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Book Review: Bad Paper

Posted on 11 November 2014 by David Merkel

This book has two significant types of insights: on people and on market failure.? It does well with both of them, but spends most of its time on the former, because it is more interesting.? That said, the second set is more important, and is buried in a few places in the second half of the book.

With people, this book answers the following questions:

Why does this book largely take place in Buffalo, NY? Because entrepreneurs got started there, and found it easy to acquire talent there.
Why does the industry employ a lot of ex-convicts? There are some crossover benefits to having been through the rough-and-tumble of street life that gives an edge in dealing with desperate people who have bad debts.
Is there an ethical code for debt collectors? Well, yes, sort of.? Kind of like ?the code? from the movie Repo Man ? don?t tell debtors they are in legal trouble, don?t threaten, treat them with kindness, don?t buy debt where you don?t have a clear chain of title, don?t sell lists of debts to collect where the debtors have already been verbally flogged.
Do all debt collectors follow the code? Well, no, and that is one place where the book gets interesting, as various debt collectors look for edges so that they can make money off of debts that creditors have given up on.? There *is* honor among thieves, and be careful if you cross anyone powerful or desperate enough.
Can?t you use the legal system to try to recover money on the debts? Well, only at the end, and even then it is difficult, because if the debtor asks for evidence on the debt that is being collected, the debt collector usually doesn?t have it, and the case will be dismissed.? It is best for collectors to come to settlements out of court.

The book follows around debt collectors and those associated with them, a colorful bunch, who see their see their opportunities flow and ebb as the financial crisis first produces a lot of bad debts to work on, and they mine that ore until the yields get poor.? Some of these people you will gain sympathy for, as they are trying to make a buck ethically.? Others will turn you off with their conduct.

As for market failure issues, you might wonder why the credit card companies and other creditors don?t pursue the debtors themselves.? Why do they sell the right to collect on unsecured debts at such deep discounts to the face value of the debts? [Pennies on the dollar, or less?]

The creditors don?t want to make the effort to dig up the necessary data to make the case in court a slam-dunk.? It would not pay for them to do so in most cases given the large number of cases to pursue, and the relatively small amounts that would be recovered.? That?s why the debts are sold at a discount.

Some debts don?t get removed from databases when payments are made to close them out, and as such some debt collectors try to collect on debts that were once in default, but paid off in a compromise.? This could be remedied if there were a comprehensive database of all debts, but the costs of creating and updating such a database would likely be prohibitive.

Finally, you might ask where the regulators are in all of this.? Between the States and the Feds, they try to clip the worst aspects of debt collection, but they are stretched thin.? This means that for many people, the optimal strategy is not to pay on defaulted unsecured debts, and challenge them if they take you to court.

Quibbles

Lots of foul language, but you?re dealing with the lowest rungs of society, so what do you expect?

Summary / Who Would Benefit from this Book

This is a good book if you want to understand the unsecured debt collection business. ?If you have friends who are troubled by debt collectors, it might be worth a purchase, and lend the book to them. ?If you still want to buy it, you can buy it here:?Bad Paper: Chasing Debt from Wall Street to the Underworld.

Full disclosure:?I?received a?copy from the author?s PR flack.

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.

Redacted Version of the October 2014 FOMC Statement

Posted on 29 October 2014 by David Merkel

September 2014	October 2014	Comments
Information received since the Federal Open Market Committee met in July suggests that economic activity is expanding at a moderate pace.	Information received since the Federal Open Market Committee met in September suggests that economic activity is expanding at a moderate pace.	No change. This is another overestimate by the FOMC.
On balance, labor market conditions improved somewhat further; however, the unemployment rate is little changed and a range of labor market indicators suggests that there remains significant underutilization of labor resources.	Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing.	Shades their view of labor use up.? More people working some amount of time, but many discouraged workers, part-time workers, lower paid positions, etc.
Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow.	Household spending is rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow.	Shades up household spending a little.
Fiscal policy is restraining economic growth, although the extent of restraint is diminishing.		Finally dropped this bogus statement.
Inflation has been running below the Committee’s longer-run objective. Longer-term inflation expectations have remained stable.	Inflation has continued to run below the Committee’s longer-run objective. Market-based measures of inflation compensation have declined somewhat; survey-based measures of longer-term inflation expectations have remained stable.	Shades their forward view of inflation down.? TIPS are showing slightly lower inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.35%, down 0.18% from September.
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 activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate.	The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate.	No change.? They can?t truly affect the labor markets in any effective way.
The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.	The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced. Although inflation in the near term will likely be held down by lower energy prices and other factors, the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.	CPI is at 1.7% now, yoy.? They shade up their view down on inflation?s amount and persistence.
The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.	The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program.	No change.
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month.	Moreover, the Committee continues to see sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. Accordingly, the Committee decided to conclude its asset purchase program this month.	Finally ends QE, for now.
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.	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 change
The Committee’s sizable and still-increasing holdings of longer-term securities 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.	This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.	Maintains reinvestment of long-term securities, which does little to hold interest rates down, assuming that is a desirable goal.
The Committee will closely monitor incoming information on economic and financial developments in coming months 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.		Finally ends a useless paragraph.
If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will end its current program of asset purchases at its next meeting.		Deletes sentence
However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.		Deletes sentence
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate.? In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.	To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.	Highly accommodative monetary policy is gone ? but a super-low Fed funds rate remains.? Policy normalizes, sort of, but no real change.
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.	The Committee anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.	No change.? Its standards for raising Fed funds are arbitrary.
	However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.	Tells us what we already knew.
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.
The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.	The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.	No change.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Narayana Kocherlakota; Loretta J. Mester; Jerome H. Powell; and Daniel K. Tarullo.	Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Loretta J. Mester; Charles I. Plosser; Jerome H. Powell; and Daniel K. Tarullo.	Fisher and Plosser dissent.? Finally some with a little courage.
Voting against the action were Richard W. Fisher and Charles I. Plosser. President Fisher believed that the continued strengthening of the real economy, improved outlook for labor utilization and for general price stability, and continued signs of financial market excess, will likely warrant an earlier reduction in monetary accommodation than is suggested by the Committee’s stated forward guidance. President Plosser objected to the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for “a considerable time after the asset purchase program ends,” because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee’s goals.	Voting against the action was Narayana Kocherlakota, who believed that, in light of continued sluggishness in the inflation outlook and the recent slide in market-based measures of longer-term inflation expectations, the Committee should commit to keeping the current target range for the federal funds rate at least until the one-to-two-year ahead inflation outlook has returned to 2 percent and should continue the asset purchase program at its current level.	Send Mr. Kocherlakota a chill pill, and ask him to review how badly the FOMC forecasts, and how little effectiveness monetary policy has had for the good in the US.? He just wants to create another bubble, along with the rest of the doves.

