Reggie Middleton

Reggie Middleton

Resident Contrarian Badass at BoomBustBlog (you can call me Editor-in-Chief)...

Disruptor-in-Chief at, where we're ushering the P2P Economy.


Saturday, 05 January 2008 05:00

Download a "Window" into Ambac's Problems

Two simple, but unflappable tenets that I follow when investing are:

1.) Economic profit must be evident in order for the investment to be worthwhile. Economic profit exists when the reward achieved exceeds the risk assumed in getting such reward; and

2.) Simpler is better (KISS - Keep it Simple). A lack of transpasrency in the money trail of an investment diminshes its value.

Tenet number two is often misconstrued on Wall Street. Complex 'high finance' investments are not necessarily better than simpler ones. As a matter of fact, seen in light of tenet number one, increased complexity increases risk, thus reducing value.

Often vendor orientated profit is the reason for excessive complexity. If customers cannot understand the pricing (due to lack of transparency) the vendor can charge more. Vendors can then play on the customer's insecurities in that customers feel more sophisticated, knowledgeable and "cool" if they have the latest product that only the special and intelligent can understand - ala Marketing 101.

After talking with friends that specialize in structured products, risk management, and auditing industries, I came up with the idea for this piece. Why not try to offer a simplified method of looking at the risk of the monolines for the layman? Now, of course many professionals will say that the business is too complex for the layman to grasp the risks and rewards involved. Hey, that may be true, but that also brings us back to tenets one and two. If it so complex that risks cannot be seen, or so complicated that rewards are not easily applicable to the business then how valuable is the business and how risky is it really? Does such complexity really warrant a AAA rating, especially in the face of so much adversity? Complexity sure as hell appears to have stumped the management of the monolines, since they have both insured and invested in structured products for which they aren't sure of the payouts in the event of default(see below). There are simpler ways of looking at risks. When in doubt, one can always default to the market - Ambac's credit default swap spreads are reportedly trading at, or near, junk levels indicating a 20%+- probability of default (so they say on the trading desks).

I performed a decent amount of research on the two biggest monolines, which, besides being a little jovial, brought up some damn good points, not the least of which was the potential for insolvency! Nouriel Roubini queries (and rightfully so since I have queried the same and I am NEVER wrong:-), the delay in rating agency downgrading the monolines - "a business model that cannot survive without a AAA rating is a business model that cannot fundamentally deserve a AAA rating ".

Wednesday, 02 January 2008 05:00

Now, a "Realistic" View of Lennar's Solvency

Last week, we ran a what if scenario assuming the greatest possible benefit towards Lennar's favor in regards to their debt to asset situation, and we came up with insolvency. The reason for my doing such was an attempt to lend an inescapable credibility to my findings. As was stated in the earlier opinion, the mark that was given to Lennar's assets was unrealistically conservative, but was done so to prove a point. Well, now I am here to give a realistic mark, and display the scenario accordingly.

As stated in the earlier analysis, Lennar sold off a large block of assets for approximately 60% of what it was reported as on the books. This discount is to be adjusted to 50% due to some retained ownership and rights of first refusal. Since this sale included a heterogenous mix of raw land, construction in progress, and finsihed communities, it would be unrealistic to attribute the large discount solely to that of the more illiquid raw land. In addition, despite discounts of up to 56%, Lennar, Hovnanian, Centex, Pulte, and Countrywide among several other banks hosting a slew of evergrowing REOs cannot effectively move their inventory as builder backlog decreases, bank REO inventory builds, and builder inventory remains close to static.{readmore}

The National Association of Realtors released results stating sales actually rose .04% (statistically significant?), but were down 20% from last year with prices down across the board. The Times Online is reporting Shiller Says America could plunge into Japan-Style Recession.

lerah book"Losses arising from America's housing recession could triple over the next few years and they represent the greatest threat to growth in the United States, one of the world's leading economists has told The Times.

Robert Shiller, Professor of Economics at Yale University, predicted that there was a very real possibility that the US would be plunged into a Japan-style slump, with house prices declining for years.

