dwy000

You're right OEC, the coffee is fantastic. You can't get a cup of regular (filtered) coffee but if you're a fan of espresso based drinks it probably compares with the best in the world. Racemize - I'm mid-forties with a young child and it was supposed to be a quasi-retirement thing - ie move there for a couple of years, possibly permanently, and live off investments while figuring out what we wanted to do next. The ideal would be to live 6 months in the US and 6 months in Australia/NZ but that's tough with kids and even more expensive. Note the taxes are a pain in the butt. Australia year ends June 30th and you have to file both US and Australia. It's a nice lifestyle here. I don't mean to be overly negative.

Out of curiosity, what are some of the reasons? I guess besides real estate? Turar - I'm conscious this is a bit off topic for this thread and I don't want to offend any Aussie's since we really have enjoyed it for the most part but..... a) it's OUTRAGEOUSLY expensive. Not just housing, everything. Food. Clothing. Furniture. Services. I find myself buying a lot of things from Amazon or similar online sites and even having them shipped here it is still less than 2/3's the local price. My running shoes I normally pay $120 for in the US are $270 here. That is pretty typical. It was cheaper to buy New Zealand apples in NY than in Sydney. Huh? When we were looking to move the A$ was about $0.66 US and everything seemed a little expensive but you figure "what the heck". Now the A$ is above $1 US which make is offensively expensive. b) the distance and time difference really gets to you. There are very small windows to call family and I feel like I'm a bit behind the times on world/US news. I can't really explain it but you just feel removed and remote. To go on vacation out of the country, unless you're doing NZ or Fiji, you're looking at a minimum 7 hr flight each way (10 hrs to Hawaii). It hits home when we spent $500 in shipping charges to send $400 worth of presents back to the US/Canada. Now, I must admit it's improved my value investing because I go to bed before the market opens and wake up just as it closes so I have to leave open orders and can't watch every tick. c) Taxes are very high and climbing. Top tax rates are about 45%. There's a 10% value-added-tax (which adds to the expensive comment above). The new carbon tax will add significantly to electricity and gas prices. d) The shopping is disappointing. We struggled with our Christmas shopping. It's getting better and this is after living in NY so take it with a grain of salt. You don't quite appreciate the quality, price and selection we take for granted in the US but it's starkly apparent when you compare here. Imagine living in a mid sized city in the US and then moving to a fairly small town. You can get everything but it's just less selection, less competition and a little more effort. e) The weather wasn't quite the utopia we had built up in our minds. Don't get me wrong - it gets very hot and the sun shines a lot, but it's not the year round shorts and t-shirt weather you tend to hear about or expect. I might be tainted by the fact that we've had a crappy summer so far. f) If you don't like rugby, you're out of luck as a sports fan. I really, really miss baseball and football. They actually have 3 types of rugby here plus Australian rules football. In summer it's cricket. A little bit of soccer. That's it. g) We miss the American "enthusiasm" for everything. I put up a bunch of Halloween decorations that would have been considered tame in the US and I got people stopping and taking pictures and in awe. They would ask me about it and as soon as they heard my accent would say "ohhhhhh, you're American" - like suddenly that explained everything. It's little but it's funny. It's a great place to live and we've had a wonderful time. We are soooooo glad we did it. But it's a bigger transition than we were expecting and we just miss a lot of things that are taken for granted in the US/Canada.

Eric - I currently live in Sydney after moving here 2 years ago from NY. It was supposed to be a permanent decision but in all likelihood we will be moving back to the US in a year or two. It's not everything we thought it would be. We rent. The housing market here, while maybe not a bubble, is still unreasonably expensive - especially in comparision to incomes. The rental yield is about 4% (!!!!) which is even more shocking when you consider that you can easily get 6-6.5% interest on a 6 month term deposit at any bank. Note that this does not include the stamp duty in the purchase price which is paid by the buyer (5-6% of purchase price). Mortgage interest is NOT tax deductive on primary residence but is deductible for investment property. What amazes me most is the completely ingrained mentality here that housing is a great investment, always has been and always will be. I have a number of friends who have purchased "income" properties here based on that mentality. The rent obviously doesn't cover the mortgage let alone operating costs and taxes so they have to pay out of pocket each month to top up. In my view that's not an investment. Just between the stamp duty and broker fees the price has to rise about 10% just to break even on the purchase and that's with the income completely covering the investment. When I try to walk them through the math and why it doesn't make sense they simply dismiss it and say that house prices will always go up and that over a 10 year period real estate is always a good investment. One of them just kept repeating that real estate prices had doubled on average every 9 years over the past century (like this meant it was destined to continue forever). I simply don't get it. I think some of this mentality comes from the fact that Australia largely avoided the financial crisis and there seems to be a prevailing belief that they are immune to a serious downturn. I know I'll get lambasted for saying that but it really reminds me of US house flippers in 2006 and 2007 when it was believed the good times would go on forever (yes there are differences but when you hear them talk about it, it's the same mentality).

