Regarding the WaPo cartoon, If Joe can invest at 8 percent, is there some good reason why Bob wouldn't also invest his $3000 at 8 percent instead of lending it to Joe at 6 percent?
During 1926-29, they had investment trusts. The leverage was typically 3:1, though they often in turn invested in trusts, so they could get a pretty good multiplier going.
Another interesting parallel between then and now: a previous bubble bursting just a few years before. You would think with so many people being burned in the tech-stock debacle, people would be wary of betting on a new bubble. Likewise, the Florida real estate bubble of the mid-1920s affected investors all over the U.S., yet a few years later they're all gung-ho for the next bubble.
That seems like an amazing coincidence, but then it occurred to me, maybe it's not a coincidence? Maybe the previous bubble created a class of people (and enabling lenders) who were sure they could adroitly ride a bubble?
"We have carried out an enormous cleaning of our credit portfolio. We have more capital than we need, so we can say to the market that we don't need more injections. We can confirm that we have tackled the problem."
Although difficult to estimate how long the credit crunch would last, Thain said he thought it would continue for "at least" another six to 12 months.
Merrill's CEO added that, in his view, the U.S. Federal Reserve's series of interest rate cuts would do little to help the financial sector.
"The problem is not the price of money but the availability of credit and the lack of confidence. As such, to merely lower interest rates is no use at all".
Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone.
Walter Bagehot -Lombard Street,
Excellent, I've been saving this and finally got the topic.:
This is about how hedge funds (and others) can get screwed even if they follow "the rules", when things sometimes go pear-shaped.
Situation: You have a market-neutral hedge on, short an SP500 futures contract on the CME and long a matching basket of stocks on the NYSE (and/or other stock exchanges).
Now, you want to lift your hedge, selling your stocks and using the proceeds to buy back your short SP500 contract.
Problem: Difference in settlement rules between the two exchanges. The CME insists on settlement at the end of the trading day, but stocks don't settle that quickly, so it's a few days before you actually get your cash. Making you technically "screwed", even with a perfect hedge, if you've got to lift it without enough and/or liquid-enough assets.
(With a margin account you might be able to get immediate access to your funds...or in a financial panic, maybe not.)
Situations like this and related problems factored into the 1987 crash.
Just an illuminating piece of trivia, not a forecast.
Sorry to repeat from a previous post, but this is interesting (to me anyway).
rob writes: "Credit card giant Visa, which was scheduled to price its mammoth IPO Wednesday night for trading Thursday, is moving the offering up to price Tuesday night for trading trade on Wednesday."
So, are we headed for a two-day bank holiday and/or closed market on Thursday-Friday? The market is scheduled to be closed on Good Friday, anyway; many banks too, I believe.
Since BB has returned to the 1930s playbook, anything seems possible this week. I suppose it depends on how Monday goes.
Stammerin' Hank Paulson spoke today about how completely ignoring moral hazard and saving BSC was necessary to maintain confidence in our markets. The next second he is talking about how strong the banking system is and how our markets are the envy of the world. Then he rattles on about the "strong dollar" policy.
What could cause a bigger lack of confidence in the dollar than bailing out BSC? Why would anyone want to invest in a country that subsidizes crazy recklessness? BSC is now what is backing our currency! Yeah, really strong. There are so many contradictions in his speil that my head is spinning.
CR said: "And when the hedge fund does go under (the low probability event occurs), no one asks the hedge fund manager to return their fees. A short term winning strategy, with "a long-run guaranteed return on investment of -100%", is still a potential winning strategy for a hedge fund manager."
I've often read that hedge funds aren't investment vehicles, but compensation vehicles.
Angry Saver: no need to be uncivil. I understand fully the advantage to Bob. but I don't understand why Joe would settle for a $180 return (6%) on his $3000, when he could have obtained $240.
Paul: I think you're having the same problem I am in figuring out where the benefit for Joe is.
banks lend they dont invest, so the bank lending against the paper was borrowing from its depositors and lending to this guy who bought the bonds and making the spread and protected by collateral.
I think you miss the point here. The use of leverage by all the players correlates risks that their models show to be non-correlated. As such, there is no such thing as a market-neutral hedge. In fact, when extreme leverage is used by everyone, the models break down so badly as to be characterized and 'impossible' events. I guess the Ivy League math quants are not so smart. And trust me...I know this for a fact...I went to school with them.... and a few ended up at BSC...ha ha ha
To Seb and CR -
Many hedge fund manager rollover 100% (or close to it) of their compensation into their funds because they can do it on a pretax basis as deferred comp and compound (oops, hopefully compound) pre-tax dollars. Some dont, but many do. The managers/GPs will lose a lot of money when these funds go down. If you remember the same happened at LTCM - they call it believing your own BS....
By the way, Charlie Gasparino is now saying that JPM will announce a deal to buy Bear tonight. Although we know his reporting track record has been a little sketchy recently... JP Morgan Offers $15-$20 A Share for Bear Stearns - CNBC
This seemed like a good place to ask a question of CR readers, i.e, last night I read this:
Whatever its appropriate level, credit risk should be well managed and should not exceed
what is necessary to meet the Federal Reserve's monetary objectives.
Does anyone know what The Feds monetary objective is, in regard to bloating The Treasury with bogus collateral?
That simple Q, is related to this Fed speak:
With risky assets, it would make
sense to place some portion of earnings into a credit loss reserve and conduct frequent
reviews of the portfolio to assess the adequacy of the reserve. Indeed, systematic
reserving and prompt write-downs over a large, highly diversified portfolio should be an
expected part of managing such a portfolio. With risky assets, the Federal Reserve also
would need to develop standards for acquiring and retaining such assets.
Re: above Q: before you reply, I know this: SECTION 2AMonetary Policy Objectives
The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
I'm hoping this stimulates a discussion of banks and firewalls and the proscibed functions of certain financial entities that we used to impose in order for them to act like and enjoy the protections of being banks. Perhaps even an UberPost about how we used to do it.
in_the_trenches, yes, very true. And I didn't mean to suggest Hedge Fund managers were doing this intentionally - I think they do believe their own B.S.
Michael Gonsior, I think Bob lends at 6% because they are regulated - and that looks like a good loan. Bob is leveraged too - so they are actually making more than 6% on their loans.
Re: Chairman Ben S. Bernanke
At the Fourth ECB Central Banking Conference, Frankfurt, Germany
November 10, 2006
Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective
Although a heavy reliance on monetary aggregates as a guide to policy would seem to be unwise in the U.S. context, money growth may still contain important information about future economic developments.
Why do hedge fund investors invest in these "compensation vehicles"? Aren't hedge funds getting most of their capital from university endowment funds and pension funds? These are knowledgable, demanding investors, right? Why are they allowing this game to be played? Is it just a follow the leader mentality and they are all forced to chase high returns?
but I don't understand why Joe would settle for a $180 return (6%) on his $3000, when he could have obtained $240.
What CR said. Also, part of it is that Bob's $3000 loan is callable, while Joe's investment (specifically, MBS) is not. Bob gets a lower return because of that option to call the loan in, but that option is valuable to Bob (as long as he doesn't get caught in the rush to the exits, which of course he is these days). Bob is more "liquid" than Joe.