Professor Shiller, co-founder of the respected S&P Case/Shiller house-price index, said: "American real estate values have already lost around $1 trillion [£503 billion]. That could easily increase threefold over the next few years. This is a much bigger issue than sub-prime. We are talking trillions of dollars' worth of losses."

He said that US futures markets had priced in further declines in house prices in the short term, with contracts on the S&P Shiller index pointing to decreases of up to 14 per cent.

"Over the next five years, the futures contracts are pointing to losses of around 35 per cent in some areas, such as Florida, California and Las Vegas. There is a good chance that this housing recession will go on for years," he said."

My take: I believe that my blog's readers are considerably above average in financial acumen and common sense. The NAR is simply not an entity to be taken too seriously, due to the obvious conflict of interest exemplified by their ex-economist, [[David Lereah]], who published some of the most absurd BS I have ever seen come from a nationally reknown organization. Examples of his work from Wikipedia: Are You Missing the Real Estate Boom?: Why Home Values and Other Real Estate Investments Will Climb Through The End of The Decade�And How to Profit From Them was published in February 2005 at just about the tippy top of the bubble (that takes some talent). One year later in February 2006, as the market is already on it's way down, Lereah retitled his book Why the Real Estate Boom Will Not Bust and How You Can Profit from It. Lereah's previous book The Rules for Growing Rich: Making Money in the New Information Economy touting investment in technology company equities was published in June 2000 at the onset of the collapse of the dot-com bubble. This extreme cheerleading has died down substantially, but the overly optimistic spin is still evident with their new economist, Lawrence Yun.

Mr. Shiller, is a different story, though. He is to be taken seriously and has no such conflicts that I can see. BUT (there always is a but, isn't there?), you should know what it is you are looking at when you stare at his numbers. In September of last year (Happy New Year, everybody) I cautioned about misreading the numbers from the Case-Shiller index (see The Real Trend in US Housing Prices... ).

Sunday, 30 December 2007 05:00

Lennar Insolvent: Enron redux???

Required reading for this blog post is the fully consolidated Lennar analysis on my site. That analysis was performed right before Lennar started selling off bulk assets at a sharp discount, which spawned this follow up analysis.

Insolvency: a financial condition experienced by a person or business entity when their assets no longer exceed their liabilities, commonly referred to as 'balance-sheet' insolvency

I am now delivering on the long ago promise to make public the granular calculations of my opinion on Lennar's (the nation's largest home builder) recent property sales to raise cash. I looked at the date the models was completed by the analysts, and yes, it has been over a month. Well, here it is. It has not been proofread yet, so forgive any typos. To begin with, I alleged Lennar was near insolvent over a month ago. Events since then have simply validated my opinion, and intensified them as well. I believe that Lennar did the right thing by selling the assets. They simply waited too long. I have heard from at least two, unrelated private equity parties who both said, unbeknownst to each other, that they have been trying to buy land from Lennar but Lennar had been unrealistic with their expectations in terms of the valuation of the property. Now they are selling at 50% discounts. This should have been done last year. The cost to their net worth will now be astronomical, and as you can see they have already stepped into the realm of insolvency. I will have the full 60 page analysis ready for dowload in a day or two, free for registered users and super free for those who have used the invite tool in the user menu to invite thier friends to visit the blog.Wink

In the Lennar model, I backed into the valuation write down (impairment) it would take to push Lennar's fully consolidated financial statements (not the stuff they have been reporting, but the real deal with all assets and liabilities taken into consideration) into a debt to capital ratio in excess of 100%, or in other words - insolvency. The magic number is anything above 8%. At 8%, Lennar's assets no longer exceed the value of thier liabilities. This is excluding all non-recourse debt and anything that does not contractually bind the company to explicitly extend capital such as maintenance agreements, performance agreements, etc. This is telling, as you may know, since they recently sold large parcels of land and work in process at a 50% discount to reported book (that is 60% as reported in the press, less rights of first refusal and partial ownership of the new venture). This wasn't their tertiary properties (like this one in Chicago) either. Thus, any write down on much of the existing properties will probably be worse since macro conditions are worsening and a significant amount of the properties left are inferior to what they just sold. We haven't gotten very far into this story and already it doesn't look good.

