Following Buffett is Risky Business

Posted by Ray on August 25, 2011 under Main | Be the First to Comment

Today we saw a typical Buffet move as he surprised everyone by taking a $5B investment into BAC. Everyone is talking about it and praising how good this is for the company, I guess it kind of is, but there are others, like me, who are more worried now than before Buffet made the investment. I do not own BAC and I am not short BAC or any financial firm right now so I have no self serving purpose for this.

What concerned me is the fact that the figure was $5B just like the Goldman deal. This seems to be a figure Buffet is comfortable risking in times of duress. Buffet has billions on hand, but only $5B that could yield him 6% something isn’t right. Now, I considered the pre-Buffet chatter about BAC to be the typical rumor mill stuff, illiuid, cut off from the markets, huge liabilities that haven’t been realized and the like, but nothing real or substantially true. However, I admit the massive selling of pieces of their business did strike me as if they were concerned about things, but it did not strike me as they were going out of business it was merely troubling. However, now with Buffet adding in his now typical $5B ‘petty risk cash’ into the firm does make me concerned about BAC.

Clearly the firm needed the cash as it was presented to and accepted in, what, 12 hours. You do not take $5B paying out 6% when we are in a zero interest rate environment and can issue paper cheaper without raising any suspicions. Frankly, taking a middle of the night cash infusion from Buffet is strikingly similar to 2008 for my taste. BAC got hosed on this deal, as many others have already said, and they are paying way too much for this cash. A case can be made that BAC paid the premium for the Buffet ‘seal of approval’ but that seal did not work for Goldman in 2008.

If one followed Buffet in 2008 on the Goldman deal they lost out pretty bad. After the cash infusion was made Goldman dropped to $48/share, about $70/share below Buffets investment, and the average investor would have probably sold at a loss given the events of 2008. If they were smart they would have doubled up, but come on, it was 2008! Regardless, Buffet was too early and could have done much better if he waited, but more to the point what kind of due diligence did he do back then? I am thinking more than he did with BAC, but no one knows for sure. What I do know is the government had to follow up on Buffet’s investment to the tune of $700B as they had to save the whole system. The government bailed out Buffet in the Goldman deal, basically.

What is different this time is the fact that countries are going broke now, not just banks, and there is risk everywhere. With BAC not only do you have sovereign risk, but you have derivatives risk and a whole bunch of mortgage issues from put backs to just bad loans altogether. I believe this time is very different because it is sovereign risk and we have had this issue before… in the 1930’s. In the Depression Europe had defaults and many countries devalued their currency which hurt the U.S. as we, at that time, were a net exporter of goods. The European issue deepened our Depression and the same thing will happen this time around, unfortunately. Not only may BAC hold European debt on its books, but they might have CDS exposure as well, not that we would know about that, thanks Frankendodd. In any event BAC is one hot mess and the sad thing is that BAC will not drop from $110 to $48 because it is at $7 already, you do the math to see what a similar drop would look like for BAC.

I do not think BAC is finished, it might be, but I doubt it. I do believe it will be stuck in the single digits for a very long time. For crying out loud, they bought Countrywide, just a reminder.

A proposed new bond rating system

Posted by Ray on April 14, 2010 under Main | Be the First to Comment

Since the meltdown last year much attention has been paid to how rating agencies determine the difference between AAA and junk paper. In a nutshell, and as you already know, the agencies gave AAA ratings to paper that was literally worthless and according to several books I have just read it is clear that the agencies had no idea how these debt instruments actually worked, I am referring to CDO and asset backed paper. Therefore, I humbly submit this new, simplified, rating system to the SEC and the ratings agencies.

My rating system will clear up any confusion as to the safety of the bonds you buy and investors will be fully aware of the risks. I am confident my recommendations will be turned down because the last thing Wall Street wants is transparency or to give the average (or institutional for that matter) investor a shot of actually understanding the risk they are assuming when they buy fixed income. I mean, what kind of fun could we have if AAA rated paper was actually safe? I am assuming Wall Street likes the fact that they can game the system and make total junk into AAA, which is exactly what they did with ABS. The last thing they want is for investors to make money because that would mean there is less money for them to make, right Goldman?

So, here is my proposed rating system:

AAA – Will now will be called “we think you will get your money back”

AA – Will now be called “we are somewhat confident you will get your money back”

A – Will now be called “you probably will not get your money back”

BBB – Will now be called “crappier”

BB – Will now be called “total crap”

B – Will now be called “are you freaking serious?”

CCC – Will now be called “what, do you hate your money?”

Unrated – Will now be called “there is a sucker born every minute, congratulations you are the sucker”

After reading so many stories about the financial crisis there is one thing that is consistent, regardless of who is telling the story or what context that story is being told, the ratings agencies had no idea what they were doing. In fact, in The Big Short, I highly recommend that book, there were several accounts of money managers talking to the ratings agencies and they said they were totally clueless. They went on to say that their models could not even calculate negative returns, how is that possible? No one at the biggest agencies had any idea how CDO’s or asset backed securities were created. They had no interest in looking at the makeup of what was sub-prime and what was not. They never looked at individual loans and instead used an “average FICO score,” how could you give a AAA rating when you did not look at the instruments backing the bond? These agencies are clueless and they still have no clue.

