From the NY Times...

When the Swiss bank UBS and federal prosecutors face off in a Florida courtroom on Monday, the focus will be whether UBS must disclose the identities of thousands of its American clients, but much more could be at stake as well.

Published in BoomBustBlog

In case you haven't noticed, I am pretty much anti-establishment. In keeping with that streak, I feel obligated to highlight the sham that is the global asset management industry. Many high net worth individuals and institutions pay big fees to alledged geniuses to essentially have their money sit in the stock and bond markets. Here's a surprise, you can do that for free. Hedge fund performance basically tracks the performance of the stock markets, particularly in the US. There is a small amount of alpha generated, but relatively little in comparison to what is marketed and publicized. Granted, a little alpha is better than none, but that is not necessarily what the alternative asset class mantra preaches, is it?

The results of this blog and my proprietary trading accounts run circles around hedge fund results, multiple circles. Granted, I had a bad quarter, and that bad quarter was sandwiched between two calendar quarters, which pulled on the performace of two (calendar-wise) quarters, but that was nothing but giving back some profit due to my underestimating the extent to which news flow and markets were to be manipulated by the powers that be while being net short. I knew it was coming, I just significantly underestimated the extent. Even so, BoomBustBloggers should be running circles around the crowd. I will release new performance figures at the end of this quarter to see how we stand (the most recent ones were from March). To date, my valuation, forensic and macro calls have been on point for two years running. It appears there are some who don't understand that prices can, and often, diverge from fundamental valuations - but despite that, fundamentals ALWAYS win in the end. That is how you make money. When something is mispriced, you take a position in it and wairt for reality to hit. Those that have a problem understanding that are usually the hot money crowd.

See The Great Global Macro Experiment, Revisited for more on my investment style, and click here for historical performance posts and towards the latter portion of 2008 - Updated 2008 performance. You can download a model that will give you an idea of performance for all but the latest research, which as I mentioned earlier had a bad quarter (you will have to search the site for it, I will post the link in the comments section once I find it). The most recent tabulated results are here:

BoomBustBlog Performance, year to date.

About 35% to 45% of those returns (profit) were given back in the recent bear rally, but this still leaves competition dominating performance. I am also quite confident that the upcoming quarters will be quite profitable for my bearish research, recouping if not besting the top line numbers from the March tabulation. It has become quite obvious that one must be fairly prolific trader through the bear market rallies, and that is not my cup of tea. I find trading to be laborious and time consuming, but the volatility and apparent market manipulation forces one, even one such as I, to take shorter duration positions than would normally be necessary.

As the research and ideas have gotten more complicated, I will have to institute a new, more realistic method of tabulating results for distributing through the blog. The buy and hold concept unfairly skews results downwards in an envrironment when a real investor is forced to trade more often. My dilemma is that I don't want to give the impression that I am soliciting through the proffer of results. I'll have it figured out by the time I retabulate results.

Now, about those other professionals...

We have analyzed hedge fund performance by computing hedge fund alpha in both down trending and up trending markets. We used Barclay's Hedge Fund Index asa proxy for hedge fund performance. To compute alpha (Rp-Rb) we have used S&P 500 index as the benchmark index. In addition to alpha we have also computed tracking error and information ratio to give additional insights relating to hedge fund performance during up trending and down trending markets.

Published in BoomBustBlog

Brokers will soon be expected to put their clients' interests above their own. Well, it's about time.

In the WSJ:

In Obama's Overhaul, Big Change for Brokers

Buried in President Obama's proposed regulatory overhaul is a change that could upend Wall Street: Brokers would be held to a higher "fiduciary" standard that would compel them to place their client's interests ahead of their own.

Currently, brokers are only required to offer investments that are "suitable," which means as long as they don't put clients in inappropriate investments, such as a highly risky stock for an 80-year-old grandmother. The move could change the way products are sold and marketed and even how brokers are compensated.

"This is a smart

Published in BoomBustBlog

It is Mother's Day weekend, so I will be spending sparse time on the blog, but I will have some very interesting stuff concerning the government and the banking sector over the next 48 hours or so. In preparation for the posts I urge all readers, visitors and subscribers to familiarize themselves with both the technical, laymen, and legal definitions of "Fraud". Methinks that some members of the government and many of the big banks are, to put it in colloquial terms, "Busted"!

I really would appreciate a grass roots group effort from the legal minds and academics in the audience as well as I lay out the evidence and framework of what I believe to be the biggest web of deceit in the history of the finance industry. For your reference:

Wikipedia on Fraud (this is the actual definition from Wikipedia, seriously):

In the broadest sense, a fraud is an intentional deception made for personal gain or to damage another individual. The specific legal definition varies by legal jurisdiction. Fraud is a crime, and is also a civil law violation. Defrauding people of money is presumably the most common type of fraud... In criminal law, fraud is the crime or offense of deliberately deceiving another in order to damage them - usually, to obtain property or services unjustly. [1] Fraud can be accomplished through the aid of forged objects. In the criminal law of common law jurisdictions it may be called "theft by deception," "larceny by trick," "larceny by fraud and deception," or something similar (ex. Stress tests, or PPIP).

