Central banks provoke food fight
"If prices continue to rise," Jacques Diouf was quoted as saying in Monday's Financial Times, "I would not be surprised if we began to see food riots."
Why not money riots? The director general of the United Nations' Food and Agriculture Organization didn't say. He did observe, however, that food prices are rising worldwide and that governments are trying to haul them back in.
Socially responsible investing is fine for the people who like that kind of thing. For ourselves, we’ll take a pure play on human vanity. Especially does such an investment appeal when it comes with a low earnings multiple and the best kind of top-line growth available…
Late lingerers in the office last Friday stopped and stated at the news that Moody’s had taken the ratings ax to $33 billion of collateralized debt obligations, some of which had been rated on par with Treasury bills. Astounding, a pair of triple-A tranches…
On October 25, the editor of Grant’s spoke before a meeting of the New York Quantitative Finance Seminar on the subject, “Financial engineering: an oxymoron.” Following are excerpts from what he said, along with a few things he wishes he’d thought to say…
On October 25, the editor of Grant’s spoke before a meeting of the New York Quantitative Finance Seminar on the subject, “Financial engineering: an oxymoron.” Following are excerpts from what he said, along with a few things he wishes he’d thought to say…
When the debt machine coughs
To date in this century, an additional dollar of American GDP growth has required – or, at least, been associated with- the creation of $5 of new indebtedness. Whereas nominal GDP has tacked on…
A page from the Bank of Borat
"Oct. 12 (Bloomberg)–Kazakhstan's government will start buying shares of Kazakh banks on foreign exchanges next week to support prices after an 'attack' by hedge funds, Prime Minister Karim Masimov said.
"'Kazakhstan is under attack from hedge funds and we will fight back,' he told reporters in the capital of Astana today. President Nursultan Nazarbayev earlier said the country is also suffering from 'unfounded' downgrades of its credit ratings."
Buying low and selling high may make you rich, but there's no guarantee about popular. This surprising lesson the management of [COMPANY] has been recently absorbing in the classroom of Prof. Market. . . .
"It's more profitable to give financial advice than to take it," is a motto sometimes attributed to B.C. Forbes, the founder of another fortnightly financial journal. And while we at Grant's deplore Forbes's cynicism, we do not deny that he had a point. Only consider the Nasdaq-listed shooting star. . . .
To get it out of the way, we are bearish on this electronic stock-tip disseminator. . .
"Ambac's estimate of the fair value or 'mark-to-market' adjustment for its credit derivative portfolio at September 30, 2007 amounted to an unrealized loss of $743 million, pre-tax," said the October 10 press release. "The company expects to report a net loss per diluted share up to $3.50 in the third quarter."
Ambac management, the Street and the ratings agencies are of one mind on this evidently catastrophic disclosure. They agree it's bullish. Yes, credit spreads widened in the third quarter, and that fact forced on Ambac the obligation to mark its credit-default-swap portfolio to a lower market value. But what of it? Credit spreads, having widened, will sooner or later tighten. And because they did temporarily widen, Ambac can write more guarantee business at better prices. . . .
"We have very good access to the credit markets," the man from [COMPANY] was telling listeners on the [COMPANY] conference call Tuesday, "and we benefit from the market's slide to quality. Let me give you an example. We can issue one-month commercial paper now at 30 basis points below Libor."
If you can pay it back, you can borrow it. Foreign central banks, which can always pay it back (they can print it), continue to lay in U.S. dollar-denominated obligations for the high-minded purpose of manipulating exchange rates. . . .
Bearish on a money machine
The highest net margin in the S&P 500 belongs to a triple-A-rated financial guarantor that seldom pays a claim. Since going public in 1991, in fact, this paragon of profitability has borne cumulative losses, net of recoveries, of only $275 million, as it's collected $6.2 billion in premiums. It boasts the highest return on equity (15.1% in 2006, 12.6% in the first six months of 2007) and lowest expense ratios (15.3% in 2006, 14.9% in the first six months of 2007) in the financial-guarantee business. To top it off, the shares of this astonishing enterprise change hands at 7.9 times the 2007 estimate and at 1.1 times book value.
Yet, we believe, [this] is a stock to sell, or, at least, not to buy.
A phlegmatic people, Britons usually walk to the bank to make a withdrawal; they rarely run. Prior to last month's descent on Northern Rock, and putting aside some pushing and shoving outside the City of Glasgow Bank in 1878, there had not been a run on a British depository institution since the 1866 failure of Overend, Gurney, and Co. "A run on the bank was what you would expect in a 'banana republic,'" Richard Lambert, director-general of the British employers' federation, told the Financial Times last week. "That one should have happened in a mature and prosperous country like the U.K. is almost unimaginable."
Now unfolding is a meditation on the British government, governments in general, the pound sterling and currencies in general.
"What I learned on my summer vacation" was the format in which James S. Chanos addressed the August financial upheaval for the Grant's conference-goers. Topics covered included: "The wonderful world of FAS 157" (the new accounting standard for valuing hard-to-value investment esoterica); "Chutzpah, thy name is private equity"; "Infrastructure is not an asset class," and "Computers are rational, but they aren't always rational investors."
How is it, Jim Chanos had asked, that the big broker-dealers can show such consistently high returns on equity when their own star alumni, once transplanted at hedge funds, so often struggle to earn a half or a third of what their alma maters manage to produce, "no matter how leveraged they are or what bets they have on?"
After he said his piece, Sam Zell, "the capitalist of the decade, of the century and of the millennium," as he was introduced from the rostrum, fielded questions. "Commercial real estate," a woman asked,--"it's an even bigger bubble than residential real estate, is it not?"
