If an asset-backed security can produce a book return less than zero for reasons other than default, that asset-backed security should not be permitted as a reserve investment.

Compared to most of my rules, this one is a little more esoteric, so let me explain.  Reserve investments are investments used to back the promises made by a financial institution to its clients.  As such, they should be very certain to pay off.  In my opinion, that means they should have a fixed claim on principal repayment, with risk-based capital factors high enough to take away the incentive invest too much in non-investment grade fixed income claims.

Other assets are called surplus assets.  There is freedom to invest in anything there, but only up to the limits of a company’s surplus.  After all, surplus assets are the company’s share of the assets, right?

If I were rewriting regulation, I would change it to read that only “free surplus” is available to be invested in assets that do not guarantee principal repayment.  Free surplus is the surplus not needed to provide a risk buffer against default on the reserve assets.

But back to the rule.  I think the reason I wrote it out 10+ years ago was my objection to interest only securities that received high ratings, despite the possibility of a negative book yield if prepayments accelerated, and they were rated AAA, and could be used as reserve assets with minimal capital charges.  Buying an asset that can lose money on a book basis for a non-default reason is inadequate to support reserves.  (This leaves aside the ratings’ arbitrage of interest only securities, where defaults hit the yield.  Many have negative yields at levels that would impair related junk rated securities)

This can be applied to other assets as well.  Reverse convertibles that under certain circumstances can be forcibly converted to a weak preferred stock or common stock should only be allowed as surplus assets.  Risk based capital formulas should consider the greater possible risk and adjust required capital up.

Now, maybe this is a rule for another era.  Maybe there aren’t as many games being played with assets today, but games will be played again — having some sort of rule that stress-tests securities to see that they will at least repay principal (leaving aside default), would prevent a certain amount of mischief the next time Wall Street gets creative, putting other financial companies at risk in the process.

When I was running cashflow tests for life insurers, there was one scenario that was among the best for most insurers (life or otherwise).  The optimal scenario was a slow protracted rise in interest rates, say 1/2% per year for 10 years, or flat (no change).  Yes, with the slow rise, there will be unrealized capital losses, most of which will evaporate with time.  But excess cash flows will be invested at higher rates, raising the value of the firm.

I remember talking about this with people in the finance areas of other life insurers, and there was agreement — a slow rise in rates would benefit the industry as a whole.  Maybe annuity floor guaranties played into that as well.

But there are a number of parties that could not bear with the slow persistent rise.  Most governments of the world, including the US would find their budgets severely inverted if interest rates slowly rose and stuck.  As such, governments will do what they can to avoid such a scenario.  They don’t want to end up like Greece. That said, if they do end up there, expect that the governments hand losses off to bondholders, pensioners and/or medical care recipients.  The prime motive of a secular government is to survive, even if core goals are not achieved.

Thus at present, what is optimal for governments is to keep rates low for a long time.  Let savers get clipped, that government programs get paid for.  The risk here is that the bond market rebels and rates rise whether the government likes it or not.  But should that happen, and the government cannot pay on all promises made, it will force losses onto all long-term recipients of cash flows.

Perhaps policy will relax the strain on those in the private sector who have made long-term promises to pay, like pensions.  I would not count on that.  The government will be content with its own survival.

