As highly distinguished (time to kiss up to my 2 readers!) regular followers of this blog know this has been my year of attempting to humiliate myself via public predictions. I figured this is the only way for me to counter my tendency to think I am always right through the amazing trick called selective memory. In Part I, we review the last year's predictions. In Part II, we will do 2008 predictions.
Overall Q3/Q4 2006 and Q1 2007 is when my close friends would take me out to drinks hoping for a pleasant evening and instead get to watch me gesticulate wildly about "subprime", "no-doc loans", and credit spreads. I got around to committing thoughts to blog in March 2007, but these predictions were little different from what I was babbling about in Dec 2006. In any case, in the last 9-12 months, we have had the pleasure of watching the following unfold:
housing always goes up -> what's subprime? -> it is not that big a deal -> it is contained to subprime -> what is Alt-A? -> it is contained to subprime and Alt-A -> It won't affect prime -> It won't affect the housing market -> it won't affect the housing market that much, -> it won't affect the economy -> it won't affect the economy that much -> there won't be a recession -> there won't be a severe recession (that is where we stand today).
Literally thousands of extremely smart and highly paid people from investment banks, investment firms, the Federal reserve, academia and the media seemed absolutely incapable of thinking more than one step ahead at a time. They could only envision an incremental change from today's conventional wisdom. Strange.
Economist of the Year has to go to Nouriel Roubini who has been basically right every time he opened his mouth this year.
In any case, below, I go through each prediction and note how I think I did. The original post can be verified here.
Overall, this year's grade was an A- on prediction and an F- on implementation.
I was as right as I am ever going to be on predicting anything and to the best of my knowledge I did not enter into any financial transactions where financial benefits accrued to me due to that knowledge. In fact, I did not even get around to hedging Global Learning Semester's euro exposure so basically I lost one of our companies money by ignoring my own public advice.
There is certainly something to be learned from my F-, but I am not sure I would like to know what it is (!)
So this year's rewards will just have to be psychological in nature.
1. Subprime underwriting bubble and drop in underwriting standards exposed as unsustainable.
2. Complex distribution of risk in subprime mortgages through financial instruments like CDOs does very little to protect against stupid credit / underwriting risks. The thought that slicing and dicing the risk makes it somehow less risky is false.
100% correct, instead this "innovation" made it more risky because it has added counterparty risk everywhere and placed illiquidity in the hands of parties that don't have access to the Fed.
3. Stand-alone subprime mortgage originators have a 1998-style industry shake-out with tremendous drops in valuation and bankruptcies.
100% correct. Almost every standalone subprime originator is now out of business in one way or another.
1. Subprime MBS continue to underperform through 2007 and Q2 2008. We have not seen the worst of things yet.
So far, so good
2. Alt-A MBS underperform from now Q2 2007 to late 2008. The concept that this is an issue contained to subprime is put to rest by the end of Q3 2007. Keep an eye on Indy Mac as a bellweather.
100% right. IndyMac is down 83% since I made this prediction. Boo on me for not shorting.
3. Housing prices fall by 20%+ in certain regions as the appraisal cycle starts to work in reverse. In other words, lower appraised values push more homeowners into low/no equity situations, leading to more foreclosures, lower sales prices and lower appraised values. Values start falling in 2007 through mid 2008.
Right on track. According to Schiller, housing prices are down 10% in real terms and still falling.
4. Investment banking investments in subprime origination platforms in 2006 turn out to have been terrible investments at the peak of the market. Note this has already happened, it is just not fully disclosed yet.
100% correct. See Merrill Lynch and First Franklin for the best example of this. There are no counterexamples.
1. Multiple LBO funds IPO in 2007 after Blackstone. Let's say at least 3 in total but no more than 6.
Missed this one. The window closed faster than I expected.
2. High-yield credit tightens from late 07 to late 08. Spreads and covenants start to return to historical norms.
Was a little late on this by 1Q, but basically correct.
3. First higher-than-expected losses to the junior (CDO) tranches of high-yield issuances in 2008.
Remains to be seen...
4. More regulatory pressure by 2008, either regarding tax rates or fees earned by the senior MDs, particularly of the publicly traded vehicles.
5. At least one very visible PE-backed company blow-up from Q2 08 to Q2 09.
Remains to be seen. We have certainly seen deals blow up, but that is not the same thing.
6. 2008-2010 are tougher years for the PE industry as a) ability to lever deteriorates, b) revenue growth at companies slows, c) public markets are less accomodating to leveraged IPOs, d) competition for deals does not ease. Holding times increase and more time is spent on operations.
Remains to be seen, but all trends are pointing in this direction.
7. Overall, 2006-2007 vintage funds underperform. 2009-2010 vintage funds perform well as markets and valuations correct or over-correct. I have no opinion about 2008 vintage.
2007-2008 vintage distressed debt funds do well also.
#7 is a long-range prediction so if I am off by a year, I am still claiming victory!
Remains to be seen...
1. Economy weakens substantially in 2008 into a growth recession or actual recession. I am less sure of this than of my other predictions but think it is more likely than not. If this happens at the wrong time relative to the coming housing/mortgage bust, it severely aggravates issues in housing and the two cycles self-reinforce.
This is almost certainly now going to happen
2. Dollar crosses 1.40 against the Euro at some point in 07/08.
Yes, I was too optimistic as it actually touched 1.50. Another failure to profit! :)
3. All forms of credit tighten by late 2007 to mid 2008 and yield spreads start to return to historical norms
Yes. Again, I was off by 1Q
4. New President in Q4 2008 inherits a weak and vulnerable economy.
Remains to be seen, but there is no way this will not be the case...