Comments

Pretty much a nothing-burger. Few significant changes, if any.? Yes, QE ends, but who didn?t expect that?
Despite lower unemployment levels, labor market conditions are still pretty punk. Much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.? Wage growth is weak also.
Equities flat and long bonds rise. Commodity prices are down.? The FOMC says that any future change to policy is contingent on almost everything.
Don?t know they keep an optimistic view of GDP growth, especially amid falling monetary velocity.
The FOMC chops some ?dead wood? out of its statement. Brief communication is clear communication.? If a sentence doesn?t change often, remove it.
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 and fall 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, labor market indicators, inflation trends, and inflation expectations. As a result, the FOMC ain?t moving rates up, absent improvement in labor market indicators, much higher inflation, or a US Dollar crisis.

The Butterfly Machine

Posted on 23 October 2014 by David Merkel

Photo Credit: whologwhy || Danger: Butterfly at work!

There’s a phenomenon called the Butterfly Effect. ?One common quotation is “It has been said that something as small as the flutter of a butterfly’s wing can ultimately cause a typhoon halfway around the world.”

Today I am here to tell you that for that to be true, the entire world would have to be engineered to allow the butterfly to do that. ?The original insight regarding how small changes to complex systems occurred as a result of changing a parameter by a little less than one ten-thousandth. ?Well, the force of a butterfly and that of a large storm are different by a much larger margin, and the distances around the world contain many effects that dampen any action — even if the wind travels predominantly one direction for a time, there are often moments where it reverses. ?For the butterfly flapping its wings to accomplish so much, the system/machine would have to be perfectly designed to amplify the force and transmit it across very long distances without interruption.

I have three analogies for this: the first one is arrays of dominoes. ?Many of us have seen large arrays of dominoes set up for a show, and it only takes a tiny effort of knocking down the first one to knock down the rest. ?There is a big effect from a small initial?action. ?The only way that can happen, though, is if people spend a lot of time setting up an unstable system to amplify the initial action. ?For anyone that has ever set up arrays of dominoes, you know that you have to leave out dominoes regularly while you are building, because accidents will happen, and you don’t want the whole system to fall as a result. ?At the end, you come back and fill in the missing pieces before showtime.

The second example is a forest fire. ?Dry conditions and the buildup of lower level brush allow for a large fire to take place after some small action like a badly tended campfire, a cigarette, or a lightning strike starts the blaze. ?In this case, it can be human inaction (not creating firebreaks), or action (fighting fires allows the dry brush to build up) that helps encourage the accidentally started fire to be a huge one, not merely a big one.

My last example is markets. ?We have infrequently?seen volatile markets where the destruction?is huge. ?A person?with a modest knowledge of statistics will say something like, “We have just witnessed a 15-standard deviation event!” ?Trouble is, the economic world is more volatile than a normal distribution because of one complicating factor: people. ?Every now and then, we engineer crises that are astounding, where the beginning of the?disaster seems disproportionate to the end.

There are many actors that take there places on stage for the biggest economic disasters. ?Here is a partial list:

People need to pursue speculation-based and/or debt-based prosperity, and do it as a group. ?Collectively, they need to take action such that the prices of the assets that they pursue rise significantly above the equilibrium levels that ordinary cash flow could prudently finance.
Lenders have to be willing to make loans on inflated values, and ignore older limits on borrowing versus likely income.
Regulators have to turn a blind eye to the weakened lending processes, which isn’t hard to do, because who dares oppose a boom?? Politicians will?play a role, and label prudent regulations as “business killers.”
Central bankers have to act like hyperactive forest rangers, providing liquidity for the most trivial of financial crises, thus allowing the dry tinder of bad debts to build up as bankers use cheap funding to make loans they never dreamed that they could.
It helps if you have parties interested in perpetuating the situation, suggesting that the momentum is unstoppable, and that many people are fools to be passing up the “free money.” ?Don’t you know that “Everybody ought to be rich?” [DM: then who will deliver the pizza? ?Are you really rich if you can’t get a pizza delivered?] ?These parties can be salesmen, journalists, authors, etc. whipping up a frenzy of speculation. ?They also help marginalize as?”cranks” the wise critics who point out that the folly eventually will have to end.

Promises, promises. ?And all too good to be true, but it all looks reasonable in the short run, so the game continues. ?The speculation can take many forms: houses, speculative companies like dot-coms or railroads, even stocks themselves on sufficient margin debt. ?And, dare I say it, it can even apply to old age security schemes, but we haven’t seen the endgame for that one yet.

At the end, the disaster appears out of nowhere. ?The weak link in the chain breaks — vendor financing, repo financing, a run on bank deposits, margin loans, subprime loans — that which was relied on for financing becomes recognized as a short-term?obligation that must be met, and financing terms change dramatically, leading the entire system to recognize that many assets are overpriced, and many borrowers are inverted.

Congratulations, folks, we created a black swan. ?A very different event appears than what many were counting on, and a bad?self-reinforcing cycle ensues. ?And, the proximate cause is unclear, though the causes were many in society pursuing an asset boom, and borrowing and speculating as if there is no tomorrow. ?Every individual action might be justifiable, but the actions as a group lead to a crisis.

In closing, though I see some bad lending reappearing, and a variety of assets at modestly speculative prices, there is no obvious crisis facing us in the short-run, unless it stems from a foreign problem like Chinese banks. ?That said, the pension promises made to those older in most developed countries are not sustainable. ?That one will approach slowly, but it will eventually bite, and when it does, many will say, “No one could have predicted this disaster!”

Inevitable Ineffective Banking Regulation

Posted on 1 October 20141 October 2014 by David Merkel

I am mystified at why people might be outraged or surprised that the Federal Reserve does a poor job of overseeing banks. ?The Fed is an overstaffed bureaucracy. ?Overstaffed bureaucracies always tend toward consensus and non-confrontation.

I know this from my days of working as an actuary inside an overstaffed life insurance company, and applying for work in other such companies. ?I did not fit the paradigm, because I had strong views of right and wrong, and strong views on how to run a business well, which was more aggressive than the company that I worked for was generally willing to do. ?Note that only one such company was willing to hire me, and I nearly got fired a couple of times for proposing ideas that were non-consensus.

This shouldn’t be too surprising, given the past behavior of the Fed. ?In 2006, the Fed made a few theoretical noises about residential real estate loan quality, but took no action that would make the lesser regulators do anything. ?It’s not as if they didn’t have the power to do it. ?One of the great canards of financial reform is that regulators did not have enough power to stop the bad lending. ?They most certainly did have enough power; they just didn’t use it because it is political suicide to oppose a boom. ?(Slide deck here.)

