September 21, 2009
Perusing the FTfm, the Financial Times’ rather sleepy weekly review of the fund management industry, is rarely an occasion for close reading and sharpened wits. I usually get to it before my first cup of coffee is finished, right about when my sleepy eyes get their first rub of the day. Any industry professional who wants to grind his/her axe in the light of day and has shelled out for a publicity agent can and has gotten column space in FTfm’s pages. Which is why it’s hardly worth reading past the “Movers and Shakers” column.
Today, however, the FTfm caught my eye, and not in a good way. John Chapman, “a former senior official at the Office of Fair Trading,” has produced what may be the most hackneyed, lazy and misleading opinion piece I have ever seen in a world-class financial news outlet. For the full piece, click here. For the blow-by-blow dismantling it deserves, keep reading below.
Let’s start with Mr. Chapman’s thesis (paraphrasing and italics mine): “the EU draft directive on alternative investment managers is a welcome first step, but we must go further to eliminate socially undesirable hedge fund and private equity activities.” Ok, heavy-handed indeed, but let’s see some support for why hedge fund activity is socially undesirable. In the interest of time, and because Mr. Chapman only attempts glancing blows at private equity, I will focus only on his vendetta against hedge funds. Mr. Chapman believes the following:
- Unregulated financialization has brought the worst recession for 75 years
- Ok, I’ll give him the benefit of the doubt here.
- Hedge funds are both central to financialization and basically socially undesirable
- Every leg of this stool is not long for this world.
- hedge funds can put the entire system at risk, as in LTCM in 1998
- True, LTCM did put the entire system at risk. But that problem was solved privately amongst the fund’s creditors and other investors with the help of the Federal Reserve Bank of New York, and did not demand the taxpayer bailouts of recent regulated bank failures. In addition, hedge funds learned hard lessons in this case and have functioned more as financial stabilizers rather than destabilizers (ie, leaning into asset bubbles rather than contributing to them)
- hedge funds knock over government policies (UK 1992, SE Asia 1997)
- Even if this is correct, do you object to this as a matter of personal preference for government policies regardless of their economic viability? Given central banks’ track record over the last 10 years, I would side with the Davids rather than the Goliaths.
- hedge funds spawned complex financial instruments with more unquantifiable risks
- Hedge funds do not “spawn” complex financial instruments. The sell-side does that–sometimes in order to meet demand, but mostly just to capture economic rents. Hedge funds may be more demanding in hedging out unwanted residual risks in their positions, and they are doing so as quantifiably as possible (their livelihood depends on it). If you don’t understand an instrument or can’t quantify the risks, don’t buy it (I’m talking to you, CDO-cubed-hungry European banks)
- The high fees ordinary investors must pay to access HFs far outweigh any advantages, such as “making markets more efficient and diversifying pension fund portfolios”
- Hmm, where is the evidence for this assertion? The entire hedge fund industry operates on the concept of attractive risk-adjusted returns NET of all fees. If it isn’t there, the hedge fund goes out of business. Ask real hedge fund investors over the past 20 years what the added value of their hedge fund investments has been. You might be surprised at how much better off they are vs any mix of equities or bonds.
Mr Chapman recommends the following palliatives, which would result in eliminating undesirable hedge funds, their accompanying hazardous financial innovations:
- fees should be lower and “less risk-based”
- Explain this concept of a less risk-based fee structure. I have no idea what you’re referring to.
- a specific tax on hedge fund buying and selling would hit the right target
- Yep, if you don’t want hedge funds, increase the transaction costs even further. Good luck with the rest of your portfolio.
There are a couple other unrelated volleys lobbed at various targets (the bonus culture, the rise in UK equity turnover from 88% of GDP in 1995 to 296% in 2007, UK corporate short-termism, American capital markets aggression) which have no bearing on his argument. In addition, Mr. Chapman appears to try whenever possible to aggrandize his own historical timeline of commentary, to minimum persuasive effect. “I” does not add credibility here, I’m afraid. A better grasp of facts on the ground and on the basics of the art of argumentation would go further.
August 26, 2009
At this stage in the economic conflagration, with Fed Chief Ben Bernanke recently reappointed for a second term, a little perspective and soul-searching is advisable for us little guys. While Anglo-Saxon central banks encourage spending with trillions of units of fiat currency, a few of us are wondering what the implications of this course of action may be.
Given economic prognostication is not my bag (and arguably, not one of economists, either), I’ve decided to create a little thought experiment in the Rawlsian tradition. My veil of ignorance, however, will not set up a pure state of fair play in which people with no personal histories stand in an empty room and try not to step on each other’s toes. Instead, my veil of ignorance assumes rather the opposite. I am imagining a world in which many people’s worst fears are actually true: that we are all truly alone.
Now, before you shut your laptop in horror, keep in mind that this is a thought experiment–it’s supposed to be a little wacky. Let’s follow the thread.
