I haven't written in awhile. I've put off writing as I awaited crucial developments and decisions that never materialized. If I just wait another week, I'll be able to write about that financial reform bill...In the face of the largest financial crisis since the Great Depression somehow healthcare reform topped the agenda. Two years and counting and I have nothing tangible to report.
I am a worrier by nature, I always worry that tomorrow is worse than today. But what I've seen in the past year worries me even more than usual. Here are some of my troubling observations:
- A breakdown in values going from the Protestant work ethic and frugality to one of narcissism and materialism. The nation continues to gorge on its credit addiction and the country has not galvanized in the face of adversity. Sacrifice is only mentioned in the context of what others have to do.
- Boston University Professor Laurence Kotlikoff estimates that the true value of US debt is around $202 Trillion. Unfunded liabilities, especially in the pension world, not the Madoff Fraud are proving to be the real scandals uncovered by the financial crisis.
- I'm paying more taxes than ever before and I have no tangible benefits. And I know I am not alone. Aside from funding the ongoing wars in the Middle-East what else am I getting? The potholes on the I-95 leading into Manhattan are still there.
- The way China swallowed up America's $700 billion fiscal stimulus package. What remains unchanged is the fact that sections of the US economy are simply uncompetitive. The Chinese have an edge in manufacturing. So when the fiscal package was unleashed, it went directly to Wall Street and to Chinese exporters. Buy American? How can you when Wal-mart doesn't even sell American anymore?
- The financial industry continues to be "untamed":
- The congressional inquiry into Goldman Sachs degenerated into a legalistic hairsplitting masterclass between to Harvard lawyers (Levin and Blankfein). It was clear that the people who were supposed to be in charge and now meant to make things better lacked basic financial knowledge, let alone the ability to legislate effective regulation over a complicated industry. The other realization was how well-versed the financial industry had become in pushing the boundaries of ethics while playing within the grey zone of legal boundaries. And on the rare occasions where big finance is taken to task, inconsequential fines are imposed at best. - Continued unregulation of the bond and derivatives market.
- Continued dilution of the Volcker rule as the financial reform bill is passed through both houses. Massachusetts Senator Scott Brown has been negotiating extensive comprises on this. Why do we have someone, whose main achievement prior to winning the senate seat was posing nude for cosmopolitan magazine, making such important decisions?
- The obstruction of Elizabeth Warren to head the newly formed consumer protection agency.
- Continued ethos that free markets function best if left to govern themselves.
- How excessive compensation continues to be unaddressed. Even broaching the topic could be interpreted by some as "Un-American".
What does this all mean? We will not have financial stability for a long time and the PIMCO case for a "new normal" economy characterized by high unemployment, low economic growth and deflation doesn't seem so far-fetched now. We are looking at a broken economic system. And what's bad for America, is bad for the world.
Politically, I am even more disturbed:
- The idea of two or more opposing factions coming out to passionately debate a position, ultimately arriving at an optimal solution is a fallacy. The only role of the opposition in America, is to undermine the incumbent, at any cost.
- America has one political party with two corporate wings. The thin margin of support that separates a Democrat or Republican administration means that both parties are beholden to special interest groups, vying for that additional faction will push them over the fence on election day. What separates a donkey from an elephant is who they take money from.
- America has been unresponsive and unable to react to big problems as it is politically paralyzed. If neither party is able to make painful but necessary decisions in the short term for longer term gain, who will? Don't tax you, don't tax me, tax the man behind the tree. The government cannot cut spending, nor can it raise taxes any further. Who will provide the magic needed to reduce the deficit then?
- The symbiotic relationship between big business and big government in America. In deciding 5-4 to uphold the continued practice of campaign finance, the US Supreme court has protected the right for any entity with sufficient resources to lobby (or buy) a political decision over at Washington. So the very people supposed to regulate oil, finance and healthcare companies continue to be heavily influenced by the very people they are meant to regulate.
