Thursday, December 20, 2007

Another interesting article about Bear...

Making a market all by yourself...

Now investigators are trying to determine whether Cioffi and his team
crossed legal lines. The Klios provided the Bear hedge funds with a
ready, in-house trading partner. Their financial reports, which were
reviewed by BusinessWeek, show many months in which the Cioffi-managed
Klios traded only with the Cioffi-managed Bear funds. For example, in
April, 2006, one Klio CDO bought $114 million worth of securities from
one of the Bear funds. Such trades, says Steven B. Caruso, an attorney
who represents several Bear hedge fund investors, may be "indicative
of an incestuous, self-serving relationship that appears to have been
designed to establish a false marketplace."

If that's why the trades were made, the maneuvers could have falsely
boosted the hedge funds' returns—and the fees Cioffi and his team
collected. In an e-mail to Cioffi and co-manager Matthew Tannin cited
in a legal filing, Raymond McGarrigal, another executive at the Bear
funds, gushed about the Klio setup, writing that "one of the great
things we've done is allow the Klio to buy assets from the hedge
fund." Lawyers for Tannin and McGarrigal declined to comment.
The End of an Era?

Full article:

Wednesday, December 19, 2007

Latest on Bear... stated here previously, lawsuits aplenty from the fallout.

Bear Stearns Sued by Barclays Unit Over Fund Collapse
2007-12-19 17:47 (New York)

By David Glovin and Yalman Onaran
Dec. 19 (Bloomberg) -- Barclays PLC, the U.K.'s third-
biggest bank, sued Bear Stearns Cos. over losses caused by the
implosion earlier this year of a hedge fund that invested in
subprime mortgages.
Barclays Bank PLC, a unit of London-based Barclays, claimed
the New York-based securities firm hid negative financial
information about the collapsed fund, according to a complaint
filed today in Manhattan federal court. Barclays said it was the
``sole participating shareholder.''
The collapse of the Bear Stearns fund was ``one of the most
high-profile and shocking hedge fund failures in the last
decade,'' Barclays said in the complaint, which seeks unspecified

Tuesday, December 18, 2007

What precision...

A very precise estimate for the Russian markets next year. One wonders aloud: "Why not 31% or 33%...or any number in between?

Russia's RTS May Surge to 3,000 in 2008, Banks Say (Update2)

By William Mauldin

Dec. 18 (Bloomberg) -- Russia's RTS Index will climb 32 percent to 3,000 by the end of next year as government spending shields the economy from a global slowdown, according to UralSib Financial Corp. and Renaissance Capital.

UralSib's Chris Weafer, the top-ranked Russian equity strategist in Thomson Extel's 2007 survey, and Renaissance's chief strategist Roland Nash recommended buying shares of OAO Gazprom, Russia's biggest natural-gas producer, and companies that will benefit from government investment in refining, smelting, railroads and electricity.

Sunday, November 25, 2007

Silly market analogy of the month.

The mechanics of gravity are "slightly" different from market movements...whether plotted on the traditional euclidian X and Y axes, or compiled into different statistical packages. My target for this year was 1320 for the S&P, and I thought this was pessimistic...and the proliferation of "the end is nigh" analogies such as the below makes me think that we may be in for a rally.

SAN FRANCISCO (MarketWatch) -- "Perched on the edge of a cliff."
That's how one economist describes the U.S. economy as the markets get ready for a busy week of data, including numbers about the already damaged U.S. housing market, orders for durable goods and personal income and spending.
"What we're looking for is confirmation that indeed the U.S. economy is slowing sharply in the fourth quarter," says Ellen Zentner, an economist at Bank of Tokyo-Mitsubishi UFJ. Zentner said that within a month, it could be apparent whether the economy is slipping into a recession or not.
"The U.S. economy is really perched on the edge of a cliff right now," says Zentner...

Tuesday, November 20, 2007

Now the dollar does matter...

One could add a nice politically minded narrative that includes Ron Paul's recent lambasting of Bernanke, but the truth is the dollar matters to the Fed, and it is now disclosing more of its hand. By deeming the rate cut a "close call", it has finally begun to take steps in ameliorating inflation expectations, which has ticked up considerably since its actions starting September 18. It is still in between the Scylla of inflation and Charybdis of housing-led recession...and it knows that the financial economy (an admittedly loosely defined term) has always followed the real economy and the engine of housing.

By Brian Blackstone
WASHINGTON (Dow Jones)--Though last month's decision by the U.S. Federal
Reserve to lower official interest rates was a "close call," officials were
worried enough about the chances of a severe housing-induced downturn to act,
according to the minutes of that meeting released Tuesday.
The minutes dwelled extensively on the economy's vulnerabilities, suggesting
that while officials adopted a neutral view of economic and inflation risks
last month, they probably see the potential downside from weak growth as the
bigger worry.
Reflecting the jittery balancing act officials face, they also seemed more
worried about the dollar than in previous meetings, calling its recent
"significant" decline an inflation risk.
"Many members noted that this policy decision was a close call," the Fed said
in the minutes of the Oct. 30-31 Federal Open Market Committee meeting. Minutes
are usually released with a three-week lag, but October's were moved up one day
so as not to conflict with the early market close Wednesday ahead of

Monday, November 19, 2007

A banking problem.

As I have said repeatedly, a financial crisis is immiminent in China. Central planning (unless of the U.S. Fed variety I say with a little sarcasm) cannot work as a doctrine. Investors and institutions with shiny new deposits in Yuan will have to deal with risk a magnitude greater than "sovereign risk".
However, I must admit that this problem is as old as international investment, and with the present era of fiat money and its ability to create and destroy money at an unprecedented rate, I think we will find that global capital flight will be exacerbated. "Its different this time" should read to any investor as "I have 6 months to find buyers of my securities inventory at favorable prices before a crash".

The below illustrates some of what I said above - do you really want deposits with Chinese banks and their centralized monetary system?

China Freezes Lending to Curb Investing Frenzy
November 19, 2007;PageA1

SHANGHAI -- Chinese authorities are slamming the brakes on bank lending, in
their latest attempt to curb the runaway investment threatening to overheat
what is soon to be the world's third-largest economy.
In recent weeks, regulators have quietly ordered China's commercial banks to
freeze lending through the end of the year, according to bankers in several
cities. The bankers say that to comply, they are canceling loans and credit
lines with businesses and individuals.
A China Banking Regulatory Commission official here confirmed that local and
Chinese subsidiaries of foreign banks have been asked to ensure that loans
at the end of the year don't exceed the total outstanding on Oct. 31.

Sunday, November 04, 2007

C to disclose more write-offs...

I don't want this to become a news blog, but the number of write-downs from major houses is something that can't be ignored. I know very few people (myself decidedly NOT included) who know how to "properly" value a security backed by cash waterfalls originating from mortgages. It's interesting to note that the banks taking the largest write offs had these things in their own inventory, and not in the inventory of their in-house hedge funds...

By David Enrich and Robin Sidel

NEW YORK (Dow Jones)--Citigroup Inc. (C) is poised to announce billions
of dollars in further writedowns on mortgage-related securities,
according to people familiar with the matter.

The announcement is expected to come as early as Monday morning, in
advance of Citigroup submitting its quarterly report to regulators, the
people said.

The size of the additional writedowns was still under discussion Sunday
by Citigroup directors, but people estimated they could be $7 billion to
$8 billion. That would come on top of about $2.2 billion in
mortgage-related writedowns and trading losses that Citigroup reported
last month as part of its third-quarter earnings.

Friday, November 02, 2007

Hey Stan, its on Tuesday???

Two of the largest banks lose their CEOs within a week. With the interdependence of the banks, more will likely follow.

NEW YORK (Reuters) - Citigroup Inc (C.N) Chief Executive Charles Prince plans to resign this
weekend, the Wall Street Journal said, as the widening subprime mortgage crisis deals a final blow
to a reign long under attack.

The largest U.S. bank by assets plans to hold an emergency board meeting on Sunday, at which Prince
will step down, the newspaper said on Friday, citing people familiar with the situation.

Its hard to lose $8 Billion and not get sued...

Headline risk is something that is difficult to quantify! I appears that Merrill was attempting to smooth earnings and/or create a buffer zone for mortgage-related losses. They moved these losses off balance sheet via repo (repurchase) transactions with some hedge funds, thus avoiding dreaded "mark to market" losses.

Deals With Hedge Funds
May Be Helping Merrill
Delay Mortgage Losses
November 2, 2007; Page A1

Merrill Lynch & Co., in a bid to slash its exposure to risky mortgage-backed securities, has engaged in deals with hedge funds that may have been designed to delay the day of reckoning on losses, people close to the situation said.

The transactions are among the issues likely to be examined by the Securities and Exchange Commission. The SEC is looking into how the Wall Street firm has been valuing, or "marking," its mortgage securities and how it has disclosed its positions to investors, a person familiar with the probe said. Regulators are scrutinizing whether Merrill knew its mortgage-related problem was bigger than what it indicated to investors throughout the summer...

Thursday, November 01, 2007

Its hard to lose 2 Billion and not get sued...

Bear Stearns may face forensic review of its "High-Grade Enhanced Leverage funds". They will have even more problems if it is found that their proprietary desk was dumping unprofitable positions on the two funds. This is going from bad to worst for Bear, and it seems the media wants to have all the chiefs of the investment banks involved in the credit crisis to fall on their swords.

INVESTMENT BANKING Investors want Bear funds probe

(From The Daily Telegraph (LONDON), provided by LexisNexis)
Publication: The Daily Telegraph (LONDON)

James Quinn Wall Street Correspondent

BEAR Stearns chairman and chief executive Jimmy Cayne is to come under yet more pressure after investors in the bank's two collapsed hedge funds joined together to lobby for forensic probes in to their demise.

Institutional and private investors accounting for more than 25pc of holdings in each of the two funds have combined in order to attempt to vote off Bear Stearns as controlling party from each of the two High-Grade Enhanced Leverage funds

Wednesday, October 31, 2007

Excellent growth and let's cut rates again!

