Fear and Greed Blog

One might wonder why, with all the activity in the markets (okay, EXTREME volatility), I haven't had much to say.

That would be a bit misleading. I've been a little busy, but I plan on catching up over the next week or so.

I had a great time over the last few weeks refreshing and updating my skills by taking a class in distressed security valuation at NYU's Stern School of Business. Unlike Professor Altman, the Adjunct Professor that taught the class is a practitioner (hedge fund manager) - and I'm not sure that he would appreciate my mentioning his name, so I won't. He also brought in a top bankruptcy attorney to instruct us on the current law and to give us a better feel for the restructuring process; and what an investor in distressed securities needs to be aware of.

Both teachers were excellent speakers, passing along important information with good humor and letting students feel at ease with their down to earth styles.

As I mentioned in my post on Professor Altman's class, the learning experience at Stern is remarkably different from my tenure 20 years ago. Certainly that is to be expected, but the information that is now easily available over the Internet significantly improves the students' education (while raising the expectations of their work product). The changes in technology have also made it easier for students to really become engaged in the classes.

Back in the early 1990s, I was very involved in the restructuring business at Deloitte (in the valuation practice) and I participated in two of the week-long seminars conducted at NYU's Law School by the late Larry King. These seminars gave me an excellent understanding of the bankruptcy law at the time. I also travelled to the Bankruptcy Judges Conference in San Antonio where there were numerous useful lectures, and opportunities to network with other restructuring professionals.

Of course, I also took Professor Altman's Bankruptcy and Reorganization class while I attended NYU.

All of those learning opportunities, however, were related to the old Bankruptcy Law.

I now feel much more comfortable with the changes made to the Bankruptcy Law in 2005. As I mentioned in an earlier post, I expect there to be significant growth in the distressed/restructuring markets over the next few years. This course has updated my skill set to better identify, and profit from, the upcoming wave of opportunities.

Bottom line, I've been focusing on learning the past few weeks (in addition to my more normal activities). I expect to be writing more regularly, at least for the next few weeks.

Professor Ed Altman graciously allowed me to attend his Corporate Bankruptcy & Reorganization class at NYU last night. I had taken the course when I attended NYU's graduate business school, but this was a different experience - in a positive way (when I have a chance, I will write about the improvements I observed).

Professor Altman opened the class with a simple question. Who is responsible for the recent problems in the credit markets (this is my attempt to paraphrase, I'm not sure of the exact wording of the question)?

This is a question that has been the subject of much speculation in the blogosphere and in the news. Much of what is being said through those media is, in my opinion, way off base.

The students identified many of the same parties that have been cited elsewhere, but generally with better insight than the public discussion.

They pointed to the regulators, ratings agencies, loan originators, investment banks, etc. We even had a student that had been with a bulge bracket firm point out that, in the summer of 2006, his firm had identified similar issues and aggressively cut back on risk. That shows that, at an individual investor/firm level, losses could be averted.

In my opinion, all of those entities were party to the conditions creating the housing/sub-prime/structured debt bubble - I just don't believe that they were "responsible."

It is true that there were frauds and other improper activities that occurred; many of which would not have been possible without the lax lending environment. I strongly believe, however, that such activities were more the exception than the rule (I believe that this will be eventually borne out by any future investigations).

My statement, in the class, was that the blame falls on an unregulated capitalist system. It is normal for markets to overreact, both positively and negatively.

Not to beat a dead horse, but it comes back to Fear and Greed!

Each party in the process acted in their own interest, as they perceived it at the time. In the case of the consumer real estate market, the momentum of the market led to that special level of fear and greed - Euphoria!

When markets move to extremes, participants are driven by the fear of not taking advantage of the "sure thing," and the desire to make as much money as possible (greed).

Don't get me wrong. I'm a capitalist. I'm not in favor of excessive regulation. I just recognize that manias are part of the price of participating in our economy. There is no acceptable way, in my opinion, to regulate against crowd psychology.

Ultimately, as happened this year, something occurs to prick the bubble. Either too much product (stock, CDOs, oil, etc.) becomes available - overwhelming supply; or demand dries up as the marginal buyer is no longer willing to pay a premium, recognizing, perhaps, that there's no such thing as a free lunch (remember, supply equals demand at equilibrium).

The effect of declining bids is then magnified as parties that used leverage to buy in (or are, like hedge funds, vulnerable to redemptions) are forced to liquidate positions.

In today's market, the biggest problem is opacity.

While hedge funds and proprietary trading desks are always engaged in some form of poker in their trades, usually at least they understand their positions. With all of the CDOs, CLOs, ABCP, etc., most of the parties really don't know what they own.

Because of this lack of clarity, the bid/ask spreads tend to be enormous.

Given that most investors now have to mark their investments to market, this means huge problems. If holders mark their investment to the bid, they would have to report significant losses - whether or not the asset has greater value. If they don't use the bid, then it's hard to justify another measure.

David Einhorn gave an interesting lecture at Columbia a few weeks ago discussing some of the issues specific to this bubble.

Bill Gross, in his November Investment Outlook, also had some interesting insights.

It appears that this situation is going to take a long time to play out.