This portion goes from February 2010 to April 2010.

Probably the biggest new thing I did at the blog was start “The Rules” series.? Personally, I think all of them are best articles, because they proceed from deeply held beliefs of mine.? So I start with those:

The Rules, Part I

There is no net hedging in the market.? At the end of the day, the world is 100% net long with itself.? Every asset is owned by someone, regardless of the synthetic exposures that are overlaid on the system.

The Rules, Part II

Unless there is a natural purchaser of an exposure that one is trying to hedge, someone must speculate to a degree to allow you to hedge.? If the speculator is undercapitalized, risks to the financial system rise.

The Rules, Part III

The assumption of normality for asset price changes is wrong in virtually every financial market setting.? The proper distributions are fatter tailed and more negatively skewed.

Normality allows researchers to publish, regardless of the truth.

The Rules, Part IV

Governments that scam the asset markets (and their citizens) take all manner of half measures to defend failed policies before undertaking structural reform.? (This includes defending the currency, some asset sales, anything that avoids true shrinkage of the role of government.)? The five stages of grieving apply here.

The Rules, Part V

Massive debt issuance on a sector-wide basis will usually have a slump following it, due to a capacity glut.

The Rules, Part VI

History has a nasty tendency to not repeat, when everyone is relying on it to repeat.

History has a nasty tendency to repeat, when everyone is relying on it not to repeat.? Thus another Great Depression is possible, if not likely eventually.

When people rely on the idea that a Great Depression cannot occur again, they tend to overbuild capacity, raising the odds of another Great Depression.

The Rules, Part VII

In a long bull market, leverage builds up in hidden ways within corporations, and does not get revealed in any significant way until the bear phase comes.

The Rules, Part VIII

Illiquidity is a function of total transaction costs, which can be considered barriers to entry.

The Rules, Part IX

Attempting to control a system changes it.

The Rules, Part X

The more entities manage for total return, the more unstable the financial system becomes.

The shorter the performance horizon, the more volatile the market becomes, and the more index-like managers become.? This is not a contradiction, because volatile markets initially force out those would bring stability, until things are dramatically out of whack.

The Rules, Part XI

Could an investment bank go to junk status?

The Rules, Part XII

Growth in total factor outputs must equal the growth in payment to inputs.? The equity market cannot forever outgrow the real economy.

And that’s the end of the “rules” posts for now.? They express deeply held beliefs of mine.

My next group of posts dealt with banking reform:

• A Few Notes From the Fordham Conference
• Dumb Regulation is Good Regulation ? How to Regulate the Banks
• A Summary of What Bank Reform Should Be

Most of it comes down to getting the risk-based capital formulas right, raising capital levels, and most of all avoiding borrowing short to lend long.? The asset-liability mismatch is the core of why banking crises happen, because the liabilities run when asset levels are depressed.

The next group deals with debts and liabilities of nations and other lesser governments:

• Default, Inflation, Higher Taxes ? Choose One
• Ignore anyone who tells you that debt levels don?t matter.
• A Question of Cultural Failure
• A Question of Cultural Failure (II)
• Of Credit Ratings, Sovereign Risk and Semi-Sovereign Risk
• More on Sovereign Risk and Semi-Sovereign Risk
• The Virtue of a Big Bang
• The Logic of Shared Pain
• Promises, Promises (Deals with the huge entitlement promises all over the world)
• The Whole Earth is Owned; Debts Net Out to Zero

Debt-based economic systems are inherently inflexible.? Governments that make long-term promises without pre-funding them scam their taxpayers, and those to whom they make promises.? All solutions are ugly once the willingness of a government to pay on its promises is questioned.

What is Liquidity? (IV)

My point is that you can?t take illiquid assets and make them liquid.

Moat, Float, Growth

Warren Buffett labors to preserve the company he has built, so that it can last far longer than he will.? An impossible task, but what is Buffett if not one that does things far beyond what most of us can do?

In Defense of the Rating Agencies ? V (summary, and hopefully final)

I never did go on CNBC for this.? They figured out what I told them: “This wouldn’t make for good television.? It’s too complex.”? But it does come down to my five realities:

• Somewhere in the financial system there has to be room for parties that offer opinions who don?t have to worry about being sued if their opinions are wrong.
• Regulators need the ratings agencies, or they would need to create an internal ratings agency themselves, or something similar.? The NAIC SVO is an example of the latter, and proves why the regulators need the ratings agencies.? The NAIC SVO was never very good, and almost anyone that worked with them learned that very quickly.
• New securities are always being created, and someone has to try to put them on a level playing field for creditworthiness purposes.
• There is no way to get investors to pay full freight for the sum total of what the ratings agencies do.
• Ratings can be short-term, or long-term, but not both.? The worst of all worlds is when the ratings agencies shift time horizons.