Friday, February 12, 2010

Comedy on CNBC This Morning

Nouriel Roubini was a guest/host on today's CNBC morning program. Among the topics were, of course, in what phase of recession/expansion the US economy currently is.

Roubini is pretty clear about his belief that unemployment will persist for a year or so, with a weakening economic picture next year.

The comedic moment came when Roubini reiterated his view that there isn't any real private sector growth, and most companies have figured out how to do more with fewer employees. In particular, he emphatically declared,

"Those jobs aren't coming back."

CNBC's senior economic idiot, Steve Liesman, then retorted that Roubini ignored the recent data showing a minor downtick in continuing jobless claims.

As Roubini attempted to explain his contention that a few thousand people, more or less, employed, was a mere drop in the bucket compared to the tens of millions of jobs needed to restore employment to pre-recession levels, Liesman began to shout over the Columbia economics professor.

As well as being funny, it was sort of a pathetic moment. Here's a so-called journalist and wannabe-economist, Liesman, who's dumber than paint, yet fancies himself the equal of genuinely-trained, degreed economists, yelling at a well-respected economist's legitimate and substantiated positions.

Roubini sort of scowled at the treatment from CNBC's resident economic buffoon, and finally waited until Liesman finally shut up.

How many more episodes like this will it take before CNBC finally fires Liesman and hires an actual economist for the network's economics coverage?

More On Scott Patterson's "The Quants"

I last wrote about Wall Street Journal reporter Scott Patterson's new book, The Quants, here on Monday of this week. At the time, I'd read less than a third of the book.

Yesterday morning I finished it. I'd still recommend it as a very useful read. However, as I made my way through more and more of the book, it began to feel not only like a cross between Tom Wolfe and Michael Lewis, but Ayn Rand began to appear, as well.

By that I mean the following. When I read Atlas Shrugged, it took very little time to realize that Rand was a poor writer when it came to doing much more than espousing her philosophies. Character development and, in particular, romantic scenes in her book were so poorly written that I learned to just optically scan over those passages and return to full reading comprehension when they had ended.

Another major annoyance, and what I would call a glaring defect, is Patterson's apparent need to label certain phenomena with cute names. Perhaps it stems from post-The Right Stuff style requirements. When Tom Wolfe coined that term, it was a relatively new idea. And, anyway, Wolfe made somewhat of a career, as a leading writer of the new school of the late '60s, labeling phenomena.

Patterson calls the interconnected financial markets of the modern era The Money Grid, while the much-sought after inefficiencies in financial markets, when found and implemented to create wealth for the quants, becomes The Truth.

By the book's end, I'd become sickened by the word "truth," he'd employed it in so many predictable, silly passages.

I like Patterson's WSJ columns, and even his book. But he's no Tom Wolfe. Not yet, anyway.

Patterson does, however, a truly wonderful job cataloging the roots of modern quantitative trading in financial markets. That's why the first third of the book is so captivating.

When he turns his focus to the books four main contemporary characters- Peter Muller (Morgan Stanley's PDT) , Boaz Weinstein (Deutsche Bank) , Cliff Asness (AQR) and Ken Griffin (Citadel)- he becomes infatuated with their personal lives, idiosyncrasies and immense wealth.

As a result, the last third of the book can be read quite quickly, because so much of it cites all manner of numbers of total fund assets, losses, equity, and personal fortunes of the protagonists. Plus their various romantic couplings, births of children, latest expensive mansion purchase, etc.

To put Patterson's book in perspective, let me express it thus. He provides deep and numerous empirical confirmations that several things which I have long contended, and expressed in prior posts on various related topics, are, according to Patterson, true of this class of quantitative traders:

1. They all exhibit a shallower comprehension for the human behavioral aspects of financial markets than their mentors.

2. With each succeeding generation of acolytes, the belief that pure mathematical and statistical methods can apply, sans contextual understanding, to financial markets grows stronger, and the awareness of key underlying, limiting assumptions grows weaker.

3. Crucial dimensions of risk management for both the hedge funds, and the instruments they often trade, e.g., leverage, collateral, and ability to meet an instrument's, such as a credit derivative swap's obligations, are profoundly separated from the actual trading activities.

