Comments on Q1 2012

Equities got a year's worth of return in the first ninety days of this year, but the glide path that took us there was not encouraging. We take what we can get, however, we have not had a recovery:

The current recovery began in the second half of 2009, but economic growth has been weak. Growth in 2010 was 3% and in 2011 it was 1.7%. Who knows what 2012 will bring, but the current growth rate looks to be about 2%, according to the consensus of economists recently polled by Blue Chip Economic Indicators. Sadly, we have never really recovered from the recession...

Click to read more ...


FHFA-OIG’s Current Assessment of FHFA’s Conservatorships of Fannie Mae and Freddie Mac

We present a link to and an excerpt from a report by the Federal Housing Finance Agency, Office of the Inspector General. We believe it is important and suspect it will receive limited coverage because it is counter to the currently fashionable narratives. The short story is one we already knew: Fannie & Freddie are big time bust. And don't you know Dodd-Frank is silent on the topic. Well, why not? Both those Senators were essentially parties at interest in Fannie & Freddie.

As to the matter of large scale capital flows & macroeconomic outcomes, our country is slowly awakening to the quaint, old fashioned notion that results & outcomes matter.  They matter very much. 

White Paper: FHA-OIG's Current Assessment of FHFA's Conservatorships of Fannie Mae and Freddie Mac

"As a practical matter, however, the Enterprises’ future solvency – and, thus, emergence from the conservatorships – is unlikely without legislative action. FHFA officials have stated that the PSPAs have made it virtually impossible for the Enterprises to emerge from the conservatorships. For example, the Enterprises currently owe Treasury $183 billion, and are required to pay 10% dividends on Treasury’s outstanding investment. Merely paying the 10% annual dividend (i.e., $18.3 billion, presently) would not reduce Treasury’s outstanding investment. Moreover, the Enterprises have had to borrow from Treasury at least part of their dividend payments to Treasury, thus increasing the value of their outstanding debt. As a result, it would appear highly unlikely – if not mathematically impossible – for the Enterprises to buy themselves out of the conservatorships. FHFA’s Acting Director has stated that:

[T]he Enterprises will not be able to earn their way back to a condition that allows them to emerge from conservatorship. In any event, the model on which they were built is broken beyond repair... "

The magnitude of these losses are huge, the loss of national wealth permanant, and the burden on the US economy and younger generations of American huge... all driven by defective policy and corruption. For insight into the nature of corrupted governance & markets we recommend Reckless Endangerment by Gretchen Morgenson.

Private markets provide mechanics for change of governance in face of failure. That mechanic seems to be lacking in the political arena. The same political class continues to regulate increasing sectors of our economy by the same defective methods. The agency costs of failed political goverance are too high to sustain. Remember the wisdom that brought us here: we see it repeatedly in the regulation of financial markets, health care, and Fed policy.

 "on the basis of historical experience, the risk to the government from a potential default on GSE debt is effectively zero" Implications of the new Fannie Mae and Freddie Mac Risk-Based Capital Standard by Robert & Peter Orszag and Joseph Stiglitz, 2002




Reforming Money Market Funds: A Response to the Squam Lake Group

Updated on Tuesday, March 20, 2012 at 10:00AM by Registered Commenterhb

Updated on Monday, April 16, 2012 at 09:29AM by Registered Commenterhb

Updated on Friday, April 27, 2012 at 10:38AM by Registered Commenterhb

Updated on Friday, June 8, 2012 at 10:44AM by Registered Commenterhb

Updated on Thursday, June 14, 2012 at 01:36PM by Registered Commenterhb

Updated on Friday, June 22, 2012 at 10:06AM by Registered Commenterhb

Updated on Monday, June 25, 2012 at 11:40AM by Registered Commenterhb

Updated on Tuesday, November 27, 2012 at 09:28AM by Registered Commenterhb

The money markets are central to critical issues such as credit creation, systemic risk, and investor confidence. They function on a macro level to allocate globally short term credit, unsecured in the case of commercial paper, and secured in the case of repo.

