Friday, March 28, 2008

Letter to a friend

Part of a on-going discourse with a friend in the financial industry, who described apprehension with this market...

Well, we like your sentiments...we get paid to take risk, and there is alot of risk out there.

So, you have a "path" that you think the economy will drift towards. How many variables have you not thought about or that will materialize randomly? Have you quantified your thoughts and affixed NUMBERS (which can be compared to other numbers) to these thoughts?

We have put quite a bit of thought into this, so let's walk through it.

First, the assumption that deleveraging alone will cause financial earnings to suffer for many years is suspect. Deleveraging among the financial sector will have a limited effect on the real economy. There is a historical precedent for this - S&L crisis as well as market behavior from the clearing of the junk bond/Milken disaster.

As for the "consumer" question. Investment-led recovery is also a possibility. It would take a one-sentence change in the tax code and billions of dollars would come home to the U.S. and can (and has) happened that quickly.

Don't fight the Fed. The Fed has made it clear: It shot the main transgressor of irresponsible financial leveraging in the face (BSC)...and now it is saying "I am a merciful deity...obedience is required" It will continue to provide the short-term funding as needed (it has gotten a good look under the hood of short-term finance facilities like the Repo market, off-shore carry fundings, etc.). We are not standing in its way.

We have been playing around with a 150 MB excel file that details the cash flows due from the derivative waterfalls. Not all of these assets are worthless. In our humble opinion, now is the time for greed, not fear.

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