International Investing

I asked one investment banker what might cause half of North America’s top corporations to default. No ordinary economic recession or natural disaster short of an asteroid strike could do it: no hurricane, for example, and not even ‘the big one’, a catastrophic earthquake devastating California. All he could think of was ‘a revolutionary Marxist government in Washington’. That’s not a likely scenario, yet the cost of insuring against it had shot up ten-fold. Normally one can buy $10 million of end-of-the-world insurance for between two and three thousand dollars a year. By early last November, the prices quoted were between twenty and thirty thousand, and even then it was difficult to buy in quantity – at least, said the banker, ‘not from anyone you trusted’.

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All this activity explains the attractiveness of the end-of-the-world trade. The trade is the buying and selling of protection on the safest, super-senior tranches of the investment-grade indices. No one buys protection on these tranches because they are looking for a big pay-out if capitalism crumbles: if nothing else, they have no reason to expect that the institution that sold them protection would survive the carnage and be able to make the pay-out. Instead, they are looking to hedge their exposure to movements in the credit market, especially in correlation. Traders need to demonstrate they’ve done this before they’re allowed to book the profits on their deals, so from their viewpoint it’s worth buying protection, for example from ‘monolines’ (bond insurers), even if the latter would almost certainly be insolvent well before any pay-out on the protection was due.

Let’s say you file a claim with the insurance company after a disaster. Instead of getting a check, the insurance company tells you that it would prefer NOT to pay the claim since that would put the insurance company in a precarious financial position. What would your reaction be? Some banks are confronting a similar question with their CDS insurance.

Bond insurers such as Ambac, MBIA and FGIC are talking to banks about wiping out $125bn of insurance on risky debt securities in what could be the only way to limit the damage surrounding the bond insurers.

Discussions about “commuting” these insurance contracts, which were sold by bond insurers to banks in the form of credit default swaps, have taken on a renewed sense of urgency amid a rash of ratings downgrades in the bond insurance, or monoline, sector last week.

If agreements are struck about the value of the CDS contacts - and the discussions could take months - it could be significant for the entire financial system, which is clogged up by the uncertainty around the value of derivatives and complex bonds linked to mortgage-backed securities.

Remove the part about “Who Don’t Own Stock” and you’ve got a legit story. Another silly rule designed to prevent conflicts makes analyst guesses less trustworthy.

You’ve almost certainly seen it: Every time an analyst on CNBC comes on to talk about a stock there is The Screen. We find out whether they own the stock, their family owns the stock, their firm owns the stock, their pet owns the stock, etc.

More often than not, the answer is “none of the above”: They don’t own the stock they’re talking about, and neither does anyone they know.

I say these people with no conflicts shouldn’t be trusted. How am I to take seriously someone in the financial services business who tell people to own a stock, but doesn’t own it themselves? They have no skin in the game, and in a business entirely built around wealth creation, self-interest and greed, that makes me suspicious.

Great John Carney post at Dealbreaker.com. The cure is worse than the problem:

“Of course what’s really happening here is that the hedge fund managers are taking the fall for the collapse of Bear, and the even broader reverberations from that, including the controversial merger, the bailout and the credit markets’ woe,” law professor Larry Ribstein writes. “As with Enron, the public is screaming for action. When in doubt, throw somebody in jail. The public will eventually calm down, by which time the now impoverished defendants will be in jail or being exonerated on appeal.”

How can doctors get fat off the tax payer if the tax payer has a choice? MD lobbyists are preemptively shoring up their bottom line under the guise of safety. Add this to the existing list of readymade excuses to steal from the tax payer whose greatest hits already include, “it’s for the children,” and “the war on drugs/terrorism/poverty/whatever people are riled up about this week.”

Especially telling is how they try to make “medical tourism” to be a dirty word. No doubt they already have a press release and legislation written to whip out at the slightest pretext when there is some accident during an overseas procedure.

Is there any group left with the integrity to just do their job and not get rich off the state?

People conducting stem cell research with animals and humans also have a responsibility to report on treatments that fail, Hyun said. He joked that a journal ought to be established called Cell: Failures.

The guidelines will condemn the use of stem cells to treat patients “as unproven medical innovation” when it occurs outside an approved clinical trial, and especially when patients are charged. Scientists and doctors shouldn’t participate in such trials “as a matter of ethics,” Hyun said.

The committee said it hopes its recommendations will guide regulators in various countries develop rules for how and when to approve clinical trials and treatments.

The headline quote from Gordon Gekko from the 1987 movie Wall Street show this has been common knowledge for decades: Fund managers cannot beat the index after fees.

According to this Bloomberg article, consumers are finally starting to catch on:

When Fidelity Investments opened the Magellan Fund in January to new shareholders for the first time in a decade, the company hoped to stem withdrawals. Instead, investors have pulled $1.8 billion from the $41 billion fund.