Money market funds are defined in the Investment Company Act of 1940 Act and influenced by investor preferences as expressed within that regulatory framework. Historically and as a practical, functional necessity the money markets have been geared to the very lowest levels of perceived risk, which is to say very short term exposures (average maturities of 30- 45 days) to the very highest quality credits. Historically, one whiff of trouble … reputational, credit degradation, informational risk or whatever is not clear and simple… and you have investor flight, which is what happened to the TBTF’s (Too Big To Fail) in the Great Unpleasantness.

Today those same problems remain.  Money funds today operate with no capital whatsoever. They are cash repositories and warehouse massive systemic risk: broadly put, short term, rolling AA- credit & liquidity risks ... sovereign, corporate & financial.  And the nature of that risk has qualitatively changed for the worse over the last decade.

Click to read more ...


Observations on tactical asset allocation

We thought we'd share an excerpt from a recent posting from Vanguard regarding the effectiveness of active management, this time with respect to the very fashionable jargon of 'tactical asset allocation'.

Vanguard | 03/08/2012

Tactical allocation mutual funds, which offer portfolio managers the flexibility to shift between asset classes as market conditions change, have proven popular with investors in recent years. But do they deliver?

An article in MorningstarAdvisor looked at the performance of 210 tactical funds to see if they provided a safe harbor during the summer 2011 stock market correction, while also capturing gains during the bull markets that preceded and followed that correction. The goal was to find how many funds provided a better risk-adjusted return than Vanguard Balanced Index Fund.

"Our extended study found scant evidence that these funds delivered on their goal of delivering competitive returns with a smoother ride," according to the article. "Most gained less than the Vanguard fund, were more volatile and prone to downside, or both."

An update to earlier Morningstar research, the report covers only the 17-month period ended December 31, 2011. However, Vanguard has studied similar questions over longer periods and made similar conclusions.

We're not recommending a security here, just providing another datapoint and a suggestion to consider the methodology the next time you're feeling smarter than the market.


Inflation, deflation & asset classes

A recent article in WSJ referenced a helpful analysis for those interested in the risks of inflation or deflation by asset class. The primary source was the Credit Suisse Global Investment Returns Yearbook 2012

For the short story, go to p.14 of the Yearbook.


That which is seen and that which is unseen by the Fed

Updated on Monday, February 6, 2012 at 09:01AM by Registered Commenterhb

Updated on Tuesday, February 7, 2012 at 08:22AM by Registered Commenterhb

Updated on Monday, February 13, 2012 at 08:05AM by Registered Commenterhb

The testimony of Ben Bernanke yesterday (2/2/2012) to the Committee on the Budget of the U.S. House of Representatives was marked by an assertion as to the health of the US capital markets, that in response to a question that cited an opinion piece in the WSJ by Kevin Warsh excerpted below:

 "Private investors are crowded out of the market when the Fed shows up as a large and powerful bidder. As a result, the administration and Congress make tax and spending decisions—with huge implications for our standard of living—with heightened risks around future funding costs."

The transcript of the testimony has not yet been published as of this writing, so we quote, sort of, Bernanke's response:

 “The capital markets are all okey dokey. Never better. Next question.”  

We return to that issue because we disagree. We think the narrow context of his response is facially misleading. First, we stipulate

Click to read more ...


Legal & settlement considerations in various Euroland scenarios

Pillsbury Winthrop Shaw Pittman, LLP, has published an important advisory bulletin Cracks in the Eurozone.

It provides a helpful primer to understand the magnitude and uncertainty of the large scale contractual processes at work in Euroland.

More later.


Caedite eos! Novit enim Dominus qui sunt eius

Updated on Wednesday, January 4, 2012 at 09:48AM by Registered Commenterhb

Updated on Thursday, January 5, 2012 at 08:20AM by Registered Commenterhb

Updated on Friday, May 4, 2012 at 08:55AM by Registered Commenterhb

We probably should talk about investments, although what I want to do is rant about our domestic policies which are destroying so much of our economy, so much of our national value. We'll get to both, and pictures are a good place to start.

This year's markets were uninspiring at best, frightening at worst. US equites struggled to hold near even while foreign markets, both developed and emerging, suffered. As always we select broad indices for illustrative purposes and note these are graphs of prices, not total returns.

Click to read more ...


