Monday, April 13, 2020

Guest Review: @pdxsag on The Shipping Man by Matthew McCleery

[Our correspondent @pdxsag writes in with his review of a CBS favorite book.]

Matthew McCleery's novel The Shipping Man is an entertaining romp through the financial side of international ocean shipping. The protagonist, Robert, is a disaffected hedge fund manager that gets himself pulled into the shipping industry through an escalating series of chance encounters which would have waived off any sane person. Unfortunately for Robert, as a 3rd tier portfolio manager experiencing something between a mid-life crisis and the painful awareness he is soon to be losing the station in life to which he and his family had grown accustomed, he could be considered anything but sane.

I shan't spoil any of the book. CBS reviewed it in May 2013 and gave it a 5/5. It's written in the breezy style of an airport book, but contains no less wisdom, insight, and jaundiced view of Wall Street finance than a dry, non-fiction polemic aimed at ending the Federal Reserve banking cartel.

Ironically, I believe its lessons on shipping finance are going to be increasingly applicable to non-shipping finance as the Federal Reserve continues its Martingale Strategy of dealing with the monetary crises of its own making for the foreseeable future.

In chapter 3, Robert still with his Wall Street-centric mindset visits a German banker hoping to score a ship in a distressed asset sale for 50 cents on the dollar...

“What goes up must come down,” said Robert.

“This is the point. It is already down. What goes down must come back up again,” Gerhard insisted.

“I am not familiar with that particular law of physics. This loan of yours is in default. The collateral is worth significantly less than the loan balance,” Robert said and pointed aggressively.

“Aha,” the German said with his finger sticking up in the air. “The loan balance may currently be greater than the value of the ship in the open market; however, if you look at the value of the undiscounted cash flow she can generate during her remaining 27 years, then the loan is actually quite sound, which is precisely why you want to get control of this ship.”
And therein lies the con of the crony capitalism that the Federal Reserve has been engaging in with accomplices at the gigantic hedge funds (Bridgewater, Citadel, and BlackRock) and investment banks (Goldman Sachs, JPMorgan, and Morgan Stanley). Robert cannot force Gerhard to sell him the loan, and Gerhard has no interest or desire to sell Robert the loan at 50 cents on the dollar.

The con today is that for virtually all the investable financial assets available in retirement saving accounts, Roberts of the world are able to force Gerhard to sell his loans.

(Perhaps not surprisingly, for the one asset class which cannot be forcibly called, cash and short-term treasury debt, real yields are negative.)

This played out in real-time in March in the mortgage REIT space (a small corner of the equity market). They are marketed to retirees looking for yield in an otherwise yield starved world. Of course financialization being what it is today, we have (ahem, had) leveraged ETF's on baskets of mREITs. As the stock market sold off in a panic in March, all correlations went to + or - 1. This forced leveraged mREIT products to zero and they were forced to liquidate into an illiquid market. In a truly free market, this is how it should be. Those with the foresight to keep a buffer of liquidity were able to step in and trade their liquidity buffer for the underlying mREIT common stocks which were trading at small fractions of their book values. The Preferred shares were trading at 20-25% yields and 40% and less of par. It was a broken market and in a true laissez-faire capitalist system prudence was being rewarded.

Then the following week the next shoe dropped. Some of the mREIT companies were sent margin calls as their long book of mortgage bonds sold off and their short book of Treasury paper rocketed (again, those correlations). The losers were forced into liquidation themselves, and the “winners” were forced to sell off substantial portions of their bond portfolios such that they are permanently impaired and their remaining book values are off 40-60% since the end of December (1). Long-term many of these companies now exist to service their Preferreds. They won't be able to rebuild their portfolios adequately, especially as new bonds are expected to be far lower in yield, to have any profits left-over for the common stock side.

As it should be, you might say. Laissez-faire capitalism. I said so myself.

However, here's the Fed’s con: at the time of the margin calls not a single bond payment had been missed. Underwriting today was not the farce it was leading into the GFC. Many middle class and upper middle class office workers are working from home and politicians at the time were making noises about supporting newly unemployed and furloughed workers with various fiscal programs. Not one week later the Federal Reserve responded similarly in kind with monetary programs aimed at the mortgage bond market. It was all entirely predictable. If there's one thing bureau-ticians can be relied upon it is fighting the last war.

Nonetheless, before that happened, the margin calls went out, mortgage bonds were blown out to ready and willing gigantic hedge funds and the investment banks with lines of credit directly and indirectly to the Fed. It was no different from Robert being able to force Gerhard to sell the mortgage on the ship for 50 cents on the dollar. Then two weeks later, after the Fed announced it's formal back-stops and Congress had passed their stimulus programs, the bonds were back to more normal pricing.

The hedge funds and investment banks in real life were able to foreclose upon and then flip back out for a quick profit the bond assets of the mREITs, while Robert in the fictional Shipping Man could not.

As for what this portends for at-home investors. I think it is that we're all Shipping Men now. Despite (or should I say because of) protestations to the contrary, (“I don’t see a financial crisis occurring in our lifetimes” -Fed Chair Janet Yellen, June 2017) financial markets are no less cyclical than before any of us were born. Sell when everyone wants in, buy when everyone wants out, and expect the Federal Reserve and central banks will continue their Martingale Strategy until some exogenous event calls in their bankroll. It won't be called in by each other. And, at present time it won't be called by the WuFlu -- the virulence just isn't there for it.

I'll leave you with a quote from George Carlin. “It's a big club, and you ain’t in it. You and I are not in the big club.”


CP said...

People who concentrate positions remind me of the live hog trader on the CME who accumulated a fortune and was considered a genius at trading hogs. He knew hog fundamentals cold. Well one year he just knew hog supplies were going to be severely constrained so he built up a full limit long position in hog futures because how could he lose? Well, the USDA came out with one of their periodic pig crop reports and it was super bearish with apparently a huge crop of pigs on there way to market. Well the market tanked limit down for several days and the genius hog trader lost 36 million dollars, his exchange seat, his home in Winnetka and eventually his wife and family. Long story short, the USDA revised their pig crop report as an incorrect number had been entered into the USDA computer; too late for our friend, and the market reversed course and was limit up for several days.

CP said...

If you took an economics course back when you were an undergraduate, you may think that you know what the Federal Reserve does. Your monetary policy education, however, is probably out of date. March 23, 2020, is a date that means little to most people, but it is, as Smialek dubs it in a chapter title, “The Day the Fed Changed.” This is the story of a revolution, but because there were so many things happening in those days of Covid panic, not many people noticed.