I've decided to make this update as conservative as possible, so I will apply the greatest possible benefit of doubt towards Lennar's favor. For instance, the largest property sale was reported at a 60% discount. I reduced it to 50%. I will assume that that reduced discount is 100% overshot as compared to the rest of Lennar's current inventory and further reduce it by 50% to apply it as a mark to market at 25%. Now, I will redcue that even further for work in process and finished homes and assume a 15% discount on those properties since they are more liquid than raw land (eventhought the original sale included whole finished communities, work in process and raw land and still came out to a 50% off sale). So let's assume we have a weighted average of about 18% discount to current inventory book values. I feel this is extremely conservative, particularly if you read A note on mortgages, overly optimistic recovery rates and recent events... , where in California a 33% price reduction would not move a finished existing REO. Centex, Beazer, Hovnanian, et. al. are having similar issues despite some discounts considerably over 30%. Alas, let's stick with our 18% mark, and consider it the mark that will be fed into the Lennar model.

Saturday, 29 December 2007 05:00

A personal email on the monolines, pt. deux

This is a second set of email between me and my friend, the big willy of corporate finance. The first set is here. Here we really get into it as the classical corporate guy versus blue collar working stiff class conflict scenario. Okay, I may be exaggerating a bit, but we do challenge each other's knowledge and grasp on the topic at hand. Just to let you know, this is a really smart and accomplished guy whos is highly positioned. I remember when he was just getting started. I lent him his first set of books on structured products. Oh no! It looks like I helped to create a FrankenFinance Monster :-) All jokes aside, he is a very good friend, and I am using these email exchanges as content because I believe they illustrate a very interesting point in my view of the market vs. many of those who may be opposed to my way of viewing things. Sometimes, when you are too close to something for too long, you can't see the forest because those damn trees keep getting in your way!

He is the penultimate insider, I am about as outside as an outsider can get. We are polar opposites, yet friends for 22 years and counting. Now, on to the story... I had to modify some portions since I cannot represent any form of investment record publicly.


Wall Street Big Willie

You lost me in the first paragraph with ........"since much of the structured prodcut insurance should technically be booked at a loss at inception of the contract" .....(ridiculous since the earned "spreads" would obviously offset any losses AND actuarial analysis would clearly disagree) .

Dec. 28 (Bloomberg) -- Billionaire investor Warren Buffett is
starting a bond insurer to take U.S. local-government business away
from companies including MBIA Inc. and Ambac Financial Group Inc., the
Wall Street Journal reported.

Berkshire Hathaway Assurance
Corp. opens for business today in New York State, Buffett, chairman of
Omaha, Nebraska-based Berkshire Hathaway Inc., said in an interview
with the newspaper...

Buffett, who said in October he
was looking for investments to absorb $45 billion of cash, is
challenging the bond insurers as they struggle to retain the AAA credit
ratings that allow them to guarantee debt. The top rankings of MBIA,
Ambac and other so-called monolines are under scrutiny amid concern
they don't have enough capital for the $2.4 trillion of debt they


``The monolines are hurting so now is a good time for Buffett to be getting into the market,'' said Matthew Maxwell, a London-based credit analyst at Calyon, the investment banking unit of Credit Agricole SA. ``Investors might feel more comfortable investing in bonds insured by Buffett than those backed by an insurer with the legacy of the credit crisis hanging over them.''

Buffett, 77, told the Journal he will also seek permission to operate in California, Puerto Rico, Texas, Illinois and Florida.

Berkshire Hathaway has AAA ratings from Fitch Ratings, Moody's Investors Service and Standard & Poor's and its guarantee would enable municipal bond issuers to cut the cost of financing everything from hospitals to schools to sports stadiums.