Sure, they are now downgrading this junk paper, 2 years later, but where were they when defaults were at 4-5%? This is why I am confident that the U.S. and the U.K. will keep their AAA rating right up until the day these countries are in receivership. After all, past actions do dictate future results. For example, Did AIG keep their AAA rating pretty much right up until they were acquired by the government? How about Freddie and Fannie, by the way there was never a government guarantee to this debt, it was merely implied, read a prospectus if you don’t believe me, did they not keep a AAA rating until the end? Then there is Executive Life, an insurer in the early 1990’s that collapsed with the help of Michael Milken’s junk bonds, which kept their AAA rating right until they were in receivership. Executive Life was downgraded only after receivership.

These firms cannot foresee risk or rate risk properly. After lawsuits were filed these firms defenses revolved around “free speech” and not around actually rating risk. Seriously? They now admit that one needs to do their own research and not trust their ratings alone. This must be news to all the insurance companies or pension funds that can only invest in A to AAA paper only. What they are telling you is that their ratings are not real and must have been always been fake. So, how can you trust their ratings on such things as sovereign debt? One simple question, do you think the U.S. will ever actually pay off its debt, all $12T worth of their debt? Not a chance, but they keep the U.S. at AAA and that is why their ratings are a joke.

P.S. – Sorry for the bad attempt at humor, come on, I am a geek, what do you expect?

LIBOR Overnight Shoots Higher

Posted by Ray on March 16, 2010 under Main | Be the First to Comment

Just a week or so ago the overnight LIBOR rate, this is the rate banks loan money to each other at (such as prime plus LIBOR or similar), was a paltry .17% and today it is a whopping .22%. While this is might not seem like a huge issue, and it is not on its own, it is a signal of something. Perhaps it is signaling that the wall of liquidity is coming to an end or that there is more risk lending to institutions than originally thought. Or, perhaps, Zero Hedge’s rumor mill was right and some of the GSE’s cut off 10 European banks from lending which caused the overnight rate to shoot up, it looks like they had it nailed.

I typically do not act or comment on rumors because some 90% are not true, but this one I watched because LIBOR was one of the signals preceding the credit crisis beginning in 2007 to 2008. If this rumor ends up being true, and it looks that way, I think there will be some negative implications for the equity markets as the rally is liquidity driven. However, LIBOR at .22% is nothing to worry about, at all, and unless it climbs higher I would not be worried, but it is on my ‘watch’ screen as it has implications. Also, the LIBOR rate is outside of the Fed’s control, frankly, as they already spent all their ammo in that department.

Well, let me rephrase that, they would need to start up recently closed programs and institute new programs in order to bring down the interbank lending rate. The markets are not fully healed and credit is still tight meaning that trust is still lacking in many areas. Credit is merely trust and, frankly, would you really trust a European bank right now? Who knows how much Greek debt they hold or other PIIG debt they have on the books. If you do not know you cannot trust them. If you can’t trust them you do not extend credit to them or you charge them more for credit to cover the potential risk. It is a vicious cycle and the system cannot handle any other shock or it will be in jeopardy again.

I am not saying there is much to read into, yet, but keep an eye on it as little things like the LIBOR usually signal or are the first sign of potential larger problems. It also looks like the Zero Hedge rumor mill was on to something, I am going to email them to see if they have a follow-up on the story. In the mean time, do not look for anything exciting from the Fed meeting, nothing will happen and the language will not change, which should concern you as well. Trade carefully and the market that is in front of you, I bought August VIX calls today as volatility is way too cheap, historically the VIX is at 20, and there seems to be no one betting it will go down, look at the put action.

Jim Cramer

Posted by Ray on July 6, 2009 under Annuity News, cnbc, Main | Be the First to Comment

OK, there are lot’s of things we could say about Mr. Cramer, but you know what I kind of like what he does. Before you get the wrong impression I do think he is dangerous and makes some bad calls, i.e. the housing bottom, but he does get people interested in stocks which is a good thing.

Even though I strongly disagree with most of his views he brought up an interesting idea tonight. He says that the government should issue a 30 year bond paying 5% which he shamelessly called the Cramer Bond. The general idea is interesting, but who would give the government money for 30 years only to receive 5%? Now, he did say make it tax free, but still that is betting that inflation will stay below 5%, which it really has never done.

He says you will double your money after 14 years, plus a few months, and they should be offered directly to the public with no fees. All good ideas, but Jim a product already exists like that.

There is a product that is rated AA that guarantees to double your money in 10 years, without taxes until you withdraw the funds. It is not right for college planning, but it is perfect for retirement planning. Not only that it allows you to participate in the market and you could, potentially, do much better than a simple doubling of your money. You have different investment options and a guaranteed fixed account, sounds better than 5% doesn’t it?

There is a catch, there are fees and you have to buy it through a broker. What is it? It is a variable annuity with living benefits. You can choose a guaranteed minimum account balance option or a guaranteed income benefit, but nonetheless it is better than your proposal. I know it is not as sexy as a high tech stock or some other off the wall investment, but it meets the needs of investors, period.

Say what you will about annuities, there simply is no other investment that can do what they do. Yes, you will take a risk through both investments, but that is mitigated through guarantees, but also the risk of the insurer. However, I feel much better about insurers risk than I do about the massive debt being issued by our government. Not only that, inflation will be an issue so 5% is not good enough.

Good idea, one of your better ones, but as usual you miss the obvious. I cannot wait until I get the tell all book written by one of your employees. Should be an interesting read!