths the various nations are likely to take as they try to solve their various deficit problems, and how that will affect the world and local economies and our investments. We make sure you have access to our speakers and get your questions answered, and you’ll come away with excellent, practical investment ideas.

This conference sells out every year, and it looks like it will do so this year. You do not want to miss it. There is a physical limit to the space. Every year I have to tell people, including good friends, that there is no more room. Don’t wait to sign up. There is still an early-registration discount. And while it pains me to say it, you must be an accredited investor to attend the conference, as there are regulations we must follow in order to offer specific advice and ideas. Click on the link and sign up now. https://hedge-fund-conference.com/2010/invitation.aspx?ref=mauldin

Germany, Greece, and Spain

Let’s start with a little theater of the absurd. Quoting from a Reuters story (you can’t make this up!):

“Greek opposition lawmakers said on Thursday that Germans should pay reparations for their World War Two occupation of Greece before criticizing the country over its yawning fiscal deficits.

“How does Germany have the cheek to denounce us over our finances when it has still not paid compensation for Greece’s war victims?” Margaritis Tzimas, of the main opposition New Democracy party, told parliament.”

This was during a debate in the Greek parliament on how to handle the Greek debt. And it was echoed by both the left and right political parties. Somehow they forgot about the German government paying 115 million deutschmarks in 1960, not a small sum back then. It seems that many Greek politicians are still in the denial stage of dealing with this crisis.

In Germany, it is becoming increasingly clear that there is little political will to bail out the Greeks without severe austerity measures that will further increase an already deep recession. But I wrote about that last week. Nothing has really changed, except that it has become even less clear how all this will unfold. But whatever happens, there is no positive outcome for the Greeks. Only less bad outcomes.

Well, a few things did happen. The rest of the EU took away the vote on some issues from Greece, and there are noises that if the Greeks do not take severe enough measures, they (the EU) will step in and take over. Now THAT would be an interesting spectacle. Just what the market likes: lots of confusion. Try selling a Greek bond in the midst of a modern Greek tragedy.

There are those, both in Europe and without, who think a default by Greece will mean the end of, or at least do serious damage to, the euro. Count me among the skeptics on that, as a default by California would not do much damage to the dollar. Greece is only about 2.5% of the Eurozone GDP. It would be a problem, and maybe even a crisis, as European banks have large Greek debt exposure; but Germany in fact could bail out its banks a lot more cheaply than bailing out Greece. And Portugal is even smaller.

I wrote in 2003 that I thought the euro (then at $.88) would go to $1.50 (it got to $1.60) and all the way back to parity ($1) over the course of many years. I still think so. It has and will be a long and rocky road. It is still not clear how all of the problems in the eurozone countries will be resolved, and by that I mean the serious entitlement liabilities they will face in the middle of the decade.

Oh, and as a reminder, I wrote last year and at the beginning of this year that the dollar was going to get stronger. I got more than a few people telling me I was, well, wrong, with varying degrees of politeness. (You need a thick skin to write this letter!)

Two Views on the Euro

My good friends David Kotok and Dennis Gartman illustrate the two sides of the euro debate. Dennis has long been a euro skeptic, and of late has been especially forceful as he writes about the problems of the euro. David runs around with serious international thought shapers in Europe. David wrote a letter to Dennis this week, and Dennis responded. I am taking the liberty of reprinting part of that conversation, as it sets up the discussion we will have nicely.

Dennis,

Most of the time you and I are simpatico in view. But this time we are on totally opposite sides. You predict the EUR is toast. I think it emerges from this stronger than ever and that the weaker system is now the deficit-ridden US. I have organized and chaired conferences and seminars in Europe for the last decade as program chair of the GIC, www.interdependence.org. The next one is in June in Paris and Prague, to which I am inviting you with this email.

In the course of this decade those meetings have ranged in location from south (Italy) to Baltic (Estonia) to west (Ireland). All of these meetings were multinational. None of them had language or cultural barriers. All of these various hosts were gracious and hospitable and welcoming. All of them had goodwill among nationals of the various European countries. None of them had internal antagonism.

Come with me in June and see this with your own eyes. Europe wants a hard currency and better economics and knows how to get it. The Greeks will end up better off and the politics will force it.

I am a euro bull. All the best. By the way, I still want you to come fishing with me.

David [Kotok]

Dennis answered.

David,

I’m writing from Calgary this morning. Nice town, and not all that cold. Nice people out here in Canada’s west. I always feel better about the world when I get to the Canadian west.

We do indeed disagree on the EUR, David, and I hope you are right, but I fear you are wrong. These cultural differences are simply too great to be overcome. I have always been a EUR skeptic, and have been surprised that the whole experiment has lasted this long, but the Germans are not going to allow any of their money to be shipped to Athens to defend Greeks who have no pride in their own country [and are] tax-paying scofflaws. The German’s felt put-upon by the rest of Europe when they paid for the cost of reunification entirely, and they have no intention of now paying for Greeks who thumb their noses at law and fiscal responsibility.

