Thursday, December 13, 2012

The Doomsday Gene or Just Awful Trading?

There seems to have been no shortage of bears in the world over the past several years. A re-read of investment letter writers,  strategy pieces from buy side firms, or most notoriously, ZeroHedge, can attest to this. And despite the dour headlines, of sovereign debt crises, one macroeconomic disaster after another, or the dire state of political confidence and leadership across the western world, few of the curmudgeonly uber-pessimists have made money in what should have been proverbial salad-days for the Kaczynski-ites. So despite the near torpedoing of the PIIGS, their sovereigns and their equity markets,the best returns have more reliably been on the long side, while the one's who have been most vocal in trumpeting the impending apocalypse have little to show for it in terms of banked investment returns for their investors.

Ignoring whether from the unrequited pessimist's perspective this should, or shouldn't be, or why it is or hasn't been something else, one can not entirely reject the potential mitigating excuse that "it ain't over 'til 'it's over".  Keynes of course would have countered that "the market can remain irrational longer than you can remain solvent". The nihilist would add that in the long-run, we are all dead. And all could agree , at the very least,  on this much.  That "they" - the uber-bears, the financial eschatologists, the doomsdayers, the macro-dispensationists - haven't in the main made money needs some explaining that consists of something more convincing and durable than government conspiracies, plunge protection teams, cabals of jewish elders of zion. Their failure to capitalize says something important that is worthy of examination by anyone who invests or trades. 

Of course it could just be bad luck, or simple ineptitude. But I fear something bigger is at work. There is an adoption of a fundamental belief that is not far removed from doomsterish cults that believe "The End of the World Is Nigh". For en-masse, this group is making the same mistake - they   believe that a trade is more than a trade. What does it take to believe that a trade is more than a trade? Conviction? Yes. Phobias and self-doubt? Indeed. Psychological projection of something-or-other? Likely.  Ideology? That helps. Righteousness - both absolutely and relatively? Black & white thinking? Yes, and yes. Even I am not sure where I am going with this but it seems to lead to a rather provocative thought.

Perhaps, just as some have suggested that there might be a "God Gene" which proposes that a specific gene (VMAT2) predisposes humans towards spiritual or mystic experiences, so too might there be a Doomsday Gene, a yet-to-be-identified gene that predisposes humans towards a belief in "The End of The World As We Know It". This would account for unitary market views, the failure to cover or reverse positions in investments when events are quite obviously changing and/or pessimism towards underlying causes is shifting right before everyone's eyes. They would be prone to see only the negative, interpreting every glass of water as half-empty, and dismissive or oblivious of things that run counter to a highly-anchored and well-insulated belief system - one that they undoubtedly feel they've arrived at through independent thought but which they, one might posit, likely acquired as a result of their genetic predisposition. It would explain a lot with a little.

The existence of this genetic predisposition likely extends to the beginning of time. Within hunter-gatherer societies, it might have provided a counter-balancing cautionary fear that was useful in preventing overly-bold expeditions such as assaults upon woolly-mammoths armed but with a table spoon. During agrarian times, it might have helped insure villagers kept sufficient grain reserves to protect against periodic  drought and resulting famine. As a result, like homosexuality, it's usefulness within the gene-pool has carried it through time to survive modernity.

Every religion has deep eschatological roots, both within their mainstream, and their offshoots.  From the Jews and the Book of Daniel, to Jesus himself, to the second coming, along with all manner of historic and modern dispensationalism, from the Zoarastrian Frashokereti to the hindu Pralaya, the Norse Ragnarök to the Buddhist, Yam, Nostradamus, even Isaac Newton (who was afflcited) have developed and subscribed to apocalyptic doomsday end-of-world belief systems that bear striking resemblances to the financial versions that repeatedly cause shorts to overstay their welcomes and not recognize when things are getting ... errr .... ummm let's just say "less bad".  Like the burning embers of a fire, it smolders, fanned perhaps by the same predisposition that drives Stendhal's Syndrome, Jerusalem Syndrome and, for the Japanese, Paris Syndrome.

What IS different today, from days of old, is that (apart from the world NOT having ended) there now is a system of instantaneous mass distribution. Those potentially sufferering, and those who may be so genetically predisposed can now meet up at any hour of the day or night, excite each others' fears and worries, with all manner of topical charts, and half-truths, and together, figure out ways to undermine the action that might lead to political and/or economic improvement as well as sabotaging their belief that something, anything, might be improving and require a painful change in dearly held belief structures.

Before we completely dismiss those afflicted however, we must appreciate their virtues and accept that they can be perceptive and bring lateral or alternative perspectives to the foreview. And they often have good senses of wit (though don't expect them to buy the beers since they usually are in need of money for obvious reasons). It is likely that we all have friends that fall into this category. And this is fine and is as it should be. Just be careful when they are offering financial or trading advice, and whatever you do, under no circumstances, give them your money to invest. There are much cheaper and more constructive ways to be otherwise occupied or entertained.

Friday, December 07, 2012

The Cats In The Hat Won't Be Coming Back

It is approximately one year since Olympus' two-decade cover-up of zaitech  losses was outed.  Former Chairman & President Kikukawa and the other most culpable officers and directors have pleaded guilty; Mr Woodford has been exonerated and published his "Kiss & Tell"; Olympus lives on (with the aid of its domestic saviours) still a world-class med-tech unit attached to a sinking legacy ball & chain imaging unit, and, little has changed in Japanese corporate S.O.P.

It is no coincidence then, on the anniversary, that I have just finished reading Mr. Woodford's account entitled "Exposure" published by Portfolio Penguin. It is a good read. Not because it is well-written (few, if any, business biographies are). Not because good triumphs over evil. Not because we like him (I am agnostic, not having met him), nor because he is a superhero (which by most measures, he is not). It is a worthy read because at its essence, it is a good story - one that has the requisite suspense and that, in the end, satisfies the reader because Truth, with an upper-case "T") DOES resoundingly trump Deceitful Lies. While it is billed as a story where virtuous David will be victorious over Goliath, in reality, Goliath, (to mix metaphoric fables) is felled by a mouse who shoves a proverbial thorn into his foot, after which Goliath brings about his own syphilitic-like misfortune before committing seppuku. Given the current state of financial markets, corporate governance and transparency in Japan, the triumph of Truth is a moderate victory, albeit within a seemingly endless losing war.

Whatever else Michael Woodford may or may not be, he is earnest. He defines the word. He does everything correctly (even his eventual defiance is diplomatic with the perfect amount of rectitude) respecting convention and culture, from the non-Japanese corporate point of view. From where I sit, as a jaded, borderline-cynic, financial-markets person, this is both refreshing and amusing. He is parachuted into boardroom-central from the periphery, oblivious of what is about to hit him. His first surprise and disappointment: despite the billing and the hype, he's not really CEO. The wily Chairman has given Mr Woodford a title, the grunt work, while keeping the cat-bird's seat for himself. Woodford is perplexed, but not as much as the curious reader who is wondering why these details weren't agreed before. Surely Nissan's Ghosn and Sony's ex, Howard Stringer, despite Japanese cultural aversion to litigiousness have quite detailed contracts. This and a few other slights, seemingly causes Woodford to change his opinion of his former mentor, Mr Kikukawa. Twenty years is a long time to work with someone, get drunk with them, and still not know *who* they are. I joke sometimes that one doesn't really *know* someone until they come and stay at one's house for a while, nonetheless two decades of corporate carousing salary-man-style seems like plenty of time to peer inside your bosses character and realize that he is a dick (even if he was your protector), and you should watch your back. Was the cultural gulf THAT wide?

Earnestness is not far removed from naiveté. Woodford comes across as being an uncomplicated person, seemingly giddy that he has arrived at the top. Perhaps because of his humble origin, he's fearful of risking or losing it all. Iconoclasts, in any event, rarely rise to the top from within Japanese organizations. Mr Woodford, it appears, hasn't violated this rule and rose to his level having respected protocols and conventions in a way necessary to fit in and adapt. Woodford, by his own account makes it clear from early in the story that he isn't The Boss - which miffs him, but not enough to make a stand. He rationalizes, but whatever he does appears to be from a point of weakness because it's a plum job, and he is now in rarefied air that few gaijin have reached. Likewise, despite voicing his concerns about the Gyrus acquisition, he backed off and didn't press the issue - one that if he had, might have brought the affair to conclusion several years prior. By comparison, FDR was reported to have respected General Marshall because even though FDR was known to be bully, making demands and getting his way, Marshall apparently could NOT, would not, be bullied by his boss (or anyone), such that Marshall would threaten to withdraw his services if his wishes were not acceded-to - threats FDR knew to be serious, and that resulted almost universally in FDR's (rare) retreat. One wonders if Kikukawa would have treated him so, had Mr Woodford displayed more of that mettle.

