Search Results for “Unstable” – Page 5

The Best of the Aleph Blog, Part 16

Posted on 9 June 201210 June 2012 by David Merkel

I try to do “The Best of the? Aleph Blog” pieces between 1-2 years after original publication.? Why?? It gives time for reflection, time for series to complete, time for me to be proven wrong/right, etc.? I would have preferred that readers do this job for me, so that I could be neutral, but I realized that I am the one that has the most concentrated interest in doing this, so that is why I do this.? The main benefit for me in doing this is when I submit free content to “Wall Street All Stars,” I know what I think is good stuff, and I utter a few words to explain how my wisdom has proven right, or fell on its face.

This episode covers the era of November 2010 through January 2011.

On Investment Modeling, Part 1

On Investment Modeling, Part 2

On Investment Modeling, Part 3

On Investment Modeling, Part 4

Investment modeling is tough, you omit some bits of reality, and deny other bits of reality.? In this four-part series, I try to explain how difficult good modeling is, and how to make it better.

Flavors of Insurance, Part I

Flavors of Insurance, Part II (Life)

Flavors of Insurance, Part III (Personal Lines)

Flavors of Insurance, Part IV (Commercial)

Flavors of Insurance, Part V (Reinsurance)

Flavors of Insurance, Part VI (Brokers)

Flavors of Insurance, Part VII (Health)

Flavors of Insurance, Part VIII (Financial)

Flavors of Insurance, Part IX (Title)

Flavors of Insurance, Part X (Conglomerates)

Flavors of Insurance, Part XI (Banks and the Insurance Business)

Flavors of Insurance, Part XII (Summary ? The End)

This was a unique series where I tried to bring my expertise to bear on a complex industry.? I wrote the original piece in 2003, and it never got published.? I used OCR to scan it and one of my brighter children to edit it, so you have my original text, plus my commentary in 2010, pointing out where I was right and wrong.

Time to Grow Up

I am an advocate for a brainy libertarianism that reflects the intelligence embedded in the Bible, coming form the Creator Himself.? I do not back what the t-party has to say, whose positions reflect personal selfishness.

Nonidentical Twins: Solvency and Liquidity (III)

Now, when a government is overleveraged, but interest rates are low, the situation is potentially unstable.? A rise in rates could tip the scales.? Market actors would conclude that they can?t survive at rates high than a certain threshold, so sell the debt now, in case rates would get so high.? That action forces rates higher, leading to a self-reinforcing panic.

Sometimes this happens in advance of a debt refinancing, leading some politicians and bureaucrats to say the forever bogus phrase, ?This is not a solvency crisis, this is a liquidity crisis.?? Sorry, if you play near the cliff, don?t complain if you happen to fall off.

Liquidity crises do not happen to governments with low debt levels.? Liquidity crises are solvency crises during the panic phase, before they are revealed to be solvency crises alone.

The Value of Fair Accounting

Why fair value accounting has value to investors.? This should be a “duh” moment, because everyone should understand this.

2010 Financial Report of the US Government

My annual post on the topic, describing the deterioration of the situation.

A Portrait of Maryland?s Public Companies

I explain why Maryland, my adopted homestate, has the mix of publicly traded companies that it does.

Why We Don?t Need the Fed

We would do better with a commodity standard, and even a gold standard.? The Fed hoodwinks us with its pretended efforts to maintain value.? I genuinely mean that we could do better without the Fed.? Put James Grant and Steven Hanke in charge of our monetary policy, and we will do well

On Human Fertility

A controversial topic, but fertility rates are falling more rapidly than the demographers expect. Why? It is politically correct to say that the planet is running out of resources, a bogus idea, but often stated.? As it is, because of changes in the way that women and men view their roles, fewer children will be born.

And as for a guy who has sired three children, and adopted five (far more difficult), I would simply say that we are better off with more children in homes that care about the results of how children turn out.

Sorted Weekly Tweets

Posted on 1 June 2012 by David Merkel

Maryland vs. Illinois

@AmyResnick One more note: MD benefits from the presence of Johns Hopkins, biotech, NIH, the REIT industry, hotel industry, etc. $$ Jun 02, 2012
@AmyResnick Martin O’Malley spoke2the Baltimore CFA society. Slick. Made many of us wonder if we lived in the same state that he governs $$ Jun 02, 2012
@AmyResnick That’s true.We live next to the US money sink, DC, and we profit from the woes of the nation along with Virginia. $$ Jun 02, 2012
@AmyResnick If my state passed a budget like that, I would b ill & annoyed. Oh wait, I live in the People’s Republic of Maryland. Never mind Jun 02, 2012

