Comments on: More on Bank of America

By: Hal Horvath

Hal Horvath — Mon, 05 Oct 2009 19:34:13 +0000

Precisely.

I harped on this several times, and on a lot of forums also.

Here’s a couple of bits from Feb:

http://findingourdream.blogspot.com/2009/02/what-to-do-about-banks.html

http://findingourdream.blogspot.com/2009/02/more-on-banksor-on-not-becoming-japan.html

By: hmf284

hmf284 — Wed, 30 Sep 2009 04:15:26 +0000

This is so well reasoned & thought through from both perspectives, as you would expect from a first-rate legal mind. Thanks for the update.

By: Uncle Billy vs. Mont Pelerin

Uncle Billy vs. Mont Pelerin — Tue, 29 Sep 2009 10:05:49 +0000

Well we watched the movie of Simon and Larry Fish (great name!). As we munched popcorn and tried to read between the lines, we kept wondering — where is Simon from? Yorkshire? Throw us a bone here. Also, regarding the use of “we” in the video – Simon says “we” again when talking about our issues with the financial system, but is he American? Just here for a extended visit on her majesty’s secret service like he was back in the USSR?

Noticed also what nice things he had to say about the quixotic Jaime Caruana LaCorte (whose ancestors founded the first banks in Malta and Valencia).

By: Steve Waldman

Steve Waldman — Tue, 29 Sep 2009 07:23:19 +0000

i think the underlying here is BAC’s guaranteed assets, not BAC itself. (BAC historical stock price understates its asset volatility precisely because of state guarantees, written and implied.) so i treated the price as constant (on the presumption that BAC hasn’t remarked the assets since the deal was inked), and let “volatility” cover all changes. but you’re fundamentally right — it may be a matter less of volatility than that the expected value of the assets has shifted from well below BAC marks to something somewhere close to the marks. but since there’s no analogous situation with widely traded, constantly marked assets, and i wanted to keep my parallel orthodox, i let “volatility” cover the case, on the theory that the marks represented a zero-point and the range of everyone else’s expectations capture valuation uncertainty. if you let the “real” market value of the underlying change despite the formal marks remaining constant, than its much more straightforward to think of this in terms of a change on in-the-moneyness.

the core point is that the value of the put option has changed in a manner that far exceeds the loss of time value. whether you attribute it to a change in volatility from marks or value of the underlying is in a sense definitional.

By: Bayard

Bayard — Tue, 29 Sep 2009 04:10:39 +0000

All I can say is, considering the vile travesty that the TARP and bank bailouts (guarantees, etc.) are, isn’t there some way the the government can hold BOA’s feet to the fire to get us taxpayers more skin? It looks to me like they are walking away much too inexpensively. But this is a moral issue for me and for most taxpayers. We’ve suffered for years from the abuse foisted upon us by the financial oligarchy, and we want our pount of flesh, anywhere we can find it.

By: 3-D

3-D — Tue, 29 Sep 2009 03:46:56 +0000

The even worse crime is that every person involved in all the bad decisions and every bankster involved in taking the money won’t be poor, destitute, or imprisoned when this is all said and done. They’ll be well off, employed, or at least employable at obscenely high salaries.

By: Ted K

Ted K — Tue, 29 Sep 2009 03:16:48 +0000

Steve,
Better get that i in interfluidity. Remember self-promotion is the name of the game. COME ON Bro!!! If you worry too much about America’s economic future and moral sense you’re going to miss the gravy train!!! (haha)
http://www.interfluidity.com/

By: Ted K

Ted K — Tue, 29 Sep 2009 02:46:04 +0000

Just imagine a bank named after your own country, which doesn’t even know how to carry assets on it’s balance sheet. Don’t you think most 3rd year University business students could manage that much??? But not Bank of America http://www.businessinsider.com/bank-of-america-admits-its-asset-values-are-lies-2009-3
Then after Bank of America is rescued by Obama and the taxpayers, show absolutely no gratitude at all.
http://online.wsj.com/article/SB125292937349508441.html
In essence what you have with Ken Lewis and Bank of America is a large fat baby that urinated and dumped in it’s diaper. And after Mommy (Obama and the taxpayer) changed their diaper and gave them a new diaper, Baby (BAC) cried because the new diaper wasn’t comfortable enough.

By: q

Mon, 28 Sep 2009 23:30:27 +0000

the question of what volatility to use is far from cut and dried. there is no market for ‘volatility expectations’ on several-year BAC puts. generally one would use a long term average vol (something like a 90 or 180 day moving average). i don’t have a bloomberg terminal up right now, but i’d imagine that the difference is less than you think it is.

on the other hand, the value of the underlier is i would imagine much higher, making the put option worth a lot less valuable now than in december or march.

By: Linus Wilson

Linus Wilson — Mon, 28 Sep 2009 21:30:38 +0000

If the Value of the Insurance on 5/6/09 < $3.575 billion, then taxpayers were shortchanged.

Thanks for spotting the error!

By: Brian

Brian — Mon, 28 Sep 2009 21:06:31 +0000

With measured brevity, you are right on!!

By: Steve Waldman

Steve Waldman — Mon, 28 Sep 2009 20:19:53 +0000

This is really just another way of saying what Linus said, but you could make this very clear via your put option analogy.

The government sold BAC a several year put option at a time when expected volatility of the underlying was very high. (One also might argue that at those times and given the not-widely-traded underlying, such a put option would have been directionally expensive, as the market anticipated bad news that was not reflected in BAC’s marks, but that it could not arbitrage away. But pointing to volatility is more orthodox, and is sufficient to tell our tale.)

BAC asked the government to repurchase the option, and negotiated a price that arguably compensated the government for the time value of the option lost.

However, the option would have lost value not only, or primarily given its long expiration, due to time. If we take the option as being pretty near the money, the option’s value would have fallen much more due to the drop in volatility expectations. The government was very gentleman-like with BAC (but not with taxpayers) in deciding to hold expected volatility constant for the purpose of buying back the option, even though those volatility expectations have collapsed.

By: Ted K

Ted K — Mon, 28 Sep 2009 19:37:22 +0000

I hope Mr. Kwak will excuse me, this is not directly related to the topic, but in a very broad way it touches on the issue. Professor Joseph Stiglitz gave an interview with James Surowiecki of “The New Yorker” magazine. Professor Stiglitz drops many pearls of wisdom here.
http://link.brightcove.com/services/player/bcpid41945846001?bclid=41803761001&bctid=42015071001

By: James Kwak

James Kwak — Mon, 28 Sep 2009 18:53:21 +0000

Thanks. You’re right – that’s the way to value it.

I think your inequality sign is backwards.

By: Linus Wilson

Linus Wilson — Mon, 28 Sep 2009 15:43:05 +0000

James, I thought you presented a nice discussion. Using your logic, the way to value the guarantee would not to prorate the insurance. Instead, the government should have done the following calculation:

(Value of Insurance on 1/15/09) – (Value of Insurance on 5/6/09) = (Fee to Exit the Insurance).

The Value of the Insurance on 1/15/09 was worth more than $4 billion, according to the term sheet. If the Value of the Insurance on 5/6/09 > $3.575 billion, then taxpayers were shortchanged. I suspect they were.