Hi-IQ academic ****heads can go straight to hell.

This is the essence of "financial innovation" folks: IT IS A SCAM.

But Gen, thieving bankers are as valuable as professional athletes and movie stars. lol.

Quote:

Goldman Sachs board member and Harvard professor Bill George defended the firm's massive bonuses and compared employees' compensation to that of professional athletes and movie stars during a recent interview.

In an interview posted Dec. 23, 2009, George told the ideas web site Big Think "I think that one feels like the shareholder value is made up in people and you need the people there to do the job and if you don't pay them for their performance you'll lose them and it's much like professional athletes and movie stars I think."

http://www.huffingtonpost.com/2010/01/06....

I am amazed at the simple terms with which Karl describes this mess, yet people still fail to get it. I recently gave a presentation to the entire mathematics department of a major university on the history of efficiency gains throughout society via mathematicians (focusing on those that had REAL impacts on society, not this financial "innovation" krap), and all the students could talk about after was which firm on W-Street they were going to work for.

Stunned. Simply, stunned.

Is that guy's name for real? Intriligator?

Tomeuchre,

I'd love to read that presentation if you can post/email the notes/slides.

Think of a ballon tied with a quadrillion dollar string connected to an anchor (insurance) in the middle of the ocean, it ain't gonna float forever.

One of your best tickers yet Karl. Thanks for helping financial illiterates such as myself understand this stuff so clearly.

Could not agree more. The whole PIK/Toggle thing has been the red flag we look for here at my company. Just being aware af those existing debts have kept us far away from certain companies (mostly owned by PE) and have saved us BIG losses.

Here...this is from my bloomberg terminal..just today.

Treasurers Embrace Pay-in-Kind Bonds as Ghost of Lehman Fading
2010-01-06 05:00:35.0 GMT


By Bryan Keogh and Shannon D. Harrington
Jan. 6 (Bloomberg) -- Companies are selling debt with terms last seen before credit markets froze, showing why the world’s biggest bond fund manager says another bubble may be brewing.
JohnsonDiversey Holdings Inc., a Sturtevant, Wisconsin, maker of cleaning supplies, and Wind Acquisition Holdings Finance SpA, parent of Italy’s third-largest mobile-phone company, sold bonds that can pay interest in new debt instead of cash, the first such deals since 2007, according to Bloomberg data. Goodman Global Inc. raised $320 million to pay its owner, leveraged buyout firm Hellman & Friedman, a dividend, one of at least seven similar offerings since November.
Two years after credit markets seized up, treasurers are luring investors to junk bonds that returned a record 58 percent last year, as measured by Bank of America Merrill Lynch indexes.
U.S. sales of $162 billion beat the all-time high of $149 billion in 2006, Bloomberg data show. The rally means “choices are limited and the value is diminishing,” according to Bill Gross, who runs the world’s biggest bond fund at Newport Beach, California-based Pacific Investment Management Co.
“Six months ago I wouldn’t have imagined being able to do this deal,” said Karim-Michel Nasr, head of corporate development in Paris at Weather Investments SpA, Wind’s holding company. “It is an issuer’s market, but in the sense that investors are looking for companies that are pushing maturities out, storing up cash for a rainy day.”

Capital Access

At least two dozen borrowers since November have asked lenders to change terms of debt agreements to permit bond sales, extend loan maturities or pay dividends to their owners, Bloomberg data show. Access to capital means defaults will likely drop to 3.9 percent by November from 12.7 percent a year earlier, New York-based Moody’s Investors Service says.
Speculation that companies will have less difficulty making payments has led investors to accept lower interest rates and looser borrowing terms. The extra yield demanded on junk bonds instead of Treasuries narrowed to 6.39 percentage points at the end of 2009 from almost 19 percentage points on March 9, Merrill Lynch indexes show. Speculative grade debt is rated below Baa3 by Moody’s and BBB- by Standard & Poor’s.
“Investors are beginning to let their guard down and consider some riskier structures in the credit markets,” Scott Minerd, who helps supervise more than $100 billion as Guggenheim Partners LLC’s chief investment officer, said in an e-mail.