The other issue in the specific context of MBS is that Joe might well have bought the 8% bond from Bob in the first place. If the 8% investment came off the broker's shelf to start with, then it's possible that Bob pockets some nifty fees from having created that bond. By keeping the market for margin loans inexpensive and liquid, Bob assures a market for the securitization side of his business. Remember how long GM went on making low rate loans to its customers to buy cars with?
Finally, it is possible that Bob actually knows more about that MBS (a lot more) than Joe does. Bob might well think it ought to pay more than 8% for its true risk. By making the margin loan to Joe, Bob can let Joe be in the "first loss" position if anything goes south (again, this is always assuming Bob believes he can get out fast enough if the worst happens). So if Bob thinks the real "risk-adjusted return" of the MBS is closer to 6.00%, he's not giving up much.
OK, Alea's report that Bear had 17 billion in liquid assets on Tuesday has me extremely concerned. Bear wasn't lying. They were liquid. And while Bear has some long-term solvency issues that didn't change between Tuesday and Thursday. This collapse was 100% short-term and psychology. If this wasn't a bear raid (with the nifty new tool of buying CDS!) it absolutely could have been. We have now been handed a script to take down any market player with substantial leverage. Anybody.
If I were in Wall Street, I'd be panicked too. Even if nothing else happens short-term, everybody will have to de-lever now, and quickly, which is going to bring its own suite of headaches.
scotty_at_the_helm said: "...Does anyone know what The Feds monetary objective is, in regard to bloating The Treasury with bogus collateral?..."
JMO, but I think that's sort of a red herring. I think the Fed's true-but-unspoken objective is to keep employment growth sound on the "easing" side and keep inflation from persistently rising on the "tightening" side.
Also JMO, what the Fed is doing now is more of a "police action" instead of a "war", since the problems aren't economy-wide.
lawn grass writes:
The fees get paid, no one else gets anything.
I thought the investment industry mantra was "we share the profits, you take the losses." (This socialize the losses addendum must be a dream come true.)
Sounds as though if they announce the Bear deal tonight at least relative calm will reign tommorrow.
krugman on hank paulsons helluva-job today on the sunday talk shows:
" Do not send the man who declared, back in April 2007, that the housing correction had reached bottom and that the subprime problem was largely contained to all the Sunday talk shows to declare that our financial institutions, our banks and investments banks are very strong. It just feeds the panic. "
I'm a money market-type person and you really have only one thing to do, which is look at prospectus material and read every single word! If you don't get it, do DD and use the net. You need to understand what securities are traded and the time periods. Early last year I was shocked at a tiny slip of paper enclosed with a Vanguard prospectus, which explained in fine print, little things related to Vanguards VIPERS and how they are connected to money market funds. I had to scratch my head and then moved out of the Prime MM into the Treasury MM. Felt much better after that!
One UK economist warned that the world is now close to a 1930s-like Great Depression, while New York traders said they had never experienced such fear.
A Goldman Sachs trader in New York said: "Everyone is in a total state of shock, aghast at what is happening.
In the UK, Michael Taylor, a senior market strategist at Lombard, the economics consultancy, said on Friday night: "We have all been talking about a 1970s-style crisis but as each day goes by this looks more like the 1930s.
In other words if taxpapers don't cough up more money to the banks the world will end as we know it. Fearmongering at its finest coming to you from bankers.
If this 401K money were my year 2040 walking around money I would whole-heartedly DCA into this downturn.
Unfortunately, that is not the purpose of my 401K investments. Every dollar I put into the 401K avoids 37% marginal tax rate, and I plan on taking out the money to fund my business activities later this decade, since I can survive on $15K/yr, so my early withdrawals are essentially taxed at 10% (the penalty + a bit).
I'm bearish about the next few years since I just don't see the E side of P/E holding out for the broad indices. In my Roth (which is the real retirement vehicle), I am in fact DCAing into stocks I think will still be industry powers in the 2020-2040 timeframe.
CR -- returns are not the only way to measure hedge fund performance. The more important measure is the funds stability of performance called the Sharpe ratio. Although I dont know much about CMBS investing strategies, I doubt the simple strategy the cartoon describes can actually result in decent Sharpe ratios.
If you are an investor putting in money with a fund manager that does something this dumb then you have no one to blame but yourself.
I'm a money market-type person and you really have only one thing to do, which is look at prospectus material and read every single word!
My sister writes them for a living and anybody that would base their investment decission solely on reading a prospectus should not be in the investment business.
Re: We're at just about a -17.7% correction right now.
Major bear markets (like 1973-74 and 2000-2002), when corrections of 40%-50% occur, only happen rarely (and we just had one a few years ago).
IMHO, The S&P500 is still at least 5% overvalued and the reality is that earnings will be going down, so the market value and yield of most indexes have more downside than upside IMHO. The slight dotcom correction we had was also an issue of equilibrium, where valuations had to be matched with market realities (of supply and demand. The Fed IMHO, should not be bailing out Bear due to antitrust issues, but also, because there are still tons of subprime resets coming and the banks that played in this casino, need to melt into the ground and never return, which will over time result in most indexes getting smashed in a liquidity trap -- regardless of the politics at The Whitehaus or with the printing press. The Ownership Society Debacle is going to take 10 years to fix!
Got a money market fund? Read the portfolio. My bank account swept into a money market fund. Last fall, when I got my report, I read the securities list, which was full of short term paper from SIVs and other stuff I couldn't identify. Some even had a footnote g: security in default. The next day, I moved to a treasury money market fund.
Builders in the U.S. broke ground in February on the fewest houses in 17 years and factory production fell, a sign the deepening real-estate slump is dragging the economy into a recession, government reports this week may show.
The central bank will lower the benchmark rate by a full percentage point to 2 percent this week, according to futures trading.
Angry Saver, most money markets fund are pretty safe (IMO). It depends on their investments and the name on the fund. As an example, the odds of a high quality fund breaking the buck is extremely low - most institutions will take any losses to protect their name.
I think this worry is being overstated. If we slide into a depression (IMO extremely unlikely), all bets are off!
With risky assets,
it would make sense
to place
some portion of earnings
into a credit loss reserve
and conduct
frequent reviews
of the portfolio
to assess the adequacy
of the reserve.
Indeed,
systematic reserving
and prompt write-downs
over a large,
highly diversified
portfolio
should be an expected part
of managing
such a
portfolio.
With risky assets,
the Federal Reserve
also
would need
to develop standards
for acquiring
and retaining
such assets.
One of the difficulties lies with the clearing firm. It sets the margins and therefore the amount of leverage traders (and their trading vehicles) are allowed to assume. Both know that higher leverage implies higher risk, but also implies more commissions and fees for the clearing firm and the possibility of higher returns for the trader. More risk means more opportunity for profits until an adverse move wipes out one or the other or both.
Sound familiar?
The use of strategies that will certainly blow up over the long term can be very profitable. The article reminds me of a fuller explanation of the effect, as written by Glyn Holton (I actually found this blog through his.)