Buffett, who said he would charge more than existing financial guarantors, would present competition for Armonk, New York-based MBIA, as well as Ambac and FGIC Corp. of New York, as they try to convince Moody's, Fitch and S&P that they deserve to keep their top ratings. Suuuurrrree they do! Look here icon Ambac Valuationmodel 03december2007 Ver1.0%281%29 (878.65 kB 2007-12-24 15:41:20)

Fitch has given MBIA and Ambac less than six weeks to raise $1 billion each or face losing their AAA ratings. Moody's and S&P earlier month placed MBIA's ranking on negative outlook. MBIA on Dec. 10 said it will get $1 billion from private-equity firm Warburg Pincus LLC to bolster its capital and Ambac took out reinsurance on $29 billion of securities it guarantees. These companies with a mere $2 or $3 billion of capital are struggling to overpay for $1 billion in financing just to keep a rating they don't deserve. How in the world can compete against a $45 billion capitalized, conservative insurer with a sterling track record and reputation? These companies are done, don't even bother to stick a fork in. I told you they were done before, they are extra crispy now for the only new business for them to write is business that they shouldn't write. That Warburg Pincus investment in MBIA is money flushed down the toilet.

`Mass Destruction'

Bonds sold by state governments make up about 33 percent of the insurance premiums collected by MBIA, the biggest of the monolines, and 50 percent of revenue for No. 2 competitor Ambac.

The companies stumbled as they expanded beyond municipal securities into structured finance securities such as collateralized debt obligations, which package pools of bonds and loans and slice them into separate pieces.

Buffett, who has described derivatives as ``financial weapons of mass destruction,'' told the Journal he will focus on insuring municipal debt rather than CDOs.

New York-based monoline ACA Capital Holdings Inc. is struggling to stave off delinquency proceedings after the value of the CDOs it guaranteed plunged. S&P cut ACA's rating by 12 levels to CCC after the company posted a $1.04 billion third- quarter loss.

ACA Financial Guaranty Corp., a unit of ACA Capital, said this week it will seek approval from the Maryland Insurance Administration before pledging or assigning assets or paying dividends.

Smelling Opportunity

Buffett has profited in the past from turmoil in the insurance business. Berkshire's after-tax profit from insurance underwriting soared to $2.5 billion last year from $27 million in 2005 after providing insurance cover for coastal properties vulnerable to storms as some premiums quadrupled because of record U.S. hurricane losses.

``If Buffett smells an opportunity, his track record suggests there is one,'' said Georg Grodzki, head of credit research at London-based Legal & General Group Plc. ``Buffett seems to believe the market is viable and the bond insurer has a future.'' Yeah, I agree. It's the monoline derivative insurer that is DOA.

Separately, Berkshire Hathaway agreed to buy the reinsurance unit of ING Groep NV for about 300 million euros ($440 million), the biggest Dutch financial-services company said in a statement today.

Berkshire's Class A stock reached a record $151,650 a share on Dec. 11, having surged 25 percent this year. The stock had only three losing years since 1988.

Friday, 28 December 2007 05:00

The Ambac FAQ


Below is an excerpt from the FAQ that Ambac posted on their website, along with my comments. The most of the full FAQ and more of my comments are seen further below.

What percentage of the $550 billion par of guaranteed obligations are represented by direct subprime RMBS and by CDS on ABS CDOs, including the CDO-squared deals?

