Ahead of the pack
Aug. 21st, 2007 12:50 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
peterbirksOh well, it's nice when what you spot as significant on Saturday, the Financial Times finally realizes is the front page story on Tuesday.
Part of the problem is that, whenever the BBC or a major newspaper deigns to put business on the front page, just about the most complex thing that it can cope with is the level of the FTSE 100.
So, here's Pete's easy guide for the non-financiers as to the important things which are happening at the moment.
1) Data from Dealogic showed that companies in Europe failed to refinance more than 80% of asset-backed commercial paper that matured yesterday. Yes, 80%. What does this mean? It means that there are a lot of chief financial officers out there who are tearing out their hair. Why? Because their "computer models" will have allowed for the cost of refinancing going up; perhaps those with a bit more foresight than the rest will have allowed for it going up significantly. But you can be sure that none of the models allowed for the market drying up completely.
What does this mean for companies? Well, KKR Financial said that it might have to raise $500m in an emergency rights issue. In other words, if the banks won't provide financing, we will go to the investors, in the hope that investors will be less scared than the banks. And what happens if the investors say no as well? Hmm, fucked if I know. But when we are talking about "emergency rights issues", institutional investors can smell blood. They will want a deep discount.
2) All that money which is not available to refinance corporate paper has gone into T-Bills (as mentioned here on Saturday). This was what caused the Fed to cut its discount rate on Friday. The panicked flight to safety in the short term (4-week bills) reached such a level that, following its fall in yield from 4.62% to 2.94% last week, at one point it fell another 175 basis points. At that point the arbitragers (the guys who used to work for LTCM in the mid 1990s?) must have spotted what looked mysteriously like free money. The 3-month bill was paying more than 2.5% (itself down 120 basis points from Friday) and the one-month bill was paying less than 1.5%. So, in they moved. The result was that the "flight to safety" knocked on to the 3-month bill (and also onto longer-term bills), down 66 basis points on the day to just over 3%, while the one-month bill fell a net 62 basis points to 2.33%. Some traders made one fuck of a lot of money yesterday. But those rates are unbelievably low compared to the minimum base rate (see below).
3) This is now way beyond the matter of subprime. One company that could not refinance yesterday was Ottimo Funding. It has no subprime mortgage liability; its credit rating is triple A. And guess what the banks said? Yep. "We don't give a fuck. Our money's in Treasuries".
4) Half of the $1.1tn in commercial paper comes due in the next three months. If there are no refinancers, that either means there is 500 billion dollars of emergency rights issues, or further forced selling of loan assets - not just subprime mortgages -- all loan assets. This could be a good time to buy fairly safe debt relatively cheaply.
5) The failure of the Fed's move on Friday to halt the flight to safety generated a few amusing comments. As per usual, John Authers had some interesting points to make. As he observed acerbicly
"The stockmarket has got the US Federal Reserve's message. The money market has not. Unfortunately, the message was intended for the money market".
So, while Radio Five's "Wake Up To Money" was talking of "calmer waters", it was talking about the stockmarket. Perhaps they should have been looking at what mattered -- the money markets, where the waters were anything but calm.
As Authers also observed:
In other words, this is uncharted territory. The free market is a wonderful thing ... when it works. As Lex of the FT observed, "the Fed does not necessarily have the weapons required to address the underlying problem".
And that's the nub of the matter. You can cut interest rates to 0%, but if risk aversion is so great that no-one is willing the lend anyone else any money, at any credit spread, then the Fed cannot invoke a law that makes the banks lend the money.
Well, that's the theory. In practice, I foresee some long meetings behind locked doors over the coming weekends, at which some bankers' arms will be seriously twisted.
So, let's assume liquidity returns (after some arm-twisting). Credit spreads (i.e., the gap in rates paid between "safe" and "risky" investments) will initially be artificially wide. The way to make money would be to bet on those spreads narrowing gradually over the coming 12 months. That would also mean a gradual shift out of T-Bills, resulting in the prices of those bills slipping back (i.e., the yields improving).
