Friday, August 21, 2009


A couple commentors mentioned upcoming option ARM resets as a reason to be more bearish on housing. I wanted to make some quick comments about that.

First let me say that option ARM resets are a tricky thing. Most ARMs were underwritten in 2005 to early 2007. During 2005, 12-month LIBOR averaged 4%, during 2006 5.33% and in 1H 2007 it averaged 5.33% again. So the reset itself isn't a worry at all.

Its the recast that matters. The switch from the "Option" period to the full amortization period. The tricky part there is that most option ARMs have a 5-year "Option" period. That would mean that 2010 would be a big year for recasts, and 2011 even bigger. We wouldn't "burn out" on these things until mid 2012.

However, most option ARMs also have a provision where if the negative amortization gets to 15% (i.e., you owe 115% of the outstanding balance), it automatically reverts to the fully amortizing amount. Certainly if a borrower has managed to fall that far behind within the first couple years, the odds that that loan winds up in foreclosure is pretty high. Anyway, it throws off the theory that there is suddenly going to be a bunch of recasts in 2010 and 2011. Many of those loans are already recasting because of the neg-am element.

Here is how I see it. I track a large group of whole loan "prime" mortgage securitizations. My group is from 2006 and about half are Option ARMs, the rest are full amortization ARMs. Most are also limited documentation. So while the credit score said prime, everything else about the loan said "questionable." I created this grouping back in 2007 to track how seemingly good borrowers who took out bad loans performed. Its a pretty good gauge of how Option ARMs are doing.

The 90+ delinquency (which includes foreclosures) is currently 11.5% of the original balance for the whole group. The figure continues to climb month-by-month but the pace has slowed considerable. The last 5 months its increased by about 0.3% per month, vs. over 1%/mo. during most of 2008. So that's point 1, that the pace is clearly declining. Worth noting that the pools with mostly option ARMs are about 2.5 times the delinquency level of the full amortization loans.

Second, I track a similar group of sub-prime loans. That series has completely burned out, with the 90+ figure sitting at 17.5% for the last six-months. So basically what's going to happen in sub-prime has already happened.

Put these two together and you could conclude that the continuing rise in price foreclosures is just making up for the lack of rising sub-prime foreclosures. I don't know if the math of that exactly works, and I am sure that the sub-prime and prime loans were not typically in the same neighborhoods, but point is that a lack of new sub-prime foreclosures is at least something of an off-set.

If you drill down into some specific Option ARM deals, you find some very interesting info. Here are some stats on one of the deals in my list.

Pool Factor: 63.2% (meaning 36.8% has paid off)
# of Loans: 496
WALTV: 83.5% (so few loans are being forcibly recast)
90+ Delinq: 39.5%

Now here is what's interesting to me. 37% of this loan has paid off. Another 40% is not paying. That means the potential new problems are only 23% of the remaining principal. I pull several other deals with the same kind of circumstances. What we're seeing here is that the loans that never should have been made are already turning bad (the 40%). The loans that were made to actual good borrowers are paying off rapidly. What remains in between isn't a very large number.

That's the facts as I see them. I'd love to hear the other side. Just post a comment!

Thursday, August 20, 2009

SMACKDOWN WEEK: Slimy? Mudhole? My home this is!




I'd like to start by describing my generic view of consumer decision making. People make decisions based on their own circumstances. So whether the Solos decide to buy Jaina and Jacen a new summer wardrobe or to keep the ragged stuff from last year is all about how the Solos are doing. The fact that unemployment is rising galaxy wide isn't an important factor in their decision making. Obviously if Han is worried about his job in particular, that would make a difference, but if he expects the smuggling market to remain strong, 5% overall unemployment or 7% or 10% isn't going to impact their decisions. Not by a large degree anyway.

I'll put this another way to illustrate the point. What if unemployment were especially low? Han could still lose income for one reason or another. People still lose their jobs in good times. So I argue that the Solo family's spending habits are a function of their specific income level and perceived stability. A poor macro picture in and of itself isn't relevant.

What's the conclusion for overall spending? Its that statistics like consumer confidence is over-rated. I've looked at the correlations, and consumer confidence is, at best, a coincident indicator. In other words, consumers don't lose confidence and then the economy weakens. The economy weakens and then consumers feel less confident. That tells you the confidence in and of itself has no bearing on economic activity. One doesn't cause the other.

