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Things Our Grandfathers Said
Sep. 20th, 2008 01:59 pmThe best value of the week for those aspiring to GOM status is the Saturday Financial Times. Not only is it a stonkingly-good read (I noticed yesterday that for two weeks in a row I had actually failed to get round to reading The Guardian on Saturday, even though I had bought it, because I had spent so much time reading the FT), but it is also guaranteed to get me spitting feathers at least 50 times before lunch.
The normal bollocks is, of course, in the personal finance section, where Merryn Somerset Webb is a shining light of clarity and common sense amidst the biggest collection of spewy shit that you can imagine. Personal Finance sections usually employ twenty-something journalists who would rather be writing about fashion and columnists who really should not be allowed to have anything sharper than a crayon -- and even then they would probably try to eat it.
One particular smmart-eyed individual said that the reasons investors are advised to "ride out" volatility is because it is "notoriously difficult" to time markets. This pretends to a Buffett argument, while actually missing the point. If you are a Buffett investor, with a very long time frame, then, sure, ignore the short-term volatility. But it is no argument to recommend avoiding a strategy just because it is "difficult". Fuck me, if it were easy, we would all be doing it.
This non-argument is then compounded by the statement that "missing just the top 10 days" would have a significant impact on investment return", while missing the top 40 days would be "disastrous". Readers know that I have no time for woolly terms in what is a scientific business (one day I will have the time to cite the overuse of "usually", "often" and "rarely" in poker books in authors' unscientific attempt to justify various strategies, without any proof that the reccommended line is maximum EV overall).
How about this line? If you miss the worst 10 days in stockmarket performance, your investment return increases "significantly", and if you miss the worst 40 days, it increases by whatever the inverse is of "disastrous". What the writer is doing is two things:
1) He's saying that you, the reader, are an amateur, so leave market timing to the professionals, who know better.
2) He's saying thhat you, the reader, have a decreasing marginal attitude to money. The gain of an extra £10,000 is less satisfying than the loss of an extra £10,000 is disappointing.
Neither is necessarily true.
Provided you leave only a percentage of your assets in equities (the "gambling" part), then trying some market timing makes a lot of sense. Sure, you may perform slightly worse than average, or you may perform slightly better, but at least you will have had some fun along the way. And if you have a brain only slightly larger than that of your average fund manager (a fact that I would consider highly likely) then you would probably outperform the market by just showing a little bit of judicious timing.
++++++++++
Merryn Somerset Webb, I was pleased to note, spotted the Irish and Spanish property connection (see this blog, er Thursday), and expressed reasonable doubt that the US largesse on troubled mortgagees was unlikely to extend to a 2-bed apartment in Palma or a €1m mortgage on a Georgian townhouse in Dublin. Beware the Ides of March on the Spanish coast. Bargains to be had there soon, methinks.
Merryn is a bit too much of a fan of the deflationary scenario and is, I think recommending the Northern Rock five-year fixed rate a bit too heartily. But it's a reasonable enough line.
++++++++++
The temporary ban on short-selling by the FSA had its lighter moments. The regulator issued 29 stocks that could not be shorted, only to put out a "corrected" list of 32 stocks a few hours later. Between 10am and 1pm we weren't allowed to short Resolution. That was lucky, because the thing was merged into Pearl a month or so ago and is not listed. The "new" Cowdery Resolution vehicle hasn't yet raised its capital in an IPO. And the FSA missed Schroders off the list, which apparently had a high proportion of its stock (4%? Something like that) out there in shorting land. Lovely to know that our Regulator keeps its finger on the pulse.
The list itself remained a hodge-podge. Brit Insurance was on there, but Amlin wasn't. There was no Chaucer or Catlin. Close Brothers, like Schroders, was only added at the last minute. And Man Investment Group (surely a candidate for an attack if it;'s really all the short-sellers' fault?) remains off the list.
++++++++++++++++
Even those who are saying that "you can't just blame short-sellers" seem to be falling for the line that it was all the fault of the quants for inventing more and more complex derivatives that no-one can understand. That too misses the fundamental cause. If you ask yourself the simple question "why were these instruments created at such a rate in the early 2000s?" then you get closer to the answer.
When the dotcom boom went bust, the US faced a recession. Not a depression, just a recession. The really good times looked like being over.
To combat this, Alan Greenspan cut interest rates in the US, hard and fast. My money market fund paid about 0.1% for a year. He created "easy money".
