Milken Institute: Global conference – credit markets

 EmailPrint This Post Print This Post

The Milken Institute recently hosted a conference exploring the current crisis in the credit markets and a host of possible solutions to solve it. A summary of the discussion is provided in the paragraphs below, with the video clip at the end.

“David Malpass of Encima Global opened with a basic rundown of the importance of credit as the underpinning of any healthy economy, stressing the importance of proper valuations and accurate ratings. Without well-functioning credit markets and proper credit allocation, he warned, expansion will be limited.

“According to James Walker of Fir Tree Partners, the core of the crisis came from off-balance-sheet securitizations in mortgages; cars and credit cards; and securitization of securitization (i.e. CDOs). This securitization phenomenon was driven over the past 15 years by a combination of financial institutions, investment management firms and rating agencies with little skin in the game operating under misaligned incentives to generate fees rather than execute accurate, well-considered analysis. Through this process, Walker said, these asset managers essentially became ‘asset gatherers’, and the world became a global casino with governments acting as the house and taxpayers taking the losses.

“Michael Milken (the moderator) turned the discussion to the question of ratings, pointing out that almost 17,000 instruments received AAA ratings in 2007, while today we only have four US companies holding that distinction. He noted that much of the exuberance in ratings was driven by analysts’ over-reliance on historical asset appreciation, pointing out that schools typically teach students backward-looking regression analysis as a way of charting the future. The flaw in this model is that raters really need a realistic grasp of future dynamics to understand where things are headed. ‘The past can’t pay you interest,’ Milken remarked.

“Echoing points raised by Milken and the other panelists, Stephen Nesbitt of Cliffwater noted that many institutional investors were hurt because they looked to the past and trusted the ratings firms to provide realistic evaluations of risk. Over the past 35 years, credit has been a bad deal for these investors, Nesbitt said, pointing out that Treasuries actually would have provided a better return. He cautioned that just because an instrument has a high rating or good spread doesn’t mean it’s attractive. Milken summarized these points by noting the importance of looking at “facts rather than perception”.

“To round out the discussion, Milken challenged the panelists to focus on solutions. Walker said the key lies in the equitization of debt, otherwise known as deleveraging. Currently there is just too much debt out there at the institutional, corporate and consumer level. To remedy this, Walker proposed banks build tangible common equity and deleverage through asset sales. Corporations must swap debt for equity, pursue secondary equity offerings and enter bankruptcy if necessary. Finally, Walker argued that consumers need to similarly raise their savings rate, restructure debt and enter bankruptcy if needed.

“Stephen Tananbaum of GoldenTree offered his thoughts, focusing primarily on the corporate side since he feels it’s easier to change the balance sheet for corporations than consumers, at least in the near term. He spoke of his experience in working with distressed firms, noting that companies are generally receptive when approached with a reasonable offer. He also made the point that the market may be willing to value debt equity at a higher price.

“Milken seized on this last point, noting that in good times, a firm’s value will likely go up when it takes on debt. In the current environment, however, enterprise value may actually go up when equity is swapped for debt.”


Click here for short bios of the speakers.

Source: Milken Institute, April 28, 2009.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

OverSeas Radio Network

Leave a Reply

You can use these HTML tags

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>




Top 100 Financial Blogs

Recent Posts

Charts & Indexes

Gold Price (US$)

Don Coxe’s Weekly Webcast

Podcast – Dow Jones

One minute - every hour - weekdays
(requires Windows Media Player)
newsflashr network
National Debt Clock

Feed the Bull