As a result, I would not have enacted Dodd-Frank, because I like my laws simple. ?Instead, I would have fired enough?of the regulators to make a point that they did not do their jobs. ?How many financial regulators were fired in 2008-2009? ?Do you hear the crickets? ?This is the #1 reason why you should assume that it is business as usual in banking regulation.

You won’t get assiduous regulation unless regulators are dismissed for undue leniency. ?I have heard many say in this recent episode with Goldman Sachs, the New York Fed, and?Carmen Segarra that those working for the Fed are bright and hard-working. ?I’ll give them the benefit of the doubt; my own dealings with those that work for the Fed is that most of them, aside from bosses,?are quiet, so you can’t tell.

Being quiet, and favoring the powerful, whether it is bosses, politicians, or big companies that you regulate is the optimal strategy for advancement at the Fed over the last 30 years. ?It doesn’t matter much how bright you are, or how hard you work, if it doesn’t have much impact on the organization’s actions.

I try to be an optimistic kind of guy, but I don’t see how this situation can be changed without firing a lot of people, including most of the most powerful people at the Fed, lesser banking regulators, and US Treasury.

And if we did change things, would we like it? ?Credit would be less available. ?I think that would be an exceptionally good thing, but most of our politicians are wedded to the idea that increasing the availability of credit is an unmitigated good. ?They think that because they don’t get tagged for the errors. ?They take credit for the bull market in credit, and blame everyone except themselves and voters for the inevitable bear market.

Also, if we did fire so many people, where would we find our next crop of regulators? ?Personally, I would hand banking regulation back to the states, and end interstate branching, breaking up the banks in the process.

Remember, the insurance industry, regulated by the states, is much better regulated than the banking industry. ?State regulators are much less willing to be innovative, and far more willing to say no. ?State regulation is simple/dumb regulation, which is typically good regulation.

But whether you agree with my policy prescription or not, you should be aware that things are unlikely to change in banking regulation, because it is not a failure of laws and regulations, but a failure of will, and we have the same sorts of people in place as were there prior to the financial crisis.

Postscript

I would commend the articles cited by Matt Levine of Bloomberg regarding this whole brouhaha:

A bit more on Carmen Segarra.

Apparently the place to discuss regulatory capture is on Medium. Here is Dan Davies:

Regulated institutions generally have better contacts and relationships with the top central bankers than their supervisors do. And for whatever reason, top central bankers never developed the necessary knee-jerk aggressive response to any attempts to make use of these relationships to affect the behaviour of supervisors.
So banks never need to listen to their line-level regulators because they can always get those regulators’ bosses’ bosses’ bosses to overrule them. Here is Felix Salmon, mostly agreeing. And here is Alexis Goldstein with a litany of Fed enabling of banks. Elsewhere, Martien Lubberink explains the transaction that got so much attention in the Fed tapes, in which Goldman agreed to hang on to some Santander Brasil stock for a year before delivering it to Qatar. He thinks it was pretty vanilla. And Adam Ozimek has a good point:

This American Life ep should lower avg est corruption belief. Goldman and NY Fed secretly taped & all u get is in non-confrontational nerds?

Volatility Can Be Risk, At Rare Times

Posted on 19 September 201419 September 2014 by David Merkel

There is a saying in the markets that volatility is not risk. In general this is true, and helps to explain why measures like beta and standard deviation of returns do not measure risk, and are not priced by the market. After all, risk is the probability of losing money, and the severity thereof.

It’s not all that different from the way that insurance underwriters think of risk, or any rational businessman for that matter. But just to keep things interesting, I’d like to give you one place where volatility is risk.

When overall economic conditions are serene, many people draw the conclusion that it will stay that way for a long time. That’s a mistake, but that’s human nature. As a result, those concluding that economic conditions will remain serene for a long time decide to take advantage of the situation and borrow money.

When volatility is low, typically credit spreads are low. Why not take advantage of cheap capital? Well, I would simply argue that interest rates are for a time, and if you don’t overdo it, paying interest can be managed. But what happens if you have to refinance the principal of the loan at an inopportune time?

When volatility and interest spreads are low for you, they are low for a lot of other people also. Debt builds up not just for you, but for society as a whole. This can have the impact of pushing up prices of the assets purchased using debt. In some cases, the rising asset prices can attract momentum buyers who also borrow money in order to own the rising assets.

This game can continue until the economic yield of the assets is less than the yield on the debt used to finance the assets. Asset bubbles reach their breaking point when people have to feed cash to the asset beyond the ordinary financing cost in order to hold onto it.

In a situation like this, volatility becomes risk. Too many people have entered into too many fixed commitments and paid too much for a group of assets. This is one reason why debt crises seem to appear out of the blue. The group of assets with too much debt looks like they are in good shape if one views it through the rearview mirror. The loan-to-value ratios on recent loans based on current asset values look healthy.

But with little volatility in some subsegment of the overly levered assets, all of a sudden a small group of the assets gets their solvency called into question. Because of the increasing level of cash flows necessary to service the debt relative to the economic yield on the assets, it doesn’t take much fluctuation to make the most marginal borrowers question whether they can hold onto the assets.

Using an example from the recent financial crisis, you might recall how many economists, Fed governors, etc. commented on how subprime lending was a trivial part of the market, was well-contained, and did not need to be worried about. Indeed, if subprime mortgages were the only weak financing in the market, it would’ve been self-contained. But many people borrowed too much chasing inflated values of residential housing. ?As asset values fell, more and more people?lost willingness to pay for the depreciating assets.

We’ve had other situations like this in our markets. Here are some examples:

Commercial mortgage loans went through a similar set of issues in the late 80s.
Lending to lesser developed countries went through similar set of issues in the early 80s.
The collateralized debt obligation markets seem to have their little panics every now and then. (late 90s, early 2000s, mid 2000s, late 2000s)
During the dot-com bubble, too much trade finance was extended to marginal companies that were burning cash rapidly.
The roaring 20s were that way in part due to increased debt finance for corporations and individuals.

At the peak some say, “Nobody rings a bell.” This is true. But think of the market peak as being like the place where the avalanche happened 10 minutes before it happened. What set off the avalanche? Was it the little kid at the bottom of the valley who decided to yodel? Maybe, but the result was disproportionate to the final cause. The far more amazing thing was the development of the snow into the configuration that could allow for the avalanche.

This is the way things are in a heavily indebted financial system. At its end, it is unstable, and at its initial unwinding the proximate cause of trouble seems incapable of doing much harm. But to give you another analogy ask yourself this: what is more amazing, the kid who knocks over the first domino, or the team of people spending all day lining up the huge field of dominoes? It is the latter, and so it is amazing to watch large groups of people engaging in synchronized speculation not realizing that they are heading for a significant disaster.

