According to the recent TIM (Trade Ideas Monitor) report for the week of September 18-24, 2009, bullish broker sentiment continued to decrease. The TIM Sentiment Index (TSI) was down 1.74 points in North America to 51.05, slightly bullish (see previous post and the youDevise website for additional information on the TIM report). The TSI Worldwide Index was down 5.14 points to 47.58. Total new long ideas as a percentage of all new ideas sent to investment managers by way of the TIM decreased 6.31 points to 62.05%.

As for individual securities in the U.S. and North America, King Pharmaceuticals (KG), American International Group (AIG), and E*Trade Financial (ETFC) were stocks with long broker sentiment, while YUM Brands (YUM), MetroPCS Communications (PCS), and AK Steel Holdings (AKS) had short broker sentiment. In general, the information technology, health care, and financial sectors had long broker sentiment, while the materials and utilities sectors had short broker sentiment.

According to the recent TIM (Trade Ideas Monitor) report for the week of September 11-17, 2009, market sentiment moderated after being bullish last week. The TIM Sentiment Index (TSI) was down 1.86 points in North America to 52.78 (see previous post and the youDevise website for additional information on the TIM report). The TSI Worldwide Index was down 3.89 points to 52.72. Total new long ideas as a percentage of all new ideas sent to investment managers by way of the TIM decreased 0.86 points to 68.36%.

As for individual securities in the U.S. and North America, DryShips (DRYS), Kroger (KR), and U.S. Steel (X) were stocks with long broker sentiment, while Sprint Nextel (S), American International Group (AIG), and Goldman Sachs (GS) had short broker sentiment. In general, the utility, energy, and consumer staples sectors had long broker sentiment, while the information technology sector had short broker sentiment.

There is an interesting commentary by Michael Lewis (see the recent Bloomberg article). In the article, Lewis highlights how the hysteria over AIG is obscuring the real problems at the core of the current crisis, one of which are homeowners defaulting on homes they could not afford, and the government instead throwing money at opaque institutions, the workings of which no one really understands or can challenge. With one line, Lewis captures the problem and current situation:

"The guy who defaulted on mortgages on his six spec houses in the Nevada desert has turned himself into the citizen enraged by the bonuses paid to the AIG employees trying to sort out the mess caused by his defaults."

Here is hoping we can head Lewis's call for getting to the root of the problem, and quickly. It is not that we should turn a blind eye and forgive the guilty and the negligence on Wall Street, but instead should focus more of our energy on the solutions to our problems, beginning with identifying and admitting its root causes. As uncomfortable as it may be, for many of us the problem and solution begins with us.

There is an interesting post over at the Business Insider Clusterstock blog regarding the bonus tax bill that recently passed in the House and is now on its way to the Senate. The bill was written mainly in response to the recent AIG bonuses that Congress wrote into the previous 1000+ page bill that no one read (or had time to read). Apparently, some members of Congress have finally gotten around to reading the bill they passed - or at least their constitutes did - causing outrage, both real and opportunistic. The bonus tax would essentially apply a 90% tax rate to bonuses paid at firms which have taken over $5 billion from the Government TARP program. While I cannot really disagree with trying to spend bailout money wisely, attacking the bonuses in this way after the same body passed them just weeks before seems not only wrong, but reactionary. In addition, you have to wonder why Congress decided on the 90 percent number. If the bonuses are unacceptable, why not 100 percent? Is 10 percent OK for poor performance, while 20 percent is an outrage? Furthermore, why are only big companies affected? Is it just the size, or is there some other guiding principal? In case you are interested, the companies that reach the $5 billion bailout threshold and are potentially affected by the bill include some of the usual suspects, along with a few others who want to get out of the lineup as quickly as possible:

• AIG
• Bank of America
• Citigroup
• General Motors
• GMAC Financial Service
• Goldman Sachs
• JPMorgan Chase
• Merrill Lynch
• Morgan Stanley
• PNC Financial Services Group
• US Bancorp
• Wells Fargo
  

While it looks like the bill will fail in the Senate, since it seems to be unconstitutional (kind of a sticking point), it certainly gives you an idea of which companies are likely to be the targets of future hostility against wealth creation. It also gives you an idea why more and more companies and states are looking to pay back TARP money as quick as possible, and reject any future stimulus and TARP-type funding. Investors can certainly expect the companies on this list to have difficulty going forward as their best talent moves to companies not affected by any future legislation impacting companies on the government dole. Their competitors, on-the-the-hand, are going to have a field day snatching up talent that is trying to escape lower paying government wages, along with the restrictions placed on such businesses.

A few weeks ago in a post I made a comparison of how both baseball and the markets had a steroid problem, although with the markets the steroids were in the form of leverage, loose lending standards, poor risk management, complex derivative products, unrealistic valuations, and unethical behavior, among others. Another comparison is unfortunately coming to bear. As with baseball, as long as the markets and the government continue to focus more on the juicers, and less on the solutions for fixing the current problems, both will continue to suffer and fail to reach their objective - reminding us of the opportunity that the markets have for making our lives better. Even though daily 450 foot home runs are a thing of the past, hitting a natural home run is still a thing of beauty, and something to be encouraged, both on the field and in the markets.

