Month: September 2013

Some Graphs on Fed Policy

Some Graphs on Fed Policy

Posted on by David Merkel

I don’t want to spend a lot of time on the Fed.? I do want to shine a light on their lack of forecasting abilities.? You have to understand, they are cheerleaders for the US economy, and usually (though not now) defenders of fiscal policy.

The following figures are based off my weighted average estimates taken from the Fed’s guidance.

Let’s start with their forecasts of GDP growth.

central tendency_10374_image001

Note that GDP estimates have been wildly optimistic, and have come down over time.? Why should these people have charge over monetary policy?? They don’t show any competence.? It’s as if they have one failed theory that they share — neoclassical economics.

central tendency_22274_image001

Yes, the unemployment rate has come down, but much of it it due to discouraged workers. Also, younger people are having a hard time finding work, while oldsters are having to work to survive.

Now let’s look at the hyper-optimistic PCE deflator:

central tendency_26254_image001

Inflation has been falling as the PCE measures it, and CPI also.? Asset inflation has taken the place of goods and services price inflation.? Eventually, that will switch, when the relative need to consume rises, as it did in the ’70s.

Now let’s look at the expectations for the Fed Funds rate:

central tendency_29831_image001

Fed funds continually moves down over time. The Fed overestimates when they will tighten, because the economy is far weaker than they expected (go back to graph 1). The final graph confirms this:

central tendency_1915_image001

Thus the futility of the Fed. After almost two years of giving guidance, they are no closer to tightening than when they started.? Tightening is 27 months away, if their estimates are right, same as they thought in January 2012.? Tightening seemed further away when more aggressive QE was introduced, but that quickly abated, like a drug addict adjusting to higher doses.

Lousy Forecasters

The Fed’s ability to forecast, since it began communicating more under Greenspan, has never been good.? They are always too optimistic, and assume the powers of monetary policy are high, when they are low.? This applies double to abnormal policy like QE.

Perhaps the Fed could do us a favor.? Stop the shenanigans, and let the yield curve get a normal slope between 2- and 10-year Treasuries, around 1%.? Also end QE.? Then tell Congress that the ball is in their court, and the Fed won’t do any more “stimulus.”? Then Congress would have to face their own shortcomings, and decide if they are Keynesians or Austrians, and act.? Congress dallies because the Fed acts.? Voters can punish Congress; they can’t punish the Fed, much as it deserves it.? If we need a recession to clear away bad debt, so that we can grow again, let’s have it, and stop the asset inflation that the Fed engenders.

As it is, I don’t think QE is doing much good at all for the US, unless monetizing the debt is something good, which historically leads to high inflation.

Redacted Version of the September 2013 FOMC Statement

Redacted Version of the September 2013 FOMC Statement

Posted on by David Merkel
July 2013 September 2013 Comments
Information received since the Federal Open Market Committee met in June suggests that economic activity expanded at a modest pace during the first half of the year. Information received since the Federal Open Market Committee met in July suggests that economic activity has been expanding at a moderate pace. Shades their view of GDP growth up.
Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Some indicators of labor market conditions have shown further improvement in recent months, but the unemployment rate remains elevated. Adds weasel words because the participation rate is falling, and wages are stagnant.
Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen somewhat and fiscal policy is restraining economic growth. Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen further and fiscal policy is restraining economic growth. Shades their view of housing down.? The Fed hasn?t learned that they can?t control the long end of the yield curve
Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. Apart from fluctuations due to changes in energy prices, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. Little change.? TIPS are showing similar inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.45%, down 0.05% from July.
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. Any time they mention the ?statutory mandate,? it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. No change.Emphasizes that the FOMC will keep doing the same thing and expect a different result than before. Monetary policy is omnipotent on the asset side, right?
The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market. Does not take credit that the tightening of financial conditions happened largely because of FOMC communications.
The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term. No change.? CPI is at 1.8% now, yoy.? It may be closer than they think.
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. The notable paragraph, saying that the ?taper? is not starting because fiscal policy is not as stimulative as the Fed wants.
the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy 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. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy 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. No real change.Operation Twist continues.? Additional absorption of long Treasuries commences.? Fed will make the empty ?monetary base? move from $3 to 4 Trillion by the end of 2013.

 
Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.
The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will closely monitor incoming information on economic and financial developments in coming months No change. Useless comment.
The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. No real change.
The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives. In judging when to moderate the pace of asset purchases, the Committee will, at its coming meetings, assess whether incoming information continues to support the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective. Drops the concept that they might increase the pace of purchases.? Aside from that, this section says about the same thing as July.
Asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s economic outlook as well as its assessment of the likely efficacy and costs of such purchases. New sentence, but it really doesn?t add much.? Didn?t we know that already?
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. No change.Promises that they won?t change until the economy strengthens.? Good luck with that.
In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. Not a time limit but economic limits from inflation and employment.Just ran the calculation ? TIPS implied forward inflation one year forward for one year ? i.e., a rough forecast for 2014, is currently 2.39%, up 19 bp from July.? Here?s the graph.? The FOMC has only 0.11% of margin in their calculation.