- 25% of Americans think President Obama is a Muslim (up from 17% when he took office, hmmm, I wonder how that happened?). Less than 50% believe he is Christian. Do you think that has anything to do with the fact that he's Black? Let's not pretend that being a Muslim does not have negative connotations in America. If that were the case, why the controvery over building a Mosque close to the 9/11 site?
On the other side of the world, China continues to post sizzling growth numbers. Questionable numbers some may contend, but it is difficult to argue that the general trajectory of the country's success has been anything but up. Communist China, with its authoritarian regime and lack of human rights (noticed how socialist economy has been dropped from the list lately) has been doing more than "ok".
The powerful force of globalization has been work. My cousin reminded me that when he was young the exchange rate between the SGD and GBP was 8 to 1. Today GBP/SGD is 2.11. Everything made in the UK was branded and the best, everything made in Asia was low cost junk. Things have changed.
I'm not concerned with will be No. 1 in the world. Only time will tell. What is far more interesting is the alternative political and economic systems that China offers. Francis Fukuyama prematurely declared the end of history and the last man by predicting that the world would essentially converge in a liberal democracy as other forms of governments had failed.
Going forward, this will be the central focus. How will the world respond to a new system of "Capitalism with Chinese Characteristics"? And no, I have not abandoned my position as a Cedalion Investor--The single most important global development is the rise of the middle class in countries like China, India and Brazil. We are talking about hundreds of millions, potentially billions stepping out of abject poverty. The largest car market in the world today is China, just ask GM how important the China market is.
Let me leave you with an observation, the Chinese worker earns less than a tenth of what the American worker does, and there are five Chinese workers for every American. Yes, the US is in the self-congratulatory habit of broadcasting how the American worker is the best in the world. Just ask yourself how true and sustainable this is when virtually all manufactured goods are produced in China? I would also like to remind you that your iPod and computer you are typing on are made there, so it's not just lead-laced Barbie I'm referring to.
Thursday, August 19, 2010
Wednesday, December 9, 2009
Financial Innovation
I've said it before and I'll say it again, we don't need more financial innovation! I'm glad both Pauls, Volcker and Krugman, are on the same page.
Ask a banker why he/she is entitled to a multi-million dollar bailout and the answer is this: its the only way to attract and retain talent in a dynamic industry like finance. And without talent, there would be no financial innovation.
So explain again how financial innovation has benefitted us (the general public)? Well, I am told that financial innovation has made the capital markets more efficient, price discovery has improved and risk has can be better managed by distributing them across different parties through the use of derivatives.
So let me ask you again, what has financial innovation done for society? Let's look at specifics, let's look at good and the bad:
The Good:
- ATM Machines: No more waiting in line at the bank teller.
The Bad:
- Subprime Mortgages: You get a giant loan to buy the house of your dreams and you don't even have to prove you can afford it! Oh wait, you think you can afford it because you've been lured in by teaser rates (adjustable rate mortgages) that go from 2% to 20% after the first two years.
- Alt-AA Mortgages: Same as the Subprime, it's a little harder to get because you have to make up a more a believable income when you fill in the forms. But don't worry, no one really checks on what your REAL income is.
- Asset Backed Securities (ABS): Package a bunch of these mortgages together, pretend they make money and sell them off a sucker (preferably a bank too big to fail)
- Collateralized Debt Obligations (CDO): Package a bunch of ABS's, take them off your company's balance sheets, complicate things by dumping them in a Special Purpose Vehicle (SPV), tell everyone that it's 100% safe because its bankrupcty remote, and just mint money!
- CDOs Squared: CDOs of CDOs. Now things have gotten so complicated, neither the buyer nor seller really understands what they own or are trying to sell. But does it really matter when money is made so easily?
- Naked Short Selling; Removal of the Uptick Rule: You get to drive a proper brick and mortar business into bankrupcty by continuously short selling and driving the price down. Bankers say its better for us because it makes pricing more efficient.
- Derivatives: It's a bet on whether the price of something else goes up or goes down. There are two ways you get to profit from it consistently, i) you can predict the future because you are God; ii) you have information that no one else has (don't ask me how he got it).
