All posts by Chris Evans

The Populist Cry- “No Bailouts For Anyone!”

Let’s imagine a world where we go along with Ron Paul and refuse all bailout money to every financial institution that is in trouble.  We let them all go under.  Let the chips fall where they may.  Many believers of this hands-off economic policy seem quite secure – as if they not only know that the fallout will be benign or that they know they won’t be injured in the ensuing tsunami. 

Can we imagine a world where all the major banks closed, most money market funds went into liquidation and any borrower who needed to roll over debt was shut down.  The FDIC would be broke so don’t expect to get the $250,000 maximum from your savings account.  The stock market would be down about 90%.  All the debts you have like your car lease and your mortgage – they would all be intact, but you would would have no income.  Let’s not forget that the average citizen began this mess with virtually no savings.

So all the people who want to pull the plug are either

  1. far more liquid and insulated from catastrophe than I am or
  2. failing to appreciate how huge the downside will be in a system without a solvent financial industry

Are all these people hording gold bars or $100 bills in their mattresses?  Maybe they’re short the stock market.

Maybe they haven’t thought this through at all.

College Education Arbitrage

The two most overpriced goods in the US economy are health care and private education.  In the latter case we have been told that the cost of teachers has risen because these highly educated people could easily go and work on Wall St. or Silicon Valley.

Now all those fabulous job opportunities have dried up, yet tuition rates are unchanged as are professor salaries.  So after all tuition paying parents have suffered a loss of 40% in their net worth, they are now looking at their options and public education institutions are back on the table.  Many excellent students will now go to their local state university rather than pay $40m for a private college unless they can argue that it’s worth it. 

This will cause the spread to narrow between the quality of student that goes to each institution.  Rankings will narrow between them as many of the most overpriced mediocre private colleges suddenly find that applications dry up.  Here are some of my favorites:

  • Short USC vs. Buy UCLA – they’re right next door to each other, UCLA is ranked higher and costs less than half as much (for a California resident).
  • Short Boston University vs. Buy U. Mass.  U Mass is ranked 102 and costs $10m while BU is #50 and costs $37m!  (honorable mention on the short side to Northeastern – $34m).  U Mass is going up at BU’s expense.
  • Short USD vs Buy UCSD.  UCSD is ranked 35 and costs $9m for in state applicants while USD is ranked #102 and costs $34m! (honorable mention on the short side to Pepperdine- $37m and ranked below almost every UC college).
  • Short U. of Miami vs. Buy U of Florida.  The former costs $35m and is ranked #51 while the latter costs only $4m and is ranked higher at #49.
  • Short Wake Forest vs. Buy UNC Chapel Hill.  Wake forest is ranked only 2 spots ahead of UNC and costs $30m more for a state resident!

Any private college that depends on location to attract students is in trouble.  Will people continue to pay huge extra $ for good nearby skiing or to just be in (say) Boston?  How important is a tan at $40m/yr when you can get the exact same tan down the street for 1/4 or 1/8th the cost.  Luxury good prices for mediocre education are coming to an end.

Why is AIG Only Our Problem?

If all the major AIG losses come from it’s London operation by trades done with all kinds of international counterparties then why is this ONLY a problem for the US government?  A huge percentage of those swaps were done with foreign banks to save them from failing  a BIS test for minimum capital.  When the US makes good on these trades for AIG it is saving  many foreign banks.  The US government should demand that some of the money come from the European Union.

When the US government pays out these CDS obligations to say Goldman Sachs or Barclays bank, it is paying (apparently) 100 cents on the dollar.  Isn’t AIG bankrupt?  These trades should be settled like they would be in a bankruptcy court.  

Are we so afraid that its counterparties are so fragile that they may fail if the taxpayer doesn’t fork out the full 100 cents?  If they do pay out 100 cents then shouldn’t the taxpayer get compensated with equity in the bank they just saved?

Death of the Morning Paper

We are all familiar with the problem of advertisements migrating to the web and away from newspapers.  The loss of revenue is devastating and everyone expects most papers to be gone in a year or two.  About 10% of the adult population actually reads a newspaper every day.  The readership decline has been steady and looks irreversible. 

The papers can’t fix the advertising problem but they can address the readership slide.  The internet now gives everyone the headlines so what is the point in reading yesterday’s news when you already know what happened.  You must be seeking more depth or you don’t have a computer.

The newspaper can’t sell yesterday’s news.  It has to change its print copies to tell you something that either wasn’t in the web headlines or give you an opinion or commentary on that news item.  Young people don’t read newspapers and they don’t watch the nightly news. They do watch Jon Stewart. 

The newspapers have to get rid of simple reporting and produce more investigations, analyses, commentary and criticism. 

That’s So “07”

The world is a different place than it was in the bubbly ‘95-‘07 period.  In the old world every communications major became a real estate agent.  Fabulous new retail stores were opening every day.  Everyone was contemplating some kind of house renovation.  Every cocktail party conversation included some discussion of massive unrealized real estate gains – usually in a primary residence.

