Posts filed under “Really, really bad calls”
“People are starving for yield because rates are at zero. They’re taking more risk than they think.”
-Paul Tramontano, Constellation Wealth Advisors,
One of the factors that caused the great credit crisis to spread far and wide was the “reach for yield.” This is one of the most expensive ways a fixed income investor can obtain a higher potential return on their bond investments.
Note that I used the term “higher,” not “better,” and the word “potential,” not “actual.”As we have seen, high yielding junk paper often goes bust, making the yield grab an exercise in foolish futility. Thank goodness bond investors learned their lesson in the credit collapse of 2008-09.
Only not so much.
In 2009, bond buyers poured $7.8 billion into higher-yielding municipal bond funds, more or less ignoring the precarious financial conditions of cities and states.
Rather than accept ultra low yields as a consequence of Federal Reserve action in 2001, bond buyers poured into various mortgage backed securities. Even though they were paying 250 to 350 basis points more than Treasuries, they were rated the same: AAA.
This time, they are eschewing the fraudulent AAA ratings from Moody’s and S&P, and instead are buying naked junk. The bet is that the cities will be bailed out, and their grab for higher yield will be safely rewarded.
This is MORAL HAZARD writ large. Bailouts encourage irresponsible behavior, as their are no negative consequences.
“High-yield municipal bonds rated BB+ or lower by Standard & Poor’s or Ba1 by Moody’s Investors Service, 10 levels below investment-grade debt, have returned about 31 percent in the last 12 months compared with 11 percent for investment-grade municipal securities, according to the indexes from S&P/Investortools.
U.S. state and local government tax revenue fell 6.7 percent as of September from a year earlier, marking the fourth consecutive quarter of decline, according to a December Census Bureau report. That may drive defaults higher this year and next, according to Moody’s, which didn’t provide a number. The New York-based company also said it expects “somewhat higher rates of default” among bonds not rated and those below investment-grade.”
Investors in these funds would do well to remember that Return OF Capital is more important than Return ON Capital.
Defaults Signal Bursting Muni Junk Bubble on High-Yield Surge
Bloomberg, March 10 2010
As previously noted, Verizon has been very obnoxiously spraying unwanted services and icons on my Blackberry desktop.
I am sure somewhere in the unreadable fine print we gave permission for this garbage, but that doesn’t make this any less obnoxious, and it doesn’t make Verizon any less of a giant telecom douchebag for doing this.
At the time we last mentioned this, the solution was to hide the icon. A better solution would be to leave Verizon, but for some of us (NYC), the alternatives are not better.
There seems to be a better solution, found by Ned — simply follow these steps:
1. Go to Options (the wrench on my BlackBerry)
2. Advanced options
3. Service Book
4. Select Bing or Slacker Radio, or whatever
5. Left Click (Blackberry button)
The rhetoric you use to make your point says a lot about a) the strength of your argument; 2) you personally. There is no better example of this then some of the OpEds about the current and past Presidents. They are rife with bad logic, political animus, and sheer partisanship. I don’t care id they…Read More
Its as if Charlie Gasparino never left: Be sure to see the discussion — more of a yelling match — of Predatory Lending on CNBC. My issue isn’t the opinions of the various parties, its the unchecked ignorance that takes arrogant pride in ignoring facts. Its borderline unwatchable. Kudos to Janet Tavakoli for politely explaining…Read More
Harry Markopolos, the Madoff whistleblower whose new book, No One Would Listen is out tomorrow, had a brief interview in the Sunday NYT magazine. This quote leapt out at me: > Q: Where did you learn about finance? A: You don’t learn much in grad school. Half the formulas they teach you are false. It’s…Read More
Category: Really, really bad calls
One of the most disappointing policy initiatives of the Administration to date has been the expensive and ineffective attempts to fight foreclosures at all costs. The net impact of this is to artificially prop up home prices and reduce the number of real estate transactions. In the high foreclosures regions (California, South Florida, Arizona, Las…Read More
One of the oddest things to come out of the entire credit crisis, recession and muddling recovery has been the sudden re-emergence of deficit hawks. While a few honest deficit hawks are out there — the Peterson Institute is a good example of a group looking at long term structural issues, not immediate fiscal concerns…Read More
I love this: The Dynamite Prize in Economics is to be awarded to the three economists who contributed most to enabling the Global Financial Collapse (GFC), or more figuratively, to the three economists who contributed most to blowing up the global economy. Here’s the short list: Fischer Black and Myron Scholes Eugene Fama Milton Friedman…Read More
The usual crowd of ne’er-do-wells are seeking to divert attention from their own roles in the crisis, and shift blame elsewhere. These people make up a big chunk of the Its All Fannie’s Fault! crew. By muddying the waters, they hope to avoid retribution for their own roles in what occurred. As the mid-term election approaches, we should expect to hear more from this crowd.
The reality of crisis causation is far more complex and nuanced. Looking at the many factors that independently contributed to the collapse, and prioritizing them by degree of causation is not easy. A sophisticated approach is required to separate the prime and secondary factors.
Rather, than just repeat my list of factors what were the causal factors, today I want to try a different approach. Let’s do a “Causation Analysis” of the biggest factors to see if we can determine not just the various elements that contributed to the credit collapse, but which factors actually caused it to occur and what merely exacerbated the collapse, making it worse.
Understand that this is a theoretical discussion based on counter-factuals — what is likely to have occurred if various elements leading up to the crisis were different. We are trying to discern the differences between primary and secondary factors, separating the causes from the exacerbators.
Whenever someone asserts as a cause an event or force relative to a particular outcome, you should always ask: “Is this a “BUT FOR cause of that outcome?” In terms of a specific result or outcome, “But for” this factor, how would the outcome have changed? Would the result have been the same or different?
My top 3 list of crisis “BUT FORs” are:
1) Ultra low rates;
2) Unregulated, non bank, subprime lenders;
3) Ratings agencies slapping AAA on junk paper.
Why are these “But Fors?” But for these things occurring, the crisis would not have happened:
-If it wasn’t for ultra low rates, the housing boom would likely have been much more modest; further, bond managers would not have been scrambling for yield, and searching for alternative products to low yielding Treasuries;
-If it wasn’t for the sub-prime lenders, the credit bubble would not have inflated; further, millions of unqualified borrowers would not have been able to purchase homes they could not afford;
-If it wasn’t for the ratings agency fraud, the enormous market for this high yielding junk paper — mislabeled as AAA — would not have existed; further, the primary purchasers were firms that were only permitted to buy investment grade bonds. No A+ or better rating, no sale.
Hence, these factors are huge causative elements — BUT FOR them, there is no boom and bust, no crisis and collapse. Bond managers could not have owned all of these securitized sub-prime mortgages; the credit default swap market would have been much smaller, perhaps 1/10 its size; Sovereign wealth funds around the world could not have purchased all this bad paper; Iceland does not collapse. That is these are the big 3 — why I label them the prime cause of the crisis.