Posts filed under ‘Banking’

Bond-Choking Central Banks Expand Investment Menu

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Central banks around the globe are choking on low-yielding bonds, and as result are now expanding their investment menu beyond Treasuries into equities. Expansionary monetary policies purchasing short-term, low-rate bonds means that central banks have been gobbling up securities on their balance sheets that are earning next to nothing. To counteract the bond-induced indigestion of the central banks, many of them are considering increasing their equity purchasing strategies. How can you blame them? With the 10-year U.S. Treasury notes yielding 1.66%; 10-year German bonds eking out 1.21%; and 10-year Japanese Government Bonds (JGBs) paying a paltry 0.59%, it’s no wonder central banks are looking for better alternatives.

More specifically, the Bank of Japan (BOJ) is planning to pump $1.4 trillion into its economy over the next two years to encourage some inflation through open-ended asset purchases. Earlier this month, the BOJ said it has a goal of more than doubling equity related exchange traded funds (ETFs) by the end of 2014. According to Business Insider, the BOJ is currently holding $14.1 billion in equity ETFs with an objective to reach $35.3 billion in 2014.

I can only imagine how stock market bears feel about this developing trend when they have already blamed central banks’ quantitative easing initiatives as the artificial support mechanism for stock prices (see also The Central Bank Dog Ate my Homework).

While expanded equity purchases could break the backs of bond bulls and stock naysayers, some smart people agree that this strategy makes sense. Take Jim O’Neill, the chairman of Goldman Sachs Asset Management, who is retiring next week. Here’s what he has to say about expanded central bank stock purchases:

“Frankly, it makes a huge amount of sense in a world of floating exchange rates and such incredible opportunity, why should central banks keep so much money in very short term, liquid things when they’re not going to ever need it? To help their future returns for their citizens, why would they not invest in equity?”

 

How big is this shift towards equities? The Royal Bank of Scotland conducted a survey of 60 central banks that have about $6.7 trillion in reserves. There were 13% of the central banks already invested in equities, and almost 25% of them said they are or will be invested in equities within the next five years.

While I may agree that stocks generally are a more attractive asset class than bubblicious bonds right now, I may draw the line once the Fed starts buying houses, gasoline, and groceries for all Americans. Until then, dividend yields remain higher than Treasury yields, and the earnings yields (earnings/price) on stocks will remain more attractive than bond yields. Once stocks gain more in price and/or bonds sell off significantly, it will be a more appropriate time to reassess the investment opportunity set. A further stock rise or bond selloff are both possible scenarios, but until then, central banks will continue to look to place its money where it is treated best.

The central bank menu has been largely limited to low-yielding, overpriced government bonds, but the appetite for new menu items has heightened.  Stocks may be an enticing new option for central banks, but let’s hope they delay buying houses, gasoline, and groceries.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

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April 28, 2013 at 11:31 am Leave a comment

Investing in a World of Black Swans

In the world of modern finance, there has always been the search for the Holy Grail. Ever since the advent of computers, practitioners have looked to harness the power of computing and direct it towards the goal of producing endless profits. Regrettably, nobody has found the silver bullet, but that hasn’t slowed down people from trying. Wall Street has an innate desire to try to turn the ultra-complex field of finance into a science, just as they do in the field of physics. Even JPMorgan Chase (JPM) and its CEO Jamie Dimon are already on their way to suffering more than $2 billion in losses in the quest for infinite income, due in large part to their over-reliance on pseudo-science trading models.

James Montier of Grantham Mayo van Otterloo’s asset allocation team was recently a keynote speaker at the CFA Institute Annual Conference in Chicago. His prescient talk, which preceded JP Morgan’s recent speculative trading loss announcement, explained why bad models were the root cause of the financial crisis. Essentially these computer algorithms under-appreciate the number and severity of Black Swans (low probability negative outcomes) and the models’ inability to accurately identify predictable surprises.

What are predictable surprises? Here’s what Montier had to say on the topic:

“Predictable surprises are really about situations where some people are aware of the problem. The problem gets worse over time and eventually explodes into crisis.”

 

Just a month ago, when Dimon was made aware of the rogue trading activities, the CEO strenuously denied the problem before reversing course and admitting the dilemma last week. Unfortunately, many of these Wall Street firms and financial institutions use value-at-risk (VaR) models that are falsely based on the belief that past results will repeat themselves, and financial market returns are normally distributed. Those suppositions are not always true.

Another perfect example of a Black Swan created by a bad financial model is Long Term Capital Management (LTCM). Robert Merton and Myron Scholes were world renowned Nobel Prize winners who single handedly brought the global financial market to its knees in 1998 when LTCM lost $500 million in one day and required a $3.6 billion bailout from a consortium of banks. Their mathematical models worked for a while but did not fully account for trading environments with low liquidity (i.e., traders fleeing in panic) and outcomes that defied the historical correlations embedded in their computer algorithms. The “Flash Crash” of 2010, in which liquidity evaporated due to high frequency traders temporarily jumping ship, is another illustration of computers wreaking havoc on the financial markets.

