10 January 2009 – The Aleph Blog

Book Review: Dear Mr. Buffett

Posted on 10 January 200911 January 2009 by David Merkel

This is not your ordinary Buffett book.? In one sense, that is because it is not a Buffett book.? When I read other early reviews on the web, I concluded that they hadn’t read the book.? I read almost all of the books that I review at my blog.? If I have not read the book, but have skimmed it, I tell you so in the first few paragraphs.? I also purposely avoid reading the stuff that the PR flacks include with the books.? I find it fascinating how many reviewers rely on the crutches provided.

Why is this not an ordinary Buffett book?? Because it concerns how an expert on derivatives came to know Mr. Buffett, and how the current crises were seen in advance by both of them.? This book’s greatest strength comes from its ability to explain the messes we are currently in.? No solutions, mind you, and Mr. Buffett ain’t handing out any of those either, but understanding how we got to where we are is of value, and Janet Tavakoli is nothing if not a good writer on those points.

There is a second theme — how a derivatives expert came to appreciate value investing.? After all, when short term investing is focused on a variety of arbitrage situations, why not think long, and look for long term capital appreciation?

In the book, much of the current crisis gets examined up through September 2008.? Unlike many, she was right in advance on many of the topics that would eventually bite us:

CDOs
Subprime mortgages
Hedge fund underperformance
Failing Financial Guarantors
And more…

She also disses the overrated Nassim Taleb, saying that the current events are not a “black swan,” but predictable, given the overage of leverage.? I agree, having written about these thing before the bust hit, while still admiring Taleb’s focus on nonlinearity and feedback cycles.

Janet Tavakoli and Warren Buffett share a similar philosophy on derivatives.? That is what motivates this book.

How can they be a systemic hazard?
How might one use them properly?

I heartily recommend this book.? One reading this will understand our current crisis very well, and will gain in his understanding of how our markets work.? That said, the virtues of the book do not come from Mr. Buffett, but from one who intelligently admires his views on derivatives and other matters.

You can buy the book here: Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street

PS — I write book reviews, and I hope you like them, because unlike other reviewers, I read the books.? I use Amazon because their service is good, and they offer a fair commision to those influencing those that buy through them.? My view is that if you need to buy something through Amazon, entering the site through one of my links will not increase your costs, and I will get a small commission.? Thanks to all who buy on Amazon through me.

Jargon

Posted on 10 January 200920 June 2017 by David Merkel

When I was an actuary interacting with the investment department inside a life insurance company, one of the things that I learned early was that there was an inpenetrable jargon on the part of the bond investors that neophytes had to learn.? My boss, the best actuarial businessman that I have ever known, insisted that we have a weekly meeting with the investment department, and in their offices.? Being on their own turf made them freer to talk their own lingo, and that helped us learn it.

When I went to work in an investment department years later, the shoe was on the other foot.? I was still learning investment lingo, but when the actuaries showed up, I was there to translate.? Not surprisingly, there is jargon on both sides, often with the same term having two different names, because it is used two different ways.

It was true until the day I left the firm, where I heard a bond term I had never heard before.? We have a lot of jargon in investing, whether it is fixed income or equities.? There is additional jargon in insurance.

Here’s my offer: I try to define what I write about, but if I fail to define something adequately, let me know in the comments, and I will add an entry to the new Jargon page.? Let me know; I live to serve.

A New Goal For TARP Money: Create Mutual Banks

Posted on 10 January 2009 by David Merkel

Call this a wild idea, but if the government wants to leverage its efforts in encouraging credit in the US economy, it should consider seeding mutual banks.? The US government would contribute money to 435 new banks (say $250 million to each), one for each congressional district, with the provision the government’s stake could be bought out at 1.5x what it put in.? The government would have a preferred dividend of 3 month LIBOR plus 5% or so.

The mutual banks would attract deposits, because the institutions would be healthy.? WIth the leverage from deposits, these new mutual banks would make loans that many current lenders would shun because their balance sheets are compromised.? They would be smaller institutions, not large like Fannie, Freddie and the FHLBs.? Depositors would own 2/3rds of the banks, with the government’s preferred stake getting 1/3rd of the votes.? These banks would pay dividends to depositors above any interest paid, in proportion to the profit earned on balances deposited.? (CDs being a higher cost source of funds would not get much of a dividend.)? The dividends would be paid out of profits in excess of what is needed to maintain the bank’s capital levels.

The mutual banks must remain mutual for 10 years, after which, they can be demutualized, with shares going to existing depositors in proportion to the cumulative profit earned off of each account for existing depositors.

That allocation system, similar to what is done with mutual insurers (“the contribution principle”) solves a lot of problems: people rushing to deposit when they hear about a demutualization, or, small depositors that think they will get a biggish slug of stock.? Sorry.? This is yet another area where the insurance industry is a lot brighter than the banking industry, and why?? We have actuaries, and you don’t. ;)? Actuaries are the best kept secret in business, at least, that is what the Society of Actuaries tells me. ;)? This insures fairness in who gets equity, and how much.

Now, this provides a much sweeter deal to depositors than what they currently have at their banks.? It is almost as good as a credit union, except these are subject to taxation.? (As the credit unions should be.)

This raises the objection: what of our current banks?? Will you let them go bust?? Why not prop them up?

This is one of the stupidities of how the current TARP was set up.? We reward incompetence.? Better we should allow the institutions to fail, wipe out the common, preferred, sub debt, etc.? After that, transfer the deposits and clean assets to the new mutual banks in the vicinity, and let the FDIC reconcile the crud through a new RTC.

This would set the incentives right.? Failure gets punished.? Depositors get rewarded for depositing in healthy institutions.? The government makes no big promises, but the interests of depositors are protected.

This puts the stick in front of existing banks.? No handouts, and more competition.? Show that you can delever and deliver, and you will survive.? Aside from that, we consolidate the failures into new healthy institutions.? With big failures the FDIC kicks additional funds into the affected mutual banks absorbing problems, but with an increased ownership interest to be bought out.

This is my idea of how the government and private industry could cooperate, with low ultimate costs to the taxpayer, while not subsidizing incompetence.? Such a deal.? Should I send it on to the Obama Administration?