Search Results for: The Education of a Corporate Bond Manager

The Best of the Aleph Blog, Part 15

The Best of the Aleph Blog, Part 15

Posted on by David Merkel

This stretches from August 2010 to October 2010:

The Education of a Corporate Bond Manager, Part VII

On the value of credit analysts.

The Education of a Corporate Bond Manager, Part VIII

On price discovery in dealer markets, and auctions gone wrong.? I never knew that I could haggle so well.

The Education of a Corporate Bond Manager, Part IX

On the vagaries of bulge-bracket brokers, and how a good reputation helps on Wall Street.

The Education of a Corporate Bond Manager, Part X

On how we almost did a CDO, and how it fell apart.? Also, how to make money in the bond market when you reach the risk limits. 😉

The Education of a Corporate Bond Manager, Part XI

On my biggest mistakes in managing bonds.? Also, on aggressive life insurance managements.

The Education of a Corporate Bond Manager, Part XII (The End)

On bond technical analysis, and how to deal with a rapidly growing client.?? Also, the end of my time as a bond manager, and the parties that came as a result.?? Oh, and putting your subordinates first.

Queasing over Quantitative Easing

Queasing over Quantitative Easing, Redux

Queasing over Quantitative Easing, Part III

Queasing over Quantitative Easing, Part IV

Queasing over Quantitative Easing, Part V

Queasing over Quantitative Easing, Part VI

The problems with the Fed’s seemingly “free lunch”strategy.? Pushes up asset prices and commodity prices, benefiting the rich versus the poor.

The Economic Geography of Publicly-Traded Companies in the United States by Sector

The Economic Geography of Publicly-Traded Companies in the United States by Sector (II)

Shows what US states have diversified vs concentrated economies by sector, and what states dominate each sector.

Portfolio Rule One

Industries are under-analyzed, relative to the market on the whole, and relative to individual companies. Spend time trying to find good companies with strong balance sheets in industries with lousy pricing power, and cheap companies in good industries, where the trends are not fully discounted.

Portfolio Rule Two

Purchase equities that are cheap relative to other names in the industry. Depending on the industry, this can mean low P/E, low P/B, low P/S, low P/CFO, low P/FCF, or low EV/EBITDA.

Portfolio Rule Three

Stick with higher quality companies for a given industry.

Portfolio Rule Four

Purchase companies appropriately sized to serve their market niches.

Portfolio Rule Five

Analyze financial statements to avoid companies that misuse generally accepted accounting principles and overstate earnings.

Portfolio Rule Six

Analyze the use of cash flow by management, to avoid companies that invest or buy back their stock when it dilutes value, and purchase those that enhance value through intelligent buybacks and investment.

Portfolio Rule Seven

Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.

Portfolio Rule Eight

Make changes to the portfolio 3-4 times per year. Evaluate the replacement candidates as a group against the current portfolio. New additions must be better than the median idea currently in the portfolio. Companies leaving the portfolio must be below the median idea currently in the portfolio.

The Portfolio Rules Work Together

How the portfolio rules work together to create a “margin of safety.”

The Rules, Part XVIII

When rules become known and acted upon, the system changes to incorporate them, making them temporarily useless, until they are forgotten again.

When a single strategy becomes dominant, it can become temporarily self-reinforcing.? Eventually, it will become self-reinforcing on the negative side.

A healthy market ecology has multiple strategies that are working in separate areas at the same time.

The Rules, Part XIX

There is room for a new risk model based on the idea that risk is unique among individuals, and inversely related to the price paid for an asset.? If a risk control model has an asset becoming more risky when prices fall, it is wrong.

?The Rules, Part XX

In the end, economic systems work, and judicial systems modify to accommodate that.? The only exception to that is when a culture is dying.

?Managing Illiquid Assets

Illiquidity is an underrated risk.? Most financial company failures are due to illiquidity, which usually takes the form of too many illiquid assets and liquid liabilities.? Adding to the difficulty is that it is generally difficult to price illiquid assets, because they don?t trade often.

Of Investment Earnings Assumptions and Century Bonds

If we could turn back the clock 65 or so years and set up a more conservative method of accounting for pension liabilities, we would be much better off today.

Who Dares Oppose a Boom?

This piece won a small prize, and in turn, I received three speaking engagements.

Fairness Versus Economics

Fairness Versus Economics (2)

People care more about fairness than improving their own economic/social position.

Earnings Estimates as a Control Mechanism, Flawed as they are

Earnings Estimates as a Control Mechanism, Flawed as they are, Redux

Earnings estimates have their problems, but they exist to give us a flawed method of estimating the future performance of companies.

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That’s all for now.? Never thought I would do so many long series when I started blogging.

The Best of the Aleph Blog, Part 14

The Best of the Aleph Blog, Part 14

Posted on by David Merkel

This period of the Aleph Blog covers May through July of 2010.? The one big series that I started in that era was “The Education of a Corporate Bond Manager” series.? The idea was to describe how a neophyte was thrust into an unusual position and thrived, after some difficulties.

The Education of a Corporate Bond Manager, Part I

How I learned the basics, and survived 9/11.

The Education of a Corporate Bond Manager, Part II

How I learned to trade bonds, and engage in intelligent price discovery.

The Education of a Corporate Bond Manager, Part III

What is the new issue bond allocation process like, and what games get played around it?

The Education of a Corporate Bond Manager, Part IV

On the games that can be played in dealing with brokers.

The Education of a Corporate Bond Manager, Part V

On selling hot sectors, and dealing with the dirty details of unusual bonds.

The Education of a Corporate Bond Manager, Part VI

On dealing with ignorant clients, and taking out-of-consensus risks.

Then there was the continuation of “The Rules” series:

The Rules, Part XIII, subpart A

On the biases the come from yield-seeking.

The Rules, Part XIII, subpart B

Repeat after me, “Yield is not free.”