Sharper - agree on most of your point. For hedge funds, I'm not sure it would change much (they already are charged higher capital as they need to be internally rated just like the banks - although depends on what they're rated). Virtually all derivative trading with hedge funds (and interbank) is done on a fully or over-collateralized basis and Basel II capital weightings net out cash/treasury collateral so the risk and capital there is much reduced. Interestingly the bank losses on hedge funds have been minimal since the lessons learned from Long Term Capital (LTCP refused to post upfront collateral) and held up very well during the market meltdown. My personal concern on the trading side is more due to the rehypothecation of the collateral as proven out by MF Global. I still contend that investing in banks is a black box and you should focus on management not assets. You'll never know what youre getting so better to bet on the jockey than the horse.

Not to harp on about it too much but the other issues that get my goat are: a) under Basel - most developed countries sovereign debt gets a zero capital weighting. Zero. So those Italy bonds? Same capital requirement as US gov't bonds - none. If you're going to credit weight capital for other assets, why not credit weight them all. b) the accounting provision under which you to mark-to-market your own debt obligations (liabilities) - and then take the markdown as a gain!!!! I get the argument that if you're marking to market the assets why not the liabilities as well but come on. To be able to show a strong equity cushion because your own bonds have dropped from 100 to 70 is ridiculous.

Sharper - Basel II and III both require capital for operational risk as well as credit risk so I'm not sure a Basel IV would add anything there. Maybe refine it a bit but it's not something new. It's really a case of apples vs. oranges to compare the capital levels under the old Basel I to the newer Basel II and III. The whole purpose of Basel II and III was to introduce increased capital for increased credit risk. Under the old Basel I capital requirements a loan to MSFT or JNJ (AAA rated entities) required the same capital as a loan to a CCC rated entity - which is obviously nuts. It incentivized banks to move way down the credit curve. Basel II/III helps but it's certainly not a cure all. I think the biggest problem is that it puts the fox in charge of the henhouse. Higher capital is required for lower rated assets but it's based upon the bank's internal ratings for the asset. So if you want to keep your capital down you just put a higher internal rating on the loan. The other thing I think it will do is re-incentivize and grow the securitization market. Because of the high capital cost of asset (and especially lower rated assets) banks will want to underwrite for the fees and then get it off the balance sheet to reuse that capital again. Holding loans will be quite expensive. For retail banking it means higher fees since the capital requirements are higher and therefore spread income lower. Just my opinion of course.

Clouldn't happen to 2 nicer, more trustworthy people.

Txlaw - I initiated a LUK position recently too so the recovery in JEF is nice to see even from a 2nd tier position (finally!). I'm not exactly sure what they're seeing in JEF to give it that much of the portfolio - or what I'm missing - but now having Berkowitz on board helps reiterate it. I wonder how much discussion goes on between Bruce and guys at LUK.

I thought it was interesting that not only did he add to his LUK position but initiated a position in JEF - which is LUK's largest holding (by far).

I can't wait to see how the CDS aspect plays out on the bank P&L. Most of the banks in reporting their Greek exposures give a "net" number after hedging. If they're taking a 50% haircut on the debt but can't get that 50% back on their so-called-hedges it could be a massive loss. Or a massive gain for anyone who'd been selling the CDS and shorting the bonds.