WWB's book of the year award: Currency Wars by James Rickards

Currency Wars by James Rickards  is a well written, understandable & exquisitely logical explication of the economic theory, policy & political economy that currently drives Fed policy. It is stunning in clarity, understandable and reflects the knowledge & perspectives of an obviously seasoned market practitioner who also has a detailed command of current scholarship & theory. The book is not the studiously inaccessible, self-referential work of an academic.

If you have ever had the unpleasant task of telling a sovereign state that… “we regret that in light of current conditions in the market, we have no bid for your paper and do not anticipate a change in that posture in the near to intermediate term. As your staff knows we have no available capacity with respect to our trading lines. We are seeing from time to time your paper trade away from us in the secondary markets at significant discounts and in disorderly manner. We will continue our dialogue and keep you apprised of market conditions as they develop”… you tend to develop a certain sensitive and personal understanding of liquidity.

So, if you’d like to follow how game theory, including war games, foots to the non-linear responses of chaotic systems, give it a go and partake of a very public  & needed sheep dipping of the policies of Bernanke & Timmy Geithner.  A complete reading in one sitting is a rare event, and you might just do it. 

We recommend the book to promote a broader, more accurate understanding of monetary policy & risk management in the context of global dynamics, and that to bring about constructive and timely reform.


Kurtosis and systemic risk: policy makers need to get a clue

When we see phenomena we think we intuitively understand, and it's important, we try to kick the tires a bit. Intuition is good, confirmation by fact is better. Here we take the S&P 500 for a broad proxy of the US equity market and further take VFINX, Vanguard's 500 Index Fund, as our guinea pig. We downloaded 10 years of daily data and found some of the pictures of interest, some entertaining, one vitally important. Here we go:

Here is the time series of daily price data from Jan. 3 to Sept 27, 2011 downloaded from Vanguard. You know its ugly, but take a look anyway.

Here is the same data sorted by % size of daily gain or loss. Less ugly, but only due to style of presentation. If we hadn't put the drop down line in, it might have passed for semi normal. But it seems a little longer on the left side, yes? Of the 185 data points, 100 are negative.

Same data displayed differently, or as a matter of conceptual art perhaps a "splatter chart" of someone's viceral reaction hitting the floor.


So how does this volatility stack up to a decade of price behavior?  Below we chart the minimum and maximum one day % changes of the past decade (specifically from 9/21/2001 to 9/27/2011). Well, so far it seems there are only three worse years:


Interestingly, so far this year's standard deviation in and of itself is about average, but the dispersion seems to be increasing.


We took at look at the kurtosis over the last decade. You can see the definition in the picture (bolding courtesy of editor). The trend since mid to late 2007 is not encouraging. Others have found similar results, that is increasing excess kurtosis, in the yields of 90 day T-bills. This is systemic risk.


This bears particular import for the operation of global capital markets, and in particular for alternative assets as a class. Most of the literature we've seen indicates that adding alternative assets to portfolios of traditional asset classes can increase kurtosis of the overall portfolio (think pensions & endowments) if unartfully done. We also suspect that the notion of kurtosis induced by alternative assets isn't even examined in by most small institutional & retail investors. And certainly most alternative assets are soldpresented on the basis of mean variance risk/return space which is the quintessential apples to oranges.

Policy implications

At some point the Fed, regulators, and policy makers have to get a clue. They are manufacturing systemic risk and mere repackaging doesn't help. Granted some of this is spillover form Europe, but at the end of the day in the financial sector we still have large scale asymmetry in the treatment of the too big to fail financial sector, that in the form of socialized risk and privatized return. We are still left with increasing aggregates of black box counter-party risk. 

We have utter chaos in the regulation of the non-financial sector, and we have a chaotic tax code that incents the mis-allocation of productive capital. And they continue taking economic water out of one side of the bucket to put in the other side without regard to leakage or fundamental damage to the bucket....We note that free trade bills have languished without action for the last 3 1/2 years; the Senate undertakes consideration of Currency Exchange Rate Oversight Reform Act, our very own modern version of Smoot Hawley; an energy policy designed to throttle exploration & production; and a Rube Goldberg tax code.