Although you are truly alone, without a single direct instance of sensory feedback from another human being, you nonetheless carry on a rather “normal” human life. You work, you eat, you sleep and there is a mechanism by which you are compensated for your labor in units of exchange that you can use to procure supplies for yourself. The twist is: everything you know is abstract. You never come into contact with a narrative involving another human being. [Note that my scenario does not preclude the use of language and the pursuit and fruits of scientific inquiry, which may compromise the rigor of my "truly alone" assumption, depending on your underlying philosophical beliefs.] As compensation for this lonely state of affairs, however, the entire world is your playground. Any product of nature, any (abstract) artifact is available to you, given you can afford it (prices and wage levels are similar to those of the real world).
What are the first things that come to mind? Well, for me, it’s the thought that in this situation, nobody can “get a life,” because the social constructs that mete out value judgments on the validity of one mode of life over another do not exist. You are free to pursue whatever tickles your fancy. In fact, there is no way for a person in this state to have knowledge of other lifestyles, except by deducing the ostensible utility they may get from the dizzying array of baubles they encounter. In the words of Andy Dufresne, they must either get busy living or get busy dying. This is life without the Joneses.
What are the implications for an individual’s economic decisions in this state? Well, if we throw in some real-world variability around income streams and outlays, we could expect a person in this state to adhere rather closely to the old Microeconomics 101 concept of a “rational actor.” In order to cope with a possible decrease in income, our rational actor sets aside some extra savings in order to smooth consumption patterns (two weeks without food can get a brother down). In fact, we can imagine our rational actor to be hyper-vigilant, given the lack of soothing peer commentary and barrage of “you’re ok, buy more” advertising. When you’re staring into a void, you tend to horde resources.
What have we described here? Is it so far-fetched? Compared to phenomena in the real world, it appears to be. In the United States, for example, the majority of people in the first decade of the twenty-first century got on just fine with negative savings, leveraged to the hilt on a large, illiquid asset class prone to historical price volatility (houses). In fact, they appeared to prefer this state of affairs, as any accumulated equity in the asset was promptly withdrawn to fund second houses, vacations and impractical personal transportation devices designed to be obsolete in a few years.
Juxtaposing our description of life without the Joneses and that of the real world, we are able to isolate the effect of the “madness of crowds.” When the Joneses are around, in societies otherwise generally aligned with the tenants of classical liberalism (personal responsibility, fiscal discipline, rational actors), we get phenomena like MP expense rows, Ponzi schemes and economic structures with so little margin for error that a trickle bursts the dike and wipes out The Little Dutch Boy and the rest of Flanders (or, in this case, Lithuania). Stories surface about outwardly “successful” people who are privately foundering in debt. Does society doom us to inelastic demand for higher living standards, or just of whatever is defined as upwardly mobile? As one journalist observed at the end of last year, even when we are forced to cut back on spending, we do so reluctantly, inventing new social pecking orders (frugality chic, anyone?).
The value of our thought experiment sans Joneses becomes clear when we accept that in the end reality is not so different, epistemologically speaking. When we strip away what we’ve been told we know from what we really know, the world becomes a much more uncertain place. Nassim Nicholas Taleb, author of The Black Swan, is an advocate of this position, but unfortunately his fervent-bordering-on-apoplectic-schtick too often undermines his message.
Most people are concerned about doing right under a known set of circumstances, however much they may be based on falsehood and hearsay. Isn’t it time to consider doing right by a different standard? To get busy living with a little humility and skepticism? What would you do without the Joneses?
May 13, 2009
The nature of this post is somewhat odious, inasmuch as it’s about people NOT brought low by the global economic crisis. And no one likes preening braggarts. Unfortunately, I didn’t start this blog in order to gain universal approval (I can assure you my viewer stats are close to nonexistent). So bear with me as I tickle your gag reflex.
Let’s say you grew up and came to some level of financial maturity during the “Great Moderation.” Aside from your early childhood years (1977-1981), things have been going pretty well. GDP chugged along, unemployment fell, inflation was a non-issue for most items (although paying for college was a toughie) and productivity gains accrued mostly to the upwardly mobile knowledge worker. Even the “blip” of 2001-2002 didn’t really hurt your employment prospects if you knew what you were doing. Bottom line, if you worked on your human capital during your formative years and you didn’t blow your salary on trivial material things (shades of Max Weber), you should be sitting on a decent money pile right about now. Crucial to this scenario, of course, is that you DIDN’T do what everyone on the planet said to do, ie, buy stocks (“you’re young, you can take the volatility”) and get on the property ladder as soon as you possibly can (“mother nature ain’t making any more land”).
