Entries in uncertainty (8)


Comments on recent market events

Perspective is important to maintaining a clear head in face of market turbulence.

Below is a picture of the last 6 months price performance of VTI (in green), Vanguard Total U.S. Stock Market, which represents approximately 95% of the tradable US equity market. We added BIL (orange) , SPDR 1-3 Month T-Bill ETF (0.2yr) which tracks short term Treasury bills, and VEU (blue), Vanguard FTSE All-World ex-US, a proxy for all non-US equities.

You can see the decline of VTI of about -5.6% over the last 6 months and -8.5% for VEU. Not a good or pleasant thing.

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Come play the backtest and overfit game!

 We've written before about the risks of excessive back testing in our posting The Effect was Never There... It Was Just a Random Pattern. But now thanks to the good folks at the Scientific Data Management Group at Lawrence Berkeley National Laboratory at UC, we have a nifty little gizmo that will take you for a test drive.

Give it a go on the link below: then open your own quant hedge fund!

Backtest Overfitting: An Interactive Example

If you want to actually read about the toy before you use it, well, you go here, Backtest Overfitting Demonstration Tool: An Online Interface, a paper in the Big Data & Innovative Financial Technologies Paper Series. If you do that, however, you are not qualified by disposition to run a quant fund.

One suspects this phenomena, which is rampant in the investment arena, is going to get some attention in the form of litigation or regulatory scrutiny. In the meantime caveat emptor. A different group is coming to the same conclusion:

"We argue that most claimed research findings in financial economics are likely false."

Remember, kids, actual results may vary!





The Fed, collateral and repo: more systemic risk?

Updated on Saturday, July 20, 2013 at 05:13PM by Registered Commenterhb

Updated on Monday, July 22, 2013 at 09:44PM by Registered Commenterhb

Updated on Monday, July 22, 2013 at 10:11PM by Registered Commenterhb

We’ve had the FT article of April 23, 2013, The Misuse of Collateral Can Help Create Systemic Risk by Satyajit Das, on our desk for several months. It is highlighted and underlined, and we borrow from it liberally here (in fair use we trust). His article was prescient.

The thesis is simple enough: in the main collateral is now the basis of our primary financial institutions, most capital markets transactions, and source of liquidity, which is to say, our entire financial system. One might infer that collateral is what you use when you have no capital. He highlights, excerpted below, some consequences, intended or not, of the increasing dependency on collateral. Translation: “you can run, but you can’t hide.”

First, it shifts the emphasis from the borrower or counterparty’s creditworthiness to the collateral. Parties normally ineligible to borrow or transact in the first place are able to enter into transactions. Rapid growth in debt levels, derivative contract volumes and the shadow banking system (hedge funds or structured investment vehicles) are dependent on the use and availability of collateral.

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The failure of governance and the uncertainty curve

Updated on Thursday, February 7, 2013 at 06:56AM by Registered Commenterhb

Updated on Friday, February 8, 2013 at 05:09PM by Registered Commenterhb

Updated on Monday, February 11, 2013 at 08:42AM by Registered Commenterhb

Updated on Friday, March 15, 2013 at 10:02AM by Registered Commenterhb

Phineas Taylor Barnum constructed and marketed his fraudulent Figii Mermaid to the crowds, and his spirit lives on.  

"I am a showman by profession...and all the gilding shall make nothing else of me,"[1] .  

At least Barnum, setting aside for a minute the notion of authoring two autobiographies, remained sober in his perception of reality.

For stark contrast we would highlight for the attention of our national policy makers that certain corporate issuers of investment grade debt have periodically traded at negative spreads to their US Treasury benchmark, that is at lower rates than the comparable Treasury note.  A capital markets redux of The Emperor's New Clothes

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What's wrong with the Fed

John Cochrane of University of Chicago provides the best explanation of why & how the Fed is off track in his recent article The Federal Reserve: From Central Bank to Central Planner



A progress report on Dodd-Frank

Davis Polk has done an excellent job of detailing the complexity of process & progress in the Dodd-Frank Progress Report. It's also commendable to see lawyers communicate with pictures.


The free citizens of the US need only look at the red stuff (late) and the blue stuff (due date unknown) and ask:"If this were my business and these were my projects, what would I do with these project managers?"

Well, the bad news is that it is your national business, and they are our collective projects.


If you have the misfortune to be regulated by the red and blue stuff, well, this is the picture financial oppression and paralysis. It is also how we manufacture systemic risk, how government transfers wealth to politicians & regulators who monetize their ability to dispense economic privilege.

