The carpenter and his tools

It's a poor carpenter who blames his tools for a shoddy job.

May 21 (Bloomberg) -- Moody's Investors Service said it's conducting ``a thorough review'' after the Financial Times reported that a computer error was responsible for Aaa ratings being assigned to complex debt securities that slumped in value.

In an up market the glitch is called a "feature." In a down market the glitch is called a "bug."

Banks obtained the highest grades in 2006 and 2007 for constant proportion debt obligations, funds sold in Europe that used borrowed money to speculate on an improvement in credit quality. The subprime crisis caused banks including UBS AG and ABN Amro Holding NV to unwind their CPDOs, triggering losses of as much as 90 percent for investors.

Some senior staff at Moody's were aware in early 2007 that CPDOs rated Aaa the previous year should have been ranked as many as four levels lower, the FT reported today, citing internal Moody'sdocuments. The firm adjusted some assumptions to avoid having to assign lower grades, the paper said.

Senior staff was aware of the problem, but when the moneytrain is rollin' few are brave enough to point out that the wheels look loose and might be in danger of falling off.

`If it is true, does that mean other products haven't been rated correctly?'' said Puneet Sharma, Barclays Capital's head of investment-grade credit strategy in London. ``Will they be downgraded? It could lead to turmoil.''

Rest easy Puneet, surely this is an isolated incident.

Moody's and Standard & Poor's stripped CPDOs of their Aaa grades this year as rising defaults in the U.S. housing market increased the cost of credit-default swaps referenced by the funds by as much as 670 percent in the past year.

Guess there's no penalty for piling on at this point.

``The integrity of our ratings and rating methodologies is extremely important to us, and we take seriously the questions raised about European CPDOs,'' New York-based Moody's said in an e-mailed statement. ``We are therefore conducting a thorough review of this matter.''

I love it when hookers talk about integrity, especially when they still have lastnight's mascara and lipstick smeared all over their face.

Moody's has ``adjusted its analytical models on the infrequent occasions that errors have been detected,'' the statement said. ``It would be inconsistent with Moody's analytical standards and company policies to change methodologies in an effort to mask errors.''

Computer glitches aside, it never ceases to amaze me how these supposedly brilliant builders of analytical models account for the possibility of a black swan event occurring by just tossing out the possibility. And since Wall St. is ruthlessly efficient when it comes to sucking up all the best talent that money can buy, it occurs to me that the programmers working for ratings agencies are not necessarily the best and brightest.

Where the rubber meets the pavement

Ever since environmentalism became a shibboleth of the left, and therefore the Democrats, I have wondered how they would react when the time came to reconcile their actions with their purported beliefs. It appears I will not have to wonder much beyond the DNC in Denver this summer:

Caterers find eco-standards tough to chew

Fried shrimp on a bed of jasmine rice and a side of mango salad, all served on a styrofoam plate. Bottled water to wash it all down.

These trendy catering treats are unlikely to appear on the menu at parties sponsored by the Denver 2008 Host Committee during the Democratic National Convention this summer.

Fried foods are forbidden at the committee's 22 or so events, as is liquid served in individual plastic containers. Plates must be reusable, like china, recyclable or compostable. The food should be local, organic or both.

How are we ever going to make the shift from fossil fuel to vegetable oil power if fried food is forbidden? That's a serious question I keep meaning to ask somebody with a "powered by vegetable oil" sticker proudly displayed on their bumper.

And caterers must provide foods in "at least three of the following five colors: red, green, yellow, blue/purple, and white," garnishes not included, according to a Request for Proposals, or RFP, distributed last week.

...All the pretty colors of the rainbow.
Reading this far I was reminded of the first Burning Man theme camp planning meeting I attended a few years ago. We had settled on a genie-type theme and purchased a used golf cart we intended to turn into an art car. One of my camp mates proposed turning the golf cart into an elaborate motorized genie bottle and she had done some nice sketches to show us what she had in mind. We all agreed that it looked great, then somebody asked her for a list of materials and a rough outline of the building plan so we could get started. Her confusion over the question turned to slight irritation when she realized that not only did she not have any specs, we weren't going to do it all for her. The vision quickly turned to dust.
I imagine the person who was tasked with creating the DNC catering RFP is similar to my idealistic camp mate that year.

The shrimp-and-mango ensemble? All it's got is white, brown and orange, so it may not have the nutritional balance that generally comes from a multihued menu.

"Blue could be a challenge," joked Ed Janos, owner of Cook's Fresh Market in Denver. "All I can think of are blueberries."

Ed nails it. Blueberries being the only exception that immediately springs to mind, every first year culinary student knows that putting blue on a plate is a cardinal sin.

Caterers praise the committee and the city for their green ambitions, but some say they're baffled by parts of the RFP.

