Showing posts from November, 2008

The View Through the Bushian Looking Glass

GM got a stern dressing down when it showed up in Washington with Detroit's other suffering automakers, hat in hand, seeking a bailout. Would you rescue an outfit with these characteristics:

The company is on shaky financial footing, perhaps insolvent. It is guilty of overpaying workers (blue-collar employees got generous union contracts that provided unsustainable benefits). Its core business suffered from stunningly bad decisions (not developing enough good high-mileage or green vehicles, for example, leaving the company with unpopular products it has trouble selling).

The verdict: Let it perish! But what about the following supplicant:

The company is on shaky financial footing, perhaps insolvent. It is guilty of overpaying workers (white-collar executives got outrageous bonuses and salaries that didn't reflect the long-term viability of the operations they oversaw). Its core business suffered from stunningly bad decisions (taking on too much leverage and acquiring risky, compl…

The Consequences of Efficiency (in practice)

Back in September I wrote about the flip side of “efficiency” in capital markets, singling out sec lending as a culprit.

Last month, A.I.G. asked for additional $38 billion in financing on top of the $85 billion it has already received, raising questions, according to the New York Times, “about how a company claiming to be solvent in September could have developed such a big hole by October.”

Here is a crucial part of the answer:
While about $7 billion of its quarterly losses … were connected with the insurance coverage ... a bigger share of the losses, about $18 billion, were incurred because the assets in A.I.G.’s investment portfolio had fallen in value. Of that total amount, losses of a little less than $12 billion were on investments made under A.I.G.’s securities lending program.To understand what is taking place in the financial markets, on top of the theory, one must also know the nitty-gritty of the ways money is made. Only then theory could be deployed to connect the dots. Theo…

Give Me a Lever Long Enough and I'll Buy the World

When the definitive history of this financial crisis is written, the role of leverage should get a hard look. In the ailing credit markets, leverage turned what should have been chest pains into a full-blown heart attack. The “seize up" metaphor became especially apt.

Those following the storyline closely will know that leverage at Wall Street investment banks soared from levels of 12-1 to 30-1 in about four years. But what does that mean? To the average guy on Main Street, leverage is a rather abstract, foreign concept. However it's critical to grasp the destabilizing power of leverage to understand the mess we're in.

The standard definition of leverage compares money borrowed to equity. So if you take out a $3 million loan and your only equity is a $300,000 house, you’re leveraged at 10-1. But there's another way to look at this idea that illustrates the vulnerability created.

Let's say you buy a stock option (that financial engineers have dreamed up) that behaves …

Lehman On My Mind

Speaking of politics, those who track polls say that McCain’s fate was sealed on Friday, October 10. That is the day the Dow Jones opened 750 points down and McCain said that the U.S. economy was fundamentally sound. Almost immediately, his poll numbers which had been consistently close to Obama’s, sank and never recovered.

If so, blame the Lehman bankruptcy for at least contributing to McCain’s loss, with all the implications that follow. October 10, you recall, was the settlement date for the credit default swaps on Lehman. The dreadful opening of the markets in the U.S. was in anticipation of multi-billion dollar losses by Lehman CDS writers that was estimated to be in the order of $400 billion. It turned out that, thanks to netting, the ultimate payable amount was less than $6 billion. On that news, the Dow Jones recovered, but not McCain’s poll ratings.

The Lehman bankruptcy established a high water mark for the dislocated rates and prices and, in that regard, has become a de facto…

Wall Street’s Deafening Silence

Throughout the long dark days of this financial crisis, one thing that has struck me is the silence of Wall Street’s public relations machines. I keep waiting for one bank, any bank, to give us their best-spin version of what went wrong, or why they aren’t as bad as all those others – or to say something. Surely they must see how vilified they have become. Shareholder activist Nell Minow even quipped that the Street is one bonus away from having the villagers descend with torches.

But when “60 Minutes” did its exposé on the financial crisis early on, none of the major Wall Street banks would comment, apparently in any form. None of them even sent what I call the “coward’s note” – that carefully crafted defense/statement that is read on air at the end of the broadcast segment. Later, when the bank CEOs went to Washington to sign off on billion-dollar bailouts, they left the meeting with Treasury Secretary Paulson and fled to their limousines. They adroitly dodged the press corps waiting…

Election Night Musings on Why We Fail to “Get It”

Vols. 1 and 2 of Speculative Capital were published by the Financial Times in 1999. Vol. 1 came out in March and was FT’s “Book of the Month”. It got a respectable review and relatively strong sales which increased over time.

Vol. 2 followed in June and, as far the options discovery was concerned, was an instant dud. No one reacted to it.

The silence surprised me. There were large and active equity, fixed income, commodities and FX markets with tens of thousands of users and traders. Option valuation was, and remains, a mandatory subject in all business school programs. Surely the proof that options were not what everyone had thought they were had to be newsworthy.

After a few months, the comments began to trickle in and they were uniformly critical. The 100-plus page proof, that an option is not a right to buy or sell but a right to default, somehow had failed to make its mark; even a few who praised it had not understood it. There was, furthermore, this weird reciprocity, as I did not …