At the moment, there just HAS to be an arbitrage opportunity between the one-month, three-month and 12-month T-Bill rates. For once, it could be the hedge fund arbitrageurs -- those hated guys who used to be at LTCM, that actually provide some of the liquidity that gets the money markets out of noughth gear.
Part of the problem is that, whenever the BBC or a major newspaper deigns to put business on the front page, just about the most complex thing that it can cope with is the level of the FTSE 100.
So, here's Pete's easy guide for the non-financiers as to the important things which are happening at the moment.
1) Data from Dealogic showed that companies in Europe failed to refinance more than 80% of asset-backed commercial paper that matured yesterday. Yes, 80%. What does this mean? It means that there are a lot of chief financial officers out there who are tearing out their hair. Why? Because their "computer models" will have allowed for the cost of refinancing going up; perhaps those with a bit more foresight than the rest will have allowed for it going up significantly. But you can be sure that none of the models allowed for the market drying up completely.
What does this mean for companies? Well, KKR Financial said that it might have to raise $500m in an emergency rights issue. In other words, if the banks won't provide financing, we will go to the investors, in the hope that investors will be less scared than the banks. And what happens if the investors say no as well? Hmm, fucked if I know. But when we are talking about "emergency rights issues", institutional investors can smell blood. They will want a deep discount.
2) All that money which is not available to refinance corporate paper has gone into T-Bills (as mentioned here on Saturday). This was what caused the Fed to cut its discount rate on Friday. The panicked flight to safety in the short term (4-week bills) reached such a level that, following its fall in yield from 4.62% to 2.94% last week, at one point it fell another 175 basis points. At that point the arbitragers (the guys who used to work for LTCM in the mid 1990s?) must have spotted what looked mysteriously like free money. The 3-month bill was paying more than 2.5% (itself down 120 basis points from Friday) and the one-month bill was paying less than 1.5%. So, in they moved. The result was that the "flight to safety" knocked on to the 3-month bill (and also onto longer-term bills), down 66 basis points on the day to just over 3%, while the one-month bill fell a net 62 basis points to 2.33%. Some traders made one fuck of a lot of money yesterday. But those rates are unbelievably low compared to the minimum base rate (see below).
3) This is now way beyond the matter of subprime. One company that could not refinance yesterday was Ottimo Funding. It has no subprime mortgage liability; its credit rating is triple A. And guess what the banks said? Yep. "We don't give a fuck. Our money's in Treasuries".
4) Half of the $1.1tn in commercial paper comes due in the next three months. If there are no refinancers, that either means there is 500 billion dollars of emergency rights issues, or further forced selling of loan assets - not just subprime mortgages -- all loan assets. This could be a good time to buy fairly safe debt relatively cheaply.
5) The failure of the Fed's move on Friday to halt the flight to safety generated a few amusing comments. As per usual, John Authers had some interesting points to make. As he observed acerbicly
"The stockmarket has got the US Federal Reserve's message. The money market has not. Unfortunately, the message was intended for the money market".
So, while Radio Five's "Wake Up To Money" was talking of "calmer waters", it was talking about the stockmarket. Perhaps they should have been looking at what mattered -- the money markets, where the waters were anything but calm.
As Authers also observed:
But the three-month Treasury-bill yield fell on Friday, showing a continued flight to quality. On Monday morning, the T-bill yield fell more than 120bp, to 2.53 per cent. Usually it stays close to the Fed Funds rate, which stayed at 5.25 per cent.
This is the sharpest move in T-bills in decades, dwarfing anything from the tech bubble, or even the Black Monday crash of October 1987.
In other words, this is uncharted territory. The free market is a wonderful thing ... when it works. As Lex of the FT observed, "the Fed does not necessarily have the weapons required to address the underlying problem".
And that's the nub of the matter. You can cut interest rates to 0%, but if risk aversion is so great that no-one is willing the lend anyone else any money, at any credit spread, then the Fed cannot invoke a law that makes the banks lend the money.
