As I looked at replacement candidates for my portfolio, I ran across many companies with negative tangible net worth. Knowing that intangibles often have value, I looked for the gap that should exist between free cash flow (earnings, less depreciation, amortization, and capital expenditure) and earnings, and more often than not, it was not there.
Ugh, as a buyside insurance analyst, I often encouraged management teams to not buy back stock, but build up capital against contingencies. It was a contrarian point of view, and not listened to for the most part.
I understand the troubles that come from managements that keep too much of a reserve on hand. That’s not the problem now. In the bust phase of the credit cycle, companies with more reserves do better. The disciplines that minimize net working capital are worthless now in the bust phase.
As I have said before, the boom-bust cycle cannot be repealed.
Mom Blogs – Blogs for Moms…
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Corporate Anorexia…
The boom-bust cycle cannot be repealed….
Dear David-
I ran across an article in Institutional Risk Analytics which hypothesizes that many of the CDS’ issued by AIG were accounting ‘window dressing’ for the purchaser, offset by private ‘side letters.’
The author says that this is a well-known wheeze in reinsurance, for which AIG has been repeatedly fined. AIG’s innovation, he speculates, was to transplant the technique into credit insurance.
http://us1.institutionalriskanalytics.com/pub/IRAMain.asp
I don’t really have the background to form an intelligent opinion on this hypothesis. I would be interested in your views.
I’ve been mystified by AIG’s gargantuan taste for CDS risk. I also recall the suspicious willingness of various prominent investment banks to help Enron construct fraudulent SPEs.
This is an issue, but if side letters are still going in any big way, it is news to me. AIG does have reinsurance issues though, and I am doing a little digging there.
Also, if there were side letters on the CDS, that would only benefit AIG, and we are not hearing anything about that publicly… the government would want to collect on the side agreements, subject to not pushing a lot of other things under.