“As the Interest Compounds”

by Dram_man on June 17, 2009

Just when you think it was almost over, the damn thing threatens to come back to life. This was buried today in the Korea Times:

According to the source, the Texas-based [Lone Star] fund’s strategy is to wait until markets fully recover and make an attempt to sell KEB at around 18,000 won per share. If they are unable to sell at that price, they will dump KEB shares and file a lawsuit against the Korean government for the losses incurred by the rupture of the deal with HSBC.

This may take a rather maudlin turn. In fact, it makes me want to write the Lone Star soap opera:

Johnny Greyken hooks up with Korea, just after Korea’s break-up with IMF. Korea, thinking this is love, gave Johnny couple rings and matching sweaters, something all of Korea’s friends do. What Korea did not know is Johnny is no diffrent that his friends, Carlyle and Newbridge.

As soon as Korea finds its relationship is about the share the same fate as those of Carlyle and Newbridge, it goes crazy. Korea starts stalking Johnny, saying how they have “so much” together, this is real love, and the classic “if I can’t have you, nobody can”. This is followed by a bizarre set actions, that can only be described as deranged. Korea’s craze climaxes in crashing and ruining a church wedding where Johnny is about to marry HSBC using the same couple rings Korea gave Johnny.

Will Johnny get revenge? Will Johnny and Korea come together? Will Korea force Johnny to give its ring to their ugly sister? What ever happened to the ugly matching sweaters? Find out in the next “As the Interest Compounds”…

(Meanwhile, Greyken, you got screwed. Get over it.)

{ 13 comments… read them below or add one }

1 Wedge June 17, 2009 at 10:39 am: I’m going to have to go ahead and disagree with you on the last line. You don’t “get over” getting screwed by billions of dollars. However, I’m not sure how Lone Star would win a lawsuit, what with sovereign immunity and all that.
2 KrZ June 17, 2009 at 10:41 am: “about the share the same fate”
3 Brendon Carr (Korea Law Blog) June 17, 2009 at 11:47 am: As it stands now, Lone Star would have to sue the Republic of Korea in the courts of the Republic of Korea — where the Republic of Korea does not enjoy sovereign immunity, it must be noted. Lawsuits against the Republic of Korea (and by the Republic of Korea) are common in Korean courts, and the outcome is not fixed in favor of the government. At least not in all, or even most, cases. In this case, there would surely be an attempt at interference by parties in and out of government.

Still, I’d bet there is no bigger supporter of KORUS Free Trade Agreement ratification than John Grayken and Lone Star’s investors — the KORUS FTA will allow a foreign investor with a claim against the state to bring it to an international arbitration body rather than the courts of that state.
4 Dram_man June 17, 2009 at 11:58 am: Good observation, however I would think Korea could persuasively argue in arbitration that the provisions of KORUS FTA should not be applied ex post facto.

While avoiding discussing the merits of Korea’s culpability, I would think that LS would have greater grounds to recover damages in a Korean civil court since in the HSBC deal they can show a clear monetary loss.
5 Dram_man June 17, 2009 at 11:59 am: Wedge> I hate to make the comparison, but at some point I think Greyken should take Bobby Knights famous advice on rape.
6 brand confucian June 17, 2009 at 3:12 pm: This isn’t a case of bleeding hearts. I hope Lone Star can be heard before a Korean court. I hope they’ll make a formal complaint to the WTO as well. Someone needs to answer (if not pay for) the blatant protectionism that went on in this case and cost Lone Star considerably.

For a great recap on this case, and a fantastic comment on protectionism in Korea and around the world, I highly recommend a listen to the Korea Society’s podcast featuring Henry Seggerman, manager of Korea International Investment Fund, on protectionism. http://www.koreasociety.org/external/podcast.html
7 Linkd June 18, 2009 at 10:03 am: This is fascinating. “e-collar” crime?

Can’t cut&paste from the site, but basically someone started an online bank within a virtual world called Eve, collecting deposits of “interstellar credits” (like the acorns in cyworld) and making loans to other players who pledged their spaceships as collateral. He collected about 9 trillion in deposits, and only made about 1 trillion in loans.

