Landmark Links May 2nd – Imperfect Solution

Duct Tape Car Fix - 21

Lead Story… It’s one thing to spot a change in the direction of a market before it occurs.  It’s completely another to devise a way to profit from that change. We are now about a decade removed from the housing crash and ensuing Great Recession.  Some of the largest fortunes in history were made betting against the housing market when a handful of risk-takers not only saw the impending mortgage disaster coming but concluded that purchasing credit default insurance against subprime mortgage bonds was the way to make a fortune.

Fast forward to 2017: the mortgage market is far tighter than it was in back in the housing bubble.  Most subprime lending was snuffed out by a combination of regulation and the scars of economic catastrophe brought on by exploding mortgages and other sketchy financial products.  Housing prices have recovered but sale and start volumes haven’t come close as an ever-growing population continues to grapple with housing supply that is growing too slowly to stabilize price. Today’s tight credit underwriting and limited supply make it less likely that we are in an echo housing bubble, despite the rising prices.  Buyers are far more stable financially than they were 10 years ago and there simply isn’t enough supply to cascade markets drastically lower as happened during the crash.

While housing seems to be on solid, if expensive ground, retail most definitely is not.  The trend towards online shopping has been eating into retailers profits for years now and seems to be hitting critical mass, resulting in a raft of vacant shopping malls / big box centers,  and bankruptcies, especially at the lower end.  As such, it was no surprise that the Wall Street Journal’s Serena Ng profiled a hedge fund manager who has been leading the charge in attempting to profit from the demise of American retail.  His vehicle of choice?  Betting against a Commercial Mortgage Backed Securities Index using credit derivatives (emphasis mine).

As a youth Eric Yip spent weekends working in a small shop at the bustling Burlington Center Mall, where his parents sold housewares and rock band T-shirts. That has given Mr. Yip the insight to make one of the most talked-about trades on Wall Street: a “short” wagering that many malls across America are doomed.

These days, Burlington Center is a silent place. Of around 100 stores, only about a dozen remain open. Macy’s and J.C. Penney are gone, leaving Sears as the last anchor tenant. Vacant properties surround a dry fountain whose centerpiece, a life-size bronze elephant, used to spout water onto its back.

The mall’s ghostly presence has spurred a financial wager that Mr. Yip, now a New York hedge-fund manager, is pitching to investors many times his size. Starting in late 2015, he began visiting shopping centers across the U.S. to take their vital signs. Concluding that dozens faced a fate akin to Burlington Center’s, as internet shopping becomes more dominant, he placed a bearish bet on an obscure index linked to the performance of bonds that are backed by commercial mortgages.

So far, so good. A slice of the index, which Wall Street calls the “CMBX 6,” has tumbled 6.3% since the start of this year, according to IHS Markit . The decline is good news for anyone shorting the index, or betting on it to fall, as he is.
Mr. Yip’s hedge fund, Alder Hill Management LP, gained 8% in the first quarter of 2017, said people familiar with its performance, fueled in part by the bearish bets on two index slices.

Mr. Yip has been pitching his idea to other investors. Earlier this year, he circulated a 58-page report that mapped out a dire outlook for regional shopping centers and said more than two dozen whose debt was reflected in the index were likely to default. He presented his thesis to a group of investment firms at a lunch in Midtown Manhattan.
The daring trade, potential payoff and Mr. Yip’s aggressive marketing have drawn comparisons to the way a few canny traders and hedge funds bet against an index tied to subprime mortgage bonds during the housing bubble a decade ago. That wager proved lucrative when housing went into a deep swoon and thousands of homeowners defaulted.

Mr. Yip said investors could make huge profits if, for instance, Sears Holdings Corp. were to file for bankruptcy, which his report called “likely just a matter of timing.” The closure of a sea of Sears stores could lead some other retailers to break their mall leases, he said, ultimately leaving struggling malls for dead.

Sears Holdings says it isn’t in peril. Howard Riefs, a spokesman, said the company has sold assets and taken other steps to “improve [its] operational performance and financial flexibility.” Sears closed 150 of its approximately 1,430 Sears and Kmart storesso far this year.

Corvex Management LP, Aurelius Capital Partners LP and Gratia Capital LLC have all made negative bets on the index similar to Mr. Yip’s, according to people familiar with the funds. The volume of outstanding bets on the index has swelled by more than $2 billion since Mr. Yip began shopping his trade around.

While many people are bearish on the future of malls, there’s little consensus about how an investor might successfully bet against them.

Any downturn in commercial real-estate debt is thought unlikely to be as brutal as the housing meltdown, partly because most of the bonds are backed not just by malls but by a wide variety of properties, including hotels and office buildings.

The index Mr. Yip is betting against has a higher concentration of shopping centers than similar financial instruments, but still only around 40 of the roughly 1,500 loans underpinning the index’s performance are mall debt. Debt of weaker malls makes up less than 15% of the index, according to Bank of America Merrill Lynch.

Many of the mall-based loans would have to default, and their properties be liquidated, before investors with bearish bets could collect a windfall. Skeptics say mall owners have tools at their disposal to improve their properties before they spiral into default.
“The CMBX is a very blunt tool” for betting against malls, said Alan Todd, head of commercial mortgage research at Bank of America Merrill Lynch. While retailers are downsizing at a faster clip, not every mall will be similarly affected, and the time between store closures and ultimate mall failures can vary significantly, he added.

