Thursday, November 13, 2014

The Truth Hurts

Yes, I admit that I am surprised, that The People are surprised, that Bank FX Desks routinely (and I emphasize 'routinely') predated customer orders. This is, judging by the long list of things diddled when People have the opportunity(s) and incentive(s) do do so, Standard Operating Procedure, endemic not just to Banks, but, more or less, I am sad to say, most of the human enterprise. Banks undoubtedly are eyebrow-raising, less for their routine seeking of advantage at others' expense (let's term this 'business'), but rather for the breadth and magnitude of their repeated gluttony in a profession where trust is, I daresay, rather crucial to the entire undertaking.

Yet, what I, personally, find most surprising about The Banks, and the cast of characters who run, and inhabit them, is that they are incredulous, and somewhat mystified, to the suggestion that people really do hate them. Take the case of one of the largest American money-center banks where an uncle of mine was engaged to help them understand how to exploit opportunities on their newly-embarked-upon course of "Bancassurance". Specifically, he was asked by their Board to help them understand how to cross-sell insurance services from their newly-acquired insurance arm, into their existing customer base. My uncle, being a pioneer in focus groups, and brand-extension, did what he does best: conductive exhaustive focus-group study of the issue and analysis before presenting his findings to the Board. His results were categorical. He told them, in no uncertain terms, they had almost no chance of selling their subsidiary's insurance to their existing customers. "On what basis?" they asked rather angrily. He said it was obvious: all his research showed that people HATE their bank. It almost didn't matter which one. Most people think the other banks are better than their own, so you actually have a far better chance of selling their subsidiary's insurance to anyone BUT their customers. Awkward silence ensued. Meeting was quickly adjourned. Contract abruptly terminated shortly thereafter. And (unusually for him) no further work from this giant Bank. The truth is painful, yet people in general, and it would seem, bankers in particular, go to great lengths to avoid it.

(NB: The American experiment in Bancassurance, like Mitterand's disastrous nationalization of the French banks was eventually reversed, the ill-informed "guilty" architects, of course, inculpable, and unpunished.)

Wednesday, November 12, 2014

"Bear's Anonymous" - Finance's Answer to A.A.

The following is a voyeuristic peek into a meeting of the Stamford, CT branch of "Bears Anonymous", duly held a Rippowam High School….recounted in 2007 and rediscovered, and ever so apt in 2014.

(Camera pans on participants taking their chairs , seated in a circle in a school room (a dozen or so men and women of varying ages. The moderator, a clean-cut optimist, who is always "fully invested" clears his throat and begins...)

Moderator: I'd like to welcome everyone this evening. I understand this is a big step for most of you: but the mere act of admitting you have problem is the first step to overcoming it. We have a number of new faces here tonight and I'd like to welcome all of you, as well as those who are returning. First and foremost, we are here to share our problems, support each other, so we can begin the road to recovery. Remember: there are many faces to our affliction, but the only requirement for 'BA' membership and attendance is that you must refrain from "going Short". In time, you may even learn to appreciate the liberating exhilaration of being long. (Moderator turns to early-thirties man) Let's start with you, Sir. Please Introduce yourself and begin...

Chuck: Hi everybody. My Name is Chuck, and I am a bear. I have had a bearishness problem for a long time. Not just a predilection for the usual contrarian stuff, which when I look back I have had since I've been a child, but a real nagging and pressing fear that the financial sky is about to fall at any moment.

I don't know where it first began. Maybe it was 1987. Yeah, that scarred me. I was naive, I guess, and long, and got slapped 20% that day in Oct 87. I tried to get out, but ended up exiting at levels near where it closed. A couple of years worth of savings just vaporized, that was!! But as things recovered, I was out of the market and then I didn't get back in because it looked to me like the world was really was going to end with thirld world debt, the S&L crisis, and the massive commerical real estate crash that seemed bound to cause a depression. Then, in 1991 when the UAL deal exploded - you know all those Reagan deficits coming home to roost - I thought that we were set for an ever deeper recession, but I was wrong, and again uninvested when the market started rallying. Come 1994, the bond market exploded and it looked like the end again - budget deficits, trade deficits, political gridlock and remember we were still working off the thriftbank and S&L issues, not to mention the near-destruction of the Texas oil patch and US agricultural sectors. Damn! If that wasn't enough to keep me out of the market, I don't know what is, but it did, and I was sure that I'd get a better opportunity to get in later.

