A Wall Street star has exploded! Venerable investment bank Lehman Brothers has filed for Chapter XI bankruptcy protection after failing to find a deep-pocketed suitor or partner. Some on the street believe that the dissolution of Lehman will be conducted in an orderly fashion around the street. I am not so sure. Look for more pain among banks and investment banks.
Word is that major firms were trading "as normal" with Lehman on Friday. Lehman said in its filing that its broker-dealer operations would continue as usual. Yeah right. I am not sure if Lehman would be permitted to pay for trades once CH XI is filed. There could be a ripple effect of settlement failures around the street. Bondholders will recover a substantial amount. Street was thinking between 70 to 80 cents on the dollar. Preferreds are probably toast. LEH swaps look like crap now.I was telling people Merrill will look for a bank partner for months. No one wanted to listen. I wanted to describe all this on Friday, but was not permitted to publish. Merrill investors have dodged a bullet. Owners of CFC A and B should be doing cartwheels. I do not think that BAC is hurting for money if it is buying Merrill.AIG is in deep trouble. I-Lease and Am. Gen. will be ok, beaten up, but ok. If AIG cannot successfully restructure, it could be worse for the street than Lehman.The Fed is expanding its Term Security Lending Facility. Up until now, the Fed would only take investment grade debt securities as collateral. Now it will take common equity as well! The Fed increased its Primary Dealer Lending Facility by $25 billion to $200 billion. Also, a group of banks and investment banks, including C, have created a $70 billion fund to ensure liquidity for the market. How this will work exactly, I am not sure, but it smells like the MLEC which was suggested last fall to bailout SIVs.The Fed's action has made the Government the primary repo market participant. The government did not to bailout anyone, but what does it think accepting anything short of stereos and jewelry as collateral is? Look for financial stocks to get crushed. We are at the precipice of a major recession. This will separate the wheat from the chaff. Only the strong will survive. Weaklings will either be gobbled up by stronger companies or fail.
Monday, September 15, 2008
Saturday, September 13, 2008
He's Not Heavy. He's my (Lehman) Brother
Here we go again folks. Another Wall Street icon is on the brink of collapse. It is the same old story, bets on an inflated real estate market fueled by easy money (accommodative Fed) and alchemists (Ivy League quants) who believed they could turn lead-like structures, consisting of subprime mortgages, risky commercial real estate loans, LBO loans, credit card receivables, auto loans and whatever they could cram into a structure, into gold. Common sense says that a chain is only as strong as its weakest link. These rockets scientists (some quants are actually rocket scientists) thought different. Thus, they created the CDO (collateralized debt obligation). Wall Street firms and banks believed that they could lay off the risk of such structures by using off-balance sheet vehicles such SIVs. Events of default triggers brought these structures careening back onto financial institutions balance sheets. The result has been billions of dollars in writedowns and losses and the near failures if two Wall Street firms (Bear and Lehman) and the conservatorship of GSEs FNMA and FHLMC.
The question now is: Will Lehman survive? My guess is that it will survive as pieces carved up by banks and private equity firms. The next target on the radar screen appears to by Merrill, which kept writing subprime loans right up until the bitter end (buying subprime lenders to generate new loans fro its structures). While a Merrill (or Lehman) bankruptcy is not likely, the horizon is not sunny for neither Wall Street investment bank.
The strategy here is to hold onto Lehman, Morgan Stanley, Merrill and even Goldman bonds, but preferred holders had better beware of how potential "rescue plans" affect this asset class. Mr. Paulson has set a few dangerous precedents with the GSEs.
In my internal use only publication I created at my employer (taken out of publication for being frighteningly accurate) I warned last month that credit spreads would widen in the corporate bond and preferred markets. Thus far this has been the case. Mr. Paulson believed that his takeover of the GSEs would stabilize the financial sector. Instead, he frightened investors away and has made it nearly impossible for financial institutions to raise Tier-One capital in the equity and preferred securities markets.
