The Credit Crisis Financial Stocks Short Journal

[Daal]

Quote from inks2002:

follow your blog and this journal a lot, got a basic question, in the commodity rise as far as inflation goes which commodity producing stocks would you think would make a good long "inflation trade" I would think something like DRYS or maybe SEED or POT? But there has to be something else out there. I was looking for a commodity stock that would expose me to a long corn or long sugar trade. Just picking your brain.

I tend follow the Jim Rogers theory of playing the commodities themselves. I remember back in 08 where I was doing all this work of reading 10-qs and stock picking oil shares then I would see there was little difference between my shares the XLE and even worse USO outperformed everything.
I was exposing myself to stock risk without much compensation.

Now when I decide to play the inflation trade(which I dont think I will do for the next 12 months), I will probably buy calls in commodities, go long stuff like RJI, RJA, oanda gold/silver, short 30y treasuries, short US dollar perhaps some XLE XLB for volatility purposes

 

[Daal]

John Hussman is clarifying his position on why US private debt needs to be reestructured
http://www.hussmanfunds.com/wmc/wmc090323.htm

I believe I understand his argument now. He is saying without reestructuring the 'corporation' US Private Sector the current stream of income wont be able to service that debt and at the same time the collateral for the debt is declining in value. So, if I understand him, he says 'if you dont do my plan then RGE/IMF/Goldman estimated credit losses will reach $10-$14T'

Still he bashes the authorities all the time and he is YET to factor his amargeddon scenario in the expected return for the SP500 for the next 10 years. I wonder why...

 

[Daal]

Where I think he is still wrong is with regards to outright confiscation(haircut) in bank bonds.

Its wrong because the I dont think I ever read about a banking crisis where the government risked something like this. The swedes guaranteed liabilities. If a bank cant roll over their debt it could very well fail, so the taxpayer would endup on the hook anyway as the debt markets stay shutdown and everyone heads to the FDIC bond program for liquidity. If Geithner goes to congress and asks for 'haircut authority', thats it, there is no debt market for banks for at least 2-3years(after WM debt wipeout the bank debt market has been almost totally shutdown, so the taxpayer is ALREADY on the hook for all the FDIC bonds issued)

On top of this the administration would choosing to create counter-party fears all over again and further depress risk taking, with a 'haircut' authority there would be great uncertainty of on what else would be haircut (hence lots of markets would shutdown, 'buyers strike' as meredith whitney puts) next and who would fail as a result(and who would fail as a result of failures), fear would set in. Geithner and Obama dont have the courage to do something like this, furthermore it would be against the law to haircut a bank with Tier of 9%+, they would open themselves to lawsuits. If they do get the guts to ask for that authority to disregard tier 1 or force banks to bring Tier 1 down then XLF goes to $2 as it would essentially say 'daddy is mad at the banks, equity is worthless'

 

[Daal]

With regards his estimate of $10-$14T in losses, it seems like a strech to think they could get that high. He says
"Even so, there is no way to prevent huge, ongoing losses, because the cash flows off of these assets are not sufficient to service the debt."

The cash flows of course should include the national income. If the total peak to through decline in GDP will be 6% like Shilling and RGE forecasts that will be a shock to the system but it should not create anywhere near $10T in losses, to get losses to be that high what kind of default rates is he predicting?

Problably gigantic ones where asset prices(including stocks) cant find a bottom(keep in mind that this would have to happen during a period where the risk free rate will be close to 0%), networths continues to dwindle and unemployment reaches 15% or something, GDP does down by 12%+. Under that scenario stocks wont compound 10% a year for 10 years, more like you will break even with dividends added at best, so it seems that Hussman is just trying to sing the populist song but his financial bets actually tell he is not putting his money where is mouth is, so at this point I would rather operate with the assumption that total losses will be somewhere in between IMF/Goldman and RGE numbers and regard Hussman figures as a fat tail populist cry

 

[rros]

Quote from Daal:

With regards his estimate of $10-$14T in losses, it seems like a strech to think they could get that high. He says
"Even so, there is no way to prevent huge, ongoing losses, because the cash flows off of these assets are not sufficient to service the debt."

The cash flows of course should include the national income. If the total peak to through decline in GDP will be 6% like Shilling and RGE forecasts that will be a shock to the system but it should not create anywhere near $10T in losses, to get losses to be that high what kind of default rates is he predicting?