You said it JSA. I love this stock. Not only do they generate $1bn in free cash flow per year, they use it almost exclusively to return cash to shareholders. The dividend keeps going up and the share count goes down in giant steps. Last year they took on over $2.5bn of debt and will use that cash to do more share buybacks (it's the only debt on the company). Despite the negative same-store-sales headlines, ROE has gone up every year for the past 5 from 15% to almost 30%. Now that's good capital allocation.

Paulson was always an average manager at best. He had one good call (give him credit - it was the mother of all calls) which he will milk for all its worth - but I think you're now seeing a reversion back to the mean. Give me Berkowitz, even after this disasterous year, any day over Paulson.

Kiwing - good catch!! My mistake entirely. In my haste I put "sell CDS protection" instead of "buy CDS protection". You are right, that would double the exposure instead of negate the exposure. I meant they would buy protection to offset the loan risk Looking again, with the prices I used in the example I should have changed the bond to a sell instead of the CDS position to a buy. They would sell the bond (pay 200bps) and sell credit protection (income of 220 bps). Collect net 20bps. In a default, they would gain on the bond short position but pay out on the CDS they sold - in theory, in exactly the same amount.

I have attached the bankruptcy proceeding documents between Lehman and BoA. They are pretty interesting reads. Thanks for the tip dwy000. One is a summary by the individual managing the derivatives settlement for the debtors and the other is the settlement details with BoA and Merrill. The haircuts on their claims are quite large and with three years passed hopefully all the other counter parties agree to the framework settlements. One question, the documents refers to primary and guarantee derivative claims. What's the distinction between the two? The attachments were found here: http://chapter11.epiqsystems.com/LBH/docket/Default.aspx?rc=1 Thanks Grenville! I'd only seen the summary and not the documents themselves. Makes me glad I didn't go to law school. Re primary vs. guarantee - the guarantee claims would be ones where the trade was done out of a legal entity that wasn't the primary trading vehicle (i.e. where the primary claims are) but for which the primary entity had provided a full guarantee. It would just collapse the legal structure to aggregate to a single claim.

Kiwing - good catch!! My mistake entirely. In my haste I put "sell CDS protection" instead of "buy CDS protection". You are right, that would double the exposure instead of negate the exposure. I meant they would buy protection to offset the loan risk

You are correct. If the position moved back to flat before Lehman filed and FFH was just waiting to get the $10m collateral back from Lehman when they filed, FFH would have an unsecured claim against the bankruptcy estate. As timely as the day's headlines, note that BoA just settled this exact issue with Lehman this week!

By the way, Michael Lewis's book The Big Short gives great insight into how this works in a much more lucid and humorous manner than I can. I was almost laughing through the section where Mike Burry was trying to get accurate collateral marks on his positions from BofA. They were claiming it was worth 95 (because that's where they were marking their own positions) but wouldn't buy it off him at 65.

Hi oec2000, That's a good question, it's exactly what happend with Lehman (and AIG) and it's something that drives much of the risk management. The interesting part is that if counterparty B can't pay you back, technically you don't lose any cash but your loss is the cash that you still have to pay out on the hedge you have on the other side. As a result, if you really think A won't pay you, the best thing to do is take off the hedge and go naked on the underlying risk. By the way, I say "position" and "hedge" but these are interchangable because if they're offsetting it's just two positions in opposite directions so it doesn't really matter which one goes bad and which one stays good. Also, while it's simpler to think of directly offsetting trades, the bank actually runs a "book" of trades and they just try to keep a matched/hedged book as opposed to specific matching trades. Regarding collateral. As a backdrop, because the positions are all marked to market and collateral is adjusted each day, your risk is really only a 7-10 day move in the underlying position (rates, gold, FX, equity, whatever). That's because if you make a collateral call on day 1, the hedge fund will dispute the marks on the positions to try and buy time (marks are legitimately disputed all the time so this is not a big red flag). Then 2-3 days later the bank will say "enough" just pay the collateral we will settle the dispute as we go. Long story, but by the time you actually declare a default and close out the trade 7-10 working days have gone by and the position can continue to move against you. That's why the real risk management comes in taking off the hedge (or other side of the trade) so you don't keep paying out on the other side. But it's a fine line because now you're unhedged so if the fund comes thru you could have lost money on the position. With that in mind, the Master Agreement will stipulate whether you can "rehypothocate" collateral. This means that if I post US Treasuries to you as collateral, you can use those treasuries to post to another party as collateral of your own even though technically it's not your money. You wouldn't normally do that with a small hedge fund but it's necessary between the big banks because the amount of collateral is in the billions and it just wouldn't work to have separate collateral. So, to longwindedly answer your question, if B goes into liquidation, party A would declare a default, offset the amount it owed to B with the collateral posted to B and basically walk away even. Now in reality that rarely happens because as per above there will be a mismatch and if there's too much collateral A will claim it back and if there's not enough, A will pay out the extra owed to close out the trade. In addition, bankruptcy courts cause problems because they can "freeze" the situation and will not permit A to cancel the trades (this is A's worst nightmare but happens all the time). A will generally put on another hedge/position with another counterparty to replicate the lost hedge it had with B to keep the book flat. Hope this made sense. I never thought a value board would care about this level of detail. It goes to show the quality of investors here.