Which brings me to my point: there was an insidious trap laid for savers over those many years since 1981. Asset bubbles. More than you can count on one hand, and rolling. Rolling like a coaster and making everyone sick in the process. Bonds, Stocks, Housing, Commodities, Shipping Rates, Bonds again, Fine Art, African Banks, Cocoa, thimbles. Well, savers, you wanted it. You wanted it when you balked at the million dollar tract home in the middle of nowhere. You wanted it when you scoffed at Google’s business model back in 2002. You wanted it when you decided to go all green and NOT drive a car on principle. And yes, you finally got it: everything is going to get a LOT cheaper, effective immediately if not retroactively. Debt deflation is not pretty, but at least your cash pile’s terms are improving.
Oh, but hang on a sec. You’re in cash, you say. Hmmm. USD-denominated scraps of paper? Ok, here’s where it gets tricky. You see, our beloved government did their darndest to avoid Armageddon for private enterprise this year and last, but they certainly upped the probability of a publicly-owned, heavily-indebted hell. A hell that the government may be tempted to cool down by inflating their way out of paying on the terms at which they borrowed. Lucky them, only THEY get to pull that one. Those jokers with their sovereign right to print money.
So, that cash under your mattress is next in the asset bubble cross hairs. When might this become a problem? Historical precedents, as you may have figured out by now, aren’t so helpful. What to do about it? Well, the gold bugs are always happy to make their case, but then again they’ve been doing that since the Vienna School rose to prominence, with mixed results.
Here’s a thought: pick your spots and take your well-earned place among the spending classes. Spend on those assets that people have been trying to sell you for years (before you really needed them). Spend prudently, but take advantage of these low prices. And then, if your remaining dollars have any purchasing power left, lend it to your formerly creditworthy compatriots and sovereign nations at soon-to-be-eye-popping interest rates. That’s right: party like it’s 1981.
April 18, 2009
Ken Lewis, embattled CEO of Bank of America, destroyed a local bridge yesterday near the bank’s headquarters in Charlotte, North Carolina in a rampage similar to that of the fictional mutant larvae “Insectosaurus.” An eyewitness described the aftermath of the event: “Towards the end, I covered my face, but I could still see Lewis’ crazed, googly eyes as he gnashed at the suspension cables.”
April 5, 2009
…from approx. 500 BC:
The court is corrupt,
The fields are overgrown with weeds,
The granaries are empty;
Yet there are those dressed in fineries,
With swords at their sides,
Filled with food and drink,
And possessed of too much wealth.
This is known as taking the lead in robbery.
Far indeed is this from the way.
- Lao Tzu, Tao Te Ching, Book Two, LIII, 121-121a
March 6, 2009
An entire LSE-sponsored recent discussion on journalism’s failure to cover the financial crisis, replete with the stars and duds of the primary British outlets came across like a bunch of cry-babies compared with this exemplary piece of work. Get a grip, people, the “where was CNBC?” cry and hew is, was and always will be an exercise in misplaced teeth gnashing, no matter how entertaining it is.
How about this? Ask not for “warnings,” “whistle-blowers,” “seers” and “witch-doctors,” rather: “thorough,” “intellectually curious” and “sometimes brave” reporting on the beats we’ve been given. Stick to your investigative instincts within a broader understanding of and appreciation for existing power structures. CONFRONT PEOPLE WITH FACTS. Ok, rant over.
March 5, 2009
… Bethany McLean’s new Vanity Fair piece on the hedge fund industry is a good read with a surprisingly “fair and balanced” tone and a wee bit of accuracy. For those who can spend 10 minutes for more insight, it’s recommended. I especially appreciate the discussion of the mood at various hedge fund conferences. Honestly, I wouldn’t want to go back to West Palm Beach if my life depended on it. I’ll know that my (former) industry is punching at its weight when I’m driving to the Holiday Inn in Minneapolis to seek out some talent I’ve heard about. Begging for 5 minutes of time with a 27-year-old at a swanky resort is not my idea of “sourcing new funds.” The article quotes a grumpy veteran who just about sums it up:
“The shocking thing was how easy it was to get in from 2002 to 2006,” says one longtime manager. “All you had to do was raise your hand and say I’ll take 2 and 20. That was the barrier to entry. It boggled my mind.”
I often wondered who had funded a lot of these managers. My firm funded about 0.005% of the industry (50 out of 10,000). Here’s a hint: take a look at Madoff’s investor roster, you can find it here–these guys weren’t exercising one synapse of their critical faculties (oh, and you too, SEC). It may have been all that champagne on the golf course…
February 19, 2009
Once again, Willem Buiter presents us with a clear-eyed exposition–this time of Obama’s new Homeowner Affordability and Stability Plan. I highly recommend reading it in its entirety.
The most disturbing aspect of this issue is that Obama is merely delivering on his promise of change by and for the people. The Homeowning class has been the majority for some time in the US. The problem now is, against all odds, against all economic rationality, homeowners’ equity position in those homes is at all-time lows. When the majority gets in a mess, populism rises and the sanctity of contracts is eroded. Unfortunately, policymaking in the Obama administration is going down an all-too-depressing, predictable path.