Then, the CEO of the bank used a separate online black market to sell the interstellar credits to game players for an undisclosed amount of actual cash. The depositors of course have started a run on the bank, but there’s not enough credits to pay them all back. The Eve gameworld also doesn’t have an FDIC to guarantee their deposits.

The fallout is remarkably real-world-like, and poses the same sorts of dilemmas that real-world governments face in deciding whether to save a failing bank or just let the market sort it out. Give it a read, if this is your kind of info-porn.

http://www.breakingviews.com/2009/06/15/virtual%20bank.aspx?sg=nytimes
8 Linkd June 18, 2009 at 10:23 am: Apparently Starbucks has discovered that it doesn’t make enough coffee:

The latest mad plan by Howard Schulz and his executive team to fix Starbucks (SBUX) is to have stores grind beans each time they make a new pot of coffee. Apparently, the beans are only ground in the morning now.

According to The Wall Street Journal, current brewing methods mean �customers can be forced to wait, choose another type of coffee or leave the store empty handed.�

The current generation of managers running Starbucks, with the founder as CEO, has just figured out, after two years running the company, that its stores do not brew enough fresh coffee. That is an extraordinary revelation and says a great deal about why Starbucks has faltered. It is a company which was founded on good coffee but built on flashy stores and overpriced beverages and food. Now Starbucks wants to get back to its roots by eliminating the chances that its coffee may not be fresh.

http://247wallst.com/2009/06/17/starbucks-sbux-another-quick-fix-that-is-no-fix/
9 Dram_man June 18, 2009 at 10:52 am: That SBUX thing is interesting, not just for the snarky implications, but the deeper trends it may be hinting at. It used to be people went to SBUX for expresso based drinks, this indicates that some time ago (years perhaps), they economized down to the brewed stuff (reverting back to American habits perhaps?), found the product lacking, and so opted out.

(Cute online bank like by the way)
10 R. Elgin June 18, 2009 at 12:48 pm: That is amusing “Linkd”. Starbucks also has that problem with shipping coffee to Korea. It is my understanding that they ship by sea and when it arrives in Pusan, the regular roast is already expired and that is another reason why their regular roast is not very good here. The darker roasts (espresso) can last longer but that must be used up on the spot.
Per ROK drop (and others) Dunkin Donuts opened a coffee roasting facility here in Korea, which already beats Starbucks in terms of freshness (only).
11 Linkd June 18, 2009 at 1:17 pm: Negative interest:

Mr. McClelland�scredit card company was calling yet again, wondering when it could expect the next installment on his delinquent account. He proposed paying half of his $5,486 balance and calling the matter even.

It�s a deal, the account representative immediately said, not even bothering to check with a supervisor….

After a balance has been delinquent for six months, regulations require the card company to reduce the value of the debt on its books to zero. If a borrower has not paid by this point, chances are he never will.

�The creditors would rather have a piece of something now instead of absolutely nothing down the road,� said Adam K. Levin, the founder of the consumer education Web site Credit.com….

During the boom, nonpayers were treated more harshly because, paradoxically, their debt was more valuable. Collection agencies were eager to buy bundles of old debt from the card companies for as much as 15 cents on the dollar. In a healthy economy, even the hopelessly indebted can pay something.

In this recession, where collection agencies have little hope of collecting from the unemployed, that business model is suffering. Experts say 5 cents on the dollar is now the most a card company can hope to get for its past-due accounts.

Another factor undermining the card companies is the rise of debt settlement firms. These are profit-making companies that charge fees, nearly always in advance, to bargain with creditors on a consumer�s behalf.

Settlement companies are under fire from regulators, who say they promise much and deliver little. But their ubiquitous ads, which make a settlement seem not only easy but also a moral victory over shamelessly gouging card companies, have done much to spread the idea…

Consider Bedros Alikcioglu, a gas station owner in Newport Beach, Calif. He owed $112,000 on four cards and was paying $3,000 a month in interest and late fees. �It was so hard to earn that money, and paying it to nowhere didn�t make sense anymore,� said Mr. Alikcioglu, 75.

He signed up with a debt settlement company named Hope Financial, which negotiated deals with his creditors to settle for about 35 percent of his balance. Hope Financial is charging Mr. Alikcioglu about 12 percent of his original debt.