The Rules, Part XIII, subpart C

Reaching for yield always has risks, but the penalties are most intense at the top of the cycle, when credit spreads are tight, and the Fed?s loosening cycle is nearing its end.? It is at that point that a good bond manager tosses as much risk as he can overboard without bringing yield so low that his client screams.

The Rules, Part XV

Securitization segments a security into liquid and illiquid components.

The Rules, Part XVI

“Governments are smaller than markets; markets are smaller than cultures.“

A fundamental rule of mine, but one with a lot of punch.

The Rules, Part XVII

On the differences between panics and booms.

The Journal of Failed Finance Research

Much research fails quietly, but other researchers don’t learn about the dead ends.? Better that they should learn of the failures, and avoid the dead ends.

How I Minimize Taxes on my Stock Investing

Sell low tax cost lots and donate appreciated stock to charities.

Place Political Limits on Overly Compliant Central Banks

Gives a simple rule to control central banks so that they avoid the present troubles.

Yield, the Oldest Scam in the Books

Yes, offering yield is the oldest way to trick people into handing over their money.

A Summary of my Writings on Analyzing Insurance Stocks

A good place to get started if one wants to get up to speed on insurance stocks, but there is a lot there.

Economics is Hard; the Bad Assumptions of Economists Makes it Harder

Going over Kartik Athreya?s letter criticizing nonprofessional economics bloggers.? Why the math behind macroeconomics and microeconomics doesn’t work.

Why Are We The Lucky Ones?

When you are a part of a small broker-dealer, all manner of harebrained deals get offered to you.? This explores three of them.? Note: management did not ask my opinion on the fourth deal, and that is a large part of why they no longer exist.

One more note: the guy who was going to pledge $5 million of stock in example 2 for a $1 million loan?? The stock is worth $7,000 today.

Watch the State of the States

The economics of the states tells us a lot more about the national health because they can’t print money to buy national debts.? (Though they can can raid accrual accounts…)

We Might Be Dead In The Long-Run, But What Do We Leave Our Children?

My view is that neoclassical economists are wrong.? Aggregate demand has failed for four reasons:

  1. Overleveraged consumers will not readily buy.
  2. Citizens of overleveraged governments will not readily spend, for fear of what may come later from the taxman, or from fear of future unemployment.
  3. Aggregate demand is mean-reverting.? It overshot because of the buildup of debt, and is now in the process of returning to more sustainable levels.? The same is true of private debt levels, which are being reduced to levels that will allow consumers to buy more freely once again.
  4. When the financial system is in trouble, people get skittish.

The Market Goes to the Dogs, Which Chase Their Tail Risk

Complex and expensive hedging solutions, many of which embed some credit risk, can be less effective than lowering leverage, and (horrors) holding some cash.

Fishing at a Paradox. No Toil, No Thrift, No Fish, No Paradox.

This one had its detractors, because I believe the paradox of thrift is wrong.? Too much aggregation, and it does not allow the dynamism of the economy to adjust over time, even from severe conditions.

Against Risk Parity, Redux

Against Risk Parity, Redux

Posted on by David Merkel

Here are two articles to read on risk parity:

Pro: Pick Your Poison

Con: The Hidden Risks of Risk Parity Portfolios

I’m on the “con” side of this argument, because I am a risk manager, and have traded a large portfolio of complex bonds.? For additional support consider my article Risks, Not Risk.? Or read the second half of my article, “The Education of a Corporate Bond Manager, Part X.” There is no generic risk in the markets.? There are many risks.? Interest rate risk and credit risk are different topics.?? There are bonds that have interest rate risk but not credit risk — long Treasuries.? There are bonds that have credit risk but not interest rate risk — corporate floating rate notes, my favorite example being floating rate bank trust preferred securities.

It is not raw price volatility that drives investment results as much as the underlying drivers of the volatility.? For fixed income, I described those in the two articles linked in the last paragraph.? During non-credit-stressed times, a bank’s 30-year floating rate trust preferred security is roughly as volatile as a five-year noncallable bond that it issues.? But during times of credit stress, the first security becomes volatile, whereas the second one doesn’t.? The first moves in line with 30-year swap yields, LIBOR, and long junior bank spreads.? The second moves in line with 5-year Treasury yields, and short senior bank spreads.? The underlying drivers have little in common, and when things are calm, their volatilities are similar, because the drivers aren’t moving.? But when the drivers move, which in this case is one correlated driver, credit stress (30-year swap & junior bank spreads go a lot higher), the volatilities are very different, the first one being high and the second one low.

Thus equating volatilities across a bunch of asset subclasses, investing less in the volatile, and levering up the non-volatile, is hard to do.? History embeds all the curiosities of the study period, and calls them normal, and that past is prologue.

From the Pick Your Poison article above, what I think is the (lose) money quote:

Gundlach insists most money managers misunderstand junk bonds, comparing them to 5-year Treasurys to determine how rich their yields are, when the correct comparison should be to 30-year Treasurys.

How can Gundlach compare junk bonds, which do better when the economy heats up, with long-term Treasurys, which get killed when the economy revs up and the Fed raises interest rates?

That?s irrelevant, he responds. The thing to look at is volatility, because that tells you the odds you will have to sell at a loss when you need to raise cash in an emergency. On that basis, junk bonds that were trading at a seemingly reasonable spread of 5 percentage points, or 500 basis points, to 5-year Treasurys in mid-2011 were actually trading at an intolerably low 250-basis-point spread to the proper bond. (By then DoubleLine had cut its junk bond allocation from 10% to 1%.) Sure enough, junk fell 12% as the year went on, and the spread to 30-year Treasurys has doubled since mid-2011.

?It?s called risk parity,? Gundlach says. ?There?s only two investors who seem to understand it?me and Ray Dalio,? the highly successful manager of $122 billion (assets) Bridgewater Associates.

Personally, I don’t think Gundlach makes his money that way for his funds, but in case he does, how should a good bond manager view junk bonds?

