Fitch and Satyajit Das Explained the Credit Crash Before It Happened (2005, 2007 Reports)

Possible Effects of Overlapping Credit Markets Fitch 2005
I found a research report written by derivatives expert Satyajit Das in February 2007 titled "Credit Crash?" (Wilmott). If you want to learn about credit derivatives, this is the paper to read. The first synthetic CDO was engineered by JPMorgan in 1997, when its credit derivative team sold a BISTRO, or Broad Index Secured Offering, which allowed them to sell $10 billion of credit risk. It was done by accident to get a bonus. The report opened with a quote from Alan Greenspan on credit default swaps in 2006, who Satyajit disagreed with.
"On 18 May 2006, Greenspan (speaking at the Bond Market Association) spoke eloquently about the stabilising effect of credit default swaps (“CDS”) on the international financial system

“The CDS is probably the most important instrument in finance. … What CDS did is layoff all the risk of highly leveraged institutions – and that’s what banks are, highly leveraged – on stable American and international institutions.”

We will critically examine whether the position espoused by Greenspan is in fact true." (read more)
Near the end he provided a diagram titled "The Coming Credit Crash" which was based on this diagram from a July 18, 2005 Fitch report ("Hedge Funds: An Emerging Force in the Global Credit Markets") h/t securitzation.net.

It is amazing how fragile this market was and how CDS failed to contain it. There was even detailed data on subprime MBS deal performance.

Question: If retail investors were able to trade senior debt, leveraged loans, ABS, CMBS and credit default swaps alongside institutional investors using an online brokerage, would systemic risk have been mitigated with increased price transparency and liquidity? It is funny to me that retail investors are "accredited" enough to blow their money on penny stocks that have no underlying revenues, earnings or even capital, but not able to participate alongside hedge fund manager John Paulson in an ABX Index for pennies betting against pools of subprime mortgage-backed securities (trading insurance). Why couldn't a discount brokerage provide deal performance from data providers Lewtan, CoreLogic or Intex, like they provide S&P reports for stocks.

Look at this chart of select tranche spreads of ABX.HE indices (06-01 BBB, 06-02 BBB, 07-01 BBB, 06-01-BBB-, 06-02 BBB-, 06-03 BBB-) from this Nomura report in 2007. The report also breaks out "deal-collateral characteristics" for each series, "deal loan characteristics", "deal underwriting analytics" and "deal prepayment speeds". Were credit hedge funds and investment banks long MBS portfolios not watching this data? Or was it strictly a liquidity problem?

Source: Nomura via Securitization.net

I also stumbled upon this Bloomberg oped by Paul Wilmott on May 24, 2011 titled "Bankers Can’t Avoid Risk by Hiding It".

Are Credit Default Swaps Associated with Higher Corporate Defaults? (By New York Fed Staff)

I always wanted to know this.
Are Credit Default Swaps Associated with Higher Corporate Defaults?

May 2011 Number 494
JEL classification: G21, G33

Authors: Stavros Peristiani and Vanessa Savino

"Are companies with traded credit default swap (CDS) positions on their debt more likely to default? Using a proportional hazard model of bankruptcy and Merton’s contingent claims approach, we estimate the probability of default for U.S. nonfinancial firms. Our analysis does not generally find a persistent link between CDS and default over the entire period 2001-08, but does reveal a higher probability of default for firms with CDS over the last few years of that period. Further, we find that firms trading in the CDS market exhibited a higher Moody’s KMV expected default frequency during 2004-08. These findings are consistent with those of Henry Hu and Bernard Black, who argue that agency conflicts between hedged creditors and debtors would increase the likelihood of corporate default. In addition, our paper highlights other explanations for the higher defaults of CDS firms. Consistent with fire-sale spiral theories, we find a positive link between institutional ownership exposure and corporate distress, with CDS firms facing stronger selling pressures during the recent financial turmoil."

Continue reading: http://www.newyorkfed.org/research/staff_reports/sr494.html

Carl Icahn Issues Warning; CDSs Were Extremely Risky The Way They Were Used (CNBC)

On CNBC last night, after the Ira Sohn conference, hedge fund manager and shareholder activist Carl Icahn warned there could be another "problem" because nothing has changed inside these investment banks [video after the jump].
"I do think though that there could be another major problem. Now, will it happen next week? Next year? I don't know, and certainly nobody knows. But I don't think the system is working properly. I really find it amazing that we're almost back to where it was, where there's so much leverage going on in the investment banks today. There's just way too much leverage and way too much risk-taking with other people's money."

