Nearly random link farming

 Today, May 17, is the 220^th anniversary of the Buttonwood Agreement.  The beginning of everything we nowadays mean by the phrase “Wall Street.”

Here’s a link that may shed some light on symbolic significance thereof.

John Travolta is the subject of some amusing allegations.

Well … I find them amusing, anyway.  And it seems I’m not alone.

This week’s Kentucky Derby did nothing for the horse named Alpha, but it did a favor for fans of murder mysteries.

And The Onion is on the case.

Some history of the phrase “person of interest.”

Which is also apparently a television show?

I’m reading a book by Detlev S. Schlichter. He may consider this a preliminary shout-out. Here’s the amazon page.

Acknowledgements

I'm getting close to the publication of my book, Gambling with Borrowed Chips.

I recently composed an acknowledgements page.  Since that also makes for sort of a neat little bio, I'll include it here.

---------------------------------- 

Acknowledgements

I’ve dedicated this book to Hans Schroeder, because it was through my involvement with his baby, The Pragmatist, that I first became part of the discussion of the great public issues of most concern to me. That magazine, the result of collaboration between Schroeder and estimable Jorge Amador, was dedicated to the proposition that liberty works, in concrete and demonstrable ways, and that coercion fails. The way to advance the cause of liberty, then, is to explain how and why it works. That simple insight has carried me forward ever since.

I’d like to thank Lee Miringoff, of Marist College, Poughkeepsie, New York, who gave me some practical experience polling, back in the late 1970s, at the start of what has since become the Marist Institute for Public Opinion.

I thank Myrna Gans, Steve Leo, and Susan Glass. I retain my memories of their comradeship in a suite of law offices in Bridgeport, CT in the 1980s as among my few pleasant memories of what was, for me, an unhappy experiment.

I thank Robert Katz, also a friend in that place and time, for doing his best to turn me into a practical politician, hopeless though that cause proved to be.  

I thank Associate Justice Clarence Thomas for citing an article of mine in his concurring opinion in 44 Liquormart v. Rhode Island (1996). It was a signal honor and, as a result, I have since flattered myself that I played a small role expanding the scope of first amendment protections. I also thank whatever clerk drew that article to Justice Thomas’ attention.

I thank Henry Cohen, who encouraged and advised me in the course of writing that article and many others over many years.  

I’d also like to acknowledge Kristin Fox, Johann Wong, and everybody who did the heavy lifting to bring HedgeWorld into existence as the Clinton years came to an end. Because of their efforts, I had the opportunity to cover and learn about the issues that I discuss in this book in greater depth than would have been possible by any other route – and to do so while pulling down a salary and calling my discoveries work.

Thanks are due to the great figures of the econoblogosphere, the loners sitting at their keyboards in their pajamas who have created a cyberspatial haven for intense debate over how markets work. I have in mind especially the late Greg Newton, of “Naked Shorts,” who was able to scan a 280 page court filing on the demise of the Plus Funds and find the one newsy nugget.

Gary Weiss, Roddy Boyd, Tracy Coenen, have all made their marks on my understanding of these issues and on this book, as has that discreditable felon, Sam Antar.  

I thank Christopher Holt for founding AllAboutAlpha, and Kristin Fox – yes, the same one thanked above! – for carrying on as the AlphaFemale there.

I thank Rosalie Schultz for a long and stimulating correspondence. I am sorry that I let it lapse, and hope she forgives me that. 

I thank Cicily for much, but in particular for suffering with me through Oliver Stone’s second “Wall Street” movie, a crucial moment of inspiration.

Other debts will become obvious within the body of the text. Still others probably won’t. But all those to whom I owe debts know who they are, and to all: Thank you.

Oh, and if it isn’t obvious: No one mentioned above should be held responsible in any way for the opinions or the blatant mistakes of what follows. 

Wall Street ... Huh?