The reaction was the same at the Dodge & Cox Balanced Fund, which was shut for four years until February. The $29 billion fund suffered $824 million of net redemptions through May, according to estimates compiled by Chicago-based Morningstar Inc.

Outflows from these once best-selling U.S. mutual funds underscore the increasing reluctance of individual investors to pay managers to pick stocks, especially for subpar returns. Established names such as Magellan or Bill Miller’s Legg Mason Value Trust are no longer enough to attract billions of dollars of investors’ cash.

“I don’t care which fund is reopening, I’m not tempted to put my clients’ money in there,” said Bob Frey, founder of Bozeman, Montana-based Professional Financial Management Inc., who oversees about $70 million.

Previously a $5 move would be front page news. Now it’s just to be expected:

Crude oil for July delivery rose $5.07, or 3.9 percent, to settle at $136.38 a barrel at 2:48 p.m. on the New York Mercantile Exchange. Oil reached a record $139.12 a barrel on June 6. Futures have doubled in 12 months as investors looking to hedge against the dollar’s drop helped push oil, gold and corn to records this year.

From Whiskey & Gunpowder:

China added more to global economic growth in 2007 than the U.S. That’s the first time a country other than the U.S. has contributed more to global GDP since at least the 1930s. This little history-making milestone typifies a growing list of Chinese economic achievements… and American shortcomings. “On issue after issue,” Zakaria writes, “China has become the second most important country on the planet.”

The Economist puts up the sentence (headline) and the chart of the day in this article on housing prices.

Unfortunately, new figures this week reveal that house prices have already fallen by more over the past 12 months than in any year during the Great Depression. The S&P/Case-Shiller national index fell by 14.1% in the year to the first quarter. Admittedly, other property indices show smaller drops, but most economists now favour this measure. The index goes back only 20 years, but Robert Shiller, an economist at Yale University and co-inventor of the index, has compiled a version that stretches back more than a century. This shows that the latest fall in nominal prices is already much bigger than the 10.5% drop in 1932, at the worst point of the Depression.

Outside of Fortune, very few publications write good business stories. The Wall Street Journal has interesting articles and does good reporting, but rarely writes about the internal drama of Wall Street in such a readable way. It’s like something Bethany McLean or Kurt Eichenwald would have written. Part 3 will be out tomorrow. Read part 1 and part 2. Here is an excerpt:

Mr. Upton recited the damage from numbers scratched on a yellow legal pad: Since the previous Friday, the firm had nearly exhausted its $18.3 billion in cash reserves, leaving it with $5.9 billion. But it still owed Citigroup Inc. $2.4 billion. Mr. Molinaro buried his head in his hands. Mr. Schwartz looked ashen and left abruptly.

Just a few blocks away on East 48th Street, Mr. Dimon, the J.P. Morgan CEO, was celebrating his birthday with his family at the Greek restaurant Avra. The banker, who could be painfully blunt, was annoyed when his cellphone rang. It was reserved only for immediate family and business emergencies. Reluctantly, he picked up.

It was Mr. Parr, the Lazard banker representing Bear Stearns. He asked if Mr. Dimon could speak with Mr. Schwartz. Moments later, Mr. Schwartz called. “Let’s do something,” he told Mr. Dimon, who was now on the sidewalk outside. Mr. Dimon couldn’t fathom making a deal that night, but he agreed to try to help.

Bear Stearns’s offices were then filling up with lawyers. The firm’s usual corporate counsel, Cadwalader, Wickersham & Taft LLP, sent over a large team, and dozens of bankruptcy specialists were also called in. The attorneys fanned out over a suite of rooms on the sixth floor: One large group prepared a bankruptcy filing; the other worked on various rescue scenarios involving cash infusions from other parties.

Mr. Schwartz arranged an emergency board meeting to brief directors that Thursday night. It was late, so most phoned in. James Cayne, who’d remained as chairman after stepping down as CEO Jan. 8, missed part of the discussion because he was playing in a bridge tournament at a Detroit hotel.

Directors authorized an emergency bankruptcy filing, but Mr. Schwartz still held out hope that a rescue could be arranged. A bankruptcy filing for Bear Stearns — with its nearly 400 different subsidiaries — would be immensely complicated. If the firm could make it through Friday, executives believed, they could come up with a more tenable fix to their problems.

Around midnight, Matt Zames, a senior J.P. Morgan trader, arrived with a team to look over Bear Stearns’s books. The group appeared stunned by its financial position. “We need to talk to the Fed,” said Mr. Zames. “Where are they?” Bear Stearns officials directed them down the hall to the firm’s legal library, where officials from the New York Fed had been gathered for several hours.