"Buffett agreed to buy a combined $750 million in debt from wallboard manufacturer USG Corp., motorcycle-maker Harley- Davidson Inc. and Sealed Air Corp., the maker of Bubble Wrap shipping products, in the past three months paying between 10 and 15 percent.
"Buffett also agreed in September and October to spend $8 billion on preferred shares of General Electric Co. and Goldman Sachs Group Inc. that pay 10 percent annual interest. This month, he agreed to buy convertible notes from Swiss Reinsurance Co. worth 3 billion Swiss francs ($2.6 billion) that pay 12 percent annually."
While Buffett’s bond investments might be mandated because he is using insurance float, it stands to reason that if he was overly concerned about very high rates of inflation, he would not be doing most of these transactions.
If Buffett was concerned about high inflation or a deteriorating dollar, he would simply do what he did before: forget about yield and invest in foreign currencies. For example, he could simply buy yen forwards or yen bonds if he thought the U.S. currency faced imminent destruction.
Granted, Buffett’s recent Swiss Re position has this dollar-hedge effect. But if Buffett expected hyperinflation, he would be making very different investments. He would be investing in hard assets or securities related to them.
With high domestic inflation, anything interest-bearing or financial is rat poison – yet Buffett has been investing heavily in dollar-based, fixed-income securities. Evidently he isn’t overly concerned about high inflation.
Here is a chronology of the CDO meltdown, laying bare what true junk ABS-CDOs actually were. Yet, with over 76% of these instruments that were issued at the market's peak currently in default, it stands to reason that we're pretty close to being done with this, or at least that the most intense phase of the crisis is behind us.
Almost half of all the complex credit products ever built out of slices of other securitised bonds have now defaulted, according to analysts, and the proportion rises to more than two-thirds among deals created at the peak of the cycle.
The defaults have affected more than $300bn worth of these collateralised debt obligations, which were built from bits of other asset backed securities (ABS) such as mortgage bonds, other CDOs and structured bonds, or derivatives of any of these, according to analysts at Wachovia and Morgan Stanley.
So-called CDOs of ABS caused huge losses to banks such as Merrill Lynch, UBS and Citigroup, which held large amounts of the supposedly safest, top-rated chunks of them. They have since been damned by bodies such as the Bank for International Settlements as being too complex to risk manage effectively.
CDOs of ABS were used increasingly at the peak of the credit bubble to keep the securitisation machine moving by recycling hard to sell bits of subprime mortgage bonds and other risky tranches into new structures with top-notch credit ratings.
However, the ratings of these deals proved unsustainable, as evidenced by the fact they have accounted for 92.9 per cent of all 16,587 ratings downgrades globally from all rating agencies since the beginning of last year, according to Morgan Stanley.
The way these complex and risky transactions were exploited at the peak of the bubble can be seen in data from analysts at Wachovia, who reckon that 47.6 per cent of all CDOs of ABS by volume issued since the market substantively began in 2002 have now hit an event of default.
By their records, the first three years of the market saw less than 100 deals sold per year and less than 10 per cent of those have defaulted. The number of deals done rose to 133 in 2005, less than 20 per cent of which defaulted, and 89 in just the first half of 2006, about one-third of which have defaulted.
However, the real peak of the market saw 147 deals done in the second half of 2006 and 172 done in the first half of 2007 – of which 68 per cent and 76.2 per cent, respectively, have now defaulted.
The way these CDOs have performed has especially hurt the new wave of specialist credit hedge funds, which sprang up in recent years and became heavily dependent from creating and managing such deals. They were drawn to such business by a belief in the sustainability and predictability of the fees it would generate.
However, about one-third of the CDOs of ABS that have defaulted, or almost $105bn worth, have been or are being liquidated – often leading to losses for investors and putting further pressure on market prices of the bits of mortgage bonds and other CDOs they are selling.
Fannie Mae and Freddie Mac, the mortgage-finance companies seized by regulators, may need more than the $200 billion in funding pledged by the U.S. government if the housing market continues to deteriorate, Federal Housing Finance Agency Director James Lockhart said.