In four wild days on Wall Street last week, August 8th to August 11th, the indexes went on the most jagged roller coaster ride they've had since anybody has bothered keeping indexes.  A record down day Monday, most of that gained back Tuesday, the gains lost again on Wednesday and re-conquered on Thursday.  The only time in history there have been moves of 400 points or more in each of four trading days, and they all came in alternation, as if the charts wanted to create their own "W".

What was going on? 

One possible theory is that this was all a reaction to the S&P downgrade of US Treasury debt instruments.  How could both the ups and the downs be a reaction to the same event?

On this theory, Mr Market himself was having a tough time making up his mind whether the S&P downgrade was a big deal for him.  This should certainly caution folks such as yours truly against professing our own dogmatic views on that.  After all,  according to some theorists, Mr Market is an idealized model of efficiency and rationality.  Nobody has ever said that about me!
 
Actually, false humility aside, my guess is that the downgrade a medium-sized deal, and it could become a big deal yet. Last week's wild "W" could reflect that.   

There are lots of pension funds and other institutional investors out there with AAA mandates of one sort or another.  This might be a charter clause or by-law, or it might be a Labor Department regulation, but for one reason or another, a given pension manager may be required to keep at least X% of the portfolio in AAA bonds. It makes a great deal of difference whether the US Treasury bonds help satisfy that mandate. If they don't, then demand for US bonds could take a serious hit, forcing yields up, with nasty consequences either fiscal or (if we choose to monetize it) inflationary.

But ... it is my impression that most of these asset managers are allowed to average out the ratings.   If you were taking three course in school and had an A from two professors and a B+ from the other one, what would your average grade be? It would still be "A."

Since two of the major rating agencies still say AAA and the other one says AA+, the US Treasuries have an average rating of AAA, and even the asset managers with the most conservative of mandates can still buy them.

The S&P downgrade puts us a big step closer to the moment when THAT might change. The next downgrade -- either a step further frm S&P or down to AA+ by Fitch or Moodys, would be an average changer, which would in turn make it a game changer.

Thus: this is a medium deal because it could be a step toward a really big deal event.

ECMH, A Tidy Theory

Some notes toward what will eventually become chapter 9 of my book, "ECMH, A Tidy Theory."

The efficient capital markets hypothesis is the view that, given minimally liquid and transparent markets, publicly listed securities will trade at prices that fully reflect all available information.

Comes in three varieties: weak; semi-strong; strong. Discuss each. Here is a helpful link for an analytical take.

I. Some consequences:

A) even the weak version indicates that stock price movements are random. This is counter-intuitive. If markets are rational, shouldn't they be predictable, i.e. non-random? Isn't a "random walk" what a drunk does?

B) if you believe either the strong or the semi-strong version, you will conclude that an investor without material non-public information can never beat the market. It is impossible to beat the market unless you are a crook!

C) Thus, the type of advice that legions of well-paid Wall Streeters are paid to give is worthless. Active asset management in general is worthless. Hedge funds are a star system that preys on the gullible, etc.

Those are the consequences. Let's clear up a couple of misconceptions about the theory:

II. Misconceptions

A) That giving credence to ECMH requires the view that all traders are rational. Consider micro and macro cosms, brain cells, etc.

B) That you can give credence to ECMH and still beat the market by taking a contrarian position.

III. Arguments

But why should we believe the theory in any of those forms?

I won't make this presentation a historical one. This chapter needs to be analytic. Still, near the end I can introduce a historical fact, that though it has its roots in classical economics, the clear formulation of ECMH had to wait for 1965, and publications by Eugene Fama and Paul Samuelson.

Wall Street Journal front page yesterday

Look at the WSJ front page yesterday. It struck me as the reflection of a very odd news sense. The most newsworthy piece there is the A-head (which is usually their "human interest" story). The A-head involves the anniversary of the fall of the Berlin Wall and manages to bring to light details that are new to me.