But the good news is that the market and the United States has the ability to suffer through the current toxcity of policy and leadership.  No doubt the outcome of the election will impact valuations. Intrade now prices the probability of BHO's re-election at 47%.  Even with a sensible regime change, we're in for a long slog, but we're is not ready to piss on the fire and call in the dogs1

In the context of a seven to ten year time frame equities are not unattractive at these levels, but the meaning of the kurtosis graph is that you better buckle up. The investment premise is simple: you'd better not be investing for near term value. Getting from here to there will be the trick, and adaquate liquidity will be important.  If we get some sensible policies in place and some new leadership, then the values offered today may very well look compelling 7-10 years forward. But as our President is known to say, "let me be very clear": it's going to be a bumpy ride from now to then.


1  Colliquial expression of cultures in the Appalachian & southwestern regions of the United States.


Observations on foreign bank liquidity

Today's WJS  advises that

For the past three months, European banks have been largely unable to sell debt at affordable prices to investors, who are wary of the banks' vulnerability to risky euro-zone government bonds and other loans.

At $34 billion, the amount of senior unsecured debt issued by the Continent's financial institutions this quarter is on track to be the smallest of any quarter in more than a decade, according to data provider Dealogic. - Europe's Banks Face New Funding Squeeze

Let's see ... from more than $250 billion in QI and QII in 2009 to $34 billion.

We looked at the short end of the curve and see that the foreign financials have racked up a 28% decline in outstandings since the peak in June (see the big red arrow below).

Bloomberg reports

The eight biggest U.S. money-market funds reduced their investments in French banks by 46 percent to $42 billion in the past 12 months, data compiled by Bloomberg and published Sept. 9 in the Bloomberg Risk newsletter shows.

This is particularly precarious for banks, given that liquidity pressures over year end can be stressful even in good years. Saavy liquidity managers are starting now to fund through year end, but there is, evidently, a substantially declining bid for even the shortest of foreign financial paper in our domestic markets.

Where does it go? The Euro commercial paper market is simply too small and, oops, low-to-no bid there anyway.

Below we present outstandings of various segments of the US commercial paper market:

This is the US$ funding crisis everyone's been anticipating. Last we heard France was trading around 1.96% for 5 year credit default swaps, and Italy about 5.03%, so its not clear that sovereign support for the banks will bring much to the party. The Germans need to play.

If there is some good news it is to be found in the blue & green: there is a growing supply and demand for non financial domestic commercial paper. It's good to see some credit creation, however modest and the financial outstandings seem, well, sideways is good enough.


The ECB thing

The inquiry:

This is what I've gotten so far... let me know if this makes sense. 

The gist is that the central banks of the world, implored no doubt by the ECB, intend to create programs to allow banks cheaper access to short term USD funding.  The ECB already does this but will now extend the duration of their loans.  One of the concerns the ECB is juggling has been the pending liquidity crunch in Eurobanks holding a ton of bad Sov. paper.  These banks haven't been able to access repo funding markets at rates that weren't damaging their already fragile capital levels (leverage was so 2007... right?... right?... oh...) so the central banks of the developed world have essentially colluded to provide funding at rates and durations at which the free capital markets would not provide.  I am not clear on the time frames here...

WWB response:

The ECB does not have enough liquidity or capital to replace the US$ liquidity lost by the euro banks… that to include the Euro and US repo markets; the ECD markets; the ECP markets; and the USCP markets (probably not available for euro banks now I suspect (hit CP GO for a look) or if it is it won’t be next week). One questions whether the ECB + Germany + France + Othereuro + [limited?] US support is adequate.

So, the US Treasury, Fed and few remaining semi- solvent euro sovereigns are probably funding for now the Euro Central Bank via some non-visible means like private gold loans or swap lines of various types or other undisclosed transactions, this a bridge to the unstated & unknown Uber plan… a mega GLOBAL TARP, a liquidity facility underwritten by undercapitalized sovereigns to prop up the Euro banks with no capital and a boatload of bad sovereign debt.   