Now, how do you get this easy money into the economy? There are various ways that you can do it wrongly, and the UK, Spain, Ireland and the US just about covered them all. Let's suppose you are Midtown Bank, Oklahoma, and you can borrow money at 0.5%. Wow, you say, that's a good deal, I only have to lend it out at 2% and I'm quids in. Salesmen are recruited to find borrowers.
The problem was, there just wasn't enough good credit out there. There was no shortage of demand. What there was a shortage of was good demand. So, Midtown Bank, Oklahoma, found no shortage of takers when it offered loans at 2%. But Midtown Bank Oklahoma, realized that it now had $10bn in loans on its books, which isn't good when you are capitalized at only $500m. It couldnt keep all of that 1.5% for itself without dramatically increasing its capital. This in turn reduced return on equity. More efficient, therefore, to pass the loans on, keeping a small slice of the profit (say, 0.1%, for yourself). For a small bank, 0.1% of $10bn is a nice chunk of change if you are capitalized at only $500m (it's 10% ROE on your capitalization). Who said that there was no such thing as a free lunch, the bankers said to themselves as their profits went up along with their bonuses?
Now, it's at this point and at this point only that derivatives and structured finance comes into play. Lots of Midtown Banks in lots of Oklahomas were doing the above, creating a huge pool of mortgage debt. Other investors, however, didn't want to take a lien on a house in Midtown, Oklahoma. What the suits wanted was a "product" that was triple A rated but which paid a higher percentage than the (at that time very low) treasury rate. So, the various investment banks sliced and diced the huge pool of mortgage debt and turned it into something else. The rating agencies, who really ought to learn a bit about correlation, gave the new products a triple A rating, and everyone was happy.
It gets a bit more complex than that, because these collateralized mortgage obligations got sliced and diced again and, in addition (and it was this that brought down AIG) the liability to default on those CMOs and CDOs was (theoretically!) shifted from investor to AIG via a credit default swap. All of this was done to keep the suits happy because their investment now yielded more than Treasuries, but looked, to anyone but an expert, to be risk-free.
But you and I know that this is always an illusion. If x yields more than y, then there is a higher default risk at x than y, no matter how much you juggle things around and pretend to have transferred the risk along.
But, the nub of the matter is, none of this would have happened if easy money had not been pumped into the economy in the wake of the dotcom boom. Greenapsnn, a man lauded with a ridiculous number of honours for "maintaining stability", was the man who lit the long-burning fuse. And Greenspan, the man who had in the 1990s presciently referred to "irrational exuberance" has to shoulder the blame. He can't say "but I didn't think that it would have this effect", because everyone in the market behaved exactly as they would be expected to behave, given what he did.
______________
The normal bollocks is, of course, in the personal finance section, where Merryn Somerset Webb is a shining light of clarity and common sense amidst the biggest collection of spewy shit that you can imagine. Personal Finance sections usually employ twenty-something journalists who would rather be writing about fashion and columnists who really should not be allowed to have anything sharper than a crayon -- and even then they would probably try to eat it.
One particular smmart-eyed individual said that the reasons investors are advised to "ride out" volatility is because it is "notoriously difficult" to time markets. This pretends to a Buffett argument, while actually missing the point. If you are a Buffett investor, with a very long time frame, then, sure, ignore the short-term volatility. But it is no argument to recommend avoiding a strategy just because it is "difficult". Fuck me, if it were easy, we would all be doing it.
This non-argument is then compounded by the statement that "missing just the top 10 days" would have a significant impact on investment return", while missing the top 40 days would be "disastrous". Readers know that I have no time for woolly terms in what is a scientific business (one day I will have the time to cite the overuse of "usually", "often" and "rarely" in poker books in authors' unscientific attempt to justify various strategies, without any proof that the reccommended line is maximum EV overall).
How about this line? If you miss the worst 10 days in stockmarket performance, your investment return increases "significantly", and if you miss the worst 40 days, it increases by whatever the inverse is of "disastrous". What the writer is doing is two things:
1) He's saying that you, the reader, are an amateur, so leave market timing to the professionals, who know better.
2) He's saying thhat you, the reader, have a decreasing marginal attitude to money. The gain of an extra £10,000 is less satisfying than the loss of an extra £10,000 is disappointing.
Neither is necessarily true.
Provided you leave only a percentage of your assets in equities (the "gambling" part), then trying some market timing makes a lot of sense. Sure, you may perform slightly worse than average, or you may perform slightly better, but at least you will have had some fun along the way. And if you have a brain only slightly larger than that of your average fund manager (a fact that I would consider highly likely) then you would probably outperform the market by just showing a little bit of judicious timing.
