Tuesday, September 30, 2008

Public finance, private pain

Rather a frightening trend emerging here. Which are the three European banks most under strain the last few days (Fortis and Glitnir aside)? Dexia, Natixis and Hypo Real Estate. What do they have in common? Parents or subsidiaries with a big line in public finance.

Dexia combines a retail operation with a big franchise lending to public sector clients, and a monoline insurer. Natixis used to own a struggling monoline, and public finance is a business line of one of its parents, Banques Populaires, which, together with Caisse d'Epargne, had to bail out the monoline and now bail out Natixis. Finally, HRE owns Depfa, a Dublin-based bank, which until very recently had a big public sector franchise.

So we had a bunch of banks essentially financing a franchise lending to the public sector, either directly, or through private infrastructure borrowers, using wholesale funding. It should have been a very profitable enterprise, since governments, particularly European ones, are rather wary of defaulting. It's the wholesale funding bit that hasn't been working well the last few days. Banks don't like lending to banks.

I'm not sure we can call this a shoe that's waiting to drop to any great degree. Some of these institutions have co-operative members, retail deposits and deep-pocketed government shareholders. More importantly, government has powers of taxation, which will put a floor on how many loans to government go bad.

But I am going to go slightly further and observe some small similarities with what happened to the monolines, which also used to make most of their money from taking on public sector credit risk. Staid institutions yearning to boost their return on equity strayed out of their franchise but did not subject their funding model properly to the stresses of a different business model.

For the monolines it was the use of ratings agencies to determine their cost of capital rather than the capital markets. For the public finance lenders it has been not communicating their business properly to the capital markets, though I'll accept that telling funding partners any kind of story right now would be rather difficult. Still, let's see how the public sector fares with the loss of this funding source.

Monday, September 29, 2008


Couple of items inspired by Gawker, which is strange, because I don't read it any more. I feel bad to do this because, according to Gawker, the New York Sun's demise is imminent, but it ran a right loan of old nonsense this morning about hedge funds.

[Digression: I can't say I'll miss the Sun at all, and not only because its several thousand degrees of magnitude less amusing than its boisterous British namesake. If you ever wonder how it's possible to be a part of the media conversation while operating a shoestring reporting operation, here's your answer: you can't. Also useful confirmation: there aren't enough right-wingers in New York to buy a paper that takes its policy cues from Richard Perle.]

Anyhow, the Sun's business reporter, Jule Satow, produces a very peculiar article right now about how New York is going to lose top financial talent to hedge funds based outside the city. I picked up on it by watching In The Papers, and knew before reading it that it was going to start from a disastrous premise.

In fact, even Mrs. Cutesome, who doesn't spent her time bitterly throwing rocks at prominent financial journalists like I do, felt moved to chime in. "Doesn't she know that all of the big hedge funds are based in Greenwich anyway?" Mrs Cutesome knows this only too well from a fruitless phase of interviewing at one or two of these funds.

So what's going on here? The city's investment banking titans are indeed shrinking, and are indeed losing people. So far so depressing. So, the conclusion is that hedge funds, despite producing some horrible returns, and what the normally staid Pensions & Investments is calling a Bloodbath ahead, are going to start sprouting like plants after a desert rainfall.

This is presumably based upon two, largely unspoken, assumptions. That hedge funds will emerge stronger because they're not publicly-traded, and their managers are more humble than investment bankers (they're not), a trope of which Tom Wolfe, writer of one of the most epically bad discoveries of the hedge fund industry I've ever read, is very fond.

The second is that New York City, with its punitive tax rate, is somehow not doing enough to make them happy. Because extremely tasty tapwater, decent public transportation, over-the-top shopping options, and a vast pool of inexpensive labour is the least that they can expect. I suspect that the industry analysts that pepper Satow's piece are going very soon to start angling for subsidies to keep them in the city.

And I pray that the normally very lucid Barry Ritholz was given a question along the lines of "how easy is it to run a hedge fund outside Manhattan" rather than asked to opine on the likelihood of the rest of the world stealing our investment funds. He certainly included enough caveats to suggest he doesn't agree wholeheartedly with the article's thrust.

Actually, to be fair, most of the last two third of the article doesn't agree with the thrust, so I'm going to be generous and suggest that the Sun's precariously perched subs massacred the piece. The Sun always worked from this subtext that New York suffered as a solidly Democratic liberal playground that wasn't grateful enough to its capitalist overlords. Strangely enough, this didn't help it build a mass readership here.

Monday, September 22, 2008

Sleep-Deprived CDS Rant

Catching up from a couple of days spent at a conference last week, which might as well have been a cave, so divorced from connectivity the venue was and so divorced from the crisis the discussion was.

