continualevolution's posterous

WSJ: credit freeze impact

[high anxiety chart]
Credit markets essentially run on confidence. Buyers of debt are lenders and they expect to get paid back, with interest. When companies fail and debts go unpaid, lenders get nervous. In usual circumstances, the lenders will simply charge higher rates and set tougher conditions for loans.

Adding to the lack of confidence: Nobody knows how bad things could get or how much bad debt remains in the system. Much of the trouble is in the opaque "credit derivatives" markets. Credit derivatives are investments derived from other credit-market instruments, like securities backed by mortgages.

While that sounds straightforward, financial engineers came up with multifarious ways to slice, dice and package these derivatives. Now people are having trouble figuring out what these investments are actually worth.

http://online.wsj.com/article/SB122316380777805279.html

 

European banks levered upto 60x, more than US banks

[eurolev.png]

It's less well known than it should be, but Europeans banks have long been gaming their regulators, having far less than the actual capital reserves that they needed given their balance sheets. AIG filled the hole, selling credit defaults swaps to European banks via which they could tell regulators that they were adequately covered -- at triple-A, no less -- while carrying less cash than required.... European banks are generally more levered than their U.S. counterparts. With that coming into plain view in the absence of the regulatory arbitrage cover provided by AIG's swaps, that helps explain what we are now seeing on the Continent at present ...

EconomopicData: Investment Bank leverage increased compensation rather than ROE


While Lehman's net income did in fact rise dramatically from 2003-2007, it pales in comparison to what Lehman Brothers (and others) paid their employees. In 2007, Lehman paid their employees well in excess of $300,000 per year ON AVERAGE. To see how large this was in comparison to the net income of the firm, if salaries in 2007 were at 2003 levels per employee (still $260,000+), return on equity would have been 30% instead of the 20% level reported.

 

To pay for these increased salaries and still reach their 15-25% return on equity (from a growing equity base), Lehman increasingly turned to leverage (when a firm needs to return almost $4B rather than $2B to reach their target, strategies that previously would have been turned down, are now accepted. These lower returning strategies are then amplified through leverage).

As can be seen below, this is exactly what happened. From 2003-2007 average salaries skyrocketed as banks outbid one another for new talent (more projects requires more employees), leverage increased dramatically as Lehman's went from less than 24x to 31x (and remember this is more leverage off of a larger base number), all the while return on equity wasn't able to keep up with both the increase in salary or leverage.  http://econompicdata.blogspot.com/2008/09/downfall-of-investment-banking-model.html

Bill Miller performance has slipped dramatically this year

Miller's performance has slipped dramatically after his winning streak ended in 2006. He is the only manager to beat the Standard & Poor's 500 index for 15 straight years till 2006.

Legg Mason Capital Management, a unit of Legg Mason of which Miller is chairman and chief investment officer, owned AIG and Freddie in its clients' portfolios.

LOSING STREAK

Miller said Buffett's investment in Goldman and Constellation Energy Group showed that the stock market was nearing a bottom. "He's got a finely attuned sort of psychological sense as to when you are close to the bottom," he said.

His main Legg Mason Value Trust fund is the worst performer in the large-cap growth area among peers and is down 35.9 percent so far this year to Tuesday's close, double the 17.80 percent drop in the Standard & Poor's 500 index, according to Lipper data.

The fund has also shrunk in size -- down to $9.7 billion at the end of June from $16.5 billion at the start of 2008.

Another fund managed by Miller, the $4.5 billion Legg Mason Opportunity Trust fund, was also ranked at the bottom among multi-cap growth funds, losing 36.5 percent so far in 2008.

Miller said the Value Trust would widen its portfolio as valuation spreads across sectors were compressed now. The fund had 35 holdings as of the end of June.

Clients have pulled out $28.8 billion from Legg Mason's faltering equity funds, including Bill Miller's, in the six months up to June 30.

More recently, state pension funds of Massachusetts and Baltimore have axed Legg Mason from managing portfolios due to the funds' poor performance.

But Miller said some new clients were showing interest and Legg Mason Capital Management had recently won an institutional mandate that brought in more than $1 billion in assets.

http://biz.yahoo.com/rb/080925/business_us_miller_investorsbiz.html?.v=1