I think Cash for Clunkers is an illustration of this point. Consumer confidence is still quite low, but give them a good enough deal on a car and they're ready to buy. Ready to take on a major financial commitment despite this purportedly weak sentiment. (Don't through me comments suggesting that I liked this program, I didn't. I'm just making a point.)

I have a similar view of the wealth effect, be it from financial assets or one's home. It all depends on an individual's situation. Let's zoom our targeting computer onto home values. There is a certain segment of the population that was using home equity to fund spending. Clearly that group will have to pare back spending. But there is a large segment of people for whom that peak value in homes is a meaningless number. I bought my house in 2001. It probably rose in value through 2006, then has fallen a solid 15 or 20% since. But none of that matters since I've never taken any equity out. I've just been sending my checks in every month.

I'll go even further and say that for most people, the biggest influence on how much money they choose to spend is how much money is currently in their checking account. The candy bar was called "Pay Day" because people celebrated Pay Day by buying stuff like candy bars! That is to say most people make decisions based on very short-term considerations. Not high-minded thoughts like "I've lost money in my 401(k) and I therefore need to save more if I'm going to retire in 29 years." For most regular Joe Americans, they can't (or choose not to) think that far ahead.

Point here is that if you take a consumer with a fairly stable job and good home equity, they aren't doing anything differently today than they did two years ago.

If I stopped here you might think I'm pretty bullish on consumer spending. In the short-run, I'm probably more bullish than a lot of people. But in the intermediate term, a number of factors are going to retard growth in consumption in a profound way.

Let's take my presumption above as truth, that most people make consumption decisions based primarily on how much cash they currently have access to. In the short-run, maybe that hasn't changed much. Like I said, if you didn't spend your home equity, it doesn't matter that your home value has declined a bit. That is, until you want to move. Then you need to come up with more cash to make your next down payment. I said that people might not change their current buying habits just because their 401(k)s declined, but eventually when they do to retire, they are going to have less money. For people closer to retirement, they are either going to have to save more aggressively or keep working, which is de facto savings.

Then there is the reality that consumer credit is going to be harder to come by. We know home equity loans are going to be more difficult just because of the lack of equity. But we also know that generally retail credit is not going to reach the same levels seen during the securitization boom. There just won't be enough capital to fund it at that same level. The reality is that these "0% financing for 12 months" deals were quasi-price reductions, but typically banks were involved in supplying the credit. I think those kinds of deals will be less prevalent. Not non-existent, but less common.

Taxes are another issue. I expect both federal and local tax rates to increase in the coming years. The feds might only target the rich, but locals will probably target more insidious increases, like sales tax or governmental fees. Clearly if we increase the price of everything by 1%, that's going to impact consumer spending.

Finally, I think we're going to enter a phase where unemployment is going to remain fairly high for an extended period. I don't think we'll stay at 10% for too long, but I think we'll still be above 7% at the end of 2010. Maybe even well into 2011. So even under my thought that consumers react to their own circumstances, more consumers are being impacted by "circumstances" than in past recessions. In fact, if more workers stay in the work force past normal retirement age, that increases the size of the work force and thus keeps unemployment high.

Bruce Kasman of J.P. Morgan back in April said he thought the economy was going to bounce into malaise. I think consumer spending will be similar. Consumers have some degree of pent-up demand for goods which will create a deceptive bounce in the next few months, but then we level out into a mediocre growth rate.


Somewhat paradoxically, my view of housing is pretty bullish, at least when contrasted with mainstream opinions.

First, you have to think about what caused the housing bubble/crash in the first place. I'm not talking about the deeper underlying causes, which we can debate, but the more proximate causes.

  • Lending conditions become too easy, causing demand to increase
  • Supply increases in response, both from new starts and rehabs
  • Losses from sub-prime cause banks to pull back lending, demand falls
  • Foreclosures rise, largely because of loans made to borrowers who could not afford regular payments and/or reset levels.
  • Builders/rehabs still have a substantial supply over-hang. They can't destroy supply as demand falls, so prices fall.
The housing problem is therefore no more complicated than a simple supply/demand imbalance. In fact, one could argue that the supply/demand imbalance wasn't even that large, but that the contagion was great because of the impact on the financial system.