Companies

GM cuts $26bn from pension liability http://t.co/wL7hlRab $GM buys annuities from $PRU, and cashes out other pensioners; amazing gain. $$ Jun 02, 2012
Groupon Sinks to New Low as Lock-Up Expires http://t.co/NuE7dA9b A $GRPN share is now cheaper than the amount 1 can save w/a Groupon. 😉 $$ Jun 01, 2012
Chesapeake Valuation Seen Luring Major Deal http://t.co/1n6fnjzZ Natural gas assets r not worth as much; too much marginal cheap supply $$ May 31, 2012
Toyota Tsunami Recovery to Be Seen in 93% U.S. Sales Gain http://t.co/UlO4SSzC $TM stock below where it was one year ago, as w/many autos $$ May 31, 2012
“Chesapeake?s equity and net debt was valued yesterday at $9.19 for each barrel of oil equivalent” Key phrase: “barr? http://t.co/KAcfGoyH May 31, 2012
@TheStreetHub @abnormalreturns will publish my pick 4 the next decade next week. It may not beat $CHK, but there is less risk to it. $$ May 31, 2012
@TheStreetHub Once fracking starts, difficult2turn off economically; there r a lot of places to frack; don’t c NG prices rising anytime soon May 31, 2012
$JPM CIO Swaps Pricing Said 2 Differ From Investment Bank http://t.co/4jgUCTry via @BloombergNews | Not2surprising since trades moved market May 31, 2012
Icahn?s Chesapeake Stake Puts Governance Before Value http://t.co/csRUxisS Icahn has his own version of “doing well by doing good.” $$ $CHK May 31, 2012
Toll Buying Half of a 2,379-Home California Subdivision http://t.co/RDIUQiNK ?There?s not much inventory now in Orange County…? $$ May 31, 2012

Miscellaneous

Heavy rain on Baltimore. Just went out with 3 of my kids. We dug a trench diverting water awa from the house. Boy, did we get wet & dirty $$ Jun 01, 2012
@Alpha_Rook I was proud of their initiative & that they executed my idea, and not theirs, which would not have worked. Yes, it was fun. $$ Jun 02, 2012
Dating Shanghai-Style Draws 38,000 Hopefuls as Weddings Fall http://t.co/ECmp4ppU More men than women, but fewer desirable men than women $$ Jun 01, 2012
Indian-American wins U.S. Spelling Bee http://t.co/ZkjzSSAP Nandipati became the 5th consecutive Indian-American winner & 10th of last 14 $$ Jun 01, 2012
Defectors Cast New Light on Korean Camps http://t.co/TOQtTM3s US intervenes in so many places; one that is @ the top of the list ignored $$ May 31, 2012
Thx, I’m Touched & Impressed $$ RT @valueprax: Notes – AlephBlog Digest #1 – David Merkel On Corporate Bonds ( #bonds http://t.co/vXSPiApn ) May 31, 2012
Energy assets in front line of cyber war http://t.co/4UZG5wJx Ability2use stuxnet2take over SCADA systems running energy/utility assets risk May 31, 2012
10 Things Presidential Candidates Won’t Say http://t.co/8l3tPGEz 1. “I’m powerless to change the economy.” Honest talk u will never hear $$ May 29, 2012
For Healthy Eating, Bitter Is Better http://t.co/A3gPQIYV “It’s also the first step toward eating a broader, healthier diet.” $$ May 28, 2012
Sudan, South Sudan Trade Accusations Ahead of Crisis Talks http://t.co/XFpu79GQ Unless there is a way to share oil revenues, war is possible May 28, 2012
Funds May Wrong-Way Bets Before Price Slump http://t.co/u3garjlL ?surprising to see so much on the long side…trend is down in commodities” May 28, 2012
Why ‘Value’ Stocks Lag http://t.co/Uy5nwkC8 After reading this article & the comments on it, I still don’t get value is doing poorly $$ May 28, 2012
@felixsalmon I would be honored to have you as a client. I’ve done well over the last 12 years, but not the last 16 months. $$ May 27, 2012

Eurozone

Euro Area Is Running Significant Risk of Breakup, Rehn Says http://t.co/1Wx5nAEq Presence of negative German short rates is a danger sign $$ Jun 01, 2012
Negative interest rates are like antimatter. They never exist for too long, and the presence of a lot of them means things r dangerous $$ Jun 01, 2012
Berlusconi Says ECB Must Print Euros or Italy May Say ?Ciao? http://t.co/a1sAsDIJ Taking aim @ those who ejected him, back in the hunt $$ Jun 01, 2012
@The_Dumb_Money It’s the 5%+ spread over bund yields that gets people antsy; it indicates a crisis in Italian ability to pay; unstable. $$ Jun 01, 2012
“German 2-yr yields fell below 0 for the 1st time this wk while the yield on similar-maturity Spanish notes rose 11.8 bps to 5.11% today” $$ Jun 01, 2012
It may be wrong, and may harm Italy deeply, but it makes for great politics by encouraging popular resentment of fore? http://t.co/0xm4RY5l Jun 01, 2012
Why France Has So Many 49-Employee Companies http://t.co/nKcECoQK “Sir, we r up to 49 again, shall I start another new company?” “Oui!” $$ May 31, 2012
Spain Ejects Clean-Power Industry With Europe Precedent http://t.co/SFhWg1lF Amazing what happens when u stop subsidies;companies fold/leave May 31, 2012
Iceland Property Bubble Grows With Currency Controls http://t.co/o5IUO1hF Classic. Trapped cash needs 2 protect value so buys real estate $$ May 31, 2012
ECB Opposes Spain Bank Idea http://t.co/Vx9tdeua Spain has reached its notional credit limit, can’t borrow more w/o driving rates up $$ May 31, 2012
EU Proposes ‘Banking Union’ http://t.co/3lK74rxE This is an easy thing to propose, but hard to achieve without nations giving up power $$ May 31, 2012
Greek Democratic Left Demands Euro Pledge to Back Syriza http://t.co/cmkcflzR They dream that they can stay in Euro, and not pay promises $$ May 29, 2012
Leveraged Loan Defaults May Surge to 25% in Europe, Moody?s Says http://t.co/vUpMQisS If credit tightens in Europe, many defaults come $$ May 29, 2012
Greek Pro-Bailout Parties Gain Amid Euro Collapse Concern http://t.co/Ta2m8TDC “Greece is the only country…we can say it?s a failed state” May 28, 2012
Spain roundup: http://t.co/WtGRfFDP & http://t.co/KGwBE4gY & http://t.co/MvlXpx2R Credit situation for Spain as a whole is troubled $$ May 28, 2012
Unsecured Creditors Face Losses in EU?s Plan for Failing Banks http://t.co/xCQFqJqv No free lunch; watch unsec rates rise 4 bonds & CP $$ May 28, 2012
@japhychron No decoupling there that I can see. The likely credit panic is in Europe, with limited spillover the US. $$ May 27, 2012