Rest of the World


  • Aflac Wins Wider Access to Japan Post’s Insurance Sales Network http://t.co/IDyLX4dR7c Looks like a win 4 all sides. FD: + $AFL $$ Jul 26, 2013
  • Echoes of the Asian Crisis http://t.co/ZzDbO9TtFV India, Turkey, Brazil, South Africa– all r running substantial current-account deficits $$ Jul 26, 2013
  • Measuring Mario Draghi’s Promises 1 Year On http://t.co/HTs9YDuBXp Mario gambled & won so far. Have the banks used this calm time well? $$ Jul 26, 2013
  • China risks deflation trap as true GDP crumbles http://t.co/5UnQRRi340 Whole economic sectors that recently drove growth have stalled $$ Jul 26, 2013
  • Boring But Important: ECB Relaxes Collateral Rules http://t.co/K4wOPXivpW ECB is wiling 2take less creditworthy collateral, aiding growth $$ Jul 26, 2013
  • Egypt’s Vanishing Currency Black Markets http://t.co/t8FNvy09Ow The military has brought temporary calm, but can they run the economy? $$ Jul 26, 2013
  • Ma Says Taiwan People Override Missiles in Meeting Xi http://t.co/ziCaK6rCFN Taiwan & China might get along, were it not for old grudges $$ Jul 26, 2013
  • Japan Prices Rise Most Since ’08 in Boost for Abe: Economy http://t.co/1Fyej1sMMp May seem 2b a boost, but wait till interest rates rise $$ Jul 26, 2013
  • Moody’s Sees Local Default as $21 Billion Matures http://t.co/63ThxfEOT1 How China deals w/defaults will have a long term market impact $$ Jul 26, 2013
  • An American General Warns the Israeli Right http://t.co/st9ByUkiyz Arabs either get their own state, or they get Israeli political rights $$ Jul 25, 2013
  • No Menstrual Hygiene For Indian Women Holds Economy Back http://t.co/ToN7a7iYts Be grateful that you don’t live in India if u r a woman $$ Jul 25, 2013
  • Egypt General Stokes Protest http://t.co/DFcjL1Rc9L U.S. Suspends Planned F-16 Delivery as Military Chief Calls for Anti-Morsi Rallies $$ Jul 25, 2013
  • Pope Calls for More Just Society http://t.co/JLrQ4GWtPb Airy-fairy, what do you mean by just? Eliminating crony capitalists & socialists $$ Jul 25, 2013
  • China Coal-Fired Economy Dying of Thirst as Mines Lack Water http://t.co/kvQnHgtqfE China can command projects 2b done; can’t make water $$ Jul 24, 2013
  • Troubled Currencies http://t.co/2jGEw6om6f Iran, North Korea, Argentina, Venezuela, Egypt & Syria. Dig the stats: http://t.co/GR9V3YsvNc $$ Jul 24, 2013
  • Mandela’s Wealth-Sharing Dream Fades in South Africa http://t.co/nRroLnSyoI Black elite replaced a White elite, little change 4 most $$ Jul 23, 2013
  • Record Downgrades Foreshadow First Onshore Default http://t.co/cF5fse1yI3 Reaction 2a default in China will b interesting $$ #willtheyletit Jul 21, 2013
  • China Communist Party Fate Seen Resting on Farmer Rights http://t.co/GWstYr2R10 Will Communist Party grow up & recognize property rights? $$ Jul 21, 2013
  • ‘Desperate’ Cuba voyage is latest scrape for North Korean fleet http://t.co/ET7Y0n1DdE Interesting story on how bad NK merchant marine is $$ Jul 20, 2013
  • Hitting China’s Wall http://t.co/BIU1vF563V Late to the party, Krugman realizes that China’s economy has to rebalance 2 more consumption $$ Jul 20, 2013




  • Detroit’s Bankruptcy: What You Need to Know http://t.co/8Y3SFcRIFA Nice summary of how most of the major parties r affected & process $$ Jul 26, 2013
  • How Detroit Drowned in a Sea of Troubles http://t.co/l2aMlTRApk Most disasters result from a series of small bad decisions $$ #detroit #FTL Jul 26, 2013
  • Now That Detroit’s Gone Bust, Is Your City Next? http://t.co/3C9sPJNqAw’s-gone-bust-your-city-next Consider San Diego, doesn’t fit model $$ Jul 23, 2013
  • How Detroit Affects Muni-Bond Investors http://t.co/FhAnmighaI If Detroit forces losses onto bondholders, other municipalities will mimic $$ Jul 21, 2013
  • Detroit Bankruptcy Judge Rhodes Is Ponzi-Law Scholar http://t.co/VgdMDjfTAD Sound like a bright, no-nonsense guy; rules over big problem $$ Jul 21, 2013
  • Detroit Bankruptcy Likely to Spark a Pension Brawl http://t.co/pJybP68iHo How much will benefits b cut4active, deferred & retired workers $$ Jul 21, 2013
  • Pension Payouts May Turn on Whether State or Federal Law Prevails http://t.co/fnTcOfO0i3 If State Law, then defined benefits r protected $$ Jul 21, 2013
  • Moody’s: Detroit bankruptcy filing credit negative http://t.co/2BTQBZ71FI Will b interesting 2c which classes of bonds recover $$ well Jul 20, 2013


Obamacare / PPACA


  • Bobby Jindal and Scott Walker: Unworkable ObamaCare http://t.co/8IDiKwfzye Opaque rules, big delays & rising costs: The chaos is mounting $$ Jul 26, 2013
  • Will Obamacare Kickstart Health-Care Revolution? http://t.co/E3rffobd6G More likely to boost overall spending until we scrap & start over $$ Jul 25, 2013
  • Obama’s New York Model http://t.co/qn9dtCQ7Km How NY state destroyed its insurance market using ObamaCare rules. PPACA now deregulates $$ Jul 24, 2013
  • Union Fears ‘Destructive Consequences’ From Obamacare http://t.co/liizu2UBnf Overly complex laws often r attacked piece-by-piece $$ Jul 20, 2013




  • US States And Local Pensions Deficits Still in the Red Zone? http://t.co/absZaz1TRM Big issue. Govts didn’t put in $$, stretched assumptions Jul 26, 2013
  • Corporate Pension Plans Start Return Toward Fully-Funded Status http://t.co/6ay0QU03ep Yields up, risk assets up, DB pension funding up $$ Jul 25, 2013
  • David Skeel: Facing Up to America’s Pension Woes http://t.co/jIVvhQqa7B If you have a public pension, your income will b cut, get ready $$ Jul 25, 2013