But the other three front page headlines are:

1. Business Spending Looks Up (a worthy subject, though it could well have gone into pages 2 or 3).

2. Vatican in Bold Bid to Attract Anglicans (I would certainly have put this further inside -- important as it is to wavering Anglicans thinking of undoing the effects of Henry VIII's rashness.)

3. Mattel Hopes Barbie Facelift will Show Up Younger Rivals (the WSJ has a separate Marketing section precisely for such news items as this. What's with the front page treatment here???)

There were at least six stories breakinbg that morning that would have been more fit subjects for the WSJ (in its older pre-Murdoch days) that any of those. I'll call them "Alt" front page stories. I'll paraphrase them hereafter rather than reproduce them literally as with the italicized headlines above.

Alt1. A bipartisan panel led by Volcker is saying some important things about the debt/equity bias in the corporate tax system. That's at p. A4 here.

Alt.2. The fight over Medicare cuts and how that is feeding into the broader health care debate. Page A8.

Alt.3. Important news from Afghanistan, Karzai Accepts a runoff. That is at A13. Twelve whole pages behind the Barbie news.

Alt. 4. Taiwan's worries about mainland China's military buildup. A16.

Alt. 5. Important angle on the Galleon insider-trading arrests arrest -- connection with McKinsey. This is at C1. To be fair, the front page of the "Money & Investing" section is a pretty important piece of real estate. It is the page to which hardcore readers turn first. Still, it strikes me as more worthy of Page 1 than "Business Spending Looks Up." THAT could have fittingly headlined the C section (not that I intend drastic surgery.)

Alt. 6. US Bancorp's Buying spree continues. Are we seeing the rise of new "too big to fail" institution for the next round of bail-outs. This story raises that important question from the back of the bus. Page C5.

If this kind of news sense is the secret of the WSJ's new success, I fear for us all.

On the bailout bill's passage

That was a sad spectacle. I cheered when the back-bencher's rebellion wrecked the "leadership's bipartisan compromise."

Likewise, I mourn now that the "leadership" has put down the rebellion.

"Ah," you say, "but they had to be practical. Wall Street tanked after the bill failed Monday."

So, what did Wall Street do after the bill's passage Friday? See the above graph.

The Dow Jones was up for the day by about 1% of total value when voting began. It fell immediately (this is the 1:12 peak and drop on that chart) when the early numbers on the C-Span screens showed that the bill was heading to passage.

As the process dragged on, the index recovered, returning almost to the earlier intra-day high, by about 1:25 in the afternoon.

Then the finality of it, realization the mess HAD passed, and the index dropped dramatically. And kept dropping, so that it was in negative territory for the day by 2:30.

And well I'm on the subject, can we please retire the use of "Main Street" as a metonym for "the broader economy"? I'm tired of it, I suspect you dear reader are tired of it, and even the people who keep using it are likely tired of it.

As far as the broader economy is concerned, the bailout likely substitutes the scary prospect of a brief sharp panic (followed, as such a panic was in the period 2001-03, by a prompt recovery) for the scarier prospect of a very long period in the doldrums. A lost decade or more.

After all, what has the bill done? Will this money recapitalize and de-leverage the banks? No. As I read it, it will simply allow them to jigger their numbers and pretend that they've been recapitalized.

But pretending that they're making loans will be more difficult. Pretending that the loans are going to productive borrowers will be trickier still. The experience of Japan throughout the 1990s seems dispositive here.

Get ready for a brief and malaise-plagued Obama presidency, followed by the rise of a new hyper-conservative reaction. Get ready, in short, for President Huckabee after 2012.

What is to be done?

There are reports this morning of a done deal on Capitol Hill. The degree of concord may again be over-stated.

Nonetheless, the wisest discussion I've yet found of how policy makers might overcome the Wall Street crisis, how they might in the process "save capitalism from the capitalists," is that set out here on the faculty page of a professor at the graduate school of business, University of Chicago.