Financial Sector

Regulators Adopt New Tools to Prevent Another Flash Crash http://t.co/8aClpGWw These regulations seem reasonable. I’m not used 2 saying that Jun 02, 2012
Volcker Rule? We need a Slurpee Rule http://t.co/a1GNBm7e “Lose $1B -> lose your job.” Great, can we apply this 2 government officials 2? $$ Jun 01, 2012
Bank says: We?re defaulting, but don?t you dare! http://t.co/PmYEk4kW Strange that many think they don’t have to pay if their creditor is BK Jun 01, 2012
Insurance Supervisors Ready to Identify Too-Big-To-Fail Insurers http://t.co/bve0otvq Less risk than banks; liab structures can’t acelr8 $$ May 31, 2012
Woman Who Couldn?t Be Intimidated by Citigroup Wins $31 Million http://t.co/CaznlXxA Post-2008 $C employee blows whistle onlousy mtges $$ May 31, 2012
Look for corporate incest, where capital structures are interlaced between parent & subsidiaries. $AIG had that in sp? http://t.co/2zz1qwmo May 31, 2012

Speculating on the Long Bond

@shamir_k @SoberLook Only 10% of my portfolio; ask u what I asked Shiller, Hoisington & Lacy Hunt: when do u leave? $$ FD: +$TLT Jun 01, 2012
@SoberLook I have too many friends who were burned on $TBT, it will b right eventually… but the trade was 2 popular amid deflation $$ Jun 01, 2012
@SoberLook True enough. I just sold my last TIPS. $TIP Thinking of kicking out my last chunk of $TLT. FD: Long $TLT (me & clients) Jun 01, 2012
Ten-Year Treasury Yield Hits Record Low http://t.co/xkfc1JP2 The benchmark 10-year U.S. Treasury yield sank to an all-time low of 1.659% $$ May 31, 2012
CHART OF THE NIGHT: What A Difference A Year Makes http://t.co/VLqVDCiK Global deflation drives people2grab 4 predictable income streams $$ May 31, 2012

Federal Reserve

He’s pretty connected $$ RT @pdacosta: Done deal? Morgan Stanley Fedster Reinhart now sees 80 percent chance of Fed easing in June. Jun 01, 2012
Rosengren Says Renewed Fed Operation Twist to Spur Growth http://t.co/5lz5Zwof If we all clap Tinkerbell will live! Hasn’t worked yet… $$ Jun 01, 2012
They assume that lowering long Treasury rates will aid growth; it did not work in the Great Depression & WWII. The Fe? http://t.co/IYHxbtML Jun 01, 2012

On Gold

David Einhorn Mocks Warren Buffett?s Stance on Gold http://t.co/JreRqj49 Good piece, I have questioned it as well: http://t.co/jNVrf700 $$ Jun 01, 2012
@vjnttp That’s why I included a link to my article on the topic; it’s more complicated than what Buffett wrote in his annual report $$ Jun 02, 2012

My Goof on NFP

@andrewhorowitz I don’t trust the ADP #s. My model uses 4 wk avg of jobless claims, adjusts4past model errors b/c errors r autocorrelated $$ Jun 01, 2012
@andrewhorowitz Yes, a little above consensus, that’s what the models show, personally I’m more bearish but the models r better than me. $$ Jun 01, 2012
@Estimize I looked at estimize for a place to lodge an NFP est, and couldn’t find it. Do you do those? May 31, 2012
@joelight It’s a blend of 2 models which have different error properties — their point estimates r 145 & 171K. Don’t know CI 4 combined $$ May 31, 2012
I don’t do this often, but here goes — projecting NFP at +158K +/- 13K May 31, 2012

