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Cash and Carry Trade
Sep. 6th, 2007 11:02 am"Bank Changes Stance On Turmoil"
went the headline of the FT this morning. Ah-hah, I thought, clearly the Bank of England now thinks turmoil to be a good thing.
But, no, nothing so radical. The BoE merely conceded that turmoil existed. This was rather on a par with the Indonesian government denying that there had been any unusual weather activity on December 26 2005, only to change its mind when faced with amateur videos recording 20-foot waves blasting into beach resort — not that the Indonesian government did that. I'm just using it as a hypothetical example.
After levelling off at 6.6%, the three-month Libor rate followed US rates up at the beginning of this week, indicating a return of risk-aversion.
We're now beginning to get official figures coming through, so the guys in the suits no longer have to work on gut feelings. Pending sales of US homes fell by 12.2%, rather than the 2% that was anticipated, and tomorrow's non-farm payroll number could cause a rapid overreaction one way or the other. I think I've commented in the past on the insane significance appropriated to this figure by the markets. Just see how they react and then jump in about an hour or so later. There is always a bounceback.
But the most interesting development has been the emergence of a large number of operations asking investors for funds in order to buy distressed debt. Incredibly, the free market is working ... well, sort of, and not quite in the manner anticipated.
As I mentioned in the early days of this subprime meltdown, there would likely be some forced sellers of debt, and this would be an opportunity to make some cash. So it's quite nice when Goldman Sachs, Lehman Brothers, Blackstone and others agree with you.
Unfortunately, the whole thing has hit a bit of a brick wall, because the big banks seem unwilling to discount the debt by as much as the buyers are willing to pay.
This is a bit like when a housing price crash starts. What you get is not a change in price, but a loss of liquidity. Group A is willing to pay a certain amount, while Group B is unwilling to sell at that amount, because Group B's mentality is still stuck in the different times of a few months ago. Eventually the prices converge and liquidity returns.
As for the risk aversion, it struck me this morning that the reason banks are unwilling to lend to other financial institutions is because they do not know where the risk has gone. We know that, say, 95% of borrowers are fine and 5% are in trouble. The problem for the lenders is, they have no way of knowing which is which.
In other words, this is not a solvency crisis, this is a transparency crisis. This gives me the opportunity to blame Sarbanes-Oxley, and I never miss that opportunity.
Sarbanes-Oxley, in its naive attempt to increase transparency by requiring companies to reprot far more than they had to previously, created the niche in which unlisted companies with private capital, as well as structured sliced and diced products, could become more popular. What the legislators and regulators need to realize is that you canot compel transparency, because if it is in a business's interests not to be transparent, then it will find a way so to do.
What you need to do is to make transparency desirable. Then it becomes much easier to avoid companies which are not transparent, because counterparties will say to themselves "Hmm, why do they want to be opaque about this?"
( two hands )
went the headline of the FT this morning. Ah-hah, I thought, clearly the Bank of England now thinks turmoil to be a good thing.
But, no, nothing so radical. The BoE merely conceded that turmoil existed. This was rather on a par with the Indonesian government denying that there had been any unusual weather activity on December 26 2005, only to change its mind when faced with amateur videos recording 20-foot waves blasting into beach resort — not that the Indonesian government did that. I'm just using it as a hypothetical example.
After levelling off at 6.6%, the three-month Libor rate followed US rates up at the beginning of this week, indicating a return of risk-aversion.
We're now beginning to get official figures coming through, so the guys in the suits no longer have to work on gut feelings. Pending sales of US homes fell by 12.2%, rather than the 2% that was anticipated, and tomorrow's non-farm payroll number could cause a rapid overreaction one way or the other. I think I've commented in the past on the insane significance appropriated to this figure by the markets. Just see how they react and then jump in about an hour or so later. There is always a bounceback.
But the most interesting development has been the emergence of a large number of operations asking investors for funds in order to buy distressed debt. Incredibly, the free market is working ... well, sort of, and not quite in the manner anticipated.
As I mentioned in the early days of this subprime meltdown, there would likely be some forced sellers of debt, and this would be an opportunity to make some cash. So it's quite nice when Goldman Sachs, Lehman Brothers, Blackstone and others agree with you.
Unfortunately, the whole thing has hit a bit of a brick wall, because the big banks seem unwilling to discount the debt by as much as the buyers are willing to pay.
This is a bit like when a housing price crash starts. What you get is not a change in price, but a loss of liquidity. Group A is willing to pay a certain amount, while Group B is unwilling to sell at that amount, because Group B's mentality is still stuck in the different times of a few months ago. Eventually the prices converge and liquidity returns.
As for the risk aversion, it struck me this morning that the reason banks are unwilling to lend to other financial institutions is because they do not know where the risk has gone. We know that, say, 95% of borrowers are fine and 5% are in trouble. The problem for the lenders is, they have no way of knowing which is which.
In other words, this is not a solvency crisis, this is a transparency crisis. This gives me the opportunity to blame Sarbanes-Oxley, and I never miss that opportunity.
Sarbanes-Oxley, in its naive attempt to increase transparency by requiring companies to reprot far more than they had to previously, created the niche in which unlisted companies with private capital, as well as structured sliced and diced products, could become more popular. What the legislators and regulators need to realize is that you canot compel transparency, because if it is in a business's interests not to be transparent, then it will find a way so to do.
What you need to do is to make transparency desirable. Then it becomes much easier to avoid companies which are not transparent, because counterparties will say to themselves "Hmm, why do they want to be opaque about this?"
( two hands )
