MORE CAUSE FOR CONCERN

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.

"CAN THE ISLAND OF TOBAGO PASS A LAW TO BIND THE ENTIRE WORLD"

That is the question posed in one of the most famous conflict of laws cases the title of which I, of course, cannot remember.  It was back in 1840or there abouts and even I wasn't born yet but the principal is well-asked today as we go fumbling around trying to make believe that if we bark, all others will jump.

Dodd/Frank is once again highlighted as how not to write legislation in what could be an important and dangerous disagreement between the U.S and the Euros concerning swaps and derivatives--you know, those things that no one understands and everyone hates.  Granted, it might not have been a good idea to have these contracts floating about without any real idea of the value of individual positions and the requirement that they now be traded through a clearinghouse might be a good one (more on that later), but when you realize that this business is not solely an American one and therefore if you try to pass legislation that attempts to govern the entire world, somebody might get upset.  The requirement that anybody doing business in the U.S.--not just being physically present mind you, but trading into and out of as well--be bound by the the rules of the U.S. clearing house and thereby subject to all U.S. laws pertaining to the same as Dodd/Frank so states, did in fact get the Euros upset and we are now at a stalemate as to how to proceed.

It is all so silly, really.  Like the Queen of Hearts, Congress has produced a verdict before the trial and run around screaming "off with their heads" in response not to market requirement but, like the rest of that garbage law, to political pandering.  Unfortunately, this is not a simple as throwing a bunch of lawyers together in a room and demanding language on which both sides can agree.  Oh no.  Now we are talking about the right of nations and sovereign egos and that is a very different thing indeed.  And then of course is the substance of the thing which the pols will claim was fully discussed and which I can assure you was never fully understood.  The clearinghouses themselves.

You see, the concern was that in the crisis, no one knew what exposures were where, or to put it another way, who was on the other side with Lehman and for how much.  Now a clearinghouse takes that concern away, or at least it appears to, as the clearinghouse guarantees the fulfillment of obligations traded through it.  There is one small problem, however.  Who spies on the spies or who guarantees the clearinghouse?  No one loses sleep over facing Third-Fifth National, but if it is DeutscheBank?  As the former manager of Man United used to say, "Squeaky bum time, lads."  And so we go into the future with not exactly the lame leading the blind, but certainly with the creation of problems that could have been avoided if some people had paid a bit more of attention to the business in hand rather that to howling of the Crazy Lizzys of the world who now, unfortunately, find themselves with even more power to expand the rubbish heap which they produced.


Eric Holder, the Attorney General of the United States, announced his intention to resign today.  Holder is a race-baiting, lying, malfeasant, extorting thug.  Aside from that, I don't like him very much.