‘More Cautious’

Gross said Nov. 13 that he’s growing more concerned about corporate bonds because the economic recovery isn’t assured. The firm is “more cautious,” Paul McCulley, a money manager and member of the firm’s investment committee, said Jan. 4 in his 2010 outlook posted on Pimco’s Web site.
The U.S. unemployment rate was at or above 10 percent in October and November, compared with an average of 4.6 percent in
2006 and 2007.
Fund managers have little choice but to buy high-yield debt with looser restrictions as investors pour into the market, said Edward Altman, creator of the Z-Score that calculates bankruptcy probabilities.
“Very lenient terms” show “there’s definitely been a shift back to the issuer,” said Altman, a finance professor at New York University’s Stern School of Business. “I don’t see the fundamentals justifying it.”
Investors added a record $153.2 billion to U.S. bond funds in 2009, according to Cambridge, Massachusetts-based research firm EPFR Global. Of that, $21.3 billion went to funds focusing on junk-rated debt, compared with outflows of $1.9 billion in 2008.

‘We Forget’

Bondholders lost 26 percent on junk debt in 2008, according to Merrill Lynch indexes. The collapse of Lehman Brothers Holdings Inc. caused yield spreads to widen from a record low
2.41 percentage points the previous year as investors fled all but government debt.
“I’m looking at some of the things that are being priced and I’m saying, ‘Wow, how quickly we forget,’” said JohnsonDiversey Chief Financial Officer Joseph Smorada. The market is “starting to get a little dangerously aggressive,”
he said.
The company sold $250 million of so-called toggle debt due in May 2020 on Nov. 20 that allows it to pay a 10.5 percent interest rate either in cash or notes for the first five years.
The first pay-in-kind bonds since 2007 were part of a $2.6 billion recapitalization in which New York-based LBO firm Clayton Dubilier & Rice Inc. agreed to buy a 46 percent equity interest in the company.
Moody’s gave the notes its fifth-lowest ranking of Caa1, saying the debt is five times more than adjusted earnings before interest, taxes and amortization costs. It has had negative free cash flow the past three years, though it’s expected to break even in 2010, Moody’s said.

‘Dangerously Aggressive’

“In early 2009, I don’t think we could have borrowed a nickel if our life depended on it,” Smorada said. Investors submitted bids for almost four times the amount of notes offered, he said.
Investors haven’t lost discipline and companies are mainly selling bonds to refinance or cut interest expenses, said William Cunningham, the head of credit strategy and fixed-income research at State Street Corp.’s investment unit in Boston.
Companies in the S&P 500 Index held 8.2 percent of their assets, or about $2 trillion, in cash and short-term investments during the third quarter, up from $1.6 trillion, or 6.4 percent, a year earlier, Bloomberg data show.

‘A Difficult Time’

“It’s something we need to watch,” Cunningham said. “But is it the early signs of froth and excess? Not when you look at the numbers. I’m pretty confident that were an aggressive deal to come, or any sort of deal that has much looser credit standards or covenants, if it were to come by a company that had deteriorating fundamentals, investors would give that credit a difficult time.”
Wind Acquisition of Luxembourg raised $1.1 billion last month selling 7.5-year, 12.25 percent notes in dollars and euros that allow it to pay interest with more debt until 2014. Wind, controlled by Egyptian billionaire Naguib Sawiris and the parent of Wind Telecomunicazioni SpA, boosted the offering 50 percent as demand rose.
S&P cut Wind’s credit rating one level to B+ from BB- as the company used the sale to pay a dividend to its parent. The Dec. 9 downgrade reflects “a more aggressive financial policy”
as the company sustains “weaker” units, S&P analyst Leandro De Torres Zabala in Madrid said in a statement.