- Credit Default Swaps (CDS): Get insurance companies and treasury deparments to write banks a blank check. Hey, what's a $50 billion write-down when AIG, the Federal Board of Reserve, Bank of England and the Swiss National Bank will bail you out regardless? Wait, it gets even better, you get to write $50 billion off AND pay yourself a bonus.
Banks should be boring utility companies providing credit that greases the wheel of the economic engine, no different than a gas or water company providing us with things essential to the running of a modern day society. All other functions are unecessary, dare I say, even parasitic.
Ask a banker why he/she is entitled to a multi-million dollar bailout and the answer is this: its the only way to attract and retain talent in a dynamic industry like finance. And without talent, there would be no financial innovation.
So explain again how financial innovation has benefitted us (the general public)? Well, I am told that financial innovation has made the capital markets more efficient, price discovery has improved and risk has can be better managed by distributing them across different parties through the use of derivatives.
So let me ask you again, what has financial innovation done for society? Let's look at specifics, let's look at good and the bad:
The Good:
- ATM Machines: No more waiting in line at the bank teller.
The Bad:
- Subprime Mortgages: You get a giant loan to buy the house of your dreams and you don't even have to prove you can afford it! Oh wait, you think you can afford it because you've been lured in by teaser rates (adjustable rate mortgages) that go from 2% to 20% after the first two years.
- Alt-AA Mortgages: Same as the Subprime, it's a little harder to get because you have to make up a more a believable income when you fill in the forms. But don't worry, no one really checks on what your REAL income is.
- Asset Backed Securities (ABS): Package a bunch of these mortgages together, pretend they make money and sell them off a sucker (preferably a bank too big to fail)
- Collateralized Debt Obligations (CDO): Package a bunch of ABS's, take them off your company's balance sheets, complicate things by dumping them in a Special Purpose Vehicle (SPV), tell everyone that it's 100% safe because its bankrupcty remote, and just mint money!
- CDOs Squared: CDOs of CDOs. Now things have gotten so complicated, neither the buyer nor seller really understands what they own or are trying to sell. But does it really matter when money is made so easily?
- Naked Short Selling; Removal of the Uptick Rule: You get to drive a proper brick and mortar business into bankrupcty by continuously short selling and driving the price down. Bankers say its better for us because it makes pricing more efficient.
- Derivatives: It's a bet on whether the price of something else goes up or goes down. There are two ways you get to profit from it consistently, i) you can predict the future because you are God; ii) you have information that no one else has (don't ask me how he got it).
- Credit Default Swaps (CDS): Get insurance companies and treasury deparments to write banks a blank check. Hey, what's a $50 billion write-down when AIG, the Federal Board of Reserve, Bank of England and the Swiss National Bank will bail you out regardless? Wait, it gets even better, you get to write $50 billion off AND pay yourself a bonus.
Banks should be boring utility companies providing credit that greases the wheel of the economic engine, no different than a gas or water company providing us with things essential to the running of a modern day society. All other functions are unecessary, dare I say, even parasitic.
Monday, May 18, 2009
Interview with Charlie Munger
Charlie Munger has been another consistent voice of reason. It is only fitting that Warren Buffett's long time partner at Berkshire Hathaway get some air-time. There's really not much for me to add to his wisdom, I'd recommend you go through the entire interview which can be found here. It's recent, topical and addresses many of our concerns about finance and the global economy.
Did you know Google was supplementing your brain?
The internet has revolutionized the way we find and sort information. What most of us don't realize is how it has affected the way we think, to the point where we are "infantizing" our minds.
Many of us have lost the ability to read deeply. Research that used to take us days of being holed up in a library is now available in neatly formulated abstracts at our fingertips. We quote and act upon internet extracted information without having a solid grasp of the underlying principals or the broader context. An especially dangerous undertaking in the world of investments. It's even argued that when we jump on the search engine, we are really searching for convenience rather than actual information.
This makes complete sense if you understand what the world's most powerful search engine--Google is trying to accomplish. Sergei Brin and Larry Page, the founders of Google, view working on a search engine as a way of working on artificial intelligence. Page was quoted last year as saying that Google "was really trying to build artificial intelligence and to do it on a large scale."