The reason you can’t conceive of how it works or makes sense is that it doesn’t. It cannot work unless Germany, France and all the others including the US all play for size (recall the word “overwhelming” by Timmy G, you know the fellow who said there was "no risk" of a downgrade for the US?). You are thinking, "no way US taxpayers would support committing of huge amounts of scarce US (read that taxpayer) capital to such a venture!"

Consider that Timmy G, Fed, and Treasury are not concerned with that quaint notion. It is likely we're already in for size, such and duration to be expanded and defined later. Since it's election time, and Congressional inactivity is always a good thing, how about a Congressional hearing? A little transparency on swap or currency line usage or risk limits? 

Back to the ECB thing. This is the final rounds of injecting CTBPApynm (Capital To Be Pissed Away, perferably yours, not mine) before the euro thing likely grinds to a halt. 

They may have bought some time … a few weeks, possibly days, or months (who knows since there is no disclosure of the means, magnitude, or duration of the temporary support)… to raise capital for the banks which, if successful, will also be CTBPA. 


  1. inject temporary capital
  2. threaten negotiate with Euroland
  3. hope you can get out
  4. discover you can’t
  5. repeat 

Repeat, that is, until the a) viable sovereigns (France & Germany & some US) go all-in or b) until you hear “BLAMMO” which will be the sound of serial Euro bank failures working their way up the collateral base, which will be insufficient. In the latter case, the losses will be realized by commercial entities and specific sovereigns to the fullest extent possible. Those sovereigns will then default or restructure because they’re broke and also have no access.  In the former case, the standards of living will decrease by a significant multiple of the unrealized losses. Think of that as a reverse, large scale negative Keynesian multiplier less further large scale costs for friction, agency, and corruption.



A Time to Choose

Thanks to the folks from Zero Hedge for bringing Ronald Reagan's speech "A Time to Choose" to our attention. It is a must watch.  We confess to a bit of copycatting, but we want it to go viral.

We agree with ZH's observation that it is eerie how the conditions and issues in 1964, some half a century ago, directly parallel those that we face today. What is quite different, particularly in contrast to the Republican debate of last night ... and we stipulate a purposely stilted format and importunate hosts, 'braying' does come to mind...is Reagan's effectiveness of language & presentation in connecting a cohesive framework of thought.

We encourage the younger crowd to consider the research for this speech in a proper historical context: this was before the internet. This may in turn place the substance & intent of the criticism of Reagan as ~a mere actor, a dumb cowboy~ in proper context and intent.

We suppose we should write something about investing or the market, but in the meantime and given the degree of control the government has over our economies, we encourage all to consider this speech. We're channelling the very same issues today but our station is such that the costs are so large and the consequences so grave they can no longer be hidden.


Worth a look if you don't know the technicals

This talk on algorhythms is worth a look, particularly the aspect on predictive models for consumer behavior.


Watson Wilkins & Brown, LLC, on the debt deal

What has changed with the new debt deal?

In the debt deal we had a large scale and global demonstration that there is a fundamental, costly, and cumulative flaw in the governance process of the US. One suspects that very few people actually understand the magnitude of the problems of our debt, unfunded liabilities, and increasing macro-economic drag of the costs of regulation.

I don’t buy the notion that the debt ceiling deal is a model of American republican democracy at work.  To the contrary: it is emblematic of the problem. We don’t know if we want to be a market economy driven by innovation and freedom or a socialist economy driven by redistribution of wealth. 

The markets know that and are just going to hang out and price in, every day, the continuing drag of opportunity cost and inefficiency, until we get the major question sorted out.

As it stands now, citizens shall soon lack even the ability to buy an incandescent light bulb. This, perhaps a small thing, but one that diminishes that Shining City on the Hill.

Won’t it save the AAA ratings? Are AAA ratings important to the US?

Let me answer your question with a question. What was the economic value of the enterprise of the United States three weeks ago?  What will it be three weeks from today? The answer to both is about the same as it is today, maybe a bit less, maybe a bit more.

What do we know today that we didn’t know before? Well, we know that Lisa Jackson thinks that under the Clean Air Act "For every $1 we have spent, we have gotten $40 of benefits in return. So you can say what you want about EPA's business sense. We know how to get a return on our investment…" and that this ethos, certainly not logic, remains a driving force behind our national policies that drive capital formation, investment, and employment. There are manifold examples of other continuing policies of the administration that are even more destructive of economic opportunity which we leave to others to explore.