Then came large cap cap growth and technology speculation. Germany and Japan were in near-depression, yet investors were paying silliest prices for big-pharma and global large cap growth. Who would thought they could continue to grow like that and justify the high prices? Not me. I missed it again.

All the while, I told myself: "It's ok. It's good to be prudent. The reckless will suffer like the Okies of the 30s. And, after all, it's only opportunity cost. Better one in hand than none in the bush". And I probably had a hundred other justifications and rationalizations for my bearishness, just in case I gnawed through these.

1998 came along and finally, finally, I was proven right with the unraveling of LTCM and bitch-slapping of Russia! Now we would witness the frightful reckoning, the deleveraging-yielding-to-parsimony that was needed to return assets to Graham & Dodd value and redeem America's sense of thrift! So I sat on the sidelines, waiting for the real blood in the streets that was imminent. But the Fed cut rates for fear of Y2K, the tech bulls ploughed ever-more money into the market. Some said don't fight the Fed, but I rationalized my bearishness that the Fed was "pushing on a string" and their efforts would have no effect.

The market did crash in 2000 - the tech and dotcom market anyway - and the broader market stood at 5 year lows, but I looked back to the financial history of the 30s and thought that when it hit its lows in 2002 that this could continue for a decade, especially with the Gulf War imminent and, with near-zero rates, it really looked like the Fed was pushing on the proverbial string. So I sat tight, waiting for a better entry point that was certainly around the corner.

Then weak dollar, credit bubbles, twin deficits, foreign accumulation of US reserves, muddling war in Iraq, incessantly rising energy prices and peak oil, and on each occasion - Aug 04, Mar and Nov 05, May and Nov 06, Feb 07 the market swooned, corrected, only to rally even more strongly out of the trough as if it were teasing me, taunting me, seducing me then mocking my now increasingly irrational fears and bearishness. And they were irrational, they must have been irrational right? for the market continued its inexorable rise on each occasion, laying waste to the rationalization or justification of the day for NOT being long long long.

In 2008, I felt vindicated. All my fears were realized. The world WAS going to on. It was so bad, I took all my money out of the bank, for fear of their collapse, and put it under my mattress. But be careful what you wish for. Things became so bad, I was afraid even money wouldn't have value, so I went out and bought gold (coins). Even the Fed rescue looked like it might not work. And then, there were new bank regulations which made it impossible to get a loan, all that shitty foreclosed housing to work through, and of course the EURO - oh my god - the EURO was bound to cause the biggest upheaval since the Panic of 1907, and Japan was imploding with deflation, while the Chinese were creating the largest bubble the world had ever seen. Would YOU have invested"??

It's taken nearly twenty-five years - almost the entire length of this grand new experiment in seemingly unlimited and unrestricted credit - for me to realize that this really and truly is MY problem. The world is just the world, and it's not going to end tomorrow, and that its better to suffer with the fools in the event the system unravels, than sit idly by and watch alone, a big pile of savings become a small pile of savings. Where o' where is joy in THAT?

In turning over a new leaf, and recognizing that I have a perpetual bearishness problem, I have terminated my newsletter subscriptions and vowed never again to watch or read Marc Faber, David Tice, Dr. Hussman and Fred Hickey. I will not read ZeroHedge, Peter Schiff, Max Keiser, anyone named "Rickards" and especially anyone like Mike Shedlock who wraps their politics so deeply into their strategy vision, they cannot possibly provide objective counsel. And I will make Investors Business Daily my read of choice in the financial markets. I will personally go and apologize to Abby Cohen, Vic Niederhoffer and Charles Gave for all those less-than-nice things I said about them. Further, I have vowed to place 50% of my money into a Vanguard global equity Index Fund, and also have vowed not to look at its asset value more than once a quarter. I have taken 25% of my funds and placed in them in a global balanced fund, and earmarked the balance for disciplined allocation on any subsequent drops, to momentum strategies. I have also asked my doctor to prescribe some little blue pills that will help me see the bright side of life, and stop being so pessimistic. And I have told my secretary NOT to hang up on salesmen that cold call for you never know when a good idea might fall on one's lap through a seemingly altruistic phone call. And I am going to stop all that stupid exercising and dieting in a bid to be "fat and happy", enroute to my ultimate goal of being fat, happy, AND lucky!!