The book's billing readies the reader for the heroic fight of a virtuous whistle-blower pit against the nefarious greedy forces trying to silence him. The actual details, however, differ and complicate the story, First, Mr Woodford wasn't the whistleblower. An anonymous loyal, but conscience-troubled Japanese employee provided the information to an investigative journalist who exposed the scandal in his magazine, Facta. Facta broke the story, revealing the allegations, which got sufficient traction to not only impact the share price, but cause some large shareholders (including Nippon Life) to ask the company for clarification. At this stage, it is unlikely the affair would have gone away. The numbers were too large. The details provided and published by Fatca, too specific. More importantly, the truth was too pregnant, and the scheme to dispose of the losses, too half-baked and ridiculous to stand up to outside scrutiny. The newly appointed Woodford, excluded from any prior knowledge about the zaitech losses or earlier and repeated attempts to repair and prevent discloure, was quickly caught in the cross-fire as the revelations were made shortly after his appointment. Here, we must be clear, that as a result, he was fighting for HIS life and reputation, and new position at the pinnacle, as much as that of the Company. For HIS sake as an officer and director and now man-sort-of-in-charge, he needed answers, for which there no reasonable ones provided or, for that matter available.

Early-on, there is a question that keeps popping into my mind. What would Mr Woodford have done if Chairman Kikukawa, upon offering him the job - but before official appointment - had sat him down, confided in him, and said "this is the situation, my boy". "It's a mission you do not have to choose to accept, but we're up to our necks in nattō*, and we need you to tow the line. No hard feelings if you don't accept, but for the sake of everyone, we need your silence if you balk..." Would he have walked away quietly and acquiesced, given he wasn't under personal attack? Would he have been content to remain European Chairman and await a moment of revelation that might be another opportunity lead the company in the future? Would he have kept the confidence for the sake of friends and colleagues? It's easier to be brave when you're cornered and have no other reasonable course of action. I cannot say with honesty what I would do, despite what I think my moral compass would tell me to do. Mr Woodford may not honestly know the answer. I would suggest that few could answer it until they are actually there, however well-intentioned or perfect their hindsight.

* * * * * * *

The Investigation Report dated January 12, 2012, available on Olympus' official website here: is the apex of investigative forensic accounting. It resembles an epic tragedy, both in terms of its cast of characters and plots twists. The report was a formidable effort, completed in less than two months. It displays the single-mindedness that the company applies to its product engineering combined with Japanese thoroughness and wholesale effort in pursuit of a goal. No detail, however small, is excluded. Only after reading, can one imagine how many people must have been complicit. Clerks, lawyers, accountants, bankers, advisors. And however discreet and loyal they may be, one cannot help wondering what a payment is for, why an entity is being created, whether a circular collateral arrangement isn't odd. Only after reading the report can one realize how much effort and expense they went to hide to prevent disclosure of the losses - both in terms of time, and money. This metaphorical financial bath-tub ring (original zaitech losses) like the one in "The Cat & Hat Comes Back", will not go away as they try to clean up what is a simple (though significant) problem, only to see it morph, and grow into a larger more intractable problem with the application of each half-baked solution, until it is so bad they need the extraordinary "Voom!". But Michael Woodford was NOT Voom! There is no Voom! for what ails the Japanese system. In the Olympus case, Voom! was old Japan, the status quo of time-honored alliances and obligation between banks, industrial enterprise and government, sending out the army of little Cats in the Hat, to repair the exterior as quickly as possible, and so, making it disappear from view, back under the Hats of the Cats, after which it looks clean, it looks as it was, and if we didn't KNOW it was there, we would be none the wiser. "That's right...nothing here to see...move on please!"  But the behaviour that felled Olympus is  not gone - just hidden, again, in order to remove the unpleasantness from public consciousness.

There are numerous important lessons here for readers in general and managers, and traders in particular. Others may have touched upon a few. But many of the most important ones have been ignored, I think. These include: (1) Never, ever, EVER try and trade yourself out of a loss; (2) Operating companies should not speculate outside their area of expertise for speculating is hard-enough for dedicated speculators; (3) Coming clean early with mistakes almost always trumps getting caught later with dishonesty. (4) If following the herd down a perditious route, one must take care not to be the last one left; (5) Listen to all approaches by investment bankers with the utmost of cynicism; (6) There are few free lunches. (7) If your excuse is too implausible or convoluted to convince your old schoolteacher, it is half-baked and you will be caught in your deception. Japanese organizational inertia carries unstoppable forces that can be harnessed for much good, but, when it goes awry, is capable unthinkable stupidity.

All these lessons are highly pertinent. There were warrant bonds issued (free money). They could have arbitraged a reasonable profit with no risk. They got greedy and speculated. And lost, bearing witness to the maxim: pigs get slaughtered. They then threw good after bad. Lost again. Then they tried to repair with risk of loss, and lost. They tried to hide them (their only success), but this was costly, and time consuming, and in any event, hiding is NOT the same thing as settling or disposing. To continue the deception, the circle of trust necessarily must be enlarged making it ever-more risky. Several times in the interim, other listed companies  confessed to the same, and came clean clean. Olympus missed or willfully ignored all of them. Time, can be your your friend in deception, but it is just as often your enemy. Laws change. Windows of opportunity close. Auditors change. Comrades leave. You look are now all that's left of the herd. Oooops. The rest is history.

Despite the foregoing, having downplayed Mr Woodford as The Hero, one must ask whether Kikukawa and the other co-conspirators are truly villains, rats or fraudsters? Let's try and see it from their perspective. Consider if revelation at the time of incurring them would have caused bankruptcy or similar? Have Olympus' constituents (employees, suppliers, bankers, customers, service providers, shareholders) - which it was Kikukawa's role and duty to shepherd - of which shareholders are but one, done better in the long run with the scheme? Does it not bear some similarity to what governments and monetary authorities did in 2008, and continue to ("extend and pretend", or "kick the can down the road")? To be clear, this is not a question about judging or exonerating Olympus corporate behavior. Laws were, of course, transgressed. But it feels like it needs to be asked...if only to establish intention, and by extension, shades of guilt. The world has been harsh in the language used in describing events, and to some extent it clouds their predicament, response and attempted resolution. There is a harsh linguistic for malfeasance and cheating for parochial gain. There is something again for bad behaviour involving organizational gain but NOT involving personal gain, and something wholly other - something the descriptive english language not yet invented, something peculiarly Japanese which relates to actions meant to protect one's affiliated organization and constituents against organizational harm and loss. I posit that Olympus' management and board, being guilty of the latter, have been universally accused and vilified for the former - of being John Grisham-like villains, where in reality, they were Laurel & Hardy-ish in their buffoonery and cock-ups - each action intended to make it better, but in practice, as events conspired, literally compounding the problem. Never failing to miss an opportunity to miss an opportunity to come clean, it festered like a huge repugnant white zit until ooooozensplattersploozing over the guilty.

Enron, Adelphia, Tyco, Worldcom, by contrast, were entirely different. They were frauds. They were driven by the parochial greed of likely sociopathic individuals, in a zero-sum war of "For me and mine at the expense of everyone else". Kikukawa and Olympus, for all their flaws and even personal his vanity as described by Mr Woodford was, at worst unrelated to such motivations, and at best the complete opposite of the sociopath driven by individual greed. Mr Kikukawa, and the other complicit officers and directors, rather than being hung and quartered as racketeering fraudsters, might be seen through an entirely different lens, one in which they were, in their own albeit warped and twisted way, defending the complex web of affiliations and obligations called Olympus - something bigger than any of them, to which individually honest men will conspire to no end in order to protect the honor of the organization. Their crime(s) - reflecting a society where a proposed marriage of relations might get torpedoed due to the stigma of family member's affiliation with a disgraced organization, or that spawned The Seven Samurai - through this lens, are poor judgment, and despite intentions that could be seen as not less-than-self-serving, being inept in failing to achieve their objective of repairing losses, and missing the opportunity to come clean and spare greater shame, once the initial bankruptcy threat had passed.