We boldly predict the AAA ratings of the US will not hold because we have too much debt and a decreasing ability and willingness to pay it off. The ratings are largely irrelevant except as an indicator of long term economic & cultural decay. They may be seen as an accumulation of bad policy, bad political decisions rendered by the voters, and poor leadership over time.

We do note that even if we are wrong on the ratings call, we will be right in this ken: recall GM’s paper trading at junk levels in the capital markets while carrying investment grade ratings all around?  As a capital markets issue, generally, the rating agencies are irrelevant. They are generally behind the game and even if they understand the credit, which sometimes they don’t.  And by the way, aren’t the agencies regulated as deemed systemically important institutions?

The capital markets price credit risk every day. Go look.  Last count there were about 65 entities trading better in the markets than the US government.  Probably more today.

How will this be fixed?

People will vote in November 2012.

We have to decide whether we want to be a market & innovation driven economy or an economy based on redistribution of declining stocks of wealth. Productive people and capital will decide whether to stay or go elsewhere.

In the meantime the debt will compound, the spending will compound, the demographics of the country will age, domestic capital formation will stagnate, investment will decrease, interest rates will go up (barring another recession), and investors will look for ways to mitigate financial & regulatory oppression.

How will the market be changed by this deal?

I don’t know, but this is one of the few times in modern history when retail and large scale institutional investors may come close to informational parity, largely due to the complete unpredictability of political outcomes, the lack of enforceability of political contracts (will the SOB’s do what they promise?), and the now increasingly valid questions about the sustainability of rule of law in the US.

Try to allocate capital to create wealth in that environment.

Go hire a Wall Street law firm and ask about the certainty of senior secured creditors’ rights in “systemically” important credits, like Chrysler or GM or GE. Or compare the answers to “What do you think about the possibility of something big & bad happening in the markets?”  A quant geek will talk about six sigma events, kurtosis and the like, while Joe Everyman will say, “Sure seems more likely”.  Which can you take to the bank?  And meanwhile, some Wall Street analyst demonstrates complete dis-utility while bleating that XYZ Company is $.01 over expected EPS. No one cares.

No one cares because it does not solve the problem.

Is the debt ceiling deal good thing?

No, not really. In one sense it is very destructive because it perpetuates the language and manner of a continuing fraud on the American people … by that I mean the entire construct of disinformation where by common meaning and reference are inverted and no longer have validity.  Disinformation & newspeak are working.

Material liabilities are hidden, off budget, and off balance sheet. Taxes are no longer called taxes, but ‘revenues’ and tax reductions are not tax reductions but ‘tax expenditures’. Reductions are not real reductions but reductions from some fictional abstraction called a Baseline which has no relation to actual spending except to facilitate more of it.  Debt limits don’t limit debt, but provide a forum for an increase in debt. "Investments" are not investments, but political allocation of scarce capital resouces away from highest & best use. The government wants to invest in a high speed train, you want to invest in your kid's college education. Your personal priorities as to how you want to allocate your resources count less and less every day. Same with corporations, it just takes a different form.

So we are where our governance has delivered us. No one should be surprised at bad outcomes. Most know that if an entity repeatedly consumes rather than invests, it doesn't work. Or if an entity makes lots of bad, over leveraged investments over time, it doesn't work. 

More problematic is that no one believes the process or manner of conduct of the game is effective or reputable anymore. A friend commented “I don’t know what can be done to get these guys into reality”. The reality of the political class is different: they are in the wealth transfer business, not the wealth creation business.

They are in the business of monetizing their ability to dispense economic privilege to their preferred constituencies, the costs of which are huge & borne by all of us. They extract a variety of personal commissions in currencies that are mostly alien to those in the commercial world (extortions, soft emoluments of political votes or payments for economic privilege, power or other) and create macro costs that are huge & real, but kind of hidden.  

The target has always been other peoples’ money, but now the incremental drag on GDP and force of unsustainable leverage has upped the urgency: “I’m out of money. Give me yours.”

