If you have to make it simple, Warren Buffett is in the compounding business. That is what he has done since he was a young boy. He started with selling gum. He moved on to working inside the family firm.
Once his father moved onto DC as an idealistic Congressman, Buffett had a paper route, and as his assets began to grow, he bought a farm and other assets.? He was always trying to grow his net worth.? That is a constant with Buffett ? he has always tried to grow his net worth.
By the time he linked up with Ben Graham, there were still a lot of ?cigar butts? to pick up and puff.? In that era compounding was easy because the post-depression competition was so low in stock-picking.
But by the late 1960s almost all of the ?cigar butts? had been picked up and smoked.? Easy pickings were gone, and Buffett was saddled with an unproductive textile company ? Berkshire Hathaway, and a mediocre-to-bad department store in Baltimore.
He decreased the activities of the textile company, and reinvested the free cash flows predominantly into insurance, including buying half of GEICO.
(As an aside, Buffett was not a great manager of insurance companies at the beginning, and even the middle.? His early companies had their issues.? Jack Byrne did well running GEICO, followed by Tony Nicely.? Buying Gen Re was a mistake, at least initially ? he bought something so complex, and he assumed that all would be fine, setting himself up for losses in the derivative book, and also in the casualty book, where they were reinsuring losses to avoid accounting issues.)
Then came the era of investing permanent capital, where he bought the ?sainted seven,? and they produced profits for him.? He made more money off his public equity investments in the era of the 80s & 90s, but in short order thereafter it shifted.? Berkshire Hathaway was no longer an investment company akin to a closed end fund or a business development company ? it was a full-fledged conglomerate.? That?s how we should think of it today.? Berkshire Hathaway is a conglomerate that gets a lot of its funding from insurance premiums.
He occupies a unique niche in business.? He will acquire entire firms that are attractive to him, does not change their underlying culture, and rarely if ever sells them.? This appeals to entrepreneurs who built a unique culture, and love their employees.? They will sell to Buffett, because alternative acquirers very likely would destroy the employees and culture for the sake of short-term gain.? Buffett is focused on the long run, and is willing to let a subsidiary underperform for a while, before he sends in additional management to sort things out.
On Buffett?s Wisdom
Buffett has a tremendous memory. He knows all manner of statistics regarding industry, which informs him in his investment decisions.? That is one reason why he makes so many wise decisions.
But another area of Buffett?s wisdom was against the Efficient Markets Hypothesis.? Whether in his debate against Michael Jensen in 1984, which helped to produce the article, ?The Superinvestors of Graham and Doddsville [PDF, 13 pages],? or in his annual shareholder letters, that risk is not volatility ? risk is the permanent impairment of capital.
If you work with a margin of safety, and buy companies that will produce free cash flow, and can grow free cash flow, you will be safer than most investors, and probably more successful as well.
According to the book, his wife Susie approached Astrid Menks to care for Warren with food, and other aspects of personal care.? But for a man to have his wife abandon him, with no prospect of return, a pretty 30-year old woman with few requirements would test most men in terms of their fidelity.? According to the book, Susie was surprised that Astrid moved in with Warren.? I think that was naive on her part.? If you want to be a wife, be a wife.? Make up your own mind on what you want, and fault yourself for bad decisions.? Adultery is a bad thing, but Susie is the most to blame by leaving Warren.
Warren is/was a simple guy.? If Susie never left, he would have been happy.? Indeed, he was depressed when she left.? But she got tired of the neglect, and abandoned her marriage vows to him.? She should have borne the neglect, and stayed with him — marriage vows are permanent.? Marry in haste, repent at leisure.? We have no idea of how much Susie may have pleaded with Warren to be connected to her and the family, but the eventual result was a virtual divorce from Susie, which led to another relationship, even though the legal fiction was maintained.
Buffett also had many friends and mentors in the value investing community, most of whom learned from Ben Graham.? In the early years, there was a “Graham Group” that would get together to discuss the principles of Ben Graham.? Bit-by-bit, the group slowly became the “Buffett Group,” because Warren was Graham’s most apt disciple.
But there was one peer who got him thinking more broadly, Charlie Munger.? There were a number of people who thought they would benefit from knowing each other.? They were right; at the very first meeting they hit it off, and found it hard to end the conversation.
