Using Veritas to Construct the "Per…

29-04-2017 Hits:49157 BoomBustBlog Reggie Middleton

Using Veritas to Construct the "Perfect" Digital Investment Portfolio" & How to Value "Hard to Value" tokens, Pt 1

The golden grail of investing is to find that investable asset that provides the greatest reward with the least risk. Alas, despite how commonsensical that precept seems to be, many...

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The Veritas 2017 Token Offering Summary …

15-04-2017 Hits:49498 BoomBustBlog Reggie Middleton

The Veritas 2017 Token Offering Summary Available For Download and Sharing

The Veritas Offering Summary is now available for download, which packs all the information about Veritas in a single page. A step by step guide to purchasing Veritas can be downloaded here.

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What Happens When the Fund Fee Fight Hit…

10-04-2017 Hits:48814 BoomBustBlog Reggie Middleton

What Happens When the Fund Fee Fight Hits the Blockchain

A hedge fund recently made news by securitizing its LP units as Ethereum-based tokens and selling them as tradeable (thereby liquid) assets. This brings technology to the VC industry that...

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Veritaseum: The ICO That's Ushering in t…

07-04-2017 Hits:50685 BoomBustBlog Reggie Middleton

Veritaseum: The ICO That's Ushering in the Era of P2P Capital Markets

Veritaseum is in the process of building peer-to-peer capital markets that enable financial and value market participants to deal directly with each other on a counterparty risk-free basis in lieu...

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This Is Ground Zero for the 2017 Veritas…

03-04-2017 Hits:50112 BoomBustBlog Reggie Middleton

This Is Ground Zero for the 2017 Veritas Offering. Are You Ready to Get Your Key to the P2P Capital Markets?

This is the link to the Veritas Crowdsale landing page. Here is where you will be able to buy the Veritas ICO when it is launched in mid-April. Below, please...

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What is the Value Proposition For Verita…

01-04-2017 Hits:52681 BoomBustBlog Reggie Middleton

What is the Value Proposition For Veritas, Veritaseum's Software Token?

 A YouTube commenter asked a very good question that we will like to take some time to answer. The question was, verbatim: I've watched your video and gone through the slides. The exchange...

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This Real Estate Bubble, Like Some Relat…

28-03-2017 Hits:33717 BoomBustBlog Reggie Middleton

This Real Estate Bubble, Like Some Relationships, Is Complicated...

CNBC reports US home prices rise 5.9 percent to 31-month high in January according to S&P CoreLogic Case-Shiller. This puts the 20 city index close to an all time high, including...

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Bloomberg Chimes In With My Warnings As …

28-03-2017 Hits:51335 BoomBustBlog Reggie Middleton

Bloomberg Chimes In With My Warnings As Landlords Offer First Time Ever Concessions to Retail Renters

Over the last quarter I've been warning about the significant weakness in retailers and the retail real estate that most occupy (links supplied below). Now, Bloomberg reports: Manhattan Landlords Are Offering...

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Our Apple Analysis This Week - This Comp…

27-03-2017 Hits:51223 BoomBustBlog Reggie Middleton

Our Apple Analysis This Week - This Company Is Not What Most Think It IS

We will releasing our Apple forensic analysis and valuation this week for subscribers (click here to subscribe - lowest tier is the same as a Netflix subscription). As can be...

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The Country's First Newly Elected Lame D…

27-03-2017 Hits:51534 BoomBustBlog Reggie Middleton

The Country's First Newly Elected Lame Duck President Will Cause Massive Reversal Of Speculative Gains

Note: Subscribers should reference  the paywall material here for stocks that should give a good risk/reward scenario for bearish trades. The Trump administration's legislative outlook is effectively a political desert, with...

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Sears Finally Throws In The Towel Exactl…

22-03-2017 Hits:53978 BoomBustBlog Reggie Middleton

Sears Finally Throws In The Towel Exactly When I Predicted "has ‘substantial doubt’ about its future"

My prediction of Sears collapsing once interest rates started ticking upwards was absolutely on point.

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The Transformation of Television in Amer…

21-03-2017 Hits:52992 BoomBustBlog Reggie Middleton

The Transformation of Television in America and Worldwide

TV has changed more in the past 10 years than it has since it's inception nearly 100 years ago This change is profound, and the primary benefactors look and act...

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Counterparty risk – why isn’t this in the media? Don’t these guys read my blog:-)

All futures contracts offer extreme leverage over the physical commodity for which they represent a forward price. I will make a representative sampling of Morgan Stanley’s asset holdings to illustrate a point:

 

  • US Government and agency securities 1,000:1
  • Foreign currency $1 million:1
  • Equity indices are 250:1
  • real estate indices, the multiplier is $250:1
  • 1 month LIBOR is 2,500:1
  • Interest rate swaps are 10,000:1
  • Gold 50:1
  • Coffee 37,500:1

 

Now, Morgan Stanley has a large and lucrative prime brokerage business. This is the business where the banks provide infrastructure and research for hedge funds (wouldn’t it be funny if I got this research from Citibank or Morgan Stanley?) and loan them money on margin. They regularly give up to 20:1 margin to their good customers, with many customers receiving much more. They also enter into OTC arrangements with these clients, basically accepting credit risk (and market risk, hedged or unhedged) with the funds as a counterparty. These funds are not banks, and do not carry statutory capital requirements or minimum credit ratings. They are just pools of private capital. Hey, you know I’m cool with that. The issue is, how do you quantify the amount of credit risk assumed? Every bank does it differently. It is not standardized, and it possibly not even done very well. Nominally, as reported by MS, this counterparty exposure is 112% of capital. That is a lot. But wait!!!! Let’s look at the anatomy of a relationship.