"I think it's a great idea for our community and our environment. The question is, how practical is it?" asks Nick Agro, the owner of Whirled Peas Catering in Commerce City. "We all want to source locally, but we're in Colorado. The growing season is short. It's dry here. And I question the feasibility of that."

Agro's biggest worry is price. Using organic and local products hikes the costs.

"There is going to be sticker shock when those bids start coming in," he says. "I'll cook anything, but I've had clients who have approached me about all-organic menus, and then they see the organic stuff pretty much doubles your price."

Mr. Agro,

Please resist the urge to use words like "practical" and "feasibility", for they have no meaning in the eco-lexicon. Just make it happen, and if you're not prepared to put the good of our planet above your personal profits, we will find somebody that does.

Signed, DNC

P.S. we've noted your propensity to question authority, and we're not happy, but we'll address your insouciance after the convention.

The document, which applies only to the host committee's parties, came after months of work that involved discussions with caterers and event planners along the Front Range, says Parry Burnap, Denver's "greening" director.

Months of work filled by many, many hours spent in committee and sub-committee meetings to come up with the RFP. There's nothing bureaucracy loves more than more bureaucracy.

Thousands of other parties hosted by corporations, lobbying groups, individuals, nonprofits and more will happen in Denver during the convention, Burnap says. None of them is subject to the committee's green agenda.

The committee's effort to host eco-friendly events, she says, hinges on its determination not just to put on a smart convention but to transform Denver into a top-shelf green city.

What's a law without a gaping loophole afterall? I hope somebody keeps score of all the non-conforming parties that take place and who hosted them.

"We are hoping that everything we are doing for greening (the convention) has some legacy value," she says.

The RFP, for example, will likely live on after the convention in a brochure the city will distribute widely to help guide local businesses interested in improving their green practices.

It will have legacy value alright. My guess is that the DNC will host a small handful of perfectly "eco-friendly" parties and showcase them as the rule rather than the exception.

Burnap says taking the organic and local route may be more costly, but the committee thinks caterers will find ways to comply and still make a profit.

"It takes some creativity because some of these things are more expensive," she says. "But we're at the front end of a market shift."

One of two things will happen. The caterers will sacrifice a large percentage of their profit margin and "make it happen" for the "greater good" or they will cheat and charge organic prices for non-organic products. Most people are not able to tell when a filet mignon has been replaced with an "eye of round" which is a much cheaper cut of meat, for example. Who will be able to tell if the avocados used in the guacamole are organic or not? Catering is hard work fraught with unforeseen hassles and much pressure in order to put out a quality product that the clients are unlikely to even fully appreciate. I would be shocked if any caterer that was not independently wealthy would sacrifice any part of their already slim profit margin. Cheating would be far easier, especially when the theme is all a pose in the first place.

Joanne Katz, owner of Three Tomatoes Catering in Denver, cheers the committee's environmental aspirations and is eager to get involved with the convention, but she wonders if some of the choices the committee is making are really green.

Compostable products, such as forks and knives made from corn starch, are often imported from Asia, delivered to the U.S. in fuel-consuming ships. But some U.S. products are made from recyclable pressed paper. Which decision is more environmentally sound?

"Customers are beginning to demand these things, and we don't have all of the information," she says. "And we are doing the best we can, one project at a time."

Ms. Katz,

Your wondering is troubling. We will deal with you after the convention, too.

Signed, DNC

Burnap acknowledged that figuring out what is most green can be difficult.

"Maybe in 20 years, there will be better analysis for us to make better choices," she says. "One we are talking about now is, is it better to compost or to recycle? If you are using a cup for a beverage, is it better to be (plastic) and back in the materials stream, or compostable, biodegradable waste and go into the waste stream or compost? There are no definitive answers."

Composting for the convention hasn't been entirely figured out yet, she says.

What a wonderful nation we live in; where the greatest problem of the moment seems to be whether it is better to compost or to recycle? I wonder what a typhoon survivor in Burma, or an earthquake survivor in China, or a Darfur refugee, or, or, or--thinks is the biggest problem of the day?

The committee is working with other groups to develop a carbon-footprint "calculator" that will measure the environmental impact of each event and suggest an "offset" — a fee — that will go toward a fund helping to match carbon losses with carbon gains.

"That's a fun one," Burnap says. "If these event planners will calculate and offset, it will start to get the money flowing into the Colorado Carbon Fund, a fund that will reinvest in renewable energy here in Colorado."

Whoooopppieeeee! Boy I know nothing gets my motor revved quite like carbon-footprint calculations. Next up, a self-administered root canal sans novicane!

I hope they don't plan on encouraging people to walk around Denver during the convention, since it has been proven in the U.K. that walking kills the planet.

The only advice I can give to the caterers of Denver is to get all of your money up front, in cash.

