The Walrus Was Paul

Here’s Another Clue For You All. The Walrus Was Paul (Looking Through A Glass Onion)


Former Fed Chairman Paul Volcker (AKA the inflation slayer) expressed his concerns regarding the Fed’s independence, the amount and kinds of collateral the Fed has accepted as part of its liquidity programs and the Fed possibly being seen as a backstop for poor financial decisions.


Although he expresses concerns over the Fed’s role in rescuing the financial system and engineering a buyout of Bear Stearns, Mr. Volcker concedes that the Fed may have had little choice but to step in. He states: “I can understand why they felt they had to act. I can imagine they were faced with a problem and a very short time frame and worried about the contagion and loss of Bear Stearns."

Mr. Volcker comes down heavily on banking regulators. He asks the question: "Why were [the banks] permitted to set up those off-balance-sheet entities that may or may not have had some formal relationship with the bank? They were not regulated and [banks] didn't hold an adequate amount of capital against them. Why did that happen after the experience of Enron?"

The answer to that question is an easy one. When times are good, financial institutions make money. These off balance sheet vehicles generated large quantities of cash for institutions doing the securitization. Many of these SIVs had assets which were rated AAA. How dangerous could they be? Everyone believed the quantitative models. After all, the modelers in question were, literally, geniuses. Unfortunately, high degrees of intelligence were mistaken for infallibility. History is littered with the wreckage of such fallacies. Wall Street still has faith in the Quants. A search off Wall Street Job sites indicates that Quants are in the highest demand. We just need better models for “next time”.


It’s Getting Better All The Time

Today’s Wall Street Journal “Credit Markets” column discusses the recent spate of new bond issuance in the credit markets. Some companies have been taking advantage of a better credit market environment to issue debt for shareholder friendly activities such as share buybacks. There has been some investor interest in the high yield market, especially in the energy sector. Investors and banks are still shying away from LBO debt.


Investors who have been focusing on the financial sector may not realize that credit spreads in non-financial sectors are not nearly as wide as those in the financial sector. It is not uncommon to find a BBB-rated industrial trading with tighter spreads than A-rated financials.