We have talked about skimping on advertising and insulting the customer by underhanded surprise charges here on DailySpec. Many companies also make mistakes in a downturn with their workforce. Since pay is generally a big expense, it often gets shortsighted management by the numbers.

Here are a few shortsighted mistakes I've seen.

1. Cut the workforce too far, to the point of poor customer service. This quickly loses many of your best customers, since their business is more highly sought after in a downturn.

2. Firing or alienating the wrong employees, i.e. the most productive ones. Many wiser companies use downturns to poach the best employees. This has many causes that often boil down to socialism maxim: not judging or ignoring merit is the fairest system. A few examples: across-the-board pay freezes, vote on firing or pay cuts for everyone, firing by seniority, firing by division, region or department without offering any of the best employees opportunity to move within the company.

3. Clinging to and rewarding the failed "risk takers." "Risk takers" in quotes because this is how they justify their high salaries, but often it only the company's money or reputation on the line.
a. I've seen many poor, unprofitable or highly risky products not pulled soon enough, because the salesmen love them. Of course they do, anybody can sell $1 for 95 cents. Many companies fall for the old line "we'll make it up in volume" during a downturn.
b. In desperation of downturn, offer the most competitive commissions, attracting the lowest level salesman/conman. Often these salesmen are not happy unless somebody's been tricked by their cleverness. They need a clear loser, while they are winners. The customer, of course, will be second, but the company is a distant third.
c. Perhaps more common in the investment world is the golden parachute, or heads I win tails you lose, such as AIG's infamous contracts. But I've seen more than one terrible portfolio manager negotiate a big raise and promotion after the fact for the trauma they have endured during a downturn.

4. Ostracize or publicly hang the prophets. Rather than reward the wise for sounding an alarm during the bubble, ruin their career for being right, while the powerful where wrong. The Old Testament is full of prophets despised and hated by the corrupt and evil rulers because they shined the light on their immorality. We have already read of the many risks managers ignored and demoted for trying to temper risks during the housing boom. But many will likewise more quietly be found to come up short for some trumped-up charge as the prophets are reminders of great mistakes made by those politically powerful.



At the White House meeting earlier yesterday, P@ulson, on his knees asked Pel0si not to allow the negotiations to blow up, according to a participant in the meeting.

There is so much money at stake for former partners and friends.  What would happen if they didn't do the deal? Exactly what happened when WaMu was picked apart.

Russ Humbert reports:

S N O N H MI recently visited the Sam Noble Oklahoma Natural History Museum in Noman, OK. They described a Buffalo hunt where the wolves and Native Americans would drive a herd of bison into a stampede. Keeping them moving in a  fluid, fast, well worn path, into a natural corral of cliffs, where the wolves and hunters had them trapped at the gate. The herd couldn't move. Those in the front saw sudden death in a bolt, those in the back had no room to move, or know another way to get out. They'd slaughter them all, with the women and children waiting at the top to butcher and skin them and turn their bones to instruments.

The Liquidity Trap: it's very fast and fluid moving with the herd, till suddenly it ain't.



There is the meme going round that somehow a "bear" market is different. That bear markets are the opposite of the hot hand. That because for multiyear periods in 29-43 and in 68-82 the S&P index gave zero returns, that this is "proof" that bear markets are not random. That Bear markets are different, they have such strong momentum we must throw out the zero correlation results that apply to "normal times".

That such a couple of strings of bad luck is "proof" that we should throw out the random walk theory. In fact a certain contributor to this web site has written a book on these "secular range bound bear markets"

If I understand his summary correctly, he is basically suggesting that we abandon randomness and predict a long secular bear, reverting to economic arguments, because 4 "secular range bound bear" existed for more than 5 years and 1 "depression" lasting from 1929-33, and then returning by 1943 in about the last 120 years of the Dow. His suggestion is that we ignore the dividend returns and go with the P/E. This of course, despite no correlation to change in P/E and change in Index. Hence forget the numbers, go with the economics. Of course I am not suggesting that the P/E or economics over these "secular bears" where not bad. Sure, due to the outlook of Labor Unions, Japan eating our lunch in manufacturing, high capital gains and tax on the rich that drove the P/E down in 1968-1982, to very low levels… But this is all in hindsight.
This of course has the media in a frenzy, those without the numerical literacy buy the story hook-line and sinker.   Even many, that should know better, have bought into the argument calling for an "inevitable depression".

If anyone remembers the first e-mail I sent to this web site was just about such "hot-hands" in basketball. My response to the coaches was that randomness is much more clumpy than we think.

It would appear to me that the burden of proof goes to those claiming these streaks are proof of inevitable structural failings continuing (having "momentum") i.e. to the "secular bears" camp, not those claiming "bear markets don't exist except in hindsight."

But what does a simulation say simply using randomness: how abnormal are these "secular bears". My simple simulation using 9% drift per year and 20% volatility with log normal distribution using 500 separate 120 year periods, suggests that it is pretty close to average. Slightly above average, but nothing close to "proof" of a "secular bear" that is anything but random fluctuation. (The 9% drift assumes 2% dividend each year which over the last 100 years was probably too generous to the bears camp. I did use Excel random generator, which I understand has some problems. So someone may want to use code with a "real" r.n. generator to verify the results).

My results average of 3 "secular bears" per 120 year period, but  many 6, 7, 8 separate (separate by at least 1 year with new high) periods. Average max length without new high 11 years, but many  15/16 and 17 year periods.   Of course if you allow 1 year new high before going range bound ( like the 2000-? secular bear)   this  extends such "streaks".

So  it would seem to me that what we have seen is only slightly above average.   Which I would suggest the meme has more to do with  psychology and "bear baiting" than economic inevitability.

Now this is not to suggest that understanding the new new meme on why USA is doomed is not worth  while short term as I suggest this will catch many on the wrong foot short term. Just expect it: when the random news goes the bear way the short term swings will be big. Nor is this to suggest that some poor fool with a 5-10 investment time horizon and low tolerance for risk, whose advisers don't understand the risk, should be 100% + in equity, thinking 10% drift means risk free 5-10 years out.

Indeed: Et tu counters?



 I found myself lying awake in my bed last night thinking about the Nobel Prize Winner. No! Not like that….but about what he said in Stockholm last week. Expected Utility Optimization. What he said is that the goal of asset allocation should be optimizing the expected utility for the actual investor in question, and that the mean variance model should just be looked upon as a special case. And of course he is right. I mean, by the way he sets it up, he is right by definition. But….I am thinking how it would play out in the real world. In my fantasy, a consultant would sit down with an investor, asking questions to find out his preferences. Of course this is already happening in a general sense but here it would end in a very specific investor utility function). Then the asset allocation would be done based on the utility function.

I am thinking that what will be overlayed on the usual return/risk models, are constraints (e.g cutting off tail risk, smoothing out fluctuations and what have you) and while the model presumably maximises return given a risk level and those added constraints; if we add constraints there must be risk premia transferred to someone else? By definition, since the investor specified his utility function (and given that the formulas and models held up and he got "what he wanted") he is better off than before, but so must someone else be?

I am not sure this new allocation model will start a revolution in the way asset allocation is done. I think however that finding situations where other investors are up against constraints, could help open up possibilities and profits. In the micro realm, many traders prefer to cut off the risk of gaps against them, by not holding overnight. This might open up possibilities for traders well capitalised and with good stomach, to do just that (this must be tested). Other suggestions are welcome.

Adi Schnytzer critiques:

AdiIt never ceases to amaze me that people who know markets and work in them don't realise that we don't know the probability that anything will happen tomorrow unless we are in a fair casino. So the idea that anyone can maximize expected utility is nonesense since you don't know the probabilities. I am currently working on developing a risk index as a follow-up to such an index developed recently by Aumann. He cutely argues that even though we don't often know the probabilities to assign to events, it's important that, in principle at least, we have an index. Well, I've been looking for real life examples of his index (and my follow-up) in stock and derivative markets, and simply cannot find one. As a top bookie once said to me: "If I only knew the winning probabilities of the horses, I wouldn't need to know winners; I'd be making a fortune anyway." Spot on.

Jim Sogi adds:

Martin talked about "…cutting off tail risk".

The thesis that outliers shape the future is intriguing, but also that the risk cannot be eliminated. The idea that one can cut left tail risk is an illusion that in itself creates a greater risk. As Phil says, it also cuts right tail return.

Jeff Watson concurs:

Risk can be quantified, assumed, bought, sold, transferred, created, subordinated, reassigned, split, delayed, diluted,  fragmented, hedged against, and layed off……. Risk can respond to some methods, but it is still risk, and is near impossible to eliminate.

