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WHEN LEADING FUND MGR TALKS, DO PEOPLE
LISTEN:
"BIGGEST HOUSING PRICE DECLINE
SINCE THE GREAT DEPRESSION"
by
Econotech
Date, 2007
Apr
13 (Econotech FHPN)--“The one thing they [investors] shouldn’t go
anywhere near is a CDO or residential mortgage-backed securities rated
triple-A by Moody’s and S&P because these securities are going
to get downgraded by the hundreds of billions because they are secured
by sub-prime and Alt-A mortgages where there’s going to be massive
defaults … most of them appear to have been sold to hedge funds and
foreigners and pension funds. Interviewer: Who owns them? Heebner: No
one wants to talk about it … They [hedge funds] buy a pool of
mortgages that yield 8%, and they borrow against the yen and pay 3% [a
yen carry trade], and they lever it ten to one, and so you have a
lucrative profit. The hedge fund that you’re running, the manager
gets 20% of the gain. So even if you go a year before you go broke in
the hedge fund, you get rich until the thing gets shut down. So
there’s a huge incentive to gamble recklessly here in the hedge fund
business … They [largest investment banks] created, they invented
this machine. They’re the ones that came up with the idea of
securitization. They know the products are toxic. I don’t think
they’re going to suffer losses. They simply passed them on to
everybody else ... The only impact [on the i-banks] this will have
when it shuts down is that the profits flow from it will get less …
So, they know the product is toxic; they’re not going to get caught
[financially]. Interviewer: And basically you think they’ve disposed
of all the risk. They created it, they made their fees, and they got
rid of the risk. Heebner: That’s right.” Kenneth Heebner, manager,
CGM Realty Fund, Bloomberg video, Apr 12, my transcription
“They [investment banks] know the
[mortgage securities] product is toxic; they're not going to get
caught,” Kenneth Heebner, Co-Founder, Capital Growth Management
Heebner, a very experienced mutual fund manager, is one of the tiny
handful of the absolute best out of many thousands. According to the
Bloomberg video, his CGM Realty Fund had a 5-year cagr of 30%. CGM as
a whole manages more than $6 billion, so this is real money, not
economists’ forecasts.
I.e., when Heebner talks, serious financial people listen. He’s not
a permabear. In fact, despite his strong views on the residential real
estate market that I quote in the next section below, he said he
currently doesn’t think this will lead to a U.S. recession.
“Heebner, manager of the top-performing real-estate fund over the
past decade … co-founded Capital Growth Management in 1990 … known
for making concentrated investments in a few industries. He sold
homebuilders after owning them from 2001 to 2005, record years for
home sales. He bet against technology and telephone stocks in 2000,
correctly timing their collapse.” Bloomberg , Apr 12
On April 4 I posted an article titled “When Citibank Chief Exec
Talks, Do People Listen: ‘A market correction is coming, this time
for real’” link.
Likewise, Heebner also has very important comments on real estate
prices, which follow in the next section.
I chose to lead with the above quote because I wanted to focus first
on the issue of the hyper-speculative nature of global capital
markets, who wins, who loses, a major theme of my web site link.
That issue is also taken up below with respect to private equity.
Heebner says that the creators of the “toxic” mortgage products,
the largest investment banks, i.e. the Goldmans and Lehmans of the
world, will not be the losers. They almost never are. Their motto for
the rest of the world could be the proverbial, "Heads I win,
tails you lose."
"would estimate that housing
prices in '07 will decline at least 20% in a lot of markets from where
they are today ,” Kenneth Heebner, Co-Founder, Capital Growth
Management
"I think it’s not only sub-prime, I think the Alt-A mortgages
are going to default on a huge scale also … As we get a large amount
of these two and half trillion of mortgages going into default …
You’re going to see foreclosed houses dumped onto an already weak
market where homebuilders are struggling to sell their spec houses.
And so the price declines that have started will continue and maybe
even accelerate in some of the hotter markets. I would estimate that
housing prices in '07 will decline at least 20% in a lot of markets
from where they are today … What you’re going to see is the
biggest housing price decline since the Great Depression … The
consequence of this is going to be a big decline in housing prices …
… housing prices in the inflated markets, that’s California,
Arizona, Nevada, Florida, and parts of the northeast, they have to
decline a lot before it’s attractive to buy rather than rent …
They’re [mortgage losses] going to dwarf those [Resolution Trust –
S & L crisis of the early 190s] losses … It could easily
approach a trillion dollars. That dwarfs anything that has happened.