He's been saying for years that hedge funds are incapable of the returns that they claim.
Here's his take on things: (PDF warning) http://www.riskexpertise.com/papers/Skewed.PDF
Everybody is interpreting Bear's demise through credit models, leverage models, liquidity models, etc.
But there's another way to see it: an overcapacity model.
I've been saying for some time there's huge overcapacity in all types of financial services.
If Bear is good in biz units that people actually need, why doesn't anybody want to buy them at a decent price?
If mortgages and hedge funds are permanent businesses, Bear should be worth more than $15 per share.
But they aren't. So, the contraction in those industries follows realtors and mortgage brokers, and it's a lot bigger than Bear.
And then there's overcapacity in securities brokers, insurance agents, bank branches, etc.
A normal economy doesn't need all these financial bodies.
Then, we'll get to overcapacity in retail, restaurant, government, etc. A lot of those people, hopefully, can get retrained to do real work in manufacturing or agriculture.
All I'm saying is that a fresh prospectus (not an annual report) gives an investor some basic theory as to the level of risk, which is still true with Bears and Thorn, i.e, if you read the generallized information they provided, which was out-dated, you still should have had a feel for the level of risk. Furthermore, many of the investors at Bears, voted to not continue to be part of the Bear strategy, which involved a lot of risk.
Obviously no fund, bank or corporation will reveal its true positions and what distorts this further is the current Fed program to trade toxic crap for greenbacks. If Bear could have waited a week, this would be a none issue, but IMHO, because The FBI and SEC were monitoring reporting very closely, the disclosure we now have, resulted in the market being efficient and investors running away as fast as possible.
In regard to money markets, I agree with CR to some degree that reputation is critical, and the trading going on right now is very careful versus being too risky. Nonetheless, lots of money markets are very deep into repos and securities which may not be liquid, thus if these MMs have too many exchanges (out too fast like Bear, the bucks will be challenged and liquidity will be a very real concern!
This is almost a liquidity trap and I still suggest that a prospectus is a great tool for gathering hints for potential risk.
Also, part of it is that Bob's $3000 loan is callable, while Joe's investment (specifically, MBS) is not. Bob gets a lower return because of that option to call the loan in, but that option is valuable to Bob
more to the point, Bob's loan is for a much shorter duration than Joe's MBS.
I agree. Even if the losses reached a trillion it won't bring down a 13 trillion economy. It also ignores the fact the people that sold those houses got the cash and they will spend it or invest it. Personally I think the fear mongering is meant to suck the public into socializing the losses to keep the old boys club intact on Wall Street.
I went to college with Andy Lo and he was very level-headed then. While Jim Glassman, a year or two ahead of us and since of Dow 36,000 fame, was writing articles in the school paper about "revolution for the hell of it."
It illustrates yesterday's post about character and lending. I'll bet Tanta would make a loan to Andy Lo.
Obviously no fund, bank or corporation will reveal its true positions
Well I think you answered my concern quite well yourself. A prospectus is a carefully worded sales pitch. It's why they use lawyers to write or approve them.
Re: Too many home loans have been neither responsible nor prudent,'' Fed Chairman Ben S. Bernanke said at a conference on March 14. He called forstrong oversight'' of mortgage lenders, and didn't discuss interest rates or the economic outlook in the text of his speech.
Oversight, what does he mean, as he passes the buck, who had oversight of the banks that played fraud games for 8 years?
As far as the moronic concept of self-regulation, how about this:
A Wall Street self-regulatory body -- the Financial Industry Regulatory Authority -- is examining Goldman's blockbuster profits as well.
It doesn't matter who we talk about in regard to being asleep on this subprime watch, because, with all the collusion, everyone was looking the other way, including Uncle ben and greenspan...
Even if the losses reached a trillion it won't bring down a 13 trillion economy
Are we /really/ more productive now than we were in 2000 with its $10T economy? Actually, in year 2000 money the $13T is reduced to $11.3T already.
At the end of the day what drives prosperity is creation of wealth -- intermediate goods, trade goods, capital goods -- and social capital like high-tech know-how and solid, impartial legal systems.
By definition we will always have an economy no matter how sh*tty it gets.
The question is surplus wealth & the standard of living for all americans that this wealth provides.
We as a nation have gotten far, far away from these fundamentals lo these past 20-odd years.
No work here. Ag has been automating/getting consolidated for the last 30 years. Heck,tractors are on the way that will use gps and not have to even have a driver in the seat. They already have gps steering so the driver doesn't even touch the controls.
1500 acres of grain farming is currently doable as a 1 man operation...You might need a small amount of part time help during planting and harvest time.
Yes, yes, yes, but.... I can pull out my little prospectus and go, gee, The Prime Money Market has verbage like, they invest 25% of the assets into agency securities, CDs, banker's acceptances, commercial paper, and if securities are unrated, they must be issued by a company with a debt rating of A3; they also invest in munis, derivaties and repos. Then they discuss stuff like how they compute the redemption values (NAV) and hint about the difference between conventional share classes or the market value of the shares, such as VIPERS. Then, you can get a feel for holdings as of a certain date about correlations involving GSE issues, e.g, you might see that of the net assets, almost 10% are in repos, and that some of these old outdated holdings are connected to Countrywide, Bears, Leh, GS, etc....
So, all I'm saying is, this laundry list should have been a wake up call a year ago, and even if the holdings are dynamic, you get an idea of the level of risk, and do not get me started on Pension Fund liabilities!
more to the point, Bob's loan is for a much shorter duration than Joe's MBS.
Well, yes, my explanation was a little simple and not very technical.
But I tend to assume that people who are comfortable with the term "duration"--or who already understand that the loan has a shorter duration than the bond--wouldn't ask the question in the first place. In any case, Michael is asking why Bob wants a short duration asset, not whether it is a short duration asset. No?
A lot of folks who probably could have answered Michael's question even better than I did just didn't bother to do so. Perhaps that's because it's harder to explain these concepts to to newbies than it is to talk shorthand among oldbees.
Although I dont know much about CMBS investing strategies, I doubt the simple strategy the cartoon describes can actually result in decent Sharpe ratios.
The Sharpe ratio measures volatility. Until the mortgage meltdown started last year, MBS were quite stable and that would have had a great Sharpe ratio.
Let's go back to financial basics and review a brief issue related to De Broglie, who conceived that financial electrons or not just particles but also waves. These waves are strung out over the circular path around the core "banking" nucleus. Hence when Schrodinger heard what was being laid down, he came up with a few equations which excited a dude named Born, who proposed that the financial wave did not describe the behavior of the particle, but instead, the wave describes the "probability" of a particles location (at any moment).
Thus, as I sum up my lecture on quantum finance, we had a bunch of young retards tinkering with models and pushing buttons and switches and toying and playing, adjusting and then the damn model broke, yah!
The perterbation related to these retarded non-dynamic models has now shifted and the energy levels are very screwed up and to make a very long point very short, the financial energy of the system is going to either shift in a discontinous leap backwards in an implosion, or the flip side which will be the more natural expansion of entropy, where this system will become more chaotic and less connected, yah, disconnected.
