Ethics – Page 8 – The Aleph Blog

Finding Meaningful Work in a Complex World

Posted on 10 July 2012 by David Merkel

This post isn’t for everyone.? My target is mostly college students, and parents with children who are getting close to adulthood.? Others may benefit from it, because we all have younger friends that we want to help.

What to study in college?? Do I even need college? What sort of job should I work for, or what kind of business should I create?? These are big questions, but I want you to view them through a different lens: where are there needs?? What can I do to solve the needs of others, that people/institutions would be willing to pay for?? Then: which of those things would I enjoy doing?

The last question is the least important.? Yes, we all want to do something we think is cool.? “Do what you love, and you will never work a day in your life.”? That’s nice work if you can get it, but often there is no one to pay for what you love.? Some will be creative and create their own gig.? That’s rare for most people, but is worth pursuing if you are finding paid demand for the human needs that you meet.

Some needs are simple, like public order.? I have one child who wants to be a policeman, and is presently a favorite of his advisors in the local police explorer post.? He has a well-defined path to a career he will like; an associates’ degree will help him, and later a bachelor’s degree if needed.

Other needs are more complex, like education.? Kids will always need to be educated.? I have one child who can take a room full of small children and make them behave; she has the “knack.”? You can’t teach the “knack.”? Maybe you can develop it if you are the oldest of eight kids.? Even with lesser intellectual gifts, she will be a more effective teacher because education with young kids requires classroom control more than brilliance.? (As an aside, if we want to reform the schools, my solution is to end teacher credentialing.? What teachers get taught in college positively harms their ability to educate.? After that, we need to move back to a basic curriculum and avoid fads.? Where I live, parents are pulling their kids out of the public schools for private and home schooling, because of fads that try to impose a pedagogy that does not work.? As I sometimes say, “It is dangerous to have unaccountable idealists in important positions.”)

I have another child pursuing biochemistry.? Seems to be a real growth area, with a lot of applications.? Bright kid, will go far.

Then I have two ninth graders.? One is interested in industrial work using computers; that’s promising growth area.? The other wants to be my assistant one day and is reading basic books on investing, and asks me questions.

Enough about my family — I think it is wise for young people to consider the needs/desires of others first when they are looking at their life’s work.? Perhaps the summary question should be: “What do other people need that I would like to do?”? “Do I need more training to do that?”? And for parents, spend time with your kids describing occupations, telling them what other people do.

It’s a complex world, and it is likely to get more complex — the division of labor is widening, not shrinking across nations.? On the bright side, this reduces the probability of war.? As business interests get spread over multiple nations, the politics of war get messy.

Let me summarize it this way: the concept of “follow your bliss” is inherently selfish, and there is no reason why it should be rewarded.? But the idea of meeting the needs of others is significant and good.? It is humble, and would that more of us brought humility to our callings.

Value comes through serving others. That is a humble route to prosperity.

Little Revenues, Large Losses, Negative Net Worth

Posted on 12 June 2012 by David Merkel

You can guess that I am talking about promoted penny stocks.? From now on, whenever I write about this, I will update this table:

Ticker	Date of Article	Price @ Article	Price @ 6/12/12	Decline
GTXO	5/27/2008	2.45	0.0395	-98.4%
BONZ	10/22/2009	0.35	0.018	-94.9%
BONU	10/22/2009	0.89	0.0799	-91.0%
UTOG	3/30/2011	1.55	0.07	-95.5%
OBJE	4/29/2011	2.90	0.04	-98.6%
LSTG	10/5/2011	1.12	0.1525	-86.4%
AERN	10/5/2011	0.0770	0.0014	-98.2%
IRYS	3/15/2012	0.261	0.16	-38.7%
NVMN	3/22/2012	1.47	1.3	-11.6%
STVF	3/28/2012	3.24	0.46	-85.8%
CRCL	5/1/2012	2.22	1.12	-49.5%
ORYN	5/30/2012	0.93	0.75	-19.4%
BRFH	5/30/2012	1.16	0.765	-34.1%

Personally, I find the consistent losses to be impressive.? All of the companies that I wrote about more than three months ago have losses greater than 86%.

Tonight’s loser is Luxeyard [LUXR].? I got this sorry excuse for research today. Six months ago the company, was called Top Gear, Inc., was based in Israel, and had the goal of becoming a leading kosher food certification organization.? As a result of an acquisition of Luxeyard, and spinout of the kosher food certification efforts, the company is a website for selling luxury goods.

