The Finance Professionals' Post

Book Review: Anglo Republic

Anglo Republic is the story of the remarkable rise and fall of the Anglo Irish Bank—once one of the fastest growing financial institutions worldwide, an in-depth review of how, "a small Dublin bank became too big to fail and too rotten to save—and how it dragged an entire country to the brink of bankruptcy." Anglo Irish had a spectacular rise on the Irish property boom, and an equally dramatic fall into eventual oblivion in 2008. Along the way, the Irish government and bank regulators, management, and board appear to have been largely oblivious to the bubble they were riding, and its end result. While the cast of characters may be unfamiliar to American readers, the book is a graphic chronological record of a bank failure, authored by journalist Simon Carswell, Finance Correspondent of the Irish Times. Carswell covered the Anglo Irish story throughout its peril.

Book Review: Reckless Endangerment

Is the love of money in fact the root of all evil? Perhaps. It was overwhelming greed and overreaching ambition that led to one of the greatest economic downturns of our time, the 2008 Recession, also dubbed the "Great Recession". 

This recent financial crisis resulted in a mass demand for literature which details the facts surrounding the financial meltdown. Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led To Economic Armageddon  is the best book on the roles of major mortgage companies, Fannie Mae and Freddie Mac, who intensified the housing boom through the pursuit of loans and agressive lobbying.

Real Estate: The Bubble, the Bust, and Beyond

With a decline of 24% in U.S. home prices since its record high in March 2007, this year marks the longest real estate bear market since the beginning of World War II. There is much public debate about when housing’s problems will end and a new bull market will begin. Financial history can provide us with some important insight into the longstanding pros and cons of real estate investing and clues to its future as a popular investment choice.

Recent Research: Highlights from July 2011

“The Role of Speculators During Times of Financial Distress.” The Journal of Alternative Investments (Summer 2011). Naomi E. Boyd, Jeffrey H. Harris, and Arkadiusz Nowak.

One of the best-known and largest hedge fund failures was the 2006 failure of Amaranth Advisors, LLC. The authors use detailed, trader-level data to examine the role of speculators during times of financial distress—in this case, the failure of Amaranth. They find that speculators served as a stabilizing force during the period by maintaining or increasing long positions, even while prices fell. The authors develop two testable propositions regarding liquidation versus transfer of positions and conclude that the probability of transfer was more likely for distant contract expirations and for contracts more dominantly held by the distressed trader. The article also examines the role of speculators in providing liquidity and mitigating the effects of liquidity risk by evaluating the change in the number of traders, the size and time between trades, and a Herfindahl measure of speculative trader concentration during the crisis period.

Recent Research: Highlights from April 2011

“The Impact of Illiquidity and Higher Moments of Hedge Fund Returns on Their Risk-Adjusted Performance and Diversification Potential.” The Journal of Alternative Investment (Spring 2011). Laurent Cavenaile, Alain Coën, and Georges Hübner.

This article studies the joint impact of smoothing and fat tails on the risk–return properties of hedge fund strategies. First, the authors adjust risk and performance measures for illiquidity and the non-Gaussian distribution of hedge funds returns. They use two risk metrics: the Modified Value-at-Risk and a preference-based measure retrieved from the linear exponential utility function. Second, they revisit the hedge fund diversification effect with these adjustments for illiquidity. Their results report similar fund performance rankings and optimal hedge fund strategy allocations for both adjusted metrics. They also show that the benefits of hedge funds in portfolio diversification persist but tend to weaken after adjustments for illiquidity are made.

A Blueprint for Mortgage Finance Reform

JUMP TO: TIMELINE | Q&A | THE ADMINISTRATION'S PLAN

The goal of reforming housing finance should be to ensure economic efficiency, both in the primary mortgage market (origination) as well as in the secondary mortgage market (securitization). By economic efficiency, we have in mind a housing finance system that

• corrects any market failures if they exist; notably in this case is the externality from originators and securitizers undertaking too much credit and interest rate risk as this risk is inherently systemic in nature;
• maintains a level-playing field between the different financial players in the mortgage market to limit a concentrated build-up of systemic risk; and
• does not engender moral hazard issues in mortgage origination and securitization.

Motivated from economic theory, we argue that such a mortgage finance system should be primarily private in nature. It should involve origination and securitization of mortgages that are standardized and conform to reasonable credit quality. The credit risk underlying the mortgages should be borne by market investors, perhaps with some support from private guarantors. There should be few guarantees, if any, from the government.

Commentary: Footprints and Foreclosure

The global economy now uses 1.5 times the earth’s capacity to regenerate the natural capital we use every year, up from the 1.4 times of the prior year, according to a report of the well-respected Global Footprint Network. In their Living Planet Report 2010, released this week but based on 2007 data, the most recent available, WWF together with the Global Footprint Network and the Zoological Society of London record the most significant milestone since we crossed parity (an ecological footprint of one) back in 1975. This is not good news.

Why Have REITs Been So Strong?

Despite the recent slump in the real estate economy, publicly traded REITs (real estate investment trusts) have been outperforming dramatically. REITs are also significantly ahead of the stock market, beating year to date returns of 2.3% for the S&P 500 and 5.2% for the Russell 2000 (see Table 1).  That’s not much of a surprise, since REITs have surpassed the stock market over nearly any historical period since inception of the FTSE NAREIT U.S. Real Estate Indexes in January 1972.

Tails, I Win; Heads, You Lose

About a decade ago, in the advent of the Internet era, Wall Street was consumed with the “paradigm shift” occurring in the “New Economy,” where earnings no longer mattered and all that counted were “eyeballs.” Remember that drivel? Based on this flimsy, overweening logic, many investment bankers managed to convince successive waves of investors to buy the IPOs of companies that were little more than a few recent college graduates holed up in quasi-loft spaces south of San Francisco’s Market Street or in the shadow of Manhattan’s Flatiron building. Who can forget such spectacular flameouts as Globe.com and Pets.com? For a while, though, the ruse worked and many people got rich. 

