When a financial system is based solely upon the faith people have in it, maintaining this faith becomes of paramount importance. In the absence of sound financial and economic policy, maintaining people's faith in the system becomes the politics of spin management where public policy reduced is to a confidence game.
The problems in the global credit markets, wrought by overzealous financial institutions, taking advantage of imprudently lax credit standards, are throwing a wrench in the spokes of the global economic and monetary systems, particularly in the United States. The latest proposal to try to manage this potentially monumental financial crisis is the creation of what, in my opinion, should be called a super bailout fund. This is essentially a fund, created by a consortium of banking institutions, that can be used to dump assets into when they believe there is not an acceptable alternative buyer. Wouldn't it be nice if, whenever we wanted to sell something and couldn't find a buyer that would pay what we wanted, we could just create a fictional buyer to take the asset off our hands.
One of the best analyses I've seen on this subject was done by economist Nouriel Roubini, and can be found at his blog http://www.rgemonitor.com/blog/roubini/220816.
The timing of putting this plan together is interesting. This push was reported to occur last weekend. Interestingly enough at least three major banks report earnings this week. Citibanks presentation of its dismal result are already known, with a decline in profit of 57%. It looks like quite a bit of spin managment going on here, in order to keep the confidence of potential new money boosted. From accounts I've read this fund will be seeking new money coming in to it. An interesting bit of financial sleight of hand; create a buyer to support a price on suspect assets and we now have a market pricing mechanism, then suck in new money until the real solvency issues cause it to implode.
Tuesday, October 16, 2007
Tuesday, October 09, 2007
Valuation Issues
The key metric in being able to evaluate an investment is knowing what it is worth. With a publicly traded investment such as a share of common stock, there is ongoing price disclosure generated by prices offered, and the prices accepted by a multitude of buyers. Reoccuring episodes of irrationality and over exuberance suggest that this may not be the perfect method of determining the true value of a given security. However, since what a willing buyer will pay a willing seller is the final arbitor of current value, the transparency of price disclosure by the market forces of the multitude at least has the merit of establishing a more level playing field as a starting point. Indeed, some financial theorists argue that markets are efficient to the extent that current prices determined by market forces are an accurate representation of true value. Be that as it may, an entirely different issue arises when investments are illiquid. Alternatively, if the value is determined by reference to a valuation model, this may contain self-serving, or otherwise erroneous assumptions.
For example, one of the problems, recently creating turmoil in the global financial markets, has been the valuation of Collateralized Mortage Obligations(CMO). When subprime mortgages are bundled together and packaged with other mortgages, assumptions need to be made about such things as the default rates of these mortgages. With a minimal history of these mortgages, there is also minimal information about default rates. Nonetheless, this had not stopped trillions of dollars of these securities from being created, and consequently being valued by, at best, an arbitrary method, and at worst a self-serving procedure of malfeasance. Consequently, when these valuations were challenged by the real market conditions of defaulting mortgage holders, these valuations became glaringly inadequate.
The latest example, after a litany of tens of billion of dollars of losses being claimed by the likes of Bear Stearns, Citigroup, Merrill Lynch, Deustche Bank, and having the Central Banks of the world pump $500 billon into the global banking system to try to avert a global financial catastrophe, is Ellington Capital Management, a $5.2 billion debt-focused hedge fund which recently announced it had restricted withdrawals from its fund because of the difficulty of valuing the securities in its portfolio. Along the same line, a Wall Street Journal article(Pricing Tactics Of Hedge Funds Under Spotlight, October 6, 2007) cites academic research findings which show that hedge fund managers sometimes "cherry pick" valuations to give a more positive appearance.
The bottom line is that these shenanigans, under the guise of free market capitalism, are anything but champions of free market capitalism. At core, these tactics erode the strength of a vital and strong economic system by distorting the efficient allocation of capital based upon fundamentally sound information.
For example, one of the problems, recently creating turmoil in the global financial markets, has been the valuation of Collateralized Mortage Obligations(CMO). When subprime mortgages are bundled together and packaged with other mortgages, assumptions need to be made about such things as the default rates of these mortgages. With a minimal history of these mortgages, there is also minimal information about default rates. Nonetheless, this had not stopped trillions of dollars of these securities from being created, and consequently being valued by, at best, an arbitrary method, and at worst a self-serving procedure of malfeasance. Consequently, when these valuations were challenged by the real market conditions of defaulting mortgage holders, these valuations became glaringly inadequate.
The latest example, after a litany of tens of billion of dollars of losses being claimed by the likes of Bear Stearns, Citigroup, Merrill Lynch, Deustche Bank, and having the Central Banks of the world pump $500 billon into the global banking system to try to avert a global financial catastrophe, is Ellington Capital Management, a $5.2 billion debt-focused hedge fund which recently announced it had restricted withdrawals from its fund because of the difficulty of valuing the securities in its portfolio. Along the same line, a Wall Street Journal article(Pricing Tactics Of Hedge Funds Under Spotlight, October 6, 2007) cites academic research findings which show that hedge fund managers sometimes "cherry pick" valuations to give a more positive appearance.
The bottom line is that these shenanigans, under the guise of free market capitalism, are anything but champions of free market capitalism. At core, these tactics erode the strength of a vital and strong economic system by distorting the efficient allocation of capital based upon fundamentally sound information.
Wednesday, October 03, 2007
Latest Delusional Market Behavior
The latest "sugar rush" to keep the market pumped has been the implicit promise of Big Daddy Fed coming to the rescue of the United States' economy and financial system. The concept of lowering interest rates to make credit, and consequently liquidity, more available is an idea which would have more play in an environment where solvency issues were not the context in the background.
The chorus of more sober voices highlighting the serious underlying economic issues are, as usual, being drowned out in favor of the voices of hyperbole espousing more faith based investing themes such as "stocks always go up in the long run", the worst of the credit crisis in behind us, etc. These spinnings, by and large, invite a "trust me" perspective in the absence of a more evidentiary decision process.
What remains largely unsaid is that we appear to be at the later beginning stages of a collapsing housing market, rather than at the end stages. The consequences are likely to be felt in job losses, decreased consumer demand, and increasing insolvencies and foreclosures. These latest exhuberances of the financial markets are likely to end poorly after having sucked in a multitude of additional naive investors impressed by its glitter.
The chorus of more sober voices highlighting the serious underlying economic issues are, as usual, being drowned out in favor of the voices of hyperbole espousing more faith based investing themes such as "stocks always go up in the long run", the worst of the credit crisis in behind us, etc. These spinnings, by and large, invite a "trust me" perspective in the absence of a more evidentiary decision process.
What remains largely unsaid is that we appear to be at the later beginning stages of a collapsing housing market, rather than at the end stages. The consequences are likely to be felt in job losses, decreased consumer demand, and increasing insolvencies and foreclosures. These latest exhuberances of the financial markets are likely to end poorly after having sucked in a multitude of additional naive investors impressed by its glitter.
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