From New York to Nicosia

From Nuriel Roubini’s blog

Here are two examples of how uncertainty and opacity has vastly increased in financial markets.

First, you take a bunch of shaky and risky subprime mortgages and repackage them into residential mortgage backed securities (RMBS); then you repackage these RMBS in different (equity, mezzanine, senior) tranches of cash CDOs that receive a misleading investment grade rating by the credit rating agencies; then you create synthetic CDOs out of the same underlying RMBS; then you create CDOs of CDOs (or squared CDOs) out of these CDOs; and then you create CDOs of CDOs of CDOs (or cubed CDOs) out of the same murky securities; then you stuff some of these RMBS and CDO tranches into SIV (structured investment vehicles) or into ABCP (Asset Backed Commercial Paper) or into money market funds. Then no wonder that eventually people panic and run – as they did yesterday – on an apparently “safe” money market fund such as Sentinel. That “toxic waste” of unpriceable and uncertain junk and zombie corpses is now emerging in the most unlikely places in the financial markets.

Second example: today any wealthy individual can take $1 million and go to a prime broker and leverage this amount three times; then the resulting $4 million ($1 equity and $3 debt) can be invested in a fund of funds that will in turn leverage these $4 millions three or four times and invest them in a hedge fund; then the hedge fund will take these funds and leverage them three or four times and buy some very junior tranche of a CDO that is itself levered nine or ten times. At the end of this credit chain, the initial $1 million of equity becomes a $100 million investment out of which $99 million is debt (leverage) and only $1 million is equity. So we got an overall leverage ratio of 100 to 1. Then, even a small 1% fall in the price of the final investment (CDO) wipes out the initial capital and creates a chain of margin calls that unravel this debt house of cards. This unraveling of a Minskian Ponzi credit scheme is exactly what is happening right now in financial markets.

So combine an opaque and unregulated global financial system where moderate levels of leverage by individual investors pile up into leverage ratios of 100 plus; and add to this toxic mix investments in the most uncertain, obscure, misrated, mispriced, complex, esoteric credit derivatives (CDOs of CDOs of CDOs and the entire other alphabet of credit instruments) that no investor can properly price; then you have created a financial monster that eventually leads to uncertainty, panic, market seizure, liquidity crunch, credit crunch, systemic risk and economic hard landing. The last two asset and credit bubbles in the US – the S&L real estate bubble and bust of the late 1980s and the tech stock bubble of the late 1990s – ended up in painful recessions. The latest credit and asset bubble was much bigger: housing, mortgages, credit, private equity and LBOs, credit derivatives, corporate re-leveraging. So, the current bust and de-leveraging of the financial system is likely to lead to another painful economic hard landing.

Scientists crack levitation, for goodness sake’s.

From the Telegraph

Levitation has been elevated from being pure science fiction to science fact, according to a study reported today by physicists.

In earlier work the same team of theoretical physicists showed that invisibility cloaks are feasible.

Now, in another report that sounds like it comes out of the pages of a Harry Potter book, the University of St Andrews team has created an ‘incredible levitation effects’ by engineering the force of nature which normally causes objects to stick together.

Professor Ulf Leonhardt and Dr Thomas Philbin, from the University of St Andrews in Scotland, have worked out a way of reversing this pheneomenon, known as the Casimir force, so that it repels instead of attracts.

…

The force is due to neither electrical charge or gravity, for example, but the fluctuations in all-pervasive energy fields in the intervening empty space between the objects and is one reason atoms stick together, also explaining a “dry glue” effect that enables a gecko to walk across a ceiling.

Now, using a special lens of a kind that has already been built, Prof Ulf Leonhardt and Dr Thomas Philbin report in the New Journal of Physics they can engineer the Casimir force to repel, rather than attact.

….

Micro or nano machines could run smoother and with less or no friction at all if one can manipulate the force.” Though it is possible to levitate objects as big as humans, scientists are a long way off developing the technology for such feats, said Dr Philbin.

The practicalities of designing the lens to do this are daunting but not impossible and levitation “could happen over quite a distance”.

Well, well. No surprise here. Cerberus is not showing up to play nicey-nicey with the UAW, all positive commentary from the past to the contrary. Nardelli as the CEO is a very explicit cost-cutting message. We will see how happy the unions end up being with this new owner.

To me this is the most interesting private equity deal of the year. Either Cerberus can slash and flip in which case this will be a legendary transaction up there with Bonderman and Continental or the UAW will make its last stand and bring this whole thing crashing down. I am taking as a given that Cerberus is not going to turn Chrysler into Toyota, take a 20 year strategic approach to the business and redesign the whole culture from scratch.