The question now is: Will Lehman survive? My guess is that it will survive as pieces carved up by banks and private equity firms. The next target on the radar screen appears to by Merrill, which kept writing subprime loans right up until the bitter end (buying subprime lenders to generate new loans fro its structures). While a Merrill (or Lehman) bankruptcy is not likely, the horizon is not sunny for neither Wall Street investment bank.
The strategy here is to hold onto Lehman, Morgan Stanley, Merrill and even Goldman bonds, but preferred holders had better beware of how potential "rescue plans" affect this asset class. Mr. Paulson has set a few dangerous precedents with the GSEs.
In my internal use only publication I created at my employer (taken out of publication for being frighteningly accurate) I warned last month that credit spreads would widen in the corporate bond and preferred markets. Thus far this has been the case. Mr. Paulson believed that his takeover of the GSEs would stabilize the financial sector. Instead, he frightened investors away and has made it nearly impossible for financial institutions to raise Tier-One capital in the equity and preferred securities markets.
Tuesday, September 9, 2008
Show Me The Money
Reader, Charliein asks if the danger of the GSEs stem form their serving two masters (shareholders and the government). Charliein is absolutely correct! The GSEs were created to provided stability during economic disruptions and to encourage and stimulate home ownership. When they were created they did not serve two masters. They were government agencies. However, Congress came up with a great idea. Why burden the Federal budget with debt when we could have the private sector provide the funding and we will regulate them? Brilliant!
The GSEs issued five kinds of securities to raise capital. First are agency bonds. These have always carried the implied backing of the U.S. Government. Therefore, they offered fairly low rates for investors due to their safety. The GSEs MUST the use proceeds of these bonds to purchase mortgages from lending institutions. Proceeds cannot be used to repair damaged balance sheets. That is what subordinate bonds, preferreds and common equity are for.
The GSEs do not hold the majority of mortgages they purchase. They securitize them into Collateralized Mortgage Obligations or CMOs. These are bonds which get their cashflow from the repayment of the underlying mortgages. Although CMOs issued directly by banks are backed ONLY by the underlying mortgages. CMOs issued by the GSEs are backed by both the mortgages and the GSEs. If the underlying mortgages default (and they are over-collateralized), the GSEs will repay investors principal.
The three other securities have no implied backing. They are subordinate notes, preferreds and common equity. Although these securities have no implied government backing, many investors were willing to accept lower yields (or dividends in the cases of common and preferred) generated by these non-senior asset classes. The reasoning was that the government would not let the GSEs fail. No one ever considered "conservatorship" as being an option, including myself.
Now that we know the different kinds of securities issued by the GSEs, let's discuss how the GSEs got into this mess.
Being shareholder owned, GSE management had a legal obligation to maximize shareholder profits. However, as government sponsored enterprises who could borrow at low rates, Congress via regulator the Office of housing enterprise and oversight (Ofheo) has an obligation to oversee the GSEs to make sure they were managing risk properly and using sound business practices. The GSEs' predicament was the doings of both GSE management (common equity shareholders) and more so, Congress. Here is where the conflict lies.
The GSEs made substantial campaign contributions to the very lawmakers regulating them (Congress). As long as their balance sheets looked "OK" Congress left them alone. The GSEs ability to raise large amounts of capital at low rates permitted Congress to use the GSEs for their pet social projects. Have an area of the Country which needs cheap mortgage financing to encourgae home ownership (or for political payback). Freddie and Fannie mortgage standards could be changed for those areas only, to make those loans possible.
Since Congress was essentially being paid off and had free reign to use the GSEs to further its members social agendas, Congress turned a blind eye to some of the speculating GSE management undertook to increase profits. That is how we arrived at this point. The bailout was also politically-charged.
As the mortgage market began to collapse as borrowers went delinquent or defaulted on mortgages, the GSEs needed to raise capital to compensate for losses (note: it was not their core mortgages which blew up the GSEs, but subprime mortgages it wrote - some at the behest of Congress- and the subprime loans in which they invested).