The more we rely on Google, the more we rely on artificial intelligence and less on our brains. Now, I am not suggesting a search engine boycott but I am contemplating a serious review of my work habits. Our challenge going forward is to continue to harness the power of enabling tools such as Google without impairing our ability to read and think.
The whole debate can be found here.
Many of us have lost the ability to read deeply. Research that used to take us days of being holed up in a library is now available in neatly formulated abstracts at our fingertips. We quote and act upon internet extracted information without having a solid grasp of the underlying principals or the broader context. An especially dangerous undertaking in the world of investments. It's even argued that when we jump on the search engine, we are really searching for convenience rather than actual information.
This makes complete sense if you understand what the world's most powerful search engine--Google is trying to accomplish. Sergei Brin and Larry Page, the founders of Google, view working on a search engine as a way of working on artificial intelligence. Page was quoted last year as saying that Google "was really trying to build artificial intelligence and to do it on a large scale."
The more we rely on Google, the more we rely on artificial intelligence and less on our brains. Now, I am not suggesting a search engine boycott but I am contemplating a serious review of my work habits. Our challenge going forward is to continue to harness the power of enabling tools such as Google without impairing our ability to read and think.
The whole debate can be found here.
Sunday, May 17, 2009
Personal Credit Crisis
Count yourself lucky if you've no debt related problems. But regardless of what your financial sitation may be, you'd still find this personal account of a credit crisis both chilling and illuminating.
You'll see just how slippery a slope the debt spiral can be. More importantly, how one can go from being financially sound to being avalanched by a mountain of debt in a short period of time.
Awareness of the onerous terms that creditors were seeking proved to an inadequate defence. The writer, believe it or not, is a financial journalist who had written about sub-prime mortgages. One emotional slip was all it took for the misery to follow.
The price of financial independence? Eternal vigilance.
You'll see just how slippery a slope the debt spiral can be. More importantly, how one can go from being financially sound to being avalanched by a mountain of debt in a short period of time.
Awareness of the onerous terms that creditors were seeking proved to an inadequate defence. The writer, believe it or not, is a financial journalist who had written about sub-prime mortgages. One emotional slip was all it took for the misery to follow.
The price of financial independence? Eternal vigilance.
Thursday, May 7, 2009
Truth, not Sophistry
For the unaware, there's a huge debate raging over how business schools should be fixed.
It is argued that business schools are the root cause of the crisis, the singular focus on the upside combined with economic imbalances have resulted in taking our eyes of the more important systemic risks. Business schools have also fueled the crisis by becoming banking factories, churning out everyone ranging from the "just following orders" financial sector rank and file to the very leadership deemed to be the most culpable. This is also a debate cutting across philosophy, education, ethics, financial incentives and many other areas of expertise which are beyond me.
However, if I had to pin down a single aspect of business school I would like to see changed, it would be this: Business schools should be institutions and purveyors of Truth, not Sophistry. We all know what truth means. But the truth (no pun intended) of the matter is, we've allowed that thin divide between truth and sophistry to disappear entirely.
So for the sake of clarity, "Sophistry" is defined by Merriam-Webster's as: subtly deceptive reasoning or argumentation.
Sophistry is now embedded in almost every aspect of modern business. Some argue that the seeds were sown with the case method, where students are essentially rewarded for finessing questions from professors and later in life, clients. Others think that it begins with the job interview process where students form dedicated teams to come up with model answers evidencing their "passion in finance".
Subtle deception, compounded over decades and practiced en masse, unchecked, unappreciated, institutionalized and internalized by students is best exemplified by the enormous build up of complex derivatives sold and held by the "too big to fail" banks over the years. Think of the number of mental contortions that transpired to get us to where we are:
1) You began by securitizing and splitting up worthless assets so they could appear to be valuable.
2) Then you had to take them off the balance sheets so they would not appear worthless at the corporate level.
3) Eventually, you sold them to other people fully knowing what you had done in 1) and 2).