"I know a lot of my friends on Wall Street will hate my saying this, but the Glass–Steagall thing, or something like it, wasn't a bad thing. In other words, a bank should be a bank. Investment bankers should be an investment banker. Investment bankers serve a purpose, their purpose is raising capital and whatever, but I think today, and i know a lot of people won't like hearing this, what's going on today I think we're going back in the same trap; and I will tell you that very few people understood how toxic and how risky those derivatives were. CDSs were extremely risky the way they were used, and you know, you look at Wall Street and say, hey, they did it, but then you can't really blame the Wall Street guys. You can't blame a tiger. If you take a fierce man-eating tiger and put him in with a lot of sheep, you can't blame the tiger for eating the sheep, that's his nature. And that's the nature of Wall Street guys."

Ok, I think I get it. Wall Street guys are the tigers, and American taxpayers are the sheep for bailing them out? Remember, Wall Street should have gone down with the sheep they slaughtered.

I still don't understand why investment banks haven't been disrupted by the internet and social networking yet. These i-banks obviously do not provide value in current form; well maybe for hedge funds and institutional clients that get to play in their illiquid markets (retail investors are accredited enough to blow their money on fraudulent penny stocks but not able to buy the ABX Index (credit default swaps on pools of subprime mortgage backed securities) alongside hedge fund manager John Paulson who made billions LOL, read more). Electronic investment banking has to be a trillion dollar opportunity for an internet venture capitalist. SecondMarket and Prosper.com (on the consumer side) are kind of making moves in this space. The problem is the existing financial infrastructure is still in place which isn't transparent and permanently misprices risk in the system. Plus the incentive structures and the assembly line of fraud at these banks, and this preposterous "accredited investor" rule, makes the problem even worse. Read my post on July 10, 2010: Accredited Investor Rule is Nonsense (Exposed in 2008), Knock Down Existing Financial Infrastructure.

Fukushima a Stake Through Nuclear Industry's Heart - Guest Post

Guest post by OilPrice.com (interesting view on nuclear)

Fukushima a stake through nuclear industry's heart

Despite the managed media campaign by Tokyo Electric Company, the Japanese government and nuclear industry flacks worldwide, the 11 March 9.0 on the Richter scale earthquake, followed by a tsunami that off-lined TEPCO's six reactor Daiichi Fukushima nuclear power complex represents a global mortal blow to the nuclear power industry, which had been optimistic of a renaissance following worldwide concerns about global warming. While TEPCO's PR spin doctors along with Japanese government flacks will continue to parsimoniously dribble out information about the real situation at the stricken reactors while blandly assuring the Japanese population and the world that all is well even as nuclear lobbyists bleat "it can't happen here," all but the most obtuse are beginning to realize that catastrophes at nuclear power facilities, whether man-made (Chernobyl) or natural (Fukushima) have radioactive pollution consequences of potentially global significance.

SAC Makes Decent Trade In Domino's Pizza (DPZ) After 5.3% Stake In January

DPZ October 2010-May 25 2011 (StockCharts.com)
In a premium link fest I posted on January 25, 2011, I linked to a DealBook article titled "SAC Takes a Slice of Domino’s". I wanted to watch this trade.

At the end of Q4 2010 (12/31/2010), SAC Capital disclosed that it owned 1,065,841 shares or 1.77% of DPZ (*at the end of Q3 2010 SAC owned 39,000 shares). A couple weeks later, according to a 13G filing on January 24, 2011 (after an event on January 12), SAC Capital Advisors LP disclosed a 5.3% stake or 3,190,753 shares in Domino's Pizza. At the end of Q1 2011 (3/31/2011) SAC owned 62,510 shares of DPZ, so it looks like SAC dumped DPZ shares two months too early! No? DPZ jumped from $18.5 to $24.5 in May.

I'm mainly showing how you can track hedge fund trades using 13D, 13G and 13F SEC filings. Of course I'm not sure if these trades were long only in nature or as a hedge against undisclosed short positions, or on credit default swaps (hidden over-the-counter credit derivatives that trade on public company debt). That is why I did this post last year: "Don't Be Misled By 13F Filings, They Don't Disclose Shorts, Credit Default Swap Exposure (CDS)".