Since the GSEs could not use AAA-rated agency bonds to repair their balance sheets, they had to use one of the other, aforementioned, vehicles. They couldn't issue subordinate debt as the market for it is limited and they needed Tier One Capital and sub debt is Tier Two (explanations of capital buckets and Basel II would require another discussion). The GSEs could have issued equity shares (and they have from time to time), but that would dilute shareholders further and, since teh equity dividend was already reduced to 5 cents per share, many investors would have stayed away in droves. That left preferreds.
Although technically a kind of equity (senior to common), preferred investors have no voting rights and trade (and usually treated as) long-duration, callable, very subordinate debt. Unlike common equity, investors (mostly banks, insurance companies, pension funds and mom & pop) looking for income. Since preferreds are callable at par ($25 or $50 depending on the issue), price appreciation is limited. The dividend is the attractive feature.
Due to mismanagement and poor oversight, Treasury secretary Paulson and his advisers determined that there was nothing left to do but to take over the GSEs (thanks in no small part to the urging foreign central banks who own billions of the senior debt and wanted an almost explicit guarantee).
If Mr. Paulson took over the GSEs, he had to preserve the senior notes (the reason for taking them over as they need to issue more to keep the mortgage market alive). He also had to proctect the subordinate note holders as, being debt, a default of subordinate debt would cause a technical default and a possible involuntary bankruptcy. Still, to appease politicians (mostly those who caused this mess, he had to sacrifice some investors to avoid criticism over bailing out investors at the expense of taxpayers.
The logical choice would have been common equity holders, but since they were down to 5 cents a share, the criticism would have come anyway. Mr. Paulson was adamant that the next senior class of investors, preferred holders, be wiped out along with common holders even though, like bond holders, were investing for income and had no vote or say in the running of the company.
The Government has done a marvelous spin job of saying how the punished Wall Street in favor of Main Street. However, this rings hollow when one considers that preferred holders consist largely of regional and local banks, pension funds and retired individuals. They blew up Main Street! To add insult too injury, the Government is paying itself 10% (higher than any outstanding preferred) on special GSE preferreds which only it can purchase. It would be cheaper for the GSEs to pay existing preferreds, even when lower bond borrowing costs (not much lower when one considers that treasury benchmarks may rise as much as credit spreads will narrow, negating the borrowing advantage).
Another side effect is that retail investors (the main players in the preferred market) will stay away from preferreds issued by banks. Although companies traditionally would not suspend preferred dividends unless facing bankruptcy, a precedent has been set and troubled banks may be more inclined to suspend common and preferred dividends if they are in trouble. Banks need to come with traditional non-cumulative preferreds to pad their Tier One capital ratios. Good luck doing that now. Feedback I have received from brokers is that they will in now way market preferreds to clients given what has happened to GSE preferreds. Now banks and brokerage firms will have difficulty raising necessary Tier One capital. Look for more trouble in the financial sector this Fall.
Although this post was quite lengthy, it is actually an abridged version of the story. Maybe tomorrow I will explain CDOs, CLOs and other exotic structures which helped blow up the economy.
The GSEs issued five kinds of securities to raise capital. First are agency bonds. These have always carried the implied backing of the U.S. Government. Therefore, they offered fairly low rates for investors due to their safety. The GSEs MUST the use proceeds of these bonds to purchase mortgages from lending institutions. Proceeds cannot be used to repair damaged balance sheets. That is what subordinate bonds, preferreds and common equity are for.
The GSEs do not hold the majority of mortgages they purchase. They securitize them into Collateralized Mortgage Obligations or CMOs. These are bonds which get their cashflow from the repayment of the underlying mortgages. Although CMOs issued directly by banks are backed ONLY by the underlying mortgages. CMOs issued by the GSEs are backed by both the mortgages and the GSEs. If the underlying mortgages default (and they are over-collateralized), the GSEs will repay investors principal.
