The stress test that the Fed uses, which involves a 50% decline in stocks, a 25% decline in real estate, and 11 % unemployment is totally ridiculous. [Supervisory Scenarios 2014 32 page pdf]. It assumes that one wouldn't have a dynamic strategy involved to curtail risk on the way down, and that an event that has only happened 3 times in last 125 years would happen again, and that banks should run their assets as if it were to happen imminently rather than handling them dynamically with decision making under uncertainty the way all are taught in business school.

It must be a propaganda method to diffuse attention from all the hundreds of billions that they gave to the banks during 2008, and a method of flexionism if you get the drift that Mario Puzo and Janine Wedel write about. It is amazing that this bank or that bank only failed the test qualitatively. What a sponge for flexionism is such a "qualitative " test which allows the greatest amount of bargaining and begging. What a world we traverse.

Rocky Humbert writes: 

I just browsed the Fed document to which Vin alludes. It can be found here.

I didn't read the document closely, but it's unclear what the pass/fail criteria entails. That is, whether the test is "insolvency" versus "solvency" or some level of capital after the stress. Perhaps someone else knows the answer to this?? It's key to understanding whether the stress tests are ludicrous.

Structural engineers design buildings and bridges for Category X hurricanes and Y richter scale earthquakes. It is accepted that these are extreme and rare conditions and engineering for these stresses involve substantial costs. It is also accepted that the structure may sustain damage in the calamity but will not experience sudden catastrophic collapse. My guess is that the same sort of mindset is at work here. Dynamic risk management is not possible in structural engineering for obvious reasons. In financial institutions, if one believes that the amount of stress/risk in the financial system is static, then dynamic risk management may not work either — because risk will simply move from one institution to another institution … but the overall stress remains in place. Would anyone disagree with this characterization.

Ultimately, I believe the question is whether the Fed should be engaged in ANY stress tests. Once the answer is yes, then we are debating about the magnitudes. And the debate is similar to whether the new Tappan Zee Bridge must tolerate 100, 150 or 200 mph winds before it collapses….

The key difference is that an contractor can put a price on the incremental cost of each 50 mph tolerance. I am unaware of any cost benefit analysis from the Fed in setting its stresses. And I propose that this absence of cost/benefit analysis is where an objective critic should focus his energies. 

anonymous adds: 

Then, there is the further question. Since the Fed has the only checkbook that never needs to be balanced, why is it engaging in the pretense that it cannot "save" any member bank no matter how "stressed" it becomes? I understand why it is important for everyone who trades to follow the entrail readings of the Delphic Committee; but, as the R-Man notes, it becomes difficult to understand how there can be "any cost benefit analysis from the Fed in setting its stresses".

As I reread Sumner's History of American Currency, I find myself wondering if the R-Man's fellow alumnus could possibly understand our modern minds. Could he truly understand how we define money as central bank credit and then actually worry about whether the sovereign can run out of the ability to print/digitize its legal tender? I doubt it.

From the Preface:

"I regard the history of American finance and politics as a most important department which lies as yet almost untouched. The materials even are all in the rough, and it would require a very long time and extensive research to do any justice to the subject. I hope, at some future time, to treat it as it deserves, and I should not now have published anything in regard to it, if I had not felt that it had, at this juncture, great practical importance, and that even a sketch might be more useful perhaps than an elaborate treatise. It follows from this account of the origin and motive of the present work, that it does not aim at any particular unity, but consists of three distinct historical sketeches, united only by their tendency to establish two or three fundamental doctrines in regard to currency."

Yale College, 1874.

Mr. Isomorphism writes in: 

Anonymous, I find your final paragraph especially compelling, even more than the rest of your argument. However probabilities of catastrophe cannot be estimated. It's dubious whether they can even be quantified. Also human or social costs resist economic quantification. Against an unmeasurable times an unquantifiable, what basis do regulators have for precisely calibrating the cost and dimensions of their bulwark?

It seems to me one cannot reasonably do MB=MC, but rather very loose upper and lower bounds are the best one could argue with.