 
In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. No change.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. No change.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Charles L. Evans; Jerome H. Powell; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen. Two doves leave the FOMC
Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations. Voting against the action was Esther L. George, who was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations. George continues to make her point that is the same as mine in my piece Easy In, Hard Out; that the Fed may have greater problems as a result of its abnormal policies, whatever they do in the future.

?

Comments

  • No taper yet.? Equities, long bonds, and gold rally.? The FOMC says that any change to policy is contingent on almost everything.
  • They shaded their views of housing down and GDP up.
  • Longer statement.? They think that if they use more words, they will be clearer.? Longer statements are harder to parse and understand.
  • Current proposed policy is an exercise in wishful thinking.? Monetary policy does not work in reducing unemployment, and I think we should end the charade.
  • In the past I have said, ?When [holding down longer-term rates on the highest-quality debt] doesn?t work, what will they do?? I have to imagine that they are wondering whether QE works at all, given the recent rise in long rates.? The Fed is playing with forces bigger than themselves, and it isn?t dawning on them yet.
  • 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.
  • GDP growth is not improving much if at all, and much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.
On Principles-Based Accounting for Financials

On Principles-Based Accounting for Financials

Posted on by David Merkel

I may lose some friends in the industry for writing this.? Accounting bases vary for three reasons at minimum:

  • Accurate portrayal of the change in value of the firm (GAAP, IFRS)
  • Assuring solvency of financial institutions (Statutory)
  • Making sure taxes get paid (Tax)

Here’s the problem: when assets or liabilities get complex, accounting rules have a hard time setting values for them.? This is especially difficult for anything that does not trade regularly, if at all, and anything that has unique personal characteristics.? The value of a life insurance contract varies from person to person, even if major underwriting variables are the same.

But this applies to other areas.? Living benefits for variable insurance contracts do not have a good theory behind them, because the performance of asset markets is unpredictable.

Another example: letting banks set reserves for credit losses off of internal models.? Remember the rating agencies calculating subordination levels for ABS, RMBS & CMBS?? These securities had never been through a failure cycle, so they used default rates from non-securitized lending.? But those that lend and retain the risk are more conservative than those that lend and sell the risk.

The internal models have the potential to be more accurate than accounting rules, but they have greater potential to be more liberal, as management teams lean on accountants, quants, and actuaries for a desired accounting result.

I think it is better the the accounting standards setters to spend some money, hire people with expertise, and craft better rules.? Here’s another example: I think that the pension accounting standard should not allow investment earnings and discount rate assumptions higher than 2% over the ten-year Treasury.

I am in favor of rules-based accounting for solvency purposes.? Let the regulators be conservative.? Principles based accounting might be fine for GAAP/IFRS, but it destroys comparability across companies, and makes equity analysis a lot harder.? Better to have rules-based accounting there too.

If we had God doing accounting, yes, principles-based would be better, because he knows the future perfectly.? But we don’t know the future, so we have to build in conservatism via rules.

I have two more ideas for accounting simplification.? First, tax financial companies on their GAAP income.? That aligns taxation with their priorities.? If they offer a modified GAAP income that reflects how value is delivered, tax them on that.? Income should be taxed on the true increase in value.

Second, eliminate the statutory accounting basis by using GAAP/IFRS, and boost the level of statutory capital that financial firms need to hold.? Adjust the capital levels off of the business mix, penalizing secondary guarantees.

These two proposals would radically reduce the accounting efforts that financial firms go through, while increasing taxes, and enhancing solvency.

One final note: require that those who prepare the squishy parts of financial statements have an ethics code, like CFAs and Actuaries.? That’s not perfect, but training in ethics generally makes people more conservative in accounting.

On Robotic Content

On Robotic Content

Posted on by David Merkel

I use Yahoo Finance as a news source for the companies that I track.? It is the most comprehensive free news source on the web for corporate news.? If you know of a better one, let me know.

That said, I get irritated by robotic content.? Pieces that seemingly have no human hands touching them.? This stuff is low value, even negative value in some cases.

