Friday, October 3, 2008

A little learning is a dangerous thing but a lot of ignorance is just as bad.

A little learning is a dangerous thing but a lot of ignorance is just as bad.
Bob Edwards

I have decided to explain the crisis and why the plan is useless once and for all to myself - it is really an economy of scale issue as it is the question I get the most (Yes, I know you are wondering why people even bother to ask me anything being an European Elitist Arrogant High-horse something as a "friendly anonymous visitor to my site called me!)....these days....but let me try:

The background is this:

Imagine you have a bank - for arguments sake let us call it : Banque Paulson & Bernanke - their corporate motto's is: "We create moral hazards better than anyone else -faster".....

This bank BP&P got an asset side which really mimics a traditonal portfolio:

A little stock, a little government bonds(10%), a little (sorry a lot) of mortgages(30%), a little lending(40%), a little Real Estate(20%) and other on-and-off balancesheet vehicles...

- It is - obviously- all funded day by day in the money market.

The portfolio is leveraged 10 times - which happens to be the average leverage in commercial banks.

Now - the market (portfolio) is down 15% - meaning you are insolvent by 50% -- i.e 10 x 15% = 150% minus your capital = -50% - but your "bank" --- allows you to keep the portfolio because tomorrow they "hope" the market will be better.....(The Church going traders I call them..)

Then one day the Congress and its two parties called We-got-zero-clue and We-got-even-less-clue gets call from The White House - some geezer who doesn't know what an CDO is shouts: "Fire, Fire - pants on fire ......." Please send in the Mortgage Firebrigade..... fast!

Congress goes into panic and decides they will buy ALL MORTGAGES and ALL MORTGAGE INSTITUTIONS in the country.

Fine.....but hang on... lets go through this...

If the GOVERNMENT buys only the mortgage loss from my portfolio what happens next?

Well if we deal a market-prices the mortgage portfolio is off my book @ 20 cents in the dollar... so my cash goes up but the loss remains in place plus taking 30% of loss off still leaves me short a few bucks...but even if they bail-out out without loss' on my mortgages I am still short: (100 USD - 30% in mortgages equals 30 USD x 10 leverage = 300 USD x 15% loss = equals 45 USD I am getting 45 USD back - but I am down 50 USD net - leaving me 5 US dollars short (Yes, this is constructed portfolio but.. point is still the same....)

- and IF... the others parts of the portfolio continues to fall --- BP&B is still even more insolvent.


Because you are NOT dealing with the real issues:

1. Funding is done day by day - with massive mismatch in time - Bad business model is environment of scarce credit creation.
2. Leverage - in a perfect storm EVERYTHING becomes correlated. .meaning falling...
3. Mortgages - there are 4.5 mio. unsold homes, so whether government or private sector owns them does not matter - its all math.....
4. Solvency - portfolio of BP&B still insolvent - why should anyone deal with them?
5. Transperency - how do I know BP&B is honest?

The right solution would be to let everyone go bankrupt - but if you want to spend the tax payers money the government needs to think like a Private Equity Fund - buy on the bid, restructure balance sheet,give new management upside in equity, sack the old management, and buy equity upside leverage.

There was God forbid an excellent Swedish model for this before - Imagine that recommending anything Swedish is a first for me......but DO realise this is PURE SOCIALDEMOCRATIC policy and hence I can not support it, but it did work before....

So......if the deal adresss real issues it will work, but I doubt BP&B will survive longer than a few quarters more, and neither should they....


Calling it a strategy is an insult to the word itself, but.....

85% cash
Long USD vs EUR as we broke uptrend since 2000 - meaning lower EURUSD
Small short T-bonds
Small long upside stocks...

Nice week-end

Steen Jakobsen


Anonymous said...

To me it seems they want buy at a price so high that the capital is preserved. Which should wreck the mortgage market, as then there are several market prices and I don't think that the US govt can artifically pump up prices. In addition with all these funny new accounting tricks, distrust will be embedded in the financial sector until resolution. Sentiment has changed: People know now that they are screwed.

Greetings from another European elitist :-)

Anonymous said...

SJ - thanks for the shoutout. Interesting way to look at it, but something to keep in mind is to trade what the market will do, not what it should do. The world we live in/trade is one where policymakers will not countenance a systemic collapse. Moreover, it is not historically unprecedented to do what US is doing now, as many countries have nationalized banks and mortgage markets in the past. And now that the crisis has hit Europe the policymakers are no longer willing to stand by and let the market tough it out(wait until European real estate adjusts to levels consistent with per-capita incomes; if we had a bubble you guys had a frenzy) Trichet's hike in July going to be biggest monetary policy mistake of the decade, along with FF at 1% from mid 03-June 04. If the right solution is for everyone to go bankrupt, then the next 5 years will be global depression. Andrew Mellon followed your advice in 1930 (liquidate labor, liquidate capital, liquidate land, etc) and that didn't work out too well for the world. Ben Bernanke did his PhD Thesis on causes of Great Depression, and you think they are going to stand by and let banks go under and libor go to 10%? I hope you are staying away from EDZ8 then. Remeber Keynes' beauty contest, what market should do is irrelevant, now more than ever.

Anonymous said...

With a little over 10x the insured limit of cash sitting in my Barclays account, might I guess that you'd suggest that I not only remove such a deposit from an institution that struggled for cash during a three day period 2 weeks before the Northn Rock debacle and had to borrow from the Bank of England to stay afloat...but exit the pound market altogether for USD or EUR? Why?What happened to suggesting the CHF? I have no confidence in the USD and gold is so high, I'm looking at my jewelry and debating a fire sale..Should I buy cheap Chinese art and hope for the best? For the layman, the nonbanker, what should we, as individuals be thinking and doing? What is within our power to do both politically and financially speaking? ps- you are many things, Mr. J, but arrogant isn't one of them in my humble opinion. By attacking you personally, the "anonymous" contributor can rationalize their discounting of your opinions. Sticks and stones remember...