November 2011 – Page 3 – The Aleph Blog

The Best of the Aleph Blog, Part 12

Posted on 3 November 2011 by David Merkel

This portion goes from November 2009 to January 2010.

Yes, I was one of the eight bloggers that made it to the first meeting with the US Treasury:

My Visit to the US Treasury, Part 1

My Visit to the US Treasury, Part 2

My Visit to the US Treasury, Part 3

My Visit to the US Treasury, Part 4

My Visit to the US Treasury, Part 5

My Visit to the US Treasury, Part 6

My Visit to the US Treasury, Part 7 (Final) (if you have to read only one of these, read this one)

How to Regulate the Banks, and other Financials

It comes down to diversification, leverage, and liquidity.

Notes from Recent Travels

Commentary on the health care bill, and also the AIG Bailout, and the Fed’s reprehensible actions.

Problems with Constant Compound Interest (4) (and more)

Retells my story interacting with the Federal Reserve bank of Richmond, and makes the application to commodity investing.

Post 1100 ? On Thanksgiving

Points out where we need to be thankful.? Even amid crisis, we have many things going well.

The Right Reform for the Fed

Criticizes a lame editorial that Ben Bernanke wrote in the Wall Street Journal.

On Sovereign and Quasi-Sovereign Risks

Talks about the relative riskiness of foreign debts, and the value of being able to tax.

Where the Rubber Meets the Road at Home

Explains how I teach my children about economics and other matters.

Uncharted Waters

Laments the low return on equity culture the US Government creates by trying to keep interest rates low.? (Sound familiar?)

My TIPS, Treasuries, and Inflation Model

An amazing model that describes the forward inflation and real yield curves.

On Contrarianism

“With markets, it doesn?t matter what people say.? What matters is what they rely upon.”

Not so Cheap Trills

One of a number of pieces that I wrote to fight the concept of trills, a form of debt more dangerous than any other I have seen

One Dozen or so Books on Economics

Many clever books on economics that major on history, and minor on theory.

Yield = Poison (2)

The perils of reaching for yield.

Fat Fed Profits Do Not Create a Healthy Economy

Large Seniorage profits for the Fed are not a positive for the economy as a whole.

R Bonds R Bad 4 U

A veiled attempt to raid pension assets to fund the US Government by those aligned with the Obama Administration.

Rationality versus Time Horizons

To come back to the beginning of this article, the fetish of rationality exists in economics because the math doesn?t work without it.? Many tests of rationality have failed, yet the profession does not give up, because their skills are useless if man is not economically rational.

Cram and Jam

There are many distortions of accounting data, and this gives you two of them.

Double Down Institutional Investing

Deals with the asset-liability mismatch in much of endowment investing.

Fear the Boom and Bust ? an Economics Lesson

My commentary on the Keynes vs Hayek videos up to that point.

In Defense of Home Bias

It is very rational to invest closer to home and this article explains why.

The Forever Fund

One of my best pieces ever, where I defend Buffett’s purchase of Burlington Northern, because it is irreplaceable.? This helps to explain how Buffett manages for the very long term, and does well at it.

Redacted Version of the November 2011 FOMC Statement

Posted on 2 November 20112 November 2011 by David Merkel

Comments

This release of the FOMC statement was really kind of a nothing-burger, aside from the hawks going with the majority, and Evans arguing for looser policy.
The main shift in the FOMC?s economic reasoning is that GDP growth is improving.? One quarter on the GDP data should not get us that definite.
In my opinion, I don?t think holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy is located.
Also, the reinvestment in Agency MBS should have limited impact because so many owners are inverted, or ineligible for financing backed by the GSEs, and implicitly the government, even with the recently announced refinancing changes.
The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
The Fed is out of good policy tools, so it will use bad policy tools instead.

Questions for Dr. Bernanke:

Why do you think that holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy is located?
Why will reinvestment in Agency MBS help the economy significantly?? Doesn?t that only help solvent borrowers on the low end of housing, who don?t really need the help?
Couldn?t increased unemployment be structural, after all, there is a lot more competition from labor in emerging markets?
Isn?t stagflation a possibility here?? I mean, no one expected it in the ?70s either.
Could we end up with another debt bubble from keeping short rates so low?
If the Fed ever does shrink its balance sheet, what effect will it have on the banks?
Is it possible that you don?t really know what would have worked to solve the Great Depression, and you are just committing an entirely new error that will result in a larger problem for us later?

