Here are some posts that have caught my attention over the last month, but I never commented on because of the increase in volatility placed more of a premium on covering current events.

1. Will we ditch GAAP accounting for IFRS?  Personally, I don’t want to learn a new set of rules, but if it improves our ability to invest in a more global era, then maybe it will be a good thing.
2. Do we care if we have auditors or not?  BDO Seidman recently got hit for damages of $521 million.  If this damage amount stands, it will bankrupt them, and possibly eliminate the #5 auditor in the US.  My argument here is not over guilt, but merely the size of the award.  That said, if the damage amount stands my solution would be to award 30% of the ownership of BDO Seidman to the plaintiffs.  Let them earn it through shared profits.
3. Peter Bernstein takes my side in the understating inflation debate.  As I have said before, if you want to smooth inflation, use the median or the trimmed mean, which is more statistically robust than excluding food and energy.
4. Jeff Matthews comments on how many companies that paid large special dividends, or bought back too much stock are regretting it in this environment.  What should they say to shareholders, but won’t?  I’ve said that for years at RealMoney, but during a boom phase, who listens?
5. I found it fascinating that private issuances of equity via 144A are exceeding IPOs at present.  Only the big institutions get to invest, and they can only trade it to each other.  I experienced that as a bond manager, but for equities, this is new, and a growing thing.  Question: most trading will then be negotiated block trades as in the bond market.  If a mutual or hedge fund buys one of these 144A issues, how do they price it?  With bonds, it doesn’t usually matter as much, because things usually move slowly, but with equities?
6. Can we time the value premium?  (I.e., when do we invest in growth versus value?)  The answer seems to be no.  Value strategies work about two-thirds of the time, which makes them dominant, but not so much so as to overcome the more sexy growth investing.  This allows the anomaly to continue.  The end of the article concludes: The bottom line for investors is that the prudent strategy is to ignore the calls to action you hear from Wall Street and the media and adhere to your investment plan. The only actions you should be taking are to rebalance your portfolio and to harvest losses when that can be done in a tax-efficient manner.  I like it.
7. I’ll say it again.  Be careful with ETNs.  They may have tax advantages versus ETFs, but the hidden risk is that the sponsor of the ETN goes bankrupt, in which case you are a general creditor.  With an ETF, bankruptcy of the sponsor should pose little risk.
8. Hit me again, please.  If financials didn’t hurt me recently, then it was cyclicals.  Ouch.  Both are at risk, but for different reasons.  Financials, because of a fear of systemic risk.  Cyclicals, because of a fear of a slowdown stemming from an impaired financial system being unwilling/unable to lend.

I’ll try to post on the other half of this on Monday.  Have a great Sunday.

If I have the energy this evening, I’ll put up two posts: the first on the near-term, and the second on longer-dated issues.  Then, next week on Monday, I hope to continue addressing the balance sheets of the companies in my portfolio.  I still believe that credit quality will not in general improve, but that companies that can benefit from additional financing and obtain it will be the best off in this environment.

