Check out this article from the New York Times on the Greenspan legacy.  In my time at RealMoney, I took some heat for being a critic of Greenspan.  I won’t list all of it, but I will echo this one post:

		Aaron Task
		Speaking of Permabears…
		7/26/2006 1:27 PM EDT

Thanks for the response, Rev.

Meanwhile, Merrill’s Rich Bernstein has an interesting note out arguing that the Fed’s 450 basis points of tightening “has not yet severely impacted the U.S. economy” because the expanded use of credit derivatives has created an alternative source of liquidity.

“Whereas the majority of Wall Street is focused on the traditional growth/inflation trade-off, we hope Mr. Bernanke is also considering this new and expanding form of credit creation,” Bernstein writes. “Our belief is that he is indeed quite concerned, and that despite current dovish jawboning, he will ultimately tighten more than investors currently expect.”

Position: Awaiting the Beige Book.

		David Merkel
		By Default, No Credit Where It Is Not Due
		7/26/2006 2:23 PM EDT

Aaron, I read the Rich Bernstein piece. I usually agree with what he writes, but not this time. The amount of yield compression created by credit default swaps is 50 basis points at best, which doesn’t even come close to the 450 basis points that the FOMC tightened. Now, if someone makes the argument that the rates on corporate bonds 10 years and longer haven’t increased significantly over the past 27 months, I would agree with that, but that has little to do with credit default swaps, which are a short maturity phenomenon for the most part.

I thought of writing a note on the article cited in Bernstein’s piece, but ran out of time yesterday. It is a horrendously optimistic article, and too short-sighted. Credit derivatives, as I have noted before, have induced two anomalies into the credit markets. First, they make spreads artificially tight on the short end. Second, they create demand for bonds after they default.

Both of these are “tail wagging the dog” phenomena. When the market for making side bets gets bigger than the main business of financing corporate credit, something weird is going on. The real test will come when we get the next spike in investment grade defaults. When we had the last spike, the credit default swap market had notional amounts smaller than the corporate bond market. Now the credit default swap market is more than four times the size of the corporate bond market in nominal terms. When it happens, all of the negative effect of too much insurance chasing too few bonds to be insured will be revealed.

One more aside, the idea that the low default rates since 2003 is unusual is wrong. We had a longer period in the mid-90s. The effect of credit default swaps and collateralized debt obligations on default in the short run is modest at best (even the article says CDOs lower borrowing costs by 3-5 basis points).

In the long run, it may make the default problem worse. Whenever you lend a debtor money, he immediately looks more creditworthy because of the liquidity. When the liquidity goes away, as it always does for some minority of corporate borrowers, the debt problem is worse not better.

Position: none, but my bet is that Buffett is right on credit derivatives, and Greenspan wrong (why does that seem like an easy bet?)

I’ve always been a skeptic on the macro-level of derivatives, because they don’t change anything for the system as a whole, unless the losing party is undercapitalized.  The seeming calm that derivatives helped to induce merely shifted volatility to parties that could not bear losses under significant stress.  Talking about a “Great Moderation” during a bull market is hooey.  It’s a Great Moderation if lending terms are stable in a bear market.

Greenspan is a bright guy, but like many bright guys who become beholden to the DC establishment, they circumscribe their reasoning to the politics that they live in.  Few of us have the stomach to speak truth to power; I wonder what I would do under the same cirumstances, though my constitution says I would be a short-lived creature in DC, which does not want to hear the truth.

My guess is that Greenspan will fare badly in history books one century from now.  The inflation that he induced, and the false confidence he engendered will be villified.

There has been only one other time in my life where I felt so skittish about my methods: June-September 2002.  I got whacked hard by the market then, harder than at present, but I bounced back October 2002 – January 2004, making it up and then some.

I don’t count on that now, but I will give you may industry ranks as of this week:

Running my usual screens, I get a bunch of new tickers to consider:

ABD     ABG     ACE    ACGL    ADCT    AEG    AEL    AFG    AFSI    AGII    AHL AIG     AIZ    ALL    ALU    AMPH    AMSF    AN    ANEN    ARRS    ASI    AWH    AXA    AXS    AZ    CB    CBG    CHEUY    CIEN    CINF    CMVT    CNA     CNO CPHL    CPII    CRMT    CRNT    CTV    DFG    DSITY    EBF    EIHI    EJ    ENH    ENTG    FFG    FMR    FNSR    FSR    GBE    GCOM    GILT    GLRE    GLW    GNW    GPI    GSIG    HALL    HCC    HIG    HMC    HMN    HYSNY IHC INDM ING IPCR IRS JDSU JLL KGFHY L LGGNY LNC LTXC MET MHLD MIG MIGP MRH MRVC MXGL NDVLY NSANY NVTL OB OPLK OPXT PAG PEUGY PFG PL PMACA PNX PRE PRU PTP PUK PWAV RE RFMD RGA/A RNR RTEC RUSHA RUSHB SAFT SAH SAIA SEAB SUR SWCEY SYMM TER THG TLAB TM TMK TRH TRV TTM UAM UFCS UNM UTR VOD VR VTIV WRB XL YRCW ZFSVY

Some of these are on the last list, and some of them I own.  Personally, my “green zone” methods are making me queasy at present because in a credit crisis, trends tend to persist a lot longer, so I will be more likely to look at names that are stalwarts in this crisis.  My investment methods are not purely quantitative.  I use quantitative methods to assist my qualitative reasoning.

As such, I have a few more tickers to toss into the hopper, many of which are safe names, or, names in the red zone that seem cheap:

AA    ABX    ALL    ALOG    BGP    BHI    BKS    BRNC    CAG    CNI    CP    DD    DLX    DOW    DPS    EOG    FCX    HAR    HCC    HOLX    HPQ    IBM    ITW    ITW    MCF    MET    MMM    MSFT    NBR    NYX    ORCL    PBR    PFG    POT    PRU    RDC    REXI    RTI    SII    TAP    TEL    TIE    TM    VEIC    WMT    XTO

Together with my last post, these are the tickers that I will compare against my existing portfolio to choose new names for my portfolio.  As for where I got the batch of tickers for my last post on this topic, my method is to take every idea that I hear over a quarter that I think is interesting, and I note it down, or print it out.  It is eclectic in that sense, but when I analyze the ideas at the end of the quarter, I try to forget where I got the ideas, so that I can analyze them fresh.  I am the main analyst here, and I try to avoid believing the arguments of others when I do my final analysis.