"I'm sorry," Zell replied, "but I don't agree with you.
"My concern," Gary Carmell, a Newport (Calif.)-based real estate investor, mused the other day, "is that there will be a paradigm shift in which investors start scanning the globe and come to recognize that plain old boring multinational companies offer a better risk-reward relationship than our beloved bricks and mortar."
"There are three near certainties," Jeremy Grantham, chairman of GMO, Boston, and one of Wall Street's original (and most successful) quants, assured the Grant's conference goers. "These near certainties will happen whether or not there is a credit crisis. If there's a credit crisis they will happen fast; if there isn't, they will happen slowly, but they will happen. They are. . .
Summertime of aberrations
Asked what gave him the confidence to refer to the July-August credit crisis in the past tense, Mohamed El-Erian, CEO and president of Harvard Management Co., collected his thoughts. "First," he said with a broad smile, "English is not my mother tongue." And he continued as follows: "I think that, for now, we are in a healing process. . . .
"We believe it is not a massive bubble." So Chen Xiaosheng, general manager of Shanghai-based SYWG Research described China's stock market--the so-called A-share market--to the Grant's audience. Chinese stocks are up for the best of reasons, he insisted: Profit growth is soaring, consumption is booming and corporate governance is improving.
"There will be some minor lawsuits," Sean Egan, founding partner of Egan-Jones Ratings Co., predicted. He was referring to the expected chastisement of the government-sanctioned ratings bodies for their contributions to the structured-assets disaster....
Ian McCulley writes:
"Bloggers, cranks, and gold bugs have been muttering about the inflationary fallout of the Fed's 50 basis point cut to the funds rate on September 18. A weakening dollar and strengthening commodities will have inflationary consequences, they cry. But measured inflation is on the decline, and appears to have reached its cyclical peak sometime last year. . . .
No taxation without representation
The German economy needs one interest rate, the Spanish economy another. But what those disparate economies get is the same rate, the one the European Central Bank sets. If only the ECB could change places with the Federal Reserve, the governor of the ECB, Jean-Claude Trichet, must sometimes muse. In America, it's one rate--4.75%, down from 5.25%, following Tuesday's FOMC action--for one country.
But matters are not so deceptively simple as that...
Without financial failure, Mervyn King, governor of the Bank of England, was saying on September 12, genuine financial success is impossible. If wayward banks and their careless depositors could always depend on their hovering governments for timely succor, the world would be impoverished. . . .
[COMPANY], buys up portfolios of defaulted consumer receivables for cents on the dollar and proceeds to dun the debtors. It calls them on the phone or pursues them in the courts, or both. Not many Americans wake up in the morning with a song in their hearts because the next recession, or consumer-credit event, is 24 hours nearer. [COMPANY]is one of this unusual group.
On the Great Plains, sirens warn of approaching tornadoes and sirens sound the all-clear. Not so on Wall Street. No timely klaxons send investors scurrying off to safety ahead of a cyclical blow or tell them when it's safe to climb out of the cellar.
Now unfolding is a speculation on when the danger may pass in residential mortgage finance...
At 79, Boone Pickens is attracting more media attention than ever, virtually all of it positive. At any given moment, he may be quoted on the pricing prospects for oil and natural gas or pictured giving money to another worthy cause. Recently, he made news commenting on Chinese air quality... The whole world wants to talk to Boone Pickens.
In the wake of the bad jobs report two Fridays ago, one sell-side analyst turned his face to the wall and wrote: "The coming 2008 economic recession, followed by peak ARM mortgage resets in 4Q-2008 and 1Q-2009 suggest to us that EVEN this 325 bps of rate cuts may NOT be enough to stave off a massive seizure and collapse of the US economy--including a FAILURE of a national home builder, or two, and a FAILURE of a major financial institution." . . .
Strongest currency, best bourse
Readers of The New York Times may refuse to believe it, but Iraq has turned into a capital magnet. The only thing stronger than the Iraqi currency is the Baghdad stock market. Money is sometimes misinformed, but it is never insincere. Something is afoot in Iraq.
Flush times are trusting times. Cheap and accessible credit induces a belief in the benevolence of man, in the soundness of money and in the integrity of financial statements. Bulls in bull markets learn to believe. Not for them the tedious work of reading financial footnotes or straining to understand just how $100 million of triple-B-rated mortgage-backed securities could plausibly be transformed into a structure of which the top $80 million could be rated triple-A. In a rising market, it's more profitable not to ask.. . .
Now comes the contraction phase of the cycle, and with it a new belief system. . . .
Detroit's house prices, an associate real estate broker in Detroit, told a caller from Grant's last week, "are falling really fast. I mean, they're falling hard. It's shocking. Houses that were priced at $85,000 two years ago are now selling for $45,000."
Colleague Adam Rowe traveled to the Motor City before Labor Day to search for investment value. . . .
Change in the monetary weather
Wait long enough and the inevitable will happen. The inflationary effects of foreign central-bank reserve accumulation are finally beginning to show up in official statistics.
It can't please Jim Cramer, pyrotechnic CNBC commentator, that the Federal Open Market Committee remains focused on the inflation in goods and services rather than on the deflation in stocks and bonds. On Wall Street, few seem pleased. . . .
Now comes the inevitable repricing of mispriced debt, and with it, a great debate: Can a credit contraction be benign? Can it, in fact, be bullish, for stocks or bonds or the economy?
Angelo Mozilo reconsidered
Bears, too, live in houses, and they accept that most Americans will continue to sleep under roofs, rather than inside automobiles or on park benches. Conventionally sheltered, the average Joe and Jane will continue to need a mortgage. This wellspring of trust in the American way of life inevitably leads a value-seeking bear to put aside his bearishness.
