Day: December 14, 2007

If Hedge Funds, Then Investment Banks, Redux

If Hedge Funds, Then Investment Banks, Redux

Every now and then, you get a reader response that deserves to be published.? Such was this response to my piece, “If Hedge Funds, Then Investment Banks.”? I have redacted it to hide his identity.

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I read your latest blog entry with interest because I have worked in the derivatives business and as a part of that helped to set up General Re’s financial subsidiary in 19XX – General Re Financial Products (GRFP). I was one of XX people that started that business from the ground up. I left shortly XXX Buffett arrived on the scene but I still knew a large number of people that remained and I have very good information about what happened there. I may be a bit biased so you should consider where I am coming from as you continue to read.

To be short about it, what happened at GRFP after Buffett took over was a complete mess. I can give you more information on that if you like but I will simply say that what Buffett writes about GRFP, has spin on it. Let me give you a somewhat quick example. Of that $104 million loss he refers to, how much of that could be attributed to salaries and operating expenses? How much of it was due to the forced unwinding of trades on the wrong side of the market? We know that there are high operational costs (these people are paid very well with nice offices, technology, etc.) and that one would expect to pay to get out of these transactions even if they are being marked perfectly correctly. It SHOULD cost money to unwind these trades. So why doesn’t Buffett, who normally gives us so much information, tell us how much of the loss was due to mismarking and how much was due to expected costs? I’ll let you guess at that answer. There’s a lot more to this story but let’s move on…

I am sure you felt safe quoting someone like Buffett – meaning he is likely to get things right almost every time, but even Buffett is not perfect and he has his blind spots. I believe that derivatives may be such a blind spot. I could go into detail about where I see holes in Buffett’s arguments however the bottom line is that I believe the vast majority of transactions done in the derivatives market are plain vanilla transactions that are extremely easy to mark. Did you know that the US Treasury market is now quoted as a spread off of swaps? That is how liquid the plain vanilla instrument is these days. These transactions will certainly not have two traders both booking a profit even though they are on opposite sides of a transaction. Bid/ask spreads in the plain vanilla market are less than 1 basis point per year in yield. I am certain there are exotic transactions that are mismarked for all the reasons that Buffett mentions but how many of these are really out there? My suspicion is that the total number is small enough to not be of any huge concern from a systematic standpoint.

Here is something interesting to consider. Why would the leader of a AAA-rated institution (a financial Fort Knox) that competes in many ways with other large financial institutions wish to lead people to believe that those other institutions may be engaged in a business that is particularly risky?

Just thought I would add my two cents (looks more like 25 cents now).
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For the record, both he and I are admirers of Buffett, but not uncritical admirers.? The initiator of a trade usually has to offer a concession to the party facilitating the trade.? Forced sellers or impatient buyers typically don’t get the best execution.? What my correspondent suggests here is at least part of the total picture in the liquidation of GRFP.? All that said, I still think there are deadweight losses hiding inside that swap books of the major investment banks.

Post 400

Post 400

Time to take a moment to reflect on what?s happened over the last hundred posts (as WordPress counts them), together with what has been going on in my life, and what is in store for the future on my blog.? Ten months is a long time in blog terms.? Let’s start with what I have gotten right and wrong.

Right:

Wrong:

  • National Atlantic
  • Stock-picking generally
  • Blog programming

In general, my macro commentary has been pretty accurate.? At this juncture, being bearish on the dollar and credit have been winners.? No telling when that will change.? That said, my hand has gone cold in the market since value stocks went cold.? Beating the value index is not enough for me, thank you.? National Atlantic is a continuing problem, though it seems to have found buyers around $4.

Now, if someone had told me when I started this blog that more than one-third of my readers would be outside the US, I would not have believed it.? 19% of my readers are from Canada, 7% from the UK and 4% each from Uruguay and the Netherlands.? Hey, thanks for reading me; I hope what I write is relevant to you.? And thanks to the readers from China, Germany, France, Brazil, Singapore, Hong Kong, Australia, Japan, Spain, Italy, India, South Korea, Taiwan, and Bermuda.? I may not be a global traveler, but my blog gets around.

Where? do my readers come from?? In order, Abnormal Returns, The Kirk Report, The Big Picture, Stumble Upon, The Street.com, FT Alphaville, Random Roger, and VIX and More.? Most of the rest find me through search engines (Google) or RSS.? Seeking Alpha (Aleph — Shalom) is another source, and really don’t know how big that is, as well as other syndicators.

For the last four months, I have been trying to obtain work or build an asset management business.? Though the latter has been cold, I have received several job prospects, and I should have an announcement soon on what I will be doing.? I have sometimes said that this blog is an option on a business.? That has proven true for me.

Other improvements have been the continuing series on personal finance and book reviews.? Both of those came as a result of reader feedback.

On the negative side, the job hunt has left me little time to contribute to RealMoney.? Most of my blogging is at night, and RM is during the day, when I am trying to work.? I’ll see how much I can contribute to RM in the future.? I owe them a debt of gratitude for inviting me to write for them.? It sharpened my investment writing skills more than I would have expected.

Also on the negative side, I know that I have to do blog repairs.

  • My left margins aren’t quite right.
  • My top banner should lead back to the home page.
  • I need to anti-alias my banner.
  • An error message comes up when comments are posted (the comments do post, though).
  • The same is true when I post articles.
  • My descriptive permalinks are gone.
  • And more…

Anyone with a good lead on PHP programming should e-mail me.? I suspect the changes should not be too great.? Otherwise, I will? slog on, and do it myself.

In closing I want to thank referrers, syndicators, readers, blogs who link here, and especially commenters (even if you don?t agree, but keep it civil.? I end with a question for my readers.? What do you all want from my blog?

  • More on equities
  • More book reviews
  • More macro commentary
  • More personal finance
  • Something else
  • Or, the same mix that you are currently getting

Let me know.? It is a pleasure to write for all of you.

Full Disclosure: Long NAHC

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