So predicting an end to generalized home price declines is as simple as determining when supply is meeting demand.

Ask yourself, how did we know supply was not matching demand before? Because even as prices fell, demand didn't seem to pick up. We can see this in housing transactions. From March 2007 through January, existing home sales declined from 5.75 million units to 4.05 million units. Perhaps more telling is the fact that the figure only showed an increase in 5 out of 21 months. New home sales show a similar pattern although more severe. Units fell from a peak of 1.4 million units to a paltry 329,000.

Since that time we've shown pretty strong increases in both series. New home sales are up 17% off the bottom, existing up 6.7%. Both series have increased 4 out of the last 5 months.
Demand is meeting supply.

It doesn't really matter that total demand is much lower than in the past. Not in terms of home prices. If you are talking in terms of contribution to GDP or some such, then yes, overall activity isn't adding to GDP like it once did. But in terms of home prices continuing to decline, as long as supply meets demand, there isn't any reason to expect more declines.

I also consider the Case Shiller Index, which looks like its bottomed. I have long argued that that index is fraught with lags and other data problems. But if its lagging, then you'd say that housing might actually be better than indicated. Absent some catalyst to the negative, I don't see homes continuing to decline.

This isn't to say that home prices will start rising in spectacular fashion. I think demand is just now meeting supply because buyers think homes are cheap. If they were to rise above "cheap" then buyers would pull away. Plus all the problems consumers have that I mentioned above apply to housing. But inflation-level home price increases are perfectly reasonable.

The best argument for another leg down in home prices is accelerating prime foreclosures. I can't deny that prime foreclosures are high and rising. But I also think there is a substantial difference between a classic foreclosure and a bad loan foreclosure.

This downturn started when a set of loans, most of which never should have been underwriten (i.e. no doc loans), started going bad. A good percentage of these loans were de facto investment loans, even if they were supposedly underwritten with a residence pretense. For this and other reasons, these loans were not only bound to go bad, but they were bound to produce above-average losses for the lending bank. Think about a half-completed rehab gone bad. What can a bank do buy sell it as aggressively as they could?

Furthermore, these loans were concentrated in particular areas. If you wanted to do a flip, you did it in a "hot" neighborhood. So when they started going bad, all the banks were trying to sell houses in the same general areas within a given city. This is a factor that I think hasn't gotten enough attention. You have 10 houses on the same block for sale, each chasing the rest of them lower and lower trying to get the one buyer who wants to live there. Obviously this is a recipe for some ugly price changes.

I'm not here to say that all of the bad loans went to sub-prime borrowers. Look at any option-arm securitization and you'll see "prime" borrowers. The reality is that if someone took out a truly bad loan, one that the borrower never really could have afforded, then the loan must be at least two years old by now. By August 2007, the mortgage securitization market was already in shambles and the joke of the NINJA loan was already well known. I'd guess that July 2007 was about the last time you could get a classic no-doc mortgage. So in order to claim there is a wave of mortgage defaults coming, you have to explain to me why these people would default now instead of a year ago.

Now of course, we have unemployment rising and that certainly has an impact on foreclosure rates. But this is totally different than the bad loan foreclosures, in my mind. Unemployment-type delinquencies are more likely to be resolved through a modification. The borrower eventually finds a job and can resume payment. In addition, those foreclosures would be more spread out. Again, I think people underestimate the impact of concentrated foreclosures. If there is one foreclosure in your neighborhood, it doesn't destroy the value of all the other homes. Six or seven is a different story.

Next time on SMACKDOWN! Uh... I'll decide tomorrow!

Wednesday, August 19, 2009

SMACKDOWN WEEK: The Greedy Trade Federation


MORE BULLISH: Brokerages

I get it. I really do. In February, the situation for banks looked as dire as the Jedi on Genonosis. Surrounded by hordes of battle droids, the capital markets shut off both for debt and equity, there was no apparant solution. Nationalization seemed like a legitimate option.

Turns out there was a ready-made clone army which was able to rescue the reminants of the Jedi attack force and bring the banking system bank from the brink. Who knew? Certainly not me. I thought the Stress Tests were, at best, a useful regulatory tool. Who knew they would inspire so much confidence? I don't know that Geithner himself can claim he really knew it would work so well.