Dr. Zingales sees the issue as one of an expedited bankruptcy proceeding. In bankruptcy, what happens is that equity is wiped out, and debt is traded for equity. This means that those who had control of the enterprise formerly take the first wave of loss, and those who had lent them money move into the position of greatest risk, and of greatest control moving forward, vis-a-vis that enterprise.

We can not wait for bankruptcy proceedings to move forward in the case of the investment banks of Wall Street. There simply isn't enough time. But that doesn't mean that the principle should be scrapped.

There is no need to put taxpayers on the hook at all. The stockholders of the investment houses at issue must logically take the loss, and the bondholders must step up to the plate, in a way that maintains continuity for the counter-parties of those institutions.

Janet Tavakoli, an influential consultant, the principal of Tavakoli Structured Finance, is echoing Dr. Zingales' message, as she does here for example.

I'm happy to be counted in their number.

[Note: By use of the term "echo" I didn't mean to make a judgement about chronological priority. Ms Tavakoli reminds me that she advocated related views more than a year ago, as here. All who advocate a debt-for-equity swap as a crucial part of the proper government response to this situation are taking the truly capitalistic side, whatever the chronology of it. Call it 'echoing' one another without chronological presumption.]

Deregulation as a Scapegoat

No debate analysis here. I don't do tactical campaign stuff.

I do want to take a look at the notion, though, broached by Obama, that "deregulation" is the cause of the present Wall Street crisis. I think that a mistaken diagnosis, and reform instituted on such a premise will likewise be mistaken.

The current Wall Street crisis appears to have taught many of our nation’s politicians that every important piece of financial deregulation in the last thirty years has been an error. In this scramble to ‘learn from our mistakes,’ each of several measures – each blameless, and each indeed a forward step for the U.S. and world markets – has come under fire.

I refer for example to: the securitization of mortgages; the abolition of the walls that for decades kept commercial banking apart from investment banking, and that kept both sorts of banks isolated from insurance companies; the exemption of over-the-counter derivatives from a regulatory system designed for standardized exchange-listed products; the abolition of the uptick rule. Of those changes only one, the the abandonment of the uptick rule, can be blamed upon -- or credited to -- this administration. These are all the new “usual suspects,” rounded up when something has gone wrong in “Casablanca.”

In order to think straight about such matters, we might begin by abandoning the label “subprime crisis." Yes, subprime mortgages are inherently risky. That's what the word "subprime" means, after all: more risky than prime. The current troubles may early on have taken the form of a subprime problem, but if it had been only or chiefly that they would have long since have settled down.

What we have is the aftermath of a credit bubble. That bubble burst, which is what bubbles do. The bursting in turn caused an equity bubble to do likewise, because the equities are so leveraged. That, in turn, is inspiring moronic socialistic moves by alleged free marketers.

One key lesson is never learned, however often this sort of drama plays out: that what causes a bubble to burst is precisely the fact that it has been blown. The seeds of the bust are always planted by the boom. Only in October weren’t some of the administration’s admirers complaining that it wasn’t receiving enough credit for the record-high stock market index figures of that time? The Bushies should get exactly as much credit as they are willing to shoulder blame: because the Dow 14,000 of October is one facet and the Dow 11,000 of the following September is another facet of the same fact, the fact of boom-bust psychology.

Question: what is it that markets are good at?

Answer: aggregating information. Any price (whether the price of a barrel of crude oil, a newly manufactured pencil, or a share of equity in a corporation) expresses information. It either does so accurately (and keeps the whole productive system humming) or it does so inaccurately (and throws sand into its gears).
Leonard Read’s famous 60-year-old fable about the price of a pencil makes this point marvelously well.

Let’s observe, while we are so close to the point, that the Securities and Exchange Commission’s decision to impose an emergency ban on short selling was idiotic. Capital markets are obviously less efficient without shorting than they are with it, simply because shorts bring information to the table.

At any rate, every one of the deregulatory moves listed above was a good idea, one that smoothed the flow of information into prices, and so assisted the optimal alignment of incentives throughout the economy.

