Level 3 Decimation?

Level 3 Decimation?

October 29, 2007

Martin Hutchinson is the author of “Great Conservatives” (Academica Press, 2005) — details can be found on the Web site http://www.greatconservatives.com

There’s a mystery on Wall Street. Merrill Lynch last week wrote off $8.4 billion in its subprime mortgage business, a figure revised up from $4.9 billion, yet Goldman Sachs reported an excellent quarter and didn’t feel the need for any write-offs. The real secret of the difference is likely to be in the details of their accounting, and in particular in the murky world, shortly to be revealed, of their “Level 3” asset portfolios.

Both Merrill and Goldman have Harvard chairmen – Merrill’s Stan O’Neal from Harvard Business School and Goldman’s Lloyd Blankfein from Harvard College and Harvard Law School. Thus it’s pretty unlikely their approaches to business are significantly different – or is a Harvard MBA really worth minus $8.4 billion compared with a law degree? (The special case of George W. Bush may be disregarded in answering that question!)

We may be about to find out. From November 15, we will have a new tool for figuring out how much toxic waste is in investment banks’ balance sheets. The new accounting rule SFAS157 requires banks to divide their tradable assets into three “levels” according to how easy it is to get a market price for them. Level 1 assets have quoted prices in active markets. At the other extreme Level 3 assets have only unobservable inputs to measure value and are thus valued by reference to the banks’ own models.

Goldman Sachs has disclosed its Level 3 assets, two quarters before it would be compelled to do so in the period ending February 29, 2008. Their total was $72 billion, which at first sight looks reasonable because it is only 8% of total assets. However the problem becomes more serious when you realize that $72 billion is twice Goldman’s capital of $36 billion. In an extreme situation therefore, Goldman’s entire existence rests on the value of its Level 3 assets.

Climate Change is Investment “Megatrend” – Deutsche

BEIJING – Government efforts to tackle climate change are creating a “megatrend” investment opportunity that should tempt even those skeptical about the nature and pace of global warming, Deutsche Bank analysts said on Thursday.

“The climate change markets are being created by governments through their regulation,” said Mark Fulton, the bank’s global head of strategic planning and climate change strategist.

“Whether you believe the science or not, investable markets are being created by governments, and these investable markets we think will grow significantly over the next 20 to 30 years,” he said at the launch of a report on climate change investment.

The bank has attracted around 6 billion Euros (US$8.55 billion) into climate change funds, which target firms with products that cut greenhouse gases or help people adapt to a warmer world, in sectors from agriculture to power and construction.

It is hoping to tap into a growing awareness of the cash to be made from cleaner technology — once more a preserve of idealists than hardnosed investors.

“We believe the shift away from a carbon-based economy is a megatrend that will shape the asset management industry for many years,” Kevin Parker, global head of asset management, said in a statement.

“We expect return opportunities in sectors like renewable energy, water, and agribusiness will justify dedicated strategies.”

The fund is not seeking tiny start-ups or firms with radical environmental credentials. Companies must have a market capitalization of at least 200 million Euros and a minimum 20 percent free float to be considered.

Its top ten holdings include French utility Veolia Environnement, Spanish building and construction group Acciona and diversified US manufacturer United Technologies Corp.

Around 50 percent of its investments in clean technology, some 20 percent energy efficiency and over 25 percent in firms focused on adaptation, Fulton said. He declined to comment on current or future performance.