Anyway, given how far we've come, I get why a Bank of America can rally from $2.5 to $17. Is $17 too high? Maybe, but that's not the point here. The point is, some kind of huge rally in bank stocks fits with how much things have improved.

The "systemically important" banks (i.e. the Stress Test 18 not including GMAC) have now managed to raise about $53 billion in new equity capital through stock sales. Many have increased their capital position further through earnings retention, asset sles, etc. That is all fantasic news, especially since as a tax payer, I'm a shareholder in all of these firms.

But the story doesn't end there. There is almost universal agreement that the situation at large banks is much improved. It isn't just about new capital raised or even access to capital. Its also because large banks have gotten much more aggressive about recognizing and/or provisioning for losses. I picked five of the largest true banks: J.P. Morgan, Citigroup, Bank of America, Wells Fargo, and PNC. Over the last year, loss reserves at these banks have increased by $20 billion, from a total of $20 billion to $40 billion. According to the FDIC, there is currently $193 billion in total loss reserves among all FDIC insured institutions, up from $121 billion one year ago.

Let's do the math. Loss reserves in the overall system was $121 billion one year ago, $20 of which was our five large banks. Loss reserves then increased to $193 billion, $40 of which was the Big Five. So other than those five, loss reserves increased by about 51%, whereas loss reserves increased by 100% at the Big Five.

Do you think that loan losses have increased at the largest bonds at double the rate of all other banks? Think about that while you read on.

Loan loss reserve as a percentage of loans tells a similar story. The Big Five have loan loss reserves equal to 3.9% of total loans. I estimate that all other banks have only 2.3%. In fact, I estimate that while the Big Five account for 13.6% of all loans, they actually account for 21.1% of all loan loss reserves.

Are big bank's loan portfolios really that much worse? Maybe they are somewhat worse, but what seems more likely to me is that big banks are further along in terms of recognizing potential problem loans. And this makes sense. What does a typical regional bank loan portfolio look like? Local loans right? Small businesses, local developers, etc. I was driving through a small town a few weeks ago and pointed to an empty building that looked like it was once a convenience store or small resturant. I said the loan for that building didn't come from J.P. Morgan or Wells Fargo. It came from someone like First Community Bank of Mos Eisley.

All banks like to think they have above average loan portfolios. And why not? I'm sure they all think they have loan officiers with extremely high midi-chlorian counts. Otherwise the bank wouldn't have hired them. I'm also sure when management asks the loan officers about certain loans, they are given an optimistic picture. Afterall, the credit officer has his own ego and reputation. But we know in reality that not all banks can be above average, and even some of the above average banks are going to suffer greater losses than they expected.

One final thought on large banks vs. small banks. The big banks took large losses in securities early in this cycle. Stuff like CMBS, leveraged loans, etc. Most of that stuff needed to be marked to market, and thus the loss on these should already be recognized. In the case of CMBS and other securities, there have been substantial improvements from the worst levels, actually adding to bank profits. Small banks didn't get into as many problems with securities, which is to their credit, but it also means that their losses are yet to come.

On to where I'm more bullish: regional brokerages. Sure I think Goldman Sachs and Morgan Stanley will make their money. In fact, the IPO and bond underwriting business looks much better now than it did six months ago, which will clearly benefit the big boys.

But I also think we're ushering in an era of diminished liquidity, which will benefit regional brokerages disproportionately over large brokers. Back in the good old days of 2006, if I wanted to sell 2 million Pepsi bonds, I'd just call 3 or 4 dealers and collect competitive bids. Dealers were happy to committ their capital. Today not so much. Today if you want best execution on a bond you need to work a little harder, actually find an end account that wants to buy the bond.

In a world where capital commitment was the name of the game, Goldman Sachs had a severe advantage over someone like Stephens. The former had all the capital in the world. The later had to watch their pennies. So what did Stephens' salemen do? They spent their time developing relationships with end accounts. When a bond came for the bid, the Goldman salesman just called his desk. The Stephens salesman called his accounts.

Now Goldman is less willing to committ capital. Now the Goldman trader might not be willing to bid at all, or maybe bid something silly cheap. Whereas the Stephens salesforce is doing exactly what they always did, call their accounts. Those firms are better suited to thrive in the new, lower liquidity world, where its less about capital and prop trading and more about relationships and finding sources of liquidity.