GDP growth galloped along today at 3.9%, and yet YOUR Fed cut rates. Interesting.

Our all-knowing eye in the sky Fed calculates GDP by obtaining "nominal" GDP then subtracting a price deflator (in other words, they subtract some inflation amount from nominal GDP) Nominal GDP growth was 4.7%, the deflator is .8%, and so we get that 3.9% number...which was mid/late 90s type of growth.

I will not get into details, but, suffice to say, I don't believe that the GDP Deflator was a 40yr. low .8%. This is important because the deflator is subtracted from current nominal GDP growth (4.7%) to obtain "real" GDP growth: 3.9%.

I simply do not take such a sanguine view of inflation, in light of obvious indicators of increased inflation expectations (gold, dollar index, commodities, etc., etc.) no matter what data the Fed is providing at the moment. I will take market reaction over a central government's data processing unit any day of the week.

Wave of Litigation

As if an 8 Billion write-off was not enough, Merrill is being hit with a shareholder lawsuit. They will not be the only ones, and sooner or later all the large investment banks that had subprime exposure will be embroiled in litigation.

It will be interesting to see the Plaintiff's try to circumvent the business judgement rule in law as applied to "reasonable" securities will also be a good test to determine the facility of our legal system to conceptualize complicated securities.

Article below:

NEW YORK (Reuters) -

An investor lawsuit has been filed against Merrill Lynch & Co Inc
(MER.N: Quote, Profile, Research), contending that the company issued
false and misleading statements about its exposure to risky mortgage
investments, the plaintiffs' lawyers said on Tuesday.

The lawsuit, which the lawyers said was filed in U.S. District Court
for the Southern District of New York, seeks class-action status. It
was brought by law firm Coughlin Stoia Geller Rudman & Robbins LLP on
behalf of an institutional investor, Life Enrichment Foundation.

The complaint accused Merrill of issuing materially false and
misleading statements about its financial exposure to collateralized
debt obligations (CDOS) containing subprime mortgage securities.

The company's statements "were materially false due to their failure
to inform the market of the ticking time bomb in the company's CDO
portfolio due to the deteriorating subprime mortgage market," the
complaint said.

Also named as defendants are Stanley O'Neal, who was ousted as Merrill
chairman and chief executive on Tuesday, firm Co-Presidents Ahmass
Fakahany and Gregory Fleming and Chief Financial Officer Jeffrey

The complaint was brought on behalf of purchasers of Merrill stock
between February 26 and October 23.

A Merrill representative was not immediately available for comment

Wednesday, October 24, 2007

Stress Testing

A popular online encyclopedia defines a "stress test" as the following:

"Stress testing is a form of testing that is used to determine the stability of a given system or entity. It involves testing beyond normal operational capacity, often to a breaking point, in order to observe the results. Stress testing may have a more specific meaning in certain industries."

Most people in the quantitative financial community (yours truly included) have performed "stress tests" on portfolios of financial assets - sometime one has to "sum up possible futures and average to the present" (or simply ask "what is the worst thing that can happen?) to get a good idea of what your portfolio might look like when "Black Swans" arise.

It goes without saying that there is an initial decision of magnitude with regards to the stress test - how stressful do you want the test to be?

Today, the CEO of a very large investment bank that was forced to write-off over 8 Billion in financial assets stated (paraphrasing) that his "risk managers" never thought to provide a harsh stress test and that events caused asset prices to go below the "most punitive" stress event scenarios.

Quantitative aptitude (the ability to run models) is a different skill set from creativity (the ability to imagine events that might be more stressful than one has seen in the past).

More on the Paper Dragon

Warren Buffet has weighed in on the China question.

An economy based on defacto central planning and cronyism cannot enjoy double digit GDP growth forever.

It would better serve an investor to think about the ramifications to global asset prices WHEN China's stock markets "correct" than to think about investing in Chinese companies.

Tuesday, October 09, 2007

The convergence of "risk".

"Convergence" has long been talked about in terms of ReInsurance and capital insurance contract is just a binary put option, for example. A collection of these options will likely converge (Central Limit Theorem) into stable normal distributions. But notice in the article how local (micro) knowledge regarding specific ("idiosyncratic" in the finance lexicon) risks can obviate the need for assessing risk as a truly random variable in a population.

Here is a pretty good (albeit general) discussion of how Reinsurers think about risk, it is not exhaustive by any means, but it does illustrate the fact that "risk" is not "beta" or sigma/SDEV or any single measure. "Risk" has many origins. We just choose to distill its antecedents into something more tractable.


interesting section:

"So I think volatility and liquidity concepts are concepts applicable to low-risk, relatively low-return risk classes. Casualties, reinsurance and Cat reinsurance are high-return, high-risk classes. And they demand a different set of technical tools and methodologies to accurately assess the risk and actually -- accurately price the risk.

So when I look at investment banks and I look at VAR, value at risk, which is a daily measure, and I look at [reinsurers], which is capital at risk, which is an annual measure, one measures daily volatility. One measures downside risk. I think, again, for those risks which are long term in nature, which are difficult, which are severe, you're much better off with the CAR concept than you are with the VAR concept.

We have within the organizations, all the reinsurers represented today, we have great quantitative skills. Our actuaries are as smart as the quants in many cases, in all cases. At a number of our capital markets competitors, when a math major leaves college, it can go two ways. They can either go become a quant on Wall Street, or they can become an actuary for the insurance or reinsurance industry. I haven't been able to see any kind of difference in terms of the capabilities of the people who take either one of the two paths. They tend to be very similar.

I think the difference is, is that while the math is generally the same between capital markets and reinsurers, I think the atmosphere within which they work is distinctly different. There is a long culture within insurance and reinsurance companies of asking the actuary to come up and give you the long -- the bad answer, the answer you don't want. The worst thing as a CEO is when the actuary walks into your office and says can I talk to you.

I'm not sure that that always happens sometimes on the capital markets side, where in fact it is difficult to see how the actuary or the quant has the ability to withstand the blandishments sometimes perhaps of the trader. In our shop and in most reinsurance shops, the actuary and the underwriter are coequal in terms of their analysis and coequal in terms of their authority to put the Company at risk."

Sunday, October 07, 2007


I debated for some time whether or not to post the following article from the New Yorker:

Why? Because in a world where conformity and timidity guarantees a certain amount of safety, there will always be iconoclasts who see the world not as risk, but as opportunity. We should celebrate the "failure" of these individuals, not villify them for not playing it safe.

The tragic/flawed hero subject of the article is someone I have alluded to several times on this blog. I would agree with the article that Victor is someone who has an almost preternatural ability to shoulder risk (in all forms of his life). He just cannot seem to tolerate a day without the presence of thought-concentrating levels of risk. This perspective towards life and investments should serve as more inspiration than cuationary tale.

(Of course, I have to disclaim part of the above with the caveat that investors should always be aware of what the strategy and risks a fund is employing. In this case, it was clear: To generate high returns, one must take high amounts of risk. There are no free lunches, and the current malaise effecting several prominent hedge funds serves to illustrate that funds advertising high returns and low risk might suffer from the "past performance is no guarantee of future success" mantra)

What the article does not say is how generous a man he is and will continue to be. I never had Abalone (a shell-fish delicacy) in my life prior to meeting Vic Niederhoffer, and his teachings and way of analyzing the world has caused me and hundreds of others immense benefit. He will do more than merely "survive".

Friday, October 05, 2007

No surprise...

About criminal investigations at Bear following the closure of a couple of its fixed income hedge funds (which had drifted considerably from the strategies their prospectus and disclosures said they would follow) due to large (70-80%) losses. This headline risk is something most financial institutions discount...but one can see how quickly it can cause massive damage to a firm.

Federal Prosecutors Launch Probe of Bear Stearns Funds
October 4, 2007 7:01 p.m.

Federal prosecutors have launched a criminal investigation into two
Bear Stearns Cos. mortgage-related hedge funds that collapsed during
the summer, according to people familiar with the matter.

The U.S. attorney in Brooklyn has made a request to Bear Stearns for
information related to the hedge funds, whose failure cost investors
$1.6 billion, said these people. The probe is in the early stages, the
people added, and has not generated subpoenas.

The specter of a criminal investigation is clearly bad news for the
embattled Wall Street firm, which is already under the microscope by
the U.S. Securities and Exchange Commission. Thursday, two weeks after
reporting an abysmal third quarter marred by broad declines in their
asset-management and fixed-income operations, Bear officials tried to
put a positive spin on the firm's future during an investor gathering
at its New York City headquarters.

Wednesday, October 03, 2007

The Paper Dragon redux...

Markets are, as evidenced by the recent peformance of the Hang Seng, finally waking up to the Macro prospects for China in light of a depreciating dollar against a Yuan that the PRC will not allow to
appreciate. Something has to give, and it will. As I have said many times, China (which I have pejoratively called "The Paper Dragon") is in deep trouble. If it allows the Yuan to appreciate, its export industry will be "adversely effected". If it does not, rampant money creation (read: inflation) is the result.

Now, academics (in China, no less) are waking up to the facts of life as well. China will now face an immense challenge to its legal rule set as the temptation to keep politically connected (yet functionally bankrupt) businesses afloat...which is the "objective necessity" (to borrow from the incomprehensible Marxist lexicon) of central planning. Ruling with an Iron Hand on a sliding scale indeed.



Not all of my readers will agree that large Chinese banks are basically insolvent, but I am very skeptical that the published figures correctly state the extent of bad loans. They almost certainly understate the extent of expected bad loans associated with the surge in new lending over the past three years.

The option framework predicts that in such a case investor perceptions of the quality of management or of levels of non-performing loans will have little to no impact on the share price performance of Chinese banks. Instead share prices will primarily reflect investor perceptions of changes in China’s underlying economic volatility. China’s banks are expensive, in other words, not because they are in good shape, but rather because there is so much future uncertainty about the Chinese economy, and it is increases in that uncertainty, not improvements in the quality of the banks, that are most likely to drive prices up.