Mr. Uncle Ben is unfortunately running a ship with an un-attached rudder and the seas are very choppy. The problem he has (now), is to make a choice between focusing on measuring the momentum of realtime events, and thus over-reacting, or to let events unfold and to gage the effects of time too slowly. This is The Heisenburg Uncertainty Principal.
GOD's Speed and may your electrons flow freely between your legs!
Although I dont know much about CMBS investing strategies, I doubt the simple strategy the cartoon describes can actually result in decent Sharpe ratios.
Sharpe ratios are not a good way to measure the performance of investments that have non-normal or skewed returns.
Here is a link to an interview with William Sharpe, the Nobel prize winner and creator of the Sharpe ratio.
There now many ways to look at risk in a security or a portfolio beta, tracking error, standard deviation, the Sharpe ratio, and others. As a pioneer in risk and risk management, what is the right way for advisors and investors to look at the riskiness of their portfolios?
Answer: If you do insist on using a single number it must capture aspects of both risk and return. This is the purpose of the Sharpe ratio. It is the ratio of reward to variability; and shows the excess returns over a T-bill rate, divided by the variability. Ideally, however, you should see the whole picture. If you picture the return distribution as a normal bell curve, risk is a measure of the dispersion of the returns, and return is a measure of the center. If it is not a nice smooth bell curve, then you need to know the character of the tails what is the probability of a really disastrous outcome?
Rich said "I've been saying for some time there's huge overcapacity in all types of financial services.
If Bear is good in biz units that people actually need, why doesn't anybody want to buy them at a decent price? "
Rich, that's the first explanation of Bear Stearns that has made any sense to me. Every other explanation is full of contradictions. We can't let BS fail because it provides crucial services, but it is failing because no one will use it's services. It's a liquidity problem, but the Fed is providing liquidity for 28 days. It's doing the same thing as a bunch of other firms, but the fact that it is failing doesn't mean all those other firms will fail too.
If you are right then we should let BS fail. The overcapacity needs to be drained out and why not now?
Lots of nice links in the thread... thanks esp. to Troy and Ozymyandius for great PDFs.
And Tanta, thanks for your multipart answer to Michael's question... the possibility of multiple motives on Joe's part calls into question who is the driver, and who is being driven, in this back-scratching operation.
In general terms, I agree with you. But you may be wrong about one thing: 14-1 may not actually be typical. Carlyle Capitals gearing ratio was apparently 32X! Even with AAA munis, a miniscule miscalculation would be more than enough to wipe out even a supposedly hedged position in a matter of minutes if the market moved sharply against them. We are probably talking about contracts in the tens of billions of dollars! (And if the counter-parties are in trouble, that's exactly what were talking about----a fund with less than $600 million having enough leverage to control billions and billions). 14X is bad enough---especially given the known risk that a sizable number of counter-parties might not be able to perform in a difficult environment---but 32X means that even a relatively small fund like Carlyle Capital could spark a worldwide financial financial meltdown.
The financial regulators (such as they are) need to get a handle on this. How could they have allowed such gearing ratios in the aftermath of Long Term Capital Management, which, as you may recall, very nearly caused a worldwide financial meltdown when its highly leveraged bets on the bond markets blew up. The central banks need to set a margin limit of 3-1 or maybe 5-1, at the most for hedge funds and other investment funds. And then they need to immediately start de-leveraging and making bank holding companies reflect every activity on their books.
And one condition of any rescue should be that boards agree to claw back the outrageous bonuses paid to the people who got us into this mess----starting with Prince and ONeil and continuing with a total recoupment of the last five years worth of compensation of all hedge fund managers if their funds cant meet margin calls.
And when the hedge fund does go under (the low probability event occurs), no one asks the hedge fund manager to return their fees. A short term winning strategy, with "a long-run guaranteed return on investment of -100%", is still a potential winning strategy for a hedge fund manager.
And if you are Too Big To Fail, you will be saved!
ben bukkake was first
Wall Street fears for next Great Depression
Wall Street fears for next Great Depression -
Business News, Business - The Independent
Crash of 2008.
YouTube - Crashof2008 Channel
Regarding the WaPo cartoon, If Joe can invest at 8 percent, is there some good reason why Bob wouldn't also invest his $3000 at 8 percent instead of lending it to Joe at 6 percent?
It's the leverage stupid!
During 1926-29, they had investment trusts. The leverage was typically 3:1, though they often in turn invested in trusts, so they could get a pretty good multiplier going.
Another interesting parallel between then and now: a previous bubble bursting just a few years before. You would think with so many people being burned in the tech-stock debacle, people would be wary of betting on a new bubble. Likewise, the Florida real estate bubble of the mid-1920s affected investors all over the U.S., yet a few years later they're all gung-ho for the next bubble.
That seems like an amazing coincidence, but then it occurred to me, maybe it's not a coincidence? Maybe the previous bubble created a class of people (and enabling lenders) who were sure they could adroitly ride a bubble?
"We have carried out an enormous cleaning of our credit portfolio. We have more capital than we need, so we can say to the market that we don't need more injections. We can confirm that we have tackled the problem."
Although difficult to estimate how long the credit crunch would last, Thain said he thought it would continue for "at least" another six to 12 months.
Merrill's CEO added that, in his view, the U.S. Federal Reserve's series of interest rate cuts would do little to help the financial sector.
"The problem is not the price of money but the availability of credit and the lack of confidence. As such, to merely lower interest rates is no use at all".
Merrill CEO says has tackled biggest problems: report
| Reuters
Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone.
Walter Bagehot -Lombard Street,
Excellent, I've been saving this and finally got the topic.:
This is about how hedge funds (and others) can get screwed even if they follow "the rules", when things sometimes go pear-shaped.
Situation: You have a market-neutral hedge on, short an SP500 futures contract on the CME and long a matching basket of stocks on the NYSE (and/or other stock exchanges).
Now, you want to lift your hedge, selling your stocks and using the proceeds to buy back your short SP500 contract.
Problem: Difference in settlement rules between the two exchanges. The CME insists on settlement at the end of the trading day, but stocks don't settle that quickly, so it's a few days before you actually get your cash. Making you technically "screwed", even with a perfect hedge, if you've got to lift it without enough and/or liquid-enough assets.
(With a margin account you might be able to get immediate access to your funds...or in a financial panic, maybe not.)
Situations like this and related problems factored into the 1987 crash.
Just an illuminating piece of trivia, not a forecast.
Sebastian
Sorry to repeat from a previous post, but this is interesting (to me anyway).
rob writes: "Credit card giant Visa, which was scheduled to price its mammoth IPO Wednesday night for trading Thursday, is moving the offering up to price Tuesday night for trading trade on Wednesday."
So, are we headed for a two-day bank holiday and/or closed market on Thursday-Friday? The market is scheduled to be closed on Good Friday, anyway; many banks too, I believe.
Since BB has returned to the 1930s playbook, anything seems possible this week. I suppose it depends on how Monday goes.