Well, at least the disclaimer tells some truth this time:

NBT Equities Research and/or its publisher, ChangeWave, Inc., dba NBT Communications has received $35,000 and been pledged 75,000 shares of rule 144 common shares in LuxeYard to assist in the writing of this advertisement.

Next Media LLC paid $1,500,000 to marketing vendors to pay for all the costs of creating and distributing this report, including printing and postage, in an effort to build investor awareness.

Next Media LLC was paid by non-affiliate shareholders who fully intend to sell their shares into this advertising campaign.

Prior holders of Top Gear, and those who sold Luxeyard to them have paid the research liar to bull up the price so that they can sell into it.? Those who buy Luxeyard are dumb; really, really dumb.

Anytime a third party promotes a stock to you, and it is not a normal Wall Street “We provide research so that we can do IPOs and get trading volume,” avoid it.? All of these promotions are scams.? They don’t make money.? Average investors lose, even those that think they can play the speculation game.

Again, I ask why promotions like this are legal.? If the disclaimer is small type (this one was 7.5 points), and the regular type encouraging investment is 12+ points, I think the disclaimer should not be valid, and the author, publisher, and backers should be subject to lawsuits, that they forfeit their ill-gotten gains.

Pennies from Hell

Posted on 31 May 2012 by David Merkel

I had lunch with Eddy Elfenbein today, and we had a great time together.? After all of the time that we have e-mailed, linked, etc., it was great to make the acquaintance.

Before I start tonight’s post, that makes me want to say this: if you are a blogger that likes me, and you are traveling to the Baltimore/DC area, email me, and let’s get together.? Even if you are marginal on me, try me, and if I accept I will buy lunch.

Many of us as bloggers do a service for the investment community; I have sometimes said that we are the conscience of Wall Street.? Well, tonight’s post is another post to warn people away from a class of investments that almost always loses money: promoted stocks / penny stocks.

As I looked through my archives, I was surprised at how many promoted penny stock I have written about — there were eleven.? Not what I intended when I started this blog, but I go where I think I am needed.? So, what has the performance been of the promoted penny stocks since I wrote about them?

Ticker	Date of Article	Price @ Article	Price @ 5/30/12	Decline
GTXO	5/27/2008	2.45	0.04	-98.4%
BONZ	10/22/2009	0.35	0.02	-94.3%
BONU	10/22/2009	0.89	0.10	-88.8%
UTOG	3/30/2011	1.55	0.05	-96.8%
OBJE	4/29/2011	2.90	0.05	-98.3%
LSTG	10/5/2011	1.12	0.15	-86.6%
AERN	10/5/2011	0.0770	0.0016	-97.9%
IRYS	3/15/2012	0.261	0.160	-38.7%
NVMN	3/22/2012	1.47	1.35	-8.2%
STVF	3/28/2012	3.24	0.53	-83.6%
CRCL	5/1/2012	2.22	1.34	-39.6%

Can I say “Ouch?!”? This is almost as bad as the dot-com bubble, except there are no successes to give the illusion that if you pick them right, you will do fine.

But today, after coming home from lunch, I went to the mailbox and found three (THREE!!) penny stock scams in my mail, two from the same promoter.? I could be wrong, but I think the frequency of penny stock scams is increasing, perhaps out of desperation for some people to make money.

One of the promotions was Circle Star, which I have mentioned before, though this was through a different promoter, and you can see the promotion here.? The writer received $75,000 for his efforts.? Enough said.

Then there was Oryon Technologies [ORYN], Inc.? This company that masquerades as a technology and apparel company, was a mining company three months ago.? It has never earned a dollar of revenue.? Enough said.

The last one was Barfresh Food Group, Inc. [BRFH]? Smoothies as a patentable investment idea is ridiculous.? But at least the disclaimer on this one is honest:

Do not invest in this company unless you can afford to possibly lose your entire investment. NBT Equities Research and/or its publisher, ChangeWave, Inc., dba NBT Communications has received thirty five thousand dollars and been pledged seventy-five thousand shares of rule 144 common shares in Barfresh Food Group Inc. to assist in the writing of this advertisement. Primo Strategies LLC paid one million three hundred thousand dollars to marketing vendors to pay for all the costs of creating and distributing this report, including printing and postage, in an effort to build investor awareness.

and

Primo Strategies LLC was paid by non-affiliate shareholders who fully intend to sell without notice their shares into this advertising/market awareness campaign, including selling into increased volume and share price that may result from this campaign. The non-affiliate shareholders may also purchase shares without notice at any time before, during or after this campaign. A non-affiliate shareholder acted as advisor to Primo Strategies LLC in this market awareness campaign, including providing outside research, materials and information to outside writers to compile written materials as part of this campaign.