Enron was a hundred billion dollar loss, this is going to be far
greater than that.” Kenneth Heebner, manager, CGM Realty Fund,
Bloomberg video, Apr 12, my transcription
“a new Bloomberg/Los Angeles Times poll … Most Americans remain
sanguine about home prices, the poll showed, with more than half
expecting homes in their neighborhood to hold their value over the
next six months. Twice as many respondents said home prices will
increase as those who predicted a decline. A majority said slowing
home sales nationwide will hurt the economy.” Bloomberg, Apr 11
Here's the link
to the full Heebner Bloomberg video, a short ad appears first, and at
times it has been unavailable.
“The overarching question is why
public companies can't do the same things [as private equity] to
create the most value,” Michael Mauboussin, Legg Mason strategist
In addition to mortgage-backed securities, CDO’s, etc, that Heebner
discusses above, private equity and m&a continue to be key issues
in the global financial markets, with m&a reaching $1 trillion in
the first quarter, a record on pace to top last year’s nearly $4
trillion.
Here is a recent comment on private equity from Michael Mauboussin,
the highly regarded strategist for Legg Mason (e.g., see reviews of
his books on Amazon at link
and link):
“The overarching question is why public companies can't do the same
things [as private equity] to create the most value. That hasn't been
satisfactorily answered by many executives. If there are ways to
create value, why aren't they doing those as public companies? Why do
they need to be private? Those are concerns that should weigh on
public shareholders … That's the right word: incentive. Two things
in particular make these transactions attractive to an executive.
First, often the ownership stake or equity stake of the executives can
rise quite a bit. They're more leveraged to the success of the
operation, so they stand to do better financially. Second, there may
be corporate actions, asset sales, downsizing or other capital
allocation decisions that managers may feel are truly in the best
interests of the value creation for the company, but there's a
perception that making those moves as a public company would be
unpopular. That's a perception, not a reality, but perception is
important. So when you go to an executive and say the prospects are
for you to have more skin in the game and do very well financially if
this works out, and to have more latitude to make tough decisions,
that's the one-two combination that draws executives.” Legg Mason
strategist Michael Mauboussin, printed interview, MarketWatch, Apr 4
Mauboussin’s points seem somewhat similar, though more polite, than
those I made in my Dec 19 article, “World Needs Better ‘Face of
American Capitalism’ than Private Equity, Goldman Sachs” link.
In short, private equity is a leading symptom of massive
under-investment in real innovation and productive capital:
“my main criticism of private equity and the rest of the global
hyper-speculators, such as hedge funds and investment banks like
Goldman Sachs (mainly a very large hedge and private equity fund), is
the economically unproductive ways in which they “earn” their
extraordinarily high returns on leveraged legal looting (ROLLL) … If
all this shareholder value enhancing was supposedly done by CEOs
already, then after two decades of it, what could possibly be the role
of private equity in now supposedly greatly providing even more of the
same? However, if public companies haven’t enhanced shareholder
value by such draconian actions and now need to be wholesale taken
over by private equity, then the whole system of “free capital
markets” and corporate governance that the ex-Goldman Sachs U.S.
officials mentioned above are trying to persuade China and the rest of
the world to adopt was perpetrated for the benefit of the very few who
have become unfathomably rich. Even if the day of reckoning of the
current immense wave of private equity deals were continued to be
postponed another year or two, this unproductive use of capital
already has greatly distorted global capital market flows, corporate
incentives, and thus corporate allocation of scarce and critical
resources, especially all-important human talent.”
“Income inequality grew significantly in 2005, with the top 1
percent of Americans … receiving their largest share of national
income since 1928, analysis of newly released tax data shows … The
new data also shows that the top 300,000 Americans collectively
enjoyed almost as much income as the bottom 150 million Americans.”
NYT, Mar 29
I doubt this enormous concentration of income and wealth in the top
1/10th of 1 percent can be adequately explained by educational levels
without significantly accounting for the effects of unprecedented
unproductive global hyperspeculation.
Of course, love him or hate him, Jim Cramer can be counted on to be
brutally frank and honest, more so than any other recognized name on
Wall Street. Here’s his recent take on private equity:
"They [private equity firm Cerebus Capital Management] have to
break the union. The key strategy behind everything they’re doing is
to crush the unions. That has to happen … the Goodyear model is the
model for Cerebus … Cerebus is a very smart company. The lynchpin of
the strategy, I believe, is to break the union … I’m pro-union,
I’m against manipulation." Jim Cramer, "Wall Street
Confidential" video, Mar 29, my transcription, on Cerebus'
strategy in the U.S. auto sector.
This is a very old story, several decades old, that’s almost
finished, union busting came into vogue at least as early as one of
Pres Reagan’s very first acts as president in breaking the air
traffic controllers strike (emulating the City of London's Margaret
Thatcher).