The two faces of Citigroup

Banks, like all businesses outside of the non-profit realm, are in the business of making money. The difference between banks and most other businesses is that banks do not create anything tangible. Of course they make tangible products possible by providing financing for companies that do actually create things, but the value in a bank resides in the intellectual capital of its workforce.
Any industry that promotes the promise of a big payday tends to attract the most clever among us, and there is no shortage of clever people on Wall Street. It is safe to say that if it is possible to squeeze a dollar out of a rock, lever it to return $100 and charge 20% for the service, Wall Street has come up with 25 ways to do it.
Auction rate securities (ARS) are one of the many inventions of Wall Street. Pitched to municipalities, port authorities, school districts and other entities that don't always grasp the full meaning of caveat emptor, they were assumed to be as "safe as cash" while providing a little extra yield. Like many things that work great until they don't, it turns out ARS aren't exactly as safe as cash.

Citigroup Leads Wall Street Drive to Hurt Taxpayers

May 9 (Bloomberg) -- Taxpayers from Massachusetts to California are paying Wall Street banks to end derivative contracts gone bad as they exit the collapsing auction-rate bond market, with penalties in some cases topping $10 million and compounding the pain of rising borrowing costs.

Sacramento County, California, paid Morgan Stanley $5 million to cancel an interest-rate swap agreement when it refinanced $79.5 million in auction-rate securities last month. The fee added to the cost of the bonds after the rate on the securities more than doubled to 9.8 percent in March as dealers stopped supporting the market.

As you may have heard, there's a home price melt down going on out there. Sacramento County is one of the hardest hit areas in the nation. This is good news for those who have been patiently saving towards a down payment on a starter home. It is not so good news for a county government with a declining tax base. Can Sacramento County really afford an extra $5million just to cancel a deal gone bad?

States, cities, hospitals and colleges face penalties exceeding $10 million to terminate swaps that failed to protect them against higher rates, according to interviews with borrowers and advisers. That's on top of the $1 billion in fees they're paying to dealers to help sell bonds that would replace auction-rate securities they sold, based on industry averages.

Citigroup, based in New York, was the top underwriter of auction-rate securities in the municipal market, arranging $55 billion in sales between 2000 and the end of last year, according to data compiled by Thomson Reuters. Zurich-based UBS AG, which said on May 6 it will close or sell its municipal bond department, underwrote $42 billion, followed by Morgan Stanley of New York at $22 billion and 19 others.

The banks are earning fees on both sides of the trade and us taxpayers are footing the bill. That's a nice hedge if you're the bank.

All this is just a drop in the bucket though:

Citigroup Plans to Shed About $400 Billion of Assets

May 9 (Bloomberg) -- Citigroup Inc. Chief Executive Officer Vikram Pandit plans to get rid of about $400 billion of assets over the next three years as he starts to whittle away at the company built by Sanford``Sandy'' Weill.

When he's done, Citigroup may cease to be the biggest U.S. bank, a title the firm has held for a decade. ``There will be more'' divestitures, Pandit told shareholders at a meeting today at the bank's New York headquarters.

The company, which lost $5.1 billion in the first quarter, has booked more than $40 billion of credit losses and writedowns since the subprime mortgage market collapsed last year. The shares dropped in New York trading today, as analysts said they were unimpressed by Pandit's proposals for returning to profitability.

What is it that causes some of the most clever people in the world to rack up such huge losses?
Besides being the most lucid resident of Berkeley, Michael Lewis, author of the famous Wall St. book Liar's Poker, remains one of my favorite columnists. He has this to say:

To both their investors and their bosses, Wall Street firms have become shockingly opaque. But the problem isn't new. It dates back at least to the early 1980s when one firm, Salomon Brothers, suddenly began to make more money than all the other firms combined. (Go look at the numbers: They're incredible.)

The profits came from financial innovation -- mainly in mortgage securities and interest-rate arbitrage. But its CEO, John Gutfreund, had only a vague idea what the bright young things dreaming up clever new securities were doing. Some of it was very smart, some of it was not so smart, but all of it was beyond his capacity to understand.

Ever since then, when extremely smart people have found extremely complicated ways to make huge sums of money, the typical Wall Street boss has seldom bothered to fully understand the matter, to challenge and question and argue.

New New Thing

This isn't because Wall Street CEOs are lazy, or stupid. It's because they are trapped. The Wall Street CEO can't interfere with the new new thing on Wall Street because the new new thing is the profit center, and the people who create it are mobile.

Anything he does to slow them down increases the risk that his most lucrative employees will quit and join another big firm, or start their own hedge fund. He isn't a boss in the conventional sense. He's a hostage of his cleverest employees.

