Remember my friend Mike, the world's third smartest man? His daughter was married last weekend in Darien Cn. and that's where we have been for the past week along with a few other stops to see old friends on the Right Coast. Wonderful wedding, wonderful young couple. It's been a while since I have tooled up and down I-95 and even for an old New Yawker the experience is now maddening and terrifying. It's not that we don't have rush-hours; we do--they run from 5:23 to 5:41 every day. We try to avoid them, but the volume of traffic on that stretch of road from the Westchester border to Darien is astounding. Apparently bumper to bumper every day. I simply can't understand how the good folks do it.
Anyway, I expressed my view that having been so close to the endoftheworldasweknowit things didn't seem to have changed all that much. Damn few Fiat Cinque Centos on I-95, not many houses in Darien on therightsideofthehighway for sale under a couple of mil, the hotel was jammed and the shops seemed to be prospering. 'Yeah" said Mike, "things go on."
"We came very close," said I.
"Yeah, said he, "but it's Never, Never."
"Still?"
"Certainly! You didn't think this was going to change anything did you?"
"Rather silly of me I guess."
Not silly, bloody stupid."
"Now Michael..."
"No, I really mean it. Look, even these guys in Washington don't really understand. They're off trying to fix things that don't matter any more. They're trying to fix the car companies because that fixes the Unions and nobody cares. They're trying to fix the banking system and it's changing right in front of them and they can't see it. They're trying to fix health care and nobody wants it fixed because it really isn't broke and nobody understands it anyway. And that's the real problem; nobody cares except those trying to fix all the wrong things."
'Because it's Never, Never."
"Exactly, it's Never, Never."
I've been thinking about that conversation and there's a big element of truth in it. Apparently the pundits are now in full agreement that the greatest financial and economic disaster since the Great Depression lasted a little over 9 months and is now over. The stock market has gained 50% in four months and people are feeling flush again. Some guy at Citibank is about to make $100,000,000 which I guess he needs to keep up the castle in German he bought a few years back and Goldman is making more money than anybody can believe by just being there and having the fastest computers on the street. The Leader and Our Hero along with the rest of the mob are telling us it's all their doing, despite having done essentially nothing of any note and insisting that it would have happened even quicker except for Dubya. Maybe they're right. Remarkably, they keep selling debt on and off the street (and keep making more of it) and no one seems to care. Oh there is the occasional hiccup as when The Leader, sans teleprompter, steps on it but hey, we all do that, don't we? And when Our Hero demolishes The Leader's promise that the middle class(as hereinafter defined) will not have their taxes raised by "One Dime" as he did yesterday. But it seems that our friends, the Chinese, have decided that they are in a bit of a dollar trap after all and may not be prepared to rock the boat for a while, so why worry. A while may be forever. It's Never, Never.
What we are witnessing is truly a remarkable period and the past few months has been without precedent. Can the trend continue? If my friend, Mike, is correct, it will. Because it's Never, Never.
Oh, I guess I should have done this at the start. When credit cards were introduced to England, the conversations went something like this...
"What's that then?"
"It's a credit card"
Wat's it fo'"
"To buy things"
Wha', you don't need money?"
"No."
"Serious?"
"Yes."
"You really don' need money?"
"Right."
"Never?"
"Never."
Got it?
Showing posts with label credit enhanced. Show all posts
Showing posts with label credit enhanced. Show all posts
Monday, August 3, 2009
Wednesday, May 20, 2009
EASY ISN'T IT?
Thinking like Mike, that is. The answer to yesterday's question is of course greed. You had a number of firms doing a nice, easy business, making a bit here and a bit there when some really smart guy said, "Hey, why can't we apply this business model to other area, guaranteeing debt for banks, corporates, ANYBODY!" Of course the anybodies of the world didn't have any real taxing power and no one gave much of a thought to the fact that if their credits were not rated triple A there must be a reason. And it was off to the races.
Now guaranteeing the primary obligations of a corporate's direct obligations is one thing; there is historical evidence of performance, usually sound projections, products to be analyzed and assets to be valued. Remember, it is not the issuer that is rated but the paper that is issued meaning that multiple bonds of a single issuer may be rated at different grades depending upon structure, security, maturity and a host of other different criteria. The funds obtained are used in the growth of the business. That of course is the case if there is a "real" business involved. But what happens if the issuer has been created just to issue debt, relying on the income stream from debt instruments purchased by the same debt of the newly created issuer? Whoa, you say, this gets dicy. Yep, sure does. Nobody can figure out these so-called special purpose corporations ("SPCs") so the easiest thing to do is to get a company, such as AIG, which has a Triple-A rating to guarantee the debt issued by the SPC and we all go home happy. This is a highly complex exercise made particularly so by the nature of the debt purchased to support the issuance that I've made to sound easy; trust me it's not. What has to be determined is the odds against non-performance of these myriad slices of debt and for that you need a whole bunch of really smart math guys, known in the trade as "quants" to tell you what the odds are. They create models for each circumstance and based upon these models a risk profile is created and the price at which one is prepared to guarantee is agreed. The mathematics is, by definition, always correct; the assumptions, however, may be very, very wrong. But it was easy money; what good is a Triple-A rating if you can't use it? The problem of course was that much of the SPC issuance that was credit enhanced was related to real estate debt, and when folks began to realize that the massive creation of such debt had led to ridiculous liquidity which led to mother of all bubbles is when the excrement hit the revolving device.