The problem with many of these models, even for the ones that work in the short-run, is that behavior and correlations are constantly changing. Therefore any strategy successfully reaping outsized profits in the near-term will eventually be discovered by other financial vultures and exploited away.

Another pundit with a firm hold on Wall Street financial models is David Leinweber, author of Nerds on Wall Street.  As Leinweber points out, financial models become meaningless if the data is sliced and diced to form manipulated and nonsensical relationships. The data coming out can only be as good as the data going in – “garbage in, garbage out.”

In searching for the most absurd data possible to explain the returns of the S&P 500 index, Leinweiber discovered that butter production in Bangladesh was an excellent predictor of stock market returns, explaining 75% of the variation of historical returns. By tossing in U.S. cheese production and the total population of sheep in Bangladesh, Leinweber was able to mathematically “predict” past U.S. stock returns with 99% accuracy. To read more about other financial modeling absurdities, check out a previous Investing Caffeine article, Butter in Bangladesh.

Generally, investors want precision through math, but as famed investor Benjamin Graham noted more than 50 years ago, “Mathematics is ordinarily considered as producing precise, dependable results. But in the stock market, the more elaborate and obtuse the mathematics, the more uncertain and speculative the conclusions we draw therefrom. Whenever calculus is brought in, or higher algebra, you can take it as a warning signal that the operator is trying to substitute theory for experience.”

If these models are so bad, then why do so many people use them? Montier points to “intentional blindness,” the tendency to see what one expects to see, and “distorted incentives” (i.e., compensation structures rewarding improper or risky behavior).

Montier’s solution to dealing with these models is not to completely eradicate them, but rather recognize the numerous shortcomings of them and instead focus on the robustness of these models. Or in other words, be skeptical, know the limits of the models, and build portfolios to survive multiple different environments.

Investors seem to be discovering more financial Black Swans over the last few years in the form of events like the Lehman Brothers bankruptcy, Flash Crash, and Greek sovereign debt default. Rather than putting too much faith or dependence on bad financial models to identify or exploit Black Swan events, the over-reliance on these models may turn this rare breed of swans into a large bevy.

See Full Article on Montier: Failures of Modern Finance

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in JPM, Lehman Brothers, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

May 20, 2012 at 6:02 pm Leave a comment

Ping Pong Vet Blasts Goldman

Source: Photobucket

In a recent New York Times op-ed, Greg Smith, former Goldman Sachs Group Inc. (GS) employee and ping pong medalist at the Jewish Olympics, came out with an earth-shattering revelation… he discovered and revealed that Goldman Sachs was not looking out for the best interests of its clients. I was floored to discover that a Wall Street bank valued at $60 billion would value profits more than clients’ needs.

Hmmm, I wonder what new eye-opening breakthrough he will unveil next? Perhaps Smith will get a job at Las Vegas Sands Corp. (LVS) for 12 years and then enlighten the public that casinos are in the business of making money at the expense of their customers. I can’t wait to learn about that breaking news.

But really, with all sarcasm aside, any objective observer understands that Goldman Sachs and any other Wall Street firm are simply middlemen operating at the center of capitalism – matching buyers and sellers (lenders and borrowers) and providing advice on both sides of a transaction. As a supposed trusted intermediary, these financial institutions often hold privileged information that can be used to the firms’ (not clients) benefit.

Most industry veterans like me understand how rife with conflicts the industry operates under, but very few insiders publicly speak out about these “dirty little secrets.” Readers of Investing Caffeine  know I am not bashful about speaking my mind. In fact, I have tackled this subject in numerous articles, including Wall Street Meets Greed Street written a few months ago. Here’s an excerpt**:

“Wall Street and large financial institutions, however, are driven by one single mode…and that is greed. This is nothing new and has been going on for generations. Over the last few decades, cheap money, loose regulation, and a relatively healthy economy have given Wall Street and financial institutions free rein to take advantage of the system.”

 

As with any investment, clients and investors should understand the risks and inherent conflicts of interest associated with a financial relationship before engaging into business. While certain disclosures are sorely lacking, it behooves investors and clients to ask tough questions of bankers and advisors – questions apparently Mr. Smith did not ask his employer over his 12 year professional career at Goldman Sachs.

Reputational Risk Playing Larger Role

Even though Goldman called some clients “muppets,” Smith states there was no illegal activity going on. Regardless of whether the banks have gotten caught conducting explicit law-breaking behavior, the public and politicians love scapegoats, and what better target than the “fat-cat” bankers. With a financial crisis behind us, along with a multi-decade banking bull market of declining interest rates, the culture, profitability-model, and regulations in the financial industry are all in the midst of massive changes. As client awareness and frustration continue to rise, reputational risk will slowly become a larger concern for Wall Street banks.

