Morons and oxymorons

It's fun to switch on a business news channel to hear morons talking in oxymoron. The world economy is going to witness negative growth this year. All major US banks are saddled with toxic securities that causing insecurity among investors. There aren't any truly bankable bank in US. The US govt plans to help banks dispose their toxic assets will give a boost to bank stocks.

What the hell is going on in here? Just few decades have passed when comedian Bob Hope said that a 'bank is a place that will lend you money if you can prove that you don't need it'. The banks of 21st century became a place that will lend you money if you can prove that you don't deserve it. I'm not joking. That's precisely what Ninja loans are. (Ninja stands for No Income, No Job, no Assets).

I'm glad that I'm watching this drama from sidelines. I'm glad I've no toxic assets to dispose off. When did I first think of toxic assets? I think it was 2005. Britney Spears displayed her assets so well on a song called titled 'Toxic' that she got a Grammy for best dance recording. It wasn't what music lovers would call 'music', yet it sounded like music to financial firms in wall street. Caution was thrown out of windows and in came craziness. The craze for 'toxic' securities saw the financial world going into a direction where people just forgot something very fundamental. A four letter world called risk.

The song 'toxic' says it all
'There's no escape
I can't wait
I need a hit
Baby, give me it
You're dangerous
I'm loving it'

And the hit came.. a bit late and a whole lot more powerful than asked for. It knocked out many financial giants and the rest were found leaning on government support. But the tremors were felt far and wide and we are still reeling under aftershocks.

Many would ask a question, could it have been predicted? The answer is a definite yes. Most of the times, common sense, open eyes and open ears are enough to keep you out of harms way but this precondition is stricter than it seems. We get biased by what we see and hear and start ignoring the writings on the wall. Before this crash came crash, we had precedents too. We had not completed even a decade from the last boom in 1999 where people were telling that profits doesn't matter…Eyeballs do. Many lost their balls in crash that came with the new millennium.

Seven years later( June 13th 2007), in US the interest-rate spread between the main junk-bond index and the ten-year Treasury bond shrank to 2.4 percentage points. People were willing to investing in junk bonds giving 7.7% when the safest for of fixed income instruments, US govt bonds were giving 5.3% yield. Such a small risk premium for such a big risk was unheard of.

In stocks the situation was even worse. Jeremy Grantham in his April 2007 letter reported the 'first ever negative sloping' risk return line which indicated that 'investors are paying for the privilege of taking risk'

And then there was real estate…mother of all manias. In Nov 2006, Peter Schiff gave a talk to the Mortgage Bankers Association where predicted the doom in real estate as well as the general economy. I have nothing to say about the speech (you better watch it if you haven't) except the climax that came during question answer session. A guy asked 'Peter, as a lender myself and as a property owner and wider [question] about real estate, on what's going on….Should I just slit my wrist?'

The pendulum is going slowly towards the other extreme. People are being extra cautious and hurting themselves even more in the process. Last month, Warren Buffett said in an interview to CNBC 'the interesting thing is that the toxic assets, if they're priced at market, are probably the best assets the banks has, because those toxic assets presently are being priced based on unleveraged buyers buying a fairly speculative asset. So the returns from this market value are probably better than almost anything else, assuming they've got a market-to-market value, you know, they have the best prospects for return going forward of anything the banks own.'

In US the banks are now unwilling to give loans even when the cost of capital has fallen to unprecedented lows due to government support. These banks are able to get money at 1% whereas the lending rates continue to be high. In India, although the banking sector is on strong footing, there is a definite unwillingness to part with the cash. Such a strong comeback of risk aversion is giving rise to irrational things happening all around.

Consider FCCBs. There are companies who are able to buyback their FCCBs at huge discounts, which implies that the bond holders fear that these companies aren't going to make it, yet the market capitalization of same companies is rising. This means that the stock holders, whose claim on returns and principal is secondary to the bondholders, are more confidant about the capability of their companies to come out of downturn alive.

Ok. Coming back to (oxy)morons. The entire economy, we are told, is a phase of deleveraging (Have you ever used a lever? Yes, try deleveraging!). The rally, you see, was just a bear market rally. The markets went down due to profit booking(if people are doing profit booking when market is half its peak, when the hell do they book losses?). The biggest question is the shape of recovery…whether it will be U shaped, V shaped or W shaped. Who said you need to know ABC of finance to talk about it. You can start with UVW.

References
Jeremy Grantham's letter
http://www.scribd.com/doc/7257647/Jeremy-Grantham-Letter-Q1-07

Peter Schiff Mortgage Bankers Speech
http://www.youtube.com/results?search_type=&search_query=Peter+Schiff+Mortgage+Bankers+Speech&aq=f