The target is other peoples’ money, and it is a target rich environment … your firm's money, your money, your parent’s money, your kids’ money.

Tell them no.

What is your economic outlook?

WWB are not economists, and we generally don’t fare well in any forecasting. But you asked, so … from our perspective, we just locked in a huge cloud of uncertainty across all dimensions of the US economy until well after the 2012 election. That uncertainty will be transmitted to global economies.

Look for nominal growth of 0%<GDP<2%, if not a few quarters of negative numbers. We expect employment will flatline, go sideways to nominally up, but would not be surprised to see that too go negative from time to time.  We anticipate corporate capital budgets will be trimmed, limited to only near term high certainty payoffs or strategically important or competitively disruptive initiatives. Emerging markets may continue to attract new capital investments on the margin, but that goes away in a heartbeat if corporations see uncertainty in global demand: “Who shall buy these widgets?” And that likely happened today.

So our takeaway

  • Liquidity first, long term investment second. We could be sideways for a while.
  • Diversification & risk parameters run the book.
  • Now is not a good time to reach for higher expected returns or yield ("never" is a good time to reach for yield)
  • If you think you have a good macro bead on what happening, you’re likely wrong.

Look for some more big volatility, perhaps some Europigbanks go boom and get nationalized … again … and then it’s going to get really quiet. Volatility will vanish, but it will be the scary kind of quiet, when absence of volatility indicates fear.  People will have their risk books tucked away. Volatility will drop because nothing will be happening.   

The Fed’s out of ammo.  The banks are out of capital. The government’s broke. The language is false. Prices are unreliable. Things get quiet during a rebuild.  Standards of living decline. It’s a grim business, and it's slow.

Where we go from there is the issue.

If you believe that the US will be a market driven economy, equities actually look good if you have staying power.  Private investment in wealth creating businesses (non-listed, low/no regulation risk) will be increasingly more attractive IF there is a restoration of rule of law, contract rights, and sensible regulatory costs.

If you believe that the US will devolve more completely into a redistributionist economy, gold, diamonds and portables look good as do opportunities in the black market. The alternative will be to join Jeff Imeldt on the President’s Council on Employment or get a job with the government. FDIC and FINRA will be hiring. 

I’d personally not bank on the shovel ready stuff: it might be a while. So the short answer is that we have to wait until the elections for clarity and then probably another year after that to even have a clue.



In case you were wondering

This sent in from London by an institutional credit salesperson, a friend and former colleague.

A Visualization of United States debt

We have not verified the analysis, but thought it intriguing enough to share.


Where's my state? Or a helpful retirement guide...

We thought we'd share this graph from The Revenue Demands of Public Employee Pension Promises of June 2011 by Robert Novy-Marx, University of Rochester, and Joshua D. Rauh, Kellogg School of Management.

This work is timely and a hugely beneficial public service, so share it with your friends. Everyone seems to be fascinated by the picture that shows by state unfunded pension liabilities plotted against municipal debt, both as a % of Gross State Product which we present below: 


Anecdotally, we report a general preference by viewers, quelle surprise, for the lower left quadrant. Our sample is biased, if not entirely limited, to tax payers, and we haven't gotten to any state representatives or members of Congress ... yet.

We also note the co-ordinates of the center mass as estimated by blink test seems to be around [17%,17%]. So if we restate the financials to include All Actual Adjusted for Undervalued  & Inaccurately Disclosed liabilites (AAAUID) we get the center mass at effectively 34% AAUID liabilities to Gross State Product. As a proxy that puts them in good company with Nepal, Bolivia, Democratic Republic of Congo and New Zealand as you can see here (we stipulate imperfect method, but it's close enough for government work, eh?).

We ask: why are the material liabilities of states and municipalities in need of ABO adjustments? The authors state 

Plan actuaries typically assume that the expected return on their portfolios will be about 8 percent, and then measure the adequacy of assets to meet liabilities based on that expected return. This accounting standard sets up a false equivalence between relatively certain pension payments and the much less certain outcome of a risky investment portfolio..