Entertaining such thoughts is undoubtedly repulsive to western shareholder-first and good corporate governance sensibilities. But it must be remembered that in the early 1990s, Olympus was a much smaller company. The zaitech losses were sufficient to, if not bankrupt then threaten the company's independence, and certainly its honor. S.O.P. at the time, all across Japan, was to defer losses and pray. The entire system was designed to support them in such efforts - Japanese brokers had special departments dedicated to helping clean up similar problems - as did foreign banks and brokerage firms including our most venerable. Olympus' FIRST repair-bonds, if my information is correct (overlooked by the Jan 12th 2012 Report and Mr Woodford), were structured by foreigners, lest we in the west be become too moralistically hypocritical, as the recent ex-smoker chides the one unable to find the fortitude to quit just yet. For it was, and probably still is, the Americans, British and French bankers who possess the most questionable morality, most devious know-how in circumventing global audit firms, along with the wherewithal to conjure appropriate supporting opinions from well-known law firms, such as those supplied to Lehman's Repo 105, or dubiously-disclosed Synthetic CDO structures, and off-balance sheet SIVs with far less socially-minded intention. Again, despite what is laid out above, I am not condoning their actions. But as history is written by the victors, those wanting a more complete picture must take care not to succumb to righteous revisionism from which crucial context is lost.

Some will vilify the Olympus old guard on grounds of violating the primacy of shareholders' interests. Despite the dramatic drop in the share price as a result of the revelations, such critics might evaluate outcomes under alternative scenarios. Original losses were equivalent to the prevailing market cap Olympus. At the time, this would have resulted in either bankruptcy (less likely given the underlying business), a huge dilution to raise sufficient capital to continue independently; or a forced merger, likely on poor terms with another Sumitomo-group firm. All would likely have compromised shareholder value for shareholders at that time. Jobs - both in Japan and abroad would have been at risk; growth of the crown jewel (med tech) might even have been jeopardized or never evolved the way it did had Olympus lost independence. Management, quite literally, cheated death, and legacy core shareholders were likely better served.  Subsequent investors acquiring shares regretfully won't be as thankful. Deferring recognition for a decade, the company grew large enough to absorb losses without threatening the existence of the firm.

It was 2001 when Kikukawa took the helm, and if we are to believe him (according to testimony at his autumn trial), this is when he found out. At that time, he claimed that HE suggested 'fessing-up, but, was allegedly told by by the CFO (who was very culpable) that this would "be crazy". Apparently disagreement exists in Japan too, though in this case, he acquiesced.  Sadly, for most involved, he didn't confess when he could have.  They missed the chance when Yakult and a dozen others DID were forced to come forward, caught up in the SECs case against PEI's Martin Armstrong and Cresvale for their loss-hiding and repair-bond transgressions. THIS may prove the most fatal error in management judgement. For after Enron, and uproar resulting from the sheer number of companies that had done exactly the same thing - zaitech spec, resulting losses, and subsequent loss concealment - laws changed. Now, culpability involved more than a deep bow and a pay-cut. Now, continuing loss deferral was no longer just organizational loyalty, and shame avoidance, but self-interested prison avoidance. Ultimate disposal took on new and urgent meaning. This was still a different motive than the American Gang of Four, but over time became no less parochial in nature.

Deferral is not disposal. Disposal meant figuring a way to move a billion through the income statement so it could match the needed write-down in the balance sheet. Disposing of a billion-plus dollars in extraordinary losses without transgressing laws that would result in prison was always going to be tricky. Now, I would have thought IF you were going to try to do it, then the Camera division might have been plausibly large enough to provide cover. But this would have required much wider spread complicity. The "kitchen sink method" used by western companies for decades whereby one searches high and low for any write-down to get it all out might have been an option during this time for an enterprise with 8, 9, $10 billion in revenue.

Those are the limits of my contrapreneurship. It is likely that disposal was impossible. It is just harder to keep a secret in modernity with the internet, globalization, and increasingly electronic slime trails. Having said that, whoever hatched Olympus'  hare-brained scheme to use elephantine advisory fees tied to flea-sized acquisitions deserves whatever fate they receive. What were they thinking? No one would notice? It was so weird and obviously wrong it challenged deeply-held feelings of loyalty resulting in  a leaked revelation. This is where the previous analogy with the Kurosawa's Seven Samurai stops. Olympus' guilty should have figuratively fallen on their ritual swords for the sake of the company - even if it meant jail. Here, by this time, given the absurdity and preposterousness of the dispoal efforts, Mr Woodford, by being earnest and diligent and staying the course was always going to win. He makes it sound like a dead heat, and it probably felt like that to him and his family, under siege as they were. But since the stakes, for the system were high, authorities and old Japan had to give the appearance of being concerned with international norms and foreign shareholders - especially the good long-term ones like Southeastern and Harris Associates - (as opposed to carpetbagging activists). With enough attention, this was always going to be greater than the inclination to rally behind Olympus. He really needn't have worried (unless Yakuza's pension funds were heavily long Olympus and...). And in a small way, this is progress, if not for honest business practice, then for Truth.

Tuesday, December 04, 2012

Insider Trading Secrets Revealed: It's All In The Haiku

US Attorney for the Southern District Court of New York, Preet Bharara, may have his work cut out for him in trying to land the big fish atop what many believe to be the largest and most profitable insider trader endeavor ever.

Bharara is rumoured to have secretly questioned former employees of the target, none of whom are under investigation nor under threat of being charged, but nonetheless were believed to have given the US Attorney important insights into how it worked. After the revelations, the mood of his legal team was reported to be decidely sombre.

Here is what he has learned: Analysts, portfolio managers, brokers with juicy tips, have long been under strict instructions never to reveal material non-public information to the big fish since as everyone knows, that's illegal under current laws and their interpretation by the higher courts. But that doesn't mean the big fish doesn't want to know. Or trade accordingly should it become known. But, in order to not transgress the law, he needs to figure "it" out himself, whatever "it" is. To be free to act and trade in such situations, he needs to have the equivalent of an epiphany, or miraculous revelation, one that no court could prove, nor jury unanimously find, was the result of receiving inside information.

Enter the obscure and enigmatic Japanese art of Kōans and Haikus. The Kōan is an ancient form of teaching representing an allusive metaphor, conveyed by a perplexing story, parable, dialogue or series of impenetratable questions that confront the seeker with a riddle of sorts. The purpose is to provoke sudden awakening in the unenlightened or in western parlance, cause an epiphany, of precisely the type the big fish needs to insure no jury would ever be able to make the connection between something that superficially makes no sense, and that which requires years of rigorous zen-buddhist training to tease out.

To demonstrate, examine this Kōan:

Blind Man: Ha, ha, never assume because a man has no eyes he cannot see. Close your eyes. What do you hear?
Boy: I hear the water, I hear the birds.
Blind Man: Do you hear your own heartbeat?
Boy: No.
Blind Man: Do you hear the grasshopper that is at your feet?
Boy: [looks down and sees the insect] Old man, how is it that you hear these things?
Blind Man: Young man, how is it that you do not?

or this...

The pupils of the Tendai school used to study meditation before Zen entered Japan. Four of them who were intimate friends promised one another to observe seven days of silence.

On the first day all were silent. Their meditation had begun auspiciously, but when night came and the oil lamps were growing dim one of the pupils could not help exclaiming to a servant: "Fix those lamps."

The second pupil was surprised to hear the first one talk. "We are not supposed to say a word," he remarked.

"You two are stupid. Why did you talk?" asked the third.

"I am the only one who has not talked," concluded the fourth pupil.

To the ordinary person, this just reminds them of Master Po of Kung-Fu, who was the Blind Guy with the white eyes and Fu-Manchu talking riddles to the flash-backed young David Carradine. To the trained Master, however, he KNOWS this has a deeper more important meaning. The first one, properly interpretated should be read as "ZOLL 2-be bot by Japs - Back up the Truck". The second is bit more complicated but can be deciphered as: "CSCO's quarter will be light by a dime - Drop 4 million shares!" Less wise interpretors might just understand it as "CSCO - Get outta' Dodge now". Yet, when a Federal investigator goes through email communications with a fine-tooth comb, he will not be able to see anything unusual in the enigmatic riddle or the 900 year-old humorous parable - certainly not its embedded meaning.

Haikus are stylized verse, of seventeen syllables typically in 5-7-5 pattern across three respective lines, juxtaposing imagery of two seemingly unrelated ideas, to the unitiated even random ideas, obscured within a hidden thread or connection. The big fish, unknown to even close friends, is a Master in these arts, rapidly and accurately able to decrypt the seeming artistic riddle and extract the hidden meaning which would result in an actionable trade, with no discernible connection between the original material non-public information and the subsequent trade.