Very Brief Update on Global Financial
Markets: Risk of "Volatility Shock"
In my Apr 4 article link,
I noted: “each [global major index] etf has rebounded from the
decline that started at the end of Feb and is now nearing or at its
previous high. Should they take out those highs, especially EEM
[emerging markets], perhaps in another manic run along with rising
commodities like last April, this might then trigger another sharp
decline, like last May-June.”
For now, that scenario seems to playing out, especially in the
continued enormous speculation in China’s equity markets, now up
more than 50% this year, and any commodity that feeds into China’s
economy. I also noted the recent loss in relative strength in
India’s equity market as a possible cause for concern, and that also
continues.
I also noted there that updated data plugged, by a major investment
bank, into a leading economic indicator developed by a Fed researcher,
while not yet signaling recession, was well on the way to doing so.
Since 1962, on six of the seven occasions when it has reached the
March level, it then went on to continue moving up through the signal
threshold and correctly forecast a recession (when the indicator was
at this level in early 1984, the threshold was reached but not
breached, hence the indicator has correctly forecast 6 of 6
recessions, with no false signals).
I would like to add two things regarding this. First, as I’ve
discussed elsewhere (e.g. the section "Why I Like Charts and
Leading Indicators" in my Sep 26 article, "Global Markets
Hope 'Mid-Cycle' 'Soft Landing,'" link)
while I greatly prefer leading economic indicators to economic model
forecasts, since the latter usually miss the turns, I much prefer
charts to both, trying as best I can to stay aligned with their main
trends, as I’ve mentioned several times before.
Second, I have a great deal of respect for the work of perhaps the top
provider of leading economic indicators, Economic Cycle Research
Institute (link). While
ECRI stopped posting a chart of its Weekly Leading Index (WLI) on its
web site a few years ago, it still does post media comments, such as
follows:
“”We’re hitting bottom on the economic growth and we should
expect more positive surprises as the year progresses,” said
Lakshman Achuthan, managing director at the Economic Cycle Research
Institute … Achuthan says it’s normal to have “a lot of
confusion” during this time. “We don’t have any recession here,
I think those fears are largely being laid to rest by a lot of the
data coming out,” he said. “But we’re still having of [sic] what
seems to be a cyclical bottoming in the growth rate in the economy,
and when you’re at a turning point like that, you’re going to get
mixed data.”” CNBC, Apr 9
Just look at how confused Wall Street is as it flip-flops almost
daily, indicated by futures contracts, on its what is the Fed going to
do guessing game. My advice for a "big picture" is to follow
leading indicators (e.g. Conference Board and OECD provide others),
but most especially key longer-term market charts as closely as you
can.
And critically, especially in periods like this with extremely low but
slightly increasing financial market volatility, do NOT underestimate
the very real possibility of financial “volatility
shocks” mentioned here by the IMF, which markets and
forecasters always underestimate (in part due to human psychological
nature, part to huge vested interests), but which can do great damage
to capital preservation:
“Against the backdrop of continued global growth, none of the
individually identified risks by themselves threaten financial
stability. However, with volatility across asset classes close to
historic lows and spreads on a variety of credit instruments tight,
investors may not have adequately factored in the possibility that a
“volatility shock” may be amplified given the increased linkages
across products and markets. Institutions may well be acting in
accordance with their own incentives, but collectively their behavior
may cause a buildup of investment positions in certain markets,
possibly resulting in a disorderly correction when conditions change.
For instance, the rapid growth of some innovative instruments, the
rise in leverage in parts of the financial system, and the growth of
carry trades suggest that market participants are expecting a
continuation of the low volatility environment and that a sustained
rise in volatility could perturb a wide range of markets”
“Summary” section, “Global Financial Stability” semi-annual
report, April 2007, IMF
What Private Equity, I-Banks and
Hedge Funds Taketh Away, Can Philanthropy Give Back?
