fueled by lemons
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After finding former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin not guilty of misleading investors, one juror revealed just how convincing the defense had been:
[Juror] Hong said that if she had money, she would invest it with Cioffi and Tannin.
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TIME magazine has called it over – thanks for coming, everyone, and please watch your step as you disembark the ride. In an article titled “More quickly than it began, the banking crisis is over,” the intrepid financial analysts at TIME lay out their argument:
But, the great banking crisis of 2008 is over. It began last September 15 when Lehman Brothers filed for bankruptcy and bottomed when Citigroup (C) traded below $1 last month. Most analysts believe that mortgage-backed securities which included packages of subprime home loans failed when mortgage default rates went up and housing prices raced down. That is only partially true. Banks made a tremendous series of ill-advised loans to private equity firms, hedge funds, commercial real estate holders, and the average man with a credit card balance which he cannot pay.
When people look back on the near-collapse of the banking system they may say that the Congress and Henry Paulson threw enough money into the path of the oncoming failure of the credit system to slow it down so that the government could properly go through the process of guaranteeing parts of the balance sheets of firms including Citigroup (C) and Bank of America (BAC). The initial TARP may also have provided time for the new Administration to put together its widely hailed bank “stress test” program meant to determine which of the big financial institutions have dysentery and which do not. Finally, the hundreds of billions of dollars that went into the largest banks late last year allowed Secretary Geithner to produce his public/private partnership to buy toxic assets off of bank balance sheets.
All of those plans, no matter how well-intentioned they may seem, are unnecessary now. Wells Fargo (WFC) indicated that it made about $3 billion in the first quarter of the year and declared its buyout of the deeply troubled Wachovia to be a success. Wells Fargo (WFC) said that the low cost of money from the government combined with a surging demand for mortgages was all the medicine that it required.
There you have it. The bailout, TARP, TALF, the guaranteed balance sheets: all massive successes! So too were the stress tests and PPIP which have not even started. The authors are careful to cover themselves in the (highly likely) case they are wrong, noting that “The banking crisis may be over, but what is left is a reclamation job that will probably take years to complete,” and leaving the door conveniently open for an article on what will presumably be known as the second banking crisis, now that the first is behind us.
It’s also interesting to note that one of their indicators is that Citigroup traded below $1 (“in the pennies” as they put it). It is left to the reader’s imagination why the $1 mark is of any significance for calling a bottom. Most likely, they simply regard it as the lowest point the stock has reached, followed by a rapid multiple-times gain. By the same logic, Bear Stearns represented the end of a previous banking crisis (the Nothingth?) shortly before JPM put the storied firm out of its misery.
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George Soros has written an opinion in today’s WSJ calling for the regulation – and elimination – of CDS.
He notes that CDS are instruments which allow speculation on default:
What makes [CDS] toxic is that such speculation can be self-validating.
I find his nature-of-the-security argument severely lacking:
The negative effect is reinforced by the fact that CDS are tradable and therefore tend to be priced as warrants, which can be sold at anytime, not as options, which would require an actual default to be cashed in. People buy them not because they expect an eventual default, but because they expect the CDS to appreciate in response to adverse developments.
AIG thought it was selling insurance on bonds, and as such, they considered CDS outrageously overpriced. In fact, it was selling bear-market warrants and it severely underestimated the risk.
AIG underestimated their MTM risk, to be sure, but they had negotiated their MTM risk away via collateral-free counterparty agreements. In this paradigm, AIG’s real downfall was their credit-rating downgrade, which forced them to post collateral. There’s no question their risk management was awful, but were they not downgraded they’d still be solvent, since few of the CDS they sold have actually defaulted (and consequently mandated cashflows).
This begs an interesting question (and points out the ridiculousness of the rating agencies) — if you have an institution which is solvent at credit rating A and insolvent at credit rating B, which one should it have?
But Soros isn’t finished:
[I]t’s clear that AIG, Bear Stearns, Lehman Brothers and others were destroyed by bear raids in which the shorting of stocks and buying CDS mutually amplified and reinforced each other….
And AIG failed to understand this.
So let’s review. A company whose “expertise” is financial products didn’t understand how they work, but George Soros can explain it succinctly in a WSJ opinion. Sounds to me like the problem lies with AIG, not the CDS.
But Soros would argue that the fault for taking down massive institutions like Bear, Lehman, and AIG lies with crazy speculators, not with any failures of those firms. And we should act now to prevent these crazy individuals from taking down any more institutions, especially – say it ain’t so – a government arm like the Treasury.
Now where would a timid investor like Soros get an idea like that?
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Obviously the news of the hour is that J.P. Morgan is buying Bear Stearns for $236mm, or just $2 a share, meaning the firm is worth only a fifth of the value of its own midtown headquarters. The Yankees paid more for their third baseman.
More gravely, despite the WSJ headline, there is no “rescue” here. Bear has a book value of $84; the $2 price appears to be more of a formality than anything else. JPM is opportunistically buying the profitable prime brokerage business for a fraction of what its worth; getting the rest of the company is a bonus. Maybe the Bear Stearns brand will live on in some way (shades of Dillon Read), but it looks like the PB and anything else of value will be integrated with JPM as quickly as possible. And so the same firm which first alerted the public to the financial crisis when two hedge funds failed last summer is now that crisis’ first major casualty (ex hedge funds).
I wouldn’t want to be Joseph Lewis right now… the $1.1 billion he invested in Bear last fall is now worth about 98% less, or just $20 million. Talk about a writedown.
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