Essay of the Week: 7/8/07-7/14/07

Today’s essay comes from a former Muslim radical called Ed Husain. He writes of his experiences in Saudi Arabia in an essay in The Australian called Barely veiled menace. I doubt that what is recounted here will surprise anyone, but it is an interesting essay none the less.

I have one quibble with the essay though. The author repeatedly refers to the Saudi youth as being sex starved and he blames the strict separation of the sexs for many of the problems that he observes. But I think he has the cause and effect mixed up.

There are a lot of non- Islamic cultures in the world who have worse sexual problems than the author describes in Saudi Arabia. Sub-Sahara Africa springs to mind right off the bat. So do some Caribbean countries.

I think that popularity of many of seeming harsh sexual regulations in Islam stems from the fact that many woman fear that things would be even worse for them without those regulations. Certainly a large part of the Taliban’s popularity stemmed from the fact that they gave greater protection to the woman of that country then the Warlords did.

This company is a little late to the party.

People in America just don’t want to have to deal with risk anymore. Nowadays every single asset under the sun is “hedged” in an effort to make sure there is no possibility of loss. Now a man has started up a company called Rex & Co to “hedge” people’s equity risk in their houses.

As best as I can figure out, Rex & Co does this by buying shares in a house. Only, these shares do not give Rex & Co any control over the house. All they give is the right to some money when the house is sold. This is way that the San Francisco Chronicle describes it…..

Bill and Elaine Nolan paid top dollar when they bought their Tiburon house a few years ago at the height of real estate frenzy. Now, of course, the market is cooling rapidly.

So Bill Nolan, who deals with money all day long as a partner in an investment management firm, wanted to diversify. He turned to a startup based on a new concept: Let homeowners tap their equity without taking on debt.

Nolan contracted with Rex & Co. to receive $100,000 cash in exchange for a 10 percent stake of the home’s future appreciation. When the Nolans sell their home, they’ll pay Rex the $100,000 plus 10 percent of their home’s appreciation above its current value of $2 million. For example, if the home sells for $2.5 million, the Nolans would pay Rex $150,000 — the original $100,000, plus 10 percent of the $500,000 gain in value, or $50,000. If the home were to depreciate, Rex would share in that loss as well

.
(The Nolan house is atypical because of its high value; more typically, a $100,000 Rex payment would be in exchange for a larger share of a house’s appreciation.)

“It was an interesting opportunity to take some cash out of the house and hedge against any decline in home value,” said Bill Nolan, who plans to invest the money in his business. “It was a way to hedge against the (real estate) market being flat or not performing as well as the equity market; to pull money and put it into something else I felt had a reasonable chance of outperforming the real estate market.”

I can understand why Mr. Nolan might be feeling a little nervous about how the value of his house might hold up. What I can’t see is why Rex & Co would make this kind offer at this particular time.

Sure, Rex & Co are taking a hefty share of the valuation gains (on most houses it is about 50%) for taking only a small share of the house’s equity . But they have no control over when the house is sold, what kind of condition it is kept in, or anything like that. It seems to me that by taking a large portion of the valuation gains they are removing a lot of incentive from the owners to seek the best possible price. That don’t seem so smart to me.

Mr. Nolan seems to be perfectly awere of that fact. According to the San Francisco Chronicle story….

Nolan said he might consider ending his Rex deal if Tiburon houses go down in value, so that Rex would share in the loss on his home. “The beauty of it is that no one else can ‘call’ me on the option; I own the trigger point,” he said. “No one else decides, ‘This is an opportune time, home prices have risen, we’ll call Mr. Nolan on our option to give us our 10 percent.’ ”

To be sure, there are some safe guards in place. The main safe guard seems is that if you sell your home within 10 years after the deal is made you have to pay an early sale penalty of some kind. Rex seems to be relying on this to insulate itself from short term fluctuations in the real estate market. After all, the long term trend in the real estate market is always up right?

Well, in the past the long term trend was always up. But in the past the US population was growing at a far faster rate then it is projected to do in the future. If Rex is basing his plans around the idea that the historical trend will continue I think he will find that he is sadly mistaken.

