Tuesday, October 28, 2014
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
TO: Luxor, SAB, White Elm, Tiger Eye et. al.
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
a Silver Spoon
change the rules.
(with apologies to Private Eye & EJ Thribb)
Wednesday, October 15, 2014
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
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.
Monday, October 06, 2014
Today, I am breaking convention by posting a piece as a favor to a reader who is restricted from publishing by his employer, but wished for comments from a thoughtful audience. On his behalf, I gratefully ask interested readers for their constructive comments.
* * * *
Some Consequences of Government Regulatory and Monetary Policy on the Private Sector and Capitalist Systems
There has been much speculation about the end game to the US Government Debt "build out" that found it's start in the Reagan era and continues unabated today. Doomists say it's the end of Capitalism, while Socialists claim it's the natural result of the central government's responsibility to it's people. I should start by acknowledging that this paper lacks in the exactness and completeness that would qualify it as academic. I would not qualify as an academic or an expert. As someone working my entire career in various segments of the capital markets, I've had the good fortune to observe the evolution of the system and the broad reaching impact that technology has had upon it. This missive is my attempt at tying together and unifying a number of seemingly disparate observations. My hope is that, in producing it, I inspire further thought and data gathering that might support (or for that matter refute) the system, as I describe it. My wish is that in doing so, we might find a way to adjust the system or better prepare for the outcomes.
Money is a strange beast. It is everything and nothing at the same time. It is a placeholder for usefulness and a measuring stick of scarcity. It's creation is as mysterious to most as its destruction and it is the measure and means by which most everything is exchanged. In response to the outcome and effects of the 2008 financial crisis the US Federal Reserve embarked upon a policy course aimed at injecting the financial system with a massive dose of liquidity, with a goal to resuscitate a global system undergoing the equivalent of a massive heart attack. This policy was selected as the best choice to accomplish the following:`
Concurrent with the swift and decisive application of Monetary response, the public, though its elected officials, demanded that the Government implement a new set of more stringent banking regulations, in the hopes of ensuring that Banks would maintain the discipline and capital required to avoid future financial calamities. So under a changed regulatory regime, where does this liquidity go, what happens to it, and what are the side effects of its application?
- The Government's creation of Money for the assumption of private sector at risk assets to revive the banking system through the public assumption of impaired collateral in exchange for the "good" collateral comprised of US Government obligations.
- The Government's creation of Money for the manipulation of rates to spur private sector investment and generate economic growth. Spur Lending by ensuring that the means to finance debt could be obtained cheaply and simultaneously encourage saved capital to take the risk needed to revive capital formation, and encourage employment.
- The Government's creation of Money to support its own public sector investment and enterprise and in this manner, directly spur employment through government funded projects.
The Banking system effectively squirrels money away to support regulatory mandated de-leveraging of the Financial system. Changes in Banking regulations, accounting standards and Insurance Asset risk ratings, have increased the statutory pool of money needed to support a dollar of liabilities. As a result, the cost of debt-based risk capital increased to reach the equivalent hurdle rate per unit of capital supporting it, as lower leverage requires higher returns to equilibrate statutory capital returns.
The unintended consequence of increased regulatory risk controls is the creation of the less regulated shadow banking system. Non-bank lending requires less statutory capital to support a unit of risk. While the intent of reducing systemic risk is noble on the Government's part, it is a blunt instrument approach and only results in the formation of alternative systems to which the risk now resides. In effect, many of the risks previously borne on depositors has shifted to the hands of shareholders. Unfortunately, lower rates of deposit return have also encouraged depositors, seeking higher yield, to become the unsecured shareholders to the very risks which regulators sought to have them avoid.