Fraud for profit involves industry professionals. There are generally multiple loan transactions with several financial institutions involved (ex. PPIP). These frauds include numerous gross misrepresentations including: income is overstated, assets are overstated, collateral is overstated, the length of employment is overstated or fictitious employment is reported, and employment is backstopped by conspirators. The borrower's debts are not fully disclosed, nor is the borrower's credit history, which is often altered.

Now, I want all who participated in the secondary equity and bond offerings, in addition to all retail investor sheep who honestly bought financial stocks in this latest rally or those who lost money going short or bearish in it to keep this Wikipedia definition of fraud in their back pocket, for if it rings true (and I am no lawyer), my understanding that significant damages through the potential of RICO, securities fraud (a practice in which investors make purchase or sale decisions on the basis of false information, frequently resulting in losses, in violation of the securities laws) and a plethora of other remedies may be within reach if you suffer significant damages. You know, damages as in reality settling in, the truth escaping, these insolvent banks stocks dropping back down to earth along with all of your money. Again, I am no lawyer, but these are the thoughts and uneducated legal opinions that pop into a laymen's mind. My next post will start laying the groundwork that I used to come to these conclusions and opinions.

Published in BoomBustBlog

Early in 2008 I named Morgan Stanley the "The Riskiest Bank on the Street" (see historical links at the bottom of this article). Well, now its time to update my opinion. Who deserves the title "The Riskiest Bank on the Street" now? Well, let's see what the market says...

As defined by Wikipedia: Cost of Captial - Capital (money) used for funding a business should earn returns for the capital providers who risk their capital. For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital. In other words, the risk-adjusted return on capital (that is, incorporating not just the projected returns, but the probabilities of those projections) must be higher than the cost of capital.

This means that one should not simply glance at accounting earnings and declare all is clear on the western front. Whatever return your company generates has to exceed the cost of investing in said company. Well, of the bulge bracket, who has the highest cost of capital? Who has the highest bar? Who does the Street see as the Riskiest Bank on the Street?


Well it seems as if the company that had the highest cost of capital apparently had enough risk to actually implode. Is there a pattern here? If so, I must be the only one that recognizes it because the current number one spot (the graphed number one spot already collapsed) traded over $130 per share last week.

For those that don't believe in Cost of Capital in measuring risk, I bring you to another metric. As defined by Wikipedia: Leverage (or gearing due to its analogy with a gearbox) is borrowing money to supplement existing funds for investment in such a way that the potential positive or negative outcome is magnified and/or enhanced.[1] It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity. Deleveraging is the action of reducing borrowings.[1]

Financial leverage

Financial leverage (FL) takes the form of a loan or other borrowings (debt), the proceeds of which are (re)invested with the intent to earn a greater rate of return than the cost of interest. If the firm's rate of return on assets (ROA) is higher than the rate of interest on the loan, then its return on equity (ROE) will be higher than if it did not borrow because assets = equity + debt (see accounting equation). On the other hand, if the firm's ROA is lower than the interest rate, then its ROE will be lower than if it did not borrow. Leverage allows greater potential returns to the investor that otherwise would have been unavailable but the potential for loss is also greater because if the investment becomes worthless, the loan principal and all accrued interest on the loan still need to be repaid.

Margin buying is a common way of utilizing the concept of leverage in investing. An unleveraged firm can be seen as an all-equity firm, whereas a leveraged firm is made up of ownership equity and debt. A firm's debt to equity ratio is therefore an indication of its leverage. This debt to equity ratio's influence on the value of a firm is described in the Modigliani-Miller theorem. As is true of operating leverage, the degree of financial leverage measures the effect of a change in one variable on another variable. Degree of financial leverage (DFL) may be defined as the percentage change in earnings (earnings per share) that occurs as a result of a percentage change in earnings before interest and taxes.


Goldman Sachs Stress Test Retail Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb - 17 pages

Goldman Sachs Stress Test Professional Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb - 131 pages


Derivatives allow leverage without borrowing explicitly, though the "effect" of borrowing is implicit in the cost of the derivative.

  • Buying a futures contract magnifies your exposure with little money down.
  • Options do the same. The purchase of a call option on a security gives the buyer the right to purchase the underlying security at a given price in the future. If the price of the underlying security rises, the value of the call option will rise at a rate much greater than the value of the underlying security. However if the rate of the call option falls or does not rise, the call option may be worthless, involving a much greater loss than if the same money had been invested in the underlying instrument. Generally speaking, a put option allows the holder (owner), the investor, to achieve inverted-leverage and/or inverted enhancement--- sometimes called inverse enhancement and/or inverse leverage.
  • Structured products that exist as either closed-ended funds, or public companies, or income trusts are responding to the public's demand for yield by leveraging. That's a good idea. Let's refer to Goldman Sachs as a Structured Product!

Risk and overleverage

Employing leverage amplifies the potential gain from an investment or project, but also increases the potential loss. Interest and principal payments (usually certain ex-ante) may be higher than the investment returns (which are uncertain ex-ante).

This increased risk may still lead to the optimal outcome for the entity or person making the investment. In fact, precisely managing risk utilizing strategies including leverage and security purchases, is the subject of a discipline known as financial engineering.

