 Ron Insana is the founder and Managing Director of Insana Capital Partners, a RIA with approximately $100 million under management. He currently serves as a regular contributor on CNBC, providing commentary on market and political events. Previously, he was the editor of CNBC’s Street Signs.
Insana was the keynote speaker at the Reuters Advice Point Forum in New York on April 9. Below is a summary of his presentation.
Insana believes we are now in the most complex environment the financial markets have ever experienced. “It is decidedly different from the crash of 1987, mostly because the issues are more opaque and downright confusing. This is true for all participants, including the top money managers,” he says.
“Now we are confronted by the combined effects of financial engineering, leverage, and liquidity,” says Insana. The world GDP is $50 trillion (a quarter of which is the US economy), but there is an estimated $750 trillion in notional value in derivatives. Insana qualifies this estimate by the fact that some double-counting may be involved but, even after adjusting for possible double-counting, the size of the derivatives market and the inherent leverage in the system is “staggering.” Insana cites $25 trillion in credit default swaps where, in some cases, the party on one side of the transaction does not know the identity of the counterparty.
Insana refers to the sub-prime crisis as the “tip of a fuse that goes to multiple incendiary devices.”
On the subject of leverage, Insana notes that Goldman Sachs recently decreased its leverage from a “mere” 32x to 27x. The insignificance of this is evident from the fact that Long Term Capital Management’s leverage was 25x at the time of its failure.
Insana believes the crisis is more than a sub-prime crisis. He cites $240 billion in bank write-offs, but estimates the figure will ultimately be as high as $1 trillion. The failure of Bear Stearns boiled down to counterparty risk which became “extraordinarily large.” The failure of one major financial institution, such as Bear Stearns (the fifth largest investment bank) could have brought down the financial system, and Insana believes the Fed acted appropriately. “The Fed did not break its charter,” he says. Insana believes the LTCM failure was “peanuts” compared to the Bear Stearns failure, where “we would have had something from which we could not have emerged.” Counterparty risk is also the central element behind the Bank of America/Countrywide and J.P. Morgan/Bear Stearns transactions. In both cases, the acquirer was buying the firm with which it had the greatest counterparty risk. “Nobody can write down a sizable amount of debt and maintain tier one capital requirements,” he said, which is essential for an investment bank to remaining in business.
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