True believers in the competence of central bankers and the stability of the international monetary system may now stop reading and turn the page. We are about to espouse techniques to capitalize on the incompetence of central bankers and the instability of the international monetary system.
The trouble with [this COMPANY] is that mortgage securitization is its bread and butter. It was a terrific business while it lasted, but now it's stopped. In the second quarter--before things got really bad--"transaction management" revenues plunged by 41.8%, to $28.1 million, from the $48.2 million posted in the second quarter of 2006.
The stock market has been notified of this discontinuity, of course. The [COMPANY] share price, quoted today at 82% of book value, has fallen by 67% in the year to date. And because some 60% of the corporate assets comprise goodwill and intangibles, book value isn't much of a pillar for the reeling bulls to lean on.
Still, we believe we see an important positive. . .
Roll call of the bag holders
Simon Mikhailovich, of Eidesis Capital, joked at the Grant's conference in April that the ultimate owners of subprime-backed paper were "agriculture cooperatives in Taiwan who don't report to the international media." As it turns out, some do, because no fewer than seven Taiwanese financials have reported U.S. subprime exposure. . . .
The international monetary system is a simpler piece of plumbing than it might appear. The United States emits hundreds of billions of dollars a year into the world's payments channels. Foreign central banks print the currencies with which to buy the dollars that profit-seeking entities shun. Result: gushing global liquidity with all the attendant froth.
There's only one mystery about "Bretton Woods II," as the brokerage-house economists are pleased to call this happy set of conventions. And that mystery is whether it's too good to last.
New lows in the indices of junk bonds, tradable bank debt, residential subprime mortgages and commercial mortgage-backed securities indicate that the caravan of credit has picked up stakes from the Heights of Accommodation and is proceeding on the return cyclical journey to the Depths of Stringency.
Triple-A's to the woodshed
"Not your father's triple-A" was the headline over the Grant's article that warned of coming troubles in the highest reaches of structured finance. The date was April 20, and our investment analysis favored the one and only triple-A-rated issuer that can lawfully print its own dollars. That would be the U.S. Treasury, a very different kind of obligor than the structured kind. Do we happen to have a current example of the structured kind? Why, yes. . .
Now begins a fresh look at a company that is not only the "world's largest unhedged gold producer," as new management proudly trumpets, but also, arguably, the leader in big-cap gold-mining disappointment. . . .
In the hall of mirrors of relative currency values, the euro is evidently strong. But that is because the dollar is absolutely laboring. Bearish on the dollar, Grant's is--if possible--even more bearish on the euro. . . .
Field guide for the mortgage opportunist
Grant's does not happen to believe that the bear market is close to ending. We doubted it even before the Standard & Poor's bombshell, followed by a secondary explosion from Moody's, on Tuesday. But, knowing from hard experience how short can be the useful half-life of a deeply held investment opinion, we are trying to prepare for the next cycle. How to analyze distressed mortgage assets? How to value them? How to buy them? . . .
Not the least ominous thunderhead to form in Tuesday's S&P conference call was the threat to $100 billion or so of mezzanine collateralized debt obligations. A mezzanine CDO is a pile of debt collateralized by triple-B-rated asset-backed securities, mainly RMBS. All told, S&P said on the call, 218 CDOs own tranches of those downgrade-bound RMBS, of which 168 are mezzanine CDOs.
At the fall Grant's Conference, Paul Singer delivered an analysis that exactly anticipated Tuesday's fireworks (Grant's, October 6). . . .
Stand between a farm-state politician and the tooting ethanol gravy train and you take your life in your hands. Then, again, [THIS COMPANY]. has had no choice. It's among the world's biggest corn buyers. In the first quarter alone, it took down $140 million of what the grain bulls worshipfully call "yellow gold."
"Reserve" is a status not quickly conferred on any national currency. Nor, once conferred, is it lightly withdrawn. The pound sterling reigned as the world's reserve currency long after the British lion started to lose its teeth. Nevertheless, history stands still for no monetary brand. What might the reserve currencies of tomorrow be?
Mr. Market trumps Mr. Bernanke
The recent run of stronger-than-expected economic data has popularized the notion that the Federal Reserve will sit tight for the rest of the year. Hints from the Fed that it will focus more on still-elevated headline inflation add to the hawkish tone. Doves, meanwhile, are curious how this stance sits with a housing market that appears nowhere near bottom and a subprime lending crisis that grows less "contained" by the day.
Wall Street needs a haircut
Though Bear Stearns and its creditors could not agree on what to do, they clearly saw what not to do. A free and open auction of the funds' unwanted collateral was the course of action to avoid, they concurred. Price discovery could wait until the return of blue skies and normal pulse rates. The first order of business was price suppression. . . .
Since February 9, the day Blackstone handed over a check for $39 billion to Sam Zell and the other smiling owners of Equity Office Properties, real estate stocks on both sides of the Atlantic have been laboring. Priced for perfection, the likes of IYR, the iShares Dow Jones U.S. real estate exchange-traded fund, have encountered imperfection in the shape of rising interest rates and a whiff--the merest whiff--of risk aversion among previously insensate lenders....
The debt boom of the 1980s turned to bust on Oct. 13, 1989 (it happened to be a Friday), with the collapse of plans for a $7 billion leveraged buyout of UAL Corp., parent of United Airlines. What event might mark the close of the credit frolics of the mid-'00s?
As this publication turns out the lights and climbs into bed, the Japanese yen is setting record lows against the New Zealand dollar, which pays its holders 8%, and the euro, which yields 4%. The Japanese unit is making heavy weather against the U.S. dollar, which returns 5%-plus, as well as against a host of other currencies that yield an overnight rate much higher than the 0.5% on offer in the world's second-largest economy. . . So, then, it's decided: Everybody sell the yen.
