Mar 12, 2009

A Week on Wall Street: Day 4

Dynamic Credit Partners

This firm is an expert in dealing with CDOs, toxic or otherwise. Our host took us through the process of creating such an investment and explained how a bank could take $100 of bonds, repackage them to appeal to investors' different maturity/credit preferences, and create securities worth $102 (the $2 was kept as profit for the bank). We examined a pitchbook for one deal that went south rather quickly, the collateral in the CDO was 95% subprime residential mortgage backed securities (RMBS). Whoops! Although the pitchbook had several pages of boilerplate on the various risks of the investment, there was no real analysis of which risks were the most important. A possible justification for lawsuits - investors in the subordinated classes (e.g. below the A tranche) were not informed that their cash flows could be diverted to the senior tranches if the collateral was downgraded by the ratings agencies. This was surprising to me, because why should the lower tranches suffer as long as the collateral was still performing? But that's what the waterfall of cash flows called for. The CDO we looked at had 6 tranches, and currently 5 of those tranches were non-performing and completely worthless. The top-rated A tranche was trading for 7 cents on the dollar.


It would be hard to mistake Barron's offices for the well-appointed accommodations of any of the investment firms we visited - it had the appearance of a threadbare newsroom. Tough times for the print media in general, and the financial press is no exception. Demographic shifts - the average age of a Barron's reader is over 50. There is no doubt that investors will keep getting older, but eventually they'll consume content in electronic form only. Bad news for Barron's (and the rest) - rates for online ads have always been less than print ads, but it was hoped the two prices would converge around the average of the two. Instead, they're converging at the substantially lower online rate. Maybe they can clawback some of this differential with better targeted ads?

Cowen and Company

Although business was holding up better than many other firms here, the outlook here was quite pessimistic. Expenses are being cut to the bone - as is prudent - but if everyone cuts expenses until "things start to turn around" it seems the entire economy could easily get trapped in a deflationary spiral.

Completely unsubstantiated rumor of the day: Madoff will plead guilty to everything - the only thing he wants in return is protective custody in jail for the rest of his live, because many of the billions of dollars he is alleged to have lost belonged to organized crime syndicates/drug cartels in South America and Europe. It is an understatement to say they are unhappy with his investment performance and would likely seek to have him killed in prison.

Random observation: under normal circumstances, labor is a cheaper input than capital. In recent history, capital became cheaper than labor, which led to rampant inflation of investment bankers' salaries. The huge profits recorded in good years were actually returns to capital, not labor, but bonuses were paid out anyway.

Overall mood: approaching maximum bearishness.

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