Still trying to get used to posting here. How do I incorporate your post in my reply for reference? Thanks. "Do the banks like WFC and BAC organize the derivative related business to reside in a subsidiary that is isolated from the rest of the subsidiaries and the retail side of the bank? Ie, if things did go bad, they could put the whole thing in runoff? Or do they treat the derivative side of their business as something like their regular operations and want to avoid hurting their reputation (reputation risk)? Fairfax has a non stated policy of standing behind their subs even though they are isolated in terms of risk. " No, they generally do derivatives out of the main banking entity. This is primarily for capital reasons since you can't count the derivative as a hedge if it's in a different legal vehicle than the underlying asset being hedged. In the late 90's a couple of lower rated banks and insurers set up derivative vehicles that were AAA rated seperate vehicles for the exact purposes you were suggesting (the most famous of which was CSFP, Credit Suisse Financial Products) but these went by the wayside largely due to the capital/hedging issue. Funny the comment on Fairfax. As a risk manager I used to insist upon a written guarantee from the parent for us to deal with a subsidiary. The marketers used to whine "do you really thing they'd let their subsidiary go under?" But the resounding answer is yes. That's exactly why they wouldn't give a written guarantee. When I hear things like BofA contemplating whether to file Countrywide for bankruptcy it makes me want to send the headline to the sales guys who called us crazy. Unfortunately not all the financials out there have the integrity of a Fairfax.

"Do you think the insiders/CEO's of these organizations have a feel for the risks? i.e. can we take a lazy approach and follow the management when they invest their own money especially when they appear to be trading so cheaply?" Hi Granville - thanks for starting the new thread. Re insiders/CEO's - boy, that's a good question. The short answer is no, I don't think they have a direct feel for the detailed risks, but they do have a feel for their risk managers, processes and procedures. A big money center bank would have millions and millions of trades on the books (number of trades, not notional amount). They tend to be done out of a variety of different areas - FX, equity derivatives, CDS, interest rates, etc. The individual desk would have very good knowledge of the trades but the risk management usually sits overtop of these different products and therefore doesn't have the same detailed knowledge but can see across the risks. If a bank puts on a trade with hedge fund whereby they are effectively short 1mn oz's of gold (notional of $1.6bn), the systems would capture that and the risk reports would show an increased exposure to lower gold prices. The bank then manages these underlying risks as a whole - i.e. they may have risk limits on gold whereby they can't lose more than $50m if gold moves by 10%. If this trade took them above that, they'd have to buy gold to hedge. There's added complication if that trade is in say Swiss Francs because now you have gold risk, FX risk, inerest rate risk, counterparty risk, etc. Virtually all of the risk is managed on "confidence interval" basis - i.e. they set limits based upon a 95% or 99% confidence interval in how much the underlying (gold in this case) could move in a given period. And as 2008 and most other crisises proved, all these risk parameters fall apart when you get a move that exceeds 99% confidence interval. The tough part as an investor looking at the banks is that the reporting of that gold trade is zero if the price hasn't moved. So the risk is there but it's not going to show up on the financials. And if they have a similar trade on with another counterparty where they are long the same amount of gold, now you've doubled your notional amount of gold trades to $3.2bn, doubled your credit risk (i.e. one on either side) but negated the gold risk so even if gold prices moved you wouldn't see it in the financials. Probably more detail and confusion than you were asking about but I hope it made sense.