Tuesday, August 18, 2009


Its time for another SMACKDOWN week. This time we'll be looking at areas of the market and the economy where there seem to be extreme views and/or those where there has been an extreme run of late. In each piece, I'll contrast an area where I'm more bullish with one where I'm more bearish. I suppose you'd say these will be areas where I'm more bullish/bearish than average, but in truth with so many extreme views out there, its tough to say how meaningful average views are these days. Hell, if we contrasted my view with the average blogger, my expectation that the sun will most likely rise tomorrow would seem like naive optimism.

I'll start with one area I won't be covering. The stock market itself. I suppose if you asked me whether I think stocks will be higher or lower two years from now, I'd say probably higher. But my confidence in that view is pretty low. Lately I've found more success trading on my short-term view, trying to make small gains add up over time, than trading on a long-term macro view.

I would also say that while I expect the market to be higher in two years, we could also see some very scary swings in between. I think the factors that kept volatility low in the past, namely leveraged investors who were willing to take on small arbitrage opportunities, is gone and isn't coming back. The result will be larger swings in all sorts of markets from bonds to stocks to commodities. No one leans against small moves, and therefore the small moves become big moves.

Anyway, here are some of the topics I plan to cover. If you have other ideas, please e-mail me. I won't promise I'll write about it (because I might not have a strong opinion) but the feedback is nice.

  • Commercial real estate
  • Banks
  • Consumers spending
  • Inflation
  • Housing
  • Commodities
  • Municipals
  • The dollar and foreign participation in U.S. markets

Finally, I know I haven't been posting and or e-mailing people back much. I'm sorry, just been really busy. I've always focused this blog on writing more quality than quantity. If you'd like to subscribe by e-mail, there is a link on the right-hand side of the page. This will save you the trouble of checking the site so often.

Wednesday, August 12, 2009

Consumption: A person of some importance I believe

Is anyone else bothered by the following: In the opening minutes of A New Hope, C3-PO warns R2-D2 that "There will be no escape for the Princess this time." Then presumably less than 24 hours later when Luke stumbles accross the hologram of Leia begging for help from Obi-Wan, C3-PO seems to not know who she is:

LUKE: Who is she? She's beautiful.

THREEPIO: I'm afraid I'm not quite sure, sir.

LEIA: Help me, Obi-Wan Kenobi...

THREEPIO: I think she was a passenger on our last voyage. A person of some importance, sir -- I believe.

Maybe this is what you get for seeing a movie 498 times...

Anyway back to economics. Merrill Lynch is out with a intriguing analysis in their latest Credit Market Strategist. "The Myth of the Overleveraged Consumer." Before you dismiss this as blindly bullish bullshit from the Bull, let me tell you that the report isn't terribly rosy in its conclusion. But it does cause one to really think about what drives consumption in the U.S.

First, they estimate that the top 10% of Americans in terms of disposable income account for 42% of consumption. The 40-90 income percentile ("the middle class") accounts for 46%, leaving just 12% for the 0-40 percentile.

Combine this with the balance sheet of these various income categories:

Merrill's headline says it. The middle class is over-leveraged, not The Consumer. What we see is that the over-leverage of the middle class impacts 46% of spending even though its about 60% of the population.

The differential is even more stark when you look at wealth lost as a percentage of assets. Because the middle class' net worth is mostly their home, the crisis has hit them harder:

We think of the wealthy as being hit hard because of how poorly financial assets have performed, but stocks have rebounded at least somewhat. Homes have not. Add to that the fact that the wealthy tend to have a cushion of assets to support spending should they experience a temporary loss of income. So the highly paid commissioned salesman might not cut back much if his/her income is down for a year. S/he might just spend some savings. The middle class doesn't have that luxury.

The point is that the wealthy can keep spending at approximately the same rate, and if they represent 42% of consumption in normal times, then maybe consumption won't fall as much as we feared. Of course, we can't just dismiss the middle class' position. I stand by my idea that consumers overall can't spend at the same rate and will have to continue balance sheet repair.

But this does make you question certain popular trades. Like selling luxury brand companies for "trade down" stocks. If the wealthy are spending but the middle class is cutting back, who gets hurt more? Wal Mart or Tiffany? Toll Brothers or Ryland?