  • Crack spread 101 http://t.co/aBScYANDQk For a primer on how crude oil refiners make $$ , start here. FD: + $VLO $PSX $MPC Volatile beasts Jul 26, 2013
  • Pimco Prepares for Life After Bill Gross http://t.co/PzFgWZZxRK The key mind that built Pimco; how will it survive without him? $$ #notwell Jul 26, 2013
  • Is Your College Going Broke? http://t.co/D0xoknDZRd Forbes rates 925 schools on financial strength. Scores here 4 free; c who will live. $$ Jul 25, 2013
  • Global Oil Supply Shock? http://t.co/QO1jcw8hjk Special report on Crude covering the US, Canada, Russian Supply, & global demand factors $$ Jul 22, 2013


Monetary Policy


  • Fed Chief Choice Shapes Up as Race Between Summers, Yellen http://t.co/zXurDGlmMY Sad that it comes to this, neither is competent $$ #FTL Jul 25, 2013
  • Bernanke Seen Slowing QE to $65 Billion in September http://t.co/roO9X8TQFb Y r we listening 2 economists? I don’t c QE tapering in 2013 $$ Jul 24, 2013
  • Fed Criticized on Oversight of Bank-Owned Commodity Units http://t.co/6S07xD8quN Fed has never used its role as lead bank regulator well $$ Jul 24, 2013
  • Biggest Banks Face Fed Restoring Barriers in Commodities http://t.co/daCEcXpwYM Asset allocations to commodities drove financialization $$ Jul 24, 2013
  • Gonzalo Lira: The Democrats Finally Embrace Money Printing http://t.co/hgnJcw3m6F Democrats realize the larger QE is, they can spend more $$ Jul 24, 2013
  • Right now, Larry Summers is the front-runner for Fed chair http://t.co/Gajh9jbKHR Reverse psychology 2 scare us 2 beg Obama pick Yellen $$ Jul 24, 2013
  • Why Fed Has Failed to Lower US Unemployment http://t.co/c7HxlBAoEP Main reason:monetary policy can’t solve unemployment, regulatory issue $$ Jul 22, 2013
  • Janet Yellen for Fed Chair http://t.co/zXW8cR9nKD @calculatedrisk makes a good case 4 Yellen; I would prefer someone more skeptical $$ Jul 20, 2013


Daily Journal


  • If $DJCO is managing >$100 million in stocks, then y aren’t they filing a 13F-HR w/the SEC as other managers do? http://t.co/nMRJMwC2TL $$ Jul 24, 2013
  • Munger Triples Publisher’s Value With Panic-Era Stock Bet http://t.co/AOAnQdJyun Cagey Munger times the bottom w/quality companies $$ $DJCO Jul 24, 2013




  • Easing of Mortgage Curb Weighed http://t.co/2dsxUG9cPy The Apostles of ez debt underwriting preach their gospel 2 regulators in DC $$ #FTL Jul 24, 2013
  • Americans Gambling on Rates With Most ARMs Since 2008 http://t.co/WUIyZLyRQt Proving again that u “Can’t teach a Sneech.” $$ #FTL Jul 24, 2013
  • Athene’s James Belardi, a Controversial Player, Gets Into the Annuities Game http://t.co/FFnKBzJPv3 Regulate him 2 the strictest degree $$ Jul 23, 2013
  • Nontraded REIT Pulls In Bundles Of Cash http://t.co/e51BfrLHhX Avoid any illiquid investment where the promoter knows far more than u $$ Jul 23, 2013
  • Housing Recovery Increasingly Prices Out First-Time Buyers http://t.co/LPInUpbjmJ A good thing; ppl need 2 save&make bigger downpayments $$ Jul 23, 2013
  • Commodities and banks, a recap http://t.co/SerwTZVNTj @izakaminska gives a primer on the financialization of commodities $$ Good read $STUDY Jul 23, 2013
  • Resigned to reform, Wall Street tries a different tack in DC http://t.co/sEANnYTqET Look at the insurance industry, it’s better regulated $$ Jul 23, 2013
  • Gorilla Flipping Homes as Rebound Revives Rapid Trades http://t.co/Z0V3aBPtlL Interesting niche: w/scale buys worst homes, rehabs/flips $$ Jul 22, 2013
  • Mortgage applications fall as refinancings dry up, big opportunities for REITs http://t.co/R5q7RXcJJT REITs can issue private mortgages $$ Jul 22, 2013
  • Prudential Hits Back on Risk Status http://t.co/I2B3ZawBJy $PRU right & FSOC wrong, problem isn’t size, asset quality, but liab liquidity $$ Jul 22, 2013
  • In other words, unless a life insurer is writing biz that is immediately or contingently terminable, they don’t go bad in a crisis $$ $PRU Jul 22, 2013