For example, take the following haiku:

old pond . . .
a frog leaps in
water’s sound

To the trained Master, of which it must be pointed out there are incredibly few, so few that prosecutors will find it difficult to find an expert to explain it to a jury, let alone convince the jury this is like a secret code with embedded messages, this can only mean "Trials Going Well! - Buy ELAN large"

To the layman, it would like two grown men innocently sharing an appreciation for poetry. What could be wrong with that? It seems absolutely preposterous to even suggest that there is a secret message inside, let alone material non-public information about an Irish Pharmaceutical company that caused an epiphany which was transformed into a $750 million dollar long position quicker than you can say "Captain Jack Sparrow". You can see the reason for Mr Bharara's sombre mood.

Even more cryptic is the next example:

the first cold shower
even the monkey seems to want
a little coat of straw

The uninitiated, looks at this looks and see the gibberish of some art-school type trying to impress his EMO girlfriend. However, to the highly trained Master this screams out: "ELNs new Drug Sucks!!!! Sell ALL - Borrow against the Entire Kingdom and Short a billion more!!". THAT is how powerful these Haiku's can be in calling up the powerful embedded imagery necessary to translate the inner message into a bold epiphany and action.

For Mr Bharara, regretfully, no one will believe it. It is too far-fetched. Too perfect. Too beautiful. THAT is why the Big Fish is a Master and .. ummm ... errr...the Big Fish, and Mr Bharara for government.

(NB: Haikus courtesy of Bashō, via wikipedia, and yes, I know Master Po and Kung-Fu were Chinese/Shaolin creations but they were convenient for illustrative purposes and in any event most important ideas had their origins on the mainland anyway... )

Monday, December 03, 2012

The Southern New England Hedge Fund Association 
Choral Society 
Christmas Concert, 2012
Greenwich, CT

December 7th, 2012, 7pm
Tickets - $15 
(Free! with all contributions of material non-public information)

(Compliance politely requests that everyone attending please turn-off their cell phones, and we would like to remind everyone that all photography, e-mails, or recording of conversations whether landline or cell is strictly forbidden and will result in your removal from the venue, and being struck from our lists)

First Set - Celebration

All I want for Christmas Is My Two Top Tips (Sung by Greenwich Country Day School Choir (Miss Hewjaphee's Class)
Santa Claus is Coming to Town
The Gift (Lower Manhattan Sell-Side Choir)
I Wish It Could Be Christmas Every Day
The Man with All the Toys (Sung by Mystery Soloist)
Silent Night
Last Christmas

*   *   *  INTERMISSION  *   *   *

Second Set - Reflection

There's a New Kid In Town (P. Bhara, Soloist)
Christmas Won't Be The Same This Year
Blue Christmas
Hark, the Herald Angels Sing (With help from the Level Global Singers)
Blame It On The Mistletoe (Boies' Choir)
Run Rudolph Run
Christmas Without You
Hard Candy Christmas
Children Go Where I Send Thee (Sung by Fred Waring, IV)
Away in a Manger

(We would like to remind all of our members that most Insider Trading is against the letter of the law and can be hazardous to your errr ummm business continuity, and so we kindly ask that you refrain from insider trading while on the premises unless accompanied by your compliance officer. Thank You).

Tuesday, November 27, 2012

The London Almanack Revisited

I bought a stack of rather old books at an estate sale some years ago. Within the lot I purchased was a tattered, leather-bound, compendium containing six years of "The London Almanack" running consecutively from 1853 through 1858. Thumbing through its worn and mildewed pages I chanced upon general interest articles of the day, court circulars, ministry staffing, board-listings of companies and their periodic changes, social diaries, etc. What stood out was the ubiquity of The Military in just about every aspect of life, and the wholesale absence of Hedge Fund and Private Equity Managers amongst the notable and glitterati-of-the-day. There were the Royals, of course, followed by land-owning aristocrats and the clergy who were well-represented, statesmen and ministers, and the odd artist mentioned here and there, after which, finally, on the bottom rung, the very occasional dash across a page by a City of London financier or budding commercial scion. But atop the pedestal of admiration, clearly stood the man in uniform (and I do not mean the blazer, blue-oxford & khaki’s of HF/PE issue). Today, of course, the military man is wholly absent, and one would be challenged to find a statesman of note outside the most senior ministers or cabinet officials in the vicinity of the social stratosphere. Now, upon the pedestal of the nation's attention, predominantly sit entertainers (NB: sportsmen are entertainers) and money-men.

Of course, in the era of my tattered Almanacks, Britain was solidly an Empire – one that took more than a few muskets and large-cannoned stinkpots to hold the domain together. But one could argue that today, the US Military is no less important to America’s dominance, given the amount of collective wealth expended by our rulers upon soldiers and their toys, and that the The Generals and their Lieutenants shouldn’t be socially licking the shoe-bottoms of Harvard Law grads trading public company shares upon their materially non-public clinical data, or denied their walk down the Red Carpets of NY or LA. Yet outside of General Petraeus, who will now be remembered for his indiscretion in the bedroom, rather than his prowess in the theaters of battle, one would be challenged to recall a single US military figure outside the serious guy who got so furious at Bush-the-Second for stitching-him-up at the UN. This is not a slur, on General Powell, and is intended as the opposite for was a model public servant taking the bullet for his boss, though I do wish (and I'll bet HE wishes) that he'd shredded the shoji-paper-like evidence underpinning the planned campaign in Iraq, which, if he had, HE might have been America’s first black President. Back on topic, perhaps in some places, the military men still rate in the public's fascination and admiration. But today, both in NY and London, the society pages are equally devoid of uniformed men (excepting those wearing a football kit).

Commerce and trade were hardly admirable pursuits for a gentleman in the days of my London Almanack, whilst the business of money itself, was even lower still, as it was, unsavourily associated with usury. Yet between then and now, finance has not only been rehabilitated from its Shylock-back-street ex-communication during the middle ages, but so entirely transmuted in its peception that it sits at the pinnacle of desirablility. Moreover, I would posit, this is not for what it does or what it is, or its social function, but ENTIRELY for the very real bling and glamour that its pursuit delivers to its disciples. Yes, it sounds genteel, important and purposeful when embedded in the NYT Sunday Society page weddings & engagements blurb that refers to the Groom's activity as a Senior Analyst in the venerable buyout firm of Fiddle-Faddle Leveraged Acquisition Ventures, or a Global Macro CDS Long-Short Portfolio Manager at Diddle Doodle & Daddle Hedge Fund Management. But should it's pursuit and its many faceted pursuers deserve their central place in our admiration? For those waiting breathlessly, this is not today's question and nor, despite the barbs, am I judging, but, rather, observing.

And asking a different question: "Will this place on the pedestal continue to be held in the future? Obvious Answer: Probably not. And this isn’t because The People have voted against Bain-like, Romney-esque balls-to-the-wall maximum edge-of-the-envelope extraction in favour of deeper social meaning – the latter being a direction the people are running away from as fast and furiously as possible. Nor is it because we have, over the last decade, seen a more-or-less continuous exposition of what passed as success for what it has all-too-often closely resembled: cheating, tunneling, gaming, corrupting, mis-representing, to the outright frauding, thefting, and private misappropriation-ing at the expense of others and the system a-la Boesky, Scrushy, Frankel, Skilling, Ebbers, Rigas, Lay, Madoff, Rajuratnam, Kozlowski, Cioffi, Waksman, Gupta, Mozilo, and so forth. Rather, it will be for the same simple reason that in 1856, few could have imagined that the day would come that neither Military officers nor Clergy would reign supreme. That, in time, social mores, usefulness and opportunity would not only make their pursuits redundant, but borderline despised. And just as disastrous and grotesquely-brutal wars pursued at public expense undermined the Military's glamour, dishonest financial extraction and exploitation does similar to finance today. And though the moment of knocking finance off its perch clearly is NOT here…yet, Galleon and SAC-like insider-trading scandals, the kind that the typical citizen viscerally feels to be deeply unfair, and that the cognoscenti have little doubt of their veracity however difficult they may be for public justice to fully prosecute and irrespective of how well-lawyered the directly and tangentially associated may be, hasten the moment such pursuits are purged from our collective fascination. The public's distaste results not from some puritanical Scarlet Letter-like prudeness, but rather because fairness, trust, and confidence, are essential to the functioning of institutions and our social system, with corruption and similar venality undermining the its most basic machinery.

