Wednesday, March 26, 2008

Waiting For Vulture Funds To Begin Descending

Unlike the play“Waiting For Gadot,” the Vulture Funds will show up. It is only a matter of time that they do. If we can learn from the real vulture’s mentality, it may be a little bit longer before the Vulture Funds begin their circling. This is because, like the real vultures, the Vulture Funds will not attack until the prey is very sick or dead. So, the lack of the Vulture Funds descending to feed can be viewed as a sign that the bottom has not been reached.

Why We Need The Vultures
It is ironic that investors are now welcoming Vulture Funds. In the current economic state of inaction, Vulture Funds provide a way of getting the economy going again by sopping up the defaulted and near defaulted investments currently held by the financial institutions. By taking the ‘bad’ investments off of financial institution’s books, Vulture Funds will allow them to once again have healthy balance sheets.

It sounds simple but, as with all things, it is not. The reason why the Vultures Funds have not yet descended to feed is that the banks themselves are still putting up a fight. Like a wounded animal fending itself to its last breath, the banks are in denial of their weaken financial health. Look at Bear Stearns. They were publicly stating just few days before being taken over by JP Morgan that they had sufficient liquidity. If anyone knows the movie “Monty Python And The Holy Grail", the banks are like the black knight who proclaims that the loss of his limbs are "mere flesh wounds.”

In a word: delusional.
Why The Fed Is Not Helping
Federal government is seeking various ways to prop up the failing markets from housing to mortgages to MBS. The housing market is broken and needs to fail so that banks can get their senses together to lend prudently. Irrational lending standards based on taking made up income and asset numbers at face value to lend hundreds of thousands of dollars did not make sense. It didn’t make sense in the 1970s, the1980s, and it still doesn’t make sense. Now the Fed steps in and allows Fannie Mae and Freddie Mae to increase their purchase of MBS on to their books and increase the limit for a ‘confirming loan’ to absurd levels that are not even uniform. Leave it to the Federal government to take something simple and make it very confusing.

Will this help? No. It is simple. The folks who took out the loans that are now in trouble will not qualify for the new loan limits because they never really qualified for the mortgage in the first place. It was only because the banks allowed ‘liar loans’ and other creative financing methods were these folks ever able to get a mortgage. So, with the increased loan limits it does not help the real symptom but makes an incremental improvement for those seeking jumbo loans. It is analogous to a German surgeon who operated on a patient’s rectum instead of her leg. It makes no sense.

The MBS market mess is a direct result of the housing and mortgage mistakes. Now, with FNMA and FHLMC being able to buy up to $200 billion in MBS, it is utterly ridiculous. These two GES were under tight capital requirements for their financial malfeasance not too long ago. Now, they are being paraded as ‘heroes’ who will come to save the MBS market with their balance sheet. As the song by OMC goes: “…Want to know the rest; Hey, buy the rights, How bizarre…”

When Will The Vulture Funds Descend?target="_blank" rel=nofollow
It is very interesting to note the proliferation and growth of Special Purpose Acquisition Companies (SPAC). Perhaps the SPAC will become the Vultures that will sop up the excesses. Given that the banks are not yet done with their write-downs, it may be a few more quarters before the Vultures really show in force.

May your trading be profitable!

Ed Kim
DISCLOSURE: The author holds no long or short positions in FNMA and FHLMC at this time.

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