I sat down this evening with my trading notebooks. It was a reminiscence of 11-14 years in the past. I may produce another chapter of “education of a corporate bond manager” from the books. But it gave me a flavor of what I learned (rapidly) as a mortgage bond manager 1998-2001. So let me share a few more bits of what I learned.
1) Avoid esoteric asset classes. I am truly amazed at how many people believed that securitization created a lot of value, when it was more incremental. There were many who proclaimed “Buy every new ABS structure,” because it had worked well in the past.
In his first-quarter letter to investors of Greenlight Capital, David Einhorn lashed out at regulators. He claimed that the market is "fractured and possibly in the process of breaking completely." Q1 2021 hedge fund letters, conferences and more Einhorn claimed that many market participants and policymakers have effectively succeeded in "defunding the regulators." He pointed Read More
Sadly, that is a bull market argument, and many would lose a lot of money following that advice. In 2008, it all came crashing down for unique structures.
2) Avoid volatile asset classes. Collateralized Debt Obligations are volatile, and not worthy of being investment grade. That said, when I was younger, I erred with CDOs and we lost money. Never invest with those whose incentives are different from yours.
3) There was also a period where CDO managers would buy each others BBB tranches — it was a way of lowering capital costs, at least on a GAAP basis. We did that with NY Life, but never got the benefit, because we never did our CDO.
4) The are many asset sub-classes that have “only been through a bull market cycle.” That is the nature of new ideas that are introduced to applause. But those are bull market babies. Avoid sub-asset classes that have never seen failure.
5) There was the desire that we could originate our own commercial mortgages, with me doing the work of a full mortgage department. I conveyed to my boss that this was impossible even if I dedicated 100% of my time to the process, and then he would not have me for the reasons he hired me. This came up many times, and took a long time to die.
6) But at a later date, something better came up, doing credit tenant leases. They are illiquid, but they have good protection. The credit tenant guarantees the mortgage. If there is non-payment, the property is yours. I can get into securitized lending. This was a great deal, but my colleagues in the firm overruled me, and foolishly. Why give up protection, when you can’t get a safe yield at an equivalent spread.
7) I also learned that in the merger in 2001 that little things mattered. So when they came to meet us in Baltimore in mid-2001, we took them to an Italian Deli that we liked. They loved it, saying that there was nothing like it in Burlington.
I will continue this in the next part/episode.
By David Merkel, CFA of Aleph Blog