Construction Materials Outlook: Some Hope on the Far Horizon

The Finance Professionals' Post spoke with Jack Kasprzak, managing director of Equity Research at BB&T Capital, for his outlook on the three principal sectors of the construction materials sector—public works, housing, and commercial building—in the run-up to NYSSA’s Fifth Annual Construction & Materials Conference, to be held on September 29.

In Recovery: Looking Forward with Abby Cohen

Abby Joseph Cohen, CFA, is the president of the Global Markets Institute at Goldman Sachs, and the firm’s senior investment strategist. She’s been with the company since 1990, and became a partner in 1998.

Cohen’s career, which started when she joined the Federal Reserve Board in Washington, DC, as an economist, has been the subject of a Harvard Business School case study. She is the former chairman of the board of AIMR (Association for Investment Management and Research, now CFA Institute) and the recipient of that organization’s Distinguished Service Award.

The Ghost of Credit Past: The Specter of the Heilig-Meyers Fiasco Haunts Today's Failed Lenders

“Heilig-Meyers: From AAA to Junk Bond”

“CDO Ratings Are Whacked by Moody’s—AAA to Junk in a Day Raises More Questions about Credit Agencies”

The first of these headlines appeared from Credit Card Management in 2001, and announced the collapse of what was then one of the largest American furniture retailers. The origins of that collapse lie in the late 1990s, when Heilig-Meyers began to service its own debt. As much as 75% of its sales were made with two-year installment loans.

Safe House: The Housing Market and the End of the Recession

A great deal of attention has recently been devoted to examining trends in the housing market and to predicting possible outcomes of the recession. If housing is at the center of the current storm, how soon will recovery in this sector offer the rest of the economy some shelter from the nasty weather? Inevitably, stabilization in the real estate market has to be achieved through reestablishing the broken link between real values and market prices.

Distressed Real Estate Assets on the Rise—And So Is Investor Interest

The quantity of distressed commercial real estate assets (properties and loans) in the United States will continue to increase as the deleveraging process unfolds over the coming years. The implosion of the global financing market coupled with the longest and deepest economic recession since the Great Depression has increased stress on both properties and their owners. A shutdown of the securitized lending market (CMBS market) is increasing the demand of properties needing to be refinanced, but the dislocated financing market is limiting the supply of new loans available. 

REITS: Real Estate With A Return Premium

The FTSE NAREIT US Real Estate Index Series is designed to present investors with a comprehensive family of REIT performance indexes that span the commercial real estate space across the US economy, offering exposure to all investment and property sectors. The product suite provides investors with an index series that has additional transparency that acts as a catalyst for growth in the ETF and index fund arena.

This research, compiled by NAREIT provides a detailed comparison of the investment performance of publicly traded REITs and private equity real estate funds, as well as the reasons for REITs outperformance. NAREIT used the FTSE NAREIT Equity REIT Index (an index of 106 U.S. REITs with an aggregate market capitalization of $295 billion whose constituents manage estimated property assets of $500 billion) to measure the performance of REITs.

Click here to read the special report REITS: Real Estate With A Return Premium.

Hive Mind: Organizational Psychology and the Financial Crisis

Economists agree about the mechanism for the current financial crisis: a plunge in real estate prices led to widespread mortgage defaults, crushing the value of securities backed by those assets. This caused banks to shut down available credit and sent the global economy into a tailspin. “If there hadn’t been a housing bubble, we wouldn’t be having this tragedy today,” says Hersh Shefrin, PhD, professor of behavioral finance at Santa Clara University and the author of Ending the Management Illusion: How to Drive Business Results Using the Principles of Behavioral Finance (McGraw–Hill 2008).

Whither Efficient Markets? Efficient Market Theory and Behavioral Finance

The notion of efficient markets has been the subject of rigorous academic research and intense debate for more than a century. As early as 1889, George Rutledge Gibson wrote in The Stock Exchanges of London, Paris, and New York that when “shares become publicly known in an open market, the value which they acquire may be regarded as the judgment of the best intelligence concerning them.” A reference to the concept of efficient markets is also found in French mathematician Louis Bachelier’s 1900 dissertation Théorie de la Spéculation. But it wasn’t until the mid 1960s, through the independent work of MIT economist Paul A. Samuelson and Eugene Fama, then a PhD candidate at the University of Chicago, that the efficient markets hypothesis (EMH) gained widespread acceptance.

Real Estate Portfolio Allocation and Today’s Marketplace: While Private Real Estate Struggles, Listed Real Estate Begins to Rebound

After a rocky end to 2008 and a tumultuous market environment through first quarter 2009, individual and institutional investors worldwide are closely examining their portfolios—assessing losses, identifying opportunities, and looking for signals from the marketplace as to what may be next. Despite the looming credit crisis, equity markets have improved, and there have been optimistic whispers that the worst may be behind us. But what is going on in the real estate market?

Moody’s Updated Modeling Parameters for Rating Corporate Synthetic CDOs and Cash Flow CLOs

In recent months, as the credit crisis that started in the summer of 2007 has spread across various sectors, and economies around the world are confronted with a deep and long recession, synthetic CDOs and cash flow CLOs—whose ratings have been relatively stable—have started seeing substantial downgrades.

During the past few months, Moody’s has revised and updated the key modeling parameter assumptions that it uses to rate and monitor CDOs and CLOs backed by corporate debt. These changes alone have led Moody’s to downgrade—in many cases by several notches—a large number of CDO and CLO tranches, and many remain on review for possible further downgrade.