Here are some examples:

  • “Glance” pieces from the AP, where they mention price moves.
  • Anything from Zacks… the level of analysis is low, and they don’t get who a company’s competitors really are, because they rely on computer databases.
  • “Options Now Available For” articles.? That’s not needed.? We all see when new option series are listed, particularly for those that use options frequently.
  • Stock Pops & Drops — from CNBC, not useful.? We all can see what goes up and down, and often there is no significant reasoning on why it goes up or down.
  • Valero Energy Corp. Now #197 Largest Company, Surpassing PPL Corp — Forbes, this stuff is useless.? Who cares about the order of market capitalizations.? Why not do this for Russell 2000 stocks?? It would be absurd.
  • RenaissanceRe Holdings Larger Than S&P 500 Component PerkinElmer — who cares about market cap ranks?
  • Travelers Companies Becomes #15 Most Shorted Dow Stock, Replacing Procter & Gamble –who cares about shorting if it is not severe?

Robotic content is of no value.? Intelligent investors know it already.? Unintelligent investors will not get the significance.

Human interpretation and understanding is valuable, and should be sought after.? I understand the business need to put out “content,” but where is the wisdom that takes raw data, and turns it into knowledge?? That takes a person to do that.? And that is why for now, I screen out robotic content.

Book Review: The Year Without Pants

Book Review: The Year Without Pants

Posted on by David Merkel

I debated whether to review this book or not.? But I have read the whole book, and I can tell you that it is a great book.? The internet has changed the terms of work for many, and for many programmers they can work where they like.

The author has written many books, and he was invited by WordPress to be a leader of a team inside WordPress.? This tale describes how a guy who used to work for Microsoft could succeed in an unstructured environment like WordPress.

During his tenure, his team created great products for users, like Jetpack, and a consistent comment system.

The title of the book stems from the idea? that bloggers write in their pajamas — they don’t wear pants.? But WordPress powers over 20% of the websites of the internet.? It is a quiet and significant power over the internet.

The book deals with the culture of WordPress, the challenges of offering software versus offering a website, and more.? The creation of Jetpack, and a new comments system occupy a large portion of the book.

Only non-local businesses can benefit from this book.? Most businesses require people to be together regularly.? The book overstates that it is the future of work.? Being local is a big thing, particularly when services are personal, or when transport costs are high.

Quibbles

There are a few grammar errors in the book; it could have used a better editor.? Was there an editor?

Who would benefit from this book: Anyone trying to understand how to manage a dispersed workforce would benefit from this book.? If you want to, you can buy it here: The Year Without Pants.

Full disclosure: The publisher sent me the book after asking me if I wanted it.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.

 

A Letter from a Special Reader

A Letter from a Special Reader

Posted on by David Merkel

When you start blogging, you never know who might read you.? At least I know that the Great Firewall of China is not blocking me yet.

Here is the e-mail I received:

Hi David

glad to write to you and I found your email in your blog

plz call me banny and I live in china mainland and do business in china. my work is capital market.

here I have 2 questions hope to discuss with you.

1 have you ever heard of chinese fixed income product named xintuo? the return rate is from 9-15% per year. do you think this kinds of product is attractive to western investor?

2 as I know us mutual fund is very good and only american can invest in it, and most of the mutual fund is not open to thos people who are not american. it there any way to invest in such mutual fund? from offshore structure?

hope to know your idea about this

banny

Dear Banny,

I do not know about xintuo.? I do know that it is very difficult to earn returns of more than 3% over government debt yields under most conditions over the long-run.? One thing I write about at my blog is that dishonest people use high yields as a means of cheating people out of their money.

When high yields are offered, people get tempted to invest.? But how do you know whether the yields can be maintained?

  • Is there an independent auditor of the financial statements?
  • Do you get financial statements regularly from whoever guarantees the return of principal at maturity?
  • Do you know what the xintuo is doing?? If they are not transparent, I would avoid them.? With most frauds the investors had little idea of what the manager of the assets was doing.
  • Is there a neutral third-party custodian who holds the assets for the good of the investors, and not the asset manager?

Be careful here.? Many Chinese wealth management products sound like Ponzi schemes.? They promise high returns, but it is likely that they are paying exiting investors with the money of entering investors.

On American actively-managed mutual funds: a few are good, maybe 10-20% of them.? The rest are bad.? They charge high fees and deliver performance less than the market.

As to how available they are to foreign investors, I myself was solicited to mirror my strategies for European clients.? There was not enough interest, so that did not happen.? We have a saying in the US, “Where there is a will, there is a way.”? If enough foreign money wants to invest in a US mutual fund, someone will come up with a way to do it.? In China, you may have to figure out ways to circumvent currency controls, but if you can, you can do it.

I wish you the best, and if you meet some of my friends in China, tell them Elder David greets them.

Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

 

Rest of the World

 

  • Chinese Buy Sydney Homes at Unprecedented Rate, McGrath Says http://t.co/EsRV6O2E99 Stylish flight capital does not come cheaply, mate $$ Sep 14, 2013
  • Rajan Hailed as Swings Drop Amid Gundlach Warning http://t.co/Cxn6tDBDqe Rajan has courage to defend the Rupee & slow the Indian economy $$ Sep 14, 2013
  • Aniston?s Salad Isn?t Enough as Quinoa Farmers Reap Golden Crop http://t.co/CkkKzTR5lC Bolivian farmers rejoice growing quinoa makes $$ Sep 14, 2013
  • Catalan Separatists Pull Off Human Chain But Referendum Is Harder http://t.co/Yy15a6AfPW Reaching the limits of bad policy, risking wars $$ Sep 12, 2013
  • Norway Pledges to Limit Oil Spending http://t.co/IzVJKwunbq Probably smart, because it is easier 2 overspend an endowment than underspend $$ Sep 12, 2013
  • Shipping Rates Seen at 2010 High on Record Ore to China http://t.co/rCXg6JUlzf Means China is likely not rebalancing to consumption yet $$ Sep 10, 2013
  • Youngest Japan Boards Beating Oldest With Stocks Rising 139% http://t.co/JDXARNyCku Returns were 52% for other firms over the last 3yrs $$ Sep 10, 2013
  • Syrian Christians Pack Passports Fearing Islamist Onslaught http://t.co/vcaHMVzJpz More Coptic churches in US, next comes Syrian Orthodox $$ Sep 10, 2013
  • Russia to Brazil Intervention Adds to U.S. Debt Distress http://t.co/wPiBAG35Z7 The real Q is what they are buyingw/the $$ they sell? Sep 09, 2013
  • Syria Vote May Derail Obama?s Agenda in Congress http://t.co/oGoHtSGUzD Argues that Obama has to win the Syria vote 2 avoid looking weak $$ Sep 09, 2013
  • Ancient Golden Treasure Found Near Jerusalem Temple Mount http://t.co/tLRWZfsNEm Byzantine coins dating from 4th – 7th centuries $$ menorah Sep 09, 2013
  • India?s Middle Class Hit as Rupee Plunge Pushes Up Prices http://t.co/AlN4xRJKI3 Another example of how inflation hits the poor hardest $$ Sep 08, 2013
  • Tokyo Defeats Madrid, Istanbul for Rights to 2020 Olympics http://t.co/gikYyiO4pY Tokyo wins the prize to build Olympic white elephants $$ Sep 08, 2013

 

US Politics & Policy

 

  • US Faces Long-Term Care Crisis, Report Says http://t.co/uu68sNvNWz Unsolvable unless we rein in costs, redefine what Medicare will cover $$ Sep 14, 2013
  • States Face Decision on Saving Trains http://t.co/Ps5L9Wk631 Federal subsidies end on short Amtrak routes, will states pick up tab? $$ #bus Sep 14, 2013
  • Walmart Wins in DC http://t.co/ixe7uC1U6C “Mayor Gray has chosen jobs, economic development and common sense over special interests” $$ Sep 14, 2013
  • Republicans Holding Next Fed Chairman?s Fate Stay Quiet http://t.co/k7oIqCtP6w GOP sits & grins over no-win situation 4 democrats & Obama $$ Sep 14, 2013
  • How Wal-Mart?s Waltons Maintain Their Billionaire Fortune http://t.co/duLt9Ogtod This is y defining income more important than tax rates $$ Sep 12, 2013
  • How to Preserve a Family Fortune Through Tax Tricks http://t.co/xHI585uI8W Graphic showing how GLATs, CRATs & Family LPs work $$ #lowertaxes Sep 12, 2013
  • Even a Railway Line Can?t Dodge the Keystone XL Controversy http://t.co/ykz7FdFdoS Given the delay, new projects replace the need 4 K-XL $$ Sep 12, 2013
  • New York Mayor Race Worries Business http://t.co/AQUazQsdYa De Blasio pursues policies that made Detroit the great city it is now $$ #FTL Sep 12, 2013
  • California city backs plan to seize negative equity mortgages http://t.co/LmTGRhptuK Fail: loss of financing for city & new homeowners $$ Sep 12, 2013
  • GE, IBM Ending Retiree Health Plans in Historic Shift http://t.co/Plbc1CK4fG Obamacare leads large corporations 2shed retiree healthcare $$ Sep 12, 2013
  • Fraud Stealing $100M Shows Flaws in US Crop Insurance http://t.co/zTEg7Z0UG4 System relatively easy2cheat.Graphic: http://t.co/GkJ8RT0BLn $$ Sep 12, 2013
  • NSA Violated Privacy Protections, Officials Say http://t.co/b4cEoloHz5 Much as it would unemploy my friends, we need 2 end the NSA $$ Sep 11, 2013
  • Five Revelations From New NSA Documents http://t.co/khGGuAsqpU Government violated its own rules repeatedly, showing no respect 4the law $$ Sep 11, 2013
  • Intel clashes w/Obama’s election-year al Qaeda claims http://t.co/r6vM2wtjMz The successes against al Qaeda undone by spread 2 new areas $$ Sep 10, 2013
  • Kerry’s ‘Gaffe’ Beats Military Strikes http://t.co/Il4bA172Y1 Hey, getting the chemical weapons out of Syria is @ least a small win, yes? $$ Sep 10, 2013
  • Crop Insurers? $14 Billion Some See as Money Laundering http://t.co/39r6zZQrcz Difficult 4 crop insurers 2 lose as US Taxpayers foot bill $$ Sep 10, 2013
  • DeVry Lures Medical School Rejects as Taxpayers Fund Debt http://t.co/Ek4gXsIkHB Long article on how Caribbean med schools compete w/US $$ Sep 10, 2013
  • The Terrorism Risk Insurance Act: Time to End the Corporate Welfare http://t.co/NPlTkozP4n There is no need to subsidize terror insurance $$ Sep 10, 2013
  • Taxpayers Turn US Farmers Into Fat Cats With Subsidies http://t.co/aLE07PrkFt Crop insurance sends all the risk of farming to taxpayers $$ Sep 09, 2013
  • In Conversation With Michael Bloomberg http://t.co/dtJ4WJZnaZ Long somewhat hostile article asking Bloomberg his views, plans, etc. $$ Sep 09, 2013
  • Dear NSA, Thanks for Making Us All Insecure http://t.co/3sfMaeyR1L NSA weakens security 4all, harms interests of US Internet Corporations $$ Sep 08, 2013
  • it also lowers global trust in the US, fragments the internet, & encourages nations that censor & monitor the internet by US bad example $$ Sep 08, 2013