This has happened in many countries undergoing reform besides China. For example when Mexico’s 18 banks were privatized in 1991-92 as part of the massive economic and political reforms the country was undergoing (I was part of the team at credit Suisse First Boston that advised the government on the privatization), their purchase prices far exceeded even the most optimistic estimates provided by the advisors, the government, and the banking industry, which were largely based on discounting expected earnings.

Tuesday, September 18, 2007

Headfakes and Credibility

Ah, to be so wrong is a wonderful thing...and something the Fed will likely have to experience as well after the election.

So what is it then, a "calamity" as Mr. Poole said a little over a month ago? Something else? Who knows?, and that is the problem.

After the Fed has preached a new era of "transparency", after it has enumerated the importance of headline vs. core measures of inflation, even after it has reminded us it holds an "infaltionary bias" time and time again, we now have a 50 basis point cut.

And, adding insult to injury:

"Today's action is intended to help
forestall some of the adverse effects
on the broader economy that might otherwise
arise from the disruptions in financial markets..."

"Forestall"??? The fed has now jettisoned its "data dependent" stance (which obviously is an ex-post determination) for a shiny new machanism called "forestalling" What does this mean and how do they do this? What credibility does the Fed now have?

Predictably, the dollar has been "adversely effected" by this and will likely have its worth month in perecentage terms in 30 years.

Oh, and lest I forget, all commodity metals closed limit up today.

Everyone who reads this column should keep a very close eye on 3rd quarter GDP figures, if they come in hotter than expected, more fireworks to follow.

Thursday, September 13, 2007

Fed Funds

Notwithstanding the housing markets, LIBOR, and related credit/financing difficulties, how can the Fed raise when:

1. CPI annualized at 4.5 percent
2. Equity prices still up for the year
3. Chinese import price increases
4. Dollar weakness
5. ** ...adding to GDP via increased exports
6. Commodity prices Oil, gold, etc.


1. Shift from "core" to "headline" as starting point for inflation expectations
2. Bernanke's awareness of Miller in 79 pegging to the inflation rate and not above it to contain inflationary exectations
3. Needing the housing market to calm things down to acceptable levels
4. The geopolitical situation in the middleast subsiding somewhat...less incentive for oil importing countries (Japan, China), to subsize out security outsourcing services by buying our government debt. (I have no doubt that the recent move by the Saudis was precipitated by Iran's newfound diplomatic cooperativeness...)
5. Possibility of lates employment figures reflecting demographic changes, and unemployment too "low" (from Phillips curve and other "useful rule-sets" that the Fed "considers")

Most economists predict a rate cut...but then again most economists (who respond to polls taken by business publications) work for institutions where that would be a beneficial outcome. Then, if the Fed stands pat, as I think, they will express shock at the Fed "going against expectations". Inflation expectations formed by the consumer are VERY different than the expectations garnered from economists.

Wednesday, September 12, 2007


The dollar is declining yet again on participants acting on the future direction of interest rates as implied by the futures markets...and I will playfully throw in "Yen carry trade" to complicate matters on the cuasation of dollar depreciation.

Bernanke will have his hand firmly on the inflation expectations machine, and the price of oil is not helping the cause. I have said several times on this blog that HEADLINE inflation figures (which includes energy and commodity costs) are the Fed's new preferred mechansism for measuring inflation in this current market regime...and if that is the case, then a rate cut is not in the cards next week.

I also think that, in light of LIBOR rates, which have increased heavily due to it being the only viable financing vehicle for longer-term debt obligations and the now-frozen CDO/SIV/MBS markets, Bernanke might well refuse to move on rates at all. He must pay attention to rate differentials.

All that being said, I am watching U.S. fiscal position (i.e., the budget deficit) ever more closely at the moment, as this is the key to understanding dollar strength and money supply. The following article is an excellent essay on that subject:

Friday, September 07, 2007


Bernanke is being pressured from just about all sides to cut rates.

From Greenspan to Congressmen, he is being pressured to cut rates.

However, it is extremely difficult to put the inflation genie back in the bottle once its out. Money supply figures continue to drift higher, and common inflation figures are still running a bit hot for the Fed to gravitate from its stated position that Headline inflation is its concern.

But then we have the troublesome second edict of the Federal Reserve: (the first being "price stability)


So today's print of 4,000 net jobs added to the economy only fuels the calls for cuts. This is a very difficult exercise in timing, and Bernanke is going to have to commit himself to a position rather than simply say his job is to facilitate price stability AND full employment. This decision has to come soon.

Tuesday, September 04, 2007

Talking your own book...

..this is a somewhat pejorative term that some traders and investors use when it is obvious a proponent of a certain investment strategy has a position in same. The spectrum of human behavior is sufficiently narrow to ensure that this happens so often as to consider it an afterthought. Still, on some occassions, it still behooves one to practice this exercise in assessing when a "well known" economist or bank pundit has a decided interest in the outcome.

Case in point below. Mr. Feldstein is a director with AIG, which holds massive amounts of sub-prime debt why would he take the view that the fed should cut when just last year he thought inflation was of paramount concern to the fed? It is unfair to single out Mr. Feldstein as it seems every Wall St. bank also wants the Fed to cut for what is surely sound economic reasons having nothing to do with their own funding difficulties and financing prices...

Feldstein Warns of U.S. Recession, Urges Fed Rate Cut
2007-09-02 10:31

By Scott Lanman
Sept. 2 (Bloomberg) -- Harvard University economist Martin
Feldstein said the U.S. housing slump threatens a broader
recession, and the Federal Reserve should lower interest rates.
``The economy could suffer a very serious downturn,''
Feldstein, head of the group that charts America's business
cycles, told a Fed conference in Jackson Hole, Wyoming,
yesterday. ``A sharp reduction in the interest rate, in addition
to a vigorous lender-of-last-resort policy, would attenuate that
very bad outcome.''
Feldstein made a case for lowering the overnight lending
rate between banks to 4.25 percent from 5.25 percent to cushion
the economy from the fallout of defaults on subprime mortgages.
Chairman Ben S. Bernanke told the same gathering on Aug. 31 that
the Fed will do what's needed to stop the past month's credit-
market rout from ending the six-year expansion.
Lowering interest rates may result in a ``stronger economy
with higher inflation than the Fed desires,'' a situation that
Feldstein described as the ``lesser of two evils.''

Monday, August 27, 2007

Where to start???

The past 10 days serves as an excellent illustration with regards to the proper selection of significant variables going forward.

As the popular press has stressed, quantitative funds who have modeled the markets based on the historical relationships (be they correlative or factually dependent) between sets of prices have suffered some unsettlingly correlated losses.

These numerical relationships are, to put it mildly, "under stress". There are certain members of the press who see the results and quote some amporphous quality called "trading wisdom" and harken back to open-outcry systems, which by implication must be better during these conditions. But what do they mean by this?

Simple: The ability to utilize a deep-thinking form of educated common sense. It is the ability to "connect the dots" using metaphorical and narrative arguments as opposed to data-driven statistical or combinatory reasoning.

And, giving a nod to Soros, any system with thinking participants will produce self-sustaining bubbles as competition will chase profits and drive down the opportunity costs of prudent restraint..."No covenants on your Sub-prime backed equity tranche mortguage securities?? Who are we to argue?? Nobody else is either!! Give us the fee and see you later."

Quantitative analysis is no different. The investment industry has been flooded with brilliant mathematical minds all employing similar (or worse, functionally indentical) trading algorithms. Many have spectacular historical results which bred competition and duplication, using the same arbitrage arguments, the same financing vehicles to fund the trades and the same amount of leverage to make the crumbs on the floor look like loaves of bread.

And then someone yells "FIRE!!!" in the factory with one emergency exit, and the devil takes the hindmost.

Friday, August 17, 2007


and early.

The capital markets were moving to re-price risk categories. As I stated in the last post, beyond the initial euphoria of today, what will the logical interpretation of the Fed's surprise cut in the discount window rate today be?

I suppose we will have our answer monday, but this observer believes that the move will stoke suspicion that the capital markets (especially the credit markets, with CP rates blowing out today in spite of the cuts) are not as healthy as they appear an that a "calamity" may have arisen...

Thursday, August 16, 2007


A problem with saying that you will not lower rates barring "calamity" is that if you do indeed lower rates, participants will surmise that ragnarok is indeed upon us.

Wednesday, August 15, 2007

Fed watch...

As I have stated a few times before, the Fed cannot cut now. It is between the rock of inflation expectations (using Headline inflation as opposed to core inflation as criteria) and the obvious point that additional cuts will be calamitous for the dollar due to interest rate differentials with other currencies.

And today we hear from Bill Poole, noted inflation hawk, who squelches hopes for a rate cut barring "calamity" (whatever that is...) The following is from Bloomberg:

``It's premature to say that this upset in the market is changing the course of the economy in any fundamental way,'' he said in an interview in the bank's boardroom. ``Obviously, there could be an impact, but we have to rely on some real evidence.''

Barring a ``calamity,'' there is no need to consider an emergency rate cut, Poole said. His comments were the first by a Fed official since the U.S. central bank joined counterparts in Europe and Asia to inject emergency funds after a surge in money- market rates. The Fed has added $71 billion of reserves in the past five trading days.

Poole, 70, said businesses have maintained their hiring and investment plans and banks have sufficient capital to weather the credit-market turmoil. The St. Louis Fed chief stressed that the best course is for policy makers to assess the latest economic data when they next meet Sept. 18. The comments contrast with the certainty that traders put on a rate cut next month.

``If the data confirm the market's view that the economy is sagging, we'll have to decide whether to share that view,'' said Poole, who votes on the rate-setting Federal Open Market Committee this year. He cited the monthly jobs, retail sales and industrial production reports as key gauges he'll be watching.


Lots of this today as every asset manager in the known universe has a theory of why the credit crunch has happened and what will happen now that its here.

