Thursday, April 22, 2010

Fred Hickey on Government Speak

Reminding us of the fragility of the current u.s. political economy


"What Irritated me the most about the health care debate was the sham argument that it would somehow reduce the nation's deficit. The history of these giant entitlement programs is clear. After adjusting for inflation, Medicaid now costs 37 times more than it did at its launch, way, way beyond the original projections. Medicare cost nearly eight times what Congress had initially forecast. Social Security -- all you need to know is that there's absolutely no money put aside for the pensions promised to the baby boomers just beginning to retire. All the money that I've put into the Social Security system (and I pay both the employee and employer contributions) for more than thirty years supposedly to finance my retirement is gone, used to fund the pensions of others who have come before me. Indeed, this year there will not even be enough 'pay-as-you-go' receipts to cover the year's Social Security outlays, forcing the government to borrow an estimated $28 billion to fund the payouts

" Yet the House Speaker Nancy Pelosi had the nerve to declare last month that, "Over the life of this (health care) bill, it will create 4 million new jobs and cut the deficit by 1.3 trillion dollars." House majority leader Steny Hoyer: "In truth it is the biggest deficit reduction bill any of us will have an opportunity to vote on in this congress and indeed other congresses as well." What kind of turnip truck do they think we fell off of?

"All these savings will supposedly be created by adding 32 million currently uninsured Americans essentially to the poorly functioning Medicaid program. I guess eventually the program may grow enough to add 4 million more bureaucrats to the government's payroll, but the new jobs won't come from the private industry. Caterpillar (and a long list of other private companies) recently came out with estimates of their additonal first-year costs. Giant manufacturer (and exporter) Caterpillar forecast their costs would increase by $100 million; and noted that it could 'ill-afford cost increases that place us at a disadvantage versus our global competitors'

"The saddest part about the 'Decade from Hell' is that we didn't learn anything from it. We're losing manufacturing jobs because our companies are non-competitive. Our solution: make them less competitive. The country is burdened by enormous debts. Our solution: spend (mostly waste) record amounts of money and pile on even more government debt. The social safety nets are woefully underfunded. Our solution: massively increase entitlement benefits. We don't save any money. Our solutions: Drive interest rates to zero, drastically increase tax rates on investments and encourage more consumer spending (cash for clunkers, ect.). The Fed continually creates debilitating asset bubbles: The solution - create some more

"We have been deluding ourselves for years. Our spendthrift policies would have led to an earlier crisis if not for the willingness of foreigners to fund our follies, thanks to the U.S. dollar's position as the world's reserve currency. When many of the biggest lenders (Chinese, Russians, and others) began to hesitate recently, reducing their U.S. Treasury holdings, a new source of funding was required to avoid a funding crisis. That's when the Fed stepped in this past year by monetizing the debt, directly (through $300 billion of U.S. Treasury Securities purchases) and indirectly (with over $1.4 trillion of mortgage purchases). I find it utterly preposterous that just a few weeks ago Fed Chairman Bernanke told Congress: "We're not going to monetize the debt" as the Fed has been doing exactly that through its 'quantitative easing' money printing operations for more than a year. There can be no sugar-coating this. Our government leaders are not telling us the truth."