 

Financial Sector Today

 

  • Why looser lending standards won’t help you http://t.co/p36wvJj6YC Lending standards fall in markets hit by crash & now prices r rising $$ Sep 14, 2013
  • Berkshire, AIG Join Battle Over Lucrative Business http://t.co/P87xoC3YZp $BRK.B roils industry expanding in excess-and-surplus insurance $$ Sep 14, 2013
  • House Talk: When an HOA Forecloses http://t.co/7Auan3ZFg2 Yes, your homeowners association can foreclose if you don’t pay your dues $$ Sep 08, 2013
  • Upside: Emerging-Market Bond Bargains http://t.co/2wIcJ5a8r5 They look cheap, but Q is how they adjust 2 tighter world monetary policy $$ Sep 08, 2013

 

Financial Crisis Fifth Anniversary

 

  • TARP didn’t save banks, it ruined them: Kovacevich http://t.co/o6BjBjNqbK Contradicts Paulson who said the TARP funds were voluntary $$ Sep 14, 2013
  • By every measure, the big banks are bigger http://t.co/nmfyAJ2CG9 The top 6 banks hold 67% of all assets in the banking industry $$ Sep 14, 2013
  • A Toxic Subprime Mortgage Bond’s Legacy Lives On http://t.co/NdJy3NLyih Story of CWABS 2006-7 Borrowers, Investors & Others Touched by It $$ Sep 14, 2013
  • Lehman’s Cold Dead Hand Is Still Reaching Out For Money http://t.co/tbqVCB32LV Many games can b played w/derivatives of a BK counterparty $$ Sep 14, 2013
  • Five years after Lehman, risk moves into the shadows http://t.co/9hootI4MGa Bank runs still possible due2 repo, margining, putable debt $$ Sep 12, 2013
  • 2008-2013: The Financial Crisis in 9 Charts http://t.co/2JmO98tqzA GDP, S&P500, Finance profits, employment, income, cars, homes & more $$ Sep 12, 2013
  • Lehman Brothers Abyss Had Paulson Seeking Prayer Amid Crisis http://t.co/y5ucZK5dNX I’m getting tired of seeing Paulson in the news $$ #long Sep 12, 2013
  • Embracing Wynne Godley, an Economist Who Modeled the Crisis http://t.co/dEm8njuXmT The right answer involves Minsky and the Austrians $$ Sep 12, 2013
  • Financial Crisis: Lessons of the Rescue, A Drama in Five Acts http://t.co/EIdEVqnkWa John Taylor blames Govt policy for creating crisis $$ Sep 09, 2013
  • Henry Paulson Defends Fannie Mae Bailout http://t.co/Rtvjlv8vsF As a result, we have maintained an overleveraged economy, more govt debt $$ Sep 09, 2013

 

Central Banking

 

  • Why Michael Woodford Thinks the Fed Should Taper http://t.co/Lyy1oLnhfC Contends that we need more safe assets in the financial system $$ Sep 14, 2013
  • Is the Demographic Shift Weakening Monetary Policy Effectiveness? http://t.co/SDaTi4zItG Older ppl react less 2changes in interest rates $$ Sep 10, 2013
  • Fed wants yet another tool in its swelled policy kit http://t.co/5BvNPM0ro6 fixed-rate, full-allotment overnight reverse repo agreements $$ Sep 09, 2013