Politics & Policy


  • Letters About 401(k) Plan Costs Stir Tempest http://t.co/mFQnQ8k59A problem is that is hard 2 service small account & give them advice $$ Jul 25, 2013
  • Uncertainty and the Slow Labor Market Recovery http://t.co/IvXzr0Dt6l SF Fed estimates that policy uncertainty has held back employment $$ Jul 23, 2013
  • Feeling the heat on climate change http://t.co/MFMu4gUghd Climate is like markets; unpredictable, constantly varying, makes fools of us $$ Jul 23, 2013
  • Parents Shell Out Less Money for Their Kids’ College http://t.co/BD3WIz4bhp Fewer will attend college, instead they will enter trades $$ Jul 23, 2013
  • Reining in the audit industry’s reality distortion field http://t.co/8d6Uakd1p6 Acctg stds 2 flexible & auditors 2 chummy w/cos need chg $$ Jul 22, 2013
  • Tax break that corporate America wants kept secret http://t.co/0si0ts8gpG Not secret, corporations have negotiated taxes w/IRS 4a while $$ Jul 22, 2013
  • Warren’s Mistake About Wall Street Risk-Taking http://t.co/qY6jsau0Lg Crisis came b/c too many financed illiquid assets short-term $$ Jul 22, 2013


Market Impact


  • It’s Possible to Graduate Debt-Free. Here’s How: http://t.co/GsypSp77mo Scholarships, online courses, use your skills 2make $$ & summer job Jul 24, 2013
  • Three Big Money Mistakes You Could Be Making Right Now http://t.co/lysIFIkV6o Simplified: B careful what you spend; ez 2 waste $$ Jul 23, 2013
  • Gold futures hiccup indicates demand outpacing supply http://t.co/mF13t0jDaE Too much paper gold chasing too little gold; take delivery $$ Jul 23, 2013
  • Investors, Analysts See End of Commodity ‘Supercycle’ http://t.co/SEddMlCxug Probably true intermediate-term, but not long-term $$ Jul 22, 2013
  • Investors Struggle With Cash Conundrum http://t.co/qgTjBIegEy Cash is unique & useful, preserves value when inflation or real rates rise $$ Jul 22, 2013
  • SEC’s White Takes on Two Billionaires in One Day to Make Mark http://t.co/o9F6N9fdoz I like the current aggressive posture of the SEC $$ Jul 21, 2013
  • Junk Bonds Jump as Bonds Boom http://t.co/RA46qT8g8A Yield lust resumes as bonds begin to rally more generally amid new issuance $$ Jul 21, 2013




  • Advances That Regrow Babies’ Hearts http://t.co/rDJ7c3sEih “Our theory is that a newborn heart has amazing growth potential…” $$ #Cool Jul 23, 2013
  • Does it matter if students can’t write? http://t.co/b8txYKVd0K Yes! Ability 2 write is a proxy for ability 2 analyze qualitative data $$ Jul 24, 2013
  • Wrong: How an Introvert Can Be Happier: Act Like an Extrovert http://t.co/cGEZEr6xu4 B what u like 2b & you will b happy; don’t force chg $$ Jul 23, 2013
  • Duchess Casts Midwife Tradition Aside for Royal Birth http://t.co/EX1mfFiiae 4 normal births midwives r the best, they give better care $$ Jul 23, 2013
  • SIM Cards Have Finally Been Hacked, And The Flaw Could Affect Millions Of Phones http://t.co/hKQbe2x2zp Watch yr cell phone bill 4 chgs $$ Jul 22, 2013
  • Forget campfires, more kids heading to entrepreneur camp http://t.co/6KwzH0rv0J Interesting idea, maybe I’ll send one of my kids $$ Jul 22, 2013
  • Burger Binges at Red Robin Fuel Hospitality Hiring Spree http://t.co/ri97tWIuBd Optimistic sign 4 job growth on the low end of wages $$ Jul 22, 2013
  • What happens to entrepreneurs after their one-hit wonder falls from favor? http://t.co/yYpIqHrsyU 4 examples: what happens after hot->not $$ Jul 22, 2013
  • A Buffett Fortune Fades in Brooklyn http://t.co/bCvLZYVSaw An unscrupulous charity invades the principal of an endowment & fails badly $$ Jul 21, 2013
  • Rise of the Warrior Cop http://t.co/f9vCdBjBiu Cops become more like soldiers, trampling on rights of Americans 2 life, liberty & virtue $$ Jul 21, 2013
  • Fifteen Years After Autism Panic, a Plague of Measles Erupts http://t.co/N7UmpedzYi The measles return after 15+ years of low vaccination $$ Jul 21, 2013
  • Germiest Places – 8 Ways to Protect Yourself in Restaurants http://t.co/BDDbA4i9p3 U may never again feel the same about ketchup bottles $$ Jul 21, 2013