Well, that's the theory. In practice, I foresee some long meetings behind locked doors over the coming weekends, at which some bankers' arms will be seriously twisted.
So, let's assume liquidity returns (after some arm-twisting). Credit spreads (i.e., the gap in rates paid between "safe" and "risky" investments) will initially be artificially wide. The way to make money would be to bet on those spreads narrowing gradually over the coming 12 months. That would also mean a gradual shift out of T-Bills, resulting in the prices of those bills slipping back (i.e., the yields improving).
At the moment, there just HAS to be an arbitrage opportunity between the one-month, three-month and 12-month T-Bill rates. For once, it could be the hedge fund arbitrageurs -- those hated guys who used to be at LTCM, that actually provide some of the liquidity that gets the money markets out of noughth gear.
![[identity profile]](https://www.dreamwidth.org/img/silk/identity/openid.png){kind=small}
best blog
Date: 2007-08-21 02:30 pm (UTC)for anyone working in an investment bank environment and playing poker on top, it´s just the nuts! keep up the good work!
Marc
Re: best blog
Date: 2007-08-21 03:24 pm (UTC)PJ
My head hurts
Date: 2007-08-21 03:34 pm (UTC)I would say I'd like to see what your hard guide for financiers looks like, but then I realised that I probably wouldn't like to see that!
Lurker
no subject
Date: 2007-08-21 07:39 pm (UTC)fiscally naive.
no subject
Date: 2007-08-21 09:02 pm (UTC)But the bit at the beginning wasn't too bad, was it?
The arbitrage potential can perhaps best be gleaned from "When Genius Failed", which described the mispricing between two closely related Treasury bills (one new, one not so new) because of a difference in liquidity (and liquidity, of course, has a value). As the proportionate difference in age declined, so did the difference in liquidity, so the price converged. We are only talking about small fractions of a per cent here. But it was enough, if you bet in billions, to make lots of cash.
Now, let's take a one-month bond and a three month bond. At the moment, one will mature three times earlier than the other. But in a month's time, one will mature tomorrow, while the other will still be 62 days away from maturing. In other words, 30 days from now, one will mature 62 times faster than the other. Usually the price differential is fairly marginal, but if there is a big price differential (i.e., if one month bonds yield far less than 3-month bonds which yield far less than 12-month bonds) it would be child's play for a trader to put together a cocktail of trades that was guaranteed to make money as time progressed and the prices converged. If we take the previous LTCM play, where the differences were fractional and the variation in liquidity was marginal, then what money could be made when the differences are large and the variation in liquidity is huge? . I'm no specialist in this area, which was why I merely said that there had to be arbitrage opportunities. I leave it to the quant guys to work out exactly what they are. But, trust me, someone at this very moment is doing just that.
PJ
no subject
Date: 2007-08-21 09:21 pm (UTC)f.n.
Tapping your insight...
Date: 2007-08-21 11:01 pm (UTC)IS THIS AVAILABLE ON THE WEB?
Wow, I hadn't considered that this information even existed!!!
Great blog, Pete. (This week might be a good one to put in an tip jar...)
no subject
Date: 2007-08-21 11:06 pm (UTC)Just looked up KKR on Google, and you'll be fascinated to know that the second one down headlines as "At KKR Financial LLC, we are building the premiere credit investment platform — leveraging our years of industry insight, deep relationships and investment." Leveraging, insight, deep relationships (a tiny hint of Ivan Bosky there) and investment (possibly with other people's money. Or not, as the case may be). The top one is more or less verbatim as you say. Ho ho, eh?
I think that SOC has worked well for you this time. It always did with GH; don't see why it should change now. It's a bit difficult to pick the most interesting of your five points -- I still think that (3) is under-represented in the financial media, despite matt's wise words, but as far as I'm concerned, that's old news. I'll go for five, Mr Chairman, but a bit later.