The risks inherent in subprime mortgages, and in the instruments built from them, are in principle familiar and manageable. Why have they not been managed? Because there are a lot of new restraints on the free flow of information that impeded that risk management task. None of these restraints by itself would have been disastrous, but they’ve had a cumulative effect. Consider the condition of an artery near the heart of an over-eater. It is hard to say which donut is fatal. But in sum, they are. They create the arterial gunk that will block the flow of vital blood/oxygen/information to tissue that needs it.

Gordon Crovitz had a fascinating op-ed piece on this subject in Monday’s [Sept. 22]Wall Street Journal, under the headline, "Information Haves and Have-Nots."

The money quote. "There are now about half as many Wall Street analysts as in 2000. Former New York Attorney General Eliot Spitzer eviscerated the profession with $1.4 billion in settlements and a new mandate for how the industry would be structured, which made the analysts uneconomical....The now-former senior executives at Bear Stearns, Lehman and Merrill must wish they had been able to retain all those star banking analysts."

Another Spitzer legacy that has contributed to our present troubles was his Ahab-like pursuit of Hank Greenberg, effectively kicking him out of the executive suites of the insurance company Greenberg did so much to build -- AIG.
Other issues that contributed to the crisis: a ramping up of insider-trading prosecutions (including a perp walk for Ralph Cioffi and Matthew Tannin in June). The people who are deterred from trading by insider trading prosecutions are being who are … the best informed. The whole idea of criminalizing such trades strikes at the heart of the real function of markets.

Further, there is room for concern that the federal bankruptcy courts have become part of the problem. This March, Judge Posner, of the 7th circuit court of appeals, suggested that bankruptcy trustees need to be reined in, writing: “While the management of a going concern has many other duties besides bringing lawsuits, the trustee of a defunct business has little to do besides filing claims that if resisted he may decide to sue to enforce.”

In particular, trustees have become quite aggressive of late in pressing claims for fraudulent conveyance. The result is that counter-parties to any institution that may even be close to bankruptcy, which may even be rumored to be close to bankruptcy, have gotten very jittery. Why set one’s self up to be the defendant in a lawsuit brought by the next aggressive trustee?

It is a legal climate that encourages “runs on the bank,” and that is what we have gotten.

So the right lessons to draw emphatically aren’t lessons about how deregulation has “gone too far.” Nor are they lessons about the GSEs, or about the greedy golden-parachute-endowed CEOs.

No. The right lessons to draw are that the information arteries in the U.S. market system have become clogged, and after the immediate crisis has passed, the U.S. will have to take up a new metaphorical diet to keep that from happening again.
In the meantime, though: what is to be done? How can the immediate situation best be addressed?

I'll have something to say under that heading tomorrow.

Dysfunctional system discounted

We may be at a bottom for the present Dow-index bull market.

Keep the confetti in storage, please. I'm merely suggesting that the upward bounce this week [the chart alongside this text shows you yesterday's contribution] might not be a trap, just the Dow's tricky way of tempting you into renewed exposure. It might, rather, mean that a process of discounting the value of a (previously) overvalued system has run its course.

My theory, FWIW, is that much of this drop has been the consequence of a dysfunctional bankruptcy system.

People have become afraid of owning equity in finance corporations because those corporations so frequently and easily become the target of lawsuits by trustees or DiP on the slightest of pretexts -- consider the fall-out from Manhattan Investment Fund, or Refco, and the institutions that are targeted in such cases.

Anyway, the stock market swoon caused by such factors has reached its natural end. All the discounting that our dysfunctional bankruptcy system requires has been accomplished. So we've found a bottom of sorts.

BTW, nothing I say is to be understood as investment advice. This is a blog dammit! You're reading this for free and its worth every penny.

That said ... suppose I'm right. If the Dow has found its bottom, discounting everythig that needed to be discounted as a result of the revelations of last year ... does that automatically means we're going up now?