Comments, Replies, & Retweets


  • Planning would be better http://t.co/eoCliTfLP2 Jul 25, 2013
  • @JLGull1 It applies to Berkshire Hathaway, Perry Corp, Markel, and many other holding companies Jul 25, 2013
  • @kaylatausche Honored to have you following me. Keep up the good work at CNBC; you do it well. Jul 24, 2013
  • @chadstarliper What I saw was fwd rates 5 years out move up pretty hard, and not move back, much Jul 24, 2013
  • @chadstarliper I agree w/ that, though in the short run, most don’t look at the fwd cv. But didn’t the fwd cv move when BB said “taper?” Jul 24, 2013
  • @chadstarliper But it does affect the yield the debt is offered at vs the open market Jul 24, 2013
  • @srochetrading thanks Jul 24, 2013
  • @chadstarliper QE is buying ~50% of US debt issuance, Democrats would like that to continue. Jul 24, 2013
  • @srochetrading I don’t know GL that well, would @ProfSteveKeen talk 2 me if I asked him? Jul 24, 2013
  • I just left a comment in “Warren Buffett sidekick Munger creates a mini-Berkshire at Daily Journal” http://t.co/T4S7rdjHVp Jul 24, 2013
  • I just left a comment in “Warren Buffett’s long-term stock picks – MarketWatch” http://t.co/1DB0TniNTu Jul 24, 2013
  • I just left a comment in “Stagflation: The Fed’s worst nightmare – Irwin Kellner – MarketWatch” http://t.co/cHFQluVzPY Jul 23, 2013
  • @Bonjubs Yes, being a Christian, a Libertarian, a loving father & husband, adopting 5 children & having 3, are all crimes against humanity Jul 22, 2013
  • @Bonjubs Rebellion is almost always a mistake. It has not helped most of the Arab Spring. Most long-lasting change comes via peaceful means Jul 22, 2013
  • RT @StevStiffler: ʇǝǝʍʇ sıɥʇ pɐǝᴚ oʇ ǝuoɥd ᴚnoʎ uᴚnʇ oʇ ǝʌɐɥ ʇupıp noʎ ɟı ʇǝǝʍʇǝᴚ Jul 21, 2013


Okay, time for the promoted stock scoreboard:

TickerDate of ArticlePrice @ ArticlePrice @ 7/25/13DeclineAnnualizedSplits
















































































































































Tonight’s loser in waiting is North American Oil & Gas Corp [NAMG].  Formerly known as CalendarDragon, a software company, it became North American Oil & Gas.  If the company were as good as the promoter says it is, it would never have bought a penny stock shell.  It would have negotiated with private equity companies.  Why would you make great claims, and yet:

  • Have negative income, always
  • Negative net worth
  • No revenues, always

Note the risk factor from the 8-K:

We have no oil or gas reserves, and the probability of an individual prospect ever having oil and gas is extremely remote and therefore any funds we spend on exploration will likely be lost.
The probability of an individual prospect ever having oil and gas is extremely remote. In all probability, the property does not contain any oil and gas. As such, any funds spent on exploration will probably be lost which will have a negative effect on our operations and a loss of your investment.

This is a constant with promoted stock scams.  They work on dud companies, then a promoter tells a story.  The SEC should prosecute such newsletter writers.  The scams could not work without them, at least for now.

Anyway, expect losses here, as usual.  The major energy companies have a far better idea of where they can find energy than a few people can.

Finally, please note in the 4-point type that the writer is getting paid over $100,000 to write the piece, and he does not have a lot of costs, because it is done online.  I saw the ad at Bloomberg.com.  Hey, Michael Bloomberg, Hopkins Grad like me!  Do you want to be associated with penny stock promotions?  You don’t have enough money already?

This stuff stinks.  Really stinks, like flatus.

I was reading an article at Bloomberg.com yesterday, If Only Everybody Was Paid More.  Okay article, mostly even-handed, then I looked at the comments section, and a writer was kvetching about companies didn’t care about their stock price because management had more than enough money to do what they wanted.  The stock price did not matter, because secondary trading puts no money into the hands of the company.

I started to write a comment, “You don’t understand the stock market…” but after ten minutes, I realized that I had a blog post, and so I copied it to a file, and am completing it now for my readers, who are far larger, and more intelligent than the comment stream at Bloomberg.com.

The price generated by secondary trading does the following to help a company:

If the price is low relative to net assets or potential earnings, it will attract new shareholders that will angle for change.  Those investors will aim for control, or for certain value-enhancing actions like a special dividend, a spin-off, etc.

If management/board thinks the price of the stock is undervalued, they will be among those buying shares in the secondary market, improving the value of the shares for the remaining shareholders.

If management/board thinks the price of the stock is overvalued, they may look at other companies to buy that are reasonably priced or cheap that will make their firm more useful.  At that point, their stock is a useful currency for acquisitions.

The stock price also serves as a guide to dividends, as it goes higher, often the dividend will go higher.  As the stock price goes lower, the dividend will stay the same, until it is unsustainable.  When it is unsustainable, the dividend will drop precipitously or be eliminated.  When that happens, the stock price will drop more, but the company’s bonds will rally.

A company with a high valuation and excess cash may pay a special dividend to enhance the value, as Microsoft did in the last decade.

Companies with a high valuation may decide to do a secondary offering if they run across an idea that they want to try internally that will require a great degree of investment.

Corporate bond and loan pricing is affected by the stock price.  Typically companies with high valuations get lower rates than those with low valuations.

Note that if stock valuations get too low, investors start to distrust the preferred stock, corporate bonds, and bank debt, in that order.