Merrill's piece closes with a warning. All the government programs will eventually come at a cost: rising taxes on the wealthy. Now we find out if that code is worth the price we paid.

Tuesday, August 11, 2009

Muni Insurance: A passenger on our last voyage

MBIA is down $1, which is about 20% on a downgrade by J.P. Morgan. This after surging to almost $7 in recent days on reports that the company might be able to foist some of their MBS exposure back to the originating banks.

The interesting question to me (since I wouldn't actually touch MBIA's stock with a 10-foot Gaffi Stick) is whether there is any possible business left for MBIA even if the optimistic view of their legal battles comes to fruition. As we all know, MBIA is attempting to separate their muni and structured finance businesses in an attempt to someday write new muni insurance contracts. But is that still a viable business?

Before we answer that, we need to look back at what muni insurance was all about. There is a myth out there that muni insurance was used primarily by weaker credits as a means of lowering their interest expense. That's not really true. I did some digging through old MBIA investor presentations (funny to hear them boast about "penetration" into the structured finance business) and found this chart from 2006:

There's nothing magic about 2006, I just wanted a period which was clearly before structured finance risk started becoming a problem to show what muni underwriting was like during the "good times." We see 28% of the total par outstanding was in GO munis. I did some rough calculations and it comes out to something like 44% of muni underwriting was in GO's. Notice also what you see very little of: healthcare, housing, industrial development (zero). In other words, the riskier segments of the muni market are clearly under-represented.

The point is to say that muni insurance was not typically used as a true credit enhancement, at least not in terms of avoiding default. By now you've heard the stellar record of GO bonds, which almost never default. So who needs the insurance?

I argue that the need for muni insurance is borne more out of information asymmetry than actual credit enhancement. By this I mean, investors in municipal bonds often struggle to get complete and up-to-date information about a given municipality. Take for example a random school district in Pennsylvania: Glendale School District. Go to their website and try to find their financials. I couldn't find them. So if you had bonds for the Glendale School District, how would you follow their financial performance? You could potentially get someone from the Superintendent's office to send you reports, but odds are they would only be produced annually and with a long delay before the report is available.

Imagine if a corporation wanted to sell bonds, but refused to report regular reports. Would the bond be sellable?

Muni insurance filled this gap. The insurer could demand certain information and/or legal language in the bond deal that investors could not. Especially not individual investors. In that way, muni insurance was a little like title insurance on a home. No one expects to use it, it very rarely comes into play, but in the event that something truly crazy happens, like the Orange County scandal, investors are covered. The insurer deals with it.

So I'd say that municipal bond insurance served a certain public purpose. Allowing local municipalities to sell bonds at attractive rates.

And yet, I still think muni insurance is a dying business. Why? Because in a way, MBIA/FGIC/XLCA/Ambac's problems are very similar to Fannie Mae and Freddie Mac's. The for-profit nature of the firm got in the way of realizing the public purpose. Now obviously MBIA was never a "public" entity in the way Fannie/Freddie were, but I think the point stands. Investors aren't going to trust insurance the way they used to ever again.

Still, the need for resolving this information availability problem remains. I ultimately think the better solution is for states to form their own credit enhancement programs. This could be accomplished through a bond bank, which is common in Indiana and California. It would have to be altered from some of the existing bond bank programs, where the underlying credit was only whatever municipalities participated in the specific issue. In the old days, a California Communities bond issue might only be backed by 2 or 3 local California towns, but would also carry Ambac insurance. That used to be fine, but now its obviously not going to work. California could alter their bond bank program such that a surplus account is created to make up any losses on individual loans, which would allow for a better overall rating on their program.

Another possibility is some sort of state intercept program. This would be where the state agrees to backstop local municipal school district deals. There are such programs in force in Texas, for example. The problem here is that such programs are usually only available for school district bonds, not for other local government needs. So if Pflugerville School District needs a new roof on the high school, that can be done through the Texas Public School Fund. But if the town of Pflugerville needs a new roof on City Hall, there is no state help.

I would like to see these kinds of programs expanded without the help of the Federal government. One of the problems that always worries me about municipal finance, and its lack of transparency, is that good fiscal management can't always been differentiated from budgetary shell games, especially on the local level. Again, this is an area where the muni insurers were a benefit since they could enforce certain standards better than individual investors could. I could see a state-level insurance pool filling this role, making sure local issuers keep to some standard of good fiscal management. But if it rises all the way up to the Federal level, there will be too much distance between the issuer and the guarantor.