Not so fast, we say--again (Grant's, January 26). Your editor, who invests in Japanese equities, carries a torch for the yen, though, admittedly, there are days when he wonders why....
From Russia, with dollars
Whom to thank for the dollar's springtime rally? The bulls may write a handwritten note to the nations that absorb redundant greenbacks. They are the ones that print money (rubles, renminbi, etc.) with which to buy money (dollars). But even the most free-spending central banks have limits.
Mortgage derivatives are us
"Who owns this stuff?" is everyone's favorite question about subprime mortgages and the gingerbread Victorian asset-backed structures that house them. "Hedge funds, European insurance companies and Asian central banks," is the stock answer. "A Canadian bank" is a phrase almost never heard–-at least, not until the May 31 conference call of the Canadian Imperial Bank of Commerce.
How much are you willing to pay for the great India growth story? Specifically, what's the right price for a profitable and fast-growing Indian bank? There are several schools of thought on the subject.
Now under way is an exposition on India's state-owned banks, or, rather, state majority-owned banks, as the public holds the stubs....
In their hurry to put in the top in the income-producing property market, the real estate bulls lost track of a few details. In one case, it was the contract.[An] unexplained decision by a [COMPANY] to back away from its announced purchase of prime Manhattan property had prompted some to worry that the eminent New York City real estate concern was overextended. . . .
On Sunday, the editor of Grant's addressed the President's Meeting of Fairfax Financial Holdings Ltd. at Niagara-on-the-Lake, Ontario. Following is the text of his remarks:
Just the other day, Kevin Warsh, a governor of the central bank of the populous country on the other side of Niagara Falls, was singing the praises of financial innovation. Asset-backed securities, derivatives of all kinds, hedge funds etc., he said, have made the world a far, far better place. No more do banks have to retain the loans they make or brokers merely distribute the securities they underwrite. And a good thing, too, said Warsh, who proceeded to quote numbers so fantastic that his London audience must have begun to wonder if they were correctly parsing his American accent. . . .
Ordinarily, central bankers don't much concern themselves with food prices. They rarely go hungry, and, besides, they have their theories. But the recent jump in the cost of eating may at last command their attention. It could hold the key for the dollar and dollar-denominated interest rates....
Only 20 years ago, Japanese investors were paying the kind of prices for U.S. real estate that left the American sellers agog. Now the national roles have reversed. It's the American buyers who are astounding the Japanese sellers.
Oil and water don't mix, except in the operations of the Natco Group, born the National Tank Co. in Tulsa, Okla., in 1926. Eighty years on, Natco (NTG on the Big Board) is a top-flight provider of wellhead process equipment and services to the oil and gas industry. Its technology helps to extend the productive life of aging wells. But here is the rub: Its stock price is intertwined with the oil price. Which focuses the investment question on a great imponderable: Whither the oil price?
Now begins a microeconomic exploration of what Jeremy Grantham, a founder and in-house sage of Boston money manager GMO, has termed the first universal, all-asset bubble
In general, the buyers of investment-grade bonds don't read the text of the prospectus, let alone the indenture, let alone the footnotes to either. They don't have time, they say. And they don't have the documents.
All the more reason for vigilance in a time of nonstop deal making....
"To get it out of the way," colleague Ian McCulley writes in a confessional vein, "let's all admit that this company is not really a traditional value stock. It's more of a call option on an idea that seems reasonably priced given that its potential target market is any unbanked population on earth, the sum total of which could be four billion."...
The curious surge in money supply
The yield curve is flat, the Federal Reserve is unaccommodative and the residential mortgage market is constricted. Yet growth in the broader measures of money supply is quickening, M-2 and MZM to the fastest rates in four years. "The discontinued M-3, which is kept alive on the blogosphere. . .is supposedly growing at double digits."...
Atlas of monetary derangement
Within the next week or so, the G-8 finance ministers will assemble in Potsdam, Germany, and the Chinese government travel team will alight in Washington, D.C. However, the most intriguing city on the monetary map may be neither Potsdam nor Washington, but the broiling capital of Saudi Arabia. From Riyadh last week issued new complaints about the rising rate of inflation in that kingdom and in neighboring Gulf states.
. . . Now begins a speculation on whether an inflationary outbreak among America's creditor nations could hasten the unhinging of current monetary arrangements, known in learned circles as "Bretton Woods II."...
The announced purchase of little MedImmune by giant AstraZeneca at a price half again as high as the one that MedImmune commanded before it put itself up for sale last month is good news at one remove for every biotech investor. Savoring it, he or she may entertain a plausible hope of finding a seat at the feast table of M&A.
Now begins another Grant's-sponsored biotech tour, led, as usual, by Dan DeClue, portfolio manager at Arnhold & S. Bleichroeder Advisers, New York. . . .
A Paris Hilton impersonator, told reporters at a "Free Paris Hilton" rally in New York last week that the U.S. labor market hung in the balance....
"Here comes an optimistic question," quipped Warren Buffett as the Grant's special correspondent, Jondavid Klipp, made his way to the microphone during the Sunday press conference at the Berkshire Hathaway meeting nearly two weeks ago in Omaha. The question came in two parts....
On Tuesday, the editor of Grant's addressed the New York Hard Assets Investment Conference. Following is the gist of his remarks:
Ladies and gentlemen, we used to be alone, but we aren't any longer. And that fact introduces a new risk to our beloved gold price....
Frederick E. "Shad" Rowe writes from Dallas:
On April 14, the Austin American-Statesman reported a "seismic shift" in the asset allocation of the $109 billion Teacher Retirement System of Texas (TRS)....