Also consider the stock options, profit-sharing plans, and any 401(k) match that happens in the corporation.   They have a significant effect in motivating employees to do better.  As the price rises, so does morale.  Vice-versa when the price falls.

To summarize: the price that a stock trades at is very important to a corporation, even if it is not receiving any money directly as a result.  In general, the higher the stock price in the secondary markets, the greater the number of financial options that management has, and vice-versa.

Corporate Effects

The stock price matters to defined benefit pension plans, endowments, etc., because it affects solvency and ability to spend.  It affects fund managers, because a high market capitalization makes it more painful for them not to own your stock, if they benchmark against an index that the company in question in it.

And, if you get big enough, index inclusion means you get a dedicated bunch of shareholders that aren’t leaving anytime soon.  The rewards get bigger until you get into the Holy Grail, the S&P 500.


So, yes, it does matter what the stock price is to a corporation, even if the company does not receive any money as a result of the trading.

I read this article yesterday, Does it matter if students can’t write? at the Financial Times.  I say, yes it matters.

I’m not the greatest writer.  I have no books to my credit, so far, only a blog where I have written 2.5 million words over a 6.5 year period. Oh, and my lost writings at RealMoney.  Contact me if you can get them back.

I never thought I would write so much when I was young.  I was a math & science guy.  That said, I was one of three guys who managed the creation of the top yearbook in the nation in 1979, as evaluated by two separate judging committees.  We had talented copy editors, of which I was not one of them.

Today, when most writing is short cycle, and we find proofreading errors in even the best publications, we tend to deprecate writing.  I want to explain why learning to write clearly is important.

If you want to show that you can evaluate qualitative data well, you must be able to write well.  Good ability to write shows that you can evaluate the softer data that is often more important than the raw numbers.

Qualitative reasoning is as scarce as quantitative reasoning.  Being able to express it in a structured way, so that most can understand it takes skills in writing.

Thus I would say to all:

  • Learn math and science.
  • Learn reading and writing
  • Together, they are more powerful than separate.  I am glad I have both skills.  Skills in both can be developed, if you are patient.

So apply yourself to learning.  After all, that is one reason why God created man.  (For that, read Ecclesiastes… and if you don’t get it, email me.)

Crashes are the result of a shift from a positive self-reinforcing cycle to a negative self-reinforcing cycle.

Cycles in business and investment tend to be self-reinforcing.  That is true because most men don’t think, they imitate.  Economics needs to revise its view of man as rational, because it hurts to think differently.  It is much easier to go with the flow of your relatively successful neighbors, and imitate them.  Thinking for yourself is needless effort to many.  Why bother with that when doing well is a simple thing?

The trouble is, early imitators are few, because the signal is not so big.  Late imitators are many; the signal is big, and wrong.  The dumb money arrives at the end of a boom.  At that time, asset prices are so high that the asset must make gains over the next ten years in order to cover the capital cost of the investment.  At peaks, it would pay better to hold fixed income, and not play in the hot asset.

At the peak, it only takes a few sellers to overcome the market, because all of the dumb money is exhausted.  They are fully invested.  Valuation-sensitive buyers are wary.  This is one reason why markets rise slower than they fall.  Credit expands to aid the boom, but when the bust comes, new credit is cut off rapidly.  Thus we have crashes, and the economy never moves as quickly as the market, but the economy moves with more persistence.

I want to attack this from a different angle.  In 1929, before the crash, there was an article by J. J. Raskob in Ladies Home Journal entitled, “Everybody Ought to Be Rich.”  Think about that title.  Stocks flew as a result of the easy money policy of the Fed in the ’20s.  Some had invested in the market and made a fortune up to 1929.  Was that sustainable? No.  Did many keep it? No, very few.

But now suppose that everyone had invested in the market in mid-1929, off of Mr. Raskob’s advice.  Stocks would have soared further, and crashed worse.  Why?  The pricing of stocks is not arbitrary — a high price must be justified by high earnings relative to where an investment grade bonds yield.  As it was, the highly indebted economy of 1929 was ripe for a fall, with earnings and bond yields falling dramatically.  At least the Great Depression solved their debt problem — the Great Recession isn’t doing it for us.

But can everyone be rich?  Gotta break it to you, the answer is no.  Part of it is relative — there will always be some differences wealth/income because of a number of factors: some work harder, some work faster, some invest better, some get a better starting position, etc.

But part of it is absolute.  Some jobs don’t make sense unless you have less-skilled workers to accept lower wages for picking fruit, daycare, delivering pizza, etc.  In a society where almost all people marry and have more than two kids naturally on average, that means many of those low level jobs will fall to the young.  In societies where the birth rate is low, a lot of those jobs go to immigrants from poorer nations.  Now if you accept the idea that there is a spread of abilities in people, you know that there are less-skilled people by the time they arrive at age 25.  Some of it is natural.  Some of it is laziness.  Some of it is bad planning.  Many of those that are less skilled will occupy the low-end jobs, and in a society with reasonable population growth, there won’t be much room for immigration.