I read the "simple" cartoon and it all still make absolutely no sense. It sounds alot like a Las Vegas table game.
Where exactly was "value" created?
Any comments on Gretchen Morgenson's latest column?
FAIR GAME; Rescue Me: A Fed Bailout Crosses a Line - NY Times
Stammerin' Hank Paulson spoke today about how completely ignoring moral hazard and saving BSC was necessary to maintain confidence in our markets. The next second he is talking about how strong the banking system is and how our markets are the envy of the world. Then he rattles on about the "strong dollar" policy.
What could cause a bigger lack of confidence in the dollar than bailing out BSC? Why would anyone want to invest in a country that subsidizes crazy recklessness? BSC is now what is backing our currency! Yeah, really strong. There are so many contradictions in his speil that my head is spinning.
What hedge fund manager wears a hat, or a suit for that matter....
Paul,
What makes you think that you need to create "value" to make money.
Winston - oh yeah - silly me.
CR said: "And when the hedge fund does go under (the low probability event occurs), no one asks the hedge fund manager to return their fees. A short term winning strategy, with "a long-run guaranteed return on investment of -100%", is still a potential winning strategy for a hedge fund manager."
I've often read that hedge funds aren't investment vehicles, but compensation vehicles.
S.
Angry Saver: no need to be uncivil. I understand fully the advantage to Bob. but I don't understand why Joe would settle for a $180 return (6%) on his $3000, when he could have obtained $240.
Paul: I think you're having the same problem I am in figuring out where the benefit for Joe is.
banks lend they dont invest, so the bank lending against the paper was borrowing from its depositors and lending to this guy who bought the bonds and making the spread and protected by collateral.
thats why the bank didnt buy the bonds.
just a didactic.
"You have a market-neutral hedge" - Sebastion
I think you miss the point here. The use of leverage by all the players correlates risks that their models show to be non-correlated. As such, there is no such thing as a market-neutral hedge. In fact, when extreme leverage is used by everyone, the models break down so badly as to be characterized and 'impossible' events. I guess the Ivy League math quants are not so smart. And trust me...I know this for a fact...I went to school with them.... and a few ended up at BSC...ha ha ha
To Seb and CR -
Many hedge fund manager rollover 100% (or close to it) of their compensation into their funds because they can do it on a pretax basis as deferred comp and compound (oops, hopefully compound) pre-tax dollars. Some dont, but many do. The managers/GPs will lose a lot of money when these funds go down. If you remember the same happened at LTCM - they call it believing your own BS....
By the way, Charlie Gasparino is now saying that JPM will announce a deal to buy Bear tonight. Although we know his reporting track record has been a little sketchy recently...
JP Morgan Offers $15-$20 A Share for Bear Stearns - CNBC
This seemed like a good place to ask a question of CR readers, i.e, last night I read this:
Whatever its appropriate level, credit risk should be well managed and should not exceed
what is necessary to meet the Federal Reserve's monetary objectives.
Does anyone know what The Feds monetary objective is, in regard to bloating The Treasury with bogus collateral?
That simple Q, is related to this Fed speak:
With risky assets, it would make
sense to place some portion of earnings into a credit loss reserve and conduct frequent
reviews of the portfolio to assess the adequacy of the reserve. Indeed, systematic
reserving and prompt write-downs over a large, highly diversified portfolio should be an
expected part of managing such a portfolio. With risky assets, the Federal Reserve also
would need to develop standards for acquiring and retaining such assets.
Re: above Q: before you reply, I know this: SECTION 2AMonetary Policy Objectives
The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
I'm hoping this stimulates a discussion of banks and firewalls and the proscibed functions of certain financial entities that we used to impose in order for them to act like and enjoy the protections of being banks. Perhaps even an UberPost about how we used to do it.
in_the_trenches, yes, very true. And I didn't mean to suggest Hedge Fund managers were doing this intentionally - I think they do believe their own B.S.
Michael Gonsior, I think Bob lends at 6% because they are regulated - and that looks like a good loan. Bob is leveraged too - so they are actually making more than 6% on their loans.
Best to all.
Michael Gonsior,
I just made a general statement about leverage. It was not directed at you or anyone else here.
Don't let the name spook you. I'm actually much more concerned than angry.
Re: Chairman Ben S. Bernanke
At the Fourth ECB Central Banking Conference, Frankfurt, Germany
November 10, 2006
Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective
FRB: Speech--Bernanke, Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective--November 10, 2006
Although a heavy reliance on monetary aggregates as a guide to policy would seem to be unwise in the U.S. context, money growth may still contain important information about future economic developments.
An educated populace would grok this preso, but I guess a cartoon is a good first step.
Why do hedge fund investors invest in these "compensation vehicles"? Aren't hedge funds getting most of their capital from university endowment funds and pension funds? These are knowledgable, demanding investors, right? Why are they allowing this game to be played? Is it just a follow the leader mentality and they are all forced to chase high returns?
On Friday, 3/14/08, Lehman announced it had secured a 2 billion line of credit from 20 or so banks.
IMO, Lehman was next in line to face a bank run. Their mortgage book is bigger than Bear's book.
Maybe the fed is finally getting proactive instead of reactive.
The fees get paid, no one else gets anything.
CR,
Could you kindly offer an opinion on the safety of money market funds?
JoeB asked: "...Is it just a follow the leader mentality and they are all forced to chase high returns?"
Essentially, yes, dopey as it sounds.
S.
Thanks, CR -- it makes a bit more sense now.
but I don't understand why Joe would settle for a $180 return (6%) on his $3000, when he could have obtained $240.
What CR said. Also, part of it is that Bob's $3000 loan is callable, while Joe's investment (specifically, MBS) is not. Bob gets a lower return because of that option to call the loan in, but that option is valuable to Bob (as long as he doesn't get caught in the rush to the exits, which of course he is these days). Bob is more "liquid" than Joe.
The other issue in the specific context of MBS is that Joe might well have bought the 8% bond from Bob in the first place. If the 8% investment came off the broker's shelf to start with, then it's possible that Bob pockets some nifty fees from having created that bond. By keeping the market for margin loans inexpensive and liquid, Bob assures a market for the securitization side of his business. Remember how long GM went on making low rate loans to its customers to buy cars with?
Finally, it is possible that Bob actually knows more about that MBS (a lot more) than Joe does. Bob might well think it ought to pay more than 8% for its true risk. By making the margin loan to Joe, Bob can let Joe be in the "first loss" position if anything goes south (again, this is always assuming Bob believes he can get out fast enough if the worst happens). So if Bob thinks the real "risk-adjusted return" of the MBS is closer to 6.00%, he's not giving up much.
Joes 8% is a long term risk-Mortgages
Bob 6% is a short term risk-roll over loans
Bob didn't want/couldn't take on long term risk for regulatory reasons.
OK, Alea's report that Bear had 17 billion in liquid assets on Tuesday has me extremely concerned. Bear wasn't lying. They were liquid. And while Bear has some long-term solvency issues that didn't change between Tuesday and Thursday. This collapse was 100% short-term and psychology. If this wasn't a bear raid (with the nifty new tool of buying CDS!) it absolutely could have been. We have now been handed a script to take down any market player with substantial leverage. Anybody.