So, apply for four credit cards, shop your ass off for $120K worth of whatever your whims desire, then score a “moral victory” by paying off about $45K.

http://finance.yahoo.com/banking-budgeting/article/107200/credit-bailout-issuers-slashing-card-balances;_ylt=Ah5pjlVT5gcai6loHlIZgNK7YWsA?mod=bb-creditcards
12 Linkd June 19, 2009 at 4:28 pm: More financial infoporn. He’s talking about the role ratings agencies played in the downturn, which is vastly more interesting than the potential role that Apple might play in freeing the average Korean from the tyranny of WiFi or CDMA or whatever makes our cell phone service so excellent here.

…I can best illustrate the agencies’ disregard for the quality of their data sets by reference to a product unrelated to mortgages: the constant-proportion debt obligation, or CPDO.

This obscure little product was launched in late 2006 to great fanfare. And it was, indeed, an ingenious little fraud of a product. Here’s how it worked.

Some clever structurer noticed that, historically, investment-grade companies don’t default very often. Rather, they deteriorate for a while first, get downgraded to junk status, and eventually they default. That’s why the short-term ratings for relatively low-rated investment-grade companies may be reasonably high: even BBB companies are generally good for the next 90 days; if they weren’t, they wouldn’t be rated BBB. And this suggested the possibility of a trading strategy.

What if you bought a portfolio of investment-grade corporate debt and, every six months, purged it of the bonds that were downgraded to junk, replacing these with new investment-grade bonds. Obviously, you’d expect the downgraded bonds to underperform the remainder of the pool, so you’d have losses you need to make up, so assume you also sell out of a handful of bonds that have done well, and replace these with higher-yielding bonds that are still investment-grade, thus keeping your yield relatively constant. You’d still expect some losses if you wanted to keep your average rating relatively constant, though. So you need some excess yield to make up for these losses.

You find that yield by leveraging the portfolio. After all, it’s an investment-grade portfolio, very unlikely to default in the short term. You can borrow very cheaply short-term, invest in longer-term bonds, and earn the spread differential. If the bonds go against you, that’s OK, because you’re going to hold them to maturity and you’ll always be able to roll your short-term borrowing. And, if you can get a high enough degree of leverage, the excess in current yield from the differential between where you borrow and the yield on your portfolio should more than pay for the cost of rolling out of your losers every six months. And if you do that successfully, you’ve got a trading strategy that never loses principal, but has a surprisingly high expected yield. Sound good?

Well, it sounded great to the ratings agencies, who blessed this strategy by giving it a AAA rating.

How did they justify that AAA rating? By looking at the historic cost of rolling credit derivatives on indices of investment-grade corporate issuers, which generally have a high-BBB rating. These had been around for about three years when the first CPDOs were rated, and the roll had never cost more than 3 basis points. Factoring in that cost, at a leverage of 15-to-1, and using historic 6-month default rates for the portfolio (since the index would be rolled every six months), the proposed trading strategy would never lose money. Hence a AAA rating.

Let me reiterate that, just to drive the point home. The ratings agencies said: you can take a BBB-rated index, leverage it 15-to-1, and follow an entirely automatic trading strategy (no trader discretion, no forecasting of defaults or anything, just a formula-driven adjustment to the leverage ratio and an automatic roll of the index), and the result is rated AAA.

Needless to say, this worked out really well for all concerned. But that’s not really the point. The point is: the notion that you could grant a AAA based on a trading strategy for which there was at best three-years of data (three years that encompassed not a single recession, I’ll note) is mind-boggling. And, worse than that, nobody at the agencies apparently stood up and said, “wait a second: how can you turn a BBB into a AAA by leveraging it 15-to-1? That’s impossible!” Which, of course, it is.

http://theamericanscene.com/2008/12/23/ahi-quanto-a-dir-qual-era-e-cosa-dura-esta-selva-selvaggia-e-aspra-e-forte-che-nel-pensier-rinova-la-paura
13 snow June 21, 2009 at 5:52 am: Very interesting stuff, Linkd. I’ve heard that the ratings agencies, the Fed and regulators all had a hand in the current mess. Of course, the solution proposed by many governments is for more regulation, more power for the federal reserves, more power for governments, either individually or worldwide. We can thank the government fools for greatly helping to get us into this mess and now they’ve come to ‘rescue’ us.