Practice Looking Surprised

As I pointed out in my post on the Citicorp secondary stock offering, driving the price below half of the Q3 book value may put all those poor abused bankers that have to take stock instead of cash into the multi-generational kind of money in the future.

The clue sitting right in front of you is that the most senior crew at Goldman is taking 100% of their bonus in stock, even though the stock never had its final plunge, and even though it is already doubled from the bottom.

Of course, the individuals won’t pay any current tax on that part of their annual compensation, and the company will be able to deduct those “phantom” compensation expenses before doing anything rash like paying dividends or taxes.

Oh, the beauty of it all.

We can watch the spectacle of  just one company setting aside a $20 billion bonus pool, a company that still enjoys taxpayer largesse in the form of low lending rates and full taxpayer guarantees on some of the capital  that company (Goldman) is using to go about its business.

And now the company gets to hold onto the cash, its workers get to dilute the shareholders with their newly issued stock, and the only ones who don’t win are the taxpayers, who take a triple whammy of no cash, and no upside, and all the downside if the loans and commercial paper they guaranteed can’t be paid.

Imagine what it might look like five years from now when all the earnings from all that cash that didn’t get paid out sits there and compounds the value of that stock those altruistic bankers took instead of cash.  I hope there are enough buildings needing naming at various Ivy League colleges and major hospitals, because there will be some serious fortunes needing to express themselves for the ages.

So, what’s the big surprise?

This is it:  Investing in bonds and loans to big corporations is going to translate into surprisingly huge increases in earnings and “book value” capital at those banks and Wall Street dealers.  With the re-emergence of the CDS (Credit Default Swap) business to absorb the investment demand, the sky is once again too low a limit.

How can I tell the future like this?  Hasn’t the socialist government ruined our economy forever, according to the corporate propaganda machine that hides behind its ever-weaker disguise as “liberal” press?  Why, yes.  That’s why the stock market has been crashing all year.  That’s why junk bond issuance is nearing $200 billion, and that’s why companies are doing takeovers.  Because business is so bad.

But wait!  There’s another bubble in the making, and the boys from Wall Street are ready to ride it to the top!  Check out this Bloomberg headline:

Loan Derivatives Climb as Scarcity of Real Debt Boosts Swaps

Are they kidding me?  I fault the under-40 crowd for not knowing what a real recession feels like, and all of us for not learning the lessons of debt deflation from the Depression.  But really!  This just happened three years ago, with exactly the same song with exactly the same lyrics.

This is the tune they were singing in 2006/2007 when the ABS CDO world went crazy issuing “synthetic” CDO’s using credit default swaps because there was a shortage of lower-rated subprime mortgage bonds.

In case you forgot, those synthetic deals can be pretty funky, with all-but-unheard-of exceptions built into them that even allow the most junior bonds to get paid ahead of the most senior bonds when it is obvious to everyone that there won’t even be enough money to pay the AAA bonds.  Yikes.

It’s as if the ship is about to sink and the captain and crew saved a lifeboat for them alone, and jumped aboard before leaving the passengers to go to the bottom.

I’d certainly think twice about investing in any of these new “synthetics” if I had too much cash lying around.  At the very least, I would put examination of the moral character and history of the managers above analysis of the credit risk of the reference credits.

Either that, or I would clearly let my stakeholders know that I had allocated a big chunk of cash to “black” on the next spin of the wheel.

One thing is for sure:  If the LCDX synthetic loan index goes out near its yearly highs, every bank holding junk bonds or loans to leveraged monsters like Wrigley will print big upside surprises in their annual reports.

Those who stepped up and filled the demand with CDS will amaze us all with their profits.  The best part, for those who fill the synthetic demand is that they don’t have to tell anyone whether they traded them, how much, and whether they went long or short.  Of course, we wouldn’t want to rush into adding regulations or capital requirements to this business, since it might force some of our best and brightest to go work for those up-and-coming hedge funds in Surinam.

I’m not particularly  shocked to find out that there is gambling going on in here.  I just didn’t think the gamblers would be so quick to take up the House on its offer of credit again.



2 Responses to Practice Looking Surprised

  1. W.Kinsolving says:

    And how does the retail (read: “amateur sheep waiting to be shorn”) get in on this?

    • hhill51 says:

      Don’t worry… you won’t get in on it, it will get to you.
      If you want to slacken the demand, pull your money out of junk bond mutual funds, or at least slow down the buying.
      The invention of the CDS market allowed the banks to “create” more bonds than existed, so any amount of demand can be satisfied. Heaven help you if your dollars turn out to be the last of the demand on the upswing.

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