Tuesday, August 7, 2007

Don't Worry, Be Happy

Adding insult to injury, the two Bear Stearns hedge funds that went belly up recently have filed for bankruptcy in the court of...the Cayman Islands. The fact that most assets were held and managed in NYC is of little consequence to the legal state of incorporation, which was in fact the Caymans. And here's another fact: 3 out of 4 hedge funds in the whole world are incorporated there, a miniature country of three islands 100 square miles in total, with a population of 45.000 souls - there must be something in the air, eh? Their main industry is financial services, but by that they mean being the de jure corporate seat - the de facto part takes place in more properly exciting locations, like Manhattan and The City.

There comes a time, however, when the law of the land must be invoked, e.g. liquidation under bankruptcy. Creditors will have their day in court and so will management, of course. The judge, who is not going anywhere anytime soon (except perhaps to the aptly named Pirate's Den Pub down the road) will most definitely keep in mind that there are plenty of other such statelets with sun, rum and lax incorporation laws ready to pounce on the juicy fee business generated for hundreds of his legal brethren active in the incorporation and registry business in George Town. That being the case, what are the chances that the local courts will rule against management?

To make sure that the sunny courts of Cayman will be totally unhurried and unmolested in reaching their just decisions in due time, Bear Stearns has also filed in Manhattan courts a motion for protection against all lawsuits there, while the process goes on down south. Let's see if that judge grants them their wish...

Meanwhile, the stock market bounced yesterday on (unsubstantiated) hearsay that the government will somehow intervene to limit the hemorrhage in the credit market. Earth to Mars: there isn't enough money in the till to bail out every one, or even some, of the troubled "institutions". Oh, the Fed will soon enough decide that interest rates need to come down substantially to "better reflect the current business environment", but this time they will be pushing on a string. As I have said before, it is not the price for using the money that matters now (interest rates), but the fear of principal loss - and for that there is no price. When the situation reaches a certain qualitative point, the higher the interest someone is willing to pay to borrow money, the less the chances of his getting it. Lenders see that as a desperate sign of panic and stay away. Greed is suddenly replaced with "better safe than sorry". Then the specialized vultures will eventually swoop in, pay ten cents on the dollar and fly away to await the next cycle. At that price they can afford to wait a long time, sipping a rum punch by the pool of the Ritz-Carlton - in Grand Cayman, of course...

P.S. Today, we learn of another victim of margin calls: Luminent Mortgage (NYSE: LUM ...where do they come up with those names?). Things are becoming more and more sudden... I mean REALLY sudden: the stock was near $11 a month ago, with an all time high of $15ish. Five days ago it was at $8 and today it is trading at 75 cents. You want fast? This is what the word vertigo was invented for. And remember, for each unmet margin call there is a major lender who is taking the hit.


  1. I tend to pbe in phase with your analysis and comments. But to be honest, at least the two previous corrections could have made us saying exactly the same (and I personnally said the same in the last correctin of March) : the crddit cycle is at the end, this correction is different from the others, etc etc. So why sould it be really so different this time ?As you know, in each correction, the world becomes black suddenly and the critics find then a justification in their rethorics which reinforce and probably exagerate their judgment. This cycle is a bit different, as it is connected to the real estate, il takes longer for the crisis to develop and we could be surprised again by the investors reactions

  2. The cycle is not connected just to real estate - this was just the first domino to fall because it was the weakest (sub-prime).

    Why is it different? Because it is happening: this is not the expectation of a severe credit crunch, but the real deal. Spreads have zoomed, LBO and takeover financing pulled, the issuance of bonds plunged by as much as 90%. This is no correction, it is a crisis and if it lasts another month or two it will become a disaster. Credit is always important to the economy, but now more so than ever.

    The Fed and Treasury know this, of course, and are working hard to come up with SOMETHING. I think the Fed will act first and fast and will temporarily take away some of the intense heat - but I think it will quickly become apparent that this will be an opportunity to unload at any price, because right now there is no price.

    I believe that the credit cycle has changed from bull to bear and now the moves up will be the brief "corrections" to the main move down.

    All the best

  3. "I believe that the credit cycle has changed from bull to bear"

    We all have to fully grasp the REAL meaning of "tight money".

    For some of us (especially the older ones or those who have lived in poorer countries) this is easier to grasp.

    For the other ones, just ask your daddy or the dad of your dad for some practical daily-life experience.

  4. I agree that this is a question of the value of the underlying collateral. The LTV one might say, with leverage stacked on top of leverage. It is a question of the effect that this will have on equity values and one must ask themselves, "is it by any stretch of the imagination bullish for asset values?".... If the answer to this question is yes, then I must be living in some other planet.

    Best regards,


  5. Also, evryone seems to be focused on the Fed for today. Is there anyone out there that belives that the Fed can reasonably make timely changes in the landscape. At this point in time, I'm feeling that the sooner that this crisis plays out the less severe it will be.... We being given a choice here for the execution, death by hanging or death by dismemberment.


  6. The crisis has been put on hold for almost 5 years now....Can they keep this charade of a debt driven eCONomy going for another 5 years?....I don't think so...IMO...

  7. So, when do you expect that the first major investment bank is going to walk hat-in-hand to the discount window of the Fed to unload some of this stuff?

    Anybody know where to look to find out when that happens?

  8. Well, you can't unload the stuff on the Fed - you can borrow against it at the discount window, assuming it is acceptable collateral. Usually AAA asset backed paper is acceptable at 85-95% of MARKET value (not face).

    You can find the info at: www.frbdiscountwindow.org

    The data on who is borrowing and how much is not available on an institution by institution bases, as far as I know. But if you find otherwise please let me know


  9. Unload was probably the wrong word. Maybe monetize?

    I'm feeling that we are at a short term bottom. Pricing in the markets seem irrational. Look at spreads between 30 year jumbo's and 10 year treasuries.

    Somebody is going to wake up and realize that if high income borrowers with 20% down payments are defaulting in high numbers the only "safe" investment's going to be in Idaho farm land and ammo.

    I'm guessing that the blow-out is a short term event as hedge funds and REITs are forced to sell their most liquid assets to meet margin calls.

    The markets are going to unfreeze and spreads are going to return to normal. But the sub-prime, neg-am, alt-a, ninja loans are probably gone for good in this cycle.

    Of course, the drying up of credit is going to put a serious impact on consumer spending. That will probably be enough to put us into recession.