Sandy Leeds, 30 Quick Thoughts Learning From the Real by GarrettPendergast

VIEWS: 4 PAGES: 25

									     30+ Ideas From the Real World




McCombs Alumni Conference
Friday, March 27, 2009
Sanford J Leeds
sandy.leeds@mccombs.utexas.edu
     This Lecture is All Over the Place:
     A Tribute to Jim Nolen




McCombs Alumni Conference
Friday, March 27, 2009
Sanford J Leeds
sandy.leeds@mccombs.utexas.edu
Slide 2: Homebuyer Leverage




What was the median combined loan-to-value

for subprime purchases in 2005 and 2006?




Hints:

Median -- half the people had higher percentage
and half had a lower percentage.

"Combined Loan to Value" is different than "Loan
to Value". Combined Loan to Value includes both
the senior mortgage and the piggyback loan.

Purchase mortgages does not include refinancings.

                                    Slide 2
Slide 5: Commercial Banks




Loans                Deposits

Securities           Debt (Bonds)

Other                Equity           8%




                            Slide 5
Slide 6: LBOs Were an Arbitrage

Imagine that you can buy a company at 20X earnings and you can issue
debt at 5%:

(1) if you pay 20X earnings, that means that your "earnings yield" is 5%.
In other words, you have 5 cents of earnings for every dollar you pay.

(2) if you can borrow at 5% to buy a dollar of earnings and earn 5%,
you're even.

(3) if you can deduct the interest and cut costs, you're going to be very
profitable.

(4) since you have to put very little equity into a deal, you make high returns.


Conclusion: investors were searching for yield and that pushed up bond and
loan prices. High bond and loan prices mean that interest rates were low.
From the investor's perspective, debt was expensive and equities were
cheap (or fairly priced).

LBO funds bought what was cheap (stocks) and sold what was expensive
(bonds and loans).

                                           Slide 6
Slide 10: The U.S. Two-Step


Step 1: Invest $25 billion in Citi preferred stock.


         Let time pass.


Step 2: Convert into common equity. Use conversion price of $3.25.

         This gives US 7.69 billion shares.

         Private pfd shareholders will convert into 8.3 billion shares.


         Total shares outstanding will be 21.44 billion shares.

         We will own 36% of stock.


After the deal was announced, the stock closed at $1.50.
We had turned $25 billion into $11.5 billion.
No one complained…


Citigroup is now worth $3.

                                                Slide 10
Slide 15: Madoff's Red Flags

1. Service providers were not segregated.

2. Obscure auditors

3. Unusual fee structure.

4. Heavy family influence.

5. Feeder funds did not mention Madoff.

6. Lack of staff.

7. Extreme secrecy.

8. Blackbox strategy.

9. Market size.

10. Consistency of returns.




Source: "Madoff: A Riot of Red Flags" by Greg N. Gregoriou and Francois Serge Lhabitant.

                                            Slide 15
Slide 16: The AIG Bailout Went to Banks (Some of Which Were Foreign)


1. We’re
a
nation
of
morons.



2. Implying
that
we
should
not
be
bailing
out
foreign
counterparties
makes
no
sense.



3. This
is
the
meaning
of
systemic
risk.



4. The
real
outrage
is
that
AIG
compensated
these
counterparties
at
100
cents
on
the
dollar.



5. The
@inancial
institutions
that
dealt
with
AIG
clearly
did
not
assess
counterparty
risk.



6. The
failure
to
negotiate
settlements
with
these
counterparties
may
re@lect
poorly
on
CEO
Liddy.



7. It
took
an
inordinate
amount
of
time
to
learn
the
identity
of
the
counterparties.

8. These
counterparties
and
their
CEOs
have
lost
the
right
to
claim
that
they
didn’t
need
their

   direct
government
bailout.






                                                    Slide 16
Slide 17: AIG Reward Failure With Bonuses


1.   The
employees
have
a
contract
and
our
legal
system
is
dependent
upon
parties

     honoring
contracts.




2.   Emotionally,
there
is
something
offensive
about
paying
a
bonus
to
employees
of
a

     company
that
would
be
in
bankruptcy
but
for
the
fact
that
they
created
systemic
risk.




3.   It’s
hard
to
estimate
whether
the
loss
of
con>idence
in
contracts
is
more
signi>icant

     than
the
loss
of
trust
in
our
>inancial
system
and
our
bailouts.