There's an aphorism that states, "you can't cheat an honest man." It means that in order for a scheme to work, the one being solicited for the deal needs to feel like they're getting something for nothing. In the case of ARS, the purchasers thought they were getting a debt instrument as safe as cash but with a higher yield. Just as many of the most clever among us end up on Wall St, many of the not-so-clever among us end up in government, especially local government.

The late, great Milton Friedman had this to say:

There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, why then you really watch out what you’re doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I’m not so careful about the content of the present, but I’m very careful about the cost. Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m sure going to have a good lunch! Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government. And that’s close to 40% of our national income.

So there you have it. Clever people fleecing not-so-clever people spending money that doesn't belong to them. I have a feeling that the other industry that attracts clever people in search of riches, the law industry, will make out OK in all this too.

And some believe we should have higher taxes...

Level 3 Asset Watch

DJ Merrill Level 3 Assets $82.4B At 1Q End, 8% Of Total Assets
Tuesday, May 06, 2008 4:37:57 AM (GMT-07:00)

Merrill Lynch & Co. (MER) said Tuesday that its Level 3 assets at the end of the first quarter increased nearly 70%, to $82.4 billion, from $48.6 billion at the end of the fourth quarter.
The Wall Street firm said the Level 3 assets, which include assets measured at fair value on a recurring and non-recurring basis, increased because of the recording of trading assets, for which the exposure was previously recognized as derivative liabilities at the end of the fourth quarter.
The company said it also transfered $5.6 billion of European commercial real estate mortgage loans into level 3 that had previously been classified in Level 2.
"During the first quarter of 2008, there was a decrease in the liquidity for these products, resulting in the increased use of unobservable inputs to derive their fair value," Merrill said.
In its quarterly report filed with the Securities and Exchange Commission, Merrill said Level 3 assets as a percentage of total assets amounted to 8% at the end of the first quarter, compared with 5% at the end of the fourth quarter.

In an earlier post I talked about level 3 assets as the bucket that banks dump the stinkiest of their dirty laundry into. Management literally guesses what the asset is worth and assigns it that value. Here's an interesting screenshot that captures the current top 18 companies sorted by their level 3 assets:




Merrill is number 3 at the moment. Citigroup and Goldman Sachs own the number 1 and 2 spots respectively. The question that continues to nag me is if by definition level 3 assets are assigned a best guess value in the first place, how can we take seriously what a company says they have in their level 3 bucket? Where's the tipping point?

If it were not for financial institution convertible security secondary offerings floated to shore up their sick balance sheets, investment bankers would have little to no business to speak of so far this year. That would make their balance sheets look even worse.

I see more writedowns to come.

Global Warming Mulligan #1

In this crazy, mixed up, topsy-turvy world--where anything can cause everything, or even nothing at all--it makes perfect sense that a cooling trend can be interpreted as further evidence that man is causing global warming.

Ocean Cooling to Briefly Halt Global Warming, Researchers Say

April 30 (Bloomberg) -- Parts of North America and Europe may cool naturally over the next decade, as shifting ocean currents temporarily blunt the global-warming effect caused by mankind, Germany's Leibniz Institute of Marine Sciences said.

Average temperatures in areas such as California and France may drop over the next 10 years, influenced by colder flows in the North Atlantic, said a report today by the institution based in Kiel, Germany. Temperatures worldwide may stabilize in the period. `

`Those natural climate variations could be stronger than the global-warming trend over the next 10-year period,'' Wood said in an interview. ``Without knowing that, you might erroneously think there's no global warming going on.''

Germany's universities have been going downhill since they quit charging tuition; arguably longer. I assume that the Leibniz Institute of Marine Sciences is staffed by many graduates of German universities. But honestly, is "don't believe your lyin' eyes" the best they can offer the world?

``Natural variations over the next 10 years might be heading in the cold direction,'' Wood said. ``If you run the model long enough, eventually global warming will win.''

Yes, Dr. Wood, and if you ran your model even longer, I bet global cooling would win. Variations in global temperature is the nature of, er, global temperature variation afterall. By the way, what does global warming win?

Here's my favorite part:

``We thought a lot about the way to present this because we don't want it to be turned around in the wrong way,'' Keenlyside said. ``I hope it doesn't become a message of Exxon Mobil and other skeptics.''

Cause, like, only shills for BIG OIL don't believe in global warming.




This is a picture of Palm Jumeirah, which is a man-made luxury island just off the coast of Dubai. It has more than doubled the waterfront area of Dubai and created luxury homes for thousands of people. I was reading an industry report today from a well-known investment bank and it stated that there is estimated to be $1.5 trillion invested in Dubai and the greater surrounding area over the next 5 years. Dubai, is at sea-level. I wonder how serious those who are going to invest $1.5 trillion at sea-level consider the imminent threat of rising tides due to anthropogenic global warming?

I hope Al Gore is translating "An Inconvenient Truth" into Arabic. Who else can save them from themselves?