First, ignore Treasuries — they aren’t relevant to the price performance of junk bonds.? I’ve run the regression of Treasuries vs junk bond index yields many times.? It’s barely significant for BBs, and insignificant thereafter.? Second, look at stock market indexes of industries that lever up and issue junk debt.? Junk corporate debt is a milder version of junk stocks, i.e., the stocks that issue junk debt.

Third, a corollary of my first reason, realize that risks with junk aren’t driven by spreads, but yields.? With highly levered, or very junior debt, it does not trade on a spread basis, but on a price basis.? Anyone looking at spreads will see too much volatility versus yields and prices.

But mere volatility won’t tell you the riskiness.? Indeed, when economic times are good, junk will do well, and long Treasuries do poorly.? Now, maybe that makes for a very noisy hedge, but I wouldn’t rely on it.

And, volatility is a symmetric measure, which as bond yields get closer to zero, the symmetry disappears.? Most asset classes display negative skew and fat tails, which also makes volatility problematic as a risk measure.

Going back to my first piece on the topic, if I were applying risk parity to a bond portfolio, it would mean that I would have to buy considerably more of shorter and higher quality instruments, and lever them up to my target volatility level, somehow with spreads large enough that they overcome my financing costs.? Now, maybe I could do that with mispriced mortgage securities, but with the problem that those aren’t the most liquid beasties, particularly not in a crisis if real estate is weak.

I guess my main misgiving is that levered portfolios are path-dependent, as pointed out in the GMO piece above.? You can’t be certain that you will be able to ride through the storm.? The ability to finance short-term disappears at the time it is most needed.

Now, if you can get leverage after the bust, and invest in beaten-up asset classes, you can be a hero.? But that’s a time when only the most solvent can get leverage, so plan ahead, if that’s the strategy.? If an investor could consistently time the liquidity/credit cycle, he could make a lot of money.

As the GMO piece concludes, the only benchmark that everyone could hold would be a proportionate slice of all of the assets in the world, which implicitly, would strip out all of the leverage, because one would own both the shares of the company, and the debt it owes, and in the right proportion.

So I don’t see risk parity as a silver bullet for asset allocation.? I think it will become more problematic, as all strategies do, as more people show up and use it, which is happening now.?? First in the hands of the master, last in the hands of a sorcerer’s apprentice.? Be careful.

PS — I have respect for the skills of Gundlach and Dalio.? I’m just skeptical about what happens to risk parity when too many use it, and use it without understanding its limitations.? And, here is a nice little piece about Bridgewater and its strategies.

Learning to Like Lumpiness

Learning to Like Lumpiness

Posted on by David Merkel

Simplistic financial plans assume a smooth return that the client will earn.? Why?? No nefarious reason, but planners don’t know the future, so they either:

1) Assume an average rate as a baseline for calculations, or

2) Display the average, median, or some? percentiles from a series of randomly estimated possible futures.

But life isn’t that way.? Markets are lumpy.? High and low returns happen more frequently than average returns.? What’s worse, returns tend to streak over years and decades.? So much for the Efficient Markets Hypothesis.

So what to do?? Better to be like the great moral philosopher Linus van Pelt, who carried a candle at night, and his sister Lucy asked him why he was doing so.? Linus replied, “It is better to light a single candle than to curse the darkness.”? After Linus left, Lucy mused for a moment, and shouted, “YOU STUPID DARKNESS!”

Volatility is a fact of life, and even the volatility is volatile, with regions of seeming stability, and regions of extreme booms and busts.

My “single candle” is simple — it is an adjustment of expectations, which involves reasoning that when things have been horrible, after some amount of time, it is time to take risk again, before it is perfectly obvious to do so.? Same thing when things are great, it may be time to take risk off the table.? I would add that delay in doing so is not a failure — lumpiness means that trends run further than would be reasonable.? But when the momentum wanes it is time to change.

I’ve been in the situation multiple times, but it is really difficult to get permabulls or permabears to recognize that something has shifted.? I wrote about this a number of times in my series “The Education of a Corporate Bond Manager.”? I was constantly fighting those who were hanging onto the old trend too long.

And at another firm, I could not convince my boss to go long once the nadir of the credit crisis had passed.? He expected more trouble to come, while I looked at the bond market and found an absence of distressed credits.

The lesson of both cases is that opportunities to earn total returns or preserve capital are lumpy.? If the market is longing for safety now, it will likely do so for a while, and the same is true for bull markets.

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Many retirees say “I just need a certain reliable income of X%/year. Please get that for me.”? We may as well tell these people to buy a CD or annuity, except that Fed policy makes the rates inadequate for their needs.? And yes, this is a deliberate policy of the Fed, picking on the elderly and the conservative in order to fund marginal lending that might? result in some tiny increment of growth.

It is far better to ask three questions:

1) Where are we now in the credit risk cycle? Rising, Peak, Falling, or Trough?

2) Where are yields on high-grade corporate bonds now?

3) Can you afford to spread your yield needs over five years?

Bond investors need to realize that most returns of the bond market are earned at three times: first, after the nadir of the credit cycle, credit-sensitive bonds soar.? Second, during deflationary times, buying long-dated Treasuries.? Third, when inflation is running, rolling over short-dated fixed income claims.? Beyond that, one can clip bond coupons during abnormal times of stability.

By asking the above first two questions, we can ascertain whether it is a favorable time to take risk or not, and what sort of risks to take.? The last question is more of a reasonableness check on the client.? If he has to have the return every year without fail, tell him to seek it at a bank or insurer, and see if he is pleased with the results.

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But now take it one step further.? When will our stupid economists and politicians get it through their heads that lumpy economic growth is normal, and even that it is desirable that growth is not smooth?? Effort to produce a smooth economy led to a debt build-up, which ultimately sabotaged growth.? Far better to let small recessions do their work, and leave the Fed funds rate high until marginal investments are repriced, with the attendant bankruptcies.

