Global Crisis/Innovation Blog

Kyle Bass Sees What is Plainly Visible But Unseen

By Shlomo Maital 

  

 

 

 

 

US house prices/median family income, 1978-2008

In a previous blog, I quoted Peter Drucker, who “saw what is visible but unseen”, just by looking out the window.  Kyle Bass did the same. He worked at Bear, Stearns, becoming at age 28 the youngest senior managing director in the firm’s history.  He is now the managing partner of Hayman Advisors LP, an investment firm which he founded in 2005-6.  Bass is famous (notorious?) for foreseeing the subprime mortgage crisis and profiting from it immensely, when most of us just didn’t see it. He realized before anyone that private bank debt would become sovereign debt, and that Greece’s debt was too big for Greece to be able to pay back.  He bet on that — when Greece’s interest rates were nearly equal to Germany’s.  He won big time.   He was recently interviewed on the BBC program “Hardtalk”.  Here is what he said:

   “ in 2001 [Fed Chair Alan]  Greenspan traded the dot com bust for the housing boom, lowered interest rates to 1%, because he thought that was how to come out of the dot.com bust aggressively.  Then he quit…handed the  reins to Bernanke.  We [at Hayman]  looked at:    median home prices, median income that had moved in parallel for 50 years…and at affordability. When Greenspan created the housing boom, there was massive divergence between median income and median home price [see figure above]…home prices took off, median incomes stayed stable…     How did we profit? When you are a fiduciary, like Hayman, people invest their capital with us, in order to not lose and to make good risk adjusted returns…  in 2006 we had a portfolio of investments all over the world… the hedge we did, we bet against the bottom 3% of subprime securitization, it cost me 1% a year.. it was the best asymmetric hedge I’d ever seen in my life…   we were long in the fund, so this was our hedge, just in case something went wrong. We knew something would go wrong.  We had a good hedge against it.  We lost on other investments, profited on the subprime hedge, and made profit overall.  

    “We have a large portfolio of global investments. And enormous hedges in Europe and in Japan.   We  realized the crisis would move from housing, to banks, to govt. We did math which other people did not do.  As the housing problem metastasized, it started to move globally, what we saw was,  beginning of 2008 to Q2 2009, every time a highly levered institution got into trouble,  in US and EU, the Central Banks took those bad private risks/assets and moved it onto the public balance sheet.  [It was called a ‘bailout’, ‘too big to fail’.]   We decided in mid-2008, there would be either massive delevering (deleveraging, write-off of bank debt, including bankruptcy), or would the move onto the govt. balance sheet.  The latter happened – in the US and partly in the EU they moved bad private assets onto the govt. balance sheet.    No one did this calculation…looked at how big debts were, how big revenues were, for govts.  What solidified our search was:  for Iceland, 300,000 people, $20 b. GDP,  3 Iceland banks had over $200 b. worth of assets!.  When the Icelandic banks went bad, it sank the country.  No regulator existed, deciding to put limits on the size of banking system relative to GDP…because it generated revenues, jobs.     

     “The global debt scenario?  Yes, we took bets against Greece…  for a $1,000 bet, you could make $700,000 profit, in the initial stages, 2008.  Greece’s sovereign debt traded as if it were German sovereign debt… it was within 11-17 basis points of German debt.  That’s 11/100 of one per cent.  There were great asymmetric hedges then.  Today,  all the asymmetry hedges in the world lie in Japan.  

   “The only way to resolve EU problems is to have massive debt restructuring, write-downs.  You know Europe is in trouble when it has a German Pope, and an Italian Central Banker.  World sovereign debt has grown in the  last 9 years from $80 trillion to $210 trillion. That’s  12% / yr., while GDP grew at 4%.   It is not sustainable.  The “PIIGS” (Portugal, Iceland, Ireland, Greece, Spain) are heading into insolvency.  There is noo solution but – either pay the bills, or  debts have to be written down.    Germany itself has defaulted twice in the last 100 years.  Germany hasn’t recapitalized its banks.. UK,  US HAS!  EU banks have three times the leverage of US banks.  EU hasn’t recapitalized its banks.    Issue Eurobonds (with no country on the face)? So profligate Southern European countries continue to spend wildly and Germany foots the bill.    Profligate countries blackmail Germany every time.  It’s not to Germany’s benefit.   How many of your relatives would you go joint and severally liable with?   EU won’t work unless it has centralized taxing authority, until every one of the 17 Euro nations cedes sovereignty.  This is a tall order.   The [bond] market is telling us, it won’t work.   Japan? It  will fall big time.  Japan has the single worst balance sheet problem with sovereign debt in the world…    in Japan: a xenophobic society, population decline, they will lose 27 m. people in next 40 years to demography…private assets of the public in Japan are close to $13.2 trillion…but govt. debt is $15 trillion – the first time in history a country’s sovereign debt exceeds private assets…. In Italy, the 10 yr rate went from 5% to 6%:  and Italy went to full crisis, in one percent!  Japan spends 50% of central govt. tax revenue on debt service, and  half is interest… if Japanese interest  rates rises 2%, debt service will alone exceed govt. revenue!”

   Kyle Bass went to college (Texas Christian University) on a combined academic/sport scholarship (he was a champion diver).  As a talented high diver, he knew how to take leaps others did not.  His leap into betting against subprime mortgages was a huge success. Perhaps then, we should listen to what he says about the euro and Japan.