Wednesday, February 13th, 2008
Feb. 13, 2008 - Warren Buffett, live on CNBC, proposed to buy the muni-bond portfolio from the monoline insurers, an offer, which if accepted would be very good for muni-bond holders (as it would protect the bond’s AAA ratings and their pricing) and Berkshire Hathaway, and would effectively leave the CDO portfolios right where they are. This could in no way be misconstrued as a bailout. This is Warren Buffett doing what he does best. Ahhhh…Capitalism at its finest.
Here is the excerpt of the transcript from CNBC.
Becky Quick: We know Warren that you’ve already put a plan out where you are, in fact, a bond insurer yourself. You have a new company that’s doing that. But beyond that, Ambac, FGIC and MBIA, they all have some significant problems. What do you think needs to be done?
Warren Buffett: Well, last Wednesday, as you know we have formed a new bond insurer. And last Wednesday, Berkshire Hathaway made a firm offer to the three largest bond insurers, who in aggregate I think, insure about 800 billion (dollars) of tax exempt bonds.
And what we said we would do is, and we gave a copy of this, of course, to the Superintendent of Insurance of New York. We said we would form, we would add to our company’s resources five billion dollars. That five billion dollars in the new insurance company, we would pledge that there would be no dividends or any kind of distributions or management fees taken out of that for ten years, so all the earnings of that company would be retained to build up the claims-paying ability.
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And we offered to take over the liabilities for the whole $800 billion of these three companies for a premium that would be equal to, essentially, one-and-a-half times the remaining premium left over the life of the bonds. They have what they call an ‘unearned premium reserve’ which reflects the original premium less the amount that’s been proportionately earned. And we said, for one-and-a-half times that amount, we would take away all of their liabilities so that the $800 billion in bonds would carry a real triple-A insurance, and would sell in the market as if it had real triple-A insurance. Whereas now the bonds sell at significant discounts.
And we provided additionally that if they felt that this premium was too high or that they could do better that for thirty days, they would have the backstop of our offer which would be totally firm, and if they came up with anything better for themselves and for the holders of their insured bonds, that for a break-up fee of one-and-a-half percent of the premium, that they could go and take the other deal. So that the world would know that, one way or the other, that that the municipal bond insurance problem was behind it. It would be either with our offer or some other offer that they went out and obtained.
So, we put that out there to the three largest insurers and if they should decide to take it, eight-hundred billion of bonds that are now selling as if they were uninsured, or even in some cases a little worse. They’re probably selling on balance maybe 5 percent below where would sell for if the insurance was regarded as good, which is 40 billion on 800 billion. We will see what happens.
Good Luck Mr. Buffett, and good luck muni-bond holders…
Tags: ABK, Bailout, capitalism, CDS, Credit, Credit Market, Dollar, Earnings, risk, Warren Buffett
Posted in Bonds, Credit Markets | No Comments »
Sunday, February 3rd, 2008
Feb. 3, 2008 - The nature of the economic strength and stability of the BRIC (Brazil, Russia, India, China) countries is a less well known or understood fact among investors. There remains a wide gap between perceptions and reality.
Remember 1997 and 1998? Many investors, excited about the growth of Asian and emerging countries in the late nineties and invested their money found out about credit related risk first when the 1997 ‘Asian Contagion’ occurred and was followed upon by the Long Term Capital Management bailout which unfolded in 1998. These events destabilized global markets and investors were taken by surprise as markets melted down.
For this reason, its important to go back to that time and re-examine Malaysia and Thailand, as examples, of where investors were excited by the rapid economic growth, but ignored the then inherent high credit risk, much to their expense. A decade ago (yes, a decade ago) when all of this was happening, only 3% of the grand total of emerging markets sovereign debt was rated as investment grade by any of the ratings agencies.
In 1997, only 10 out of 120 companies that form the MSCI Emerging Markets Index, had ADRs.
Excited by the G7 debt-financed growth, investors made bets that were inherently risky to their preservation of capital, not simply volatile. Circa 1997, emerging markets were in debt to the industrialized world by about $100-billion in the current account deficit column, and dependent on the kindness of their G7 financiers.