My name is Chuck. And I have a bearishness problem. But I have now acknowledged my problem in hope that such recognition is the first step towards getting better. Thank you.

(applause of other members, camera pans on circle and focuses in on upon late twenties girl with tears in her eyes; Camera fades out, other members get up and give Chuck a group hug - but not a 'Bear-Hug'.)

(NB: While the author neither admits nor denies having a bearishness problem, the above account is entire (well, mostly anyways) fictional.

Tuesday, October 28, 2014

Perception of Reality vs. Objective Reality

A recent article in the New York Times cast a seemingly jealous eye upon the Dutch pension system. Why? By comparison with the US, the Dutch system appears scrupulous, fair, but most of all typically Dutch in the brutal honesty with which they objectively deconstruct and tackle contentious issues. In America, by contrast, even after bi-partisan commissions comprised of eminent panel members try to get to the bottom of something, we seem no more enlightened as to where truth lies (no pun intended) or how to tackle it for the greater good of the public's interest.    

Pensions speak volumes about contrasting national characters. Sober-minded Danes and Dutch have transparent and logical approaches that attempt to maximize reality in actuarial analysis, funding and benefit requirements, while minimizing the fantasy of projecting above-market returns, and limiting the ability of pigs to feed at the trough. Canadians, too, have well-run, transparent systems that reflect their earnest, solutions-minded national character. Germans's rely almost wholly on pay-as-go reflecting their confidence to make tough fiscal choices when required, while the UK institutionalizes the rape and theft of savers and beneficiaries for the advantage of the City and her Managers, a legacy microcosm of UK class-based inequity. America's system reflects her faith in hope and fantasy over preparation and analysis, and plagued by the same byzantine structure incrementally etched by lobbyists and interest groups, that makes America's healthcare system The Very Best In The World. The New York Times is of course to polite, and would appear too partisan were it to represent the image of the US system as such.  

I, must admit that I, too, am jealous of the Danes and The Dutch. So much acrimony over public policy would be disarmed if more peoples were capable of similar detached objectivity. So much angst would veritably disappear from our broadsheets and evening news. The energy could then be rightfully focused upon coping with what might often be a painful solution requiring shift and behavioral change, rather than exhausting oneself in an attempt to avoid confronting the problem itself.
A striking analogy springs to mind from the realm of industrial sociology, that is worthy of recounting, for it was a vivid attempt to objectively measure our national perceptions against a benchmark of some objective reality. Some three decades ago, researchers used driveshaft manufacturing within the auto-parts industry, as a baseline. If memory serves me correctly, the german conglomerate Bosch had plants manufacturing more or less the identical piece in four different countries - Holland, Spain, the UK and USA. Each of the plants, similarly equipped, had precise data on their quality as measured by their defect rates. The consultants set out to measure the workers attitudes towards the quality and effectiveness of their work, by asking them questions that measured their perception of the quality of their work. This might have value to firm when faced with wage demands, or consolidation decisions. The results, were striking, though not  unsurprising.     

The Dutch workers had a high opinion of the quality of their work. This was set against a low defect rate, giving the Dutch perception of reality a characteristically close approximation to objective reality (as measured by the defect rates). The British workers had a low opinion of the quality of their work. This was exemplified by high defect rates, making their perception of reality reasonably-close to the  objective reality of their work. Workers at the Spanish plant had a reasonably low opinion of their work  , which was at odds with the high quality of their efforts evidenced by a low defect rate. This was an interesting result - probably one there company would prefer to keep hidden from their Spanish workers.  Perhaps @Ibexsalad can verify whether self-deprecation is endemic to the Spanish national character.  At the American plant, survey results showed workers had a very high opinion of the quality of their work, completely at odds with the relatively high objective defect rates of the output of the plant. And it is precisely this gulf - between perceived reality and objective reality - which has proven problematical to overcome whether in politics, public policy, or, as in this topic, pensions. To be entirely fair, it is the stuff that helps put men on the moon, and cure cancer, but it also is the stuff that gives us Enron, 'AAA' sub-prime securitisations, Detroit, Puerto Rico, and ant-fuckingly irrelevant public-policy obsessions with creationism, same-sex marriage, and abortion while proverbial Rome burns and decays.  