 

Other

 

  • Detroit?s Bankruptcy and Pension Solution Depends More on its Planned Recovery and Rebirth – Not Just Cutting Costs http://t.co/RbkP5qNbeo! Sep 14, 2013
  • The prior article tweeted I disagree with. There r many high sounding words, amounting 2 “If we all clap, Tinkerbell will live!” $$ #nohope Sep 14, 2013
  • Insight: In Silicon Valley start-up world, pedigree counts http://t.co/tg1ox11QsK The school u went 2 or the firm u worked 4 matters $$ Sep 13, 2013
  • MIT?s Williams Decodes Economics of Gene Sequencing http://t.co/jPeJXSGK7d Economist connects intellectual pprty & incentives 2 research $$ Sep 12, 2013
  • Intergovernmental Panel On Climate Change Admits Global Cooling? http://t.co/qZCWogzNwD Climate changes; it always changes $$ Sep 12, 2013
  • Financial Secrets Revealed! (Just Don?t Ask Where They Came From) http://t.co/5U6tugKpWV @retheauditors tells journos&readers2check facts $$ Sep 11, 2013
  • Fate or Destiny? http://t.co/FyEmhLLK0K @reformedbroker goes on hiatus? My but I will miss him. The financial blogosphere will miss him $$ Sep 11, 2013
  • The Weak Recovery Explains Rising Inequality, Not Vice Versa http://t.co/5fWR45Z3gi When growth was strong, incomes more even $$ Sep 10, 2013
  • Alcoa, H-P & Bank of America to Be Replaced on DJIA http://t.co/lDsl4dYVTL Nike, Visa & Goldman Sachs enter $$ $V $GS $NKE $AA $HPQ $BAC Sep 10, 2013
  • 10 ways to wipe out your retirement savings http://t.co/HjTw5raXEd Complexity, leverage, low diversification, self-custody, slick-talkers $$ Sep 09, 2013
  • Are the Baltic Dry Index Telling Us to Expect Stronger Economic Activity? http://t.co/5xZSe3HvTT BDI has been turning up lately, so maybe $$ Sep 09, 2013
  • http://t.co/Ti2RuDFD37 Did you read the deal terms? Looking at a special dividend of ~$5/share plus ~0.23 shs of $VZ per sh of $VOD. $$ Sep 09, 2013
  • AT&T Gets Tentative Approval to Fund Pension With Preferred Stock http://t.co/FS7tWqkxo8 In BK, pref stock worth little;PBGC holds bag $$ $T Sep 08, 2013

 

Verizon Bond Deal

  • How to Borrow $49B with a Stroke of a Pen http://t.co/v4djHDzgjh Bond deal of $VZ had weak covenants versus most investment grade deals $$ Sep 12, 2013
  • Verizon Nets $2.09 Billion Windfall for Bond Sale Buyers http://t.co/3EWb3AvE6z In order to get the deal done $VZ had to offer 4%+ gift $$ Sep 12, 2013
  • Verizon Pays Premium to Top Apple Bond Record http://t.co/VqnMkvWvn4 I would b wary of holding much long $VZ debt. Who doesn’t own it? $$ Sep 12, 2013
  • Verizon Plans $20B Debt Sale http://t.co/uwWhFrvlwY Biggest ever, & on top of $48B+ of existing debt, will have 2have juicy yields $$ $VZ Sep 10, 2013
  • Verizon may boost size of bond offering: sources http://t.co/CGF0NsXD24 $VZ gets ready 2 issue biggest USD corporate bond deal EVER $$ $25B+ Sep 10, 2013

 

Wrong, Etc.

  • Gundlach Says Fed Is Mistaken in How It?s Ending Easing http://t.co/LPAZUFia7n This article does not make clear what Gundlach objects to $$ Sep 12, 2013
  • 4 investment tips that you should never use http://t.co/hjfumLxV3u Mixed analysis where the author knocks down falsehoods and straw men $$ Sep 12, 2013
  • Confused: Buffett?s investing advice is a portfolio killer http://t.co/nQF65PRnaD More a criticism of Peter Lynch than Warren Buffett $$ Sep 12, 2013
  • Wrong: Systemically Important Banks in the Post-Crisis Era http://t.co/seuYEsF5L4 Long, and misses liquidity issues like repo financing $$ Sep 10, 2013

 