There are economic periods when optimism incites to a widespread and excessive use of leverage, what is called overleverage. One of its forms, associated to the subprime crisis, was the practice of financing homes with no or little down payment, playing on the hope that the price of the assets (the property in this case) will rise. Another form involved the five largest U.S. investment banks, which borrowed funds to invest in mortgage-backed securities, increasing their leverage between 2003-2007 (see diagram). During September 2008, the five largest firms either went bankrupt (Lehman Brothers), were bought out by other banks (Merrill Lynch and Bear Stearns) or changed to commercial bank holding companies, subjecting themselves to leverage restrictions (Morgan Stanley and Goldman Sachs).

Well, on the topic of leverage, who do you think is the most leveraged bank? Notice that these leverage ratios below are unadjusted. That means that they will go up significantly if I took the time to extract the accounting shenanigan trash that is used to give the impression of lower leverage (this adjustment is explictly done in the 131 page Goldman Sachs Professional Stress Test).


Notice that although Goldman Sachs is the leveraged risk winner as of now, but they would have probably been beaten by Merrill Lynch. Hey, where is Merrill Lynch by the way? You know, it can get pretty painful for guys to play hide the "leveraged" sausage. If you know what I mean...

Okay, for you real stubborn guys and gals who don't think the cost of capital or leverage are legitmate determinants of risk, let's take a look at other popular risk metrics. Surely they will vindicate the riskiest bank on the Street, right? Below, please find the Goldman Sachs VaR and Risk Adjusted Return on Risk Adjusted Capital Chart.


Now, as we can plainly see, Goldman Sachs has steadily trended down in its RARORAC and steadily trended higher in VaR. In other words, risk has steadily increased as risk adjusted return has steadily decreased.

For those who feel I am simply blogging in sanscrit, let's pull up the Wikipedia definitions for VaR and RARORAC:

Value at Risk (VaR):

In financial mathematics and financial risk management, Value at Risk (VaR) is a widely used measure of the risk of loss on a specific portfolio of financial assets. For a given portfolio, probability and time horizon, VaR is defined as a threshold value such that the probability that the mark-to-market loss on the portfolio over the given time horizon exceeds this value (assuming normal markets and no trading in the portfolio) is the given probability level.[1]

For example, if a portfolio of stocks has a one-day 5% VaR of $1 million, there is a 5% probability that the portfolio will fall in value by more than $1 million over a one day period, assuming markets are normal and there is no trading. Informally, a loss of $1 million or more on this portfolio is expected on 1 day in 20. A loss which exceeds the VaR threshold is termed a “VaR break.”[2]

The 10% Value at Risk of a normally distributed portfolio

VaR has five main uses in finance: risk management, risk measurement, financial control, financial reporting and computing regulatory capital. VaR is sometimes used in non-financial applications as well.[3]

Risk adjusted return on capital (RAROC) is a risk-based profitability measurement framework for analysing risk-adjusted financial performance and providing a consistent view of profitability across businesses. The concept was developed by Bankers Trust in the late 1970s. Note, however, that more and more Risk Adjusted Return on Risk Adjusted Capital (RARORAC) is used as a measure, whereby the risk adjustment of Capital is based on the capital adequacy guidelines as outlined by the Basel Committee, currently Basel II.


Broadly speaking, in business enterprises, risk is traded off against benefit. RAROC is defined as the ratio of risk adjusted return to economic capital. The economic capital is the amount of money which is needed to secure the survival in a worst case scenario, that is it is a buffer against heavy shocks. Economic capital is a function of market risk, credit risk, and operational risk, and is often calculated by VaR. This use of capital based on risk improves the capital allocation across different functional areas of banks, insurance companies, or any business in which capital is placed at risk for an expected return above the risk-free rate.

RAROC system allocates capital for 2 basic reasons:

  1. Risk management
  2. Performance evaluation

For risk management purposes, the main goal of allocating capital to individual business units is to determine the bank's optimal capital structure—that is economic capital allocation is closely correlated with individual business risk. As a performance evaluation tool, it allows banks to assign capital to business units based on the economic value added of each unit.

Now that we're all up to speed, let's take this one step farther. Below you may find the One-Day Trading VaR of GS with a 95% confidence level.


Here we find proof that Goldman Sachs has indeed usurped Morgan Stanley for the title of "Riskiest Bank on the Street".


Hey, notice how Goldman Sachs has trended DOWNWARD regularly and steadily over the one year period. As a matter of fact, the only company that had a lower risk adjusted capital return was Lehman. So let's compare what is happening now... Oh yeah, we can't because Lehman has already collapsed. What does that portend for Goldman who appears to operate quite similarly?


