Ex-Goldman-turned-Hedge-Fund-Manager Cliff Asness is known for his candor when giving an opinion on a topic of social importance. The man cuts the crap and just lays it out there. It’s a long (albeit hilarious) read and I urge everyone to have a look. Believe me, it’s really funny.
Zero Hedge (an awesome finance blog which manages to avoid the usual pretentiousness through heavy sarcasm and humor) has posted a note outlining the potential scenarios regarding the recent discovery of a briefcase containing $134 Billion (yes, with a “B”) in U.S. Treasury bearer bonds.
Bearer bonds are different from normal Treasury notes in that they entitle whoever is holding them to trade them, receive coupons, etc. Since 1982, the Treasury has only issued their securities in “book entry” form, meaning the Treasury maintains a list of holders electronically. This change was made because of the immense number of outstanding notes which made maintaining records of holders and paying coupons in a timely fashion very difficult.
Since the change, bearer bonds only make up about 1% of all outstanding Treasury debt. Thus, $134B is no small number – especially to be found all together, neatly, in one briefcase (hidden in the lining of the case).
Zero Hedge theorizes the potential cases here: either the bonds are amazing forgeries or the Treasury has been lying to the public about the true outstanding amount…
Zero Hedge: An Open Letter To The Secretary Of The Department Of The United States Treasury
This article is a must-read if only to laugh at how ridiculous it all sounds. For those of us who actually work in this environment, it’s even funnier because it’s spot-on true.
Courtesy of Arvindh Rao, Bank of America/Merrill Lynch Chief Economist David Rosenberg has written what I believe to be an amazingly forward and honest article on the current state of the market. He cautions that the surge in the stock market from the March 9 lows, while possibly the cycle low for this bear market, may not imply the start of a new bull market.
History teaches us that many, many rallies such as the one we have witnessed recently have occurred, each one serving mostly to drive the shorts out of the market than provide returns for longs. This seems to be the period in which we build a new base for the next bull market, but we are by no means there yet.
Wisdom says, “follow the money,” and the big-money players have not put a dollar into equities yet. Fixed income continues to outperform the stock market and until new fundamental lows (the contraction of market P/E ratios, multi-quarter profits for conglomerates, and the stabilizing of unemployment and asset deflation) are set.
I think everyone should take two minutes to read the article below before deciding that it is time to start buying stocks. If the market declines from here out, as is quite probable when you see a 30% rally in two months, a small investor can become permanently disillusioned and lose a lot of money watching his nest egg once again decline in value.
Collateral 101: How It Works at AIG and Elsewhere http://viigo.im/cuW
This topic has come up in conversation with friends, on web forums, and in the media quite a lot lately, so I thought I’d give a couple of words about my opinions on the matter.
President George W. Bush’s legacy will not be as illustrious and positive as that of former President Clinton (sex scandals aside, the man is undoubtedly one of the most loved presidents in the last half a century).
A comment made on a popular web forum states:
It’s obvious that the integrity of the current administration is at an all time low.
What is most unfortunate for G. W. is that a lot of what has happened to our economy – I’m not touching the global politics aspect with a 10-foot pole – was simply unavoidable not because of his actions and policies, but because of those which preceded him. Many fail to realize, whether purposely or simply due to the shortcomings of human memory, that the problems being handled by the current administration were set into motion by the previous one. Remember, it was former Fed Chairman Alan Greenspan, who, in 1999 spoke in front of the world and lauded credit derivatives, setting in motion the bull run in mortgages that led to their crashing last August.
The quotes I reference in this post are all taken directly from Chairman Greenspan’s speech given on March 19, 1999, found on the Federal Reserve’s website.
The reason that growth has continued despite adversity, or perhaps because of it, is that these new financial instruments are an increasingly important vehicle for unbundling risks. These instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it. This unbundling improves the ability of the market to engender a set of product and asset prices far more calibrated to the value preferences of consumers than was possible before derivative markets were developed. The product and asset price signals enable entrepreneurs to finely allocate real capital facilities to produce those goods and services most valued by consumers, a process that has undoubtedly improved national productivity growth and standards of living.
Greenspan goes on to admit that these derivatives remain untested in trying economic times. He cannot predict what will happen when the market goes kaput.
While nothing short of a major economic adjustment is likely to test the underlying robustness of the derivative markets, there are reasons to believe that there are some fundamental strengths in these markets. First, despite the growing use of more exotic over-the-counter instruments, the vast majority of trades are relatively straightforward interest rate and currency swaps. The market risk on such swaps is presumably less daunting to individual counterparties than their underlying exposures, or presumably the swaps would never have been initiated. Moreover, the credit risks are increasingly subject to comprehensive netting and margin requirements that, although they do not fully remove the risk, significantly ameliorate it. And so far as banks are concerned, capital requirements are applied to such risks as they are to loans that create credit risks quite similar to those of derivatives.
Major economic adjustment? Well, here we are, nine years after he made said speech. Netting effects of the securities, we see, have not “significantly ameliorated” risk, as he predicted. The capital requirements set for banks regarding these credit derivatives were NOT sufficient as they were for “normal” derivatives. They have enabled leverage beyond Greenspan’s foresight and now it’s all unraveling. The real failure was that the Fed did not maintain control of this new product and their laissez-faire policies, to quote Jim Cramer, caused the major hurdles now facing the United States’ banking system.
This approach to regulatory capital requirements is not altogether satisfactory. The most sophisticated derivative dealers parse their derivatives book in more detail. And certainly a single point estimate cannot capture the range of losses that might reasonably be experienced. Hence, in evaluating derivatives risk, far more stress testing of the lower probability outcomes is a necessity. Even a one in 500 occurrence does happen once every 500 times, and if that occurrence could threaten the franchise value of the derivatives counterparty it is an important concern for risk aversion.