Retweets, Replies, and Comments

  • @munilass I read this and thought that things haven’t changed much since Heraclitus and Parmenides. Would like to hear his thoughts on Godel Sep 14, 2013
  • @jeffdanoff1 Of course I know that. I detest Paulson’s 5-year anniversary self-justification obfuscation. Kovacevich shoots straight. Sep 14, 2013
  • RT @munilass: Feynman’s lectures are now available online (Volume 1) http://t.co/K4TfrMkQuD (via @jtc_19) Sep 14, 2013
  • @munilass @BarbarianCap I too have appreciated your writings. They are worth keeping. If you don’t want to pay to do it, I could host them Sep 14, 2013
  • I just left a comment in “Buffett?s investing advice is a portfolio killer – Jeff Reeves’s Strength in Numbers – Ma?” http://t.co/6oyVHvcKgK Sep 12, 2013
  • Thanks @munilass | I knew u had written about this in the past. I’m a generalist w/bonds, so I thought I would show it 2u4 your thoughts $$ Sep 12, 2013
  • Hey @munilass — I would b interested in your opinion on this from The Committee For A Responsible Federal Budget http://t.co/GwHTQNSzfy Sep 11, 2013
  • Commented on StockTwits: @Financial_Iceberg Saw that & tweeted it yesterday. The question is how long China can c… http://t.co/b7dmG6PvE3 Sep 10, 2013
  • I just left a comment in “David Einhorn was right about this stock – MarketWatch” http://t.co/koU5CehwBZ Sep 09, 2013
  • @mcuban @howardlindzon Here is my reply, 2 large for twitter: http://t.co/qSgjjTYFRe Yes, most retail investors r dumb, but money can b made Sep 07, 2013
On Blogging Long-Term (Post 2200)

On Blogging Long-Term (Post 2200)

Posted on by David Merkel

When I started blogging in February 2007, I did not know that I would be able to write on new topics for so long.? But I committed to writing two short posts a night initially, which became one long post per night, excluding the Sabbath.

I have admiration for many of the long-term bloggers who churn out content regularly.? It takes effort.? It’s not easy to come up with fresh content on a regular basis.? My well is not dry, but sometimes I wonder.? Still, I have the following when things seem dull:

Much as I have non-consensus views on many matters, it is not my goal to write about those views all of the time.? I want to teach people about investing, and get them to avoid many of the traps that are common in the markets.

I try to write about a wide number of issues in the markets, both hot and cold, private and public.? My goals is to create skeptical investors that invest in valuable investments after doing sufficient research.

Much as I have become a better writer through blogging, that was not my goal in writing here or at RealMoney.? It is my goal to educate.? I want people to make better decisions, and avoid the scammers who push illiquid investments.? If an investment is illiquid, it deserves three times the scrutiny as to its value.

Avoid investments that lock up your funds.? I have two of them, one an incredible success, and one a horrible loss. On net, I have won, but I wish I had not invested in the loser.? Hindsight is 20/20 — could I have seen it in advance?? No.? Nor could I have seen the incredible turnaround in the other investment, which is now distributing 30%/year.

I like writing for my audience.? And thanks for reading me.? I am open to allowing a simpler commenting system.? If that is something you would like, please let me know.? In the past, I have been reluctant to do that because many comments on the internet are low value.? But if you want me to loosen up comments, let me know.

The Rules, Part LIV

The Rules, Part LIV

Posted on by David Merkel

When do employee and corporate incentives line up?? Ideally, incentive schemes should reward people with a fraction of the additional profitability that resulted from the additional work that they did.? Difficulties: measurement impossible in many cases, people could receive a bonus when the firm is not profitable, neglects synergies (both positive and negative).

Though I wrote that in 2002, I formulated the idea in the late 1980s.? The concept of how bonus/incentive systems should work intrigued me.? Part of it also stemmed from Warren Buffett’s observation that he would never hand out stock options, because employees can’t control P/E expansion or shrinkage, but employees have some impact on profits, if fairly measured.? So Buffett would offer profit incentives, rewarding employees with a share of the profits over a given threshold.

The first time I mentioned the idea publicly was at the Fellowship Admission Course for the Society of Actuaries in 1991.? The first case study was on a misuse of employee incentives, and I commented something close to “rule” that I mentioned above.? After I said that, a female consulting actuary based in Australia said that it was one of the stupidest comments she had ever heard.? But beyond that, she didn’t explain.? The discussion moved on.? I didn’t make too much of what she said, because she offered no reasons for her opinion.

In 1994, my best boss came to me, and said, “Well, you drew the short straw.? You get to try to redesign our compensation system for our representatives.”? He described to me the current system, and what the overall goals were.? I assented, and he left.? Shortly after that, the division’s Radar O’Reilly, “Roy” came to me and said, “You got the compensation project?”

I told him that I had been given the project, and he told me not to put too much time into it early, or it would suck up gobs of time, and besides, no compensation scheme over the past five years had lasted longer than a year.? I thanked Roy, he was a loyal friend, and never told less than the truth.