SAC Capital is one of the largest actively managed hedge funds with $14 billion under management (or $16 billion in the 3/31/2011 filing; not sure if that's AUM) and is currently being investigated for insider trading. Two portfolio managers already plead guilty to insider trading charges earlier this year. It is interesting how this company runs. Steve Cohen, who runs the firm, gives various portfolio managers "hundred of millions of dollars to invest", while he runs a $3 billion book. At DealBook:
"Unlike many hedge funds that are controlled by one portfolio manager who makes all the investment decisions, SAC is decentralized; 142 small teams are each given control over hundred of millions of dollars to invest."

David Stockman: Vicious Sell-Off In Bond Market Could Force Action on Budget Deficit, Debt

10-year Treasury Yield
David Stockman, former budget director under President Reagan, appeared on Bloomberg TV on May 23 and warned that a major dislocation in the bond market could force congressional action on the $1.5 trillion budget deficit and national debt ($6 billion a day borrowing spree). The catalyst could be the end of QE2, when the Fed stops buying Treasuries. He said both parties are advocating a "de-facto" default by not addressing the issue (cut spending and increase tax revenues). Watch the Bloomberg video after the jump. I threw up a chart of the 10-year treasury yield (via St. Louis Fed). When the 10-year yield breaks through that downtrend line from 1982, watch out for bond vigilantes. Here are a few quotes from the transcript.

On when Washington will get to the point of discussing raising taxes:
"I think [Washington will discuss raising taxes] only when we get a major, thundering conflagration in the bond market."

"For the last 10 years, Congress has been lulled to sleep by the central banks that keep buying all the debt and therefore holding down the real cost of interest on the middle and long term debt that we are issuing every day.

"And frankly, bond fund managers who somehow think that the tooth fairy is going to arrive and fix this problem, when it's clear that is not going to happen, and that we have sovereign risk on the debt of the United States, just as clearly as the world is now discovering there are sovereign risks in the European debt issues and so forth."

On whether there will be a 9/11-style crisis in the economy:
"That kind of crisis would be a vicious sell-off in the global bond market. That could come sooner than people think, because the Fed is getting out of the market with QE2 ending.”

"For the last six months, the Fed has bought nearly 100% of this $6 billion a day that's been issued. Once they are out of the market, where is the new bid, where is the new demand going to come from? The Chinese are getting out of the market because finally they are having to deal with the rip-roaring inflation they have had. The people's printing press of China will not be buying as much U.S. debt because of its own internal problems.”

"When we get to real investors, what are some of the real investors saying today? PIMCO is short the bond, they're selling, they're not buying.

"When we get into a two-way market when real investors began to look at real risk, begin to look at the gong show in Washington and the magnitude of the gap that we are borrowing, I think we're going to get a re-rating of sovereign risk. We're going to get a huge dislocation in the global bond market, and then maybe the wake-up call will finally come."

St. Joe is Whitney Tilson's Largest Short Position, Berkowitz Wants $JOE As Largest Position

T2 Partners VIC slides (see below) 
Keep an eye on the St. Joe ($JOE) value war. Now value manager Whitney Tilson, of T2 Partners, has joined the fight. Tilson told CNBC's Fast Money on 5/3/2011 that St. Joe was his largest short position and that $JOE "is worth half to a third" of its current price. JOE was trading around $26 that day, so $8.6-$13 per share? He joins hedge fund manager David Einhorn, of Greenlight Capital, who released an extensive research report last October explaining why $JOE was worth $7 to $10 a share. According to David Einhorn's Q1 Investor letter, Greenlight Capital was still short JOE shares. JOE is currently trading at $21.85, so decent timing so far.

Here is what Whitney Tilson said on CNBC. Watch the video after the jump.

On a potential sale:
JOE inflection point
"I think there was a flurry of activity to try and sell it but given the stock is trading at two or three times what we think it's really worth, and how depressed the real estate market is and so forth, we think there's almost no chance of the company getting sold."

St. Joe should be valued based on timberland assets:
"Basically they have 500-plus thousand acres of timberland that's worth $7 to $10 a share, and then they have a bunch of beautiful developments that were built at the peak of the market that are basically most of them are ghost towns at this point. The bubble burst and they're largely empty. and that is these developments which we think have virtually no value, nor will they ever, account for being valued in the marketplace. well over $1 billion and we think there's almost no value there."

