Thursday, August 23, 2007

Not So Smart "In an era of easy money, the pros forgot that the party can't last forever "

What a difference 6 month made..... It was in early February when Business Week ran this cover story It's A Low, Low, Low, Low-Rate World .

Looks like the "Cover Story Indicator" has worked once more.....

Was doch 6 Monate für einen Unterschied ausmachen.....Anfang Februar hat Business Week noch die folgende Titelgeschichte It's A Low, Low, Low, Low-Rate World gebracht.

Es sieht so aus als wenn der "Cover Story Indicator" mal wieder ganze Arbeit geleistet hat.
Not So Smart / In an era of easy money, the pros forgot that the party can't last forever

The boasting and bluster that marked the just-ended era of easy money varied depending on the speaker and his stake in the boom. But the underlying message was consistent: This time it's different. When it came to the hazards associated with borrowing, the old rules no longer applied.

The titans of home loans announced they had perfected software that could spit out interest rates and fee structures for even the least reliable of borrowers. The algorithms, they claimed, couldn't fail. With similar bravado, buyout firms bid up private equity deals, arguing that investors had an insatiable appetite for the increasingly risky and mammoth loans used to fund them. "I don't think it's a bubble," David M. Rubenstein of Carlyle Group told the Financial Times in an interview last December. "I think really what's happening now is that people are beginning to use a different investment technique, and this investment technique, private equity, adds real value."

> This chart from Bespoke shows how well timed the "Low, Low......Rate World" cover was.....

> Dieser Chart von Bespoke zeigt wie gut die Titelgeschichte "Low, Low, ..Rate World" abgepaßt war.

Hedge funds were all too happy to enable the leverage arms race. They, too, borrowed to the max so they could gorge on the debt that financed the housing and buyout booms. "The consumer has to be an idiot to take on those loans," John Devaney, chief executive of United Capital Asset Management, said in May, referring to dicey adjustable-rate mortgages. But since there were plenty of "idiots" out there, and legions of lenders eager to serve them, Devaney and other hedge fund managers eagerly devoured the securities confected by investment banks from batches of dubious home loans. This securitization, the argument went, would spread the risk far beyond banks and mortgage companies. In March, Devaney bragged that mortgage-backed securities were one of his "best-performing investments.

"It didn't work out that way. In June, Devaney's Horizon funds booked a loss of more than 30%, according to Hedge Fund Alert. Shortly after, United Capital suspended redemption requests by investors trying to pull out. Devaney did not return calls for comment.

> maybe he is the guy on the cover.......:-)

> ist wahrscheinlich der Typ auf dem Cover :-)

Making sense of this mess is daunting. One good place to start: the ways various financial players indulged in layer upon layer of leverage, much of it far from transparent. Mortgage lenders threw out common sense underwriting standards. Wall Street sliced and diced the loans, creating the illusion that risk somehow disappeared in the process. Hedge funds then multiplied the leverage by borrowing copiously to buy securities based on the rearranged mortgages. In their version of the game, private equity firms used loads of debt to launch unprecedented buyouts.

bigger / größer

> Looks "contained"´to me....

> Sieht für mich ziemlich "contained" aus......

What some of the smartest guys in each of these fields seemed to forget is that new paradigms can crumble suddenly. Many miscalculated how long the period of easy credit would persist.

Mortgage companies argued their algorithms provided near-perfect precision. "We have a wealth of information we didn't have before," Joe Anderson, then a senior Countrywide executive, said in a 2005 interview with BusinessWeek. "We understand the data and can price that risk."

PRIVATE EQUITY: `A GOLDEN AGE'
As recently as April, buyout legend Henry Kravis proclaimed a "golden age" of private equity. Perhaps he should have called it a golden age of CLOs—collataralized loan obligations.

Like mortgage lenders, the giants of private equity have relied on complicated investment pools to fund their binge. CLOs are cousins of collateralized debt obligations. Managers of the investment pools buy groups of risky, junk-rated loans from banks that have financed buyouts by Kravis and his competitors. The CLOs package the loans, then divide them into risk levels. While the individual loans carry low credit ratings, three-fourths of the securities marketed by CLOs magically boast AAA marks. (That's because some investors give up extra yield in exchange for better protection against losses.)

The financial alchemy has allowed private equity firms to attract a whole new base of investors, including pension funds and insurance companies that never would have bought those risky loans outright. U.S. CLOs raised $100 billion in 2006, quadruple the amount two years earlier.

Buyout firms have generally fronted 30% of the equity in recent deals, vs. just 15% two decades ago. But that doesn't mean firms have been more cautious. Steeled by the seemingly insatiable demand for CLOs, they became bolder and bolder in the deals they pursued. After Kohlberg Kravis Roberts & Co. and Texas Pacific Group's $44 billion bid for Texas energy giantTXU in February, analysts began putting odds on imagined future megabillion-dollar targets like Home Depot Inc. (HD )

As private equity firms bid up the prices for ever-larger LBOs, the transactions began getting riskier. A key measure of leverage, a company's total debt divided by operating earnings, skyrocketed from 4.7 in 2004 to 7.0 in the second quarter of 2007, according to Standard & Poor's (MHP ) LCD. Meanwhile, the ability of companies to cover the interest payments of that debt dropped sharply; the ratio of profits to interest fell from 3.4 to 1.8 in that period.