Could the Goldman glow as the leading Wall Street investment bank finally be getting tarnished? Well, besides their earnings collapsing by about 2/3rds in 2011, the selection of Morgan Stanley (MS) and JPMorgan Chase (JPM) ahead of Goldman Sachs as the lead underwriters in the Facebook (FB) initial public offering (IPO) could be a sign that reputational risk is playing a larger role in investment banking market share shifts.

The public and corporate America may be slow in recognizing the shady behavior practiced on Wall Street, but eventually, the excesses become noticed. Congress eventually implements new regulations (Dodd-Frank) and customers vote with their dollars by moving to banks and institutions they trust more.

I commend Mr. Smith for speaking out about the corrupt conflicts of interest and lack of fiduciary duty at Goldman Sachs, but let’s call a spade a spade and not mischaracterize a situation as suddenly shifting when the practices have been going on forever. Either he is naïve or dishonest (I hope the former rather than the latter), but regardless, finding a new job on Wall Street may be challenging for him. Fortunately for Mr. Smith, he has something to fall back on…the professional ping-pong circuit.

***Other Relevant Articles and Video:

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in FB, GS, MS, JPM, LVS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

March 17, 2012 at 4:57 pm 1 comment

Draghi & ECB Pass Trash and Serve Brussels Sprouts

ECB (European Central Bank) President Mario Draghi made it clear with his most recent monetary banking announcements that he is perfectly willing to shovel the sovereign debt trash around the financial system, but he just doesn’t want the ECB to gobble up heaps of the smelly debt.

On the same day that Draghi lowered the key benchmark interest rate by -0.25% to 1.00%, he also reduced the lending credit rating threshold for acceptable banking collateral to “single-A” and offered banks endless three-year loans with . But wait…there’s more! In typical infomercial fashion, Draghi had an additional stimulative gift offering – he halved the reserve requirement ratios for European banks.

Although Draghi is handing out lots of hugs and kisses to the banks, including infinite amounts of three-year loans, he is also providing very little direct love to European debt-laden governments. In other words, Draghi isn’t ready to pull out the printing press bazooka to sop up mounds of trashy sovereign debt (i.e., Greece, Italy, and Spain). Draghi may be willing to make the ECB the lender of last resort for the banks, but he is not signaling the same lender of last resort commitment for careless governments.

Despite Draghi’s public aversion to bond buying (a.k.a. QE or quantitative easing), he indirectly is funding quantitative easing anyway. Rather than having the ECB accelerate the direct purchase of besieged sovereign debt, he indirectly is giving money to the banks to purchase the same struggling bonds. Sneaky, but clever…I like it.

Eat Your Brussels Sprouts!

Draghi in his new role as ECB President is clearly trying to be a responsible parent to the Euro leaders, but as a result, he could be placing himself in trouble with the law. I haven’t contacted my attorneys yet, however Mario Draghi is blatantly infringing on my patented “Brussels sprouts mandate” that I regularly use at the dinner table with my children. On any given night, by 6:30 p.m. my kids are practically frothing at the mouth for some unhealthy dessert delight. The problem with the situation is unfinished Brussels sprouts sitting on their plates, so with respected authority I command, “If you want dessert tonight, you better eat your Brussels sprouts!” Normally this is not a bad strategy because my plea usually results in an extra consumed sprout or two. Ultimately, given the softy that I am, all parties involved know that dessert will be served regardless of the number of sprouts consumed.

Draghi, in dealing with the irresponsible fiscal actions of the sovereigns, is using the same precise “sprout mandate.” In a recent press conference, here’s how Draghi delivered his tough talk:

“All euro-area governments urgently need to do their utmost” for fiscal sustainability. “Policy makers need to correct excessive deficits and move to balanced budgets in the coming years. This will strengthen overall economic sentiment. To accompany fiscal consolidation, the governing council has called for bold and ambitious structural reforms.”

 

Just as it makes sense for me not to say, “Hey kids, don’t worry about eating your vegetables, save room for the ice cream sundae buffet,” it probably doesn’t make sense for Draghi to inform European leaders, “Hey kids, don’t worry about those massive debts and deficits, the ECB will give you plenty of money to buy up all that trashy sovereign debt of yours.”

Hypocritical Or Shrewd?

I applaud Signore Draghi for implementing his bold actions as lender of last resort for European Banks, but isn’t it a tad bit hypocritical? The ECB President talks seriously about Basel III capital requirements, yet he is easing rules on collateral and reserves. Why is it OK for the ECB to condone reckless behavior and introduce moral hazards for the banks (i.e., limitless ECB backstop), but not for irresponsible governments too? If I am a European bank with continuous access to ECB loans, why not roll the dice and risk shareholder capital in hopes of a big risky payoff? I’m sure Jon Corzine at MF Global (MFGLQ.PK) would appreciate similar financial backing. What’s more, how credible can Draghi be about his tough fiscal love and anti-quantitative easing stances when he is currently offering never-ending amounts of money to the banks and already buying collapsing sovereign bonds as we speak?