Get your bids in early: it's campaign season.



The small matter of unfunded state & municipal pension liabilities

The fraud of Social Security becomes the fraud of General Motors becomes the fraud of California and moves soon to a theatre near you. Owners of municpal paper take note.

The FT today reports US cities face big public pension deficits excerpted below.

Big US cities could be squeezed by unfunded public pensions as they and counties face a $574bn funding gap, a study to be released on Tuesday shows.

The gap at the municipal level would be in addition to $3,000 bn in unfunded liabilities already estimated for state-run pensions, according to research from the Kellogg School of Management at Northwestern University and the University of Rochester.

Now how could that have happened?

Thematically, its the same old stuff.  Shall we take a little flashback to General Motors? Kudos to Tony Jackson of the Financial Times for his article GM is just a hedge fund in disguise (Aug 22, 2010 also excerpted below).

As public offering for GM rev’s up, one might well ask, “How is this going to work?” Well, it’s not going to. The US government, or rather the current & future US taxpayers, have provided us with another opportunity to short a pig. Let’s set aside the sobering competitive reality that we as consumers already know well. No one buys their cars. That’s why they went bust. Let’s further set aside the sobering global competitive threats of Ford, Honda, Toyota, and Hyundai.

GM has pension liabilities of some $100 billion, funding of which is well, running a bit short. Quelle surprise! The stated deficit of some $27 billion bananas is, of course, based on the assumption that the existing pension assets earn 8.5% for the rest of time in eternity AND that GM operates with sufficient profitability and cash flow to fund its pension expenses and everything else.

Well, good luck with that 8.5%. What…? You need a bigger number, no problem? Just pop the asset mix and up risk a bit. Why not? 

The reality of all this is that GM…is in economic terms a hedge fund, with its operations a mere sideline. And as a hedge fund, it is fairly racy.

Mr Ralfe calculates that only 35 per cent of its assets are in investment-grade bonds, either Treasury or corporate. The rest is spread across real estate, equities, hedge funds, private equity and so forth.

This poses an interesting question. Why would investors put their money into GM, rather than into regular hedge funds that are not distracted by the vexing business of selling cars in competition with the giants of Asia?

Oh, good. But wait, there’s more. The first half operating earnings of GM were about $2.9 billion (the highest since 2004) so let’s double it to ballpark 2010’s annual operating earnings, well, call it a little less than $6 billion. Let’s set aside the hockey stick earnings forecast by management and soberly assume that the 8.5% sustainable investment return on the pension assets is overly aggressive, at least at the front end of the period. GM then has to dedicate at least all of its operating earnings for the next 6-8+ years minimum to merely funding the pension liability. Forget about growing warranty expense or debt service or funding unsold inventory. Kaboom! We’re all shareholders on this bus.

Now, let's now move our gaze to California which is now in a funding crisis, acutely short of cash with limited financing options...  all dressed up, sitting by the phone at 7 pm on prom night. CALPERS, being helpful sympathetic types, lob in a call. They know a good deal when they see it, the opportunity to buy every politician in the state with make a prudent bridge loan to a large politically & economically important state whose pensions they run.  CALPERS is, of course, the California Public Employee’s Retirement System. They’re proposing to lend to the state. The cash, of course, comes from the pensions of the state's employees.  Oh, did we mention that many of the CALPERS' pension plans have funding deficits also? Something about understated liabilites and under performance of investment assets…

 Flash back to GM: GM’s annual payments to its US pensioners are running at $9.3bn. On US fund assets of $85bn, that ostensibly requires a return of 10.9 per cent.

Flash back to the Social Security trust fund: there is no social security trust fund.

Systemic risk, anyone?




We're all Bozo's on this bus: the wisdom of Dodd-Frank

Updated on Friday, July 23, 2010 at 11:46AM by Registered Commenterhb

Updated on Wednesday, July 28, 2010 at 02:36PM by Registered Commenterhb

At some point Congressional imbecility becomes malfeasance. The Wall Street Journal today reports: Standard & Poor's, Moody's Investors Service and Fitch Ratings are all refusing to allow their ratings to be used in documentation for new bond sales, each said in statements in recent days. Each says it fears being exposed to new legal liability created by the landmark Dodd-Frank financial reform law.... That is important because some bonds, notably those that are made up of consumer loans, are required by law to include ratings in their official documentation. That means new bond sales in the $1.4 trillion market for mortgages, autos, student loans and credit cards could effectively shut down.

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