I know many of you new readers are wondering, "Who the hell is this guy?". Well, this guy is someone who has been pretty good at ferreting out weak companies on the verge of collapse:

There is the call of the fall of REITs and commercial real estate in 2007 - "GGP has finally filed Bankruptcy, Proving My Analysis to be On Point Over the Course of 18 Months". I also called Bear Stearns (Is this the Breaking of the Bear? [Sunday, 27 January 2008]), Lehman Brothers CRE implosion connection (Is Lehman really a lemming in disguise? [Thursday, 21 February 2008]), Countrywide and Washington Mutual (Yeah, Countrywide is pretty bad, but it ain’t the only one at the subprime party… Comparing Countrywide with its peer), nearly all of the failed or failing regional banks of significant size (As I see it, these 32 banks and thrifts are in deep doo-doo!), MBIA (A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton) and Ambac (Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion Market Cap and Follow up to the Ambac Analysis), among others - well in advance.

More Goldman Sach's Research:


Goldman Sachs Stress Test Retail Goldman Sachs Stress Test Retail 2009-04-20 10:08:06 720.25 Kb - 17 pages

Goldman Sachs Stress Test Professional Goldman Sachs Stress Test Professional 2009-04-20 10:06:45 4.04 Mb - 131 pages

Free research and opinion

§ As Reality hits, the Masters of the Universe are starting to look like regular bank employees

Premium Stuff!

Goldman Sachs - strategic investment and public offering Goldman Sachs - strategic investment and public offering 2008-09-26 02:29:15 895.36 Kb

Goldman Sachs Report June 21, 2008 Goldman Sachs Report June 21, 2008 2008-10-20 16:48:01 361.18 Kb

Goldman Sachs' Bank Holding Company Fundamental Valuation and Forensic Analysis - Professional Goldman Sachs' Bank Holding Company Fundamental Valuation and Forensic Analysis - Professional 2008-12-18 10:12:37 267.49 Kb

Goldman Sachs' Bank Holding Company Fundamental Valuation and Forensic Analysis - Retail Goldman Sachs' Bank Holding Company Fundamental Valuation and Forensic Analysis - Retail 2008-10-20 15:45:05 348.99 Kb

GS ABS Inventory GS ABS Inventory 2008-02-25 06:48:56 1.22 Mb

Historical context for the "Riskiest Bank on the Street" moniker.

Banks, Brokers, & Bullsh1+ part 1

Wednesday, 19 December 2007 | Reggie Middleton

A thorough forensic analysis of Goldman Sachs, Bear Stearns, Citigroup, Morgan Stanley, and Lehman Brothers has uncovered... Last week, Morgan Stanley called Citibank the “short play of...

The Riskiest Bank on the Street
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)

Key highlights of my research on the "Riskiest Investment Bank on the Street": The Riskiest Bank on Wall Street – Morgan Stanley has US$74 billion of Level 3 assets, over 200% of its eq
Monday, 11 February 2008

A closer look at the exposure of the other brokers
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)

...- Who has the most of their assets tied up in illiquid Level 3 as a proportion to tangible equity? You guessed it, The Riskiest Bank on the Street. Now, they do have a decent amount of liquidity the ...
Sunday, 16 March 2008

19. On the insolvencies of non-bank financial institutions
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...Bullsh1+ part 1 Banks, Brokers, & Bullsh1+ part 2 Money Panic Bear Fight The Breaking of the Bear The Riskiest Bank on the Street Here comes the CRE Bust (Quip on Lehman Brothers)...
Tuesday, 18 March 2008

20. Quick Morgan Stanley update from my lab
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
This is a refresher to the The Riskiest Bank on the Street piece that I posted a few months ago on Morgan Stanley. Let me get straight to the salient points. High exposure to lev
Thursday, 20 March 2008

21. Early morning scan of events
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
For those that haven't noticed, I've begun sharing my early morning news and data routine with the blog. Here goes Monday moring EST. Is the Fed running out of ammo? Reserve
Monday, 31 March 2008

22. Reggie Middleton on the Street's Riskiest Bank - Update
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
This is the update to my forensic deep dive analysis of Morgan Stanley. It is still, in my opinion, the "riskiest bank on the street". A few things to make note of as you browse through my opinion a
Sunday, 06 April 2008

23. Banks, Brokers & Bullsh1t 3.0: Shenanigans at Morgan and Lehman
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
I've been promising to give an illustration of the shenanigans being played by the commercial and investment bank's for some time now, but I've been quite busy working on my entrepeneurial pursuits
Wednesday, 16 April 2008

24. I warned you about the risk of those I Banks
(Archived/Reggie Middleton's Boom Bust Blog/MyBlog)
...ive counterparty and credit risk to imperfect hedges to dead and depreciating assets held off balance sheet: The Riskiest Bank on the Street Is this the Breaking of the Bear? Banks, Broke...
Wednesday, 21 May 2008
Published in BoomBustBlog

I have corrected and replaced a broken link to the "Retail Subscriber Forum" in the user menu to the left of this page. Please feel free to use it liberally and freely discuss subscriber material. I just put in an interesting tidbit of info regarding the asset manager research released a few weeks ago as an incentive for all to go check it out and participate.

I know many who had a net short position felt some pain over the last few weeks. Keep in mind, I am of a position of it being an extreme bear rally, and extreme it was. The most extreme in the history of the US stock markets. For those who have faith in my research, keep in mind that the farther it rallies, the farther prices part from their fundamental values. This means the more profit opportunity there is as prices revert to mean.