If I were in Wall Street, I'd be panicked too. Even if nothing else happens short-term, everybody will have to de-lever now, and quickly, which is going to bring its own suite of headaches.
scotty_at_the_helm said: "...Does anyone know what The Feds monetary objective is, in regard to bloating The Treasury with bogus collateral?..."
JMO, but I think that's sort of a red herring. I think the Fed's true-but-unspoken objective is to keep employment growth sound on the "easing" side and keep inflation from persistently rising on the "tightening" side.
Also JMO, what the Fed is doing now is more of a "police action" instead of a "war", since the problems aren't economy-wide.
S.
lawn grass writes:
The fees get paid, no one else gets anything.
I thought the investment industry mantra was "we share the profits, you take the losses." (This socialize the losses addendum must be a dream come true.)
Sounds as though if they announce the Bear deal tonight at least relative calm will reign tommorrow.
Calm being a relative term.
Could you kindly offer an opinion on the safety of money market funds?
yeah, I'm debating to even fund my 401K this year. Hate to see it turn into a 201K or worse since I'm 100% in the MM.
We're in a sad state of affairs when I'd want to pass up the $5000 in tax savings to avoid $15K in principal risk.
krugman on hank paulsons helluva-job today on the sunday talk shows:
" Do not send the man who declared, back in April 2007, that the housing correction had reached bottom and that the subprime problem was largely contained to all the Sunday talk shows to declare that our financial institutions, our banks and investments banks are very strong. It just feeds the panic. "
A helpful suggestion - Paul Krugman Blog - NYTimes.com
wawawa-
THANK YOU!
"yeah, I'm debating to even fund my 401K this year. Hate to see it turn into a 201K or worse since I'm 100% in the MM."
There it is right there.
What happens when thousands of people like Troy opt out for a few years.
I guess it'll replace some of the revenue shortfall from the tax on bank profits (if there are any.)
I'm a money market-type person and you really have only one thing to do, which is look at prospectus material and read every single word! If you don't get it, do DD and use the net. You need to understand what securities are traded and the time periods. Early last year I was shocked at a tiny slip of paper enclosed with a Vanguard prospectus, which explained in fine print, little things related to Vanguards VIPERS and how they are connected to money market funds. I had to scratch my head and then moved out of the Prime MM into the Treasury MM. Felt much better after that!
Anonymous,
There is another scenario. People move to HARD cash. Remember, under a fractional reserve system, ALL banks are insolvent.
Play both ends against the middle long enough, and eventually you'll get crushed.
problem is my choice is the MM returning 3.2% annualized or 8 funds that have lost 10% so far this year.
Troy said: "yeah, I'm debating to even fund my 401K this year. Hate to see it turn into a 201K or worse since I'm 100% in the MM.
We're in a sad state of affairs when I'd want to pass up the $5000 in tax savings to avoid $15K in principal risk."
Consider: From 1966 to 2006 there were 19 significant SP500 corrections (equal to or greater than -10%). The median correction was -17%.
We're at just about a -17.7% correction right now.
Major bear markets (like 1973-74 and 2000-2002), when corrections of 40%-50% occur, only happen rarely (and we just had one a few years ago).
Just something to think about.
S.
From wawawa's link at 2:26 pm:
Wall Street fears for next Great Depression
One UK economist warned that the world is now close to a 1930s-like Great Depression, while New York traders said they had never experienced such fear.
A Goldman Sachs trader in New York said: "Everyone is in a total state of shock, aghast at what is happening.
In the UK, Michael Taylor, a senior market strategist at Lombard, the economics consultancy, said on Friday night: "We have all been talking about a 1970s-style crisis but as each day goes by this looks more like the 1930s.
In other words if taxpapers don't cough up more money to the banks the world will end as we know it. Fearmongering at its finest coming to you from bankers.
its the race to cash and even cash sucks. even real estate looks better.
S:
If this 401K money were my year 2040 walking around money I would whole-heartedly DCA into this downturn.
Unfortunately, that is not the purpose of my 401K investments. Every dollar I put into the 401K avoids 37% marginal tax rate, and I plan on taking out the money to fund my business activities later this decade, since I can survive on $15K/yr, so my early withdrawals are essentially taxed at 10% (the penalty + a bit).
I'm bearish about the next few years since I just don't see the E side of P/E holding out for the broad indices. In my Roth (which is the real retirement vehicle), I am in fact DCAing into stocks I think will still be industry powers in the 2020-2040 timeframe.
CR -- returns are not the only way to measure hedge fund performance. The more important measure is the funds stability of performance called the Sharpe ratio. Although I dont know much about CMBS investing strategies, I doubt the simple strategy the cartoon describes can actually result in decent Sharpe ratios.
If you are an investor putting in money with a fund manager that does something this dumb then you have no one to blame but yourself.
scotty_at_the_helm:
I'm a money market-type person and you really have only one thing to do, which is look at prospectus material and read every single word!
My sister writes them for a living and anybody that would base their investment decission solely on reading a prospectus should not be in the investment business.
Re: We're at just about a -17.7% correction right now.
Major bear markets (like 1973-74 and 2000-2002), when corrections of 40%-50% occur, only happen rarely (and we just had one a few years ago).
IMHO, The S&P500 is still at least 5% overvalued and the reality is that earnings will be going down, so the market value and yield of most indexes have more downside than upside IMHO. The slight dotcom correction we had was also an issue of equilibrium, where valuations had to be matched with market realities (of supply and demand. The Fed IMHO, should not be bailing out Bear due to antitrust issues, but also, because there are still tons of subprime resets coming and the banks that played in this casino, need to melt into the ground and never return, which will over time result in most indexes getting smashed in a liquidity trap -- regardless of the politics at The Whitehaus or with the printing press. The Ownership Society Debacle is going to take 10 years to fix!
Got a money market fund? Read the portfolio. My bank account swept into a money market fund. Last fall, when I got my report, I read the securities list, which was full of short term paper from SIVs and other stuff I couldn't identify. Some even had a footnote g: security in default. The next day, I moved to a treasury money market fund.
Sam, give me a break, they have to report holdings, what's your point?
Builders in the U.S. broke ground in February on the fewest houses in 17 years and factory production fell, a sign the deepening real-estate slump is dragging the economy into a recession, government reports this week may show.
The central bank will lower the benchmark rate by a full percentage point to 2 percent this week, according to futures trading.
Home Starts, Factory Production May Fall: U.S. Economy Preview - Bloomberg.com
Angry Saver, most money markets fund are pretty safe (IMO). It depends on their investments and the name on the fund. As an example, the odds of a high quality fund breaking the buck is extremely low - most institutions will take any losses to protect their name.
I think this worry is being overstated. If we slide into a depression (IMO extremely unlikely), all bets are off!
Best Wishes.
Reformatted Fed poetry:
That simple Q, is related to this Fed speak:
With risky assets,
it would make sense
to place
some portion of earnings
into a credit loss reserve
and conduct
frequent reviews
of the portfolio
to assess the adequacy
of the reserve.