Undercutting Efforts

The investment flood has undercut efforts to toughen restrictions that protect investors, said Alexander Dill, senior covenant officer at Moody’s in New York. Many covenants are “largely replicating” rules from 2006 and 2007, Dill said in a Dec. 10 report.
TRW Automotive Inc., the world’s biggest supplier of vehicle-safety equipment, sold $250 million of eight-year notes in November rated Caa1 with covenants “substantially unchanged” from its 2007 indenture for debt graded four steps higher at Ba3, according to the Moody’s report. The Livonia, Michigan-based company said Dec. 22 it raised $400 million in term loans as lenders amended and extended its revolving credit facility.
The restructuring, made possible by improved earnings and investors discounting an “Armageddon” scenario, provided cash until at least 2014 and reduced secured debt, said Chief Financial Officer Joseph Cantie. Companies looking at the “wall of maturities” in 2012 are “saying it’s going to be difficult, better to take care of that stuff early on,” he said.

Quintiles Dividend

Two weeks after JohnsonDiversey’s deal, Quintiles Transnational Corp., the world’s biggest tester of medicines for drugmakers, sold $525 million of 9.5 percent toggle notes due in
2014 to yield 10.06 percent, or 7.77 percentage points more than Treasuries. The deal was increased from $400 million.
Quintiles said it will use some of the proceeds to pay a dividend to its owners, which include a group led by founder and Chief Executive Officer Dennis Gillings, Fort Worth, Texas-based TPG and Bain Capital LLC in Boston. The notes have rallied since the sale, driving the yield down to 9.42 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
David Coman, a spokesman for Durham, North Carolina-based Quintiles, declined to comment.
Goodman Global, the second-largest U.S. maker of residential and light-commercial heating, ventilation and air conditioning systems, sold five-year senior discount notes last month that yield about 12.5 percent to pay a dividend. Lenders that financed Houston-based Goodman Global’s $2.6 billion leveraged buyout approved the payment of as much as $115 million.

Reduced Debt

As of Sept. 30, Goodman had reduced debt to about 4 times earnings before interest, taxes, depreciation and amortization costs from 5.6 times in the first quarter, Moody’s said in a Dec. 10 report. Pen Pendleton, a spokesman for San Francisco- based Hellman & Friedman, declined to comment.
“The companies that have done well are being rewarded by being given a little more latitude in how they operate,” said Jason Rosiak, a fund manager overseeing $3 billion at Pacific Asset Management, an affiliate of Pacific Life Insurance Co. in Newport Beach, California. “But that just leads to inferior companies down the line having the same type of access.”

For Related News and Information:
To see a list of distressed companies: DIS <GO> To read more about U.S. corporate bonds: TNI US COR <GO> For secondary-market bond trading: TACT <GO> Latest U.S. corporate bond offerings: NIM3 <GO>

--With assistance from John Glover in London and Pierre Paulden in New York. Editors: Robert Burgess, Alan Goldstein

To contact the reporters on this story:
Bryan Keogh in London at +44-20-7330-7124 or bkeogh4@bloomberg.net; Shannon D. Harrington in New York at +1-212-617-8558 or sharrington6@bloomberg.net

Very good ticker.

But you don't understand! Both AIG and Goldman Sachs can continue to make record profits. Housing prices just need to keep rising.

You can make tons of money selling 100$ a year auto insurance as long as no one crashes their car.

Great ticker.

Speaking of jobs; and a giant sucking sound...

Great Perot Moment; the little hand grenade was spot on!

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Hmm, seems like the embed isn't working?

Here' the link; short Perot video worth watching:

http://www.liveleak.com/view?i=5f2_11836....

Great Ticker.

Both parties are beholden to the banksters and the financial regulation proposed is crap. Has holes and exceptions and is just window dressing for sleezeballs (see Dodd) who are taking contributions aka "bribes" from these bastards.

We are becoming an out and out oligarchy and we need a serious rebalancing.

While I like a pro-business environment, I feel that business and the banks have been screwing us over and their interests get pushed forward and protected while the voters get screwed.

http://escholarship.org/uc/item/0sg0782h

This links to an overly long discussion of how the U.S. and global economies came to blow a series of bubbles since the 1980s to sustain growth. This is for those of you who find this an interesting topic, but if you traders think there is an insight as to precisely when the coming market crashes will in fact happen, the last sentence is telling:

Quote:

Where, when, and how it would all end is anybody's guess. - Robert Brenner, PhD.