P.S. Even in normal times, eg the FDIC's various ratios are not calibrated against an historical "utility function". If a balance is achieved it's surely between the personalities and the powers of the regulators and the regulated.



White shoe firmIt is reassuring that the secret high frequency algorithms have been secured and are back in safekeeping. As the government prosecutor said, in the wrong hands these algorithms could be used for evil purposes like "market manipulation." I will feel much better when they are back in the hands of the trading desk investment bankers who designed them so they can be utilized in their altruistic way.

Vin Humbert writes:

It is good to know that at all times one is playing against a robot that pays 1/100 of the commissions and gets paid for its orders, and gets to see your orders before putting on its trades, and is always two computers and a geographic distance of light ahead of you. As Willie Sutton said when the Dodgers lost, it makes you feel so bad you want to turn yourself in to headquarters.



C@rgill is a class outfit, with a willingness to make a market in any commodity, anywhere and any time, as long as they have an edge. I've always speculated that there was a Faustian bargain somewhere in that outfit's past. C@rgill (founded 1865) is still part of the old grain business that is very family oriented, with the Staley's, MacMillans, Peaveys, Bensons and Quinns grooming the next generation to trade the world's food supply. 

I've been on the other side of many a C@rgill trade, and usually lost money in the process.

Vin Humbert adds:

As a newly transplanted Minnesota resident, I can tell you it is equally difficult to get employed by them. Most of the postings I've been reviewing require fluency in a LatAm region language. Rarely do I see peers demanding the same (esp. Portuguese).



I am thinking about a trade. The Federal Reserve has driven short-term interest rates down. Investor fear of what's to come has pushed long-term (10yr) bond yields down as well. But Fed's actions are inflationary in the long run. Thus at some point inflation will pick up and this should drive long-term bonds lower. I cannot short stocks or bonds in my client portfolios thus I was thinking about buying either a mutual fund or an ETF that is shorts or has inverse position (through futures) of US Treasuries. My thinking is as follows if you assume a duration of 10 year bond is roughly 7 years, then my downside that the rates decline from 3.3% (an all time low) to 2.3% is about 7%. My total downside risk if rates go down to 0% is 23.1% (7% x 3.3). This is more of a mathematical downside, but not a real downside. The upside: depending on how much infaltion the Fed's actions create, inflation may run higher than we observed in the recent past, rates may rise to let's say 6%, let's make it 6.3% to keep the math simple. The upside is 21% (3 x 7%). Here I am ignoring a management fee that a fund company charges, but at the same time if, I understand this right, there is no cost of carry. The bottom line: if you assign probabilities of interest rates going down, doing nothing or going up, the expected return looks good.



Hedge Funds and Private Equity Alter Career Calculus

“I don’t think you will see M.B.A.’s less represented in executive suites, but you may see M.B.A.’s less represented in the lists of the world’s richest people,” Professor Schmalensee says.

So is business school a waste of time, or worth it for a young person starting out in a career in finance?

Peter Earle replies:

Getting an MBA was helpful for me as my academic background was in Comp Sci and History and, despite having read every book I could get my hands on, there were many gaps I needed to fill. Plus — although far less than 10 or 15 years ago — I'm told that for a sizeable number of finance/economics/business positions it remains one of the criteria used by HR professionals to screen a large stack of resumes on a "first pass" before digging deeper.
I wouldn't describe it as a waste of time, but in retrospect my career wouldn't have been much different without it. Your mileage may vary.

James Lackey asks:

What is the outcome you desire? If you want to work for Goldman you'd better start early to get into Harvard. If you want to work for the government, make connections early, be a clerk. The military, do ROTC. If you intend on working for yourself, it's best to get started early.

Without Vic and Laurel and their circle of influence, many of us would have missed out on the contacts we have made. To find a circle of erudite benevolent friends, perhaps again the Ivy League is the place to be. I was very lucky to be at the right place at the right time to meet Vic and Laurel.

What is the point of business school or being a businessman? What is your definition of success? Mine is the ability to do exactly what I love to do as a career, profit from meaningful work. Yet the huge catch: I do not want to answer to anyone.

