Monday, October 15, 2007

MLE--Mighty Large Enterprise

As the market opened on this Monday, the news from Citigroup that it had a bad quarter brought some modest selling in the early going. For detailed information on the C news, please take a look at the front page of Tuesday's WSJ. This article ties the poor quarter with another story about the new MLE SIV, this one found on page C1 of Tuesday's WSJ.

We urge you to read about the MLE SIV as it's being called. MLE stands for Master Liquidity Enhancement. We have mentioned SIV's (conduits called Structured Investment Vehicles) in prior posts but we think you should take a few minutes to find the WSJ and take a look at this new deal.

We want to spend an extra minute on it and provide you with a little information on this latest development to bail out the investors. As we had mentioned in our last (short) post, Thursday's action was the most important. The reversal seemed to indicate there might be a little selling in the near future. Then Friday, the action was muted at best.

Now we can conclude that the market had an inkling that this new MLE SIV was going to be set up over the weekend. We can't know that for sure but the way the market traded on Thursday should have led to more dramatic selling on Friday but that did not occur. The conclusion is not the only one out there but it did come to mind on Sunday evening as we heard about the news of the new bailout program.

C is the leader of the new deal and it has two big partners, B of A and JPM. These three banks were the center of the plan probably inspired by the Treasury department. The news was that the SIV would have funding of about $100 billion and an implicit government guarantee due to the Treasury's involvment up front.

Before we signoff for the evening, we wanted to mention one other WSJ article from last week. The story is about how some of the assets are priced in the current world (of no transparency). The article is found in last Friday's WSJ and is titled US Investors Face An Age of Murky Pricing. This article is a must read. The article says that there are now more assets that don't trade on exchanges than those that do.

The importance of that statement is the valuation of such securities. How do you value them when you don't have a liquid market in which to trade, a market that can tell you the value. The article says that in some cases, companies would put out an offer price and since there was No bid price, the market could use the offer price for value.

This practice is described by the article like a person would set the value of their house at what they wanted it to be and then say that was its value, even without anyone around who would look at the property let alone consider buying it. Warren Buffet is quoted as saying these securities are not marked to market but marked to myth. He suggests that companies try to sell a portion of their holdings, maybe 5%, in order to find out what the rest is worth.

The article shows three levels of valuation for assets. The first is the normal method which is to look at the price on the exchange, level 1, true mark to market. The second is called marking to matrix by some and is less precise. Values are based on "observable market data" for similar assets, level 2. Then there is level 3, so called marking to model which involves the most guesswork where valuations are based on management's best judgment and its own assumptions about what market participants might use in pricing the asset. Yes, you too can price your own assets. We were always of the opinion that something is only worth what someone else would pay for it, but if we can actually see the assets listed in these three categories we can determine for ourselves how much guesswork was used to value the company assets.

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