As before I continue to be awed at the free pass Daimler’s management is getting for: a) buying at the peak of a hit-driven company in a cyclical industry, b) selling at the bottom, c) being too weak to do what Cerberus will now do and c) destroying $36B of shareholder value along the way. That is colossal, Time Warner-AOL style value destruction, but they seem to be getting not that much heat for it.

Good overview from Edmunds

Even before the party celebrating Chrysler’s divorce from Daimler and its marriage to private equity firm Cerberus Capital Management Corp. begins for employees today, the party is over.

Last night’s announcement that the controversial former CEO of Home Depot Bob Nardelli is Chrysler LLC’s new chairman and CEO is an indication that business as those at Chrysler have known it is over.

Despite all of its claims of patience, being in for the long haul and seeming compassion, Cerberus has sent the clear message that it intends to move quickly — and likely ruthlessly — to turn Chrysler around. In fact, Nardelli’s compensation requires it.

No more Mr. Nice Guy.

Selection of Nardelli: Cost-cutting expansionist

While the appointment of Nardelli take the helm of the New Chrysler initially came as a shock to many in the industry, it shouldn’t have.

With the first private equity firm owning a car company, business will not be as usual, and neither will those who will run the business. Already, Ford went to the outside, tapping former Boeing executive Alan Mulally to run the troubled automaker.

Cerberus obviously found Nardelli attractive because of his capability in expanding a business and his cost-slashing expertise.

In its statement, Cerberus credited Nardelli, who headed The Home Depot, from 2000 to January 2007, with doubling sales as well as the number of store operations, moving globally into Mexico and China, and delivering more than 20 percent earnings-per-share growth for four consecutive years while growing dividends from 16 cents to 90 cents per share. Nardelli also has extensive senior operations experience in manufacturing and transportation, the statement noted.

Jim Grant on Grant’s Interest Rate Observer in a fantastic interview.

Not sure how to link to it directly. Paul Kedrosky has it on his blog.

From Jeremy Grantham’s quarterly letter. Register at GMO.com to get all of their commentary… Now he has always been a bear, but it looks like he is about to vindicated…GMO’s long-term record is remarkable. The letter is being passed around. Paul Kedrosky posts it too.

The Anti-risk Bet in Perspective:
A Once or Twice in a Career Opportunity

In 40 years I believe I have been offered three obvious and extreme opportunities to make or at least save money. The first in 1974 was presented by the extreme undervaluation of small cap stocks in absolute terms – many were below 5xearnings and even more yielded over 10%. And compared to the Nifty Fifty – the great high quality franchise stocks– they were almost ludicrously underpriced.

The second opportunity was in 1999 and 2000 when the extraordinary overpricing in absolute terms of growth stocks, especially technology and the internet, meant that in round numbers everything else was relatively reasonable and some assets, notably real estate and U.S. TIPS, were simply very cheap, even in absolute terms.

Well the third great opportunity is now upon us in my opinion, and that is anti-risk. It is almost certainly the most important of the three because of its diffusion across assets and countries. That is the good news, for most of the time we have to make do with modest opportunities and this one is the real McCoy. The bad news is that for equity managers the first two opportunities were easy to spot and easy to execute. Anti-risk in comparison is a diffused and complicated opportunity, and is as much or more in fixed income with all its new complexities as it is in equities.

The ideal way of playing this third great opportunity is perhaps to create a basket of a dozen or more different anti-risk bets, for to speak the truth none of us can know how this unprecedented risk bubble with its new levels of leverage and new instruments will precisely defl ate. Some components, like subprime and junk bonds, may go early and some equity risk spreads may go later. Some will prove unexpectedly rewarding and some, no doubt, will be disappointingly modest. Such uncertainties would be moderated by a complicated package approach. It will not be very easy, but some of the best hedge funds will, I’m sure, pull it off even as most of them pay the price for too much risk taking. Where we have the funds, the mandates, and the skill we will also try our very best to capture the spirit of the exercise. To conclude, I have been trying to come up with a simple statement that would capture how serious the situation is for the overstretched, overleveraged financial system, and this is it: In 5 years I expect that at least one major “bank” (broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private equity firms in existence today will have simply ceased to exist.

I have often been too bearish about the U.S. equity markets in the last 12 years (although bullish on emerging equity markets), but I think it is fair to say that my language has almost never been this dire. The feeling I have today is that of watching a very slow motion train wreck.