We might suggest that an expected return of 8% might be a tad aggressive when the 10 year Treasury is yielding 2.91%? Are we to infer they are all in on equites and leveraged 'alternative assets"? There is clearly a material failure of accurate disclosure and financial reporting here. Where is the Government Accounting Standards Board (GASB)? Where is the SEC? This is how we made the mortgage and financial crisis, and no surprise it's moved to the muni sector.

Wish list: what we'd really like to see is the graph with a few more dimensions, at minimum a surface, adding total state tax burden... and perhaps regulatory cost of compliance.

All in all, great work by these guys. 



“greek finance building on fire. euro to new highs. twilight zone” 

Thus commented a young trader on 6/29/11. We took it for our cover quote on our Q2 2011 market commentary of 6/30/11 some of which is excerpted below.

  • The quote reflects the fog of war in the global markets. Anticipate more.
  • We see a challenge to Western democratic capitalism as sovereign credits have melded with financials. The deterioration of both is a function of sustained failures of ethical leadership, agency risk, and governance. Economic mis-management of such scale poses a particular challenge to the market oriented, republican democracy of the United States.
  • Our circles believe that we have moved well past a crisis of confidence.
  • Europe will continue to muddle through the Greek restructuring with Portugal and Spain to follow, and we anticipate the standard of living in Euroland will slowly and ever so surely decline over time.
  • We leave to you to assess the probable outcomes of Congress meddling with the primal forces of the tax code & budget priorities. The menu as we see it comprises
    • a default, either technical or substantive;
    • a quick & bad fix; or
    • a good & substantive fix.
  • We havent even mentioned the electionsexcept to say we encourage all investors to get directly involved.
  • We dont know whether the last minute 400 or so point run in the Dow was driven by hedge funds trying to drive up Q2 performance (as was suggested by a manager of a $1 bn fund) or whether the market is starting to price in some probability of favorable changes in policy & governance. Champagne uncorking on rumors of Geithners resignation?
  • We  confess we dont have a cohesive view of where the markets are going and will not apologize for it. We sense that uncertainty is great, but stand contradicted by relatively low volatility. VIX has taken the role of a contra indicator?
  • We remain biased against US$ duration as a function of risk & magic by the Bernanke . We still see some value in credit spreads as a defensive fixed income play (well, its not equity…”). The yield on short term investment grade corporate debt (VCSH, ~2.8 duration) exceeded the 5 yr. Treasury of June 27 by ~ .40%.
  • The yield on the Dow (DIA) is about equal to the 7 yr. Treasury and ~12x forecast earnings, not unattractive.

In the main, however, major risk now takes the form of a known unknown (we know we dont know it): the outcome of political process of regulatory, tax & budget reform. We must note the extraordinary volatility of the 5 year Treasury yield and offer our condolences to anyone who had the temerity to be long on June 26 or 27. 


Lastly, just to keep you sleeping well, was there a leak in the informational pipeline in advance of the downgrade of Portugal that moved the market?  Welcome to the Twilight Zone.


No mas! I’ll take #1, Monty!

Updated on Wednesday, June 15, 2011 at 08:51AM by Registered Commenterhb

"Every normal man must be tempted, at times, to spit on his hands, hoist the black flag, and begin slitting throats." — H.L. Mencken (Prejudices: First Series)

We have arrived. We encourage other citizens and investors to arrive as well. We call for no increase whatsoever in the federal debt limit. We call for scheduled real reductions in the aggregate consumption by state, local, and federal government of GDP.  We believe that we are nearing the point where time is of the essence  and further believe in the necessity of enlisting the discipline of the capital markets to achieve that objective.  If the political circumstances require a technical or substantive default to invoke the discipline of the capital markets, so be it.

No more kicking the country’s can down the road. Fix it now. This posting has been simmering for a while, and the catalyst for publication, perhaps prematurely so, was Larry Summer’s article in the June 13th edition of the Financial Times, How We Can Avoid Stumbling Into Our Own Lost Decade.  His thesis, reductively put, is an infinite do-loop,

Click to read more ...


Get your health care waivers here!

In case you are wondering, here is the list of health insurance waivers granted so far.  The length of the list evidences non trivial economic value.   Let's think about that for a minute...?

In any case if you'd like to get your very own, give it a go here

Yes, you can! Or maybe not.

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