Spreads on all credit enhanced products widened, even those on "normal" debt and especially those relating to emerging market debt. You see, any holder of a debt instrument could ask for it to be enhanced; indeed you didn't have to be a holder at all, you could purely speculate in the instruments themselves. No one knew who had guaranteed whom and for that matter the exposure of an institution on one risk could not be determined with any certainty. It was the wild west with the market creating and pricing credit risk that may or may not have existed with the result predictable to many and forecast by some. In a nutshell what happened was that holders of these guarantees began to suspect that certain guarantors were overexposed and, as was their right, demanded collateral--read CASH-- to be put up in support of the guarantee. To use AIG again as an example, they ran out of cash or near cash and the game ended. By this time no one knew what the ultimate exposure was as the problem was not simple AIG but the solvency of many of their clients in relation to AIG exposure and other risk in the case of an AIG bankruptcy. The risk became systemic. There is a first law in the credit business: You never make as much in interest or fees as you lose in principal. Could this have been prevented? Perhaps. Next week, we will try to explore how and what might be done to protect the future. You see, we are off to The Large Apple for the wedding of an old friend's daughter tomorrow. For those of you in the business I know I've made this so plain vanilla as to be ridiculous but there are folks out there who really don't know what happened. My apologies if some have been bored to tears. We'll liven in up next week. Back on Monday.
Now guaranteeing the primary obligations of a corporate's direct obligations is one thing; there is historical evidence of performance, usually sound projections, products to be analyzed and assets to be valued. Remember, it is not the issuer that is rated but the paper that is issued meaning that multiple bonds of a single issuer may be rated at different grades depending upon structure, security, maturity and a host of other different criteria. The funds obtained are used in the growth of the business. That of course is the case if there is a "real" business involved. But what happens if the issuer has been created just to issue debt, relying on the income stream from debt instruments purchased by the same debt of the newly created issuer? Whoa, you say, this gets dicy. Yep, sure does. Nobody can figure out these so-called special purpose corporations ("SPCs") so the easiest thing to do is to get a company, such as AIG, which has a Triple-A rating to guarantee the debt issued by the SPC and we all go home happy. This is a highly complex exercise made particularly so by the nature of the debt purchased to support the issuance that I've made to sound easy; trust me it's not. What has to be determined is the odds against non-performance of these myriad slices of debt and for that you need a whole bunch of really smart math guys, known in the trade as "quants" to tell you what the odds are. They create models for each circumstance and based upon these models a risk profile is created and the price at which one is prepared to guarantee is agreed. The mathematics is, by definition, always correct; the assumptions, however, may be very, very wrong. But it was easy money; what good is a Triple-A rating if you can't use it? The problem of course was that much of the SPC issuance that was credit enhanced was related to real estate debt, and when folks began to realize that the massive creation of such debt had led to ridiculous liquidity which led to mother of all bubbles is when the excrement hit the revolving device.
Spreads on all credit enhanced products widened, even those on "normal" debt and especially those relating to emerging market debt. You see, any holder of a debt instrument could ask for it to be enhanced; indeed you didn't have to be a holder at all, you could purely speculate in the instruments themselves. No one knew who had guaranteed whom and for that matter the exposure of an institution on one risk could not be determined with any certainty. It was the wild west with the market creating and pricing credit risk that may or may not have existed with the result predictable to many and forecast by some. In a nutshell what happened was that holders of these guarantees began to suspect that certain guarantors were overexposed and, as was their right, demanded collateral--read CASH-- to be put up in support of the guarantee. To use AIG again as an example, they ran out of cash or near cash and the game ended. By this time no one knew what the ultimate exposure was as the problem was not simple AIG but the solvency of many of their clients in relation to AIG exposure and other risk in the case of an AIG bankruptcy. The risk became systemic. There is a first law in the credit business: You never make as much in interest or fees as you lose in principal. Could this have been prevented? Perhaps. Next week, we will try to explore how and what might be done to protect the future. You see, we are off to The Large Apple for the wedding of an old friend's daughter tomorrow. For those of you in the business I know I've made this so plain vanilla as to be ridiculous but there are folks out there who really don't know what happened. My apologies if some have been bored to tears. We'll liven in up next week. Back on Monday.
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