Part of the beauty of the “Big Short” bet against housing was that it was asymmetrical in nature.  The funds that took out out credit default swaps against mortgage backed securities were able to choose the the specific mortgage bonds that they bought insurance against.  In some cases, they were even able to influence the collateral that went into those bonds.  It was a classic example of one side (hedge fund shorts) knowing far more about a trade than the other (institutional longs).  In addition, the bonds were made up of similar assets: sub-prime mortgages.  This allowed the shorts to benefit from high concentration with little to no diversification in the underlying securities.  Those buying credit protection on CMBX (the CMBS index) don’t have a decided edge like Big Short hedge funds did for several reasons:

  1. They are betting against a diversified pool of assets – as noted above, only about 15% of the index is made up of debt from weak malls.  That’s not an insignificant number but it’s a far cry from betting against a security 100% backed by mortgages to subprime borrowers.
  2. They betting against an index rather than an individual security – The shorts aren’t able to pick out a weak bond and bet against it like they did in the Big Short.  As Alan Todd from BofAML said: this is a “very blunt tool.”  They are using a shotgun, the mortgage shorts from 10 years ago were using sniper rifles.
  3. They don’t have knowledge asymmetry – unlike the Big Short, there doesn’t appear to be any knowledge asymmetry between shorts and longs betting on or against the index.  Back in 2005, the prevailing view of the public was that housing had entered a new paradigm and would not go down in value.  Today, pretty much everyone has known that retail is a train wreck and has been for a while.  The prevailing view is that mall retail’s new paradigm is a downward spiral brought on by online shopping.  Betting against housing in the mid-aughts was a bold contrarian play.  Betting against retail in 2015-2017 hardly seems contrarian.

There is no doubt in my mind that malls are a dumpster fire and there is more pain to come from Sears, JCPenny, Macy’s etc as well as the smaller stores that rely on them for traffic.  Betting against the CMBX index may be a way for hedge funds to make some money as the market for retail continues to deteriorate.  However, due to the issues outlined above I wouldn’t expect anything close to Big-Short-like returns.  Even if Mr. Yip and his cohorts are correct on the investment thesis, their vehicle of choice is not going to be anywhere near as effective as credit default swaps against subprime mortgage bonds were.


Meh: US growth in the first quarter of 2017 was sub-par.

Warning Signs: Risk assets are booming around the world but today’s “risk-off” market is sowing the seeds of future instability.

Rise of the Machines: Here’s a summary of the entry-level jobs most likely to be stolen by robots in the near future.


Sign of the Times: A new renter survey found that tenants now consider high speed internet and wifi more important amenities than in-room laundry facilities.


How the Other Half Lives: A new luxury condo project Century City offers Botox bars and robot butlers because, LA.

On the Rise: The number of new homeowners just outstripped that of new renters for the first time in a decade.

Leveling Off: The home ownership rate has stopped falling and has stabilized for the time being.


Scheinfreund: A rapper and a sketchy promoter used a bunch of famous Instagram models to entice Rich Kids of Instagram to buy tickets as expensive as $250k to attend an exclusive music festival on a tropical island.  All hell broke loose when the accommodations and food looked like a refugee camp and all of the music acts cancelled. The ensuing chaos and social media melee made for by far the most entertaining thing I’ve read this year.

Holding On: The crucial decision that Elon Musk made when he was asset rich and cash poor was not to sell off a large portion of his stake in Tesla.

Honey, I’m Going Out Tonight: A new study found that men need to go out and drink with friends twice a week to stay healthy.  Stay tuned for the next study which measures the divorce rate of people who followed the advice of the initial study.

Chart of the Day


Gotta Eat: A hooker solicited a cop for sex in exchange for Chicken McNuggets, because Florida.

Get Off This Plane Right Meow: A woman with allergies was recently thrown off of a plane when she asked to move her seat away from a comfort cat, because United.

Bom Chicka Bow Wow: A new study found that 1 in 10 American air travelers reports having sex of some kind in an airport.  This seems really high to me.

Uncovered: Declassified documents outline how the CIA tried to spy on the Russians by surgically implanting a microphone into a cat.  It’s safe to say that Project Acoustic Kitty’ was a bust:

The research was dubbed ‘Project Acoustic Kitty’ and cost $13 million (£10 million) over its five-year development in the 1960s.  The cat’s tail was used as an antenna with a wire travelling all the way up its spine to a microphone in the animal’s ear.  The equipment’s battery pack was sewn into the cat’s chest.   Victor Marchetti, a former CIA officer, told The Telegraph that year of the gruesome creation.
He said: ‘They slit the cat open, put batteries in him, wired him up’.  ‘They made a monstrosity. They tested him and tested him.  ‘They found he would walk off the job when he got hungry, so they put another wire in to override that,‘ he added.  The final 1967 report on the project concluded it was non-practical, signalling the end of the research.


Landmark Links – A candid look at the economy, real estate, and other things sometimes related.

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Landmark Links May 2nd – Imperfect Solution

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