When the Malay and Thai governments were unable to meet current account obligations, and started printing money in order to meet them, the Fed blew the whistle upon discovering that sufficient reserves were not available to support the currency valuations. Hence the overnight slashing of Asian currencies.
At best, the general sentiment surrounding emerging markets has remained sceptical, and for this reason, as fundamentally sound as the BRIC countries economies are today, the market has been adopting the BRIC investment story very gradually. This time though, it is credit worthiness that is being overlooked.
Source: Merrill Lynch October 2006
Source: Merrill Lynch, October 2006
Today, emerging markets sit atop a current account surplus in excess of $700-billion, and it is the industrialized G7 who are in debt, by the same amount. Longer term surpluses in excess of $3-trillion are to be found on the balance sheets of mostly the BRIC countries today in the form of Foreign Exchange surpluses, and trade surpluses. China alone now nurses a trade and forex surplus nearing US$1.5-tillion. Russia, has managed to build up reserves of US$450-billion as well as Putin’s US$150-billion ‘contigency’ fund, set aside so that it may sidestep any kind of financial shock. India has amassed a forex surplus of around US$275-billion. Brazil’s forex reserves now stand at US$178-billion.
BRIC countries have been financing the debt, and driving the growth of G7 countries for the last 5-7 years. China has emerged as the worlds manufacturing hub, while India has come on very strong as its counterpart hub in services, both providing Western firms access to inexpensive educated and -or- highly-skilled labour. Russia, under Putin, has successfully emerged as a highly profitable energy and raw materials producer, second in oil and gas reserves to Saudi Arabia. Brazil has changed the regional balance in the Americas by turning itself into the winds of east-west trade in hard and soft commodities and using its strength to bolster its new economic clout in relation to North America.
China’s growth is less dependent on the health of the US economy, as is commonly perceived. A recent Economist article points out that China’s true exports-to-GDP ratio is actually below 10%, that China has been quite successful to date at rebalancing its economy in favour of domestic growth as a driver. As for India, 87% of its GDP is consumed domestically, making it quite independent from the risk of the US threatened consumer hegemony. Russians are enjoying three times the disposable income of 7 years ago and driving consumption growth, as are Brazilians.
North American and European companies are looking to these consumers to drive demand and growth to their top and bottom lines.
In a word, things have changed.
They have changed in a very meaningful, very important way. The relationship that now exists between emerging markets and G7 countries is ‘symbiotic.’ and interdependent.
Source: Merrill Lynch, October 2006
Today, around 60-70% of emerging markets sovereign debt is investment grade rated and all 120 companies that form the key MSCI Emerging Markets Index have ADR listings.
In 1997-1998, the world’s biggest western banks took advantage of bailout conditions to take ownership of Asian banks, once protected by thousand-year-old protectionist laws. Today, powerful and wealthy Sovereign Wealth Funds (SWFs) are bailing out the same banks, Citigroup, Merrill Lynch, and Morgan Stanley.
On Wall Street in the past few weeks, the sums have been bigger and the actions more benign—at least so far. This week Merrill Lynch and Citigroup became the latest to get the sovereign-wealth treatment, picking up a further $6.6 billion and $14.5 billion respectively, much of it from governments in Asia and the Middle East (see article). Sapped by the subprime crisis, rich-world financial-services groups have been administered nearly $69 billion-worth of infusions from the savings of the developing world in the past ten months, according to Morgan Stanley.
Commodities are not the only source of sovereign wealth. Many Asian emerging markets have been running current-account surpluses at the same time as they have been managing their exchange rates. As they have mopped up dollars, using government bonds, they have accumulated reserves. At first these went into safe, liquid assets like American Treasury bonds—the Asian financial crisis of 1997-98 was still a recent memory and many countries were keen to amass reserves. But economies like China, South Korea and Taiwan now have more reserves than they need to defend themselves against shocks. Their governments understandably want to earn a higher return than Treasury bonds will pay, so they create a fund to manage their assets. Source: The Economist, Jan. 17, 2008, Asset-Backed Insecurity
It has become such that neither Emerging Markets nor the G7 can allow each other to be destabilized, as evidenced by the large, noted, SWF investments, as they have each other’s economic ‘lives’ in the balance.
You might get the idea that emerging markets are correlated more to the US than they actually are, when you see that they have suffered like western stock markets, from a selloff. Their correlation is low, between .30 and .40, not zero or negative. There are those who would have us believe that the decoupling thesis is suffering from the same disease as the bull market. Those are probably the same folks, who last year began to re-write their theses from decoupling to recoupling to suit themselves this year, as the need to raise cash by selling the last two year’s profitable trades became an increasingly inevitable requirement, in order to shore up balance sheets.
Our expectation is that the credit squeeze ailing the market will come to a reversal point, at some point over the next 2-4 weeks as the banks round the corner on the cash call that has forced the wholesale liquidation of emerging markets and commodities related investing.
Emerging Markets are strong, and some of their [inflationary] growth pressures may get somewhat solved by a slowdown in the US, in the form of an imported soft landing. This is by no means advice, but if you subscribe to this thesis, then there is reason (for those of us on the buy-side) to believe that there will be a recovery in the decoupling thesis, and thus emerging markets equities throughout the second half of the year, from the current lows.
First, however, until the cash call is complete, and the future of the monoline insurers (MBIA, ABK) is resolved in the form of perhaps a bailout, we may continue to see more downside.
Now may prove to be a good time to nibble at emerging markets and commodities again and add or gain exposure as they are far more attractively priced. Here are a variety of ETFs and open ended funds (Canadian fund companies with offerings) that provide broad (diversified) and narrow exposure (country and regional funds) to BRIC and emerging markets.
On the AMEX
“Total” Emerging Markets ETFs
iShares MSCI Emerging Markets Index Fund (EEM)
PowerShares FTSE RAFI Emerging Markets Portfolio (PXH)
SPDR S&P Emerging Markets ETF (GMM)
Vanguard Emerging Markets ETF (VWO)
Dividend Emerging Markets ETFs
WisdomTree Emerging Markets High-Yielding Fund (DEM)
Multi-Region (but not Total) Emerging Markets ETFs
BLDRS Emerging MKTS 50 ADR Index Fund (ADRE)
Claymore/BNY BRIC (Brazil, Russia, India, China) ETF (EEB)
streetTRACKS SPDR S&P BRIC (Brazil, Russia, India, China) 40 ETF (BIK)
iShares MSCI BRIC Index Fund (BKF)
Latin America Regional ETFs
iShares S&P Latin America 40 Index Fund (ILF)
SPDR S&P Emerging Latin America ETF (GML)
European Emerging Markets Regional ETFs
SPDR S&P Emerging Europe ETF (GUR)
Middle East and Africa Regional ETFs
SPDR S&P Emerging Middle East & Africa ETF (GAF)
India - Barclays iPath India ETN (INP)
On the Toronto Stock Exchange
Claymore BRIC ETF (CBQ.T)
Open Ended Funds (Canadian)
Broad Mandate Emerging Markets
Tmpleton Emerging Markets
AGF Emerging Markets
Pro FTSE RAFI Emerging Markets Index
TD Emerging Markets
United-Emerging Markets Pool Cl A
CI Emerging Markets
United-Emerging Markets Pool Cl W
BMO Emerging Markets
Brandes Emerging Markets Equity
CIBC Emerging Markets Index
National Bank Emerging Markets
Region/Country Mandates
Excel India Fund
Excel China Fund
Excel Chindia Fund
Excel Emerging Europe Fund
Templeton BRIC Fund
Tags: ABK, Asia, Bailout, Banks, Blog, BMO, Brazil, BRIC, BRICs, Canada, China, CIBC, Citigroup, Commodities, Consumption, Correlation, Credit, Credit Market, Credit Risk, Currency, de-coupling, Dollar, Economy, Emerging Market, Emerging Markets, energy, ETF, Euro, Fed, FTSE, GDP, Government Bonds, India, inflation, Investment, Latin America, Long Term Capital, Long Term Capital Management, Malaysia, Markets, oil, Oil and Gas, Recession, risk, Russia, Slowdown, South Korea, Stock Markets, SWFs, Taiwan, Thesis, Trillion, Valuations, Wall Street, wisdom
Posted in Bonds, Commodities, Credit Markets, Emerging Markets, Markets, Oil and Gas, Outlook | No Comments »
Friday, January 18th, 2008
Jan. 18, 2008 - At the beginning of January we featured Ted Seides’ view Junk Bonds and Couterparty Risks, in which he asserts that the risks that remain are significant and concern the outstanding counter-party risks. Barry Ritholtz in his Big Picture blog, re-iterates that this credit mess is far from over, and that counter-party risk remains an unresolved and shrouded facet of the problem that has yet to come to light. He also makes an interesting point about Warren Buffett’s recent choice. This is a must read:
Counter-Party Risk
Barry Ritholtz, January 18, 2008
Get used to hearing that phrase: Counter-Party Risk.