No matter the view you hold, the ECB is openly demonstrating it will not sit idle watching the banking system collapse under its own watch, much like the Federal Reserve and Ben Bernanke did not sit idle in 2008-2009. Perhaps Draghi isn’t being hypocritical, but is rather being shrewd? Although Draghi wants governments to eat their fiscal Brussels sprouts, let’s not kid ourselves. Just as Draghi is willing to pass the trash and appease the banking system, if the eurozone sovereign debt crisis continues worsening, don’t be surprised to see Draghi roll out his ice cream sundae buffet of aggressive bond buying. That will taste much better than Brussels sprouts.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in MF Global (MFGLQ.PK), or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

December 10, 2011 at 2:14 pm Leave a comment

Wall Street Meets Greed Street

For investors, the emotional pendulum swings back and forth between fear and greed. Wall Street and large financial institutions, however, are driven by one single mode…and that is greed. This is nothing new and has been going on for generations. Over the last few decades, cheap money, loose regulation, and a relatively healthy economy have given Wall Street and financial institutions free rein to take advantage of the system.

Not only did the financial industry explode, but the large got much larger. The FCIC (Financial Crisis Inquiry Commission), a government appointed commission, highlighted the following:

“By 2005, the 10 largest U.S. commercial banks held 55% of the industry’s assets, more than double the level held in 1990. On the eve of the crisis in 2006, financial sector profits constituted 27% of all corporate profits in the United States, up from 15% in 1980.”

 

What’s more, the obscene profits were achieved with obscene amounts of debt:

“From 1978 to 2007, the amount of debt held by the financial sector soared from $3 trillion to $36 trillion, more than doubling as a share of gross domestic product.”

 

Times have changed, and financial institutions have gone from victors to villains. Sluggish economic growth in developed countries and choking levels of debt have transitioned political policies from stimulus to austerity. This in turn has created social unrest. Who’s to blame for all of this? Well if you watch the evening news and Occupy Wall Street movement, it becomes very easy to blame Wall Street. Certainly, fat cat bankers deserve a portion of the blame. As one can see from the following list, over the last few years, the financial industry has paid for its sins with the help of a checkbook:

CLICK TO ENLARGE

The disgusting amount of inequitable excess is smeared across the whole industry in this tiny, partial list. Billions of dollars in penalties and disgorged assets isn’t insignificant, but besides Bernie Madoff and Raj Rajaratnam, very little time has been scheduled behind bars for the perpetrators.

Whom Else to Blame?

Are the greedy bankers and financial institution operators the only ones to blame? Without doubt, lack of government enforcement and adequate regulation, coupled with a complacent, debt-loving public, contributed to the creation of this financial crisis monster. When the economy was rolling along, there was no problem in turning a blind-eye to subversive activity. Now, the greed cannot be ignored.

At the end of the day, voters have to correct this ugly situation. The general public and Occupy Wall Street-ers need to boycott corrupt institutions and vote in politicians who will institute fair and productive regulations (NOT more regulations). Sure corporate financial lobbyists will try to tip the scales to their advantage, but a vote from a lobbyist attending a $10,000 black-tie dinner carries the same weight as a vote coming from a Occupy Wall Street-er paying $5 for a foot-long sandwich at Subway. As Thomas Jefferson stated, “A democracy is nothing more than mob rule, where fifty-one percent of the people may take away the rights of the other forty-nine.”

Investor Protocol

Besides boycotting greedy institutions and using the voting booth, what else should individuals do with their investments in this structurally flawed system? First of all, find independent firms with a fiduciary duty to act in your best interest, like an RIA firm (Registered Investment Advisor). Brokers, financial consultants, financial advisors, or whatever euphemism-of-the-day is being used for an investment product pusher, may not be evil, but their incentives typically are not aligned to protect and grow your financial future (see Fees, Exploitation, and Confusion   and Letter Shell Game).

There is a lot of blame to be spread around for the financial crisis, and the intersection of Wall Street and Greed Street is a major contributing factor. However, investors and voters need to wake up to the brutal realities of our structurally flawed system and take matters into their own hands. Only then can Main Street and Wall Street peacefully coexist.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in MS, UBS, C, JPM, WFC, SCHW, AMTD, BAC, GS, STT, Galleon, RBC, Subway, Amer Home, Brookside Captl, Morgan Keegan, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

November 27, 2011 at 11:37 am 8 comments

Reality More Fascinating than Fiction

Make-believe is fun, but reality is often more fascinating than fiction. The same can be said for the books I read. Actually, all the books reviewed at Investing Caffeine have been non-fiction. My movie-viewing preferences happen to be quite similar – comedies and dramas are terrific, but I’m also a documentary fanatic. As a matter of fact, I have rented or watched more than 125 documentaries (and mockumentary, This is Spinal Tap) over the last six years.

