Over the last six months, I have had the pleasure of being a guest on The Your Life! Your Terms! Podcast three separate times. This is a proud accomplishment for two reasons.
Firstly, I am proud to have been able to share my opinions on Bitcoin with Tom and Nick and the amazing audience. While Bitcoin is only just over twelve years old since 1988 I have been searching for a solution to Fiat that Bitcoin offers. I am passionate about my discovery. Sometimes I am a little too passionate which can lead to alienation.
Accordingly, I am also proud that I did not fumble my first invite, and that led to a second and third invite on the show. I believe each episode got better, more in-depth, and free-flowing. That feeling helped me gain the confidence to propose an idea to Tom and Nick whereby I want to write a weekly blog to the Rock Star audience that links my experience in my thirty-odd year career in the credit markets with the beauty of Bitcoin.
Very simply, Bitcoin is the most important financial innovation and technology that I have seen in my career. Initially, I loved the idea of Bitcoin due to its hard-capped supply limit of 21 million coins. 21 million, for the entire world population, investment community, and everyone looking for a Store of Value that was durable, portable, transferrable, divisible, fungible, and SCARCE.
Perhaps I am a little geeky since I am an engineer by training, but when I first saw the blockchain in action on tradeblock.com, together with transactions that were being processed and stored on the blockchain, I was hooked. I am visual. For me, seeing is believing (in the tech).
This weekly blog, in which I plan to submit ten to twelve installments, will not rehash the beauty of Bitcoin and its attributes. There are plenty of good books on that subject including “Magic Internet Money, A book about Bitcoin”, authored by Jesse Berger, a fellow Canadian with whom I shared the stage at the last The Your Life! Your Terms! Show. The book is awesome. Jesse is a star, and I don’t need to re-hash his eloquent production.
What I bring to the discussion is over thirty years of risk management and survival in the credit markets. I survived because I adapted. If I realized I had made a mistake, I exited (went flat) or even reversed a position (from long to short or vise versa). In my opinion, credit markets are the most unforgiving of the capital stack. They are also the most ruthless. If you are right, you are paid a coupon and you get your principal returned. If you are wrong, the interest coupon is in jeopardy, the price of the credit instrument starts to fall towards some sort of recovery value, and all sorts of contagion and correlation plays start to come into play. In short, I quickly learned to play probabilities. Expected value analysis. You can never be 100% certain.
I said on the last podcast that Credit Traders are pessimists. That is true because the return distribution tends to be asymmetric to the downside. A credit that is outperforming its risk profile (i.e., earnings, growth, cash flows are better than expected) will not increase its coupon and share that with the debtholders. Those benefits accrue to the equity. As a result, bond traders tend to ask “How much can I lose?”.
Equity traders and investors tend to be optimists. They love growth, believe trees grow to the moon, and are generally higher risk takers than bondies, everything else being equal. This is not surprising since their priority of claim ranks below that of credit (equity is worth zero unless bonds are worth par). If you manage money professionally, equities are for capital gains, whereas bonds are for capital preservation.
Equity traders are expected to lose money on many positions provided their winners far outstrip the losers. Bond traders have a more difficult balancing act since all bonds are capped to the upside, but their value can be cut in half an infinite number of times. You need many more performing positions to offset those that underperform or default.
Credit is really misunderstood by most small investors. In fact, in my opinion, credit is also misunderstood by many professional investors and asset allocators as well. As one of Canada’s first two sell-side High Yield (HY) bond traders (the esteemed David Gluskin of Goldman Sachs Canada being the other), I have lived many head-scratching moments on the trading desks on Bay Street and Wall Street.
I worked at RBC, Canada’s largest bank, in 1988 when my job was to price C$900MM of Mexican debt for swap into Brady Bonds. At this time, RBC was insolvent. So were all money center banks, hence the Brady Plan. RBC’s book value of equity was less than the write-down that would be required, on a mark-to-market basis, on its LDC book. That was a scary discovery. Most, if not all financial analysts on the equity desks had not done this simple calculation because they didn’t understand credit. They just felt, like most Canadians do, that the big six Canadian banks are too-big-to-fail. There is an implicit Canadian government backstop. That is true, but how would the government back-stop it? Print Fiat dollars out of thin air. Print, print, print…Solution Gold since bitcoin did not exist.
My experience with insolvent money centre banks in 1988 would be re-experienced in 2008/2009 when Libor rates and other counterparty risk measures shot through the roof PRIOR to equity markets smelling the rat. Again, in late 2007 equity markets rallied to new highs on Fed rate cuts when the short-term commercial paper markets and ABCP markets were shut. The banks knew there was credit contagion looming and they stopped funding each other, a classic warning signal. And then there was 2020. In 2020, the Fed did something totally new on the QE front, it started buying corporate credit. Do you think the Fed was buying corporate credit just to grease the lending runway? Absolutely not. They were buying because hugely widening yield spreads would have meant banks were once again insolvent in 2020. Risky business that banking….good thing there is a government backstop. Print print print…Solution Bitcoin.