...I do not think that everything that happens in Texas is a precursor to events in the broader world, but when selectively applied, the theory has never failed me...
Late last week, Beijing ordered the parole of certain funds now imprisoned by Chinese capital controls. By no means will every last renminbi be set free--just $7 billion to $9 billion is likely to be liberated for investment outside the country, according to one estimate--but the order raised the possibility....
Mortgage contagion update
Can buyers of income-producing property expect to borrow 80% of the value of their purchase on interest-only terms for the full 10-year life of their loans. That such conditions were very nearly standard until only a month or so ago goes a long way toward explaining the splendid arc of property prices. . . .
Doormats to private-equity promoters, real-estate speculators and hedge-fund titans, creditors have actually staged a revolt. They have ordered the rotten apples removed from the barrel of collateral that was to support a pending sale of commercial mortgage-backed securities. Otherwise, they said, they would sit on their wallets. The issuer, none other than General Electric, submitted....
Here is what a recession isn't, David Rosenberg, chief North American economist for Merrill Lynch, advised the Grant's conference-goers. It isn't back-to-back quarters of shrinking gross domestic product. Think of it, rather, in terms of stall speed: "It's when GDP gets to 1.5% or lower. Why? Because population is rising 1.5% a year. When you get GDP growth below 1.5% a year, what it means is that real per-capita national income is actually contracting." And when per-capita national income is contracting, credit spreads are bound to be widening.
Three days later came the first-quarter GDP report. . . .
Chicken parts with turkey
"I am here to make a bullish case for distress and to explain why this technology can be a very interesting and valuable tool in the hands of some, and potentially a very destructive tool in the hands of others. Much like fertilizer, which can be used to grow heirloom tomatoes or blow up buildings--same substance, very different outcomes."
So Simon Mikhailovich, a founder of Eidesis Capital, specialists in complex debt securities, informed Grant's Spring Investment Conference-goers. . . .
Bill Ackman, founder and president of Pershing Square Capital Management, is a nonbeliever in structured finance. His doubt is all-encompassing, he told the Grant's audience. The structures are over-leveraged, the ratings are overgenerous and the bond guarantors--who stand behind the ostensibly ironclad ABS and CDO tranches--are overextended. It's a great business for the securities assemblers and ratings agencies, all right, Ackman did allow. They, at least, get paid up front. The investor constituency is the one that has to wait.
And what if the wait is in vain? Who would bear the losses? Ackman had a list....
Cheap stocks with currencies to match was the theme of your editor's presentation. Halliburton has moved its headquarters to Dubai from Houston, he observed in opening. "I don't know about you," Grant said, "but my policy is, I go where Halliburton goes."
Of course, Dick Cheney's corporate alma mater is only following the dollars. . . .
"Asset prices are clearly at historic highs. That means returns are at historic lows." So Bruce Flatt, CEO of Brookfield Asset Management, readily conceded. But he went on to make an ultra-long-term case for . . .
The story of how a Georgia banker of a certain age turned $3 million into $50 million in just over six years captured the full and undivided attention of the room. Proof of this extraordinary feat was provided by the man who accomplished it, Karl Hill, owner of Monroe County Bank, Forsyth, Ga.
The endowment manager's endowment manager had some advice for the active investors in the room. It was, in a word, "Index." David Swensen, pioneering nonpassive manager of the Yale University endowment, reminded one and all how stiff a competitor Mr. Market can be....
"It's a beautiful afternoon--cool, pleasant. And you've chosen to spend it in here, listening to an agricultural economist talk about climate change. There is one saving grace. I'm going to talk about it in a way that you've never heard. I'm going to talk about evidence."
So Dennis Avery, co-author, with S. Fred Singer, of "Unstoppable Global Warming: Every 1,500 Years," began his presentation. He was speaking because the editor of Grant's loves both capitalism and blizzards and has been wondering if the two can co-habit....
The page-one expose about financial leverage in Monday's Wall Street Journal lacked not facts but imagination. It failed to explore, as Eric Mindich did before the Grant's audience, how hedge funds and private-equity purveyors might contribute their share to an even more rotund national debt profile....
In praise of cheap insurance
Though the euro is making highs, the Spanish home-building stocks are sinking. Monetary logicians will perceive a non sequitur....
Not your father’s triple-A
On Wall Street, "AAA" is the rating of a top-flight borrower. On all the other streets, it's the organization you call to get a tow. Taking one thing with another--the proliferation of dubious, triple-A-rated "structured products" and the snowy springtime driving season--we are coming to value the tow more than we do the rating.
Now unfolding is a report on safety, real and ersatz, in the taxable fixed-income market.
Rain falls from the heavens, liquidity from the central banks. The Federal Reserve, or the People's Bank of China, or the Banco de la Republica de Colombia acquires earning assets with newly conjured money. Figuratively speaking, they "print" it.
Now begins an update on this ancient, liquidity-enriching procedure. Until just recently, it was the Asian central banks that chiefly manned the global monetary pumps. They acquired dollars with currencies they printed for the very purpose. Why? To forestall an export-depressing rise in the value of yen, renminbi, won, baht, or what have you.
The labors continue, though the hands on the pumps have changed. . . .
Nobody likes taxes except for the tax preparers, but many admire the preparers--and H&R Block (HRB on the Big Board) has a valuation to prove it. At 18 times the earnings forecast and five times book value, you wouldn't know unless you asked that the nation's top tax-preparation firm by revenue also owns a benighted subprime lender. We asked. . .
Lending recedes; ditto, inflation
Before the invention of CDOs, CLOs, ABS, CMBS, RMBS and other such vessels of indebtedness, there were "commercial banks." Some of these relics survive to this day, but they're not doing the business they did.
