Separating Fools From Their Money
Yesterday, markets in Europe were closed. But in America, they kept doing what they are supposed to do - separating fools from their money.
What is really remarkable - and entertaining - is that some of the biggest fools are the very same people who claimed to be Masters of the Universe, the hustlers who work for the financial industry. That is to say, the separators are being separated from their money too.
And the more you look into it, the more you discover that they are not masters of the universe at all - but slaves to it; nothing but clowns in the great human circus…just like us.
Last week, Bear Stearns' shareholders were separated from a lot of money; in a panic, they agreed to sell out for $2 a share. We wondered how these accountants, lawyers and market-savvy traders could have been so wrong about what they had. When the market closed on Friday they still had billions. When it opened again on Monday, they had almost nothing. How could it be?
Well, now the geniuses have had time to think; and they've come to the conclusion that they shouldn't have sold so cheap. And the buyers - JP Morgan Chase - apparently messed up too. They thought they had closed the deal, only to find that they'd forgotten to get the key documents signed. So when the sellers wanted to go back to the bargaining table, the buyers had no choice. They had to up the ante by 400%. Now, instead of paying $2 a share…they're going to spend $10, or about a billion dollars more.
So, here is the same question we asked last week: how can such clever people be so clueless about what they've got in their own pockets? Is it worth $2 a share? Or $10?
Of course, it is worth what you can get for it. But this is a financial institution. Its assets are marketable. It should be worth exactly the net value of those assets - plus the value of the operating business (typically determined by smoothing earnings over some period of years and multiplying times a capitalization factor - 5 to 20, depending on what kind of mood the buyer is in).
But in the strange new world we live in, however, it's hard to know what those financial assets are really worth. "Hence the billions of dollars sheltered off balance sheets in SIVs and conduits," explains the Economist. But the magazine goes on:
"That game is now up….the counterparties no longer trust each other."
You wouldn't know it from yesterday's market new, however. To hear the papers tell it, investors were greatly encouraged by higher-than-expected house sales and the news from Bear Stearns.
"US stages broad recovery as sentiment improves," is the headline in the Financial Times. Stocks rose, bond yields fell…and the dollar worked its way higher. The Dow went up 187 points. Oil held right at $100.
'Maybe things aren't so bad after all,' they said to themselves.
Or, maybe they are worse.
The reason house sales picked up might be because sellers are getting desperate. There are still a lot of unsold houses - about twice the usual number. Sales are a third down from their peak. And building stocks are about two-thirds below their highs. The stock market tends to follow the housing market, but with a lag of 20 months, says John Authers in the FT. "If that were to continue, it [the stock market] could fall 60% by the end of next year."
Meanwhile, say a prayer for the poor people who labor in the fields of private equity. Steve Rattner of the Quadrangle Group is in London this week. "Since July," he writes in the FT, "not a single private equity deal has been hatched above $4 billion." And deals just done before "the levers fell off the buyout machine" now threaten to sink their Frankensteinian creators.
The buyout firms had hoped to squeeze, re-structure, refinance and flip these deals quickly back onto the same public markets whence they came. This was what the Economist describes as standard procedure in the heady last days of the great financial bubble. Finance became a "game for fees and speculation," it says.
But now, the counter-parties no longer trust each other and no one is particularly eager to get stuck with these heavily-leveraged private equity deals. So they end up as "zombies," says the FT - neither living nor dead - but still drawing breath, salaries and financing costs. They are the equivalent to the "upside down" houses that are worth less than their mortgages; these companies are worth less than the loans taken out to buy them. The Irish telecom - Eircon - is one of these companies. The French builder - Kaufman and Broad - is another. K&B was bought, with plenty of leverage of course, at the very peak. Now, its shares have lost half their value -- which makes the business worth less than the debt it collateralizes.
All of which makes us think that reports of the end of the crisis may be premature.
The Daily Reckoning
Why is the US economy crashing?
Are money market funds next? – MarketWatch