Speaking of planning in general, Stefan Jovanovich adds:

I have quoted this before, but it seems worth repeating, if only to add a mite to Adi's wisdom. Planning in business is all very well, but the trouble is that your plan's assumptions always turn out to be works of fiction. As John Wannamaker said, "I know half the money I spend on advertising is wasted. If someone would tell me which half, I would very much appreciate it."

Vince Fulco concurs:

This quote has always seemed appropriate… 

Moltke's famous statement that "No campaign plan survives first contact with the enemy" is a classic reflection of Clausewitz's insistence on the roles of chance, friction, "fog," and uncertainty in war. The idea that actual war includes "friction" which deranges, to a greater or lesser degree, all prior arrangements, has become common currency in other fields as well (e.g., business strategy, sports). [Wikipedia].

Russ Humbert warns:

One of the hardest things to get people to see is that most people/businesses have a long term utility function but operate as if all risk is short term volatility.  For example, I work for a company that has a niche market and is privately held. The owner wants to pass this business on to his great-grand kids so each will be as well off as he is now.  He has only teen kids now. This niche has very little volatility of earnings and good ROEs. But this just encourages piling on the same long term risk, to minimize the short term risk.  That is: grow the core business, not diversify. We already have the leading player in this niche.  Barriers of entry: a learning curve, requires some marketing  nimbleness, and need for stable size and reputation.   However, long term this has  no good ending. Best case we double our market share and flatline growth. But many worse cases.  Bigger, deeper pocket competitor or many, learns our niche attracted by the ROE and stable vol. We are regulated out of the market. Products slowly go obsolete, replaced by Government safety net. We lose our reputation, etc.  See this in spades throughout the fallen out of favor or failed businesses, due to subprime mess.  Low vol high ROE business, until….  For the speculator this would be like choosing a strategy that 95% time gives "Alpha" in a beta model based on quarterly results of recent history.  But all the "alpha" is hidden because, 5% time it causes you to go broke or close to it.  It just hasn't happen yet, or recently.   Basically volatility as a risk measure can hide long term complacency defeating most utility functions.

Going back to the military aspect Bill Egan adds:

An interesting aspect of the fog of war is the common mistake of not reevaluating the plan often. A major cause of this error is that people confuse perseverence towards a goal (a good thing) with sticking to the particular plan they are using at the moment to achieve that goal. Criticism of the plan and proposing actual changes to deal with new information or uncertainty are considered as defeatism or disloyalty and the operationally fluid are smacked down. The no longer relevant plan is then ridden on to failure to a loud chorus of "yes, sir! yes, sir! three bags full, sir!" A pleasant sight if it is your opponent doing this but awful if it is your leadership. I have fond memories of serving as a company commander under a battalion commander who always asked us to tell him if he wasn't making sense and meant it. Good man. 

Phil McDonnell  enlightens:

PhilThere are many deep questions in Mr. Lindkvist's ruminations on Expected Utility Optimization.

My first comment would be that there are at least two distinct classes of utility function. The first class might be what can be called the Ad Hoc Class. This would include the questionnaire method of approximating one's utility function.

Other methods might be classified as normative, as in what one should ideally want to use for a utility function. As a well known example we have the Sharpe Ratio. This is based upon the normative idea that one should maximize expected return but with a quadratic penalty for increased volatility which is treated as a surrogate for risk.

The idea of using a square root function as a weighting for betting returns actually goes back several centuries to Cramer, a mathematician. His friend and frequent correspondent Daniel Bernoulli countered with the idea of a logarithmic weighting function, which is also what I espouse with extensions. Bernoulli's ideas were not translated into English until the 1950s and thus were lost to Western thinking until very recently.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008



Whenever knocking a hat off I feel, and want to tear the weekly paper to pieces, and lash out at all the nabobs,  I don't take me to Nantucket but read "The Surprise" by O'Brian. There I find a passage about how the hands like to pretend that the ship is about to go under with the non-mariner dignitaries, and how the water is going to sink it, if not the waves or the backlash. It makes me think about the reasons for all the negativism. Is it the insiders trying to scare the daylights out of the public like the mariners? Yes. What difference does it make if the economy is down 1/2% this quarter and goes up 4% a year the next several years? Or what difference does it make that there was a housing recession the worst in 25 years. Or that the financial institutions had much water on their balance sheets. Such has happened before in the last 100 years, and is it bullish or bearish when all this negativism is about. One needs a Jack Aubrey with his natural ebullience to see the sweet sailing ahead on the blue waters that beckon.

Tim Melvin replies:

It makes all the difference in the world for any of us who wish to bet on US stocks… unless we are capitalized to withstand a 20% or more drawdown in stock prices. it especially matter if you are using any leverage at all (and yes I counted it. The average peak to valley drawdown in stock prices in a recession is on the order of 30+%. we have not even come close to the 1000 SPY levels that would be normal. The last time we had stagflation, the market fell over 60% peak to valley) There will indeed be blue skies ahead someday… the question is when? The combination of a falling economy, falling real estate and higher food and energy prices is crushing the consumer. If consumers do not buy luxury items, go out to eat, to the movies or even replace wardrobes, household items and even wardrobes, the companies that make these items, the retailers that sell them, and the companies that supply raw materials have lower profits. They cant borrow to make it through bad times and the water on bank balance sheets has tightened credit.

Loathe as I am to ever be opposite to one of the men I most admire, I think that most stocks are a poor bet right now. yes we will cure cancer, technology will advance and the long term future will be bright indeed. But not right now and reality is still not priced in the stock market. The dollar gets it, and bonds are starting to. The storm must pass before the sailor can safely leave the harbor. One caught in the storm must batten down and hope to ride it out as safely as possible. many , if not most, of those who ignored the warnings of wind and tide may well perish. Not even Aubrey would sail into the typhoon unless he it was a matter of the greatest urgency. As investors and traders we have one supreme luxury. We do not have to leave the harbor, and can profit by betting on the typhoon once in a great while, or simply sail a different sea.

Vic illustrates:

Here is a passage from The Surprise: "The envoy, Stanhope, had been told that water was coming in through the sides, and a seaman had told him that this was the gravest sign of all. One of the young gentlemen added that being pooped was more likely than actual foundering, or breaking in two, though neither possibility was to be overlooked. " Stephen said "The water coming in was inconvenient and even disconcerting but it was a usual phenomenon in such circumstances, particularly in aged vessels: It was what the mariners termed "the working of the ship." And be cautioned against too literal a belief in the words of the sailors: "They take an obscure delight in practicing upon us landlubbers". Once relieved of the sensation of imminent death, Mr. Stanhope…. ". Yes, the delight the brokers take in downgrading one another, and spreading rumours of runs, and trying to run the nakeds up again as they did the last two Springs, is not too innocent, but calculated to gain increased emoluments from the government and their future colleagues at the Board, and increase their share of the prizes as the landlubbers abandon ship.

Russ Humbert writes:

Perhaps it is no coincidence that Lehman, Merrill and Morgan Stanley, having received a review from the rating agencies that downgraded but still maintained their excellent ship worthiness, that the shorts would be emboldened. After getting so much wrong on the mortgage backed front any affirmation from them is similar to an endorsement from Bush's foreign intelligence chief on Iran. And perhaps it is no coincidence that Merrill, was the first to come out stating the shorts are full of hot air on Lehman's because they see they are next in line.

It will be interesting to watch for confirmation that Ben's revival meeting with all the investment banks included thinly veiled threats to those Investment Bankers who don't support their competitive brothers and reminders that  any piling on by them would be remembered for a long time. Was there a reminder that Bear Stearns did not help LTCM in 1998? Will Ben rally the troops? Will he speak in code? And how will the other brethren react? And will the SEC this time understand that their turf is in jeopardy and launch a full assault on the rumormongers, as they did on the  hyperbole of the dot com analyst? It has been my experience that a regulator fearing a turf grab is a dangerous animal backed into his own den with the hunter thinking he is cornered. And finally, could it be that the switch in NY governors will be the wind turning against those who believe their job is to protect us from big business without regard to method because size is equal to guilty?

The President of the Old Speculators Club, Mr. Tierney, issues a warning:

"Seems to me the greatest opportunities to make money going forward over the next 18 months to 24 months is to Short Gold, Short Oil, Dollar Cost into Equities as always, Long Dollar" - A reader of this web site

An interesting observation. In that it's been almost exactly 7 years since I announced the dumping my entire portfolio except for a couple of resource stocks, some retrospection is in order.