The three other securities have no implied backing. They are subordinate notes, preferreds and common equity. Although these securities have no implied government backing, many investors were willing to accept lower yields (or dividends in the cases of common and preferred) generated by these non-senior asset classes. The reasoning was that the government would not let the GSEs fail. No one ever considered "conservatorship" as being an option, including myself.
Now that we know the different kinds of securities issued by the GSEs, let's discuss how the GSEs got into this mess.
Being shareholder owned, GSE management had a legal obligation to maximize shareholder profits. However, as government sponsored enterprises who could borrow at low rates, Congress via regulator the Office of housing enterprise and oversight (Ofheo) has an obligation to oversee the GSEs to make sure they were managing risk properly and using sound business practices. The GSEs' predicament was the doings of both GSE management (common equity shareholders) and more so, Congress. Here is where the conflict lies.
The GSEs made substantial campaign contributions to the very lawmakers regulating them (Congress). As long as their balance sheets looked "OK" Congress left them alone. The GSEs ability to raise large amounts of capital at low rates permitted Congress to use the GSEs for their pet social projects. Have an area of the Country which needs cheap mortgage financing to encourgae home ownership (or for political payback). Freddie and Fannie mortgage standards could be changed for those areas only, to make those loans possible.
Since Congress was essentially being paid off and had free reign to use the GSEs to further its members social agendas, Congress turned a blind eye to some of the speculating GSE management undertook to increase profits. That is how we arrived at this point. The bailout was also politically-charged.
As the mortgage market began to collapse as borrowers went delinquent or defaulted on mortgages, the GSEs needed to raise capital to compensate for losses (note: it was not their core mortgages which blew up the GSEs, but subprime mortgages it wrote - some at the behest of Congress- and the subprime loans in which they invested).
Since the GSEs could not use AAA-rated agency bonds to repair their balance sheets, they had to use one of the other, aforementioned, vehicles. They couldn't issue subordinate debt as the market for it is limited and they needed Tier One Capital and sub debt is Tier Two (explanations of capital buckets and Basel II would require another discussion). The GSEs could have issued equity shares (and they have from time to time), but that would dilute shareholders further and, since teh equity dividend was already reduced to 5 cents per share, many investors would have stayed away in droves. That left preferreds.
Although technically a kind of equity (senior to common), preferred investors have no voting rights and trade (and usually treated as) long-duration, callable, very subordinate debt. Unlike common equity, investors (mostly banks, insurance companies, pension funds and mom & pop) looking for income. Since preferreds are callable at par ($25 or $50 depending on the issue), price appreciation is limited. The dividend is the attractive feature.
Due to mismanagement and poor oversight, Treasury secretary Paulson and his advisers determined that there was nothing left to do but to take over the GSEs (thanks in no small part to the urging foreign central banks who own billions of the senior debt and wanted an almost explicit guarantee).
If Mr. Paulson took over the GSEs, he had to preserve the senior notes (the reason for taking them over as they need to issue more to keep the mortgage market alive). He also had to proctect the subordinate note holders as, being debt, a default of subordinate debt would cause a technical default and a possible involuntary bankruptcy. Still, to appease politicians (mostly those who caused this mess, he had to sacrifice some investors to avoid criticism over bailing out investors at the expense of taxpayers.
The logical choice would have been common equity holders, but since they were down to 5 cents a share, the criticism would have come anyway. Mr. Paulson was adamant that the next senior class of investors, preferred holders, be wiped out along with common holders even though, like bond holders, were investing for income and had no vote or say in the running of the company.
The Government has done a marvelous spin job of saying how the punished Wall Street in favor of Main Street. However, this rings hollow when one considers that preferred holders consist largely of regional and local banks, pension funds and retired individuals. They blew up Main Street! To add insult too injury, the Government is paying itself 10% (higher than any outstanding preferred) on special GSE preferreds which only it can purchase. It would be cheaper for the GSEs to pay existing preferreds, even when lower bond borrowing costs (not much lower when one considers that treasury benchmarks may rise as much as credit spreads will narrow, negating the borrowing advantage).