* * * * * * * * * *

With each passing day, larger-than-life archetypically-villainous characters diminish in number. Pessimists may rue the state-of-the-world, and the contents of the evening news may, often enough, cause one to hide all sharp objects in the house, yet, ponder, for a moment, of the idealistic though no less prescient vision of the future conjured 35 years ago by the most vilified of recent Presidents, James Earl Carter. Cars ARE now substantially more energy efficient. The use of alternative energy IS increasing, and America is becoming less-hostage to middle-eastern interests for energy. Home thermostats ARE turned lower. Rivers ARE cleaner. The cardigan HAS made a comeback. Faith HAS become more uniquitious (though I have my doubts about the virtue of the latter two). The iron curtain is gone, and an entire generation in Eastern Europe excepting Belarus, knows little to nothing of the bleak totalitarianism that's become a fast-fading memory. In all the lands of the western hemisphere south of San Antonio there is but a single totalitarian regime (Cuba), though Gordon Liddy would have his ideological issues with Chavez as Paul Singer DOES with Christina K. Gone are the Somoza, Pinochet, Torrijos, Noriega, Fujimori, Stroessner regimes, as are those of the Generals in Brazil and Argentina. Gone is apartheid, the larger-than-life Amin, Bokassa, Kabila, Taylor, Babangida, Mubarak, Rawlings, Doe, Kaunda, Toure, Bongo, Mariam, the ben-Ali family, and Qadaffi from Africa changing the face of the continent, and the lives of the people, dramatically for the better. Saddam Hussein is no more. South Korea is a model democracy, and even Pyongyang has turned down the rhetoric and turned-off the centrifuges. The Burmese generals, too, have relented. And while there remain a few stubborn boogers clinging to nose of power, they are noteworthy for their place on the tail of the political distribution, rather than in the center. This was the Carter doctrine, and somewhat miraculously, it’s arrived.

I point this out because it highlights the increasing difficulty that a James Bond-type hero has in finding a villain of such repute outside the cantankerous vitriol of the blind Abu al Hamza, the apocalypticism of Asahara’s Aum Shinrikyu, gluttonous obscenity of ex-Soviet Oligarchs, or anti-social loners like McVeigh or Breivik. All this makes me wonder whether, if Bob Kane and Bill Finger were alive and penning a contemporary version of DCs' Batman, just who, or what the villains might resemble, and what might be that dark motivating force behind a 21st century Bruce Wayne.
"Having witnessed his father brutally bankrupted and humiliated by the purchase of what were rated as 'AAA' securities comprising of sub-prime loans, the elder Wayne was driven to secretly commit suicide in order to trigger an insurance payment so his family could seat, the young Wayne swore revenge on the criminal swindlers, cheaters Frat boys and similar who conjured and sold the bogusly-rated securities...
. or how about
"Wayne was driven to combat financial predation when as a child, a NY vulture fund bought obligations at pennies on the dollar and then held out at debt scheduling causing his father to lose his job and meagre income, forcing him to emigrate to America in order to feed his family, whereupon he died trying to get across the border. Wayne swore never to forget who was responsible ..."

Imagine the variety of sub-plots, and characterizations of the villains – “….the unscupulous and corrupt hedge fund titans driven by meglomanic visions of world political and financial domination through the hoarding of riches and creation of unlimited Super-PACs to push the evil agenda of environmental devastation and human slavery and.....” Abusrd hyperbole? okay, I got a bit carried away, but the thought of Batman hunting down a Fuld-like or Mozillo-like villain BEFORE havoc has been wrought in order to foil their gestating plots, or crashing a fundraiser at the Hudson Institute BEFORE their or the API's millions are employed on unleashing anti-climate change myths on the unsuspecting citizenry, or taking out vigilante justice upon the perps of a Chinese gang of miscreants reverse-mergering their P.O.S into some shell-co. with a US listing, or helping Alfred use the bat-computer (with some help from his friend Mitnick) to hack into the bank accounts of seemingly amoral HFT predators (and their programmers) in order to empty them into the bemused but thankful hands of Medecins Sans Frontieres, Sea Shepherds or UNICEF, would bring a smile to the face of those who honestly and unrewardingly play by the rules, and, perhaps provide subject matter for DC’s next generation of 21st century super-hero storylines.

I am well-off on a tangent now, and will veer back on point, I cannot help wondering whether, in our annals, we will appear (to future generations) so parochially-minded, and whether a century from now, Dick Fuld's, Paul Singer's or Steve Cohen's grandkids or great-grandkids will take public pride in the source of their patrimony. That is of course if the down-trodden hungry masses of the future continue to have the munificence to allow their offspring - who will have done nothing to earn it - keep their inheritance, with its attendant place in the pecking order reflected in the then-prevailing Almanack.

Wednesday, November 21, 2012

Dear Jeff

Dear Mr Gundlach

First congratulations on Doubleline passing the $50 billion mark. I've been told by others that the "first 50" big handles are the tough ones, so you must be breathing easier now. I've yet to encounter such quality problems myself, but trust your growth will continue with your performance.

Secondly, I noticed from your Ira Sohn presentations that you have been attracted to rather off-the-wall serendipitous "pair trades" of assets that reside decidedly in the counter-trend side of recent performance. I don't know what your risk manager or VaR has to say about these trades, but I, for one, nonetheless admire your willingness to stick your errr ummm trading blotter out and position yourself contrary not only to momentum aficionados, and all manner of feedback-trading trend-followers, but famous fund managers, pundits, financial journalists, whinging academics, and so it would seem, the entire world. As a human being, this isolation is enough to make anyone uncomfortable and question the wisdom of one's actions, but as an investor, seeking contrarian return, it likely results in elation, and you must find it difficult to not do "more of the same" at each and every opportunity.

Thirdly, it has not escaped my notice that a number of these have paid rather well and rather quickly without the attendant spankings many contrarians are known to suffer at all-too-frequent intervals. This is quite an achievement as any bottom-smarting, blue-arsed contrarian can attest, and one which should be both acknowledged and admired.

Undoubtedly, you must now be on the prowl for additional trades that exhibit similar properties of assets trading at opposite ends of the relative value and performance momentum spectrums, and where potential short and long candidates respectively are almost, without exception, universally-loved and detested. And so in case you've overlooked it (or are still in the position of putting on the trade and therefore not yet interested in advertising the trade to a wider and now-more-attentive audience (despite all the academic momentum research), I would suggest you have a look at "Gold vs. Japanese Stocks" and "Gold vs. Softs".

It is not worth wasting too much of your precious time on the details that you undoubtedly will research yourself, but suffice to say that Gold is "expensive" to almost every asset and asset class, owned in spades by the largest and most fickle speculatibve investors, and that dissing Gold makes one more unpopular than an Orangeman marching down the Falls Road in West Belfast. On the other side, as and when the JPY trades back towards 125 vs. the dollar, company growth, income statements, balance sheets, and forecast revisions will look a lot different (and rather more attractive) than they have since JPY traveled FROM 125 to the silly levels its been inhabiting for the past few years. Few Japanese, let alone foreigners remain long Japanese equity, the equity brokerage business is almost non-existent, and even most large investors have moved their regional equity desks from Tokyo to Singapore or elsewhere in Asia. Of course I needn't tell you to insure you hedge the FX.

With regards to Gold vs. Softs, I would suggest looking more specifically at Cotton. Gold presently buys more cotton than it has for as long as the charts I can find represent. Cotton remains the benficiary subsidies. This cannot, nor will it, last. All the necessary supply-side inputs are up since the early to mid 1970 - most of them dramatically land prices; fertilizer prices, GMO seed stock, pesticides; diesel and fertilizer feedstock prices; transport, labour. Water has become scarcer and more precious. Yet Cotton remains the odd nail sticking out, hovering at mean avg prices prevailing thoughout the 1970s, (and 80s and 90s and most of noughties). There remains precious little in a human's present-day non-tech shopping basket that (in USDs) remains available for purchase at anywhere near 1970s prices and little as ubiquitious or important or utilizing inflated inputs. This ignores the imminent impacts of climate change, the increasingly-attractive substitution many farmers will be induced to make as higher prices make alternatives more attractive. And in the event of deflation, and convergence of everything else towards cotton stationary price-level, one need only imagine where the price of gold might end-up (Hint 2008 deflation scare = $650/oz = -63%). But check out the long term chart for yourself. Of course OJ, Sugar, Coffee and Cocoa are also attractive, but none as attractive as cotton I think.

Wishing you success in your investment endeavors and your boldly-imaginative and brave counter-trend pecadilloes, I am,

Yours truly,


NB Full Disclosure - I have interests in industrial-scale cotton properties

Thursday, November 15, 2012

Over-Cooked and Thrice Lucky?