Thursday, December 31, 2009

Is it all just a Ponzi scheme? - Eric Sprott & David Franklin

Is it all just a Ponzi scheme?
By: Eric Sprott & David Franklin
In our May/June Markets at a Glance, "The Solution…is the Problem", we discussed how
much debt the US government would need to issue in order to balance the budget for
fiscal 2009. We calculated they would need to sell $2.041 trillion in new debt - or almost
three times the new debt that was issued in fiscal 2008. As a thought experiment, we
separated all the various US Treasury owners and asked our readers whether each group
could afford to increase their 2009 treasury purchases by 200%. In the end, we surmised
that most groups couldn’t, and prepared our readers for the worst.
Almost seven months later, however, nothing particularly bad has happened on the US
debt front. There have been no failed auctions, no sovereign defaults, no downgrades of
debt and no significant increase in rates…not so much as a hiccup in the treasury market.
Knowing what we discussed this past June, we have to ask how it all went so smoothly.
After all – it was pretty obvious there wasn’t enough buying power to satisfy the auctions
under ‘normal’ circumstances.
In the latest Treasury Bulletin published in December 2009, ownership data reveals that
the United States increased the public debt by $1.885 trillion dollars in fiscal 2009.1 So
who bought all the new Treasury securities to finance the massive increase in
expenditures? According to the same report, there were three distinct groups that bought
more than they did in 2008. The first was "Foreign and International Buyers", who
purchased $697.5 billion worth of Treasury securities in fiscal 2009 – representing about
23% more than their respective purchases in fiscal 2008. The second group was the
Federal Reserve itself. According to its published balance sheet, it increased its treasury
holdings by $286 billion in 2009, representing a 60% increase year-over-year.2 This
increase appears to be a direct result of the Federal Reserve’s Quantitative Easing
program announced this past March. Most of the other identified buyers in the Treasury
Bulletin were either net sellers or small buyers in 2009. While the Q4 data is not yet
available, the Q1, Q2 and Q3 data suggests that the State and Local governments and
US Savings Bonds groups will be net sellers of US Treasury securities in 2009, while
pension funds, insurance companies and depository institutions only increased their
purchases by a negligible amount.
So who was the third large buyer? Drum roll please,... it was "Other Investors". After
purchasing $90 billion in 2008, this group has purchased $510.1 billion of freshly minted
treasury securities so far in the first three quarters of fiscal 2009. If you annualize this rate
of purchase, they are on pace to buy $680 billion of US treasuries this year - or more than
seven times what they purchased in 2008. This is undoubtedly the group that made the
US deficit possible this year. But who are they? The Treasury Bulletin identifies "Other
Investors" as consisting of Individuals, Government-Sponsored Enterprises (GSE),
Brokers and Dealers, Bank Personal Trusts and Estates, Corporate and Non-Corporate
Businesses, Individuals and Other Investors. Hmmm. Do you think anyone in that group
had almost $700 billion to invest in the US Treasury market in fiscal 2009? We didn’t
either. To dig further, we turned to the Federal Reserve Board of Governors Flow of
Funds Data which provides a detailed breakdown of the owners of Treasury Securities to
Q3 2009.3 Within this grouping, the GSE’s were small buyers of a mere $5 billion this
year;4 Broker and Dealers were sellers of almost $80 billion;5 Commercial Banking were
buyers of approximately $80 billion;6 Corporate and Non-corporate Businesses, grouped
together, were buyers of $11.6 billion, for a grand net purchase of $16.6 billion.7 So who
really picked up the tab? To our surprise, the only group to actually substantially increase
their purchases in 2009 is defined in the Federal Reserve Flow of Funds Report as the
"Household Sector". This category of buyers bought $15 billion worth of treasuries in
2008, but by Q3 2009 had purchased a whopping $528.7 billion worth. At the end of Q3
this Household Sector category now owns more treasuries than the Federal Reserve
So to summarize, the majority buyers of Treasury securities in 2009 were:
1. Foreign and International buyers who purchased $697.5 billion.
2. The Federal Reserve who bought $286 billion.
3. The Household Sector who bought $528 billion to Q3 – which puts them on
track purchase $704 billion for fiscal 2009.
These three buying groups represent the lion’s share of the $1.885 trillion of debt that was
issued by the US in fiscal 2009.
We must admit that we were surprised to discover that "Households" had bought so many