In 1995 I had a research article published in the Financial Analysts Journal titled “Quantifying Risk in the Corporate Bond Markets”. The article was cited by JPM in a study of Bank for International Settlements capital allocation guidelines for all commercial banks globally. When I say that commercial banks are regularly insolvent (on a mark-to-market basis) it is because of this study that essentially quantifies risk for banks that are levered 25x to their equity cushions. (Think government back-stops and Fiat implications. Think Bitcoin as the insurance.)
I worked as an HY trader when we brought new Canadian Dollar HY debt to market for Rogers Communications Inc. At that point in its life, RCI was the largest HY borrower in the world. RCI issued more debt into the US HY market than any other company. Foolish Canadian institutional investors would not own the bonds because the bonds were junk, but they owned a subordinate claim….the equity, because the equity was in their benchmark. Well if the bonds are junk, the equity is “super-junk”. More to come on this in future publications.
I worked at GMPIM, a hedge Fund in 2008/2009 in the depths of the credit crisis. My partner was Michael Wekerle (Dragons Den on TV). Wek is one of the most colorful and experienced equity traders in Canada. He knows risk. He quickly understood that there was no point in taking long positions in most equities until the credit markets behaved. We became a credit-focused Fund and bought up hundreds of millions of dollars of distressed Canadian debt in companies like Nova Chemicals, Teck, Nortel, TD Bank Prefs in the US markets, and hedged by shorting the equity which traded mostly in Canada.
This cross-border arbitrage was huge, and Canada equity accounts had very little idea why their equity was getting slashed “ruthlessly”. I remember one trade that was 100% risk-free and thus presented an infinite return on capital. It involved Nova Chem short term debt and put options. Our CIO, Jason Marks is a Harvard MBA. An extremely smart engineer who was a brilliant mathematician. But he believed inefficient markets and could not believe I had found a risk-free trade with huge absolute return potential. To his credit, when I showed him my trading blotter, and then asked, “How much can I do?” for risk limit considerations, his answer was beautiful. “Do infinity”.
At GMPIM, we also embarked on the defining trade of my credit career. It was the restructured ABCP or MAV notes. We traded over C$10billion of the notes, from a low price of 20cents on the dollar, right up to a full recovery value of 100 cents on the dollar. And it was all low risk, because we could hedge the leveraged super senior names with very targeted purchases of single-name default insurance. Wek was a risk management genius. He didn’t need to be an equity trader to understand risk. Asymmetric trades define careers, and ABCP was the best asymmetric trade versus risk, I had seen up until that point in my career.
But Bitcoin is a better trade than ABCP, IMO. Bitcoin is the best asymmetric trade I have ever seen. And I want to explain why in forthcoming credit-focused publications.
I believe my trading experience is somewhat unique in Canada. I think the various cycles I have lived through give me hindsight to opine on why Bitcoin is such an important consideration for EVERY fixed income and credit portfolio. My goal is to share these thoughts with the readers of Rock Star Inner Circle. I hope that you will provide me with questions and feedback so that I can refine my pitch. Together, we can craft a document that I would be comfortable presenting to any fixed-income investor, large or small, to explain why Bitcoin needs to be embraced as a kind of portfolio insurance.
Owning Bitcoin does not increase portfolio risk, it reduces it. You are actually taking MORE risk by not owning bitcoin than you are if you have an allocation. It is imperative that all investors understand this, and I hope to lay out the arguments why using the credit markets as the most obvious class that needs to embrace the “money of the internet”.
The plan is to start by explaining, in very general and simple terms, the credit markets. For administered rates set by the Central Bank authorities, to government bonds and rating agencies, to corporate loans and bonds from investment grade to High yield (higher risk), to structured products that were largely responsible for the Great financial crisis (GFC) of 2008 and 2009.
The GFC just transferred excess leverage in the financial system, to the balance sheet of the governments. Perhaps there was no choice but there is no question that in the ensuing decade, we had the chance to pay down the debts that we had pulled forward. We did not do that. Deficit spending increased, quantitative easing (QE) was employed whenever there was a hint of financial uncertainty, and now, in my opinion, it is too late. IT IS PURE MATHEMATICS.
The global response to the COVID pandemic has ensured that our kids' futures are doomed to eternal Fiat currency debasing. Again, simple math. Unfortunately, most people (and investors) are intimidated by math. They prefer to rely on subjective opinions and comforting assurances from politicians and central authorities that it is okay to print more “money” out of thin air. I believe the credit markets will have a very different take and this could happen in short order. We need to be prepared, and we need to understand WHY. “Slowly, then suddenly” is a reality in credit markets.
In closing this introduction I want to state three truisms:
Should we do this? I look forward to your feedback so that I can get to work. I believe Canada needs this and most importantly, all our younger generations need this too.
Reach me on Twitter at @fossgregfoss – concerned but Optimistic Canadian