The companies’ needs will depend largely on the direction of home prices, Lockhart said in an interview in Las Vegas yesterday. His comments followed statements from Fannie Mae in November and Freddie Mac Chairman John Koskinen last week that the government’s funding commitment through 2009 may fall short of what the companies need to make good on their obligations.
“When we sized the amount in September, we obviously looked at stress tests and what was happening in the marketplace,” Lockhart said. “There’s been some significant events since then that weren’t in our forecast.”
The U.S. housing market lost $3.3 trillion in value last year and almost one in six owners with mortgages owed more than their homes were worth, according to a Feb. 3 report from Zillow.com. Following a record boom, home prices are down 25 percent on average since mid-2006 amid a tightening of lending standards and an economic recession, the S&P/Case-Shiller Composite 20-city price index shows.
Freddie Mac and Fannie Mae are the largest U.S. mortgage- finance companies, owning or guaranteeing $5.2 trillion of the $12 trillion home-loan market. The government seized control of Fannie Mae and Freddie Mac after their losses threatened to further disrupt the housing market, and pledged to invest as much as $100 billion into each company as needed if the value of their assets drops below the amount they owe on obligations.
A ‘Hard Look’
Fannie Mae said in a November regulatory filing that “this commitment may not be sufficient to keep us in solvent condition or from being placed into receivership.” Freddie Mac is taking a “hard look” at whether it will need more than $100 billion, Koskinen said last week.
“It’s going to be a close question,” Koskinen said in an interview on Bloomberg Television’s “Conversations with Judy Woodruff.”
McLean, Virginia-based Freddie Mac has taken $13.8 billion in federal aid and said it will need as much as $35 billion more by the end of this month. Washington-based Fannie Mae said it may tap as much as $16 billion in funding.
Lockhart, who was in Las Vegas yesterday to speak before the American Securitization Forum’s annual conference, said Fannie Mae and Freddie Mac’s most recent requests for aid, which were larger than some expected, were driven by temporary market disruptions that may not translate into permanent losses.
“There were some temporary imbalances that made their numbers pretty dramatic,” he said.
Government Demands
Federal officials are now leaning on the government- sponsored enterprises to help stabilize the housing market. House Financial Services Committee Chairman Barney Frank said last week that the companies will be used “very aggressively” to help reduce record foreclosures.
Lockhart said Fannie Mae and Freddie Mac aren’t expected to take a loss “under any program” that requires their involvement. “We would expect them to be writing business that’s profitable at this point, not a large profit,” he said yesterday. “But we would not expect them to be writing business at a loss under any program.”
The Treasury, not the companies, would bear the cost under proposals to use the companies to drive down mortgage rates to about 4.5 percent, Lockhart said. That proposal was under consideration as part of a comprehensive housing-recovery plan being developed by the Treasury.
‘A Hot Idea’
“That was a hot idea for a while: It’s cooled off,” Lockhart said. “But Fannie and Freddie wouldn’t be asked to eat the difference. If it happened, that would be the U.S. Treasury.”
Fannie Mae and Freddie Mac may also be used to provide direct financing to single-family and multifamily residential mortgage lenders, Lockhart said. Currently Fannie Mae and Freddie Mac provide financing by either buying loans from lenders or helping them package the debt as bonds for sale to investors, thus freeing up cash to make more mortgages.
The FHFA is reviewing whether the companies’ congressional charters, which generally prohibit lending directly to the public, would restrict expanding into so-called warehouse financing.
Credit Standards
Mortgage bankers and other companies that have seen their sources of credit dry up in the past year have been pushing for the change, according to Lockhart.
“The problem is that unfortunately bankers have tightened their credit standards and withdrawn from some markets,” Lockhart said. “And as interest rates fall, if we have relatively large refinancings, we’re going to need to have mortgage bankers be able to provide mortgages in the interim before they sell them to Fannie and Freddie.”
Given that I have commented on Bill Ackman and Pershing Square lately, I've included this letter to Pershing Square IV investors, who have now lost 90% of their invested capital.