Another side effect is that retail investors (the main players in the preferred market) will stay away from preferreds issued by banks. Although companies traditionally would not suspend preferred dividends unless facing bankruptcy, a precedent has been set and troubled banks may be more inclined to suspend common and preferred dividends if they are in trouble. Banks need to come with traditional non-cumulative preferreds to pad their Tier One capital ratios. Good luck doing that now. Feedback I have received from brokers is that they will in now way market preferreds to clients given what has happened to GSE preferreds. Now banks and brokerage firms will have difficulty raising necessary Tier One capital. Look for more trouble in the financial sector this Fall.
Although this post was quite lengthy, it is actually an abridged version of the story. Maybe tomorrow I will explain CDOs, CLOs and other exotic structures which helped blow up the economy.
Sunday, September 7, 2008
Sad Day In Mudville
Thanks to self-serving large investors and shady accounting by GSE management, the Treasury has taken control over the mortgage agencies. ALL bond holders will be protected, including sub notes. This is as I expected. What I did not expect was the suspension of preferred dividends as it would harm banks, pensions and insurance companies. Preferred shares are not wiped out, they just won't pay dividend for a while.
I am sorry that this has happened to my readers. I really thought that GSE management was being forthright given the gravity of the situation. I also thought that the Treasury and regulators would not punish the preferred holders as they had no vote and could not have, in any way, prevented GSE mismanagement. They should have been treated as subordinate debt holders. This is the danger of investing in a politically-driven sector.
I am sorry that this has happened to my readers. I really thought that GSE management was being forthright given the gravity of the situation. I also thought that the Treasury and regulators would not punish the preferred holders as they had no vote and could not have, in any way, prevented GSE mismanagement. They should have been treated as subordinate debt holders. This is the danger of investing in a politically-driven sector.
Saturday, September 6, 2008
Not what I appear to be
Multiple sources are reporting that the Treasury will take over the GSEs. However, it is also being reported that common shareholders will have the value of there shares diluted, but not wiped out and that preferred holders and ALL bond holders will be protected by the government. Hear that fear-mongers? Preferreds will survive as will ALL bondholders. Although I may have been incorrect in my belief that a takeover was unlikely (Paulson caved to pressure), I was very correct in my belief that preferred holders and bond investors would come out of this intact. Look for GSE preferreds and bonds to rally sharply Monday morning.
P.S. CNBC's Fast Money had a story which stated that shareholders would be wiped out. The story has since been pulled, but broken link remains as evidence.
P.S. CNBC's Fast Money had a story which stated that shareholders would be wiped out. The story has since been pulled, but broken link remains as evidence.
Thursday, September 4, 2008
You Talking To Me?
Bill Gross has decided to extort the U.S. treasury buy threatening not to invest in any more bank offerings unless Paulson acts. I can only assume that he wants the Treasury to nationalize the GSEs and wipe out equity and preferred invest. Mr. Gross has two facts working against him. 1) Mr. Paulson cannot act unilaterally. He needs the permission of the GSEs, which themselves need approval of their regulators, which in turn need Congressional approval. 2) The damage done to banks from wiping out GSE preferred holders could do more damage to banks than anything Mr. Gross could do.
Mr. Gross wants Mr. Paulson to blow up one set of investors to help another class, one to which Mr. Paulson belongs, mortgage backed securities. He is more than a little disingenuous.
Also Mr. Gross is a liar. He states that the recent Wells Fargo hybrid deal was a retail deal because institutions would not buy it. Hello Pinocchio, your nose is growing. The WFC 9.75% fixed-to-floater was an institutional-only deal. It was not offered to retail clients anywhere, period. Don't believe me? Here is what Wells Fargo CFO Howard Atkins had to say to CNBC's Jim Cramer:
It was very much an institutional transaction," he said. "I’m not quite sure it’s being characterized as being something different.”
Atkins said that over 100 institutions took part in the offering, adding that it was "successful" and "well oversubscribed."