I had one interesting discussion, though, regarding, as it turned out, credit default swaps. There's a fair amount of discussions of these today, since what happens to such swaps in the light of the market's gyrations, will pretty much determine which and how many institutions live or die in the coming weeks.

You can get a reasonably simple look at them here, though it concentrates on laying the blame for the recent mess on elements within John McCain's coterie. [Actually, scratch that. I've just read this sentence: "Um, sirs? Is it altogether a good idea to run up debts {The writer is referring to the outstanding notional CDS} exceeding all the assets it's even possible to hold" Which is like saying that New York Life has $280 billion in debt]

I've written about them. And here's a fairly innocuous idiot's guide from the uniquely suited Julie Satow in the NY Sun.

Credit default swaps allow people who've bought debt to offset the risks of such debt defaulting, or people who don't own the debt to speculate on it defaulting. The first would be a fairly useful way for people to manage their exposures to potential credit events if they had a fairly large relative or total exposure, while the second would allow investors to profit from credit events on fairly widely-known names.

My discussion centred on a pretty bespoke type of high-yield bond, whose particulars I'll have to leave out because I've written about it during my dayjob. But such bonds don't trade much, have a small number of interested specialist investors and do have a public rating, though it is below investment grade.

I spent hours asking who was buying these bonds before a kindly banker took pity on me and explained that these bonds weren't being sold to anyone. They were kept by the underwriter and then "hedged out". I tried to get a handle on it - was it through shorting, or through the purchase of call options or what? The first didn't make much sense, since there wasn't really a close enough type of security for the holder to short, although there were a few types that might work. Call options would have been too expensive.

It was only in this discussion last week that I finally heard someone tell me that the holder was hedging them through the use of credit default swaps. Now, I'm not a huge believer in perfect markets, hell I even thought that monolines had a viable business model (Ahem). But I'm still trying to get it into my head why on earth this CDS slapped on a rather bespoke bond that was retained by the underwriter was the best way for the borrower to get his hands on the cash rather than just trying to sell the bond to someone that would love it properly.

Left behind in all the discussion about financial market interconnectedness and financial weapons of mass destruction ((c) Warren Buffet, the only man in America who is ever allowed to buy a utility) is just why CDS was always such a cheap way to hedge out these risks, so much so that an entire financial product was structured on the back of this comparative cheapness.

There are, I guess, several reasons why CDS might be cheaper than just owning the bond, including interest rate risk, liquidity risk, and other non-default risks that investors get compensated for. And I recall very vividly that some institutions (**cough**monolines**cough**) might be pricing cheaply protection either to build market share or because ratings agencies or regulators are giving them generous capital treatment, which usually involves some kind of unstable arbitrage opportunity. It certainly would explain why all those banks decided to hold on to the super-senior, or, ahem, least risky, bits of securitization deals and just hedge the exposure out through CDS.

But there's a looming sense that this crisis comes down to the financial services industry's need to eat its own young in more elaborate ways rather than performing the more prosaic task of directing capital to its users. There's a theory, which I think Felix Salmon has been a big proponent of, that demand for only the tastiest AAA paper gave us the securitization mess.

Well, that's as maybe, but a fairly large amount of the garbage swilling around in banks portfolios is more either fee-driven garbage (whether stupidly bespoke CDS deals, or LBO loans that were created to drive advisory fees), or regulatory arbitrage opportunities masquerading as hedging strategies, and it's garbage that can't really be laid at the door of the ratings agencies. There were rooms full of people at AIG Financial products whose job was to write such CDS contracts, and I cant tell you why they didn't just go ahead and buy some of those bonds, either.

Think of this as the contribution of the greasy sly kid at the back of the pitchfork-bearing crowd.

Wednesday, September 17, 2008

Pink Face Does Not Equal Sweeny

So I went over to the court today to hear oral arguments in Develop Don't Destroy Brooklyn's the appeal of its state lawsuit against the Atlantic Yards Environmental Impact Statement (EIS) and approval.

I don't usually follow the legal machinations of the AY project, since I tend to find it easier, given my background, to mock Forest City's dreams of raising competitive financing for such a greedy and speculative project. But the first department of the appellate division hears cases about seven blocks north of my office, I'd never been in a court before (I once pled a speeding ticket by mail), and I managed to shred a couple of witless renewable energy producers before lunch. So up I trundled.

And my is it a handsome building, both from the inside and on the outside. When shuttling between a condo building from this century and a row of cubicles in an an admittedly pleasant early 20th century Gramercy building it's easy to forget how much rich old stuff is scattered around New York. I think Spike Lee was trying to get the point across in the fine-looking and quite marvelous Inside Man.