There have been a slew of non-fiction books written about the recent global financial crisis, including the ones I reviewed: Too Big to Fail, The Greatest Trade Ever, and The Big Short. When it comes to videos, I have seen several TV-based documentaries covering various aspects of the global meltdown, but the Inside Job did an exceptionally good job of providing a global perspective of the financial collapse. The film was produced, written, and directed by Charles Ferguson (you can call him “doctor” thanks to the Ph.D he earned at MIT) and also narrated by Academy Award winner Matt Damon. The Inside Job provided a comprehensive worldly view by filming on location in the United States, Iceland, England, France, Singapore, and China. Not only did Ferguson break down the complex facets of the crisis into easily digestible pieces for the audience, but he also features prominent journalists, politicians, and academics who describe the complicated global events from a birds-eye view. Hedge fund manager George Soros,  former Federal Reserve Chairman Paul Volcker, former New York Governor Eliot Spitzer, and economist Nouriel Roubini, are a small subset of the heavy-hitters interviewed in the movie.

A wide range of causes and effects were explored – everything from derivatives, lack of regulation, excessive banker compensation, and the pervasive conflicts of interest throughout the financial system. Bankers and politicians shoulder much of the blame for the global crisis, and Ferguson does not go out of his way to present their side of the story.  Ferguson does a fairly decent job of keeping his direct personal political views out of the film, but based on his undergraduate Berkeley degree and his non-stop Goldman Sachs (GS) bashing, I think someone could profitably prevail in wagering on which side of the political fence Ferguson resides.

Although I give Inside Job a “thumbs-up,” I wasn’t the only person who liked the movie. The Inside Job in fact won numerous awards, including the 2010 Academy Award for Best Documentary, Best Documentary from the New York Film Critics Circle, and the Best Documentary Screenplay from the Writers Guild.

Slome’s Oscar Nominees

As I mentioned previously, I am somewhat fanatical when it comes to documentaries, although I have yet to see Justin Bieber’s Never Say Never. Besides the Inside Job, here is a varied list of must-see documentaries. There may be a conflict of personal tastes on a few of these, but I will provide you a hand-written apology for anybody that falls asleep to more than one of my top 15:

1)      Murderball

2)      A Crude Awakening  

3)      Touching the Void

4)      It Might Get Loud

5)      Hoop Dreams

6)      Lewis and Clark: The Journey (Ken Burns)

7)       The Staircase

8)      Enron: The Smartest Guys in the Room

9)      Cracking the Code of Life  

10)   Paradise Lost

11)   The Endurance

12)   Devil’s Playground  

13)   Everest: Beyond the Limit

14)   The Devil Came on Horseback

15)   Emmanuel’s Gift

I’m obviously biased about the quality of my recommended documentaries, but you can even the score by sharing some of your favorite documentaries in the comment section below or by emailing me directly. I will be greatly indebted for any suggestions offered. Regardless, whether watching a truth-revealing thought-piece like the Inside Job or A Crude awakening, or an inspirational story like Murderball or Touching the Void, I’m convinced that these reality based stories are much more fascinating than the vast majority of recycled fiction continually shoveled out by Hollywood. For those adventurous movie-watchers, check out a documentary or two – who knows…there may be an inner-documentary fanatic in you too?

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

April 4, 2011 at 11:10 pm 3 comments

Membership Privileges: Cheese Tubs & Space Travel

With Senate proposals pushing to cap debit card fees earned by the credit card companies (Visa Inc. [V] and MasterCard Inc. [MA]), you better hurry up and take advantage of underappreciated membership privileges while you still can. The card companies are not too happy, but maybe they deserve some legitimate sympathy. I mean, supporting banks that gouge customers at rates reaching upwards of 20% can be challenging for any card network oligopoly to handle. So before Congress strips away the card companies’ God-given right to siphon away fees from millions of Americans, you have the obligation to utilize the membership privileges of your credit card – even if those benefits include using Visa’s concierge services for purchasing a giant tub of nacho cheese or booking a space travel trip. Unfortunately, many cardholders are unaware they carry the power of a personal servant in their wallet or purse. Tim Ferriss, creator of Experiments in Life Design, on the other hand chose to repeatedly use his personal servant to handle some of the most mission critical responsibilities you could imagine…for example:

1)      Punch Bowl Tub of Cheese: Ferriss didn’t make his request for a tub of cheese completely uncompromising, but rather he was flexible in his demands. When the Visa concierge, David, asked Ferris what size cheese container he wanted, Ferriss reasonably responded, “Can, jar, tub, I don’t care. I just want liquid cheese, and a lot of it.”