and

Third Party/Agency Disclaimer: Content of this message is published by NBT Equities Research, LLC and/or its publisher, ChangeWave, Inc. and sent to select email lists through various marketing agencies to provide readers with information on selected publicly traded companies. Winning Media is managing a total budget of $250,000 for this and other advertisements in an effort to build industry and investor awareness. The $250,000 budget was provided to Winning Media by MarketByte LLC, a shareholder of Barfresh Food Group, Inc. MarketByte LLC reserves the right to buy and/or sell shares of Barfresh Food Group, Inc. at any time. This should be viewed as a potential conflict of interest.

This company has received revenues, but has not earned profits, and has a negative net worth as well.? It was a company searching to buy movie scripts, and realized that smoothies were a better business.? Go figure.? In general, companies that make big shifts in industrial direction are usually horrible companies.

Think about this Differently

Suppose for a moment you did have a great idea that could revolutionize a given business.? Would you:

Try to grow the business using only your own capital, and that of friends and family, and a limited number of? angel investors, until you realize that institutional capital and knowledge is needed to take this to the next level, i.e., venture capitalists.? Advertise where needed, but don’t give potential competitors too much of an idea that you are out there.
Take over a rotted shell of a public company, and use its broken balance sheet to attempt to grow.? Exchange unpayable loans for increased equity stakes for the lenders, diluting yourself.? When their stakes get big enough they engage some third parties to do a pump-and-dump.? Some bozo writes the copy, another bozo distributes it.

No credible idea would come public via method 2, they would work through venture capitalists.? So I would tell you without hesitation that there is never a reason to buy a promoted penny stock.? The large holders are the only ones with sufficient economic interest to promote a pump & dump, and they are likely the ones behind the bozos doing the promoting.

One Public Policy Recommendation

We need to codify something here, that if a brochure says in 12 point type: “Call your broker today to discuss how large a position in Circle Star Energy Corp [CRCL] you can comfortably own,”? (This was in the written brochure and not on the web, as far as I have seen.) then any disclaimer in a smaller, or less readable typeface is not valid in court.? This is an implicit form of fraud, and I believe that the writers and distributors of this drivel, as well as those that paid them should be able to be successfully prosecuted for fraud.

One last thing, to the guys who write these “analyses” that display incredible certainty and opportunity in large type, and then say that this is not really an investment analysis in tiny unreadable type — how can you look at yourselves in the mirror when you are such liars and cowards?

Why Auditors Should be Rotated

Posted on 29 March 201229 March 2012 by David Merkel

There is a proposal afoot to mandate auditor rotation every fiver years or so.? Some don’t like it.? I think it is a great idea, with large benefits relative to the costs.

My insights, or lack thereof come from working in life insurance financial reporting in a number of different ways for around 15 years.? Only on time in 15 years, in what is arguably one of the most complex industries as accounting goes, did I ever find serious questioning going on.? Should I tell this story?

Yeah, I should, because it involves the “piece of work” that I reported to at AIG who told me, “Dealing with auditors is bloodsport.”? He also said, “Dealing with reinsurers is bloodsport.”? Delicious that this came to bite him in both ways.

A certain life reinsurer who was large then (call them Geta Life), but is out of the business now (unimaginable then, but given what happened here, no surprise), reinsured a large portion of the immediate annuities and structured settlements, including rated structured settlements that the AIG domestic life companies had written.

Did the treaties pass risk?? With a vengeance they did; not only did they pass mortality risk, but all investment risks were passed as well.? For this fine service, Geta Life earned 1% per year on the surplus relief, i.e., the difference between the book value of liabilities and assets reinsured.

It was not so well understood then, but mortality risk for structured settlements did not tend to work out well.? After an injury giving rise to a court case which would structure a settlement for the plaintiff, the defendant would ask insurance companies to bid on the settlement, which was a stream of certain and life contingent payments.? When the injury impaired the life of the plaintiff, bidding would get stiffer, because it is cheaper to fund life-contingent payments to those who aren’t likely to live so long.

Or so you would think… there was one case where a two-year old boy was injured, to the point of being in a coma, and the underwriter who bid the case rated him as having the lifespan of one who was age 73.? But the money transferred to the parents in the judgement was more than enough to care for the boy, and have a lot left over for the parents.? Ding!? The kid would live a lot longer than 15 years as a result of the settlement.

Rated settlements, where one bid on impaired lives, carried the “Winner’s Curse.” If you won, you overpaid.