Today was a day that I expected to happen quite a few percentage points back, and I believe it was sparked by those that can actually count and read realizing that Goldman's results were actually awful (see Reggie Middleton's Goldman Sach's Stress Test: Breaking Ranks with the Crowd Once Again! and The Goldman Sachs Q1 2009 update is now available for download [for subcsribers]) as well as the retail sales numbers. If the alleged cream of the crop couldn't break a "real" profit after all of the machinations of the government, then banks are in a much bigger bind than the sell side shills have been leading us to believe!

Remember, I am not an active trader and I can't predict the future or the markets, thus there will be times when you will have drawdowns. I was able to warn readers of this one in advance, but I had no idea it was going to be of the depth and strength that it was. Regardless, if one followed my guidance of small positions, consistent profit taking and high liquidity, you should be in a prime position to capitalize on some of the extremely and highly overvalued financial service company and bank stocks that have run up over 100% in this rally. We literally have many research subjects back up to the prices they were at in 2008 (which drove deep triple digit profits) despite the facts their problems are the same or worse than they were last year.

I would recommend patience and prudence in jumping back into or adding to your positions, but the Goldman results and the WaMu accounting games (I will post these games in detail for subscribers) are just the writing on the wall for much of the Blog research subjects.

Published in BoomBustBlog

From CNBC: The Treasury Department is directing General Motors to lay the groundwork for a bankruptcy filing:

The Treasury Department is directing General Motors to lay the groundwork for a bankruptcy filing by a June 1 deadline, despite GM's public contention that it could still reorganize outside court, people with knowledge of the plans said during the weekend.

Fritz Henderson, the new chief executive of General Motors , says the company may still be able to reorganize without bankruptcy.


The goal is to prepare for a fast “surgical” bankruptcy, the people who had been briefed on the plans said. GM, which has been granted $13.4 billion in federal aid, insists that a quick restructuring is necessary so its image and sales are not damaged permanently.

The preparations are aimed at assuring a GM bankruptcy filing is ready should the company be unable to reach agreement with bondholders to exchange roughly $28 billion in debt into equity in GM and with the United Automobile Workers union, which has balked at granting concessions without sacrifices from bondholders. No matter how you add it up, GM bondholders are going to get the shaft. The most recent asset manager featured in my intelligence note is one of the largest bondholders, both on behalf of clients and as itself. Guess whose going to have a run on assets? To make it even more interesting, this particular company's share price ran up significantly in the most recent bear rally. This can start smelling like opportunity to follow the market price of this stock down to fundamental reality!

President Obama, who was elected with strong backing from labor, remained concerned about potential risk to GM’s pension plan and wants to avoid harming workers, these people said.

None of these people agreed to be identified because they were not authorized to discuss the process. GM declined to comment and the Treasury Department did not comment.

One plan under consideration would create a new company that would buy the “good” assets of GM almost immediately after the carmaker files for bankruptcy.

Less desirable assets, including unwanted brands, factories and health care obligations, would be left in the old company, which could be liquidated over several years.

Treasury officials are examining one potential outcome in which the “good GM” enters and exits bankruptcy protection in as little as two weeks, using $5 billion to $7 billion in federal financing, a person who had been briefed on the prospect said last week.

The rest of GM may require as much as $70 billion in government financing, and possibly more to resolve the health care obligations and the liquidation of the factories, according to legal experts and federal officials. In other words highly insolvent! It is highly unlikely you can strip the best assets from this company, then subtract $70 billion dollar and come up with a positive number.

Since replacing Rick Wagoner on March 31, GM’s chief executive, Fritz Henderson, has sent increasingly clear signals that bankruptcy is probable unless agreements are reached with labor and the bondholders by the administration’s June 1 deadline.

Unlike Mr. Wagoner, who refused until his final days at GM to consider a Chapter 11 filing, Mr. Henderson has deployed staff to work with legal and government advisers, although he does not agree a bankruptcy is inevitable.

Last week, he said GM was proceeding on a dual track, hoping to restructure out of court, but also preparing for a filing.

“If we need to resort to bankruptcy, we have to do it quickly,” Mr. Henderson said in an interview with the Canadian Broadcasting Corporation.

John Paul MacDuffie, an associate professor at the Wharton School at the University of Pennsylvania, said he saw little chance of an out-of-court restructuring, given that the Obama administration had rejected GM’s proposed revitalization plan in March. It was submitted without the concessions that were required from bondholders and the union, and which have still not been reached.

“The simplest way to frame it is that they took the loans, there were conditions on the loans, they didn’t prove their case for financial viability, and they didn’t meet the deadline, either,” Professor MacDuffie said. Sometimes the hard way is the best way.

Lawyers for GM and the government have much work to do before any bankruptcy case can begin, executives with bankruptcy experience said last week.

First and foremost, GM would have to formulate a business plan that addresses virtually every aspect of the company that it hopes to transform while under bankruptcy protection.

It would have to show how it would save billions of dollars through agreements with its bondholders and unions, how many dealers it plans to keep, and the plants and offices it plans to either close or preserve.

The plan also needs to give a candid forecast of the car market, a tricky prospect given the sharp falloff in sales over the last few months, these executives said.