The problems will continue, and, as in the dot-com bubble, all the excesses will in hindsight found to be egregious and unwholesome..."greed" some will say. "Indictment" will be uttered by the government against selectively chosen transgressors (under the oft-utilized "the more publicly known, the better" criteria).

I expect international (especially emerging market debt) spreads to blow out a bit as well, effecting equity markets further. Credit crunches are sticky.

But. Soon, very will be time to go the other way.

Monday, August 13, 2007


This is a very astute move. One day before the last day to enter in redemptions, GS announces a cash injection into two of its hedge funds that have lost significant value during the volatility of the last two weeks. This effectively shores up the "run on the bank", and is a wonderful example of an investment bank using readily marketable names (such as Hank Greenberg THE most savvy and tough businessmen on the planet) to increase confidence among its investors. A wonderful marketing move, and this is the only reason why GS would seek to publicize this bailout (which of course is denied to be a bailout). One has to applaud.

Friday, August 10, 2007

The Paper Dragon and the Yuan...

A 67% trade surplus with the US. Over 5% inflation. Chinese are angry about the Blackstone deal, and are somewhat "disappointed" with the Shanghai elites gambling the People's money away...and now appear to be involved with Bear Stearns. Interesting.

In this age of information, it is not good when a communist country displays this kind of arrogance and disregard for its very large proletariat...

Thursday, August 09, 2007


...of leverage.

First, Europe. American investors have been putting positions into the Euro markets for some time to avoid reg. T guidelines.

Second, the Yen carry is unraveling as risk positions are paired (and we see the effects of the reduced positions in short-term yields as per the previous post). Asia is melting down at the moment and fear of contagion is everywhere.

Both of these circumstances levered up positions put on by American Hedge Funds, and the funding requirements they face now are all over the press.

Rumors abound regarding several Hedge Funds who are in trouble...and for my part, I hope that a certain fund manager in CT can make it through this tumultuous period, as he is most assuredly massively short vol.

The decline should be orderly... and we should end up at 1320 or so as I stated last year. the August Fed meeting awaits as a last hope for those who are long, but Bernanke, notwhithstanding the eurodollar market (which is pricing in one, possibly two cuts) will not budge unless ENERGY decreases. Oil controls everything right now.

Flight to quality.

A yield curve like this is "usually" not good for stocks (going back 30 years). A flight to quality with attendent credit concerns and a well-publicized liquidity injection of funds from the ECB (allowing levered positions in the U.S. seeking safe haven from Reg T.)that was, um..."deft".

Observe the short end of the curve dear reader in the past 48 hours...

Date 1 mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr

08/08/07 5.04 4.95 5.01 4.89 4.64 4.64 4.69
08/09/07 4.70 4.81 4.86 4.74 4.49 4.51 4.58

Now...THAT is good old-fashioned curve steepening!

Quant funds

An interesting article in the WSJ today highlights some of the issues I have been telling people for some time: Program trading exhibits similar herd-like behavior of many other markets...and to make matters more complicated, they typically use large amounts of leverage.
Of course, there had to be other players benefiting from the other side of the trades (which may or may not be quantitiative), but the general trend to quant shops in the hedge fund industry may improve the perceived uncertainty with the presentation of elegant equations and data that supposedly quantifies "risk" that cause investors to become wildly overconfident. And when the false security of numbers fails to perform as promised, investors begin their redemptions.

The punch line from the article:

"The reliance on models can be especially problematic because many quant
hedge funds have very similar models. That means they are often doing
the same trades and buying the same shares. Moreover, because the
strategies are supposed to be market-neutral, with no net positive or
negative bent, the funds often borrow large sums so they can bet more
and achieve better returns when things go their way.

That massive borrowing adds to the pressure when markets reverse course
several times in the course of a single day, as the stock market has
done repeatedly in recent weeks, or when tried-and-true relationships
between different markets suddenly break down."

Wednesday, August 08, 2007

The Paper Dragon assumes a threatening posture...

...which is an empty threat. Again, the I remind the reader that selling into declining prices, when everyone else knows what you are doing, will only lead to severely declining prices on the assets that have not been sold yet, leading to massive wealth drain and a decline in the national balance sheet. Another wonderful example of attempting to cause hysteria and worry for political gain, which is something of a national sport in China.

Readers here are directed to the book "The Three Kingdoms" for more on the Chinese aptitutde for deception - its simply part of the game and represents their cultural and historical answer to Machiavelli and Richelieu.

In any case, below is the news article in all of its silly splendor. One must ask: Why would the Chinese do this now, and who profits from a perceived increase in the animosity between our nations?

China threatens to trigger US dollar crash

By Ambrose Evans-Pritchard

Last Updated: 9:23am BST 08/08/2007

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US Treasury bonds if Washington imposes trade sanctions to force a yuan revaluation.

Two Chinese officials at leading Communist Party bodies have given interviews in recent days warning, for the first time, that Beijing may use its $1,330bn (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress. Shifts in Chinese policy are often announced through key think tanks and academies.

Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is breaking down through historic support levels.

It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession.

It is estimated that China holds more than $900bn in a mix of US bonds.

Xia Bin, finance chief at China's Development Research Centre (which has cabinet rank), kicked off what appears to be government policy, with a comment last week that Beijing's foreign reserves should be used as a "bargaining chip" in talks with the US.

"Of course, China doesn't want any undesirable phenomenon in the global financial order," he said.

He Fan, an official at the Chinese Academy of Social Sciences, went further yesterday, letting it be known that Beijing had the power to set off a dollar collapse, if it chose to do so.

"China has accumulated a large sum of US dollars. Such a big sum, of which a considerable portion is in US Treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency," he told China Daily. "Russia, Switzerland and several other countries have reduced their dollar holdings. China is unlikely to follow suit as long as the yuan's exchange rate is stable against the dollar.

"The Chinese central bank will be forced to sell dollars once the yuan appreciated dramatically, which might lead to a mass depreciation of the dollar."

The threats play into the presidential electoral campaign of Hillary Clinton, who has called for restrictive legislation to prevent America being "held hostage to economic decisions being made in Beijing, Shanghai or Tokyo". She said foreign control over 44pc of the US national debt had left America acutely vulnerable.

Simon Derrick, currency strategist at the Bank of New York Mellon, said the comments were a message to the US Senate as Capitol Hill prepares legislation for the autumn session.

"The words are alarming and unambiguous. This carries a clear political threat and could have very serious consequences at a time when the credit markets are already afraid of contagion from the sub-prime troubles," he said.

A bill drafted by a group of US senators, and backed by the Senate Finance Committee, calls for trade tariffs against Chinese goods as retaliation for alleged currency manipulation.

The yuan has appreciated 9pc against the dollar over the last two years under a crawling peg but it has failed to halt the rise of China's trade surplus, which reached $26.9bn in June.

Henry Paulson, the US Treasury secretary, said any such sanctions would undermine US authority and "could trigger a global cycle of protectionist legislation".

Monday, August 06, 2007


Now, like every other dicatator in history, we see Chavez laying the populist and pseudo-legislative groundwork for perpetual power. Propoganda will surely follow demonstrating his "unique" sensibilities and attendent populist "mandate" from the people.

Very similar to Putin.

Thursday, August 02, 2007

Meanwhile, in the Caribbean...

...a storm of an entirely different kind of volatility is forming:

No ponts for anticipating the obvious...

...and the first suits stemming from the Bear Stearns debacle have arrived:

The Washington Post reports: Bear Stearns Cos not only is seeking bankruptcy protection, but was hit on Wednesday by a legal claim stemming from the meltdown of two of its hedge funds, sending its shares, already under pressure from woes at a third fund, to a 19-month low.

The securities firm has been slapped with an arbitration claim for allegedly misleading investors about its exposure to subprime mortgages. The claim, filed with the NASD, was brought on behalf of a 73-year-old retired insurance salesman in Wisconsin who lost $500,000, according to the man's lawyers.

Investors have been widely expected to bring legal claims against Bear Stearns, which has been particularly hard hit by the contraction in the market for loans to home buyers with poor credit histories. "I think there's probably more where that came from," said Bill Fitzpatrick, an analyst at Johnson Asset Management in Racine, Wisconsin. "I suspect they're going to be vulnerable to a series of lawsuits."

The arbitration filed by Jacob Zamansky of law firm Zamansky & Associates, together with another lawyer, Ross Intelisano of law firm Rich & Intelisano, involves one of those funds, the High Grade Credit Strategies Credit Fund. It was filed on Wednesday morning and was brought against both Bear Stearns and Bear Stearns Asset Management, the lawyers said.

Wednesday, August 01, 2007

Trial balloons from the Fed...

...via Steven Beckner:

"First, while the Fed does not want a downturn, it doesn't want booming
growth fueled by overly exuberant markets either. Second, the repricing
of risk does not come as a total surprise to the Fed. Third, it is not
the Fed's job, nor its inclination, to bail out firms like Bear Stearns
or Countrywide that have made bad bets. Fourth, as its policy reversal
in August 1998 showed, the Fed is prepared to act aggressively to ease
credit when it perceives a liquidity crisis threatens financial and
economic stability. But fifth, there is a high hurdle for such action,
and it is doubtful whether that threshold has been reached or even
approached as yet."

So much for the Greenspan put.

Friday, July 27, 2007

Liquidity is dead...long live liquidity

As the unwinding of leverage across asset classes continues and the volatility term structure is "re-priced", it is worth noting that in environments when the volatility of volatility is high, the term structure if interest rates and expected returns is profoundly skewed to short-term securities. This rational tendency of participants has its own term strucure (i.e. when is panic abated?).

Thursday, July 26, 2007

One in the hand...

After a spectacularly wrong forecast for the dollar, my only solace at the moment is a fairly good "forecast" (or "educated guess") for volatility in July. It appears that the carry trade and some of the larger players who are currently mired in credit concerns and have limited access to additional margin will not be able to prop up the market...which finally looks like accepting the obvious.