A recent post lauded the performance of IBM, hitting a multi-year high of ~$125. More recently, AXP was commended for its performance around $45. Those were among the equities I cast overboard, IBM @ $115.04 and AXP @ $39.43. As of today I would have been up 11.47% with Big Blue and 18.67% with AmEx - not exactly stunning performances over seven years (especially if one were to calculate the effects of inflation).

On the issue of shorting gold it has been an idea promoted by various List members at various times over that same time span - they have been incorrect. The concept of overpriced oil harkens back to the build-up to the second invasion of Iraq, when it was posited that the price would go back below $35; similar pullback predictions have been scattered over the past five years - once again, incorrectly.

The long dollar argument was made most forcefully by Yale Hirsch and his imported and highly regarded currency-expert henchwoman. That dates back about three years or so and, again, was incorrect.

Now the drunk who insists on looking under the street light for his lost keys because it's easier to see, may, once in a millenium, find them there. That's just luck. However, how do we judge the many sighted Street "names" who, over an extended period of time, have groped in the dark but come up empty?

More important, to whom do you listen for guidance in perilous times: the babbling and infrequently lucky drunk or to the sober and calculating historical record? The answer is obvious. Unfortunately, as has been documented and repeated innumerable times, the Market Mistress does not do the obvious.

Nor does she (nor anyone else so far) prepare meals of crow.

J. T. Holley asks:

Do you really think that we are in perilous times?

Jack Tierney replies:

Yes, I do. But in fairness, that's my nature. While many look on the markets with unflagging optimism (Vic and Laurel , L.V. Gave , Dimson et al. ), I tend to believe we have lived at a truly extraordinary time in an extraordinary country. So extraordinary, in fact, that not only those with the courage and capital, but also those who've stood and waited at the right place, have seen modest sums grow exponentially.

I am one of the latter, caught up by events and carried with the wave. Others, through risk-taking and foresight, have done substantially better, and deservedly so. However, the last 60-70 years doesn't, in my opinion, establish an immutable pattern. Historically, our past century is an anomaly. There has always existed a self-selected minority which achieved wealth through courage and daring.

But these last two (or three) generations have been unique in that wealth has "trickled down." Enough so, unfortunately, that it has become politically correct to view abundance, if not affluence, as a birthright - and one which can legislated for those who have missed out.

In itself, though, that's not enough to make me skeptical. My profit sharing account took some real whacks in '73-'75 and again in '79. I was fortunate enough to be in cash in '87, but got a minor haircut again in '91. I can live with oil crises, the slow motion crack-up of steel, autos, and aircraft. Technology, however it is defined at different times and different places, always ends up with more losers than winners.

But when major problems come out of the banking/finance sector, it's time to squeeze the pennies. Forget for the moment about those who have overspent and under saved. Instead, consider those financial institutions which have peddled gobs of their mortgage paper to pension funds, both public and private. By Greenspan's description, these are among those most able to undertake risk. In fact, they are not.

Much like myself, the memberships are made up of ordinary individuals who expect a modest sum to be available when they retire. If nothing is there, there exists no fallback positions. Already there are rumors of deficiency notices circulating… some involving major unions, others major metropolises. Jefferson County in Alabama is on the hook for over $3 billion in auction rate securities because JPMorgan and others sold them on interest rate swaps as a way to cut down on expenses.

In short, from the time of John Law, banking foul ups have had a much more severe effect on an unsuspecting public than any other business blunder. When bankers get it wrong, almost everybody gets hurt. So, yes, I'm concerned.

Stefan Jovanovich dissents:

I don't think the facts of American history support John's pessimism or his assumption that the years since the Great Depression have been uniquely profitable. The increase in wealth in the British colonies of North America from the end of King Phillip's War to the start of the Revolution was far greater per-capita than anything we have seen in the last 90 years; that is why there was an immigration boom that dwarfed anything the country has experienced since then. The period from the end of the Civil War to the passage of Smoot Hawley was equally spectacular as far as individual wealth in the North, Middle and Far West (but not the South) are concerned; and, once again, people literally flocked to the United States. Both periods depended on changes in technology that were - at least from the point of view of their effects on the rest of the world - far more dramatic than anything we have seen in our lifetimes. The improvement and broad use of Jethro Tull's seed drill was an agricultural revolution that equaled the effects of artificial fertilizer in our time, and the mating of steam power with Jacquard's loom turned India from a textile exporter to importer (with help, it must be admitted, from Britain's discriminatory trade rules).

John is right that, initially, "technology …. always ends up with more losers than winners" in the sense that machines replace people. But without that displacement no increases in wealth are possible. Socialism's real curse is that it kills all invention and change; in the name of fairness and equality Lavoisier's head is always the first to go.

The genuinely new and different improvement of our time has not been in wealth but in health. What the world has never seen before are the mortality statistics. Even with the devastations of the two World Wars and the results of Marxist national self-improvements in Europe, Asia and Africa, the change in the ability of people to be born safely, survive childhood and live long enough to suffer the diseases of old age and indulgence over the last hundred years has been breathtaking.

I wish I could share the assumption that the "public" - that anonymous sociological beast - has been duped by the evil bankers. Perhaps that has been true elsewhere in the country. But, from the point of view of California, the people who have borrowed money to buy dirt and houses and condos have been a great deal less unsuspecting than the folks who bought the securities that allowed the pyramid party to keep going. The borrowers knew they were signing for far more money than they could pay back out just the way anyone who could read knew during the Internet bubble that very few people were actually making any money from the brave new virtual world. In both cases the buyers thought it didn't matter; and, for a great deal longer than we supposedly rational business people considered possible, they were right.

My real quarrel is not with John's assumptions but with the premise that seems almost universal - namely, that bankers are still the source of enterprise capital that they were even a generation ago. Nothing that I know from direct experience or from studying the numbers for profitable non-financial public companies bears that out. We own common stock in 147 companies that do business in everything from shoes to lasers, and not one of them has relied on commercial borrowing or public financing as a significant source of cash since 2000. Of the over 100 independent business people I know here in California, the only ones people who have been able to rely on commercial credit from banks have been the folks dealing in real estate. Everyone else has been told no. Even SBA loans became dependent on the entrepreneur's having real estate that could be pledged as security.

Ironically, now that residential real estate out here is finally getting cheap enough to compete with rental prices and people with jobs and savings want to buy houses, the same bankers who issued ARM liar loans are largely unwilling to issue straight mortgages when the numbers pencil out. Having watched the Sandlers convert everyone to their cultist belief in appraisal values as the standard for credit-worthiness, most California lenders are now refusing loans because of their fears of what REO sales will do to future housing prices. The prospective buyers, who are offering to put real money down, are willing to take the risks; but the bankers still think they know the market better than people willing to put up most of their savings because they can buy a house for what it now costs them to rent an apartment.

The old bankers are always getting it wrong. That is why we end up having to find new ones.



This web site's contributors and readership consists of astute individuals looking to make informed investment decisions (or perhaps, more appropriately, trading decisions). However, it's worth remembering that many participants in the market maintain positions based on less objective criteria.

While taking a break outside today, I encountered an older gentleman returning to his workplace (a large diagnostic laboratory where he delivers lab samples to and from doctor's offices). He asked me what I did, and I replied "Investing", without going into great detail. He then asked me jokingly if I could get his investments back out of Enron. He then proceeded to explain that he had lost the majority of his 401K as an employee of Enron (he had been a petroleum engineer at a company acquired by Enron for over 20 years, then spent several stints with Enron in Houston). He reminisced that many times he had ridden on the same elevator with Ken Lay and Jeff Skilling, and had been told repeatedly, "Make sure you're buying that stock, T*****!" Now, at 76, he's a delivery driver, happy that his diabetic wife gets free lab work, but unlikely to retire any time soon. One can only hope that his eyesight and reflexes enable him to retain his current position for the foreseeable future.

After he walked away, I thought about my own fortunes. My first job in finance was with a firm that will soon cease to exist, and my immediately previous position was with a firm that recently announced substantial job cuts worldwide. Both firms pushed their risk boundaries past what might be considered reasonable bounds. Neither appears to have engaged in the fraudulent activity associated with Enron (as far as we know), but they may have arguably breached their "duties" to their stockholders in their pursuit of profits with insufficient regard for downside risk. I'm fortunate to work for a small firm that engages in high risk investment (seed and early-stage venture capital). The risk is high, but transparent and straight-forward to those who participate.