As for today, I don’t see the same debt buildup has we had growing from 2003 to 2007. The exceptions maybe student loans, parts of the energy sector, parts of the financial sector, and governments. That doesn’t mean that there is a debt crisis forming, but it does mean we should keep our eyes open.

The FSOC is Full of Hot Air

Posted on 6 September 2014 by David Merkel

I’ve written about this before, but if the FSOC wants to prove that they don’t know what they are doing, they should define a large life insurer to be a systemic threat.

It is rich, really rich, to look at the rantings of a bunch of bureaucrats and banking regulators who could not properly regulate banks for solvency from 2003-2008, and have them suggest solvency regulation for a class of businesses that they understand even less.

And, this is regarding an industry that posed little?systemic threat during the financial crisis. ?Yes, there were the life subsidiaries of AIG that were rescued by the Fed, and a few medium-large life insurers like Hartford and Lincoln National that took TARP money that they didn’t need. ?Even if all of these companies failed, it would have had little impact on the industry as a whole, much less the financial sector of the US.

Life insurance companies have much longer liability structures than banks. ?They don’t have to refresh their financing frequently to stay solvent. ?It is difficult to have a “run on the company” during a time of financial weakness. ?Existing solvency regulation done by actuaries and filed with the state regulators considers risks that the banks often do not do in their asset-liability analyses.

Systemic risk comes from short-dated financing of long-dated assets, which is often done by banks, but rarely by life insurers. ?I’ve written about this many times, and here are two of the better ones:

MetLife and other insurers should not have to live with the folly of “Big == Systemic Risk.” ?Rather, let the FSOC focus on all lending financials that borrow short and lend long, particularly those that use the repurchase markets, or fund their asset inventories via short-term lending agreements. ?That is the threat — let them regulate banks and pseudo-banks right before they dare to regulate something they clearly do not understand.

Peddling the Credit Cycle

Posted on 25 August 2014 by David Merkel

Starting again with another letter from a reader, but I will just post his questions in response to this article:

1)?How much emphasis do you put on the credit cycle? I guess given your background rather a great deal, although as a fundamentals guy, I imagine you don?t try and make macro calls.

2) ?What sources do you look at to make estimates of the credit cycle? Do you look at individual issues, personal models, or are there people like Grant?s you follow?

3) Do you expect the next credit meltdown to come from within the US (as your article suggests is possible) or externally?

4)?How do you position yourself to avoid loss / gain from a credit cycle turn? Do you put more?emphasis?on?avoiding loss or looking for profitable speculation (shorts or quality)

1) I put a lot of emphasis on the credit cycle. ?I think it is the governing cycle in the overall economic cycle. ?When some sector of the economy finds itself under credit stress, it has a large impact on stocks in that sector and related areas.

The problem is magnified when that sector is banks, S&Ls and other lending enterprises. ?When that happens, all of the lending-dependent areas of the economy tend to slump, especially those that have had the greatest percentage increase in debt.

There’s a saying among bond managers to avoid the area with the greatest increase in debt. ?That would have kept you out of autos in the early 2000s, Telecoms after that, and Banks/Finance heading into the Financial Crisis. ?Some suggest that it is telling us to avoid the junior energy names now — those taking on a lot of debt to do fracking… but that’s too small to be a significant crisis. ?Question to readers: where do you see debt rising? ?I would add the US Government, other governments, and student loans, but where else?

2) I just read. ?I look for elements of bad underwriting: loosening credit standards, poor collateral, financial entities focused on growth at all costs. ?I try to look at credit spread relationships relative to risks undertaken. ?I try to find risks that are under- and over-priced. ?If I can’t find any underpriced risks, that tells me that we are in trouble… but it doesn’t tell me when the trouble will hit.

I also try to think through what the Fed is doing, and think what might be harmed in the next tightening cycle. ?This is only a guess, but I suspect that emerging markets will get hit again, just not immediately once the FOMC starts tightening. ?It may take six months before the pain is felt. ?Think of nations that have to float short-term debt to keep things going, particularly if it is dollar-denominated.

I would read Grant’s… I love his writing, but it costs too much for me. ?I would rather sit down with my software and try to ferret out what industries are financing with too much debt (putting it on my project list…).

3) At present, I think that an emerging markets crisis is closer than a US-centered crisis. ?Maybe the EU,?Japan, or China will have a crisis first… the debt levels have certainly been increasing in each of those places. ?I think the US is the “least dirty shirt,” but I don’t hold that view strongly, and am willing to be challenged on that.

That last piece on the US was written about the point of the start of the last “bitty panic,” as I called it. ?For a full-fledged crisis in US corporates, we need the current high issuance of??corporates to mature for 2-3 years, such that the cash is gone, but the debts remain, which will be hard amid high profit margins. ?Unless profit margins fall, a crisis in US corporates will be remote.

4) My goal is not to make money off of the bear phase of the credit cycle, but to lose less. ?I do this because this is very hard to time, and I am not good with Tactical Asset Allocation or shorting. ?There are a lot of people that wait a long time for the cycle to turn, and lose quite a bit in the process.

Thus, I tend to shift to higher quality companies that can easily survive the credit cycle. ?I also avoid industries that have recently taken on a lot of debt. ?I also raise cash to a small degree — on stock portfolios, no more than 20%. ?On bond portfolios, stay short- to intermediate-term, and high to medium high quality.

In short, that’s how I view the situation, and what I would do. ?I am always open to suggestions, particularly in a confusing environment like this. ?If you’re not puzzled about the current environment, you’re not thinking hard enough. 😉

Till next time.

A Few Investment Notes

Posted on 9 August 201410 August 2014 by David Merkel

Just a few notes for this evening:

1) I’ve been a bull on the long end of the Treasury curve for a while. ?It’s been a winning bet, and the drumbeat of “interest rates have nowhere to go but up” continues. ?Here’s an argument from Jeffrey Gundlach on why long rates should remain low, and maybe go lower:

Gundlach, however, was one of the very few people?who believed rates would stay low, especially with the Federal Reserve committed to keeping rates low with its loose monetary policy.

It’s important to note that U.S. Treasuries don’t have the lowest yields in the world. French and?German government bonds have yields?that are about 100 basis points lower than those of Treasuries. In other words, those European bonds actually make U.S. bonds look cheap, meaning that yields have room to go lower.

This will trend toward lower rates will eventually have to end, but neither GDP growth, inflation, or business lending justifies it at present.

2) From Josh Brown, he notes that correlations went up considerably with all risk assets in the last bitty panic. ?Worth a read. ?My two cents on the matter comes from my recent article, On the Recent Anxiety in High Yield Bonds, where I noted how much yieldy stocks got hit — much more than expected. ?I suspect that some asset allocators with short-dated or small stop-loss trading rules began selling into the bitty panic, but that is just a guess.