Warren received a lot of respect from men in his early years.? They looked at the returns and said, “Wow.”? But his abilities suffered a bit in the late sixties, as “cigar butt” investments disappeared, there was some uncertainty, as to whether Warren would continue to invest.? Fortunately for him, Charlie Munger had given him a new paradigm, which I call “growth at a reasonable price.”
Buffett became very good at estimating opportunities, particularly opportunities that will last.? It is only under such conditions that growth investments will work.
But there are two more entities that shaped him — The Sun Valley Conferences and Bill Gates.? Gates is the more important influence, because his knowledge of the tech sector helped to refine Buffett’s view of moats, because an attractive technology that gets a large market share is its own moat.
The Sun Valley conferences had two aspects.? Buffett presented at a number of them, and during the tech bubble, he drew quiet derision from attendees.? That said, he was a sponge for information, and he understood tech.? What he did not understand was how you could get reliable free cash flow from tech businesses, where obsolescence was such a threat.
I had wanted to read this book for a long time, and I asked the publisher for a copy of the book.? No copy came, and I asked years ago.
Recently, Alice Schroeder came to speak to the Baltimore CFA Society, and after hearing her good talk, I decided to get a copy from the local library (12 copies available in the system).
This book is complex.? It’s a great book, but you have to appreciate why it was designed the way it was.? Buffett is a complex guy, as you might expect from the only man to become ultra-rich from investing alone.
That’s why the book is long.? I did not mind that; I even read the footnotes to get the nuances on when Alice’s sources did not agree.
Those that criticize Alice Schroeder as not being capable to be a biographer, neglect her significant abilities understanding investment, insurance, and from what I can gather, how a complex man ticks.
She spent years with him, and had access to all of the major sources still living.? Other authors did not have that.
As such, the book focuses on Buffett the man, and less on Buffett the investor.? That’s not a bad thing.? This is a book about Buffett, not a book about how Buffett did it (and how you can too).
The rest of my review will focus on the grand themes of the book as I see them.? Others may differ, but I see it this way:
Overcoming Insecurity
1. Buffett’s mother was a harsh woman, if the book is correct, and did not love her first two kids, of which Warren was one.? On the Mother’s side of the family, there was a history of mental illness.? In terms of early influences, this is the large one.? His Father was at home less, and Leila Buffett was a large influence.
Buffett was industrious as a child, and even during Great Depression earned money.? He quickly realized the value of reinvesting profits, and the concept of compounding come to the young man.
But as with many young men, he had his challenges in his teenage years.? He was not popular.? He got ripped out of his environment to accompany his family to DC, where his father had become a Congressman.? (Think of Ron Paul, but with more idealism, and less contact with his kids.)
Warren became a bit of a rebel, and his grades suffered.? Still amid all of it, his small businesses did well.? In High School, he eventually focused on his studies, and his grades recovered, such that he was able to go to college at the University of Pennsylvania, before transferring to the University of Nebraska at Lincoln.
2. Warren overcame insecurity through the women who cared for him.? In this sense, initially he was a sponge for love, and later, one who would learn to care for friends.? The main women in his life were Leila Buffett, Susie Buffett (wife), Susie Buffett, Jr. (daughter), Kay Graham (Washington Post), Sharon Osberg (bridge partner), and Astrid Menks (mistress, and current wife).? If I may, let me say that men need women to admire them, or they don’t feel whole.? Because Buffett’s mother was sparing with love, Buffett sought a wife, and against all odds, found one that would care for his emotional needs.
Susie was more complex than that, and with Warren’s significant travel, after two decades, she began to seek activities that rewarded her.? This was the beginning of the end of their marriage in real terms, though not legal terms.
This is a tough book to review, because I generally respect the author, but there are many things I don’t like about the book.? Let’s start with the main one:
My friend Alice Schroeder came to speak to the Baltimore CFA Society early in November.? It was a great talk, and afterward, I took her back to the Amtrak station.? What was our main topic of conversation?? The many authors with limited or no dealings with Warren Buffett who invoke his name in order to get better sales.? I won’t name names.? I have relationships with a number of them.
I will review “The Snowball” soon.? Alice Schroeder spent around five years creating that lengthy book, and I can see why she would be upset over those that use Buffett for their own personal gain.
This book is another example of that.? Only chapters 1 and 2 have anything to do with Buffett, and there he is quoted extensively to the point where he should be listed as a secondary author, and get a cut of the royalties.? But in the next nine sections have almost nothing from Buffett; it is all the philosophy of Larry Swedroe.