But then I had to think.? Surely there had to be a way that would work here, and maybe putting in some development time in on the front end could pay off, maybe?

I had been playing around with reduced discrepancy point sets with my free time.? Like Assurant, my boss gave me eight free hours per week to come up with new ideas, and temporarily, I created the best method of creating structured randomness — how best to have “r” points represent an n-dimensional unit hypercube.? The practical upshot was that I could create scenario analyses that were far more accurate than any others around.? (Note: better methods emerged within 10 years, and I never published my work, because my insights were intuitive rather than provable… but it enabled me to do some amazing things for the next ten years.)

I set up my profit model, and chose my criterion: Try to pay commissions equal to 1.25% of the Present Value of the Gross Value Added.? My model had four components.? I can’t remember all of them now, but the last one was the most significant, an item called the “revenue bonus.”? Over a certain threshold offices (with multiple representatives) would receive extra compensation for exceeding targets.

It leveled out the amount paid versus the Present Value of the Gross Value Added.? Success, except that my best boss ever had one of our two fights over it — he thought it was a horrible idea — we could be paying out too much money in a bad year, or too little in a good year.? I argued? that it was better than what we currently had, and that we could tweak it in future years.? We will learn from the errors of the method.? He told me that it was fine for me to present it to the chief marketing officer and the CEO of the division, but he would not be behind me.

Much as I respected him, I had done my work, so I presented it two days later to the CMO and CEO.? They went gaga for the idea, and in the meeting my boss said “I see it now.”? Later, he came to me and apologized, and as is usual with me, I accepted it, saying it was no big thing.

So what happened?? Not only did the compensation scheme work for a year, it stayed in place for four years without modification, while sales and profitability grew dramatically, and the division grew to be the star of the company.

That said, after the CEO retired, the CMO became the new CEO, and I got transferred to a different division to clean up operations and financials there.? After four years, the representatives complained that the scheme was too tough, and they needed some low hanging fruit to motivate them.? And so my scheme was abandoned, and sales did not improve, but they were worse.

Profit-based incentives work if they are structured right.? You want representative to write good business, and should incent them to do so.? Offering them a percentage of the expected improvement of the value of the company is a smart thing.

On Big Corporate Bond Deals

On Big Corporate Bond Deals

Posted on by David Merkel

We are going to see the biggest corporate bond deal price tomorrow.? Verizon is raising money to buy out Vodaphone’s 45% stake in Verizon Wireless.? The amount sold will be at least $20 billion, and could be as? high as $50 billion.? They are going to have to pay up to do so, because:

  • Verizon already has almost $50 billion in debt
  • Large deals run into the position limits of institutional bond investors.

Institutional bond investors? typically have holdings limits based on:

  • Percentage of exposure to a sector
  • Percentage of exposure to an industry
  • Percentage of exposure to a ratings category

There will be other limits tailored to the needs of the client, which frequently stem from the length of their explicit or implicit liabilities.? Explicit liabilities are simple — you know when cash will be demanded.? Implicit liabilities estimate when cash will come or leave depending upon performance.

With respect to bond ratings, Verizon is in a tough spot, because it will be the largest nonfinancial bond issuer, with nearly $100B in debt, versus AT&T, with $76B in debt.? That presents its own challenge, because the US telecom sector is dominated by two companies, Verizon and AT&T.? How much do you want to buy when two companies dominate the sector?? One failure would be huge to the bond market, but then again, duopolies tend to be profitable, so long as they don’t overleverage, like Fannie and Freddie.

Big bond deals are tough, because many bond managers will say, “I am already full on the name,” or “I can only take $XX million more of the name, and then I am full.”? This is especially true for Verizon, since they are rated Baa1/BBB+/A- from Moody’s, S&P, and Fitch.? That’s a high BBB rating, but far better to have a low single-A rating.

Thus the pricing has to be attractive, so that buyers that are not dedicated to corporates have interest — balanced funds, income funds, endowments and pension funds.

My Advice

Unless the yields are similar to those for BB junk bonds, I would pass on this deal.? The reasons are simple:

  • Typically the results on large corporate deals are bad in the short-run.
  • You will not have a large audience to re-sell your bonds to.? Most parties will be stuffed full.
  • Technology is sufficiently dynamic that Verizon Wireless could lose its protected boundaries much as landlines have.

I am usually a skeptic of big bond deals.? It is usually a sign of weak thinking among buyers.? I avoided big deals during 2001-3, and ended up the better for it.

So be wary, and avoid Verizon bonds for a time, until the market normalizes.? It looks like the syndicate will stuff the market full, but good.

Full disclosure: long VOD, and as a result will probably receive shares of VZ

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