2)      Crossword Magicians: Why get flustered with a USA Today crossword clue (“Blue Grotto Locale”) when you can simply ring Maurice, your trusty Visa crossword concierge to solve the puzzle? Ferris used this approach and found the method much classier than using a computer or phone to find the answer. The answer to 62 across: ISLE OF CAPRI.

3)      Feeling Blue? No problem, daily affirmations are just a few keypad strokes away from your fingertips. Getting told he was “good enough” by Jamie the concierge was a little ambitious, but Ferriss was satisfied by receiving a third party affirmation service along with a gratuitous note from Jamie letting him know what a good person he was.

4)      Going Galactic: Now that he was getting warmed up, Ferriss had loftier goals (no pun intended). Specifically he requested the concierge to “book a trip to space.” Ferriss was not let down – the Visa Signature concierge came through with a $200,000 price quote from Virgin Galactic.

5)      Looking at Limitations: Overall, the concierge service delivered on its mission of fielding random requests and answering questions. Nonetheless, Visa Signature needed a  little more time to complete a self assessment of the services Visa could NOT perform (e.g., plan a wedding, call a friend, or write an article). Eventually Ferriss received an adequate response and went on to complete his prank-a-thon.

 Believe it or not, some financial institutions provide services to you without charging you an arm and a leg. Maybe the card companies already have enough arms and legs to keep themselves content, but given political pressure on Visa and MasterCard, you better book that space flight and place that cheese tub order ASAP.

Read Full Tim Ferriss Article on Concierge Services  (post was originally published on Credit Card Chaser)

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct positions in V, MA, Virgin,  or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

May 21, 2010 at 12:41 am Leave a comment

Ball & Chaining the Rating Agencies

After sifting through the rubble of the financial crisis of 2008-2009, Congress is spreading the blame liberally across various constituencies, including the almighty rating agencies (think of Moody’s [MCO], Standard & Poor’s [MHP], and Fitch). The Senate recently added a proposed amendment to the financial regulation bill that would establish a government appointed panel to select a designated credit rating agency for certain debt deals. The proposal is designed to remove the inherent conflict of interest of debt issuers – such as Goldman Sachs Group Inc. (GS), Morgan Stanley (MS), UBS, and others – shopping around for higher ratings in exchange for higher payments to the banks. The credit rating agencies are not satisfied with being weighed down with a ball and chain, and apparently New York Attorney General Andrew Cuomo is sympathetic with the agencies. Cuomo recently subpoenaed Goldman Sachs Group Inc., Morgan Stanley, UBS and five other banks to see whether the banks misled credit-rating services about mortgage-backed securities.

Slippery Slope of Government Intervention

Many different professions, inside and outside the financial industry, provide critical advice in exchange for monetary compensation. In many industries there are inherent conflicts of interest between the professional and the end-user, and a related opinion provided by the pro may result in a bad outcome. If government intervention is the appropriate solution in the rating agency field, then maybe we should answer the following questions related to other fields before we rush to regulation:

  • Should the government control which auditors check the books of every American company because executives may opportunistically shop around for more lenient reviews of their financials?
  • Perhaps the Securities and Exchange Commission (SEC) should dictate which investment bank should underwrite an Initial Public Offering (IPO) or other stock issuance?
  • Maybe the government should decide which medicine or surgery should be administered by a doctor because they received funding or donations from a drug and device company?  

Where do you draw the line? Is the amendment issued by Al Franken (Senator of Minnesota) a well thought out proposal to improve the conflicts of interest, or is this merely a knee-jerk reaction to sock it some greedy Wall Street-ers and solidify additional scapegoats in the global financial meltdown?

In addition to including a controversial government-led rating agency selection process, the transforming regulatory reform bill also includes a dramatic change to ban “naked” credit default swaps (CDS). As I’ve written in the past, derivatives of all types can be used to hedge (protect) or speculate (e.g., naked CDS).  Singling out a specific derivative product and strategy like naked CDSs is like banning all Browning 9x19mm Hi-Power pistols, but allowing hundreds of other gun-types to be sold and used. Conceptually, proper use of a naked CDS by a trader is the same as the proper use of a gun by a recreational hunter (see my derivatives article).

Solutions

Rather than additional government intervention into the rating agency and derivative fields, perhaps additional disclosure, transparency, capital requirements, and harsher penalties can be instituted. There will always be abusers, but as we learned from the collapse of Arthur Andersen on the road to Enron’s bankruptcy, there can be  cruel consequences to bad actors. If investment banks misrepresent opinions, laws can lead to severe results also. Take Jack Grubman, hypester of Worldcom stock, who was banned for life from the securities industry and forced to pay $15 million in fines. Or Henry Blodget, who too was banned from the securities industry and paid millions in fines, not to mention the $200 million in fraud damages Merrill Lynch was forced to pay.

