Book Reviews – Page 13 – The Aleph Blog

Book Review: Acts of God and Man

Posted on 15 February 2012 by David Merkel

Do you want to read an entertaining book about risk and insurance?? Right, I know that it is not likely that anyone could do that, but this book succeeds at the the task.? How does it do that?

1) It approaches the topic without using a lot of math.

2) It introduces you to the practical problems that anyone would face in trying to insure against any catastrophe.

3) It offers an entertaining story at the end of each chapter, some of which build off of prior stories.? The stories have farfetched elements to them, but they illustrate the main points that the chapter has made, while making you laugh.

The author gives no hints to his views on religion, but uses the concept of “acts of God,” to describe events which are out of our control, and thus need risk pooling (insurance), to contrast with “acts of man,” which potentially are controllable, though often not practical to do so.? Insurance may still have a role there, but there will be many more terms and conditions in the insurance contract.

One dominant theme of the book is how one estimates likelihood in the absence of a large amount of data.? Do you:

a) take what little data you have, and calculate an estimate? or,

b) get expert opinion on the matter, and let the small amount of data modify the experts?

The book takes the second position.? I lean toward the first position, but am not dogmatic about it.

When you are done reading this book, you will likely have skepticism toward much economic, sociological, and biometric research, because their foundations are very weak.? Estimates made are not from repeatable processes.

This is a good book.? It takes some effort to read, because the concepts are dense, but the structure of the book lightens things up.

Quibbles

Math error on page 89 — 1.5 should be 1.25.

Who would benefit from this book: Those who want to understand insurance, probability, or research better would benefit from this book.? If you want to, you can buy it here: Acts of God and Man: Ruminations on Risk and Insurance (Columbia Business School Publishing).

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

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.

Book Review: Encyclopedia of Municipal Bonds

Posted on 14 February 2012 by David Merkel

Joe Mysak is one of the true experts in the municipal bond markets, journalist or not.? He has covered municipal bonds at Bloomberg since 1999, and has covered municipals since 1981.? I have read his work for over 12 years, and I have been impressed.

So when he writes an encyclopedia of Municipal Bonds, it’s gonna be dull, right?? There are entries that are short to define simple but important concepts, but the glory of the book are the long articles, because they describe how the municipal market evolved its structure.

It’s not a dull book, if you want to understand how the Muni market came into existence, and how it acts today.

The long articles are the best, and they include:

The Arkansas Default in 1933
Auction-rate securities
Bell California pay scandal
Chapter 9
Convention Centers (stop the madness)
Default (and why it is different for munis)
Escrowed to Maturity
Garbage bonds
The Implosion at Heartland
House Museums
How Initiatives and Referendums Could and Could not affect muni financing.
Muni bond insurance — a topic I have often criticized.
Jefferson County, Alabama
Pension bonds, particularly those of New Jersey
Orange County’s default
Pension obligations, and their effect on munis
Moody’s changing their ratings for munis in 2010.
The effects of derivatives on naive municipal executives, who thought the got it.
Tobacco bonds.
Tourist attractions (bad bets for muni bond financing)
Yield-burning. (using the tax-exemption to earn arbitrage profits of some kind.)

It is the controversies and legal cases of the bond market that have had the most impact on how the market behaves today, and that is how the book covers its topics.

I learned a lot from reading this, and most muni investors would learn still more.? This book is well written, and explains the issues in detail, without resorting to unnecessary verbiage.

Quibbles

None.

Who would benefit from this book: Most investors in muni bonds would benefit from this book.? If you want to, you can buy it here: Encyclopedia of Municipal Bonds: A Reference Guide to Market Events, Structures, Dynamics, and Investment Knowledge (Bloomberg Financial).

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

Book Review: The Hedge Fund Mirage

Posted on 14 January 2012 by David Merkel

In 2003 a financial gun was put to my head, telling me to relocate or be severed.? I took severance because of all the ties my family had to the area.? I landed at a hedge fund near me, one well enough run to be immune to the criticisms of this book.

The first thing you have to understand is that corporate form is not a factor in performance.? It does not matter whether you manage a mutual fund, unit investment trust, hedge fund — what matters are your ideas, not the legal form you inhabit.

But, some of the problems with hedge funds, as a opposed to open-end mutual funds, is that:

1) Many hedge funds go out of business, and as they do, their bad performance is not recorded, and sometimes lost.

2) Hedge funds with good performance give the databases their early performance.? Bad early performance does not get reported.

3) The activity of investors chasing trends is more pronounced in hedge funds than in mutual funds, with a loss of returns of 5% in hedge funds, versus 3% in mutual funds.? This is all due to greater volatility.

4) Double alpha is generally not achievable, because most managers good at longs are not good at shorts, and vice-versa.? Going long and short are different skill sets.

The Author has a lot of experience with hedge funds, having invested with them for many years.? He knows the foibles, the pitfalls, and most of the factors that lead to subpar results.? Above all, he understands that there is no magic to hedge funds.? Just because you call you investment fund a hedge fund does not mean you will deliver market-beating results.

Aside from the book some of the works the book cites are valuable, particularly the work by Dichev and Yu, which deals with how hedge funds do well when they are small and do badly when they are big.? Trend chasing always leads to bad results, and institutional investors are not immune.

Quibbles

None.

Who would benefit from this book: Most investors would benefit from this book.? Particularly those that advise institutional clients and high net worth individuals would benefit. If you want to, you can buy it here: The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True.

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

Book Review: What Works on Wall Street (4th Edition)

Posted on 8 December 20118 December 2011 by David Merkel

I previously reviewed the First Edition.? Now it is time for the Fourth Edition.? Rather than do a teardown, I think it would be more useful if I explained how the book can best be used.? Here goes:

There has been a lot of research done on stock returns, the results of which have encouraged investment in:

Cheap stocks relative to book value, earnings, sales, EBITDA, FCF, etc.
Stocks with strong price momentum.
Stocks with strong earnings quality.

And such is true of this book.? And so, I encourage investors to focus on earnings quality, cheapness, and maybe, momentum, which hasn’t done so well of late.? (Probably too many following it.)

Now, the wrong way to use the book is to look at the highest returning strategy of the past, and follow it.? Since they test so many strategies, the one at the top is an accident of the historical period it covered.? Far better to be more humble and use a strategy that borrows from many successful strategies.? In doing that, there is less chance of amplifying the noise of the past.

Quibbles

The danger of this book is data-mining.? The deeper you dig to find what would have worked best in the past, the more you mirror the idiosyncrasies of the past, which does not then reveal the long-term principles that generally work, over intermediate-term periods.

Far better to stick with “pretty good” methods that never reach the top, but usually work.? Don’t be concern about hitting home runs, as much as getting on base regularly.? I say this because it works well for me and my clients.

Who would benefit from this book: Most investors would benefit from this book, if they are careful not to grab for the “brass ring” and imitate the strategy that has worked best in the past.? If you want to, you can buy it here: What Works on Wall Street.

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

Book Review: Exile on Wall Street

Posted on 15 November 2011 by David Merkel

Why do you do what you do?? Do you do it for money?? Many do.? Do you do it because you love it? Some get to do that.? Do you do it because you think you have the truth, and want to make it known?? Few do that.

Mike Mayo seems to be one who works for the latter two reasons, and that made him unusual on Wall Street.? As an analyst of bank stocks on Wall Street, Mike Mayo was not always right, but he was right more often than not.? He had a strong desire to tell what he saw to be the truth, which did not win him friends amid general overleverage in the banking sector (the banks lent too much).

Wall Street does not exist to make the buyers of the securities rich, rather, Wall Street exists to help companies get financing; the large profits of Wall Street come from the creation of stocks, bonds, and other securities to institutions and individuals.

There may be a question, though: if Wall Street does not exist to enrich the buyers of securities, then why do they employ analysts who try to point out value to potential buyers?? Even today, it is because Wall Street wants to make money off of the underwriting of future securities.? After all there is no money to be made in the secondary trading of ordinary securities anymore.

That is why the opinions of analysts still remain roughly 65% bullish, 30% neutral, and 5% bearish.? Their posture reflects the way Wall Street positions itself for those they make money from: securities issuers, not securities buyers.

And similar to rating agencies, it has to be that way, because only the securities issuer has a concentrated interest in the issuance of a security, and for bonds, the rating.

So what happens when a rare smart truth-teller, Mike Mayo, comes along, and does not care about the revenue generation potential of his opinions?? He gets a good reputation from institutional investors, but often loses his job inside investment banks, because he was not profitable for them.? Some clever investment bankers would use a negative opinion from Mike Mayo to sell products to fix the problems of the bank in question, but that was rare.

Book Structure

This book is part autobiography, and part a financial economics text.? We learn about those who raised Mike Mayo, and those who influenced him in his career development.? We also learn about the economics of Wall Street, as I have described above.? But behind all of it is the nagging question, “Why do you do what you do?”? In an area rife with ethical conflicts, where money goes more rapidly to those who will be cheerleaders and promoters rather than truth-tellers, asking the questions that disturb the soul are uncommon, but affected the author.

In short, the book tells of his life, and how he came to be a bank analyst.? It goes through his successes, and some of his failures.? It spends too much time on his correct analyses of Citi (Citigroup).? It shows him learning how to be professional, and take the emotion out of issuing opinions, and reactions to opinions.

It takes us through three phases of his opinions: mixed, bullish (1994-1998), and bearish (1998+).? He was willing to be bearish and lose credibility in the short run.? Of course, what do we call someone who is wrong in the short run?? We call them wrong, though those who are patient may still benefit.

After that, the book offers his opinions on what is wrong with finance, which he summarizes as ABC: fix the Accounting, put insolvent banks into Bankruptcy, and reduce the Clout of banks. All salutary suggestions I think.

Quibbles

Though he spent time on some of his failures, he should have spent more time there.? That said, I am impressed by his determination.

Saving the big banks from themselves still seems to be an afterthought rather than a goal, despite all of his efforts.

Who would benefit from this book: Most investors would benefit from this book.? It will make you skeptical of investment banks; it will teach you how Wall Street thinks.? Beyond that, you might enjoy the story of someone who tweaked the nose of Wall Street, and survived (for now).? If you want to, you can buy it here: Exile on Wall Street: One Analyst’s Fight to Save the Big Banks from Themselves.

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

Book Review: Manias, Panics, and Crashes (Sixth Edition)

Posted on 12 November 201113 November 2011 by David Merkel

This is the first book that I have reviewed twice.? I reviewed the third edition of the book previously, but I am reviewing the sixth edition now.

Kindleberger places the manias, panics, and crashes on a common grid, to see their similarities,? In it he draws on a number of common factors:

Loose monetary policy
People chase the performance of the speculative asset
Speculators make fixed commitments buying the speculative asset
The speculative asset?s price gets bid up to the point where it costs money to hold the positions
A shock hits the system, a default occurs, or monetary policy starts contracting
The system unwinds, and the price of the speculative asset falls leading to
Insolvencies with those that borrowed to finance the assets
A lender of last resort appears to end the cycle

The advantage over the third edition is that you get to hear about the Asian crisis LTCM, the tech bubble, Madoff, and the present crisis (banking & housing, soon to be sovereigns).

The main point for readers is to beware when monetary policy is easy, banking regulation is lax, and many seem to favor buying the asset du jour, often with leverage.? What is self-reinforcing on the way up will be self-reinforcing on the way down, but with greater speed and ferocity, as bad debts have to be liquidated.

Quibbles

Hindsight is 20-20.? If the US Government had rescued Lehman, something else might have proven to be “too big to rescue,” that the government might allow to fail, but miss the connectedness of the institution.? I do think the US Government should have been a DIP lender to troubled firms, but not a buyer of equity.

Who would benefit from this book: Most investors would benefit from this book.? It will make you more skeptical of assets that seems to be doing unnaturally well; it will also make you more skeptical about catching falling knives in the market.? If you want to, you can buy it here: Manias, Panics and Crashes: A History of Financial Crises.

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

Book Review: Bonds — The Unbeaten Path to Secure Investment Growth

Posted on 11 November 2011 by David Merkel

What do you do with a book that has one major thing wrong, and a lot of minor things right?? I?m not sure, but my compromise is to give it a low num1er of stars on Amazon, and mention the good and bad points.

In a perverse sense, it makes sense that someone will write a book pushing high quality bonds when the yields are so low.? There are always those that push foolish retail investors to act amid low rates.? ?It?s time to preserve value,? as low rates lock in low returns, but will low returns from bonds beat stocks, commodities, or cash?

I think not.? At present, high quality bonds are return-free risk, as James Grant would put it.

Now, the authors allege that bonds match/beat the performance of stocks over the long run.? But their argument relies on buying and rolling to an unusual bond ? the long Treasury bond.? I?m sorry, but few could have bought and rolled that, the volatility is too great.? The same argument applies to junk bonds as well.? Bearing the excesses of maturity risk or credit risk over time can yield great returns, but few can live with the volatility.

I am not a backer of the idea that the equity return premium over bonds is big, but I do back the idea that it is positive.? Equities outperform bonds by about 1%/year, with a lot of noise, which makes the outperformance dubious to na?ve watchers.? You need at least 40 years to demonstrate the effect.

The authors push their perverse view that a portfolio of high-quality bonds will outperform stocks.? Are they betting on the Second Great Depression in the process?? That?s what it would take, with rates so low.

Further, by limiting their fixed income purchases to AA bonds or better, the authors ensure that their clients lose money from their lazy investing, when it is well-known that BBB bonds return the best even after default losses.? I suspect the authors don?t want to deal with the stress that comes from occasional losses, which is a lazy way to run an investing business.? Good bond investing makes more on credit spreads than it loses on default losses.

The same argument applies to their avoidance of structured securities (ABS/MBS); intelligent investors can make extra money there.? Broad prohibitions of any investment should be a red flag to investors, particularly when the authors have no evidence.

Back to their five initial questions, with my answers:

1)????? Everyone I know has the bulk of their money in stocks, and stocks always outperform bonds.

Sorry, but the authors obfuscated to make their case.? Over the long run, stocks have outperformed bonds by 1-2%/year, but that outperformance comes in spurts, it is not level.? The authors deceptively made their case by arguing the spurts were abnormal.? Sorry, but abnormality is a normal part of markets.

2)????? I won?t be able to retire with the returns from bonds.

Particularly true with the lame way the authors invest; starve on their very modest interest income.? Investment returns are lumpy, but people want smooth returns.? Markets can?t be changed, but can people discipline themselves to wait for lumpy returns when they come?

3)????? I understand stocks, but bonds are too complicated.

Bonds are simple, but yield little now.? Stocks yield more, but yes, can go down.

4)????? Bonds won?t keep up with inflation.

No they won?t, but stocks, particularly cyclical stocks will do far better.

5)????? Bonds don?t provide any growth.

One of the biggest lies of this book is that bonds provide growth as a result of investing what you don?t spend.? That is not growth, that is savings.

All that said, unless the investor can discipline his emotions, he is probably better off investing in bonds, even though he will earn much less.

Quibbles

Page 52 ? The authors did not do their homework: the Old Testament did not prohibit interest; it prohibited taking interest from the poor, to avoid enslaving them.? Business loans were permitted.

Pages 330-331 the authors make a lot out the disadvantages of bond funds, but aside from paying an upfront load, the disadvantages are small relative to individual bonds over a long time period.

Page 362 ? the authors don?t fully get stable value funds.? Yes, the attempt to create them for anyone to invest in did not work, but for 401(k)s, which is the majority of the market, there was never an investigation, and they function well to this day.

Who would benefit from this book: No one would benefit from this book.? It deceives and preys on the ignorance of average investors who have been burnt by the stock market.? If you want to, you can buy it here: Bonds: The Unbeaten Path to Secure Investment Growth.

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

Book Review: Waffle Street

Posted on 8 November 20118 November 2011 by David Merkel

Imagine that you had a privileged position analyzing mortgage securities, only to see your world blow up as the prices of residential real estate began to fall across the US.? You have now been fired.? You’re young, with a beautiful wife, and your first baby on the way.? Now what do you do?

You take a job at a local Waffle House.? Waffle House is a quirky comfort food purveyor stretching across the South, and rural areas of the US.? Living outside Baltimore, the nearest one to me is 30 miles west.

The author goes through indoctrination, and since Waffle House restaurants are open 24/7, he gets the night shift, and has to deal with all of the kooks.

That makes the book all the more entertaining.? In my younger years, I ran the night shift for three years inside convenience stores in major cities.? I met my share of nuts during those times.? If you haven’t been there, serving those who are up during the night, you don’t understand that they are different, a little off, compared to those that are working when the sun shines.

The book alternates between the nuttiness of a bright guy serving nuts and the lower classes, and him explaining how the economy works.? An odd formula for a book, but he makes it work.

I recommend the book, and I write this as one who was skeptical of the book when the PR flack asked me if I wanted it.

Quibbles

The comment on page 238 that an insurance company is a hedge fund in drag is utterly wrong.? Hedge funds have short liability structures, and often go out of business because they lose money, and investors leave them.? Insurance companies have longer liability structures, and they survive many situations that would otherwise kill a hedge fund.

Who would benefit from this book: Most investors would benefit from this book.? It entertains, and distributes knowledge casually, as if one were taking bites out of waffles.? If you want to, you can buy it here: Waffle Street: The Confession and Rehabilitation of a Financier.

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

Book Review: The Greatest Trades of All Time

Posted on 5 November 2011 by David Merkel

This book grew on me. Think of it as “How I hit a home run in investing.”? Who are the sluggers that earned outsized returns?

But, there is a problem here, and the book would have been better if it had recognized the problem.? In a few cases, the “greatest” made one (or a few) good decisions.? In more cases, they made many good decisions that compounded over time.

Was the first group lucky? Maybe, but when things work out for the reasons that you specify in advance, I think not.? The problem of the first group is repeatability, which for John Paulson, is proving to be an issue for his asset management shop at present.

The investment markets are cruel.? No matter what you have done in the past, the question comes, “What have you done for me lately?” The pressure is high, so no wonder that one of the investors that the book mentioned has gone into hiding.

There are two more dimensions here.? Imagine an investor that made some amazing gains , but then craters.? There are some brilliant investors for which that has been true: Livermore, Niederhoffer, Keynes, and more… how much credit should we give to the gains, if the price is flameouts?

Second, imagine someone who is the best in class at a low-return area of the asset markets, like Jim Chanos in short-selling, or Bill Gross at Pimco.? They may not earn that much, but the skill level is really high.? But is the skill level so high when they chose areas of the market to work in that are low -return?

Maybe the book should have featured private equity players, or real estate investors, or those that have managed university endowments well… there are other investors that would be comparable or better to the returns of some in this book.

Or ask, where is Buffett?? He would deserve a spot here, not for any one trade, but for the multitude of clever trades and mergers he has done over the years.

Quibbles

The book needed a better editor.? Information on Templeton is repeated.? Beyond that, most of the ideas on how an average investor could try to replicate the strategies of the great investors are akin to drinking near-beer.? They are too weak, but on the other hand, without the brilliance of the investors, an average person would not know when to but and sell.

With those caveats, I recommend the book highly.? It is well-written, and it will fill out knowledge gaps in amateur investors.

Who would benefit from this book: Most investors would benefit from this book.? If you want to, you can buy it here: The Greatest Trades of All Time: Top Traders Making Big Profits from the Crash of 1929 to Today (Wiley Trading).

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

Book Review: China and the Credit Crisis

Posted on 4 November 20114 November 2011 by David Merkel

This is a book that is bullish on China; it does not visit any of the arguments of the bears.

That said, there are many reasons to commend the book:

It accurately describes China’s foreign policy including its interactions with the developing world, which are often far more logical and consistent than US policy.
It is fair in its rendering that China may have been a factor in the credit bubble, but was not the primary instigator.
It describes how China has grown to interact with global organization on its own terms.
It describes the history China/US relations fairly, including the rough spots where China and the US don’t see eye-to-eye, and sometimes play dirty.

Places where I think the book misses

It will be difficult to displace the US Dollar as the global reserve currency.? So long as export-driven nations sell goods on net to the US, and want to keep their currencies artificially cheap, they will have to buy US dollar-denominated assets in order to make that happen.

Pretend currencies like Strategic Drawing Rights are a nonsolution.? It has no active market, and reflects a view that one can have a single monetary policy for the world.? If a single monetary policy for the Eurozone does not work, how much less the world as a whole?

Beyond that, though China is a leading nation economically in Asia, Asian nations are more diffident to follow China’s lead politically.? Outside of Asia, China’s diplomatic moves have been received more favorably, say, in Latin America and Africa.? Asian nations have a long history with China, and realize that its size and power needs a counterweight like the US.? I agree with the author that the US lost a lot of credibility diplomatically after 9/11, given the way that we responded, but the US still has a lot of favor among Asian nations in a way that China can’t replace.

Finally the book fails to develop the details of China’s economic/financial system, and as such, falls into the hole that China bulls often do, neglecting the huge buildup of bad debt inside the major Chinese banks.

Yes, China has set up asset management companies to relieve the banks of bad debts, and transfer the losses to the MOF.? The question remains how long can this go on?? Probably a long time, because China discriminates against average consumers for the good of the Party, and the banks that aid the Party’s efforts.

Though on net I recommend this book, you would also benefit from Red Capitalism, and Uprising: Will Emerging Markets Shape or Shake the World Economy.

Quibbles

Date error on P. 38 should have been 1999, not 1990.

Who would benefit from this book: If you want to understand the Chinese economy, you will like this book.? If you want to, you can buy it here: China and the Credit Crisis: The Emergence of a New World Order.

Full disclosure: The publisher asked if I wanted the book.? I said “yes” and he sent it to me.