1. First a few macro pieces.  I usually don’t comment on Nouriel Roubini.  To me, he seeks too much publicity.  Is the present situation worse than LTCM?  Yes and no.  Yes, the entire housing market and housing finance areas are affected, as well as some levered areas in corporate credit — CDOs and loans to private equity.  No, at least not yet.  During LTCM, the solvency of at least one major investment bank (the rumor is Lehman) nearly went down.  That would have been worse than what we have at present by a fair margin.
2. This piece from Paul Kasriel is interesting.  He brings up the correlation of seemingly unrelated asset classes, and hits the nail on the head by explaining that it id the owners of many risky classes of securities that are forced to sell due to margin calls that drives the rise in correlations.  Then he makes another hit on a favorite topic of mine, Chinese inflation.  That is the greatest threat to the value of the US Dollar and the end of Chinese stimulation of the US through the recycling of the current account deficit.  (At an ISI Group lunch late in 2006, I suggested that Chinese inflation was the greatest threat to the global economy.  Jason Trennert thought it was amusing.)
3. I disagree a little with this otherwise useful piece from Investment Postcards.  In the middle of the graphic it reads “Subordinate bonds (junk-bond quality) on balance sheet.”  Usually not true.  Banks are typically more senior in the financing structure, unless they originated the loans themselves, and retain the equity residual.  In the first case, there is low probability of a large loss.  In the second case, a high probability of a more modest loss.
4. Countrywide has certainly scared a number of people, including depositors.  First time I’ve seen anything resembling a bank (S&L) run in a while.  Here’s a quick summary on what went wrong.
5. Now, US mortgage lenders are not the only ones having trouble, but also those in the UK.  Part of the issue there is that a larger part of their mortgage finance is adjustable rate, which makes rising short rates proportionately more painful there.  Maybe the Bank of England, which has been among the more aggressive inflation fighters, will have to loosen soon.
6. One problem with securitization is that that legal documents are complex, and arguments over which party has what right become more common when deals go bad.  I’m no lawyer, but expect to see more situations like this one between CSFB and American Home.
7. Okay, a rundown.  What markets have been hit so far?  Emerging markets, real estate and funds that invest in real estate,  merger arbitrage and LBOs, art, many hedge funds (an article on the demise of Sowood), high yield debt, and the stock market globally.  I’m sure I’ve missed some, but I can’t remember a time when so many implied volatilities went up so much at the same time.
8. What’s not hurt as much?  Life insurance companies, though you sure can’t tell it from their stock prices.  I like Life the best of all my insurance sub-industries.  This area will come back sooner than most financials.
9. What might have scared the FOMC most?  The move in T-bills.  It was the biggest rally over one or two days ever, as the Wall Street Journal concludes, that is panic.  Such an incredible bid for safety demonstrated a lack of confidence in the banking system, as well as other riskier elements of the markets.  It’s rare for T-bills and LIBOR to get so out of whack.
10. But maybe things aren’t that bad, after all, US corporate earnings are rolling ahead at over a 10% rate.  I can live with that.
11. Is Citadel a rescuer of Sentinel, or a rogue-ish clever firm that took advantage of panic at weakly managed Sentinel? Penson argues for the latter, but if there were multiple bids considered, it may be a difficult case for Penson to prove.  I would guess that Sentinel is toast, and that their clients will take most of the financial hits.
12. Now, will the carry trade finally blow up?  After the move in the yen on Thursday, some thought so.  Some felt that it would plunge the world into a deflationary collapse.  I don’t think it will be that bad, but it will lead to inflation in the US, and an increase in the purchasing power of Asia and OPEC, at the expense of the US and a host of smaller countries (NZ, Iceland, etc.).  The parallels to LTCM are interesting; that’s the last time the carry trade got blown out.
13. Finally, Hurricane Dean.  I wasn’t so bold two days ago, but I felt that damage to the US would be limited.  I’m more certain of that now.  (Someone tell the Louisiana Governor that there is no bullseye on her state.)  I’m an amateur meteorologist, but what I do in situations like this is measure the deviation of the track of the storm from the forecast.  In my experience, deviations tend to persist.  That told me that Dean was likely to miss Texas.  That’s more likely now; bad news for Mexico.  Pray for those in harm’s way.

Sometimes I think that the Keynesian and Austrian Schools of economic thought can be merged into a consistent synthesis that would disagree about the goals of policy, but largely agree on how economies work.  One of the men that would help promote such an idea would be Hyman Minsky.

One of the beauties of capitalist economies is that they are dynamically unstable.  Businessmen as a whole for a variety of reasons tend to over- and underestimate the desirability of doing business as a group.  There at least two reasons for this.  First, there is trend-following, because success by one businessman causes others to try it, until it is overdone, then a large number of businessmen drop out, setting the stage for the next cycle.  Second there are shocks correlated across the system, whether it is monetary policy (too high/low for too long), tariffs, tax changes, wars, technological shifts, etc.

This instability is actually a plus for the system, because each period of failure creates the seeds for the next round of success, as vulture investors pick over the assets of failed firms and redeploy them to longer lasting practical uses.  The decks have to be cleared of bad ideas every now and then, or else the marginal efficiency of capital declines, along with overall interest rates.

But central banks prolong cycles by bailing out marginal ideas and not letting them purge, also creating a culture where risk is not respected, because the central bank will ride to the rescue.  Today, we are at such a “Minsky Moment,” where we rescue the marginal, and overleverage some currently healthy segments of the economy, while housing-related and high-yield related items die a lingering death.  We will likely set up the seeds of the next bubble in the next year, while we reconcile only the most egregious of business ideas.  (Amazing how many real estate agents and mortgage loan brokers there are, huh?  Same for investment bankers… time to redirect these bright people to solving operational business problems, and away from financing issues.)

Now, maybe this time we run into the brick wall, where inflation rises amid weak business conditions, as it did in the 70s.  At that point, the economy will take the pain.  Bernanke will keep the economy from a 30s experience, but possibly at the price of a 70s experience.  After all, which would you rather have, depression or stagflation?   Both are unpopular words, and I hate dragging them out, but if the price of avoid Depression is Stagflation, the present FOMC will take that cost.