Indeed,
systematic reserving
and prompt write-downs
over a large,
highly diversified
portfolio
should be an expected part
of managing
such a
portfolio.
With risky assets,
the Federal Reserve
also
would need
to develop standards
for acquiring
and retaining
such assets.
From: scotty_at_the_helm | 03.16.08 - 3:08 pm | #
scotty_at_the_helm:
Sam, give me a break, they have to report holdings, what's your point?
Bear Stearns, Carlylye and Thornberg reported their holdings.
One of the difficulties lies with the clearing firm. It sets the margins and therefore the amount of leverage traders (and their trading vehicles) are allowed to assume. Both know that higher leverage implies higher risk, but also implies more commissions and fees for the clearing firm and the possibility of higher returns for the trader. More risk means more opportunity for profits until an adverse move wipes out one or the other or both.
Sound familiar?
The use of strategies that will certainly blow up over the long term can be very profitable. The article reminds me of a fuller explanation of the effect, as written by Glyn Holton (I actually found this blog through his.)
He's been saying for years that hedge funds are incapable of the returns that they claim.
Here's his take on things: (PDF warning)
http://www.riskexpertise.com/papers/Skewed.PDF
Everybody is interpreting Bear's demise through credit models, leverage models, liquidity models, etc.
But there's another way to see it: an overcapacity model.
I've been saying for some time there's huge overcapacity in all types of financial services.
If Bear is good in biz units that people actually need, why doesn't anybody want to buy them at a decent price?
If mortgages and hedge funds are permanent businesses, Bear should be worth more than $15 per share.
But they aren't. So, the contraction in those industries follows realtors and mortgage brokers, and it's a lot bigger than Bear.
And then there's overcapacity in securities brokers, insurance agents, bank branches, etc.
A normal economy doesn't need all these financial bodies.
Then, we'll get to overcapacity in retail, restaurant, government, etc. A lot of those people, hopefully, can get retrained to do real work in manufacturing or agriculture.
Sam,
That was very Green Eggs & Ham!
All I'm saying is that a fresh prospectus (not an annual report) gives an investor some basic theory as to the level of risk, which is still true with Bears and Thorn, i.e, if you read the generallized information they provided, which was out-dated, you still should have had a feel for the level of risk. Furthermore, many of the investors at Bears, voted to not continue to be part of the Bear strategy, which involved a lot of risk.
Obviously no fund, bank or corporation will reveal its true positions and what distorts this further is the current Fed program to trade toxic crap for greenbacks. If Bear could have waited a week, this would be a none issue, but IMHO, because The FBI and SEC were monitoring reporting very closely, the disclosure we now have, resulted in the market being efficient and investors running away as fast as possible.
In regard to money markets, I agree with CR to some degree that reputation is critical, and the trading going on right now is very careful versus being too risky. Nonetheless, lots of money markets are very deep into repos and securities which may not be liquid, thus if these MMs have too many exchanges (out too fast like Bear, the bucks will be challenged and liquidity will be a very real concern!
This is almost a liquidity trap and I still suggest that a prospectus is a great tool for gathering hints for potential risk.
Also, part of it is that Bob's $3000 loan is callable, while Joe's investment (specifically, MBS) is not. Bob gets a lower return because of that option to call the loan in, but that option is valuable to Bob
more to the point, Bob's loan is for a much shorter duration than Joe's MBS.
CalculatedRisk:
I think this worry is being overstated.
I agree. Even if the losses reached a trillion it won't bring down a 13 trillion economy. It also ignores the fact the people that sold those houses got the cash and they will spend it or invest it. Personally I think the fear mongering is meant to suck the public into socializing the losses to keep the old boys club intact on Wall Street.
And then there's overcapacity in securities brokers, insurance agents, bank branches, etc.
When I was in Japan in the 90s it was common to see 6-10 different bank branches around every subway stop in Japan.
When I was there in 2002 I noticed that a lot of those banks weren't around any more.
I went to college with Andy Lo and he was very level-headed then. While Jim Glassman, a year or two ahead of us and since of Dow 36,000 fame, was writing articles in the school paper about "revolution for the hell of it."
It illustrates yesterday's post about character and lending. I'll bet Tanta would make a loan to Andy Lo.
scotty_at_the_helm:
Obviously no fund, bank or corporation will reveal its true positions
Well I think you answered my concern quite well yourself. A prospectus is a carefully worded sales pitch. It's why they use lawyers to write or approve them.
Re: Too many home loans have been neither responsible nor prudent,'' Fed Chairman Ben S. Bernanke said at a conference on March 14. He called forstrong oversight'' of mortgage lenders, and didn't discuss interest rates or the economic outlook in the text of his speech.
As far as the moronic concept of self-regulation, how about this:
A Wall Street self-regulatory body -- the Financial Industry Regulatory Authority -- is examining Goldman's blockbuster profits as well.
Even if the losses reached a trillion it won't bring down a 13 trillion economy
Are we /really/ more productive now than we were in 2000 with its $10T economy? Actually, in year 2000 money the $13T is reduced to $11.3T already.
At the end of the day what drives prosperity is creation of wealth -- intermediate goods, trade goods, capital goods -- and social capital like high-tech know-how and solid, impartial legal systems.
By definition we will always have an economy no matter how sh*tty it gets.
The question is surplus wealth & the standard of living for all americans that this wealth provides.
We as a nation have gotten far, far away from these fundamentals lo these past 20-odd years.
We as a nation have gotten far, far away from these fundamentals lo these past 20-odd years.
Excuse me but this kind of root cause analysis is too close to morality, religion, and politics.
^ yeah, you're right, bloviations like that are pretty much noise I guess.
agriculture.
rich | 03.16.08 - 4:13 pm | #
No work here. Ag has been automating/getting consolidated for the last 30 years. Heck,tractors are on the way that will use gps and not have to even have a driver in the seat. They already have gps steering so the driver doesn't even touch the controls.
1500 acres of grain farming is currently doable as a 1 man operation...You might need a small amount of part time help during planting and harvest time.
Chris
Sam, Sam, Sam,
Yes, yes, yes, but.... I can pull out my little prospectus and go, gee, The Prime Money Market has verbage like, they invest 25% of the assets into agency securities, CDs, banker's acceptances, commercial paper, and if securities are unrated, they must be issued by a company with a debt rating of A3; they also invest in munis, derivaties and repos. Then they discuss stuff like how they compute the redemption values (NAV) and hint about the difference between conventional share classes or the market value of the shares, such as VIPERS. Then, you can get a feel for holdings as of a certain date about correlations involving GSE issues, e.g, you might see that of the net assets, almost 10% are in repos, and that some of these old outdated holdings are connected to Countrywide, Bears, Leh, GS, etc....
So, all I'm saying is, this laundry list should have been a wake up call a year ago, and even if the holdings are dynamic, you get an idea of the level of risk, and do not get me started on Pension Fund liabilities!
more to the point, Bob's loan is for a much shorter duration than Joe's MBS.
Well, yes, my explanation was a little simple and not very technical.