Don’t get me wrong.? Larry Swedroe is a very bright guy, and worthy of being read.? But his philosophy is not that of Buffett.? Yes, Buffett said a number of things stressing that average investors should invest passively, because they have no information edge.? But that’s not what Buffett does himself.
I have written elsewhere that Buffett cannot be imitated by the rest of us (Part one, part two).? (For those reading me at Amazon, please come to Aleph Blog to get links.)? Buffett buys whole companies.? Few of us can do that.? Buffett has a holding company that produces the ability to fund investments cheaply.? None of us have that, and this book by Larry Swedroe, does not even touch on the most powerful and distinct things that Buffett does to earn returns.
Chapters three and beyond are really basic stuff that average people should do to manage their investments wisely.? Larry Swedroe is great with that sort of thing. But it has nothing to do with Buffett.
That’s the main thing that irritates me here.? Don’t put Buffett in the title if the book is not about Buffett.? This book is not about Buffett, it is about how average people should manage what excess assets they have.
Now, all that said, if you read the personal finance section of my blog (which is free) you won’t gain any additional insights from this book, and you won’t pay any money either.? That said, giving a book like this to a friend who doesn’t get the management of assets could be very good for him.? Show a man a website, and he ignores it.? But a physical book — he might read it.
Quibbles
Swedroe does not get corporate bonds.? They are valuable during the bull phase of the credit cycle.? Those of us that follow the credit cycle make excess returns as a result.? You have to be opportunistic and disciplined to do this.? Yes, corporate bonds are hybrid investments — part equity, part guarantee.? But intelligent investors can do well with corporate bonds — it is much less efficient than the stock market.
Also, he overestimates the number of stocks needed to diversify a portfolio on page 68.
On page 77, he engages in data-mining to show what would have worked best in the past, which has no relevance to what will work well in the future.
On page 113, he tells a story from “Time Management for Dummies,” without attribution.
On pages 126-7, he errs, because risk and reward are not correlated.? Also, high yields usually portend risk, but that is not always true.
Finally, on page 131, he is too absolutist on corporate bonds.? Most of the time, it might be better to hold stocks and Treasury bonds, but there are times when corporate bonds are mispriced in a panic, and it is time to buy them.
Who would benefit from this book: ? If you want basic book on asset allocation for average people, this could have value.? If you want to imitate Buffett, this book will not help you in the slightest. If you want to, you can buy it here:Think, Act, and Invest Like Warren Buffett.
Full disclosure: I asked the publisher for the book, and he sent it.
If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)
Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.
This is a very good book.? It is also a hard book, so I don’t think many of my readers will benefit from it.
Score yourself:
How well you do understand bonds?
How well do you understand muni bonds?
How much do you understand about credit analysis?
Do you understand how municipal credit is different from corporate credit, including how the bankruptcy code works in each case?
If you are positive on three or four of those questions, this book will help you.? If positive on two, it might help you.? If less, forget it.? This is a book for those that have some knowledge of bonds generally and municipal bonds in particular.
I learned a lot from this book, but I have a lot of experience with bonds.? This book is a hybrid.? It is written mostly by the author, who recruited experts to write specialty chapters.
Here is my main misgiving on the book: in order to invest in high yield municipals, you really need an adviser next to you to guide you.? Even though the book says a lot of true things, there is no replacement for the person sitting next to you, who correct you in “real time.”
Aside from what is written in this book, if you are willing to put in a lot of time to understand the high yield muni market, you could do quite well.? But this is not adequate for average investors — I don’t think any book could be for high yield munis.
But the book is a really good introduction to the high yield muni market.? If you understand that it is only an introduction, the book will be valuable to you as you search for more knowledge.? This book is great, but it is not enough.? I don’t think any book could be enough, because there are a lot of complexities in these markets, and who would pay for a 2,000 page book?
Full disclosure: I asked the publisher for the book, and he sent it.
If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)
Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.
This is a good book.? It has one significant problem, though.? It is very good at describing the problems that exist, but does not follow through on the subtitle: How to Profit Now in the Volatile Global Economy.? That might be a publisher error.? They want to sell books, and a book that describes the problem will have a small audience, while a book that shows how you can profit from a problem would have a wide audience.? For the most part, this book describes the problem well, and that is good.
So what’s the problem?? Most bond managers intuitively know that most bonds either trade at “normal” or “distressed” levels — there is very little in-between.? Those are two “stable” places where bonds trade, and with a few exceptions, different groups of investors are involved in each place.? They have different ratios, standards, and metrics.