"Thanks for sharing your experience Dwy000. Do risk managers get involved with swap construction language? A large part of negative sentiment could be allayed if every master agreement required the approval of a respected risk manager. Also, Citi reports that the majority of their CDS contracts are "bilateral". Is it fair to infer that these contracts are subject to netting arrangements following a default event? " Hi Rabbit (by the way, I'm new to the Board but I've enjoyed your posts in the past). Re swap construction language: again, it's complicated but generally speaking no. The risk manager will negotiate the terms of the Master Agreement (called an ISDA) and the collateral terms, then all derivatives will be documented under that master. Each counterparty will have credit limits and the fully netted exposure under the ISDA is monitored against those limits. In a very large, complicated or risky trade, the risk manager may get involved in the trade details but the vast majority of the trades are fairly standardized. The toughest part is often ensuring that the bank's risk systems actually capture the trade properly and report the exposure properly. When Citi says their contracts are "bilateral", it means that both parties (Citi and the counterparty) both have to post collateral if they are out of the money. Originally, stronger banks could have unilateral agreements under which only the counterparty (usually a hedge fund) posted collateral but the bank didn't have to. Again, that's largely gone these days except for very small hedge funds that don't have the infrastructure to accept and hold collateral. Hope that made sense.

I'm sensitive to the person who noted that this is probably the wrong board for this discussion but.... I'm far from a complete expert on this but I was a risk manager for one of the big banks for a long time so I'm fairly familiar with the workings. And from that I can say that as an investor you can NEVER know what the true risk is at any bank. You know how much the exposure is on a single day and the nature of it but the details are sooooo much more complicated. Plus there's the fraud risk (just ask UBS). Rarely do banks like WFC or BAC use credit derivatives for outright positioning purposes. They are generally purchased as a hedge or in an arbitrage situation. This is probably even more true now that the trading books are being minimized and shut down. For example, WFC might lend $100m to General Motors. This is usually done, however, not because the loan is such a great asset but because they have to do it to win more lucrative FX, asset management or other business from GM. Not wanting the GM exposure they will buy $100m (or less) of CDS on GM as a hedge. If the hedge is an accurate one, this not only gives them protection against default of GM but also means they don't have to hold as much capital against the loan so it's win-win. In an arbitrage situation, they might buy $100m of GM bonds that pay a spread of 200bps and sell CDS credit protection on $100m that generates an income of 220bps - thereby keeping 20bps/year. The notionals are big but the risk is actually fairly minimal. On the counterparty risk: there are generally 3 sellers of CDS (ie providing the protection) - banks, hedge funds, insurance companies. These days, virtually all of the trading of derivatives between these parties is done on a fully netted and collateralized basis. That means that every day they mark all the positions between them, net off all the +'s and -'s and then whoever is out-of-the-money posts collateral in that amount to the other. The AIG situation where you are uncollateralized unless the counterparty is downgraded is now a thing of the past. For hedge funds, they generally have to post excess collateral From a capital perspective, any exposure that's fully collateralized gets a far reduced (or zero) capital requirement. The capital requirements on derivatives are extremely complicated and not all that well developed (they try hard but it's such a broad category it's tough to accurately capture it). This is a VERY simplified discussion but I hope it points you in the right direction. The reality is about 100x more complicated and intricate. I reiterate though that nobody on the outside will ever be able to fully understand the amount, nature and risks of the exposure at the banks. This is true not just of derivatives but also the general loan/securities books. BB is a genius and probably has done more work on it than anyone but, in my view, with banks you're really betting on the big picture and management.

For risk and capital purposes, virtually all of those derivatives between the big financial institutions are collateralized so the risk is really the movement between collateral calls. That's what killed AIG, not the realized losses on the derivatives but when they got downgraded it triggered collateralization of the derivatives. It doesn't negate the fact there's billions of exposure but it's not as bad as the notional amounts the press loves to quote. Now if the collateral is US Treasuries.....but that's another discussion.