CNBC’s Steve Liesman on "Unique insights on the credit crisis and the future of the banking system from a stream in Maine…"
A bonus Friday afternoon guest post via Macro Man
– a portfolio manager at a London-based hedge fund, he trades global
currencies, equities, fixed income, and commodities. Over a long and
varied career, Macro Man has been an international economist, a
sell-side currency strategist, and a currency options market-maker.
His amusing Friday afternoon topic? Market Monopoly!
With the Olympics and the summer drawing to a close, it’s now time for market participants to get themselves back from the beach, turn off the TV, and focus on making money for the four-and-bit months that remain of 2008. Yet the Olympic spirit lives on, and many of us would love to channel our inner Usain Bolt or Michael Phelps.
Indeed, over the course of his career Macro Man has met many market people who are just as competitive as Bolt, Phelps, or Tiger Woods, for that matter. Sadly, while the mind is willing, the flesh is all too often weak (in this case, literally.) How, then, can desk-driving market people bring out the Olympian that lurks within us all and keep the competitive fires burning?
Macro Man has hit upon the answer: Monopoly. The game requires no discernible athletic ability and is predicated upon acquiring assets as cheaply as possible, levering them up, and separating other players from their cash. It’s a skill set with which many (but by no means all) market punters are well-acquainted.
Of course, in Monopoly, as in life, chance can play a significant role in determining winners and losers. In real life, these slings and arrows of outrageous fortune can come from anywhere, but in Monopoly they derive from the dice and the Chance/Community Chest cards. Come to think of it, it looks like the game of Market Monopoly has already started, because some of the cards have already been drawn. Consider who’s already holding the following (vintage) Monopoly cards:
ADIA, CIC, and Temasek holdings. These SWFs already own very significant stakes in a number of banks in the US and Europe, in many cases via high-yielding preferred shares. Though it may be a case of thrice bitten, four times shy, Macro Man can’t help but think that at the end of the dilutive capital-raising process, these guys will be the only ones left with enough equity to get paid any meaningful dividend income.
Holders of 2007 vintage AA-rated ABX. Unfortunately, to collect the prize, they have to tender $100 of face. (Since this vintage card was printed, prices have fallen further. In the modern editions of Monopoly, second prize winners only get $10.)
John Thain. Mr. Thain’s tenure at the helm of Merrill Lynch has been characterized by three things: large write-downs, a fire sale of assets to clean up the balance sheet, and Merrill itself providing the funding to the buyers in the aforementioned fire sale. Alternatively, this card could represent Merrill’s settlement of its part of the auction rate securities fiasco.
Today’s guest post comes from David J. Merkel, CFA, FSA. David is Chief Economist and Director of Research of Finacorp Securities. Previously, he has been a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. Prior to joining Hovde in 2003, Merkel managed corporate bonds for Dwight Asset Management. In 1998, he joined the Mount Washington Investment Group as the Asset Liability manager after working with F&G Life, Provident Mutual, AIG and Pacific Standard Life. Merkel holds bachelor’s and master’s degrees from Johns Hopkins University.
He writes daily commentary at Aleph blog.
Dave hits on a subject that has been a favorite of pundits a lot lately — what will it take for Housing to bottom . . .
This piece completes a series that I started RealMoney,
and continued at my blog. For
those with access to RealMoney, I did an article called The Fundamentals
of Market Tops, where I concluded in early 2004 that
we weren’t at a top yet. For those without access, Barry Ritholtz put a large portion of it at his blog. I then
piece at RM applying the framework to residential housing in mid-2005,
and I came to a different conclusion: yes, residential real estate [RRE] was
near its top. Recently, I posted a piece a number of readers asked me to
write: The Fundamentals
of Market Bottoms, where I concluded we weren’t yet at a bottom for the equity markets.
This piece completes the series for now, and asks whether we are at the bottom for RRE
prices. If not, when, and how much more pain?
Before I start this piece, I have to deal with the issue of why RRE market tops and bottoms are different. The
signals for a bottom are not automatically the inverse of those for a top. Tops and bottoms for RRE are different
primarily because of debt investors. At market tops, typically credit
spreads are tight, but they have been tight for several years, while seemingly
cheap leverage builds up. There is a sense of invincibility for the RRE
market, and the financing markets reflect that. Bottoms are more jagged, with debt financing expensive to non-existent.
As a friend of mine once said, “To make a stock go to zero, it has to have a significant slug of debt.” The
same is true of RRE and that is what differentiates tops from bottoms. At
tops, no one cares about the level of debt or financing terms. The rare
insolvencies that happen then are often due to fraud. But at bottoms, the
only thing that investors care about is the level of debt or financing terms.
Why Do RRE Defaults Happen?
It costs money to sell a home – around 5-10% of the sales price. In a
RRE bear market, those costs fall entirely on the seller. That’s why economic incentives for the
owners of RRE decline once their equity on a mark-to-market basis declines
below that threshold. They no longer have equity so much as an option on the equity of the home, should they
continue to pay on their mortgage and prices rise.
As RRE prices have fallen, a larger percentage of the housing stock has fallen below the 10% equity threshold. Near the peak in October 2005, maybe 5% of all houses were below the threshold. Recently, I estimated that that figure was closer to 12%. It may go as high as
20% by the time we reach bottom.
Defaults occur in RRE when there would be negative equity in a sale, and a negative life
mortgage payment rise from a reset or a recast
The negative life events, which,
aside from changes in mortgage payments, can’t be expected, cause the borrower
to give up and default. During a RRE
bear market, most people in a negative equity on sale position don’t have a lot
of extra assets to fall back on, so anything that interrupts the normal flow of
income raises the odds of default. So
long as there are a large number of homes in a negative equity on sale position,
a certain percentage will keep sliding into foreclosure when negative life
events hit. For any individual, it is
random, but for the US as a whole, a predictable flow of foreclosures occur.
Examining Economic Actors as We near the Bottom