Treasuries in 2009. They bought 35 times more government debt than they did in 2008.
Given the financial condition of the average household in 2009, this makes little sense to
us. With unemployment and foreclosures skyrocketing, who could afford to increase
treasury investments to such a large degree? For our more discerning readers, this
enormous "Household" investment was made outside of Money Market Funds, Mutual
Funds, ETF’s, Life Insurance Companies, Pension and Retirement funds and Closed-End
Funds, which are all separate reporting categories.9 This leaves a very important question
- who makes up this Household Sector?
Amazingly, we discovered that the Household Sector is actually just a catch-all category.
It represents the buyers left over who can’t be slotted into the other group headings. For
most categories of financial assets and liabilities, the values for the Household Sector are
calculated as residuals. That is, amounts held or owed by the other sectors are subtracted
from known totals, and the remainders are assumed to be the amounts held or owed by
the Household Sector. To quote directly from the Flow of Funds Guide, "For example, the
amounts of Treasury securities held by all other sectors, obtained from asset data
reported by the companies or institutions themselves, are subtracted from total Treasury
securities outstanding, obtained from the Monthly Treasury Statement of Receipts and
Outlays of the United States Government and the balance is assigned to the household
sector." (Emphasis ours)10 So to answer the question - who is the Household Sector?
They are a PHANTOM. They don’t exist. They merely serve to balance the ledger in the
Federal Reserve’s Flow of Funds report.
Our concern now is that this is all starting to resemble one giant Ponzi scheme. We all
know that the Fed has been active in the market for T-bills. As you can see from Table A,
under the auspices of Quantitative Easing, they bought almost 50% of the new Treasury
issues in Q2 and almost 30% in Q3. It serves to remember that the whole point of selling
new US Treasury bonds is to attract outside capital to finance deficits or to pay off existing
debts that are maturing. We are now in a situation, however, where the Fed is printing
dollars to buy Treasuries as a means of faking the Treasury’s ability to attract outside
capital. If our research proves anything, it’s that the regular buyers of US debt are no
longer buying, and it amazes us that the US can successfully issue a record number
Treasuries in this environment without the slightest hiccup in the market.
Perhaps the most striking example of the new demand dynamics for US Treasuries
comes from Bill Gross, who is co-chief investment officer at PIMCO and arguably one of
the world’s most powerful bond investors. Mr. Gross recently revealed that his bond fund
has cut holdings of US government debt and boosted cash to the highest levels since
2008.11 Earlier this year he referred to the US as a "ponzi style economy" and
recomended that investors front run Uncle Sam and other world governments into
government debt instruments of all forms.12 The fact that he is now selling US treasuries
is a foreboding sign.
Foreign holders are also expressing concern over new Treasury purchases. In a recent
discussion on the global role of the US dollar, Zhu Min, deputy governor of the People’s
Bank of China, told an academic audience that "The world does not have so much money
to buy more US Treasuries." He went on to say, "The United States cannot force foreign
governments to increase their holdings of Treasuries… Double the holdings? It is
definitely impossible."13 Judging from these statements, it seems clear that the US cannot
expect foreigners to continue to support their debt growth in this new economic
environment. As US consumers buy fewer foreign goods, there are less US dollars
available for foreigners to purchase future Treasury securities. Foreigners are the largest
source of external capital that can be clearly identified in US Treasury data. If their
support wanes in 2010, the US will require significant domestic support to fund future debt
issuances. Mr. Gross’s recent comments suggest that their domestic support may already
be weakening.
As we have seen so illustriously over the past year, all Ponzi schemes eventually fail
under their own weight. The US debt scheme is no different. 2009 has been witness to
spectacular government intervention in almost all levels of the economy. This support
requires outside capital to facilitate, and relies heavily on the US government’s ability to
raise money in the debt market. The fact that the Federal Reserve and US Treasury
cannot identify the second largest buyer of treasury securities this year proves that the
traditional buyers are not keeping pace with the US government’s deficit spending. It
makes us wonder if it’s all just a Ponzi scheme.