The US economy grew more rapidly when there were no efforts at stimulus.? Yes, there were severe recessions, but the booms thereafter more than made up for it.? Though it would hurt a lot in the short-run, far better to end the deficits of the US government, and the pitiful efforts of the Fed, giving greater certainty to the private sector, that businessmen could make long-term decisions without worries that taxes, regulations, or interest rates might change dramatically.

Like it or lump it, some say.? Why choose?? Learn to like the lumpiness of the asset markets and the economy in general, and many things will go more easily for you.

Sorted Weekly Tweets

Posted on by David Merkel

Picture Credit: David Merkel, with an assist from the YouImagine AI image generator || Twitter bird flies off into the sunset

Companies

  • Missed signals: behind Trafigura’s $577mn loss on non-existent nickel https://t.co/fJNQSmKbgl  Fascinating that they never did physical checks of what was delivered. Also that they didn’t do a background check on TMT. Feb 16, 2023
  • Podcast Companies, Once Walking on Air, Feel the Strain of Gravity https://t.co/RaNTop40uS  My kids ask me to do a podcast. I tell them it’s too much work for too little gain. I would rather read than listen, unless I am driving or cutting the yard. Feb 15, 2023
  • One of the world’s richest families was thrust into the spotlight by a surprising share sale from one of its own members https://t.co/Gk6Xzr2OcU  You need a liquidity plan, akin to what a private real estate fund does. You can’t assume that no family member needs liquidity Feb 15, 2023
  • How Ben & Jerry’s ended up at war with itself https://t.co/x2W5knUvR7  The revolution eats it own children, even as they eat ice cream Feb 15, 2023
  • As tech companies shed thousands of jobs, more employees want a say in their severance https://t.co/WHDVvdwRCO  Hiring a lawyer at your severance can be valuable. Feb 15, 2023
  • On the latest episode of the Zero podcast, @AkshatRathi speaks to the founder of Imprint Energy, which developed a printable battery for internet-connected devices. https://t.co/uIdNoxfPlz  Looks promising Feb 15, 2023
  • FICO scores are flawed. These lenders say they’ve found a better way to judge your credit https://t.co/jklyVW53r3  Sowing the seeds of new consumer bankruptcies on the low end of the income scale. Avoid debt for consumption purposes. Feb 14, 2023
  • A $4B accounting shortfall typically raises alarm bells for an auditor. Somehow a PwC affiliate missed it at Americanas https://t.co/Vr72rqV6c7  PwC may have cultural problems. If you can miss something that large & not be culpable, it calls into question the value of audits Feb 14, 2023
  • As tech giants look to slim down, middle managers are feeling the pressure https://t.co/4I5JhO6ez8  Not sure if this is good or bad Feb 13, 2023

Odds & Ends

  • New Car Prices Are So High Only Rich Americans Can Afford Them https://t.co/yrGEmDSIVS  This will eventually have political impacts, as regulations affect poor people more than the rich Feb 18, 2023
  • Wanting to go big with AI in search, Microsoft could end up causing the kinds of harm it will come to regret, writes @parmy https://t.co/e9g3Mlom6D  They are not sentient. They are easily tricked. They are code. Feb 18, 2023
  • The buildout of so-called dark warehouses has begun, but the high-tech facilities are far from common due to their high price tags and the limitations of robotic technology https://t.co/i1xgwi8BKY  Not quite ready for prime time Feb 17, 2023
  • A ‘Crucial Bridge’ to History, the Codex Sassoon Could Fetch $50 Million https://t.co/z9xQGClGoF  Really, you can’t put a price on this. I bet there are Hebrew scholars worried about who will buy this, & future access. Feb 16, 2023
  • 3 amateur codebreakers set out to decrypt old letters. They uncovered royal history https://t.co/kNGYZx6YT7  But nothing significant, really… Feb 16, 2023
  • This Company Uses Machine Learning to Track Your Antibodies https://t.co/c0r5Bk1Tn4  Promising technology Feb 15, 2023
  • Two of the most-talked-about Super Bowl ads on Sunday focused on an unlikely topic: Jesus https://t.co/lDOsgH3cjM  The gospels were written for a Roman audience as eyewitness accounts of who Jesus was & what he did. Read them & ask, was Jesus a legend, liar, lunatic or Lord? Feb 13, 2023
  • @codywillard Wow, Cody. Glad you’re alive. The Lord had mercy on you and your family. Feb 12, 2023

Culture

  • Yes, Single People Can Be Happy and Healthy https://t.co/6mrXtdv6ai  It is better to be single & wish you were married, than to be married & wish you were single. That said, this article is wrong, at least for men. Married men live longer & are happier than single men, on average Feb 18, 2023
  • The adults celebrating child-free lives https://t.co/hkiZK3zrpn  Those not having or adopting children should be excluded from government pensions and healthcare benefits Feb 18, 2023
  • Some school districts are doing away with honors classes, which has made some parents unhappy https://t.co/rPHDXEx68L  All teaching only reaches a fraction of IQs. This is why there needs to be many levels of teaching: high, middle, low, if you want to have all children improve. Feb 17, 2023
  • Education should not be a social experiment. It needs to be based off of what works, not wishful theories. What gets taught to prospective teachers in college is positively harmful to pedagogy. We need to end that. https://t.co/uHyxOznUxl  Feb 17, 2023
  • Miriam Adelson, along with her late-husband, poured tens of millions of dollars into former President Trump’s reelection campaign. Now she’s leading a push to legalize gambling in Texas https://t.co/jMmlxpVWq7  Legal gambling leaves society as a whole worse off Feb 16, 2023
  • As the country emerges from a pandemic that left children zoning out over Zoom, parents are turning to the turbocharged “Russian math” method to give their kids an academic edge. https://t.co/zsdtgrNnel  The examples given are not impressive Feb 16, 2023
  • Disney has tightly controlled Winnie-the-Pooh’s image. With the copyright expired, ‘Winnie-the-Pooh: Blood and Honey’ breaks the wholesome mold https://t.co/2H3IxjRtOc  This is not good, but it is notable. Perhaps $DIS will find a way to sue. Feb 15, 2023