But this was not on the radar screen of the somewhat oblivious Geta Life, until they found that the treaties were passing large losses to them, and they decided to audit the treaty.? Sadly, the actuaries above me, who had signed the treaties before I was employed by AIG, forgot to inform the investment department that the treaty limited the trading of around 20% of the bonds of the company in ways that would be mimicked 10 years later in CDOs.

Trades may not lower credit quality
Trades may not lower yield
The cashflow profile of the assets can’t be materially changed.
And a few more things…

This problem got dumped in my lap as a young actuary, as I found we were way out of compliance with the treaty terms, selling had gone on with abandon, on assets the reinsurer relied on, reducing the investment income the reinsurer would receive in a falling interest rate environment.

So, I proposed to the reinsurer that I go back in treaty history, and select assets purchased to replace those sold that would have kept the treaty in compliance, and put those into the segregated portfolio, and inform the investment department of the rules.? Once Geta Life understood that, they agreed to my “solution.”? That solution took me several months to work out, but I got it done.

In the meantime, the reinsurance treaties with Geta Life had become so valuable to AIG’s domestic life subsidiaries that if they came into question, the subsidiaries would fail.? The accountants of the auditors, realizing that there was something big to analyze, but not knowing how to do it, called in one of their best actuarial auditors.? My ever-confident boss knew he could beat him.

I still remember critical parts of the meeting as the actuarial auditor slowly checkmated my boss, and forced him to reduce the reserve credit for GAAP accounting, resulting in a sizable loss.

Closing off the story, Geta Life was satisfied on the changes in the asset portfolios, but was still annoyed at the losses.? The changes in assets did not avail much; bad underwriting was pinching.? They came to us saying that “Reinsurance is a good faith venture. You’re not supposed to take advantage of us.? Refund our losses, or we will take you to court for not having having managed the treaty properly from inception.”

I said, “You wrote the treaty.? You accepted my asset changes.? You are supposed to absorb mortality risk, such as there is.? I am not an officer of the company, so if you aren’t happy with this, talk to my boss.”

Shortly after that, I left AIG; it was not a great place to work.? Geta Life sued AIG for damages and won (far more than they should have).? Should have produced a blip in terms of earnings, and didn’t.

Mmmmm…. back to the original point.? Should auditors be rotated?

In all my years of financial reporting, I got wind of things in other areas of the company that I served that auditors should have questioned.? Auditors have often been “lap dogs.”? Only once did I ever see a significant challenge.? More often, I saw the auditors try to help the company explain an “accounting oddity.”? (AIG had a nonstandard way of reporting deferred annuity reserves that was very liberal, and it was proposed by their auditors.)

If auditors know that they are only going to be on the job for five years, they will realize a few things:

If this is going to die in a few years, it doesn’t matter as much if it dies next year.? Maybe firm reputation is worth more than two more years of a contract.
My work will be reviewed by someone unsympathetic to me in a few years.? He will have little incentive not to tear my work up, and call for restatements.
Having a fresh set of eyes on corporate finances will lead to questioning of assumptions that get ignored because they are boilerplate to the continuing auditor.
If auditing ceases to be an annuity to auditors, they will be less complacent, and might even act like auditors on occasion.

My experience with auditors was that they spent a lot of time on the data, and rarely asked the tough questions on assumptions and methods.? They were bean-counters, not actuaries, and certainly not businessmen.

If auditors are rotated, the incentives for just letting things slide will diminish.? That’s why auditors should be rotated.

An Advanced Penny Stock Scam

Posted on 15 March 201215 March 2012 by David Merkel

Don’t buy what someone wants to sell you.? Buy what you have researched, and know that it is what you want to buy, because it is valuable.

I have an irregular series on penny stocks, largely off of advertisements mailed to me, or things found on the web.? Every promoted penny stock I have run into has done badly.

Now for all of my prior penny stocks that I have been written about, all have done horribly.

Today’s gem is iTrackr [IRYS], which the advertiser says is the “Groupon Killer,” complete with a cover page that has a dinosaur labeled “Groupon,” being hit by meteors labeled “iTrackr” and “IRYS.”? Now, this time I got a full 16-page shiny brochure, which had quotes on iTrackr from two notable publications, but in 2006 & 2007, long before Groupon was prominent… and iTrackr did not gain in profitability since then, rather, it had larger and larger losses.