The book spends a lot of time on the Eurozone, with its bevy of distressed governments.? The distress stems from deficits, over-regulation, and entitlements. The “domino effect” part of the title comes from core Eurozone banks lending to distressed fringe Eurozone entities.? If the fringe fails so do core Eurozone banks.? If core Eurozone banks fail, so does the Eurozone.
But the book offers us precious little of new information on how to profit in an uncertain environment.? The last few pages offer a few general ideas, but even with my outside knowledge I have no idea on how to apply that easily.
Quibbles
On page 43, he describes government liabilities as “future tax receipts.”? Sorry, future tax receipts are assets, not liabilities.
Full disclosure: The publisher sent me a hard copy of the book, without my asking.
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.
Before I start, a thanks to all of my readers who have voted on my reviews. Note: if you have voted on many of my reviews favorably, further votes won’t help.? Amazon limits the effects of fans.? Onto the book:
For those unfamiliar with Ben Stein, he has done a series of books on “How to Ruin…” for example: How to Ruin Your Life and How to Ruin Your Financial Life. I have not read either of those two books, but after a glance at the table of contents of each book, I can say that what he wrote there is right, even if it is short.
If you can avoid making wrong moves, right moves will occur on average.
But… most of this is simple commonsense stuff reported from a negative angle.? If you have read the personal finance category at my blog, you would know what he has written and far more, and it is free.
There is no bad advice in this book, if you understand that it is offering you bad advice.? By telling you you to do stupid things, it incites you to do what is right.
Quibbles
The book is not worth $12 to those with a reasonable understanding of the markets.? It is worth a lot to the uninformed who think they know something but don’t.? This is a book you give; it is not a book that you buy.
Who would benefit from this book: ? This is the sort of book that you give as a gift to your clueless brother-in-law.? It has value there, to raise the awareness of those who are destroying their financial lives.?If you want to, you can buy it here: How To Really Ruin Your Financial Life and Portfolio.
Full disclosure: The publisher sent me a hard copy of the book, without my asking.
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.
In order to get more return, you have to take more risk, right?? Those of us who are value investors, or bond investors, have disagreed with this idea for years.? We get the best returns by avoiding risk.
A great part of of making money in investing is not losing money.? In order to avoid losing money, you have to buy assets that are cheap relative to their value, and intrinsically safe — i.e. what is the worst-case scenario?? Could I lose a lot if things go badly?
This book is two things: it is a teardown of modern portfolio theory as posited by the academics, and the establishing of a new theory that suggests that we get better returns by avoiding volatility of investment returns.
Here’s part of the problem: Scientists are human, just like you and me, and they occasionally defend wrong ideas because they propagated in a time where some novel but wrong papers/books were written, and seemed right at the time, and the consensus accepted them, because it agreed with their biases.
That’s what happened with modern portfolio theory.? The bias of the economists was “You have to take more risk to get more return,” when the reality is that taking more risk to get more return works up to a point, and after that, those buying volatile stocks, bonds, etc., are trying to hit “home runs,” and have lost track of risk control.? People don’t estimate well in high volatility situations, and tend to lose money as a result.
Think of it this way: if you want to be totally safe, invest in cash-like instruments.? You will earn nothing.? If you want to make some money, invest in a portfolio of stocks or bonds that are stable in terms of their market returns.? If you want to lose money, invest in volatile investments.? Most investors will not know the right time to buy or sell those investments.? It is too hard; leave it to the fools that want to take long-shot bets.? Gamblers don’t win in investing.
Low volatility investing is a proxy for safety, but also a proxy for neglect.? Many companies dwell in the shadows of the market.? No one follows them.? They may be big enough to be followed, but they are in an uncool industry, like insurance.? Or they represent an out-of-favor area, where only insiders/experts are quietly playing.
This is a good book for two reasons: it tells you to avoid the idealistic theories of the academics.? Second, it tells you that avoiding risk/volatility leads to better returns.
Most successful businessmen are in the middle. They take prudent risks.? This book may do this from a quantitative investment framework, but that is what it encourages.
Quibbles
The book needed a better editor, but so do most books.? We need more grammar, spelling and typo Nazis.