Note to self: this feels similar to that unlikely moment of Bold Imagination which speculated where the Fat Tail (left) of he EUR/JPY was in 2007. Of course, that doesn't mean that one imagined it OFF THE CHART given that it now sits at, well somewhere  down
down... ... ... ... ... ... ... ... down sort of like **HERE**.  That was just luck - and don't think it was anything but. However, the determination of where was not.

Being presently agnostic and unemotional (unlike the visceral feelings I shared coinciding with the half-baked EUR/JPY above), I can't help but believe that the JPY is, in kitchen parlance, over-cooked.  Well-done. Scalded. Trop Cuit. Burnt to Crisp. That said, a similar Post Fukushima premonition in Spring 2011 was flat wrong by any reasonable measure. And one cannot forget that I thought (again erroneously) that the break in February earlier this year was "the move", and was more than "a trade', though fickle shorts were puked again.

Now, for the third time (a dozen stabs less than Kyle Bass), I believe that the "the move" is here and upon us - one that will take USD/JPY back from whence it came - to 125 and beyond, and JPYEUR back to the middle of the page. That is a 50% move. This may initially be due to "risk-off" or yet another whipping of the DGDF (dollar goes down forever) meme dear to the heart of FRB conspiricists, but once this proverbial ball gets rolling, we will look back upon this pretty chart as "the mother of all bases", or the most pronounced inverted head & shoulders ever seen in a major currency pair. Of course multitudes of reasons will spring forth to explain, in hindsight, why; and people with the position will grace the cover of Barron's (and their roundtable) touting the trade, their genius and prescience. But most of this will be fiddle-faddle, or dubious rationalization to fill airspace and column inches. For all of importance that will matter is that the herd will have been seen to turn, and leave, and the feedback loop will reinforce itself in all the wondrous and joyous ways speculators have learned to love.

It's uncomfortable (for me) in general to join the chorus, but in this case, I must open the hymn book and sing... Sayonara baby...

Monday, November 12, 2012

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Thursday, November 08, 2012

Scrabbling for Solutions

When I reflect upon my life - one perhaps (optimistically) halfway complete, there are few constants from when I was a child, through to the present. Books. The Stock Market. Tacos. Backgammon. Skiing. BBC World Service, and Scrabble. Not the makings of an adventure film or fascinating biography in even the remotest sense.

Scrabble, in particular, has never failed to amuse me. I still have vivid memories from when I was quite young, of playing against my grandfather (the principled one who used to send back his Soc Sec checks because he didn't need them), who while waiting for me to conjure a play, would mesmerize me by performing hesitation-less 3-digit by 3-digit multiplication in his head - without staring off into distant Andromeda or even moving his lips! Despite English being his third language, not a game would pass without his employing an elegantly obscure word, without the assistance of a dictionary, though it was always there when I went to look it up after a challenge.  

I would often play against my mother, too. Unassuming though my grandfather was unassumingly competitive, by contrast, my mom appeared to just enjoy the company - never fussing over some of my more borderline creations - forays that would have sounded like Esperanto, were they to exist at all in any dictionary. As I think about it now, it had nothing to do with her lack intensity or competitiveness, or even intentionally letting me win. In hindsight, it was likely that she was just recognized that despite my precociousness, and unusual attention span for a nine year old, there were limits to how long an adolescent could concentrate, and thus the optimal thing to do was to play fast and let it pass, increasing the chance we'd complete the game to the end.

Today, I find myself playing scrabble much as I write - which is to say it is, entirely, for my own amusement. Just as some play solely to win, one could write soley in a vain attempt to bully an unfortunate reader towards one point of view.   Such a player never leaves an opponent an obvious dangling triple-word score; always minimizes the freebies, rarely opens up the board unnecessarily, and when losing, typically blames his letters. These people are painful to play against, (as well as being tedious to read). Though I like the thrill of a victory as much as the next girl, I do just enjoy the journey, patiently awaiting that precious opportunity to construct an unlikely, yet elegant, crossword-like play that simultaneously creates 5 or 6 different words - even better when one uses all of one's letters in the process. It is an uncommon moment scrabble perfection.

Public policy, like simple scrabble play is all-too-often one dimensional. This is seemingly out of necessity, reflecting the reactionary nature of most politicians, and thus resulting legislation, as well as the lack of consensus and resolve required to agree upon a vision of foresight. And that accurately describes the process in good times. In the dualistic reality of modern America, opposing forces rarely meet in the middle excepting the most banal of legislation e.g. "Banning Assault Weapons in Public Schools" (a bill that itself presumes there remain some private schools where your sprog can tote along his or her trusty Kalashnikov or Uzi).

Wouldn't it be nice, however, if meaningful inroads were made into solving our problems whereupon looking at the final language of a bill, both partisan sides could cast aside their dogma, read it and say "That IS much better than nothing. It could work and provide positive benefits to the non-campaign-contributing majority of my constituents...I can live with that". Something that achieves the most with the least. Something that is a proverbial "Win-Win" for the Public Interest. The political equivalent of an elegant solution - that most gratifying of multi-crossword scrabble play. Could there be such a play in front of us?

Some of the most serious political-economic problems of our times are: income inequality at the upper bound; high cyclical and possibly structural unemployment (and under-employment) with consequential output gaps, diminished consumption, and ballooning counter-cyclical entitlement costs; diminshed monetary velocity and consequential distortionary monetary policy by central banking authorities; household deleveraging; decaying public infrastructure resulting from years of underinvestment; and, finally, sustainable public finance represented by both primary and cumulative government deficits at or near their upper bounds. With the exception of the Koch Bros. and a handful of Randian-Bootstrapping others, most would not find fault in the list. What if a single initiative could positively impact all these problems AND if not be wholly mutually-agreeable then be sufficiently less divisive so as to be acceptable?

We found out last month from Olivier Blanchard at the IMF that Govt spending multipliers have been seriously underestimated in most models. This has profound implications for public policy in general and fiscally-conservative solutions in particular - something about which they have been eerily silent. In a nutshell, spending cuts, rather than narrowing budget gaps, just seemingly exacerbates deficits. And this realization occurs at a time when demand for expenditures - whether for countercyclical policy measures or stabilizers, or for nationwide investment in crumbling infrastructure is critically-elevated.

With spending cuts not viable, perhaps we should raise taxes - and - if so, which ones? Japan, as Richard Koo has pointed out, made a grave error in raising taxes in 1997, extinguishing an otherwise nascent recovery. But admittedly, they were highly regressive consumption taxes. And their GINI was nothing like the US today. It seems that with income inequality so great in the US, the Govt could significantly raise marginal rates (in whatever form) on the wealthiest without effecting consumption in the slightest since the marginal propensity to consume for this strata is so low. In fact, one might argue, marginal income is pooling in ever-larger eddies of safety, concerned not-in-the-least about returns, but just preservation. Yet WE NEED TO SPEND in order to keep the balls of the macroeconomy in the air (i.e. blood of the economy adequately circulating) so as to not induce economy-wide liquidation at a time of high aggregate indebtedness - a event that would cause irreparable and irrecoverable economic losses in output, skills and invested capital - all which are likely to be largely unnecessary. To summarize, we need to spend, but can't, and even though we have the means (in aggregate), we won't (or they who have the means won't), whether out of fear, moral turpitude, or just plain greed, and politically, cannot arrive at a place to mobilize the resources, to invest in what's needed, which creates the virtuous circle of keeping the economy humming by better distributing income, reducing Govt expenditure by reducing the need for countercyclical stabilizers and distortionary monetary policies. Whew.

Now, heartier peoples on the planet, during times of financial crises, have inhaled deeply before paying-up as the Koreans did in 1998 contributing family silver to national treasury for the greater good. Or, like the Germans, during good times, increasing the VAT to increase the likelihood of sustainable public finance. But in America, for whatever reason, contemplating such demands causes one to be associated with Mao and Stalin, rather than Gandhi, Rowntree, Cadbury or Raiffeisen. This, in itself shouldn't prevent the better policy from being pursued. Undoubtedly, too much blood-squeezing demands for revenue (as with draconian cuts in expenditure) are likely to yield negative returns (remember that "50% of a goldmine is better than 100% of nothing"). And there ARE negative wealth effects even if this is a Miser's illness, as well as potential emigration outflows and diminished immigration even before considering the possibility of virtue in Libertarian philosophical opposition to higher taxes. Yet where-ever one falls in this debate, this MUST be reconciled with the above if we are to begin to make inroads towards a viable and sustainable solution - and have that solution be generally considered just and fair by most citizens - including sufficiently large numbers of wealth creators.