In five-point (or so) type, near the back of the brochure, there is the disclaimer.? I scan it with OCR so that you can read it at a normal size:

Disclaimer:

The xxx Newsletter and/or its publisher, Author Inc., dba blablabla.com did not receive any direct compensation (other than future subscription revenues, the amount of which is not known at this time) with respect to the publication of this Advertisement. Author Inc. has received ten thousand dollars in cash compensation to assist in the writing of this advertisement. BHB Marketing paid eight hundred thousand dollars to marketing vendors to pay for all the costs of creating and distributing this report, including printing and postage, in an effort to build investor awareness. BHB Marketing was paid by non- affiliate shareholders who intend to sell their shares.

?This publication does not provide an analysis of a company’s financial position. iTrackr Systems, Inc.’s financial position and all other information regarding iTrackr Systems, Inc. should be verified with the company. Information about many publicly traded companies and other investor resources can be found at the Securities and Exchange Commission’s website at www.sec.gov. Investing in securities is speculative and carries risk. It is recommended that any investment in any security should be made only after consulting with your investment advisor and only after reviewing all publicly available information, including the financial statements of the company. This mailing piece is not intended to be, nor should it be construed as, an offer to sell or a solicitation of an offer to buy securities, nor should it be construed as the provision of any investment-related advice or services tailored to any particular individual’s financial situation or investment objective(s). The xxx Newsletter is a bona fide publication of general and regular circulation offering impersonalized investment-related research to readers and/or prospective readers and is not an investment adviser. As such, it relies upon the “publisher’s exclusion” as provided under Section 202(a) (11) of the Investment Advisers Act of 1940 and corresponding state securities laws. The xxx Newsletter is not a registered broker dealer. Staff members of The xxx Newsletter and its affiliates may hold positions in investments mentioned herein, and may buy or sell their interests on the open market at anytime. The xxx Newsletter presents information in this report believed to be reliable, but its accuracy cannot be guaranteed. Additionally, it includes forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding expected growth of the featured company. Any statements that express or involve discussions with respect to predictions, expectation, beliefs, plans, projections, objectives, goods, assumptions or future events or performance may be forward-looking statements. The forward-looking statements contained herein (which include all statements other than historical information) involve significant uncertainties. Factors that could cause actual results to differ from the results or implied in forward-looking statements include the size and growth of the market for the Company’s products, the Company’s ability to fund its capital requirements in the near term and in the long term, pricing pressures for the Company’s products and services, the Company’s ability to obtain needed resources, and the local, regional and global markets. Forward-looking statements are based on expectations, estimates and projections at the time the statements are made that involve a number of risks and uncertainties that could cause actual results or events to differ materially from those presently anticipated. Past performance does not guarantee future results.

Emphasis mine. I wanted to split and highlight the juicy stuff.

Now, let’s think about the math of the scam: they pay the author $10,000 to sell his limited credibility to pump a penny stock.? They put $800,000 into the production and mailing of the glossy brochure.? But the market cap of the company is only $6.7 million.? They think the advertisement will create a lasting 12%+ rise in the stock that they can sell into.? Pump-and-dump.? Proclaim a biased story in big print; offer retractions in small print.

No surprise to me, this company has negative earnings (which are getting worse) and a growing negative tangible net worth.? For fun let’s look at the risk disclosures from the 10-K:

Because there is doubt about our ability to continue as a going concern, an investor may lose all of his investment in our company.? [Oh yeah, the auditors don’t believe in us.]

iTrackr has a history of losses and may not be able to generate sufficient net revenue from its business in the future to achieve or sustain profitability.

iTrackr?s cash on hand and anticipated near term sales may be insufficient to fund operations for the next 12 months.

If iTrackr is unable to fund its operations and capital expenditures, iTrackr may not be able to continue to develop and market its products and services which would have a material adverse effect on its business.

iTrackr is dependent upon key personnel whose loss may adversely impact iTrackr?s business.

iTrackr?s management systems and personnel may not be sufficient to effectively manage its growth.

If we are not competitive in the market for online sales, marketing and customer service solutions, or online consumer services our business could be harmed.

We are dependent on technology systems and third-party content that are beyond our control.

Our services are subject to payment-related risks.

We may be liable if third parties misappropriate personal information belonging to our clients? Internet users.

Our products and services may infringe upon intellectual property rights of third parties and any infringement could require us to incur substantial costs and may distract our management.

Technological or other defects could disrupt or negatively impact our services, which could harm our business and reputation.

Our promotion and marketing of our websites may not result in generation of significant revenue which may cause our business to fail.

Unauthorized disclosure of sensitive or confidential client and customer data, whether through breach of our computer systems or otherwise, could expose us to protracted and costly litigation and cause us to lose clients which may result in our going out of business and for you to lose your investment.