The financial economy always and everywhere follows the real economy. Real estate is certainly part of the real economy and the current malaise flowing through that system is not going away.

Bernanke is probably prepping the Ben-Copter as we speak.

Saturday, July 21, 2007

Gentlemen, take your positions...

This article describing the end of the star-crossed relationship between Bear Stearns and Barclays as a result of the recent Hedge Fund collapse is interesting. The "adjudicator" of public opinion is used more often (and I must quantify this) it seems in large securities cases. That this tactic would be used is somewhat obvious - reputational risk is a large component of any investment bank's cache and ability to attract and retain clients.

As I said before, this is the beginning of the story with regards to Bear's legal liability, and if the "people familiar with the situation" have it correct, that Bear did indeed step outside of accepted parameters and did not disclose this to its investors, then one can easily recommend that Bear write this entire episode off and settle very, very quickly.

Tuesday, July 17, 2007

Increasing global violence...

...admittedly based on anecdote and vividness of recall. A chinese food safety minister is executed for taking bribes. The Red Mosque is taken down the Pakistani government. However, this is something entirely different, and far more dangerous. More assassination attempts in foreign jurisdictions by mother Russia.

Security services 'foil plot to kill Berezovsky at the London Hilton'
Richard Beeston, Diplomatic Editor
Boris Berezovsky fled Britain three weeks ago on the advice of
Scotland Yard, amid reports that he was the target of an assassination
attempt by a suspected Russian hitman.

The exiled tycoon and fierce critic of President Putin of Russia told
The Times last night that he had been warned that it was not safe for
him to remain in London, where he had been living since being granted
asylum in Britain.

"I was informed by Scotland Yard that my life was in danger and they
recommended that I leave the country," he said. "I left three weeks
ago but have now returned."

Glorious theorizing...

Brad DeLong, an wonderfully well-qualified economist waxes on in an ex-post narrative of how modern China got the way it did...largely through the efforts of one benevolent dictator. This is a great article for showcasing confirmation bias and the tendency for brilliant people with PhDs to make grand "hand-waiving" arguments when the real causes are much more likely to be parochial and formed by spontaneous order.

Worst than anticipated...

Bear Sterns making the news in the wrong way: both the highly leverage CDO funds were virtually wiped out. Not too many people anticipated this and it likely holds legal ramification for Bear as the funds must have been highly leveraged in the more "speculative" tranches that fell double-digits.

By Yalman Onaran
July 17 (Bloomberg) -- Bear Stearns Cos. told investors that
assets of two hedge funds that almost collapsed last month are
virtually worthless, the Wall Street Journal reported.
The assets of the High-Grade Structured Credit Strategies
Enhanced Leverage Fund are worth almost nothing, the Journal said
on its Web site, citing people familiar with the matter.
Assets in a second fund, the High-Grade Structured Credit
Strategies Fund, are worth about 9 percent of the value since the
end of April, the Journal said.
Bear Stearns was forced to provide $1.6 billion in emergency
financing to one of the funds last month after it made wrong-way
bets on collateralized debt obligations tied to subprime


...regarding the demise of the dollar have been greatly exaggerated. The following from Bloomberg describing the heavy foreign demand for U.S. securities. The last bit regarding the oil exporting conglomerate is especially enlightening.

China, the second-largest holder of U.S. Treasuries, reduced
its holdings by $6.6 billion, bringing its total to $407.4
billion. Over the two months of April and May, China's
investments in Treasuries have slumped by $12.4 billion, the most
in at least seven years. China is diversifying its foreign-
exchange reserves, the world's largest, to seek higher returns.
Japanese and U.K. investors increased their holdings of U.S.
government debt in May, while Caribbean countries' holdings
declined, the Treasury said.
Japan, the largest foreign owner of U.S. Treasury
securities, increased its holdings by $400 million to $615.2
The U.K., which, through London, acts as a transit point for
international investors, especially those in the Middle East,
added a net $33.1 billion, bringing holdings to $167.6 billion.
Caribbean banking centers, which analysts link to hedge
funds, sold a net $28.5 billion, bringing holdings to $48
Major oil exporters -- a group that includes the members of
the Organization of Petroleum Exporting Countries, Ecuador,
Bahrain, Oman and Gabon -- bought a net $9.1 billion of U.S.

Monday, July 16, 2007

Stupid analogy of the week

Ah yes, its time to go back to the Associated Press, which seems churn out consistently bad analogies and anthropomorphism involving the markets and biological organisms. I am, of course, sometimes guilty of the same trasgression, but I would like to think I don't submit gems like the following:

"Blue chips stocks jumped Monday as news of a potential big telecom deal involving Verizon gave a boost to the Dow and put the index closer to 14,000. Overall, stocks traded largely flat as investors digested the market's huge gains of last week."

Exactly...the market and its constituent investors are "digesting" the "huge" gains of last week. And so I ask, are they also metabolizing and secreting the same gains?

Thursday, July 12, 2007

Yuan (the paper of the Paper Dragon)

In response to a friend asking about the implication of Yuan appreciation:

While standard Keynesian macro-economic analysis adequately address the various "hand waiving" or "this happens then that happens in perfect textbook lockstep like fashion", one must keep in mind the probabilities involved here. What is more likely (or more easy politically), the Chinese government (still communist) allowing state-owned businesses to fail, or continuing to prop them up for a time? For example, China injected about 50 billion into a certain domestic bank prior to its IPO simply to clean up its liabilities and zombie loans...I very much doubt they will stray from those habits should the Yuan start hurting large exporters.

We can take a lesson from the Japanese MOF on this one. Its a very similar policy model in the sense that "all" of the MOF members went to the same university and think the same way: Weak yen = good until we can actually generate domestic aggregate demand (although I really am reluctant to use Keynesian concepts in todays world of fiat currency)

Lastly, let us quantify who owns what. Notice the foreign ownership of U.S. debt securities purchased by China on a monthly basis...some simple relationships reveal themselves while comparing net purchases, the U.S. dollar, the S&P and, of course, bond yields.

Wednesday, July 11, 2007

"Slightly" off topic to investments...

...readers here will recall that I am highly interested in science, and more specifically with feedback systems. I wrote the below recently to some friends explaining one of my favorite examples of feedback phenomenae.

We all know the importance of time intervals and sample periods when
looking at the markets, and it is somewhat unfortunate we lack
millions of years of data to strengthen our inferences or provide
additional hypothesis generation.

The market is rife with feedback mechanisms, both on granular (individual stocks)
and global (indexes) scales.

Fortunately, the planet earth has a wonderful temperature regulation
feedback system that serves to illuminate why global warming is a
problem of scale – humans will have to actively engineer, on a massive
scale (like blowing up the Rocky Mountains) carbon introduction into
the atmosphere in the future if we wish to live here.

The system can be characterized thusly: Plate tectonics produces
carbon dioxide through volcanic emission, carbon dioxide warms the
planet. Warming increasing weathering (surface water is a function of
temperature, as temperature rises, water evaporates leading to clouds
and subsequent erosion). Carbon dioxide then attaches chemically to
silicate rocks experiencing weathering. This process removes the C02
from the atmosphere and cools the planet. Carbon Dioxide is
introduced again by volcanic emission (and water is needed here as
well for subduction), and on and on.

This process that has kept the Planet at a relatively constant
temperature (never below freezing and never above boiling) for around
4.5 Billion years. Planets need land, water, and plate tectonics to
achieve this system that is very good for carrying life. An oceanic
planet would not be a very nice place to live, and likely would not
remain that way for long as the lack of temperature regulation would
likely boil the planet. (in the spirit of good taste, I will withhold
jokes regarding a certain movie starring Kevin Costner, as said movie
has already experiences too much suffering)

This feedback loop is interesting to me because of its massive time
scale. In the long run (geologic scale), we should be more worried
about making more CO2. But on relatively short scales (hundreds of
years), we may have a problem with increased temperatures due to our
own actions.

Looking at the markets, it is very clear what the "geologic" drift is,
caused by an extremely complex feedback system of its own…but when you
zoom in closer, it becomes apparent that too much on one side of the
differential equation can kill 90% of "oxygen-dependent species".
Life does go on, but it takes a different scale of time for that to

Monday, July 09, 2007


I must profess a high degree of ignorance regarding the extremely nebulous world of oil. As if the movie "Syriana" was not warning enough to amateurs such as yours truly.

Still, when probed by colleagues, I hazard the following observation regarding the price of oil in the coming year:

Saudis are setting price (and letting quantity float) now, in effect "cross-subsidizing" (read: bribing) Iran. This is analogous to Chamberlain's rationale in '39.

I can see oil at 22 occurring in two legs. If the supply of oil (and others on this list know these dynamics better than I do) increases enough to compel the Saudis to drop the price target and grab Spot bids. Chavez, Putin, and the Nordics then cut production for a further fall.

Of course, other things can compel the Saudis to drop their target as well...least of all the removal of all threats to the Saudis in the area...

Tuesday, July 03, 2007


...Reaches new highs just as the following happens. This is why consulting an economics textbook can only give the observer a very partial view of the entire global macroeconomic picture. Deflation is "supposed" to cause Yen appreciation. Euro players are backing up the metaphorical truck to the carry trade.

The Japanese monetary base in June fell 4.1% from a year
earlier to Y87.63 trillion, down for the 16th straight month,
preliminary data from the Bank of Japan showed. It followed a 5.7% drop
in May. Month-on-month, the monetary base decreased a seasonally
adjusted 0.5% at an annualized rate in June after a 25.6% drop in May.

And the Nikkei obligingly rises.

Saturday, June 30, 2007

No surprise

The bank problems described below will come as no surprise to readers of this blog.

Chinese banks in $2.4bn disaster
Jamil Anderlini, Beijing
June 30, 2007

CHINA'S state auditor yesterday named three large banks for "illegal or
irregular" behaviour involving more than $US2 billion, highlighting the
massive governance problems that exist in the country's financial system.