3) That would help to explain the loss of liquidity in the bond market during the bitty panic. ?This article from Tracy Alloway at the FT explores that topic. ?One commenter asked:

Isn’t it a bit odd to say lots of people sold quickly *and* that there isn’t enough liquidity??

Liquidity means a number of things. ?In this situation, spreads widened enough that parties that wanted to sell had to give up price to do so, allowing the brokers more room to sell them to skittish buyers willing to commit funds. ?Sellers were able to get trades done at unfavorable levels, but they were determined to get the trades done, and so they were done, and a lot of them. ?Buyers probably had some spread target that they could easily achieve during the bitty panic, and so were willing to take on the bonds. ?Having a balance sheet with slack is a great thing when others need liquidity now.

One other thing to note from the article is that it mentioned that retail investors now own 37%?of credit, versus?29% in 2007, according to RBS. Also that?investment funds has been able to buy?all?of the new corporate debt sold since 2008.

There’s more good stuff in the article including how “matrix pricing” may have influenced the selloff. ?When spreads were so tight, it may not have taken a very large initial sale to make the estimated prices of other bonds trade down, particularly if the sales were of lower-rated, less-traded bonds. ?Again, worth a read.

4) Regarding credit scores, three articles:

Are We Giving Americans Too Much Credit?
FICO Recalibrates Its Credit Scores
On Credit Scores?(an old article of mine)

From the WSJ article:

Fair Isaac?Corp.?said Thursday that it will stop including in its FICO credit-score calculations any record of a consumer failing to pay a bill if the bill has been paid or settled with a collection agency. The San Jose, Calif., company also will give less weight to unpaid medical bills that are with a collection agency.

I think there is less here than meets the eye. ?This only affects those borrowing from lenders using the particular FICO scores that were modified. ?Not all lenders use that particular score, and many use FICO data disaggregated to create their own score, or ask FICO to give them a custom score that they use. ?Again, from the WSJ article:

Fair Isaac releases new scoring models every few years, and it is up to lenders to choose which ones to use. The new score will likely be adopted by credit-card and auto lenders first, says John Ulzheimer, president of consumer education at CreditSesame.com and a former Fair Isaac manager.

Mortgages are likely to lag, since the FICO scores used by most mortgage lenders are two versions old.

The?impact of the changes on borrowers is likely to be significant. Accounts that are sent to collections, including credit-card debts and utility bills, can stay on borrowers’ credit reports for as long as seven years, even when their balance drops to zero, and can lower their scores by up to 100 points, said Mr. Ulzheimer.

The lower weight given to unpaid medical debt could increase some affected borrowers’ FICO scores by 25 points, said Mr. Sprauve.

But lowering the FICO score by itself doesn’t do anything. ?Some lenders don’t adjust their hurdles to reflect the scores, if they think the score is a better measure of credit for their time-horizon, and they want more loan volume. ?Others adjust their hurdles up, because they want only a certain volume of loans to be made, and they want better quality loans at existing pricing.

Megan McArdle at Bloomberg View asks a different question as to whether it is good to extend more credit to marginal borrowers? ?Didn’t things go wrong doing that before? ?Her conclusion:

That in itself [DM: pushing for more loans to marginal borrowers as a matter of policy] is an interesting development. Ten years ago, politicians were pressing hard for banks to extend the precious boon of homeownership to every man, woman and shell corporation in America. Five years ago, when people were pushing for something like the CFPB, the focus of the public debate had dramatically shifted toward protecting people from credit. Oh, there were complaints about the cost of subprime loans, but ultimately, on most of those loans, the problem?wasn?t the interest rate but the principal: Too many people had taken out loans that they could not realistically afford to pay, especially if anything at all went wrong in their lives, from a job loss to a divorce to an unexpected illness. And so you heard a lot of complaints about predatory lenders who gave people more credit than they could handle.

Credit has tightened considerably since then, and now, it appears, we?re unhappy with that. We want cheaper, easier credit for everyone, and particularly for the kind of financially struggling people who have seen their credit scores pummeled over the last decade. And so we see the CFPB pressing FICO to go easier on people with satisfied collections.

That?s not to say that the CFPB is wrong; I don?t know what the ideal amount of credit is in a society, or whether we are undershooting the mark. What I do think is that the U.S. political system — and, for that matter, the U.S. financial system — seems to have a pretty heavy bias toward credit expansion. Which explains a lot about the last 10 years.

Personally, I look at this, and I think we don’t learn. ?Credit pulls demand into the present, which is fine if it doesn’t push losses and heartache into the future. ?We are better off with a slower, less indebted economy for a time, and in the end, the economy as a whole will be better off, with people saving to buy in the future, rather than running the risk of defaults, and a very punk economy while we work through the financial losses.

A Different Look at Neglect

Posted on 1 August 2014 by David Merkel

It’s good to look at stocks that not everyone else is looking at. ?A little neglect can be a good thing.

Companies that are a little illiquid.
Companies with a dedicated shareholder base; they don’t sell at the drop of a hat.
Companies with control investors that don’t give outside passive minority investors the short end of the stick.
Companies that have odd business models that have most investors ignore them
Companies in boring businesses.

Let’s look at this top down, looking at neglect by market sector. ?Days to turn over indicates how rapidly stocks are traded. ?A high number means they trade more slowly.

Sector	Market Cap ($M)	Dollar Volume ($K)	Days to turn over
05 – Consumer Non-Cyclical	1,536,807	7,274,592	211
07 – Financial	3,511,041	16,767,713	209
12 – Utilities	1,051,811	5,348,267	197
06 – Energy	2,425,787	14,781,550	164
02 – Capital Goods	1,253,361	7,882,012	159
08 – Health Care	2,428,969	16,080,916	151
Grand Total	23,817,027	161,861,109	147
01 – Basic Materials	947,830	6,770,631	140
11 – Transportation	594,989	4,279,380	139
03 – Conglomerates	15,805	116,462	136
09 – Services	4,936,835	37,308,869	132
10 – Technology	4,368,575	38,382,921	114
04 – Consumer Cyclical	745,217	6,867,798	109

In general, colder sectors attract more long-term holders. ?Sectors where competitive conditions change more rapidly turn over faster.

An aside before we go on — I excluded from this analysis:

Foreign stocks trading on US exchanges
Over the counter stocks
Stocks with less than $10 million in market cap
Exchange traded products

That left me with around 3900 stocks. ?As an aside, stock turnover seems have to increased, and I wonder if high frequency?trading and ETP creation/liquidation might be driving that. ?147 days for an average holding period means stocks trade their entire market capitalization ?around 2.5x per year. ?Cue up the commentary from Buffett and Munger about how most trading in the stock market is wasted effort.