To break the impasse between the means and the will, I propose that we mandate that some reasonable percentage of marginal income be mandatorily "invested" in a non-political non-governmental investment company that funds/invests in infrastructure and infrastructure renewal across the entire capital structure. The resulting debt, equity, leaseholds, revenue therefrom, or claims on resulting or related revenue streams that result will accrue to the contributors. Mandated investment might for example begin at 5% above $200,000 rising to say 20% above for example $500,000 - on a scale eventually governed by Schiller's suggestion of tying marginal rates to the GINI itself). Importantly, by design, these "investments" would have a broader mandates, longer time-horizons, lower hurdle rates of return - much lower than ludicrous PFI schemes in the UK, but which nonetheless are analysed and vetted as investments and not gifts, or transfers, resulting in an asset - be it a school, a bridge, urban subway system, housing, claims on future road or gasoline taxes, smart-grid, etc. It effectively forces recirculation without outright sequestration, while respecting accounting conventions.

This is structurally important, and would contribute towards solving (though obviously not completely solve) all the aforementioned problems simultaneously. Some key features are that it would:
(1) recognize that the eddying pools of capital, with lowest MPC, seeking safety are, beyond a point, stultifying to the economy;
(2) that by spending it or more accurately, forcibly investing it, creates skilled jobs with virtuous multiplier effects throughout public and private sectors;
(3) In the process, presumably creates long-life asset values to which value will be preserved (and grow) over the longer term since many quality infrastructure investments have productive lives much longer than their depreciated values (just look at the embarrassment of cash flows of NY Port Authority or NJ Turnpike Authority);
(4) through the creation of employment and productivity-enhancing infrastructure constructively REDUCES the Govt deficit by reducing the demand for countercyclical stabilizers;
(5) maintains integrity of property rights as ultimate ownership interests in the resulting asset values, potential future cash flows and/or return of invested capital, remains with the investor, resembling a closed-end fund.
(6) such interests could (and should) be traded in a secondary market. The market would discount these - at times heavily - but they remain an asset for patrimony and NOT a tax sequestration making them philosophically more palatable and diminishing potential negative wealth effects.
(7) Management should be beyond BOTH politicians, and investors control. Think Bernard Baruch. Investment and funding goals should be codified and agreed by the board of trustees - itself appointed from multiple constituencies else it be captured by Govt OR Investors. All investments and contracts should be completely transparent. Oversight by Trustees addresses fears of government largesse or inefficiency.
(8) Investments will likely yield further taxable gains (though initial investments if/when returned could left untaxed due to the quasi-social purpose.

Now, I have little doubt there are criticisms from all sides, and many shortcomings.
The proverbial devil is always in the detail. What precise objectives? What rates of return might be acceptable? How to allocate? Who to allocate? How to negotiate? Will it not just result in further regressive transfers of wealth from poorer to wealthier when it is progressive redistribution that is called for? How would it balance the Public's interest in most benefit for least returns, with the investors' hope/desire for most return for delivering least benefit? How will elections effect outcomes? How can it avoid/escape overt political pressure? Will it just spawn self-perpetuating bureaucracy? All valid, and so many more questions. Yet, I cannot help but think it could be a "scrabble-solution" to the difficult problems confronting us, overcoming the inability of opposing forces to meet in the middle.

(I would like to thank Steve Randy Waldman for his critical thoughts in the concept)

Saturday, October 27, 2012

Another One Bites The Dust (updated again)

Things, people, and/or ideas believed to have integrity now seemingly compromised...(the updated and expanded version)

Wen Jiabao as "Humble Servant of The People
Lance Armstrong
Top Ten Lists
Austerity as an Economic Panacea
Harvard Students' Academic Honesty
BLS Statistics
Cyclical Recovery
Book Reviews
Strong Computer Passwords
'Organic' Food
Money Velocity
Undecided Voters
The Food Pyramid
Purity of '.999 Fine Gold Bars
Penn State Football
"Top of the Pops" 
Fareed Zakaria
The "risk-free" rate
LIBOR as a Benchmark
Public Sector Pensions
HFT as a Beneficial Provider of liquidity
Diversifying properties of Hedge Fund's
Einstein's Theory of Special Relativity 
Celtic Rangers
Macroeconomic Forecasts
John Paulson
FRB Open Market Operations
Standardized Educational Testing
Swiss National Bank
A Relaxing Cruise
WTI as Oil Benchmark 
Olympus Corp.
Payment Protection Insurance
HM Revenue & Customs
Sony Playstation Network
Social Mobility
Actuarial Return Assumptions for Pension Funds
Ryan Giggs
France   AAA
Boob Jobs
David Einhorn
Nuclear Power
Deepwater Drilling
Tiger Woods
Professional Cricket
Professional Cycling
High-Frequency Trading
Professional Baseball
Professional Tennis
Municipal Bond Underwriting
The Catholic Church 
Track & Field Athletics
NCAA Sports
US Congress
UK Parliament
Analyst Research
Credit Ratings
Newtonian Physics
The Stock Market
The Food Pyramid
Incentive Stock Options
Reinsurance Brokerage 
Lou Dobbs
The Mortgage-Backed Securities Market
Hedge Funds
Social Security
Government Balance Sheets
Tooth Fairy

Errr ummm Professional Wrestling is starting to look good by comparison - at least it makes no pretensions to be anything other than it is. What's left?

Tuesday, October 02, 2012

My (Not so) Golden Rules About Investing (And Not Investing)

Trolling the blogosphere, it seems to be the season for sharing one's so-called Golden Rules of Investing. So here goes.....

Cassandra's 25-3/4 (or so) Tungsten-Filled Golden Rules          

#25-3/4. Do as I do - not as I say - but do it without delay! (NB: 13F-HR's are too late!)  
#25-1/2. The trend is your friend....errrr....ummm.....except when its not.  
#25-1/4. Whatever kind of metaphorical market animal you are (bull, coq, chicken, weasel, whatever), always remember that Pigs Get Slaughtered.
#25. Buy "The Best of Breed" companies.....unless they are priced at levels preceding the moment when Pigs Get Slaughtered, or when the trend is not your friend, or I am saying the opposite of what I am doing.   
#24. NEVER short "Best of Breed" companies...except when Pigs Are Getting Systematically Slaughtered in other "Best of Breed" companies (but don't get piggy puking out the pigs). 
#23. Cut your losses short and let your winners ride - but not when pigs are getting slaughtered 
#22. No one ever made a dime by panicking ... unless apparently you're following the previous rule #23 which says you should cut your losses short and let your winners ride.
#21. NEVER double-down (except when you have material non-public information and deep pockets) or if you're Ed Thorp, or if you're playing at The Martingale Room. 
#20. "Systems" always stop working (Even if they DID actually work at one point). So forget about asking about their "system": what you really want to know about is their Plans B&C for when it DOES stop working (and why they're not using them NOW).
#19. Diversify to control risk - except if you are Eddie Lampert
#18. Don't own too many names - unless you're Ed Thorp or diversifying to control risk per the above rule 
#17. Invest in what you know - unless you don't know a whole lot about those things. 
#16. Buy when others are (almost finished being) fearful. 
#15. Buy when there is blood in the streets - but only after it has dried a little bit. 
#14. But NEVER buy when the blood in the street is your own. (See rule #23 above)
#13. Never catch a falling knife (unless you know why it's falling and/or approximately when it's likely to stop). Catching a rather dull falling knife, however, is OK. (NB: IF you ignore this rule and try to catch the falling knife, and discover it is hazardous, and the street becomes stained with your blood, see rule #23 above).
#12. Leverage is poison! (unless you're doing risk-parity and then it's sorta kinda seems theoretically OK, but then again, maybe not just when yields are near zero and everyone else is doing risk-parity or has risk-off asset allocations and...)
#11. Cranking up risk in order to target return when vol is low is like smoking a cigarette out of your butt-hole - it's just stupid. 
#10-1/2.  A great coder is worth at least six fraternity brothers.  
#10. NEVER allocate money to anyone who feels the need to sum their aggregate number of years experience to some impressively large number. 
#9.  NEVER invest with anyone with an improbably-inflated CV. If he's embellished his Starbucks-fetching experience while an intern into something rather more grandiose - imagine what he (and it will be an egotistical 'He') is capable of fabricating in regards to his investment strategy and performance!