That is not to say that Rex’s idea could never be made to work under any circumstance. If he had come up with his idea 10 years ago he would a very rich man by now. But as it stands right now, I would bet that you would be better off putting your money in short term T-bills then in investing with Rex.

Why start something like this at the height of a housing boom? These things can easily take a decade to wind themselves out? It is not unheard of for a real estate market to stagnate in real terms over a 10 year period.

In another words, Rex’s biggest problem is that he is coming late to the party.

Hat tip: The comments section on this Calculated Risk post.

Interesting comments on a Pakistani Blog

This Pakistani blog is interesting in its own right if you like to get the perspective of people who actually live in an area. But I was particularly interested in the comments on this post here.

Their English is not the best so it will take a little parsing. Also one should remember that these are all English speakers and so not a good representative sample of the people of Pakistan. Still, it was quite interesting to read their comments.

Problems with Dell

According to Felix, Dell has been a very bad boy….

In the staredown between Dell and Nasdaq, it’s the stock exchange, not the computer company, which blinked first. Dell hasn’t filed any of its last three quarterly reports, nor its annual report for 2006, which means that, by rights, the Nasdaq should delist its sorry ass. And the Nasdaq surely would – if it wasn’t dealing with, you know, Dell. The legendary PC maker which trades tens of millions of shares a day, and which has a market capitalization of over $60 billion. Which means, basically, that Dell is too big to delist.

I vaguely remember hearing that Dell was having problems with their accounts awhile back. But I had not realized that it was this bad. Who would have thunk that Dell would fail to file a quarterly report, much less three quarterly reports and one annual report.

How the world does change.

Why crack should not be legal…

People with money have a tendency to go insane. We all know this.

But sometimes I hear of deals being done that must have been done under the influence of illegal drugs. I don’t know how else to explain this story in Winter (Economic & Market) Watch…..

Like a bad Arnold Schwarzenegger movie, the LBO crowd is right back in the game with another very large takeover, this time Hilton Hotels by Blackstone. The total purchase including the balance sheet and debt looks to be about $29 billion. Typifying just how loonie these transactions have become, HLT has operating income of about $1.2 billion, or a mere 4.1% of the take out price. Assuming $25 billion in debt, that would place debt service at about $2 billion a year. Blackstone plans no divestitures, so the math is straightforward, and the presumption is as well, just borrow the balance. This is definitely the Terminator roulette school of business economics, with now alarming amounts of debt playing the same all or none formula.

For those that did not understand the above, Blackstone took on so much debt to buy Hilton Hotels that the interest payments exceed the income that Hilton Hotels is likely to bring in for the foreseeable future. Granted, Blackstone might have some kind of deal with China, but this is still nuts.

As Felix Salmon says…..

Lenders, in this situation, are essentially taking equity-like risk. They’re looking at Blackstone’s track record, which is stellar, and counting on Steve Schwarzman being able to raise the value of the Hilton brand so much that he can sell it off in five years’ time and repay the loans in full. This is dangerously close to the “greater fool” theory of investing: my loan might not make any sense on its own, but somewhere down the line someone with an even bigger credit line will take me out. As far as I can make out, no one has the slightest intention of actually paying down any of the principal.

Thankfully, not everyone is nuts. The bigger (smarter?) bond market participants are putting their foot down as this Bloomberg story shows….

The world’s biggest bondholders have had their fill of leveraged buyouts, convinced that increasing mortgage delinquencies will drag down the U.S. economy and drive debt-laden companies into default.

TIAA-CREF, which oversees $414 billion in retirement funds for teachers and college professors, is boycotting some debt offerings used to finance LBOs. Fidelity International, a unit of the world’s largest mutual fund company, and Lehman Brothers Asset Management LLC, the money-management arm of the third- biggest bond underwriter, say they’re avoiding debt from buyouts.

Investors are getting skittish just as private-equity firms led by Kohlberg Kravis Roberts & Co. and Blackstone Group Inc. prepare to sell $300 billion of bonds and loans to finance LBOs, according to Bear Stearns Cos. In the past two weeks alone, more than a dozen companies were forced to postpone or restructure debt sales.

Is Musharraf really going to allow NATO strikes in Pakistan?

In an article in the Asia Times Online, Syed Saleem Shahzad claims that Musharraf has given NATO the green light to cross the border into Pakistan. Shahzad’s claims are pretty far reaching. Read this passage….

