Monday, December 3, 2007

Pounding the table

IBM announced another buyback today of over a billion dollars. They already did an accelerated share repurchase (ASR) agreement of $12 billion. This one isn't. Why the ASR? Because you get the immediate effect of the share count reduction, without paying for the shares.

Using the logic of the bears, why haven't these share repurchases been marked to the market? The Investment bank, shorts the shares, and IBM enters a forward sale contract. The IB, covers the short, and the contract is eventually settled by netting cash or shares.

The simple reason they are not marked to the market is because the company gets a bump in EPS, and the IB, gets the fees for the derivative transaction. Both parties benefit. What's that have to do with sub-prime?

It's a simple analogy. Now that the Investment Banks can't churn out the fees for the products they used to sell (CDO's sub-prime etc) to other institutions, they need to make it up on trading. So they say the allegations that research is designed to help trading is "ridiculous or outrageous."

Here's what I say is "outrageous and ridiculous." Let's say we have some CDO's, and we slice it and dice it, and cut it up to equity, mezzanine and senior tranches. How can investors make more of a return than what it is paying? Because the banks cost of capital goes down, the dealers who cut up the tranches get fat fees, and risk is miss-priced, but it isn't until the tide goes out, that you see who is naked. And in this case, it was the Investment Bank that was selling the CDO's, who was short. They sold it, so they knew who was naked in the water, before the tide went out.

Reminds me about the old adage about the lawyer: "If you have the facts on your side, pound the facts; if you have the law on your side, pound the law; if you have neither the facts nor the law, pound the table."

Today, Goldman's pounding the table.

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