Treasury has hired the Boston Consulting Group to help with the business plan, according to a notice posted April 8 on, a government procurement Web site.

Participation from banks also may be needed, and because of the weak economic climate, lenders are likely to insist that GM wring as much out of its operations as possible....

Finally, legal experts said, GM would have to try to prevent panic among consumers in the event of a bankruptcy filing. The government has said it will guarantee GM’s vehicle warranties.


GM faces an unfunded liability of about $13.5 billion for its plans, which had $84.5 billion in assets and $98 billion in liabilities as of Dec. 31. That amount could sink the pension agency, requiring its own bailout before a GM case could be resolved.

General Motors unsecured debt holders would have to accept two-thirds less than the face value of their bonds which would result in and additional 33% loss. Resultantly, some of the biggest holders of GM debt including Franklin Resources Inc., Fidelity Investments and Capital Research & Management Co might have to record significant losses.

However most of the above losses would not be borne directly by asset manager shareholders' but by investors in the Assets Uner Management since majority of fixed income investment is towards AUM. As of December 31, 2008 the asset manager we analyzed had $132 bn investments in fixed income (total AUM of $439 bn) of which US fixed income was at $30 bn. In contrast the company had total investment of $2.4 bn including Equities, US treasuries and other debt securities. However the company would be impacted via its $0.80 bn investment in Sponsored investment products (investment in own AUM) which would take a substantial hit following decline in bond prices. In addition the company would also get impacted on account of lower AUM fee through greater outflow of funds resulting in lower AUM fee and lower profit sharing fee.

Subscribers can download the relevant research below. I will be issuing updated research using my stress testing methodology for this asset manager as well. Spreads will most likely widen, I have the model and stress test complete and we are just tightening up the assumptions before I release it to subscribers. There is much, much more content on the way. I advise those who are risk adverse to stay out of the markets for the time being, but those who have a longer term horizon and an appetite for risk and hunger for fundamentals may see a big profit horizon coming.

pdf Asset Manager Intelligence Note 2009-03-09 11:01:30 351.07 Kb

Published in BoomBustBlog

The high leverage, low cost loans provided to buy the dead assets from the resultant bubble stemming from offering high leverage, low cost loans (just a year or two ago) will create another bubble that is destined to pop. The optimal solution is to let this current bubble pop. It appears that the powers that be really don't want the bubble to pop and fully deflate. The problem is that bubbles cannot be inflated in perpetuity. I think that's why they call them bubbles!

Pray tell, what happens to the toxic assets prices after the private sector overbids for them using excessive, low cost government leverage (or collusion, which is possible when the bank can turn around and sell a swap to the buyer to cover losses on the miniscule equity at risk) when those purchasers then attempt to resell them to normal buyers who don't have access to 6:1, sub 2% leverage on a non-recourse basis (or the cooperation of the bank to cover their equity losses)? No banks or brokerages that I can think of are offering terms anywhere near this level. Will our government continue to play Global Prime Broker ad infinitum by supplying margin to everyone who asks for it, forever? Highly doubtful!

Well, just like with the subprime crisis, once reality hits the fan, and that cheap and easy credit is no longer available, asset prices will fall - and they will fall hard - just like they did last time. Just like they will do every time. It is the the nature of a bubble. They get popped! The market can rally all it wants on the news of this latest bailout, natural market price discovery has yet to take place, and when it does, downward pricing pressure will rear its ugly head again. Only this time, the assets will fall in price after the government would have spent $100 billion to $1 trillion to buy them, and eat up tax payer monies directly. Natural market price discovery is the endgame, and the only way the bear market turns to a real, full-fledged bull market. I can't give you timing on this, but I can give you the parameters.

Now, many may be saying that the assets are now off of the bank's books so they can resume doing business. Well, that statement first assumes that all banks will sell all of their assets at that optimal price. It also assumes that there is a lot of business to be doing. We still have too many banks crowding into the same markets for one, and most importantly in terms of lending, the only retail and corporate borrowers who are crowing for debt right now are the ones that shouldn't be lent to in the first place. Back to the bubbly days of giving people and companies credit that really shouldn't have it? How fleeting is YOUR memory? Think about it. If you are a very good risk and have the capital and resources to repay loans easily, have you thought about buying a new home lately? You have a lot of people who are in trouble trying to refinance, but then again they are in trouble aren't they? I don't see prudent banks rushing out to lend to them at attractive rates. The same goes for the corporate sector. There are a lot of GGPs out there who need loans, but who really wants to lend to them? They want to lend to Berkshire, who doesn't seem to be in the market for loans right now.

We also have the issue of what happens to the losses. No amount of chicanery, engineering or magic will eliminate losses. Losses are losses and they need to be taken. It appears as if an overbid for assets with losses embedded will simply transfer those losses to the winning bidder. If the winning bidder has a super sweet deal, with nearly no risk, financed by the tax payer, then the losses are transferred from the winning bidder to the tax payer. If there is no winning bidder, then the losses remain with the bank. If the bank and the bidder collude in hiding the losses through inflated prices that are made to look profitable, ex. Mega fund buys the assets from the bank at the Truth + X percent, then turns around and buys a swap from the bank paying off X percent +1 to cover their exposure (which in reality is a guaranteed loss), then things look hunky dory until the underlying assets and or the cash flows start breaking down. Then the losses become apparent somewhere, most likely to the detriment of the taxpayer.