US Economics

RE: @SoberLook This is what stagflation looks like.? Copper reacts to GDP. Gold reacts to real rates. http://t.co/JODgLATu Jun 01, 2012
The Surprising Global Shortage of Skilled Workers http://t.co/6fnJOUZb There r skilled workers w/o work, they don’t have the *right* skills May 31, 2012
Some people kvetch. Some start their own firms, and hire people that don’t kvetch, with skills that match.? The latte? http://t.co/XO57VQa2 May 31, 2012
Totally agree, let govts protect depositors @ most, not banks RT @simonconstable: also a stupid thing to propose. Bust companies should fail May 31, 2012

Rest of the World

Dumb: China?s Blog Censorship Rules Have U.S. Parallels http://t.co/eDmN4L4X Even in colonial times restrictions on speech in US were modest Jun 01, 2012
Intervention From Rupee to Real Shows Focus on Inflation http://t.co/Mr5sIquM Emerging Markets face inflation & policy tightens, currs rise May 31, 2012
China Has No Plan for Large Stimulus to Counter Slowdown http://t.co/Zzo9hzRG Maybe they figured out extending more loans won’t help growth May 31, 2012
Egypt’s Next Leader Won’t Be A Creature of Tahrir Square http://t.co/8UEP48Vg Revolution in Egypt subverted by military & muslim brotherhood May 28, 2012

US Politics

Startup Act Shows Silicon Valley Clout Growing in DC http://t.co/mJYKPeGu How Silicon Valley pushed 4 the JOBS Act. Scammers, PE rejoice $$ May 31, 2012
Note: the same thing will happen in 10-15 years to Social Security, but it will b cut by 25%. http://t.co/PpV5XGqO A series of bad surprises May 29, 2012
Congress Unwilling to Address Disability Plan?s Shortfall http://t.co/WrtxovbX In a few years, disability payments will b cut by 21%. $$ May 29, 2012

When Correlations Rhyme

Posted on 30 March 2012 by David Merkel

Before I start this piece let me give you a blast from the past, the columnist conversation comment that I most frequently reprint, from this post:

		David Merkel
		Make the Money Sweat, Man! We Got Retirements to Fund, and Little Time to do it!
		3/28/2006 10:23 AM EST

What prompts this post was a bit of research from the estimable Richard Bernstein of Merrill Lynch, where he showed how correlations of returns in risky asset classes have risen over the past six years. (Get your hands on this one if you can.) Commodities, International Stocks, Hedge Funds, and Small Cap Stocks have become more correlated with US Large Cap Stocks over the past five years. With the exception of commodities, the 5-year correlations are over 90%. I would add in other asset classes as well: credit default, emerging markets, junk bonds, low-quality stocks, the toxic waste of Asset- and Mortgage-backed securities, and private equity. Also, all sectors inside the S&P 500 have become more correlated to the S&P 500, with the exception of consumer staples.

In my opinion, this is due to the flood of liquidity seeking high stable returns, which is in turn driven partially by the need to fund the retirements of the baby boomers, and by modern portfolio theory with its mistaken view of risk as variability, rather than probability of loss, and the likely severity thereof. Also, the asset allocators use ?brain dead? models that for the most part view the past as prologue, and for the most part project future returns as ?the present, but not so much.? Works fine in the middle of a liquidity wave, but lousy at the turning points.

Taking risk to get stable returns is a crowded trade. Asset-specific risk may be lower today in a Modern Portfolio Theory sense. Return variability is low; implied volatilities are for the most part low. But in my opinion, the lack of volatility is hiding an increase in systemic risk. When risky assets have a bad time, they may behave badly as a group.

The only uncorrelated classes at present are cash and bonds (the higher quality the better). If you want diversification in this market, remember fixed income and cash. Oh, and as an aside, think of Municipal bonds, because they are the only fixed income asset class that the flood of foreign liquidity hasn?t touched.

Don?t make aggressive moves rapidly, but my advice is to position your portfolios more conservatively within your risk tolerance.

Position: none

This article is motivated by this article from the estimable Morningstar.? Correlations are high among risk assets; the only place to lower correlations are cash and high quality long debt.? Guess what this period reminds me of?? 2006-2008 prior to the crisis.

Now there are differences, though the prime driver is central banking in both cases.? In the earlier period, they were tightening slowly.? The mistake was not tightening rapidly, much earlier.? In this era, the floodgates of monetary excess have been wide open for three years.? The error here is assuming that monetary policy can work miracles when the economy is overlevered from the prior boom.

When the ordinary actors of the economy can’t borrow because they are overindebted, monetary policy has a hard time producing any long-term useful result.?? Yes, it can spur a short-term move to risk assets.? It can twist the Treasury curve in the short-run.

This piece isn’t about monetary policy.? It’s about correlations in asset prices.? When risky assets get very correlated with each other, and the only alternative game to play is buying high quality bonds, it is an unstable situation that portends lower risky asset prices.

Color me neutral now, because the supply of cash to invest in high yield bonds, stock IPOs, and private equity is substantial.? But don’t be surprised if asset class performance reverses one year out from now.