Thursday, October 23, 2014

AAMC: How's That Working Out For You Guys


TO:        Luxor, SAB, White Elm, Tiger Eye et. al. 
FROM:      Cassandra
DATE:      24 October 2014
SUBJECT:   AAMC Altisource
In Feb 2014, I was curious as to the investment thesis(if there was one) underpinning the large positions you (individually and collectively) held in Altisource Asset Management (AAMC), and the Ocwen related entities. 
Despite my pleas, and promise to publish any such theses, no readers (or interested parties) came forth to enlighten me regarding the allure (investment or otherwise) that caused you (but not only you) to buy more and more shares, at high, and higher prices, culminating in a crackerjack-of-a-year-end mark, up more than 10-fold from beginning of the CY. 
The tone of my curiosity, was, unashamedly skeptical for reasons described in the post. Outsized positions, acquired with investors' capital, in illiquid  stocks, moving their price by eyebrow-raising amounts in the process of accumulation, with performance fees crystallizing at a single-point-in-time, which doesn't reflect liquidity or prospective unwind or investment risk, does raise potential conflict-of-interest questions, however unfounded they may be.  
So, here we are in October 2014, and I am certain many observers are wondering just how that's working out for you guys? 

Wednesday, October 22, 2014

In Memorium: Nelson Bunker Hunt

Farewell then

You were 
born with
a Silver Spoon
in your 

But, apparently
was not
enough Silver.

You said
"I was
just trying
to make 
some money"

Your catchphrase 
have been: 
"Never squeeze
the people 
that can 
change the rules.

(with apologies to Private Eye & EJ Thribb)

Wednesday, October 15, 2014

The Risk That Will Bite You Next Is NOT The One That Bit You Last

Traumatic and painful events burnish their effect upon our brains. This happens profoundly in childhood, as well as in relationships, and most definitely as readers will know,  in the financial markets. As a result, we alter behavior, and do things differently in the future. Tokyo real estate was no longer Japan's risk once it plunged skewering banks and investors in the process. Latin-American debt from the recycling of petrodollars, once a mammoth exposure has been throttled long ago. Asian countries are no longer held hostage by fickle hot-money flows. And it probably won't be large company malfeasance (like Adelphia, MCI, or Enron) drilling holes in investor portfolios that gets one fired for being contrarian. Nor is it probable that dodgy liar-loan mortgages packaged together into dubiously-annointed 'AAA' CDO's will set in motion a catastrophic global unwind. No. Rather, we will (and undoubtedly we already are) well-into the process of doing too much of precisely that thing which we shouldn't. And what ever it is, or will be, it won't be Japanese Real Estate, NT or JDSU or carelessly conjured CDOs, or whatever that thing was that buggered you soooooo much that it still hurts.

This is, in itself, one of the best arguments why Sarbanes-Oxley, and Dodd-Frank, EMIR and AIFMD are such abominable wastes of time, effort and money (for everyone except the lawyers feeding at the trough). Not that the risks they attempt address weren't risks, or that people were harmed by them. They were. It's just highly contentious whether they still are,  or will be in the future and so worthy of the draconian regulatory regime(s) imposed ostensibly to control them. It will be a VERY long time before investors, again, plough double-digit billions into a Madoff-like purported secret money-machine with no transparency and audited by some guy in a 2nd story walk-up named "Dave", or take liquid collateral held against short-duration loans to clients, and shoot-the-moon by swapping it for illiquid long-duration mortgage bonds in a suicidal reach for yield.  The germane observation here is that you cannot legislate against stupidity. And since it is stupidity (generously laced with greed) in the general sense that is at the root of risk, it will undoubtedly surface again in some other market endeavor,  asset class or investment meme,  such as myopic share buy-backs, insurance-linked securities, collectible art, high-end London Real Estate, or over-the-top deal prices with  Frankensteinian capital structures paid for Private Equity investments. Who knows?