KARACHI – Since last September, North Atlantic Treaty Organization forces in Afghanistan have been pressing Islamabad for the right to conduct extensive hot-pursuit operations into Pakistan to target Taliban and al-Qaeda bases.

According to Asia Times Online contacts, NATO and its US backers have gotten their wish: coalition forces will start hitting targets wherever they might be.

Pakistani President General Pervez Musharraf is expected to make an important announcement on extremism during an address to the nation in the next day or two.

The ATol contacts in Islamabad say that coalition intelligence has pinpointed at least four centers in the tribal areas of North Waziristan and South Waziristan on the border with Afghanistan from which Taliban operations inside Afghanistan are run. These bases include arms caches and the transfer and raising of money and manpower, the latter in the form of foot-soldiers to fight with the Taliban-led insurgency.

Operations inside Pakistan might be carried out independently by the United States, probably with air power, by Pakistani forces acting alone or as joint offensives. In all cases, though, the US will pull the strings, for instance by providing the Pakistanis with information on targets to hit.

Musharraf has apparently already told his military commanders, the National Security Council and decision-makers in government of the development.

If Shahzad is not just blowing smoke and Musharraf has really agreed to this one wonders what pushed Musharraf over the edge? Is it the problems with the Red Mosque? Did Cheney threaten to stop the flow of money if Musharraf’s did not do more to help?

I doubt Musharraf will be able to hang onto power if NATO starts crossing the border. But then, I doubt that Musharraf will be able to hang onto power for long no matter what he does. So maybe Musharraf is willing to take the gamble. Or maybe Shahzad is lying through his teeth.

Is Myanmar selling Iran Uranium?

I don’t know what to make of this essay. You should never judge people by how they come across in print. Especially when the print in question was written about them by somebody else.

But as I read this essay profiling Aaron Cohen I was inclined to dislike him. He just struck me as the kind of guy who might make stuff up.

In fairness to Cohen though, his personality also reminds me an awful lot of a man called John Fairfield who rescued a lot of slaves in the mid 1800s. Fairfield was always showing off his bullet wounds and talking up all his close calls and he was definitely for real. So maybe Cohen is too.

Why worry about this question? Well, how much credibility you are willing to give to Cohen makes a big difference on what you think of this passage from the essay that I linked to above….

Later that day, Cohen was taken to see the area’s uranium mines — where the Shans told him soil samples had been extracted by the Russians as well as A.Q. Khan, the well-known Pakistani nuclear-weapons-scientist-turned-dealer: “These mounds are everywhere, where samples were being unearthed by other partners as well, including the Iranians and the North Koreans… I am the only Westerner [to see this],” Cohen wrote.

The intelligence minister then handed Cohen documentation of Khan’s entries into Myanmar and told him that the SPDC was selling Shan uranium to the Iranians, who were processing it into material for nuclear weapons. The route from Myanmar, the minister showed him, led straight through China to Natanz, Iran. “I’m no expert on weapons-grade uranium,” Cohen admits. “But they wanted me to leave with samples of what I saw.” Restating his human-rights mission, Cohen refused to discuss transport of the nuclear material. (“It’s a death wish to have that kind of stuff on you,” he says.) But he agreed to put a stack of evidence, including photographs of the Burmese and Iranian facilities, in the right hands when he returned to Thailand and the U.S.

A.Q. Khan, the founder of Pakistan’s nuclear-weapons program, confessed in 2004 to having been the mastermind behind a clandestine network of nuclear-arms proliferation that stretched from Pakistan through Europe, the Middle East and Asia. His network sold blueprints for centrifuges to enrich uranium as well as illicit uranium centrifuges and uranium hexafluoride — the gas that can be transformed into enriched uranium for nuclear bombs.

Khan is already known to have provided complete centrifuge systems to Libya, Iran and North Korea. He was pardoned by Pakistani President Pervez Musharraf and sentenced to house arrest after declaring on television that Musharraf’s government had not played a role in his schemes. Western governments have been denied access to Khan, but the British think tank International Institute for Strategic Studies recently published a report indicating that Khan’s network is very much alive, even without its decapitated head.

