We are clearly not having as much fun taking off leverage as we had putting it on, or at least the vast majority are not. This week in Outside the Box we look at some very thought-provoking insights from my good friend Paul McCulley, who helps us think about how we got here and what will be the end point. From the letter:
"But what ailed Lehman was but a manifestation of what ailed, and ails the global financial intermediary system: the presumption that grossly levered positions in illiquid assets can always be funded, because those doing the funding will always assume the borrower is a going concern."
You need to read this when you have the time to think. The quotes from Keynes are important.
Paul is a managing director, generalist portfolio manager, and member of the investment committee in the Newport Beach office of PIMCO. In addition, he heads PIMCO's short-term bond desk. And is an avid fisherman
The weekend has brought us events that can only be described in large, over-the-top terms. The Fed agreeing to take equity on its balance sheet? How bad can things really be? Clearly much worse than most people thought last Friday. Moral Hazard has been re-introduced as Lehman is allowed to go down. I will admit to being surprised. I thought Paulson and Bernanke would put it in the too big too fail category. I think they did the right thing by refusing taxpayer money for a bailout, but it is clearly going to roil the credit markets for weeks and months. It will be interesting to see how long it lasts.
I am in La Jolla today, working with my partners at Altegris, and looking over their shoulders while they monitor the performance of some of our managers. Interesting times. But I have had the time to read two short but very interesting commentaries on the current crisis. I will have more to say on Friday, but for now let's read old friends (to Outside the Box readers) Michael Lewitt of Hegemony Capital Management (www.hcmmarketletter.com) and Barry Ritholtz of Fusion IQ (www.fusioniqrank.com).
As I send this, credit default swaps spreads are simply blowing out. I have been writing about how we would see significant problems in the CDS markets for almost two years. This is something that you could see coming yet nothing was done. I know we are now in crisis, but let's hope that the authorities learn some lessons and put in place some sensible regulations of the CDS market soon. And for the love of Pete (insert your favorite expletive here) put these (more expletives) things on a regulated exchange.
And I agree with Michael below. This is not a time to try and catch a falling knife. That time will come, but not yet. And remember things will get better and we will get through this. As I just said to Barry, "We do live in interesting times."