Because we know it is more or less deterministic, that bad things ultimately result when greed mates with stupidity, ruminating upon important yet-to-be encountered risks is a worthwhile undertaking, for risk-managers and portfolio managers alike. I would add that their bosses and investors, respectively would also benefit from meditating upon the question of "what risk will bite you in the ass - tomorrow?", but if the past is a guide, its urgency will be lost in the process. So what might be tomorrow's Big Risk? High equity prices? Tight credit spreads? Generalized relative valuation levels of asset classes to historical norms? ZIRP? Exiting ZIRP? Student or auto loan-backed ABS? China growth stall? Threats of War?  Eurozone sovereign debt kerfuffle? Bank capital ratios? Ted Cruz or Nigel Farage? The diminutive age of the average HF analyst? A butterfly somewhere in the highlands of Mexico? The homogeneity of the average Finance MBA, and the curriculum studied? I daresay they are all candidates worthy of consideration…. all potentially destabilizing…but….but….

….But I think that the big risk to be concerned about - the one that sets the present apart from the past,  - is the nature of risk itself. We feel more comfortable than ever in measuring much risk, for we have PhDs with powerful computers and software, all developing unpronounceable but impressive-sounding risk models spawning more acronyms than used by the armed forces. We use our DMAs to link directly to markets, giving the illusion of abundant liquidity that results from framing our references during subdued times, modeling it on observed turnover, bolstered by the presence of HFTs and dark pools. And yet despite these advances, we appear to understand little more than we ever did (or at least ignore it the same as ever). So while everyone does as they did before, they ignore the profound difference in the structure of liquidity,  leverage, and the interplay and consequences upon both of risk-model herding and position crowding, the latter far more subject to the destabilizing whims of short-term agent-shepherds.

Dealers and banks are providing less liquidiity, and warehousing less risk than ever, precisely at a moment in time when the amount of systemic liquidity sloshing about, trading discretionarily on a leveraged basis is highly elevated relative to historical experience. These market-making activities have been meaningfully excised - a casualty of the Volcker rule and other regulatory demands from authorities - replaced by more discerning and more discretionary liquidity providers on the buy-side.  One can argue (perhaps rightly) that both specialists and market-making securities dealers, during times of elevated vol, have always stepped away from making prices. And so they have, or least widened spreads and diminished quote size to the same effect.

But going back fifteen years to LTCM, what one saw "under the hood" was that the entire Street generally acted as a counter-trend buffer with vast liquidity-providing positions contra the flow. They were not stupid positions but attractive, positive-carry relative-value inventory accumulation. The reason they [street creditors] jointly "administered" LTCM into a managed unwind was precisely NOT to have these liquidated into an open market where they were themselves "full-up". Imagine the carnage and dislocation in their absence. The important distinction here is that the street were principals with permanent capital - NOT agents. While they may withhold the both quantity and levels at which they supply, they were, in practice, their own masters. Outsourcing the liquidity provision to HFs, or other agents raises the question - like in 2008 - whether even those that are dedicated to such opportunistic pursuits, as agents, will be in the position to what they may wish to do. With ultimate investors - whether individual, institutional or otherwise - being behaviorally hard-wired towards gamma-negative tendency, one would be challenged to imagine anything other than the classical response of pulling in one's proverbial horns, and redeeming, or putting in protective redemption notices given the lengthy notification requirements. One can imagine the destabilizing demands upon liquidity, in the absence of decisive principal capital to take the other side. I think this will translate into fatter highly-kurtotic left-tailed returns at the mere hint of serious demand flow.