Tuesday, September 29, 2009

Lesson: If you borrow, borrow a crapload

"Some US numbers have been bothering us for a while. If commercial property has dropped in value by something like 40% in the past two years, and if most of the financings of the past five years were tightly priced at higher values (as they were), then where are the bankruptcies that should be stirring up the financial waters? We have written before (September 3) about the long lag before commercial real estate problems become obvious because leases are renegotiated over many years, and our charitable view was that the lack of current problems was a function of this time-lag. However, the story of Tishman Speyer Properties LP and its investment in the Stuyvesant Town-Peter Cooper Village property in New York, the largest real estate transaction in US history, has woken us up. Its looming bankruptcy implies that the credit departments in the major banks were seeing more problems than were apparent to the average reader of the Wall Street Journal. An independent appraisal placed the value of this property at less than 40% of its purchase price. We remembered that the John Hancock Building, the premier office tower in Boston, was sold at less than 50% of its previous purchase earlier this year. So why aren’t there any rumblings in credit-land? It seems that the banks are not doing anything. “They don’t ask and we don’t tell them’” a leading property owner told us with a drink in his hand. He continued that almost all of his properties were in technical default, but that the banks wouldn’t want to press him on them. In fact he was in a powerful position as he could threaten to stop paying, forcing the bank to recognize the problem. As a result deals are being rewritten and problems are getting pushed out to the future. As a result, defaults are avoided and losses are deferred."

Tuesday, September 15, 2009

Cost of Education vs. Income over time

This is pretty crazy if you think about it...

Monday, August 24, 2009

Manifesto to invest/live by

Q2 2009 Letter from Elliot Management:

"To this, we say maybe... and maybe not. Our job, as stewards of Elliott’s capital, is not to choose one of the big possibilities (including, among other things: renewed collapse; recovery starting now; double-dip recession; recovery co-existing with a continued downturn in commercial real estate and then an inflation crisis) and aggressively position Elliott’s portfolio accordingly. Rather, our job is to preserve capital and to make some money on a consistent basis regardless of which scenario (or crazy combination of several) actually comes to pass. That is the really tricky part, because significant differences exist between them.

We have a number of positions which are progressing in their own timeframes and processes, not related to anything else in our book. We actively look for such uncorrelated situations, and we think that type of position is more of a primary focus for us than for most other hedge funds. Other positions that we own have a variety of risks which are impacted by what is happening in global financial markets. We hedge these risks either internally, with similar assets, or externally, by single assets, indices or derivatives. We will try not to lock ourselves into a rigid set of macro assumptions, attempt to control our own destiny to the extent we can, and do the best job possible on the “knowable” part of the equation (analysis and research). This is the “secret” to our longevity and consistency, even though we view it as the well-worn and time-tested contents of a broad and deep tool chest, which always come in handy but whose value is most vivid in tough times like these."

Great Quote

You could contrast this perspective with China's economic policy of 保八

Robert Kennedy on his campaign trail for the US presidency on March 18, 1968:

"We will find neither national purpose nor personal satisfaction in a mere continuation of economic progress, in an endless amassing of worldly goods. We cannot measure national spirit by the Dow Jones Average, nor national achievement by the Gross National Product. For the Gross National Product includes air pollution, and ambulances to clear our highways from carnage. It counts special locks for our doors and jails for the people who break them. The Gross National Product includes the destruction of the redwoods and the death of Lake Superior. It grows with the production of napalm and missles and nuclear warheads.... It includes... the broadcasting of television programs which glorify violence to sell goods to our children. And if the Gross National Product includes all this, there is much that it does not comprehend. It does not allow for the health of our families, the quality of their education, or the joy of their play. It is indifferent to the decency of our factories and the safety of our streets alike. It does not include the beauty of our poetry, or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials... the Gross National Product measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America -- except whether we are proud to be Americans."