Wednesday, August 05, 2009

Radian: What are you still doing here?

Radian reported a profit this quarter mostly on the back of insurance claims recinded due to misrepresentations. AIG is up big on the news, as are other insurers. It might explain MBIA's big move to the upside yesterday.

Here's something a bit odd, though. Why are all the other banks up on this news? It isn't like foreclosures are down. In fact, what Radian is saying is that they've managed to avoid paying banks the insurance they were otherwise due. How is this good?

Isn't Radian just transfering losses from their own books onto other banks? Won't the other MI's follow suit? Even the more conservative banks, e.g., J.P. Morgan or Wells Fargo have exposure to potentially "misrepresented" loans through their recent acquisitions. I suppose banks would rather Radian (and the other MIs) survive in some form. But even then, I'd have to say this is at best, a mixed event for banks. Not a clear positive.

The other day I wrote a fairly positive view of the housing market, but I reiterate, banks remain very vulnerable. I think the systemically important banks will survive, but I think there are lots more failures to come. Feels like the market is losing sight of this.

Monday, August 03, 2009

The Choosen One

Today's comments by Nouriel Roubini that there might be "light at the of the tunnel" are really only notable because of who is saying it. Roubini is one of several star economists/analysts that have come out of the recent crisis. Meredith Whitney and Nassim Taleb are two others that come quickly to mind.

Its funny how short the media's (and the investing public's) memory is. Both seem to want to find the analyst who has it all figured out. As though someone actually has the proverbial crystal ball. Every cycle the media finds the people who called the big move correctly. Today its Roubini and Whitney. But 10 years ago it was Henry Blodget and Mary Meeker.

Think about what made someone like Mary Meeker a star. She basically got one big call right: that not only the internet was going to change the world, but that it was also going to capture the imagination of investors. Whether or not you could say she called the formation bubble, she certainly had a good vision on what was driving the moment.

But when that moment passed, did the Mary Meeker's of the world see it coming? Not really. I mean, we know Blodget poked fun at some of his own calls in those infamous e-mails, but I would argue that most of the star analysts believed in the internet, even if they didn't believe in all the specific companies involved.

Now bear in mind, there is a feedback loop here. You make a bold call, it works, you get interviewed on TV, you get a huge pay raise, every one calls you a genius. Its heady stuff. Check out Henry Blodget's rapid rise on his Wikipedia page sometime. When you parlay a great call on into your dream job, isn't there some psychological impact there? On some level, wouldn't you start to think to yourself, "Gee, when I tell every one to buy, all sorts of rewards come my way. All the guys saying 'sell' are looking for work."

These analysts understood what was going on in the market and in the economy at a specific moment in time. They were smart people, to be sure, but they didn't have some sort of transcendent understanding of markets. They just had a better feel for that market, that mentality, than anyone else.

I don't see how someone like Meredith Whitney is all that different. She had a better view on banking than most, and she deserves all the credit for that. But let's not pretend like she is the next guru who truly understands banking above all others. Every story about her is prefaced by saying that she "predicted" the financial crisis. But really, does she know more about banking than people like Richard Bove? That guy apparently liked Washington Mutual stock in May 2008, according to one story I pulled up off a web search. Is he an idiot and Whitney a genius? It isn't all that simple is it?

My problem is that investors aren't really served by this deification of people who have gotten the short-term calls right. Professional traders will tell you they make about as many bad trades as good, you just try to set it up such that your good trades pay off more than your bad trades lose. But the media doesn't teach this lesson. Instead, they implicitly tell you that Nouriel Roubini has it figured out. That if only you had listened to him, your 401k wouldn't have dropped by half. Hell, CNBC often teases their interviews with stuff like, "Coming up, the analyst who called the banking crisis! See where she says the market is going now!"

It isn't about finding smart people. The guys on the CDO-squared desk were smart too. The guys who dove into the bubble were smart too. Alan Greenspan was a smart guy, and he seemed to have as good a grip on markets as anyone... until he didn't.

Take an analyst's good call for what it is. A good call. Nothing more.