As I wrote before, Pershing's TIP REIT transaction with Target was nothing more than a highly sophisticated attempt to immediately lift the stock price, and place Pershing's call options and total return swaps in the money.
But the main question that I have is, with stock prices where they are, would Bill Ackman now choose to buy Target stock, among all the other opportunities? In other words, is Target the most superior opportunity currently available?
To be clear, this is not an attack on Pershing Square or Bill Ackman, but a criticism of short-term-oriented investment strategies. With the benefit of hindsight, Ackman's leveraged Target investment appears to have been a mistake, made at the top of the market, caused by impatience.
After thinking this morning about commodities and inflationary prospects, I watched a Jim Rogers interview from 1995, which I have included below. You will have to fast forward a bit, because he appears toward the end. Here are a few of his predictions from 1995:
“Next year and the year after, I don’t think we’re going to have good times in the American stock market.”
“Inflation is coming.”
“Commodity prices are going through the roof.”
Best country to invest in right now: “Iran.”
“Everything in life comes down to timing.”
Well, it looks as if Jim's timing was profoundly wrong.
In fact, much of this flies in the face of what he said in Hot Commodities, published a decade later, which was to the effect of “if you went through the 1990s and didn't touch shares in technology companies then you missed out on massive gains," essentially meaning that it was a mistake caused by not being open to new things.
But, as you can see, he was saying the exact same stuff back then as he is today. And he certainly wasn't talking about technology.
Anyone who continues saying that inflation will come or commodities will rise is bound to be proven right at some point. This not to single out Rogers as being wrong, but to emphasize my stance on how difficult it is to predict macro events – unless, that is, you only have one perennial prediction.
What history shows is that, aside from short-term macro shocks, the best asset class to own, by far, is stocks. And if you can buy those stocks at depressed prices or in periods of intense fear, then your total return can be magnified significantly.
Land, labor, capital and commodities are combined to create businesses that increase productivity. And while any one of those factors may become relatively attractive during a boom, owning excellent businesses – or fractional interests, called stocks – is the best investment over the long haul.
Keynes predicted that the great financial fortunes – paper fortunes, such as the Rothschilds in his day – would be destroyed by long-run inflation. Clearly, this has not happened.
Quite the contrary: the countries with the most developed financial systems have always been the most prosperous, whether the Medicis in Renaissance Italy, the Rothschilds in 19th-century London, or today's commanding skyscraper in Lower Manhattan that reads, simply: "85".
Thus, while the gloom and doom is persuasive nowadays, I remain highly skeptical that the world – financial or otherwise – is coming to an end. I lean more towards John Paulson's prediction that massive returns will accrue to buyers of solid, yet beaten-down financial stocks, as the smoke clears and we emerge from this crisis.
Of course, if people do “flock to global macro” as the article says, it will bankrupt the strategy.
A problem with macro over the long term is that it often comes to resemble rank gambling. Managers can make billions on each trade – or lose billions. They sell the strategy with historic bets like George Soros and sterling in 1992. But I am sure they fail to mention the innumerable historic blow-outs.
Also, the catch is that global macro is usually way more difficult than it has been lately. Over the past few years, the strategy was insanely simple: long commodities, long BRICs, short the dollar, short financials. These were one-way bets with every manager on one side of the trade.
The interesting thing is, each time this happens, everyone says that funds can’t move the market. The markets that these managers operate in are too big to be influenced – like crude oil, last summer. And then the market collapses and in hindsight we find that everyone was on one side of the trade and it created a bubble. It is important to maintain a healthy degree of skepticism with virtually everything along these lines.
A current example might be oil production and supply. I’ve heard many people make claims that production is down and supply is down, as if we’re back in 2003. So after a decade of skyrocketing prices and activity in the energy sector, production and supply are down?
This is a complete lie, no matter what the numbers say. The government or the central bank or whoever else will diligently present figures showing a certain case; but you’ll always do better using common sense. The people producing the data are backwards-looking by definition, and always way behind the curve.
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