Competition in the social networking, online marketing and e-commerce industry is intense and our competitors have greater financial resources and development capabilities than we have, and we may not have the resources necessary to successfully compete with them.

Our services may become obsolete and unmarketable if we are unable to respond adequately to rapidly changing technology and customer demands.

The loss of our executive officers or directors, could adversely affect our business.

Our Controls and Procedures may not prevent misstatements.

Our Financial Statements for the year ended December 31, 2009 and the quarterly periods ended March 31, 2010 and June 30, 2010 were Restated as a Result of a Re-Audit by our New Independent Accountant Which was Necessitated Due to Revocation of our Former Auditor?s Public Company Accounting Oversight Board (?PCAOB?) Registration.

There will be a substantial number of shares of iTrackr?s common stock available for sale in the future that may be dilutive to its current stockholders and may cause a decrease in the market price of its common stock.

Our common stock is considered ?a penny stock? and may be difficult to sell.

iTrackr may be unable to receive a listing of its securities on NASDAQ or another national securities exchange, and this may make it more difficult for its stockholders to sell their securities.

One stockholder owns a majority of our common stock and may act, or prevent certain types of corporate actions, to the detriment of other stockholders.

If we issue additional shares of common stock in the future this may result in dilution to our existing stockholders.

There is currently no market for trading our common stock, and when such a market does develop, the trading price of our common stock may be volatile, with the result that an investor may not be able to sell any shares acquired at a price equal to or greater than the price paid by the investor.

The trading price of iTrackr?s common stock is likely to be volatile, and you might not be able to sell your shares at or above the public offering price.

The concentration of iTrackr?s capital stock ownership with insiders will likely limit your ability to influence corporate matters.

The Company does not expect to pay any cash dividends for the foreseeable future.

Not too optimistic, as you can see, and one looking through the financials would note that they are running out of cash.

Do the large holders think that they will dupe enough people to buy their shares from them, and at advantageous prices?? Hmm… maybe any price above zero is an advantageous price.? As with many promoted penny stocks, it usually looks like a future zero.

Even if the scam is legal, I don’t get how the math works.? They really think they will get a sustained 12%+ rise in the stock, adequate to turn over the entire capitalization of the company into the hand of suckers?

Which makes this double-dumb.? When even the scammers don’t make money, it is one really dumb scam.

Main lesson: don’t buy promoted stocks, and particularly not penny stocks.

PS — Why did the advisor decide to write this?? Was he that desperate for money?? If I were one who bought newsletters, I would not be impressed with the lousy analysis here.

On Financial Intermediation

Posted on 25 January 2012 by David Merkel

I appreciate Steve Randy Waldman, who writes the excellent blog Interfluidity.? Even before I started blogging, while I was at RealMoney, we interacted over CPDOs, along with Alea, and several others that were onto the scam.? That was a fun time, because aside from the Canadian rating agency Dominion, there was no one else questioning the idiocy of the AAA ratings aside from a few bloggers — we are the conscience of Wall Street, but that doesn’t mean that we get any pay as a result.? We write these things as a public service.

Recently, he wrote two? articles on financial intermediation.? Now I’d like to try my own thoughts on the topic.

Financial intermediation has two purposes: transactions and safety.? People want to buy and sell, but don’t want to have a currency where its value shifts radically day-to-day, which would complicate their decisions considerably.? They want a stable unit of account, and don’t want the possibility that they lose a lot of money as a result.? (Yes, during conditions of hyperinflation that boundary disappears, but that’s because they are already losing value already each day from holding the formerly “safe” transactional asset.? They get more careless on the intermediary, because of the risks of holding the safe asset.)

The second goal is safety/preservation/growth of purchasing power.? Can I park money or a short to long amount of time and be assured that when the term is up, I will:

Receive receive back as much or more in purchasing power terms.
Reduce my risks or the risks of those I care for from death and other calamities.

Financial intermediation leaves money on the table.? It does not seek the best investment outcome, but takes a lesser return, so that goals can be achieved with greater certainty.

Now, that provides an advantage to the financial intermediaries.? It means that they get cheap funding under most conditions.? Now, can they invest it over the likely lifetime of the funding and not lose money?? That’s a lot of what solvency regulation is about in banks and insurers.?? Because financial promises made can’t be easily analyzed for quality by those that offer money, there are two responses by the government:

Capital rules (which vary by liability and investments)
Insurance, so that users don’t have to worry about loss.