++++++++++
Merryn Somerset Webb, I was pleased to note, spotted the Irish and Spanish property connection (see this blog, er Thursday), and expressed reasonable doubt that the US largesse on troubled mortgagees was unlikely to extend to a 2-bed apartment in Palma or a €1m mortgage on a Georgian townhouse in Dublin. Beware the Ides of March on the Spanish coast. Bargains to be had there soon, methinks.
Merryn is a bit too much of a fan of the deflationary scenario and is, I think recommending the Northern Rock five-year fixed rate a bit too heartily. But it's a reasonable enough line.
++++++++++
The temporary ban on short-selling by the FSA had its lighter moments. The regulator issued 29 stocks that could not be shorted, only to put out a "corrected" list of 32 stocks a few hours later. Between 10am and 1pm we weren't allowed to short Resolution. That was lucky, because the thing was merged into Pearl a month or so ago and is not listed. The "new" Cowdery Resolution vehicle hasn't yet raised its capital in an IPO. And the FSA missed Schroders off the list, which apparently had a high proportion of its stock (4%? Something like that) out there in shorting land. Lovely to know that our Regulator keeps its finger on the pulse.
The list itself remained a hodge-podge. Brit Insurance was on there, but Amlin wasn't. There was no Chaucer or Catlin. Close Brothers, like Schroders, was only added at the last minute. And Man Investment Group (surely a candidate for an attack if it;'s really all the short-sellers' fault?) remains off the list.
++++++++++++++++
Even those who are saying that "you can't just blame short-sellers" seem to be falling for the line that it was all the fault of the quants for inventing more and more complex derivatives that no-one can understand. That too misses the fundamental cause. If you ask yourself the simple question "why were these instruments created at such a rate in the early 2000s?" then you get closer to the answer.
When the dotcom boom went bust, the US faced a recession. Not a depression, just a recession. The really good times looked like being over.
To combat this, Alan Greenspan cut interest rates in the US, hard and fast. My money market fund paid about 0.1% for a year. He created "easy money".
Now, how do you get this easy money into the economy? There are various ways that you can do it wrongly, and the UK, Spain, Ireland and the US just about covered them all. Let's suppose you are Midtown Bank, Oklahoma, and you can borrow money at 0.5%. Wow, you say, that's a good deal, I only have to lend it out at 2% and I'm quids in. Salesmen are recruited to find borrowers.
The problem was, there just wasn't enough good credit out there. There was no shortage of demand. What there was a shortage of was good demand. So, Midtown Bank, Oklahoma, found no shortage of takers when it offered loans at 2%. But Midtown Bank Oklahoma, realized that it now had $10bn in loans on its books, which isn't good when you are capitalized at only $500m. It couldnt keep all of that 1.5% for itself without dramatically increasing its capital. This in turn reduced return on equity. More efficient, therefore, to pass the loans on, keeping a small slice of the profit (say, 0.1%, for yourself). For a small bank, 0.1% of $10bn is a nice chunk of change if you are capitalized at only $500m (it's 10% ROE on your capitalization). Who said that there was no such thing as a free lunch, the bankers said to themselves as their profits went up along with their bonuses?
Now, it's at this point and at this point only that derivatives and structured finance comes into play. Lots of Midtown Banks in lots of Oklahomas were doing the above, creating a huge pool of mortgage debt. Other investors, however, didn't want to take a lien on a house in Midtown, Oklahoma. What the suits wanted was a "product" that was triple A rated but which paid a higher percentage than the (at that time very low) treasury rate. So, the various investment banks sliced and diced the huge pool of mortgage debt and turned it into something else. The rating agencies, who really ought to learn a bit about correlation, gave the new products a triple A rating, and everyone was happy.
It gets a bit more complex than that, because these collateralized mortgage obligations got sliced and diced again and, in addition (and it was this that brought down AIG) the liability to default on those CMOs and CDOs was (theoretically!) shifted from investor to AIG via a credit default swap. All of this was done to keep the suits happy because their investment now yielded more than Treasuries, but looked, to anyone but an expert, to be risk-free.
But you and I know that this is always an illusion. If x yields more than y, then there is a higher default risk at x than y, no matter how much you juggle things around and pretend to have transferred the risk along.
But, the nub of the matter is, none of this would have happened if easy money had not been pumped into the economy in the wake of the dotcom boom. Greenapsnn, a man lauded with a ridiculous number of honours for "maintaining stability", was the man who lit the long-burning fuse. And Greenspan, the man who had in the 1990s presciently referred to "irrational exuberance" has to shoulder the blame. He can't say "but I didn't think that it would have this effect", because everyone in the market behaved exactly as they would be expected to behave, given what he did.
______________