How often do we as investors/speculators encourage risk-taking behavior that bundles up participants who are unaware or uninformed about the risks involved? We can argue that anyone who takes an equity stake in any enterprise has the duty to inform themselves about the nature of their investment. If that is really the case, though, does some type of duty exist within the corporation to insulate and diversify their rank and file employees who serve in functional positions with little strategic input? Would doing so cool the market for high growth stocks, and would that chilling effect ultimately prove less expensive that the potential social burden that results from the destruction of shareholder value if and when things blow up?

Many people here have made and lost fortunes (some more than once). The difference would seem to be that the DailySpec readers were probably easily classified as willing participants. Does a duty exist to make a firm's members aware of the risks of stock concentration at least, and risk-taking strategy implications at most? I think many will state that we are all willing participants. However, we should remember that when things go the wrong way, collateral damage occurs. The question I suppose that I'm posing would be how much of that damage is needless. I can only thank reason and fortune that I'm in a good position now, and hope my new friend finds a way to enjoy some part of his golden years, even if they're not turning out as he planned.

Stefan Jovanovich adds:

"Everybody cheats" (See Breaking Away). Allowing companies to adjust the forecast rates of return on their defined benefit plans' portfolios was the way everybody in management cheated under the "old" pension plans. Allowing companies to contribute their own paper to 401(k) plans instead of cash has been the way everybody in management has cheated under the new pension plans. But it would be disingenuous to claim that the knavery is only in the board rooms. The poor, lowly employees in Enron had their own part in their financial ruin. The cheating in Enron was not just done by the senior managers of the company; it was endemic throughout the company. So was the boosterism for the stock and its price. The peer pressure to "buy the stock" came as much from lower and mid-level employees as from Lay and Skilling. Once "ordinary" (sic) employees come to "believe" in their company's stock, they become the most emphatic preachers of the new financial faith. People know when they are being greedy or lying to themselves; the question is what they do about it. Some or none or all of this may apply to the poor soul Jim Rogers met. 

Russ Humbert expands the scope of the analysis:

Why risk management is taken for granted or ignored:

1. Everybody is a genius when things are going great… It couldn't be that you got lucky. A good risk manager reminds everybody they are not as smart as they think they are. A good risk manager tells them to walk away from the table, or at least take some chips off of it. Which is always interpreted as "you are preventing us from making money". It is very hard to argue with success, if it's the gambler that just threw 4 straight 7s to Buffet at his annual meeting.

2. When everything has gone to Hades a good risk manger can't win. First he has to convince them that there are no excuses, take your losses like a man. Certainly there will be someone to blame, from the con-man to the incompetent fool; the loss could have been avoided. Learn from it. In investing, everyone has a choice. In 401k a good variety of choices with proper accounting for $ should be the only obligation from the business. Second, he has to direct them to the opportunity in the panic, rather than look for the scapegoat. When things are bad, risk is always overestimated by someone needing an excuse to cope out of making scary calls and implying nobody is to be trusted. Hurricane and earthquake insurance premiums increase after the fact. Try convincing managment now is the time to be in earthquake business when everybody is wanting to buy it.

3. Many believe risk management should be free. (For an example, look no further than nationalized health care). Nobody wants to pay for the research and personalized understanding that takes time and money. Ask your superiors for resources, on something they consider a sunk cost that constrains them, and they are not interested.

4. Many believe investment risk management is simple common sense, which can easily be regulated. Working for an insurance company, and seeing the high regulations imposed on insurance companies investments, it's clear regulations and common sense don't mix.

5. Many believe risk is not a personal choice and a cookie cutter approach for everyone works fine. Think of the millions that have suffered and died due to FDA's approach. But with personal choice comes personal responsibility. Tell this to the risk addict. Or tell this to the insanely paranoid.

6. The Lake Wobegon effect where every child is above average, clearly applies to investing. In a investing/business you can always find a area where your business does a better job of managing risk than the rest of the industry. Or if not the industry average, you can find someone that does a more shoddy job than you. Hence, you are above average in every aspect. Further it never occurs to you that everybody may be lemurs headed for the cliff. Try being the risk manager to a disfunctional buisness, I think I would rather tell a Mom her son can't move on to the next grade.

7. A close kin to Lake Wobegon is many believe they are "blessed" and therefore can ignore purdence. While risk management applies to the masses, they got G*d on their side. If its simply because they were born to the right parents that their luck can't run out. Or it could be the opposite, they have had such a string of bad luck that the Big Guy owes them. Pity the poor risk manager arguing with this.

8. The Rating Agencies are thought to be better than internal controls. Nobody considers that the ratings are a game and are often exploited. This has many parts:

a. As I wrote in an earlier post, the subprime mess is largely due to socialist industry averaging of risk management.

b. When the game is to get the rating, not to manage the risk, there are a million loopholes. Simply learn what they review, and take your risk elsewhere (hopefully this increases your returns). Hedge funds/Sharpe ratio, go with liquidity. Investment banks balance sheet, move them off balance sheet with SIV's. P&C companies, do reinsurance with side contracts like AIG and GenRe. Life and Annuities insurance companies, use variable annuity guarantees and interest rate guarantees (which are now being monitored after large loses)

c. It seems Enron bought their rating. From the magazine ad claiming "Car of the Year" to Nobel Prize. You should assume raters have some price: dollars, political, or connections and you should not consider them totally objective.



Is the Subprime mess one more indicator of the devil may care, not my fault, no care no responsibility, times we are living in? Are the Fed bailouts the ultimate back up to keep this poor social situation alive, leading to a poor thought process for the next rogue trader, head fund manager, and for that matter retail trader sitting down at his platform.

Is this ultimately leading to a internal breakdown of our own risk mismanagement on our own accounts even though at the end of the day it's us on our private accounts and we will be ultimately responsible.

How can we change the situation - When is someone going to stand up and say, "I'll take the hit , I'll wear the pain , It was me!"

Janice Dorn explains:

Maslow's hierarchy of needs is often shown as a pyramid where people go from the base to the apex in terms of what they focus on. The lowest level (base of the pyramid) reflects the most basic human needs– food, health, sleep, physiological needs). The next level is shelter and safety from danger. The next three have to do with belonging (love, affection, socialization), esteem (self and from others) and-finally-the highest state is self-actualization (evolution to a higher consciousness, authenticity, achievement of individual potential, transcendence, creativity).

Humans are unable to progress to the higher levels when they are preoccupied with the needs of the lower levels. In order to distract people from higher levels, one need do nothing more than threaten their basic needs. When people are focused on their basic needs, they do not have the capacity to deal with powerful issues such as personal responsibility. They are too busy focusing on either feeding themselves, dealing with illness or worrying if they will have a roof over their heads tomorrow.

Throughout history, the best way to strip power from a person is to divert their progress up the pyramid by doing something that forces them to stay "stuck" near the base of the pyramid.

We are not evolving. Rather, it appears that there is a not insignificant amount of devolution occurring. As long as we look to "the powers that be to get us out of this mess, the less chance we have to move through the bottom two stages and get on with creative evolution. We will, as a nation, remain, worried, frightened, and sick. The way that power was taken from kings was to poison them. They did not die, but they stayed sick and thus fell down the pyramid to the lowest level.

The person that must stand up and take the hit and wear the pain is the person who looks back at each of us in the mirror. If we cannot do this, we will turn to everyone else to rescue us, to fix the mess, to take care of us, to save us from ourselves. The war against personal responsibility and individual empowerment is in full force. We are unraveling.

Alex Castaldo notes:

I was surprised by the headline in the Financial Times on April 10 "Banks take blame for crisis".  Maybe there is hope after all. 

Russ Humbert offers a deeper perspective:

While nobody wants to take responsibility for the sub-prime mess, the media has certainly laid blame at the feet of the capitalist. "Capitalists acting too aggressive", "Capitalists only out for their own self interest", are a couple of the "causes" I have heard from the media. However, if the origins and the incentives in the sub-prime markets are studied or in other words the true "cause" is explored, it clearly was due to the markets letting socialism creep into their midst.

The timing of the GSEs entry into subprime seems highly suspect.

The deterioration of underwriting standards can be understood, if you understand the rating agency or risk management was graded almost solely on industry average and industry statistics. Such "pooling" of risk management might as well been pooling of agricultural production. What happens is nobody works. It was a mad rush to capitalize on others' efforts.