Everyone ought to be rich?  Because they invest?  If everyone were a value investor of high degree, and we parted with our excess income regularly to invest, where would the opportunities be?  In a situation like that, brighter and more motivated people would try to start businesses where they levered their own abilities without trying to play on the secondary markets, assuming they could find people to work with them.

The idea that “everyone ought to be rich” is hooey.  There are rare times when an asset class gets on a roll and seems invincible:

  • Stocks in the 20s, 50s-60s, 80s-90s
  • Bonds in the 80s-00s
  • Commodities in the 70s, 00s
  • Cash in the 70s
  • Real estate in the 20s, 70s-80s, first half of 00s

But to profit in those eras, you would have to know the right place to be, have proper discretion make wise investments, AND have enough funds socked away in order to make the wise investments.  By the time someone writes a book/article “Everyone ought to be rich,” or “How you can be rich by flipping real estate,” etc., it is too late.  And please ignore the scam ads where penny stocks create millionaires — that applies to those few selling the penny stocks, not those buying.

Few people have achieved great wealth through investing.  The ordinary sorts are those who manage other people’s money in public markets, and a lot of it, and do a middling-to-good job, so that clients don’t leave.  Other do it through private equity, but there again, they are levering other people’s money.  Then there are those that use mostly their own money, like Buffett, Munger, etc., and find undervalued situations relative to prospects regularly.  Those are precious few.

Society has people that make money off of:

  • Work
  • Lending
  • Managing physical assets
  • Managing businesses
  • Managing financial assets

That last category gets too much attention.  Most people have better advantage upgrading their skills, or owning private businesses that they understand well.  That may not make them rich, but it might make them well-off.


There are booms and busts, and each period has self-reinforcing behavior.  It is difficult to time booms and busts.  Some get the booms; some get the busts; very few get both.  It is tough to make money off of the boom-bust cycle and keep it.  It is really tough to make your living entirely through investing, unless you inherit it.  Work to enhance your skills to your best advantage wherever you work.

But no, everyone can’t be rich, and we have to accept that reality, and reflect that in government policy.  Encourage free and fair competition; eschew crony capitalism.  Don’t give anyone, rich or poor, an unfair advantage.

Finally, recognize what the neoclassical economists won’t admit — you can’t get rid of the boom/bust cycle.  It is a fact of life, and all of the tinkering with policy will never eliminate it — it will only intensify it.

People forget how crises happen after the events have passed, and begin to believe comforting fictions thereafter.  Companies typically fail when they can’t meet a call for cash to be paid.  With financial companies, it typically means that the company financed long-term, illiquid assets, with liabilities that would have to be rolled over regularly.

If you have to roll over your financing too regularly, you leave yourself open to the market environment where financing is not available.  Those environments happen more often when a lot of people are trying to finance long assets with short debt.  Eventually something fails, and all of the short-term lending markets tighten, leading to more failures, and falling asset prices, rinse, lather, repeat, etc., until finally, there are no unquestionable short debts.

Now I write this for several reasons: one is that Prudential is considered to be systemically risky by the FSOC [Financial Stability Oversight Council].  But Prudential has a long liability structure, and is not subject to runs on their company, unlike banks that play in the repo markets, or have to post a lot of margin for futures, or derivatives.

Further, solvency for insurers is governed by the states and does not consider transitory variations in asset prices to be a factor in solvency.  Solvency is a question of how asset cash flows will cover liability cash flows over numerous scenarios over the life of existing business, without new sales.  (I.e. they don’t consider the possibility that the company could sell its way out of  insolvency.  That has happened in practice infrequently, but you can’t rely on it.)

Only companies that borrow short are at risk in a crisis situation, because they have to produce cash NOW.  That is not true of Prudential.

Then there is this article at Bloomberg.  I agree with it for the most part, but many commercial and investment banks not only took liquidity risk, but credit risk as well.  There is need for rules that drive the amount of capital that a financial institution should have, and it should reflect credit risk, illiquidity, and the degree that liquidity need to be renewed regularly.  Elizabeth Warren’s proposals are well-intentioned, but too simplistic.

Better to try to emulate the good regulation of insurance by the states.  I know it is radical, but banks would be better regulated if regulation were given back to the states, and interstate branching ended.  This would end “too big to fail” in an instant. Get the Federal government out of banking regulation.  One regulator is easy to control; fifty are hard to control.  That’s on big reason why insurers are far better regulated than banks.

Now all that said, it is possible for a financial company with a long liability structure to die.  An insurer underwrites long-tailed coverages badly, but the claims aren’t coming for a long time.  Year-by-year, they raise their claim estimates, bit-by-bit.  A company that only writes the bad insurance will meet its end, but it will take claim development in excess of resources to do so, and that will take years.

Banks have around a year to react to  a growing loss of liquidity, insurers have far more time, leaving aside clauses that allow for the agreement to be canceled after a credit downgrade.

