Speculation Away From Subprime, Part 1

Subprime lending is grabbing a lot of attention, but it is only a tiny portion of what goes on in our capital markets.  Tonight I want to talk about speculation in our markets, while largely ignoring subprime.

  1. I have grown to like the blog Accrued Interest.  There aren’t many blogs dealing with fixed income issues; it fills a real void.  This article deals with bridge loans; increasingly, as investors have grown more skittish over LBO debt, investment banks have had to retain the bridge loans, rather than selling off the loans to other investors.  Google “Ohio Mattress,” and you can see the danger here.  Deals where the debt interests don’t get sold off can become toxic to the investment banks extending the bridge loans.  (And being a Milwaukee native, I can appreciate the concept of a “bridge to nowhere.”  Maybe the investment bankers should visit Milwaukee, because the “bridge to nowhere” eventually completed, and made it to South Milwaukee.  Quite an improvement over nowhere, right? Right?!  Sigh.)
  2. Also from Accrued Interest, the credit markets have some sand in the gears.  I remember fondly the pit in my stomach when my brokers called me on July 27th and October 9th, 2002, and said, “The markets are offered without bid.  We’ve never seen it this bad.  What do you want to do?”  I had cash on hand for bargains both times, but when the credit markets are dislocated, nothing much happens for a little while.  This was true after LTCM and 9/11 as well.
  3. I’ve seen a number of reviews of Dr. Bookstaber’s new book.  It looks like a good one. As in the last point, when the markets get spooked, spreads widen dramatically,and trading slows until confidence returns.  More bad things are feared to happen than actually do happen.
  4. I’m not a fan of shorting, particularly in this environment.  Too many players are short without a real edge.  High valuations are not enough, you need to have an uncommon edge.  When I short, that typically means an accounting anomaly.  That said, there is more demand for short ideas with the advent of 130/30 and 120/20 funds.  Personally, I think they are asking for more than the system can deliver.  Obvious shorts are full up, and inobvious shorts are inobvious for a reason; they aren’t easy money.
  5. From the “Too Many Vultures” file, Goldman announces a $12.5 billion mezzanine fund.  With so much money chasing failures, the prices paid to failures will rise in the short run, until the vultures get scared.
  6. Finally, and investment bank that understands the risk behind CPDOs.  I have been a bear on these for some time; perhaps the rapidly rising spread environment might cause a CPDO to unwind?
  7. Passive futures as a diversifier made a lot of sense before so many pension plans and endowments invested in it.  Recent returns have been disappointing, leading some passive investors to leave their investments in crude oil (and other commodities).  With less pressure on the roll in crude oil, the contango has lessened, which makes a passive investment in commodities, particularly crude oil, more attractive.
  8. Becoming more proactive on ratings?  I’m not holding my breath but Fitch may be heading that way on CMBS.  Don’t hold your breath, though.

Part 2 tomorrow.