Saturday, July 12, 2008

Rant II

Fundalarm is an amusing and informative site that provides sometimes caustic and usually very reliable information about mutual funds and the investment services industry. The "highlights and commentary" page they offer is updated on the first of every month. I just got around to checking the July edition this afternoon. Along with critiques of some failing investment funds and information about new fund offerings on the horizon, David Snowball (can that be his real name?) offers these tidbits on the state of equity fund investing:

Investors in the red-hot Chinese markets are feeling especially cursed. Oberweis
China Opportunities with +80% and +60% returns in the last two years has rewarded shareholders with a 35% loss so far in 2008. Several dozen funds have fared even worse...

Ultra-the-wrong-sector funds: It turns out that owning a leveraged financial sector fund is twice as horrible right now as owning a financial sector fund. But not nearly so horribly as owning . . .

India funds: These latest bright ideas from the fund marketers have been whacked for losses of between 35-45% so far this year.

Now everybody in India and China may be just whiners or they may suffer from a pernicious psychological malaise, but I doubt it. Fundalarm's numbers, by the way, are more current than what I blogged about earlier. They refer to declines suffered in the first half of 2008.

While we may not technically be in a recession as the dismal scientists define such things, the situation for us middle class types ain't at all rosy. In fact, I've been more than a little tempted to swear (not whine, mind you) as I've watched significant chunks of savings disappear from our retirement accounts in recent months. Here's a guy who plays by the rules. Saves and invests. Does what financial gurus say is smart. Actually researches his options so he can make an informed choice. Weighs the relative merits of growth, value, and dividends. Reads up on NAV's, ROA's, EBITDA's, P/E ratios, and a buncha shit like that.

And SPLAT. The financiers juggling CDOs and CMOs and what the business pages of the NY Times persist in calling "complex derivatives and mortgage-based financial instruments" outsmart themselves causing a general miasma to descend on the market while gubment
regulators and bond rating corporations sit on their thumbs and hum ditties about the wisdom of the markets and letting the market run its course and regulation is bad for the economy and de-doo-do-do de-daa-da-da in the immortal words of the Police.

Here's a good one: A synthetic collateralized debt obligation. Here's the Forbes-sponsored Investopedia's explanation:

A form of collateralized debt obligation (CDO) that invests in credit default swaps (CDSs) or other non-cash assets to gain exposure to a portfolio of fixed income assets. Synthetic CDOs are typically divided into credit tranches based on the level of credit risk assumed. Initial investments into the CDO are made by the lower tranches, while the senior tranches may not have to make an initial investment.

All tranches will receive periodic payments based on the cash flows from the credit default swaps. If a credit event occurs in the fixed income portfolio, the synthetic CDO and its investors become responsible for the losses, starting from the lowest rated tranches and working its way up. Synthetic CDOs are a modern advance in structured finance that can offer extremely high yields to investors. However, investors can be on the hook for much more than their initial investments if several credit events occur in the reference portfolio.

Synthetic CDOs were first created in the late 1990s as a way for large holders of commercial loans to protect their balance sheets without actually selling the loans and potentially harming client relationships. They have become increasingly popular because they tend to have shorter life spans than cash flow CDOs and there is no extended ramp-up period for earnings investment. Synthetic CDOs are also highly customizable between the underwriter and investors. into the CDO are made by the lower tranches, while the senior tranches may not have to make an initial investment.

Got that? It's a financial instrument based on financial instruments based on financial instruments based on a bundle of loans. (I don't think I left a layer out.) These guys were selling shit like that to each other as a matter of course. The trouble was it turned out a lot of it was backed by lousy loans. Turns out a "credit event" occurred. In fact, LOTS of credit events occurred. Gotta love those credit events. Now there are a passel of CDOs out there (synthetic or otherwise) that nobody knows how to value.

And I lose money.

McCain said in an interview today that his presidential role model is Teddy Roosevelt. It was TR, during his trust-busting period, who spoke of "malefactors of great wealth." Allowing the unregulated -- or barely regulated -- financial system to continue to operate as it has operated will guarantee more of the same. More malefactors of great wealth. There is a reason for regulation in the market. That's why Dr. Phil's dumbass comments the other day were so amazingly off pitch. Deregulation made this happen.

His era has come to an end.

1 comment:

Morse said...

That is an example of some very fine blogging. Kudos!