> It is getting worse if you consider that profit margins are close to record highs and the economy is now tanking.... So there is almost no room for error.....

> Das ganze wird noch dramtischer wenn man berücksichtigt das die Firmen momentan noch Gewinnmargen nahe der historischen Hochs haben und die Wirtscahft sich gleichzeitig abschwächt bzw. wie in den USA sogar abschmiert.... Nicht viel Raum für Fehler......

At the same time, loan terms got looser. For example, in the buyouts of Freescale Semiconductor and retailer Claire's Stores (CLE ), LBO firms peddled bonds that allowed the companies to postpone interest payments until the bonds matured—a previously unheard of feature. Such stipulations applied to 10% of all junk bonds sold in 2007, vs. virtually none 18 months earlier, according to Lehman.

The red-hot demand for even the junkiest of loans allowed many firms to delude themselves into thinking they could endlessly pursue deals. In the three months through July 31, firms announced $254 billion in buyouts, as much as in 2004 and 2005 combined, according to Thomson Financial (TOC ). One credit crunch later, the market for LBO financing has evaporated. Investors won't buy the loans at current prices, leaving banks on the hook for $300 billion in loans to buyout artists.

So far, no big deals have collapsed. The hope is that the credit environment will improve in the fall, and stalled deals will move through the LBO pipeline. But there may be more pain ahead.

HEDGE FUNDS: STEALTH DEBT
Hedge funds helped power the mortgage and buyout booms by hungrily consuming securitized subprime debt and loans used to fund buyouts. By borrowing much of the money they invest, in some transactions up to 90%, hedge funds add another potentially dangerous layer of indebtedness to already highly leveraged markets. Because hedge fund disclosure is limited, huge pockets of leverage are barely visible. This stealth debt helped cause the problems in the subprime market to spread far beyond the housing sector.

One example: the hundreds of billions of dollars in so-called repurchase lines of credit, or repo loans, that Wall Street banks have lent to hedge funds. Disclosure of these esoteric agreements is murky at best, so their precise value can't be quantified. Another tool that pumps up leverage by untold billions is the total return swap. These arrangements allow a hedge fund to capture the gains of a security without having to buy it outright and with only limited collateral.

For some funds, extreme leverage became an acute problem when the mortgage crunch caused banks to doubt the value of the subprime bonds and CDOs the funds held. Banks pulled their lines of credit, forcing funds to come up with the full value of those assets. That caused dire consequences because, in some instances, the funds paid as little as 10 cents on the dollar and now had to come up with the remaining 90 cents. Many funds, including ones from Goldman, Sachs & Co. (GS ) and Renaissance Technologies, were forced to sell better-performing bonds, stocks, and commodities to pay back nervous bankers. ....

Related links from Business Week to the cover story

Main Street Is Fed Up

Bruce Wasserstein: "Expect Lots More Embarrassment"

It's Out Of Bernanke's Reach


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10 Comments:

Blogger jmf said...


Ford CEO wants Federal Reserve to stimulate economy: Financial Times


CEO Alan Mulally has joined those calling for the Federal Reserve to stimulate the economy, saying the housing crisis and credit turmoil have turned economic growth into a "priority," the Financial Times reported Thursday.

Appearing to endorse a federal funds rate cut, Mulally said economic and credit conditions are a "big headwind" to his plan to turn around the carmaker, which lost $12.65 billion last year, according to the report

begging......

1:36 AM  
Blogger jmf said...


Redefining the American Dream


The mortgage-backed securities market thrived on a single assumption -- that consumers would pay the mortgage first. In other words, we would do anything to cling to our piece of the American Dream.....

3:25 AM  
Anonymous Anonymous said...

Couple more unhappy clowns

http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article2317472.ece

4:01 AM  
Blogger jmf said...

Moin,

unfortunately these guys have made a fortune in the past ..... :-(

4:21 AM  
Anonymous Anonymous said...

Yep, now you see how it happened. Couple of expensed spreads at "nobus", back of a napkin, 7bn + 5000. They will have severance packages too. With any luck they have been long US mortgage cos. :)

9:58 AM  
Anonymous Anonymous said...

They should have stuck to property speculating! ;)

10:24 AM  
Anonymous Anonymous said...

Clowns to the left of me,
Jokers to the right,
Here I am..
Stuck with the bill again!

WE knew... but the money was good

http://bigpicture.typepad.com/comments/2007/08/cdo-insiders-we.html

10:31 AM  
Blogger Edgar said...

The dollar is F.U.B.A.R.

11:12 AM  
Anonymous Anonymous said...

IKB bill?

"Many cannot. Germany’s Chamber of Industry told me yesterday that it had been flooded with distress calls from family Mittlestand firms unable to roll over credit lines."

http://blogs.telegraph.co.uk/business/ambrosevanspritchard/august07/marketmayhem.htm

1:17 PM  
Blogger jmf said...

Moin,

thanks fot the links.

The guy from the Telegraph has written lots of good and correct stuff in the past.

Moin Edgar,

I think we could see another test of the decade long support at 80 in the $ index.

11:43 PM  

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