Who would benefit from this book: ? There is not much math in the book, but there is a lot of discussion of academic papers on finance.? If discussion of academic papers on finance bores you, this is not for you.? If you can tolerate that, this is a very useful book for those that want to do better in investing.?If you want to, you can buy it here: The Missing Risk Premium: Why Low Volatility Investing Works.
Full disclosure: The author sent me a Kindle copy of the book, without my asking.
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.
Private equity is ill-understood by the general public because it is private.? They don’t have to file statements with the SEC, all they have to do is inform their limited partners on how they are doing.
Jason Kelly gives us a neutral view of what is going on in private equity.? I think he is neutral, because he does not come across as a fan or a critic.? Personally, I think that is hard to do with private equity, because 1) it is easy for some to become amazed at the success of some incredibly wealthy and clever businessmen, or 2) it is easy to take offense at these shadowy capitalists that have produced bankruptcies, fired many people, and have been very clever at using the tax code to pay minimal taxes.
Both of these views are caricatures and the truth does not lie in-between but embraces both views.? Indeed, in many cases,? jobs have been preserved or created through private ownership of firms.? Many firms might have died without private equity restructuring the company, leading to the loss of all jobs.
Jason Kelly takes you through all aspects of private equity:
Fundraising
Leverage
Dealmaking
Operations
Exiting (Selling)
He also introduces you to all of the major private equity shops, and their leadership.
One thing the author highlights in the book is the pervasiveness of private equity.? He notes how many businesses are managed by private equity.? In general, these are businesses with steady cash flows that can service the debt that the private equity funds borrowed to buy them.
Some private equity firms are passive, and don’t try to improve operations.? Others make a great effort to grow the companies, hiring new people in the process, and taking risks to create a better company.? It depends on the philosophy of the private equity owners.
The book does note the favored tax status of carried interest, but takes the position that the private equity investors are following the law, and that they will follow the law should it be changed.? (My simple idea is that interest should not be taxed, or be a tax deduction.)
The book does note trends:
Private equity is becoming more public, as more large private equity firms go public.
Complexity inside private equity firms is growing as they broaden the scope of services that they provide.
The owner/founders are moving on, and a new generation of management is taking the reins.
Returns may be falling as private equity gets larger.
In all, a good book, but one that may leave partisans unsatisfied.? It does not demonize or engage in hagiography.
Full disclosure: The author?s PR Flack sent me a preprint and a copy of the book.
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.
How cynical are you? How close have you been to politics in DC?
I know a lot of people who work for the US Government directly or indirectly, and they are astounded at the waste and fraud.? They are honest people, and it weighs on them.
The more I watch it, the more I think that power needs to come back to the states, and slim the Federal Government.
Now, I’m a libertarian of sorts, but what if you come to discover this as a “true blue” member of the Democratic Party?
Most people initially come to politics idealistically, and so did the author, inspired by… Joe Biden.? Now, with Mr. Biden, I did not see the thrill when I was younger.? Yes, there was more complex rhetoric, but nothing materially different then compliance with the particulars of the coalition backing the Democrats.
Be that as it may, the author went through many changes in supporting Biden and the Democratic Party.? Here’s his bio:
Jeff Connaughton holds an MBA with honors from the university of Chicago and a JD from Stanford Law school. He worked for four years as an investment banker, first at Smith Barney and then at E. F. Hutton. in 1987, he joined Joe Biden?s presidential campaign as Deputy national Finance Director and thereafter became his special Assistant when Biden chaired the senate Judiciary Committee. After graduating from Stanford, Connaughton clerked for Chief Judge Abner Mikva of the united states Court of Appeals for the DC Circuit, then followed Mikva as his special Assistant when Mikva was appointed Counsel to President Bill Clinton. in 2000, along with Jack Quinn and Ed Gillespie, Connaughton founded Quinn Gillespie & Associates, one of DC?s premier lobbying firms. He lives in Savannah, Georgia.
That’s a lot of change in 20+ years.? The book takes you from his early days, interleaving the recent versus the past, until we get to the financial crisis, at which point, the author’s faith in the Democratic Party is severely tested.? He never abandons his principles, but he grieves for his party.
His real crisis comes after Barack Obama is elected with Joe Biden as VP, and he and his boss are excluded because they have been lobbyists.? But the boss is appointed to fill the Senate seat of Joe Biden, and the author comes along as his senior aide.
They have two years to do what is right, uncorrupted by the money of politics, because he isn’t running for re-election.