The unfortunate truth is the end will be extremely messy. Sadder yet, the real miscreants will not be the ones who suffer most. Justice has become an illusion. I note once again that some very serious tax cheats have gotten off with fines, while the fellow who blew the whistle is heading to the slam. One does not need a PhD to understand that this is an afront to justice.
http://www.bloomberg.com/apps/news?pid=n....
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=abHDl5yKX9qg

Karl,
Just want to point out that a lot of this "financial innovation" has nothing to do with CDS or insurance. For instance, I think the basic idea behind structured finance (e.g., a CDO) is sound. That is, you can repackage a set of high-yielding risky securities into various "tranches" and create new securities with modified levels of risk and expected return. I agree that there's an additional level of fees due to these financial structures, but I don't think there's necessarily anything scammy or ponzi about them.
- AAG

I don't vote for the biggest handout. I vote for the person who'll give me what I'm entitled to! Since I was born an American, I'm entitled to a job so ship all these Indians home because they are not Americans and therefore not entitled.

If the risk-adjusted return on the entire package is 300bps over Ts of the same duration then once its all tranched, sliced and diced the entirety of the package must return less than 300bps.

This means as an investor you are ALWAYS getting ****ed - you're taking more risk than you're being paid for. Always. It cannot be otherwise.

Quote:

If the risk-adjusted return on the entire package is 300bps over Ts of the same duration then once its all tranched, sliced and diced the entirety of the package must return less than 300bps. This means as an investor you are ALWAYS getting ****ed - you're taking more risk than you're being paid for. Always. It cannot be otherwise.

I think that's a bit unfair. One could make a similar argument about virtually any financial institution/structure and even non-financial businesses. For example, any mutual fund, even the lowest costs index funds and ETF's, charge some sort of fee. So is Vanguard screwing investors? Even non-financial products always cost more than the sum of their constituent components. Are the buyers of any product that costs more than its components getting screwed?
- AAG

This last decade that I've been invested in Vanguard, yeah, I got screwed by 10-15%. I moved it all to MMF in Dec 07. Then, I dabbled in inflation-protected GSEs, agencies and other garbage for a couple weeks and lost $500. I'm ahead net for the duration but if you take out inflation for the period, I break even, barely. 401K's are only good if you put money in before the first bust in 2000 and rode it high, pulled it before the drop, put it back in in 2001 and rode it to the 2007 Aug high; and took profits before Fall 2008. Of course, you thought Vanguard would watch your money and take care of things. Nope, that's not the deal, for that you are on your own. Even if you had megabucks invested in one of their mutuals you'd be hosed. You have to be a primary dealer to fully benefit from this casino. The answer to your last question is almost always. There is the rare case where the sum actually is greater than piece parts but it's not guaranteed.

Quote:

I think that's a bit unfair. One could make a similar argument about virtually any financial institution/structure and even non-financial businesses. For example, any mutual fund, even the lowest costs index funds and ETF's, charge some sort of fee. So is Vanguard screwing investors? Even non-financial products always cost more than the sum of their constituent components. Are the buyers of any product that costs more than its components getting screwed?

It's not unfair at all.

The maximum return for the investor occurs when he loans the money himself.

This is impractical, so we have intermediaries. Ok, let's accept that.

But - a "more risky" instrument + "protection" to produce a synthetic "risk free" instrument is always a **** job, because if you wanted a risk-free instrument you could buy one, and further, the synthetic will always return less than the real thing!

The latter is therefore always unmarketable unless someone cheats.

It's the math, and it cannot be avoided.

Quote:

Are the buyers of any product that costs more than its components getting screwed?

Leave it to an industry of thieves that depends on other people's money to screw you even if the product costs less!

Karl. Great Ticker. Very succinct analysis of the entire problem.

Aagold has a point though. A CDO shifts the risk to the lower tranche holders. It is they who are getting stiffed, by accepting more risk (that is, the risk of the superior tranches) without a commensurate increase in reward.

Synthetic CDOs on the other hand...

But, a question for Aagold: How would you convince anybody to invest in the junk tranches without offering them insurance? Hence, can you really offer a structured financial product without turning it synthetic?

Quote:

Aagold has a point though. A CDO shifts the risk to the lower tranche holders. It is they who are getting stiffed, by accepting more risk (that is, the risk of the superior tranches) without a commensurate increase in reward.

