Thursday, December 10, 2015


Almost as though on cue, Third Avenue Focused Credit crashed today.  The firm was a relatively small (if $2.5 billion is small even by today's standards) high yield mutual fund at the start of the year that was down to about $750 million as of today when they announced their intention to liquidate.  Problem is they can't without selling the shop at liquidation prices which, as they put it, "would be unfair to those investors who wished to remain."  That, boys and girls, means management in street parlance.  My views as to what the next steps should be are not publishable in a family blog but keep in mind that those who would invest in such a vehicle should have a pretty good idea as to the risks; they are not widows and orphans.  If they don't, they are too stupid to worry about anyhow.  This isn't the first; it will not be the last.  Right now it's one-way traffic and to say the trade is a bit crowded is to engage in violent understatement.  No word as to what the gearing of Third Avenue was but one hopes it was low.

Now, here's a beaut.  There is an outfit called Depository Trust and Clearing Corporation ("DTCC").  This is a clearing house for the Repo trade which is a pretty big slug of everyday activity in the capital markets and in the commercial lending business.  Got a need for some short term financing and want to get it cheap?  Well, if you have some Treasuries or really good looking fixed rate stuff in your investment portfolio why not pledge it overnight or for a few days and borrow against it?  To the lender it's pretty much risk free...cheapest money around and DTCC is the facilitator.  

The Feds love clearing houses especially our guy Big Danny.  It provides "transparency" which allows everybody to know who's doing what to whom...or so is the story line.  Transparency reduces risk and the big effort after The Fall was clearinghouses for derivatives.  Yes sir, that will solve the problem; why not clearinghouses for everybody!

Problem is the risk is still around; it just gets transferred to somebody else.  Yep, most of goes to the clearing house.  But AH HA, you say, the clearing house has all this collateral put up by the transactors.  True, say I, but what happens if you can't get at the collateral, or to put it bluntly, you can't sell it when it needs to be sold?  You see, in times of extremis what you need is CASH.

Well today comes along DTCC and suggests that wouldn't it be wonderful if their clients were to put up a bit of back--up...say, $50 billion or so--to insure that there is CASH there when CASH is needed.  There was even talk that the Feds were, if not the instigators of the proposal, were pushing it as hard as a regulator could push the regulated...which is very hard indeed.   We all know TAXPAYER money can't be used for purposes such as this.  As for the timing...Remember that liquidity issue we have been discussing?  There is a concern, apparently, that DTCC might not be able to get into CASH fast enough if there were to be an "event."  OK, fair comment, but news flash to all concerned:  the problem was just made worse by this announcement which was obviously put out by someone not particularly happy with the arrangement (a liquidity provider?) and if DTCC  EVER has to go on a sale of collateral kick, from the standpoint of problems, you ain't seen nothing yet.

Funny thing is, there used to be a lot of players in this business...certainly all of the Clearing House Banks and the big Investment houses.  Today there are very few; no more than two or three and from what I am told they want out as well.  Why? Two reasons:, first, it was always a low margin business which was OK if you had the volume but a pain.  Second, in the good, old days before Dodd/Frank your collateral being Treasuries which by definition is risk free didn't incur a cost of capital, which it does now and which pretty much wipes out anything on a ROC basis.  So, having effectively regulated a business beyond all recognition, the Feds now find themselves looking at what is left, facing greater risk than before and being told (in effect) this is your problem now, don't ask us to backstop a situation you created.  Genius at work.  I keep reminding myself:  this is why God made Gin.

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