4.   We’re
willing
to
break
contracts
with
the
UAW
and
we’re
ready
to
change
the
law

     concerning
mortgage
modi>ications
in
bankruptcy.




5.   The
idea
that
these
traders
are
so
talented
that
everyone
wants
them
is
a
myth.




6.   Liddy’s
comments
that
we
need
to
attract
and
retain
“the
best
and
brightest”
is
offensive.




7.   We’re
seeing
what
happens
when
the
government
rushes
in
to
do
a
bailout.




8.   Congress
called
in
the
wrong
people
to
testify.




9.   This
$165
million
is
.1%
of
our
AIG
bailout.


Slide 18: The House Passed a Bill Allowing for 90% Taxation of Bonuses
   If Household Income > $250K and You Work at Fin'l Institution
   That Has Received $5 Billion


1. This
sounds
very
similar
to
passing
a
law
making
an
earlier
“legal
act”
illegal.





2. Institutions
could
avoid
this
tax
by
repaying
the
government.




3. The
speed
with
which
this
bill
has
been
written
and
passed
is
alarming.


   
­­
a
simple
example
of
the
lack
of
logic


4. This
bill
may
continue
to
destabilize
our
Dinancial
system
and
our
markets.




5. The
government
may
have
reduced
the
chance
that
we
will
recover
money
   
from
the
banks
we
bailed
out.




6. Ironically,
the
Merrill
Lynch
bonuses,
which
started
the
bonus
backlash,
would

   not
be
taxed
under
the
House
bill.



                                               Slide 18
Slide 19: Market Cap Weight the S&P 500 Earnings

We follow the S&P earnings in order to estimate whether
the market is expensive or cheap.

Each company's earnings are treated the same.

In the index, however, stocks with large market capitalization
have more importance.

We should do the same with earnings -- weight them by
importance to the index.


Imagine you have 9 companies that combine to make $100 billion.
A tenth company is in the process of failing and loses $100 billion.
The tenth market cap is close to zero.

Do you think that the earnings of the S&P are closer to zero or $100 billion?


Because of limited liability, the answer is $100 billion.


                                          Slide 19
Slide 20: DJIA

COMPANY NAME         WEIGHT PCT   CLOSE              COMPANY NAME WEIGHT PCT   CLOSE
IBM                       10.11   98.71              Merck & Co. Inc.   2.87   27.98
Exxon Mobil Corp.          7.23   70.53              AT&T Inc.          2.76   26.92
Chevron Corp.              7.09   69.15              Home Depot Inc.    2.38   23.25
McDonald's Corp.           5.65   55.16              Kraft Foods        2.37   23.15
Johnson & Johnson          5.45   53.23              DuPont             2.29   22.33
Wal-Mart Stores Inc.       5.27   51.48              Walt Disney Co.    1.94   18.92
3M Co.                     5.05   49.32              Microsoft Corp.    1.88   18.33
Procter & Gamble           4.89   47.74              Intel Corp.        1.59   15.52
Coca-Cola Co.              4.52   44.14              American Express   1.49   14.56
United Technologies        4.45   43.48              Pfizer Inc.        1.44   14.02
Boeing Co.                 3.64    35.5              General Electric   1.07   10.43
Hewlett-Packard            3.20   31.19              Bank of America    0.80     7.8
Verizon                    3.18   31.07              Alcoa Inc.         0.76     7.4
Caterpillar Inc.           3.04   29.63              General Motors     0.34    3.35
JPMorgan Chase             2.96   28.86              Citigroup Inc.     0.32    3.13


If the five highlighted stocks went to zero, the DJIA would drop 3.29%.

That would be a drop of 250 points.




                                          Slide 20
Slide
Sources


Slide
1         optionarmegeddon.com

Slide
3         Used
with
permission
from
sandp.com,
a
Web
Site
Standard
&
Poor's

Slide
11        
David
Hunkar,
"Never
Ending
Vicious
Cycle"

Slides
12
‐
13 www.agoraKinancial.com

Slide
14        directorblueblogspot

Slide
15        "Madoff:
A
Riot
of
Red
Flags"
by
Greg
N.
Gregoriou
and
Francois
Serge
Lhabitant.

Slide
22        Plexus
Asset
Management



If
you
would
like
to
be
on
my
email
list
(to
receive
weekly
updates
about

9inancial
issues),
send
me
an
email
at
sandy.leeds@mccombs.utexas.edu
.




                                                  Slide Sources

								
To top