Securitization for the World

Four at Four: Securitization for the World

By David Gaffen

The entire world has changed, but Wall Street does not appear to have noticed. Barclays PLC Chief Executive John Varley said Tuesday that the securitization markets need to normalize in order for the world’s economies to grow. “There isn’t enough balance sheet capacity (in the world’s banks) to allow the world economies to grow,” he asserted, suggesting that without the wonders of securitization (presumably provided by wizards at his bank and others), world economies would suffer. Meanwhile, there have been assertions that the $165 million in bonuses dished out to people at American International Group who tied the economy into a pretzel are necessary to keep that “talent” from going elsewhere before the insurer’s derivatives book can be unknotted. While protecting the financial system from collapse was certainly a step that needed to be taken, by now the AIG derivatives unit should be wound down and a CDS clearing market set up, post-haste. Meanwhile, the world survived reasonably well for a long time without securitization, and those who would suggest that it remains necessary for economic growth ignore the reality that the great boom in securitization led to the great bust the world is living with now. Even if it is accepted that securitization is necessary, those who engaged in it are not. For now, the government’s Term Asset Lending Facility is slowly getting itself together, and looks to be taking over this function for the near-future (Nissan sold $1.3 billion Tuesday in a TALF-eligible deal, which may help finance more than 40,000 car sales) while the private market figures out whether it has an interest in continuing in this arena. And while adults go to work at fixing the myriad problems in the economic arena, those demanding bailouts and make-whole provisions should think about just accepting responsibility for their misdeeds and moving on.

The upward move in markets Tuesday put the major averages about where they were a month ago before the massive swoon in shares brought everything to new 12-year lows. Five of the past six days, markets have ended the day higher, and Monday’s selloff doesn’t really even qualify, representing a rounding error in terms of points lost. Again, the banks led the way, even if their ability to continue recent gains — or lead the markets higher — remains a dubious proposition. “The fact that banks have stabilized makes the possibility of a market bottom that much more real, but I would not put us in the out-of-the-woods camp,” says Nicholas Colas, BNY ConvergEx chief market strategist. The market managed to shake off Alcoa’s decision — just the latest among S&P 500 components — to slash its dividend, focusing more on better-than-anticipated economic data. Recent reports show that the business environment is worsening as the recession has migrated from the residential real-estate sector, through the consumer sector, and into the business sector, where short-term and long-term spending projects are coming under scrutiny and business demand is declining. The unexpected rise in housing starts (even when eliminating the fluky data on multi-family units) and the recent not-so-terrible report on retail sales have more than a few inquisitive types hopeful that the consumer/real estate leg of this recession is at least easing somewhat, which would be a welcome sign for markets. The increase in housing starts motivated Macroeconomic Advisers to reduce its expectation for the first-quarter GDP decline to a 5.1% rate, down from its baseline expectation for 5.5%.

Warren Buffett, chairman of Berkshire Hathaway Inc., has referred to derivatives as financial weapons of mass destruction, but he was not above writing put contracts against major stock indexes in the 2004 to 2008 period, which Citigroup analysts Tuesday called “the worst possible time” due to the market’s high valuations and low volatility. “With the financial system teetering, higher volatility is increasing the value of the options for the holders of the options and hurting Berkshire as the positions are moving overwhelmingly against Berkshire near term,” they write. However, as they point out, the ball is in Mr. Buffett’s court — the put options have a duration of 15 to 20 years, and such options are held to expiry (the buyer cannot exercise them at any random time). So Mr. Buffett only realizes losses if the stock market continues to stink on a level not seen since the debacle of the Great Depression. The chances of losses for Mr. Buffett remain slim because the market would have to be lower 15 to 20 years later, and Berkshire was paid a 13% premium for its $37 billion derivatives exposure. “The markets would ostensibly have to be down by that much to show a loss,” writes Joshua Shanker, analyst at Citigroup. “It is a rare thing to have the markets decline 13.2% or more over a 15-20 year period. It happened only a few times: in the first half of the nineteenth century and at the great stock market crash of 1929.”

Shares of International Paper have regained some of their luster after hitting a 52-week low on March 6. The company was able to refinance a European loan late last week, helping assuage investor concerns about the paper company’s debt position amid sharp declines in its stock and poor economic demand. Shares ended the day higher by nearly 15% at $7.26, the highest close for the stock in more than a month, and the options market was active as investors purchased out-of-the-money calls in both March and April in expectations that the stock will continue to appreciate. More than 20,000 April call options at the $7.50 strike price changed hands, and nearly 18,000 at the March $7.50 price also were traded. “It’s just basically an accumulation of calls,” says Frederic Ruffy, options strategist at Whatstrading.com. “It looks like investors have been accumulating positions in IP calls, expecting a move higher over the past several days. There was a big spike in call volume right as the stock was bottoming out.”