Thankfully, the capitalist inspired puts in the contract led to most of those irresponsible enough to think they could get a free ride on everybody else's risk management efforts paying the price. The capitalist insisted they had a least enough skin long enough that they couldn't ignore it without getting caught. Thankfully, some of those capitalists caught this problem early enough and are driving a hard bargain to make sure this mess gets cleaned up fast and making sure it won't happen again. While this may be a high price to pay, just imagine if those aggressive capitalists hadn't all dived in at once. The march to socialism might have been slower, but like a boiling a frog, this would have slowly allowed the GSE's to eat a cancerous toxin, driving them to a slow painful unavoidable death. Or if the short sellers had not been allowed to price the actual risk, those executives responsible would have crippled the banking system and the economy for perhaps a decade, bleeding but not admitting wrong doing to stay in power (as happened in Japan).

Capitalist was the cure, socialism the cause.



Every investor should study what Spitzer's relationship was like with the media. What he seemed to be able to deliver for a reporter was: 1, to break the story, and 2, to be on the winning side of the story, exactly as long as it held the public's attention.

If you can set this up as a guaranteed coup for the reporter, they will in gratitude let you pin it on whoever you want, and escalate and over-hype the "crime." Truth and reality are the first victims in wars of reputations.

Now clearly he didn't understand that they were there only because of the two rewards as their main incentives. They weren't morally on his side, but using him like Clinton using an intern. They were on the side that offered two tangible rewards.

What I am asking myself today: was S&P's announcement, and the market's subsequent intra-day recovery, enough of an incentive to the media to change sides in its reporting of the Subprime Crisis?



Father/SonNoticing that my son (age 5) was not particularly assertive (e.g. if another kid took a toy he was playing with, he just cried) I decided to embark on argument training. The problem is that in this attempt at rounding I seem to have been rather too successful, and now he argues about everything. And that includes some chess positions, even though he can't play. He's also started memorialising examples of his being assertive in "folk tales," which need to be repeated several times a day. For example there was the time a 2 year old tried to take his plane in Pizza Hut…

I'm starting to wonder if the best someone can really do is to try to improve himself whilst just spending time with his kids, with no particular goal in mind?

Jim Sogi suggests:

One, no matter what, always let the child know that you love him, even when he fails or is bad.

Second, especially ages 2-8, be consistent with rewards and punishments.  Don't spoil the child, but guide him with firm rules. He will be happier for it in the long run.   I see so many parents unwittingly training their children to be spoiled brats, and they both end up miserable. After that, its almost too late.  Manners and etiquette should be a part of the  program.

See Living with Children by Gerald Patterson for specifics.

Kim Zussman remarks:

How to raise happy, well rounded kids? That's easy: stay married.

Mom and dad need to transcend herd psycoidology insisting that happiness-entitlement derives from the continuous hunt for new itches to scratch.  If this doesn't resonate, go to church. Then, when your kids grow up happier and well adjusted, mom and dad will be happy as well.

At a Bar Mitzvah yesterday, the rabbi and new man discussed at length the reluctant leadership of Moses on his way to Exodus, as well as themes of peace, forgiveness, avoiding war, etc.  Ironically 80% of the audience had been divorced, and the audience included numerous young people with various parent/step-parent complexes.  So much for Ashkenazi IQ.

Russ Humbert writes:

PuppiesWatching a dog raising pups, you will see that the adults are pacifist during the first weeks. The pups can cause all manner of pain and annoyance, and both the male and female dog will take it all without any aggression. Then, once they are old enough to understand, comes the discipline. They are taught to understand hierarchy of the pack. They are also taught to become top dog you must fight. This shows us several things about ourselves that many modern parents ignore.

In a society that is becoming less and less hierarchical in nature and more team oriented, less discipline is needed, but more proper peer pressure. And, governmental attempts to ban corporal punishment by parents is doomed to failure. Like prohibition, the war on drugs, and sexual abstinence. When you go against the brain's natural response, the police lose. Anyone who has been close to the foster care system in this nation, knows first hand how dismal this failure is likely to be all at the expense of the most innocent, the child.

I would suggest that in raising a child one must consider his innate strengths and weaknesses in deciding how much of team player/hierarchical structure he needs. But also one must consider that most parents simple follow the "team" approach because it is popular.

In other words, teach a child to stick up for himself, but draw the line when he disrespects you.

Scott Brooks follows up:

Unless there is something biologically wrong with a child, there is no reason for that child to become depressed and miserable if he is raised to be happy and find joy in life. Becoming "genius-like" I believe is far more about nurturing than biology. Sure, biology helps, but the right environment is far more important. A good environment can make a kid, whereas a bad environment can break him, even if has the grey matter necessary to become a genius. Training your children how to think is the key. Not just how to think about intellectual endeavours, but how to think about philosophical and emotional endeavours.

Being happy is a choice. Having a good attitude is a choice. Being smart is a choice. I was beaten down in school because they thought I wasn't very smart. They wanted to put me in special school, but my mom wouldn't let them. But I was always raised with a belief system that my life was my choice. When I went away to college, I decided to make a fresh start, since no one knew me. I played the role of the smart guy and — surprise — I was smart and got good grades. I credit all that to my upbringing: being taught to be happy, find joy, to look on the bright side and always believe that good things would happen. I "got smart" as a result of that.

Jeff Sasmor recounts:

I let my kids (girls, 14 & 16) mostly do what they want as long as they keep up good grades. When they don't I hire tutors. As a result one has an A average and the other B+ with no nagging from me. About the only exception is that I never let them fall behind in math. They have had unfettered and unmonitored Internet access since they were each about 5 or 6.

I let them explore what they want to do and I don't push them in any direction; rather, I think it's more appropriate to encourage them in what they appear to be interested in. One has become a really quite good writer. The other has self-taught herself to become a good artist and is starting a band with some friends.

They should explore while they are able; most adults do not have that luxury once they have to pay rent. They do have friends whose lives are scripted to strict schedules of sport and other activities. I don't understand this sort of parental behaviour, but then I don't understand many things that involve people's minds.



HGHGiven the remarkable performance of older players like Clemens and Pettitt, has anyone pointed out that perhaps one of the main thrusts of investigation should be whether there would be a beneficial effect for all of us in using moderate replacement quantities of substances like steroids and HGH that decline significantly with age?

I for one would like to know more and would appreciate article citations, book recommendations, and information on physicians specializing in the field.

Chris Cooper replies:

Such beneficial effects are apparent to anybody with an open mind. Nevertheless, the idea that a performance-enhancing drug might actually make you healthier is the kind of message that is not acceptable to the mainstream.  Aging is not "normal", it is a disease, and should be attacked like any other disease, with an eye to minimizing the deleterious effects.

What you are referring to is often called hormone replacement therapy (HRT).  The approach is to use drugs and nutrients to bring the body's hormonal balance back to what it was when you were a young man.  Is it surprising that if you achieve this, you actually feel much more like a young man?  Why does our culture consider this to be undesirable?  My goal is not simply to be healthy as it is commonly defined, but to strive for optimal health, a very different concept.

A good book to start with was written by my doctor Philip Lee Miller, called Life Extension Revolution: The New Science of Growing Older without Aging. Dr. Miller is in the SF Bay area. Also I've heard good things about the Kronos Centre in Phoenix.

Janice Dorn writes:

One of the contributors to my just-released book is a world-renowned authority on optimal health.  I took nine years of my life, and traveled 1.5 million miles outside of the United States to every country in the world (some many times) in search of life extension and radical wellness methods. Needless to say, it was an incredible journey, and it continues to this day.

Caveat Emptor. There are many charlatans out there, and we are in largely-uncharted waters. It is a passion for me, and I believe that the goal in this area of life is to delay, avoid and eventually reverse death.

Jim Sogi suggests:

SurfPerhaps a better way is hard effort. I still get out and surf 20 foot waves last week and take time to surf at least four times a week and train when there is no surf. No pill will keep you in shape without effort. Just the thought of a pill is enough to kill the will to motivate effort required to maintain and build strength, flexibility and stamina. It's like technical analysis, it offers an easy way without the work, and will lead to more harm than good. I see many men really going downhill. They don't stay active. Laird Hamilton says, "Keep Moving!" That is the best way to stay fit. I compete with the young guys everyday in a competitive lineup in the water for waves. I can't outperform them, but have other strengths which give advantage.  It's hard work. It takes hours everyday to stay moderately fit, and more to build strength. That's the problem, most don't and won't take the time and effort to maintain and build strength and gradually lose it. Strength from a pill won't help without the agility, flexibility and stamina that are the other components of fitness. Don't worry about the pill, just get out and spend the hours everyday to stay fit.