So, after getting my stuff x-rayed and managing to put all the wrong stresses on the word "appellate" I was directed in to the room, which was about a third full. For some reason we were all confined to the right hand third of the room, which made things a lot cozier, but the spot made it rather difficult to hear the speakers properly. I think I was second-worst dressed person in there.

Also in attendance was Norman Oder, who pretty much has the damn transcript, so do go there to get the details. Since most my notes say things like "PINK-FACE SHORT HAIR JUDGE: Did AKRF ever produce a study that didn't find blight", I'll concentrate on giving you the gist.

I can't even compare proceedings to past hearings, but based on this hearing there was a fair amount of scepticism from at least two, maybe three judges about the way that the Empire State Development Corporation declared a perfectly vibrant part of Prospect Heights blighted. There was also this simple misunderstanding about the use of Atlantic Avenue and Pacific Street as boundaries that the ESDC's attorney tried to turn into a huge brouhaha, like it was junior debate camp or something. But then I'm biased.

The argument did not hinge so much on what constitutes blight, the reason by which the ESDC is going to steal homes and my favourite boozer, but how the ESCD measures blight. Since I have very little conception of what discretion the ESDC has to do this has I can't really judge the efficacy of either side's argument.

There seemed to be a general agreement that parts of the footprint of the Atlantic Yards project are not blighted, less on how much it had to be blighted for condemnation to happen, and even less on what measures the ESDC might use to assess that. As far as I can tell, and despite the generally incredulous way that the judges questioned the ESDC lawyer, the argument will come down to whether the ESDC has to justify its decisions.

I can imagine the political appointees on the appellate court deciding that there's not really much that can stop the ESDC, since it was born in the late sixties when were all terrified that New York was going to hell in a hand cart, and all the good jazz musicians would move to LA. Let them get on with the sordid business of stopping the city turning into Detroit. That land was then tuppence ha'penny an acre has not stopped our real-estate-olitical complex from using the law to get very, very rich off the back of grassroots gentrification.

Still, the fact that the ESDC is still defending the study that was used to determine blight, and still insisting that the area is not gentrifying, gives me a little hope. It may not be enough to get the decision overturned, but there might be enough doubt about whether the ESDC has the power to make up blight definitions to get the decision kicked upstairs again.

But hey, I should probably stick to making awesomely bad financial prognostications rather than expanding into the awesomely bad legal prognostications business.

Events, Dear Boy

It's interesting that no matter how infrequently I post, it's still possible for me to drop a decent-sized clanger with pretty decent regularity. I refer, of course, to the post below, where I confidently predicted that Barclays had lost interest in the idea of building up a US brokerage business, and that financing conditions for the Atlantic Yards arena were still benign.

So, that was about 1.5 clangers. Barclays, of course, has decided to double down its bet on a presence in the US capital markets by tearing a few strips off the Lehman Brothers corpse, although how the Lehman* purchase helps it build up a retail business in the US escapes me. It's clear that John Varley and Bob Diamond have decided to fling the money of the good depositors in the banks' UK operations at empire-building in New York.

The Financial News calls it "league table glory", which is a nice way of saying that the credit crunch sure as hell hasn't extinguished vanity and hubris in investment banking. But when you've just spent $1.75 billion on bits of a bank they couldn't give away last week, $20 million a year is a manageable burden, and I don't see why Barclays wouldn't be inclined to extend the naming rights deal if financing conditions stay nasty.

The .5 clanger is that financing conditions have headed south again. Now right now, investors love them bonds, and the "Barclays Center" (that dare not speak its name) would probably be financed using bonds. But the bonds that they love are mostly low-risk stuff, and highly-leveraged construction financings for speculative team moves don't count.

Developing. Right, I'm to check out the appeal. Seems a shame to miss it when I'm only seven blocks away.

* Note the singular. Only particularly dim UK journalists would ever be tacky enough to append an 's' to a firm when giving it a shorthand.

Wednesday, September 10, 2008

Karma Burns

Well, I probably need to say something about it, don't I? Even with a head full of gin and the knuckle on my left index finger missing rather a lot of skin (and a little flesh, too).

So. That New York Times article about how the Atlantic Yards arena is starting to look a bit ropey. It certainly explains why FCR and its underwriter are insisting the deal goes down in November. Because, according to the Times' Mr. Bagli, the arena's sponsor, Barclays, can walk if the arena doesn't reach financial close in November.

Barclays must be thinking they dodged a bullet on this one. Let's assume they really thought a speculative move by a basketball team was a good way to market exchange-traded funds. The advantages right now of trying to build a retail brokerage presence in the US are pretty limited.

And while Barclays hasn't had the poor run of form of its peers, but its balance sheet is still in need of a little TLC. $20 million is the amount that Barclays could earn from a single rights issue that isn't a massive cock-up, but it's still probably mutliples of the amount that it squanders on the entire New York financial publishing industry in a year.