Monday, August 10, 2009

Nice reminder of the folly of modern finance

John Mauldin's Aug 7th newsletter (GO! must read!):

Awesome excerpt:

"The EMH also teaches us that opportunities will be fleeting as someone will surely try to arbitrage them away. This, of course, is akin to the age old joke about the economist and his friend walking along the street. The friend points out a $100 bill lying on the pavement. The economist says, "It isn't really there because if it were someone would have already picked it up".

Sadly these simple edicts are no joking matter as they are probably the most damaging aspects of the EMH legacy. Thus the EMH urges investors to try and forecast the future. In my opinion this is one of the biggest wastes of time, yet one that is nearly universal in our industry. Pretty much 80-90% of the investment processes that I come across revolve around forecasting. Yet there isn't a scrap of evidence to suggest that we can actually see the future at all."

The undue focus upon benchmark and relative performance also leads Homo Ovinus to engage in Keynes' beauty contest. As Keynes wrote:

"Professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the price being awarded to the competitor whose choice most nearly corresponds to the average preference of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one's judgment, are really prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees"

This game can be easily replicated by asking people to pick a number between 0 and 100, and telling them the winner will be the person who picks the number closest to two-thirds the average number picked. The chart below shows the results from the largest incidence of the game that I have played - in fact the third largest game ever played, and the only one played purely among professional investors.

The highest possible correct answer is 67. To go for 67 you have to believe that every other muppet in the known universe has just gone for 100. The fact we got a whole raft of responses above 67 is more than slightly alarming.

You can see spikes which represent various levels of thinking. The spike at fifty reflects what we (somewhat rudely) call level zero thinkers. They are the investment equivalent of Homer Simpson, 0, 100, duh 50! Not a vast amount of cognitive effort expended here!

There is a spike at 33 - of those who expect everyone else in the world to be Homer. There's a spike at 22, again those who obviously think everyone else is at 33. As you can see there is also a spike at zero. Here we find all the economists, game theorists and mathematicians of the world. They are the only people trained to solve these problems backwards. And indeed the only stable Nash equilibrium is zero (two-thirds of zero is still zero). However, it is only the 'correct' answer when everyone chooses zero.

The final noticeable spike is at one. These are economists who have (mistakenly...) been invited to one dinner party (economists only ever get invited to one dinner party). They have gone out into the world and realised the rest of the world doesn't think like them. So they try to estimate the scale of irrationality. However, they end up suffering the curse of knowledge (once you know the true answer, you tend to anchor to it). In this game, which is fairly typical, the average number picked was 26, giving a two-thirds average of 17. Just three people out of more than 1000 picked the number 17.

I play this game to try to illustrate just how hard it is to be just one step ahead of everyone else - to get in before everyone else, and get out before everyone else. Yet despite this fact, it seems to be that this is exactly what a large number of investors spend their time doing.

Wednesday, May 06, 2009

Amen to this

Unafraid In Greenwich Connecticut
Clifford S. Asness
Managing and Founding Principal
AQR Capital Management, LLC

The President has just harshly castigated hedge fund managers for being unwilling to take his administration’s bid for their Chrysler bonds. He called them “speculators” who were “refusing to sacrifice like everyone else” and who wanted “to hold out for the prospect of an unjustified taxpayer-funded bailout.”

The responses of hedge fund managers have been, appropriately, outrage, but generally have been anonymous for fear of going on the record against a powerful President (an exception, though still in the form of a “group letter,” was the superb note from “The Committee of Chrysler Non-TARP Lenders,” some of the points of which I echo here, and a relatively few firms, like Oppenheimer, that have publicly defended themselves). Furthermore, one by one the managers and banks are said to be caving to the President’s wishes out of justifiable fear.

I run an approximately twenty billion dollar money management firm that offers hedge funds as well as public mutual funds and unhedged traditional investments. My company is not involved in the Chrysler situation, but I am still aghast at the President’s comments (of course, these are my own views, not those of my company). Furthermore, for some reason I was not born with the common sense to keep it to myself, though my title should more accurately be called “Not Afraid Enough” as I am indeed fearful writing this… It’s really a bad idea to speak out.