Chris Cooper responds:

BodybuilderYes, a better way is hard effort. I have gotten more benefit from the sports that I train for than I have from the drugs that I take. The drugs are an incremental benefit, though, and I am certain that I am better off with them than without them. And you may find, as I do, that instead of being de-motivating, they actually increase one's desire to participate.As an example, suppose you are taking testosterone. If you are not exercising, it will do little to build muscle. You still get the other benefits, such as general feeling of wellbeing, increased libido, increased optimism. It enables you to build muscle faster, because that only happens if you put in the effort. It's not magic, you still have to do the work — but testosterone also makes it possible for older men to train as hard as they did when they were younger, because your body will recover more like it used to. 

Larry Williams opines:

The flap about HGH in baseball is pure propaganda, based on my personal extensive testing of it. I concluded it was expensive and of little, if any help, in waging the war against old man age — a view that is now also backed up by science.

Ken Smith responds:

Studies are studies and not reports from individuals. I am an individual. The studies cited older people. I am an older people. My individual report differs from the studies as reported.

I can tell you resistence exercise will promote better body tissue and that the same exercise will tear tendons, ligiments, induce on-going pain. There came a time when the benefits diminished and the pain increased.

I am reminded of a story told by an author about his last visit with his grandmother. She was quite old, in her 90s As they conversed during her feeble days, on one of those days, her last it turned out, she asked him for a small glass of wine, told him there was a time for everything, sipped the wine, closed her eyes and passed on to the next dimension.

Russ Humbert remarks:

I would not be so quick to rule it out Growth Hormone for enhancement. The Chinese women seemed to have had much success with using it for distance running in the mid 90s. Several of the women were running times better than the men. However, they also ran extreme high mileage and were practically starved while setting several women's world records before their coaches where caught transporting drugs through customs before an international competition. Several of the stars went insane under such a regiment. 

Charles Pennington enquires:

Dr AliI'm open-minded about this, and I went as far as to buy the book written by Chris's physician, who seems like a reasonable guy. But the Life Extension directory of doctors isn't re-assuring. There is just one doctor listed in Manhattan, Dr. Majid Ali, whose website is Featured there are "Hydrogen Peroxide Baths and Foot Soaks" "The Oxygen View of Pain Management," "Bowel Detox," "Water Therapy," and "Dr. Ali's Castor-cise."

I also checked for a practitioner nearby in Connecticut. Doctor Warren Levin, in Wilton CT, is at The general garishness of the site, the endless list of specialties — "Magnetic Field Therapy," "Juice Fasting Therapy," "Auriculotherapy" — and even the Ron Paul promotion (Ron Paul == more permissive environment for quacktitioners [which is fine]) all leave me skeptical.

I wonder if Chris's physician could recommend someone in Manhattan who has a more rigorous, scientific approach than these guys.

Chris Cooper replies:

Perhaps these links will be more productive:

American Academy of Anti-Aging Medicine

The American College for Advancement in Medicine

Steve Leslie extends:

Philip MorrisI think back to the 1960s when the medical profession and the tobacco industry discounted the evidentiary link between lung cancer and smoking as anecdotal. And for 40 years after that the tobacco industry still fights in courts as to smoking and COPD, lung disease, heart disease and emphysema — long after they have paid billions of dollars to settle various class action lawsuits and agreements with attorneys generals throughout the country and have watched 450,000 American citizens die every year from smoking related illnesses.

I watched my father wither away and die as a result of a lifetime of smoking cigarettes.

Now some want to debate that the beneficial effects of steriods and HGH in adults outweigh the anecdotal risk. And I think of those in professional wrestling such as Chris Benoitk who committed multiple murders of his family and then suicide, professional footballers such as Lyle Alzado, dead from brain cancer, professional baseball players such as Ken Caminiti, dead and an avowed steroid abuser, high school boys by the tens of thousands who experiment and take steroids and commit ‘roid rage and suicide, and the untold thousands of recreational users who develop enlarged hearts and forms of cancer such as prostate cancer while juicing just to get bigger muscles.

Chris Cooper clarifies:

Chris BenoitThere is no medically documented connection between suicide and anabolic steroids. The medical data also say, "Supraphysiological doses of testosterone, when administered to normal men in a controlled setting, do not increase angry behavior." 'Roid rage is a convenient media myth. Steroids may very well cause changes in feelings, but that is far from causing major behavioral changes like those suggested above.

Take Chris Benoit as an example. When doctors examined his brain they found that it resembled the brain of an 85 year-old Alzheimer's patient. It had suffered so much trauma and had so much dead tissue that normal function was not a possibility — while dangerous personality, behavior, and temperament changes were more than probable. During his time as a professional wrestler with the WWE, Benoit had subjected his body to head trauma hundreds of times, most notably with his signature "Flying Head Butt" as well as dozens of other highly flashy (and dangerous) moves.

Steroids are being unjustly demonized, just as marijuana was in Reefer Madness, followed by equivalent media behaviour regarding LSD, Ecstasy, and many other drugs. Certainly steroids have their downside, and just as with recreational drugs, should certainly not be used by minors. But perspective is not allowed in times like these, where fear is inflamed to further the objectives of those who will benefit. 

Steve Leslie continues: 

Taylor HootenI dispute Mr. Cooper’s assertion that the is no medical documentation connecting steroids and suicide or rage. That is ridiculous. At a Senate Caucus hearing Don Hooten testified that his son Taylor, while in high school, began using and abusing steroids and committed suicide.

Mr. Cooper furthermore claims that Chris Benoit murdered his family and then committed suicide because of years of suffering numerous concussions and possible dementia. Did he personally perform an autopsy on Mr. Benoit? Has he examined the autopsy report? Where does he draw his conclusions from? In short, what specific research does he quote? Furthermore, what are Mr. Cooper's qualifications in forensic pathology and/or psychiatry?

Mr. Cooper further argues that it is some sort of a myth, steroid usage and its association with massive mood swings and subsequent rage. He then compares steroids to marijuana and says that it is being demonized by an uninformed public. Not to stop there he equates such unfair demonizations with LSD and ecstacy and “other drugs.”

He diminishes the risks to an absurd level and I am severely shocked and alarmed.

Chris Cooper responds:

Don Hooten runs the Taylor Hooten Foundation, established after his son committed suicide. Now Mr. Hooten runs around the country telling everybody that it was because of steroids, when there is no evidence pointing to that. According to,

There had been no active anabolic steroids in Taylor's body for two months prior to his suicide (according to a report on the THF website) At 17, when he killed himself, his hormone levels had likely returned to completely normal, and only metabolites of nandrolone (not active compound) were still detectable.

And no, I didn't personally perform the autopsy. But here is a quote from the doctors who did, via,

SLI's tests showed that Chris Benoit's brain had large amounts of abnormal Tau protein in the form of Neurofibrillary Tangles (NFTs) and Neuropil Threads (NTs). Multiple NFTs and NTs were distributed in all regions of the brain including the neocortex, the limbic cortex, subcortical ganglia and brainstem ganglia, and were accompanied by loss of brain cells, a condition for which no other neuropathological evidence for any chronic or acute disorder could be found.

Gordon Haave adds:

QuoteIt is silly to say that one can't quote the work of someone else. That is, one can't comment on an autopsy unless one performed it himself. If we took such an approach all of the time, there would be nothing to write about.

Furthermore, in the interest of scientific inquiry, providing anecdotal stories to a statement about a lack of research does not prove anything. I have no dog in this fight, but I admire people who challenge orthodoxy.



Gordon HaaveWhat is a credit crunch?  At least in simplistic terms, one would think that it is a situation where credit is hard to come by.  Yet, per this graph prepared by the St. Louis Fed, bank lending is holding up just fine, despite a brief dip a few months ago. Yet, we hear constantly about a credit crunch, and the difficulty in borrowing money.

Let me explain something very, very clearly: If you put a lot of money on your credit cards, and default on them, you are going to have a hard time borrowing money shortly thereafter. That is not a credit crunch. Similarly, if you borrow a lot of money in order to lend to unworthy credits, you are going to have a hard time borrowing money shortly thereafter. That is not a credit crunch, it is the most basic works of a free market system, where capital is moved rapidly from productive uses to non-productive uses.

The capital markets have realized that it was a mistake to allocate vast amounts of capital to SIVs and hedge funds who added no value, but merely leveraged up loans to risky borrowers and/or sliced up assets a million different ways and passed them around in a daisy chain, while adding on a huge fees for their "genius".