Bank of China, Bank of Communications and China Merchants Bank, all of which
are listed in both Hong Kong and Shanghai, were cited for making illegal and
irregular loans to the real estate sector and for problems in their
settlement operations.

But, according to the National Audit Office's annual report, the bulk of the
money was the result of outright fraud with $US1.34 billion stolen by
individual employees in 37 separate incidents.


The REcapitulator was asked by an acquantance the other day how the CDO market is effected by the MBS markets, and I found my response was far too complicated for a layman.  This deficiency cannot stand uncorrected, and thus I write today to simplify how these two derivatives interact.

An MBS, or mortguage-backed security, is a derivative that provides cash-flow rights from a group of mortgages to a buyer of the security.  
Lenders to homes like to securitize liabilities like mortguages because it frees
up capital for other purposes in addition to being a profitable business itself.

However, when the MBS is backed by "sub-prime" borrowers, it is difficult to find bidders for the securities (one of the reasons investors like MBS's is because they exhibit a property called negative convexity, and a post on this will be forthcoming).

I-banks cater to needs of disparate investors, some of whom like very safe investments, some willing to hold more risk, and some willing to hold a great deal of risk, of course hoping to reap a more handsome reward.

So I-banks divide the MBS securities into several different "levels" (spatially speaking, not geographically speaking) of risk and return.  The levels are typically described, proceeding from lowest risk level to highest risk level, as "Investment Grade", 
"Mezzanine", and "Equity".  These categories as also known as "tranches" and are now grown up to become "CDO"s, or Collaterlized Debt Obligations - securities that depend on the values of the MBS groups so divided.

And so we follow the money.  Cash flows from the mortguage payments now flow first to capitalize the safe, from a probablistic standpoint, investment grade bonds.  Any remaining cash flows go to the mezzanine level, and then any remaining cash flow finally makes its way to the (by now somewhat nervous) "Equity" level CDO holders.

When there are mortguage defaults and slowing cash flows, firms like Bear Stearns, which opened a coupld of hedge funds for the specific purpose of investing in the "Equity" level of CDOs, get in trouble very quickly.  Since the securities depend on the cash flows from the underlying mortguages, no money flowing to the Equity level means that these securities, which are not often traded, must be valued at far, far less than when the housing market was booming.

Friday, June 29, 2007

Inflation Expectations and the Fed

It is well-known among the finance community that Ben Shalom Bernanke believes inflation expectations is a more useful predictor of future inflation trends than current (that is, "current" in the sense that CPI figures is a compliation of data gathered in the past) inflation.

Mr. Bernanke has been very transparent about this.  So now the REcapitulator is wondering how our wonderful Fed, the most important central planning organization on the planet, is going to react to the inflation expectation figures complied by the University of Michigan:

Month                Inflation Expectation (one year ahead)
July                      3.4%
June                     3.5%
May                      3.3%
April                     3.3%
March                  3.0%

This will be an interesting test for close observers of the Fed to see how Mr. Bernanke deals this report, and compare it to previous central bankers who are now part-time consultants to very large bond funds.

Wednesday, June 27, 2007

Modus Ponens

Economic theory and economists tend to make arguments based on narrative causal connections based on some sort of "equilibrium" theory.  The REcapitulator thinks pundits like Jeremy Siegel are amusing when he opines that it is "more difficult to analyze" commodities than traditional asset classes like stocks and bonds.  If "more difficult to analyze" is a euphemism for "I don't have the proper tools to B.S. an answer", then I completely understand.

Modus Ponens (B follows A, A is present, therefore we have B) is a simple logical format, and, finding little fault with the basic logical structure of the argument, we instead find that Modus Ponens is misapplied to a system that is far too complex 
to simply collapse "N" (where "N" is a very large number) variables into "B follows A".

I am reminded of Ludwig Van Mises and his unending critique of this system of thought.  This quote sums it up nicely:

"there is no experience of future happenings…the experience to which the natural sciences owe all their success is the experience of the experiment in which individual elements of change can be observed in isolation. The facts amassed this way can be used for induction…No laboratory experiments can be performed with regard to human action. We are never in a position to observe the change in one element only, all other conditions of the event remaining unchanged”

The REcapitulator agrees.  Thinking participants alter the game, and 3rd order thinking ("What does he think I think he is thinking") is not observed amongst the natural sciences.

The Fed's Perspective

This excerpt from the FT, in light of my previous post on the Fed, is important:

By Krishna Guhain Washington

Federal Reserve officials are expected to discuss ways to redirect market
attention from current core inflation to its forecast of headline inflation at
this week's meeting of the rate-setting open market committee.

The meeting, the first since the sell-off in the bond market pushed up long-term
interest rates, will end with the Fed affirming its focus on inflation risk.

However, there could be extensive changes to the statement to reflect evolving
concerns on prices.

To date, the Fed has talked about the current level of core inflation, which
excludes food and energy prices, as "elevated" and emphasised the need to ensure
it comes down.

But with core inflation as measured by the personal consumption expenditure
deflator likely to edge below 2 per cent in May, Fed officials no longer agree
on whether it is elevated or not.

Tuesday, June 26, 2007

The Fed's view

It is axiomatic when analyzing the Federal Reserve's opinion of their management of short-term interest rates (the price of Federal Funds), one must attempt to determine which factors the Fed over or under weights in their view of the economy.  

To that extent, the REcapitulator submits these words from Mr. Bernanke in his Humphrey-Hawkings testimony from 2/14/07:

Overall, the U.S. economy seems likely to expand at a moderate pace this year and next, with growth strengthening somewhat as the drag from housing diminishes. Such an outlook is reflected in the projections that the members of the Board of Governors and presidents of the Federal Reserve Banks made around the time of the FOMC meeting late last month. The central tendency of those forecasts--which are based on the information available at that time and on the assumption of appropriate monetary policy--is for real GDP to increase about 2-1/2 to 3 percent in 2007 and about 2-3/4 to 3 percent in 2008. The projection for GDP growth in 2007 is slightly lower than our projection last July. This difference partly reflects an expectation of somewhat greater weakness in residential construction during the first part of this year than we anticipated last summer. The civilian unemployment rate is expected to finish both 2007 and 2008 around 4-1/2 to 4-3/4 percent.

The risks to this outlook are significant. To the downside, the ultimate extent of the housing market correction is difficult to forecast and may prove greater than we anticipate. Similarly, spillover effects from developments in the housing market onto consumer spending and employment in housing-related industries may be more pronounced than expected. To the upside, output may expand more quickly than expected if consumer spending continues to increase at the brisk pace seen in the second half of 2006.

Monday, June 25, 2007

Paper Dragon

Readers of this blog already know the REcapitulators opinion of China.  Now, the Bank of International Settlements weighs in with a good rendition of the "somewhat" obvious...

The Chinese economy seems to be demonstrating very similar,
disquieting symptoms," it said, citing ballooning credit, an asset
boom, and "massive investments" in heavy industry.

Some 40pc of China's state-owned enterprises are loss-making,
exposing the banking system to likely stress in a downturn.

It said China's growth was "unstable, unbalance, uncoordinated and

Still Communist.  Still Centrally Planned. Still harboring great masses of people that have no access.  Hayek's "The Fatal Conceit" contained all of the intellectual groundpinnings for the refuation of such a plan.

Now let's add massive corruption and near institutionalized cronyism, which appear to be invevitable evolutionary appendages to Communism, and you have the paper dragon of China.


The REcapitulator has reviewed many prospectuses in his day.  Most of the statistical studies included therein are utterly depressing.  

The most glaring problem is the sample period of returns.  Mutual funds, as a rule, cannot help but fit their returns to the time period that produced the greatest period of compounded returns...fancy that.

And do not get the REcapitulator started on "risk" parameters such as beta or the sharpe ratio, both of which fall prey to difficulties with autocorrelation.

Since "Beta" (again:  WHY do we insist on using Greek variables in Finance?) is a measure of the covariance between an asset and the "market" in terms of the variance of the "market", autocorrelation, or the tendency for time-series data to be MORE dependent on adjacent values than values from the past, rears its ugly head.

The REcapitulator has never seen good mutual fund reports that include all the correct statistical studies...but that would not be good for marketing, now would it???

Continued discussion with a Money Manager from St. Louis...

The latest rejoinder by yours truly, after my interlocutor presented some opinions from a demographic researcher (who came to the same conclusions as myself, albeit from different premises)

With regards to small/medium sized companies vs. large (index
components), the determining factor in my view is the pure yen/$
exchange (small and medium companies that sell to the JPN consumer vs.
the larger index components who are hedged to a certain extent by
revenue streams in multiple currencies. But your friend is
right...smaller countries are a purer play (with more concentrated
Delta risk on the Yen)

With regards to demographics in general, it is challenging to
extricate short-term causations (changes in immigration policy, etc.)
vs. long-term trends. Also, property rights and the rule of law serve
as the mechanism that unlocks favorable demographics. Luxembourg, for
example, has terrible demographics upon first glance...but it is the
"new" Switzerland (although not for long as the Swiss don't want to
ruin their franchise with ****'s oft-labelled "weaponization of the

Saturday, June 23, 2007

A query from a money manager in St. Louis...

leads me to a brief and rather non-analytical "hand-waiving" discussion of the Yen:

OK, lets talk Japan. (if you want my quick and dirty answers, go to
the "So, to SUM UP" section)

First off, I have reams of data as well as anecdotal evidence that
seems to support a general "Japanese Investors exhibit herd-like
behavior greater than most other developed countries".

Secondly, we have to delve into the "Boys from Todai" to understand
how the MOF thinks (and even more importantly, how they wantus to
think they are thinking). Soros has said many times that the MOF is
one of, if not THE most sophisticated participant in the market, they
don't get pushed around and have earned their "widowmaker" reputation.

Now, I met deputy minister Iwata (again, a guy from Tokyo University,
aka "Todai") and he claims the MOF follows a neoclassical inflationary
expectations model developed by Wiksell way back near the turn of the
century. Now, do they really believe in Wiksell's formulae? NO.