Ambacâ€TMs portfolio is a highly selective sub-segment of the market. As of September 30, 2007, our direct subprime RMBS business represented 1.6% of Ambacâ€TMs $550 billion in guarantees outstanding and CDS on ABS CDOs represented 4.8% of the portfolio. Okay, so you have $3,520,000,000 here that you recognize here, but if you add that to the $22.4 billion above and then add that to the risky consumer finance (which, luckily for you, has avoided media attention) and the potential increeases in muni exposure due to under funded budgets and the decreasing revenues from practically all product lines as expained above - Houston, we have a problem! With just these two paragraphs, excluding consumer finance and 95% of ALL of your other insured liabilities, we still have $26 billion of some of your riskiest exposure compared to $1.65 billion of book equity, a $2.6 billion market cap, and $14 billion of claim paying ability! And we are only talking about 5% of the total risks insured here. Less than 10% in claims in your RISKIEST business (quite plausible) exceeds your market cap in terms of losses. Less than 6% in losses (the lower end of the current trend in the products mentioned) wipes out your book equity. Houston, we do indeed have a problem. Equity investors, take heed! I'm tired. It's 5 a.n. in the morning, and I think we have reliably come to the conclusion that we do, indeed, have a problem.

Welcome to my Boom Bust Blog. This blog is an ongoing compilation of my thoughts, observations, and opinions of global asset cycles and the investment oppurtunities they present. This blog was originally started by mistake. I posted my thoughts on other blogs, and received a lot of positive feedback and requests for a steady stream of my commentary. Thus, I started my own blog, quickly generated a loyal following of bright, articulate and interesting veiwers. That blog then morphed into this home made compilation of web based technology, for I wanted to provide for more of a community based atmosphere that facilitated interaction between not only me and the blog's constituency but amonst the constituency itself. I also wanted a a more efficient way of disseminating the more indepth opinions that I've had in the form of extensive analysis. So, here we are. The new Boom Bust Blog. Please enjoy your time with us and remain as we attempt to bring the art of financial blogging to the next level of both content and functionality.

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Thursday, 27 December 2007 05:00

A personal email on the monolines

This is an email exchange between a long time friend who is now a big willy in the derivatives field (I hope that puts a smile on your face, Mr.Willy) and me, discussing the monolines. We haven't agreed on a topic in over 20 years :-) I thought I would post it to illuminate the issue of asset recovery with structured products, or put in English - the monolines have issues...

Big time practitioner:
Yeah...... they were rescued by Warburg Pincus.
Reggie Middleton wrote:
I wouldn't go so far as to say rescued... But I know what you mean. In your opinion, can the insurer recover the ABS assets held by the CDO in the case of default, or have those assets already been pledged to the cdo itself and the insurer has only insured the tranche and not the cdo, hence have no underlying collateral to revcover?
Big time practitioner:
The insurer will not recover any ABS assets. The insurer makes its money on the spreads they recieve for insuring the senior CDO tranches. In the case of default, each CDO has a waterfall structure for payments. Certain levels get paid first. There may be administrative or other costs which the insurer recovers early in the waterfall ...... but after that, the insurer is likely to get whatever cash is left over after 'everyone else" in the waterfall is paid, which is probably nothing. But the lower the tranch rating, the less likely those holders are to get paid. No collateral to recover though.

Lennar has been in the news as of late, with the running a piece on joint ventures, and the Chicago Business News (hat tip to Michael for pointing this out) doing a piece on Lennar recieving a foreclosure filing. The followers on my blog were alerted to the dangers of the JVs, Lennar' in particular. several times over the last few months. The new media rags are late to the party. We performed a very, very extensive analysis of Lennar's off balance sheet holdings and liabilities, much of which is easily missed by just studying the 10Qs, in Voodoo, Zombies, Lennar�s Off Balance Sheet Accounting and Other Things of Mystery & Myth (a must read, IMO, for anyone who follows this space - Enron redux). I plan to follow up on Lennar's 50% haircut does not make them look any better and Lennar gets a haircut, a shave, and a mustache trim with a fully fleshed out calcuation of their position, which I have had on my desk for weeks, but unfortunately have not had a chance to post. I will dedicate today to putting out content, so stay tuned.

From the "Of course, not everything is in the financials.

On the basis of conversations with several industry sources familiar with some of the ventures, it appears that there are several issues set to unfold at the company.

A good portion of the JVs -- mostly the ones in better locations -- have 10% to 20% equity from Lennar. But some of the ventures are 50/50 partnerships with weaker secondary players, says a former Lennar employee.

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