Seven Notes

Posted on 17 March 201218 March 2012 by David Merkel

First, I have some blog news:? my hosting provider made me delete 7000 spammers out of my user database.? That left me with 200+ users.? Inadvertently, in the process, around 70 bona fide users with surnames starting with the letters J-Z got deleted.? So, if you got deleted, and have to re-register, my apologies.? I tried to be careful, but made an error when matching databases.

Second, MetLife should not have to undergo the stress tests that banks do.? Banks borrow short and lend long; they are inherently unstable.? Insurance companies generally match assets and liabilities, and are stable.? The only insurer of consequence to fail in the crisis was AIG, and it was because of derivatives and securities lending issues, areas that other insurance companies do not touch, or handle differently.

Third, why does an institutional investor use an investment bank?

When I was a corporate bond manager, we used everyone.? We wanted access to deals, and if you don’t deal with all of the majors, you are shut out.? Of course every manager deals with Goldman Sachs even if they don’t trust them.? The big guys know this and keep their brokers at arm’s length.

If you are a reporter, that is why managers will not speak on record.? If the syndicate desks on Wall Street don’t like you, they won’t give you good allocations on contested deals.

Bond managers are wise to use Goldman.? They are wiser to realize that Goldman does not act in their interests, and so, be cautious.? And to the degree that you are a smart manager, you can lessen your dependence on the big guys, and work with the hungry second tier, who know that money can be made by implementing the ideas of smart investors, so find ways to buy cheap bonds for smart investors from dumb investors, and sell rich bonds from smart investors to dumb investors.? After all, brokers only make money when assets are bought or sold.

There are few friends on Wall Street.? Big institutions know that, retail investors should learn that.? But the guy who resigned from Goldman should be aware that not all clients were muppets.? Firms I was with would avoid derivatives unless we were the ones structuring them.? If we have control, derivatives are good.? If we don’t have control, derivatives are bad.? Control is good….

You should always be thinking that those who you deal with may not be acting in your interest, and often, it is because of forces beyond their control.? I was pinned with $10MM face of Teleglobe bonds and the main broker dealing in them held (unknown to me at the time) $100MM+ of the bonds.? My efforts to sell the bonds failed because the broker had a larger position, and there was no active market.

Fourth, just because you live in America, it doesn’t mean you should get a high wage.? Particularly for manufacturing wages are declining, and why shouldn’t they decline, because productivity is not rapidly advancing.? It’s like my article on comparable worth.? Most Americans are going to have to get used to being poorer, because there are many others who can do what they do for less.? And, that partly explains the 1% vs 99% argument, because as the rest of the world grows, and the US doesn’t, it has impact on those in the US that earn too much relative to their productivity.

Fifth, imagine for a moment that you are in charge of an organization that is going to play a baseball game against the winners of the World Series.? You can choose any people to be players that have not been employed in MLB for the last five years.? How well do you think you will do?

Duh. You know you are going to lose.? Well, the same thing applies for those that are arguing that the 99% can dominate the 1%.? Short of Soviet tyranny, it won’t work.? The 1%, should it really exist as a stable organization, is too smart, and will beat the 99% nine times out of ten.

We talk a lot about democracy, though our government thwarts it when it can.? Government typically boils down to aristocracy — the rich rule, and it can’t be otherwise, unless we want Communism, like China under Mao.? In the Eurozone, under the “socialism,” the wealthy happily rule.? Only societies that are wiling to destroy wealth are willing to deny power to the wealthy.? And China is a great example here, as the wealthy increasingly dominate their government, to a greater degree than is true in the US.

Money talks, losers walk, and I never give money to politicians; it is all too corrupt.? Just realize that the deck is stacked against you.? Money finds a way to win in the process eventually.

Sixth, California will suffer for making retiree healthcare unchangeable.? Retiree healthcare in its present form is not affordable by almost everyone.? Why destroy your state by making? promises that can’t be upheld?

Seventh, after you read this, explain why you might trust Chinese statistics.? I reminds me of AIG where bad news had a hard time traveling to the top.

Peak Government Debt

Posted on 9 March 2012 by David Merkel

We’re in an interesting situation where most developed country governments are borrowing at a rapid rate, and their central banks are financing it.? Public old age retirement and health plans are underfunded.? Most major developed countries can’t grow rapidly, and there’s really nothing that can be done about it — competition from cheaper labor in developing countries is forcing developed country wages down.? We can’t grow out of the debt.

We wait for the tipping point.? When will investor sentiment change from believing debts will be paid in equivalent purchasing power, to believing that they will not get paid back in equivalent purchasing power terms?

Greece is past the tipping point.? Other nations in Europe teeter.? Is Japan nearing such a point?? They rejoice to see the Yen weakening as the BOJ finances the government deficit.? Be careful what you wish for, Japan — what is good in small, can become self-reinforcing if lenders lose confidence in the Japanese government.

Part of the trouble is with central banks repressing savers, deficits are considerably lower than they otherwise would be because short bond yields are low.? If rates rose, deficits would begin to rise gradually but distinctly in proportion to the maturity structure of the country.? That’s the tipping point.? There are only two states with an unstable equilibrium between them — government debt is trusted, and government debt is not trusted.