No. As the saying goes, if you throw a dead cat out of a skyscraper window, it will bounce a bit when it hits the sidewalk. That won't mean it's come back to life. We might simply be seeing the dead cat bounce after the discovery of a bottom. If there is no other animating force that enters the scene at this point, we could have a period of meaningless zig-zags around a horizontal line.

The Forces of Secrecy Gather

My entry one week ago was entitled "A Cheer for Bloomberg News." I want to return to the subject I discussed there, because there's been a new development.

A bit about corporate bankruptcies, though, as filler here. Whether it takes the form of liquidation or re-organization, there is a well establish order of precedence.

Imagine a newly bankrupt corporation as a see-saw with a much heavier weight at one end than at the other. The lighter end, accordingly, is up in the air. The heavy end on the ground.

In terms of the right to receive a payoff, the most senior or best secured debt instruments have first dibs, and after that payments follow in legally defined sequence with the owners of equity sitting on the ground. At some point, moving down the lever/see-saw, the tangible assets of the estate run out. But, if we're assuming that there is some good will for the ongoing enterprise, there is still some value to be distributed. The instruments that represent that point are, accordingly, sometimes called the "fulcrum securities."

A lot of jockeying goes into determining the placement of the teeter-tooter. Some interests don't want their own securities to be too high on the lever. They'd rather get equity in the re-organized company, in the hope of course that it'll prove more valuable. On the other hand, if you have a high position on the lever, and jockey to lower it in search of the fulcrum, you might miscalculate, end up below the fulcrum, and get ... nothing.

It's a very high stakes game. Further, its a game with consequences for the rest of us, because the system is supposed to work in a way that lets a productive corporation re-emerge into the higgle-haggle of the market again ready to serve customers, treat employees fairly, and otherwise embody quaint ideas of productivity. Since the public interest is involved, the process is supposed to have some transparency. Anyone ready to look through the court records (which are available on line through the wonderful PACER system) can figure out who ismaking what motion, and what they have at stake in it.

All that said: in the ongoing Northwest Airlines bankruptcy proceedings, certain Wall Street speculators have tried to operate an "ad hoc committee" to jockey for position without disclosing anything -- or very little -- about their own stakes. They want such information to the "under seal," which means that it won't be on PACER, it won't be available in paper form to somebody asking at the court clerk's desk, and the other parties to the action who do see this information will be sworn to secrecy.

As I observed last week, Bloomberg News and its counsels, to their undying credit, are fighting the good fight here, trying to obtain and make public information about the Northwest Airlines proceedings.

Unfortunately, the forces of secrecy are gathering. Two industry groups that between them represent much of Wall Street have joined in assisting the speculators in their efforts to (a) persuade the bankruptcy judge to reconsider his pro-disclosure ruling, and (b) appeal over his head if they can't.

In a memo they said that such disclosure of "proprietary and highly confidential information" will quite probably "erect a substantial obstacle to the participation of many stakeholders—in particular, those sophisticated stakeholders that are most likely to have the means and the experience to make a positive contribution toward reorganization."

Get that? The speculators want to keep their secrets because keeping secrets helps them win. They should be allowed to keep their secrets because they are so "sophisticated" that they can help the court in its goal of re-organizing.

Um, sorry. No sale. This is sounding a lot like military procurement. The bankruptcy court is like a little Pentagon, the "sophisticated" speculators are like contractors selling it weapons, uniforms, vehicles, or whatever. The greater the transparency, the less the threat that the rest of the country is being ripped off by cronyism, double-dealing, and other earmarks of the sophisticates of every age since record-keeping began.

http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_pauly&sid=alsJTc7wcqFA

Do you, dear reader, want to do something in the service of such transparecy? Okay. Write to judge Allan Gropper, of the U.S. Bankruptcy Court, Southern District of Manhattan. Tell him you approve of the stand he has taken, and he should stick with it, however many Wall Street purchased amicus briefs he receives the other way.