4) Finally, you believe your own twisted logic and start buying worthless derivatives from other banks thinking that if they do the same and sold it to you, it might be valuable.
There is nothing particularly insightful here, you don't need sharper critical reasoning to see the madness that lay within, what you needed was conscience and strength of conviction. You needed to be focused on the truth.
It is argued that business schools are the root cause of the crisis, the singular focus on the upside combined with economic imbalances have resulted in taking our eyes of the more important systemic risks. Business schools have also fueled the crisis by becoming banking factories, churning out everyone ranging from the "just following orders" financial sector rank and file to the very leadership deemed to be the most culpable. This is also a debate cutting across philosophy, education, ethics, financial incentives and many other areas of expertise which are beyond me.
However, if I had to pin down a single aspect of business school I would like to see changed, it would be this: Business schools should be institutions and purveyors of Truth, not Sophistry. We all know what truth means. But the truth (no pun intended) of the matter is, we've allowed that thin divide between truth and sophistry to disappear entirely.
So for the sake of clarity, "Sophistry" is defined by Merriam-Webster's as: subtly deceptive reasoning or argumentation.
Sophistry is now embedded in almost every aspect of modern business. Some argue that the seeds were sown with the case method, where students are essentially rewarded for finessing questions from professors and later in life, clients. Others think that it begins with the job interview process where students form dedicated teams to come up with model answers evidencing their "passion in finance".
Subtle deception, compounded over decades and practiced en masse, unchecked, unappreciated, institutionalized and internalized by students is best exemplified by the enormous build up of complex derivatives sold and held by the "too big to fail" banks over the years. Think of the number of mental contortions that transpired to get us to where we are:
1) You began by securitizing and splitting up worthless assets so they could appear to be valuable.
2) Then you had to take them off the balance sheets so they would not appear worthless at the corporate level.
3) Eventually, you sold them to other people fully knowing what you had done in 1) and 2).
4) Finally, you believe your own twisted logic and start buying worthless derivatives from other banks thinking that if they do the same and sold it to you, it might be valuable.
There is nothing particularly insightful here, you don't need sharper critical reasoning to see the madness that lay within, what you needed was conscience and strength of conviction. You needed to be focused on the truth.
The China Paradox
China is emerging from rubble of the economic crisis looking better than any other country I can think of. In terms of policy, it is pushing all the right buttons. The fiscal stimulus packages are working: The Chinese stock market has taken notice and it is up +40% for the year; the government has announced plans for full medical insurance for 90% of the rural population by 2010--thereby unlocking the high savings rate and unleashing China's huge consumption potential; but perhaps most important of all, China does not have an insolvent banking system riddled with complex derivatives resulting in bottomless liabilities.
Yet, few in the West are willing to concede the following paradox. Communist China (as Lou Dobbs would say), appears to be better at this "capitalist game" than many would like to admit. The US and the UK have long dominated economic ideology by way of the free market system. Few could challenge this until it recently became evident that a hefty portion of the Anglo-Saxon economic miracle can be attributed to consumers and major financial institutions over-gorging at the credit buffett table. While the developed world is anticipating negative growth in 2009, China is widely expected to maintain 8% growth and that figure is forecasted to rise to over 10% in 2010.
So how has China landed on its feet while the G7 takes a painful tumble? This is the second paradox: I suspect leadership may have something to do with. And by that, I plainly mean that China has had great leadership. Western commentary on China is often blinded by political rhetoric colored by human rights, Tibet, Taiwan, the environment and a whole host of other issues. The insistence of the Western media to link ideological disagreements to every news report has led to an under reporting of China true strengths. Complex issues become oversimplified into a "we are good, they are bad" vilification, playing straight into the Chinese strategem of "Hide your capability and bide your time".
Now, I am no expert on the Chinese political system. But China it seems, for all the valid criticism about the lack of democracy and rampant official corruption, has a system which places the best people in the highest offices. Take the following interview with Chinese Premier Wen Jiabao for example, at roughly 7:00 into the video he enters into a jaw-dropping explanation of Adam Smith's classic works. Am I hearing right? Is the leader of "Communist China" quoting the bible of capitalism? At roughly 22:30 into the interview, he goes on to quote Marcus Aurelius. He knows his stuff.