How he gets away with this is beyond me. I guess it is because that many investors are rats and he is a pied piper. Investors who admire Mr. Gross may be better off investing in his funds rather than listening to him and acting on their own. By the time Mr. Gross makes public statements he has already made his bets. The pied piper then leads the rats to their demise.
Mr. Gross wants Mr. Paulson to blow up one set of investors to help another class, one to which Mr. Paulson belongs, mortgage backed securities. He is more than a little disingenuous.
Also Mr. Gross is a liar. He states that the recent Wells Fargo hybrid deal was a retail deal because institutions would not buy it. Hello Pinocchio, your nose is growing. The WFC 9.75% fixed-to-floater was an institutional-only deal. It was not offered to retail clients anywhere, period. Don't believe me? Here is what Wells Fargo CFO Howard Atkins had to say to CNBC's Jim Cramer:
It was very much an institutional transaction," he said. "I’m not quite sure it’s being characterized as being something different.”
Atkins said that over 100 institutions took part in the offering, adding that it was "successful" and "well oversubscribed."
How he gets away with this is beyond me. I guess it is because that many investors are rats and he is a pied piper. Investors who admire Mr. Gross may be better off investing in his funds rather than listening to him and acting on their own. By the time Mr. Gross makes public statements he has already made his bets. The pied piper then leads the rats to their demise.
Tuesday, September 2, 2008
What’s Brown and Sounds Like A Bell?
In a Monty Python sketch, Python player Eric Idle asks the question: “What’s brown and sounds like a bell”? The answer: “Dung!” Although we do not wish to be so crass, we cannot think of a more fitting description on the so-called decoupling of the U.S. economy from those of our trading partners.
Today, the economy is more global than ever. If the economy is global, how in the world can ANY economy decouple, never mind the world’s biggest economy? I admit that the relationship between the U.S. economy may be more symbiotic (rather than the U.S. being overly dominant as in the past), but as in any symbiotic relationship in nature, when one partner becomes ill, the other(s) feel the effects as well. When that one party is considered the “host”, the effects will be felt among those who depend on the host for their survival.
The U.S. economy remains dominant. It is the world’s market place. If China was no longer able to produce goods affordably, it is likely that another country or countries would be eager and able to take its place. However, take away the U.S. economy with its benchmark consumer spending and the gears of the global economy grind more slowly.
This is what we are now experiencing. U.S. consumer spending has slowed and may continue to slow as long as the housing market is dislocated. Most major foreign economies are now experiencing varying degrees of slowing. This has burst the anti-dollar bubble. The dollar has strengthened sharply versus most foreign currencies. This has, in turn, burst the oil bubble. As we have said previously, strengthen the dollar and oil prices will fall. The threat of increased drilling and alternative energy plans has helped to push oil prices lower as well.
Although I believe that oil prices had been too high given current and future demand versus current and future supply (once other sources of oil, which would be come economically viable with oil at elevated levels, were considered), oil may not fall back to pre-bubble levels. Just as those who predicted ever-rising oil prices have been proven incorrect (for now), calling for oil to fall to $60, $70 or $80 may be premature. Remember, bubbles work in both directions. Look for oil to remain range traded at or near current levels until geo-political events dictate otherwise. Also, look for the dollar to remain range traded in the $1.40 to $1.50 ranged, until economic forces dictate otherwise.
Why is fixed income publication discussing the foreign currency exchange markets? Because I also deal in international bonds denominated in foreign currencies. Many retail investors speculate on the value of foreign currencies versus the U.S. dollar by purchasing bonds denominated in foreign currencies. Make no mistake, when one purchases a bond denominated in foreign currencies, one is speculating. This is true even of AAA-rated sovereign debt. Why is one speculating? Although investors will receive timely interest payments and return of their principal at maturity, those payments will be in the particular currencies in which the bonds are denominated. One may get par at maturity, but what it is worth in U.S. dollars may surprise some investors. If the dollar strengthens, one could lose money by investing in foreign-denominated bonds, even when receiving par at maturity.