And, for what it is worth, 12 years ago I played a large role in setting the rules for Maryland life insurers in place, both writing the law, and explaining to the legislators how it protected the public interest.? (Hey! Passed unanimously on the first try, and with the d-word! (Derivatives)? My bill allowed risk mitigation but not risk taking with derivatives.)? The then-governor dressed like a mafia don at the bill signing, for what it is worth… My boss and I and our external and internal legal counsels spent a lot of time on this, but I was the prime mover on getting it done.

As an aside, sitting around in hearings in Annapolis, not knowing when your bill will come up is a chore.? If you know me well, you know I brought work to do, and if that wore out, good books to read.? I was never sitting there with nothing, bored. In the process I learned that Johns Hopkins owns Maryland, but declines from making that public, except when they care. 😉 When they spoke up, the legislature rolls over and asks for a scratch on the tummy. Arf!

Sorry, got lost in reminiscing.? Can I say that it was weird?? (I will leave out my dealings with the Department of Insurance, which were surreal.)? I’m not political for the most part, but in the end, the Maryland life insurance investment code is one of the best of the 50 states.? Kind of sad that we don’t have more life insurers here.

The last three paragraphs were quite a detour.? Let me take a different tack.? Yes, intermediation is opaque; that is true by necessity.? Depositors and insureds do not know how their money is invested.? I am here to tell you that that is a feature and not a bug, because the regulators know you can’t analyze the safety of your deposited assets.

In most things, I am a libertarian, but in areas where average people can’t ascertain truth or or falsehood, I support some form of regulation.? Financial promises fall under that rubric, because they are hard to discern.

To close this off, my main point is this: people want financial intermediation, particularly during the bear phases of the financial cycle.? They want to be protected, and transact, and save.? It is reasonable that the government regulates this, because the ability to make future promises that people rely on is valuable to society as a whole.

Searching for the Not-Romney

Posted on 4 January 201220 June 2017 by David Merkel

Over the last six months, I have described the Republican nomination to be the search for the not-Romney.? The average Republican does not want Romney, but they don’t know who they do want, among the midgets that are running.? Thus we see candidates spike in their approval ratings — everyone except for Huntsman, as Republicans search for an alternative to Romney.

Tonight, Santorum may be the not-Romney.? Ron Paul can never be the not-Romney because he is Ron Paul; he is something in himself, and not the competitor in relative terms.

My guess is that the not-Romney, whoever he might be, will win the nomination, and maybe the election.? My best hope is for a deadlock at the Republican convention, and they choose someone other than the midgets that are currently running.

Goodbye 2011

Posted on 31 December 20111 January 2012 by David Merkel

I tried to think of a post where I would bring out the best of 2011 economically, but the best I could some up with was, “It could have been worse.” That doesn’t convey much fondness.

2011 was characterized by using debt to “solve” debt problems.? Avoid default, extend the loan.? Or, let a public entity refinance the loan.

2011 was a year of rebellion — more pointedly in the Arab world, late to Russia and China, and lazy in the US.? Lefter then most leftists, like Marx, they assume that a wimpy “protest” will produce change.? Sorry, you have to organize, produce leaders, and either influence existing parties or create a new one, or, fight (of which I am not in favor).? If “Occupy” can’t do that, it ain’t worth a warm bucket of spit.

And personally, I am disappointed in those that have come out in favor of Occupy, not because their many contradictory causes don’t have merit, but because Occupy is so singularly ineffectual.? “You say you want a revolution, weelll you know, we all would like to change the world.”? Talk is cheap.? Disorganized talk and effort is pollution, not cheap; we would pay to have it eliminated.? Either organize, or be gone.

As far as the stock market went, it was volatile, but went nowhere.? As for me, I had my worst relative performance calendar year in 12+ years being down 1% while the S&P 500 was up 2%, with dividends.

The US politics of 2011 was nothing abnormal — we have had other periods of delay and intransigence, but few where we ran such huge deficits, and for so little good.? (Congress has not declared war, after all.)? Personally, I am for Ron Paul, not because I like everything that he stands for, but because his delegates have the best odd of deadlocking the Republican Convention, and leading to the selection of another candidate far better than the midgets currently out there.? Personally, I think primaries are overrated, and think we might be better off with conventions where parties analyze/fight over who would be the best candidate.

Never have we had a world so indebted, where there are so many fixed claims asking to be paid out at par.? The future has ugly surprises awaiting creditors — you won’t get repaid in full, whether by inflation or compromise.? Overages of debt clamor to become equity, and only such a change will heal the global economy.

If you are a lender, analyze your portfolio and adjust it where you can to the strongest borrowers.