You will be hearing a lot of it in the coming year. Its one of the reasons I disagree with my friend Doug Kass about any bottom in Financials.
Consider this small concern: Given the enormous amount of hedging that was done by Investment Banks (Merrill, Morgan Stanley, JPM, Citi, etc.) if the monoline insurers fail, well, then you are no longer hedged. So while some people are arguing that the write downs are now over, I am not quite so sure.
And that’s before we get to the issues of defaults which have yet to occur. These are problems in the near future, and they are likely to cause an ongoing set of dislocations. Hence, why I expect the financial sector bottom will be a long tedious process.
But I digress. Back to the monolines and counter-party risk.
The AMBACs (ABK), MBIAs (MBI), and FGICs (a GE/Blackrock company) of the world used to have a nice little business going. They wrote insurance on bonds that cities, states and municipalities issued. It was “the vig” on getting a triple AAA rating, and the premium more than paid for itself in reduced borrowing costs. A lovely, low risk business, with little defaults and a steady revenue stream. At one point in time, AMBAC had the highest revenue per employee on the planet.
That situation was obviously intolerable. So they brought in the financial engineers. Hey, we should be issuing insurance on Credit Default Swaps (CDS) — the premiums are much much bigger than boring old munis!
Any time you hear words to that effect, you know you are dealing with an idiot of the highest magnitude. Those are the equivalent to “Give me a match, I want to see if there is any gas in the tank.”
The monolines are not in trouble because Municipalities are defaulting on bond payments. (That’s waaaay in the future). The problem is they wrote insurance — taking in that fat premiums — without properly understanding the risk.
Greater reward requires greater risk. This is such a simple formula, yet I find myself repeating it again and again. How anyone fails to understand it, quite frankly, is beyond my comprehension. These were once great businesses, and now, there is the increasing chance –perhaps likelihood — they will be zeros.
Can you imagine Warren Buffet destroying such a delightfully simple, profitable business? Me neither. That’s why Berkshire is going to own this space in a few short years . . .
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I’ve said it before, and I’ll repeat it again: To err is human, but it requires an MBA to create total clusterfuck . . .
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Disclosure: A relative used to work at AMBAK, and now works at FGIC. We don’t really discuss work, and they were NOT consulted on anything in the commentary.
Tags: ABK, Banks, Barry Ritholtz, Blackrock, Blog, CDS, Credit, Credit Default Swap, Credit Market, Currency, dig, Dislocations, Doug Kass, Economy, Facet, Financial Engineers, Financial Sector, Financials, Fixed Income, Friend Doug, Investment, Investment Banks, Junk Bonds, MBI, Morgan Stanley, Municipalities, Party Risk, Point In Time, REW, risk, Risk Business, Small Concern, Steady Revenue Stream, Vig, Warren Buffett
Posted in Bonds, Markets | No Comments »
The S&P 500 has had some wild swings since the Fed began its current easing cycle with its cut in the Discount Rate on August 17th. After rallying to new highs in October, the index has fallen 13.37%, but it is down just 3.93% since the close on 8/16. At right we highlight the performance of the ten sectors that make up the S&P 500 since the easing cycle began, as well as the performance of oil, gold, the dollar and the 10-Year. 