Alston Mabry writes:

These days one must also be wary of the University of Phoenix effect. The Apollo Group has made a pile of money offering distance learning courses and degrees, and now nearly every traditional higher-ed institution is trying to compete. Distance learning wasn't invented by Phoenix, but they have used it to change the industry.

One upshot of this is the lowering of standards in many situations, especially when a degree program can be offered online and/or at night, to working professionals whose employers are willing to foot the bill. There is an incentive for the students to just "get the degree," and a big incentive for the institution to just collect the fees and definitely not to flunk anybody. Actual education, learning takes a back seat.

Henry Gifford writes:

A few years ago I spent some time at the business school at Columbia University. I was studying math for a few years, in a different building, but when my classmates wanted to study together, they usually wanted to meet in the library at the business school, thus we spent a lot of time there. The male students said they wanted to study there because the females there were better looking than elsewhere on campus. The female students said they wanted to study there because the library was the nicest on campus, and the male students said the females wanted to be there to meet a male who had high earning potential.

I sometimes read the student newspaper for the business school, and attended a lecture or two, which I think gave me some sense of what was going on. My clearest memory was of an article about a business school trip to an African country. The first day the students met with an economics minister, the next day they went on a tour of a coffee roasting facility, and the third day they went on a tour of the local Coca-Cola bottling plant, where their van got stuck in the mud. The reporter was skillful in vividly describing the complicated interactions and various stregnths and weaknesses of the different people involved with pushing the van. Then they spent the next five days at a resort on the coast, and the article ended with a request for donations to send money to help the country out of its endless cycle of corruption and poverty.
AfriqueI wrote in suggesting the best way to help the country out of poverty would be for someone to write a business school newspaper column analyzing the various stocks offered for sale in that coutry's stock market. The column could discourage buying stock of companies run by less honest management, and encourage each student to buy five or ten dollars worth of other stocks, thereby creating a source of income that the local corrupt politicians had little power over, and a source of experience and possible profit for the business school students. For some reason my letter went unpublished.
The newspaper also made it clear that students in each class were put into small groups, to encourage stronger connections between students during school, and after, when they could help each other get hired or promoted. There was also a lot of mention of the positions held by graduates, implying the purpose of the school was to have alumni provide a leg up for recent graduates. I saw little or no mention in the newspaper of actual business principles, theory, strategy, management, or sources of information on these topics.
I was left with the feeling that it was a large fraternity house subdivided into smaller clubs, which served mainly to prepare people for corporate culture — the right way to act, how to talk without saying anything, when it was neither appropriate to be silent, how to maneuver through the office/group politics, whom to challenge and whom to back down from, etc. All the skills nescessary to survive in a large organization, obtain connections that would be useful there, and have a chance to start at a level significantly above the bottom. I thought the school would be very worthwhile for anyone interested in those things.

Albert remarks:

For me B-school has provided an invaluable education. Whether it helps with job searches in the future I can't say. But I'm coming out understanding so much more of why the world works the way that it does than I did when I started.
I will say too that for a person who goes to a good school full time, the recruiting benifits are enormous in the industries that respect an MBA degree. But it is critical for a person going full time to go in knowing where they want to go afterwards as summer internship recruitment starts in the first few weeks of the first year and typically the summer internship leads to an industry job the following year.
So, like everything, it depend what you want to do with the degree.

Vin Humbert writes:

I've just started a Masters in Financial Economics programme at Oxford. I think the curriculum (as well as the physical surroundings, which are lovely) will be a good backdrop for my current stage as a student of the markets — after several years of balancing a law career with studying the markets, I'm moving towards being a full-time trader.

Orientation started today so I can't really say too much yet about the extent to which the programme is meeting my expectations. It's a pity they use MATLAB instead of R — but just as musical training in one instrument can have benefits on another instrument, I think the MATLAB finger exercises will be useful.

And, indeed, just as Albert says, classes haven't even properly begun yet and I am already supposed to be looking for a job for after my graduation in July!


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