Excellent! Now Greenspan, even in 1999, sees the potential problem. So… why didn’t he do anything about it for his next 5 or 6 years as Fed chairman? Because the market was doing phenomenally. Why put the brakes on when you’re rippin’ and rollin’? He didn’t so much as make a peep about inadequate capital requirements for credit derivatives in financial institutions. It would have looked terrible if the Fed chairman stepped in to slow the economy while it was doing well rather than allow it to continue on its way. Politics and public opinion were more important to Greenspan at the time, so now Ben Bernanke is stuck cleaning up Greenspan’s mess with egg on his face while he does it.
Some may now argue that the periodic emergence of financial panics implies a need to abandon models-based approaches to regulatory capital and to return to traditional approaches based on regulatory risk measurement schemes. In my view, however, this would be a major mistake. Regulatory risk measurement schemes are simpler and much less accurate than banks’ risk measurement models. Consequently, they provide banks with the motive and the opportunity to engage in regulatory arbitrage that seriously undermines the regulatory standard and frustrates the underlying safety and soundness objective. Specifically, they induce banks to reduce holdings of assets where risks and regulatory capital are overestimated by regulators and increase holdings of assets where risks are underestimated by regulators.
It would be far better to provide incentives for banks to enhance their risk modeling procedures by taking account of the potential existence and implications of discontinuous episodes. Scenario analysis can highlight vulnerabilities to the kind of flights to quality and flights to liquidity that seem increasingly frequent. Stress testing of correlation assumptions can reveal the disappearance of apparent diversification benefits in such scenarios.
Great! But what happens when the models are created with data only from a bull market? What happens when there isn’t sufficient data from the previous real recession to even create a model for default? The banks followed his advice. They continued using stress models – models that, by hindsight, had more holes in them than Swiss cheese. Greenspan seems to shrug off this notion that the data is insufficient even though early creators of credit derivatives themselves admitted the lack of solid evidence.
I’d like to quote my favorite part of that speech and the main reason I’m so sick of everyone bashing President Bush for what’s going on in the market now.
History tells us that sharp reversals in confidence happen abruptly, most often with little advance notice. They are self-reinforcing processes that can compress into a very short time period. Panic market reactions are characterized by a dramatic shift to maximize short term value, and are an extension of human behavior that manifests itself in all forms of human interaction–a set of responses that does not seem to have changed over the generations. I defy anyone to distinguish a speculative price pattern for 1999 from one for 1899 if the charts specify neither the dates nor the levels of the prices.
Since the dot-com bubble burst in 2001, we’ve seen about 6-7 solid years of amazing growth. The economy has ripped, and even though the writing was on the wall (remember the big stink we were making about outsourcing killing the economy about 3 years ago?) we ignored it because there was no evidence of it. Until now. In 12 short months, we’ve reversed 7 years of gains. This problem could have started next August if the timing had just worked out that way.
Let’s pretend for a moment that it did. McCain or Obama would have been roasted on a spit for the economic woes we’d face. “The economy was fine under Bush, how did McCain/Obama fuck it up so badly???” we’d undoubtedly say.
Finally, the big “fuck you” that Greenspan, in 1999, gave to the U.S. economy of 2008.
As we approach the twenty-first century, both banks and nonbanks will need to continually reassess whether their risk management practices have kept pace with their own evolving activities and with changes in financial market dynamics and readjust accordingly. Should they succeed I am quite confident that market participants will continue to increase their reliance on derivatives to unbundle risks and thereby enhance the process of wealth creation.
Tongue-in-cheek translation: Hey big financial institutions! It’s up to you guys to take care of your own risk assessment! We’re gonna lend to you as long as you keep asking us for money! When you sit on uncle Al’s lap and I ask you, “have you been good this year and made sure to manage your risk?” I’m going to believe you when you undoubtedly tell me “Yes!” I trust you, because you’re all great people creating wonderful instruments that help someone earning $50,000/year buy a $750,000 home at 5% mortgage rates.
When he says “should they succeed” he pretty much washes his hands of the entire problem. He will not monitor the banks’ risk to see how these new credit derivatives weather trying times (as he definitely should have since their creation), but instead will put the onus on them to properly manage themselves.
Former Chairman Greenspan’s lax risk governance, combined with the FASB’s allowance of off-balance sheet assets (QSPEs, SIVs, CDOs, etc.) from their creation until only recently, allowed banks to become printing presses essentially. They could boast their amazing returns from these derivatives, show the fed and the world how low their risk was, and keep trouble from reaching the eyes of shareholders… unless the gravy train derailed. The failure here was economic policy. I do not fault the lending institutions, nor the idiots who bought into mortgages thinking they suddenly could afford a house twice as expensive for no additional cost. I point my finger squarely at the Fed for not having slowed this raging bull down a long time ago simply because it would have “stunted economic growth” if they had done it while everything looked (note: looked, not was) hunky-dory.
Greenspan left the Fed on top. He timed it absolutely perfectly. Now, hopefully, Bernanke can guide the U.S. through this storm and create a proper legacy for himself as the guy who saved the U.S. economy in 2008-2009. I only wish people would realize that while Bush’s administration has had some amazing, mind-baffling follies, the economy wasn’t one of them. The economic stumble and subsequent fall we’ve seen (and will see going forward) were created by shitty businesses domestically (see: U.S. Airline Industry, U.S. Auto Industry) and Fed policy that all but encouraged greedy lending practices.
 | Hometown: Brooklyn Age: 24 |