The CDO isn't the problem, per-se.

ALL lending transactions that involve risk inherently under-compensate the investor for the risk they take.

ALL.

The more complex the transaction the worse the under-compensation. That's not the fraud - everyone knows that. When you take intermediated risk you will inherently give up some return for the intermediation service, and as a consequence you WILL be under-compensated.

The fraud lies in the claim that one can turn a transaction with risk into one without risk while at the same time returning more than the actual risk-free rate.

THAT IS AN INTENTIONAL MISREPRESENTATION and is the essence of the scam.

A CDO that claims to have a "equivalent to Treasury Risk" tranche with greater than Treasury yield cannot in fact do so. The only way to achieve that is to lie about the risk in the underlying securities so that the "credit enhancement" permits the structure to return more than the Treasuries yet have an equivalent rating.

If you tell the truth nobody will buy the lower rated tranches - they are unmarketable. This is what Wachovia ran into and thus they wrote swaps against their own deals to be able to sell them, which is in fact a circle jerk - again, if written at the actual price of the risk there was no transaction possible for those subordinate tranches, as the blended return would be LESS than Treasuries.

It is not possible to structure a complex security (or set of securities) that BOTH has a risk-free return yet yields MORE than an actual risk-free security.

Doing so requires being able to get something for nothing - it violates the laws of mathematics, just as certainly as a perpetual motion machine violates the laws of thermodynamics.

Quote:

The fraud lies in the claim that one can turn a transaction with risk into one without risk while at the same time returning more than the actual risk-free rate.

Who ever said that the senior tranche of a CDO is risk-free? Clearly it's not. Neither are AAA corporate bonds. If they were, the spread over treasury's would be zero (which they're not).

I think your point is correct, however, if you change it to "spread over AAA corporates" instead of "spread over treasury's". Investors certainly should have been suspicious of the fact that the AAA-rated CDO tranche had a yield significantly higher than AAA-rated corporate bonds. It doesn't "violate the laws of mathematics", but it does violate the law of no-arbitrage in a free-market system.

However, I don't think this mispricing (i.e., AAA bond with too high a yield) was necessarily a "scam". That point of view implies that the banks *knew* that the yields were too good to be true and were intentionally misleading investors about the risk. Keep in mind how prevalent the assumption was that, nation wide, US housing prices never fall. I, for one, always thought that was ridiculous, but virtually everybody I talked to believed it during the housing bubble. Had that turned out to be (even approximately) true, those AAA-rated CDO tranches probably would have performed just fine.

Jonathanr: actually I don't think the lower tranches were typically insured (I believe that was done more often for the AAA-rated tranche). I think investors wanted the high yields that were offered and were willing to take the risk.

- AAG

I wanted to comment on something you said very early in your ticker.

Quote:

Actually, I don't think the job market will recover at all, if you define "recover" to be "return to a level of employment as a percentage of those working-age adults consistent with when we actually made things - that is, the 1960s and 1970s."

You have consistently hit on this theme and I think it is still understated by most people. The "new normal" extends not just to the stock market and bond market but also to the job market.

Not everyone is entitled to, or should have, a 6 figure income. Some people must do the "grunt" work and make stuff with their hands. Some people must work at menial jobs and live just above the poverty level. There is no "full employment" and there never will be and there certainly is no "full employment" at $100,000+ a year.

I'm not advocating abandonment of the "American Dream" I'm simply saying that the dream has become an entitlement mentality causing many people a to live a nightmare. It is this that has produced illegal immigrants and hair dressers who think they can live in a $500,000 home.

My life is a perfect example of what I mean. I am of above average intelligence and have a college degree, but the more I made the more I over-leveraged. It is partly social and partly psychological but whatever you call it I lived a lie. The rest of my life will be spent finding meaning and not in pursuit of the "pot of gold." I am probably a $30k - 40k person and I have to accept that.

A lot of other people need to as well.

"Leveraging up" is no longer an acceptable lifestyle and with that prices of homes, autos and the other things we (I) need must come down. Inflation of the asset bubble also inflates expectations. That cannot stand in the world of the "new normal."