#8.  NEVER invest with an investment manager who buys and then increases positions in less-liquid securities at higher and higher prices (unless those prices are likely to be demonstratively requited by per share growth metrics)

#7.  Be entirely skeptical of an investment manager who touts his self-professed superior research skills, proprietary channel checking methods, or interns sent to dumpster-dive to gain an edge. This is almost certainly first-class balderdash.
#6.  If your broker says you're his first call (and you believe him) you're an idiot.
Always assume you are the LAST one to receive a "tip" or sell-side research. Prop Desks, friends&family of potentially anyone in the research publishing & distribution chain, SAC, MW all will have had the chance to act upon it before you. 
#5.  If you pay an upfront load for the 'privilege' of investing in a fund, you're an idiot. 
#4.  If you invest in a hedge fund with anything less than annual incentive-fee crystallization, you're an idiot.  
#3.  The moment your Advisor, Letter-Writer,  Investment Guru mentions "Hyperinflation" or "Government Conspiracy" - run away in the other direction as fast as you can. 
#2-1/2.  To catch a gopher, you've got to think like a gopher.  
#2.  NEVER subsidize losers with winners - unless you're diversifying to control risk - where rule#23 will tell you to sell your losers and let your winners ride - unless the losers are "what you know" and therefore you SHOULD be investing in it - doubly-so if you have material non-public information, and especially if there is Blood In The Streets -  unless of course it's your own blood, in which case you should return to #23 and sell your losers - at least until tomorrow when you wake up and see that there is blood in the Street and you remember to be greedy when the others are fearful...
#1.  Never listen to other peoples Golden Rules - particularly those filled with Tungsten.

I Didn't Mean To Steal From You

Polite applause for the Financial Services Authority who upheld their April decision which found the now-Swiss-based Stefan Chaligné, manger of the near $130mm Iviron Hedge Fund, guilty of market abuse for his Dec 31st 2007 gratuitous ramping of US and European shares held in his portfolio. He was, the FT reported, fined GBP900,000, ordered to repay profits/fees resulting from the umm... errrr ..... [shenanigans, tomfoolery, charade, escapade, peccadillo] (please choose one), and banned for life from the UK Securities Industry. Mr Chaligné, it would seem, in the last hours, of the last day of the performance measurement and crystallization year, simply could not resist the temptation of buying more of that which he already owned, in sizes which - relative to exchange volume and liquidity - allowed him to his goose performance by nearly 300bps. ***Sigh*** It was not reported precisely how it came to the FSAs attention (the SEC? NYSE? Whistleblower? Jilted mistress or ex-wife) nor whether or why US authorities, too, who might wish to make a statement about the integrity of their preserve, have not sought similar charges or prosecution being that the sins certainly ran afoul of US securities laws forbidding the creation of false and misleading markets. 

Yet (polite) applause is still in order, I think, if for no other reason than because the FSA bothered to follow through at all on an ostensibly small, though apparently blatant case of abuse. This view is not setting the bar of justice (no pun intended) very high, but since such abuse is more-than-rampant, it is a signal to traders that they DO (however remotely) risk losing one of the best gigs in town if they are caught, not that this even is the end of the world since like Mr Chaligné and other before in similar predicament, can simply pack-up and move to, say, Geneva.
I emphasize "polite" because, according to the FT, in the appeal ruling, the three-member panel were willing to agree with Mr Chaligné that he "probably" wasn't trying intentionally to cheat his investors - apparently on the grounds that most were friends and family as well as himself. In the decision they say (to paraphrase) despite his obvious lying and willful neglect of civilized behaviour and the rule of law, it was insufficient to categorically brand him a sociopath whose intention was to profit at the expense family and friends, because (get this): what kind of guy would intentionally steal from his friends, family and self??!?. Well, where does one start with THAT one. 
First, what are family and friends to a sociopath? Not much besides cannon-fodder one would be forgiven for surmising. Perhaps his allowance was too small for his lifestyle. Perhaps he had penis-envy of the bigger-swinging dicks. Who knows. But, we do know that the fact of the matter WAS that he directly stole several hundred thousand euros. One can infer that he was below high-water mark before the ramp, since IF he was positive for the year with no hurdle, the theft would have been nearer to EURO 600,000. His argument thus may have been predicated upon the fact as he was on the wrong side of zero, and since he didn't have profits, he couldn't have been intentionally trying to steal money from them. But since he earned SOME performance fees as a result (but not 20%-like fees on a 2.7mm goosing) the ramps must have swung the fund from loss to profit for the year as a result. I think this is a bullshit excuse, and am surprised the FSA saw some merit to leave open the possibility it was somehow unintentional.

Second, the FSA only demanded he pay back investors the fees he dishonestly earned by ramping the shares. Sadly for his family, and his perhaps his now-former-friends, they likely lost a tidier sum on the difference between his average cost in and average cost out in addition to transaction costs and additional management fees charged on the subsequent, inflated, beginning of period assets. Experience suggests that the market can spot such ramps a mile away and unless it is one's intention to continue to buy gobs of stock, reversion will be short and sweet and without the ramper being able to liquidate his/her position. He should have been made to pay FULL restitution of imputed losses to investors. Mr Chaligné also asked that fines be directed to investors in the fund (himself!), and this is, again, absurd. Any fines should defray the agency's costs in pursuing the matter, for the market integrity which benefits the public interest, full-stop.
Third, he used the lamest excuse - i.e. the "Dog Ate My Homework" alibi, which in this case was that he was fearful that "his stocks might come under attack by short sellers". WHAT??!?? This is laughable, and in itself should cause he FSA to quadruple penalties and disregard any potential goodwill. Primarily because IF that was, in fact, a concern and not a completely irrelevant and oxymoronically bogus factoid, then the broker could have been given a limit order to maintain price, and IF the price DID come under attack by nefarious aliens or black-hats lurking and conspiring against his stocks, to support it, rather than sending it scurrying up the flagpole resulting from an order that specifically instructed his brokers to put the stocks up as much as possible. Second, even if we ignore this, as vigilantes are frequently told: two wrongs do not make a right. An experienced fiduciary - of the non-sociopathic variety - takes advantage of short-selling attacks to buy stock cheaper, and do it scale-down AT THE CHEAPEST PRICES. They then explain to their family and friends how smart they were buying stock CHEAP at the end of the year, rather than buying it at ever-upwards in a thin market, at prices that will certainly bugger them (financially). And then there is the chestnut about the quantity. IF the intention was to prevent getting devalued at year-end by short-sellers, there was no need to give orders of magnitudes of prevailing liquidity - especially on New Year's Eve, Dec 31st, typically a half-day of trading. It is uncertain why the FSA gave him the benefit of what should have been, beyond the shadow of doubt.

But what has NOT been contemplated, and the truly pernicious act of systematically painting a false and mis-leading market is the potential impacts the deception (not theft but deception) would have upon the decisions and perceptions of both present and future investors. As you may remember, this was the basis for the first 'shot across the bow' by regulators to Hank Greenburg at AIG (and which should have sent AIG shareholders scurrying for the exits). AIG for a decade traded at a large premium to other insurers and reinsurers because of its smooth earnings growth and, perhaps more importantly, its better-than-market underwriting results, which gave credence to its claim that it was a better, smarter and more disciplined underwriter. We now know they were managing (read intentionally smoothing) their earnings. And they were busted for this. But Hank was unrepentant. He implied it was NOT a sin because he didn't steal from investors - just moved earnings from one period to another, a common act in the insurance world (which AIG and Warren Buffet would help facilitate for you for a price). But you see, AIG was also using such unsavoury methods to transform the nature and characterization of earnings by turning underwriting losses into investment losses. So this wasn't understating earnings to save for a rainy day - the way reinsurers have operated since time began - but intentionally trying to fool all the insurance analysts and rating agencies and investors in order to convince them that AIG was better than they actually were. This illusion of quality likely caused much over-investment in AIG at higher-than-was-justified prices, and probably allowed them finance themselves at basis points less than might have otherwise been possible and grow at rates higher than otherwise possible. A seemingly small white lie causing large malinvestment. In fact, one might argue further that IF AIG had been seen as the not-so-special underwriter that they were, they might not have been able to insure the amount of subprime which they did. OK, these are a lot of ifs, but it IS a slippery slope in the descent towards insolvency. Or between increasing investor allocations or the liquidation of your hedge fund.

Mr Chaligné of course is no Hank Greenburg. And stealing from friends and family may not, after all, have been the primary objective. But the FSA should be chided for leaving the door open that it might have been vanity, when the very obvious greater sin went uncommented upon which has the grail of boosting performance to grow your business to entice more investors to give you their capital on the basis of that performance (and risk deception) which is, in the view of this investor, forever unforgivable.