Real Estate

  • America’s Priciest Neighborhoods Are Changing as the Ultra-Rich Move to Florida https://t.co/GOIJ61QsPD  The wealthy seek lower taxes and warmer places. There should be no surprise here. Feb 15, 2023
  • Turning offices into condos: New York after the pandemic https://t.co/z8zoyRUTyy  Popular concept. Tough but not impossible to execute Feb 15, 2023
  • Brookfield Defaults on Two Los Angeles Office Towers. The properties include the Gas Company Tower and the 777 Tower https://t.co/KmTLc9r9OZ  Losses go to Brookfield DTLA Fund holders, & their lenders Feb 15, 2023
  • When It’s Easy to Be a Landlord, No One Wants to Sell https://t.co/brqym7aoJS  With help from firms like Mynd that do property managment, you can keep your home w/a low rate mortgage, and rent it out Feb 13, 2023
  • Why mortgage rates spiked from 6% to 6.5% early-February 2023 & what’s next https://t.co/y6sKncYEBs  Complex way of saying “We don’t know.” Hint: the long end of the curve does not move much in response to short-term inflation. FOMC, take note Feb 13, 2023
  • The high costs of housing are influencing romantic decisions https://t.co/opJ5P2Abjw  Moving in reveals who each of you really are. Selfishness, laziness, bad communicating, substance abuse, lying… break relationships Feb 13, 2023

Adani Group

  • Adani Group tells investors that they will address deadlines to repay debt with options including private placement notes and cash from operations https://t.co/FUEWh43C3I  But will they be profitable after refinancing near-term debt at higher rates? What covenants will they make? Feb 17, 2023
  • Adani halts $847mn acquisition of coal-fired power plant in India https://t.co/hJQDR61XfB  Financing is less available. Not a good sign. Feb 16, 2023
  • That would functionally subordinate some of their public debts, making them even less valuable. I remember looking at the final private placement Enron issued. Complexity was over the top; we did not participate. I would love to see the PP memorandum leaked. https://t.co/sDRoh7P6qc  Feb 16, 2023
  • Indian conglomerate Adani Group is in talks with potential investors as it considers offering privately placed bonds for at least three of its group companies, people familiar with the matter say https://t.co/YF98mIE4Vb  Maybe they do secured debt, or add protective covenants Feb 16, 2023
  • Adani Group sees no material refinancing risk for its listed companies and has no significant near-term liquidity requirements https://t.co/frK2aP7nZq  Complex holding company structures make liquidity management difficult. I’ve lost money on a few of those. Feb 15, 2023
  • Adani Group sees no material refinancing risk for its listed companies and has no significant near-term liquidity requirements https://t.co/frK2aP7nZq  If so, keep paying down your debts, and feed losses to the shorts. Feb 15, 2023

The Markets

  • The rise of short-dated options is creating event risk on the scale of the stock market’s early-2018 volatility implosion, JPMorgan’s Marko Kolanovic says https://t.co/IRIg7SYOb8  Possibility of self-reinforcing move if 0DTE options go into the money, forcing option deals to hedge Feb 16, 2023
  • A once arcane corner of Wall Street is now in demand as borrowing costs soar and $6 trillion of bond maturities loom https://t.co/XZsM1nDN43  The corporate bond market is not arcane, & though there will be bankruptcies, this is not a crisis. Feb 16, 2023
  • The shares have surged so much that it’s creating a dilemma for investment giant Nuveen — and posing a little-known risk to its investors https://t.co/jmcR1WpDbH  Why not do an “in kind” distribution as a dividend, or a discounted buyback, or just “ride the ask” $ENGH Feb 16, 2023
  • Credit Suisse is offering investors a hefty incentive to buy its new euro bonds just days after announcing a bigger-than-expected quarterly loss https://t.co/OeuM8J31NO  Seems desperate Feb 15, 2023
  • The mood is starting to shift in global credit markets after a three-month rally https://t.co/VRjlamNJ0W  Credit rally overdone & difficult to get away from LIBOR #liborwasbetter Feb 13, 2023

Non-US

  • Nigeria is trying to gain more control over its vast cash economy by compelling citizens to swap their old money for newly designed naira bills. But the plan is running into serious trouble https://t.co/63mjaLLbBQ  Difficult to outlaw cash when financial systems are underdeveloped Feb 16, 2023
  • It’s undermining Beijing’s attempt to engineer an economic recovery tied to consumption https://t.co/GrjowTdfdT  Efforts to get Chinese to consume more creates financial speculation via low rates on personal loans. Feb 15, 2023
  • More than 200 construction bosses face arrest in Gaziantep and cities across Turkey’s earthquake zone. https://t.co/sCgMpMdLup  Corruption leading to deaths Feb 15, 2023
  • Japan is quietly experiencing its biggest outbreak of the pandemic https://t.co/rbwea15TwH  Elderly population is more likely to die. Medical resources are stretched. Feb 15, 2023
  • Moldova’s pro-European president accused Russia of trying to overthrow its democratic system and open a fresh front in Moscow’s war on Ukraine https://t.co/2koKvf0DbJ  Putin wants the USSR back. Feb 13, 2023