Their losses have caused dislocations in the credit markets, and there me be worse things yet to come.  But, entities that don't actually add any value in the world should have a hard time borrowing money, that does not mean there is a credit crunch.

Alston Mabry explains:

A credit crunch is when I have trouble covering my action.

Anything else is natural market forces, clearing prices, etc., etc.

Russ Humbert writes:

While agreeing with much of what Prof. Haave said, there is a credit crunch of sorts, a loss of confidence in the rating agencies. A quick look at the investment grade ratings credit spreads confirms this. Going from year lows OAS spreads of 33, 54, 74, 104 for credits AAA, AA, A to Baa. (9 year lows ); Jumping to 84, 153, 179, 222 at end of 11/30, with AA reaching record spreads; higher than 2000 and 2002. The AA to Baa spreads seem to be moving in parallel while this occured. Hence rather than simply fleeing from poor credit, the risk premium has increased for most of the investment bonds equally. It would be as if, in your analogy, many deadbeats found how to sneak in an raise themselves to a very high FICO score — ruining your high credit rating.

Ken Smith ruminates:

Seems to me no one in government is producing a graph that extrapolates the above data to the future. What about that? Kurt Vonnegut inquired aloud "Why is there never a Secretary of the Future?" Government has Secretary of Defense, Secretary of Agriculture, etc. but no Secretary of the Future.

In short, no one is dedicated to plan for the future; every bureaucrat and every CEO and every householder is dedicated to short-term goals.

You might chime in to say everyone in the financial industry is dedicated to the future; with due respect I decline that argument. Yes savings are now in the form of 401k and IRA funds, these purportedly are future-thinking instruments. Purportedly. That's the joke. None of them have calculated taxes and inflation that occur in the future.

Taxes and inflation wipe out all gains that purportedly will occur in the future. A simple experiment with extrapolation will prove this to any and all who take on the task of proof. We cannot escape three things in life: taxes, inflation, death.

Three things. But of course there is more. Health, for one thing. A health issue can and does and provedly wipe people out — financially. Who can plan an individual future with such an issue? We don't know ahead of time if we will wake up one morning with dementia. 

Greg Van Kipnis critiques:

I am not sure who Prof. Haave is debating or criticizing, however,…

… a credit crunch usually can be defined by the result of a general drying up of short-term credit such that the yield curve inverts. Many things can cause such an outcome, but they are all destructive to economic activity in the near-term.

In the current situation we have something different happening which I am calling a mal-distribution of credit. Obviously the yield curve is not inverted in the treasury market, but it seems to be for poor credits as evidenced by the widening of credit spreads at the short end.

The leading issuers of credit are hemorrhaging equity due to mortgage-related asset write-downs more rapidly than new sources of equity are being tapped to create credit to satisfy the needs of traditional borrowers. Good credits are still able to offset lost access to money markets, e.g. witness the shrinking CP market, by raising money by other means, which currently are lumped by the Fed into the C&I category. As your graph shows that category is exploding. Poor credits are getting rationed out. Many anecdotes are showing up in recent weeks to underscore that development.

If everything happened simultaneously the negative effects of the mal-distribution would show up immediately. The squeeze is likely to intensify as more financial institutions are credit downgraded. To head this off the brighter firms are doing what UBS did and the rest will wither. The 4-fold Fed/Treasury actions of the past month (MLEC , mortgage-terms jawboning, FF/ Discount rate drop, TAF/Swap-Lines) are all attempt to speed the restoration of the mal-distribution of equity. Collectively these are unprecedented historical developments.

So far no one has been "bailed out", whether they are stupid derivative issuers or investors, or stupid mortgagees or mortgagors. There will be bankruptcies, shot-gun marriages, and arrangement of necessity before this is over. The key for the monetary/fiscal authorities is to replace destroyed credit with new credit so the general economy will not be crippled. To pull this off successfully will require extraordinary good luck and judgement.

Gordon Haave responds: 

I wasn't debating anyone in particular, but rather the global meme that the financial system is in collapse.  It's not. Credit is being denied to people who are bad risks.  Because those people tend to be somewhat powerful, they have created this credit crunch meme in order to try to get bailed out. So, I agree with almost everything that you wrote, except that I disagree re: the monetary and fiscal authorities having to replace destroyed credit with good credit.  They don't need to do anything. All they need to do is let the markets clear.  

A few months ago,everyone said that the monetary authorities needed to do something, meanwhile the markets have been clearing, the prices have been set (as seen by the equity injections into the banks).  There is nothing to do except let the markets clear.

There is a market rate for credit.  It reflects time preferences.  If the Fed creates extra credit, it distorts the markets, it makes it appear that people are demanding more investment than they really are (hence the real estate boom).  When it becomes clear that was not the case, that investment gets cleared out. The answer is not to keep distorting the market, but simply to let it clear.

Carlos Nikros remarks:

Like the definition of an asset price bubble, there's much subjectivity in the definition of crunchiness. Although I mostly agree with Prof. Haave, some aspects of the current economic backdrop are not favorable for borrowers with good credit, as opposed to impeccable credit. For instance, A2/P2 commercial paper isn't an easy sale right now. Yes, the corporate bond market is open for business, but if an issuer is not a well-known credit, it has to fight for attention in order to get its deals done smoothly.

Gregory van Kipnis concludes:

Amish BuggyFor an analogy for how we can be of the same moral-philosophic persuasion yet have significant differences, consider different 'sects' of Amish. One splinter group was called the 'motor-Amish' and another the 'electric Amish' and the third the 'mirror' or 'image Amish'. The first believed that using motor vehicles for certain applications was OK, the second condoned the use of refrigeration and phones for a subset of the congregation to satisfy the FDA rules for milk or getting emergency help, the third did not ban mirrors or any reflective metals from the household. They were all still Amish, but they fought like heck on Biblical interpretation.

Well, I do believe that markets will clear and should be left to clear. But, just as a winding mountain road without guardrails will clear itself of many foolish divers who will go off the cliff, many innocents will be carried away as well. If the damage were only limited to single drivers I'd be content to leave things as they are. Even the most ardent Austrian School adherents understand social costs and the proper limited role of government to address them, however. If markets were atomized with numerous buyer and sellers, no impediments to entry and exist, and wide distribution of information, the 'clearing' process would be swift and fair. Our markets are semi-rigid and relatively concentrated due to complex institutional arrangements. They won't clear neatly. Many innocents will be carried away.

So when I spoke of replacing destroyed credit with new credit, I had in mind the lessons learned and taught by Friedman and Bernanke (among others) in their studies of the causes of the Great Depression. They were clear that many stupid things were done to trip the economy into recession, but when credit was extinguished, partly due to loans' being called in to meet runs on banks, and was not temporarily replaced by some Governmental agency, the recessions cumulated into a disaster.

I know, I know, I can already hear a response from someone that "once you start with regulations to protect people in the name of the people (men united in councils), then lies and deceptions will begin" (I badly paraphrase Tolstoy and Leonard Read). That is the risk we take when we create government. If we are led by men of high standards, who vote their conscience and willingly take personal responsibility for their decisions, the risks are small. I believe the Fed, at least, is governed that way today.

Stefan Jovanovich voices his dissenting view:

The revised standard version of 20th century American history that Dr. van Kipnis is preaching is very much the current gospel. It is what William Poole means when he says that "(m)acroeconomists today do not believe that policies to stabilize the price level and aggregate economic activity create a hazard. Federal Reserve policy that yields greater stability has not and will not protect from loss those who invest in failed strategies, financial or otherwise. Investors and entrepreneurs have as much incentive as they ever had to manage risk appropriately. What they do not have to deal with is macroeconomic risk of the magnitude experienced all too often in the past." Poole quotes a passage from David Cannadine's recent biography of Mellon as an indication of how truly awful things once were before we had professional economic management. "Mellon constantly lectured the president on the importance of letting things be. The secretary belonged (as Hoover would recall) to the "leave it alone, liquidationist school," and his formula was "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate."