Impairment charges needed:
"Sales prices of some of the lots and houses that are being sold are being done at, you know, 10% or 20% of the peak valuation. Yet St. Joe hasn't taken any impairments on these assets and we think they're going to have to."

And then there's the long side. The Fairholme Fund, run by Bruce Berkowitz, owns about 30% of the company and wants to own more. From Institutional Investor on 5/19/2011:
"Fairholme’s logic is relatively simple: St. Joe’s fortunes will rise again when real estate does; the land was purchased cheaply, paying them to wait; the new airport, on land donated by the company, will spur development in the Panhandle; and new company management will help. With Northwest Florida Beaches International Airport opened last May, the region should be able to develop not just as a vacation spot but as a commercial hub, Berkowitz contends."

"Although St. Joe currently represents less than 3 percent of Fairholme’s assets, Berkowitz hopes to make it a more significant holding. “Our game plan will be to make it a bigger part of the portfolio,” he says. “We’re not wasting our time or our shareholders’ or partners’ time. I hope one day St. Joe is our largest position.”"

Other large mutual funds and institutions bought a huge chunk of shares recently. I addressed this in my previous blog post on 4/24/2011:

EUR/USD Breaks 1.40; Resumes Downtrend From 2007 (Big Red Candle)

EUR/USD via FXstreet.com
About two months ago I mentioned that the 5-year downtrend on EUR/USD (Euro in U.S. Dollars) was in play. It broke the trend, hit an exhaustion point, and then failed to confirm itself. Look at the huge red candle on the monthly chart! EUR/USD is now trading at 1.3991 after it hit a peak of 1.494 on May 4. Eurozone debt fears could be getting serious again, if that's what the Euro is pricing in. Spain and Italy were in the news this morning, see links on my previous post. Commodities and equity index futures are taking a hit this morning (except gold). Keep an eye on the S&P trendline when the market opens and $22 resistance on UUP (US Dollar Index ETF).

July Crude Oil -2.78% at 97.32
June E-mini S&P -1.09% at 1313.25
Gold spot -0.04%% at 1508.72
Silver spot -0.97% at 34.69
US Dollar Index (NYBOT) +0.60% at 76.30

Macro Reads (Housing, Cash, QE), Eurozone and LinkedIn IPO Wars - 5/22/2011

Robert Shiller's Housing Index
(The Big Picture, 4/13/2011)
Macro

Farmland best bet in gloomy outlook, says Yale's Shiller (InvestmentNews) - *Robert Shiller gave his outlook on the housing market during a Fox Business segment on 5/19/2011. I embedded the video after the jump.

Once bullish, contrarian Jim Grant (of Interest Rate Observer) likes cash now (AP)

To Eat and Survive in LA: On Track for a Million Food Stamp Users by Gregor Macdonald (Gregor.us)

Housing in North America: Peak Oil’s Primary Victim by Gregor Macdonald (Gregor.us)

Richard Koo (Nomura Research Institute) Explains Why An Unwind Of QE2, With Nothing To Replace It, Could Lead To The Biggest Depression Yet (Zero Hedge)


Eurozone action

Massive blow for Spain's ruling party clouds Euro outlook; S&P cut outlook for Italy to "negative" from "stable" (FXStreet)

European Stocks Sink as Debt Concern Deepens; Commerzbank, Santander Slide (Bloomberg)

S&P’s Italy Warning May Fan Contagion as Greece Cuts (Bloomberg)


LinkedIn IPO Wars

The LinkedIn IPO debate (Felix Salmon)

Primitive Underwriting for Web 2.0 Deals (LinkedIn should have done a Dutch Auction) (ReformedBroker)

Was LinkedIn Scammed? by Joe Nocera (New York Times)

Even The "Smart" Arguments Justifying LinkedIn's IPO Pop Are Bogus (Business Insider)

Two replies by blogger The Epicurean Dealmaker, a pseudonymous investment banker: "Jane You Ignorant Slut" and "Dan You Pompous Ass" (? lol).

Why Linkedin Didnt Use An Auction & Why Their Bankers Didn’t Screw-Up by The_Analyst (Stone Street Advisors)