They take on High Frequency trading.? Regardless of tighter spreads, is the amount offered at the spread similar-sized, or smaller?? Further, what happens in a crisis?? Do the market makers and specialists hold to their roles, or conveniently abandon them, amid crisis.? The latter seems to be true.? The philosophy is: to the degree that we have laws providing structure to markets, so that many people can trade easily, knowing that things are basically fair, we must review all practices that give unfair advantages to some.
In the process of trying to reform HFT, Ted worries that something like the “flash crash” will happen in advance of its occurrence, further burnishing his reputation as a thinker on markets.? Ted Kauffman asked: who is served by ever-greater liquidity? (P. 185)? From my angle, studies need to be done studying “percentage liquidity” seeing how spreads divided by average bid/ask size have to be done — narrow spreads don’t mean much if you can’t do much volume there.
On pages 204-5 of the book, it describes the gamut of Ted’s ambitions regarding the financial crisis:
Back in the senate, Ted had three great insights.? First, this wasn?t a time for vague legislation that kicksthe can back to the very regulators who?d failed in the lead-up to the crisis; Congress needed to draw hard statutory lines, just as it had during the great Depression. Second, Wall street?s inherent conflicts of interest had to be resolved through structural reform, such as by reinstating Glass-Steagall or imposing size and leverage limits. Third, he wanted to take the fight straight to the megabanks on too-big-to-fail, makingWall street defend against structural reforms it opposed,at least to increase the chance that other provisionsopposed by the banks, like the Consumer Financial Protection Bureau, would pass.
One thing he knew that I knew then and now.? The banking regulators did not use the tools that they had to do their jobs.? They were quiet accomplices as the leverage bubble built.
On page 228, Ted introduces “…the safe Banking Act of 2010, the Brown-Kaufman amendment would have put limits on the
size of and leverage used by megabanks by:
imposing a strict 10 percent cap on any bank holding company?s share of the united states? total insured deposits;
limiting the size of non-deposit liabilities at financial institutions (to 2 percent of U.S. GDP for banks, and 3 percent of GDP for non-bank institutions);
setting into law a 6 percent leverage limit for bank holding companies and selected non-bank financial institutions.”
The most radical of the proposals is the middle one, which aimed to limit repo financing at financial institutions; it would have been much more effective than the Volcker Rule.? Most of the problems in a financial crisis stem from short-term liabilities financing long-term assets.? This attempts to address the short-term liabilities that do not stem from deposits.
As the author comments on page 229:
Remarkably, although there is a prudential cap on the amount of deposits the largest banks can hold, nothing limits bank liabilities like repos, which often must be rolled over every day.
This is insightful, and the insight should be extended to securities lending, and derivatives, where margining must be adjusted day-by-day.
As Ted proposes breaking up the too big to fail banks, he runs into a lot of resistance.? This includes pseudo-intellectuals like Larry Summers who argues on page 234:
Summers?s [sic] second argument was that, if we broke up the megabanks into smaller banks, ?it would actually make us less stable. Because the individual banks would be less diversified, they would be at greater risk of failing because they wouldn?t have profits in one area to turn to when a different area got in trouble.?
What Summers didn’t get is that complexity creates more risks than diversification erases.? Complex banks are typically not well-managed as far as bad times are concerned; diversification disappears during the crisis.? And if we had a lot of small banks, yes, we would have more failures, but no, the system would be more secure.? The system is at risk from the 4 to 20 banks that are so large that the US Government must bail them out.
As it was the Brown-Kauffman amendment failed, and a pity that it did.? Would that it had become law, as opposed to the watered-down “Volcker Rule.”
At the end the author leaves DC after his patron leaves office, and restarts his life in Savannah, Georgia.? He adjusts to the happiness of life outside the Beltway, and realizes that a life outside of politics can be pleasant.
Quibbles
Page 149 — there is no way that short-selling is behind 50% of trading on a normal basis.? If that is true, I have to rethink a lot.
Page 152 — Even with naked short selling, it is really difficult to move a stock’s price down.? I would encourage the SEC to try some experiments where they nakedly short a stock, and see if they can make money off it.? I bet they can’t.
Page 179 — spelling error: peak s/b peek.
Who would benefit from this book: ? This book will tell you how much DC is in thrall to the power of money.? Doesn’t matter which party, their ideals are up for sale.?If you want to, you can buy it here:?The Payoff: Why Wall Street Always Wins.
Full disclosure: The author’s PR Flack sent me a PDF file of the book.
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