Alas, what Governor Poole fails to note is that this is very much Hoover's version of history. To the end of his life Hoover blamed Mellon for questioning Hoover's presumption that he could "re-engineer" the American economy in the same way that he planned food relief to Belgium and Holland after World War I. Governor Poole and Gregory would seem to share the former President's abiding faith that the application of science could domesticate the feral wildness that results from unregulated buying and selling. What they also share is a complete absence of any skepticism about the unintended effects of allowing "some Governmental agency" to "temporarily replace" "extinguished credit". When the government tries to manage economic risk, it either debases the currency by handing out far more money or promises of money than it can reasonably expect to take in or it establishes a world where prices are administered, not negotiated. In either case, the efforts of "men of high standards" (sic) to "stabilize the price level and aggregate economic activity" create a hazard that is far greater than any credit crisis. They destroy growth and pricing itself, and they risk turning nearly every citizen into a lobbyist or (worse) a lawyer. Friedman and Anna Schwartz are quite clear that the primary causes of the Depression were (1) the passage of the Smoot-Hawley Tariff (which Mellon literally begged Hoover to veto) and (2) the Federal government's attempt to administer the economy through the NRA, etc. Compared to Mellon's prescription (which was to let the markets find out on their own what stocks and farm land were worth), the Hoover-Roosevelt solution was the one that truly ended in liquidation.

There is no way that limited or unlimited government can "address" the problem we have right now without creating greater harm. The mountains of imaginary wealth created by loans against the security of 1800 sq. ft. stick and stucco 1950s bungalows in Pacoima are simply not worth what people thought they were - just as RCA stock was not worth what call loan supported buyers bid it up to in 1928. One does not have to be an economic fundamentalist to believe that common stock valuations usually have some discernible relationship to companies' cash flows from operations. It is also more than a matter of faith to think that, as wonderful as California real estate is, its prices most of the time have at least some distant connection to the ability of their owners to pay their mortgages. Until the homes in Pacoima once again have some vague relationship to what new buyers can afford to pay, the crisis will continue; but it will end - just as past real estate slumps have ended. But, if the wise men (and occasional women) of the Federal Reserve, the Treasury and the Federal government decide that they can "fix" the problem by legislating price levels for the paper issued on the security of those California bungalows and New York condos, we may see the People's Republic of Santa Monica bring the rent control to Iowa. "Credit creation" that tries to restore former unrealistic price levels in the midst of a panic is a bit like having alcohol for breakfast as a cure for hangover. It will - temporarily - take the edge off, but it only makes matters much worse later on.



Barry BondsI read the entire indictment; Barry Bonds says he did not knowingly use steroids. I did not see any evidence to the contrary in the indictment. The indictment looks more like a football game of pile on; if he did lie notice how the charges are extended to obstruction, being evasive (duh, who would not be evasive under that conditions, you can bet his lawyers coached him on that — plus if you read his testimony, it does not appear evasive; he answered the questions put to him.) There is no contradicting testimony in the indictment. Will be interesting to see if the prosecutor can present factual evidence otherwise. Typical DOJ stuff.

Russ Humbert adds:

It seems to me that they are trying the "Martha Stewart" trap. They got one of his trainers or someone in the know in jail. They will tell him they broke him, hope he spills it to get even. But if he doesn't they will hope he lies about something. Since the ancient games politicians have a history of using athletes for personal gain, public villain or hero.

David Lamb remarks:

Why? I doubt it's the hallowed homerun hallowed mark. I think it's because Barry is rude to the media and to anyone who he doesn't want to sign autographs for. And what if he is rude? Matt Williams was just caught but he still couldn't hit and retired the next year. Perhaps Barry knowingly took the 'roids in order to break the homerun record. As if nobody else is trying to do the same thing on the same juice. He just can hit the ball and is extremely picky on what pitches to hit.



 Does anyone understand how the gears and levers of insurance and annuities work? For me, it's a MEGO subject that I'd like to understand better. Is there a good web reference, or can someone write a brief essay that outlines the moving parts?

For instance, what are the real economic aspects life insurance products (whole/term/universal)? I vaguely understand some or all of them involve embedded optionality (since the pay-in of premia is fixed in advance) especially wrt interest rates. Is there a quick analysis of the form "product X includes embedded long-bond optionality that the buyer typically pays 2 vols vig on"?

And how best to jumble together all the tax/risk/return/optionality aspects, without doing deep financial engineering? I'd love to have a brief (but informed) soundbite I could pass on to friends/family who ask me about such things, believing (erroneously) I'm knowledgable.  

Russ Humbert responds: 

The moving parts from a insurance companies perspective: Mortality, Interest, Lapses, Expenses and profits and taxes. Its all based on the probability of surviving (both actual and as a policyholder), the time value of money. The buyer, buys because his time of death is much more a tail risk tragedy and is willing to pay more for less risk, a risk premium. But the real kicker is that any death benefit is generally tax free and any cash surrender value also accumulates tax free.

And in general it is best to have the most complete underwriting that your health can withgo without getting "dinged". You want to be the "pool" with the healthiest, least likely to die people to save mortality cost.

Generally people like to pay a level premium.

But this also means that if you lapse you probably are leaving something on the table (you paid your commission expenses early). However, this maybe really you are giving up something that would go to your beneficiary.

Term insurance is pure insurance, no cash value.

Whole life has cash value which has a margin of safety for the ins. comp. so they often share some of the "good experience" in a dividend.

Universal Life is like a saving account where they deduct your term cost monthly expenses and mortality. These often have a "back end load" I.e. an surrender charge.

One of the frustrating things is that investment for insurance companies are highly regulated, and very crazily taxed. Hence, it is hard for a insurance company to get you "efficient frontier" returns. If they are taking the investment risk the regulators see it as there duty to make sure they do things conservatively, to protect very long term policyholder. But like most regulations the definition of "conservative" must be so general as to make it highly inefficient.

This is somewhat mitigated by using "variable" products where the buyer takes the investment risk by putting the cash value into choice of mutual funds. However, these too suffer from some tougher regulations.

Further, IMHO any time taxes vehicles are involved, everyone wants more than their share of the pie. More of that tax benefits should go to the buyer.

Annuities likewise have the "tax free accumulation". A deferred annuity is a tax free build-up of a savings which you can latter "annuitize" (make it an income stream which can be a set period or for life or a combination of guaranteed payments for x year to life or lives. The payout can either be fixed dollars or fixed units per payout period (usually monthly)

PV $1 annuity = sum of Prob survive(t) X appropriate discount rate(t). Payout = Premium /PV $1 annuity.

From Anon: 

The moving parts from insurance companies' perspective: Mortality, Interest, Lapses, Expenses and profits and taxes. It's all based on the probability of surviving (both actual and as a policyholder), the time value of money. The buyer buys because his time of death is much more a tail risk tragedy and is willing to pay more for less risk, a risk premium. But the real kicker is that any death benefit is generally tax-free and any cash surrender value also accumulates tax-free.

And in general it is best to have the most complete underwriting that your health can withgo without getting "dinged". You want to be the "pool" with the healthiest, least likely to die people to save mortality cost.

Generally people like to pay a level premium.

But this also means that if you lapse you probably are leaving something on the table (you paid your commission expenses early). However, this maybe really you are giving up something that would go to your beneficiary.

Term insurance is pure insurance, no cash value.

Whole life has cash value that has a margin of safety for the insurance company, so they often share some of the "good experience" in a dividend.

Universal Life is like a saving account where they deduct your term cost monthly expenses and mortality. These often have a "back end load", i.e., a surrender charge.

One of the frustrating things is that investment for insurance companies are highly regulated, and very crazily taxed. Hence, it is hard for an insurance company to get you "efficient frontier" returns. If they are taking the investment risk the regulators see it as their duty to make sure they do things conservatively, to protect very long-term policyholder. But like most regulations the definition of "conservative" must be so general as to make it highly inefficient.

This is somewhat mitigated by using "variable" products where the buyer takes the investment risk by putting the cash value into choice of mutual funds. However, these too suffer from some tougher regulations.

Further, IMHO any time taxes vehicles are involved, everyone wants more than their share of the pie. More of that tax benefits should go to the buyer.

Annuities likewise have the "tax free accumulation". A deferred annuity is a tax free build-up of a savings which you can latter "annuitize" (make it an income stream which can be a set period or for life or a combination of guaranteed payments for x year to life or lives. The payout can either be fixed dollars or fixed units per payout period (usually monthly).

PV $1 annuity = sum of Prob survive(t) X appropriate discount rate(t). Payout = Premium /PV $1 annuity.

From Henry Gifford:

The importance of the "lapses" part of the above description is what was apparently behind the commotion last year when investors were reported to be buying old people's policies from them before they died. What the investors apparently figured out was that the expected number of policies that "lapsed," that is, the policyholders didn't keep up the payments and thereby forfeited the benefits, enabled the insurance companies to promise rather large payouts. The investors planned to maintain the payments on 100% of the policies until the people died, thereby getting handsome returns. 


Resources & Links