But now let’s look at industries:

Industry	Market Cap ($M)	Dollar Volume ($K)	Days to turn over
0715 – Insurance (Property & Casualty)	632,449	1,730,968	365
0112 – Fabricated Plastic & Rubber	3,298	10,484	315
1206 – Natural Gas Utilities	435,106	1,407,846	309
0506 – Beverages (Non-Alcoholic)	354,710	1,217,841	291
1103 – Air Courier	139,858	505,601	277
0521 – Personal & Household Products	434,008	1,574,389	276
1209 – Water Utilities	17,103	64,198	266
0724 – Money Center Banks	223,336	877,033	255
0524 – Tobacco	272,385	1,170,334	233
0606 – Oil & Gas – Integrated	438,181	1,900,557	231
0957 – Retail (Grocery)	398,981	1,740,963	229
0712 – Insurance (Miscellaneous)	51,749	227,575	227
0218 – Misc. Capital Goods	417,891	1,859,649	225
0975 – Waste Management Services	59,927	283,562	211
0730 – S&Ls/Savings Banks	1,887	9,013	209
1112 – Railroads	186,397	902,219	207
0809 – Major Drugs	227,419	1,135,147	200
0915 – Communications Services	692,373	3,519,894	197
0503 – Beverages (Alcoholic)	52,692	273,645	193
0727 – Regional Banks	1,227,813	6,422,106	191
1030 – Scientific & Technical Instruments	265,595	1,393,898	191
0706 – Insurance (Accident & Health)	247,622	1,310,785	189
0718 – Investment Services	554,225	2,934,362	189
0418 – Footwear	80,706	428,470	188
0512 – Fish/Livestock	1,917	10,383	185
0703 – Consumer Financial Services	405,697	2,203,610	184
0203 – Aerospace and Defense	402,223	2,254,100	178
0960 – Retail (Home Improvement)	169,283	956,876	177
0127 – Misc. Fabricated Products	77,222	439,594	176
0221 – Mobile Homes & RVs	5,297	31,414	169
0612 – Oil Well Services & Equipment	574,292	3,407,144	169
0106 – Chemicals – Plastics and Rubbers	173,053	1,038,370	167
0954 – Retail (Drugs)	230,495	1,417,370	163
1109 – Misc. Transportation	73,963	456,181	162
0103 – Chemical Manufacturing	353,360	2,227,847	159
0709 – Insurance (Life)	166,263	1,052,261	158
0803 – Biotechnology & Drugs	1,613,675	10,424,895	155
1203 – Electric Utilities	599,603	3,876,223	155
0415 – Auto & Truck Parts	203,596	1,324,773	154
0509 – Crops	4,889	31,874	153
0918 – Hotels & Motels	94,044	616,953	152
0609 – Oil & Gas Operations	1,386,175	9,141,482	152
0209 – Construction – Supplies and Fixtures	140,270	934,529	150
1006 – Computer Hardware	72,374	487,123	149
1036 – Software & Programming	1,152,944	7,816,781	147
Grand Total	23,817,027	161,861,109	147
0921 – Motion Pictures	159,568	1,105,864	144
1024 – Electronic Instruments & Controls	182,569	1,279,912	143
0515 – Food Processing	403,598	2,854,143	141
0909 – Business Services	446,084	3,157,933	141
0812 – Medical Equipment & Supplies	436,733	3,130,033	140
0930 – Printing Services	7,170	51,557	139
0109 – Containters & Packaging	81,869	590,633	139
0933 – Real Estate Operations	594,286	4,295,888	138
0206 – Construction & Agricultural Machinery	137,131	991,809	138
0303 – Conglomerates	15,805	116,462	136
0969 – Schools	21,108	160,274	132
1115 – Trucking	44,104	336,398	131
0939 – Rental & Leasing	238,564	1,828,936	130
0130 – Non-Metallic Mining	4,789	37,031	129
0942 – Restaurants	219,661	1,709,208	129
1118 – Water Transportation	32,241	255,920	126
0406 – Appliances & Tools	55,182	456,389	121
0927 – Printing & Publishing	91,943	760,613	121
0133 – Paper & Paper Products	30,855	256,597	120
0936 – Recreational Activities	75,698	643,463	118
0124 – Metal Mining	98,839	864,894	114
0430 – Recreational Products	54,015	474,019	114
0421 – Furniture & Fixtures	31,741	279,508	114
0948 – Retail (Catalog & Mail Order)	266,904	2,421,091	110
0806 – Healthcare Facilities	151,142	1,390,841	109
0121 – Iron & Steel	76,186	704,432	108
0924 – Personal Services	41,546	386,447	108
0403 – Apparel/Accessories	89,378	848,477	105
1018 – Computer Services	1,023,238	9,989,880	102
1003 – Communications Equipment	837,801	8,227,385	102
0972 – Security Systems & Services	8,892	88,979	100
1021 – Computer Storage Devices	124,136	1,290,696	96
0963 – Retail (Specialty Non-Apparel)	216,223	2,271,386	95
0945 – Retail (Apparel)	160,390	1,696,879	95
0906 – Broadcasting & Cable TV	471,387	5,029,758	94
0433 – Textiles – Non-Apparel	11,455	123,789	93
1033 – Semiconductors	670,980	7,309,563	92
0951 – Retail (Department & Discount)	102,849	1,133,640	91
1012 – Computer Networks	14,378	159,288	90
0903 – Advertising	39,473	442,180	89
0409 – Audio & Video Equipment	11,660	130,676	89
0518 – Office Supplies	12,608	141,981	89
0215 – Construction Services	119,782	1,361,922	88
0912 – Casinos & Gaming	109,703	1,259,520	87
0424 – Jewelry & Silverware	6,527	78,568	83
0603 – Coal	27,139	332,366	82
0118 – Gold & Silver	20,871	256,842	81
0115 – Forestry & Wood Products	27,489	343,907	80
1027 – Office Equipment	4,010	51,064	79
0412 – Auto & Truck Manufacturers	189,092	2,548,454	74
0436 – Tires	8,943	126,838	71
0212 – Construction – Raw Materials	30,768	448,589	69
1106 – Airline	118,426	1,823,061	65
0966 – Retail (Technology)	20,283	329,637	62
0427 – Photography	2,923	47,837	61
1015 – Computer Peripherals	20,549	377,330	54

Again, the pattern is more volatile and controversial industries trade more frequently than the more stable industries. ?One one sense, this is obvious, because the stock market can be used for two purposes — investing and gambling. ?Gambling is much more attractive when prices are volatile, and the prospects for making a big win are significant. (Even if the possibility of big losses is high as well. ?Oh well, profits tend to flow to those ?who eliminate the downside.)