New wrinkle in credit: Ohio’s unsecured mortgages
In this very space one issue ago, Grant's was able to show that precedent abounds for state-imposed stays on mortgage foreclosures. But Ohio demonstrated our point before we actually made it, and it continues to drive the lesson home emphatically....
Invest in risky assets. Leverage those assets by 4.6:1. Pay a 91/2% dividend yield. Sleep tight.
Actually, these days, thoughtful gropers after very high yields tend to toss and turn. They are beginning to wonder about the staying power of the mainstay assets of the post-millennial debt boom: low-rated bank loans, commercial real-estate mortgages, residential mortgage-backed securities and, of course, collateralized debt obligations, or CDOs, which aggregate slices of the former claims. Alan Greenspan was recently quoted as saying that finance has gotten a bit more complicated. For once, the Maestro and Grant's see eye-to-eye. . . .
"We represent a great investment opportunity," Jaime Rivera, chief executive officer of Banco Latinoamericano de Exportaciones S.A., better known as Bladex, declared in an appearance at the New York Stock Exchange 2-1/2 years ago. Not everyone believed it. The supranational wholesale trade bank was still struggling under the weight of defaulted Argentine debt.
Moody's, Standard & Poor's and Fitch are out in force to respond to a clamoring marketplace: If the snowball of low-rated mortgage trouble keeps rolling, investors would like to know, whom might it squash? The agencies have replied in a way that, to us, sounds a little like this: "Well, it could be bad--very bad. And if it does turn out to be very bad, don't forget who warned you. But it probably won't be so bad as all that. And, if it isn't, don't forget whose ratings held up under critical scrutiny."
Pretty clearly, structured finance is too important to be left to the structured-finance experts. This is everybody's business....
Not a little of life's continuing education takes place at 35,000 feet in the air. Especially conducive to study is the semester-length round-trip flight to Tokyo from New York. Once the aircraft door closes, it's just you and the crying babies and the books you've brought.
On this particular journey, your editor opened up John W. Dower's "Embracing Defeat: Japan in the Wake of World War II" (Norton, 1999). It proved an excellent intercontinental traveling companion. The more than 500 pages of text contain some of the most harrowing facts you've ever read. Even the end notes are good for an occasional shock. . . .
Central bankers on the head of a pin
Two Fridays ago, Governor Frederic Mishkin of the Federal Reserve Board proposed that the Fed could live with a 2% "core" inflation rate. Ten days later, William Poole, president of the Federal Reserve Bank of St. Louis, begged to differ with his learned colleague in Washington. . .
A short digression on ancient history
"One can only marvel," Ronald Utt, senior research fellow at the Heritage Foundation, was quoted as saying in Tuesday's Investor's Business Daily, "[when Congress] sees a disaster sweeping through financial markets and tries to figure out how it can be a part of it." Utt was referring to legislative plans to cut off the flow of private credit to nonprime borrowers.
But the four-decade peak in residential mortgage foreclosures has other political minds racing in different directions. . . .
George Soros wrote about the alchemy of finance. We now write about the alchemy of debt ratings. The readers of Grant's have seen for themselves how a stack of non-investment-grade mortgage slices can be rearranged to form a collateralized debt obligation. And they have stared in amazement at the improvements that this mysterious process can effect in the credit ratings of the slices. More than you might suppose are reappraised as triple-A.
Now begins a voyage of discovery into the commercial real-estate wing of structured finance....
Hugo Chavez, president (and much, much more) of Venezuela, has espoused many ideas, one of which is communism. "I'm very much of Trotsky's line--permanent revolution," said Chavez a few months back. The consequences of communism are rarely bullish in the financial way, but you wouldn't know it from the pricing of Venezuela's dollar bonds. . . .
Bermuda-based Security Capital Assurance (SCA on the Big Board) is the 2006 Monoline of the Year, according to International Project Finance Magazine. On the other hand--this just in!--Security Capital Assurance also happens to be the 2007 Smallish Financial Guaranty Stock to Avoid, according to Grant's Interest Rate Observer.
Maybe International Project Finance and Grant's are both correct....
"It is not a small issue," Alan Greenspan, the noted economic consultant, told the Futures Industry Association last week amidst the tumult in subprime mortgages. "If we could wave a wand and prices go up 10%, the subprime problem would disappear."
While sitting at the head of the table of the Federal Reserve Board, Greenspan virtually held that wand in his own hands. It was called the "printing press." Now, Chairman Ben S. Bernanke has his hands on the same dollar-production machinery.
But there's no gainsaying the point that fast-rising house prices would rescue most struggling borrowers....
As specific a forecast as you’ll read here
Grant's has been a fine one for waving in front of the Federal Reserve the mounting evidence of a shambles in mortgage credit. Counting these debt troubles as a bigger monetary consideration than the slightly elevated inflation rate, we have expected a lower funds rate and a steeper yield curve. Off and on over the past turbulent weeks, we almost believed we were going to be right.
Memo to markets: We’re on our own
"Three out of four mortgages that are made are made by a person who is not employed by a bank or savings and loan," said Federal Reserve governor Susan Bies in a speech last month before the intercontinental stock-selling competition got under way in earnest. Not quite washing her hands of the tumult in subprime mortgages, but not really sounding very sympathetic, either, the soon-to-be-retired Bies went on to insist that, because of the securitization and wide distribution of mortgage credit, the world is a safer place.
We're not sure it's safer. We would say it's less predictable. Certainly, it is less familiar.