JPN, like every other macro scenario, is an exercise in timing and
cyclical response to economic stimuli. Deflation is still a problem
until domestic demand can be stimulated. Then the damn will finally
break (and your position is helped by declining US $ denominated
assets) and the rate of increase in the capital account (opposite side
of the current account, reflecting desire to net save US financial
assets) in Japan will decrease. The Yen goes up. Big.

However, since domestic demand has to be stimulated, the MOF will
intervene in the currency markets (as they have always done). This is
why me and my partner are long some JPN indexes, etc. Fiscal policy
is the lynchpin over there (as in ANY soft currency economy...and of
our friends, ###### is the one of the only ones to really
understand modern soft currency economics). And we watch fiscal
policy as a greater predictor of long-term price levels than the
short-term interest rates in distant JPY futures contracts.

SO, to SUM UP:

They will not raise interest rates soon. They are scared to death of
continued deflation. (and now there may be a good chance of deflation
here, which will not help them...but that opinion is not shared by
anyone at the moment)

The carry trade piper will most certainly be paid, and in a way that
will blow away risk parameters. NZ's economy is the size of Michigan.
What happens when the carry trade into NZ's $ unravels and those
players are forced to re-purchase Yen?

So, for the time being, I think your Yen play is a good one...but I
personally am much more comfortable with JPY assets that are more
derivatives of the general economy rather than the blatant
manipulative practices of the MOF.

Friday, June 22, 2007

Subprime woes continue to light the way...

...for acute observers trying to deconstruct how all this risk is financed.

It seems clear to the REcapitulator that foreign owned subsidiaries of US investment banks are financing massive risk-taking here in the States.  The current troubles with Bear illustrates this. Take a look at the relative repo rates of US/Euro area countries and you will see what I mean.

The VIX (which, for disclosure puposes, we have short interest in) and the implied vol. surface therein (although at the moment, the REcapitulator fails to remember all the consituent names in the VIX) is interesting.  I thought that July would be the capitulation with regards to bond yields and FED action.

Cantor is another interesting story.  The REcapitulator was unaware they traded exotic mortgages (they don't).  

And yet, they had to auction off some 350m of securities posted
by Bear, for pennies on the dollar.  How does one model that?

Thursday, June 21, 2007


Credit spreads have widened by 45 basis points since the beginning of this month on this index that tracks credit protection prices on 100 names.

The REcapitulator knows very little about the Byzantine and wild-west frontier of the credit markets (and he suspects that it is very much a rigged game), but what he does know is that when a movement like this occurs, re-hedging and re-collateralization is a very painful experience for weak hands.

Could it be possible that people actually are starting to think there may be some RISK in levering up low-yielding assets, buying higher yielding ones, and pocketing the spread?

Wednesday, June 20, 2007

Real Estate has just started...

...its descent.  The commerical RE indices have not budged very much, and the REcapitulator was speaking with a trader from a (very) large Hedge player here in Chicago yesterday...his thoughts were that this was one of the few low-risk shorts out there.  The wall of liquidity raises all ships.

But there are holes forming (and once again, the REcapitulator cannot take his own "no metaphors" medicine).  The Merill/Bear Stearns debacle continues to make the news, and traders are alight in rumours concerning some of the other large players selling inventory.  This story illustrates the difficulty of massive and extremely quick redemptions in the face of what amounts to term financing (or using the spread between two instruments as the primary financing vehicle).

July.  It may be earlier, but one would be foolish to short U.S. assets at the moment.

Monday, June 18, 2007

The Fed Model

The Recapitulator would like to take this opportunity to ask a simple little math problem:

What happens to a ratio when the denominator decreases
 and the numerator increases?

The P/E ratio (the inverse of its forward-earnings manifestation being the basis for comparison to the 10-year bond yield, which is also known as the "Fed Model"), which has never been a very good metric for valuation of companies in the REcapitulators opinion, owing to the usual retrospective/prospective predictive problems, has a special reverence for the public and sophisticated operators alike.

As for the Fed model, it has had a pretty good fun for predictive value.  The Recapitulator has long thought July expiry is a good month for short VIX puts (or hey, why not "Texas Hedge" and go long some calls or long some futures???) and he still thinks so.  As bond yields rise, forcing players to choose between similar yielding assets with vastly different risk profiles, and as the inverse of the forward earnings yield looks decidedly less rosy, we should see some excellent toing and froing next month.

Friday, June 15, 2007


Updates will be more frequent now as yours truly has time to clear some idea backlogs...and now the post:

With all this talk about weather (and 4^15 cicadas here in Chicago), I
can't stop thinking about scale. We all know the importance of time intervals and sample periods when looking at the markets, and it is somewhat unfortunate we lack millions of years of data to strengthen our inferences or provide additional hypothesis generation.

the financial markets rife with feedback mechanisms, both on granular (individual stocks) and global (indexes) scales.  Everything is connected and the thinking, human participants create another layer of complexity by adding 3rd (what do I think he thinks I am thinking??) order thinking into the mix.
Fortunately, the planet earth has a wonderful temperature regulation feedback system that serves to illuminate why global warming is a problem of scale – humans will have to actively engineer, on a massive scale (like blowing up the Rocky Mountains) carbon introduction into
the atmosphere in the future if we wish to live here.

The system can be characterized thusly: Plate tectonics produce carbon dioxide through volcanic emission, carbon dioxide warms the planet. Warming increasing weathering (surface water is a function of temperature, as temperature rises, water evaporates leading to clouds and subsequent erosion). Carbon dioxide then attaches chemically to silicate rocks experiencing weathering. This process removes the C02 from the atmosphere and cools the planet. Carbon Dioxide is introduced again by volcanic emission (and water is needed here as
well for subduction), and on and on.

This process that has kept the Planet at a relatively constant temperature (never below freezing and never above boiling) for around 4.5 Billion years. Planets need land, water, and plate tectonics to achieve this system that is very good for carrying life. An oceanic planet would not be a very nice place to live, and likely would not remain that way for long as the lack of temperature regulation would likely boil the planet. (in the spirit of good taste, I will withhold jokes regarding a certain movie starring Kevin Costner, as said movie has already experiences too much suffering)

This feedback loop is interesting to me because of its massive time scale. In the long run (geologic scale), we should be more worried about making more CO2. But on relatively short scales (hundreds of years), we may have a problem with increased temperatures due to our
own actions.

Looking at the markets, it is very clear what the "geologic" drift is, caused by an extremely complex feedback system of its own…but when you zoom in closer, it becomes apparent that too much on one side of the differential equation can kill 90% of "oxygen-dependent species".
Life does go on, but it takes a different scale of time for that to happen.

Monday, April 09, 2007

Federal Hurricane coverage and Cross Subsidization

The following article provides a nice, albeit journalistic, overview of pros and cons for a national catastrophe "backstop" fund.

The REcapitulator would only wish to remind his readers that such a fund, in economic terms, amounts to a massive cross subsidization from states that have little or no natural disaster exposure to states like Florida.  This is precisely the sort of "noise" that has no clear "diode" (keeping with the circuitry analogy) for markets to efficiently allocate available capital.  The following excerpt from the article is on point:

"While natural disasters may occur in any state, Nutter noted, most are economically modest. He also said 97 percent of all earthquake losses were in California and 75 percent of hurricane losses since 1900 were in Florida, Texas and Louisiana."

Another issue is, of course, pricing.  The Federal coverage would ostensibly cover for mega-catastrophic risk.  The REcapitulator is skeptical of any governments ability to price this
coverage in a way that optimally transmits information about the risks of mega-catastrophes.

Monday, March 26, 2007

Asset prices and the Fed

The conundrum the Fed faces with financial and real asset prices continues.  In order to effectuate the "goldilocks" economy, the Fed must manage inflation expectations whilst turning another eye to asset prices.  This behavior has some interesting side effects, the most prominent of which is what the REcapitualtor believes is an unhealthy regard for defacto central planning.

From Mishkin's latest speech, in which he all but states the management of the "correct" inflation expectations is the aim of the Fed:

"Although solidly anchored inflation expectations are indeed highly
desirable, they could pose a bit of a problem for monetary policy if
they were at a level somewhat above or below the rate preferred by
policymakers. Under such circumstances, the central bank would likely be
interested in shifting the public’s expectations in a more favorable
direction. Whether such adjustment would be easy or difficult is,
unfortunately, quite uncertain because we do not understand the
expectations-formation process very well"

Expectations are a "problem" if they are above or below the rate "preferred" by the Fed.

Mechanical inflation targeting (something that I abhor) is looking better all the time...

Tuesday, March 20, 2007


This lovely term is more affectionately known by statisticians as "fat tails", and describes probability distributions that assign more liklihood to extreme rare events.

There is a veritable ocean of literature regarding this subject, and the REcapitulator, as always, directs the diligent reader to the excellent SSRN site for further reading:

However, the REcapitulator would like to make a somewhat narrow comment. A normal distribution, or even most of the distributions that exhibit "fat tails" make the assumption that VARIANCE, the spread of possible values in relation to the expected value of a given variable, is STABLE. This is not true, as volatility in markets (as measured by the VIX) is also volatile.

If we have a normal distribution, we should also expect to see an additive generator of random variables.
But this is not what we actually see. In periods of high volatility, the generator is multiplicative.

In other words, whenever you see any statistic in markets that has a normal distribution as its intellectual lynchpin, be very skeptical of any conclusions derived therefrom.

Monday, March 19, 2007

A good example...

...of the capital markets at work, distributing risk in the appropriate manner and forcing innovation as to how risk is allocated.  As stated in the last post regarding Buffet, the risks to Hurricane-prone areas have "increased", or at least the perception of that risk has increased with Katrina.  Rating agencies who cover REinsurance companies are going to assess risk based on recent experience (the "availability" heuristic as popularized by Kahneman and Taversky's brilliant work on how humans actually make decisions).  Rates increase.

Solutions will present themself...if government will allow them to.  Finite risk, contingent capital solutions, etc.  Perhaps a private homeowners captive will sprout out of the Keys.

