One can critique Nobel laureate Robert C. Merton’s work on a number of fronts, from the CAPM model to his involvement with the 1998 failure of Long Term Capital Management. And he still doesn’t get to the true source of the current crisis — monetary policy and an erratic U.S. dollar. But I found this MIT lecture useful in explaining how changes in asset prices can drive both instability and volatility in a highly non-linear, pro-cyclical way and confound all the risk and economic models. Merton also offers a simple method to swap risk and improve returns using right-way contracts. (Hat tip: Gordon Crovitz.)
New banks, not government banks
Niall Ferguson’s latest:
The critical point is to avoid the nightmare of a state-dominated financial sector. The last thing America needs is to have all its banks run like the rail company Amtrak or, worse, the Internal Revenue Service. State life-support for moribund dinosaur banks is an expedient designed to avert the disaster of a generalised banking extinction not a belated victory for socialism. It should not and must not impede the formation of new banks by the private sector. So recapitalisation must be a once-only event, with no enduring government guarantees or subsidies.
Pulling rabbits out of hats
How has debt-laden Level 3 survived (at least so far) two crashes now? Dennis Berman tells the story.
Since 2001, it has been paying $500 million to $600 million a year in interest. Yet it has never been able to cut its long-term debt load below $5 billion. Even worse, Level 3 hasn’t made a penny of profit since 1999. Its stock has traded below $8 for the past eight years. It closed at 98 cents on Monday.
Level 3 seemed a prime target to get pulled into today’s great credit maw, where decent but otherwise cash-strapped companies go to die. By November, bond investors were seriously doubting the company’s ability to pay off $1.1 billion in debt coming due this year and next, valuing its bonds as low as 30 cents on the dollar.
But the company has convinced large equity holders to bail them out of the crushing debt load, at least for the next year. 2010 and beyond will still be rough. Berman’s article did not mention the angel who saved Level 3 during the tech/telecom crash of 2000-02: Warren Buffett.