But I tend to assume that people who are comfortable with the term "duration"--or who already understand that the loan has a shorter duration than the bond--wouldn't ask the question in the first place. In any case, Michael is asking why Bob wants a short duration asset, not whether it is a short duration asset. No?
A lot of folks who probably could have answered Michael's question even better than I did just didn't bother to do so. Perhaps that's because it's harder to explain these concepts to to newbies than it is to talk shorthand among oldbees.
Although I dont know much about CMBS investing strategies, I doubt the simple strategy the cartoon describes can actually result in decent Sharpe ratios.
The Sharpe ratio measures volatility. Until the mortgage meltdown started last year, MBS were quite stable and that would have had a great Sharpe ratio.
Back on topic with cartoons:
Let's go back to financial basics and review a brief issue related to De Broglie, who conceived that financial electrons or not just particles but also waves. These waves are strung out over the circular path around the core "banking" nucleus. Hence when Schrodinger heard what was being laid down, he came up with a few equations which excited a dude named Born, who proposed that the financial wave did not describe the behavior of the particle, but instead, the wave describes the "probability" of a particles location (at any moment).
Thus, as I sum up my lecture on quantum finance, we had a bunch of young retards tinkering with models and pushing buttons and switches and toying and playing, adjusting and then the damn model broke, yah!
The perterbation related to these retarded non-dynamic models has now shifted and the energy levels are very screwed up and to make a very long point very short, the financial energy of the system is going to either shift in a discontinous leap backwards in an implosion, or the flip side which will be the more natural expansion of entropy, where this system will become more chaotic and less connected, yah, disconnected.
Mr. Uncle Ben is unfortunately running a ship with an un-attached rudder and the seas are very choppy. The problem he has (now), is to make a choice between focusing on measuring the momentum of realtime events, and thus over-reacting, or to let events unfold and to gage the effects of time too slowly. This is The Heisenburg Uncertainty Principal.
GOD's Speed and may your electrons flow freely between your legs!
Perhaps that's because it's harder to explain these concepts to to newbies than it is to talk shorthand among oldbees.
that's true. sorry, i do that too much. anyway, some workerbees have been called in to work today, so they're in a bad mood.
Sam, give me a break, they have to report holdings, what's your point?
Another thing that concerned me about the holdings is that banks were reporting end-of-quarter pressure on SIVs as MM funds "tidied the books" a bit.
As an example, the odds of a high quality fund breaking the buck is extremely low - most institutions will take any losses to protect their name.
Banks back-stopped SIV's, until they didn't.
Banks back-stopped the ARS market, until they didn't.
Although I dont know much about CMBS investing strategies, I doubt the simple strategy the cartoon describes can actually result in decent Sharpe ratios.
Sharpe ratios are not a good way to measure the performance of investments that have non-normal or skewed returns.
Here is a link to an interview with William Sharpe, the Nobel prize winner and creator of the Sharpe ratio.
http://www.advisorperspectives.com/pdfs/newsltr24-3.pdf
The question asked in the interview was:
There now many ways to look at risk in a security or a portfolio beta, tracking error, standard deviation, the Sharpe ratio, and others. As a pioneer in risk and risk management, what is the right way for advisors and investors to look at the riskiness of their portfolios?
Answer: If you do insist on using a single number it must capture aspects of both risk and return. This is the purpose of the Sharpe ratio. It is the ratio of reward to variability; and shows the excess returns over a T-bill rate, divided by the variability. Ideally, however, you should see the whole picture. If you picture the return distribution as a normal bell curve, risk is a measure of the dispersion of the returns, and return is a measure of the center. If it is not a nice smooth bell curve, then you need to know the character of the tails what is the probability of a really disastrous outcome?
Rich said "I've been saying for some time there's huge overcapacity in all types of financial services.
If Bear is good in biz units that people actually need, why doesn't anybody want to buy them at a decent price? "
Rich, that's the first explanation of Bear Stearns that has made any sense to me. Every other explanation is full of contradictions. We can't let BS fail because it provides crucial services, but it is failing because no one will use it's services. It's a liquidity problem, but the Fed is providing liquidity for 28 days. It's doing the same thing as a bunch of other firms, but the fact that it is failing doesn't mean all those other firms will fail too.
If you are right then we should let BS fail. The overcapacity needs to be drained out and why not now?
Lots of nice links in the thread... thanks esp. to Troy
and Ozymyandius for great PDFs.
And Tanta, thanks for your multipart answer to Michael's question... the possibility of multiple motives on Joe's part calls into question who is the driver, and who is being driven, in this back-scratching operation.
This type of fraud, paying off bets when the risk is not known, was practiced by the famous con man, Yellow Kid in the 1920's.
He would, in essense, pay off bets at lower odds than the real odds: the newspapers only posted the winners, not the the racetrack odds.
I have a small story about it here:
THE BIZOP NEWS
In general terms, I agree with you. But you may be wrong about one thing: 14-1 may not actually be typical. Carlyle Capitals gearing ratio was apparently 32X! Even with AAA munis, a miniscule miscalculation would be more than enough to wipe out even a supposedly hedged position in a matter of minutes if the market moved sharply against them. We are probably talking about contracts in the tens of billions of dollars! (And if the counter-parties are in trouble, that's exactly what were talking about----a fund with less than $600 million having enough leverage to control billions and billions). 14X is bad enough---especially given the known risk that a sizable number of counter-parties might not be able to perform in a difficult environment---but 32X means that even a relatively small fund like Carlyle Capital could spark a worldwide financial financial meltdown.
The financial regulators (such as they are) need to get a handle on this. How could they have allowed such gearing ratios in the aftermath of Long Term Capital Management, which, as you may recall, very nearly caused a worldwide financial meltdown when its highly leveraged bets on the bond markets blew up. The central banks need to set a margin limit of 3-1 or maybe 5-1, at the most for hedge funds and other investment funds. And then they need to immediately start de-leveraging and making bank holding companies reflect every activity on their books.
And one condition of any rescue should be that boards agree to claw back the outrageous bonuses paid to the people who got us into this mess----starting with Prince and ONeil and continuing with a total recoupment of the last five years worth of compensation of all hedge fund managers if their funds cant meet margin calls.
When I did options, it always occurred to me you could do two hedge funds, opposed to each other (one in calls, other in matching puts?).
As long as you go for maximum volatility, you end up giving apologies to one bunch, and get your 20% from the other.
Separate parent companies, separate marketing teams. Two best friends in cahoots? It's all in the salesmanship to make the opposing pitches.
No, never did it. Bet it's been/being done.
But, "to catch a crook" (or avoid being robbed by them), you gotta think like a criminal.
"There be pi-rrrates in these waterrrrs, harrrrr!"
.
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And when the hedge fund does go under (the low probability event occurs), no one asks the hedge fund manager to return their fees. A short term winning strategy, with "a long-run guaranteed return on investment of -100%", is still a potential winning strategy for a hedge fund manager.
And if you are Too Big To Fail, you will be saved!
Just remember, "moral hazard" is only for the little people. Bankers are smarter than us -- they deserve the help!