4. As such, both senior managers of the firms engaging in these activities, as well as counterparties, bear significant responsibility for having little understanding of the pragmatic aspects of risks which were undertaken by these quantitative traders.

5. Perhaps most ironically, all of the current generation of quantitative traders believed in exceptions to Eugene Fama's general EMH model, yet, in a fallacy of composition, when, together, they exploit commonly-observed inefficiencies, they become the very agents of EMH, obliterating the profitable inefficiencies they so recently observed and on which they traded.

At the book's end, Patterson brings back several historical figures from the earlier part, including Ed Thorp, Nassim Taleb and Benoit Mandelbrot. He has them voicing knowing sentiments concerning the eventual meltdown of the quants' funds from over-leveraged, commonly-held positions which were all simultaneously undone by the behavior of other investors which had not been modeled by the quants' research.

However, my fourth point is distressingly not explicitly driven home by Patterson. He succeeds marvelously in providing all the supporting evidence. He has the salient characters, including Fama and his ilk, in the book. The stage is magnificently set for Patterson to coyly spring the ultimate irony.

But he never delivers on it.

You have to figure that one out for yourself. Which is a pity.

Because if there is any one, over-arching, ultimate Truth (my bad- I can't resist mocking his label) to the book, it is the totality of the book's contemporary content in proving that, even when quantitative mavens find and exploit market inefficiencies, to the contradiction of the Chicago School's contention, they are, in reality, simply becoming players in that school's EMH world, pushing values back in line and eliminating the profitable inefficiencies.

That so few of these quants expected this is somewhat shocking. That they persisted, and persist, still, in believing they can escape this self-fulfilling prophecy is perhaps more shocking.

After a bit more reflection, I'm going to write a post discussing, from the viewpoint of Patterson's book, the folly of the TARP, government intervention, and implicit saving of the quant funds by the federal government.

Thursday, February 11, 2010

Holman Jenkins On Apple

Holman Jenkins, Jr., wrote a very interesting column in yesterday's Wall Street Journal concerning Apple's recent product extensions, entitled "The Microsofting of Apple?"

In a nutshell, Jenkins contends that Apple is beginning to behave like Microsoft

"Rumors abound that Apple is considering a deal with Microsoft's search engine Bing to displace Google on the iPhone. Rumors abound that Apple will get into the advertising business, that it will expand its cloud services to compete with Google's. Who is this beginning to sound like?"

As the nearby price chart for Apple and Microsoft illustrates, the latter's price plateaued shortly after it won the 'browser war' with Netscape.

It can be argued, as Jenkins does, that Microsoft's spread into internet browser, its online business unit, and even gaming, gradually eroded and unfocused the company's software strengths.

The details of Jenkins' piece involve Apple's refusal to support Flash software on its iPhone and iPad, making them suspiciously built to only download material from the iTunes store.

In an era of interoperability, Jenkins notes, Apple seems content to and intent on restricting its products' owners to content available only from Apple. He also relates stories of Steve Jobs lately becoming obsessed with Google and its infringement on Apple turf, e.g., the Android cell phone operating system.

I think Jenkins makes good points. Generally speaking, when companies expand beyond their original areas of competitive advantage, their profit margins fall. Growth is purchased at the expense of margin, and, in time, the key unique elements which originally defined the firm become blurred.

In a word, well, two, really, Schumpeterian dynamics at work.

Sad to say, the areas into which Apple is rumored to be looking to grow, and, with the iPad, is growing, aren't quite so unique as its recent sources of growth. That alone should give one pause concerning Apple's future prospects.

Wednesday, February 10, 2010

Elizabeth Warren's Flawed WSJ Editorial

Yesterday's Wall Street Journal contained a very flawed and misleading editorial by Elizabeth Warren, the Harvard law professor selected by the Senate's Democratic leadership to head the TARP Oversight Panel. Here's how she begins her piece,

"Banking is based on trust. The banks get our paychecks and hold our savings; they know where we spend our money and they keep it private. If we don't trust them, the whole system breaks down. Yet for years, Wall Street CEOs have thrown away customer trust like so much worthless trash.