An recent article in the WSJ discusses the AIG risk models developed by Gary Gordton (note, Gorton, not Gordon as originally posted), a professor at the Yale School of Management. The headline of the article boldly states "Behind AIG's Fall, Risk Models Failed to Pass Real-World Test." Yet, did the models really fail? Gordton's models were developed to gauge the risk of AIG's credit default swaps, but according to the article, "... AIG didn't anticipate how market forces and contract terms not weighted by the models would turn the swaps, over the short term, into huge financial liabilities." The quote is interesting in that it highlights what may be at the heart of AIG's problems. As a result of its ignorance on whether the short-term collateral risk needed to be considered, or its belief that such risk was not something to be worried about, AIG made a decision to not have Gordton assess these threats - even stating later that it knew his models did not consider such risk. So this begs the question once again. Did the models really fail (as approached by Gordton and approved by AIG), or was it more of a lack of understanding of the very products they were modeling? I know some will ask what's the difference - in the end the models were incomplete - but the distinction is significant.

In hindsight, it is easy to point fingers and wonder exactly what risk AIG was even trying to manage. But the real problem here seems to be less about one particular modeler getting it wrong, or developing incomplete models, and more about management ignoring to consider some risk while putting faith in the very same models that were not designed to give the level of confidence or enterprise-wide coverage that is being used to engender confidence. Even the WSJ article (in the body of the story) mentions how "Mr. Gordton's models harnessed mounds of historical data to focus on the likelihood of default, and his work may indeed prove accurate on that front. But as AIG was aware, his models didn't attempt to measure the risk of future collateral calls or write-downs, which have devastated AIG's finances." Of course, this did not keep AIG from trading as though it did, and therein lies the problem. The failure here is less about modeling, or even risk management, and more about corporate management and decision making. Yet, the perception that the problem is with modeling is widespread. Even Warren Buffett is quoted as saying "All I can say is, beware of geeks .... bearing formulas." But what is the alternative? Shall we abandon all risk modeling and simply use our gut instincts? Should we just take risk off the table completely? I don't believe so. While better risk management models should continue to be developed, maybe a little humility is a good place to start. Understanding a company's limitations is key to uncovering its strengths and protecting against its weaknesses.

The current problems with Lehman Brothers, AIG, and Merrill Lynch are uncovering a number of issues that will no doubt change the way we look at the health, valuation, of operations of businesses going forward. Of interest is how the current environment has resulted in Lehman Brothers being a company with liquidity that is not solvent, compared to AIG that may be solvent (for now), but has a liquidity issue. Just last week the WSJ Deal Journal blog highlighted some of the various anomalies between Lehman's valuation and its apparent asset values as its stock price plummeted. As of Friday, the closing price of Lehman put the market capitalization of the company at around $3 billion. Yet, many analysts highlighted that the current price reflected little on the true value of the company. Analysts expected the company to receive about $3 billion for a 55% stake in Neuberger Berman - as much, if not more than the value of all of Lehman. The bonus pool for Lehman's 24,000 employees itself was estimated to be around $3 billion. On the other hand, the company has $25-30 billion in toxic real estate assets to deal with, and there-in lies the issue for Lehman. How much is the exposure, how much are they worth, and what are the potential losses? Even with the ability to spin off the real estate into another company, and further inject it with $5-7 billion in liquidity, solvency was still not guaranteed. As Ken Lewis, the CEO of Bank of America stated today, the difference between the balance sheets of Merrill and Lehman was "night and day". Time will tell on BAC's move on Merrill. In the mean time AIG is scrambling to find capital to sure up its balance sheet and keep from getting a ratings downgrade, and subsequent higher cost of capital - as if selling off assets was not a high enough cost. The Fed window may stay closed to AIG, but funds might travel out the back door before all is said and done (New York is already granting permission to access $20 billion in capital from subsidiaries, see WSJ article).

So, are the issues with Lehman, AIG, and even Merrill a result of bad risk management, lack of good regulation, poor accounting rules, circumstance, or some combination of each. The easy answer is some combination of each, but the situation is of course more complicated than that. Good risk management should help us to avoid failure, if not excessive loss when circumstances go against us, but there are no guarantees. Regulation can force us to set aside risk capital, even when we don't want to, but again, it could be argued that a good risk management system that is actually both honest and honestly followed could serve a similar purpose (whether it does and would be followed, and whether that is why regulations exist in the first place is another issue and debate). That leaves of course accounting, and I suspect this area in particular will receive a lot of attention in the coming months, especially with regard to mark-to-market. The questions of whether each of these companies would have the same liquidity issues if accounting rules were different will certainly get some play, causing it to be a busy fall, possibly followed by an busy winter, spring, and summer. For all the regulators and agencies tasked with these problems, they may come to question the validity of the old proverb: "may you live in interesting times." Right now, something a little more boring would be nice.

Update: On another site a reader responded that leverage was the problem, and any new regulations will probably overstep. I could not agree more. Just looking at things a little down stream. In fact, the mark-to-market issues may be nothing more than an identification / realization of the leverage problem. Nonetheless, I suspect the regulators will be busy trying to prevent a similar problem. Hopefully, any changes will be measured and focused with few unintended consequences.