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Thursday, July 19, 2007

New stock recommendation

I'm recommending QNTA at $2.71.

QNTA is very similar to a play I made last year called PXRE, which did very well. QNTA is trading at an even lower valuation than PXRE was. It is trading just around 0.5x book value.

QNTA is an insurance company that had a lot of exposure to Katrina. Most of the operation is now being run off. Run off is when they are not writing new insurance, but just winding down their positions. What happens in run off is that they own bonds and then have liabilities associated with their contracts for insurance. They pay what is needed on these insurance contacts (losses) and take it out of their bond holdings. The hope is that they have correctly estimated the losses and that therefore their book value stays as stated. If the losses are greater, then they can eat through their bonds (and therefore book value) more than they thought.

The same part of their operation that remains is expanding rapidly.

They are also tendering their outstanding preferreds shares. That indicates to me that they think they have enough bonds/cash to pay these and still be able to meet their insurance loss needs over the long term. That is a big positive, especially for the preferreds, which yield over 10% a face value and are trading at a discount to that. I highly recommend the preferreds, QNTAP.

I'm not sure what their ongoing hurricane exposure is for future hurricanes, since they are winding down their operations. I have enough plays (Nat Gas: CMZ, DVN) that would tremendously benefit from a new hurricane, so I feel I can take this risk. There is also a shareholder lawsuit, which might pose some risk.

A value guy named Klarman whose funds have been returning 20% in spite of his being 50% in cash bought a lot of QNTA at a slightly higher price.

Despite the risks, I really like this value play. It's usually good if you can buy at a lower price than Klarman!

Wednesday, July 18, 2007

The subprime mess and the Fed

Why look for complexity when there is simplicity?

If you want to see some great analysis, read this piece:

In it, you will see facts - simple facts about how simple what happened and is happening is.
Here are some obvious ones:

"Since 1965, the median dollar volume of single-family homes sales as a percentage of nominal GDP has averaged 8.4% versus 16.3% at the 2005 peak."

"between 1998 and 2006, with the major changes occurring in the last two or three years: ARM % of originations rose from 0.7% to 69.5% Negative Amortization rose from 0% to 42.2% Interest Only rose from 0.1% to 35.6% Silent Seconds rose from 0.1% to 38.7% Low Documentation rose from 57% to 79.8%"


What is wrong? Well, everyone wanted the rating agencies to rate everything highly; otherwise it wouldn't sell! So everyone agreed to look the other way.

It's as if the authorities have been sitting in a casino for years and now declare that they are shocked that gambling is occuring.

Put simply, there was massive overlending by the banks aided and abetted by the Fed. Now the major banks are starting to complain, because they run the risk of losing a huge amount of money, because they overlent in a risky environment. Thankfully, there are plenty of structures within the system (like Moody's and S&P) that allow them to lay the blame elsewhere and cry out that systemic risk is upon us and contagion may happen.

Why look for complexity? Bernanke is starting to doubt his inflation forecasting models and he is talking about academic concepts (like the "sacrifice ratio") as a way of preparing for interest rates cuts, even in the face of the continued threat of inflation and a plummeting dollar.

As The "Great" Mogambu Guru writes:

"For an example of more academic crap, he [Bernanke] said that the Fed uses the 'sacrifice ratio' in policy deliberations, which is an academic concept that the Federal Reserve uses to justify never raising interest rates. Essentially, the sacrifice ratio (according to is 'An economic ratio that measures the costs associated with slowing down economic output to change inflationary trends. The ratio is calculated by taking the cost of lost production and dividing it by the percentage change in inflation.'

"The rationale is provided when we learn that, 'If inflation is becoming a problem, central banks will try to cool economic growth in a bid to reduce inflationary pressures. However, this reduction in output costs the economy in the short term, and the sacrifice ratio tries to measure that cost.' Hahaha! Attempting to measure pain, as if it is just a matter of using a few constants in a few equations! Hahaha!

"The funny part - as in 'I can't believe I am hearing this crap!' - was when he announced that the Phillip's Curve was dead, and then repeatedly used it to show how inflation would come down! Hahaha! Too, too much!"

In my opinion, to help his friends at the big banks means overthrowing the important inflation lessons we learned in the 70s. To do so, Bernanke must academically define a new paradigm to justify his irresponsible actions. Why, he will aruge, fight inflation if it means a painful recession? Of course, it was the Fed who created the threat of inflation in the first place, by irresponsibly creating massive money supply growth!

The Fed is a political organization. Bernanke is a politician. If you look at him through the complex eyes of an economist you will miss the point. The point is that the power structures are putting political pressure on him to lower interest rates and he is shifting the academic landscape to accomodate them.


None of this is good for the dollar nor the long-term inflation outlook, but it is good for bankers and their bonuses. The questions are "have the bankers learned their lesson? Or will they continue to overlend?"

And as a bonus, here is another great article that debunks the current myth of a goldilocks economy: