Book Reviews – Page 14 – The Aleph Blog

Book Review: Red Capitalism

Posted on 7 September 2011 by David Merkel

Chinese Capitalism isn’t magic.? Some parts are a little sketchy.? There are several difficult to sustain aspects of Chinese economic/financial policy.

1) The banks are basically extensions of the Chinese government.

2) Loans that the banks make are often politically motivated, made to those connected within the party; many of those loans are not economic, and the loans don’t perform.

3) Asset management companies are formed to absorb the bad debts when they become a risk to the banks.? These are funded by the Ministry of Finance, which effectively shifts losses back to the government in an indirect way, often via the People’s Bank of China.

4) China has massive foreign currency reserves, but the ability to use them domestically is limited.

5) Since 2008, forcing the the banks to lend has accelerated.? In understanding the indebtedness of the Chinese nation, one must aggregate and net the debts of the banks and other financial entities sponsored by the government.? In the US, that would mean adding and netting the debts of the GSEs.

6) The financial markets of China are bank-centric.? The bond market does not play much of a role, except that the banks absorb many of the bonds, sometimes at negative interest spreads.

7) Chinese finance can be very complex, with difficult-to-understand flowcharts for cashflow and promises, some of which hide bad debts eventually absorbed by the PBOC.? They are another example of how structured finance can obscure economic results.

8 ) When companies went/go public in China, the rewards often disproportionately went/go to party leaders and friends/family thereof.

In short, what privatization has happened in China has benefited those connected to the Party, while the banking sector the economy is the slave of the Government, despite the offering of shares to the public.

I recommend this book highly, and think the authors did a good job in being realistic about China and its financial economy.? China has a weird economy.? They could subsidize and own businesses explicitly, but instead, the subsidies are hidden inside financing.

But wait, what is the endgame here?? If all of the banks are mere extensions of the government, once inflation gets large enough, the Chinese government will have to modify/abandon what they are doing.? China steals from its consumers (financial repression) to aid its producers, who in turn give money to the Party, with whom the producers are in league.

Quibbles

None.

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 try to buy it here: Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise.

Full disclosure: I asked the publisher for the book 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: Debts Hopeful and Desperate

Posted on 30 August 2011 by David Merkel

This book review is different.? It was written back in 1963, and has not been reprinted.? If you want to buy it, you will have to buy it used.? My copy used to be a part of the Newport, Rhode Island Public Library.? It is a short recounting of the economic history of the Pilgrims.? The total pages allocated to the main text are less than 60 pages.

But a good 60 pages they are.? Michael Milken once self-servingly said, ?America was built on Junk Bonds.?? If we were talking about the Pilgrims some might say their effort was financed by loan sharks, but really, it would be fairer to say that they were financed by venture capitalists, which occasionally worked on an equity basis, and also on a debt basis.

The author does not dwell on the religious views of the Pilgrims, aside from the effects it had on the financing of the colony.? Given that this was written in 1963 that is not a weakness, because writers in that era had better historical knowledge than most in the present era, in my opinion.

Though the book has only two chapters, it breaks down into 5 phases:

The decision to emigrate from Leyden (in Holland) to the New World, obtaining an initial patent, gaining financial backers who were less than reliable, to the formation of a Joint Stock company.
Leaving England and arriving at Plymouth, Massachusetts which was not their intended destination.?? Disaster happens with their Winter arrival, with many dying.? The initial ability to service the debt is poor, which leads to squabbles among the financiers.? The joint-stock company breaks up, and the Pilgrims agree to buy out the financiers at a price that gives the financiers a profit, but leaves the leaders of the colony in debt to a new set of financiers.
Socialistic policies lead to disaster, until residents get their own land to till, leading to relative local prosperity.? In order to pay down debts the Pilgrims enter the fur trade, though with difficulties.
They get a new patent, and find that their agent, Isaac Allerton, was not fully trustworthy.? Disputes over accounting embroil the Pilgrims and their financiers, probably to the detriment of the Pilgrims.
Their financiers quarrel among themselves, after which an agreement is struck, where the amounts of goods that the Pilgrims delivered are adequate to pay off the debt.

The book doesn?t deal with the aftermath.? Anyone that has read Bradford?s writings on Plymouth Plantation would recognize that at the end, Bradford was dispirited, because almost all of those who came and survived, had moved further west to get more and better lands.? The religious motives of the colony were sufficient for its founding, but proved inadequate for its continuation.? After 25 years, the debts were paid, but for the most part, the colony had evaporated.

The collective financiers earned a handsome return, between 20-40%/year, maybe.? We don?t have enough details to be certain.? All I know is that the heavenly reward of the Pilgrims was far greater than their earthly toils to pay back their financiers.

Quibbles

The book could have dealt a little more closely with the motivations of the pilgrims, and their willingness to take deals that were against their interests.? Yes, the pilgrims were not as financially savvy as those that financed them, but they weren’t stupid either.? They were desperate to get out of the Netherlands and Britain.? That desperation drove some of the bad deals they took, and made them look like a bad risk, which narrowed down who would deal with them.? Leaving that aside, financing for most colonial ventures was stiff.

Who would benefit from this book: If you want to understand the economic struggles that the Pilgrims undertook, you will like this book.? If you want to, you can try to buy it here: Debts Hopeful and Desperate: Financing the Plymouth Colony.

Full disclosure: I bought the book with my own money.

Book Review: Saving Capitalism from Short-Termism

Posted on 24 August 2011 by David Merkel

This book was surprisingly good, and ambitious.? It takes on the short-term nature of our business culture in many areas:

The nature of the problem is that the owners no longer work for the corporations, and so managers run companies for shorter term objectives.? Owners would care more about the survival and long run profitability of the firm.
Much of the financial crisis stemmed from managing for the short-term, as financial institutions moved from a originate-to-hold to an originate-to-sell model.
Corporations focused on meeting quarterly earnings estimates, possibly to the exclusion of longer-term profitability improvements.
Investment managers manage for the short run as they try to beat indexes in the short run rather than over the long term.? Investors pulling money in the short term influences that.

The book then takes on these problems, and proposes solutions:

Create the proper long-term incentives for all parties: Executives, Line managers, and Employees.? I think he gets it right.? Make them long-term, and relative to a proper market index.? Or do it on a book basis, but make the hurdles reflect the cost of capital.
Communicate to the external world that you are no longer going to play the short-term game, like Berkshire Hathaway.? No more earnings guidance, and no more pseudo-earnings guidance where the analysts get enough to publish their estimates.
Most boldly: adopt new accounting principles that revolve around free cash flow, not earnings.? Make balance sheets probabilistic.? (even as an actuary, I don’t think we are ready for that, good as it would be)
Incent investment managers properly.? This is probably the weakest part of the book, because the problem of incenting investment managers properly is probably impossible.
Finally, how to make money.? Concentrate your investments, and if you are a good investor, you will make money over the index.

Now, some of these insights are truisms: sure concentrate your investments, and if you have good insights, you will do well.? Duh.? Most professional managers don’t have good insights, but they aren’t dropping out, and their investors are sticky enough.? That will be hard to change.

But creating longer term incentives for managers and realizable goals for workers are significant ideas.? I have argued for these for some time.? At my fellowship admissions course for the Society of Actuaries, I remember arguing with a consultant over these ideas, where she told me that longer-term incentives were unrealistic.

In a similar vein much of the book argues that you should think like a life actuary (my words, not the author’s).? Discount over the long term, taking into account interest rates and likelihood of the cash flows occurring.? I can heartily back that idea, though I wonder how well the average professional would deal with the concept.? Imagine a new income statement that has a pessimistic, realistic, and optimistic scenarios, and has ranges for accrual items off of that.? I would enjoy that, but the average investor would blanch at the complexity.

Average professionals, much less investors, don’t do well with probability? They want a point estimate and that is human nature.? Are we trying to create the NEW CAPITALIST MAN here?

Maybe, and I actually like the effort, though I think it won’t amount to much. Eliminating self-interest is very difficult; channeling it is another matter.

Quibbles

The book uses the exact same quote from Peter Bernstein on pages 54 & 130… come on, you can do better than that.? Where is the editor?

Beyond that, if you are going to rework the income statement, then differentiate between investment capital expenditures, and maintenance capital expenditures.

I think the proposed excess return versus shortfall ratio is flawed.? Under your definition, a manager who beats once by a lot, and loses often by a little, but loses versus the index overall would look good.? I think it is better to just look at long term returns versus the index, and consider Buffett’s dictum, “I would rather have a noisy 15% than a smooth 12%.”

Who would benefit from this book: Those who want to see a better capitalist economy built could benefit from this book.? If you want to, you can buy it here: Saving Capitalism From Short-Termism: How to Build Long-Term Value and Take Back Our Financial Future.

Full disclosure: The publisher sent me a copy of the book for free.

Book Review: The Era of Uncertainty

Posted on 19 August 2011 by David Merkel

Many fundamental investors have been shaped by Peter Lynch.? Invest from the bottom up.? Analyze companies, not the economy. Time spent on analyzing the economy is wasted time.

This book takes the opposite approach.? If you understand the economy, and think you know how GDP growth and inflation will go, you have a better chance of choosing the right industries and outperforming.

Like my methods of investing, he looks to understand where we are in the business cycle.? After that, look for good companies that exploit the tailwind.

I became familiar with the main author in the mid-2000s, when he worked for ISI Group.? I appreciated his approach to the markets, which was similar to mine, as the bubble grew, and he and I warned about it.

Think of it this way.? If you had been reading the main author in mid-2006, and had listened to him, how much better off would you be now?? Considerably better off and I offer many warnings over at RealMoney.com before the crisis emerged.

The book will help you understand the sectors and factors in the market that affect returns, and what elements lead those returns.

Beyond that the book expresses skepticism over many of the current economic policies of the US and other governments amid the overindebtedness of much of the world.

At the end, rather than saying, “This is what you should do,” the book asks what your views are, and says if you believe in “such and so” as an economic future, this is what you ought to do.

I liked the book a lot.? I think it is of value to most fundamental investors.

Quibbles

None

Who would benefit from this book: Most fundamental investors could benefit from this book.? If you want to, you can buy it here:?The Era of Uncertainty: Global Investment Strategies for Inflation, Deflation, and the Middle Ground.

Full disclosure: The publisher sent me a copy of the book for free.

Book Review: Expected Returns

Posted on 12 August 2011 by David Merkel

How do we estimate what returns are reasonable to expect?? Most investment counselors fall back on easy rules of thumb, but is there a way of doing better?

In this book, the author takes academic research on investment returns, and tries to make it practical.? What are the main findings of the book?

Momentum works.
Value works.
Illiquid assets can work very well if you have a balance sheet that can hold them.
Carry strategies work most of the time, but when they fail, they fail big.? Same for strategies that sell volatility.

The book does a very good job in establishing that the excess returns of stocks over bonds are a lot lower than most believe.? It also supports the idea that moderate risk taking is the superior strategy.? Those that take high risks lose too often.? Those who take no risk don’t make anything significant.? Moderate risk-taking is the sweet spot.

One of the strengths of the book is that it considers almost all assets, and analyzes how many factors affect those asset classes.? The book is comprehensive; it covers everything, even if it is only an inch deep in spots.

I liked this book a lot, but it’s not for everyone.? You won’t find a lot of difficult math here, but you will find a lot of numbers.

Quibbles

I don’t agree with the idea of levering up low risk assets.? Yes, if you are? the only one doing it, fine, be a non-regulated pseudo-bank.? The trouble comes when many do it.? Eventually a liquidity crisis hits, and those levering up low risk assets get hosed.

The same is true of university endowments.? Too many thought it was easy money to invest in illiquid assets, and when the liquidity panic came in 2008-2009, they were forced to borrow, and/or sell illiquid assets at an inopportune time.

The book does cover everything, but it doesn’t cover everything deeply.? I think it is a valuable book to most who do asset allocation, but the author knows his limits, and does not claim to be expert in a number of areas.

Who would benefit from this book: Fundamental investors who want to understand the factors behind return generation can benefit from this book.? If you want to, you can buy it here: Expected Returns: An Investor’s Guide to Harvesting Market Rewards (The Wiley Finance Series).

Full disclosure: The publisher sent me a copy of the book for free.

Book Review: Secrets in Plain Sight: Business & Investing Secrets of WARREN BUFFETT

Posted on 10 August 2011 by David Merkel

I consider myself a lesser light compared to many following Warren Buffett.? Yes, I am a value investor and an actuary, so I guess I have some punch in attempting to analyze the actions of one far greater than me.

The book is organized around two main trips that the author made to the Annual Meeting of Berkshire Hathaway, with some notes from the the 2011 tacked on.

This book tries to distill the ideas of Buffett into simple concepts, and largely succeeds.? It also alleges weaknesses? in Buffett’s reasoning.? Why not consolidate similar, less profitable businesses?? Why not invest a little more in existing businesses? I partially agree: I used to call Berkshire Hathaway “a grab bag of undermanaged businesses.”? But I’ve changed my mind, mostly.

The cost of doing the first of those could be considerable.? Buffett gets certain deals because the seller knows that he will leave the business alone.? The unique culture, friendships, family relationships will be maintained.? The seller doesn’t get top dollar, but he gets the satisfaction that he was true to those he worked with and served him.? Getting these businesses cheaply is a competitive advantage for Berkshire Hathaway, even if it means a certain amount of inefficiency.? Personally, I expect the next CEO or two will centralize the company, and turn it into a normal company.

As for investing more in existing businesses, all the manager has to do is put forth the case to his boss, Buffett.? Buffett will give him a quick decision.

But the author is right, in general, Buffett has not focused on organic growth.? He has acquired all of the businesses that the owns, aside from the reinsurance business.

This book has many strengths:

It recognizes that there is a cult following around Buffett.? He’s a bright guy, no doubt, but few questions get asked him by shareholders about his main duty, that of being CEO of Berkshire Hathaway.
It points out the significance of Charlie Munger, who got Buffett to think more broadly about value, served as a “Dr. No” to Buffett’s more optimistic demeanor.
It doesn’t spend a lot of time on Buffett as an investor in public equities, which has contributed much less to the growth of Berkshire than the acquisition of whole companies.
The demographics of Berkshire’s Annual Meeting are older and white, and in general, are the patient shareholders that Buffett likes.
Omaha is an unusual place for such a large company, but the isolation is a plus if you are trying to do something different.
Understands the basic safety rules of Buffett’s investing: margin of safety, patience, think like a businessman, simplicity, read a lot, be a good judge of character, think independently, get the big ideas right, the value of cash, don’t risk the firm, etc.
Notes the value of ethics at Berkshire, even when significant mistakes are made, like the handling of the David Sokol incident.? Reputation matters; you only get one reputation, and it affects all aspects of your business.

Quibbles

Berkshire is primarily an insurance company.? I would have spent more time on that.
I would have spent less time on non-business ethical issues, like abortion, religion, etc.? Buffett is no good guide there; he is merely justifying his past actions.
The bit about the Hoopa Indians was interesting, but when Buffett said, ?I agree that we will not exercise decisions except those ministerial in nature,? he was being very clear and simple.? Buffett is not a Christian, but he was raised in a Presbyterian household.? A minister is one who does things on behalf of another.? The issue is that there are 4 California hydroelectric plants that are old.? If the Federal government destroys them, it may help in salmon production, or farmers might like the extra water for their own use.? Buffett will simply do what the authorities want done if they are willing to pay to do it.? It is not his call in a regulated industry.
Buffett’s hypocrisy on taxation is not addressed.? He backs high estate taxes and high personal income taxes, but he doesn’t pay those.? The increase in his wealth though Berkshire, which does not pay a dividend is sheltered from tax, because he never sells a share.

Who would benefit from this book: Anyone who wants to invest better could benefit from it. At five bucks, it?s cheap. A Kindle application for my laptop was free with the purchase.? If you want to, you can buy it here: Secrets in Plain Sight: Business & Investing Secrets of Warren Buffett, 2011 Edition (eBooks on Investing Series).

Full disclosure: I bought the e-book with my own money.

Book Review: Bond Math

Posted on 29 July 201129 July 2011 by David Merkel

This book is the opposite of the book Interest Rate Markets, where bond markets were described, but there was no math.? This book was written by an academic who has done many seminars for bond professionals so that they could understand the math behind bonds.

The math rarely transcends algebra, except where he used calculus to briefly explain duration and convexity.? Perhaps he could have consulted with actuaries who use discrete approximations.

One more virtue of the book is that if you use Bloomberg, which is common for bond professionals, the book explains the nuances of how Bloomberg does many of its detailed bond calculations.? It even explains why you have to interpret some of what you get from Bloomberg with caution, because it may use different assumptions than you would expect.

So if you want to learn the bond math, this book is a congenial way to do so.? I recommend it highly.

Quibbles

Now, the writer is an academic who has never managed bonds.? As such, he can’t help a great deal with bond selection or portfolio management issues.? But that’s not the main goal of the book… he’s here to teach us the math, and nothing more.

Who would benefit from this book:

Anyone who wants to learn the bond math would benefit from this book.? Go learn and conquer.

If you want to, you can buy it here: Bond Math: The Theory Behind the Formulas (Wiley Finance).

Full disclosure: I asked the publisher for the book and he sent me a copy.

Book Review: Lords of Finance

Posted on 23 July 2011 by David Merkel

I really enjoyed this book.? It taught me a lot regarding the four main central bankers and the problems that they faced between WWI and WWII.? Add in Lord Keynes and you have real party.

WWI Reparations were too large for the Germans to afford.? But worse, France and England relied on those repayments so that they could repay America on their loans.? That made the squabble over reparations far worse.

What is more fascinating is how WWI with reparations helped lead to WWII.? The resentment of the Germans to occupation, reparations, etc., led to a fighting spirit, combined with antisemitism because of hatred of bankers, and you have a lot of what drove the war.

You will learn a lot if you read this book.? It is long, but valuable.? I recommend the book highly, subject to my disagreements.

Quibbles

Crises do not come as a result of a gold standard but from overly levered banking where liabilities are short and assets are long.? The book showed minimal understanding of basic principles of banking.

As a result, don’t listen to Keynes as much as Fisher.? Fisher understood the real cause of the Depression: too much debt.? Once debt came back to normal levels in 1941, the economy normalized.? WWII did not get us out of the depression, rather, it prolonged the suffering for those at home.

Who would benefit from this book:

Those wanting a good historical understanding of the financial facts between the First and Second World Wars will get it here.? You will understand the players and their motivations.

If you want to, you can buy it here: Lords of Finance: The Bankers Who Broke the World.

Full disclosure: I asked the publisher for the book and he sent me a copy.

Book Review: The StockTwits Edge

Posted on 16 July 2011 by David Merkel

This is an unusual book.? Like most books that involve the internet, the pace of change is so rapid that it will probably not be valuable two years from now.? But in the short run there can be benefit.

The book is 46 essays from people who are engaged to some degree in using StockTwits, a popular internet site where traders and investors exchange thoughts about investments.? The internet encourages fast exchanges of data — after all, it is called StockTwits because of Twitter, not because they are fools (Twits).? There’s another investing site for Fools, Motley as it is, and it has its own charm.

But speed in gathering information on investing is more suited to trading than investing, and so it should be no surprise that the book is 90% geared to trading, and 10% to fundamental investing.

Thus the book has the most value for those who want to learn to trade better — there are 42 traders giving their opinions on how to trade.? But the average chapter is only 8 pages long, so all you get of any trader is a taste of what they do.

My advice would be to read the book, scan for the traders/investors that fit you personality well, and talk with them at their websites to get a fuller picture of what they do.? (My favorites were Eddy Elfenbein and Todd Sullivan.)

Quibbles

Personally, I would have done a book with fewer participants and longer chapters.? I also would have included more about how StockTwits itself improves investing.? Finally, I would have had that great internet finance curator, Tadas Viskanta write the last chapter.? It would have really added to the book.

Who would benefit from this book:

Traders looking for a taste of the strategies of others would benefit from this book.? Fundamental investors will find this to be thin gruel.

If you want to, you can buy it here: The StockTwits Edge: 40 Actionable Trade Set-Ups from Real Market Pros (Wiley Trading).

Full disclosure: The publisher asked me if I wanted it.

Book Review: The Wizard of Lies

Posted on 2 July 2011 by David Merkel

This is the best book that I have read on the Madoff scandal so far.? Why is it great?

It is well written.
There are few if any factual errors in the text.
She talked with a wide number of people to try to get the full story.
It’s neutral.? it doesn’t takes positions on a wide number of unanswered questions, and treats what Madoff says with skepticism.
It takes you through the previously unwritten history of the scam, where the only real doubt is when the scam started — did it start in the early ’90s, late ’80s, or in the ’60s?? We still don’t know.

Now, I have reviewed the books by Markopolous, and the Madoff “victims.” Each tries to make themselves look good.? The author of this book has no dog in the fight, and nothing to prove.

According to this book, Markopolous discredited himself via crude behavior, fear of retaliation, and inability for the SEC to understand simple quantitative investing concepts.? The “victims” did not exercise common prudence.? The biggest red flag over any investment business is no independent custodian, and that was glaring with Madoff.

Yes, they were victims, but they were people who should have known better.? To call oneself a victim here is to call oneself stupid.

There will be another article after this one to explain why the Madoff Ponzi lasted so long, and why the recoveries ended up so much higher than anticipated.

Book Structure

The book starts with the blow-up, and then reverts to telling the life story of Madoff, progressing to the eventual demise, but with many blow-ups averted in the interim.? After that, one-third of the book deals with the aftermath, with the suicides, estrangement, and aggressive lawyers that recover far more than was originally expected.

It’s quite a tale.? I learned a bunch here, and recommend the book to you.

Quibbles

None.

Who would benefit from this book:

If you want to understand how Madoff did it, this is the book to read.? If you want to get a feel for how to avoid con men, this book will also be useful.? Give it to your overly credulous brother-in-law.

If you want to, you can buy it here: The Wizard of Lies: Bernie Madoff and the Death of Trust .

Full disclosure: The publisher asked me if I wanted it.

Quibbles

The main difficulty is this: just because A follows a similar power law to B, does not mean that A & B have something in common.? There are often spurious correlations.

Who would benefit from this book:

Most serious investors and academics could benefit from the book.? It will challenge your preconceptions.? That doesn?t mean that everything Mandelbrot writes is correct, but most of his criticisms of MPT are correct.? The question becomes what to replace MPT with?

If you want to, you can buy it here:?The Misbehavior of Markets: A Fractal View of Financial Turbulence.

Full disclosure: I bought the book with my own money.