But that is only part of the story. Coincidentally, we now have near-uniformity in model risk in the name of VAR, and an increasing deployment of risk-parity approaches. Both of these are profoundly gamma-negative. Volatility, suppressed by abundant liquidity, infers diminished risk as measured by VAR, encouraging a complacent accumulation of risk using available leverage. Risk-parity often results in a similar rear-view risk-assessment, and acquisition of leverage. Faced with a spike in volatility accompanying almost any potential event (exogenous or endogenous), The Market's aggregate positioning and leverage will deterministically trigger demands for liquidity, most likely in the same direction as the shock, into a veritable vacuum, replete with classical feedback loops. This is before considering the large increase in mimetic trend-following, momentum and CTA strategies' relative size and importance within market ecosystems, and the large army of discretionary day-traders waiting for set-ups and breakouts. These are unmitigated amplifiers of already-gamma-negative feedback loops. The paradoxical result, in a world with more risk-managers than ever, using better measurement and technology, with more position limitations, thresholds, and more-than-abundant capital is a market that is likely to prove more brittle than ever before. For not only will the modern liquidity providers intent on avoiding costly adverse selection step out of the way, they too will turn and trade in the direction of the impulse. LOR's Portfolio Insurance, will, by contrast, appear benign.

To most fundamental equity, fixed-income, FX, and commodity traders, the Quant Wreck of 2007 hardly registered.  To those running systematic model-driven equity long/short strategies, recalling these mid-summer events is likely to trigger PTSD-like responses. But the lessons they burnished, worth heeding in regards to today's broader systemic structure are clear. Everything's fine until its not. Models, while useful, are always flawed. Participants habituate behavior basis the recent past - and are not forward-looking.  Leverage is poison. Participants caught in risk/margin/redemption crosscurrents cannot discriminate and can only unwind their positions. Gamma-negative behavior outweighs gamma-positive behavior by a large margin. The exit is always smaller than perceived in aggregate before the theatre fills with smoke. Feedback loops cause dramatic overshoot.  Out of the wreckage arises amazing opportunity. Dry powder is essential for credit is often impossible to obtain when the opportunities are the juiciest.

Monday, October 13, 2014

Pay Dirt ??!?

I do not admire Paul Singer. In  fact, I rather think he's a tool, and that there are sufficient honest ways to make money - both investing and arbing markets - which contrary to Financial Carpetbagging, do not leave the world worse off than before one structured one's trades.  Neither do I admire nor share most of Mr Singer's politics, which I would characterize as conceptually opposing the existence of The Public Interest. The notion that "no public interest is the best interest"  is, I believe, profoundly corrosive and destructive as a point of political departure.

Declaring my views in advance, I  nonetheless find the treatment heaped on  Elliot and its un-named beneficiary in today's Guardian's piece today utterly assinine. Not because I think he's "worth" GBP38mm (or anyone else for that matter), but because The Guardian, rather than decrying money earned, should be rejoicing that the employee took it down in the UK (and presumably will be subject to UK income tax) and didn't [apparently] use any obvious manner of deferral or avoidance scheme.  That Singer's management company paid GBP1mm in UK corporation tax, while having demagogic shock value, is irrelevant in such a global service business because it is ultimately taxed on its profits in the US, and should be be seen no differently than Silchester's Butt's large pay, who as founding principal of a similar service business, takes his down in the UK, to the benefit of HM Treasury.  While one can certainly take aim at the relative merits of performance fees in fund management (the source of excess), or the wisdom of investors' fee arrangements with Elliot (a number of whom are likely UK public and private pension funds),  Mr Singer's arrangement with one of his employees is ultimately a private affair, and should be of no more concern than what Mr Abramovich agrees to pour into Fabregas' bank acccount, Mr Beckham's privately negotiated endorsement fees, Elton John's stream royalties, or the price Steve Cohen is willing to pay to Damien Hirst for a lucite-encased shark, provided they are in line with rules set forth in law.

Perhaps the Guardian's Mr Neate has a point to make somewhere outside of his rubber-necking at the number of zero's contained in the filing - a point that might highlight the lack of social responsibility , in modernity, by today's beneficiaries, in a winner-take-all economy, or unprecedented windfalls to rentiers resulting from asset price inflation while the same macroeconomic consequences squeeze median purchasing power. Or perhaps he might focus on more pernicious systemic gaming of the tax code, or inelastic demand curves by privatized monopolies. Just gawking, however, serves little purpose at best, and in the absence of any constructive conclusions, may result in reactionary anger and envy-driven policies that would likely be very sub-optimal.