And so, DDDB says that the litigation can't be cleared by November, and unless the residual risk from litigation is small enough for the ratings agencies to sign off on the financing package regardless (which can happen, though the residual litigation risk must be pretty trivial) the financing can't get doone then.

Now I'd be chuffed to the nuts (that's happy, if your vocabulary is feeling dreary right now) if the deal didn't go down, but none of these blows are fatal. Naming rights sponsors can be replaced, and in these recessionary times I'm betting it would be fairly easy to find a utility (hello, fellow Limeys National Grid) or junk food provider willing to go after Brooklyn eyeballs. Hell some of them might not even have links to racist regimes.

And then there's the financing. I reckon, leaving the litigation to one side, that FCR could get the financing done right now. Goldman Sachs closed a pretty solid, if somewhat subsidy-larded financing for the Louisville Arena the other day. The bond insurers seem to have stablised, and right now its easier to persuade bondholders of the utility of a new basketball arena in Kentucky than of the US housing system.

No, the Atlantic Yards project won't ever get the decisive stake to the heart. There will be a dozen cuts instead, not least among them higher financing costs, discounted naming rights, restrictions on tax-exemption, Brooklyn pols refusing to chuck any more subsidies at it, and mounting losses at the Nets. At some point, FCR's stock analysts are going to start suggesting that it goes back to nickel-and-diming government agencies on a smaller scale than through gargantuan sports-related boondoggles.

So let's recap. As soon as the financing picture looks better, the naming rights deal looks ropey, and the subsidy picture gets cloudy. I've never been totally convinced that the eminent domain case was going to drive the stake in the project's heart either, but dammit if it hasn't dragged things out long enough for the developer to start needing to fight fires in all sorts of places. To drag another helpless metaphor into the melee, looks like Forest City''s game of whack-a-mole is starting to turn bad.

Friday, September 05, 2008

Suck My ROC

Oh dear. The Guardian just discovered feed-in tariffs. And it thinks that their success, for that it what it is, is proof that the system of encouraging renewable generation development is broken.

The Guardian has "revealed" that "a little-known scheme designed to promote the development of renewable energy" will net it the UK millions of pounds because it's worked. To your capitalist power trader big, that's known as a lucrative below-market power contract; to your renewable energy policy expert, that's proof that the government can step in and encourage new ventures if the market does not initially recognise their value.

The Non-Fossil Fuel Obligation was set up in the late 90s to provide renewable electricity producers with a guaranteed price for what they made. It was much more than electricity producers in general used to get when they used coal or gas or nuclear to make electricity, and it was enough for them to raise financing. But it wasn't enought to spark a massive rush towards wind power, as happened in Germany and Spain.

The government, rather sensibly, made sure that if prices went above the rather generous levels that it set then it would capture the excess. Which may, though I do not know enough about the specifics and am thus speculating wildly, be one reason why people preferred building wind farms in Germany. The UK has since replaced it with a ludicrously complicated regime called renewable obligation certificates, which sulks in second place in the stupid-ways-to-encourage-new-renewable-power-development Olympics behind the US production tax credit.

To Charles Hendry, the Conservative shadow energy minister, it's a "stealth tax", and his response is the best reason this expatriate has yet found for keeping faith with the Labour party. Hendry, at the urging of the indubitably wily, yet I fear equally dim reporter Juliette Jowit, suggested that the revenue "seems to be going into a general pot," rather than going towards more renewable subsidies.

This argument leaves to one side the awkward fact that Hendry evidently has no idea what is happening to the money that's been made from the scheme. Which makes the whole story one of those glorious UK political journalism stories that are fishing for something bad to be said the following week. Though it's unlikely that the umbrage level will rise to any appreciably intolerable level.

More worrying is that the article seems to pass off the horrible move upwards of commodity prices upwards as some kind of nefarious energy trading scheme on the part of the government rather than a largely unexpected, and basically unimportant, consequence of a worthy, if flawed, incentive regime.

We haven't yet had a decent picture anywhere of how government will reconcile making consumers absorb the higher external costs of fossil-fuelled generation (and the NFFO was a rather inelegant move towards this) and high energy prices. I doubt we'll get an indication from this tawdry little story of what way the UK government will jump. But we have discovered that the UK political class is probably ill-equipped to have a sensible conversation about it.

[UPDATE: Ah, the coherent explanation is in Oliver Tickell's piece, which explains where the NFFO revenue goes, laments the fact it hasn't been directed towards transmission projects, but does seem to indicate that it's a much better system than the ROC. But I'm still struggling to understand why it's a terrible thing that the UK government that captures the NFFO surplus when it's government that, by and large, that has to cope with the external costs of fossil fuel generation.]