“Wealthy philanthropists have the potential to do more than the
Group of Eight leading nations to lift Africa out of poverty,
according to Jeff Sachs, special adviser to the United Nations
secretary-general … "There are 950 billionaires whose wealth is
estimated at $3.5 trillion [$3,500bn]. An annual 5 per cent
'foundation' payout would be $175bn per year - that would do it. Then
we don't need the G8 but 950 people on the Forbes list," said Mr
Sachs. "Maybe private philanthropists will champion solutions to
individual problems rather than the G8," he said. He was speaking
as the OECD reported last week that aid from rich countries to Africa
remained static last year even though G8 leaders promised in 2005 to
spend $50bn more each year to 2010 on aid, with half the rise going to
sub-Saharan Africa. The so-called Gleneagles commitments were
championed by Tony Blair, the prime minister, and Gordon Brown, the
chancellor.” Lead article, FT, Apr 9
I have enormous respect for the almost super-human efforts of Sachs in
this area, along with incredible philanthropy such as that of the
Gates’ and Buffet. That said, my take on this in my April 4 article,
“When Citibank Chief Exec Talks,” link:
“Rajan [ex IMF economic counselor] does make a key point that I have
tried to make far less well several times on my web site, i.e. low
interest rates are not mainly the result of a so-called “savings
glut,” a la Bernanke, but rather also due to under-investment (I
would argue massively so) in real productive assets, in my formulation
to meet the needs of most of the world’s population, resulting in
what Rajan calls a “financing glut,” what I consistently label
global hyperspeculation. And, btw, the unprecedented amount of
philanthropy directed at these needs by Gates, Buffett, etc, which is
incredibly worthwhile and extremely admirable, is not enough, what I
would argue is that what the philanthropists consider to be a
"market failure" itself ultimately must be directly
addressed as such and changed.”
Once Again, Whither China?
Since Goldman Sachs and other i-banks, private equity, hedge funds,
etc, have long ago captured the global capital markets in the
"developed" world, that battle is mainly being fought in
"emerging" markets, most particularly China:
“Carlyle Group's bid to buy part of Chongqing City Commercial Bank
will be rejected as China stiffens opposition to buyout firms,
especially in the $5.6 trillion banking industry, three people
familiar with the matter said …The regulator is also mulling plans
to make it harder for private equity companies to purchase stakes in
banks. It is the latest setback in China for Washington-based Carlyle,
which was forced last month to scale back a planned takeover of Xugong
Group Construction Machinery Co. The Chinese government is concerned
that buyout firms seek short-term profits and don't improve companies
they buy enough, the people said.” Bloomberg, April 4.
As I put it in my Dec 19 “World Needs Better “Face of American
Capitalism” link:
“China is in the midst of a multi-year effort to try to reform its
financial system. The U.S., led by ex-Goldman chief Treasury Secretary
Paulson, is strongly trying to influence it in the direction of the
American-Anglo “free market” model, rather than perhaps the more
traditional Asian one of state dominated banking systems that produced
remarkable results in the industrial rise first of Japan then later S.
Korea, both under authoritarian regimes. China going from the huge
problems of its own state-dominated banking system to the Wall St-City
of London hyper-speculative “free capital markets” model would be
somewhat like jumping from the frying pan into the fire, but that
limited choice is the way the issue is always framed.”
And in my “Whither China?” section of my Oct 27 article “Global
Strategic Bargain” link:
“Thus, with very limited domestic and international opposition, that
basically leaves China and Russia left standing in the way of total
global domination by the hyper-speculators, two states which the U.S.
government can not currently strongly influence, to the obvious
chagrin and anger of those pushing U.S. hegemony in the current
hyper-speculative version of globalization (there is a good version),
hence the trotting out of Paulson's and Rice's current “soft cop”
approach to China. The U.S. is not really interested in “free
trade," it no longer has much that countries like China seem to
want to buy, except Boeings and soybeans, since as noted above U.S.
industry has long since been hollowed out, as opposed to Japan's and
the EU's, which are more slowly getting there, to their great dismay.
Rather, what the U.S. mainly wants from China, and everywhere else, is
unlimited capital mobility for its mega- global financial
institutions, so it can ROLLL (again, return on leveraged legal
looting) over them as they have the rest of the world. Both China and
Russia seem aware of this, and their elites are playing a fascinating
game with the global hyper speculators … One of the most important
areas to focus on is control of the financial sector. Huge Western
financial institutions have made significant investments on very
favorable terms in China’s four main banks, but China is clearly
reticent to give up too much control of its key financial institutions
and its nascent capital markets, as with Citigroup's efforts to take a
stake in Guangdong Development Bank … As it did with its industrial
state-owned enterprises, China is using the club of foreign
competition to do much of the politically unattractive dirty work, so
to speak, to shake up its four large banks and the financial sector.
In the long term, the Goldman’s will ultimately need China far more
than China needs the Goldman’s. China is at the center of East Asian
production networks that generate real savings/capital, which the U.S.
currently does not. It is critical that China continue to channel its
capital where it is needed, into China’s internal development, not
into very low-yielding U.S. securities, it holds $1 trillion in
foreign exchange reserves, that are just being printed up in massive
amounts to control and confiscate real wealth. “
© 2007 Econotech
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