Finally, let’s look at individual stocks, segmented by market capitalization.

Behemoth Stocks

Company	Ticker	Sector	Industry	Days
Berkshire Hathaway Inc.	BRK.A	07 – Financial	0715 – Insurance (Property & Casualty)	6,579
Wal-Mart Stores, Inc.	WMT	09 – Services	0957 – Retail (Grocery)	542
Exxon Mobil Corporation	XOM	06 – Energy	0609 – Oil & Gas Operations	453
Johnson & Johnson	JNJ	08 – Health Care	0803 – Biotechnology & Drugs	427
PepsiCo, Inc.	PEP	05 – Consumer Non-Cyclical	0506 – Beverages (Non-Alcoholic)	365
Procter & Gamble Company, The	PG	05 – Consumer Non-Cyclical	0521 – Personal & Household Products	362
General Electric Company	GE	02 – Capital Goods	0218 – Misc. Capital Goods	353
Wells Fargo & Co	WFC	07 – Financial	0727 – Regional Banks	345
Coca-Cola Company, The	KO	05 – Consumer Non-Cyclical	0506 – Beverages (Non-Alcoholic)	341
Chevron Corporation	CVX	06 – Energy	0606 – Oil & Gas – Integrated	339

Comcast Corporation	CMCSA	09 – Services	0915 – Communications Services	196
QUALCOMM, Inc.	QCOM	10 – Technology	1033 – Semiconductors	193
Citigroup Inc	C	07 – Financial	0727 – Regional Banks	175
Cisco Systems, Inc.	CSCO	10 – Technology	1003 – Communications Equipment	161
Intel Corporation	INTC	10 – Technology	1033 – Semiconductors	146
Bank of America Corp	BAC	07 – Financial	0727 – Regional Banks	138
Gilead Sciences, Inc.	GILD	08 – Health Care	0803 – Biotechnology & Drugs	123
Amazon.com, Inc.	AMZN	09 – Services	0948 – Retail (Catalog & Mail Order)	105
Apple Inc.	AAPL	10 – Technology	1003 – Communications Equipment	93
Facebook Inc	FB	10 – Technology	1018 – Computer Services	50

The table above lists the biggest stocks — the top ten that are less traded, and the top ten that are most traded. ?No surprises, those that are most traded are more controversial than those that are traded less. ?Also, some companies have investors with control positions, which further slows down trading as most control investors rarely trade.

Large Cap Stocks

Company	Ticker	Sector	Industry	Days
Cheniere Energy Partners LP Ho	CQH	12 – Utilities	1206 – Natural Gas Utilities	1,709
CNA Financial Corp	CNA	07 – Financial	0715 – Insurance (Property & Casualty)	1,647
Icahn Enterprises LP	IEP	09 – Services	0963 – Retail (Specialty Non-Apparel)	1,355
Spectra Energy Partners, LP	SEP	12 – Utilities	1206 – Natural Gas Utilities	1,190
Enable Midstream Partners LP	ENBL	06 – Energy	0606 – Oil & Gas – Integrated	1,166
Cheniere Energy Partners LP	CQP	12 – Utilities	1206 – Natural Gas Utilities	1,041
Thomson Reuters Corporation (U	TRI	09 – Services	0927 – Printing & Publishing	1,012
Western Gas Equity Partners LP	WGP	06 – Energy	0609 – Oil & Gas Operations	969
Enterprise Products Partners L	EPD	12 – Utilities	1206 – Natural Gas Utilities	956
Plains GP Holdings LP	PAGP	06 – Energy	0612 – Oil Well Services & Equipment	953

Citrix Systems, Inc.	CTXS	10 – Technology	1036 – Software & Programming	54
United Continental Holdings In	UAL	11 – Transportation	1106 – Airline	53
LinkedIn Corp	LNKD	10 – Technology	1018 – Computer Services	47
Yahoo! Inc.	YHOO	10 – Technology	1018 – Computer Services	47
Whole Foods Market, Inc.	WFM	09 – Services	0957 – Retail (Grocery)	45
Micron Technology, Inc.	MU	10 – Technology	1033 – Semiconductors	39
CBS Corporation	CBS	09 – Services	0906 – Broadcasting & Cable TV	37
Tesla Motors Inc	TSLA	04 – Consumer Cyclical	0412 – Auto & Truck Manufacturers	21
Netflix, Inc.	NFLX	09 – Services	0906 – Broadcasting & Cable TV	19
Twitter Inc	TWTR	10 – Technology	1018 – Computer Services	19

What fascinates me here about the low turnover stocks is the dominance of energy limited partnerships. ?Since they are income vehicles, they don’t trade as much stocks used for speculative gains.

Mid-cap Stocks

Company	Ticker	Sector	Industry	Days
CIM Commercial Trust Corp	CMCT	09 – Services	0939 – Rental & Leasing	9,382
Crown Media Holdings, Inc	CRWN	09 – Services	0906 – Broadcasting & Cable TV	4,333
Clear Channel Outdoor Holdings	CCO	09 – Services	0903 – Advertising	2,258
American National Insurance Co	ANAT	07 – Financial	0715 – Insurance (Property & Casualty)	1,756
Gamco Investors Inc	GBL	07 – Financial	0718 – Investment Services	1,627
Valhi, Inc.	VHI	01 – Basic Materials	0103 – Chemical Manufacturing	1,385
OCI Partners LP	OCIP	01 – Basic Materials	0103 – Chemical Manufacturing	1,205
Summit Midstream Partners LP	SMLP	12 – Utilities	1206 – Natural Gas Utilities	1,199
TFS Financial Corporation	TFSL	07 – Financial	0727 – Regional Banks	1,193
Global Partners LP	GLP	06 – Energy	0609 – Oil & Gas Operations	1,131

FireEye Inc	FEYE	10 – Technology	1036 – Software & Programming	21
AK Steel Holding Corporation	AKS	01 – Basic Materials	0121 – Iron & Steel	21
Ariad Pharmaceuticals, Inc.	ARIA	08 – Health Care	0803 – Biotechnology & Drugs	21
Zillow Inc	Z	09 – Services	0933 – Real Estate Operations	20
Trulia Inc	TRLA	09 – Services	0909 – Business Services	20
Sunedison Inc	SUNE	10 – Technology	1033 – Semiconductors	19
J C Penney Company Inc	JCP	09 – Services	0951 – Retail (Department & Discount)	17
SolarCity Corp	SCTY	10 – Technology	1033 – Semiconductors	17
GT Advanced Technologies Inc	GTAT	10 – Technology	1033 – Semiconductors	15
Yelp Inc	YELP	09 – Services	0927 – Printing & Publishing	12

Again. hot stocks with uncertain returns at the bottom, and stocks with more certain prospects at the top. ? Note the income vehicles in the less traded stocks.