Central Banking

  • Richmond Fed President Tom Barkin says he supported the central bank’s plans to continue raising interest rates in quarter-point increments https://t.co/R9w8bhtw3l  Driving through the rear-view mirror. My three questions he didn’t answer at the 3/22 @CFASBaltimore all came true Feb 17, 2023
  • President Christine Lagarde reiterates that the European Central Bank intends to raise borrowing costs by another half-point next month https://t.co/zGOtVri6ka  Unless you want to discover hidden weaknesses in EU financial systems, you shouldn’t invert the yield curve further Feb 15, 2023
  • Liquidity, leverage and interconnectedness? https://t.co/abqrRH6lsZ  Good interview w/@fmnatalucci. He understands financial risk and liquidity. A lot of what he said sounds like me. Where I see risk is not open-end high yield funds, but EU banks & pseudo-banks. Feb 15, 2023
  • The White House is considering nominating Austan Goolsbee, who became president of the Chicago Fed last month, to serve as vice chair of the Federal Reserve’s board of governors https://t.co/QwxJJD5Gph  We could do worse, but why not Lacy Hunt? Feb 15, 2023
  • The end of distressingly high inflation is coming into view, but the cost of goods, housing and other services is complicating path for easing consumer prices https://t.co/laCY0cZDdn  Focus on median inflation than all of the measures that drop out whole spending categories Feb 13, 2023

Economic Policy

  • How three major bills could change the American economy. https://t.co/ufiiuufFTw  Nothing useful, lots of additional debt Feb 17, 2023
  • The US Supreme Court could rewrite the rules of the internet with a challenge to the liability shield cherished by online companies https://t.co/sQfeDhzmJO  I lean in favor of allowing lawsuits against social media companies for inadequate moderation, but limiting damage claims Feb 17, 2023
  • Odd Lots Transcript: This Is What Happens If the US Actually Hits the Debt Ceiling –What if it doesn’t get lifted? https://t.co/AkPZE6hxoy  No one knows. Maybe the 14th amendment section 4 can be invoked to invalidate the debt ceiling Feb 16, 2023
  • New York City is pausing a small business loan program less than a month after it launched after an unanticipated influx of over 10,000 applications https://t.co/i9uRS9Ml2o  Why governments should not subsidize: they are either too generous or cheapskates Feb 15, 2023

China

  • China’s sweeping policy support for the property sector has been no quick fix for developers’ liquidity struggles, leaving some investors waiting until the last minute for cash https://t.co/EB7wDHkaJH  The Chinese Communist Party learns reflating a bubble is surprisingly difficult Feb 17, 2023
  • Heard on the Street: China’s fiscal position—and ability to fund other priorities—will increasingly be threatened by threatened by rising healthcare costs https://t.co/0sX2iyoBoE  Social welfare systems only work well when populations are young. Feb 17, 2023
  • Investors are buying Chinese stock funds, betting that the reopening of China’s economy will help push markets higher  https://t.co/hISEKrfwbN  ‘“There’s opportunity, to be sure, but I think those are trades, not investments,” said Nancy Tengler.’ Feb 15, 2023
  • In China, single mothers are facing fewer hurdles as Beijing tries to boost its fertility rate https://t.co/BNIeVRlIs2  Reduces abortion Feb 15, 2023

Crypto

  • Binance is considering ending relationships with US business partners as regulators turn up the heat on crypto https://t.co/8f7dIWson0  Pushing crypto out of the US is good policy Feb 17, 2023
  • Crypto platforms could soon face a new set of hurdles to hold digital assets owned by clients of hedge funds and private equity firms in the US https://t.co/m9bZLCxokL  Makes sense if you want custodial accounts. Feb 15, 2023
  • Sam Bankman-Fried was blocked from using virtual private networks while on bail, with the judge overseeing his fraud case expressing concern that VPNs present similar risks as encrypted messaging apps https://t.co/7zpiWHoMjE  From crypto-king to peasant disallowed encryption Feb 15, 2023
  • US regulatory crackdown on crypto aids Tether’s USDT, a stablecoin that’s located offshore, even as the transparency of its reserves faces scrutiny https://t.co/didoPeEO6t  US holders of Tether will appreciate the foreign domicile when Tether fails & recovering value is hard Feb 15, 2023

War

  • Hundreds of fuel vessels are taking steps to hide where they’re going https://t.co/wK67gNEjV2  Evading sanctions — there is a profit to be made, and Russia needs money for the war Feb 18, 2023
  • Many countries are reassessing their military might — and it’s not just limited to Ukraine’s neighbors https://t.co/C0QpA7rXOj  War takes resources, & budgets are stretched… what will be given up? Feb 18, 2023
  • The world’s war machine is running low on ammunition https://t.co/VAMcJLwxbp  Together with stretched government budgets and relatively tight money globally — is this why the long end is selling off? Feb 16, 2023

Pensions

  • Time Bomb of Public Pension Funding Ticks Louder https://t.co/QO6mS07lwI  One way the article could have been improved would be to add in the effects of falling interest rates, not just the long stock rally Feb 13, 2023
  • The aggregate funding level for state and local pension plans is below 50%, inviting a disaster that would outstrip the occasional municipal bankruptcy https://t.co/QO6mS07lwI  Well written. Will it take the failure of a US State to get serious about this? Feb 13, 2023

The Rules, Part LXXII

Posted on by David Merkel

Picture Credit: Kailash Gyawali || There are times when despair is rational

“There are two hard things in trading — buying higher, and selling lower.”

Currently I am selling out my position in an illiquid stock. I am patient, but I can tell that my selling is having an impact on the market.

Back when I was a corporate bond manager, I quickly learned that I had to scale in and out of positions. Even for the most commonly traded bonds, the market isn’t that liquid. While not lying to the brokers, learning to disguise your intentions, or at least frame them properly took some effort. One method I commonly used worked like this: “We need some cash. If you have someone wanting to buy $2-5 million, we will offer these at the 10-year Treasury + 150 basis points, $6-10 million T10 + 140 bps, and if they want to buy the whole wad (say 20-30 million), T10 + 125 basis points. Prices would ascend with size in selling. Prices would descend with size in buying, particularly for troubled bonds that we liked.

Usually the brokers appreciated the supply or demand curves that I gave them. Frequently I ended up selling the “the wad,” which we were usually selling because our credit analyst had a reason.

But life is not always so happy. Sometimes you have an asset that either you or the organization has concluded is a dud. Many people think it is a dud. How do you sell it? Should you sell it?