Right now, the market’s sayin’ I’m right, and for now I’m going to press the issue until the market tells me I’m wrong, David. It’s all I know to do. Expecting Papandreaou to change his fiscal spots is simply not wise. He has been a profligate all his life; so too his father. It is genetic and it aint’ gona’ change.

Be well, my friend. We can disagree and still be impressed by one another’s work. I know I am.

Dennis Gartman

Who’s right? In an odd way, both of them.

Read the rest of this entry »

Some reads for a Saturday afternoon:

• BASICLAND: Charles Munger’s parable about how one nation came to financial ruin (Slate)

• Agreement Is Near on New Overseer of Banking Risks (NYT)

• Prof Robert Shiller: Engineering Financial Stability

• Short sales grow as a cheaper alternative to foreclosure (LATimes)

• Government fines? Toyota shouldn’t worry (CNN/Money)

• Poll: Large majority opposes Supreme Court’s decision on campaign financing (WaPo)

• Survey says, the bigger the bank, the less people trust them

• War game reveals U.S. lacks cyber-crisis skills (WaPo)

• A History of the World in 100 objects (BBC)

• Management Secrets of the Grateful Dead (The Atlantic)

What are you reading?

What a pleasure:  So Matt Taibbi was discussing his most recent article in Rolling Stone, “Wall Street’s Bailout Hustle” (which we discussed here).

At his blog at True Slant, he had a few very nice comments about the approach I advocated, versus the one created by Bush/Paulson/Bernanke and continued by Obama/Geithner/Bernanke.

He writes:

“My feeling on that is similar to what Barry Ritholtz (check out his site if you haven’t), the author of Bailout Nation and one of the guys I spoke with at length for this story, proposed. He said that “we should have gone Swedish on their asses.” The Swedes after a similar bubble burst in 1992 temporarily seized control of insolvent institutions, forced banks to write down losses before they got aid, and gave taxpayers a huge share in the upside of recovery. It was a tough-love approach that really worked and forcefully addressed the moral hazard issue in a way we never touched.

That’s one way we could have proceeded. But whatever we didn’t do, we can be sure that what we did do was exactly wrong. Barry pointed out the classic pronunciation of Victorian economist/journalist Walter Bagehot, who said that in a crisis, a Central Bank should lend freely to solvent institutions against good collateral, at penalty rates. We did exactly the opposite: we lent to insolvent institutions, against shit collateral, at zero percent interest. We told these guys to drink themselves sober. Total crap thinking and totally typical.”

That is way cool . . .

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Source:
On the Bailout Hustle
MATT TAIBBI
True/Slant Feb. 19 2010
http://trueslant.com/matttaibbi/2010/02/19/on-the-bailout-hustle/

Andrew W. Lo, director of the Massachusetts Institute of Technology’s Laboratory for Financial Engineering, breaks down the hot debate over the current financial crisis and how math may have played a part. Explore the arguments for and against the claim that the mathematical models used to manage specific complex financial securities are responsible for the Great Recession. Was it systematically programmed or just human nature?

click for video

Runtime:00:44:55

Hat tip KH

Dean Baker of the Center for Economic Policy Research looked beyond the TARP to see how much Uncle Sam is subsizidizing the banks considered “too big to fail” — beyond TARP. Call it the Value of the “Too Big to Fail” Big Bank Subsidy.

His conclusions?

-The spread between big banks’ (1.15%) and smaller banks’ (1.93%) cost of funds is 0.78%:
-The annual boost to profits of 18 biggest banks from that funds-cost advantage: $33 billion;
-Pre-2008 spread in big and small banks’ funds-cost: 0.49%:
-Part of big banks’ profits from rate “subsidy” (1H09): 48%:

To give this some context, Dean compares it to the Temporary Assistance for Needy Families (TANF) and to US Foreign Aid Spending. Not including TARP, the “TBTF bank subsidy” was more than twice as large as the TANF grant for 2009; the bank subsidy is almost 20 percent larger than spending on foreign aid.

Here is something to think about: Even after the TARP has been fully paid back, the US Government is STILL bailing out TBTF banks more than we are giving bailouts to US families with hungry kids, and more than all of our overseas aid . . .

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Sources:
Value of the “Too Big to Fail” Big Bank Subsidy.
DEAN BAKER AND TRAVIS MCARTHUR
Center for Economic and Policy Research, September 202009

The Big Bank Theory
How government helps financial giants get richer
Dean Baker
Boston Review, JANUARY/FEBRUARY 2010
http://bostonreview.net/BR35.1/baker.php

Job-Creation Cacophony
BILL ALPERT
BARRONS  FEBRUARY 22, 2010
http://online.barrons.com/article/review.html

See also:
The Cost of Saving These Whales
GRETCHEN MORGENSON
NYT, October 3, 2009
http://www.nytimes.com/2009/10/04/business/economy/04gret.html

Discovery Channel – -I Love the World Commercial

Part II The World Is Just Awesome