First of all, this talk of computer models is ever so slightly distracting. As is your comment about "leaving it to the quant guys to work out exactly what is happening." I may well be mistaken in this, having applied for a few thousand jobs in the City based on actually being able to write a computer program, but the entire basis of quants appears to be "get a Maths First from Cambridge or Imperial to code a super-fast statistical analysis of the performance of any given paper we ask for, then set the thing to auto-pilot, and we'll make moolah." Nice if it works. Not so nice when every single other fucker in the City has a program looking at the same historical data, taking the same conclusions, and all tanking at the same time. Not much human interaction there, as far as I can see.
Not that I ever trusted those fuckers from Cambridge or Imperial, anyway.
It's just a guess, but it seems to me that London has far too much influence over world markets for its own good, and gets far too spooked when something goes wrong in America or Japan (not least because of the ownership of most of the trading houses these days). There isn't just a disconnect between the real economy and the financial economy. There's a disconnect between the latter (represented by manufacturing in places like China, and multinationals in the US, Japan and presumably Germany) and the former, which thanks to SOX is disproportionately represented in the City. Thus the over-reliance on computer models, with bizarre results.
Just a guess.
Interesting that bond guys always speak of "a flight to quality," by the way. Is it just the nice watermarks on T-Bills? Or are they talking of some kind of Platonic "quality", or "arete," which manifests itself in providing you with very much less returns on your money that you expected, but at least quaranteed until the US government goes bankrupt.
I mean, what sort of "quality" is that? And how the fuck is it helpful? I much prefer your "flight to safety." Who are these idiots? And why are they in charge of the banking system?
Anyway. To your point (5). AFAIK, the closed-door meeting on LTFM took precisely one weekend, and was more or less immediate. I'm beginning to wonder what the particiapnts got out of that little managed disaster -- probably more than the German central bank will get of of their current rescues. Unless Bernanke is certifiably insane, which he isn't, I think he's going to organise a similar rescue plan over the next three week, max. No idea what it will be, but it will definitely improve liquidity on American markets. I would suspect a cartel to buy options on sub-prime debt at a steep discount with government sanction and tax relief, or something like that. Looking back to LTCM, I don't know. I'd really love to know what Bear Stearns, to take a completely random example, got out of that.
Points (2) and (4). Well, yes indeed. Something Has To Be Done. But I don't see it being done soon enough. Which leads me to the nut of the question:
Bugger
Date: 2007-08-21 11:18 pm (UTC)Yup, I'm sure that arbitrageurs have made a fair bit off hysteria. (Indeed, a sensible arbitrageur would work exactly this way. Dick around for small, but guaranteed, gains for five years or so, and then pull a Soros.) Not many of us have a hundred million to spare that we can leverage on bond yield differentials. For normal people (ie not me) who wish to invest at this point, I would think that the sensible thing to do is to look at the losers, not the winners. Pick a company, which unfortunately has to be traded rather than private like KKR, that is hugely leveraged with tons of short-term debt. Look at the fundamentals. Basically, if they own, say Boots, and are going to be forced to sell it at a fire-sale price in, oh, I don't know, three weeks, then now is the time to buy Boots shares. (Assuming they're still on the market. But you get my drift.)
... and then I cut the rest of it in an attempt to fit in to the pathetic limits on LiveJournal, which I believe (judging by its nonsensical search engine) is a spawn of Microsoft. These people are living in the past.
Unfortunately, most mortgage brokers, stock analysts, and central bankers are living there too.
no subject
Date: 2007-08-23 09:58 pm (UTC)Signed,
A Third from Oxford, making far too little money
no subject
Date: 2007-08-22 09:05 am (UTC)I'd say that this is probably the coming-of-age for the credit markets: nothing like a good crisis to get the regulators really interested.
I'm must say I'm curious to see if there really is a knock-on effect in property. Some of the arguments I've seen are at least plausible.
I notice that this is the fourth paragraph that has started with an "I", btw.
Mike
no subject
Date: 2007-08-22 09:14 am (UTC)Maybe I'll do some more on herd mentality and "the financial markets and quantum physics - observer as participant".
Not because I know anything about it, but because it's a cool title, and I want to get Schroedinger's Cat into the equation.
PJ