We've all heard the cliché that a broken clock is right twice a day. Well, my son once told me that this saying is not always true. If the clock is spinning, but spinning at the incorrect speed, it could be broken without ever having been correct at least twice a day.
I'm reminded of my son's words as I read this week's Alan Abelson column in Barron's. For over 20 years, I have enjoyed the wordsmithing of Barron's resident editor and curmudgeon. But as a market timer, Mr. Abelson has historically been bearish and following his market opinions would have had the investor missing the predominance of the 25 year bull market that has seen the Dow Jones Industrial Average rise +800% since 1984. Mr. A. usually spins his bearishness though the surrogate words of analytical nabobs of negativism on a weekly basis. On the rare occasion that he grudgingly concedes that stock prices are likely to move higher, it is invariably because of something phony or ephemeral such as the dollar-drunkenness of the Federal Reserve or the irrational exuberance of the average investor. When the market does decline for a period, A.A., like the broken clock in the cliché, is there ready to say he's been telling you the right time all along.
In this week's column, Mr. Abelson demonstrates why a broken clock may never tell the right time. As he ridicules the idea of securitizing life insurance settlement policies, calling it a "scheme" and implying that it is another CBO crisis in the making, he draws the wrong lesson from the mortgage crisis and misses the value of the new instrument. Say you are a 70 years old widow and had funded a life insurance policy to leave to your child. Then, somewhere along the way, the relationship between parent and child sours and you decide you would rather spend the value of the policy to better enjoy your remaining years. With the creation of a secondary market for these policies, one can get a substantially higher price for the asset than the cash surrender value the insurance company would give you. For the investors in these pools of life settlement policies, the only significant risk is that the pricing based upon actuarial tables is accurate. But in terms of the underlying policies being paid off, this is a secure instrument, possibly as secure as a government bond. Most insurance companies are triple A rated and there has never been a default on a life insurance policy death benefit.
Mr. Abelson misses the lesson of the sub-prime crisis, which was that the mispricing of the underlying assets is what caused the collapse of the CDO/MBS market. No one group can be made the villain in the asset pricing scandal because so many factors and factions contributed to creating the housing bubble. One culprit in the creation of a real estate bubble was the largely Democrat politicians who cajoled banks to ease lending standards for low income Americans and then created tax policies that artificially advantaged buyers over renters and raised the prices of homes that many of these folks couldn't afford in the first place. Another culprit was the turn of the century Republicans, who confused over-regulation with proper regulation and made it politically suicidal to promote regulation of any kind. Congress, the overseers of Fannie Mae and Freddy Mac get a fair share of blame by allowing a quasi-government agency to warp the private loan market by alchemizing junk mortgages into investment grade government guaranteed paper. Worse, by immediately flipping the loans they created, their co-conspirators at the banks and mortgage companies absolved themselves of the future performance risk related to the paper they created. It was also Wall Street/The Banks/The Government who allowed the historic 20% deposit standards to lapse, the consequence of which was homeowners walking away from their obligations when the debt on their home exceeded their equity in the property. But most certainly, the culprit was WE THE PEOPLE who did not understand that policies and practices that decoupled the relationship between rental cash flow and a property's resale value can be both popular as well as wrong-headed. It was WE THE PEOPLE, who kidded ourselves into thinking that we could live above our means for a while and then some greater fool would bail us out before our artificially low teaser mortgages reset. These factors as well as many others turned a cyclical decline in home prices into a value pyre. There is nothing scheme-y about securitizing assets and bundling them into a new investment instrument. In of itself, it is a proven concept that has created wealth since Solomon Brothers popularized it in the 1980's.
So now it’s September 2009. The market is in the process of recovering from the recession of '08 and new exotic financial instruments tied to the securitization of assets are again being created. In the long run, such instruments positively impact consumers by creating price discovery on a series of asset classes that formerly had an illiquid market and opaque prices. The American financial market will becomes strong again, create new jobs and reemerge as one of the few sectors where we lead the world. Alan Abelson will continue to besmirch the industry that makes his publication possible and play the spoiler to every advance made by the Dow Jones Industrial Average. Alan, with all due respect, your distain for the upward march of capitalism is like the broken clock that never tells the correct time.
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