Manufacturers HanoverSo there were many billions of unloved, illiquid bonds weighing down banks' balance sheets. Sound familiar? One solution which proved successful was the Brady bond, named after the eponymous US Treasury Secretary. These came in many forms, but often had their principal guaranteed via zero-coupon government bonds.
Sir James Crosby's government-commissioned report, published yesterday, recommends that mortgage-backed securities should be covered by government guarantees. Would not the proven Brady structure, where risk is shared, be a better bet?
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I have received a headhunter's email. They are looking for a Head of Research for Commercial Mortgage Backed Securities. Amongst the requirements are a PhD and 15 years of research experience, plus a load of stuff about publishing, publishing...
This would be understandable if the headhunter were trying to fill an academic post. But this is a commercial organisation. Why not ask applicants to submit their research in this area over the last five years, and compare it to what actually happened?
Even after all we’ve seen in the markets, people are still going down the “more of the same” path. It’s a bit like those Englishmen abroad who think they just have to shout louder if the foreigner doesn’t understand.
PhD? LTCM did much better than that-they were brought down by the work of two Nobel laureates they had on the Board.
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"How do you give God a good laugh?" "Tell Him your plans!".
That was told to me as a child, and I have never forgotten it. There have been plenty of illustrations of hubris throughout the ages, from the mythical-Icarus flying too close to the sun-to the fall of the multi-Nobel-prizewinner-toting hedge fund Long Term Capital Management in 1998.
The current bunch of hedge funds seem to be coming a cropper too. They were premised on the unlikely proposition that they would perform in all market conditions. They didn't. Anyone who thought that clever people armed with equations and computers could create value ("absolute returns", "alpha"..."whatever", as my daughter would say) over and above the fat 2 [% per year] plus 20 [% of profits] in fees was suffering from what Dr Johnson said when he heard that a friend had married for a second time: "that, Sir, is a triumph of hope over experience".
It's the same problem as we have with securitisation: managing assets and structuring pools of assets are perfectly sensible. It's going too far (CPDOs/Subprime ABS/Funds of Hedge funds) which causes the problems, and ruins things for the whole market.
By the way, this is not "20/20 hindsight"-please have a look at my letter to the FT from October, 2004
http://www.ft.com/cms/s/0/ab6c40e0-2490 ... 511c8.html
My only disappointment is that no-one ever did advise me how to short these funds. Otherwise I might be writing this from my yacht. Bought from a fund of hedge funds manager.
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I do quite a lot of work in Ireland. On a recent visit I was speaking to a contact in the public sector, who was disappointed that some members of the press and others were sloppily and indiscriminately condemning securitisation en bloc, rather then taking the trouble to disentangle the positive side. The result was an article which the Irish Independent newspaper printed on 23rd October.
http://www.independent.ie/business/iris ... 06086.html
The writer was billed as "Robert Senior", which is odd, since I distinctly remember writing it myself!
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I chaired a panel at a German conference five years ago, and introduced the session by saying "Voltaire once said that if God did not exist, it would be necessary to invent Him. Can we, ladies and gentlemen, say the same about Landesbanks?". The panellist from a Landesbank did his best to defend the indefensible, but the fact remains that, even then, it was clear that Landesbanks were an anachronism, desperately looking for a role. They only still exist, of course, because they filled their boots with funding prior to 18th July, 2005 when the state guarantee went away. Otherwise these wholesale-funded entities would all be long gone.
Fast forward five years. I met the head of a monoline insurer last week. Trying to be polite, I said that it would no doubt be necessary to change the business model. The reply was short, clear and not to be repeated in this blog, but the essence was that the old monoline model is dead. This man was moving his business model well away from the old monoline approach.
Which brings us to what Nietzsche can teach us about the current markets: "Umwertung aller Werte" ("Revaluation of all values"). There are many people in the market yearning for things to be as they were. It isn't going to happen, just as we're not going back to primary school.
Setting aside those who go on about "transparency" more as a Pavlovian reaction than a subtle analysis (I've been hearing this in one form or another for 15 years or more), we need to answer the basic business question as to how we get funding from those who have it to those who need it. Traditional securitisation is not the answer, certainly at present. There are several possible ways forward-for example, I'm currently involved in a Sharia-compliant trade financing project.
But one which to my mind has a real future is covered bonds.
Covered bonds are far more flexible than in the past; are simple and transparent; and can be based on a wide range of assets, not just mortgages and public-sector debt. In addition, the "moral hazard" problem is not there, since the issuing bank is fully liable for the debt.
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