Eerily, the Pakistan-Myanmar link is backed up by a 2002 Wall Street Journal article detailing Myanmar’s nuclear ambitions: “The program drew scrutiny recently after two Pakistani nuclear scientists, with long experience at two of their country’s most secret nuclear installations, showed up in Myanmar after the 9/11 terrorist attacks in the U.S. Asian and European intelligence officials say Suleiman Asad and Muhammed Ali Mukhtar left Pakistan for Myanmar when the U.S grew interested in interrogating them about their alleged links to suspected terrorist mastermind Osama bin Laden, who Washington believes wants to develop a nuclear weapon.”

Burmese exile magazines, blogs and Web sites are rife with alleged wicked SPDC plots. But one question pops up over and over: Is there a link between Myanmar, which mines and refines uranium ore, and Iran, which requires uranium for its own nuclear projects? And, specifically, is Burmese yellowcake finding its way to uranium centrifuges in Natanz, Iran?

Cohen’s testimony suggests that the answer may be yes. From the mining sites, he was taken to meet several Shan men who said they worked as drivers for the SPDC at clandestine nuclear processing facilities near Taungdwingyi, Chauk and Lanwya. These men swore to Cohen that the SPDC was overseeing the production of yellowcake there and in several other locations, then transporting it on North Korean and Iranian ships as well as over land through China and Afghanistan, via a courier network, to the (then secret) underground Iranian plant in Natanz. They handed Cohen the coordinates for the facilities, saying that as ethnic Shans they could no longer do this work for a regime that was systematically attempting to wipe out their people. They had thrown their support behind the Shan State Army, they said, and wished him luck.

A few weeks later, Cohen hand-delivered that information to a source at the Pentagon. The following day (April 19), the International Atomic Energy Agency confirmed that Iran was running more than 1,300 centrifuges at its underground plant in Natanz (latest estimates put it closer to 3,000). Iran’s plan to install 50,000 centrifuges there to enrich uranium made headlines, with the BBC running satellite photographs of the facility. But no major media outlet noted the Myanmar connection, and the story was soon buried in the subsequent frenzy over the Virginia Tech massacre.

There is more in the essay, but you get the picture. The question is, how much of it should we believe?

So lame it needs a cane

We have been neglecting the unfolding hedge fund/CDO/subprime crisis lately. Not because it has not been interesting, but because nobody knows anything at the moment. Heck, Bear Sterns won’t even let its investors know how much money they have lost until mid July. So nobody will really know if the sky is falling until then.

So we ignored this rather alarmist Bloomberg article when it first came out. But over the weekend Macro Man did a post on it that was so funny we just had to point it out. Just to give you a taste of Macro Man’s commentary, the following is a passage from the Bloomberg article with a comment from Macro Man in bold at the end.

S&P abandoned seven-year-old criteria for determining a bond’s protection against default in February.

Under the old guidelines, S&P said a bond’s “credit support” must be twice the rolling 90-day average of the sum of value of mortgages delinquent by three months or in foreclosure plus real estate that has been seized by the lender.

Of the 300 bonds in ABX indexes, the benchmarks for the subprime mortgage debt market, 190 fail to meet the credit support standard, according to data released in May by trustees responsible for funneling interest payments to debt investors.

Most of those, representing about $200 billion, are rated below AAA. Some contain so many defaulted loans that the credit support is outweighed by potential losses. Fifty of the 60 A rated bonds fail the criteria, as do 22 of the 60 AA rated bonds and three of the 60 AAA bonds.

All but five of 120 securities in BBB or BBB- rated portions of the mortgage-backed securities would have failed S&P’s criteria, according to data compiled by Bloomberg.

None have been downgraded, though S&P and Moody’s have parts of three pools of securities linked to the index under review for a downgrade. Fitch has downgraded parts of three mortgage pools tied to the ABX and put four on watch for downgrade.

“Don’t misunderstand me: I’m not saying these others are performing great,” Robert Pollsen, a director in S&P’s residential mortgage surveillance in New York, said in an interview last month. “And they certainly might warrant our attention several months from now, which obviously we’re going to do.”

What can I say? To abandon a credit-standard test just as it starts to bite is the height of irresponsibility. And the comments from Mr. Pollsen are so lame, they need a cane.