The value restoration project, a.k.a. "correction," is a godsend for those who kept their hands in their pockets as (THIS COMPANY) ascended. Happily for them, the company's uninvested admirers, the stock price has lately made excellent progress to the downside. COMPANY'S principal holding is (##), a developer of water rights in the American Southwest. These two companies are the subjects under discussion; Grant's is bullish on both. . . .
First came the mortgage, then the mortgage-backed security and finally--what's this about America in decline?--the collateralized debt obligation. Individual mortgages are hard enough to value. Mortgage-backed securities are that much more difficult. And securities collateralized by mortgage-backed securities--i.e., CDOs--are the very devil. But the devil got his due in 2006, when, according to J.P. Morgan, $769 billion of CDOs came into the world. By the looks of things, the world could have done with less....
The award for the least remunerative analysis of Nov. 22, 2002, goes to none other than Grant's for the bearish article we published on Moody's (MCO on the Big Board). We wrote in the wake of the Enron bankruptcy. The rating agencies had conspicuously not predicted it. The recently enacted Sarbanes-Oxley law seemed to open the ratings field to new competition. And we thought we could read in the weakening pace of debt issuance a sign that the over-leveraged U.S. economy was going to need many fewer new bond ratings. Yet Moody's, the only freestanding public ratings business, traded at 24 times earnings....
Valassis Communications, an undisputed leader in a field you wouldn't want to enter, managed to borrow $540 million in speculative-grade notes at a price to yield a mere 8-1/4% on the day the stock market fell out of bed. That a junk-grade issuer was able to borrow at all while the Dow was dropping by 400 points is remarkable enough. That it was able to borrow at a cost fully 50 basis points less than observers had expected, right up until the time of the pricing, is amazing. That it was able to borrow in order to finance the acquisition of a company that, according to Valassis itself, was run by knaves or fools, can hardly be believed. Yet it happened....
"It's not just subprime," Richard X. Bove, analyst with Punk, Ziegel & Co., pointed out on Tuesday in a new report on spreading credit difficulties. While the levels of defaults and delinquencies are low, he noted, "it's the direction that counts. Bad loans. . .are rising."
Prompted by Bove, GRANT'S conducted its own survey. Our report follows....
The ABCs of credit contagion
Now unfolding is a speculation on the meaning of the disturbances in subprime. Some will avert their eyes. To these reluctant readers, we say: Credit is cyclical. It flows and it ebbs. It has been flowing since 2002, to the point today of nearly overflowing its banks (and hedge funds). A future cyclical contraction is a certainty, and it's got to start somewhere. In the possibly anomalous, possibly not anomalous, sell-off in less-than-prime-rated mortgage slices, the down cycle may have already begun....
"Good things happen to cheap stocks," is the value investor's credo, but not all cheap stocks are equally value-laden. Cyclical businesses trading at low multiples to what look like peak earnings are famously treacherous.
Hercules Offshore (HERO on the Nasdaq), though cheap and cyclical, is also, we believe, just plain cheap....
The world's biggest monoline financial guarantor, insures $(#) billion of debt on the strength of $(#) billion of equity. It insures municipal bonds, structured finance obligations and derivatives. Among the latter, as of year-end 2005, were $(#) billion of collateralized debt obligations. CDOs accounted for (#)% of the company's book of insured assets, up from zero percent in 2000.
So it's of more than passing interest when this giant guarantor of other people's credit becomes the object of the regulators' scrutiny, or when a pair of senior executives resigns on the same day....
On February 16, the editor of Grant's testified at a hearing on monetary policy before the House Committee on Financial Services. His written statement follows:
The Federal Reserve figuratively prints the thing we all want more of. Why so little of this manna seems to find its way into deserving pockets is at the top of today's agenda.
Under the law, the Fed has a dual mandate. It must protect against inflation, as defined, and promote full employment. But Congress and the American people have come to expect much more from our central bank than even that tall order. We ask, in addition, that it make an inherently risky world safe. We expect the Fed to deliver us from the consequences of hedge-fund explosions, sovereign-debt defaults, bear stock markets, bank failures, deflations and other financial and economic vicissitudes.
It can't be done....
Last week, the editor of Grant's addressed the Harvard Business School Centennial Conference on Private Equity at the Metropolitan Club in New York. His remarks, edited to include a few things he wished he had said, follow:
What's in a brand? Why, what's not in a brand? Take "private equity." What a beautiful phrase it is! What a dignified and substantial image it connotes! Imagine if, instead, the industry had had to labor under the stigma of the tarnished moniker "leveraged buyout." One shudders. ...
Brands sell, but numbers count. My thesis today is that the numbers in the U.S. credit markets don't add up. . . .
Federal Reserve Chairman Ben S. Bernanke, testifying before Congress last week (he was the other witness), sounded nothing like the deflation fighter of yesteryear. "Overall," said the chairman, "the U.S. economy seems likely to expand at a moderate pace this year and next, with growth strengthening somewhat as the drag from housing diminishes." While dovish enough on inflation to send Wall Street into temporary raptures, Bernanke also sought to justify the 5-1/4% funds rate. Students of forward-looking economic data may find him unpersuasive.
Real estate 2007: Overvaluation, overvaluation, etc.
REITs are the subject under discussion, and a timely one it is now that the smoke is about to blow away from the final battle to overpay for Equity Office Properties. . . .
It's no front-page news that the 2006-vintage subprime-mortgage originations are stacking up as the all-time worst, or that the lowest-rated tranche of the newly issued subprime mortgage index dropped like a stone. . . .
For the Mexican-food-loving, ethanol-hating hunter of investment value, Gruma S.A. de C.V., a Monterey (Mexico)-based maker of tortillas and corn flour, is one of a kind.
Now unfolding is an analysis of a company whose No. 1 estimable quality might be its. . .