One final note: Wall Street may be learning to co-operate with its regulators.  I would encourage them to again, look at the insurance industry.  Actuaries, who have a serious ethics code, are usually on every serious study committee together with regulators.  The actuaries, while not fully neutral, get treated honest dealers as industry issues get discussed.  Part of the reason here, is that so many different state regulators have to be convinced in order for anything uniform to be proposed to the state legislatures, that it takes a while for the discussions to complete, with some state regulators with a little more savvy making the case to those with less.

Fifty heads are better than one.  To the degree possible, hand financial regulation over to the states.  It is far harder to co-opt fifty state regulators than one in DC.  If that ‘s not possible, Wall Street should adopt the idea of using ethics-bound professionals like Actuaries of CFA Charterholders to interact with regulators to craft regulations that are fair for companies and the Public at large.



Speculative companies should be evaluated on cash, burn rate, probability of success, size of potential market and margins at maturity.

I rarely buy speculative companies, but it is an interesting question as to how speculative companies like Amazon, Google, or a biotech firm should be valued.  Speculative companies are like options; they often end with no value, and occasionally end with a large value.

Here are my five points:

  • Cash
  • Burn rate
  • Probability of success
  • Size of potential market, and
  • Margins at maturity.

Cash and burn rate tell you how long the company has to play before it fails.  If a company is spending cash in an effort  to produce a profitable business, how long can it do so until it runs out of cash?

That plays into the probability of success — more time means a higher probability, mostly, but desperation can aid success.  Other aspects on probability of success include the competition, novelty/reliability of the science, etc.

If the strategy does succeed, how large could the market be that is served, and how big could the margins be as part of an oligopoly?

But after all that, discount for the probability of failure, and discount the future earnings stream at 20%/year, because this is so uncertain.

As I said to colleagues at one firm I worked for in 2004, “Imagine Google gets 20% of the profits of the global advertising business 10 years out, and holds onto it?  What would that be worth?”

It would be worth a lot, and Google has probably exceeded that profitability estimate, thus the high market valuation of Google.  Give credit to people with clever ideas at the right time.

Anyway, be careful investing in speculative companies — this is an area where you will get more strikeouts than home runs.  I tend to be a singles hitter in investing, but with a high average.  But in the few cases where I look at a speculative company, this is how I do it.


Market rents are typically fixed in size.  When a strategy to exploit a particular market inefficiency gets too big, returns to the rent disappear, or even go negative prospectively, even if they appear exceedingly productive retrospectively.

If you have read me for any decent amount of time, you know I am big on economic and financial cycles, and how they can’t be eliminated.  There are two groups that think the cycles can be eliminated:

  • Politicians and Central Bankers who think they can create permanent prosperity, when all they really create is an increase in overall debt.
  • Efficient market theorists who think there are no strategies that beat the market.

It is the second group that I am dealing with this evening.  Market strategies trend.  If we have had outperformance from value investing this year,  the odds are good that we will have it next year, unless it has gone on for too many years (5+).

Ideas in investing tend to streak, get overinvested, then die.  This is one reason why I don’t believe articles about the death of various investment concepts.  We need to think about investment ecologically.  There are no permanently valid investment factors to beat the market.  There are many investment factors that beat the market over time, but not while many are pursuing them.  Imitation drives returns, and then over-imitation kills them.

That means we should be wary when a strategy has been working too well for too long.  It also means we should be skeptical when any strategy with a strong thesis behind it is declared “dead.”  That may be the very time to consider it, or maybe wait a year or two.  Many strategies are forgotten; after a time of failure it is time to remember them.

Part of this stems from the biases of institutional investors.  They think that their winnowing down of the investable universe through screening will always produce a good crop of candidates in which to invest.  But that’s not true.  Talented investors think more broadly, and are willing to consider investments that don’t fit within common screens.

The thing is: strategies go in cycles.  They are born at a time when no one loves them.  They gain currency from the good returns of those who adopt them, leading to a frenzy where many adopt the strategy, and returns are great, but now companies that fit the strategy are overvalued.  The process goes into the reverse gear where the strategy is garbage, until enough parties abandon it and the prices of stocks that would be a part of the strategy are attractive.

So when you hear:

  • Value is dead
  • Growth is dead
  • Large caps are dead
  • Small caps are dead (rare)
  • Momentum is dead
  • Low volatility is dead.
  • Quality is dead.
  • Low Quality is dead.
  • XXX industry or sector is dead.

Be skeptical, and begin edging into companies that you like in the “doomed” strategy.  Make sure they have strong balance sheets and competitive positions.  That will protect you if the trend persists.

One more note: this doesn’t work in reverse.  A strategy that has been working for a little while will likely streak.  Resist the trend when it is old, not when it is young.

Finally, remember: there are only tendencies, not laws: markets exist to surprise you.  There are theories that work in the market over time, but they do not work year after year, the results come in lumps, unlike the projections of the financial planners.

And I close by saying to all of my readers — is this not how the market works?  There is momentum, but it sometimes fails dramatically.  Ideas streak, and then collapse far faster.  I say be aware of what has been rewarded and what has not.  Sell stuff that has been rewarded too long, and that which has been recently trashed.  Buy the stuff that has come into favor, and strong companies that have been unduly trashed.