Small Cap Stocks

Company	Ticker	Sector	Industry	Days
PHI Inc.	PHII	06 – Energy	0612 – Oil Well Services & Equipment	13,434
First Mid-Illinois Bancshares,	FMBH	07 – Financial	0727 – Regional Banks	10,674
QAD Inc.	QADB	10 – Technology	1036 – Software & Programming	8,529
Intermountain Community Bancor	IMCB	07 – Financial	0727 – Regional Banks	8,374
Greene County Bancorp	GCBC	07 – Financial	0727 – Regional Banks	7,021
Oconee Federal Financial	OFED	07 – Financial	0727 – Regional Banks	6,143
Bel Fuse, Inc.	BELFA	10 – Technology	1024 – Electronic Instruments & Controls	5,131
PrimeEnergy Corporation	PNRG	06 – Energy	0609 – Oil & Gas Operations	4,303
Community Financial Corp	TCFC	07 – Financial	0727 – Regional Banks	3,608
Transcontinental Realty Invest	TCI	09 – Services	0933 – Real Estate Operations	3,168

PowerSecure International, Inc	POWR	12 – Utilities	1203 – Electric Utilities	20
Penn Virginia Corporation	PVA	06 – Energy	0609 – Oil & Gas Operations	20
Pixelworks, Inc.	PXLW	10 – Technology	1033 – Semiconductors	20
IsoRay, Inc.	ISR	08 – Health Care	0812 – Medical Equipment & Supplies	18
Quantum Fuel Systems Tech Worl	QTWW	04 – Consumer Cyclical	0415 – Auto & Truck Parts	17
Pacific Ethanol Inc	PEIX	01 – Basic Materials	0103 – Chemical Manufacturing	17
Glu Mobile Inc.	GLUU	10 – Technology	1036 – Software & Programming	15
Achillion Pharmaceuticals, Inc	ACHN	08 – Health Care	0809 – Major Drugs	14
Walter Energy, Inc.	WLT	06 – Energy	0603 – Coal	14
Plug Power Inc	PLUG	10 – Technology	1024 – Electronic Instruments & Controls	8

Look at all of the regional banks amid those that turn over less. ?Look at all of the controversial stocks amid ?those that trade frequently.

Microcap Stocks

Company	Ticker	Sector	Industry	Days
Bridgford Foods Corporation	BRID	05 – Consumer Non-Cyclical	0515 – Food Processing	20,286
Magyar Bancorp, Inc.	MGYR	07 – Financial	0727 – Regional Banks	8,948
Bowl America Incorporated	BWL.A	09 – Services	0936 – Recreational Activities	8,599
MSB Financial Corp.	MSBF	07 – Financial	0727 – Regional Banks	5,562
Siebert Financial Corp.	SIEB	07 – Financial	0718 – Investment Services	5,136
Pathfinder Bancorp, Inc.	PBHC	07 – Financial	0727 – Regional Banks	4,764
Jacksonville Bancorp Inc	JXSB	07 – Financial	0727 – Regional Banks	4,567
Oak Valley Bancorp(NDA)	OVLY	07 – Financial	0727 – Regional Banks	4,363
Howard Bancorp Inc	HBMD	07 – Financial	0727 – Regional Banks	4,308
Bay Bancorp Inc	BYBK	07 – Financial	0727 – Regional Banks	4,240

Hyperdynamics Corporation	HDY	06 – Energy	0609 – Oil & Gas Operations	16
InterCloud Systems Inc	ICLD	09 – Services	0909 – Business Services	14
BioFuel Energy Corp.	BIOF	01 – Basic Materials	0103 – Chemical Manufacturing	10
India Globalization Capital, I	IGC	02 – Capital Goods	0215 – Construction Services	8
LiveDeal Inc	LIVE	10 – Technology	1018 – Computer Services	8
Giga-tronics, Incorporated	GIGA	10 – Technology	1024 – Electronic Instruments & Controls	7
Digital Ally, Inc.	DGLY	04 – Consumer Cyclical	0409 – Audio & Video Equipment	5
DARA Biosciences Inc	DARA	08 – Health Care	0803 – Biotechnology & Drugs	4
Spherix Inc	SPEX	09 – Services	0909 – Business Services	4
USEC Inc.	USU	12 – Utilities	1203 – Electric Utilities	3

Look at all of the bitty banks that don’t get traded. ?Perfect for some of my friends who buy and hold such banks, if they can get the trade on. ?And then, look at all of the controversial companies whose stocks trade trade like a spinning top.

I encourage all of my readers to analyze situations where there are fewer eyeballs looking. ?Analyze situations where control investors limit the trading relative to the size of the firm. ?Go where others don’t go, because it is dull. ?Look for advantage where few others do. ?And after that, be willing to hold for a while — years, not months. ?Pay attention as to whether the company has a defensible business model — strong balance sheet, moat versus competition, etc. ?Then look for a reasonable to low price. ?There is the making of a good investment.

Full disclosure: long CVX & BRK/B

On Current Credit Conditions

Posted on 18 July 201418 July 2014 by David Merkel

This should be short. ?Remember that credit and equity volatility are strongly related.

I am dubious about conditions in the bank loan market because Collateralized Loan Obligations [CLOs] are hot now and there are many that want to take the highest level of risk there. ?I realize that I am usually early on credit?issues, but there are many piling into CLOs, and willing to take the first loss in exchange for a high yield. ?Intermediate-term, this is not a good sign.

Note that corporations take 0n more debt when rates are low. ?They overestimate how much debt they can service, because if rates rise, they are not prepared for the effect on earnings per share, should the cost of the debt reprice.

It’s a different issue, but consider China with all of the bad loans its banks have made. ?They are facing another significant default, and the Chinese Government looks like it will let the default happen. ?That will not likely be true if the solvency of one of their banks is threatened, so keep aware as the risks unfold.

Finally, look at the peace and calm of low implied volatilities of the equity markets. ?It feels like 2006, when parties were willing to sell volatility with abandon because the central banks of our world had everything under control. ?Ah, remember that? ?Maybe it is time to buy volatility when it is cheap. ?Now here is my question to readers: aside from buying long Treasury bonds, what investments can you think of that benefit from rising implied volatility and credit spreads, aside from options and derivatives? ?Leave you answers in the comments or email me.

This will sound weird, but I am not as much worried about government bond rates rising, as I am with credit spreads rising. ?Again, remember, I am likely early here, so don’t go nuts applying my logic.

PS — weakly related, also consider the pervasiveness of BlackRock’s risk control model. ?Dominant risk control models may not truly control risk, because who will they sell to? ?Just another imbalance of which to be wary.