It Was Twenty Years Ago Today...Compared to more recent times, doing this and several subsequent deals was like hacking through the jungle rather than driving down the motorway. Everything was new, and had to be worked out from first principles. This was a hard school, but extremely challenging & interesting. It certainly gives you a strong background for doing new things, or doing things in new ways, as I and colleagues still do.
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Fitch, the rating agency, held a seminar on the commercial paper (CP) market yesterday. CP, which is a short-term IOU, was very popular until 2007.
In the asset-backed world it was a bit of a capital dodge: if you put AAA assets on your bank balance sheet, you had to set aside 8% in capital. Park them in a CP conduit and provide a liquidity line and you used 0% capital. They called it credit arbitrage, but it was really liquidity and capital arbitrage. When the lines got called, banks such as Sachsen LB just didn't have the liquidity, and went under.
This "credit arbitrage" market has pretty much dried up, but some deals based on real assets such as trade receivables are still getting done in the CP market.
One anomaly in current markets is that if you issue in USD and swap to EUR via the spot and forward markets, you get a big saving. On 26 Jan 2009 this equated to issuing at Euribor MINUS 44bp. Efficient markets? Surely someone would arbitrage this away?
I asked in the seminar why this would be, but there was no clear and persuasive answer. One person later mentioned the imbalance in Europe between banks' USD assets and natural USD funding. In other words, European banks are short USD funding, so part of the way they are getting USD is by issuing in EUR or STG and swapping. This is the other side of the "issue USD CP and swap into EUR" trade. But much bigger.
So our CP issuers are benefiting, but there is still a real arbitrage opportunity out there, e.g. US investors could buy EUR paper and swap into USD with a big spread pickup. But arbitrage is now a dirty word. Which is another reason why the market is not efficient.
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Email received from one of the monoline insurers-they've split their business into guaranteeing municipalities (the original business), and structured finance (the business which caused the problems). A sort of good bank/bad bank approach.
What struck me was the picture of what I think is Hadrian's Wall (2nd century AD) with the slogan "We can withstand the test of time". True enough: the wall is still there, but as a historical curiosity rather than serving any useful purpose.
You wonder what gets into these ad agency types when they come up with such stuff. I recall Microsoft using the Rolling Stones' "Start Me Up" for the launch of Windows 95. The bit Microsoft omitted to play in the ad was the chorus, which would have been very appropriate for this horrible software, "You make a grown man cry..."
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The European Securitisation Forum (ESF) published its updated market report today. There are some interesting points in there:
-Total European issuance in 2008 was EUR 711bn. The highest ever: 57% higher than 2007! This brings outstandings to a huge EUR 1.74trn.
-CDOs were down EUR40bn at 48bn, ABS was up EUR 25bn at 73bn.
-But the winner is RMBS, up a massive EUR325bn at an even more massive 585bn. Just about all of which is either retained by the banks, or posted as collateral with the central banks.
-The US market, on the other hand, fell from USD 2.15trn in 2007 to 0.93 trn in 2008.
-The biggest increase in issuance was in the UK, where nearly EUR100bn more was issued in 2008 than 2007
-Auto and credit card still show remarkable rating stability
Conclusions:
-There is still plenty of structuring going on
-Outstandings continue to grow-securitisation is playing an important role in getting liquidity to banks
-There are still excellent opportunities to buy good assets at very high yields. Contrarian investors in the mould of Warren Buffett and Sir John Templeton could do very well
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There are some good soundbites in the FT at the moment. One writer says "Investment banks and hedge funds turned financial risk into financial crack with leverage." Leverage was, of course, one of the chief culprits of the 1929 crash too. Lex writes "Bankers, mourning their slashed bonuses, offer up prayers never to hear the words “residential mortgage-backed security (RMBS)” again." These comments represent two recurrent themes: "We should have seen it coming"; and "Securitisation bad".
To deal with the first one, perhaps we should have seen it coming. I have checked my files, and my first use of the phrase "too good to be true" in writing was on 27th April 2007, in the context of the dreaded CPDOs. I also got some stick when addressing a non-conforming mortgage conference in December 2006 for some slides suggesting that a bubble was a reasonable analysis. But this was like the shadows in Plato's cave-at no point did I predict what has occurred; it was just an inkling that something was not right. Most had no inkling, and the very few who called it right were Cassandras-doomed to be both right and not believed.
On the second point, it concerns me that so many people are rubbishing risk distribution. It is, nonetheless, a fundamentally sensible approach. Banks have been doing it for centuries: Bank A has a large customer and cannot prudently lend more, so sells or sub-participates some of the risk to Bank B. Everyone benefits. The moral hazard is that Bank A originates a bad loan and flogs it off whilst trousering a fat fee. That needs to be controlled, but banning risk transfer would make for a very inefficient financial system: banks would have risk concentrations, and investors would have a poor selection of low-yielding investment opportunities. That's our pensions suffering, amongst other things.
A recent research piece by Barclays stress tests RMBS to a "severe" standard, including a further 30% fall in house prices from Sep 2008, which they describe as being beyond AAA. None of the 61 AAA tranches in the UK, nor the 16 in Ireland, suffered a loss under this scenario. Yet these bonds can be bought at a yield of 3-400bp. A prudent re-opening of this market would help the housing market by getting money to housebuyers, with a knock-on effect on confidence.
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