Now there is no simple answer here — how will the government react?

Raise taxes dramatically?
Cut spending dramatically?? Tell seniors that Medicare will no longer do what it used to?
Inflate the currency?
Default?? (Can make sense when a country does not need access to the debt markets.)
Try to drive a debt reduction deal, like Greece has done, and Argentina sorta did.

Each situation has a different best investment.? That’s a boon to governments, or disaster would have happened already.? Doubt as to policy blunts the rush to panic.? There may be worry but they don’t know what to do.

One more note: when one nation passes the tipping point, the question will be raised on other nations.? Imagine a world where many developed nations default on their debts.? There would be few certainties and silver and gold would likely become new currencies.

These are just some musings of mine; all sorts of kooky things could happen, but the pressure to use the five reactions listed above will be considerable globally.? Prepare as best you can; this one isn’t easy.

The Best of the Aleph Blog, Part 13

Posted on 9 February 201220 June 2017 by David Merkel

This portion goes from February 2010 to April 2010.

Probably the biggest new thing I did at the blog was start “The Rules” series.? Personally, I think all of them are best articles, because they proceed from deeply held beliefs of mine.? So I start with those:

The Rules, Part I

There is no net hedging in the market.? At the end of the day, the world is 100% net long with itself.? Every asset is owned by someone, regardless of the synthetic exposures that are overlaid on the system.

The Rules, Part II

Unless there is a natural purchaser of an exposure that one is trying to hedge, someone must speculate to a degree to allow you to hedge.? If the speculator is undercapitalized, risks to the financial system rise.

The Rules, Part III

The assumption of normality for asset price changes is wrong in virtually every financial market setting.? The proper distributions are fatter tailed and more negatively skewed.

Normality allows researchers to publish, regardless of the truth.

The Rules, Part IV

Governments that scam the asset markets (and their citizens) take all manner of half measures to defend failed policies before undertaking structural reform.? (This includes defending the currency, some asset sales, anything that avoids true shrinkage of the role of government.)? The five stages of grieving apply here.

The Rules, Part V

Massive debt issuance on a sector-wide basis will usually have a slump following it, due to a capacity glut.

The Rules, Part VI

History has a nasty tendency to not repeat, when everyone is relying on it to repeat.

History has a nasty tendency to repeat, when everyone is relying on it not to repeat.? Thus another Great Depression is possible, if not likely eventually.

When people rely on the idea that a Great Depression cannot occur again, they tend to overbuild capacity, raising the odds of another Great Depression.

The Rules, Part VII

In a long bull market, leverage builds up in hidden ways within corporations, and does not get revealed in any significant way until the bear phase comes.

The Rules, Part VIII

Illiquidity is a function of total transaction costs, which can be considered barriers to entry.

The Rules, Part IX

Attempting to control a system changes it.

The Rules, Part X

The more entities manage for total return, the more unstable the financial system becomes.

The shorter the performance horizon, the more volatile the market becomes, and the more index-like managers become.? This is not a contradiction, because volatile markets initially force out those would bring stability, until things are dramatically out of whack.

The Rules, Part XI

Could an investment bank go to junk status?

The Rules, Part XII

Growth in total factor outputs must equal the growth in payment to inputs.? The equity market cannot forever outgrow the real economy.

And that’s the end of the “rules” posts for now.? They express deeply held beliefs of mine.

My next group of posts dealt with banking reform:

Most of it comes down to getting the risk-based capital formulas right, raising capital levels, and most of all avoiding borrowing short to lend long.? The asset-liability mismatch is the core of why banking crises happen, because the liabilities run when asset levels are depressed.

The next group deals with debts and liabilities of nations and other lesser governments:

Default, Inflation, Higher Taxes ? Choose One
Ignore anyone who tells you that debt levels don?t matter.
A Question of Cultural Failure
A Question of Cultural Failure (II)
Of Credit Ratings, Sovereign Risk and Semi-Sovereign Risk
More on Sovereign Risk and Semi-Sovereign Risk
The Virtue of a Big Bang
The Logic of Shared Pain
Promises, Promises (Deals with the huge entitlement promises all over the world)
The Whole Earth is Owned; Debts Net Out to Zero

Debt-based economic systems are inherently inflexible.? Governments that make long-term promises without pre-funding them scam their taxpayers, and those to whom they make promises.? All solutions are ugly once the willingness of a government to pay on its promises is questioned.

What is Liquidity? (IV)

My point is that you can?t take illiquid assets and make them liquid.

Moat, Float, Growth

Warren Buffett labors to preserve the company he has built, so that it can last far longer than he will.? An impossible task, but what is Buffett if not one that does things far beyond what most of us can do?

In Defense of the Rating Agencies ? V (summary, and hopefully final)

I never did go on CNBC for this.? They figured out what I told them: “This wouldn’t make for good television.? It’s too complex.”? But it does come down to my five realities:

Somewhere in the financial system there has to be room for parties that offer opinions who don?t have to worry about being sued if their opinions are wrong.