At the end of the day, enough disclosure and transparency needs to be made available to investors so they can make their own decisions. Those institutional investors that piled into these toxic, mortgage-related securities and lost their shirts because of over-reliance on the rating agencies’ evaluations deserve to lose money. If these structures were too complex to understand, then this so-called sophisticated institutional investor base should have balked from participation. Of course, if the banks or credit agencies misrepresented the complex investments, then sure, those intermediaries should suffer the full brunt of the law.

Although weighing down the cash-rich credit rating agencies (and CDS creators) with ball and chain regulations may appease the populist sentiment in the short-run, the reduction in conflicts of interest might be overwhelmed by the unintended consequences. Now if you’ll please excuse me, I’m going to do my homework on a naked CDS related to a AAA-rated synthetic CDO (Collateralized Debt Obligation).

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct positions in MCO, MHP, GS, MS, JPM, UBS, BAC, T or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

May 17, 2010 at 12:42 am Leave a comment

Goldman Cheat? Really?

Really? Am I supposed to be surprised that the SEC (Securities and Exchange Commission) has dug up a CDO (Collateralized Debt Obligation) deal with $1 billion in associated Goldman Sachs (GS) losses? The headline number may sound large, but the billion dollars is not much if you consider banks are expected to lose about $3 trillion dollars (according to an International Monetary Fund report)  from toxic assets and bad loans related to the financial crisis. Specifically, Goldman is being charged for defrauding investors for not disclosing the fact that John Paulson (see Gutsiest Trade), a now-famous hedge fund manager who made billions by betting against the subprime mortgage market, personally selected underlying securities to be included in a synthetic CDO (a pool of mortgage derivatives rather than a pool of mortgage securities).

Hurray for the SEC, but surely we can come up with more than this after multiple years? More surprising to me is that it took the SEC this long to come up with any dirt in the middle of a massive financial pigpen. What’s more, the estimated $1 billion in investor losses associated with the Goldman deal represents about 0.036% of the global industry loss estimates. These losses are a drop in the bucket. If there is blood on Goldman’s hand, my guess is there’s enough blood on the hands of Wall Street bankers to paint the White House red (two coats). The Financial Times highlighted a study showing Goldman was a relative small-fry among the other banks doing these type of CDO deals. For 2005-2008, Goldman did a little more than 5% of the total $100+ billion in similar deals, earning them an unimpressive ninth place finish among its peers. As a matter of fact, Paulson also hocked CDO garbage selections to other banks like Deutsche Bank, Bear Stearns, and Credit Suisse. The disclosure made in those deals will no doubt play a role in determining Goldman’s ultimate culpability.

Context, with regard to the fees earned by Goldman, is important too. Goldman earned less than 8/100th of 1% of their $20 billion in pretax profits from the Abacus deal. Not to mention, unless other charges pile up, Goldman’s roughly $850 billion in assets, $170 billion in cash and liquid securities, and $71 billion in equity should buttress them in any future litigation. These particular SEC charges feel more like the government trying to convict Goldman on a technicality – like the government did with Al Capone on tax evasion charges. At the end of the day, the evidence will be presented and the courts will determine if fraud indeed occurred. If so, there will be consequences.

Demonize Goldman?

How bad can Goldman really be, especially considering their deep philanthropic roots (the firm donated $500 million for small business assistance), and CEO Lloyd Blankfein was kind enough to let us know he is doing “God’s work,” by providing Goldman’s rich menu of banking services to its clients.

Certainly, if Goldman broke securities laws, then there should be hell to pay and heads should roll. But if Goldman was really trying to defraud investors in this particular structured deal (called Abacus 2007-ACI), then why would they invest alongside the investors (Goldman claims to have lost $90 milllion in this particular deal)? I suppose the case could be made that Goldman only invested for superficial reasons because the fees garnered from structuring the deals perhaps outweighed any potential losses incurred by investing the firm’s own capital in these deals. Seems like a stretch if you contemplate the $90 million in losses overwhelmed the $15 million in fees earned by Goldman to structure the deal.

Maybe this will be the beginning of the debauchery flood gates opening in the banking industry, but let’s not fully jump on the Goldman Scarlet Letter bandwagon just quite yet. Politics may be playing a role too. The Volcker rule was conveniently introduced right after Senator Scott Brown’s Senate victory in Massachusetts, and political coincidence has reared its head again in light of the financial regulatory reform fury swelling up in Washington.