You see, no matter which way you slice it, if there are substantial losses in the system it will surface somewhere and somehow - and there are substantial losses in the system. The market is rallying as if the losses have evaporated. This is a profit opportunity, but you will have to be able to swallow a lot of volatility (or be a lightning quick trader) and have a minimum 3 month to 1 year horizon. Even if the bank and the fund make it look all hunky dory, when the losses do surface and the tax payer ends up biting it, and it will be manifested in lower consumer expenditure due to lower discretionary income which will be felt directly and immediately by the banks and the banks biggest customers. Hence, the losses will come round robin.

My suggestion??? Let's stop playing these games and force those who created the losses to take them now and we can all get back to the business of being the world's pre-eminent global economic superpower. Otherwise, that title may very well be up for grabs.

I will have objective analysis of the most recent bailout plan and its potential upside and fall out very soon and will post it accordingly.

Published in BoomBustBlog

My comments on today's Bank Compensation article in the Journal:

Wall Street Pursues Pay Loopholes

Compensation Caps Drive Some Firms to Weigh Options; Higher Salaries?

Some Wall Street firms are looking for ways to sidestep tough new federal caps on compensation.

In response to expected bonus restrictions, officials at Citigroup Inc., Morgan Stanley and other financial institutions that got government aid are discussing increasing base salaries for some executives and other top-producing employees, people familiar with the situation said.

The crackdown, part of the economic-stimulus package passed by Congress and signed into law by President Obama last month, limits bonus pay for the top five executives of any recipient of taxpayer capital through the Troubled Asset Relief Program, plus the 20 next-highest-compensated employees.

...The talks also are proceeding cautiously because of the political volatility of pay, bonuses and perks on Wall Street, including outrage over American International Group Inc.'s promise to pay $450 million in bonuses to employees in the insurer's financial-products unit. What has gotten into the management of US insurers lately. This was one of the most bone-headed moves I have seen come from management since the CEO of MBIA fired Fitch because it didn't like the rating he thought Fitch was going to give it, which of course caused everybody to distrust (even more) the ratings of all the other companies that MBIA engaged. Boneheaded! Did the management of AIG not see this coming? Was there nothing they could do to smooth things over with employees until the storm blew by. Did they forget that they are roughly 80% or so owned by the government? Not many bureaucrat CPAs can pull down $3 to $6 million bonuses!

Most traders and bankers on Wall Street get a base salary of anywhere from $200,000 for managing directors to $1.5 million for a chief executive. But the lion's share of their pay comes in the form of a bonus, a tradition that began when most firms were private partnerships and partners shared directly in the annual income of the firm. And herein lies both the problem and the solution. The banks are no longer partnerships, but the employees are still getting the economic perks of partnership status (majority sharing in the [not so excess] booty) while the economic risks of the partnership status are being forced upon the shareholder (liability, longer tailed risk of trading and investment operations, etc.). For example, in trading and warehousing the leveraged MBS, CDS and CDO products, a partnership will be wielding its own capital (which is probably why these products weren't traded and warehoused back when these companies were private), hence the risk profile that was willing accepted was most likely much, much more conservative given the expected return for said unit of risk taken. Now that they companies are flush with outside shareholder capital, the AMM mentality creeps in. For those that don't know, AMM (Ain't My Money) is the Street version of OPM (Other People's Money). Now, the firm (which is actually now a company) is willing to take risks it would never have dreamed of as a private partnership funded solely by the partners. You know like 30 to one leverage (twice that if you factor in off balance sheet vehicles) on products that not only have not be tested in a downturn but also have opaque pricing and liquidation terms. The Firm (now turned Company) also is able to pay out of revenue, instead of risk adjusted profit, since,,, well,,, it Ain't Their Monies!. As an efficient, succesful private firm, the bonuses should have and did in some cases, and currently should even as a public Firm (versus a Public Company), have a string attached to it at one end that led to the revenue generated. Once the revenue became risk adjusted final profit that string was cut and belonged to the earner. Until then, that money was a ward of the firm. In this fashion, revenue that came from CDO trading should be viewed with a X year tail (where x= the average duration of the CDO), at the end of the duration the full bonus will be paid out, or would have been finished being paid out in risk adjusted pro-rata increments. That way, whenever anything blows up, the revenue generating employe takes the first hit, then corporate retained capital, then shareholders and bond holders directly - in that order. Notice how I didn't include taxpayers nor government in that hierarchy. The reason is that I believe the revenue generator will have a different set of goals in mind when generating said revenue that will protect corporate retained earnings, investor capital, and tax payer subsidies. You see, now everybody is on the same side. The revenue generator now becomes the risk adjusted profit generator. Sales people stop churning for maximum commissions and start churning for maximum satisfied client ratings. Traders stop trying to max out quarterly revenue and start looking for 5 year maximum risk adjusted returns. Shareholders gladly payout hefty bonuses, for that means they made more clean money. Basically, the I banks are now run like I run my financial operations. They are run like they are privately owned again. There is really no need to move on, I have just solved the entire compensation dilemma. Hey, Obama! I'm not even going to charge y'all for my services. Consider it my contribution to the cause, bro! That's my 60 cents worth. It was my 2 cents, but I levered up 30x!