Banks and brokers have sold deceptive mortgages for more than a decade. Financial wizards made billions by packaging and repackaging those loans into securities. And federal regulators played the role of lookout at a bank robbery, holding back anyone who tried to stop the massive looting from middle-class families. When they weren't selling deceptive mortgages, Wall Street invented new credit card tricks and clever overdraft fees.

In October 2008, when all the risks accumulated and the economy went into a tailspin, Wall Street CEOs squandered what little trust was left when they accepted taxpayer bailouts. As the economy stabilized and it seemed like we would change the rules that got us into this crisis—including the rules that let big banks trick their customers for so many years—it looked like things might come out all right.

Now, a year later, President Obama's proposals for reform are bottled up in the Senate. The same Wall Street CEOs who brought the economy to its knees have spent more than a year and hundreds of millions of dollars furiously lobbying Washington to kill the president's proposal for a Consumer Financial Protection Agency (CFPA). "

It's obvious that Warren confuses commercial banking with investment banking and securities brokerages. Thus, she paints the entire financial sector with a brush that is largely meant for a few investment banks and the securities units of perhaps one commercial bank, Citigroup.

Warren then goes on, in her second paragraph, to conveniently omit the actions of various government actors, including Barney Frank, Chris Dodd, Kent Conrad, and former HUD Secretary Andrew Cuomo, all of whom mandated GSEs Fannie Mae and Freddie Mac to buy and securitize questionable, risky mortgages.

Private sector, publicly-held investment and commercial banks were only following the lead of Washington. But Warren doesn't choose to acknowledge this fact.

Warren then characterizes all banks which received TARP funds as needing a bailout, which is very far from the truth. Anyone alive two years ago and watching the scene unfold knows that, in order to be able to unwisely inject federal funds into a few ailing financial institutions, specifically Morgan Stanley and Citigroup, then-Treasury Secretary Paulson forced a larger number of financial institutions to accept federal money. The reason given was to not stigmatize, in the eyes of the investing public, those institutions clearly about to fail without the infusion.

What you, as a reader of this blog, ought to understand from Warren's statements in her editorial is that the appointed leader of the Congressional witch hunt that is the TARP Oversight Panel can't even get the facts straight regarding the history of events which led to the creation of the TARP.

Later in Warren's editorial, she writes,

"So far, Wall Street CEOs seem determined to stop any kind of watchdog. They seem to think that they can run their businesses forever without our trust. This is a bad calculation.

It's a bad calculation because shareholders suffer enormously from the long-term cost of the boom-and- bust cycles that accompany a poorly regulated market. J.P. Morgan CEO Jamie Dimon recently explained this brave new world, saying that crises should be expected "every five to seven years."

He is wrong. New laws that came out of the Great Depression ended 150 years of boom-and-bust cycles and gave us 50 years with virtually no financial meltdowns. The stability ended as we dismantled those laws and failed to replace them with new laws that reflected modern business practices. "

As Ronald Reagan might say, were he alive,

"There she goes again!"

First, Warren continues to use the phrase "Wall Street," to refer to large financial institutions. But that term was originally meant to apply to investment banks and brokerages. None of which now exist as large institutions. Only boutique investment banks remain.

The remaining former investment banks- Goldman Sachs and Morgan Stanley- rushed to take bank charters. Merrill was sold to BofA, while Lehman and Bear Stearns collapsed.

Leaving that topic of Warren's misinformation, it's probably unfair of her to contend that the CEOs of the nation's remaining large financial institutions, all of which are now commercial banks, don't want any regulation or the trust of their customers.

As stupid as some of these CEOs are, they're not that stupid.

Warren is correct to note that Jamie Dimon's statement should be wrong. It's not really correct to say it "is" wrong, but it should be a wrong statement.

That said, Dimon is hardly the person you'd look to for a sense of history in financial markets. He spent his formative years carrying Sandy Weill's bags. It's notable, then, to observe that Dimon's mentor created what has probably been the single worst-run integrated financial services company, Citigroup. What, exactly, did Dimon learn from that which is so valuable?

However, Warren is wrong. And in a way that Dimon wasn't in his statement.

To write that we have had "50 years with virtually no financial meltdowns" is "virtually" meaningless.