The post 2008 world of lower economic growth (lower interest rates require higher levels of savings to produce the equivalent unit of purchasing power and unemployment reduces end demand) creates a conundrum for Corporate America. Corporations must satisfy shareholder's preference for growth in earnings. The means to do this can crudely be divided into three means: financial engineering (M&A, Stock Buybacks), the zero sum game for the consumption dollar (assuming no population growth), or the reduction in the unit cost of goods sold. The later has been the unprecedented beneficiary of technology based productivity gains. If returns generated by these gains are greater than the gains made per additional unit of employment or bricks and mortar enterprise expansion, then it logically follows that capital will flow into this segment of a corporation's enterprise. It is my contention that the availability of cheap capital as mandated by government monetary policy, intended to spur employment thru private sector economic expansion, has resulted in the systematic downsizing of the very labor force that capital was created to support. Simply put, investing in productivity has a higher return than investing in labor, the consequence of which is systemic under- and unemployment.
Clearly, the investment in productivity, and the readily available capital to do so, favors the largest private sector players, with the lowers percentage of inelastic fixed overhead (inelastic meaning impervious to productivity gains). These companies not only have scale to maximize productivity at the expense of labor, but also have the capacity to create accretive value for equity holders in the acquisition market by transforming smaller, less productive companies. This transformative value proposition is supported by the our Government's current Monetary and Regulatory policies. The bifurcation of the corporate have's and have-not's is the logical outcome and, unsurprisingly, repeats itself in the distribution and movement of individual wealth. So the transfer of Money from the Public sector to the Private sector in the system described logically ends in the hands of the equity holders. These unsecured risk takers reap the biggest reward per unit of private sector profit. (debt holders returns are capped in exchange for seniority and thus security, in the capital structure). This has certainly been the case since the Shift in Monetary policy which began with the Reagan era. This private sector wealth increase has disproportionately fallen in the hands equity holders who had the economic means to own disproportionate equity, or the entrepreneurs who retained it.
It's no surprise where the money flows next, once Government Liquidity has created disproportionate wealth. Asset inflation is, at the top end of Art, Wine, Real estate, Antiquities, Gems, Precious Minerals and other scarce goods, both unprecedented and perfectly logical. These items represent real insurance against the perceived risk of the current Monetary system to the beneficiaries of that system. The misperception that these assets are "uncorrelated" adds to their cache. The cruel irony here is that correlation may not be as risky as causality.
This all brings us around to the "1%", the "extinction of the middle class", and the way I believe we need to think about inflation. Asset inflation and wealth created by lower cost of goods sold will perpetuate the concentration of wealth gains to those that can afford investment over savings ( as a means of income replacement for those who's purchasing power is eroded by lower wages). As systematic un- and under-employment proliferate, purchasing power will be eroded for those who are victims of productivity gains. As they become less useful, their only defense is to deflate their economic value in an attempt to compete. This creates what I call "relative inflation", defined as the shortfall in purchasing power that occurs when the aggregate unit cost of labor decreases at a faster rate than the cost of finished goods. By example if todays milkshake costs $1 and I earn $1 after tax, I can buy a milkshake. If tomorrow's milkshake costs $1 and I earn $0.95, I have 3 choices if I want a milkshake; I can borrow $0.05, erode my savings by $0.05, or misappropriate the $0.05 or the milkshake its self. The poverty effect created by relative inflation will no doubt erode savings and increase crime. As regulations prevent increased borrowing by those who's wealth is eroded, few if any choices remain.
In summary, current Government policies (both Monetary and regulatory) combined with advances in technology, have had the perverse effect of increasing the systematic unemployment and wealth gap they were put in place to address. Rather than creating a level corporate playing field, they have actually increased the too big to fail risk while shifting economic credit risk from the regulated to the unregulated. These policies force risk aversion thru the erosion of purchasing power resulting in an ever-increasing wealth bifurcation in our population.
By investing in higher education the Government can perhaps slow down the effects of productivity on systematic unemployment, but I do not believe it would be sufficient to end the cycle. Labor shortages would only be maintained at the bleeding edge of technology, where supply requires levels of understanding that may not easily be translated to mass education.
A tighter monetary policy resulting in higher interest rates rates would negatively effect asset inflation but would benefit savers. This would be a logical way to fight relative inflation, but the economic thought consensus needed to prosecute such a policy would require a shift in economic thinking. It is my personal belief that only by understanding the interconnection of public debt, regulation and their collective effect on wealth creation and destruction, can our policy makers begin to make effective choices with intended outcomes.