The Foul Deed of the SEC in 2004

Posted on 2 November 2011 by David Merkel

It started with reading Abnormal Returns, something I do daily, and innocent enough.? But the article mentioned at SSRN was significant, and far more than a set of book reviews.? It cited a GAO study and a speech given by SEC Director Erik R. Sirri, which showed that the SEC did not materially modify its capital requirements for investment banks in 2004. So in one sense, the SEC is not to blame for the failures of the investment banks.

But in another sense, they are very much to blame.? Why?? As Buffett has said, he thinks about the things others say “can’t happen.”? Secured lending fits into another aspect of the “net capital rule,” an aspect less noticed.? That can be geared up 50 times, not the 12 times commonly considered.? Who would have thought that secured lending would be so overlent that it would push up asset prices, and that so many would rely on holding assets via short-term loans via repo?

Well, I fingered some of it at the time, but not all of it.? So the argument shifts — the SEC was not wrong for shifting its standards in 2004, which had little impact — it was wrong long before then with the net capital rule 15c3-1 by being too lenient with secured lending.

Secured lending often fails colossally, because lenders think the current value of the asset is a guarantee, when it is really subject to the conditions of the market.? When many lenders rely heavily on collateral, it proves to be less than valuable.? Also, secured lending tends to be done by leveraged entities, who think they can do it because it is safer.? When it fails, it can be like a string of dominoes.

We need to abandon the idea that the SEC made some grand shift in 2004, and rather, take up the idea that the SEC had the net capital rule wrong in the first place — it should have been tighter with respect to secured lending.?? Given the short-term nature of the repo markets, and the correlated nature of changes in repo haircuts, maybe the SEC should ban investment banks from using repo financing.? Yes, it will kill profits, but no regulator should care about that.? Regulators should care about solvency under all scenarios.

Short-dated financing of long-term assets is at the root of most financial crises.? Let the regulators move to a strict asset-liability matching framework for regulating the investment and commercial banks, where they look through the financing arrangement to the ultimate asset being financed.? Long assets deserve long financing.

Growth in Fully Converted Book Value

Posted on 1 November 2011 by David Merkel

I’m working on changes in client portfolios (and mine as well, they mirror my portfolio; I eat my own cooking!), and I spend time looking at longer-term returns on a book value basis.? I agree with Buffett; growing book value per share grows market value per share over time.

I write this because I often see companies that are cheap on an earnings basis, but have been so for a while, but have not grown book value per share (after reinvesting dividends) by much.? This comes from non-operating losses and badly-timed buybacks (or, persistent buybacks that don’t take account of current market price).

You can have a business that throws off great free cash flow, and waste it by buying back stock when the market is willing to pay too much, and the company intensifies the mistake.? Better to build up cash, and wait for a better day to buy, when shares are cheap and worth buying.

P/E is a flawed measure because few ask what is done with the E.? Is it used to good ends?? We need to look further and analyze how excess cash gets used for growth.? Stock buybacks are a minimum, but maybe waiting to do stock buybacks at lower prices is better.? Maybe buying out small private companies that can round out a product portfolio are better still.

Regardless, the goal should be to grow book value, adding back dividends.? That is a path toward sustainable growth in stock values.

David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures. Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions. Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

September 2011	November 2011	Comments
Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow.	Information received since the Federal Open Market Committee met in September indicates that economic growth strengthened somewhat in the third quarter, reflecting in part a reversal of the temporary factors that had weighed on growth earlier in the year.	Still trying to beat the dead horse that they were too optimistic about economic growth
Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated.	Nonetheless, recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated.	No real change
Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand.	Household spending has increased at a somewhat faster pace in recent months. Business investment in equipment and software has continued to expand, but investment in nonresidential structures is still weak, and the housing sector remains depressed.	Switched the order around, but no real change, aside from shading up their view on household spending.
Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks.	Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks.	No change.
Longer-term inflation expectations have remained stable.	Longer-term inflation expectations have remained stable.	No change.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.	Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.	No change.
The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.	The Committee continues to expect a moderate pace of economic growth over coming quarters and consequently anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.	Not talking about recovery but growth.? Still bearish on unemployment.
Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets.	Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets.	No change.
The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.	The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.	No change
To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative.The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.	To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September. The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.	Changed the order, but no real change.? QE2.5 continues.
The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.	The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.	No change.
The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate.	The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools to promote a stronger economic recovery in a context of price stability.	Drops discussion of policy tools.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.	Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.	Fisher, Kocherlakota and Plosser go along.
Voting against the action were Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who did not support additional policy accommodation at this time.	Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time.	Evans dissents to say the FOMC should do more policy accommodation.