But goodybye 2011, it was not a good year for me, and for many.? May 2012 be far better, and may we see orthodox policies triumph, even if prosperity lags.

PS — and eliminate or curb the Fed, please.?? If there is dirty work to be done, let Congress do it so we can vote them out.? Would that Ron Paul is our next President with a a compliant Congress that will rip out and eliminate our third failed central bank.? We would have some hard times for a number of years, but once they end, the growth would be strong.

A Large Middle Class Isn’t Necessarily Normal

Posted on 30 November 2011 by David Merkel

This is not likely to be a popular post.? Just warning you.

I have a bias that modernity is more fragile than commonly believed.? One aspect of that is income/wealth distributions.? Inequality was far more pronounced in the past, and was fairly stable in being so.? So why should the last 150 or so years not be viewed as a possible aberration?

Let me give you five or so reasons why the middle class should shrink:

1) Education — middle classes in the developed world were relatively large when the education systems produced a large portion of the educated people of the world.? That is no longer so, and relative education levels have tipped against the US.? Any surprise that we fall behind?

2) Lazy choices for majors/jobs — “follow your bliss” is stupid advice if no one wants to fund your bliss.? All prosperity comes through serving the needs of others.? Follow their bliss, not yours, and you will do well.

3) Technology — some technological advances aid equality, and some aid inequality — we have been getting more of the latter lately.? If a technology aids one person to serve many at low marginal costs, it will aid inequality, unless the technology is broadly shared and used.

4) Global Conditions — Resources are scarce.? Capital is somewhat scarce.? Unskilled labor is not scarce.? Skilled labor is somewhat scarce.? For those that have not prepared themselves to be productive by having needed skills, it is a tough time.? You won’t be carried along by the prosperity of your nation, because there are many others competing against you overseas, which was not true in the 50s, 60s, and 70s.? (Nor even the 80s and 90s, in degree…)

5) Personal Ethics — Societies that tolerate many children conceived out of wedlock, and no-fault divorce create an underclass of poor women with children, and the children are far less able to compete because they have no father figure.

6) Politics won’t change things — this is yet another hard reality.? People may vote, but money/resources “vote” more.? Especially in societies where education has slumped, power gravitates to those that will better the whole, even if it means the elites get more.

Someone please send the memo to the “Occupy” crowd, and tell them that have succeeded at being the “freak show” amid changing times, but utterly irrelevant to the changes happening around the globe.? If they have jobs, get to them, if not, go find one.? You might be relevant then.

The Foul Deed of the SEC in 2004

Posted on 2 November 2011 by David Merkel

It started with reading Abnormal Returns, something I do daily, and innocent enough.? But the article mentioned at SSRN was significant, and far more than a set of book reviews.? It cited a GAO study and a speech given by SEC Director Erik R. Sirri, which showed that the SEC did not materially modify its capital requirements for investment banks in 2004. So in one sense, the SEC is not to blame for the failures of the investment banks.

But in another sense, they are very much to blame.? Why?? As Buffett has said, he thinks about the things others say “can’t happen.”? Secured lending fits into another aspect of the “net capital rule,” an aspect less noticed.? That can be geared up 50 times, not the 12 times commonly considered.? Who would have thought that secured lending would be so overlent that it would push up asset prices, and that so many would rely on holding assets via short-term loans via repo?

Well, I fingered some of it at the time, but not all of it.? So the argument shifts — the SEC was not wrong for shifting its standards in 2004, which had little impact — it was wrong long before then with the net capital rule 15c3-1 by being too lenient with secured lending.

Secured lending often fails colossally, because lenders think the current value of the asset is a guarantee, when it is really subject to the conditions of the market.? When many lenders rely heavily on collateral, it proves to be less than valuable.? Also, secured lending tends to be done by leveraged entities, who think they can do it because it is safer.? When it fails, it can be like a string of dominoes.

We need to abandon the idea that the SEC made some grand shift in 2004, and rather, take up the idea that the SEC had the net capital rule wrong in the first place — it should have been tighter with respect to secured lending.?? Given the short-term nature of the repo markets, and the correlated nature of changes in repo haircuts, maybe the SEC should ban investment banks from using repo financing.? Yes, it will kill profits, but no regulator should care about that.? Regulators should care about solvency under all scenarios.

Short-dated financing of long-term assets is at the root of most financial crises.? Let the regulators move to a strict asset-liability matching framework for regulating the investment and commercial banks, where they look through the financing arrangement to the ultimate asset being financed.? Long assets deserve long financing.