Either there were meltdowns, Elizabeth, or there weren't. Which is it?

By the way, it is "were."

Since Warren is referring to "Wall Street" in her piece, let's start with the go-go Nifty Fifty Era in the late 1960s. And it's contemporary scandal, the mutual fund collapse of Bernie Cornfeld.

Then we had the S&L crisis of the late 1980s, during which era the first CMOs were spawned.

Let's not forget the internet stock bubble of the late 1990s. Which followed the near-meltdown arising from LTCM's collapse.

Read enough?

Evidently Elizabeth Warren doesn't know any history of the sector of which she now writes with so much apparent authority.

Warren continues to the end of her article savaging "Wall Street CEOs" as being against new regulation. Which regulation, of course, is all pure good and truth. She paints the aforementioned CEOs as evil, greedy and only desirous of slipping the regulatory noose and caring not a wit for the trust of their customers.

As I've written in prior posts, these constant appeals for just one more perfect regulatory scheme to prevent the next financial crisis reflect serious misunderstandings, or total lack of understanding, of the behavior of those involved in trading and underwriting businesses.

Old-fashioned, conventional commercial lending businesses, be they consumer or business, are fairly predictable and cyclic in their mistakes. We have sufficient regulations in place to oversee those activities. What we haven't had is effective implementation of existing regulations.

As to the underwriting and trading businesses, it's a different ballgame. Volcker is correct in calling for a complete separation of these activities from federally-insured deposit-taking institutions.

What Warren, and others, fail to understand is that there is only one motive for people in those businesses: profit. It's up to their counterparties and customers, and, in fact, anyone who deals with them, to beware. No amount of regulation will ever make them "safe" with which to do business.

Best they be sequestered in their own shark tank.

Think of the worst, most risky and rapacious behavior possible in underwriting and trading securities, and you are near right in guessing the extremes to which the best professionals in these businesses will go to make money.

This will never change. Believing it can be made to be otherwise is perhaps Elizabeth Warren's editorial's most significant flaw.

Tuesday, February 09, 2010

Pfizer's Bad Example: CEO Jeff Kindler

It was with great interest that I read Kim Strassel's piece in Friday's Wall Street Journal concerning Pfizer's CEO, Jeff Kindler's bargain with the devil over health care legislation last year.

I've written in earlier posts concerning the auto company bailouts that both government and corporate executives have unwisely failed to observe a separation that ought to remain.

Specifically, corporations ought not seek government aid, and government ought not give it.

Yet, from reading Strassel's editorial, it appears that Kindler did exactly that by pandering to the administration's and Congress' coercive threats, to be embodied in last year's failed health care bill.

Strassel details how Kindler, upon arriving at Pfizer, suddenly oversaw the retirement of free-market oriented governmenat affairs personnel, and magically hired people with ties to various Democratic powers, current and out of office.

In a variant of requesting aid for his firm, Kindler caved in to Congress on opposing the socialization of medicine, in exchange for protection from threats like drug reimportation, guarantees of purchase of branded drugs by the government, and no price controls.

Then, as Strassel carefully notes, Congress reversed itself as the going got tough. Now, reimportation is back on the table, as are Medicare drug price controls and new limits on certain pharma patents.

This just goes to show how dangerous it is for the private sector to succumb to Congressional coercion and, worse, try to jump into bed with that branch in order to trade favors.

It's always far better for industry to aggressively defend and express its own views contrary to government's. The risk to business is that, having given in on some key aspects of a business model, the impression is that the firm was either lying in the past about its business processes, or didn't really need some practice it vociferously defended.

Now, thanks largely to Kindler, Big Pharma is left looking like they agreed with Congress on many issues which are, in fact, key to their current business models.

Perhaps Pfizer's board should have been more careful in choosing its new CEO and so radically changing its pro-free market orientation.

Monday, February 08, 2010

Scott Patterson's "The Quants"

I recently purchased Scott Patterson's new book, "The Quants," about the excerpt of which I wrote here.

So far, about 1/5th of the way through Patterson's work, I would give it a huge, unequivocal "buy and hold" rating.

The excerpt was a very representative sample of his writing. But the book is much, much better than the excerpt could possibly convey.