There are options: you could hold an auction, but I will tell you if you do that, play it straight. Your reputation is worth far more than if the auction succeeds or not. You can set a reservation price but if the auction doesn’t sell, you will lose some face.

Or you can test the market, selling in onesies an twosies ($1-2 million) seeing if there is any demand, and expand from there if you can.

What I tended to do was go to my most trusted broker on a given bond and say, “I don’t have to sell this, but we need cash. Could you sound out those who own the bonds and see what they might like to buy a few million?” If we get an interested party, we can sound them out on buying more a an attractive price.

But life can be worse, imagine trying to sell the bonds of Enron post default. Yes, I had to do that. And I had to sell them at lower and lower prices. (Kind of like the time I got trapped with a wad of Disney 30-year bonds.)

And there is the opposite. You want to have a position in an attractive company, and you can’t get them at any reasonable price. You could give up. You could “do half.” Or you could chase it and get the full position, only to regret it.

If you invest with an eye toward valuations, this will always be a challenge. All that said, if you focus on quality, these issues probably won’t hurt you as much.

In any case, do what must be done. If something must be bought, buy it as cheaply as possible. If something must be sold, sell it as dearly as you can. Hide your intentions, while offering deals. In doing so, you may very well realize the most value.

The Balance: Considering Event-Driven Investing

The Balance: Considering Event-Driven Investing

Posted on by David Merkel

Photo credit: miltarymark2007

===========================

I published another article at The Balance:?Considering Event-Driven Investing.? This is one place where writing in the third person leaves a lot out.? I’ve done a lot with some types of event-driven investing.

  • Speculating on hurricanes — I did that successfully at the hedge fund 2004, 2005 and 2006.? 2006 because I thought the risk of another strong hurricane year was overplayed.? 2004 and 2005 because I had a good idea of who was underreporting claims after disasters.? That was the only time in my life that I went from long a company to short without stopping, and I covered on the day the CEO resigned, and caught the bottom tick.
  • Bond deal arbitrage — well, sort of.? I would buy target company bonds and sell the bonds of the parent.? I had to be certain that the deal would go through, but it was a tremendous yield enhancement is the right situations.
  • From the prior article, speculating on Lula’s non-impact on Brazil qualifies as event-driven.
  • Stock arbitrage — did a lot with it when I was younger.? Didn’t do so well.
  • Index arbitrage — did a neutral trade where we shorted one company out of the Russell 2000, and bought another one in.? Made no money on the trade.? We had a good fundamental justification for the trade, but it just goes to show you that this isn’t as easy as it looks.
  • I buy a decent number of spinoffs.? Most succeeded as investments for me.

Now, all that said, most areas where there are simple arbitrages typically boil down to a simple credit risk: will the deal get completed? Will the company not take an action that changes its capital structure in a way that hurts me?

Since these are relatively simple trades, the returns are relatively low like that on a short-term junk bond — at present, like the yield on T-bills plus 2-3%.? It’s not very compelling given the risks involved.? Most of the mutual funds that do that type of arbitrage have not done so well.

Thus, aside from spinoffs, at present, I don’t do that much with event-driven investing.? Many of the forms of it are too crowded, and I prefer simplicity in investing.

The Best of the Aleph Blog, Part 27

The Best of the Aleph Blog, Part 27

Posted on by David Merkel

In my view, these were my best posts written between August?and October?2013:

I completed the last of my “Manager” series, on being an investment risk manager:

The Education of an Investment Risk Manager, Part VI

This is the bizarre story of how I pulled a win out of an impossible situation against my own management, and a major life insurer.

The Education of an Investment Risk Manager, Part VII

On the time that I correctly modeled a complex structured security, and the client wouldn’t listen to reason

The Education of an Investment Risk Manager, Part VIII

The time that I?did a competitive study of the most aggressive life insurers, and how it did not dissuade my client’s management team from trying to imitate them.

The Education of an Investment Risk Manager, Part IX (The End)

A bevy of little tales about odd investment tasks that I succeeded with, and how many of them did no good for my clients.

Ben Graham Did Not Give Up on Value Investing in Theory

With quotations and links to the source documents, I show what Ben Graham really said in the article commonly cited to say that he gave up on value investing.

On Avoiding Con Men

A summary article of many of my prior articles on how to avoid being defrauded.

On Alternative Investments

Alternative investments are like regular investments, but they are less liquid, more opaque, and have higher fees.

Should You Buy Shares of Stock or Not?

Where I answer Mark Cuban the one time he tweeted to me. ?Really!

Quiet Companies Are Better

Why companies should let their filings with the SEC speak for them, and abandon the media.

Two is Company, Three is a Crowd

On game theory, and how it affects politics and civil wars.

It Works, But It Doesn?t Work All The Time

On how good investment theories fail for periods of time, and then come roaring back when most people know they will never work again.

Value Investing when Debt Levels are High

On seeking a margin of safety, when very little seems safe

A New Look at Endowment Investing

I interact with a groundbreaking paper on endowment investing — a very good paper, and I give some ways that it could be improved.

Less is More

Do you want to do better in investing? ?Make fewer decisions, and make them count.

Taleb Versus Reality

In which I take on Nassim Taleb’s views on how to reduce risk in investing, and show which half of his valid, and which half are fantasy.

To Young Analysts

What I contributed to Tom Brakke’s project for young investment analysts — what do I think they should know?

The Rules, Part XLIX

In institutional portfolio management, the two hardest things to do are to buy higher than your last buy, and sell lower than your last sale.

The Rules, Part L

Countries are firms that produce claims on assets and goods

The Rules, Part LI

65% of the time, the rules work.? 30% of the time, the rules don?t work. 5% of the time, the opposite of the rules works.

The Rules, Part LII

ge + E/P > ilongest bond

The Rules, Part LIII

The tech market washes out about every eight years or so.? The broad market, which is a more robust beast, washes out far less frequently.? My question: are these variants of the same phenomenon?

