Author Archive

• How the Toxic Assets Were Magnified
  Eddy Elfenbein, May 3rd, 2010 at 9:28 am

  One of the interesting aspects of the financial crisis is how a relatively small sector of the mortgage housing market — subprime — was able to infect the entire financial system. The WSJ has a very good article explaining how this was done (warning, it’s a little on the wonky side):

  In a memo last week, panel Chairman Sen. Carl Levin (D., Mich.) said Goldman’s work “magnified the impact of toxic mortgages” by replicating mortgage securities in debt pools known as collateralized debt obligations as well as CDO derivatives, and also in an index that tracks subprime bonds.
  The subprime mortgages that caused big losses generally were packaged into CDOs, in which dozens of mortgage-backed bonds were pooled together and slices of the CDOs were sold to investors. Another version of these CDOs didn’t contain actual mortgage bonds but were linked to them via derivatives called credit-default swaps. Through the use of derivatives, banks created many of these synthetic CDOs using the same mortgage securities, all of which would rise or fall in value depending on how the mortgages were performing. With synthetic CDOs, those who had bet that the loans would perform well were on the hook if their performance deteriorated.
  In effect, the documents said, Wall Street was “copying and pasting” what turned out to be the worst-performing securities of the mortgage boom. Such activity helped multiply opportunities for hedge funds and traders who wanted to short the housing market, but magnified the losses of those on the other side of the trades. To short a trade, in this instance, is to bet the housing market will turn down.

  In the Washington Post, Heidi Moore takes on the silly notion that only sophisticated were hurt:

  It’s not just the big clients, however, that get hurt. What Wall Street would like to ignore when it is taking bets in its casino is that a big pile of chips on the table come from regular consumers — from their bank deposits, retirement accounts, credit-card balances, car loans and mortgages. That’s why the distinction between these sophisticated investors and everyone else is nonexistent. When Wall Street banks omit information and draw profits from “institutional investors,” that means they are taking money from your pension funds, your school endowments, and your city and state governments. Other sophisticated investors include hedge funds, which take money from those pension funds, or private-equity funds, which own companies that employ 10 percent of all Americans.
  Pension funds, for instance, are considered “sophisticated investors” on Wall Street. But those are just pools of retirement money owed to workers. The pension funds, looking to expand their stash, invest in stocks and bonds sold by Wall Street. These pension funds also give their money to other funds, such as hedge funds and private equity funds, that invest that money in riskier investments, perhaps troubled companies or distressed mortgages. Pension funds play the Wall Street game to score a healthy return — but when they lose, the money lost belongs to regular people.

• Weekend Poll
  Eddy Elfenbein, May 1st, 2010 at 5:15 pm

  In honor of May Day, here’s a weekend tax poll:
  
  

• Barron’s on Johnson & Johnson
  Eddy Elfenbein, May 1st, 2010 at 5:07 pm

  Barron’s gives some love to one of my favorite Buy List stocks, Johnson & Johnson (JNJ). Here’s an excerpt:

  One of the health-care giant’s biggest virtues is its prodigious ability to generate cash. That has helped keep its debt load low. Johnson & Johnson is one of just four U.S. industrial companies with a coveted AAA rating from Standard & Poor’s. (The others: Automatic Data Processing, Exxon Mobil and Microsoft.) At the end of 2009, the company had about $14 billion in debt, compared with shareholder’s equity of $50.6 billion. Cash flow from operations came to $16.6 billion last year, up from about $15 billion in 2008. Cash and equivalents weighed in at $15.8 billion on Dec. 31.
  The company is devoting some of its cash to its quarterly dividend, which it boosted 10.2% last month, from 49 cents a share to 54 cents — marking the 48th straight annual payout increase. At $2.16 a year, the yield is a very healthy 3.3%. Bill McMahon, president of ThomasPartners, an investment advisory firm in Wellesley, Mass., with a stake in the company, says consistent dividend increases are “a good directional signal of future returns.”
  Another priority is buying back stock. In 2007, the board authorized the repurchase of as much as $10 billion in shares; $9 billion worth has been reacquired so far.
  The cash hoard also helps Johnson & Johnson to buy companies, typically for $1 billion or less, to expand its product lines or get into new ones. For example, J&J paid $1 billion last July for an 18.4% equity stake in the biotech company Elan (ELN). In exchange, it got access to substantially all of Elan’s anti-Alzheimer’s products, including bapineuzumab, a promising drug now in Phase III trials.
  In its quest to come up with new products, Johnson & Johnson pumped nearly $7 billion into R&D last year, even as it was restructuring its operations, an action expected to trim up to $1.7 billion in annual pretax costs. The company has intensified its effort to fatten its margins, which slid in recent years as patents expired on highly profitable prescription drugs. An encouraging sign: In the first quarter, selling, marketing and administrative expenses equalled 30.5% of sales, down from 30.7% a year earlier.

• Let Greece Default?
  Eddy Elfenbein, April 30th, 2010 at 11:03 pm

  A Harvard economist says yes.

  Rather than bail out Greece, therefore, the E.U. and IMF should allow it to default. This will hurt Greece’s creditors, but those entities assumed the risk when they loaned to a country long known for its profligate ways. In contrast, a bailout forces unwitting taxpayers to foot the bill for Greece’s sins. This can only breed resentment, not to mention reduced incentives for other countries to restrain their own spending.
  If Greece does default, its economy may suffer in the short term. External credit will be scare to non-existent, so Greece will have to live within it means. This will require slashed pay-scales and benefits for civil servants and drastic cuts in the number of such jobs. It will also require the repeal of Byzantine regulation, burdensome taxes and policies that force a large fraction of the population to feed at the public trough.
  But however painful this adjustment may be, it is unavoidable if Greece wants to join the first rank of nations; current policies are unsustainable from every perspective, so the sooner Greece abandons them the better.

• Mississippi Fred McDowell
  Eddy Elfenbein, April 30th, 2010 at 2:46 pm

  It’s a gorgeous day here in our nation’s capital. I think I’ve had enough of earnings reports, Senate committees and weasely bankers for one week. I’m closing the laptop, shutting off CNBC and turning over the festivities to Mississippi Fred McDowell. Enjoy.