Regulators need the ratings agencies, or they would need to create an internal ratings agency themselves, or something similar.? The NAIC SVO is an example of the latter, and proves why the regulators need the ratings agencies.? The NAIC SVO was never very good, and almost anyone that worked with them learned that very quickly.

New securities are always being created, and someone has to try to put them on a level playing field for creditworthiness purposes.

There is no way to get investors to pay full freight for the sum total of what the ratings agencies do.

Ratings can be short-term, or long-term, but not both.? The worst of all worlds is when the ratings agencies shift time horizons.

Dominoes

Posted on 11 October 201111 October 2011 by David Merkel

When I was a kid, I liked to set up large arrays of dominoes so that I could watch them fall.? Early on, I realized the errors in setup were frequent enough that I left gaps such that if I accidentally knocked down a domino, it wouldn’t destroy all of the work.? I usually put in a number of gaps close to the square root of the dominoes.? Once complete, I would fill in the gaps, and after that would come the show.

When the dominoes are set up, there is an unstable equilibrium.? Any jolt to the system will topple most or all of them.? Now, some would say the jolt causes the toppling of the dominoes, but the dominoes were arranged in order to make them all fall at once.? Whether the designer topples the first domino, or a marble from a kid brother rolls into the room, or there is a small earthquake, the array of dominoes was designed to fall.

So it was for the financial crisis.? These thoughts are my own, though others have uttered them as well.?? In order for there to be a panic that destroys a large portion of the financial system, there has to be:

High levels of leverage.
Leverage that is layered, where many parties are lending, and carry trades are common.? Parties borrow to lend more aggressively.
Collateralized lending — financial entities lend far more when lending is collateralized.? Most of the time, the existence of collateral prevents defaults.? But when things get really bad there is no protection with most collateral.
Problems with highly rated debt.? When debts are highly rated, in order to get high returns out of them, there must be a high degree of leverage applied.
There must also be general confidence that it is highly unlikely that there would be significant losses associated with the asset class.
Regulators must be similarly blind, and assume that risks are low in that set of assets.

So when the crisis struck it started in real estate lending, moving from Subprime, to Alt-A, to Prime, each one in turn more leveraged, and less likely to be prone to a crisis.? That’s why the crisis was so large.

The system had been optimized across many asset subclasses where many borrowers were trying to achieve equity-like returns through borrowing.? Thus when the overlevered previously safe asset classes began to fail, the failure was large, and had second-order effects that extended to lenders.

No one should say the current financial crisis was an accident; yes, no one aimed for it, but no, it was preventable.? It occurred from human activity that was left unchecked, building up leverage in safe asset classes, and pushing up the trading value of those assets to unsustainable levels.? Regulators had the power to bring it all to a halt, but they were complicit with the bankers.

That’s what you need to have a real crisis, and that ‘s why we still suffer from it.? The crisis will continue until enough of the safe debts have been rationalized, and the total level of debt gets paid down enough for the average borrower to borrow once again on a basis that has significant provision against adverse deviations.? Maybe we’ll get there in another 2-3 years.

The Best of the Aleph Blog, Part 9

Posted on 12 September 2011 by David Merkel

This era covered February-April 2009, the nadir and the recovery.? What a time.

Financial Versus Actuarial Models of Risk

Cashflow-based models are superior to complex models relying on unstable correlations.

Who Do You Work For?

Do you act on what gives you immediate advantage, or do you try to act on what is best for all?

On Animal Spririts

An essay on Keynes lame idea that businessmen are irrational, when it is reasonable to assume that they take risk when it is warranted, and they don’t when it is not.

The Bane of Broken Balance Sheets

An essay at the nadir of the crisis trying to point out the problems when so many entities have borrowed too much.

They Voted For Change, They Got Bush-Plus

A simple summary of the Obama Administration.? Still true today.

Translation: We Really, REALLY, Hate You Guys!!

Explains why China can’t destroy the US, but the US could harm China.

Sell Stocks, Buy Corporate Bonds (II)

Good timing for anyone that wanted to buy high yield bonds, though it was a great time to buy stocks also.

Nonidentical Twins: Solvency and Liquidity, Redux

Points out why solvency and liquidity are closely related, and why we should be doubtful when someone says, “This is a liquidity problem, not a solvency problem.”

Ancient and Modern: The Retirement Tripod

Explains why we should be distrusting of modern retirement systems.

?Do Half?

Explains how to mange assets wisely when one is less than certain.

Book Review: Trend Following

I lock horns with Michael Covel, and much as I try to be reasonable over five articles, he treats me as a Cramer-wannabe.

This was the paper that had me talk before the SIGTARP staff.? Buffett read it, and from reports, liked it.? The New York Times commented on it.

On the S&P Downgrade

Posted on 6 August 20116 August 2011 by David Merkel

So S&P downgraded the US.? Big deal.? It should have happened long ago, and many other sovereigns deserve to be downgraded as well.? Now if you want my summary views, positive and negative one the rating agencies, they can be found here:

I have another set of writings as the financial guarantors were downgraded.? I was one of the early callers that the guarantors were nor AAA.? I made the same call on the GSEs.