The Rules, Part LIV

When do employee and corporate incentives line up?? Ideally, incentive schemes should reward people with a fraction of the additional profitability that resulted from the additional work that they did.? Difficulties: measurement impossible in many cases, people could receive a bonus when the firm is not profitable, neglects synergies (both positive and negative).

The Rules, Part LV

Financial intermediation reduces volatility.? In bull markets, demand for financial intermediaries drops.

The Rules, Part LVI

Leverage and risk eventually transfer to the least regulated

The Rules, Part LVII

The more that markets are united through derivatives, the more systemic risk is created.

Simple Stuff: On Bid-Ask Spreads

Simple Stuff: On Bid-Ask Spreads

Posted on by David Merkel

Photo Credit: Eddy Van 3000
Photo Credit: Eddy Van 3000

This piece is an experiment. ?A few readers have asked me to do explanations of simple things in the markets, and this piece is an attempt to do so. ?Comments are appreciated. ?This comes from a letter from a friend of mine:

I hope I don?t bother you with my questions.? I thought I understood bid/ask but now I?m not sure.

For example FCAU has a spread of 2 cents.? That I understand – 15.48 (bid) ? that?s the offer to buy and 15.50 (ask) ? that?s the offer to sell.

Here?s where I?m confused.? How is it possible that those numbers could more than $1 apart? EGAS 9.95 and 11.13.? I don?t understand.? Is the volume just so low? ?And last price is 10.10 which is neither the ask nor bid price.? Can you please explain?

You have the basic idea of the bid and ask right. ?There is almost always a spread between the bid and the ask. ?There can be occasional exceptions where a special order is placed, such as an “all or none” order, where the other side of the trade would not want to transact the full amount, even though the bid and ask price are the same. ?The prices might match, but the conditions/quantities don’t match.

You ask why bid/ask spreads can be wide. ?I assume that when you say wide, you mean in percentage terms. ?Here the main?reason:?many of the shares are held by investors with a long time horizon, who have little inclination to trade. ?Here is a secondary reason: the value of the investment is more uncertain than many alternative investments. ?I believe these reasons sum up why bid/ask spreads are wide or narrow. ?Let me describe each one.

1) Few shares or bonds are available to trade

Many stocks have a group of dominant investors that own the stock for the longish haul. ?The fewer the shares/bonds that are available to trade, the more uncertainty exists in where the assets should trade, because of the illiquidity.

Because few shares are available to trade, price moves can be violent, because it only takes a small order to move the price. ?Woe betide the person who foolishly places a large market order, looking to buy or sell at the best price possible. ?I did that once on a microcap stock (the stock of a very small company), and ended up doubling the price of the stock as my order was fully filled, only to see the price fall right back to where it was. ?Painful lesson!

As a result, those that make markets, or ?buy and sell stocks tend to be more cautious in setting prices to buy and sell illiquid securities because of the difficulty of trading, and the problem of moving the market away from you with a large order.

I’ve had that problem as well, both with small cap stocks, and institutionally trading illiquid bonds. ?You can’t go in boldly, demanding more liquidity than the market typically offers. ?If you are buying, you will scare the sellers, and the ask will rise. ?If you are selling, you will scare the buyers, and the bid?will fall. ?There is a logical reason for this: why would someone come into a market like a madman trying to fit 10 pounds into a 5-pound bag? ?Perhaps they know something that everyone else does not. ?And thus the market runs away, whether they really do know something or not.

In some ways, my rookie errors with small cap stocks helped me become a very good illiquid bond trader. ?For most bonds, there is no bid or ask. ?Some bonds trade once a week, month, or year… indicative levels are given, maybe, but you navigate in a fog, and so you begin sounding out the likely market to get some concept of where a trade might be done. ?Then negotiation starts… and you can read about more this in my “Education of a Corporate Bond Manager” series… I know most here want to read about stocks, so…

2) Uncertainty of the value of an asset

Imagine a stock that may go into default, or it may not. ?Or, think of a promoted penny stock, because most of them are in danger of default or a dilutive stock offering. ?Someone looking to buy or sell has little to guide them from a fundamental standpoint — it is only a betting game, with volatile prices in the short run. ?Market makers, if any, and buyers and sellers will be cautious, because they have little idea of what may be coming around the corner, whether it is a big news event, or a crazy trader driving the stock price a lot higher or lower.

For ordinary stocks, large enough, with legitimate earnings and somewhat predictable prospects, the size of the bid-ask spread reflects the short-run volatility of price. ?In general, lower volatility stocks have low bid-ask spreads. ?Even with market makers, they set their bid-ask spreads to a level that facilitates trade, but not so tight that if the stock gets moving, they start taking significant losses. ?And, as I experienced as a bond trader, if news hits in the middle of a trade, the trade is dead. ?You will have to negotiate afresh when the news is digested.

As for the “Last Price”

The last price reflects the last trade, and in this era where so much trading occurs off of the exchanges, the bid and ask that you may see may not reflect the true state of the market. ?Even if it does reflect the true state of the market, there are some order types that are flexible with respect to price (discretionary orders) or quantity (reserve orders). ?Trades should not occur outside of the bid-ask spread, but many trades happen without a market order hitting the posted bid or lifting the posted ask.

And though this is supposed to be simple, the simple truth is that much trading is far more complex today than when I started in this business. ?I disguise my trades to avoid alarming buyers or sellers, and most institutional investors do the same, breaking big trades into many small ones, and hiding the true size of what they are doing.

Thus, I encourage all to be careful in trading. ?Until you know how much capacity for trading a given asset has, start small, and adjust.

All for now, until the next time when I do more “simple stuff” at Aleph Blog.

A Few Investment Notes

A Few Investment Notes

Posted on by David Merkel

Just a few notes for this evening:

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

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

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

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

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

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

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

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

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

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

4) Regarding credit scores, three articles:

From the WSJ article:

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

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

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

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

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

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

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

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

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

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

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

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

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