"The trend is to increase the base pay in light of the reduced bonuses," said Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable. "Without the revenue" that top performers provide, he adds, "these companies can't survive." Yeah, but the problem is and has been ever since the banks went public from private partnerships is that management has been focuse on raw revenue instead of what really counts for the OWNERS of the firm - risk adjusted profits. You can get away with not adjusting profits for risk for a few years, but over 10 or 20, you will receive some bite marks in your ass. Believe it!

Under the forthcoming rules, bonuses could come to no more than one-third of the total annual compensation paid to employees covered by the restrictions. Some compensation experts view the bonus limits as a mistake that turns the notion of pay for performance on its head, despite Wall Street's culpability for the recession and credit crisis.

"These are not bureaucratic positions where you're paying individuals high salaries," said Michael Karp, chief executive of Options Group. "How can you pay a banker a really high salary without knowing what kind of revenue that person generates?" Taken a step further, "How can you pay a banker a high revenue bonus without knowing what kind of risk adusted profit, that banker makes?" You can take the risk adjusted part out, for time will review hidden risks. You just have to amortize and defer profit based bonuses based upon the duration of the risk tail that accompanies the revenue generated. It is ludicrous to pay a trader 100% of the revenue based bonus of a CDO that is full of untested, unpriceable, murky clearing assets with a 5 year duration - UPFRONT!

Still, critics are ready to pounce on any potential maneuver around the federal limits. Raising base salaries would play into "a long and dishonorable tradition of responding to any attempt to curb pay excess by just putting it in a different pocket and calling it something else," said Nell Minow, editor of the Corporate Library, a research firm focusing on corporate-governance issues. Any attempt to get around bonus curbs "can expect pushback from shareholders," she predicted. If only shareholders knew how to pushback effectively. These are the same shareholders who for decades allowed there hard earned capital to flow into excessive revenue based bonuses in lieu of common and preferred dividends. I find the prowess of these shareholders somewhat suspect!

At Morgan Stanley, discussions about raising base pay levels are preliminary, and the New York company hasn't fleshed out a formal strategy, according to people familiar with the matter. Oh, I'd love to hear what they are coming out with. Cuomo probably has the subpeonas signed already!

Citigroup officials have considered designating which 25 executives will be subject to bonus limits, people familiar with the discussions said. In that scenario, the new rules might not apply to lower-ranking yet still highly lucrative traders and investment bankers, these people said. "We will comply with the restrictions, in addition to the substantial changes we have already made to our compensation structure," said a Citigroup spokeswoman. Yeah, but we will ignore fixing the haphazard compensation problem which got us into this mess in the first place. More revenue! How do you spell profit???!!! What's risk????

Citigroup has received $45 billion in taxpayer-funded capital do far, while Morgan Stanley has received $10 billion. The latest U.S. rescue of Citigroup will leave the federal government holding as much as 36% of the company's common stock. Now, only if some of our elected officials take heed to the BoomBustBlog, we can have some really effective shareholder activism to bring back the type of prudence that private owners enforced over their operations. If, and only if...

Inside banks and Wall Street firms, some executives are hopeful that the Treasury Department will water down the curbs on bonuses, inserted into the stimulus bill by Sen. Christopher Dodd (D., Conn.), during the department's rule-making process.

One possibility that banks would applaud is that the pay restrictions apply to top executives and other managers, instead of less-senior but crucial rainmakers... Be less concerned about those who make rain and cater to those who cultivate fertiile soil! It is this shortsightedness that engendered the Asset Securitization Crisis (see Global Debt - A Closer Look).

The Dodd provision sent shockwaves across Wall Street. Some bankers and compensation experts contend that top revenue-producers could bolt to non-U.S. banks or hedge funds that aren't subject to TARP-related restrictions. "It's possible we will lose some people," J.P. Morgan Chase & Co. Chairman and Chief Executive James Dimon said in a recent speech. "I'll be very sorry if that happens." It remains to be seen if this is for the better or not. After all, there are many industries and companies in the US that are best of breed and top in their game, and have achieved such without paying out 50% of their net revenues in compensation costs. Don't drink you own Kool-Aid. Bankers, money managers and traders are not smarter than everybody else. If that was the case, then I could anoint myself the smartest person on Wall Street for 2 consecutive years running (see Updated 2008 performance), but I know better - and so should you!

Raising base pay at J.P. Morgan isn't being discussed, people familiar with the matter said.

Wells Fargo & Co., the San Francisco bank that got $25 billion in government capital, disclosed last week that it increased the base salaries of CEO John Stumpf and two other executives.

A bank spokeswoman declined to comment on the raises. A person familiar with the matter said the increases were decided at about the same time that the new curbs were signed into law. Yeah, business as usual. How about a performance draw and salary clawback provision based upon a rolling 5 year risk adjusted profit pool for the CEO. That would set things aright!

Published in BoomBustBlog
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