My point is that the initial downgrades of a AAA entity come hard, but once they come, they come with vigor and speed.? S&P has cleared the way for Moody’s and Fitch to downgrade as well.? The cost for them to downgrade is a lot lower now, and they can go lower than Aa1/AA+ if they choose.? Without significant change, the ratings of the US go lower from here.

Now, some will say that there are no limits to what amount of debt a nation that controls its own currency could issue.? Typically, these are radical Keynesian economists, that like Keynes, have a simplistic model, but no sense of human nature or politics.? What could happen:

A blocking coalition against inflation elects a congress against additional borrowing, forcing a crisis versus demanded spending.
A constitutional convention removes the Fed, and/or repudiates external debts.
We could have another situation like the last one, and this time it doesn’t resolve, and we have a technical default.

The thing is, politics matters.? If we have a fiat currency, then it is politically driven.? If our politics with respect to debt repayment are unstable, then we don’t deserve a AAA.

But much as I don’t like the t-party, I do not blame them for this outcome.? I blame Obama, Bush, Clinton, Bush, Reagan, Carter, Nixon, Johnson, Kennedy, Eisenhower and CONGRESS.? They have overspent. They have created many useless programs.? They have created burdensome programs, they have turned medical care into a zoo of red tape. THEY HAVE NOT CARED FOR THE FUTURE OF THE NATION, BUT ONLY THE PRESENT!!

They have engaged us in wars that we have no business fighting.? I have not been in favor of any war we have fought since my birth in 1960.? Shrink the Defense department, please, and all the contractors that parasitically suck on it.? Shrink entitlements as well, we will not be able to afford Medicare.

It is amusing to see certain “wonks” who are not, trumpet Obama plundering Medicare to claim that he eliminated expenses there.? Do the liberals care that he is eliminating care to the elderly, because fewer doctors, and no quality doctors will serve them?

Most of the changes made in the recent agreement were an illusion. Few specific cuts were made, and a deficit commission would find changes, or else across-the-board cuts would happen.?? But given the polarization in politics, who thinks that there will be easy compromise in the future?? I don’t.

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Now as a bond manager, I tell you there should be little change from the change in ratings. Why?

The rating of the US is still AAA, which is the average of Aaa/AA+/AAA
Downgrades of bonds rarely result in price changes on average.
Whenever major sovereign downgrades occur, covenants, collateral haircuts, investment guidelines, risk-based capital charges, etc. all get changed to make sure that nothing happens as a result.? Why? Ratings are an opinion, nothing more.? No one wants actions to occur on a sovereign because of a downgrade.

There are a lot of naive people speaking and writing about the downgrade as if it means something big, and they have never managed bonds in their lives.? I am not the be-all or end-all on this topic, but I would encourage people to read the opinions of those active in the bond markets before making definitive statements that have no reality behind them.

Events like this have happened before, and the US is still AAA for now. Prudent fiduciaries will make adjustments to reflect that AAA is not the standard for making investments, capital charges, etc.? There is no crisis here.? Don’t act like there is one, because there is none.

http://alephblog.com/2011/07/16/us-vs-moodys-sp-and-fitch/

US vs Moody?s, S&P and Fitch

Waters Uncharted

Posted on 30 July 201131 July 2011 by David Merkel

I don’t know.? You don’t know.? He doesn’t know. We don’t know. You all don’t know, and all of y’all don’t know either. They don’t know.

Conjugation complete. No one knows.

I am in the odd position of being relatively bullish regarding the debt ceiling in DC, which is near me, and affects my local economy.? I think a deal will be struck, and that it will be passed by both houses, and signed by Obama.? At least, I give that 60% credibility.

Though I don’t like the t-party, I admire their adherence to principle, which is usually lacking in DC.? In general, we want more principled congressmen, except when they are more principled than we are.? We are hypocrites, and delusional believers in magic.

Most people think that there is an easy solution that will not affect them, but will hit all of the evil people who sponge off our government.? Sorry, the easy solution does not exist.? There is a tough solution that will make the rich pay, and will eviscerate the Bush tax cuts, but not change tax rates.? Change the definition of income such that improvements in economic position can’t be delayed.? Make Warren Buffett pay his fair share now, and me too.? Move back to the Tax Reform Act of 1986, and eliminate all of the deductions, and then go further, tax us all like traders, and make us pay each year on the net increase in unrealized gains.

With such a change, the inheritance tax would not be needed, because the rich, and corporations trying to avoid taxes by keeping cash overseas would all be taxed, at least for a little while, before they move to Ireland or Bermuda.

In 2013, no one expected that the US Military would descend on all of the tax havens of the world to reclaim their fair share. I jest, but what could be simpler than to force them to raise taxes, and remit them to the US.

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In the present situation, my bond portfolio is largely in foreign bonds, the next part in inflation-protected securities, and the last part in long nominal US Treasury Bonds.

What I see here is an unstable situation with potential for goods price inflation or real deflation, making long dated claims valuable.? Whatever.? It is uncharted waters, and are there monsters here?? Maybe.? We’ll soon see whether there is some sort of agreement, or whether we get to find out the consequences of a drop in liquidity, or aggregate demand, combined with a drop in future claims on wealth.