Of course, global warming (or the perception of same) only serves to increase the risk, something risk providers (REinsurance companies) will be happy to provide for a price.

Buffet's gambit

Berkshire profits up 56% year on year.  Impressive.

However, the REcapitulator, would like to simplify the way Mr. Buffet makes his money.

1.  Sell thousands of out of the money binary put options.  In the insurance lexicon this means sell property and hurricane exposure policies with defined policy limits.

2.  Price said options using a one-year history of data, with that year containing the worst hurricane in 100 years.  As an aside, The REcapitulator is aware of the non-gaussian and epistemological difficulties with the weather, but he is merely describing 
methodology here.  Take advantage of the historical tradition of offering exposure to ONE year of negative events.  In other words, double the price based on a rare event.

3.  Invest the premium from all those options/polices into the global financial markets.  Then hope (pray?) that another 100-year rare negative event does not occur.  

In other words, short the rare 100-year event, go long the global finance markets, which have a 70% liklihood of increasing year on year.  This is good risk taking.


Tuesday, March 13, 2007


The REcapitulator believes the S&P will "correct" (readers will note I hate that the market "incorrect" when some participants are long and some are short?) down to this level.  We should then see improvement in June/July.  If we do not, Greenspan's "33.3% probability", as if such precision was possible, of recession may turn out to be about 60 points too low.

Monday, March 12, 2007


The onerous (and some would say ruinous) and hastily passed Sarbanes-Oxley regulation that has eroded the competitive virtues of listing on the 
major American exchanges, and provided a windfall to consulting, legal, and auditing firms, organized resistance is forming.

Although it is difficult to extract exact causalities from the data regarding the propensities for
firms to list here in the U.S., the follwing paper by Luigi Zingales (of the REcapitulators alma mater, the  University of Chicago...which everyone knows is the greatest institution for higher
learning this side of Proxima Centauri) does support the simple logic of another one of my professors, the great Robert Aliber, who said:

"If the cost of regulation is greater than the cost of avoidance...the regulation will be avoided"

And here is a preliminary rejoinder from the political sector:

March 13, 2007

THE US Chamber of Commerce is calling for an end to quarterly earnings
guidance from companies, proposing that auditing firms be allowed to seek
private shareholders, and urging legislation allowing the Securities and
Exchange Commission to ease the burden of Sarbanes-Oxley on foreign

The recommendations come in a report that is the third high-level effort to
raise alarm about the competitiveness of US capital markets in four months,
as the issue garners attention on both sides of the Atlantic.

In January, New York Mayor Michael Bloomberg and Democratic Senator Chuck
Schumer co-authored a report warning that New York risked losing its
position as the world's financial capital to rivals such as London.

Tuesday, March 06, 2007

Mortality Derivatives

Mortality derivatives is an interesting subject, and the REcapitulator will be publishing a paper (more of a primer on the subject than delving into problems of conditional probability and mortality modeling) that will be available here.  Some excerpts from the paper are given below.

The REcapitulator is also privy to information regarding the launch of Hurricane derivatives, but he doubts that these will catch on as there is major basis risk.  The contracts (initiated by the CME) hedge against hurrican landfall (frequency), but not the severity of a given landfall.  What is an insurance company to do if the severity of a hurricane is not a price factor?  This initial attempt will hopefully spawn new innovation.

Anyway, some excerpts from the opening comments of the forthcoming paper:

The exposure of pension and insurance companies to unexpected decreases in mortality is an important risk, and one that has been increasingly difficult to predict. Actuarial assumptions regarding populations do not take into account secualar increases in life spans. To the extent that this risk can be transferred to the capital markets, it would create a more definable and predictable set of cash flows (and potentially reducing the cost of capital) for insurance and pension concerns.
While insurance companies can internally hedge their exposure to long-tail life insurance contracts through the writing of annuities, this presupposes the ability to sell annuities, a more or less contsant distribution of population, (assuming further that annuity purchasers do not buy life insurance products) and introduces other forms of risk to the overall insurance profile such as interest rate risk.

Mortality Derivatives may also be a more efficient way to price life and annuity contracts. Derivatives markets attract sophisticated participants who may have access to better information and/or more predictive financial models. This phenomenon has not been lost on the Federal Reserve, which routinely scans deriviatives markets and their corresponding implied expectations of the future in order to make policy decisions.  This “tail wagging the dog” effect, due in large part to increased leverage than cash markets,could also provide valuable informational flow with regards to pricing the primary obligations of pension and insurance companies.  These firms would have a competitive advantage versus their peers with mere active partcipation into the mortality derivatives markets.  Information garnered in this fashion could be used for capital allocation and internal hedging purposes, in addition to providing a competitive advantage to firms participating in the mortality derivatives markets by acting as the proverbial “canary in the mineshaft” in detecting unexpected events that effect mortality rates.

Saturday, March 03, 2007

Right and wrong...

But never "correct" (in the epistemological sense of the term), the REcapitulator is looking back on the last week.  Red is everywhere on financial data websites.

Volatility has indeed spiked over (in VIX terms) 20.  I was wrong about the short-term prospects for the dollar/Yen, as everyone has blamed the yen carry trade for contributing to the decline.  

And what a decline it was.  The S&P declined from 1458 to 1398 in a matter of 4 days.  Analysts at major banks (of course) bleat on about the "fundamentals" being "positive" and such.  How would they know?  Do the fundamentals change when massive selling causes inflation, stagflation, or deflation?  The Recapitulator reminds his audience that the accuracy of forecasts by bank analysts is no better than random.  Their compensation structure is entirely based on how convincing their forecasts are, not upon ex ante or ex post accountability.

So risk spreads are beginning to loosen.  Other risks are also coming to fore.  Insider trading is one such risk.  Not everyone will be caught, but it will have a chilling effect on the more "aggressive" trades.  Legal risk, like volatility in the markets, tends to cluster. Recall the flurry of activity Spitzer inititated in the early part of this century. (This is not unlike many revolutions.  The new government presents offending parties to the 
gallows.  The public enjoys an emotional catharsis, which is short-lived.  The now established
government then proceeds to do precisely what the old "evil" government did.)

So risk is increasing everywhere.  Not as serene an environment as those bank "equity strategists" would have you believe.

Tuesday, February 27, 2007

More "shocking" allegations of insider trading.

How many times must one comment on what is actually happening at 90% of the "Event Driven" hedge funds in NYC?  Why are they all clustered there, or a short drive away in Conneticutt?

"Top News February 26, 2007, 3:03PM EST
Charges Pending in UBS Payoff Case

Sources say at least one analyst at the investment firm may face charges of
selling information on ratings changes before they're made public

Here's proof some still see value in brokerage-produced stock research, even
after the research scandal of four years ago tarnished the image of Wall Street
analysts. BusinessWeek has learned federal authorities are on the verge of
busting a scheme in which at least one employee of UBS was allegedly selling
information about upcoming changes in analyst ratings on stocks to traders not
affiliated with the Swiss investment firm."


The February volatility has surfaced, but the VIX, while up nearly 18%, has not spiked as per my comments.  It is interesting to see China described as the "catalyst" for this set of circumstances. The REcaptitulator believes China is again experimenting to see just how the partial differential equation describing the sensitivity of U.S. markets to Chinese markets works.  This is a dangerous game of "chicken", and I am not sure who will blink.

Whether this redefines the nature of risk premiums in today's compressed world remains to be seen.

Monday, February 19, 2007


This is an interesting time. Volatility is historically low, and the oft-mentioned "longest time prior to a 2% decline", while flawed in the sense that structural changes in the financial sector have changed (together with Bernanke's "Great Moderation"), still looms...and that is without the Recapitulator thinking about wether or not returns are independent data points or path dependent and autocorrelated.

We are either heading for a decline or this is the largest head-fake I have ever seen in the financial markets.

Wednesday, February 07, 2007


The SEC is investigating investment banks and their equity trades. Readers of the Recapitulator know how this works. Record bonuses on wallstreet are a blessing and a curse. They are a blessing becuase they bestow status on employees, and attract the bright and ambitious. They are a curse because they attract attention from regulatory bodies. Front-running is an epidemic when information directly translates into profits (often at the expense of CLIENTS like Amaranth) The SEC will collect a few scalps, fines (that come no-where near quarterly profits) will be levied, banks will promise "greater oversight and controls", and that will be that.

SEC Opens Review of Market-Moving Stock Trading at 10 Firms

Feb. 6 (Bloomberg) -- The U.S. Securities and Exchange

Commission opened a review of how Wall Street handles
confidential information, asking 10 top securities firms for all
their stock-trading records for the last two weeks of September.

The examination is aimed at determining whether details
about trades big enough to push a stock price up or down had
been leaked to other traders, Lori Richards, director of the
SEC's office of compliance inspections and examinations, said
today in an interview.

The review appears to be the first to target a specific
period of time for a group of the biggest firms, and is focusing
on brokerages that cater to big trading customers such as hedge
funds to find evidence of insider trading, Richards said. She
declined to name the firms. The N3w Y0rk T!mes reported earlier
today that they include M3rrill Lvnch & Co., M0rgan St@nley, UBS
AG and D3utsche B@nk AG.

This is a fact-finding effort, not an examination based
on specific tips about misconduct at any particular firm,''
Richards said. The agency is acting on complaints from investors
such as mutual funds that information about their large-scale
trades may be leaking from, or exploited by, Wall Street firms
that execute the transactions, she said.

By looking at several companies at once, the SEC may be
able to detect instances in which information about a big trade
at one firm resulted in an improper trade being placed at a
separate company, Richards said. If the review uncovers evidence
of potential insider trading, it will be turned over to the
SEC's enforcement unit for possible legal action, she said.

The prime brokers provide the SEC with a window into the
trading activities of the hedge funds they serve,'' Thomsen told
a Senate panel in December. ``The enforcement division remains
optimistic about prime brokers as a source of leads regarding
unlawful insider trading.''