Waiting for More teeth

There is a difference between intelligent opportunism and blatant cheating. There is also a difference between immorally playing a game within the rules versus immorally breaking laws. Those participants breaking the law should be adequately punished, but before jumping to conclusions, let’s make sure we first gather all the facts. While the relatively minute Abacus deal may be very surprising to some, given the trillions in global losses caused by toxic assets, I am not. Surely the SEC can dig up something with more teeth, but until then I will be more surprised by Jesse Jame’s cheating on Sandra Bullock (with Michelle “Bombshell” McGee) than by Goldman Sachs’s alleged cheating in CDO disclosure.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct positions in GS, DB, Bear Stearns (JPM), and CSGN.VX/CS.N or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

April 19, 2010 at 4:35 pm 2 comments

Banking Crisis Broken Record (1907 vs. 2007)

Like a spinning and skipping broken record, our history has been filled with an endless number of banking crises. And unfortunately, the financial crisis of 2008-2009 will not be our last (read more about rhyming history). Robert F. Bruner, professor and Dean at the Darden Graduate School of Business Administration, has studied the repetitive nature of banking crises and identified core foundational aspects present in these vicious financial events.

In a period spanning 105 years (1900 – 2005) Bruner references 31 separate crises occurring across the world in various countries. Just in the last handful of decades, Americans have experienced the seizure of the Continental Illinois National Bank and Trust Company (1984), the S&L crisis (Savings & Loan – late 1980s), the disintegration of Long-Term Capital Management (1998), followed by the recent falling of dominoes in the first decade of the 21st Century (Bear Stearns, Lehman Brothers, Wamu, AIG, etc.).  What do many of these crises have in common?

In comparing the recent global financial crisis, Bruner compares the recent events to the “Panic of 1907” – the last financial crisis before the creation of the Federal Reserve System in 1913. The last few years have been rough, but a century ago San Franciscans endured the mother of all crises. This is how Bruner described the time period:

“The San Francisco earthquake of 18 April 1906 triggered a massive call on global gold reserves and a liquidity crunch in the United States. A recession commenced in June 1907. Security prices declined. In September, New York City narrowly averted a failure to refinance outstanding bonds. Then, on 16 October, a “bear squeeze” speculation failed and rendered two brokerage firms insolvent. The next day, depositors began a run on Knickerbocker Trust Company…Runs spread to other trust companies and banks in New York City. And the panic rippled across the United States.”

 

Bruner highlights four key factors inherent in these, and other, financial crises. Here is a summary of the four elements:

Existence of Systemic Structure:  In order for a crisis to occur, an economy needs a collection of linked financial intermediaries to form a system. Throughout history, transactions and deposits have connected to multiple systems around the globe.

Systemic Instability: Hyman Minsk, a renowned 20th Century economist, was known for his thoughts on his “Financial Instability Hypothesis.” At the core of Minsky’s crisis beliefs was the idea that economic slumps were caused by the credit cycle. At the late stages of an economic cycle there is a larger appetite to assume additional risk and debt. A spiraling vortex can occur as “Easy credit amplifies the boom, and tight credit amplifies the contraction,” Minsky states. 

Systemic Shock: Beyond an unstable system, a crisis needs a spark. For Bruner that spark must have four characteristics:

  • Real, Not Apparent: The shock must be “real, not apparent.” The disturbance must be disruptive enough to shake the trust of the financial system and be large enough to have a real economic impact (e.g., new technologies, massive labor strike, deregulation, or even an earthquake). 
  • Large:  The trigger of a financial crisis must be large enough to shift the outlook of investors.
  • Unambiguous and Difficult to Repeat: The shock must unambiguously stand out from the standard marketplace news.
  • Surprising: The event must be unanticipated and cause a shift in thinking.

Response and Intervention: Effectively, the response to a shock converts an overconfident boom into fear and pessimism. The reply can often be an overreaction to the existing fundamentals, which flies in the face of efficient markets and rational decision making.

According to Bruner, crises including the one triggered by the earthquake of 1906 carry the four previously mentioned elements.

Solution = Leadership

At the vortex of any financial crisis lies fear and panic, which require leadership to mitigate the damage. John Pierpont “J.P.” Morgan, semi-retired banking executive, orchestrated leadership in 1907 by organizing a rescue of “trust companies, banks, the New York Stock Exchange, New York City, and the brokerage firm of Moore and Schley.”

Time will tell and history will judge whether Federal Reserve Chairman Ben Bernanke and Treasury Secretaries Hank Paulson and Timothy Geithner provided the necessary leadership to sustainably lead us out of the financial crisis. Of course, decisions made by the key U.S. leadership figures are not made in a vacuum, so choices made by our international brethren can impact the success of our monetary and fiscal policies too.

There have been 18 substantial global bank crises since World War II and the recent credit-induced collapse will not be the last as long as Bruner’s four elements of a crisis exist (structure, instability, shock, and intervention). The ultimate outcome of a crisis will be dependent on the nature of leadership, coordinated government intervention, and regulation. The global economic record will continue spinning, but with Robert Bruner’s lessons learned from the Panic of 1907, hopefully the music will last for a very long time before skipping on a crisis again.

Read the whole Bruner article

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds and a derivative security of an AIG insurance subsidiary, but at time of publishing had no direct positions in JPM. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

February 11, 2010 at 11:00 pm 2 comments

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