Angering the President is a mistake, and my views will annoy half my clients. I hope my clients will understand that I’m entitled to my voice and to speak it loudly, just as they are in this great country. I hope they will also like that I do not think I have the right to intentionally “sacrifice” their money without their permission.

Here’s a shock. When hedge funds, pension funds, mutual funds, and individuals, including very sweet grandmothers, lend their money they expect to get it back. However, they know, or should know, they take the risk of not being paid back. But if such a bad event happens, it usually does not result in a complete loss. A firm in bankruptcy still has assets. It’s not always a pretty process. Bankruptcy court is about figuring out how to most fairly divvy up the remaining assets based on who is owed what and whose contracts come first.

The process already has built-in partial protections for employees and pensions, and can set lenders’ contracts aside in order to help the company survive, all of which are the rules of the game lenders know before they lend. But, without this recovery process nobody would lend to risky borrowers. Essentially, lenders accept less than shareholders (means bonds return less than stocks) in good times only because they get more than shareholders in bad times.

The above is how it works in America, or how it’s supposed to work. The President and his team sought to avoid having Chrysler go through this process, proposing their own plan for re-organizing the company and partially paying off Chrysler’s creditors. Some bond holders thought this plan unfair. Specifically, they thought it unfairly favored the United Auto Workers, and unfairly paid bondholders less than they would get in bankruptcy court. So, they said no to the plan and decided, as is their right, to take their chances in the bankruptcy process. But, as his quotes above show, the President thought they were being unpatriotic or worse.

Let’s be clear, it is the job and obligation of all investment managers, including hedge fund managers, to get their clients the most return they can. They are allowed to be charitable with their own money, and many are spectacularly so, but if they give away their clients’ money to share in the “sacrifice”, they are stealing. Clients of hedge funds include, among others, pension funds of all kinds of workers, unionized and not.

The managers have a fiduciary obligation to look after their clients’ money as best they can, not to support the President, nor to oppose him, nor otherwise advance their personal political views. That’s how the system works. If you hired an investment professional and he could preserve more of your money in a financial disaster, but instead he decided to spend it on the UAW so you could “share in the sacrifice”, you would not be happy.

Let’s quickly review a few side issues.

The President’s attempted diktat takes money from bondholders and gives it to a labor union that delivers money and votes for him. Why is he not calling on his party to “sacrifice” some campaign contributions, and votes, for the greater good? Shaking down lenders for the benefit of political donors is recycled corruption and abuse of power.

Let’s also mention only in passing the irony of this same President begging hedge funds to borrow more to purchase other troubled securities. That he expects them to do so when he has already shown what happens if they ask for their money to be repaid fairly would be amusing if not so dangerous. That hedge funds might not participate in these programs because of fear of getting sucked into some toxic demagoguery that ends in arbitrary punishment for trying to work with the Treasury is distressing. Some useful programs, like those designed to help finance consumer loans, won’t work because of this irresponsible hectoring.

Last but not least, the President screaming that the hedge funds are looking for an unjustified taxpayer-funded bailout is the big lie writ large. Find me a hedge fund that has been bailed out. Find me a hedge fund, even a failed one, that has asked for one. In fact, it was only because hedge funds have not taken government funds that they could stand up to this bullying.

The TARP recipients had no choice but to go along. The hedge funds were singled out only because they are unpopular, not because they behaved any differently from any other ethical manager of other people’s money. The President’s comments here are backwards and libelous. Yet, somehow I don’t think the hedge funds will be following ACORN’s lead and trucking in a bunch of paid professional protesters soon. Hedge funds really need a community organizer.

This is America. We have a free enterprise system that has worked spectacularly for us for two hundred plus years. When it fails it fixes itself. Most importantly, it is not an owned lackey of the oval office to be scolded for disobedience by the President.

I am ready for my “personalized” tax rate now.