Let’s assume the hedge fund x is offered average leverage of 20:1 by MS Prime Brokerage services. MS is now selling that leverage and accepting the credit risk of an unrated, unregulated buyer. {For the record, I am totally against rating and regulating hedge funds. If you read my blog, you know how I feel about the big rating agencies, and regulation will just drive capital offshore - for good - while making no improvement here in the states! The solution is tighter risk management in the banks and brokerages – this is a private affair!} MS is doing this with 34x leverage itself. The buyer then buys invests in a portfolio like the one listed above in the futures and OTC markets, etc. at an average of 500:1 leverage. The hedge fund is effectively utilizing it equity leveraged (500*20=10,000) 10,000x on the physical and financial underlyings to speculate (and/or hedge – yeah, right). If things go bad, ex. Subprime debt or quantitative trading model blow ups, small moves can result in 10,000x losses to the equity, and multiply the 10,000x times the equity of MS’s equity capital multiplier, and you can have a doozy of a spell. I know, it sounds quite apocalyptic and these are just round unhedged, anecdotal numbers, but I am sure at least somebody gets my point. Admittedely, this does NOT take into consideration hedging, nor does it take into consideration applied portfolio theory, diversification, correlation management, etc. and yada, yada, yada. What it does take into consideration is reality rarely quoted. What I am trying to accomplish here is an illustration of how dangerous excessive leverage can be.

 

 

 


 

Now, all we need to do is multiply this exposure by about 1,500 or so hedge funds/private clients and apply hedges that were implemented as skillfully as those in the subprime mortgage markets, and voila! Instant Morgan Stanley counterparty exposure.

Now, back to the banks…

So, now that we know what these levels 1 through 4 are, how leverage can help or hurt us equity investors, and the mystery of who loans to who and how risky it can be - how does this apply to the big banks? Well, here is a rundown of who has what and where.

In US$ bn

       

 


Level 1

Level 2

Level 3

 

Bear Sterns

29.8

188.0

20.3

 

Lehman Brothers

79.2

168.4

34.7

 

Morgan Stanley

149.8

588.2

88.2

 

Goldman Sachs

121.8

276.7

72.0

 

Wachovia

 


 


 


does not provide

Citibank

250.7

939.0

134.8

 

Chevy Chase Bank

 


 


 


does not provide

HSBC

 


 


 


does not provide

Capital One Financial Corporation

 


 


 


does not provide

Merrill Lynch

100

553

27

 

Now, looking at the raw numbers can be misleading. As you may know, most financial institutions are highly leveraged. They make their money by deploying capital. The caveat is, not all of the capital deployed is really theirs. They borrow most of it. Equity capital is what I will define, for the sake of this blog, as capital that actually belongs to the institution (and thus shareholders). All other capital will be considered leverage, in some form of fashion. This is an oversimplification, but at the end of the day, this is what it boils down to.

 

Company ($ billions)

Leverage (Volatility)

Level 2 asset as a % of equity (model risk)

Level 3 asset as a % of equity (bullshit risk)

Counterparty net exposure as a % of equity (credit exposure)

Asset write Downs as a % of Equity

Reggie's Take

Bear Sterns

30.54x

1446%

156%

61%

9.23%

Not good

Lehman Brothers

32x

818%

168%

120%

-

Very risky

Morgan Stanley

33.62x

1669%

250%

113%

26.63%

You've got some damn nerve calling others a short!

Goldman Sachs

26.81x

710%

185%

133%

-

Less asset risk, more credit risk! All in all, better than the rest.

Citibank

18.57x

739%

106%

N/A

8.66%

Hmm!, where's the counterparty reporting! I bet it ain't pretty

Mesrill Lynch

28.41x

1432%

70%

118%

20.71%

Merill is more forthcoming writing down assets than others. MS just tripled their write down

 

I think Merrill has been much more forthcoming (not necessarily on purpose) than most of their competitors. The street will report more asset write downs, & they're LEVERED UP! Here is a formula for a good short candidate: Asset write downs plus high leverage = Equity investors,”look out BELOW!” Why are O'Neil and Prince unemployed, yet the other CEO's still working?

So, as you can see in chart above, Morgan Stanley is:

· The most leveraged on the street at about 34x equity deployed

· Has the most model risk of all of its peers here

· Has 2 and ½ more bullsh1t level 3 assets than the company they had the nerve to call the short of the year (don’t get me wrong, I’m short Citibank as well, but still…), and more than any other bank on the street

· Plenty of counterparty exposure, although they don’t lead the pack here

· And lead the pack reported (that’s the key word here) proportionate asset write downs to equity (I don’t know how long that will remain true though, I see many more impairments ahead).

 

A breakdown of MS’s assets, by class.

Morgan Stanley Asset Level Analysis

         


Level I

Level II

Level III

Counterparty and cash collateral netting

Balance

Assets

 


 


 


 


 


Cash & securities deposited with clearing organizations

13.9

-

-

-

13.9

Financial instruments owned

 


 


 


 


-

US Government and agency securities

17.5

20.7

2.2

 


40.3

Other Sovereign government obligations

27.1

7.7

0.1

 


34.8

Corporate and other debt

 


116.6

43.3

 


160.0

Corporate equities

100.9

0.3

1.7

 


102.8

Derivative contracts

3.5

439.6

29.5

(410.2)

62.5

Investments

0.9

0.7

11.4

 


12.9

Physical commodities

-

2.7

-

 


2.7

Total Financial Instruments owned

149.8

588.2

88.2

(410.2)

416.1

Other investments

-

7.2

1.6

 


8.8

Intangible assets

-

0.4

0.0

 


0.4

 


 


 


 


 


 


Total

149.8

595.8

89.9

 


425.3

 

A close look at MS’s counter party credit ratings. Read the 104 basis points Halloween story in this blog for more on my take on ratings agencies. It will make you laugh.