Patterson writes in a style reminiscent of Michael Lewis crossed with Tom Wolfe. He digs deeply into the roots of quantitative trading, providing very interesting stories of Ed Thorp and his own mathematical predecessors.

Having worked at AT&T, and knowing of Claude Shannon's impact on information theory and computing, I was delighted to read of his chance involvement with Thorpe's own early work.

In any case, my early verdict is that the book is well worth buying/reading.

Cuomo, Lewis, Paulson & Bernanke...and the Martin Act

New York gubernatorial candidate and, oh, yes, current AG Andrew Cuomo has finally brought suit against former BofA CEO Ken Lewis, and his CFO, under the Martin Act, for Lewis' alleged wrongs in the BofA-Merrill Lynch affair. My initial thoughts about this go back to last March, when I wrote this post, as Cuomo began bellowing his threats to file this case.

I had a very spirited debate about this case with my business partner yesterday morning.

My partner's opinion is that what is done, is done. Let's not waste time and money picking through the wreckage of a done deal that has, by the way, actually turned out profitably for BofA. Government if full of thugs who wield too much power, usually coercively, and this case won't change that.

In fact, he noted, even Ken Lewis doesn't want his day of reckoning in court.

I have a different perspective. I welcome the opportunity for a trial in which Lewis, probably John Thain, Ben Bernanke and Hank Paulson can all be made to tell the truth, under oath, about their actions in this mess.

The motives of everyone are quite transparent:

Andrew Cuomo- currently thuggish AG of NY, badly wanting to follow Eliot Spitzer to the governorship on the back of this sensational case.

Ken Lewis- hapless, gutless former CEO of BofA who folded like a house of cards under pressure from Bernanke and Paulson, probably violating a slew of SEC regulations involving his fiduciary duty to his shareholders.

Hank Paulson & Ben Bernanke- probably engaged in illegal, improper and coercive behavior to force Lewis, against his wishes, to complete the Merrill Lynch purchase and deceive his shareholders regarding the total cost of the deal and Merrill's losses.

John Thain- recently-hired CEO of failed CIT, wants desperately to publicly clear his name in the Merrill Lynch affair.

Ideally, this trial will illuminate just who did what. From the various media accounts, someone is lying.

Bernanke and Paulson deny strong-arming Lewis. Lewis claims he didn't want to consummate the deal, but was forced to do so by Bernanke and Paulson. Thain claims he told Lewis about the losses and bonuses at Merrill. They can't all be telling the truth.

Ironically, as today's lead Journal staff editorial notes, Cuomo is personally responsible for having touched off the financial meltdown by setting higher percentages of low-income mortgages to securitize at Fannie and Freddie, while lowering downpayments.

In the recent Journal editorial, however, they made a rare mistake, claiming that because Merrill made some money for BofA last year, the deal was thus a good one. Really?

Doesn't it matter what the final purchase price was, and how much money was made? It's not clear yet whether Lewis' final string of acquisitions, including Countrywide and Merrill, will actually prove to be accretive. Maybe, with the fungibility of federal loans, we'll never know.

What better day of reckoning for the lot of them than a public courtroom and sworn testimony?

If everything goes well, there should be some perjury charges coming against someone or ones.

As I said to my business partner, I believe it's important for the public to see, if true, how federal officials Paulson and Bernanke improperly used their positions to coerce private company executives. If they abused their power, it should be made public, and they should be charged and convicted of said offenses.

We'll never curb abuses of power by high-level federal officials without making examples of those who misbehave. No matter if the events are now in the past.

Were someone with omniscience to inform us all, here's what I believe we'd learn:

-Ken Lewis abdicated his fiduciary duties to his shareholders, in order to keep his job.
-Bernanke and Paulson illegally coerced Lewis to behave improperly, keeping his shareholders ignorant of important new risks in the Merrill Lynch transaction
-John Thain informed Lewis and his BofA team of the losses Merrill was incurring, and the bonuses planned to be paid to Merrill personnel.

I may be wrong. But those are my contentions.

If I'm right, Lewis, Bernanke, Paulson and maybe Lewis' CFO should all, ideally, be wearing orange suits and raking sand traps at Allenwood.