Fifteen days into 2009, rarely does the old aphorism that the more things change the more they stay the same appear more accurate. We're talking about financial services, not politics.

The news that Bank of America, which initially did not want to take any TARP funds, is now asking the Treasury Department for money on top of the $25 billion Secretary Paulson forced them to take last fall to complete the Merrill Lynch transaction reinforces that sinking feeling.

If that weren't enough, Citigroup is denying it is in talks with the government about being nationalized, which probably means it is. Just when we think this banking crisis is receding, it returns to bite us again.
Before the economy and equity market can recover, the credit markets need to resume a semblance of normalcy. So it's worth looking around and examining a few remote areas of these markets that might provide some directional signals.

Take a look at the convertible bond arena, which is perfectly situated between the debt and equity markets. It's often said that convertible bonds can give investors the best of all possible worlds in good times-equity participation in good times and bond protection in bad times. However, convertible investors have become increasingly reliant on Wall Street to finance their portfolios. So you can imagine how they performed in the second half of 2008.

Convertible arbitrage is one of the more popular hedge fund strategies and many of these leveraged capital pools, weighed down with illiquid securities, spent the fall deleveraging as they were forced to unload whatever was liquid.

There's a general consensus that equities are very cheap at present, but history demonstrates they can remain cheap for decades. But it's a different story for convertible bonds, explain Mark Mitchell and Todd Pulvino, two savvy players in this arena who manage about $2.2 billion at AQR Capital, an institutional asset manager that runs long-only and alternative portfolios in Greenwich, Conn. Before joining AQR, Mitchell and Pulvino spent time teaching at business schools, including the University of Chicago, Harvard and Northwestern, while building one of the world's leading databases on these vehicles.

Converts are less likely than equities to remain cheap, Mitchell argues, because they typically have a well-defined, three- to five-year life. These instruments are simply the combination of a bond with a derivative, usually an option or warrant.

The balance sheet problems of some giant money center banks didn't turn around on January 1, but the convert market did. Where once there were no buyers, suddenly there were few sellers. Corporate issuers were able to take on bank debt, repurchase convertibles and lower their cost of capital. Anyway, an intriguing white paper on the subject can be found at

It's become increasingly obvious that it took years, perhaps decades, to create this credit debacle and it will take years to extricate the economy from it. Some of the crisis's beneficial aspects-Americans are suddenly on a savings spree-will cause short-term pain before generating any long-term gains.

And it remains to be seen whether we as nation will learn any meaningful lessons from our mistakes.

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