News, on January 29, of the proposed merger of [two companies] lifted shares of the intended partners by a quarter (not a quarter-point, but 25%). Following is a status report on [company], object of a bullish analysis on page one of the October 6 issue of Grant's. . . .
A Boston-based company last year delivered greater-than-market returns with little more than half its capital at risk. "Dear Partner," the 2006 year-end letter leads off, "We are delighted to report a healthy profit for the month of December and a very strong gain for the year. . . ." Then the tone changes. . . .
"Ali" the barber, let us call him, works 20 days a month at Camp Fallujah, Anbar Province, Iraq. He spends the rest of his time with his wife and children in Baghdad. Ali is hopeful about the Iraqi currency, according to a U.S. Marine officer who e-mailed this publication in response to a query from her father, the editor: "[Ali] says that the dinar has taken a slight downturn in the past few weeks, but that people in Baghdad are saying that, in five years, the exchange rate will be one-to-one. He recalled getting three dollars to the dinar once upon a time. He says that you are a very smart man to recognize the value of the dinar. Also, I don't have any more split ends."
What is sometimes described as the world's worst country might conceivably be printing the world's strongest currency. . . .
"Reader Justin Blomberg, who thought he had seen everything, recently saw puppies offered for sale on credit. Naturally, he e-mailed us, and we investigated. . . .
Joe and Jane, stay away; all others welcome
"Nearly all domestic banks and all foreign institutions that had eased terms on commercial real estate loans over the past 12 months cited more-aggressive competition from other banks or nonbank lenders as the most important reason for having done so." So finds the latest survey of senior loan officers by the Federal Reserve Board.
Up with the world's worst currency
The yen, like Howard Stern, gives offense impartially. It puts off everyone for one reason or another--except for the people who borrow it. These days, it repulses volatility traders and value buyers alike. It upsets the true believers in central-bank independence and a certain kind of monetary theorist. Costing next to nothing to borrow, and reliably losing value against the dollar and euro, it brings profit and pleasure to only one sizable financial constituency. We speak of the far-flung Army of Leveraged Speculators.
Here begins a reappraisal of the world's monetary doormat. . . .
On January 17, the president and chief executive officer of Lennar Corp. allowed himself to express the hope that the worst is over for home building: "Uncertain market conditions make it difficult to provide a 2007 earnings goal," said Stuart Miller in the fourth-quarter press release. "While we know that the margin in our backlog will result in lower profitability in the first half of 2007, we believe that if the current environment of strong employment, low interest rates and a healthy economy continues, and the market for new homes demonstrates traditional, seasonal improvement, we will meet or exceed our 2006 earnings of $3.69 a share."
It appears that Miller had not yet familiarized himself with the Fed's June 2006 working paper, "The Price of Residential Land in Large U.S. Cities". . .
Cadres perform about-face
Two weeks ago, the Chinese minister of commerce, Bo Xilai, declared that the towering Chinese trade surplus was bad--for China, that is. Here was a new departure for an official whose job description was previously that of promoting Chinese exports--and therefore, necessarily, of talking up the accumulation by China of hundreds of billions of dollars in export earnings (the sum now tops $1 trillion). . . .
No doubt, commercial banking in China is a growth business. There can be no doubt because the mainland banks are priced for a boom already. Hong Kong-listed shares of Bank of China, Industrial & Commercial Bank of China and China Construction Bank change hands at between 3.5 and 4.5 times book value and at 25 to 30 times earnings. You'll remember Bank of China (Grant's, June 2). It's the one whose "former chairman and president and the former general manager of our New York branch was convicted of accepting over RMB1 million in bribes in exchange for assisting certain companies with obtaining loan approvals." There was no word on the character of the tellers. . .
I scream, you scream, we all scream
"The junk-bond market is undergoing a sort of gentrification, appealing to more conservative investors, who, like many in the current low-yield environment, are starved for higher returns," reported the credit markets column in Saturday's Wall Street Journal. "Conservative Investors Line Up for Junk Bonds," was the crowning headline.
At least the desperate buyers have retained enough self-control to form a queue. . . .
Don Kohn, say hello to Barney Frank
"I am a central banker to my core," Donald L. Kohn, vice chairman of the Federal Reserve Board, said in a talk in Atlanta on Monday, "so I know that somewhere, somehow, something will go wrong." You don't have to be a central banker to recognize that homely truth. Fathers, mothers, generals and short sellers understand it all too well. The future never ceases to surprise.
Anyone can buy exposure to credit risk. The trick is to sell it or hedge against it. Professional investors can always find a way. They can sell short junk bonds or mortgages, or--more likely these days--buy protection against adversity in the derivatives markets. Fine for them, but what about the rest of us?
Well, the lay credit bear is disenfranchised no longer. A mutual fund is up and running to deliver what amounts to short-side exposure to the high-yield bond market. . . .
Late last month, Radio One (ROIAK on the Nasdaq), the nation's top radio network catering to African-American listeners, sold its underperforming Boston station, WKAF-FM (formerly WILD-FM). To read between the lines of the latest Radio One 10-Q report, the station produces cash flow as a rock does blood. Yet it fetched $30 million, cash.
A befuddling business, radio. . . .
It was the marginal lender who financed the marginal borrower. And it was the marginal borrower who stepped up to pay the extra dollar for the incremental house. Such was the way of the boom. Now, the marginal, or subprime, lender is withdrawing and so, too, is the marginal borrower. Following is an attempt to handicap the spreading bust. . . .
Mild weather is the principal cause of the breakdown in the price of crude oil, according to news reports, but we blame money--and have for a while (see Grant's, March 24, 2006). . . .