The Merry-go-Round Continues

Well I have just finished my fourth week of work or as my wife describes it, day 20 in the Big Brother House. After two and a half years it was quite a shock, although not in the way that one might think. If we used to joke that the most common refrain of the retired was "No time, no time" and at the time I wondered how I had ever found the time to actually work, I am now in the reverse position where I don't quite understand where I am to find the time to "live"!

Twelve hour days in which I have to have a close eye on markets and restructure/rebuild and create a new paradigm for the fixed income markets which find themselves in the middle of a "back to the future" mindset is both a physical and intellectual challenge.

So what do i mean with my "back to the future" quote.

It's actually very simple. The large investment banks have had a relatively easy ride for the last two and a half years. After receiving the national bailouts so necessary and yet so decried by the Republican party, despite the fact that the TARP plan and Quantitative Easing were first instituted under Messrs Bush and Paulson, the banks had their funding costs cut to zero allowing them to essentially play a carry game.

Carry in this sense just means that they would fund overnight at .5% and invest in longer term AAA government assets that yielded 2.5-3%, depending on the maturity of the security purchased, and clear 2-2.5% "carry" profit. Add to that the positive effects on the market place and the yield curve of QE I and II and they not only accrued carry p&l, they also made capital gains on their positions.

So where are we today. With the introduction of Basle III and the more stringent requirements for Capital levels and risk weightings in assets held on bank balance sheets there was plenty for bankers to complain about. The most comment complaint was the projected decrease in profitability as a result of regulatory enforced deleveraging due to the increased capital requirements.

Of course at the same time it opened up a whole new business of unwinding bank portfolios which held securities that were no longer capital efficient under Basle III.

And not surprisingly, the creation of these portfolios, especially .the use of AAA rated CDO's, was as a result of Basle II.

I have always maintained that the change in the calculation of risk weightings, essentially going to a rating agency based methodology was one of the prime causes for the eventual credit crisis.

What is disturbing, but completely understandable is that the introduction of Basle III addresses some of the problems inherent in Basle II, and equally importantly, opens up the door to the massive unwinding of portfolios by the commercial banks who are basically distressed sellers of assets that in and of themselves are not necessarily distressed assets.

It just means that a new account base has to be found that is not subject to the same risk-weighted capital calculations as the banks. And, again unsurprisingly, it is the Hedge Funds and CDO managers who end up buying back assets at fire sale prices which they had previously sold to the bank as bull market prices.

And just to ensure that the circus continues, the insurance industry is in the throes of dealing with Solvency 2 requirements which will force them to restructure their portfolios predicated on capital efficiency, which is supposed to relate to creditworthiness.....

So were CDO'2.