This has happened to some investors in recent weeks. We and our colleagues have received several calls asking why and how clients lost money on foreign-denominated bonds when they received par at maturity. The answer was that the U.S. dollar has strengthened. Investors must consider currency risk when investing in foreign denominated bonds.
The GSE situation has settled down. The Wall Street Journal's editiorial page has taken to defending Sarah Pailin and her pregnant daughter. I do not believe any defending needs to be done, but at least the Journal has a new bone on which to chew.
I would like to thank my readers for the kind words we have received during the GSE crisis. With all the negativity pervading the Street, our necks were very exposed (we could have looked like twits if the GSEs had been nationalized) and preferred holders wiped out). However, I believed that when all things were considered, even the most ardent GSE critics would come to realize that wiping out certain investor classes could do more harm than good.
Today, the economy is more global than ever. If the economy is global, how in the world can ANY economy decouple, never mind the world’s biggest economy? I admit that the relationship between the U.S. economy may be more symbiotic (rather than the U.S. being overly dominant as in the past), but as in any symbiotic relationship in nature, when one partner becomes ill, the other(s) feel the effects as well. When that one party is considered the “host”, the effects will be felt among those who depend on the host for their survival.
The U.S. economy remains dominant. It is the world’s market place. If China was no longer able to produce goods affordably, it is likely that another country or countries would be eager and able to take its place. However, take away the U.S. economy with its benchmark consumer spending and the gears of the global economy grind more slowly.
This is what we are now experiencing. U.S. consumer spending has slowed and may continue to slow as long as the housing market is dislocated. Most major foreign economies are now experiencing varying degrees of slowing. This has burst the anti-dollar bubble. The dollar has strengthened sharply versus most foreign currencies. This has, in turn, burst the oil bubble. As we have said previously, strengthen the dollar and oil prices will fall. The threat of increased drilling and alternative energy plans has helped to push oil prices lower as well.
Although I believe that oil prices had been too high given current and future demand versus current and future supply (once other sources of oil, which would be come economically viable with oil at elevated levels, were considered), oil may not fall back to pre-bubble levels. Just as those who predicted ever-rising oil prices have been proven incorrect (for now), calling for oil to fall to $60, $70 or $80 may be premature. Remember, bubbles work in both directions. Look for oil to remain range traded at or near current levels until geo-political events dictate otherwise. Also, look for the dollar to remain range traded in the $1.40 to $1.50 ranged, until economic forces dictate otherwise.
Why is fixed income publication discussing the foreign currency exchange markets? Because I also deal in international bonds denominated in foreign currencies. Many retail investors speculate on the value of foreign currencies versus the U.S. dollar by purchasing bonds denominated in foreign currencies. Make no mistake, when one purchases a bond denominated in foreign currencies, one is speculating. This is true even of AAA-rated sovereign debt. Why is one speculating? Although investors will receive timely interest payments and return of their principal at maturity, those payments will be in the particular currencies in which the bonds are denominated. One may get par at maturity, but what it is worth in U.S. dollars may surprise some investors. If the dollar strengthens, one could lose money by investing in foreign-denominated bonds, even when receiving par at maturity.
This has happened to some investors in recent weeks. We and our colleagues have received several calls asking why and how clients lost money on foreign-denominated bonds when they received par at maturity. The answer was that the U.S. dollar has strengthened. Investors must consider currency risk when investing in foreign denominated bonds.
The GSE situation has settled down. The Wall Street Journal's editiorial page has taken to defending Sarah Pailin and her pregnant daughter. I do not believe any defending needs to be done, but at least the Journal has a new bone on which to chew.
I would like to thank my readers for the kind words we have received during the GSE crisis. With all the negativity pervading the Street, our necks were very exposed (we could have looked like twits if the GSEs had been nationalized) and preferred holders wiped out). However, I believed that when all things were considered, even the most ardent GSE critics would come to realize that wiping out certain investor classes could do more harm than good.
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