Problably gigantic ones where asset prices(including stocks) cant find a bottom(keep in mind that this would have to happen during a period where the risk free rate will be close to 0%), networths continues to dwindle and unemployment reaches 15% or something, GDP does down by 12%+. Under that scenario stocks wont compound 10% a year for 10 years, more like you will break even with dividends added at best, so it seems that Hussman is just trying to sing the populist song but his financial bets actually tell he is not putting his money where is mouth is, so at this point I would rather operate with the assumption that total losses will be somewhere in between IMF/Goldman and RGE numbers and regard Hussman figures as a fat tail populist cry

Not sure, but I think he speaks of a debt/equity swap and not a complete wipe out of debt. Thus, leaving bondholders with some upside and ownership. Also, in the matter of high returns for the next 10 years don't forget that coming out of such deep recession immediate returns can be on the triple digits... meaning some stocks can double quickly.

 

[Daal]

Quote from rros:

Not sure, but I think he speaks of a debt/equity swap and not a complete wipe out of debt. Thus, leaving bondholders with some upside and ownership. Also, in the matter of high returns for the next 10 years don't forget that coming out of such deep recession immediate returns can be on the triple digits... meaning some stocks can double quickly.

In a voluntary debt to equity swap then I would agree with him, it wouldn't be a big deal and it would be quite healthy since only those who could and wanted to swap would be exposed to it.(there would be no failures or counter-party fears, CDS triggers,etc)

I'm referring to the populist notion of arming Geithner with a 'financial axe' authority of haircuting/putting in receivership anything he wants, this would spook the markets and induce buyers strike. I'd agree with his numbers of 10% returns, I just dont agree with that number in scenario where credit losses reach $10-$14T

 

[Cutten]

Quote from Daal:

. I'd agree with his numbers of 10% returns,

What would be your methodology for estimating that? I don't see any way to estimate equity returns with that level of precision, especially not within the typical investing timeframe of 10-30 years.

 

[Daal]

Quote from Cutten:

What would be your methodology for estimating that? I don't see any way to estimate equity returns with that level of precision, especially not within the typical investing timeframe of 10-30 years.

I would agree with this. I just find resonable to expect positive returns with US stocks at 13x Shiller PE and at 8-10x Peak earnings. The actual % I dont know but his numbers seem resonable in the assumption that the recession ends in somewhere in 2010

 

[Daal]

I'm trying to figure out if the bad assets program will change significantly likely path for XLF. Clearly if you look at the stock market reaction you would think the program is great and everything is good, however bank bonds reaction has been muted. The C bond that I own actually were flatish/slight down today(YTM 12%), BAC highest yielding bonds are trading at 10%/11%

Corporate bonds went up less than 0.5%, junk issues around 1.5%. TLT down 0.87%, it wasnt a big day on the bond market

If the private investors pay the 'hold-to-maturity' value less some kind of premium, there is little gain to the shareholder of a bank. They will be open to get diluted with a cleaner balance sheet and the asset will endup providing the same amount of cash to the bank, the bank will take a mark down in their books and lower their Tier 1 ratios, a capital raise will probably follow.

The danger is if the investor pays something over hold-to-maturity value, this would provide an immediate gain as it would increase the Net Present Value of the institution, however a capital raise would probably be necessary if the bad bank were used many times by the institution

The government is writing a cheap put on the toxic assets, in the private bidding process the bidders will bid higher than otherwise because they know their downside is protected, cheap financing also will raise the bid. What this means is that if the RGE estimate of $1.8T in losses to US banks is anywhere correct, the bad bank is likely to absorb some of these losses as the private sector will take advantage of the government generosity and pay higher prices

 

[Daal]

However one point that needs to be made is that for bank shareholders is that insolvency is not necessary for the shareholder to get killed.

All it takes is for their capital ratios(either regulatory Tier 1 or TCE 'market' capital) to fall below a certain level and they get dilluted(That happens because capital requirements work as a margin call). So frequent use of the bad bank even in the case of overpaying should lead to dillution. However I do think the bad bank will bite a chunk of the losses that would otherwise fall in banks. Its possible that I will have to cover some shorts and focus in other sectors