This is fascinating to me because 99% of the people I know, have at best, glossed over the classics in search of soundbites. By contrast, it really seems to me that Wen has really spent time on them. Most people cite Adam Smith's Wealth of Nations and talk about the 'invisible hand' of free market systems, refusing to acknowledge (probably because they never read it) Smith's other important work, The Theory of Moral Sentiments. In the moral sentiments, Wen identified the need for a 'guiding hand' in addition to the 'invisible hand'. While this all sounds academic and irrelevant it could not be more true--a 'guiding hand' could have well prevented the senseless deregulation responsible for our current mess.
I know it sounds like a stretch when I praise Chinese leadership after watching an interview. There is also much I don't know about Hu Jintao, Zhang Zemin, Li Peng and every significant Chinese leader since Deng Xiaoping, other than the fact that they are all technocrats. What I do know is that consistently sound policy, including the lifting of 700 million people out of abject poverty; and transitioning from a planned socialist economy to a capitalist economy without the problems that plague the former USSR, over two decades is not the result of mediocre leadership. Just take a look at the eight years preceding Obama and see if you agree with me.
The transcript for the interview can be found here.
Yet, few in the West are willing to concede the following paradox. Communist China (as Lou Dobbs would say), appears to be better at this "capitalist game" than many would like to admit. The US and the UK have long dominated economic ideology by way of the free market system. Few could challenge this until it recently became evident that a hefty portion of the Anglo-Saxon economic miracle can be attributed to consumers and major financial institutions over-gorging at the credit buffett table. While the developed world is anticipating negative growth in 2009, China is widely expected to maintain 8% growth and that figure is forecasted to rise to over 10% in 2010.
So how has China landed on its feet while the G7 takes a painful tumble? This is the second paradox: I suspect leadership may have something to do with. And by that, I plainly mean that China has had great leadership. Western commentary on China is often blinded by political rhetoric colored by human rights, Tibet, Taiwan, the environment and a whole host of other issues. The insistence of the Western media to link ideological disagreements to every news report has led to an under reporting of China true strengths. Complex issues become oversimplified into a "we are good, they are bad" vilification, playing straight into the Chinese strategem of "Hide your capability and bide your time".
Now, I am no expert on the Chinese political system. But China it seems, for all the valid criticism about the lack of democracy and rampant official corruption, has a system which places the best people in the highest offices. Take the following interview with Chinese Premier Wen Jiabao for example, at roughly 7:00 into the video he enters into a jaw-dropping explanation of Adam Smith's classic works. Am I hearing right? Is the leader of "Communist China" quoting the bible of capitalism? At roughly 22:30 into the interview, he goes on to quote Marcus Aurelius. He knows his stuff.
This is fascinating to me because 99% of the people I know, have at best, glossed over the classics in search of soundbites. By contrast, it really seems to me that Wen has really spent time on them. Most people cite Adam Smith's Wealth of Nations and talk about the 'invisible hand' of free market systems, refusing to acknowledge (probably because they never read it) Smith's other important work, The Theory of Moral Sentiments. In the moral sentiments, Wen identified the need for a 'guiding hand' in addition to the 'invisible hand'. While this all sounds academic and irrelevant it could not be more true--a 'guiding hand' could have well prevented the senseless deregulation responsible for our current mess.
I know it sounds like a stretch when I praise Chinese leadership after watching an interview. There is also much I don't know about Hu Jintao, Zhang Zemin, Li Peng and every significant Chinese leader since Deng Xiaoping, other than the fact that they are all technocrats. What I do know is that consistently sound policy, including the lifting of 700 million people out of abject poverty; and transitioning from a planned socialist economy to a capitalist economy without the problems that plague the former USSR, over two decades is not the result of mediocre leadership. Just take a look at the eight years preceding Obama and see if you agree with me.
The transcript for the interview can be found here.
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