Today when I see something from the old world it strikes me as weirdly anachronistic.  Many people don’t seem to have been reading the papers or opening their 401K statements.  If they did they would then see that many things that make little or no sense in the new world such as:

  • Restaurants that charge more than $17 for pasta or whose menus say “market price” for fish
  • Movies where most of the characters seem solely devoted to shopping
  • Students who think college is just an opportunity to drink and study business
  • Athletes who expect to get huge raises every year
  • Sports franchise owners who continue to give athletes those crazy raises
  • Portfolio managers who ignore price and stick to buy and hold mantras which have all failed
  • Watching CNBC
  • MIT grads who want to be quants
  • Conservatives who want everything to go back to the way it was a few years ago
  • Economists who think 3rd world countries will help us out of our economic morass
  • Private elementary schools that charge over $12m a year

Our Crazy Financial World

We may be getting to the bottom of how much AIG’s London “traders” actually lost … $500bn!!  And in August 2007 they couldn’t imagine losing $1.  That’s what their quantitative analysis was worth. (Go HERE)

And the Chinese want guarantees on the bonds they hold.  Aren’t US Treasury bonds already guaranteed by the full faith and credit of the US government?  What more do they want?

Their trade surplus is melting so their entire mercantilist model is in trouble.  It is down 50% year over year and don’t forget 30% of all their production is for export.  That’s a 15% hit on GNP.


Oral Media in a Computerized World

The new media of TV and radio are consumed differently than written media.  We are inclined to believe what people say simply by virtue of the conviction we hear in their voice.  Polemicists on extreme parts of the political spectrum have long understood this but now we are in an era where computers can look at data objectively and report, without bias, the accuracy of someone’s predictions.

In the political world we should post a record of previous prognostications on a split screen so the audience can see their past record.  In the world of markets we should see the track record of the analyst or portfolio  manager whose opinion is being solicited on (say) CNBC.

Everyone has an opinion.  Many people can sound convincing as though they have never been wrong or they have special secret information that gives them an “edge”.  Fine- so let’s see your record while we listen.

Would the audience for Cramer be as big if everyone saw his record or previous opinions while he gave you new ones?

Quants Without Stops

The NY Times had another article about math wizards and their trading efforts on Wall St.  It is such a comforting idea that genius can overcome randomness.  All you need is brains and you’ll find anomalies galore that will give Madoff style returns forever.

Alas, there’s a catch.  If the law of large numbers leads to an anomaly – a 2 or 3 standard deviation from the norm then they drool and put the trade on, believing that at some point normalcy will return.  If it deviates further then they just add to the trade.

The question then becomes: At what point do they decide that this time is truly different and exit the position?  This is the same question you should be asking the portfolio manager you have hired for your stock portfolio.  The answer is usually either:

  1. We can hold the position to expiry or maturity if we have to .. or
  2. The trade is so juicy that we have put it on in huge size so we can’t exit on weakness ; the market isn’t that liquid.

A quant suffers from the same mentality as a fundamental small cap. stock manager – the more a position goes against them the more they like it.

In all cases there must be stop loss levels attached to every trade and a mechanism must exist so they don’t immediately re-enter the position.  Usually this means the positions can’t get too big which is why hiring a manager with huge assets can be a huge mistake.

If you look at the AIG, Citibank, Merrill Lynch problems ,they all can be explained by this simple problem.  They had no stops, they were too big in every trade and they had no mechanism to keep them from always seeing value as the assets’ prices fell .

Is Greed Good?

Ivan Boesky once argued it was, since it channeled resources into profitable enterprises and rewarded aggression.  Gordon Gekko extended the argument to say that only shareholders had the best interests of a company in mind – not bureaucratic board members. 

The economic system changed in the 80’s toward rewarding management for stock performance but in a perverted way.  It swung toward options as a means of allocation, not shares.  If a manager (or trader) earns options then he has no downside.  He is implicitly driven to bet big.  Real shareholders will suffer all the losses and he (they) will be long gone.

The biggest problem with the philosophy is that even in our world of free market capitalism there are two industries that are sacrosanct: banks and accounting.  The fiduciary role of the former requires us to restrict any kind of greed from infecting their corporate culture.  The second’s accuracy and honesty are the basis upon which we believe and measure every other company’s financial performance.  If they are compromised by bad incentives then our entire system is left in the dark, without the accurate information we depend on to allocate resources.

That is why God gave us regulation. 

Greenspan’s Defense

Alan G. has written an article defending his easy money policy.  He contends that the
flat yield curve was testimony to a capital surplus that flooded into risky
assets and lowered risk premiums to bubble levels.  His efforts to reduce
liquidity by raising short rates were defeated by these conditions.

The problem is that he created this ocean of liquidity by lowering rates to
negative (“real”) levels in 2002.  The only way to correct this problem was to
raise rates by a lot – a lot more that he eventually did. 

He did exactly the same thing in the late 90’s.  As the stock market rocketed
into a crazy bubble state, he raised rates gently with an eye on CPI.  He has
always been happy to allow asset prices to rise inexorably because his defining
moment was the stock market crash of 1987 which occurred 2 weeks after he became

The massive move to outsourcing has kept goods inflation at very benign
levels for 20 years so he could always be the good guy when it came to propping
up asset markets.  His tightening moves were almost symbolic and always quickly
reversed.  The stock market eventually came to count on The Greenspan

If CPI is kept low by structural changes then excessive liquidity needs an
outlet.  That outlet is usually asset prices.  The Fed never changed policy to
address asset bubbles – I guess he never thought it was his job. 

Now he wants us to believe that there was nothing he could have done about